The markets for battery energy storage systems (BESS) are changing. This means that the way BESS assets are financed and operated is changing too. One development has been the advent of floor prices. In this explainer, we take a look at:
- What floor prices are.
- Why they are (sometimes) needed.
- How they affect investors.
- What to consider before entering into floor price agreements.
What are floor prices?
Floor prices are agreements between owners of battery energy storage systems (BESS) and their optimisers. They are contracts that span a given period of time, guaranteeing a minimum income on BESS operation. In return for this revenue stability, optimisers then take a share of the profits when a BESS asset performs above the floor price. Floor prices also help BESS owners convince potential investors of guaranteed revenue streams, making investors more likely to commit to BESS projects.
Why are floor prices needed?
Raising the necessary finances to develop a battery isn’t straightforward. It’s no longer possible to secure long-term contracted revenues. Instead, assets must participate in short-term markets. For example, in 2017, an investor could secure a 4-year contract to deliver enhanced frequency response (EFR), secure a capacity market contract, and feel confident. Failing that, they could successfully win firm frequency response (FFR) contracts 24 months in advance and still feel relatively secure.
This is no longer the case. EFR contracts are a thing of the past. The same is true for long-term FFR. With the rollout of Dynamic Containment (DC) et al., and the retirement of the old FFR service, contract lengths have decreased dramatically. As a result, it is becoming difficult to secure revenues even a month ahead.
This isn’t just a BESS issue, either. The European Electricity Balancing Guidelines specify the need for day-ahead procurement of balancing services, as a maximum. The industry has moved away from long-term revenues, and they’re unlikely to return any time soon.
So, floor prices help to bridge this gap between investors (who require revenue security) and short-term markets.
How do these changes affect investors?
At the moment, DC offers BESS assets the most profitable revenue stream available (£17/MW/h). This is due to current undersubscription levels (as of today, there are 838 MW procured of 1,400 MW), and these prices won’t last forever. (Modo’s ‘Future of battery storage buildout in Great Britain’ report covers future BESS capacity in detail.) The planned launch of National Grid Electricity System Operator’s (NG ESO) Dynamic Moderation service in January 2022 will offer another suitable market for BESS. Still, its day-ahead procurement won’t allay concerns around certainty.
This shift from medium- and long-term contracts to close to real-time procurement brings with it inherent instability, risk, and complexity. This is fine for investors willing to keep up with new services and navigate market changes (like those outlined above). However, it is offputting to those who value certainty around their investment. Many investors are used to the stability of subsidy-backed renewables projects. Therefore, they may choose longer-term contracts with optimisers, often with floor prices.
The changing face (and maturity) of BESS investment
The risk profile of BESS has changed. In 2014, nobody knew for sure whether BESS would become a bankable, viable, long-term investment. This meant that BESS investment was largely procured through private equity, willing to take on risk - concerns about technology, cost, efficiency, etc. - in return for higher interest rates.
BESS is now a proven technology, one that is only going to play a bigger and bigger part in Great Britain’s future energy system as we move towards our net zero target (and beyond). This means that the risk profile has decreased dramatically. Institutional investors are now increasingly willing to invest in BESS, in many cases financing projects with debt. As debt-to-equity ratios for projects increase, this brings a reduced appetite for risk.
Floor price contracts are a means of protecting against potential downside, and can lead to investor confidence. In order to secure this investment, asset owners may have to agree to floor prices which take a larger cut of their upside.
What to consider before entering into agreements
As outlined above, BESS owners need to consider the financial ramifications of floor price agreements. Another potential area of concern lies in floor price contract structuring. It is worth considering the following questions:
- How can BESS owners know they will get the greatest value from their floor price agreements?
- If a long-term contract is in place with a single optimiser, and that optimiser fails to get the best value for the project, is the agreement worth it?
- In a rapidly changing market, might owners be better off switching between optimisers more regularly?
- And how would this affect their investment prospects?
For investors to put money towards BESS projects, there has to be a level of trust that the optimiser is making the right operational choices for a given asset. In a relatively young market, it isn't easy to know which optimiser will get the best value for an asset long-term. Some investors will be happy to place that trust in optimisers, whilst others may want to be more hands-on. There is no ‘one size fits all’ approach.
It could also be argued that, for some investors, floor prices are redundant. As volatility increases alongside our reliance on renewables, there will be money to be made from BESS. The need for BESS is growing. In theory, all of this creates its own ‘natural floor price’, which may provide an alternative to actual floor price agreements. This won’t necessarily assuage investors, but it’s worth considering.
Summary
Floor prices offer stability in a changing market. The shift towards merchant markets and real-time procurement of ancillary services presents a problem for investors who require long-term security of project cash flows. Floor prices ease these concerns by guaranteeing a steady return on investment. In exchange for this, there is a risk that a larger cut of an asset’s value is being given away to another party.
The BESS market will only continue to grow. Investors and operators will need to decide how best to maximise long-term value with their assets. With or without floor price agreements, the future looks bright for BESS owners and investors.