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Editor's Note
Energy storage has been likened by market participants to the classic chicken-or-the-egg story. Financing is needed to get projects across the finish line, but at the same time, financiers want to see an established track record of projects before deploying development dollars. As a result, when it comes to storage, despite the tidal wave of activity that has been predicted year after year, there always seems to have been more talk than action.
However, the tide seems to be turning, as the market for energy storage is growing at an increasingly rapid pace. In the last quarter of 2020, more than 2,100 MWh of storage came online, marking a 182% increase from the previous quarter. And in January, the Energy Information Administration forecast that 81% of new capacity would come from solar, wind and storage, with storage taking up an 11% chunk.
Project sponsors are also optimistic about standalone storage assets being included in a proposed 10-year extension and phasedown of the federal investment tax credit, as part of the Biden administration’s $2 trillion infrastructure package. The industry has long lobbied for a standalone storage ITC as it could help level the playing field between renewables-plus-storage and standalone storage, which so far has been jockeying for financing on a market-driven basis.
The recent proliferation of special purpose acquisition companies or SPACs this past year has also spilled over into the energy storage market, with battery manufacturer Eos Energy Storage and distributed battery storage company Stem being taken public via SPAC mergers – a theme that deal watchers say is likely to drive activity in the storage sector for the rest of the year.
However, the industry has also faced its trials, such as winter storm Uri in February which walloped the Texas power market, causing rolling blackouts and sending power prices skyrocketing to ERCOT’s ceiling of $9,000/ MWh. All projects whose revenues were stabilized with hedges faced margin calls as a result of the volatility, which means that financing storage assets with hedges as well as merchant revenues is likely to prove more challenging. Market participants have already observed that hedge counterparties are being guided toward as-generated revenue contracts as a result.
Meanwhile, more clarity is still needed around federal and state-level incentives for storage assets, as well as from ISOs and RTOs on procurement processes, while stakeholder education will continue to prove vital, particularly around newer technologies and chemistries other than lithium-ion.
As one market participant succinctly put it, the wind industry is where natural gas was 10 years ago, solar is where wind was 10 years ago, and battery storage is where solar was 10 years ago.
To delve deeper into the opportunities and risks that lie ahead for the storage market, Power Finance & Risk brought together an experienced panel of market participants to discuss the trends and developments shaping this burgeoning industry.
Our expert panel includes senior representatives of a commercial bank, a financial advisory firm, a project sponsor and a law firm, to ensure a broad and balanced range of perspectives across the project finance sphere.
We hope you enjoy reading the resulting conversation as much as we enjoyed hosting it.
Taryana Odayar
Editor.
Taryana Odayar, PFR: Let’s start with the Covid-19 pandemic and the impact that it’s had on energy storage deals getting done this year. What have been the implications on the M&A side, the debt side and tax equity for renewables-plus-storage? Conor, why don’t you get us started?
Conor McKenna, CohnReznick: Interestingly on the financing side, there’s really no news from the Eastern front. Everything has stayed the same, especially as it pertains to standalone storage. It’s been very much focused on the opportunities that present themselves, looking at the cashflows and being able to underwrite accordingly in this market which has been fairly strong. Obviously, tax equity is a little bit different right now because for standalone storage there is no opportunity for tax credits.
Solar-plus-storage though has continued to perform in line with the rest of standalone solar. There hasn’t been a significant difference there. So, debt is strong, solar-plus-storage is in line with solar, and standalone tax equity for storage is not a thing, yet.
Sondra Martinez, Nord: From the lenders’ side, one thing that’s happening on the tax equity front – and I agree with Conor, we’ve seen it in solar standalone – is that tax equity has retracted from rolling over commitments over tax years. This is especially difficult on large projects. This has put more pressure on construction schedules, and for lenders who like cushions, that makes it a little bit more challenging.
We’ve seen a lot of projects that require equity to step in when projects need to start construction before they can get tax equity. There’s been a challenge on that front. The tax equity market, at least in our experience on the lender side and talking to sponsors, is tight. It certainly adds an additional layer of challenge to projects.
The last thing I’d say on this front, is that for solar-plus-storage, where you’re involving hedges or complicated markets, it’s a whole other story in terms of what tax equity is requesting and how debt and sponsors are then responding.
Brian Greene, Kirkland: In tax equity, overall volumes were high last year but the market was fairly constrained other than for the best sponsors. And that is in part why you’re seeing the industry really push for a direct pay in the Biden infrastructure package.
