Harmony Energy Income Trust (HEIT) has announced its annual results for the year ended 31 October 2023. HEIT says that this period saw significant delivery and achievement of its goals and other targets set out at IPO, particularly in relation to delivery of projects through construction and commencing operations, but conditions in the energy storage market and wider economy have been challenging and ITS achievements have been overshadowed by a lower-than-expected revenue landscape during the period. However, the benefits of 2-hour duration have been evident as the portfolio has performed well relative to the wider battery energy storage solution (BESS) fleet in Great Britain.
In the three-months following the financial year end, there has been a material further deterioration in revenues as the expected uplift over winter failed to materialise. The primary cause for this weak performance is the continued drop in wholesale gas prices, narrowing the daily spread potential for BESS trading revenues. In addition, a change to ancillary service auction parameters by National Grid ESO put further pressure on pricing, whilst the much-publicised new balancing mechanism software has not yet delivered in line with expectations. HEIT says that the current short-term weakness in revenues will require prudent management. However, it also says that it remains confident that the revenue environment will return to more positive levels for BESS, noting that the T-1 auction result on 20th February is a positive start, providing additional contracted income for six of its projects.
HEIT lists the following key financial highlights from its results (as at 31 October 2023):
- 8 assets with total capacity of 790.8 MWh / 395.4 MW
- 70% of portfolio operational (by MW capacity)
- Net asset value of £262.12m (115.40p per share)
- Dividend declared and paid in relation to the Period: 8p per Ordinary Share
- Tonnes of CO2e emissions avoided: 15,415 (estimated)
Five projects brought online
The 2023 year saw five projects come online, including the Bumpers project, which is HEIT’s largest BESS project and the largest in Europe by MWh. Consequently, HEIT now owns two of the three largest operational BESS assets in Europe (by MWh), including the multi-award winning Pillswood site that was energised in November 2022. Pillswood has been one of the best performing BESS sites in Great Britain during 2023 and, with the 198 MWh/ 99MW Bumpers project now energised, the portfolio moved from 0% to 70% operational within the last financial year. As at 31 October 2023, the company had five operational, one cold commissioned and two “under construction” 2-hour duration BESS projects, with a total capacity of 790.8 MWh / 395.4 MW.
Great Britain’s BESS market has deteriorated
It has been widely publicised that Great Britain’s BESS market has deteriorated and issues with National Grid ESO’s new balancing mechanism software being a key contributor. Norman Crighton, chair of HEIT, says that, despite this recent performance, independent market experts expect trading conditions to improve over the course of 2024. He notes that HEIT’s longer-duration 2-hour batteries have continued to outperform shorter-duration BESS.
Debt refinancing reflects changing risk profile
On 10 February 2023, new debt facilities with NatWest and Rabobank were put in place that increased HEIT’s available debt to a total of £130m comprising a term loan of £110m and a revolving credit facility (RCF) of £20m. These debt facilities provided funding certainty for HEIT to complete construction of the Bumpers, Wormald Green and Hawthorn Pit projects. During the last financial year, £95m was drawn across the two facilities with the remaining £35m drawn as at the end of December 2023 (post-Period) in order to fund construction milestones.
On 21 February 2024, HEIT successfully negotiated an amendment and restatement of its debt facilities with NatWest and Rabobank, whose revised structure recognises that HEIT’s portfolio is evolving from a higher-risk construction portfolio into a lower-risk operating portfolio. The term loan and RCF have been consolidated into a single long-term facility with the following key terms:
- Facility size of £130m (already fully drawn);
- an extension of the legal maturity date from June 2027 to February 2031;
- a reduction in margin to 275 bps over SONIA for the first two years, rising over time to a maximum of 350 bps in the final year; and
- a re-sizing of market standard debt covenant ratios against conservative revenue forecasts to ensure ongoing headroom in the current revenue environment.
The structure allows for voluntary prepayments during the term (subject to a fee) and for cash sweeps in favour of the lenders in the event of material revenue outperformance above pre-agreed thresholds, enabling an acceleration of de‑gearing in a cost-efficient manner whilst also reserving operational free cash flow for shareholder distributions. When coupled with a new interest rate swap (discussed in interest rate hedging section below), the aggregate cost of debt equates to 6.85% for the first two years.
