Big batteries – more to come in 2023

As storage continues to play an increasingly important role in the national grid, the revenue opportunities for batteries grows—see, for example, our discussion of the introduction of a congestion relief market under the transmission access reforms below. As expected, in addition to revenue attributable to the provision of frequency control ancillary services, energy arbitrage in the wholesale market has been a key profitability lever for operational batteries in the market in the past year, with batteries profiting from high volatility within the market and high electricity market prices, driven by factors such as unplanned power-plant outages, significant demand and elevated global gas prices.

In addition to the development of standalone big battery systems, developers are pursuing opportunities to co-locate renewable energy and storage facilities. In the VRET 2 auction run by the Victorian Government and concluded last year, four of the six successful solar farm projects will contain battery energy storage systems, totalling 600MWhh of storage capacity. The benefits of new or retrofitted hybrid facilities are two-fold:

• it provides the renewable facility with a means to store its generation in periods of high congestion and low demand in the network; and
• it provides generators with an opportunity to provide a firm energy solution to offtakers in the market (see further discussion on 'firm' PPAs below), in addition to the option to run the renewable and storage components as separate facilities.

Historically, whilst many of the country's big battery storage installations (eg at Hornsdale, Gannawarra, Dalrymple North etc) have been built next to, or near, existing wind or solar farms, they have different connection points and operate independently due to the complexities involved in receiving approval from AEMO for the battery to share the same connection point as the renewable facility under the National Electricity Rules (NER). However, last year, Sapphire BESS became the first big battery to receive approval of its performance standards to connect to Sapphire Wind Farm under the NER 5.3.9 procedures. It is the first time these procedures have been applied to include retrofitting a generation plant with a grid-scale BESS via a shared connection point, and provides another option for renewable developers to consider.

The rise of batteries has resulted in more corporate offtakers looking to secure a 'firm' power purchase agreement (PPA) offering, either directly from renewable generators or through renewables-backed retail agreements. Under a 'firm' PPA, the volume of energy contracted is firm (as opposed to load following)—ie during a specified period of time, the contracted volume is fixed regardless of the generation output from the renewable facility at that point in time. The generator or retailer takes the risk of providing this firm contract volume, and this is possible where the relevant contract is underpinned by a battery.

We have seen the emergence of new revenue structures. A key common denominator between these structures is that they offer a fixed revenue stream for the battery project, which can be leveraged by the developer to secure financing.

• Revenue sharing arrangements: a structure which is becoming particularly popular is a revenue sharing type arrangement. A good example of this is the revenue arrangements entered into between Genex and Tesla in respect of the Bouldercombe battery project in Queensland, which we discussed in our last Insight and involved Tesla controlling operation of the battery and guaranteeing a minimum level of net revenue from the facility, in exchange for taking a share of the profits. Another developing offtake structure we are seeing in the market is one where the battery owner enters into a tolling-type arrangement with its counterparty, where the counterparty agrees to pay a fixed tolling fee on a regular basis during the term. In exchange, the counterparty is entitled to a level of control over the operation of the battery, usually pursuant to an agreed dispatch operating protocol, and also a share of the net revenue.
• Support agreements: another revenue arrangement is a 'support' services agreement, usually entered into with a government entity, AEMO or a network service provider like TransGrid. Under these arrangements, the counterparty reserves a certain amount of capacity from the battery for the purposes of providing certain system strength services to the network upon demand. The Waratah Super Battery and Victoria's Big Battery were both awarded system integrity protection scheme (or SIPS) contracts by the relevant state governments and network service providers.
• Other: federal and state governments have implemented and/or announced their intention to implement various revenue underwriting schemes directed at storage providers. An example of this includes New South Wales' long-term energy service agreements (LTESAs) for firming and long-duration storage, which will be awarded to developers pursuant to competitive auction processes. These LTESAs are option contracts, which will provide the storage provider with an option to sell their electricity at an agreed minimum fixed price. Another example is the proposed Capacity Investment Scheme (discussed in more detail below).

The majority of battery cells used in a BESS continue to be manufactured outside of Australia, exposing all BESS projects to international supply chain constraints. Across all sectors, international manufacturing and construction supply chains have been seeking to overcome the combined effects of COVID-19, the war in Ukraine, other geopolitical tensions and global escalation and inflation of currencies, interest rates, materials and commodities. In a BESS-specific context, the demand for batteries has placed significant pressure on the availability and affordability of the critical minerals required in the manufacturing process. Lithium prices have remained high, as demand for lithium outstrips the available supply, which has resulted in delayed procurements and increased costs. While lithium shortages are attracting the news headlines, the demand for other critical minerals commonly used in a BESS, such as graphite, cobalt and nickel, are also emerging as future supply chain challenges. Despite these challenges, lithium batteries remain popular as a utility-scale technology that is still significantly less capital intensive and quicker to deliver than other proven battery technologies (such as pumped hydro) and emerging battery technologies (such as hydrogen).

