Feed-in Tariff vs Tolling Agreements in U.S. Energy Storage

Introduction

The energy storage market in the United States is experiencing rapid growth, driven by the increasing adoption of renewable energy sources and the need for grid flexibility. As intermittent renewable generation from solar and wind farms continues to expand, energy storage systems, particularly battery energy storage systems (BESS), play a crucial role in balancing supply and demand, enhancing grid reliability, and enabling the integration of clean energy resources.

In this dynamic market, two key agreement structures have emerged: feed-in-tariffs (FITs) and energy storage tolling agreements. These agreements offer distinct approaches to incentivizing and monetizing energy storage assets, each with its own advantages and implications for project developers, investors, and utilities.

Feed-in-tariffs are government-backed policies that provide long-term contracts and guaranteed prices for renewable energy generators, including those paired with storage systems. These tariffs aim to accelerate the deployment of renewable energy by mitigating market price risks and encouraging technology cost reductions through economies of scale.

On the other hand, energy storage tolling agreements are private, bilateral contracts between storage asset owners and offtakers or optimizers. In these agreements, the asset owner provides storage capacity to the offtaker, who controls the charging and discharging of the system and receives the market revenues. The asset owner is compensated through fixed capacity payments and variable operation and maintenance fees, effectively shifting the merchant risk to the offtaker while retaining ownership of the asset.

Both feed-in-tariffs and tolling agreements play crucial roles in the energy storage sector, offering different mechanisms for financing, risk management, and revenue optimization. As the U.S. energy market continues to evolve, understanding the nuances of these agreements becomes increasingly important for stakeholders seeking to navigate the complexities of the energy storage landscape.

Feed-in-Tariff Agreements

Feed-in tariffs (FITs) are government-backed policies that offer long-term contracts and guaranteed prices for renewable energy generators to export electricity to the grid. These agreements typically span 10-25 years, providing price floors that are often set above market rates to incentivize investment in renewable projects, including those paired with energy storage systems.

FITs emerged in the early 2000s as a mechanism for countries to accelerate their transition to renewable energy sources and meet national clean energy targets. By eliminating merchant price risk through fixed, predetermined rates, FITs helped de-risk capital investments in solar, wind, and other renewable technologies during their earlier, more capital-intensive stages.

At their core, FIT programs feature a few key components: guaranteed payments per kilowatt-hour (kWh) of electricity exported to the grid, long-term contract durations to provide certainty, technology-specific tariff rates (with some explicitly rewarding hybrid renewable-plus-storage plants), and guaranteed grid access for eligible projects. Many schemes also include periodic degressions or step-downs in the tariff rates to encourage continued cost reductions as markets scale.

The primary benefits of FITs lie in their ability to rapidly deploy renewable energy capacity and drive down technology costs through market growth. By transferring the merchant risk from developers to ratepayers or governments, FITs create a stable investment environment that attracts project financing and lowers the cost of capital. This policy mechanism has proven effective in jumpstarting renewable energy adoption, particularly in nascent markets.

However, FITs have also faced criticism for their potential to overpay for renewable generation, burden ratepayers with above-market costs, and create market distortions or boom-and-bust cycles if not properly designed and managed. As such, many jurisdictions have transitioned from FITs to more competitive procurement models or hybrid incentives that combine fixed payments with exposure to wholesale market prices.

In the context of energy storage, FITs can be structured in several ways:

1. Direct FITs that include storage as an eligible technology, with specific tariff rates for storage projects or hybrid renewable-plus-storage plants.

2. Hybrid incentives that combine a FIT for the renewable generation component with separate upfront rebates or investment tax credits for the co-located storage system.

3. Time-of-use (TOU) adders or peak-pricing multipliers within the FIT structure, rewarding storage systems for discharging during high-value periods and improving grid reliability.

4. Feed-in Premium (FiP) models that provide a fixed premium on top of wholesale electricity prices, allowing storage to capture upside from price arbitrage while retaining partial revenue certainty.

Energy Storage Tolling Agreements

Tolling agreements have emerged as a key contracting mechanism for monetizing utility-scale battery energy storage systems (BESS) in the United States. At its core, a tolling agreement is a long-term contract where the owner of a BESS asset provides storage capacity to an offtaker or optimizer. The offtaker has the rights to control when the battery charges and discharges, as well as the ability to bid the asset's services into various energy markets.

The operational structure is designed to align incentives and leverage specialization. The BESS owner is responsible for development, construction, and maintenance of the asset, while the offtaker optimizes the battery's dispatch and market participation. This bifurcation allows each party to focus on their respective strengths—the owner on asset management and the offtaker on trading and portfolio optimization.

From a financial standpoint, tolling agreements provide bankable revenue streams that facilitate project financing. The owner receives fixed monthly capacity payments, which provide a predictable base cash flow akin to a contracted revenue floor. There are also variable payments to cover the BESS's operating expenses, as well as potential performance bonuses or penalties based on metrics like roundtrip efficiency. Importantly, the offtaker retains any upside from energy sales and ancillary services revenues.

Compared to traditional power purchase agreements (PPAs) for energy generation, tolling deals shift more operational and market risk to the offtaker. With a PPA, the seller captures energy revenues while the buyer simply purchases electricity. Under a tolling agreement, the offtaker must supply the energy for charging the battery and is exposed to volatile wholesale pricing when discharging. However, this risk is balanced by the ability to dynamically optimize when to buy and sell energy/services based on market conditions.

