Deciphering the Energy Storage Value Proposition

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Introduction and Summary Findings While energy storage has grown rapidly over the past couple of years and several hundred MWs of projects are under development, the value to investors of energy storage remains somewhat nebulous. This paper identifies leading energy storage

technologies, defines key applications, reviews current leading battery projects, and estimates investor returns for differing applications and markets. Further, the paper discusses the key factors driving storage economics and investor returns.

Today, in the right application and market, battery storage can provide attractive returns. Clearly, there are other applications where the economics today do not meet a minimum threshold. The storage economic proposition will improve in all applications as capital costs fall, which they are expected to do. By its very nature, storage offers multiple value streams. A rational investor would take advantage of all possible value streams, so long as each value stream in practice can be realized and there is no “double counting” of benefits.

Storage Technology Discussion Grid reliability and power quality are generally met through the integrated contributions of generation, transmission, distribution, and customer assets as depicted in Exhibit 1.

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In real-time operations, the electric system (which could be a small utility system managed as a balancing authority or a large ISO footprint, also managed as a balancing authority) has to be in perfect balance between load and generation at every instant. To achieve this, system operators (small utility or large ISO) have to rely on a hierarchy of reserves and capabilities which can be called upon in different time frames (Exhibit 1). Some reserves are available through the generation system based on their physical characteristics (e.g., ramping, spinning reserve), while other capabilities such as system inertia can be made available through transmission system operation. Yet other capabilities like power quality can be maintained by taking advantage of equipment such as capacitors located close to the customer.

Two key events are spurring energy storage technology development – (1) increasing generation from uncontrolled renewable generating assets with variable output (i.e. wind and solar), (2) increased desire to manage variable

generation from these renewable resources with cleaner technologies. To meet these and other grid needs, numerous storage technologies have been developed or are currently under development. As depicted below, typical short duration technology options include flywheels, lead acid batteries, and lithium ion batteries. Common long duration storage solutions include pumped hydro, to a lesser extent compressed air energy storage, and lithium ion batteries as well. Also of note are the new technologies currently under development, many focused on various flow battery chemistries which could serve either short or longer term needs. There are also many new and novel energy storage technologies under development. One such technology, not shown in Exhibit 2, is a gravity rail system recently deployed in Nevada in which train loads of rock are raised to mountain tops using low cost electricity which is then recovered during periods of higher prices by lowering the rail cars. This device operates using the same potential energy concept as pumped storage hydro.

Exhibit 1: Energy Storage Response by Application

Source: Southern California Edison

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White Paper | Deciphering the Energy Storage Value Propositon

Mature storage technologies include lead-acid batteries, compressed air energy storage (CAES), pumped storage hydro (PSH), flywheels and lithium ion batteries. With better performing technologies, traditional lead acid battery sales for the stationary market have waned and flywheels have suffered vendor attrition. While CAES and PSH have been employed at scale, they are only applicable where the geography or geology is appropriate. Lithium ion battery costs have experienced, and are predicted to continue rapid price declines driven by economies of scale primarily from their use in vehicular applications, and learning curve effects resulting in strong competition both with other storage technologies and between lithium ion battery vendors. Driven by these changing economics, EPRI opines that lithium ion batteries will be the dominant battery technology for at least another decade and perhaps beyond 2030. Based on this view and the emerging ubiquity of lithium ion battery technology, the battery investment analysis presented later in this paper is focused on lithium ion battery technology.

Several battery technologies are beginning to show promise, though maturity remains some years away. Perhaps most notable is the class of flow batteries, led by vanadium redox batteries, an example of which was recently installed for Avista in Washington State. Flow batteries offer better cycling, greater longevity, essentially no cell degradation, and are more customizable than Li-Ion

Source: Electric Power Research Institute (EPRI)

batteries; however, their size limits them to stationary applications, which limits application and may ultimately extend the time needed to meet the scale required to sufficiently lower costs. Both Sodium Ion and Metal-air (zinc-air, lithium-air) batteries are also making progress, though the technology is nascent.

Storage End Uses and Value Streams As mentioned briefly, storage applications can range from very short duration requirements like frequency response and regulation, operating and planning reserves, to longer term needs of energy management (e.g., to store energy from renewable resources generated in off peak periods an consume it during on-peak periods). Exhibit 3 indicates the rated power and discharge time for each key storage technology available to meet the system frequency response and regulation, operating and ramping, and energy management needs. As shown, Li-Ion batteries are quite versatile in terms of the range of applications they capture. For example, such batteries can respond quickly (seconds) to cover frequency response and regulation needs with small storage sizes and at the same time cover longer duration storage needs where speed of response is less critical. Flywheels, on the other hand, can provide an even quicker speed of response and hence are ideal for frequency response applications but the storage duration or capability is much smaller.

