Published on
October 1, 2025
Unit Economics of Risk in Energy Storage Projects
Explore the key unit economics and technology risks affecting profitability in energy storage projects, from battery degradation to thermal issues.
Understanding the economics of energy storage projects boils down to analyzing unit costs and risks. These projects are evaluated based on metrics like cost per kilowatt-hour (kWh) and Levelized Cost of Storage (LCOS), which reveal the financial performance of storing and delivering energy. However, the profitability of such projects is heavily influenced by technology-specific risks like battery degradation, thermal issues, and technology obsolescence.
Key Insights:
- Battery Degradation: Lithium-ion batteries lose about 1.5% capacity annually during daily use. This impacts long-term costs and revenues.
- Thermal Challenges: Poor temperature management can shorten battery lifespan by up to 40% and increase safety risks.
- Technology Obsolescence: Rapid advancements can make older systems less reliable or cost-effective over a 15-20 year project life.
- Risk Modeling Tools: Monte Carlo simulations and reliability models help quantify how risks impact project returns.
Effective risk management strategies - like performance guarantees, warranties, and advanced financial modeling - are essential to ensure these projects remain profitable while attracting investors. By addressing risks early, developers can optimize costs and improve financial outcomes.
Main Technology Risks in Energy Storage
Energy storage systems come with a range of technology-specific risks that can significantly affect their financial outcomes. These risks, while varying across different battery types and technologies, share a common thread: they can drive up costs and reduce returns, ultimately impacting project valuations. Let’s take a closer look at how three major risks - battery degradation, thermal challenges, and technology obsolescence - affect the economics of energy storage.
Battery Degradation and Performance Loss
Battery degradation is a key factor that reduces usable capacity, limits power output, and increases safety concerns. Over time, this wear and tear can shorten a battery's lifespan or lead to expensive replacements.
The financial implications are hard to ignore. For instance, lithium-ion batteries typically degrade at a rate of about 1.5% annually when subjected to a daily full charge-discharge cycle. For energy storage projects designed to last 10 to 15 years, these losses can make up a significant portion of the total cost of ownership.
"The problem is that these decisions rarely account for battery degradation, which introduces a hidden cost that compounds over time."
- Laura Laringe, CEO and co-founder, reLi Energy GmbH
Degradation generally occurs in three stages: an initial rapid loss (around 5% capacity due to SEI formation), a long period of stability, and a sharp decline after about 12% capacity loss. The depth of each charge-discharge cycle also plays a critical role. Shallow cycles - say, 10% - can dramatically extend the number of cycles and energy throughput compared to deep cycles (100%), making operational strategies crucial for minimizing degradation.
One case study illustrates the financial impact clearly. By neglecting degradation, a project incurred costs of $30 and generated revenues of only $22, resulting in a net loss. However, when degradation was factored in, revenues dropped by 40%, but degradation-related costs fell by over 75%, turning a $7.70 loss into a $6.60 profit.
Thermal Management and Safety Issues
While degradation eats away at capacity and raises replacement expenses, temperature-related challenges introduce another layer of risk. Poor thermal management can compromise battery performance, shorten its lifespan, and, most alarmingly, create safety hazards - all of which can severely impact project economics.
For example, operating a battery outside its optimal temperature range (59°F to 95°F) can cut its lifespan by up to 40%. Even a slight temperature increase - just 1°C in the 86°F to 104°F range - can reduce battery life by two months. Maintaining a temperature difference of less than 9°F across the battery pack is critical to preventing hotspots and uneven aging.
"Effective temperature management is critical for the operation of lithium-ion batteries. These batteries are prone to thermal runaway, a dangerous condition where the battery's temperature increases uncontrollably, generating flammable gases such as hydrogen, propane, and butane."
- James Wheeler, CFEI, P.E., P.Eng, Principal Consultant, Envista Forensics
The consequences of poor thermal management are not just operational - they can be catastrophic. For instance, a solar farm battery fire in upstate New York caused $7 million in damages, and insurance claims related to such incidents have exceeded $10 billion. Additionally, strict safety measures, like physical spacing requirements, can lower energy density. Decommissioning a 10 MWh system alone can cost up to $2 million, with fire and explosion risks accounting for as much as 70% of those costs.
Technology Obsolescence Risk
Beyond physical and operational risks, outdated technology poses a significant threat to long-term project value. As technology evolves rapidly, older systems can become less effective - or even unsupported - over the typical 15- to 20-year lifespan of an energy storage project. This can impact both reliability and financial performance.
"Product obsolescence is unavoidable, particularly due to the swift advancements in technology and evolving customer demands."
