Energy storage: Warranties, insurance and O&M issues
Standard warranties for lithium-ion batteries covering both performance and defects are two years, but extended warranties can be purchased. A warranty beyond 10 years does not make sense because so much of the battery would need to be replaced after year 10. Insurance can also be purchased. Operations and maintenance of batteries is complicated because the operator relies on software to optimize performance. Rates of deterioration of the battery depend on how the battery is used. A group of storage experts and a tax equity veteran talked about these and other subjects at Infocast Storage Week in San Francisco earlier in the year. The following is an edited transcript.
The panelists are Jon Cozens, chief commercial officer of New Energy Risk, Sam Jaffe, managing director at Cairn Energy Research Advisors, Neil Maguire, CEO of Adara Power, Carl Mansfield, general manager of NantEnergy, and Ed Rossier, director of project management and renewable energy investments at US Bank. The moderator is Deanne Barrow with Norton Rose Fulbright in Washington.
MS. BARROW: Let’s start with warranties and insurance products that help storage projects get financed. Jon Cozens, your company, New Energy Risk, underwrites technology performance. How does it work?
MR. COZENS: Take any energy generating asset, not a storage asset, that has a nameplate output of 100 units. That asset is put into the field, and the output is sold. Imagine financing is obtained from a bank, and the bank requires a debt service coverage ratio of 1.0. Suppose that satisfying this requirement requires the asset to produce at least 60 out of the 100 units of nameplate output per quarter. We simply insure that the asset will produce 60 units in every quarter for the entire term during which the debt amortizes. That was our baseline insurance warranty product. Insurers always look for balance-sheet support. They look for a developer to make a guarantee that is similar, if not stronger.
Pivoting into the storage world, there are usually two types of warranties. First, there is usually a product warranty, which is a guarantee against defects. The warranty provider promises to repair the product if there is a defect. We do not focus on this type of warranty so much.
The second type of warranty is a performance warranty. This is our main focus. In storage, we insure four key attributes of a system over time. These are capacity, energy or power, availability and round-trip efficiency, or some combination of all of those.
Building on that, we have had success insuring demand-charge reductions. This product ensures forecasts by energy service companies of peak demand, making the battery available, with the right stated charge both to charge or discharge as required, and having an algorithm that accurately predicts the peak and reduces demand charges. That sums up the evolution of insurance products we have seen over time.
MS. BARROW: Sam Jaffe, it is difficult to model and predict degradation and deterioration over time. How then do you provide a warranty that guarantees output?
MR. JAFFE: That question needs to be answered. It is not answered fully today.
One option is self-insurance. This is where the developer says, “if the battery fails, in six years’ time, we are going to back it up with our balance sheet.” It is not a financially smart move for the developer, the power purchaser or the cell manufacturer. Self-insurance is being phased out, but I know of situations where it is still used.
The other way to do it is to oversize the system. If the developer has contracted to provide a certain amount of power over time and is concerned that in year eight or nine, the system will not be able to deliver the required power, it will just build a bigger system. Again, this is not an efficient way of doing it. There needs to be a robust, financially stable insurance market for these products that goes beyond just the battery manufacturer’s one-year warranty, which is really not of value.
MS. BARROW: Carl Mansfield, NantEnergy offers a novel rechargeable zinc-air battery. Lithium-ion has emerged as the dominant technology, but the storage industry is bursting with innovation. Speak to the role that warranties and insurance play in new technologies gaining a foothold in the market.
MR. MANSFIELD: While we have a novel zinc-air battery technology, which has made some pretty amazing progress over the past decade, we are still deploying lithium battery technology in our projects. We also have hybrids that combine lithium and zinc-air together.
The major advantage of the zinc-air product is that it is optimized for very low cost, long duration for backup, and so it is ideal for lead-acid or diesel-generation displacement. We announced last year that we have broken the $100-per-kilowatt-hour cost barrier on that product.
As far as new products are concerned, we are both a buyer of batteries, where we get the warranty the vendor provides, and also a manufacturer of batteries, where we have to provide warranties ourselves.
Most manufacturers will sell an extended warranty if the purchaser wants it.
The standard warranty today is two years, both for performance and as a general product warranty. Most projects that are financed need a longer warranty.
There is a particular challenge in the commercial and industrial solar market, where the primary purpose of the battery is to provide demand-charge management for the C&I customer on whose premises the battery is installed. A warranty from the vendor guaranteeing that in 10 years, the system will have 75% of year-one capacity is all well and good, but it provides no value to the host customer. You could have 150% of year-one capacity at year 10, but if the system is not being dispatched correctly, it delivers no value to the host customer.
