A long time coming: DESNZ publishes long duration storage consultation

The Government’s long duration electricity storage consultation, published on 9 January 2024 (the “Consultation”), aims to address the challenges and opportunities associated with investment into long duration electricity storage (“LDES”). The Consultation outlines a comprehensive policy framework based on a cap and floor support mechanism, including potential design parameters, eligibility criteria and delivery routes. The deadline for submitting responses to the Consultation is 5 March 2024.

The Consultation states that deploying up to 20GW of long duration electricity storage could result in system savings of up to £24 billion. As well as this, LDES could provide much needed low-carbon flexibility in the system, potentially reducing emissions by up to 25% in 2035 (according to LCP Delta and Regen (“LCP”) analysis commissioned by the Department of Energy Security and Net Zero (“DESNZ”)). Despite this, there has been little investment in LDES assets in recent memory and, for this reason, the Government has proposed to put in place a policy framework to enable such investment in LDES.

Barriers faced by LDES projects

Following a Call for Evidence published in July 2021, key barriers to the deployment of LDES were identified, including high upfront capital costs, long build times, lack of a track record of more novel technologies, lack of revenue certainty, and lack of market signals (more information on the Call for Evidence is set out in our previous LawNow article here). The Government’s response to the Call for Evidence was published in August 2022 and can be found here.

DESNZ has proposed a cap and floor mechanism as the most appropriate policy intervention for enabling investment in LDES.

The Consultation details a set of policy objectives based on the barriers identified in the Call for Evidence, which such policy intervention needs to address. The policy objectives include:

• policy alignment (ensuring any policy intervention compliments wider energy policy);
• reducing system costs (ensuring consumers are protected from unnecessary system costs);
• enabling investment;
• providing system benefits (incentivising storage projects to respond to market signals and maximise benefits to the whole system); and
• timing of delivery (ensuring projects can be delivered in a timeframe that maximises benefit to the system, meets public commitments and helps meet the country's net zero targets).

As part of the Consultation, the Government is looking for feedback on these policy objectives and its preferred policy intervention approach.

Cap and floor mechanism design

The proposed cap and floor mechanism would provide minimum revenue certainty for investors (the floor) to provide debt security as well as a regulated limit on revenues (the cap) to avoid excessive returns. When revenues fall below the floor level, they would be topped up by consumers and when revenues exceed the cap, excessive returns would be passed back to the consumer.

The following key attributes that have been identified have been used to develop the potential eligibility criteria for an LDES cap and floor mechanism:

Design parameters

The key parameters which have been considered in the Consultation and the proposals for those parameters are as follows:

• Capacity: drawing from modelling prepared by LCP, the Consultation outlines that the scale of the benefits LDES projects offer depends largely on certain attributes, such as longer duration, higher efficiency, a lower cost of capital, and location constraints across Great Britain. Taking these attributes as well as the current and potential pipeline of LDES projects into account, the DESNZ’s minded-to position is to not set a specific ambition for the overall capacity of LDES deployment at this stage.
• Cap and floor level: the Consultation proposes that the floor level should allow a project to recover its debt-related costs, providing certainty to investors, while the cap level should be such that projects are incentivised to operate to maximise the available storage and gain a fair return on equity investment, whilst protecting consumers from excessive cost.
• Gross margin: the floor level will represent the minimum amount of annual gross margin that a project is guaranteed to earn, with consumers topping-up revenue below. The cap will represent the maximum amount of annual gross margin revenue that a project can earn, over which revenue will be returned to consumers. Using gross margin rather total revenues earned is appropriate for storage assets as it allows for the costs of buying electricity to charge the asset to be taken into account.
• Dispatch distortions: to avoid floor distortions, such as operators deliberately keeping revenues under the floor if guaranteed returns are too generous, and cap distortions, such as operators reducing operation as they approach or are over the cap threshold, the Consultation proposes various mitigation measures, including:

•  setting the floor at the cost of debt;
• setting availability and performance requirements and penalties;
• setting soft-caps  to return gross margin on a sliding scale; and
• introducing a multi-year review periods.

The use of multi-year review periods, which allow assets to transfer revenues between years to smooth out periods above/below cap, has been used successfully in the interconnector cap and floor.

