The need for integration of an increasing share of renewable energy sources into our energy systems is well-known, continues to attract significant political and business attention, and is presenting an increasingly urgent global challenge. Technologies to produce electricity from renewables are becoming more cost-effective, which opens up the potential for integrating them into a wide array of markets that previously were not viable due to the more financially attractive position of their fossil fuel counterparts.
However, countries that have already integrated a significant share of renewable energy sources in their energy systems are approaching the upper boundaries of both technological and financial feasibility due to the fluctuating nature of renewable production. Under current technological and policy regimes these countries are seeing financial and system-based inefficiency as a result of increasing the share of renewable energy sources.
For example, Denmark is already capable of exceeding its national electricity demand solely from wind energy production and, on windy days, Denmark is a net exporter of electricity as generation exceeds demand. Similarly, Germany is able to cover national energy demand from solar energy alone under the right conditions. In these energy systems, increasing the share of renewable energy sources to meet ambitious 100% renewables targets in the coming years does not depend on much higher efficiency and capacity on the production side. Rather, it is about finding an answer to the problem of intermittent production and its misalignment with demand.
Testing battery storage as enabler of the future energy system
Battery storage is widely seen as the answer to that challenge and as the key enabler of the next step towards fossil free energy systems. By integrating
battery storage in existing and future electricity grids the intermittent production of electricity from wind and solar can be stored during periods of peak production and consumed during periods of peak consumption.
For example, Denmark produces large amounts of electricity from wind power during the night when demand is low. This is economically inefficient as there are no buyers for this electricity. This creates diminishing financial returns and reduces the rationale for expanding Denmark’s wind capacity, unless storage capacity can be integrated into the energy system. Several other countries are facing similar national or regional constraints on the further expansion of their renewable generation capacities.
However, that situation may be changing. On 1st March a 630kW Lithium-ion battery became our new neighbour at PA’s offices in Nordhavn, Copenhagen. The battery is located in the basement of a parking structure and will be the centre of the new “EnergyLab Nordhavn” project, which will supply enough electricity to power 60 households in the area’s new developments for 24 hours.
The project has a number of interesting features. Firstly, it provides further testing of the practical applications of the most dominant battery technology. Secondly, it will offer insights into the advantages of integrating demand-response and storage as a new component in, and alternative to, the traditional electricity grid and its potential expansion. Finally, it will also provide useful evidence for the potential business models for the commercial application of battery storage.
Expectations for future technological development
In a recent study of the German battery storage market “Battery energy storage. Unlocking grid-scale battery investments in Germany” PA examined a number of these questions as well as provided an outline of the current maturity of different battery technologies and expected future technological developments.
We analysed the recent and future developments in the technology and market for battery storage. The study showed that the cost of technologies has been reduced by 50% during the last decade with further reductions of 20%-40% expected in the next three years. Despite some caution among established actors in the energy market as well as with potential new entrants, PA’s experts expect to see a 50% annual growth rate as costs are reduced.
Projects like the EnergyLab in Copenhagen will help to demonstrate the viability and sustainability of new business models for battery storage and highlight the need for uncertainties about policies and dominant technological designs to be resolved. More details about technological developments and projects in battery technology can be found on PA’s Next Generation Utility website.
Implications for business models and the advent of new entrants
The arrival of new technology carries an inherent threat of disruption to the incumbent players in a sector. Over the past decade we have already seen an increasing number of new entrants in the electricity sector as the liberalisation of previous monopolies has enabled new downstream business opportunities, in particularly in retail. At the same time, many incumbent utilities have increased their focus on either the up or downstream part of the electricity value chain, i.e. the production or sale of electricity. The midstream part of the value chain, distribution of electricity, has become a less appealing proposition for most utilities as this capital intensive and maintenance heavy operation has offered little commercial value.
The future increases in battery storage are likely to present both opportunities and threats to existing business models and firms. It will also bring new players into the market who are using battery technology to introduce innovative approaches.
Implications for established business models
The decreasing costs of generation from renewable energy sources and the cost reductions in batteries identified by the PA study will overcome the constraints of intermittency and create increasing price pressures on upstream generation. The increase in renewable energy in energy systems in recent years already seen some utilities operate their traditional generation plants at or below cost levels. Indeed, many regions have already found that the generation costs of solar or wind are lower than for coal, previously the least costly source of electricity.
As the costs of battery technology continue to decrease the financial attractiveness of operating traditional generation facilities will continue to reduce. The current positive effects on the business case for these facilities stem from the sale of electricity externally or in addition to the supply generated by intermittent solar or wind. However, as we approach a point where the costs of producing and storing a kWh of electricity from wind or solar falls below that of generating the same kWh from a coal-fired power plant the remaining financial advantages of the traditional business model of large centralised electricity production may disappear.
