The Inflation Reduction Act and Standalone Battery Tax Credits
In the interest of gaining insights on the effects of the storage + solar rule changes in the Inflation Reduction Act (IRA), Gridmatic evaluated revenue for existing co-located battery + solar systems in ERCOT in 2021.
We used Gridmatic’s backtesting methodology, as described in Gridmatic Storage Report and verified by DNV.
Storage + solar Investment Tax Credit before the Inflation Reduction Act
Before the Inflation Reduction Act (IRA), batteries had to be co-located with solar installations to qualify for the Investment Tax Credit (ITC). ITC rules required the battery to charge when solar is producing and get at least 75% of their energy from solar to qualify for the ITC.
The pre-IRA rules posed challenges in sizing battery systems given that optimizing battery charging became unpredictable due to reliance on weather-driven solar output. For example, a battery co-located with a solar array that matches the array’s capacity could be less profitable than one that has half the solar array’s capacity, as shown in the example below.
The graph shows the cumulative $/MW storage profit for a battery system in ERCOT co-located with solar, operating with the objective of maximizing storage merchant revenue. This example illustrates a case where a smaller battery would have cumulative profit of $249,537/MW, outperforming a larger battery at $237,536/MW. The profits are shown with a red line (where the battery is half the size as the solar array) and a blue line (where the battery is the same size as the solar array).
Investment Tax Credit for standalone storage with the Inflation Reduction Act
With the IRA, batteries are now treated independently for tax purposes; they no longer have to be co-located with solar, and they have fewer operational constraints. Batteries can be operated as standalone systems without solar and still qualify for the ITC. The backtesting analysis shows the effects of operating in this fashion.
The graph below shows that cumulative profit for the same battery would have been $278,975/MW as illustrated by the yellow line, a 12% increase for a battery with half the capacity of the solar array, and 17% higher than a battery the same capacity as the solar array.
Sources of revenue
In addition to the impact on total revenue, the IRA rule changes will likely affect where revenue is derived, as illustrated in the graph below.
With the pre-IRA co-location rules, when storage capacity is the same as solar output, storage revenue is primarily and equally from RRS and RegUp, with both at 42%, while other market products play smaller roles – RegDown (10%), real-time energy (RT) (5%) and the ORDC adder (2%).
When battery capacity is half the size of solar with the previous co-location rules, the picture changes, and RegUp provides a greater portion of storage revenue at 46%, with RRS dropping to 35%. Other market products include RegDown (12%), RT (5%) and the ORDC adder (2%).
If the IRA rules had been in effect in 2021, results would have shifted further toward RegUp and RegDn. The main drivers of storage revenue in this scenario are still primarily RegUp at 38% and RRS at 34%, but other market products would have played a much bigger role, with RegDown at 20% and RT at 7%, while the ORDC adders would continue to be 2%.
One reason for this effect is that the standalone storage often performs RegDown at night, while the storage + solar could not perform as much RegDown at night because of charging limitations. Another difference is that storage + solar performs more RegUp during peak solar output hours than standalone storage because that’s when the system is least constrained and can seek the highest value product.
There are three key takeaways from this analysis in terms of impact on the storage industry in 2023 and beyond:
- There will be less financial incentive to co-locate batteries with solar, therefore more standalone batteries.
- Batteries co-located with solar will charge more frequently from the grid; hence, the mix of products they provide the grid will change.
- The capacity of batteries co-located with solar will be closer to the interconnection capacity of the grid at that location because their size won’t be constrained by solar production levels.