Regulating battery storage investments

As variable renewable energy penetration grows across power systems, battery storage systems are set to play a pivotal role in facilitating the energy transition whilst preserving system resilience and reliability. In many jurisdictions around the world where capacity markets are not readily established or feasible, the investment in battery storage systems is expected to be primarily driven by power utilities. As with all investments carried out by power utilities, ultimately, capital costs will be borne by customers through electricity rates.

Regulators have an important role to play to ensure that the accelerated investment in battery storage is not detrimental to customers. In that sense, they must ensure that battery storage investment proposals presented in price control reviews are reasonable (i.e. justifiably proportionate and adequate) and that costs are set to be efficiently incurred.

Considerations for return on investment

In our experience, regulations need to be set out well in advance to facilitate the smooth implementation of such programmes, whilst ensuring the impact of battery storage investments on consumer rates is minimised. Battery storage assets as “network assets” are typically legitimate to enter the regulatory asset base of the power utilities making those investments – i.e. eligible to full cost recovery, including the return on their investment. Hence, they directly translate into consumer rate increases.

Therefore, the following key aspects are worth considering when reviewing such capital budget plans:

• Investment approval criteria: on what basis can a regulator deem that the proposed battery storage asset is reasonable in terms of a given technology, rated capacity and storage duration, or at a given point in time? 
• Efficiency review: what tools, sources of information and pre-existing knowledge can be leveraged to review the proposed costs and gain comfort that they would be incurred efficiently to customers?
• What is the nature of power system modelling studies that should be carried out to validate the investment (e.g. the proposed rated capacity, storage duration and commissioning timeframe)? How should they be leveraged to inform the proposed decision and/or recommend the consideration of alternatives?

Investment approval criteria

Battery storage assets, like any other core network asset, should meet the principles of reasonableness and efficiency. However, in our experience, “reasonableness” and “efficiency” can be perceived as incredibly subjective unless they are meticulously defined. This exposes customers to some level of unpredictability and regulators to severe criticism (and potentially legal action) from regulated utilities. The most effective approach is to define reasonableness and efficiency threshold through specific tests, whereby an asset is deemed reasonable with costs efficiently incurred when all reasonable efficiency tests are met.

Ricardo have supported several jurisdictions, such as Bermuda and Uganda, in articulating such tests in the context of investment evaluations. Examples of such tests are highlighted below:

Table 1. “Reasonableness” criteria for approval/rejection of capital investment 

Table 2. “Efficiency” criteria for approval/rejection of capital investment 

Practicality of investments

Another aspect that is essential to consider at this stage is the practicality of the investment, verifying that developable land has been identified with realistic prospects of securing relevant permits and leases and that can accommodate the full scale of the asset(s) considered. It is equally important to ensure that any leasing costs have been incorporated into cost estimates quoted and under review.

One measure of efficiency that regulators must look out for is the estimated cost of the asset. In the absence of a cost-competitive procurement process, the regulator must verify whether the costs proposed are reasonable and proportionate to the asset. To check the values, regulators can make use of several datasets and sources found online, such as:

• NREL’s Annual Technology Baseline Data
• Other NREL documents and cost projection updates
• IRENA reports

Reference costs obtained through literature review should then be adjusted to reflect:

• Any country premium reflecting higher/lower cost of labour and trade than countries where reference costs have been drawn from (e.g. shipping costs, premium on labour costs, import tariffs, etc.)
• Risk premiums associated with macroeconomic factors such as local/international inflation and foreign exchange
• Learning rates reflecting any anticipated decrease in costs between the year where reference costs are dated from, and the potential commissioning date for the investment considered. This is particularly relevant for battery storage assets.
• Economies / Diseconomies of scale where the investment is done at a scale that is larger / smaller than the reference assets.
• Technology differentials where the type / specifications of battery storage assets considered differs from the reference assets.

Power system modelling studies

Whilst regulators may be persuaded that further battery storage is needed on the system in the face of increasing distributed generation penetration and utility-scale intermittent power, further analysis will be required to verify that both the size/specifications and timing of the proposed programme are adequate and proportionate. Not only this, but also that the proposed asset is expected to remain used and useful for the whole of its economic life to ensure that the investment ultimately paid for by customers is delivering on intended benefits over the right period.

This requires carrying out several types of studies:

1. Long-term capacity expansion and dispatch planning studies. The purpose of these studies is to evaluate supply and balancing requirements of the system, considering existing, committed and potential investments. Such studies should be:
   1. Performed at a detailed level of granularity (at least hourly) to correctly consider the dynamic response of battery storage systems to system imbalances.
   2. Representative for every year of simulation – this will typically involve selecting an appropriate number of representative days per year, which depends on seasonal variations of demand, supply and resource availability in that specific location.
   3. Covering a time horizon running at least until the end of the expected economic life of battery storage systems considered for implementation.
   4. Informed by the best available sources of technical, economic and financial information and consider sensitivities of results to the most prominent assumptions.
2. Transient power system stability studies – in simple terms, to ensure that the dynamic response of battery storage systems (and therefore the size and specs thereof) is adequate to offset perturbations that may be caused by the loss of any single generation, storage or power transmission asset.

Conclusion

Battery storage assets are set to represent an increasing share of regulated asset bases. This sets a challenge for regulators – but we at Ricardo empower them through the articulation of a systemic and transparent series of tests tailored to their specific context and legal framework, providing access to our consolidated and frequently updated set of reliable cost references, and by carrying out modelling studies that can help in streamlining evaluations and ensuring investments approved remain future-proof whilst supporting the decarbonisation of power systems.