Sector focus: How energy storage could be a game changer for utilities
We assess the potential for energy storage with lithium-ion batteries and discuss where investors are likely to find good opportunities.
31 March 2016
In 2015 one of the worst performing stocks in the Eurostoxx index was RWE - a German utility that has suffered amid low power prices and regulatory pressures.
Low power prices are partially a consequence of declining commodity prices, which will lead to lower tariffs, and partially due to the increasing penetration of renewable energy.
The deflationary force of free wind and solar fuel raises a fundamental question mark over the future of the European utility industry.
This is something that investors have to be aware of not just in Germany, but across the globe, as the world leaves the fossil fuel age.
Both solar and wind energy are inherently intermittent sources of power.
For instance, on some days the spot price for power (the bars in the chart below) turns negative in Germany as the combined output of wind farms and solar panels exceeds demand.
Chart 1: German intra-day power prices turn negative as production outstrips demand
Source: Agora Negative Strompreise (PDF)
With greater dependency on such sources, the matching of supply and demand is becoming increasingly difficult, which is an issue for traditional power producers like RWE.
Lithium-ion storage solutions gaining momentum
Some industry insiders have predicted that large scale power storage will be the solution to this problem.
Their view is that with the right type and amount of storage solutions, there would be no need for any coal, gas or nuclear power plants when relying predominantly on intermittent renewable energy sources for power production.
If bulk storage were to materialise, conventional generators such as RWE would face insurmountable challenges.
Ever since Tesla introduced two different types of lithium-ion based storage solutions, the idea of bulk energy storage has gathered momentum.
Proponents of the technology are of the view that with increased production scale, the cost of these solutions would fall so much that it would make bulk storage of renewable energy more affordable.
Indeed, it seems very likely that all-in costs of battery storage solutions, such as those based on lithium-ion, will become cheaper.
Nonetheless, the costs are still likely to stay high and the capital expenditures significant for reaching adequate storage backing.
Cost and lifespan are the inhibiting factors
Even under more optimistic scenarios for cost declines, the investments are so costly that it seems unlikely that bulk storage with lithium-ion batteries can ever compete with fully depreciated fossil fuel plants to balance the grid on a large scale.
A second issue is that lithium-ion batteries are not the most suitable for a prolonged charging and discharging cycle over many years.
Any user of electronic appliances can observe this phenomenon with older consumer electronics goods: a laptop battery for instance will lose much of its capacity after three to five years.
This becomes a meaningful problem when the scale is providing an entire country’s power supply. It has real ramifications for returns in the utility industry and for large commercial or individual users of electricity too.
With both cost and life span an issue, bulk storage with lithium-ion batteries seems like an idea for the rather distant future.
There could be applications, such as fluid-state batteries (whose internal chemicals can easily be replaced, thus extending the battery’s life span), that will achieve bulk storage in an efficient way. But these have yet to be commercialised.
This does not mean though that lithium-ion batteries will not have some application either at the utility level, or for individual users.
For utility providers, lithium-ion batteries will be much more efficient in balancing demand and supply than the current existing generation equipment.
This will be very important in managing the grid more effectively and for bringing electricity costs down further.
However, energy storage is likely to be a niche application for lithium-ion batteries compared to their use in electric vehicles (EVs).
The winners in storage will therefore likely be those players that also dominate the EV market. As more electric vehicles are being produced, cost reductions for batteries will, as a side effect, help to catalyse the storage market too.
Chart 2: Lithium-ion capacity by application: consumer electronics (CE), electric vehicles (EV) and energy storage (ESS)
Source: Industry data, CLSA.
What does this mean for investors?
The traditional power producers like RWE will most likely face continuous pressure unless they endorse renewable energies more pro-actively, something that RWE is currently working on.
The battery manufacturers with the largest scale and cost advantage will likely be those that produce batteries for the EV market.
It will likely be difficult for those focusing only on battery technologies outside of the EV market, to achieve cost efficiencies. This could become an issue for niche manufacturers, such as Saft.
Samsung SDI, LG Chemical and Tesla might stand a better chance of developing their battery businesses and selling in both the EV and the electricity market with competitive prices.
While there are currently certain technological differences in making batteries for EV versus power storage, we believe that the field will likely converge over time.
Once the rapid adoption phase of batteries in the grid or in cars begins to slow down, the commoditisation of the hardware will likely drive out any excessive profits the industry may have achieved.
In this phase, asset light technology firms will most likely be the more interesting investments.
What is familiar to investors as the “internet of things” will also affect how EVs or stationary batteries interact with the grid.
The smart grid1 and matching of volatile power supply sources such as renewables with demand will require software and consulting solutions that will command a much higher value in the market than pure hardware.
Firms like Sonnenbatterie and STEM are already at the forefront of this development.
In essence, we believe these types of companies will become the new Microsoft or Google of the power-mobility industry and in our view, represent a far more compelling investment than one in pure hardware firms.
1. A grid that uses technology to control and distribute electricity at optimal times of supply and demand.↩
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