How independent technical due diligence accelerates energy storage financing.
Terence Schuyler and Michael Kleinberg, DNV GL
Third party independent engineering and technical due diligence has long been a requirement of lenders and developers for power and infrastructure project financing. Lenders require project developers to undertake the necessary risk management step of providing independent assessment reports on the design, engineering, construction, contracting and performance predictions for energy infrastructure projects. This has been the norm throughout the history and evolution of our modern electrical system, whether applied to coal-fired power, gas turbine or hydroelectric plants. The ability to finance and the terms associated with it are directly linked to the appetite for perceived risk that lenders are willing to accept.
Both Technology Evaluations and Independent Engineering reviews include visits to field to observe the performance of operating systems. Credit: DNV GL.
As more innovative technologies and system architectures raise the possibilities of less expensive, more cost-effective and sustainable ways to produce and distribute electricity, market growth depends on understanding and quantifying their associated technical and financial risks. Whether through traditional or creative funding mechanisms, lenders for new and emerging renewable energy projects must ensure that the technologies and project designs are reliable and robust enough to satisfy the performance and lifetime projections that are integral in the deal structures they will support.
Early-stage technology is traditionally funded through cash or owner-operated sources in demonstration projects, until such time as the technology and projects are deemed “bankable.” This process has been undertaken by both the wind and solar industries in their respective market growth. Energy storage projects have, until recently, also followed this trajectory. In the last five years lenders have become more comfortable with the track record and predictability of most solar and wind technologies primarily through their reliance on the risk mitigation and assessment reports that have been conducted by independent engineering firms in the past. However, lenders still require emerging technologies, in particular, to undergo the rigors of independent assessment reports to secure confidence in future returns and thus become bankable.
Energy storage is viewed as the next enabling technology that will be required to cost-effectively facilitate grid modernization, while allowing for the full potential of renewable energy power generation and distribution to be realized. The rapid pace of development of new storage technologies and project deployments is widely viewed as following the same path as solar and wind with respect to the need for mainstream financing. However, unlike solar and wind — which rely on debt, equity and PPA financing structures with predictable fixed revenues and built-in cost escalators — energy storage projects have the potential for multiple use applications within a given project enabling variable revenue streams. This increased flexibility serves as both an opportunity for creative project development and a risk to realizing full revenue projections.
State RPS uncertainty, insurance protections, product guarantees, energy capacity warranties and government tax incentives are all key challenges to sustainable growth and adoption of energy storage. As regulatory and utility policies are just now emerging that will help firm up the revenue potential and array of potential financing structures, one common denominator will prevail — the need to offset perceived risk through independent validation and technical due diligence.
Similar to the Technology Adoption Life Cycle introduced by Geoffrey Moore, technology bankability will have to cross the chasm of risk. Credit: DNV GL.
Whether for large-scale utility or distributed applications, energy storage projects have the potential for multiple and variable revenue streams. Credit: DNV GL.
The energy storage industry is seeing many new software providers partnering with product manufactures and project developers. The near-term applications that include behind-the-meter bill management (e.g. demand reduction) ramp rate and frequency response control (grid support) and cyber-security and reliability (future revenue protections) will all require detailed due diligence and validation to facilitate project financing. Energy storage project financing will rely on well-reputed independent engineering firms to conduct the two most prominent risk-mitigation services needed to facilitate bankability and accelerate market growth: 1) Technology Evaluation assessments of the products and integrated systems (often referred to as Bankability Studies) and 2) Independent Engineering assessments of the projects being introduced for funding (often referred to as IE reports).
Independent Technology Evaluation reports (or Bankability Studies) focus primarily on assessment of the technological aspects of the products and include a high-level review of the company, manufacturing, quality, and business model, and generally report on the list of topics in Table 1.
Although required by the developers and lenders, these Technology Evaluation reports are typically contracted by the product or system manufacturers. They include an intensive two-phase evaluation with the first phase intended to provide critical feedback on issues or gaps that can be filled to further facilitate the product bankability. This report phase proves particularly valuable to companies entering new regional markets with differing regulatory and certification standards, and for those unfamiliar with the expectations of the lenders. The final report is often used by the manufacturers as a critical marketing tool and is provided to potential customers as well as the financial community. These reports are also evaluated and referenced in support of the project IE report process.
IE reports are most commonly contracted by project developers and provided directly to the project lenders. The result of these reports often determines the go/no-go decisions to provide funding and is used to determine the rates and terms of deal structures. The full scope of work for IE reports typically cover both the pre-construction and final construction phases of the project financing and focus on the topics listed in Table 2.
Time-of-use energy charges and multi-component demand charges require intelligent storage dispatch controls to optimize customer bill reductions with or without co-located PV. Credit: DNV GL.
With the increasing number of energy storage systems (ESS) entering the market, targeting a wide variety of applications, the IE review will specifically focus on the commercial maturity of the selected technology and an assessment of how well the technology matches the intended application. In an ESS system, the technology section will typically include a high-level review of the selected batteries, system configuration, power conversion hardware, battery management system (BMS), as well as a review of the monitoring, communications and control systems, and balance of plant. Performance of existing installations will typically be assessed with respect to tracked metrics related to the target application. For example, a historical regulation performance score can be assessed for project targeting ISO frequency regulation.
A unique aspect of ESS that is creating new demand for independent validation is the operational and advanced storage dispatch control software and (BMS) being layered on top of the battery technology itself. In addition to the hardware and system integration, this link in the system value chain is the fundamental determinant of the revenue streams and cash flows used in forming the lending structures. As the economics become more favorable, energy storage control software for peak shifting, energy firming, and grid resiliency applications will also require detailed analysis and third-party validation. As more opportunities arise for aggregated storage to participate in utility and ISO capacity and regulation markets, aggregator control layers will require further layers of validation. Without independent validation of this key component, the reliability and robustness of the other aspects of energy storage projects may be meaningless, or impede adoption and market growth.
Finally, to assess the revenue requirements for the installation, an independent review of the storage contracts and performance agreements is undertaken. These may include ISO or utility capacity contracts, demand response contracts, ancillary service agreements, and/or customer performance guarantees. Understanding the contracted performance requirements and potential penalties for under-performance is required to capture the risk to near term and future project revenues.
Fortunately, lessons learned in the sustained growth of wind and solar project financing will accelerate the adoption of energy storage as many of the standard tools required for assessing risks have been well honed. Confidence in the results of these independent engineering and technology assessments depends on the integrity and reputation of the firms conducting the studies.
Terence “Terry” Schuyler is a principle consultant at DNV GL where he serves as project manager conducting third-party independent technical due diligence evaluations of PV and energy storage power electronics/inverters, energy storage products and integrated PV/ES systems (often referred to as Bankability Studies).
Michael Kleinberg, PhD, is a senior consultant specializing in energy storage and advanced distribution system analysis. Michael is actively assisting California utilities in developing and assessing their 2014 storage request for offers (RFOs) and has led development of DNV GL’s energy storage cost-effectiveness model, ES-Grid. Michael is leading technical due diligence efforts to support investment in multiple large-scale energy storage projects being developed across the U.S. ◑