- ScienceDirect
Older systems may struggle to meet current performance benchmarks, and outdated software can introduce cyber vulnerabilities or lead to unexpected outages. To address this, proactive lifecycle management, regular technology assessments, and maintaining strong vendor relationships are essential. By accounting for obsolescence in financial planning, investors can better prepare for necessary upgrades and stay competitive in a fast-changing market.
Measuring Risk Impact on Project Economics
Understanding the economic impact of technology risks requires more than just identifying potential issues like battery degradation or thermal management challenges. It demands precise tools to quantify how these risks affect project returns in dollar terms. By using advanced modeling techniques, investors and project developers can move beyond guesswork and make data-driven decisions. Let’s dive into some of the methods used to simulate and analyze these risks.
Monte Carlo Models for Battery Performance
Monte Carlo simulations are a powerful tool for generating long-term, probabilistic revenue estimates for battery energy storage system (BESS) investments. These simulations use probability distributions to map out potential outcomes for critical variables like degradation rates, efficiency losses, and performance metrics.
Take, for instance, a study conducted in April 2024 that analyzed a hypothetical 10 MW, 0.5-hour BESS in Taiwan's day-ahead frequency regulation market. Researchers used Monte Carlo simulations to evaluate risks tied to both market factors (such as price volatility and volume uncertainty) and technical issues (like equipment degradation and operational defects). For the conservative P90 scenario - where there’s a 90% chance of meeting or exceeding the forecasted return - the expected return was 8.65%, with a debt service coverage ratio of 1.189[1].
"To our knowledge, none of the literature to date has addressed the long-term risk perspective of BESS investment. This study aims to fill this gap by developing a long-term probabilistic revenue estimate that considers these risk factors using Monte Carlo simulations."
- IEEE Access
Monte Carlo’s strength lies in its ability to simulate thousands, even millions, of scenarios. This generates distributions for key financial metrics like Net Present Value (NPV) and Internal Rate of Return (IRR). For energy storage systems, battery degradation is a major concern. Lithium-ion batteries have a finite cycle life, and as they degrade, they may fail to meet performance standards, triggering financial penalties under pay-for-performance contracts. By defining parameter distributions, sampling values, and calculating financial outcomes, this model provides a comprehensive view of potential risks and rewards.
Sensitivity Analysis for Risk Variables
Sensitivity analysis is another critical method for evaluating risks. It isolates individual variables to determine which factors have the greatest impact on project economics. For example, studies consistently show that capital costs and electricity prices are key drivers of Levelized Cost of Storage (LCOS).
Global sensitivity analysis (GSA) goes a step further by examining how multiple variables interact. A study published in July 2025 analyzed a seasonal power-to-gas-to-power energy storage system and found that the temperatures of the combustion chamber and methanation reactor were the most influential factors affecting system efficiency and overall costs.
By identifying the variables that cause the largest fluctuations in project returns - whether it’s roundtrip efficiency, system lifespan, discount rates, or operational expenses - developers can focus their due diligence on the areas that matter most, improving both risk management and project planning.
Reliability Models for System Performance
Reliability modeling translates technical failure probabilities into financial insights, making it easier to understand how system breakdowns affect long-term project economics. One effective approach is the Universal Generating Function (UGF) method, which is particularly useful for analyzing multistate energy storage systems. Unlike binary models that classify systems as either operational or failed, UGF accounts for gradual degradation, offering a more nuanced view.
Markov models are another valuable tool, capturing the likelihood of transitions between different system states. For example, Sandia National Laboratories' Probabilistic Grid Reliability Analysis with Energy Storage Systems (ProGRESS) tool uses Markov Chain Monte Carlo simulations to evaluate resource adequacy over an entire year (8,760 hours). This approach incorporates charge-discharge cycles, state-of-charge updates, and failure-repair dynamics.
"The universal generating function (UGF) method is very effective for analyzing the reliability of multistate systems."
- IEEE Xplore
By accommodating gradual performance declines rather than sudden failures, these models help quantify system availability, performance levels, and maintenance requirements. When integrated into financial projections, they enable developers to calculate risk-adjusted returns that account for the full range of technical uncertainties over a typical 15- to 20-year project lifecycle.
At Phoenix Strategy Group, we leverage these advanced models to guide smarter investment decisions.
[1] IEEE Access, Techno-Economic Investment Risk Modeling of Battery Energy Storage Systems Participating in Day-Ahead Frequency Regulation Market, 2024.
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Financial Risk Management Methods
Energy storage projects come with unique technology challenges, making risk management tools critical for protecting investor returns and securing financing. Below, we’ll explore financial tools and contractual strategies designed to address these risks.
Insurance and Performance Guarantees
Performance guarantees are a cornerstone of managing technology risks. They shift responsibility away from project owners to equipment manufacturers and service providers, covering short-term defects and long-term degradation through well-structured warranties.
