Growing momentum and less red tape 12 min read
Despite the challenges faced in the energy transition, the development of grid-scale batteries continues to grow as further revenue and financing opportunities emerge.
Building on our previous annual big batteries Insight articles —Big batteries – more to come in 2023 and Big batteries - charging up for 2022— we take a look at what's happening in the battery market, and the future opportunities and challenges in this space.
Key takeaways
- Momentum for new investment in battery projects is rapidly building.
- Revenue opportunities continue to grow and diversify as owners and offtakers look at novel ways of sharing risk and reward, and developers grapple with integrating revenue underwriting schemes into their offtake offerings.
- Critical mineral prices have fallen as growth in mineral production has outstripped growth in battery production. The oversupply of critical minerals is expected to continue at least in the short-term, which should keep prices competitive for battery supply through 2024.
- Market participants, including financiers, are developing a greater understanding of technology risks and split construction contracting, which are typical features of battery energy storage systems (BESS) projects. The bankability assessment of these issues depends in large part on a rigorous due diligence and gaps analysis underpinning the contract negotiations, along with the capability and experience of suppliers and contractors.
- Governments continue to make significant investments through measures like the Capacity Investment Scheme (the CIS), the long-term energy service agreements scheme, and other state-based programs such as the recently announced Queensland Battery Industry Strategy (the Queensland BIS).
What we are seeing in the market
Greater price competition due to lowering critical mineral prices
The end of 2023 and early 2024 saw significant decreases in the prices of lithium, nickel and cobalt. From their peaks, nickel, lithium and cobalt prices have fallen in the order of 60%, 80% and 65%, respectively. Despite the global uptake of batteries and electrical vehicles, growth of battery production in 2023 did not meet forecasts, such that the supply and availability of battery critical minerals outstripped demand for them.
While the critical minerals production market is beginning to respond to revenue pressure from reduced prices (through curtailments and suspensions to mining operations), there remain significant stockpiles of minerals to support battery production in the short term. There are diverse views on whether the situation is temporary, cyclical or structural. However, on the whole, these factors have, at least in the short term, resulted in better battery supply cost outcomes for developers and this is expected to continue, at a minimum, through 2024.
Split contracting becoming the norm
While the cost of certain aspects of battery supply may have improved (noting the question mark around whether this is temporary, cyclical or structural), the construction market in Australia remains challenging. In the past five years, the construction market has been subject to significant pressures through supply chain constraints, labour shortages, inflation and geopolitical tensions. While the civil contracting scope of battery projects is less onerous compared with certain other project types, there is a limited pool of civil and electrical contractors who have the skills, capacity and labour force to work in the remote and rural regions where batteries are required.
In addition, civil and electrical contractors have taken on significantly less risk in recent years in response to market pressures. Accordingly, there has been a continued proliferation of split construction contracting structures, with project owners wrapping interface risk and taking on connection and site condition risks across storage and generation assets.
With sponsors and financiers getting more comfortable with these structures, split construction contracting structures are expected to be the predominant model going forward. Even so, civil and electrical contractors in the Australian market have been under financial pressure, due to the challenges in the market. These pressures have resulted in the delay of some projects, with alternative contractors required – in some cases, mid-procurement – to provide comfort to project owners and financiers, given concerns around financial capacity to deliver.
Innovative revenue structures
Given the range of diverse offtake structures, we continue to see the market playing with ways in which batteries can be used to provide returns on equity investment and, increasingly, to support project financing, as discussed further below.
Revenue underwriting schemes, such as the expanded CIS, remain a key feature in the battery offtake market (see our companion Insights: Capacity Investment Scheme now open for business and Bidding into the Capacity Investment Scheme? Plug into our deep dive into the clean dispatchable 'CISA'). We are also still seeing revenue sharing and system support services agreements, as reported on in Big batteries – more to come in 2023. However, developers are grappling with how the underwriting or support services agreements, in particular, will work with other offtake structures, and how to account for future revenue streams when bidding into these government schemes.
In addition, we are seeing:
Akin to a de facto ownership or a 'fixed-term asset lease' arrangement, a 'physical tolling agreement' in a battery context is a capacity payment model where the offtaker pays a fixed charge for a fixed term. In exchange, the developer makes the battery available to the offtaker, which is able to charge and discharge the battery at its discretion (within the bounds of the agreed operating envelope), and is entitled to all revenue attributable to the electricity discharged from the battery. The offtaker is responsible for obtaining and maintaining all Australian Energy Market Operator (AEMO) registrations, all network costs and all costs associated with charging the battery, and for ensuring compliance under the Renewable Energy Target scheme.
'Virtual tolling agreements' are similar to 'physical tolling agreements', with some key differences. First, the developer is the Registered Participant / Intermediary, and is therefore responsible for charging and discharging the battery. While this means that the developer has operational control over the battery, the offtaker will retain a level of control over how dispatch offers are made, usually by requiring the developer to comply with an agreed dispatch / bidding protocol. Second, given the developer is the entity making dispatch bids, the revenue structure is typically calculated on a contract for difference basis, taking into account the net revenue from the battery and the fixed tolling fee payable by the offtaker. Last, given the developer (as the Registered Participant / Intermediary) will be responsible for obtaining and maintaining AEMO registrations, and paying network and battery costs from a regulatory perspective, virtual tolling agreements will typically include mechanisms to pass these costs through to the offtaker.
Baseload PPAs offer a stable revenue stream to asset operators, through fixed payments in return for a continuous supply of power over a specified time. A good example of this structure is the recent agreement signed between Neoen and BHP for the Olympic Dam copper mine in South Australia.
