Italy’s third Capacity Market auction expected to open new opportunities for large-scale storage

The first two Italian Capacity Market auctions (with delivery in 2022 and 2023) have not met their targets. As a result, auctions cleared at maximum premiums. The third auction, which will take place next week, might hold positive news, as some improvements in the process emerged. 

Some improvements in the process should lead to higher participation, Aurora Energy Research’s Associate Michele Scolaro told pv magazine. For example, the exclusion of the environmental impact assessment, known as the VIA, from the requirements for new projects and a clearer definition of derating factors for different durations of storage that favors longer duration assets are likely to increase interest in the auctions.

Aurora expects larger participation of batteries driven by their increasingly attractive case. Another positive factor is that assets built for delivery in 2024 might already be allowed to participate in the Ancillary Services Market (MSD) from their first year of commissioning, capturing another crucial revenue stream. 

But there is a caveat.

“While these developments seem to point toward larger participation, the timeline of the general procedure was not favorable, especially for new entrants in the market. In particular, the time between auction and delivery (it is called T-4, but the delivery is in less than two years) might be prohibitive. Also the short time between the final discipline — published in November 2021 — and the auction — February 2022 — will prevent many players to participate with assets that would have made the auctions more competitive under a less tight timeline,” said Scolaro. All in all, he expects the third auction to be still more competitive than the first two.

Future Development: MSD

A complete reform of dispatch extending the participation to MSD to new technologies is expected in one to three years.

In general, timing will be crucial for the development of batteries. Scolaro explained that some of the services and locations with the highest value will be cannibalized quickly on the ancillary services market. 

“We expect less cannibalization on the day-ahead and intraday market due to the high RES penetration expected in the coming years that will increase price volatility. The ideal timeframe is to be one of the first assets to be there once batteries are allowed in the MSD, or to then wait for further decreases in the cost of the technology to capture the increase of volatility in the day-ahead/intraday.” 

Future Development: Retirement of Baseload Capacity

Mentioning Enel’s project in Priolo, Sicily, Scolaro suggested that several batteries should already be built in 2024/2025. The key development supporting the case for batteries is the retirement of baseload capacities. 

“Sardinia is very interesting, as the two coal plants, Fiume Santo and Sulcis, will be phased out, leaving a big gap on MSD. The target was to close both in 2025 but it will not be feasible before the Tyrrhenian Link; 2028/2030 is more likely for Fiume Santo. Capturing the gap left behind by coal will be a crucial value driver for battery investments in Sardinia.” 

Currently, there seems to be some interest in the conversion of the coal plant into a gas-powered plant in Fiume Santo. “Its potential realization is closely linked to the methanization of the island that is currently not reached by natural gas,” Scolaro stressed. 

Competition between renewables and gas is indeed set to remain, but the retirement of baseload capacity will most likely open the doors to both investments. 

In the Apulia region, Enel is planning to convert to gas the large coal plant in Brindisi Sud, to be closed by 2025. This currently covers the majority of MSD volumes. Also in Sicily, the phase-out of A2A’s oil plant in San Filippo del Mela is expected in the coming years. The plant currently provides large volumes on the MSD.

For the third auction round, Sardinia is divided into two sub-zones, North and South, to reflect that capacity is needed in both parts of the islands to compensate for coal closures (one plant in the north, the other one in the south) and poor intra-zonal interconnection. “We expect a higher concentration of battery deployment in Southern Italy and the islands.”

Future Development: Future High Volatility

Scolaro explains that, while the current volatility is the result of a shock that we expect to normalize in a couple of years, the high volatility expected in the 2030s is driven by fundamentals, such as more RES and the retirement of baseload capacities. 

“This means that we expect it to remain for a longer period of time. So while single-year revenues might be even higher now than what we expect in the 2030s, these revenues will only be achievable for only a fraction of the battery lifetime, typically around 15 years. In addition to that, the cost of the technology now is much higher than what we expect in the 2030s.”

The general point is that shocks that lead to higher volatility in energy prices make the case for batteries stronger. 

“The current spike of gas and carbon prices led to record-high absolute levels of prices and volatility. The average daily spread was on average €114/MWh in January 2022. These levels are already above what would make the investment in a battery profitable, of course assuming it can capture them for the entire lifetime,” Scolaro said, adding that Aurora expects gas prices to normalize in the medium term. High volatility decreases the need for batteries to resort to revenues from the Capacity Market and the Ancillary Services Market. 

Future Development: Gas, Lithium Prices

“Assuming even higher gas prices than today, and assuming they will remain at those levels for several years, the case for batteries will be even stronger: under that scenario, the limiting factor would not be the economics of the project but simply the speed at which developers can build projects.”

On the other hand, the risk for battery developers due to uncertainties around lithium’s supply is more related to delayed deliveries and shortages rather than battery prices. 

“Battery developers would usually sign contracts with battery producers one to two years before delivery for a fixed price, which would protect them from the price volatility of components. From the manufactures’ perspective, the volatility of components might instead lead to heavy losses on the contracted orders with potential for further reduction of supply capacity and most importantly delays in case of shortages of components.”

Scolaro explained that shortages and delayed deliveries would be detrimental for battery developers: they could, for example, lose a Capacity Market contract in case they are not able to bring the plant in operation within the required timeline. Prices could also be a key element.