• Gaming risks: to mitigate gaming risks – i.e., asset operators entering into agreements with third parties to exploit the cap and floor scheme – the Consultation considers whether to introduce transparency requirements, ban vertically integrated offtake and supply agreements within an umbrella company, and develop a deemed revenue index to approximate market behaviour (though the Consultation recognises the latter option could be complex). An example of “gaming” would be where an asset owner sells electricity below market rate to a downstream supplier that is part of the same umbrella company. The supplier would be able to make additional profit by selling the cheaply sourced electricity at the higher market prices at the expense of the consumer.
• Administrative allocation: the Consultation proposes running the scheme as an administrative process, as opposed to a competitive process, in order to ensure:

• that the projects that provide the most system benefits are successful, not just the cheapest projects;
• a range of LDES technologies are supported; and
• the policy objectives set out above are achieved.

• Contract length: the Consultation proposes that the length of the contract be based on the project lifetime. This is deemed appropriate due to the fact that the technical lifespan of the eligible assets varies from 10 years to over 50 years. This approach ensures that a variety of technologies will be able to be supported without the Government having to undertake onerous, and ultimately uncertain, forecasting for each type of technology.
• Revenue opportunities: the Consultation sets out that LDES assets in receipt of cap and floor support should be able to operate in available electricity system markets, such as wholesale markets, system balancing, and the Capacity Market.
• Additional finance support: the Consultation is seeking views as to whether additional financing support, such as support from the UK Infrastructure Bank, will be required to address barriers to investment into LDES.
• Pre-qualification criteria: the Government are still considering what pre-qualification criteria should be included, but examples include the financial position of the project, connection location and grid agreement, land/lease ownership, planning permission, environmental permits, and whether the project has an electricity generation licence. This draws on experience from the interconnector cap and floor, the CfD and the Capacity Market.
• Additional factors: the Consultation also seeks views on cap and floor design considerations for exceptional events, periods in which projects must demonstrate commitment, progression and possible performance, and start and commissioning dates.

Further detail of the above considerations can be found in Annex C to the Consultation.

Delivery routes and funding mechanisms

The Consultation sets out two possible routes for delivering the LDES cap and floor scheme:

• Option 1: including a special licence condition in the electricity generation licence.

All projects would require a generation licence if the scheme was delivered through this route. Ofgem would be the main delivery body of the scheme and would be responsible for issuing licences and implementing the special licence conditions. Ofgem would also be responsible for assessing bids and negotiating and managing contracts with successful projects. This is the delivery route used for the interconnector cap and floor.

The Consultation envisions funding for Option 1 to be through the Transmission Network Use of System (“TNUoS”) charges. Where a project falls below the floor level, revenue would be topped up by way of TNUoS and, where projects revenues exceed the cap, projects would have to transfer the amount back to the consumer through TNUoS charges.

• Option 2: Government delivery via a CfD-style scheme.

This option envisions the scheme being delivered in a similar way to that currently used for the CfD scheme and proposed for the Carbon Capture, Usage and Storage Dispatchable Power Agreement. The Government would make key policy decisions, be the main delivery body, assess bids, and negotiate contracts. A third party, such as the Low Carbon Contracts Company, would then manage the contracts.

If Option 2 is chosen, funding would likely be obtained via a supplier obligation levy. This is a compulsory levy on energy suppliers and is currently used to pay for the CfD scheme.

The Consultation does not include a minded-to position on its preferred delivery route and seeks stakeholder feedback on this and the relevant funding mechanism.

Conclusion and next steps

The Consultation marks an important step to address the well-versed issue of lack of investment signals for  LDES. Industry has welcomed the progress that this Consultation represents, however concerns have been raised in terms of:

-        Timing: it has taken over 2 years to progress from the initial Call for Evidence in July 2021 to the publication of this Consultation. While the upcoming second REMA consultation is due to set out a clearer direction for the wider reform of the electricity market, a significant amount of uncertainty remains on the LDES investment case, not least in light of the upcoming national election. Detailed policy design and the efficient deployment of this LDES scheme will be required as soon as possible in order for GB to be able to reap the predicted system benefits by 2035.

-        Technology: the wholesale exclusion of lithium-ion batteries from the scope of support has raised concerns from industry, including 1) lithium-ion battery projects are currently not viable at 6 hours’ duration; 2) market distortions could arise from subsidising some LDES storage technologies and not others; and 3) the risk of consumers funding more expensive LDES projects when cheaper alternatives, e.g., lithium ion, are available. Similar concerns have been raised in relation to the exclusion of projects with a TRL below 8 and projects with capacities below 100MW / 50MW.

DESNZ intends complete the detailed design for the scheme once it has received responses to the Consultation. Responses are to be submitted by 5 March 2024 – responses can be submitted here.