It took a single lightning strike to instantly shut down 5 per cent of the UK's power on 9 August 2019. The bolt hit a transmission circuit just before 5pm, triggering a rare simultaneous outage at both the Hornsea offshore wind farm and the Little Barford gas power station. The loss of these large generators meant that the frequency of the country’s electricity grid fell to 48.8 hertz – below the lower limit of 49.5 hertz at which National Grid's Electricity Systems Operator (ESO) must maintain the power system.
When this kind of drop-off occurs, power is automatically shut off somewhere on the network to prevent frequency from falling further. In this instance, it just so happened that the lights went out in parts of central London as rush hour was getting under way. Traffic lights stopped working, trains ground to a halt and passengers stranded on platforms navigated out of stations using the torches on their mobile phones.
Although power and services were mostly restored within a few hours, the 9 August blackout was the UK’s largest in more than a decade – and it could have been worse. Batteries were part of the reason the disruption was contained. At the time, National Grid (NG.) had a total of 200 megawatts (MW) of its own frequency-response batteries at its disposal. These assets are able to provide on-demand electricity in the event of a shortfall elsewhere on the network.
The grid operator was also able to call on nearly 300MW of battery storage put in place by other organisations. “When the battery storage assets detected that drop in frequency, they ramped up their output milliseconds later,” explains Markuz Jaffe, an investment companies analyst at Peel Hunt. “This really speaks to the value they have on the grid.”
By the end of the decade, the consultancy Rystad Energy predicts that the UK will have some 24 gigawatts (GW) of battery storage installed – with enough energy in reserve to power 18mn homes for a year. As the country comes to rely on renewable energy sources, such as wind and solar, reliable sources of back-up power will be needed for days without a strong breeze or adequate sunshine.
In the recent past, gas or coal-fired power stations were responsible for grid-balancing activities. Some facilities, known as peaking plants, are only ever brought online to provide support during periods of high electricity demand. But as the UK moves towards a net zero energy system, it will need to stop relying on these fossil fuel assets. Last autumn, Drax (DRX) delayed the closure of its coal units at the request of the UK government, in order to provide 1.3GW of emergency back-up following Russia's invasion of Ukraine and the energy market turmoil that followed. But Drax has said it will not do the same this year, citing "technical, maintenance and staffing reasons". The UK's only other coal-fired power station, meanwhile, is due to close next year. But battery assets can pick up the slack. As of last month, there was 2.4GW of battery storage capacity operating in the country, as well as 66GW in the development pipeline. On a cold day in the UK, peak UK electricity demand stands at around 60GW.
The opportunity for investors seems obvious: policy dictates that there should be a massive battery build-out in the near future, but work has only just begun. “There are a lot of new assets coming online, and the revenue is predictable to a certain extent because we know how power demand varies throughout the day,” Jaffe says. “You’ve also got the backdrop of the electrification of transport and heating, and more renewables coming onto the grid. Batteries stand to benefit from all these factors that might inject volatility into the system.”
There are currently a handful of ways for UK-based retail investors to gain exposure to this prospective battery boom. Smart Metering Systems (SMS) derived around 12 per cent of cash profits (Ebitda) from its battery storage assets last year, a proportion that's likely to grow in the future. But the most straightforward way to invest in the sector is via one of three listed investment trusts: Gore Street Energy Storage (GSF), Gresham House Energy Storage (GRID) and Harmony Energy Income (HEIT).
But it will not be plain sailing to a battery-powered future. Like their peers across the wider world of UK infrastructure, the battery funds have struggled in the face of rising gilt yields, and falling power prices have also had an impact. June was particularly difficult for renewable energy infrastructure (REI) players – the average share price total return fell by 5.9 per cent, compared with 3.4 per cent for conventional infrastructure trusts. For the three battery trusts, the average fall was 5.4 per cent.
As of mid-July, the London-listed trio of battery funds traded on an average discount to net asset value (NAV) of 16.8 per cent. By 8 August, the discount has widened further still to 19.4 per cent. This figure is a measurement of the difference between the value of an investment trust’s underlying assets and the value indicated by its share price. If a fund is trading at a discount, as opposed to a premium, it's a sign that markets have a bearish outlook on its near-term prospects.