HEIT says that the debt re-financing also addresses near-term risks around debt service in the event that the recent low revenue environment continues. HEIT’s Board has instructed the investment adviser to explore potential asset sales in order to reduce gearing levels which would better position HEIT for long-term stability and growth. It says that, once any asset sale process is concluded, it will also consider further initiatives to provide value to Shareholders, such as share buybacks.
Interest rate hedging
At the beginning of the last financial year, HEIT had an interest rate swap in place in relation to its initial debt facility of £60m. The interest rate swap fixed the SONIA element of interest payments on this facility at a rate of 2.478% per annum. Multiple rises in Bank of England base rates since the Swap was contracted increased its value significantly. In connection with the extension of the debt facility (described above), HEIT chose to break this swap in July 2023, crystalising the mark to market value at the time of £6.1m. An interest rate cap of 5.25% was put in place in relation to the variable SONIA element of the increased facility, at a cost of £2.8m. This interest rate cap was valued at £1.1 million as at 31 October 2023.
Post Period, the Company restructured its debt facilities as described below. The Company broke its interest rate cap at this point (receiving a payment of £0.5 million) and replaced it with an interest rate swap for the SONIA element of this loan. The new interest rate swap fixes the SONIA element of the loan at a rate of 4.101% per annum.
Grid connections delays continue to be an issue for the sector
As noted above, the 2023 year saw five projects come online, a number of which were completed ahead of schedule. HEIT says that, where projects have been subject to minor delays, this has been largely due to grid connection constraints. It says that it has worked hard with DNOs and suppliers to ensure that delays have been less significant than those experienced by many other GB BESS owners. A report by Modo Energy in January 2024 noted that 60% of BESS projects were delayed by more than nine months. Against this backdrop, HEIT delivery track record is strong with only the Rusholme project suffering significant delays, representing 8.8% of the portfolio (by MWh).
The delays to the Rusholme project (70 MWh / 35 MW) were caused by the DNO’s inability to connect the project in line with originally planned timelines. The project has been “cold-commissioned”, meaning all batteries are on-site and have been tested to the extent possible. HEIT says that the root cause of this delay has now been successfully resolved, with the DNO having re-mobilised on site. The project is expected to energise in late Q2 2024.
Tendering process aimed to diversify HEIT’s supplier base
Wormald Green (66 MWh / 33 MW) and Hawthorn Pit (99.8MWh / 49.9 MW) are still under construction. These projects were acquired in December 2022, along with a third project, Rye Common and, post-acquisition, key commercial contracts in relation to Wormald Green and Hawthorn Pit were signed in February 2023. The quick pace of contracting was made possible because of a comprehensive tender process in advance of acquisition. HEIT says that the aim of this was to diversify its supplier base, encourage competitive tension for future tenders, and minimise the amount of time between acquisition and the start of construction.
As a result of this process, HEIT engaged Envision International Trading Limited and Envision Energy International UK Limited to supply and install its ENS‑L7300‑3300 BESS in relation to the Wormald Green and Hawthorn Pit projects. Envision Energy International UK Limited is also contracted under long term maintenance and services agreements in relation to these two projects.
Key factors which influenced the Company’s choice included Envision’s track record in the renewables sector, specifically its independent battery cell manufacturing capabilities; its commitment around BESS delivery dates (in line with the Company’s project energisation timetables); and its strong ESG policies and initiatives.
HEIT has also appointed Keltbray Energy Limited as balance-of-plant contractor, and bp as the revenue optimiser. The latter was appointed in September 2023 following an extensive tender process involving fifteen potential suppliers. The relevant projects will be optimised utilising software developed by Open Energi (a company acquired by bp in 2021).
Similar to Rusholme, both projects have taken delivery of battery cell modules and are expected to become operational in Q2 2024. Along with the energisation of Rusholme, this will make the Company’s portfolio of eight BESS projects 100% operational (790.8 MWh / 395.4 MW).
Rye Common disposal
The third acquisition of December, made 2022 alongside the Hawthorn Pit and Wormald Green purchases, was the Rye Common project (198 MWh / 99 MW). Similar to Wormald Green and Hawthorn Pit, this project was acquired “shovel ready”, although the relevant construction contracts were still to be put in place. HEIT says that, given the challenging capital raising environment, it was not able to raise the additional equity required to construct this project. Alternative funding options were considered including potential vendor financing and other deferred capex structures, however it was ultimately determined by the Board that a sale of the project should also be explored.
