Exploring Battery Energy Storage Systems: Financial Modelling Approaches and Best Practices

Battery Energy Storage Systems (BESS) are revolutionizing the energy sector by providing efficient and reliable solutions for storing and managing electricity. In our webinar on 23rd July 2024 and hosted by Forvis Mazars, experts Ben Kwan, Ashima Khandelwal, and Hitansh Doda discussed various financial modelling approaches, their advantages, limitations, and best practices, while highlighting common errors in battery financial models and insights on how to avoid them.

This post is based on a recent webinar discussing Financial modelling and BESS systems

Introduction to Battery Energy Storage Systems

A BESS can be broken down into three main components: the battery system, the energy management system, and the power conversion system. The battery system contains rechargeable battery cells wired together to form modules, which are then stacked into racks and housed in containers. The energy management system is a computer operating system that manages the charging and discharging of the battery cells. The power conversion system converts DC current from the battery to AC current for use in the grid.

Benefits of Battery Energy Storage Systems

BESS offer several key benefits, including improved use of renewable energy, backup power, reduced dependence on the grid, a reduced carbon footprint, and long-term cost savings. There are two types of battery systems: standalone batteries, which operate independently, and co-location batteries, which sit alongside renewable generation sources like solar or wind farms. Lithium-ion batteries are preferred due to their cost-effectiveness, high energy density, short response time, eco-friendliness, and long lifespan.

Financial Modelling of Battery Projects (BESS)

Battery projects are typically modelled using a structure that includes input sheets, calculation sheets, and output sheets, along with a key output sheet or dashboard. The financial modelling process starts with the input sheet, followed by the timing sheet, which models the project timeframe and various timing flags and counters. The construction sheet models equity and debt drawdowns, upfront fees, and interest during construction. The operation sheet models revenue and costs during the operations phase, while the debt sheet models debt repayments and banking ratios. The return sheet models distributions and equity returns, and other components like depreciation and tax are included before putting together the three-way financial statements: cash flow waterfall, P&L, and balance sheet.

Best Practice Financial Modelling Approach

Forvis Mazars emphasizes six key themes for best practice financial modelling: accessibility, responsiveness, tailoring to the end user, simplicity, accuracy, and adaptability. Keeping the model simple is crucial, avoiding unnecessary complexity and long formulas. Binary flags can be used as alternatives to multiple IF statements, and simplifying assumptions can help reduce the length and complexity of formulas.

Ben Kwan, a Partner at Forvis Mazars, highlighted the importance of simplicity:

“To keep it simple, don’t model things which are not needed. If there is no need to have something like a cash sweep in your model, then don’t model it.”

Revenue Stacking in Battery Projects

Revenue stacking refers to earning revenue from multiple sources using the same capacity. The four main sources of revenue in battery projects are capacity payments, arbitrage revenue, frequency-controlled ancillary services (FCAS), and event-based revenue. Capacity payments are earned for having the capacity to provide power to the grid, regardless of actual usage. Arbitrage revenue is generated by exploiting price differences in the electricity market. FCAS payments are received for maintaining and stabilizing the grid’s frequency. Event-based revenue is generated from specific occurrences like floods or storms.

Financial Modelling of Revenue Streams

Capacity payments are modelled using binary flags calculated from the start and end dates of the payment period. The periodic capacity payments are calculated from annual payments, considering the percentage of capacity contracted. Arbitrage revenue is modelled by calculating the difference between the sale price and the spot price, considering storage costs. FCAS revenue is modelled using the degradation index, capacity, escalation, and price, with payments calculated based on the megawatt enabled for the services multiplied by the clearing price. Event-based revenue is modelled using input revenues from major and minor events provided by market consultants.

Ashima, a manager at Forvis Mazars, explained the concept of capacity payments:

“Capacity payment is a very popular arrangement for storage projects. It acts as a safety net and ensures a steady flow of income, making it easier for developers to secure financing.”

Cost Modelling in Battery Projects

Construction costs vary based on factors like capacity, technology, location, and type of project. The biggest cost relates to building the actual battery system. Operation costs include charging costs, O&M, land lease costs, rates, insurance, and other fees, typically modelled on a fixed cost basis and escalated by an escalation rate. Capacity expansion costs, or repowering CapEx, are incurred to increase the capacity and life of a battery, funded through a CapEx reserve account.

Key Financial Modelling Challenges

Common modelling challenges in BESS projects include determining project capacity, integration with renewables, cost and economics, lifecycle management, and performance. Debt service coverage ratio (DSCR) and debt sizing are crucial for project finance models. DSCR measures the relationship between cash available and debt service, while debt sizing optimizes the debt limit for the project’s capacity. Scenario analysis helps in running different scenarios and comparing outputs to identify the range of returns.

Hitansh Doda, an Associate Director at Forvis Mazars, emphasized the importance of DSCR:

“DSCR is used to determine the size of the loan that lenders will make available and to match the size of each repayment to cash generated in each period. It’s crucial for ensuring the project’s financial stability.”

Conclusion

Battery Energy Storage Systems are essential for the future of renewable energy, providing efficient solutions for storing and managing electricity. By understanding the financial modelling approaches, best practices, and common errors, stakeholders can optimize their financial models and ensure the success of their battery projects. Forvis Mazars’ expertise in auditing and building financial models offers valuable insights for navigating the complexities of BESS projects. You can watch the webinar here

For more insights into BESS storage projects and associated financial modelling/analysis, please refer to this recorded webinar:

Co-located BESS and Long-duration Energy Storage

Here are some financial modelling tutorials that we recommend:

1. Excel Shortcuts: Enhance your productivity with a comprehensive list of Excel keyboard shortcuts. Explore the tutorial
2. LLCR – Essential Project Finance Ratio: Understand the Loan Life Cover Ratio (LLCR) and its importance in project finance. Explore the tutorial
3. Best Practice Approach to Copy-Paste Macros in Financial Models: Learn the best practices for implementing copy-paste macros in financial models. Explore the tutorial
4. Average DSCR in Financial Modelling: Discover the methods to calculate the average debt service coverage ratio (ADSCR) and their limitations. Explore the tutorial
5. Cash Sweep Analysis in Project Finance: Learn about the key features of modelling cash sweep calculations and their application in project finance. Explore the tutorial