Taking on Storage Part Two: Risks and How to Mitigate Them

Part one of this article identified changes in the energy storage market that are driving deployment and improving the economics of storage technologies.

Market stakeholders face many risks, from regulation to litigation, but there are mechanisms available to mitigate them.

Regulatory Risks

There are two main types of regulatory risks.

One is the generic risk that a changing regulatory environment poses to new technologies. The other is the more specific risk that the investment tax credit may not be available or as beneficial as expected.

One need look no farther back than 2015 for an example of regulatory risk at the state level. The Nevada Public Utilities Commission terminated the state net metering policy; residential rooftop solar companies announced they were pulling out of the state. Although key aspects of the policy were later restored, the experience is a lesson to anyone trying to develop a new technology that relies on favorable government policy for support.

At the federal level, the risk currently is the lack of clarity about the regulatory treatment for energy storage. This is becoming more relevant in projects that combine energy storage with renewable power generation and make retail sales.

It is not clear under existing law whether the storage unit qualifies for regulatory exemptions typically claimed by small-scale renewable energy generators or how adding storage to a small power plant affects the generator’s own regulatory exemptions.

For example, FERC includes storage within the definition of “generating facility” in its form small generator interconnection agreement and has proposed to do the same for its form large generator interconnection agreement.

However, energy storage is a unique animal. It is a hybrid in the sense that it shares some features in common with generating facilities and other features in common with transmission assets and load. This means it should be able to provide, in theory, a broader range of services than these other assets. The storage NOPR is one step toward integration of new storage technologies into wholesale markets, but a lot of work remains to be done to realize the full potential of storage.

One smart strategy for tackling regulatory risks is to combine energy storage with other generating assets. For example, many rooftop solar companies are deploying storage alongside solar installations. Combining storage with generating assets with stable revenue and well-defined market participation rules helps mitigate the risk that changes in market rules may reduce or eliminate revenues from a specific storage service.

Another option in the face of regulatory uncertainty is to try to get certainty.

For example, one can ask for interpretive guidance or a declaratory order from FERC stating how the commission will apply its regulations to a certain set of facts. These options typically require both time and filing fees, but they could help settle important questions.

Some state regulators also offer a procedural option of requesting declaratory relief or an advisory opinion on regulatory matters. For example, in September 2017, Tesla obtained an advisory ruling from the Massachusetts Department of Public Utilities that said certain small-scale batteries paired with solar generating facilities are eligible for net metering. The ruling was issued in fewer than four months after Tesla filed a petition and prompted Massachusetts to open a general docket on eligibility of energy storage for net metering.

A third mitigation strategy is to draft storage contracts to address potential changes in the regulatory regime. This could mean including a mechanism to revisit pricing in the event of a change in law. Alternatively, the parties could be required to enter into good-faith negotiations to restore the benefit of each party’s bargain after a change in law.

The other regulatory risk is that an investment tax credit will be claimed on the cost of a storage facility, but then the mix of electricity stored changes over the first five years when the credit is exposed to full or partial recapture. The IRS requires no more than 25 percent of the energy stored come from other sources than the solar or wind facility of which the storage device is a part and then the percentage of other energy storage determines the amount of investment tax credit that can be claimed. For example, if 10 percent of the storage energy is from other sources the first year, then only 90 percent of the full ITC can be claimed. If the percentage of other energy stored increases in any of the next four years, the credit is subject to partial recapture.

The best mitigation method for this type of risk is thorough and accurate modeling of system operation under the full range of operating conditions, and with the system providing all anticipated energy services, to estimate the fraction of charging energy supplied by the linked solar or wind project. To the extent the offtaker has a right to control charging, the owner may want to build in a right to recover any ITC-related recapture or losses.

Market Risk

ISO and RTO market rules allowing “merchant” storage are often the same rules developed for conventional generators and, as such, may not adequately reflect operating capabilities or performance risks that are unique to energy storage. This may limit the ability of storage to compete in the market and make the potential revenue stream more unpredictable than it is for other market participants.

FERC regulations designed to provide fair compensation for the unique operating characteristics of energy storage would eliminate some of these risks.

FERC adoption of the 2016 NOPR would help. Until it does so, the best mitigation for this type of risk is to become intimately acquainted with the rules of the market you intend to bid into, and to write into contracts a right to renegotiate penalties and revenue allocation should market rules change.

The ISOs and RTOs also offer various working groups and stakeholder forums in which to raise issues and become involved in market design. It may be prudent to take full advantage of these opportunities if a substantial investment is anticipated.

Interconnection Risk

Few utilities currently have significant experience with storage, and developers proposing novel storage projects to inexperienced utilities should expect that the interconnection process will take time.