The sale process took place during summer 2023 and HEIT says that the project attracted multiple bidders at attractive prices demonstrating the continued high level of interest for BESS projects and the quality of Harmony Energy Limited’s pipeline. In aggregate, the proceeds of the sale (together with recycled cash previously allocated to this project) represented a 1.5% premium to its carrying value as at 30 April 2023 (as set out in the Company’s interim results). HEIT comments that the successful sale of the project at this value demonstrated the appetite for such projects from private investors whilst also validating its carrying values for such projects.
Investment pipeline
HEIT has a right of first refusal (ROFR) that gives it an exclusive right of first refusal over Harmony Energy Limited’s pipeline of projects, which it says is both substantial and well-developed. HEIT has, exercised this right in relation to 494.4 MW, leaving at least 505.6 MW still to be acquired (subject to financing).
Market overview – commitments to decarbonise power supply
In October 2021, the UK Government set a commitment for all electricity generation to be decarbonised by 2035, subject to security of supply. To meet this target, the UK must replace fossil fuel-based electricity generation with low carbon power from renewable sources such as wind and solar. This ambition was reinforced by the UK government in a recent pledge at COP 28, together with other countries, to triple global renewable generation capacity to 11 TW by 2030.
Largely as a result of this policy, traditional UK baseload power capacity is forecast to decrease due to challenging economics and the mandated closure of coal fired power generation whilst the installed capacity of intermittent renewables (i.e. wind and solar plant) is forecast to increase from 40 GW in 2023 to 135 GW in 2060.
This growth in renewables necessitates an increase in flexible capacity such as BESS with installed capacity expected to increase from 3.6 GW at the end of 2023 to at least 18 GW by 2060. It should be noted that 3.6 GW is 16% below National Grid’s assumed operating capacity for their Winter Outlook 2023/24, showing that the amount of installed capacity is lagging behind current National Grid requirements.
Alongside this supply-side shift to intermittent renewables supported by Flexibility, are significant changes in the expected demand profile. Electrification of heat and transport is expected to increase total demand by 90% by 2060, with peak demand forecast to increase by 48%. This is a reversal of recent trends in which electricity demand has fallen as a result of improvements in energy efficiency, the cost-of-living crisis and low global output since Covid-19.
This backdrop of increasing peak demand, coupled with greater penetration of intermittent renewables, remains central to the business case for BESS. Baseload power prices will decrease as more power is generated from renewables, However, the average spread between peak and off-peak pricing (the “Wholesale Price Spread”) is forecast to increase from around £75 / MWh in 2023 to £120 / MWh in 2030 and £136 / MWh in 2060. This is driven by off-peak prices being increasingly set close to zero when renewable output is high, whilst peak prices will continue to be set by reference to commodity prices (gas and carbon) which are both forecast to increase with carbon increasing significantly throughout the rest of this decade.
Wholesale Price Spreads therefore mirror this projected increase in commodity prices, and this is the fundamental macro driver behind the BESS business case which continues to underpin the market valuation of projects.
BESS revenues markedly lower in 2023
BESS revenues during the last financial year were markedly lower than those generated during the same period in 2022. HEIT says that, whilst a reduction from the remarkable highs of 2022 was expected and built into third party revenue forecasts, the scale and the speed of the reduction has exceeded market expectations. BESS revenues in November and December 2023 and January 2024 (i.e. post-Period end), deteriorated further, which was also contrary to expectations.
There are multiple drivers of this reduction in revenue. The first is the saturation of ancillary services which began towards the end of 2022 and is now a well-established position. This saturation was largely expected and already built into forward-looking revenue projections. The second key driver, and the most relevant to HEIT, is a reduction in wholesale price volatility. 2021 and 2022 had both seen high wholesale price volatility – in 2021 this was driven by rising fuel prices and low wind output leading to frequent scarcity events which drove high peak power prices. In 2022 wind output increased, reducing scarcity events. However, a marked surge in commodity prices drove power prices higher. This combination of high renewable output and high commodity prices contributed to high spreads and created the ideal conditions for BESS revenue performance.
Wholesale Price Spreads in 2023 have narrowed due to the reduction in commodity prices (particularly gas and carbon prices), Great Britain importing a large volume of energy from Europe (via interconnectors) and a material reduction in consumer energy demand.
