What role does market power play in the incentives for energy storage investment

Market power plays a significant role in shaping the incentives for energy storage investment through its impact on the structure and dynamics of electricity markets and the revenue streams available to storage operators.

Influence of Market Power on Revenue Streams and Incentives

1. Capacity Markets and Capacity Payments:
   In markets where capacity payments or similar regulated incentives exist, these mechanisms often serve as a major revenue component for energy storage. Capacity payments remunerate storage providers based on the amount of installed capacity they offer to ensure system reliability. The presence and design of these markets are influenced by market power dynamics, as system operators seek to balance supply adequacy and market competitiveness. In some geographies, capacity payments can cover 20-30% of storage revenue, and in cases with infrastructure-like schemes (e.g., Italy’s MACSE auctions), they can nearly cover 100% of revenues, reducing merchant risk and making investments more attractive.
2. Market Structure and Merchant Revenue Potential:
   Market power can affect prices and volatility in wholesale electricity markets, directly impacting the merchant revenue potential of storage assets. In more competitive markets with less concentration, prices can better reflect supply-demand fluctuations, creating arbitrage opportunities for storage through energy time-shifting and participation in ancillary services. Conversely, in markets with high market power concentration, dominant players may suppress price volatility, reducing these arbitrage opportunities and thus lowering the financial incentives for storage investments.
3. Regulatory and Policy Incentives Interacting with Market Power:
   To mitigate market power concerns and enhance storage investment incentives, policymakers design complementary policies such as investment tax credits (ITC), manufacturing credits, and demand response programs that provide financial benefits independent of wholesale market outcomes. For example, the U.S. Inflation Reduction Act extends a 30% ITC to standalone battery storage, enabling more predictable returns and reducing investment risk even where market power might limit merchant revenue streams.
4. Market Participation Models Influenced by Market Power:
   Storage operators may also participate in demand response programs and virtual power plants (VPPs), where they aggregate distributed storage to provide grid services. These programs can offer additional, stable revenues that hedge against the uncertainty caused by market power dynamics in wholesale markets, further incentivizing storage investments.

Summary

Market power affects energy storage investment incentives primarily by influencing the price formation and volatility in electricity markets, which determines merchant revenue potential. Capacity markets and regulated incentives created to secure reliability also shape investment returns, often serving as critical revenue streams. To counterbalance the negative impact of market power on merchant opportunities, financial incentives such as tax credits and participation in demand response and VPP programs have become important. These layered incentives reduce investment risks and improve the economics of energy storage projects in markets subject to varying degrees of market power.

Thus, market power acts both as a challenge and a driver for tailored incentive structures that encourage energy storage investment by stabilizing and enhancing revenue opportunities across different market contexts.