In addition, if a proposed project will provide frequency regulation or any other service that may require on-peak charging, it is possible that the utility will require costly network upgrades that would otherwise not be necessary.

The best mitigation may be to recognize that as more utilities gain experience with storage, the duration of the interconnection agreement process will decline. Until then, developers can minimize delays by ensuring that their interconnection applications are clear and complete, by responding rapidly to utility information requests, and by maintaining frequent communication with utility personnel.

The cost of network upgrades required for interconnection may be reduced by avoiding services that will require on-peak charging, but the value of such services may exceed the incremental cost of the network upgrades. Developers can ask the utility to do an interconnection feasibility assessment early in the process. This will help identify the lowest cost interconnection location.

Litigation Risks

State programs to encourage particular types of participants in wholesale markets are at an increased risk of litigation following the Supreme Court decision in 2016 in Hughes v. Talen Energy Marketing.

The case involved efforts by two states to encourage construction of new gas-fired power plants. The decision has led to questions about exactly where the line is between state and federal jurisdiction when a state’s actions may affect wholesale power markets.

Challenges to other state subsidies are currently working their way through the courts and may provide greater clarity. Any state laws or programs that favor storage may be at risk to challenge.

Energy storage is also subject to other general litigation risks, including environmental, human impact and intellectual property risks, but at a higher level due to its novelty.

The environmental risk varies greatly depending on the technology and siting. Battery leakage is one example of an environmental hazard that is unique to some storage technologies. There is also environmental risk associated with disposal after the equipment is decommissioned. New technologies have no track record.

The evolving nature of the storage market and rapid deployment of new technology makes storage a prime target for intellectual property challenges.

The parties to a storage contract can allocate litigation risks in the contract. Consideration should be given to requiring liability insurance for the various environmental, intellectual property and other risks.

Performance Risks

New technology carries obvious performance risks. Poor performance jeopardizes contracts and could subject developers to heavy non-performance penalties in certain wholesale markets.

Manufacturer warranties and other performance guarantees and even insurance policies can help. They exist currently for rooftop solar, for example. They need to be developed for storage. Developers should make sure that adding storage to other forms of generation will not invalidate any performance guarantees attached to the generating facility.

Performance risk should be considered both in terms of initial system performance risk and long-term performance risk.

Developers usually buy batteries directly from the manufacturer and focus primarily on system integration. If the developer does not have a comprehensive understanding of battery capabilities and limitations, such as maximum charge and discharge rates, thermal requirements and cycle life, there is a strong possibility that the control room will mismanage the battery, and the overall system will be unable to satisfy power purchase agreement performance expectations, with the potential for adverse financial impacts or litigation.

The primary mitigation for this type of risk is to have a thorough understanding of battery capabilities and limitations and to design a system that will reliably provide all contracted services for the duration of the contract.

This requires accurate modeling of battery system operation. Some battery services, such as fast ramping, demand-charge reduction and spinning reserve, can be much more taxing on some batteries than others. This should be reflected in the model.

Many Power Purchase Agreements have terms that exceed expected battery lives.

If storage services are required for 20 years, then the developer must plan for battery replacement at appropriate intervals. Earlier replacement will be required for batteries that allow deep discharge than for storage devices that are designed primarily for backup power and frequency regulation. Developers frequently underestimate the costs of system operations and maintenance.

The main mitigation for this risk is to come up with an appropriate O&M plan based on a thorough understanding of how the battery will work. In addition to periodic battery replacement, this includes having spare power conditioning equipment (inverters, voltage converters) and service technicians available to address unplanned outages or degraded capabilities. Most energy storage systems have continuous monitoring and, to an increasing degree, developers are providing this service in-house. This enables faster detection and resolution of system performance. Independent engineers evaluating system design usually also evaluate the O&M plan.

This article was originally published in Norton Rose Fulbright’s Project Finance NewsWire here and was republished with permission.

Lead image credit: CC0 Creative Commons | Pixabay


Caileen Kateri Gamache is Sr. Counsel with Norton Rose Fulbright. She works with project developers, investors, utilities and financial marketers to find solutions to complex energy regulatory issues, develop ideas into operational projects, draft and negotiate material contracts and close deals. 

Deanne Barrow is an Associate with Norton Rose Fulbright. Her practice focuses on the representation of sponsors and lenders in the development and financing of energy and infrastructure projects in the US, Latin America and the Caribbean.

Ken Collison is Vice President, ICF. He has expertise in transmission studies, power system reliability studies, critical infrastructure protection, transmission and ancillary services valuation, generation analysis, utility restructuring, and strategic studies.

Shankar Chandramowli is a Senior Associate with ICF. He has over five years of experience in energy policy research, transmission and distribution planning in ISO/RTO markets, economic analysis of energy systems, optimization modeling, drafting policy memos and public stakeholder engagement for research inputs.

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