New business models are likely to be deployed in the upstream as new entrants or incumbents explore options that deploy distributed energy resources in combination with or complementary to a battery facilitated platform, where electricity can be sold on market terms or with support from subsidies. Potential investors will look for opportunities to invest in business models, schemes and projects with guaranteed power purchase agreements from the operators of such platforms. This will allow them to enjoy the benefits of stable returns from the production of solar or wind energy over the long term. In contrast to incumbent firms, new entrants will not be constrained by existing production facilities that risk becoming “stranded assets” and constrain their ability to invest in new business models. Those firms will need to experiment with a number of hybrid business models and partnership structures to overcome these constraints and survive the disruption from new entrants.
The emergence of new business models and opportunities
The feasibility of the emerging business models is contingent on the ability of firms to combine the right technology, technical setup, costs of service, battery usage from the services provided, as well as strong market positions and commercial agreements. All these factors must be included in the business design to develop an appropriate financial model to generate profits. Companies will also need to make sure they have the right capabilities to continuously identify, develop and exploit opportunities in this emerging market. The common factor in exploiting these opportunities successfully is the need to combine technical knowledge and in-depth market understanding.
This should focus on exploring the wide range of opportunities including:
Primary reserve market
The most obvious business opportunity is the provision of back-up capacity, or primary reserve power. In many markets weekly tenders are held, where providers of electricity can bid for contracts to supply back-up capacity to ensure supply during demand surges or temporary reductions in supply from power plants. While this opportunity may increase as more renewable energy projects are brought online, PA also expects that lower battery costs will increase competition and reduce profitability in the future. Among the key capabilities needed to exploit this opportunity are energy trading, and an understanding of technical design and ability to analyse future markets and policy trends to mitigate risks.
Peak shaving for industrial customers
A significant business opportunity in battery storage will be the provision of electricity to industrial and commercial customers. These customers typically pay premiums for utility supplied electricity when they exceed certain peaks in consumption. These make power purchase agreements with battery owners attractive as these can be deployed and prevent them reaching these peaks in their traditional utility contracts. Exploiting this opportunity will require a commercial mind set and in-depth industry knowledge, combined with technical capabilities to design individual setups.
Curtailing grid investements
Public or private operators of electricity grids will be potential customers for battery owners for additional capacity in certain areas. The Nordhavn project is an example where battery capacity could be an alternative to expanding grid capacity to serve new developments. Similar opportunities will exist for rural areas where extending new connections or establishing or maintaining existing grid connections may not be feasible. This means that grid owners with service obligations will be willing to compensate third parties to operate batteries rather than incurring the costs of expanding, extending or maintaining existing grid capacity. Technical knowledge and deal-structuring capabilities are expected to play an important roles in this business model.
Investors, new entrants as well as incumbent utilities, will look to the arbitrage market for attractive future opportunities. Business models will focus on charging batteries during periods of high production and low consumption, while selling during peak consumption. This will provide a “buy low, sell high” opportunity, with earnings stemming from the margins. A combination of market knowledge, trading capabilities and technical knowledge will be key components to realise these opportunities in intraday or day-ahead trading.
The above figures illustrate the differences in operational profiles of battery projects today and in the future. While the primary business model for battery projects consists of providing primary reserve power and peak shaving, the future potential is more complex. Providing a number of different services from the same battery project will create profit for owners and investors. However, while this mitigates dependencies on limited revenue streams, it also increases operational complexity and the capability requirements.
Remaining uncertainties and future perspectives
A number of uncertainties remain in the battery market, such as the continuous technological change (see PA’s “Battery energy storage. Unlocking grid-scale battery investments in Germany”). There is also a lack of clarity about short, medium and long term political support for removing barriers to an attractive and efficient battery market, as well as large national and regional differences in market attractiveness and potential.
However, as the questions regarding technological uncertainty are answered, political and market uncertainties are reduced, and attractive business models emerge we may see the biggest shake-up of the established utility sector since the introduction of commercial renewable energy technologies. While utility scale wind and solar favoured the incumbent utilities there is less certainty about how well existing utilities’ business models and capabilities match those needed to succeed with battery projects and to ensure profitability in this new environment.
This makes it clear that the battery market will be an influential factor in shaping the future of the electricity markets. To help inform the discussion about the parameters for success for the future utility business models, PA has developed a series of whitepapers and frameworks – which are available on PA’s Next Generation Utility website.