Exhibit 2: Energy Storage Technology Maturity

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As discussed above, energy storage may serve three generic system needs - frequency response and regulation, operating and ramping, and energy management. By applying storage in either the transmission, distribution, or customer portion of the electric delivery system, the energy storage owner/ operator may solve one or many system issues and in doing so, earn revenues from supplying multiple service to the grid. For example, in some jurisdictions batteries are paired with renewables to supply quick power bursts to network segments thereby assisting in frequency response when, for instance, clouds pass overhead. After that burst, additional slower acting higher power resources step in to maintain system frequency.

Energy storage applications in the transmission and distribution systems are sometimes termed “utility scale” or “in front of the meter” solutions, while those sited with consumer facilities are often termed “behind the meter” solutions. Storage applied in transmission infrastructure

support the bulk delivery of electricity, ancillary services, and infrastructure weaknesses. When added in the distribution systems, storage may also support a challenged infrastructure, as well as enhance customer energy management. When applied “behind the meter”, storage may improve energy quality, support local infrastructure, or help to reduce customer energy costs.

Exhibit 4 represents the range of potential storage applications (end uses) across the electric delivery system. A storage system could earn revenues from several sources, depending upon where it is placed in the system (geography), what services the system is designed to serve (design), the market in which the system operates (market), type of owner (owner), and incentives. As the color coding in Exhibit 4 indicates, there are several common storage value themes including: upgrade deferral, voltage/ VAR support, power quality, reliability, load time shifting, and renewable firming.

Source: EPRI, Pace Global

Exhibit 3: Battery Energy Storage Capability

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Exhibit 4: Battery Energy Storage End Uses

Each storage theme is discussed below in Exhibit 5.

Exhibit 5: Battery Energy Storage Application

Service Definition Concept Commercial Sample Value Proposition

Upgrade Deferral (non-wires alternative)

Apply storage in lieu of a delivery system upgrade or replacement

Rather than replacing an aging transformer on a ‘like-for-like’ basis, install a battery on the low side of the transformer to augment peak supply thereby reducing the peak loading and the cost of the replaced transformer.

Con Ed’s Brooklyn-Queens Demand Management project 1

Very high cost of traditional upgrade; speed of installation

Voltage and VAR Management

Reduce electric line losses and increase grid efficiency

Fast acting storage placed in the distribution system combined with global and local dynamic VAR controls to control voltage variations.

Part of NSP Belle Plaine Solar/ Battery project 2

Provides multi-purpose flexibility unlike capacitor-only additions

Power Quality Frequency regulation Apply storage rather than other fast acting technologies to maintain system frequency

NEC Energy Solutions PJM regulation system 3

Provides multi-purpose flexibility unlike capacitor-only additions

Reliability Augment system capacity to increase reliability

Installed in the transmission, distribution, or customer location to support one or many customers

AES San Diego and SCE peaking system ( in response to Aliso Canyon gas leak) 4

Reliability; Speed of Installation

Load Shifting Energy arbitrage Charge battery during off-peak and discharged during on-peak/ super-peak. Requires spread between on and off peak energy. Also relevant in systems with high renewable curtailment.

PG&E Yerba Buena Battery Energy Storage System (BESS) pilot 5

‘buy low sell high’

Renewable Firming Use storage to reduce variability of renewable generation

Combine storage with renewable generation to ‘firm’ otherwise variable renewable generation creating a dispatchable carbon-free energy source

AES Hawaii solar/ storage system 6

Create dispatchable resource

1 http://www.utilitydive.com/news/coned-awards-22-mw-of-demand-response-contracts-in-brooklyn-queens-project/424034/2 http://www.minnelectrans.com/documents/Grid-Modernization-Report-NSP.pdf3 http://www.utilitydive.com/news/nec-energy-solutions-plans-60mw-of-storage-for-pjm-market/398142/4 http://aesenergystorage.com/category/pressreleases/5 http://www.utilitydive.com/news/pge-completes-battery-system-performance-pilot-project-in-caiso/430336/6 https://www.greentechmedia.com/articles/read/aes-puts-energy-heavy-battery-behind-new-kauai-solar-peaker

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Exhibit 6: Battery Energy Storage Tax and Depreciation Eligibility

Fundamental Economics of Storage As discussed in the previous section, storage applications are numerous. However, based on current capital costs, energy storage economics are typically only attractive when multiple value streams are realized. This ‘revenue stacking’ is often necessary to meet or exceed investment hurdle rates in battery energy storage applications. The section below discusses the various factors that affect energy storage value.