Frank Genova, Convergent: Yes. From our perspective as the only owner-operator in the room, we’re approaching half a billion dollars of assets on the balance sheet. That owner-operator model is important for Convergent. In addition, our assets tend to be sub-transmission, distribution-scale.
So with that context, we recently worked with CohnReznick on a $125 million tax equity and debt financing of eight storage-plus-solar deals. As everyone has said, even for utility-scale deals with strong sponsors that have established precedent with the big banks, things were challenging. For companies like ours that are trying to raise tax equity for $5 million to $20 million individual deals, the market was challenging, and it was even more so during the majority of the pandemic.
PFR: Frank and Conor, could you walk us through the $125 million tax equity and debt financing you worked on? What were some of the challenges around that and how did you overcome them?
McKenna, CohnReznick: Sure. On the front-end, Frank and I launched a transaction where you get tax equity and debt financing for a portfolio of solar-plus-storage assets. And it was in the heat of Covid that we launched, where, as Brian had said earlier, things were a little bit constrained. Not a little bit – they were very constrained. It was hard to find anybody looking to provide financing other than to the biggest sponsors in the market.
So, on the front-end, one of the headwinds we had to deal with was trying to get the attention of potential investors. And what it meant was trying to broaden the scope of who we were looking at as a potential partner, as opposed to just the standard names.
It took some extra legwork and a lot of flexibility on Convergent’s part to try and find the right investor. And then also to couple that with the right debt provider. There were a lot of inter-party things that worked through their journey into the market.
But there are certain nuances here that were specific to bringing somebody in that wasn’t a regular participant on the financing side. Frank, if you want to get into that a little deeper, that would be great too.
So, a sizeable portfolio and the business case is very straightforward. Basically state-sponsored tariffs, state-sponsored incentives. But even at that scale with stable revenues and cashflows, as Conor said, it was very challenging
On the debt side, for us, being owned by ECP [Energy Capital Partners], we can be opportunistic with financing. So, we tend to gravitate towards the higher-yield, more structured deals.
This portfolio was an example of something that we viewed as very straight down the fairway with the exception that it is distributed and there are multiple assets. But from a fi- nancing perspective, more broadly for Convergent, having been in energy storage for 10 years, we’ve taken the view that flexible capital is critical to growing the business at a proper pace.
So, we’ve always been opportunistic, and we’ll only view and consider financing if it’s accretive for the business and consistent with what we’re trying to achieve. And the financing that CohnReznick and Convergent achieved in this deal was absolutely that.
Obviously, tax equity has to be in at the right time. You can’t recap or address later, which creates some inefficiency and barriers for companies like ours that focus on these more bespoke, smaller, non-utility scale deals.
McKenna, CohnReznick: If I can just put a finer point on it, generally tax equity has not been known for being creative or problem-solving. So, bringing up something that’s middle of the fairway but new to them, makes it harder. On top of that, the typical tax equity players were all pretty full up and while Convergent is a very strong name in the storage space and ECP as it’s parent company is a strong company, we couldn’t get their interest and had to go to somebody that was a little bit further afield to get the tax equity. So, yes, complexity on top of complexity with that aspect. It was challenging but we were able to get through it.
PFR: Sondra and Brian, did you see any creative structures in the market last year around lending to storage or storage-plus-renewables?
Martinez, Nord: I agree with what Conor said. It’s been said many times – there’s been a lot of talk about storage and less action. But, this is the year of all the action. We know of and are seeing many large projects come to the market – a combination of standalone and storage-plus-solar.
There were a couple of landmark transactions last year that came to market, but this is the year where all the very large sponsors are coming with these types of projects. If a project is straight down the fairway for a large sponsor, it’s going to be relatively easy to obtain financing.
Where financing will be increasingly complicated, and especially after what happened in ERCOT, is going to be around deals that are more merchant on the battery storage side or are trying to capture various revenue streams, and deals that have hedges. This will especially be true for storage-plus-solar deals which need tax equity because one thing that complicates tax equity and hedges and the ITC has to do with various issues around col- lateral and first liens.
If regulators are looking for a reason why storage should be a bigger portion of the overall allocation of the grid, the Polar vortex in Texas should represent a great example as to the importance of addressing things like the tail risk that we saw as they go forward.
As for what will happen with hedges and standalone battery storage, I think it will follow the route of gas projects. Gas projects don’t get encumbered from a lender standpoint by being back-levered and sharing collateral with tax equity.
Tax equity complicates a collateral story for lenders when, on top of that, you have a hedge and a potential first lien. Some of these challenges are coming to bear now based on what happened in ERCOT over the winter. The market’s now trying to figure out the po- tential solutions.
