What’s the true cost of battery storage arbitrage?

• ‍Instances of battery storage being used for price arbitrage are soaring
• ‍But Fitch has warned batteries used for arbitrage could degrade faster
• ‍Battery degradation can lead to 46% revenue decreases and increased fire risk

Among the many uses for battery storage systems is price arbitrage. Basically, this means storing electricity when prices are low and discharging it when prices are high. Data from the US Energy Information Administration indicates that the proportion of US utility scale battery storage being used for price arbitrage has increased dramatically in recent years. Back in 2019, only 17 per cent of US utility scale battery capacity was used for price arbitrage, but this had soared to 59 per cent in 2021. In California alone, more than 80 per cent of the state's total capacity of 2,339 MW of battery storage in 2021 was used for arbitrage.

As S&P has highlighted, battery storage arbitrage maximises its potential “when it can charge from $0/MWh prices set by renewable resources on the margin and discharge when expensive gas, coal or oil are setting the price”. Unsurprisingly, 93 per cent of new battery storage in 2021 in the US was co-located with a renewable energy resources in order for it to be charged directly from a zero-cost resource. “Areas with high solar penetration like California will increasingly see a ‘duck curve’ in day-ahead hourly prices where daytime prices drop and evening prices increase, creating the belly and head of the duck, respectively,” S&P has said. “Battery storage can lessen this impact by generating in those peak net demand hours.”

Despite states like California having high solar penetration, natural gas units will still set the price for more than 40 per cent of the hours of the year until 2030, but, as S&P points out, “renewables increase in their time on the margin”, thereby significantly changing the hourly fuel on the margin from 2023 to 2030.  With more than 20 per cent of the 1pm local time day-ahead prices being set by renewables and another 60% set by cheap nuclear, battery storage can charge at very low prices.  After the sun sets, the evening fuel on the margin more often becomes oil, which is more expensive than gas, offering higher prices for battery storage discharge.  Assuming a four-hour battery storage system, the annual revenue accumulated from the top four hours' prices minus the four bottom hours' prices of each day, or TB4, increases up to $55/kW-year by 2030. Day-ahead arbitrage revenues are higher in 2023 due to high gas prices setting a particularly high evening price, but as gas prices return to normal, the arbitrage potential decreases in 2024, followed by a continuous increase as renewables deployment increases, S&P says.

However, while price arbitrage may be a key component of an effective battery storage revenue-stacking opportunity, it may also be an extremely costly exercise. Last month, analysts Fitch Ratings said battery energy storage systems could face faster asset degradation and higher capex volatility than renewables and thermal peaking plants, “especially if they use arbitrage strategies”. Fitch added that, although the operational risk profiles of battery storage are generally lower than those of thermal assets, “we may raise our metrics thresholds for BESS to reflect risks related to volatility of arbitrage margins, use profiles and capex”.

The concern for investors is that arbitrage is riskier than the provision of capacity and ancillary services under merchant schemes, long-term offtake agreements and regulated frameworks. The heightened risk is due to the fact that arbitrage requires active management, which implies margin volatility and less visibility over when and by how much the asset will be charged and discharged, Fitch says.

Degradation rates and life expectancy of battery storage largely depend on the use – that is, frequency, depth of discharge and the style of operation – as well as battery chemistries and external conditions, such as temperature. A high proportion of arbitrage in revenue could spur degradation, reducing the visibility over the pace at which an asset loses capacity, Fitch has said.

Degradation can have a significant impact on battery storage system profitability. One study showed that degradation can lead to a reduction in battery system revenue in the 12-46 per cent range. Perhaps more seriously, as Mitsubishi has highlighted, batteries that have degraded to a significant extent can cause battery overheating that leads to thermal runaway, which can, in turn, lead to “fire, explosion, sudden system failure, costly damage to equipment and possibly personal injury”.

Incorporating price arbitrage mechanisms into plans for the development of energy storage projects can make such schemes appear to offer an attractive return on investment, but careful consideration should be given to the impact of price arbitrage on battery degradation when considering revenue stacking opportunities.

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