What are Tolling Agreements for BESS? Achieving Project Bankability and Securing Merchant Upside via LAYR

Mode: The asset receives the market price based on the performance of the trader.

Main benefits: Higher returns can be achieved during favourable market conditions.

Main Risks: Market risk - returns can be less favourable than expected or diminish over time. Performance risk - optimizer can underperform.

Mode: The asset receives a fixed income and has no exposure to market volatility.

Main benefits: The asset receives a fixed income and has no exposure to market volatility. Stable, planable, secured cash flow that enables project finance.

Main Risks: Counterparty (credit) risk, opportunity losses in favourable market conditions, contractual obligations in tolling contract.

Mode: A % share of the asset is tolled, the remaining asset receives the market price.

Main benefits: A stable cash flow that allows a higher loan-to-cost ratio while keeping some of the upside for higher equity returns in favourable market conditions.

Main Risks: Substantially the same risks as for fully merchant and fully tolled, but to a lesser degree.

Mode: The asset receives the market price with a discount in exchange for a minimum payment in case the market price drops below the floor.

Main benefits: Downside protection for market periods with low returns, participation in high market prices (albeit with a discount), might enable project finance (if the floor level is high enough).

Main Risks: Sacrificing upside in return for a the downside hedge, counterparty (credit) risk, Performance risk: trader can underperform, Market risk: only extreme downside is protected.

For lenders, financing BESS assets can be challenging compared to other asset classes, due to the volatile nature of the expected returns, i.e. the market risk associated with BESS revenues. While a few banks are comfortable financing smaller BESS assets with fully merchant revenues, the depth of the financing market for assets exposed to merchant risk is limited, as is the typically achievable loan-to-cost ratio. We've observed that many banks are now hesitant to finance BESS assets without at least 50% of their revenues secured through a bankable tolling agreement, or charge high interest premiums or offer very low loan-to-cost ratios. Therefore, securing cash flows through a tool such as tolling becomes increasingly relevant given increasing project- and portfolio sizes and corresponding capital needs.

Why is this the case? 

1. Market Volatility: Electricity markets are highly volatile. While BESS assets are uniquely positioned to profit from this volatility, it's impossible to predict with certainty what market conditions, and therefore BESS revenues, will look like in the long term over the asset life time. This uncertainty makes it difficult for lenders to project future cash flows.
2. Performance Risk: BESS assets are an active asset class, meaning their revenues depend on skilled commercial management. A poor operational strategy can lead to underperformance. For a lender, this introduces significant risk, as the project’s ability to service its debt relies directly on the performance of the Optimizer.
3. Nascent Asset Class: Compared to mature asset classes like real estate, BESS is still a relatively new asset in the German and European markets. The limited availability of historical data and long-term performance track records makes lenders and investors naturally cautious.

Lenders are primarily concerned with getting their principal and interest back. Predictable, long-term cash flows increase their trust in the project's ability to cover the debt service for the loan's tenure. This is where a tolling agreement becomes essential for bankability.

Why aren't there more BESS Tolling Agreements in the Market?

By now the relevance and positive impact of tolling agreements on BESS projects are clear. Nevertheless, according to Aurora, there have only been 6 tolling agreements in Germany, half of which have been signed by terralayr.

💡 To close these agreements terralayr and our contract partners had to overcome many of the complexities typically associated with BESS tolling contracts:

1. Bespoke Nature: Tolling agreements are typically bespoke, long-term contracts (often 5+ years). Without a "market standard," tenders can become overly complex, and negotiations can drag on. Offers often come in different formats, making them difficult to compare.
2. Long-Term Risk Mitigation: The long duration of these contracts means they must account for numerous "known unknowns," and "unknown unknowns," and fairly distribute them between the asset owner and the toller. This can lead to lengthy discussions on clauses related to things like Redispatch or "Change-in-Law."
3. Project Finance Requirements: Since tolling agreements are often used to secure project financing, the requirements of lenders must be incorporated into the contract. This adds another layer of complexity on top of the needs of the asset owner and the toller.
4. Commercial Gap: Asset owners often benchmark against merchant revenue predictions or historical performance, while tolling prices must account for uncertainty and long-term risk. This often leads to a commercial gap that needs to be overcome during negotiations.