Whether or not the storage technology is novel, the warranty will always depend on the application. If the battery will be used for a telecommunications application at a cell tower, and it needs to have a system life of five years or 10 years and a specific expected cycling, then we can guarantee the system will meet those requirements.
MS. BARROW: Adara Power, formerly known as Juice Box, deploys lithium-ion batteries. Neil Maguire, do you have any thoughts on predicting deterioration and how warranties can be provided around deterioration?
MR. MAGUIRE: I used to work at a lithium-ion cathode material coating company making 18650 cells. Those are small cylindrical cells of 18 millimeters by 65 millimeters in size that were first introduced in 1991. We are now in year 28 of lithium-ion cells. We could put those cells under different temperatures and different C-rates, meaning the amount of current you push and pull, and we could get almost any life cycle you want out of the battery. It is all about how the battery will be used.
A company like LG Chem will provide an energy throughput warranty. What this means is that it warrants that the battery will deliver a certain amount of energy over a 10-year life.
The number of times a day the battery is cycled will affect how many years of use you can get out of it. So the energy throughput is key. LG Chem requires the operator to maintain the battery at a certain temperature and state of charge — do not keep it all the way up or all the way down — or that voids the warranty. The warranty comes with many conditions obviously written by an electrochemist in South Korea. The conditions put the onus on the operator to track the data to protect the customer and to enable it to go back to LG Chem with proof that the system was controlled in accordance with the warranty conditions.
MS. BARROW: Can you share any best practices for tracking and storing data that could be needed to make a warranty claim?
MR. MAGUIRE: The battery vendor will have a very specific list of data that it requires. It will usually want to see data logged at 15-minute intervals. It will want to see the maximum current running through the system for a period and the minimum and maximum state of charge of the battery. The data is tracked with a software controller and stored on the cloud. With Amazon Web Services’ cloud repository, for example, you can scrape off the relevant information for a warranty claim and, at a moment’s notice, produce a report for LG Chem or Samsung.
Tax equity concerns
MS. BARROW: Ed Rossier, you are a tax equity investor. What most concerns you when evaluating a storage project that is looking to raise tax equity?
MR. ROSSIER: We worry about catastrophic failure, but we also have some upside risk that is dependent on optimizing operations over a longer term. We focus on what might happen to cause the downside or prevent the upside from occurring.
If the project is expecting to receive an investment tax credit that is dependent on not charging the battery from the grid, then the big risk we worry about is what controls are in place to ensure that that there is no grid charging. IRS guidance is not clear about how that should be shown. The industry, collectively, is still trying to decide what needs to be shown in the event of an audit. The investment tax credit recapture provisions are draconian in the case of energy storage.
The last panel talked about the desire for flexible use cases and how some projects are built without knowing exactly how they will be used. That is a little challenging from our perspective because if the industry is going to scale, it needs to get the story straight. Bankers are inherently lazy, and we already have to deal with tax equity, which is really complex. I have three kids under seven, so I may have 2% of my brain left to understand the energy storage warranty, and the warranties we have seen so far are really complicated and seem to be individually negotiated.
We have to process the complexity of the warranty terms, where the risk is allocated, the creditworthiness of the entity standing behind the warranty and potential changes in use cases over time. That is a lot to get through on any individual project.
MS. BARROW: Digging deeper on the ITC recapture risk, what kind of metering data should a battery operator keep in case the IRS audits a project? How do you prove that the battery was charged, at least 75% or more of the time, not from the grid, but from a renewable energy source, so that you are eligible for the ITC?
MR. MANSFIELD: To begin with, we do not claim that the battery is charged 100% of the time from the on-site solar. We usually claim around 90%, depending on the site. Our approach is to conduct extensive metering and logging of data at all of our sites so that we capture and store energy production data, both from the solar and in and out of the battery in real time.
Our view is that a 15-minute interval calculation on an annual basis is sufficient to provide an audit-proof claim that you are meeting the requirements for ITC eligibility. We have had an independent third-party review of our approach, and it concurred with our opinion.
MR. MAGUIRE: To meet a target of 100% charging from solar, we produce data that shows how much solar power is produced each day, as well as data showing when the battery was charged. Those two data sets can then be overlaid.
It is important for the data to be available if the IRS ever comes, but I know of no case so far where the IRS has ever asked for such data. I am not sure that it would know what to look for right now, with all due respect.