Tolling agreements have become popular as they allow asset owners to secure reliable long-term income, offtakers to procure flexible capacity without owning the battery, and both parties to benefit from specialization in their core competencies. While deal terms are still evolving, tolling appears poised to become the predominant commercial structure for standalone BESS assets participating in U.S. wholesale electricity markets.

Comparative Analysis: Feed-in-Tariff vs. Tolling Agreements

Feed-in-tariffs (FITs) and energy storage tolling agreements represent two distinct approaches to facilitating investment and revenue generation in the energy storage sector. While both mechanisms aim to promote the adoption of energy storage technologies, they differ fundamentally in their structure, risk allocation, and impact on market dynamics.

Key Differences and Similarities

FITs are government-backed policies that provide long-term contracts and guaranteed, above-market prices for each kilowatt-hour (kWh) of electricity exported to the grid by renewable generators, including those paired with energy storage systems. In contrast, tolling agreements are private, bilateral contracts between a storage asset owner (the "toller") and an offtaker or optimizer, where the toller provides storage capacity in exchange for fixed and variable payments, while the offtaker controls the charging and discharging of the system.

FITs shift the market price risk to ratepayers or the government, offering a predictable revenue stream for project developers and investors. Tolling agreements, on the other hand, transfer the merchant risk to the offtaker or optimizer, who aims to maximize the value of the storage asset by optimizing its dispatch in response to market signals.

Impact on Market Volatility and Financial Security

FITs insulate renewable energy and storage projects from market volatility by providing a guaranteed, fixed price for the electricity generated or discharged. This price certainty enhances financial security for project developers and investors, enabling them to secure financing more easily and mitigate exposure to fluctuations in wholesale electricity prices.

Tolling agreements, in contrast, expose the offtaker or optimizer to market volatility, as their revenue is directly tied to the prevailing energy and ancillary service prices. However, the storage asset owner benefits from a predictable revenue stream through the fixed capacity payments and variable compensation components, which can facilitate project financing and provide a degree of financial security.

Role in Risk Management and Revenue Optimization

FITs are primarily designed to de-risk capital investment in renewable energy and storage projects, accelerate the achievement of renewable energy targets, and encourage technology cost reductions through market scale. They offer a straightforward risk management solution by eliminating merchant price risk for project developers and investors.

Tolling agreements, on the other hand, play a crucial role in revenue optimization for energy storage assets. By transferring dispatch control to specialized trading entities or load-serving entities, tolling agreements enable the dynamic optimization of storage assets in response to market signals, potentially maximizing their total system value and revenue potential. However, this approach also requires effective risk management strategies from the offtaker or optimizer to navigate market volatility and ensure profitability.

Both FITs and tolling agreements have their merits and drawbacks, and their suitability depends on the specific market conditions, regulatory environment, and investment objectives of the stakeholders involved. As the energy storage market continues to evolve, a combination of these mechanisms, along with other innovative financing structures, may be necessary to drive widespread adoption and unlock the full potential of energy storage technologies.

Market Trends and Future Outlook

The U.S. energy storage market is experiencing rapid growth driven by declining battery costs, increasing renewable energy penetration, and supportive policies and incentives. As renewable sources like solar and wind continue to expand, energy storage will play a crucial role in balancing intermittent supply and enabling a more resilient and flexible grid.

While feed-in tariffs (FITs) were instrumental in kick-starting renewable energy adoption in several states and municipalities, their use for energy storage has been limited. However, there is growing interest in implementing FIT-like programs specifically tailored to energy storage systems, particularly for behind-the-meter residential and commercial applications. These programs could provide long-term revenue certainty and accelerate the deployment of distributed energy resources.

In contrast, tolling agreements are gaining significant traction in the utility-scale energy storage segment. As merchant battery projects become more prevalent, tolling agreements offer a way to secure bankable revenue streams and shift market risk to experienced energy traders and utilities. Major players are actively pursuing tolling deals, and the contract durations are expected to extend beyond the current 2-7 year range as the market matures.

Regulatory changes will play a pivotal role in shaping the future landscape. The extension and potential expansion of the Investment Tax Credit (ITC) for energy storage could provide a substantial boost to the industry. Additionally, the Federal Energy Regulatory Commission (FERC) is actively working on removing barriers to energy storage participation in wholesale markets, which could unlock new revenue streams and enhance the economic viability of storage projects.

At the state level, revisions to net metering policies, the implementation of clean peak standards, and the introduction of performance-based incentives could drive increased adoption of energy storage, particularly when coupled with renewable generation. However, the pace and specifics of these regulatory changes will vary across different states and jurisdictions, creating a complex patchwork of opportunities and challenges for market participants.

Conclusion

As the energy storage market continues to mature, it is essential for stakeholders to carefully evaluate the suitability of these agreements based on their specific objectives, risk appetites, and market conditions. Feed-in-tariffs may be more suitable for early-stage markets or smaller-scale projects, while tolling agreements are gaining traction for utility-scale, front-of-meter battery energy storage systems in deregulated markets.

The strategic use of these agreements can play a pivotal role in unlocking the full potential of energy storage systems and accelerating the transition towards a more sustainable and resilient energy future. By leveraging the strengths of both approaches and combining them with other incentives and value streams, market participants can optimize revenue streams, manage risks effectively, and contribute to the overall growth and stability of the energy storage market.