Impact of high energy and metal prices on battery investment

The Russian invasion of Ukraine has unsettled both energy and metals markets. In this blog, we explore what this means for both existing and new build battery storage projects.

Before we discuss the economic impacts, we first and foremost recognise the human and geopolitical consequences of Russia’s invasion eclipse the economic ones and the cost of the war will be first and foremost a human one.

Limited gas supply from Russia has resulted in record wholesale electricity prices

Currently wholesale electricity, natural gas and carbon prices have reached record levels, with GB electricity and gas prices around nine times higher than those seen at the beginning of 2019. Gas prices increased across 2021 with the restriction of gas supplies from Russia, with only long-term established contracts being honoured and Russian controlled storage sites failing to be replenished. The UK, which is heavily reliant upon gas-fired generation, saw an almost direct pass-through into wholesale electricity prices.

This is against a backdrop of high global gas demand for power generation following the Fukushima incident which led to the shutdown of nuclear powerplants in both Japan and Germany. High prices in Asia, for which gas demand tends to remain high across the summer due to air-conditioning loads supporting electricity demand, means importing Liquified Natural Gas (LNG) will be expensive in summer.

Additionally, Germany is looking at legislation to ensure storage levels meet a mandated level (thought to be over 80%) before the beginning of next winter. This requirement would be placed on storage capacity holders with the market area manager (Trading Hub Europe – THE) stepping in to purchase additional volume through the use of strategic-storage based options (SSBO’s) if required.

Meanwhile, the shutdown of the Groningen gas field (once the largest in Europe) is expected to go ahead in mid-2022. Concern around earthquakes that have resulted from the extraction of gas from this field has led to this shutdown and will further tighten gas supplies.

Belgium, which committed to phase-out nuclear power generation by 2025, has announced it will seek to extend the life of two nuclear reactors by ten years. The Belgian Prime Minister Alexandre De Cross stated that "This extension should make it possible to strengthen the independence of our country regarding fossil fuels in a chaotic geopolitical context".

In response to the ongoing invasion, the UK has announced a phase-out of Russian oil imports by the end of 2022. A new energy supply strategy is expected to be announced, coinciding with the release of the Spring Statement, in which it is expected the UK’s commitment to net zero will be reaffirmed but extraction of oil and gas from the North Sea will be increased.

High gas prices have had a knock-on impact to the price of carbon under the European Emissions Trading Scheme (EU ETS). In this scheme generators purchase carbon credits which allow the owner to emit one tonne of carbon, the supply of these credits is restricted and will fall over time to incentivise decarbonisation. Due to the increase in gas prices and gas-fired generators have been running less often whilst coal generators have been running more heavily. As coal is more carbon intensive there has been an increased demand for carbon credits leading to a rise in prices.

With the need to replenish stock levels, falling domestic production and competition from Asia gas prices are expected to remain elevated for the foreseeable future, carbon prices as a consequence will remain elevated.

A sustained period of high and volatile intraday price spreads

High gas and carbon prices have led to greater intraday price spreads (the difference between the maximum and minimum electricity price within the day). Low prices have recently arisen during periods of low demand overnight in which there is either sufficient renewable generation to set zero or even negative prices (occurred over the holiday period last winter). High prices are set during periods of high demand and/or low renewable output when gas peaking plant is required to meet demand, commanding a higher price due to their lower efficiency and having to recover their start-up cost over a short duration action.

We saw an increase in price spreads in winter 2020/21 caused by low wind output, high demand and plant unavailability (see our blog here). Across winter 2021/22 there has been a sustained period of very high price spreads, the drivers for this differ in two respects:

1. High gas and carbon prices resulting in higher wholesale electricity prices and higher spreads (in absolute terms) between peak and off-peak prices.
2. High levels of scarcity value during periods of system tightness, with day-ahead electricity prices spiking to over £1,500/MWh and balancing prices as high as £4,000/MWh. Together with National Grid ESO and Frontier Economics we are currently working to understand in detail the drivers for these high prices.

Some of this high pricing is a result of older, less flexible capacity such as coal and CCGTs commanding very high prices during periods of system tightness. Most of the remaining coal capacity is scheduled to close in September 2022, and to the extent, this is replaced by smaller, more flexible capacity we may see a decrease in scarcity pricing.

Irrespective of this, this period of high fuel prices is set to continue, batteries are well placed to capitalise on the resulting high price spreads.

But the costs of producing battery cells is increasing

Due to the significant returns that have been seen through both energy and frequency response (Dynamic Containment) markets interest in battery storage is high. In the 2025/26 T-4 Capacity Market auction over 3.3GW of new build battery storage capacity was awarded a contract (much higher than the c. 0.5GW levels seen in previous auctions).

However, the price of metals used in the production of batteries is increasing.

There are two types of lithium battery, in which the cathode (one of the main metallic components) consists of either:

• LFP - Lithium Iron Phosphate (LiFePO4) which contains no cobalt or nickel
• NMC - Lithium Nickel Manganese Cobalt Oxide (LiNiMnCoO2)

However, it has been reported by the Times that coal plant operators have been approached to delay closure to help to ease the pressure on the energy system.

Cobalt is a relatively rare and expensive metal and because of this considerable research has been undertaken to look at replacing its use with Nickel, which is normally comparatively cheaper. However, the recent conflict has led to a significant increase in Nickel prices with Russia being the third-largest producer.

Lithium prices have significantly increased in the last six months due to lithium plants shutting down during the pandemic and being slow to restart. At the same time, there has been a large increase in demand for electric vehicles in Europe, China, and the US. The Ukraine conflict so far has had little impact on lithium prices; a protracted conflict could have a substantial impact on lithium prices. It is speculated that the eastern region of Ukraine has reserves of 500,000 tonnes of lithium oxide, which if borne out, would be one of the largest reserves in the world.

These price rises threaten the delivery of the 3.3GW of new build projects as at the moment there are no significant penalties for non-delivery (other than giving up the contract itself). As batteries are relatively quick to construct, taking just under a year to connect to the grid, some developers may simply choose to delay build as they are not obligated to be online until 2025. They will then forgo the high returns evident in the energy and frequency response markets and potential additional revenues from the preceding T-1 capacity market auctions.

Good news for existing storage assets but a period of uncertainty for new build

Continuing high gas prices will act to support intraday price spreads. These may act to counter the oversupply in the Dynamic Containment (DC) market and prop-up DC prices as operators choose to switch to energy markets when opportune. However, these higher upfront costs together with the increasing difficulty to obtain grid connections may hinder the delivery of new build assets.

For more details see our latest publication ‘Has 2021 changed the outlook for battery storage investment?’ and on-demand webinar.