As the use of coal power tails off, imbalances in between supply and demand are expected to drive more power price volatility and returns for battery energy storage systems (BESS) and the funds that specialise in them.
Returns of BESS investments for the likes of Gore Street Energy Storage Fund PLC (LSE:GSF) and Gresham House Energy Storage Fund PLC (LSE:GRID) should remain high, analysts at Berenberg predict, given that they depend on the growth of electricity markets and part of their revenues are linked to power price volatility.
National Grid currently forecasts a requirement for over 30GW of energy storage in the UK by 2050, up from about 1.3GW at the moment.
Alongside that backdrop, the cost of batteries has declined by 88% over the past decade and is expected to continue to drop.
Lower capital expenditure requirements should drive up use of BESS in the power system, Berenberg said.
The energy trading market looks to be a profitable area, especially as the spikes in the gas price in recent months have indicated.
Frequency response (FR), including dynamic containment (DC), was the main source of revenue for the London-listed funds in 2020 and is expected to be significant in 2021, but Berenberg sees trading becoming the main revenue stream for BESS in the near future, which would suit more investments in longer-duration batteries.
“Longer-duration batteries have a higher cost but we understand are optimal for the merchant market which includes FR as well as the trading market. Upgrading is an option for battery storage systems but the potential costs related to grid connections, planning permissions and system downtime are currently unknown to us.”
As Berenberg noted, both Gore Street and Gresham House Energy Storage have been successful in providing shareholders with significant returns, and both shares trade at a premium to net asset value (NAV).
Gore Street Energy Storage Fund, the first London-listed energy storage investment trust, targets an annual dividend rate of 7% of NAV and a total gross, unlevered internal rate of return of 10-12% from its portfolio of projects.
The company will not invest in any projects under early-stage development, save in respect of construction and final delivery of the battery systems, the key components of the projects.
Gresham House Energy Storage Fund, meanwhile, is the larger of the two at just over GBP0.5bn, with the fund investing in utility-scale battery storage systems, with targeted unlevered/levered NAV total return of 8%/15% net per year respectively.
“Given that FR is the main revenue stream for both funds at this point, we prefer Gresham House Energy Storage for the large operational portfolio and the investor-friendly fee structure,” Berenberg said.
“Also, the investment manager is aligned with shareholders holding a stake in the fund. Gresham House Energy Storage does not disclose the average cost of acquisition of its portfolio.
“We appreciate Gore Street’s strong focus on cost and access to a wider geography with a pipeline in North America. Having said that, and given the different market dynamics, investing in these markets could be challenging. We will be watching the development of this part of the portfolio with interest and retain caution.
The analysts concluded: “We believe there is significant further growth potential in the London-listed BESS market and opportunity for high future returns as power price volatility remains.”