MS. BARROW: Ed Rossier, are you comfortable with claiming an ITC assuming full solar charging?
MR. ROSSIER: The projects we have financed so far have been behind-the-meter, residential projects. The Massachusetts SMART program seems to be driving the current interest in tax equity for solar-plus-storage projects. We are just starting to look at projects that are not strictly residential. In the beginning, residential solar systems for the most part could not be charged with grid power, so there was no control needed other than the design of the system. That is starting to change. If a system is able to charge from the grid, then we would expect some kind of buffer.
MR. MANSFIELD: The decision about how much ITC it is reasonable to claim should also depend on the application. A system that is providing demand-charge management for a C&I customer can technically charge 100% of the time from on-site solar, but doing so will sacrifice performance of demand-charge management. On the other hand, if the system is providing standby backup power only, without demand-charge management, then it is possible to get pretty darn close to 100% solar charging.
MS. BARROW: Switching gears, Neil Maguire, the complex part of operations and maintenance is the operations part, not the maintenance part. Why is storage different from, say, solar, where O&M is somewhat commoditized?
MR. MAGUIRE: Maintenance for solar projects is very well understood at this point. It involves cleaning the panels and replacing parts that are under warranty, like the inverter or the panels. That kind of maintenance requires going out to the site and incurring direct labor costs.
With a battery, there will be some outdoor systems such as an HVAC or air-conditioning system with filters. There will be maintenance requirements for that equipment, but other than that, site visits are only necessary to check fuses and connections, and to take voltage and current measurements. The maintenance part does not involve a lot of direct labor.
The operation of the battery is far more complicated because it involves tracking data for the warranty, as we discussed, and also operating the system in such a way that it achieves the demand-charge management or the peak-shifting performance that has been guaranteed to the customer.
This requires manning a network operating center to look constantly for inverter faults or communication gaps. There is a lot more interaction with the system. On top of that, certain modifications may be needed to reflect electricity tariff changes. For example, on March 1, new tariffs became effective in California. They are rolling out over the next year. Firmware updates will be necessary at that point to modify when the battery charges and discharges, and at what rate. Storage requires more effort. It requires a lot of fine tuning.
MR. COZENS: I agree. Before the illustrious world of insurance, I was in the energy procurement department at Pacific Gas & Electric and Southern California Edison, back when solar was $130 a megawatt hour.
Maintenance used to involve Windex and paper towels. It is totally different now. When setting up a warranty — and if you choose to use insurance behind it — you should think through how the battery should perform, the different temperatures it will be subjected to depending on different conditions at the site, and how it will be maintained.
MR. MAGUIRE: If the system is third-party owned, the O&M treatment means going to the site to verify the efficiency and the output of the equipment, not just a general changing of filters and other physical tasks. The O&M agreement should require the manager to make sure the system is hitting efficiency and other performance numbers.
MS. BARROW: What kind of costs are we talking here? Can you give us a benchmark?
MR. MAGUIRE: That is a little tougher. If you buy enterprise software, it will come with a maintenance agreement, which is normally 12% to 18% of the total cost. That pays for firmware updates. If new electricity tariffs or new use cases come out, then you have software people who are making changes and rolling out firmware updates. Part of the O&M fee is to fund continual, sustaining engineering on the firmware.
The other part is sending people out to sites. I would say the cost is in the range of 3% to 5% of total project costs per year for the O&M on energy storage.
MS. BARROW: Does anyone have different numbers?
MR. ROSSIER: I agree with the prices. They are consistent with what we have been quoted.
We have encountered challenges around software. Software is provided as an ongoing service contract, and one of the concerns we have is what happens if the software provider decides to pivot or goes bankrupt and can no longer provide the service. Who steps in, and what does that look like from an investor standpoint? There could also be a hardware component. Do you have to find a competitor, and are there enough competitors that are reliable and proven in the US that we can swap out the O&M contractor? How long would that take, and how do you plan for that possibility?
MR. MANSFIELD: Software is one of the fundamental differences between storage and solar. Solar has fewer moving parts because it gets deployed in the field and is left alone. You clean it and that is all you have to do.
With battery storage, you can have a system with 100% of year-one capacity, but if the software does not dispatch it correctly, it will not produce savings for the customer.
If the company –- large or small — that wrote the software and was managing the system goes bankrupt, it would be challenging to replace that control. You would have to rip out the control and put in a new system that is capable of interfacing to the onsite hardware. That is your only real option.
