Third party ownership models have played a big role in the growth of the residential and commercial solar industry over the past few years. Solar leases and Power Purchase Agreements (PPAs) enable customers to install solar panels without the upfront costs, because a third party lending institution provides financing in exchange for ownership of the system and certain incentive benefits.
The success of third party ownership models in the solar industry has led many to ask whether similar models could work in the energy storage industry. Here are some thoughts on the potential for this model to apply in the storage industry.
Defining the value of storage
Third party ownership only works when the lenders can receive some benefit in exchange for funding the up-front costs of installing the system. What are the potential benefits derived from an energy storage system? In certain circumstances, energy storage systems can enable customers to save on their utility bills and even generate revenue through participation in programs administered by the transmission grid operator.
One of the ways energy storage systems save money for customers is the reduction of demand charges. Many utilities charge a fee based on the peak demand from a customer, known as a demand charge. By discharging energy from a storage device during peak hours, customers can shave their peak demand, thus lowering demand charges. Some customers pay over 50% of their utility bill in demand charges. For customers like this, energy storage can translate into significant immediate savings on energy bills. These types of savings present attractive opportunities for third party financing.
Energy storage can also generate new sources of revenue through participation in what are known as the ancillary services markets. Ancillary services are services that are essential to a functioning electricity grid, but which fall outside of the three better-known categories of generation, transmission, and distribution. One type of ancillary service is known as frequency regulation.
Grid operators need to constantly match supply with demand to ensure the frequency of the transmission grid stays very close to 60 Hz (significant deviations can cause grid failure). If frequency dips below the optimal range, the grid operator sends a signal for generators to increase output; if frequency rises above the optimal range, the grid operator signals the need to reduce the output from generators. The generating companies receive payments for providing this service.
Although this service has traditionally been performed by power plants, energy storage devices can perform this service as well as, or even better than, traditional power plants. Power plants take time to ramp up their production, which means they do not respond perfectly to the grid operator’s signal. But many energy storage devices, such as flywheels and batteries, can discharge nearly instantaneously. This allows them to respond more quickly to the signals coming from the grid operator, thus ensuring the system stays closer to the optimum 60 Hz.
Many grid operators are currently revising their market rules to ensure they fairly compensate these faster-responding energy storage resources in their frequency regulation markets. One limitation in existing rules is that they generally require frequency regulation services to be performed by an asset that can generate some minimum amount of output (in California, the threshold is 500 kW, in the PJM Interconnection, the threshold is 100 kW). Residential and smaller commercial energy storage systems would need to be operated as one aggregated resource to participate in these markets.
The lender’s perspective
Quantifying these various value streams is crucial to attracting third party financing for energy storage. But because these benefits require systems to be installed and studied over time, we have not yet seen a significant investment in these systems by third parties. However, as market rules develop and pilot projects begin generating more information, interest from lenders seems to be growing.
Here are some of the key questions that many lenders seem to be asking as they evaluate the energy storage market:
How will the systems perform?
As noted, the cost savings and revenue streams associated with energy storage depend on how well they perform, and in which specific markets they are located. Because energy storage systems are not yet widespread, there is a relative lack of information about how well storage performs in operation. What are the precise demand charge reductions that can be achieved by a given system? How do those vary across utility territories? How will the systems perform over their entire lifecycle, accounting for degradation over time? How will this performance change with the introduction of new energy storage chemistries? Lenders want to gather information on how well the storage devices perform to ensure they will generate enough value to cover the financing.
Where are the markets?
The key markets for energy storage are those where utility rates and market rules translate into the greatest value for a storage asset. Currently, the highest utility rates are in California, the Northeast, and Hawaii. In addition, key markets include those with high demand charges, high concentration of customers with high peak demand, and markets with rules in place to allow for participation in frequency regulation markets by fast-responding energy storage devices.
What incentives will apply to storage?
In addition to sharing in the customer’s utility bill savings, a critical component of third party financing in the solar industry has been the ability for the lender to take advantage of tax credits and other incentive programs designed to encourage solar installation. Currently, this includes the Investment Tax Credit (enabling owners to reduce their tax liability by 30% of the cost of the solar system), state and local rebate programs, renewable energy credits, and other incentives.
There is some potential that the Internal Revenue Service will allow existing incentives, particularly the Investment Tax Credit, to apply to energy storage systems co-located with qualifying solar photovoltaic systems. In addition, some states like California allow energy storage devices to qualify for rebates on the basis of the amount of power they can produce. And there is hope for passage of federal legislation that would extend the Investment Tax Credit to stand-alone energy storage systems.
What is the value of the storage system in the secondary market?
In a typical lease or PPA agreement, the lender retains ownership of the solar energy system and can foreclose and sell the system in the secondary market if the borrower falls into default under the agreement. Assuming a similar arrangement for storage, in the event that a loan falls into default and the lender needs to foreclose on the asset, what value will it command on the secondary market? The resale value for solar systems is more well-defined than energy storage systems today. As markets for energy storage develop, more information on the secondary markets for these assets will become known.
Anyone looking to obtain third party financing for energy storage systems should keep these thoughts in mind when approaching potential investors. Clearly identifying the value of the system and providing information on some of the unanswered questions will go a long way to securing financing of an energy storage system.