How Battery Swaps Unlock Finance - Miranda Energy

Ed Porter (0:00)

I'm your host, Ed Porter. Welcome back to Transmission.

Over 200 megawatts of battery exposure across Europe, yet Miranda Energy doesn't own a single battery. What it owns is the volatility. This story starts with a problem. Chris owns solar farms that have been losing value as midday prices fall. Building a battery next to them would have taken years. Buying a battery's earnings through a contract was faster.

Here, he's bringing exposure to battery returns and volatility. That sounds like a good solution, but the devil is in the detail. For the battery owner, what happens when the asset goes offline, you still pay out the battery's returns. And will lenders finance against these contracts? What length of contract is sensible? Chris Kennedy is the founder of Miranda Energy. He's writing 10 year swaps in markets big trading houses haven't reached yet. He's also expecting that the market has underpriced volatility. If this episode gets you excited about the world of swaps and options, check out the recent SSE StackGraph swap deal struck on the Modo Energy Index, extra transmission episode to follow, or ask Ko, our AI energy analyst, how these swaps work in practice. Let's jump in.

Hello Chris, and welcome to Transmission.

Chris Kennedy (1:21)

Thanks for having me.

Ed Porter (1:22)

Our pleasure. And as ever, we're gonna get straight into it. So, what is one thing that people get wrong about their head swaps?

Chris Kennedy (1:29)

Basis risk.

Okay. And for the listeners who don't know exactly what basis risk is, is the difference between what the actual battery produces and then what is owed under the darehead swap. And I think part of the problem with the problem, part of the problem with the problem of the basis risk is I think it's misunderstood in two dimensions. One, and again, we're recording this now today in Berlin, Energy Storage Summit, and about two hours ago, your colleague very graciously and definitively explained why ancillary services are asymptotically approaching some terminal value, and they will be coming less of an important element on the full revenue stack. So I think the first point is the basis risk about the differential between what the battery produces and what is owed under the darehead swap can become mitigated simply by the fact that that will be the revenue stack. And I think the second thing is really the darehead swap is evolving over time, and in its simplest form, it's nothing other than one party pays fix, another party pays the top minus the bottom of the darehead auction. And that's its simplest form. But another way to mitigate the basis risk between what the battery owes, and what the battery produces, and what's owed under the swap, is then to calibrate the swap with some kind of asset linked profile. And what we're doing now with clients, and we've seen this really evolve over the past couple of months, is move away from just give me the top minus the bottom, but rather give me the top minus the bottom, but let's add in an RTE function.

Or give me the top minus the bottom RTE plus some kind of degradation schedule.

Ed Porter (3:25)

An RTE being Brown-Troop Efficiency, so you're trying to account for the energy lost in the battery.

Chris Kennedy (3:30)

Correct. And we can take that as a formulaic way of, it is a number and it's easy to incorporate that into the swap formula. But here I think is really the real secret sauce are two things.

And again, we were talking about an hour ago to a lender, and that lender was saying, well, we don't finance against day-ahead swaps because the owner of the battery has potential unlimited liability under the swap. And again, also for the listeners to make it simple, if I'm paying a fixed price and they're paying me the top minus the bottom, well, the top minus the bottom could theoretically be infinite, so that could lead to unlimited liability and banks don't like that.

Ed Porter (4:14)

And it should work out nicely, right? So the idea of selling away the floating should be nice because they should be exposed to the floating because the battery should buy at the bottom and sell at the top. And so the battery should receive in the floating amount and then out to whoever wants to buy the floating, it should be able to pay that out. But then the risk is that you kind of sign this contract, right? And you're responsible for selling the floating and you hope that you have an asset that's generating this floating element. But if your asset's offline or the grid connection is out, then I think that's where sort of the finances get a bit nervous, right?