Compare that to solar where O&M is a commodity. You can just shop it around. If an O&M provider or the developer that built the project and is doing the O&M is no longer around, it is easy to get a new O&M guy before anything has to be done at the site. With storage, some downtime will be required.
MR. MAGUIRE: I agree. We are a small private company, but in the time I used to be sitting on panels at these conferences, some larger solar companies like Sungevity, SunEdison and SolarCity have consolidated or collapsed.
Even though we have great software engineers, we cannot take somebody else’s code and figure it all out and start maintaining it. We would have to pull out the controller, install a new industrial computer and have a Modbus interface to the inverter. If the inverter is not one with which we are already familiar, then it could end up being a three-month effort before we take control.
If the software provider goes out of business, the system will not stop working immediately. There will be time to swap out hardware and software.
MR. MANSFIELD: When we are underwriting storage projects, we have an independent engineer evaluate the contracts, the scope and the qualifications of the software provider. I am not completely convinced the IEs are really able to underwrite software and controls. It is something that gets pushed into their scope of work, but it is not the core competency of a lot of IEs to speak to software capabilities.
MS. BARROW: Sounds like a call for IEs with software engineering and computer coding knowledge. Given the importance of software, is there a place for escrow agreements? They require the software provider to put its code in escrow with a third party, and the code is only released if something happens to the provider.
MR. MANSFIELD: We have not done that with our software and we have not had someone ask us to do that. I am not sure that we would want to do that.
MS. BARROW: Why not?
MR. MANSFIELD: Because of the complexity and overhead cost. The approach that we have taken historically at Sharp Electronics and now NantEnergy is to convince customers that our solution is bankable.
MR. COZENS: There is always an intellectual property angle, whether it is a royalty-free, nonexclusive technology license that is given to lenders and insurers or putting the intellectual property into escrow. This is true of just about every storage deal we have done.
MS. BARROW: I would like to move into a segment we will call “rapid fire” because I have a series of short questions. The idea is to establish some data points that may be useful to
Beginning with length of warranties for a lithium-ion battery, I heard that someone on an earlier panel say two years is standard, and I heard someone else say one year. What is standard? Sam Jaffe, start with you.
MR. JAFFE: It could really be anything depending on how much you pay, but the traditional lithium-ion manufacturer warranty that comes out of the box is going to be one or two years.
MS. BARROW: What is the standard length of capacity maintenance guarantees?
MR. JAFFE: That is when you get into extended warranties. Capacity maintenance guarantees are project-specific and get negotiated with the manufacturer. Negotiation only works for very large projects. Guarantees for residential projects are not typically negotiated.
MS. BARROW: Does anyone have different data?
MR. MAGUIRE: In C&I projects, capital costs for storage systems range from about $500,000 to $3 million, and we have to give a 10-year warranty. To qualify for incentives under California’s self-generation incentive program, every piece of gear needs a 10-year warranty.
We typically get a three-year warranty from the LGs and the Samsungs of the world, and an extended warranty can be purchased to cover a total of 10 years. The standard warranty is 10 years but, as Sam said, there is a cost to it.
MS. BARROW: In terms of cost, is it proportionately more expensive to extend the term beyond the 10-year standard? Would the additional cost of a 15-year warranty equal the cost of a 5-year warranty or does it not work like that?
MR. MAGUIRE: A warranty is provided with a design target in mind. A 10-year warranty will not have a design target of 10 years because half of the batteries will need to be returned under warranty. The design target would have to be at least 14 or 15 years.
I would not give a 15-year warranty, and I do not think anybody in the space should give a 15-year warranty. It would require planning for replacements after 10 years. It is difficult to project ahead what prices will be at that time. Prices are coming down. It could be possible to replace the batteries for maybe 35% of what they cost now.
I think a 15-year warranty is a waste of money.
MR. MANSFIELD: You can get any warranty you want, but the caution I would give — particularly with a lithium product — is to look out for any caveats that give the supplier an out.
Financiers like longer warranties, but for a system integrator like us, longer warranties are not that useful.
MS. BARROW: Sam Jaffe, you work a lot with sizing storage systems to provide capacity under PPAs and other kinds of offtake agreements. How common is it for utility offtakers to allow a certain level of degradation in the required capacity over the term of the PPA?
MR. JAFFE: I have not seen that. A contract will require a certain amount of megawatts to be delivered, and the provider has a duty to provide that amount of megawatts. The system may need to be oversized.
MS. BARROW: We talked about how capacity degradation depends on how the battery is used. Is degradation linear over time assuming the use case does not change?