For instance, many lithium-ion battery manufacturers now provide End-of-Life State of Health (SoH) guarantees, ensuring that batteries retain 70-80% of their original capacity after 10 years. Some warranties are structured annually, setting limits on degradation rates, while others use penalty-based warranties that adjust coverage based on how the equipment is used.
"Performance guarantees and equipment warranties mitigate technology risks by shifting these risks away from the project company and to the technology vendors." - Morgan Lewis
Battery warranties often include strict operational conditions, such as limits on daily usage cycles, total energy throughput, average state of charge (typically below 50% annually), and C-rate restrictions. Violating these conditions can void warranties or accelerate wear and tear.
Thermal management is another critical focus. Warranties often require service providers to maintain stable battery temperatures, as high temperatures can significantly speed up capacity loss.
"Warranties are available from suppliers of batteries which guarantee their useable energy capacity (i.e. the SoH) for a defined period, typically up to ten years, based on defined usage parameters." - Hunton Andrews Kurth
Performance insurance offers an extra layer of protection, covering physical damage from extreme weather or other environmental factors. This is particularly important for limiting unexpected costs that can disrupt financial projections.
To ensure these guarantees are reliable, lenders often require backing from creditworthy counterparties. This may involve letters of credit or guarantees from parent companies, especially when dealing with suppliers with weaker financial standings.
Contract Risk Allocation
Contracts like Power Purchase Agreements (PPAs) and operational agreements play a key role in distributing risks among project participants. These agreements assign responsibilities based on each party’s ability to manage specific risks.
- Physical Toll agreements transfer market risks and price fluctuations to buyers, granting them full control over asset operations.
- Virtual Toll agreements allow buyers to decide charge and discharge schedules while paying fixed fees.
- Revenue Swap contracts strike a balance, where buyers pay set amounts and share market revenues.
"Offtake agreements are a key enabler for financing electricity infrastructure projects, including renewable energy and battery energy storage systems (BESSs). There are two reasons for this: Long lifespans... and High spot market volatility..." - CORE Markets
Hybrid renewable and storage projects often require even more intricate contract setups. For example, Physical Toll arrangements might cover the entire hybrid system under one contract, while Run of Meter plus Toll or Revenue Swap structures separate agreements for the renewable and storage components.
Operational and maintenance responsibilities also feature prominently in contract negotiations. These agreements clarify who handles tasks like warranty compliance tracking, firmware updates, staffing network operations centers, and optimizing performance. Such clarity helps lay the groundwork for creative financing solutions that lower project risks.
Financing Structures for Risk Reduction
Given the uncertainties tied to energy storage technology, innovative financing approaches are vital. These strategies complement other risk management tools to secure better returns while minimizing exposure.
- Portfolio financing pools multiple projects, spreading risks across them to offset potential losses from individual ventures.
- Merchant-tolerant debt accommodates projects reliant on volatile market revenues by using lower leverage and cash sweep mechanisms that adjust debt payments to actual performance.
- Sculpted debt repayment schedules align repayment obligations with anticipated battery degradation over time.
"Project finance is an exercise in risk allocation. Financings will not close until all risks have been catalogued and covered." - Norton Rose Fulbright
The Inflation Reduction Act of 2022 has introduced new opportunities, such as tax equity investments for standalone energy storage systems. By allowing tax credit transferability, developers can access liquidity sooner, easing financial pressure and reducing risks.
Government support programs are also stepping in. For example, the UK is developing frameworks for procuring "dynamic response services" from storage systems, while Greece and Italy are exploring regulated return mechanisms for energy storage projects. These initiatives aim to stabilize revenues and mitigate market risks.
Another approach, develop and flip strategies, enables developers to sell projects after the initial development phase. This allows them to recycle capital and transfer operational risks to buyers better equipped to handle them.
Since capital costs account for about 40% of energy storage project economics, fine-tuning financing structures is crucial. Effective risk management can lower technology-related financing costs by up to 25%, while neglecting these factors could drive costs up by over 115%.
At Phoenix Strategy Group, we specialize in helping energy storage developers navigate these complex financing arrangements. We evaluate the economic impact of various risk allocation strategies, ensuring projects are structured to achieve the best possible returns while keeping all stakeholders protected.
Key Takeaways for Energy Storage Investment
Main Lessons on Risk and Unit Economics
Understanding and quantifying technology-specific risks is essential for building accurate unit economics models and properly valuing energy storage projects. Over the past few years, the energy storage sector has seen significant advancements, including a dramatic decline in battery prices - some segments have experienced cost reductions of over 70%. These shifts have fundamentally reshaped how unit economics are calculated.