Capacity market
The capacity market consists of two annual auctions which are designed to provide security of supply for the following year (based on the T-1 auction) and for four years into the future (based on the T-4 auction). Contracted assets are paid an availability fee to guarantee availability to respond to stress events, which are periods of very high demand. HEIT says that this revenue stream can be combined with all other revenues and is a secure, passive part of the revenue stack.
Ancillary services
The current suite of National Grid ESO ancillary services is referred to collectively in this section as Dynamic Frequency Response (DFR). These services are divided into “high” and “low” frequency services as described below. Auctions take place on a daily basis for delivery the following day and prospective service providers bid by communicating to National Grid ESO how much capacity they are able to provide, and at what price.
Dynamic frequency response high (DFR(H))
A high-frequency event is caused by energy supply exceeding demand, which causes the frequency to be higher than the target set by National Grid ESO. DFR(H) services are used to correct high frequency events by either increasing demand or decreasing supply in order to restore balance. BESS responds to this type of event by consuming power, i.e. charging the battery.
A key strategy for HEIT’s assets during the last financial year was to bid into this type of service for part of the day and then sell any power consumed on a scheduled, bilateral basis via the wholesale market during the evening peak period. HEIT’s assets do not pay for the power consumed whilst providing DFR(H) services, and therefore a greater spread could be achieved. This explains why a large proportion of the Company’s revenues during the Period came via Dynamic Regulation – a sub-category of DFR (see section titled Dynamic Frequency Response Low (DFR(L)).
This strategy saw increased competition from both 2-hour and shorter duration BESS during 2023, despite being less effective for shorter duration BESS due to the limited volume which can be stored. The introduction of the Enduring Auction Capability in November 2023 places further pricing pressure on this strategy (see further details below). The Investment Adviser monitors such trends closely and has regular strategy meetings with Tesla’s Autobidder operators (engaged as revenue optimisers in relation to the Company’s current operating projects).
The Autobidder software makes a judgement as to whether the DFR(H) clearing price(s) represent better value than charging via the wholesale markets. HEIT says that, until we witness a widening of peak/off-peak spreads in the wholesale markets, it is anticipated that it will continue to participate in DFR(H) for as long as such strategy continues to demonstrate best value. It comments that recent analysis by Modo Energy which tracked and compared two BESS assets (one 1-hour duration and one 2-hour duration) operating the same DFR(H) & wholesale strategy concluded that the 2-hour duration BESS earned more £/MW whilst also cycling less.
Dynamic frequency response low (DFR(L))
A low frequency event is caused by energy demand exceeding supply, causing the frequency to be lower than the target. DFR(L) services are used to correct low frequency events by either increasing supply, or reducing demand.
BESS responds to this type of event by generating power, i.e. discharging the battery.
As with DFR(H) services, HEIT’s assets would not be paid for the energy throughput (in this case, the energy discharged from the battery) whilst participating in this service. For DFR(L), this creates an opportunity cost – the BESS could reasonably achieve better value discharging via the wholesale markets – so DFR(L) services have traditionally cleared at higher pricing levels than DFR(H) services as bidders demand higher compensation for this opportunity cost.
Wholesale trading
Wholesale trading refers to the buying and selling of power via the day ahead or intra-day power exchanges. In its basic form, it refers to buying cheap power when demand is low (and increasingly when renewable energy generation is high), storing this power for a period of time and then selling when the price increases, profiting from the “spread” between peak and off-peak prices. The average spread in the wholesale markets is expected to increase as the growing proportion of renewable generation increasingly displaces use of older, thermal plant during periods of off-peak pricing (when it is not economic for the latter to operate), leaving peak prices linked to commodity prices such as gas and carbon. Wholesale markets are active until one-hour prior to delivery of power (known as “Gate Closure”).
Balancing mechanism and the open balancing platform
The balancing mechanism is National Grid ESO’s last minute tool to balance supply and demand in real time. This is active from Gate Closure and spreads are typically significantly wider than seen in wholesale markets. To date, BESS revenues from the balancing mechanism have been limited by National Grid ESO’s systems and ability to dispatch a large number of small assets. In response to this issue, National Grid ESO recently released the Open Balancing Platform (OBP).