An ITC for standalone battery storage is an interesting proposition and the market will ultimately speak to what it wants and needs. Certainly with the cost declines and the PPAs we’re seeing on the capacity side, I’m not sure it’s needed for all projects but probably for projects that are more complicated.
In other words, I know it’s complicated, I know it’s rough. However, it’s an effective way for the government to support the proliferation of these opportunities more broadly in the market. And admittedly, it doesn’t necessitate through the structuring or greater application of debt for these projects. It just helps the market grow.
And that’s the job of the ITC – to help markets grow and support emerging markets like storage that are going to be integral to the sustainability of our grid. And environmental support as well for solar and wind.
Greene, Kirkland: We host an energy storage conference two times a year – the last one was in January – and the consensus at that time was that it was going to be a strong year with or without the ITC but with the ITC the growth would be “supercharged.” I think that is still the case.
Genova, Convergent: Yes, based on the deals we have that are operating, under construction and moving through contracting, I would agree. Like many others, we’re tied in and connected with folks on Capitol Hill, trying to get a read on exactly what legislation might look like especially from a transitional or timing perspective. That’s really important for us, as we’re literally putting steel in ground every month.
But I agree with Brian, we’ve built up a half a billion dollar business without an ITC. One of the key distinctions of storage is that it’s an active resource, not a passive resource, to Sondra’s point. And that complicates but also reinforces the revenue models for these deals. That’s one of the reasons why there are storage projects built without an ITC. The value is there.
But obviously the passing of an ITC, or a cash grant, or a direct-pay option would be extremely meaningful to our portfolio or pipeline. So, it definitely is a supercharged situation.
Martinez, Nord: I would agree with both Brian and Frank. We’re seeing a number of opportunities and how much it assists the market will be determined by what the government decides to do.
PFR: Sondra briefly touched on winter storm Uri and the impact of that on the Texas market. What has been the fallout there and the impact on hedges for storage and renewables-plus-storage? And Frank, is Convergent working on any projects there?
Genova, Convergent: We don’t have anything operating there right now. We tend to take a different view on Texas and ERCOT more broadly. We do have some irons in the fire, but the business model is pretty different than what you’re seeing a lot of folks doing from a standalone storage perspective.
Greene, Kirkland: I’d be interested in Sondra’s take on this too, but as for the project pipeline in Texas, I would expect more scrutiny from lenders going forward. For deals with hedges, lenders will be focused on making sure that in the downside case – if there is another event like Uri – that their debt service will be protected.
PFR: And is that something that you’ve been seeing or expect to see? What have you been hearing from clients?
Greene, Kirkland: We’re working on a few projects in Texas that slowed down right after Uri, but they are now proceeding. I would compare it to last year with Covid force majeure concerns where there was an increased amount of diligence, and sponsors had to be ready with answers to the difficult diligence questions posed by lenders.
McKenna, CohnReznick: We’re doing the workouts for a number of different wind assets that have really gotten into a tough spot and we’re working with all parties to get through this. In terms of complexities, we’re seeing it on all ends there.
What happened in Texas couldn’t be a better example of how complimentary storage can be towards what’s already on the grid. Especially when your cogen plants are not working, because it wasn’t just a wind problem where the turbines were frozen, there were issues with conventional generation as well and that was the majority of the issue.
But in situations where you have storage available for support, you would think the utilization of storage in that market could have saved the rate payers substantial amounts of money. And the grid resiliency that’s being provided by this should be helpful.
Martinez, Nord: Yes, Conor, I would say regulation would have helped Texas because there was a big weatherization issue that tripped off most projects. It also impacted some battery storage deals. Texas is a unique market, it has its own challenges just in the way it’s designed. It can cause problems because you can’t have a project offline, whether it’s solar, storage, wind, gas, and have price hikes and be in a hedge where you don’t perform.
It’s a financial transaction and creates a lot of issues. I would agree with everybody, deals are going forward and Texas is in need of storage because they’re in need of reserve margin, they’re in need of capacity.
We’re also seeing hedges being reshaped and the terms changed. The result is going to be a little bit more merchant in projects because there’s going to be a desire to under-hedge, if you will, and try and force hedge parties into more as-generated types of revenue or types of contracts to prevent these large liabilities with price spikes and mismatches. It’s evolving right now as deals are moving forward and all market participants are looking into it.
