Energy storage is on track to become a billion-dollar annual industry in the next three to five years, while many solar developers view it as the next viable growth opportunity. But while developers and some small private equity firms move into solar-plus-storage, major banks are hesitant to dive in.
Without actualized financial backing, full-fledged market growth is stalled. What the industry is battling is a classic case of the chicken or the egg: Will more development spur more investment, or will more capital bring in more projects?
The challenge: Missing key financial must-haves
Over the last year, countless developers have added storage to their service offerings, and for good reason — energy storage installations totaled 311 megawatts in 2018, and will grow to 4.4 gigawatts by 2024.* But in their excitement to pursue storage opportunities, some developers are glossing over key financing requirements.
Foremost is a consistent and reliable revenue stream. To date, the majority of existing storage assets have been installed under pilot programs with large one-off incentives, much like most solar projects eight to 10 years ago. The heavy reliance on incentives is causing projects, and the market more broadly, to be volatile — as it is constrained or propelled by cumbersome and slow-moving policy issues that are difficult to predict.
When the Federal Energy Regulatory Commission approved Order 841 in February 2018, for example, projects stalled in their tracks as the industry debated how each independent system operator and regional transmission organization should accommodate batteries on the grid. Transitioning from inconsistent incentive-backed projects to market-based project financing will require bankable, long-term revenue streams.
Equally important to consider are the operational risks of a solar-plus-storage project. With little market penetration, there are a number of questions yet to be answered about solar-plus-storage. Wood Mackenzie reports that while storage-plus-renewables have become increasingly prevalent in the market, there are still few examples of its economic outcomes. This is in part because the technology itself is ever-changing, which presents issues for financial modeling.
While lithium-ion has led the charge among battery chemistries, alternative battery options have infiltrated the industry and brought with them a wide range of price points. And as the technology changes, the software integrations and deployment strategies that support it have to adapt quickly to be effective. The changes in battery technologies, software integrations and price are ping-ponging across the industry, creating a game that’s a little too exciting (and risky) for investors to join in without careful, nuanced vetting.
Financiers look for fixed cash flow, strong software and deep balance sheets
These unknowns make it difficult to model a straightforward projection of revenue. Unlike solar, assigning a value isn’t as simple as understanding the relationship between energy produced and the power-purchase agreement price. For PV systems, as long as there is a financeable cash flow stream, values can be attributed to an asset, then stacked and calculated. Even for some simple storage projects, a capacity payment for a storage asset that’s concrete can be valued with some risk analysis.
For most storage projects, though, it’s a bit trickier. Some developers are calculating a merchant revenue that they expect the system to produce and then attributing that value to the asset. But layering merchant value behind a solar system is an issue for many financiers because projected merchant revenue streams vary too widely, making them too unstable to get behind.
At this stage, financiers are staying away from large merchant evaluations and looking for fixed or largely fixed cash flow, or revenue flow that can be financed. In the meantime, developers should prepare for any kind of risk associated with value-stacking or merchant valuation on the asset to accrue to the equity holder or developer of the asset, at least for the next few years as the industry continues to emerge.
Another major piece of the valuing assets puzzle is software. Software can be either a saving grace or a silent killer in a financier’s decision to invest in a solar-plus-storage asset. Not only does much of the financial risk of the assets come from the software, but much of it can also be solved with it.
For example, in order for storage to qualify for the federal Investment Tax Credit, a minimum of 75 percent of the storage asset must be charged by the solar system it’s supporting. Otherwise, the project doesn’t qualify. Software is key for operating and maintaining the solar assets to ensure that the requirement is met. At this point, financiers are looking for strong software providers, with a proven track record and deep balance sheets, to take on that risk in the asset.
Considering these factors, it becomes clear that the current constructs in most regional markets are not ready for storage financing. Either there is a lack of incentives to install storage at scale or the incentives are not enough for developers and financiers to assume the long-term operational risks in rolling out storage at scale.
If there’s a will (or a program offering a fixed add-on), there’s a way
Luckily, there are promising programs lighting the path forward. The Massachusetts SMARTprogram is attractive because it provides a fixed, bankable financial bonus for PV projects with storage. This takes away the possibility for merchant valuation of assets, instead adding a fixed value of about 3 cents per kilowatt-hour to 7 cents per kilowatt-hour to the PV project and ushering in a straightforward cost benefit analysis for risk-rejecting financiers.
Another is California’s Self-Generation Incentive Program, which offers cash grants to developers for storage in exchange for their help in peak-shifting the grid. This is enabled by the strong penetration of solar in the state, which has traditionally reduced higher daytime retail energy prices and raised lower nighttime prices.
By generating energy during the day, then releasing it through storage at night, storage projects are helping flatten the energy demand curve, bring down nighttime retail electricity prices and manage grid-peaking. These simple cash grants for storage offer an easy-to-calculate, fixed-value add-on to the revenue stream.
Above all, financiers are excited about these programs and storage and PV-plus-storage more broadly. Storage solves issues that are created by solar, and solar’s not going anywhere.
Sripradha Ilango is the chief financial officer at the independent renewable power firm Soltage.