Improvements in Wholesale Energy Storage Drive Competition

Supply side and market challenges, along with competition, are abundant in this growing sector.

The phrase “batteries not included” won’t apply to wholesale energy markets for long, and with the door to this untapped market set to swing open, it is clear that energy storage has come a long way. But even as the landscape for storage in wholesale markets is improving, there remain significant risks for potential participants.

With grid operators recently forced to comply with a FERC order that seeks to facilitate energy storage in wholesale markets, the regulatory commission is now considering numerous tariff revisions that will help create opportunities for energy storage in these markets.

Those who are engaged in the wholesale energy business with an eye toward storage – merchant generators, power marketers, investors, manufacturers and developers, for instance – would do well to monitor the compliance submissions by Regional Transmission Organizations and Independent System Operators in their relevant markets. But even as wholesale markets evolve to become friendlier to storage technology, market participants should consider the potential regulatory and market risks they face should they decide to invest in storage. This article will discuss some of these risks, advocating for an informed approach to risk tolerance and strategically timed market entry.

Market Challenges and Revenue Streams

To evaluate market risks, analysis must begin with basic notions of supply and demand. Because storage facilities do not independently produce electricity from a fuel source, the primary revenue stream for storage merchants derives from their ability to reap profits from time-based arbitrage – the ability to purchase and store energy when prices are low and sell it when prices are high. The higher the spread, the higher the profit. In recent times, this spread has been driven by the increasing development of intermittent resources – think solar and wind, as prominent examples – that produce electricity inconsistently. Conditions are most ripe for energy storage in markets where these resources are now prevalent, creating price volatility across daily and hourly time frames. Accordingly, meaningful growth in storage demand will strongly correlate with the supply curve of intermittent resources. Assuming that demand for intermittent resources continues to increase sharply, with more solar and wind sources entering the grid, and further assuming that these resources exacerbate a steep and jagged load curve, there will be increasing demand for energy storage.

The other revenue stream for storage systems lies within the ancillary services markets, which are necessary for the normal functioning of electricity markets and more independent of intermittent resources. These services include frequency regulation, capacity reserves, spinning reserves, black start and voltage support. This market also has been driven largely by the increase in intermittent resources creating grid volatility, and many forecasts depend on intermittent resources as the primary market driver for ancillary service demand. However, equipment associated with solar and wind energy, such as advanced inverters, can now perform some of these services independently, such as frequency regulation and voltage support. Increasing adoption of these technologies could actually create additional competition to storage merchants for ancillary services.

Looking at the Supply Side

The supply side of the equation faces many variables that are, at best, difficult to predict or quantify. Storage differs from other forms of energy generation in that it can be sited almost anywhere, and small systems can be constructed with little capital. Unlike capital-intensive, traditional generation sources – coal, nuclear and, to a lesser extent, gas – energy storage faces few, if any, barriers to entry, other than those imposed by RTO/ISO tariffs, such as minimum offer sizes or duration periods.

This lack of barriers would lead to a more efficient market, to the benefit of customers, but it will have the converse effect on solar merchants, particularly early entrants who underestimate the rate of supply growth. Unless rising demand is able to keep pace with this rising supply, a glut of storage systems would flatten the load curve between peak and nonpeak hours, narrow the price spread and reduce the primary source of revenue, possibly dramatically. Additionally, the likely significant decline in storage costs in the near future could further penalize early entrants who paid higher capital costs.

State incentives and mandates could also contribute to oversupply in certain markets, depending on how they are implemented. States that mandate certain thresholds of storage capacity, even if that storage is adopted at the retail level, will invariably exert downward pressure on wholesale prices by narrowing the load range between peak and off-peak hours.

Other value streams available to storage systems may be even more vulnerable to oversupply. Ancillary services such as frequency regulation have served as vital revenue streams for storage facilities that provide service on RTO/ISO systems, most prominently in the PJM market. The market can support only a limited supply of storage units for this limited purpose, hence the need for RTO/ISO systems to revise tariffs, permitting storage systems to stack these revenues with those from the capacity market. The value of these ancillary services, however, could diminish significantly if large volumes of batteries enter the capacity market, with most, if not all, endowed with the ability to provide both capacity and frequency regulation services. In markets where ancillary services are more sensitive to supply than capacity, this supplemental revenue could evaporate quickly.

Fielding the Competition

The energy storage market will also face significant internal competition among various technologies, as the new regulatory framework will incentivize not only batteries, but also traditional forms of storage, such as pumped hydro and modern flywheels. Those traditional technologies are experiencing a renaissance of their own through technological innovation and cost efficiency. Each of these technologies comes with advantages and disadvantages, and while having a diverse portfolio of storage technologies enhances grid reliability, intrinsic benefits do not translate into additional revenue absent regulatory intervention. In reality, technologies that fill only niche roles will be ill-suited for wholesale markets if they cannot compete with other technologies that produce greater volume at a lower cost during most service cycles. As with any emerging technology, there will be a few winners and many losers, and as the market saturates, certain technologies will be viable only in limited settings, more likely on the retail side of the market.

Electric vehicle aggregation provides a separate looming risk. If consumer tastes follow industry forecasts and shift to electric vehicles, then in markets such as the California Independent System Operator (CAISO), which have implemented policies enabling distributed resource aggregation, groups of individual vehicle owners could quickly devour market share. There is also a substantial regulatory risk that other markets will roll out aggregation options in similar fashion.

All of this remains speculative, and none of the above should detract from the significance of FERC Order 841, which has unquestionably opened the door to substantial opportunities for storage merchants in wholesale markets. That alone represents significant progress toward effective grid utilization of energy storage technology. But prudent investors will not overlook the risks when their capital is at stake, and a confluence of one or more of these risk variables could significantly diminish anticipated returns. While the market potential for energy storage – and renewable energy as a whole – remains bright, with falling costs and additional regulatory reforms poised to induce rapid development, these factors could also lead to stiff competition for storage merchants in wholesale markets.

An attorney with McCarter & English, Nathan Howe advises companies on energy and environmental legal issues, representing them in litigation before courts or regulatory agencies, providing guidance in transactional matters, and navigating complex regulatory schemes. Reach him at [email protected].

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