Facilitating investment in long duration energy storage

Key takeaways from the Response

1. The government has decided that an LDES cap and floor scheme should be introduced as the optimal policy to accelerate and streamline LDES investment, in recognition of strong industry backing. This scheme ensures developers a minimum level of revenues (the floor) while limiting maximum revenues (the cap) over an extended period of, in this case, 25 years or until the first refurbishment of the asset. The UK government’s proposal is to link the level of the floor to the cost of debt. The Response notes the potential impact on projects which are not debt-funded and suggests exploring alternative funding methods going forwards. The Response also proposes that these levels be calculated by reference to gross margins, with detailed considerations for operating expenditure, tax allowances, network charges, revenues from the capacity market and future market to be provided at a later stage.
2. At the request of the UK government, Ofgem has agreed to act as the regulator for LDES, taking on the role of investment framework delivery body – a strategy favoured by industry. Ofgem’s recognised expertise and track record in successfully implementing a cap and floor approach for electricity interconnector investment and delivery over the last decade is particularly acknowledged. Government expects this decision to aid swift implementation. It also responds to many investors’ preference that the scheme be delivered by an independent body. As an independent regulator, Ofgem may need to gather additional evidence before its Board can formally approve the details of the LDES investment framework  to support project delivery.
3. The cap and floor scheme should offer two application routes, one for established technologies and one for more novel technologies.
4. Recognising concerns raised in responses to the Consultation about the ineligibility of some technology types (such as lithium-ion batteries), government has confirmed it will take a technology neutral approach, provided that it meets the definition of electricity storage and the minimum stream eligibility criteria. However, it maintains its principle of additionality: only projects that could not otherwise move forward to investment decisions should be supported. This is broadly aligned with one aspect of the assessment which government and Ofgem may be required to undertake under the Subsidy Control Act 2023.
5. To address concerns around potential gaming risks of the cap and floor scheme, government has commissioned an in-depth study on mitigations. Government will work with Ofgem to consider how best to address these risks ahead of the final regime opening for applications.

Forward look

Significant further detail is still required from both the UK government and Ofgem, particularly in relation to the ‘Technical Document’ due for publication later in 2024 and  further information to be published as the regime goes live in 2025. Aspects of Ofgem’s broader work package are likely to have significant read across too. We  expect potential developers to be paying close attention to several areas, including:

• How gross margin is to be calculated, the details of which are fundamental to the overall framework. Key decisions regarding the calculation methodology will significantly impact whether the regime is, in fact, investable and achieves its desired purpose.
• Dispatch distortion and gaming risks mitigation measures (i.e. the risk that LDES operators act in a commercially sensible manner, which, when judged (likely retrospectively) may not be seen as being in the best interests of consumers). There is a particular concern about the risk of storage not being dispatched during times of tight margins and high prices. Over recent years, Ofgem has published a variety of letters of potential relevance to this area³.  It will need to draw on this experience to establish a regime that is sufficiently clear and predictable to encourage developers to enter the market.
• In late September 2024, Ofgem published an open letter⁴ setting out its proposals for a separate temporary cap and floor mechanism for TNUoS charges to be paid by generators. This initiative aims to mitigate the impact of volatility in these charges, especially given the uncertainty surrounding the broader market reforms under REMA. Due to limitations in Ofgem’s authority to modify the relevant codes it is relying on NGESO to propose these changes. This interaction with wider changes to network charging could significantly impact LDES.
• The outcome of Ofgem’s  latest decisions on cap and floor support for electricity interconnectors remains pending. While Ofgem has yet to publish a final decision following the consultation that concluded earlier this year, its ‘minded-to’ proposal was to reject six out of the seven proposed projects in this third round of evaluations.⁵ This position highlights the increased scrutiny Ofgem applied to issues such as deliverability and consumer benefits compared to earlier application windows. How this heightened scrutiny will influence Ofgem's approach to the initial LDES applications remains uncertain.