Renewables require energy storage to smooth out peaks and troughs in generation, but the two asset classes are very different. Storage is a much riskier investment, which excludes institutional capital. Could a tolling commercial structure unlock battery energy storage systems for infrastructure funds?

Unlike wind and solar, energy storage revenues are not supported by regulated mechanisms such as feed-in tariffs (FiTs) or contracts for difference (CfD). As such, battery energy storage systems (BESS) must compete in wholesale power and ancillary services markets to generate income.

This reality, combined with high capital costs, makes BESS investments too risky for conventional infrastructure funds seeking long-term stable revenues with a low risk profile.

Tolling agreements are emerging as a possible means of fixing this. Two recent deals ignited interest in this alternative business model for financing BESS.

Gresham House, an alternative asset manager, signed in June a two-year fixed price contract with Octopus Energy. This provides 568 MW of BESS capacity with aggregate generation of 920 MWh.

Then, in August, BESS developer Penso Power signed a seven-year tolling deal with Shell for the 100 MW / 330 MWh Bramley BESS. This is currently under construction in Hampshire. The asset will be the longest-duration large-scale battery in Great Britain when it comes online in Q4.

“It’s eye-catching, not least because Bramley will be a three-hour duration asset, allowing Shell to operate at the market’s leading edge in the UK, where margins are frequently deepest due to a lack of competition,” said Charles Lesser, partner at cleantech advisory Apricum.

“Tolling has always offered a different commercial model, enabling storage assets to be treated more like core infrastructure. When BESS revenues are depressed, tolling becomes attractive,” he added.

Apricum partner Charles Lesser. Photo: Apricum

Different model

Under a tolling deal, the ownership of the BESS asset is separated from the operation via a tolling agreement. This is similar to a lease or rental agreement. The lessee pays a fixed tolling fee to the owner to use the asset to generate revenue. In return, the owner agrees to maintain the asset and ensure its availability to the lessee.

For the tolling deal to work for the lessee, it must be confident it can make enough money trading electrons and providing grid services to pay off the tolling fee and cover its cost of capital. Key to this is in-house trading expertise and negotiating down the tolling fee to an acceptable level.

For the asset owner, the advantage is guaranteed income from an asset with an uncertain revenue profile. This paves the way to release and recycle capital via debt financing. The downside is reduced, or no, exposure to merchant upside from improved market conditions for BESS. There is also a loss of control over how the asset is used.

Reallocating risk

“Tolling agreements shift the risk from investors to optimisers, creating a win-win situation,” says Thomas Fridrich, an energy economist at Germany’s Federal Institute for Geosciences and Natural Resources (BGR).

“This model opens the door for risk-averse infrastructure investors who were previously deterred by BESS complexity and volatile returns.”

A key challenge for BESS investment has been meeting the internal rate of return expectations (7-10% IRR) of infrastructure investors, Fridrich said.

BESS technology costs are dropping across the board, from lithium-ion to other promising chemistries. “This decline paves the way for lower tolling revenue thresholds, making BESS projects even more attractive for investors.”

Quantifying value

Neither Penso nor Gresham released many details about their respective deals. Analysts have tried to draw out assumptions on the key economic parameters.

Fridrich said the Bramley BESS project would achieve an IRR of approximately 6.8%, assuming a 20-year operational lifespan “without major overhauls and a standard tolling agreement structure”.

To boost this to 8% or even 10%, the tolling fee would need to rise to €75k or €84k per MW per year, respectively, Fridrich said.

Modo Energy came up with similar figures.

An estimated toll of £75k per MW per year could deliver “suitable returns” for the owners of Bramley, according to Modo Energy.

The project would provide an unlevered IRR of 10% over a 25-year project lifetime. This is based on an estimated capital expenditure of £900,000 per MW and fixed revenue of £108,000 per MW per year across the seven-year tolling agreement tenure.

“This level would also provide upside for Shell,” Joe Bush, market analyst at Modo Energy, said in a note.