One striking indicator of progress is the 98% drop in the overall incident rate for Battery Energy Storage Systems (BESS) between 2018 and 2024. However, challenges remain - 72% of BESS failures still occur within the first two years of installation, making quality control during deployment a top priority. Manufacturing defects account for the majority of these issues, with 28% specifically tied to fire detection and suppression systems.
"The major result is that the perspectives of electricity storage systems from an economic viewpoint are highly dependent on the storage's operation time, the nature of the overall system, availability of other flexibility options, and sector coupling." - Reinhard Haas et al., Energy Economics Group, Vienna University Technology
Errors in estimating the state of charge - ranging from 10% to 30% - add considerable uncertainty to financial projections. Additionally, capital costs for storage systems can vary significantly based on operational hours. For instance, projects operating at 500 annual full-load hours can face costs up to four times higher than those running at 2,000 hours per year, making operational planning a critical factor for success.
The risk landscape also differs across storage technologies. Pumped hydro storage dominates, accounting for 97% of electricity storage in the EU, but its geographical constraints limit its scalability. Meanwhile, lithium-ion batteries, which make up 90% of large-scale battery storage capacity, face challenges related to resource availability, particularly lithium. These dynamics underscore the importance of integrating precise risk assessments into project models.
Practical Risk Management Steps
To address these risks, developers need to adopt specific strategies. For example, 73% of operations and maintenance (O&M) staff report encountering technical issues monthly, revealing a disconnect between technical performance and financial management.
Manufacturers typically offer 10-year warranties for batteries, but developers should also negotiate additional capacity guarantees to ensure long-term performance. Lithium-ion battery systems generally operate for 10-15 years before requiring major overhauls or replacement, making warranty management a key part of financial planning.
Pre-development technology screening is another essential step. Evaluating BESS chemistries, such as LFP versus NMC, based on site-specific conditions and market trends can help minimize future performance issues.
"Despite headlines generated by incidents like Moss Landing, the outlook for the BESS insurance market remains stable. New monitoring technologies, improved design standards, and evolving risk assessment methods are creating a more resilient power generation industry." - Geoffrey Lehv, SVP, kWh Analytics
Clear contractual agreements are critical. These should define EPC (Engineering, Procurement, and Construction) scopes, performance guarantees, and commissioning protocols, including Grid-Forming tests. O&M agreements should address key areas such as thermal management, availability targets, and spare parts planning. Equipment supply contracts should include independent third-party factory audits to verify both quality and ethical sourcing.
Physical and electrical separation between battery components and critical infrastructure, like transformers and substations, is crucial to minimize losses from events such as thermal runaway. Additionally, developers should avoid routing renewable energy output directly through BESS to prevent total revenue loss during battery outages.
Risk quantification tools, such as probabilistic modeling or Monte Carlo simulations, can help developers better understand uncertainties and craft effective mitigation strategies. Certifications like IECRE Project Certification can further reduce technical risks, making projects more attractive to financiers and potentially leading to better financing terms.
Phoenix Strategy Group supports developers by integrating risk quantification into unit economics for precise project valuations. Their financial modeling expertise ensures that technology-specific risks are accounted for, enabling more informed investment decisions and stronger financial outcomes.
FAQs
How do Monte Carlo simulations help evaluate risks in battery energy storage projects?
Monte Carlo simulations offer a practical way to assess risks in battery energy storage projects by accounting for uncertainties in performance, safety, and economic factors. By running thousands of iterations with different input variables, these simulations generate a spectrum of possible outcomes, giving a clearer picture of potential risks.
This method helps project developers and stakeholders make smarter decisions by showing the likelihood of various risk scenarios. It also aids in improving safety strategies and refining project valuations, ensuring that large-scale energy storage systems are managed with a focus on minimizing risks.
How does battery degradation affect the financial performance of energy storage projects?
Battery degradation plays a big role in shaping the financial outcomes of energy storage projects. As batteries age and their usable capacity drops, their efficiency takes a hit. This not only drives up maintenance costs but also cuts into overall profitability. Plus, frequent replacements due to degradation can lead to higher capital expenses, throwing off cash flow predictions and straining budgets.
To navigate these challenges, it's crucial to factor degradation into financial models. By including detailed forecasts, project developers can better anticipate risks and maintain financial stability, especially in the fast-changing U.S. energy storage market.
What strategies can help manage technology obsolescence and maintain the financial viability of energy storage projects over their 15-20 year lifespan?
Managing technology obsolescence in energy storage projects demands a forward-thinking strategy to secure financial stability over time. This involves a few key actions: routinely evaluating existing technologies, scheduling updates at regular intervals, and building solid relationships with vendors to keep pace with new advancements.
Another essential step is introducing a technology lifecycle management program. This program should factor in potential component replacements and system updates. Tackling these challenges early helps ensure projects remain efficient, avoid surprise expenses, and stay aligned with their financial and performance objectives.
