Building More Energy Storage Means Building the Right Incentives

In recent years, the falling costs and increasing capacity of lithium-ion battery technology have given rise to a proliferation of grid level energy storage. As prices continue to drop for batteries and other competing storage technologies—such as pumped hydro, compressed air, and reversible fuel-cells—we can’t ignore the need to create smart ways to pay for their installation and operation in the face of changing demand.

In a future with a renewable grid, energy storage will be used for more than just load balancing the grid from the day-to-day needs caused by our variable energy sources and different levels of customer demand. It could be required to potentially store large quantities of energy for periods of weeks to months to facilitate energy consumption during peak periods such as winter heating months. To enable the proliferation of renewable power, long-term energy storage will become just as important a service as short-term power supply.

Due to the fickle nature of energy demand and supply, these storage assets may or may not be used on any given day. Storage providers will need to be incentivized to build storage and be paid for it even if the resource is underutilized. If they aren’t, they will be unlikely to build enough storage capacity and the grid operator may be forced into the use of expensive, short-term peak power (with higher prices that get passed on to customers).

Bloomberg’s BNEF reports that the amount of deployed energy storage will multiply by 122 times, from “9GW/17GWh deployed as of 2018 to 1,095GW/2,850GWh by 2040” and this growth will be primarily driven by a halving of the cost of batteries by 2030. Moreover, there are many energy storage projects being built in conjunction with renewable power developments due to these falling costs and the ability to balance intermittency. Smart contracting for storage could help accelerate this deployment of utility scale storage assets. 

We reviewed a public request for proposal contract that was made available a few years ago by Southern California Edison (SCE), and found that this contract included three sources of income for an energy storage operator:

1. An ongoing payment for capacity of energy (watt-hours) provided
2. Compensation for operations and maintenance cost of the storage unit
3. A multiplier to the payment, if the monthly utilization of the unit met certain requirements

Conversations with players in the battery storage space (such as AMS, which develops artificial intelligence to price and dispatch energy storage) have indicated that batteries also provide ancillary services like regulating the frequency of power. Tiny injections of stored power can help the grid and the individual electricity power markets to maintain their frequency (Hz) requirements.

Though these contracts seem fair at surface level, the key element to note is the utilization related payment. If we have to build more storage than is needed on the average day, we must also build extra storage for days with peak energy demand. 

Since this extra storage may not be utilized frequently, storage contracts should integrate a minimum payment scheme that gives a base payment to the operator no matter what the utilization rate of the battery is, and therefore ensure the operator is compensated appropriately for their investment. Unlike the SCE contract, there might be no penalty for failing to meet utilization requirements (unless there was a mechanical failure) and the storage operator could earn a bonus for high utilization. This would be a way to incentivize enough storage to be built to continue supporting the ongoing energy transition.  

Girish Sankar

Wharton School

Giridhar Sankar is currently pursuing a master’s of business administration from the Wharton School and a master’s of international studies from the Lauder Institute.