“With [battery storage], a lot of the assets are still in the construction stage, so you see higher discount rates to reflect that,” says Elliott Hardy, a research analyst at Winterflood. “One of the main reasons the sector potentially looks cheap is the fact that you’ve got quite a lot of battery assets coming online over the next year or two across most of the funds.” At the moment, these new additions merely look like capital expenditure (capex) costs – once they're connected to the grid, they’ll be cash flow contributors.
But renewable developers in the UK have famously had to deal with long wait times to connect projects to the grid. It’s estimated that the country has the longest such queue in Europe. Stifel analysts, highlighting recent delays to projects under construction at Gresham House Energy Storage, said in March that they "expect grid connection dates are the main source".
Trading opportunities
Markets might also be wary given the battery funds’ relatively limited trading history. Gore Street was the first of the cohort to go public in May 2018, followed by Gresham House in November 2018. Newcomer Harmony began trading in late 2021. And there is still some uncertainty surrounding the trio’s future revenue streams.
Some of the first battery storage systems provided what are known as 'ancillary services' to the grid – meaning they were paid to be on standby in the event of a sudden drop in frequency.
But this market has become saturated as more batteries come online and it’s believed that energy trading will soon become an important source of earnings. Within this field, there are a number of different markets – day ahead, intraday, and so on – where stored power can be sold. In late March, the managers of the Gresham House Energy Storage Fund said they would “focus more meaningfully on trading” in future.
Winterflood's Hardy says: “We're moving from a predominantly ancillary services-based revenue structure, where these assets are just providing a regulatory service to the grid, to more of a wholesale, trading-based approach where the potential for return is greater, but revenue is less secure."
While Harmony Energy Income is entirely UK-focused, it has been anticipating the saturation of the ancillary services market since its IPO. It therefore chose to install two-hour duration batteries, which are better suited to trading activities, across its portfolio. Storage duration refers to the amount of time a battery system can discharge at its power capacity before becoming depleted.
As it stands, battery funds already have a relative lack of revenue security compared with other renewables trusts, for whom at least two-thirds of revenues are typically fixed. Stifel thinks the battery sector's attraction to investors would "increase meaningfully" if 30-40 per cent of revenues could be fixed for longer periods. Countries outside the UK offer greater potential for longer-term contracts, but all three funds have been signing one- and 15-year contracts over recent months.
Gore Street’s assets are the most diversified in terms of battery duration and location. The fund has storage sites in the UK, Germany, Ireland, Texas and California. The US systems all have two-hour durations, whereas the installations in Ireland have an average battery duration of 30 minutes. These variations are driven by the differing revenue opportunities in each market. Unlike its competitors, the fund thinks its future earnings will be driven by providing ancillary services to different regions – rather than trading energy domestically.
“We have said that in the energy storage market, one needs to be diversified by energy system,” says Alex O’Cinneide, chief executive of Gore Street Capital. "We don’t, as yet, see trading as a big revenue opportunity for energy storage – it is driven by grid balancing.” In Texas, increasingly extreme weather events create opportunities in wholesale power markets as prices spike in line with fluctuations in supply and demand. Grid balancing could also play a bigger role in the UK in the future if batteries begin to be favoured by National Grid's balancing mechanism.
Gore Street also owns two-hour assets in California as it thinks these are best placed to take advantage of the spread in peak prices found on the state’s grid. The other advantage is the US federal government’s generous subsidy regime. Under the Inflation Reduction Act, utility-scale energy storage projects can access investment tax credits worth around one-third of capex if construction begins by the end of 2024.
“In California and Texas, we can get 30 per cent of our capex back the day we switch on an asset. That is not available to us either in mainland Europe or the UK,” says O’Cinneide. “As an investor with a global mandate, which we have, why would we not prefer the US?"
Fund managers at Gresham House say the delays are the main bottleneck facing the UK battery storage sector today. The industry is adamant that planning reforms and policy support are needed to ensure their systems can start contributing to the energy mix.
Some investors might look at the macroeconomic and sector-specific hurdles facing battery projects and not unreasonably conclude that they’re risky prospects. But there’s no escaping the fact that they’re also critical pieces of infrastructure for the 21st century.
“There are not many other assets that are as efficient as a battery in terms of managing the potential issues that come with increased [renewables] on the grid,” Hardy says. “They are really important in terms of balancing that supply and demand.”