Coming back to the ITC for a minute, as Conor knows, that’s where it’s more complicated, not just because of collateral positions but also in terms of hedges and who provides liquidity. While all hedge deals in every market need some ability to balance liquidity lines, it will be interesting to see how the ERCOT winter storm shapes where that money goes, and whether draws on liquidity lines prime tax equity. As we look at the build out of storage projects, these factors will all be an important part of the overall story, especially with solar-plus-storage hedge deals.
PFR: A question for everyone – would you say that hedging structures for storage projects are becoming more common or intricate? And have you seen structures that have been traditionally used for merchant gas-fired plants, like revenue puts and heat-rate call-options, being revamped for energy storage?
McKenna, CohnReznick: California’s typically one of the leaders in terms of markets, and we recently closed a deal there between S&B USA and Capital Dynamics. It was unique compared to some of the larger projects we’ve seen. It was 400 MWh of storage or a 100 MW stabilized storage system. What was unique about it was that the amount contracted was relatively low compared to the merchant aspects.
What we’re seeing, as opposed to a greater move towards full tolling, is people looking like they want to take advantage of those outsized opportunities in various markets and the energy arbitrage that you would typically see in a lot of natural gas plants.
Like what Frank was saying before, this is active management and therefore the desire for long-term hedging might be less than you would see from typical renewable energy projects.
Genova, Convergent: We don’t have any hedged products in our portfolio and most deals benefit from multiple revenue components. Even deals with relatively larger merchant positions have some form of stable, underwriteable revenue stream that would allow us to bring financing to the project later.
Having done this for 10 years, looking at active dispatch and the analytics behind it, merchant pricing exposure is certainly an important consideration, but the dispatch or operation engine is equally important. I’ve been talking to banks for a long time and there’s been a lot of progress, but we’ve shown a number of banks, including Sondra’s bank, our portfolio. And I don’t know if we’re there yet on an individual project basis to efficiently underwrite a complex, five-component revenue deal for a $15 million or $20 million asset.
Because, again a lot of it has to do with the analytics – the upfront and operational optimization behind the scenes. So, our approach has been – putting tax equity aside – bulking up a portfolio and diversifying it. Geographic diversity, business case diversity, combining different merchant revenue streams and then potentially recapping at a corporate or portfolio level, because that active or operational risk is a reality for battery assets.
PFR: What about PPA structures for renewables-plus-storage – any bespoke contract structures there?
Greene, Kirkland: One thing that’s really interesting to me is this new idea of 24/7 PPAs, like the announcement between AES and Google. What’s driving that is there’s such a strong demand – among tech companies in particular and other corporates – to really re- duce their carbon footprint.
And they’re looking at data in a more and more sophisticated way. Whereas they used to look at getting a PPA with, say, a utility-scale solar or wind farm sized to match the load of a data center, now they’re looking at tracking their energy usage on an hour-by-hour basis.
So, the concept of combining assets and entering into a PPA with a company like Google, where you’re supplying their power 24/7 from a variety of different sources, is a very interesting market development.
These first large deals will help the market get comfortable with the technology and for lenders to have these assets and see how they behave, and start building up that experience.
The level of interest from lenders is going to depend on the sureness of the revenue streams and the complexity. As you move from capacity contracts to tolling agreements, to fixed-shape hedges, to layering on additional merchant streams, or just the ability of equity or frankly for offtakers to use a battery however they choose, that is going to decrease the number of lenders who will look at those types of transactions. If you think about merchant in general, the same is true across the market. There are more lenders who will take no merchant risk, and as you move up in terms of the amount of merchant revenue there are fewer lenders willing to take that risk.
For more complex battery usage deals, lenders will worry more about technology risk, whether they truly understand efficiency, degradation, replacement, etc. and so the structures will also move according to that. There will be shorter amortization profiles, there might be more cash sweeps, and there might be more concerns about operating expenses or capital expenses built into the structure. And there will be fewer lenders.
Pricing will move accordingly, and the cheapest deals in the market will happen because they’re the simplest. That’s where we’re seeing the market now and this is the year that financing opens up for these larger scale battery storage transactions.
But I agree with Brian, I think what AES is doing in mixing and matching is a really interesting way to truly provide firm, clean power.
PFR: From a macro perspective, what has been driving the demand for storage, especially from utilities issuing more RFPs for renewables-plus-storage and standalone storage? Is it that thermal plants are retiring, levelized cost declines? Conor, what do you think?
McKenna, CohnReznick: Okay, number one, there is a significant desire for people to get into something new, interesting and sustainability-related, but not be beholden to the same merchant curves or as-generated requirements that you typically see from conventional renewable energy.