“Merchant revenues in Modo Energy’s central forecast scenario over this period are £96k/MW/year. This means that Shell could make a £21k/MW/year spread in this scenario, equivalent to an optimisation fee of 22%.”

But the actual toll level could sit within a wider range.

Finding acceptability

“A toll of between £60k and £90k/MW/year could deliver an unlevered IRR of between 9% and 11%, respectively. However, at the lower end of this range, Penso would likely feel like they are giving away too much value. Meanwhile, at the upper end, Shell would feel like they are taking on too much risk for not enough upside,” Bush noted.

Finding the sweet spot for a tolling fee is not easy. Falling costs could widen the narrow band of acceptability.

Gore Street reported average revenues of £77,300/MW in its annual report. A tolling agreement at £70k/MW leaves optimisers with little room to cover risks and generate profits. However, “as capex continues to fall, investors will be comfortable accepting lower tolling revenue, translating into better margins for optimisers,” Fridrich said.

(Mis)aligned incentives

Tolling is a fundamentally different setup to the conventional profit-sharing model for BESS investments. Until now, parties developed BESS projects by splitting the up-front costs and responsibilities to receive a corresponding share of profits. This provided an alignment of interest and incentives.

Tolling changes that alignment, creating tension between parties, said Ed Porter, director of industry at Modo Energy.

“One party wants to use the asset to maximise revenue, while the other wants to protect it from wear and tear, because they are holding the O&M [operations and maintenance] contract and will optimise the asset post-toll,” Porter said.

Gore Street Energy Storage Fund, London’s first listed energy storage fund, said this is why it is steering clear of tolling agreements for now.

“Tolls often come with increased cycle rates, which can degrade the battery, while putting in place stringent availability requirements and penalties if they dip below that level,” the fund said in its latest annual report.

“As an active manager with an in-house commercial and asset management team working in unison to maintain availability while engaging in a wide range of optimal revenue streams, we would not rush to give up that control.”

Worth the wait?

Striking a viable tolling agreement requires “lengthy contractual negotiations to define usage parameters and clauses for liquidated damages that are acceptable to both sides,” Porter said. This makes a tolling agreement “much more complex and slower to bring forwards” than a traditional profit-share deal.

For example, a company might need six to 12 months to negotiate and approve the underwriting agreement for a BESS tolling deal. But the same company might wrap up the approvals for a profit share in as little as one week, Porter added.

On the flip side, a tolling deal paves the way for higher gearing ratios through revenue certainty. The debt/equity split might be as high as 80% when leveraging a market leading credit rating such as Shell’s. This is compared to 60-65% for a merchant-based profit share.

“Is tolling a new era for BESS? In part yes, because these deals [Penso-Shell, and Gresham-Octopus] will give confidence to other risk committees considering underwriting other assets, and demonstrate certainty around future BESS returns,” Porter said.

“But of the 140 sites operational in the UK, I don’t see 100 of them signing tolling agreements tomorrow,” he concluded.

Evolution, not revolution

Tolling agreements will open the door to new capital pools. But it is no silver bullet for channelling investment into the BESS space. One constraint will be limited appetite among traders to strike these kinds of deals, Apricum’s Lesser said.

“It would be tempting – but wrong – to assume that tolling is the future,” he told E-FWD. “Trader appetite is growing, but it will be finite. We’ll see more tolling agreements, from other traders and in other European geographies, but it’s not likely to become the dominant commercial model because it would concentrate market risk, and traders aim to manage risk.”

*PensoPower is expanding its 100 MW Minety BESS asset in Wiltshire to 150 MW. Photo: PensoPower*

Striking such deals with top-tier traders also requires knowing the right people. PensoPower CEO Richard Twaites was previously chairman at Limejump, the energy storage and renewable energy trading company.

Shell bought Limejump in February 2019. In September 2020, they signed a contract to trade and optimise the power output from the largest battery asset in Europe – the 100 MW Minety BESS in Wiltshire – which was developed by PensoPower.

“They [Penso] get preferential treatment with Shell. I’m not sure anyone else could have got this deal done,” an industry source told E-FWD, speaking on condition of anonymity.

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