While the notion of steady power output is typically associated with conventional power plants, a baseload PPA aligns well with projects that combine batteries with renewable power. However, it remains to be seen whether single asset developers can offer these types of contracts, or whether the seller needs to be able to leverage a portfolio of renewable generation to mitigate the risk of offering a firm contract from intermittent sources, even with a battery attached.
Mainstream commercial financiers entering the market
The last 12–18 months have seen interesting developments in the Australian project finance market for renewables. While deal volumes for standalone greenfield generation projects were low, BESS projects tended to feature across portfolio financings and standalone financings. As more mainstream commercial financiers have entered the market, their bankability assessment of battery projects has focused on the split engineering, procurement and construction contracting approach, and associated gap risk, technology risk, the balance between offtakes and merchant risk, and the strength and revenue certainty underpinning the proposed offtake arrangements.
While project financiers traditionally prefer a wrapped contracting structure, recent transactions (both in the battery sector and the renewables sector more generally) demonstrate that split contracting structures are becoming more common and can be bankable. For battery projects, this often involves the supplier delivering the battery packs (and providing supporting warranties), while a 'balance of plant' contractor provides the residual supply and installation capacity to the project. Whether such a structure is bankable will largely depend on a rigorous gaps analysis process underpinning the contract negotiations, along with the capability and experience of the contractors themselves. Financiers will also be looking to the contractors to take price risk, given that, while critical mineral prices are lowering and volatility in prices may not be as high as we have seen in the past year, there remains a question mark around how stable prices will be.
As we noted in our 2023 update, sponsors seeking to increase their equity returns continue to pressure financiers to take on greater merchant exposure, although the market has not moved dramatically in this respect during 2023. A key component of the bankability analysis continues to be the level of contracted revenues underpinning the financial model, as well as the offtaker's credit rating.
The nature of the offtake itself is important. While a baseload PPA is likely to attract financiers (as discussed above), virtual tolling agreements offer an intriguing alternative, which will require further bankability assessments. Alternative solutions such as the system support agreements that AEMO offers will continue to be assessed on a case-by-case basis, as will the bankability issues with the long-term offtakes currently being worked through under schemes such as the CIS regime (see our Insight).
The increasing number of battery transactions financed without the involvement of government supported financiers such as the Clean Energy Finance Corporation (the CEFC) is a positive sign for developers and the market generally, demonstrating that with the right fundamentals, projects can be viably supported by commercial financiers (either on a co-located, hybrid or standalone basis). However, we expect that government support will continue to play an important role going forward as the financing market seeks to meet new challenges, given the government's adaptability to new offtake methods and mandate to drive these projects forward. This may be in the form of debt finance from government-supported entities such as the CEFC; however, it could also be other, less direct, forms of support, such as system strength arrangements with government entities.
Finally, the offtaker's credit quality will continue to be a focus for lenders when assessing BESS projects. As a growing number of non-traditional retailers enter the market, financiers are being asked to consider counterparties that may not have credit ratings that would typically have been required for a bankable project. As a result, we are seeing innovative credit support mechanisms being incorporated into offtake and financing structures.
What's on the horizon
The recent surge in utility-scale battery storage activity is expected to continue through 2024 and onwards, underscored by government-led investment schemes and the successful progression of major battery projects.
The State Government has announced the five-year $570 million Queensland BIS, which aims to foster battery industry innovation, commercialisation and growth in the supply chain.1 It will complement the existing Queensland Renewable Energy and Hydrogen Jobs Fund, which has committed an additional $500 million for the state's publicly owned energy businesses to invest in large-scale and community batteries.2
A number of significant battery storage projects are progressing in 2024 and aiming to reach financial close and commence construction, which sends a positive market signal for further storage and capacity investment in Australia. Examples are the 1.2 GW / 2.4 GWh Melbourne Renewable Energy Hub, Akaysha Energy's 415MW / 1660 MWh Orana battery and 850MW / 1680MWh Waratah Super Battery in New South Wales, AGL's Liddell battery, and ZEN Energy's Templers BESS Project.
From 3 June 2024, the new Integrated Resource Provider (IRP) participant registration category will enable a streamlined registration process for both hybrid and standalone utility-scale storage facilities. This new registration category recognises the two-way energy flow capabilities of these facilities, eliminating the need for separate registrations as a Scheduled Generator (for generating /discharging) and a Market Customer (for load/charging).
To ensure a smooth transition for participants registering for the new category, AEMO has released an IRP Transition Plan, outlining, among other things, the steps required for existing and new Integrated Resource System participants (ie BESS and pumped hydro participants).
New BESS participants registered after 9 December 2021 ('New IRS Participants') will automatically transition to the IRP category, but will need to return a Transition Application form to provide storage capacity information before a dispatchable unit identifier for a single bidirectional unit can be established.
Under the National Electricity Rules, BESS participants registered before 9 December 2021 ('Existing IRS Participants') will need to transition to the IRP category and submit a Transition Application form before 3 September 2024.
The development of co-located batteries, often integrated with wind or solar generation, appear to be on the rise in 2024. Whether developers are looking to develop a hybrid facility from the start or to 'bolt on' a battery to an existing renewable plant, 'co-location' seems to be a buzzword at the moment.
While a co-located battery offers many advantages over a standalone facility, it can create complexity. Hybrid facilities are grappling with how best to structure their revenue arrangements. Further, those looking to add a battery to an existing generator face the renegotiation of the connection agreement (and associated generator performance standards), new or amended development approval, and potential consent rights or rights of first refusal under existing offtake agreements.
There are many opportunities in the battery storage space, which is rapidly growing in volume and development of innovative offtake, contracting and financing solutions. To find out more about how the market is evolving, and how best to capture these rapidly expanding and diverse opportunities, please get in touch with any of our experts below.