Whilst grid-scale battery projects remain an emerging technology and as such carry inherent risks from a bankability perspective, we have started to see a growing maturity of the financing market. The strong returns produced by existing operating assets has stimulated a material increase in the number of sponsors looking to bring projects to market and incorporate debt into their funding envelope. The CEFC has led the development of the market through its project financing of Neon's Victoria and Capital battery projects and its ability to take on a heightened level of risk compared to traditional commercial lenders. Infradebt, a specialist infrastructure fund manager, has also provided senior debt financing to the Bouldercombe battery project (as sole lender) and to the Capital battery project alongside CEFC as a co-financier. A number of mainstream commercial lenders are now looking to support the growing pipeline of projects, aided by the proven performance of existing Australian assets and a greater understanding of operational constraints.

Certainty of revenue lines and the volume of merchant risk that financiers are willing to take continue to underpin debt structuring discussions. Financiers have, to date, focused on battery projects that have traditional offtake arrangements and secure cashflows. However, as seen with the development of traditional renewables assets classes such as solar and wind, there is increasing pressure for financiers to take on greater merchant exposure to enhance equity's upside from volatility in the wholesale market.

As noted above, a key development of the market over the past 12 months has been the emergence of new revenue structures that offer fixed revenue streams (revenue floors, underwrites etc). These structures have enabled sponsors to demonstrate a minimum level of secure cashflows against which debt service can be made. Novel, untested revenue products will nevertheless continue to represent a challenge from a credit perspective for financiers looking to lend into the battery sector over the coming 12 months.

Standardisation of the structure of the performance guarantees regimes and degradation profiles given by developers and suppliers will also be important. Whilst we have seen a divergence in terms to date, the developer and battery supplier market is broadening, and it will need to respond to sponsor and financier requirements to enable projects to be bankable.

Federal and state government initiatives will have a crucial role in developing the market over the coming year and building momentum for project financing to become part of the usual capital stack of battery projects moving forward.

The Federal Government announced a national framework for a revenue underwriting mechanism that is intended to unlock around $10 billion of investment in, and fast-track the development of, clean dispatchable energy (ie batteries and long-duration storage).

The Capacity Investment Scheme (CIS) will involve regular open tenders to determine the projects that will gain support and the price that will be considered the 'revenue floor' for underwriting purposes. The agreed 'revenue floor' will help cover project operating costs and debt repayments, with the Government agreeing to pay the difference when the project fails to reach the 'revenue floor', and a share of profits returned whenever revenues exceed an agreed 'revenue ceiling'.

The CIS will complement existing state and territory-based schemes, such as the NSW Electricity Infrastructure Roadmap, which means it will not alter competitive tenders currently underway. The first auction is expected to occur in 2023.

Australia has large reserves of critical mineral resources and essential battery materials, but currently focuses only on the mining and distribution of raw materials. In an effort to increase the global competitiveness of Australia's critical minerals and battery production industry, the Government has announced the following strategies which seek to combat supply chain constraints, strengthen the vertical value chain and cement Australia's position as a global supplier of processed critical minerals and batteries:

• National Critical Minerals Strategy: the Government has committed to developing a National Critical Minerals Strategy (Strategy). In a Discussion Paper released on 2 December 2022, the Government noted that the Strategy is focused on developing new sovereign capabilities and industries, building reliable and competitive supply chains and supporting clean energy technologies. It is intended to help add value to Australia's large reserves of critical minerals, grow our domestic downstream processing and manufacturing industries and support decarbonisation. Further detail in relation to the Strategy can be found in our Insight.
• Australian Made Battery Plan: the Strategy will be implemented alongside the Australian Made Battery Plan (Plan). The Plan involves the development of a National Battery Strategy which will outline actions for governments and industry to help build scale and competitiveness, the development of a Battery Manufacturing Precinct to boost domestic manufacturing of batteries, and the establishment of a Powering Australia Industry Growth Centre which will provide advanced technology and skills development to businesses looking to manufacture renewable energy technologies locally. The Government released an Issues Paper on 3 February 2023 to kick-start an industry consultation process for the National Battery Strategy with the goal of developing a globally competitive domestic battery manufacturing ecosystem in Australia. Consultation on this issues paper close 17 March 2023.

We expect the Government's focus on advancing growth in the critical minerals and battery manufacturing sectors will complement the development of big batteries across the nation by bolstering Australia's vertical battery supply chain and attracting international investment in clean technologies.

In November 2022, the Energy Security Board (ESB) released the Transmission Access Reform Directions Paper, which represented the latest instalment in the ESB's work in transmission and access reform. The Directions Paper proposed a 'hybrid model' which included three possible solutions to transmission access issues in order to provide better signals to encourage investment in efficient locations and remove incentives for non-cost-reflective bidding. One of the solutions was a congestion relief market (CRM)—an 'opt in' market that incentivises providers of congestion relief (such as batteries) to locate in congested parts of the network and act in a manner to decrease total congestion. Participants would continue to bid into the energy market as they currently do, but would also have an opportunity to access an alternative revenue stream and increase profits by bidding into the new (and separate) CRM. At the Energy Ministers' meeting on 24 February, the Ministers endorsed the CRM model and instructed the ESB to work with senior officials to progress this as a priority. Draft recommendations for the detailed design of this model are expected to be released this month. Further information in relation to these reforms can be found in our Insight.