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The attraction of energy storage income

High-yielding energy storage funds are growing at a rapid rate
The attraction of energy storage income
  • Energy storage funds are growing at a remarkable rate
  • Despite high premiums and uncertainty over this investment area their prospects look good

If there’s one trend to underpin the next decade, it’s the transition to clean energy. Renewable energy equipment prices have fallen at a remarkable rate and renewable generation accounts for roughly 40 per cent of the UK’s power supply, up from 6.5 per cent in 2010. This proportion will continue to increase, alongside growth in total power supply, with cars and heating increasingly electrified.

Ben Guest, head of the new energy division at asset manager Gresham House, estimates that in the next 20 to 30 years total power consumption might be two to three times higher than current levels and significantly more of it will be powered by renewable sources. By its nature, renewable energy powered by wind and solar is volatile. Guest says that energy generated from renewables in the UK can fluctuate from nearly nothing to twice the 40 per cent average.

This is where batteries play a critical role. Because renewable power supply is so volatile and intermittent, National Grid (NG.) needs to curtail it very quickly during periods of high supply. At present, National Grid primarily ramps gas-fired generation up or down with combined cycle gas turbines to balance supply. But trials were carried out last year to see how batteries could fulfill this role, and Guest says the trials suggest that at least £100m could be saved by consumers if batteries are used in lieu of combined cycle gas turbines. National Grid also reports that using batteries to do this should become an enduring solution in 2022, creating a new source of revenues for batteries.

Batteries currently make money by managing short-term imbalances in supply and demand, known as frequency response, to ensure that electricity frequency remains at 50 hertz (+/-1 per cent). These are constant small tweaks to the grid to reflect fluctuations such as when more people have lights on or a gust of wind picks up. This process used to be managed by coal-fired power plants.

Another source of revenue for battery storage funds is trading power prices in the wholesale market or balancing mechanism. They buy electricity when it's cheap and sell it when it's expensive. As renewable energy leads to greater volatility in power prices, the long-term prospects for this revenue stream are attractive. And it may help market efficiency by avoiding the unnecessary and costly curtailment of renewables and other balancing costs, while reducing the use of fossil fuels.

There is a risk that over time trading revenue opportunities could become arbitraged away. But Guest argues that this is far in the future as battery installations will be outweighed by growth in renewables for many years.

  

How to invest in battery storage

There are two investment trusts listed in the UK that specialise in battery storage: Gresham House Energy Storage Fund (GRID) and Gore Street Energy Storage Fund (GSF) which were launched in November and May 2018, respectively. 

Gresham House Energy Storage had assets under management of £371.8m at the end of March, comprising 30 per cent of the UK’s battery storage capacity. It has 17 operational battery projects and 12 in the pipeline. Guest says that the fund has about 1,200 megawatts (MW) generated from existing and pipeline projects, and should hit this level within the next two years. He also expects the market to grow to about 3000 MW in this timeframe because, as renewable energy contribution rises, there is increasing demand for batteries to keep the grid stable.

Following a share placing that raised £135m last month, Gore Street Energy Storage has net assets of £233m invested in nine operational and five construction projects.

One of the main attractions of these trusts is their income, with both paying a 7p dividend per share. Because they trade on high premiums to net asset value (NAV) – 11 per cent for Gresham House Energy Storage and 6.6 per cent for Gore Street Energy Storage as of 14 May – their yields equate to 6 per cent and 7.7 per cent, respectively. 

At the end of last year, 76 per cent of Gresham House Energy Storage's revenue came from frequency response activity, 10 per cent from trading and 9 per cent from triads – the three half-hour settlement periods of highest demand on the British electricity transmission system. The remaining 5 per cent came from the capacity market contract, which pays generators to ensure that generation capacity is built to the level required to meet demand over the longer term.

Frequency trading is also Gore Street Energy Storage's largest source of revenue, although capacity takes up a larger proportion of its revenue partly because of its exposure to Ireland. 

Although these trusts are fairly new, they have benefited from a substantial discount rate applied to the valuation of new plants which has tended to move upwards once they are operating. Gresham House Energy Storage’s NAV has risen 13 per cent over the past year and Gore Street Energy Storage's has risen 12 per cent.

In a world of low interest rates, battery storage is an area with great growth potential. Even if there is some uncertainty around valuations and yields gradually come down as the market matures, they still offer promising and attractive returns.

Daniel Lockyer, senior fund manager at Hawksmoor Fund Managers, says that he has invested in both trusts to spread manager and liquidity risk. He likes that energy storage funds are not as sensitive to power prices as conventional renewable energy infrastructure trusts. They benefit from heightened volatility rather than the absolute level and, as the proportion of renewable energy increases, volatility should also increase.  

Although the two trusts are similar, Gresham House Energy Storage has better battery storage plant quality. But this may level out because Gore Street Energy Storage has deliberately delayed building battery storage plants as the technology keeps improving. It also has a significant presence in Ireland, although Gresham House Energy Storage plans to expand into this country. 

According to broker Winterflood, neither trust has gearing (debt). The maximum level of gearing Gore Street Energy Storage can take on is 15 per cent, but this is under review. Gresham House Energy Storage has an upper limit of 50 per cent borrowing but its managers expect it to be materially below this level. Gearing lowers the cost of capital and can reduce drag from uninvested cash. 

 

Battery risks

The trusts' revenue forecasts are carried out by independent consultants and have a material impact on their NAV. This means that they are partly dependent on judgment of a nascent industry. If the revenue forecasts become more conservative, as was the case with Gore Street Energy Storage's from 2019 to 2020, they will have a negative impact on the trusts’ NAV. 

Broke Stifel says that valuing battery projects is more complex than valuing wind and solar assets. The multiple and changing revenue streams available make forecasting future revenues and NAV valuations particularly challenging. 

The revenue earned by the trusts is also likely to be volatile. Only a minority of their revenues come from fixed contracts so there may be periods, such as last year, when they are unable to cover the dividend. Gresham House Energy Storage’s dividend cover was 0.78 times in 2020, for example, which Stifel says reduced its NAV by 2.7 percentage points. But coverage below one times was caused by cash drag as funds were invested. However, this has been reversed so far this year with the dividend 1.3 times covered in the first quarter, boosting its NAV.

 

Diversified exposure

Some broad renewable energy infrastructure trusts are also investing in batteries, including two trusts managed by Foresight Group. JLEN Environmental Assets (JLEN), for example, has four investments in battery storage systems including the recent acquisition of a 50MW lithium-ion battery energy storage plant in Wiltshire. This was a co-investment with Foresight Solar Fund (FSFL) With each taking a 50 per cent stake.

Performance
FundPremium to NAV (%)Assets (£m)Yield (%)1 year NAV total return  (%)3 year NAV cumulative total return (%)1 year share price total return  (%)3 year share price cumulative total return (%)
Gore Street Energy Storage6.62377.71219924
Gresham House Energy Storage11.002576.015n/a21n/a
JLEN Environmental Assets14.907456.5113-322
Foresight Solar4.401,0047.0410211
Source: Winterflood, 14.05.21