The balancing mechanism is National Grid ESO’s primary tool for balancing supply and demand, as well as managing system needs in real time. BESS can be “dispatched” to either charge or discharge in short bursts (currently up to 15 minutes) multiple times per day. Historically, BESS has represented a small proportion of overall dispatch volumes within the balancing mechanism (1.7% of total dispatches in 2023), as the National Grid ESO control room operators have favoured more established technologies which dispatch in large volumes, rather than cheaper and more efficient BESS capacity.
Being subject to strong incentives to keep balancing costs down, National Grid ESO is committed to increasing BESS dispatch rates and volumes in the balancing mechanism. National Grid ESO has published its “balancing programme” incorporating multiple enhancements to be implemented on a staggered basis between December 2023 and Summer 2025 with the express purpose of enabling greater use of storage assets in the balancing mechanism. The plan includes new control room processes and training, software updates, regulatory changes and launch of new services. The three key enhancements which are of particular interest are:
- The OBP & “Bulk Dispatch” functionality: launched in early January 2024 (after an initial launch in December 2023 was aborted after a few days due to a technical fault), this new software enables National Grid ESO controllers to dispatch multiple assets simultaneously (up to maximum of 300 instructions per hour), rather than via individual instructions (average rate of 6.5 dispatches per hour);
- Fast Dispatch: expected in Spring 2024, will enhance Bulk Dispatch so that National Grid ESO can call upon BESS in the BM to respond to time-sensitive frequency-correcting actions (e.g. in response to a sudden large outage, such as an interconnector trip); and
- New Storage Parameters: a change designed to give National Grid ESO controllers confidence and capability to dispatch BESS for longer than the current 15-minute limitation. This was due to be available from Winter 2024, but National Grid ESO recently announced an ambition to bring this initiative forward to 1 March 2024.
HEIT says that it remains too soon to forecast the net impact of the planned enhancements, and a frustrating level of inconsistency by National Grid ESO has been observed whilst OBP “teething” issues are ironed out. However, there are positive early signs, as since OBP’s first launch in early December, the total BESS volume dispatched via the balancing mechanism has increased. According to Modo Energy, 1.1 GWh of BESS volume was dispatched per day in January 2024, an 80% increase on November 2023.
It is already well documented that 2-hour duration BESS can outperform shorter duration BESS in the balancing mechanism, as more MWh creates opportunity for more transaction volume. Modo Energy predicts that the OBP and subsequent enhancements will enable 2-hour duration BESS to enjoy an uplift in the present value of lifetime revenues by 13-20% (central/high scenarios).
National Grid’s auction methodology
Post-Period end, on 2 November 2023, National Grid upgraded its auction methodology and bidding structure in relation to ancillary services. This is known as the Enduring Auction Capability (EAC). The changes implemented increased the linkage in pricing between services, and also enabled participants to bid negative pricing to win volume (i.e. pay to provide the service). This has increased transparency for participants and reduced the cost for National Grid ESO to procure ancillary services. It follows, however, that service pricing has been driven down, reducing revenues captured by BESS.
The EAC has impacted the DFR(H) & wholesale trading strategy that HEIT commonly used during the Period (as described above). This is because the clearing price for the DFR(H) service can now be negative, meaning that the Company has to pay to charge (narrowing the potential spread achievable). As described above, a 2-hour duration BESS continues to outperform its shorter-duration peers when utilising this strategy, and the Investment Adviser is keeping the situation under close review.
Market outlook
As has been previously explained, short-duration BESS is more reliant upon ancillary service revenues than 2-hour duration BESS. HEIT says that the continuing saturation of the ancillary services market along with EAC is, certainly, a material factor in the recent revenue performance of the whole BESS fleet in Great Britain. However, the Investment Adviser anticipates that 2-hour duration BESS will accelerate away from ancillary services with a proportionate increase in revenue generated via the wholesale markets and the balancing mechanism. It says that this should result in increasing divergence of asset performance, depending upon duration. Despite the technical teething issues in National Grid ESO’s implementation of OBP, the recent increase in dispatch rates witnessed in the BM is an encouraging sign of this, it adds.
More widely, other factors such as the expected increase in energy demand and the continued strong build out of intermittent renewable generation plant, coupled with the relative shortfall of Great Britain’s BESS capacity, should support Wholesale Price Spread growth, reversing recent trends, in the adviser’s view. It thinks that, given HEIT’s position as the largest portfolio of exclusively 2-hour duration BESS in Great Britain, HEIT is well positioned to continue to outperform the wider market and maximise emerging revenue opportunities.