Capital Costs: Battery capital costs have fallen by 33 percent over the past 5 years. Costs are expected to fall by another 40-50% over the next 5 years 7. Most cost declines occurred in the cell costs, but the costs of the DC to AC power conversion and battery management systems have declined

as well. Capital costs materially impact battery investment returns as demonstrated in the case studies below.

Availability of Federal Tax Credits and Accelerated Depreciation: Energy storage qualifies for accelerated depreciation as a 7 year property. In terms of federal tax credits, energy storage does not qualify for investment tax credits (ITC) on a standalone basis, or if added to a solar system after the solar installation was completed. However, if the battery is installed simultaneously with a solar installation, the energy storage portion and the solar portion then qualify for ITC. The qualification is based on IRS private letter rulings. Exhibit 6 depicts the ITC eligibility based on ownership and grid supply criteria.

Source: NREL

Recently, legislation was introduced to enable energy storage to capture ITC benefits on a standalone basis, similar to the solar ITC schedule. All forms of energy storage will be eligible as long as they are at least 5 kW in capacity. If smaller than 5 kW, they may qualify for credit by aggregating with other storage resources.

Incentive Payments: Several states such as California and New York provide Self Generation Incentive Payments (SGIP) 8. For example, Southern California Edison (SCE) provides a base SGIP payment of $1.30/W for systems between zero and 1 MW. The incentives reduce to 50% of base for systems between 2 and 3 MW, and 25% of base for systems larger than 3 MW. The eligibility is based on either a standalone energy storage system or one paired with solar. ConEd in association with NYSERDA has developed a demand management program that provides incentives capped at 50% of the installed battery energy storage costs. 9

Regional Differences and Participation in Wholesale Markets: Availability of incentives and access to revenue streams is market dependent. For example, in New York and California, reduction of residential and commercial demand charges may serve as a significant revenue stream. These benefit streams may not be available in other regions. Reg. D 10 requirements in PJM and other ISOs created a demand for energy storage during the early years of BESS. However, regulation prices are market dependent and may vary from year to year based on market demand and competition amongst resources.

Wholesale capacity market regimes and clearing prices will likely influence battery economics once energy storage becomes eligible to participate in the wholesale energy and capacity markets. FERC recently issued a Notice of Proposed Rule-making (NOPR) directing ISO’s to propose guidelines under which storage can participate in wholesale energy and capacity markets. 11

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Price Certainty: Uncertainty in pricing of the several market driven revenue streams such as capacity prices and frequency regulation may make financing BESS projects more challenging. More predictable revenue streams such as long term contractual capacity payments tied to a peaking application will likely improve the financial viability of energy storage projects. For example, front of the meter BESS projects that recently came online in the SCE and SDG&E in response to reliability issues have a contractual capacity payment. Altagas, that was selected by SCE to build, own, and operate a 20 MW x4 hour storage system 12 will be paid fixed monthly resource adequacy (RA) payments for a period of 10 years 13. The project will also retain the right to earn energy payments if called upon by the CAISO. However, RA payments in California can vary from year to year similar to capacity prices in centrally administered capacity markets but can be higher in more constrained zones.

Ownership and Control: The ownership of BESS systems can impact both the value and flexibility of BESS. Different ownership models include utility ownership, private ownership, or customer ownership. Some argue that utility ownership can optimize operation of distributed storage resources and provide an incentive for utilities to rate base storage investments. However, operation of BESS should be agnostic to ownership. In NY, utilities are being asked to play the role of a distribution platform provider. Most of the 100 MW utility scale storage installations in 2016 were owned by non-utilities and a vast majority of installations occurred in ISO regions. This is also true for projects under development. This is partly because utilities have little experience with owning and operating BESS. As BESS becomes more mainstream, we are likely to see increased utility ownership. A number of utility pilots currently are focused on distribution or transmission deferment.

Storage Valuation Case Studies To evaluate battery storage economics, a cash flow model was developed to determine the levered internal rate of return (IRR). Three applications were considered; two behind the meter installations, one in PJM and the other in NYISO; while the third was an in front of meter application in NYISO. All batteries were long duration (4 hour storage). The analysis assumes that multiple revenue streams are simultaneously available with the market rules being supportive of the battery earning these revenue streams. The analysis further considers the practical aspects of battery operation by assuming that hours reserved for capacity applications are not available for other non-capacity end uses or applications.