There’s also, in general, significant amounts of liquidity whether we’re talking about the debt side or the equity side, which is then driving the desire to put this capital to work. There are macro trends that people are looking at, saying I want to get on the ground floor when we’re thinking about what this might look like if more coal gets retired, if natural gas gets retired.
As more renewable energy comes on to the grid, there are intermittency aspects that will need to be addressed and storage makes the most sense to do so.
All these aspects come together and are coupled with the fact that price curves are coming down strongly on a lot of technologies which make it more viable in more markets.
Genova, Convergent: We started the business formally in 2011 and shortly after that we were pricing fully integrated lithium systems at $2,000/kWh. Now we’re buying them at $200/kWh. That’s exactly an order of magnitude change and that’s by far the biggest driver.
The second, being in the trenches, owning, operating and originating, is stakeholder education. Three or four years ago, it was common for utilities or large-scale industrial customers who are our offtakers of these solutions to not fully understand them. Many early conversations distilled down to, ‘Wait a second, you’re taking a battery that’s used in my phone, and you’re going to save me all this money or create this resiliency on my network with it?’ These were very foreign concepts.
Now, it’s hard to pick up a newspaper with- out reading about batteries in some fashion, whether it’s EVs, or Tesla, or whoever. So, the mass adoption of this concept fundamentally, coupled with the fact that we’ve had order of magnitude changes in pricing over the last nine years, are the big drivers.
Martinez, Nord: I just want to add to what Frank said because that’s a really important point – the acceptance of the technology. Utilities as grid operators are worried about preventing brownouts and are in desperate need of capacity or the ability to deal with, let’s say in California, a lot of intermittent renewable power. They want to feel confident in the solution, because ultimately, the grid operator is concerned about keeping stability on the grid and the lights on. Education has been really important to increasing the acceptance from both a lender perspective, starting with getting the contract, and with helping utilities move over the line.
You can look no further than the automotive industry, where most large manufacturers are now saying we’re going to go completely EV in five years’ time. So, it’s not just for the power industry, but across the board that there’s starting to be an acceptance and a better understanding of the technology and what that means for reliability.
Greene, Kirkland: We represent a lot of private equity investors at Kirkland, and there’s really been a ground shift in the last year in terms of the focus on ESG among LPs. Aside from being a growth industry, energy storage projects and energy storage companies fit that mandate and are a good investment from an ESG perspective for private equity funds.
Genova, Convergent: The proof is in the pudding as it relates to stakeholder adoption. Conor and I worked on this large distributed solar-plus-storage portfolio which includes NWA [Non-Wires Alternative] con- tracts with utilities where the asset is pro- viding local capacity to alleviate overloading on substation infrastructure. We have five or six other projects in the portfolio that are storage only which are providing that service to the utility under some kind of capacity agreement.
This is, to our knowledge, the first hybrid resource which is leaning on solar production, with a battery alleviating a grid or a system issue in lieu of a traditional solution. That’s pretty amazing when you think about it. We’re really proud of those deals, and it’s just proven how far we’ve come over the past ten years.
PFR: That’s very interesting. Do you want to add some context on how that came about?
Genova, Convergent: Yes. Some of the early-mover energy storage states are also a great example. Initially, utility offtakers in California were saying, ‘We’re mandated to buy storage, we don’t care where it is, so we’ll contract for it. If it comes to market, great. If not, we’ll tell everybody we told you so.’
Now, California utilities have taken a different approach. They said, ‘Wait a second, we have to buy this stuff, but these systems can actually provide value to the system. Why don’t we provide some guidance to the market as to where we’d like to see them?’
And that’s just a little example from an early-mover, which has proliferated across the United States. These are typically very complicated problems that are well documented, with years of load data, load forecasts projecting out 10-plus years, identified issues with multiple circuits, multiple substations.
A lot of the credit goes to our utility partners for being so forward-thinking, leaning on a hybrid solution like this. Solving a very complex problem that is traditionally ad- dressed with pipes and wires. We’re seeing a lot more of that, much more complicated RFPs, and a very thoughtful approach from investor-owned and publicly-owned utilties.
McKenna, CohnReznick: I’m dying a little bit here just because the truth is for me, and I’m the boring banker out there, but the further away you are from what’s called mainstream adoption, the less likely I am to see it. Trying to get to the idea of bankability for some of these technologies is harder without a track record. There’s so many things that have to happen for it to really make sense for Sondra and other capital providers.