MR. JAFFE: No. Long-term battery testing data shows degradation is not linear. It tends to be stochastic, and it is hard to predict when a particular system will fail. Obviously if the permissible operating ranges are exceeded, then that will affect degradation, but you can still have unexpected outcomes. Anyone who has certain expectations and a high level of certainty regarding degradation may be surprised.
MS. BARROW: Ed Rossier, when you invest tax equity in residential rooftop or C&I solar paired with storage, what percentage of the portfolio do you allow to contain batteries, and has that percentage increased over time?
MR. ROSSIER: It was low to begin with but, yes, it has crept up over time. It depends on the developer and its balance sheet. Let’s say it is 5% of the portfolio. We rely on the developer to make us whole if there are any issues with performance.
MS. BARROW: Would you say 5% is in most cases where things are today?
MR. ROSSIER: I don’t want to be pinned down to a number, but 5% is a good target.
MR. MAGUIRE: With the change in time-of-use rates in California, a lot of developers and solar installers are now quoting energy storage in every deal.
Under Southern California Edison’s GS3 time-of-use rate, the energy charge during peak periods, which are from 4 to 9 p.m. or 5 to 8 p.m., are as high as 40¢ a kilowatt hour. Demand-charge management is popular, but with time-of-use rates, energy arbitrage is becoming a significant play. Energy storage will be combined with solar to shift output into the evening. This is maybe specific to California with the new time-of-use rates, but 100% of solar contractors are now offering battery storage.
MS. BARROW: One concept that often appears in offtake agreements and credit agreements is change-of-control restrictions. This means if the current owner of the project changes, there are pre-agreed requirements on who will be considered qualified or experienced enough to step in. For solar and wind projects, this could be expressed in terms of a number of megawatts the new owner must have had under operation or ownership in a recent number of years, say the past three years. Ed Rossier, what benchmarks are emerging for utility-scale storage? What would you consider to be a qualified or experienced owner or operator?
MR. ROSSIER: They are still evolving. The qualified transferee or replacement-manager concept is pretty well agreed to in solar, although it is still somewhat negotiated, but I do not think there is a standard yet for energy storage. The expectation is that some very large Fortune 500 company will step in as a new operator-owner. The reality will be something totally different when a deal breaks, but hopefully we are still a little ways off from crossing that bridge.
MS. BARROW: We are down to the last question. What is involved in decommissioning a battery storage facility and disposing of used cells, and what are the costs associated with it? Sam Jaffe?
MR. JAFFE: It differs by country. The European Union has specific regulations dealing with the obligations of the original buyer of the battery to ensure that there is some form of recycling.
However, we are not at the stage where recycling is very real in practice. When it does happen, it tends to be that the battery is burnt and the slag deposited in a recycling pit or landfill.
Disposal is a key potential liability at the end of the life of a battery. In fact, that liability is driving a lot of European carmakers to repurpose their electric vehicle battery packs into stationary storage. It is a way to fob off the obligation to the next guy, plus there is a cost-savings benefit by doing so.
That is the situation in Europe and China, too. I think it is inevitable that North America, or the US, will eventually have similar regulations.
MR. MAGUIRE: The car industry has had to deal with battery disposal before the power industry. A company in Los Angeles called “The Kinsbursky Brothers” specializes in recycling and repurposing electric vehicle batteries. All of the Toyota Prius batteries from all the junkyards go back to the dealers and are then transported down to a recycling facility. Toyota then de-manufacture the packs. It removes plastics and circuit boards to get to the battery itself — in the case of an electric vehicle, nickel metal hydride. Then it melts down the remaining battery and skims off different materials.
Many of the leftover materials have residual value. With lithium-ion batteries, the nickel manganese cobalt is a valuable material. There is less residual value in iron-phosphate batteries, but the disposal process is the same. They are routed back to approved recyclers, de-manufactured and the metals recovered.
MR. JAFFE: Just to be clear, nickel-metal-hydride batteries contain the element lanthanum and other precious metals. However, there is nothing of that degree of value in lithium-ion batteries, except for the cobalt. You can make a lot of money recycling a cell-phone battery, which is lithium cobalt oxide, because about 70% of that battery is cobalt. You cannot make a lot of money recycling nickel-manganese-cobalt batteries today.
MS. BARROW: So depending on the underlying chemical make-up of the battery, the residual product may either be valuable or a liability.
MR. JAFFE: Yes. It depends on the chemistry and also the development of new technologies for recycling, which will be critical for making the process work economically.