The dominant revenue stream in PJM (Case 1) was demand charge reduction (DC), while frequency response was a secondary stream (FR). In NY, for the first application (Case 2), the primary revenue stream was demand charge (DC) reduction with day-ahead demand response (DADR) being the secondary application. For the second NY application (case 3), installed capacity was the primary revenue stream, with energy arbitrage and substation deferral being the secondary.

New York also provides incentives payments for behind the meter applications. These were recognized and evaluated, but not considered in the summary graphic below.

The analysis considered a number of performance and cost elements such as extended warranty expenses, fixed costs, cell replacement costs, charging costs, and other factors. The economic analysis assumed a system life of 15 years. However, due to cell degradation prevalent in Li-Ion batteries, cell life is generally limited, and for this analysis a cell life of 8 years was assumed and cell replacement costs were considered. The battery investment is considered viable if the achieved return exceeded the target of 14%, a typical hurdle for merchant investors. The target return was based on expected after tax cost of equity returns assuming that battery storage cash flows are exposed to merchant risk. The target returns may be smaller if the battery application involves a long term PPA with a credit-worthy counterparty.

Exhibit 7 illustrates the project levered after tax returns for various end-use applications. For each use case, sensitivity analyses displayed the impact of capital costs on project IRR. As expected, project IRRs increase with declining capital costs with current capital costs assumed to be approximately $500/kWh for a 4 hour duration battery 14. The NY use case focused on ConEd (Case 2), target returns are achieved at higher capital costs relative to the PJM case because the higher demand charges in the ConEd region ($240/kW-yr.) relative to PJM ($130/kW-yr.) provide greater revenue. In PJM and in the other NY use case (Case 3), the target returns are achieved when capital cost fall below about 40-50% of current costs. In Case 3 with the primary use being an installed capacity resource, target returns are achieved at approximately 45% lower costs despite accessing three revenue streams. This is partly because of lower wholesale installed capacity payments during the winter months (average annual payments being $90/kW-yr.) and energy arbitrage revenues being materially smaller relative to the installed capacity revenues.

Beyond application and market, several other factors may impact battery economics. Sub-station deferral revenues can be high in certain cases resulting in attractive returns, but these are extremely location specific 15. Access to incentives also plays a key role in achieving target returns, but as capital costs decline, the need for incentives also declines. Battery cell degradation, often overlooked in battery economic calculations, can materially impact expected returns. If cell augmentation costs are considered, project IRRs were lower, but the impact of cell degradation is minimized as capital costs decline.

A key takeaway from the analysis is that battery storage broadly can be financeable on a merchant basis when capital costs decline by about 50% relative to current levels. Given the large price declines seen over the past few years and continued expected declines; this is potentially achievable over the next 5 years.

7 Source: Pace Global proprietary learning curve model.  8 SGIP ( Self Generation Incentive Payment) Note that Pacific Gas and Electric and San Diego Gas & Electric also administer the SGIP.  9 Battery energy storage systems is one of the eligible technologies along with others. 10 PJM’s Reg D is designed for fast ramp units such as storage and can provide mileage at a much faster rate than conventional generation. 11 In response to the NOPR, NYISO recently issued a blueprint for the participation of DER (including storage) in the wholesale markets. 12 The battery capital costs are in the range of $2000/kW or $500/kWh. 13 https://www.sce.com/NR/sc3/tm2/pdf/3455-E.pdf 14 A capital cost of $600/kWh was assumed for the Coned service territory. 15 The BQDM project in the Coned service territory had substation replacement costs of $1.2 Billion for a 60 MVA capacity. This translates to $20,000/KVA. The auction cleared at $985/kW-year with 22 MW of DER offers accepted. However, for this analysis, substation replacement costs of $2000/kVA were assumed which is more typical outside of densely populated areas.

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Subject to changes and errors. The information given in this document only contains general descriptions and/or performance features which may not always specifically reflect those described, or which may undergo modification in the course of further development of the products. The requested performance features are binding only when they are expressly agreed upon in the concluded contract.

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Exhibit 7: Summary of Case Study Results

In conclusion, while the industry has known for some time that from a technical perspective, energy storage will likely disrupt the energy industry in many ways, it is only just now that battery economics are beginning to reach levels sufficient to attract substantial capital. As capital costs decline over the next five years and resultant investor returns grow, battery projects across a multitude of applications and markets will be viewed as economically appealing. The electricity storage industry has potential to disrupt the energy industry given the large cost declines and changing regulations and customer needs. Costs continue to come down and while battery energy storage value proposition is currently tied to niche market applications, multiple value streams, and incentives, continued cost declines over the next few years and lowering of regulatory and market barriers will enable the battery energy storage market to take off.

Source: Pace Global analysis