Greene, Kirkland: I had the same reaction as you. For any new technology, proving the track record to make that technology bankable is an issue. What will be interesting to see over the next year or two, is whether the DOE Loan Programs office – now led by Jigar Shah, formerly of Generate Capital – is successful in driving the bankability of new technologies.
I’m hopeful and it will be great to see that program work. They have something like $40 billion authorized for different types of projects. It would really be great to see that put to use.
Genova, Convergent: I guess it’s probably up to us to bring new technologies to the banks! I could talk for hours on this topic, but the headline here is, again, having done this for a while, the sharp declines in integrated lithium solutions have completely decimated the emerging technology space.
You had a number of emerging technology companies out there two or three years ago who were targeting scaled unit pricing of $350/kWh to $400/kWh. And that made a lot of sense when lithium was at $600/kWh. Now lithium’s at $200/kWh for a four- or five-hour system. That really upended the emerging tech space and prevented many from raising capital. The graveyard is a mile long. Lithium has established a stranglehold on the market for good reason, despite an interest in deploying new technologies.
For us, everything in our portfolio is backed by a multi-billion dollar bankable balance sheet. Our view, is even though we’re not financing our deals now, we certainly want to realize that margin compression at some point and we need a perfectly structured PF deal to do that. So, everything in our portfolio is backed with proper warranties and guarantees from solid credit integrators.
There are some bigger players out there that have interesting solutions. Where you’re going to find value is in the longer duration technologies. And specifically, redox flow systems where at four or five hours, they’re close to the benchmark for lithium. But redox systems have the ability to decouple power and energy, where adding energy is just adding anolyte and catholyte which has a very, very low marginal cost. So, at six, seven, eight hours, these solutions are cheaper, in our opinion, than lithium.
Other important considerations are operating costs and augmentation profiles. These systems can operate for years and years without needing battery swap outs and those kinds of things, which are material. So, not only are they extremely competitive and cheaper than lithium in that range, but the operating profiles are going to be cheaper, driving the LCOE [levelized cost of energy] down further.
Now, again, these are big balance sheet businesses that we’re looking at, so the financability concerns are less pressing. But that’s the sweet spot in our view – long duration will have a place in this market over the next few of years.
PFR: Sondra, what about you, is Nord willing to be a little bit more adventurous in terms of financing something new on the technology side?
Martinez, Nord: Well, if Conor is the boring banker, I don’t know how you’d describe a commercial banker! Everyone stated accurately that lithium is new in many ways for the commercial market. There’s an adoption needed before getting comfortable with that technology. Currently, we’re not looking at new, interesting storage technologies, as we need a proven track record. Right now, that’s certainly the simple lithium type of systems. It’ll be interesting to see if this falls the way of solar in terms of the way crystalline pushed out all other forms of new technologies.
Frank makes a good point – application could be the differentiator here and obviously, balance sheet is important. Right now, for the projects we’re seeing, I only expect to see one technology. Equity has, for some years, been getting comfortable with that technology as has the automotive industry.
As for the utilities, what Frank described was really interesting because it shows that utilities trust the technology. They wouldn’t be seeking it for very specific uses if they didn’t have comfort that it could perform.
There’s a lot of market acceptance around this type of technology and we’ll see that proliferate over the next couple of years in terms of deal flow. And then we can talk to you about new technologies after people get a little bit more experience with the current “new” technology.
PFR: That sounds fair. And as Brian mentioned, there’s also the DOE’s Loans Programs Office, so perhaps some of the more innovative technologies could get funding from there in the meantime. Apart from that, what other federal incentives, or even state-level incentives, could be helpful for storage?
McKenna, CohnReznick: Everything and anything that helps support a burgeoning as- set class like storage is going to be helpful on some level. The degree to which it’s helpful is always hard to get right. No one’s going to get it right because it hasn’t been done enough yet.
And also, the people that are the smartest about it, guys like Frank, they’re not in positions to make the policy. They’re there to try and advocate but there’s a whole lot of stakeholders involved. We're seeing a lot of 15-20-year contracts and we're seeing the technical advisers get us there. We're certainly seeing equity feeling comfortable.
The different use profile is going to change the financability, the number of banks, the pricing, the structures. But for large sponsors, large deals, simple deals, there’s no need for other means of financing since we’re seeing a very strong response in the bank market.
PFR: How are banks pricing construction risk versus operating risk at the moment for standalone storage?
Martinez, Nord: Banks are looking at construction on the storage side similarly to how they look at construction on the solar side, which is more modular and relatively speaking, simple construction. And it’s priced accordingly.
