In recent weeks, the share prices of the three battery storage funds have nosedived, more than reversing the modest gains they had made since it started to become clear that interest rates had peaked last October.

Gresham House Energy Storage (GRID ) has now experienced a 55% fall in its share price year-to-date. It trades on a 66% discount to its June 2023 net asset value (NAV – the last available – but there must be a good chance that the next valuation – as at 31 December 2023 – will come in lower than this.

Similarly, Harmony Energy Income Trust (HEIT) is down 56% year to date and trades on a near 70% discount.

The share prices of these battery funds have been sliding for a while, but the trigger for the recent share price weakness was a note published by Matthew Hose of Jefferies on 25 January 2023, which called into question the sustainability of the dividends on the three battery storage funds. They simply have not been generating enough income and things seem to be getting worse. Now, both GRID and HEIT have suspended dividend payments.

Batteries can perform a variety of functions, many of which are related to ensuring the smooth working of the national grid in an environment where supply is increasingly variable because of the higher proportion of energy being supplied by renewables.

In part, the sector’s problems are born out of its own success. In the UK, we are one of the leaders in battery storage installations and this success is starting to weigh on margins. For example, revenues from ancillary services, such as frequency response, that keep the frequency on the grid stable, have been falling. This was expected and built into the companies’ business models.

Capacity market revenues – where companies bid for contracts to supply energy when called up at four hours’ notice – are steadier, but not a huge part of the revenue stack for these businesses.

The bigger opportunity to work with the grid is to participate in the National Grid ESO (electricity system operator) balancing mechanism. This aims to match power supply with demand and here batteries can provide a useful service. Battery owners bid to supply or store power in response to the shifting supply/demand balance on the grid.

Last September GRID warned that that falling ancillary services revenue was not, as it had expected, being offset by higher trading revenues. In particular, there was a problem with the National Grid ESO not using battery storage within the balancing mechanism and this was weighing on its revenues.

System needs to catch up

As far as I can make out, the grid’s systems are not yet fully equipped to cope with battery storage and, as a consequence, gas plants are being fired up in response to supply shortages rather than the ESO opting to use batteries. The grid is opting to buy power from gas plants at higher prices than battery storage projects are prepared to supply it – battery storage is being ‘skipped’ in the balancing mechanism. That increases the UK’s vulnerability to volatile gas prices and means that we are burning more fossil fuel than we need to. It is also keeping power prices higher through the day than they otherwise would be.

That latter point is important because not only is this adding to our fuel bills, it is also reducing the intra-day volatility of power prices. This makes it harder for battery companies to profit from buying and storing power when prices are low – sometimes, if there is way too much power available, they can get paid to store it – and selling it when prices are higher. This is another factor weighing on revenues.

The industry wrote an urgent letter to National Grid ESO in July last year warning that this was happening. The 80 members of the Electricity Storage Network, which represent most of the battery storage players, warned that their inability to dispatch power to the balancing mechanism was putting billions of pounds of investment at risk.

National Grid ESO is implementing changes to its operational practices that will start to rectify the issue, but these will take time.

An upgrade, planned for December 2023 but not operational until late January, allowed National Grid ESO’s systems to call on multiple batteries simultaneously. This is a good first step.

Fast dispatch (to launch in the next few months) will make it easier for the grid to call on multiple batteries more quickly – increasing their usefulness.

However, the final upgrade in late 2024 is needed to allow batteries to dispatch energy to the grid for more than 15 minutes at a time. This is key. Most of the time the grid needs power for longer than 15 minutes. Battery storage is usually set up so it can deliver power for an hour or two hours. However, the grid’s systems will not currently let it call on batteries for longer than 15 minutes.

If all of this seems faintly ridiculous – it is. Again, as with the multi-year long queue for grid connections, the monopolistic body at the centre of it all just does not seem up to the job. The situation will get fixed, after all there is a decarbonisation argument as well as a monetary one to using batteries for this job rather than gas plants, but it will take time.

Investors will have to be patient. It is not as though hitting the managed wind-down/liquidation button will solve the problem. We should also be very wary of a cheeky bid for one or more of these funds while the problem persists. The one with least exposure to the issue is Gore Street (GSF ) which is well ahead of its peers on diversifying internationally.

James Carthew is head of research at QuotedData.

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