Net Zero and Digitalisation
18 November 2021
Data-focused business models and a “digital first” approach are now recognised by the UK Government, regulators and market participants alike as the key to coordinating, modernising and decarbonising an evermore complex energy system.
As a result, investment in the underlying digital solutions and smart infrastructure is not just increasingly attractive: it is imperative. The UK Government’s energy digitalisation strategy stresses that every part of the energy system still needs to be digitalised – demand, supply, markets and networks – thus creating investment opportunities at every step of the energy life cycle.
Here we set out the key legal issues when investing, and protecting that investment, in two commonly targeted digital solutions – power storage and trading, and smart metering.
The Key Challenge
The top-down model of centralised power production for passive consumers is being rapidly replaced. Energy systems are becoming more disparate, volatile, and must balance the ongoing transition to renewable (and intermittent) power inputs with increasingly active and flexible consumers who are discovering the energy-as-a-service industry (and, in particular, their ability to export power back to the grid). Integrating these new models, engaging consumers and achieving the wider electrification of the economy, all in the drive toward net zero, requires something that we currently do not yet have – a fully digitalised energy system.
Power as an asset
Data-driven grid flexibility services and the underlying power trading help provide the balance the electricity system requires. Energy storage is an increasingly important part of this.
The primary concerns for storage asset owners are (i) the optimisation of those assets once purchased or constructed, and (ii) maximising the revenue streams that can be established out of the power they hold. In the case of the latter, asset owners often employ digital platform providers to trade the power on wholesale markets using AI-driven algorithms, who pass the income obtained through revenue stacking back to the asset owners, minus trading commission .
When structuring these arrangements with service providers, and in order to maximise their return on investment, asset owners will need to consider the following:
| Revenue Issues |
Different markets offer different cash settlement periods, so any energy trading agreement must include reconciliation mechanisms, clarify when revenue is deemed cash-settled, and clearly structure how the service provider receives commission from the revenue achieved by trading the asset. |
| Costs |
When defining revenue, the parties must clearly allocate liability for trading costs, including costs in respect of transmission, distribution, wholesale taxes, costs to charge the asset, aggregator and intermediary fees, and any collateral cover posted with trading parties. |
| Asset Sale |
Providers often want their trading services to "stick" to the asset, and so may require the novation of the trading services contract to any party which purchases the asset as a condition precedent to the sale. Failure to successfully novate the trading services may result in the owner having to pay an early termination fee. |
| Performance |
As the market for trading services develops, asset owners are increasingly looking to include review provisions, whereby they can benchmark the provider's performance against its competitors, with the ultimate sanction for non-competitive performance being an early withdrawal by the owner. |
| Other Contracts |
Asset owners must align the trading services with their other contractual relationships, such as those dealing with grid connections or asset maintenance, and ensure the service provider's services do not put the owner in breach of these other contracts. Where a service provider offers SVA (supplier volume allocation) only, the asset owner will likely be required to agree to multiple additional terms, flowed down from the relevant supplier, to ensure that the asset owner transfers ownership of the power exported from the asset, and associated benefits, to that supplier. |
| Maintenance and Operations |
Service providers require asset owners to maintain the assets (generally pursuant to O&M contracts), to ensure enough capacity is always available for trading. Asset owners should however set out clear parameters within which the service provider can utilise their assets to trade capacity. This is to ensure providers do not cause the assets to run too “hot”, potentially invalidating the owner’s warranties with asset manufacturers, or limiting the recourse available under the O&M contracts. |
| Data | The asset performance and trading data is valuable, and so its ownership and permitted use should be made clear between the parties. |
| Agency |
Asset owners may need to delegate certain authorities to service providers which act as trading agents, to allow them to enter trading agreements on behalf of the asset owner. That being the case, a power of attorney is often required between the parties. The asset owner needs to ensure that the terms of that power of attorney are carefully crafted to provide appropriate guard rails around the scope of the service provider’s agency. |
| SaaS |
The above considerations are particularly relevant for a fully managed trading service, however service providers are beginning to offer access to their trading platforms through software-as-a-service business models. Additional consideration should be given to the standard SaaS issues (such as availability and support), together with consideration of the above issues through a SaaS lens, where the provider is not conducting the trading itself. |
Smart meters and consumers
Engaging consumers and deploying their collective decarbonising effect is vital to achieving net-zero. The data collected by smart meters allows consumers to visualise and reduce their energy use, allows for smarter grids, and enables new digital offerings through which consumers can interact with the market.
The smart meter rollout programme is more than five years old and was originally due to be completed by 2020. However, delays to the programme and the scale of capital outlay required have meant that rollout is still yet to touch millions of energy consumers in the UK. The investment gap, coupled with the appeal of stable, long-term revenues and low-risk maintenance obligations enjoyed by smart meter owners (known as “meter asset providers”, or “MAPs”) from meters installed with energy consumers have together meant that the market for ownership of MAP companies has seen refreshed interest from infrastructure funds and private equity over the past couple of years.
When considering investing in MAPs, there are key risks impacting meter portfolios which potential purchasers must investigate carefully through due diligence. In particular:
- Technical obsolescence: the pace of technological change will inevitably mean that smart meters become dated, and may no longer communicate or function as intended as we move away from existing technology like 2G and 3G. The potential move from natural gas to hydrogen as a mainstream energy source could also render installed gas smart meters obsolete. It is therefore key to assess the level of protection that a MAP enjoys in respect of potential obsolescence events (and attendant replacement/refreshment obligations). If the MAP’s exposure to such risks has been structured appropriately, then rather than a potential impediment to investment, technical obsolescence could represent a substantial revenue opportunity for the MAP.
- Change in law: a change in law, including to the standard meter specifications SMETS1 and SMETS2 or the Smart Energy Code, could result in large groups of smart meters becoming non-compliant. Investors should assess where the liability sits for ensuring compliance, as between energy suppliers, MAPs, and meter manufacturers. A change in law can also result in multiple additional costs including the cost of upgrades, removal programmes, additional manufacturer and installation costs, and removal charges. Where a change in law results in a decreased life period for a meter portfolio, it will be important to assess how lost rental payments are accounted for.
- Warranty protection: investors should ensure they attain visibility of how warranty coverage is flowed through from manufacturers to energy suppliers, via the MAPs. MAPs are essentially funding middle-men in a smart meter rollout, and as such should attract minimal exposure in respect of the relationship between meter manufacturers and their ultimate customers – the energy suppliers. Often the MAPs do not offer warranties which are backed off with manufacturers, and instead assign their rights to claims and compensation with manufacturers to the energy suppliers, or offer confirmation that manufacturers have given indemnities capable of assignment to the energy suppliers. Investors should track the warranty coverage through to the manufacturers where possible to understand what recourse is available to energy suppliers, what MAPs are required to do to facilitate any claims, and for how long that coverage lasts.
Key takeaway
Opportunities to invest in the growing importance of digital technologies in the UK energy system will continue to emerge. When capitalising on these opportunities, investors need to account for new asset classes and new provider relationships, and take note of the pace of technological change, as well as legislative updates to accommodate them. Deploying strong legal protection is key to protecting such investments in a rapidly changing industry.
Authors: Adam Eskdale and Christopher Bates