Genova, Convergent: There’s not much spread in the rates or terms for the construction portion versus the take out portion, at least that we’ve seen. That said, those rates and terms vary widely based on the business case – if it’s a straight down the fairway deal, rates have varied around Libor-plus-250 to 300 for most. In the more complex deals we’re doing, we haven’t really tested the market but, as noted, our strategy there is to go in with a portfolio in lieu of one-off financing.
From what we’ve seen, when folks try to do these one off, complex, non-diversified deals, banks like Sondra’s have to get rather fancy in their structure, which drives the implied cost of debt much higher than the headline number. So, that doesn’t make much sense to us.
As noted, based on our capital structure, we’re in a bit of a different position than most. However, there are other players in the space that need to go that route. Everyone in the market is happy that the banks are generally comfortable, and willing to work and be creative. But our strategy is to not force the banks to be overly creative.
PFR: There are a number of ongoing sale processes for energy storage platforms, like Broad Reach Power and Key Capture Energy. Is there more value crystallized in obtaining both the team and the platform as opposed to just the underlying storage assets or pipeline?
Maybe the value proposition has evolved a little bit. Initially, there were a number of investors who just wanted to get into the market and buy a pipeline. And that has shifted and there’s more of a premium now for a management team and track record versus just getting a set of assets.
McKenna, CohnReznick: I would agree. I think that what you’re seeing in storage is similar to what you might be seeing in DG because the scales are similar in terms of the size of the teams. Usually, for utility-scale, they’re much larger teams or it’s a different style of approach than what you’re seeing potentially with DG and storage.
But there’s a lot of activity right now for mid-sized players that have what Brian’s saying – a decent pipeline and a track record. It’s not a hypothetical “bragawatts” pipeline, it’s a real pipeline. And if you have that, as well as a few hidden assets in the ground, then what you’re seeing is investors with a strong desire to participate.
They may have seen the progression as it happened in solar where you’d try and start out with projects and the cost of capital get pretty competitive, pretty quickly. So, they’re trying to say, ‘Look, let’s circumvent that entirely. I’m going after a platform early on and supporting them, and therefore, have the ability for the greatest amortization of the assets and can let somebody else buy the assets if they’re a cheaper cost of capital.’
But to Brian’s point, you have to believe that you’re going to have somebody like Frank who can lead a team and then grow it into something substantial. And to do that, you need some sort of track record. It’s harder and that’s where the focus has been, from what we’ve seen.
Genova, Convergent: Yes. We were one of those companies in 2019, when we sold Convergent to ECP. My gosh, it was two years ago, but it feels like it was yesterday.
As noted, storage is different. It’s an active resource, it needs to be managed throughout its life cycle. In terms of the origination or development program, if you’re just chasing LBMP [locational based marginal pricing] spreads, or ancillary services spikes and that kind of thing, okay, the development model for solar and storage in that specific vertical is not all that different.
But in our case, the origination and development model is completely different than solar origination, evidenced by the past deal that I walked you guys through. Operating storage requires a platform built on information, analytics, etc., which traditonal developers typically don’t have; there’s also a very, very different approach to originating high-yield assets in this market, which is why you’re seeing strategic investors and private equity shops looking to buy platforms.
This is not only because it’s necessary to monetize the asset or investment, but because it is a great pathway to build more pipeline.
To Conor’s point, you can consider recap and putting deals in the hands of the lowest cost capital after that. But we’ve seen it as a very strategic way for some of these players to get into the business and facilitate their own pipeline growth.
PFR: That’s really interesting. We’ve also seen quite a few foreign investors coming into the space. Qatar Investment Authority made a $125 million equity investment in Fluence, the JV between Siemens and AES. And Macquarie GIG took a stake in esVolta. Are we likely to see more foreign players enter the US market this year?
McKenna, CohnReznick: The answer is that you’re going to see foreign players, but it depends on their general cost of capital. Foreign, domestic, it doesn’t matter as much. There are different drivers for everybody to look into investing in stuff like this in the US market.
If it feels like the marginal best opportunity is here for, let’s call it interesting reasons, that’s great. If it’s more for macro reasons like trying to have more dollar-denominated investments or if this is a balance against their existing portfolio of oil and gas, or whatever else they have in the US, okay fine. That all makes sense.
But I don’t think about it any more as foreign or domestic, it’s just a matter of what your driver is. And if the driver makes sense, yes, you’re going to see more of them doing it.
