Key Energy Storage Contract Issues

(Orrick) – The storage industry has been boosted by the successful completion of the first wave of non-recourse battery energy storage project financings and the increase in utility procurement of battery storage projects and products. Indeed, private developers have recently closed hundreds of millions of dollars of financings for large battery projects. Moreover, utilities have procured hundreds of megawatts of utility-owned battery projects through EPC, BOT or similar contractual acquisition structures and have executed numerous contracts for battery project services and products.

Of course, the successful development and financing of any type of energy or infrastructure project requires many different building blocks, including site control, permits, interconnection, regulatory exemptions, EPC, O&M, PPA/offtake revenue contracts, and others. Although each of these is important, our experience has revealed that the most unique and critical issues to ensure the viability and finance-ability of battery storage projects arise primarily in the area of dependable offtake revenues. This article takes a closer look at contractual issues related to this issue.

OFFTAKE REVENUE CONTRACT STRUCTURES AND ISSUES

The variety of offtake revenue contracts for battery storage projects has expanded rapidly. Today’s offtake revenue contracts for the sales of products and services from battery storage projects generally fall into two categories. The first category relates to projects which are connected to the energy grid “in front of” a customer’s revenue meter (“front-of-meter” contracts), including energy storage tolling agreements, capacity sales agreements and hybrid power purchase agreements. The second category relates to projects which serve the electric load of a customer “behind” the customer’s revenue meter (“behind-the-meter” contracts), including utility services agreements and C&I host customer agreements. We evaluate below each of these types of contract and some of the key issues often negotiated between the contract parties.

Key Contract Structures and Issues; Front-of-Meter Contract Structures

Offtake revenue contracts for front-of-meter battery storage projects usually take one of three forms: the energy storage tolling agreement, the capacity sales agreement or the hybrid power purchase agreement (PPA). The energy storage tolling agreement and capacity sales agreement are similarly structured and typically govern the sales of products and services from a stand-alone battery storage project. In contrast, the hybrid PPA applies to a renewables or conventional energy generation project (e.g. solar, wind, gas or other project) integrated (and typically co-located) with a battery storage project.

  • ENERGY STORAGE TOLLING AGREEMENT

The energy storage tolling agreement is structured like a standard tolling contract for a gas-fired generation project, and provides the offtaker (typically a utility) with capacity, energy and other products generated by a grid-connected, stand-alone battery project. As the “seller” under the agreement, the project sponsor is responsible for developing, owning, operating and maintaining the battery project, and retains technical operational control of the battery. As the “buyer” under the Agreement, the offtaker typically exercises full authority to charge and discharge the battery, subject to the battery’s operating limitations and other agreed dispatch parameters. In addition, the offtaker typically pays for and delivers all charging energy from the grid to the battery, and acts as “scheduling coordinator” or “market participant” for the battery in managing its scheduling arrangements. The offtaker pays the project sponsor a fixed (usually monthly) capacity charge for its right to utilize the battery’s capacity, and frequently a variable operating or “energy” charge for dispatches instructed by the offtaker. The capacity charge may be subject to reduction for decreases in capacity, availability or efficiency of the project.

  • CAPACITY SALES AGREEMENT

The capacity sales agreement is a variant of the energy storage tolling agreement, and has been used in jurisdictions such as California, where utilities seek to contract for resource adequacy benefits or other capacity attributes required to be procured by the utilities. Three principal differences exist between a capacity sales agreement and an energy storage tolling agreement. First, under a capacity sales agreement, only the capacity and capacity attributes of the battery storage project are sold to the 2 offtaker. The project sponsor is entitled to sell all of the battery’s other products, including energy, ancillary services, etc., to third parties or on a merchant basis. Second, the offtaker pays the project sponsor a monthly capacity charge, but no variable or energy charge. Finally, the project sponsor retains not only technical operational control of the battery, but also full authority over charging and discharging. The project sponsor and offtaker may agree to certain exceptions to these arrangements, for example the offtaker’s right to dispatch the battery during a limited number of peak hours during each calendar year.

  • HYBRID POWER PURCHASE AGREEMENTS

Hybrid PPAs contemplate the sale of bundled products from a generation facility integrated with a battery storage project. Hybrid PPAs were initially expected by many in the renewables industry to become the predominant vehicle for battery storage deployment in the United States, primarily due to the federal investment tax credit that may be available to battery storage projects integrated with solar or certain other renewables facilities. Although hybrid PPAs have been deployed for a number of years in islanded areas, such as Puerto Rico, to help utilities smooth intermittent renewables production flows for grid stability purposes, they only recently have become more common in the mainland U.S. During just this past year, a number of utilities in the western U.S. have executed PPAs for hybrid solar/storage projects and numerous RFOs for such projects are currently pending.

One form of hybrid renewables PPA is structured like a standard as-available take-or-pay PPA for a renewables generating project, and has been used in islanded areas where the offtaker is primarily interested in stabilizing 3 intermittent renewable energy flows. This type of PPA requires the project sponsor to install a battery system which is typically charged only by the on-site renewable generation project, and is then discharged to moderate renewable intermittent energy flows to the grid. The project sponsor sells as-available energy bundled with any other available products (capacity attributes, renewable energy credits, etc.) to the offtaker, and receives a fixed or escalating price in return, typically per MWh. The hybrid project must satisfy minimum levels of operating and technical requirements assessed based on the battery’s performance in smoothing out energy flows. The project sponsor, not the offtaker, typically has full discretion to charge and discharge the battery, subject to operating parameters set forth in the PPA.

