Following a similar announcement from Gresham House Energy storage (GRID – click here to see our coverage of this from yesterday), Harmony Energy Income Trust (HEIT) has also issued a trading update ahead of the publication of its quarterly Net Asset Value update and audited annual results later this month. Like GRID, HEIT says that BESS revenues for the year ended 31 October 2023 were markedly lower than revenue generated in the same period in 2022 and it is postponing its first quarter dividend for the current financial year. However, it also says that, if the situation continues for an extended period, this will impact its ability to pay dividends, so further cuts could be on the cards.
Weaker revenue environment in 2023 and January 2024
HEIT says that, whilst a reduction in BESS revenues was expected from “the remarkable highs” of 2022 and built into third party revenue forecasts, the scale and the speed of the reduction has exceeded market expectations. It says that there are multiple drivers of this reduction, both macro and sector-specific, and these are detailed below:
Saturation of ancillary service markets
HEIT says that a high rate of build-out of BESS in Great Britain led to saturation of ancillary services and has driven clearing prices to record low levels. It says that this was widely anticipated and it had positioned its 2-hr duration portfolio specifically to protect against this event and take maximum advantage of the inevitable shift by BESS towards wholesale market revenue strategies and the Balancing Mechanism (BM).
Reduction in wholesale power price volatility and spreads
HEIT says that, with its 2-hr duration portfolio, this issue is more relevant to it than the ancillary services detailed above. Wholesale spreads for its 2023 financial year and the first quarter of its 2024 financial year have narrowed primarily due to a reduction in natural gas prices, itself due to milder than expected weather and high levels of European reserves. In addition, Great Britain has imported a large volume of energy from Europe (via interconnectors) and high consumer prices have encouraged a material reduction in consumer energy usage.
Wholesale price spreads are forecast by independent experts to increase during 2024 and beyond. This is driven by a range of factors including increased consumer energy demand (as the cost-of-living crisis eases), continued electrification of the country’s heating and transport infrastructure, greater penetration of intermittent renewables and an increase in pricing for natural gas and carbon.
Implementation issues with National Grid ESO (NGESO) Open Balancing Platform
Another key factor in recent revenue weakness is NGESO’s continued sporadic use of BESS in the Balancing Mechanism. HEIT says that, despite a well-publicised policy and comprehensive plan from NGESO to increase BESS dispatch rates in the Balancing Mechanism via process and software enhancements over 2024 and 2025, the December 2023 launch of the new “bulk dispatch” software was curtailed due to technical issues.
Since its re-launch on 8 January 2024, NGESO appears to only be using its Open Balancing Platform intermittently. As a consequence, HEIT’s portfolio is seeing some days of high Balancing Mechanism volume, and some of zero. BESS projects utilise algorithms and AI software to execute revenue strategies, and so the inconsistent use of Open Balancing Platform by NGESO not only limits BESS volumes in the Balancing Mechanism, but also creates uncertainty over how much daily capacity BESS can dedicate to other strategies and services.
HEIT’s investment adviser is in ongoing dialogue with NGESO on this topic directly and also via stakeholder interest groups. NGESO also has a published ambition to operate the Great Britain system with zero carbon emissions by 2025 (by reducing its use of coal and gas) and a consistent use of the Open Balancing Platform with BESS by NGESO would, in HEIT’s adviser’s opinion, help accelerate NGESO’s progress towards this goal and should also result in a near-immediate and marked increase in the Company’s revenue performance.
HEIT’s portfolio is outperforming peers
HEIT says that, despite the problems described above, its operating portfolio continues to out-perform peers (on a £/MW basis). Its Pillswood (Phase 1) and (Phase 2) projects ranked first and third respectively for the calendar year 2023, and every one of its five operating assets appear in the Top-10 leaderboard for January 2024 (excluding non-BM units and estimated revenue from the Embedded Export Tariff – Source: Modo Energy).
Operational free cash flow forecast to increase in 2024
HEIT says that its operational free cash flow is forecast to increase in 2024 as its remaining three projects (c. 236 MWh / 118 MW, equating to around 30% of the current portfolio) complete construction and begin operations. Crucially, HEIT says that it has sufficient cash reserves to complete construction of these projects. In addition, revenues going forward will be supported by HEIT’s existing Capacity Market contracts, for which delivery only began in October 2023.
First quarterly dividend ‘postponed’ but more cuts could follow
HEIT paid a total dividend of 8p per share in relation to its last financial year ended 31 October 2023.However, for the first quarterly distribution in relation to the current financial year, (2 pence per share, which HEIT expected to be declared later this month and pay in March) the Board, with the backing of the Investment Adviser, has decided to postpone this declaration. HEIT says that while the reasons for the recent low revenue environment are understood, and the market conditions are expected to improve, the short-term outlook remains uncertain. It says that, if these conditions do continue for an extended period, this will impact on its ability to pay dividends. It is well understood that BESS revenues can vary across the course of a year and therefore prudent cash management is required.
HEIT’s strategy for 2024
HEIT says that its board is preparing to implement a series of short-term actions which it says would better position it for long-term stability and growth. These actions will include a restructuring of the Company’s existing debt facilities (to reflect that 70% of the portfolio’s MW capacity is now operational), coupled with one or more asset sales. Any cash proceeds from such sales would be used, in priority, to reduce gearing and then to fund future dividend distributions for the current financial year and next. HEIT says that these distributions could take the form of income and/or capital distributions.
HEIT says that its ambition remains to pay 8 pence per share per annum and that any funds available after the payment of dividends could be used to repurchase shares. Further updates will be made to shareholders in due course.
Asset Valuations have been consistent
HEIT says that, despite the recent weak revenue environment during 2023, the discount rates applied to its “operating” and “under construction” assets have remained stable. Asset valuations have been supported by long-term average revenue forecasts from independent experts, as well as evidence of market transactions. It cites the sale by the Company of its Rye Common asset in September 2023, at a 1.5% premium to the carrying value, is an example. HEIT’s investment adviser continues to observe a high level of appetite amongst private investors for BESS assets, especially whilst 2-hr duration operational BESS projects are relatively scarce and well-positioned to outperform once revenues conditions improve.
Full Year Results for the year ended 31 December 2023 Results and Q1 FY2024 NAV
The Company is currently completing the audit of its financial results for the year ended 31 October 2023 and expects to publish its annual report and accounts alongside its Q1 NAV for the period ended 31 January 2024 in the week commencing 26 February 2024.
[QD comment: Like GRID’s shareholders yesterday, HEIT’s investors will be very disappointed by the dividend cut and what now appears to be a difficult outlook for the rest of the year, while National Grid ESO implements its new software. As we noted yesterday, revenues from the ESO had been expected after the software upgrade and it has been a disappointment to the market that this has not come through.
To give some additional context, the current situation is ludicrous. It appears that, rather than drawing on the BESS assets, National Grid is choosing to fire up gas instead, at what will ultimately be a higher cost to consumers, to address supply shortages. Battery storage projects that stand ready to supply are being ‘skipped’ in the balancing mechanism. We understand that National Grid ESO is implementing changes that will rectify the issue but the final and perhaps most important upgrade is not due until late this year.]