Genova, Convergent: The reality is that the North American storage market is way more advanced than anywhere in the world. In Europe and most regions, the lack of clear market signals and structure prevent the kind of adoption for storage that we’ve had here in North America. That’s just the reality and they’re moving up the curve quickly, but based on existing market structures elsewhere, it prevents the proliferation and larger scale of adoption that we have here.
At Convergent, we’re not international – other than Canada – but we do keep tabs on market evolution and we’re very close with a bunch of financial players and private equity funds throughout the world. And they love the model and the sector. It makes a lot of sense, they know it’s coming to Europe, but it’s hard for them to get their hands around deals. There just aren’t enough of them. And there’s so many of them here, which is another reason why you’re going to see international players, especially the European utilities and financial investors, continue to look for deals here
Martinez, Nord: That’s right, Frank. The power market in the US is so large and diversified, and there are different authorities to capture different yields in different markets. We also see a lot of European investors entering the space.
PFR: Something else that we’ve seen a lot of and which has been written about extensively in the trade press, has been the proliferation of SPACs. We saw storage companies like Stem and Eos being taken public via SPAC mergers. What role will SPACs continue to play in the storage market this year?
Greene, Kirkland: We represented Star Peak Energy Transition on its business combination with Stem. Between 2020 and to date in 2021, Kirkland & Ellis has closed over 120 SPACs, so we’re pretty close to that market.
About a month ago, the SEC released a statement that could result in warrants being issued in connection with SPACs to be treated as debt rather than equity. And that has slowed the market down, but deals are still going forward, albeit at a slower pace. At the end of March, there were around 400 SPACs looking for targets.
And for all the reasons we’ve mentioned previously in the discussion, energy storage companies are going to continue to be a top target for SPACs.
Genova, Convergent: Brian’s view on this is definitely the most educated. In a lot of ways, the SPAC process is a capital raise in every situation.
The existing companies and their investors are not exiting, they’re only selling minority interests in the business for the most part. So, what it comes down to, outside all of the complexity and barriers and some of the recent issues that Brian identified, is if the SPAC market improved – recently some of these companies were trading up more than 5X before the recent move to the downside – it’s another pathway to what used to be, and still is a really cost-effective form of capital.
For ESG companies in general, there’s a lot of interest from the retail and institutional space and generally, the current public market has a limited number of pure-play opportunities. That’s what’s driven a lot of the interest – the fact that ESG is front and center, and for good reason. And the market got caught in between, saying this is really attractive and we want this, and there was just a shortfall in public instruments to invest in.
That’s driven some of it, but at the end of the day, it’s really a capital raise and a theoretically more efficient way to go public.
PFR: Before we wrap up, is there anything you’re hoping to see for the storage market this year in terms of financing, contracts or even state-level incentives?
Martinez, Nord: From my viewpoint, there’s a lot of activity. We are looking at or working on five deals that are very large with either solar-plus-storage or standalone storage. That is an indication of all the behind-thescenes work, at least on the utility-scale side, that large sponsors have done. These deals are now coming to the market and this will be the year that all the hype actually flips and there will be a lot of action. The market is excited about that and it provides me a lot of hope for the future of what can be done or what will happen in the storage industry.
Genova, Convergent: Some clarity on the ITC legislation for standalone storage and the transition plan for renewables would be great. That’s definitely high on our wish list and it seems like there are some pretty strong tailwinds there. Obviously, this is politics, so we have our eye on it, and it’s going to be a core focus for everybody in the sector.
Outside of that, there’s a lot of momentum in the space right now. Two years ago, I would have asked for more momentum and now we have it. On the federal side, the state side, public service commissions, utilities, it’s really just keeping it up. We’ve never been more bullish about the sector and things are absolutely moving in the right direction
Greene, Kirkland: Yes, agreed. There’s a lot of momentum and it looks like it’s going to be a strong year. I’ll talk about some things that could propel that even further. The first is continued regulatory reform. There are different proposals before FERC with respect to solar-plus-storage, and storage as transmission could really help drive the market.
In terms of state incentives and programs, you have some states that have really good programs. I would mention New York, California and now Virginia. Those are states that both have a strong program and/or a sufficient market size to really make a dent. You’re likely to see more state programs coming out in the next year or two.
And people should keep an eye on the Biden infrastructure package. We’ve talked about the ITC but there are a number of things in the Biden infrastructure package that could really boost both renewable energy and storage. There’s a clean energy standard, for one. There’s a transmission ITC, which is really key to the level of growth in renewable energy and storage in cetain areas of the country.
Finally, I would mention federal procurement, which hasn’t been talked about as much but could have a real and immediate impact.