Another form of hybrid renewables PPA authorizes the offtaker to decide when to charge and discharge the battery system, and also whether to charge the system from the on-site renewable generation or from the grid. This structure is utilized by offtakers seeking to exercise more control over the project, and is increasingly popular with utilities and other load-serving entities in the western U.S. Where any battery charging is from the grid, there may be a reduction in investment tax credits that may otherwise be available (see further tax detail on page 16). Variability exists in compensation structures in hybrid renewables PPAs, but typically the sponsor receives either (i) an energy charge ($/MWh) for energy delivered plus a capacity payment in relation to the battery system ($/kW-month) or (ii) just an energy charge ($/MWh), but with an agreed “adder” per MWh to compensate the project sponsor for the battery system.

 

Key Contract Structures and Issues

Offtake revenue contracts for front-of-meter battery storage projects contain a variety of commercial and legal issues. These issues include “standard” issues usually found in tolling agreements and PPAs, including completion/schedule guarantee issues, curtailment, performance guarantees, defaults, limitations on liability, etc. We have described here three other issues which are unique for offtake revenue contracts for front-of-meter battery storage projects.

Compensation Structures

One set of issues arising frequently in front-of-meter contracts is the flexibility, fairness and accuracy of the compensation and payment formulas. Some front-of-meter contracts clearly allocate all current and future products and services from the battery to the offtaker, while others are not entirely clear on how future products and services will be compensated, if at all. In our experience, many utility contract forms do not address the possibility that the battery system may provide new “products” and generate future value streams not contemplated as of the execution date, and are unclear on both the sponsor’s ability to sell to those products and the offtaker’s obligation to accept or pay for them. To the extent economic viability of a project may depend on additional revenue streams, the contract should clearly address these issues.

In addition, details within compensation formulas of many “form” battery storage project contracts used in the market are often unclear or fail to contain necessary detail. This is most common in battery system fixed capacity charge formulas and project availability calculations and formulas. Among other issues, these forms frequently fail to ensure that the project is considered “available” during periods including force majeure events, grid curtailments and other similar circumstances. Similarly, certain contracts may premise capacity payments on the availability of both current and future capacity attributes, including those which are not yet available in the market. Because these formulas may assign different weights or values to different capacity attributes, it is critical for project sponsors to ensure that the formulas accurately and fairly value each type of current and future capacity attribute, allow any necessary flexibility to the project sponsor, and also account for any relevant change in law risks.

Compensation provisions and formulas must also be consistent with the metering arrangements for a hybrid project. Depending on whether a hybrid project uses an AC- or DC-coupled battery system, the parties will need to determine at which point(s) to measure the MWhs generated, stored and/or discharged for different purposes of the PPA. Because efficiency and other losses due to the battery’s operation could reduce the amount of MWhs ultimately delivered to the offtaker, the PPA must also be clear on which party is assuming the risk for those losses, the amount of which will vary depending on the amount and manner of use of the battery system. As a separate matter, if the co-located generation project is a solar or wind facility and the project’s economics are dependent on receipt of the federal investment tax credit for the battery, the project sponsor will need to ensure that the hybrid PPA contains relevant restrictions on the offtaker’s utilization of the battery so as not to jeopardize the battery storage project’s receipt of tax benefits. See page 16 for additional details on the applicability of tax benefits to hybrid projects.

Change in Law

The rules and protocols relating to the definition and compensation of energy storage products and related interconnection arrangements are not yet settled in several markets. Change in law risk is therefore one of the most sensitive and highly negotiated issues in offtake revenue contracts for battery storage projects.

Certain products, like capacity-based products (e.g., Resource Adequacy in certain jurisdictions) and ancillary services, may be contractually required to be provided by a battery storage project and are defined and ascribed value by state law or the applicable ISO/RTO tariff. A change to the legal definition or requirements could require the project sponsor to incur substantial costs to continue complying with the contract’s obligations. As just one example, ISO/ RTO capacity attributes rules frequently require a battery storage project to be capable of discharging continuously at its maximum capacity for a specified number of hours in order to obtain credit for resource adequacy or other state-mandated capacity attributes (e.g., four hours). Offtake contracts for front-of-meter projects often require the project sponsor to provide capacity attributes and to “take all actions” to qualify for these benefits throughout the delivery term. If a project sponsor installs a battery designed to discharge at maximum capacity for the specified number of hours, and the rules then change and increase the number of hours, the project sponsor could be required to incur significant upgrade costs to comply.

A project sponsor can adopt one of several contractual approaches to reduce change in law risk, and the most effective method depends on the project sponsor’s risk tolerance and the offtaker’s long term product requirements and flexibility. One option is for the project sponsor to agree to comply with certain contractual requirements up to a pre-agreed compliance expenditure cap over each contract year or over the entire delivery term. Alternatively, the project sponsor may agree to comply with all relevant obligations so long as no modifications to the battery storage project are required. Finally, a sponsor may include a set of “operating parameters” of the battery system and simply agree to provide any and all products consistent with those parameters.

Offtaker Dispatch Authority

The scope of the offtaker’s dispatch authority over the battery arises frequently as an issue in capacity sales agreements and hybrid PPAs. In capacity sales agreements, the offtaker may require dispatch authority during periods when it expects increased congestion in the battery’s service location or pricing node. The parties will need to evaluate how a temporary transfer of dispatch authority impacts the project’s scheduling, metering and compensation arrangements. In addition, the project sponsor may wish to limit the offtaker’s dispatch rights to the extent they could reduce the battery’s capacity or efficiency performance levels.

In a hybrid PPA, if the offtaker has dispatch authority over a battery system, the project sponsor will need to include relevant operating parameters and limitations on the offtaker’s discretion. In addition, if the co-located generation project is eligible for federal investment tax credits, the hybrid PPA should include appropriate limitations on the offtaker’s ability to charge from the grid.

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The above is excerpted from Orrick’s Energy Storage Update 2018.

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