Can microgrids help to meet rising US energy demand?

Neha Jatar is a managing director in EQT’s Infrastructure fund, having joined EQT in 2018. Neha co-leads the transportation and logistics sector and has led investments in Osmose Utilities Services, a leading provider of asset health services for utilities and telecoms in North America, First Student, the largest provider of student transportation to school districts across North America, and most recently, Scale Microgrids, a developer, owner, and operator of microgrids and advanced distributed energy resources in the US.

The mismatch between power demand and supply due to rapid load growth, the large-scale integration of renewables, and extreme weather events is putting a strain on ageing grid and transmission and distribution (T&D) system. This increased pressure is limiting access to power for critical assets, increasing outages, and driving higher and more volatile power prices in many regions across the US. Microgrids have emerged as a key solution to these challenges.

What is a microgrid?  

A microgrid is a local electrical grid consisting of multiple generation technologies controlled by a single entity able to operate in parallel with the grid or in island mode (separate from the grid). In contrast to alternative technologies – single-technology distributed energy resources (DERs) or a generator set – microgrids address several grid challenges. Microgrids provide resiliency via islanding, increased speed-to-market through quicker access to power than via utilities (particularly helpful for customers with high value of lost load), and cost savings and predictability compared to grid power through load optimisation (e.g. peak shaving). 

This is achieved through advanced software and hardware that enable real-time monitoring and controls, enabling coordination across numerous DERs and co-optimisation of multiple revenue streams. As a result of their ability to meet multiple customer needs across energy independence, cost savings, and sustainability, microgrids have broad applications across a range of commercial and industrial (C&I) sites, fleets, data centres, and other critical infrastructure including hospitals, universities, and communities. 

Microgrid deployments generate more than 90% of their revenue under MSAs, or take-or-pay structures that are fixed-price, fixed-volume, long-term contracts, with renewal terms of upwards of five years and that are supported by an average useful life of up to 40 years. In the future, as market mechanisms evolve, up to around 5% of revenue is expected to be uncontracted, generated through ancillary services like voltage regulation and frequency stabilisation. These services will contribute to overall grid stability and generate demand response and virtual power plant revenue streams with prices set by daily market levels and volumes dependent on daily trading.

A growing sector sparks investor interest

The deployed market for microgrids is expected to grow by more than 20% per annum to around 65GW over the next ten years relative to approximately 1,250GW of expected load demand, with over 50% of overall growth driven by data centres (AI and advanced computing needs) and electric vehicles (both commercial and consumer). Overall, the addressable market for microgrids is at an inflection point caused by extreme load growth (over 3% per annum). This is increasingly resulting in higher power prices in the form of both T&D charges and retail energy prices, an inability to access power for new deployments (most acute for new data centres, as seen with five-to-seven-year interconnection queues in key regions), and increased resiliency needs due to grid outages. 

In addition, a continued improvement in the unit economics of microgrids – resulting from lower capex costs, increased customer education, corporate decarbonisation goals, and legacy resiliency solutions (such as diesel gensets) reaching the end of their useful lives – will continue to make microgrids more broadly investable and will spur penetration over the next decade. 

The competitive landscape for pure-play microgrid providers is fluid and still emerging with several players offering more than one type of DER solution. Today, providers across the microgrid and distributed energy resource landscape include Scale Microgrids, Enchanted Rock, PowerSecure, AlphaStruxure, and Greenscape, in addition to broader energy services businesses such as Engie and Ameresco. Other notable providers of single-technology DERs and community solar projects include Altus Power, Standard Solar, Luminace, Catalyze, and Madison Energy Partners. While the market is fragmented, those with an established track record of modular, reliable deployments, financing and structuring experience, and speed of delivery through control of the value chain have a distinct competitive advantage. 

Software is also critical to adding value across the customer lifecycle, particularly in optimising the development process around a unique customer value proposition, thereby reducing customer acquisition costs through advanced scenario modelling. However, true technology differentiation is limited today, with providers using a mix of custom and third-party applications. As the market matures, differentiation through investment in areas such as dispatch optimisation, grid services participation, remote asset management, and predictive maintenance will become increasingly important. 

There is significant interest in microgrids from private capital, owing to the strong investment characteristics of microgrids and advanced distributed energy resources, the high barriers to entry from long-term, contracted assets and an early-mover advantage, and recurring and protected cash flows with little exposure to merchant trading revenues.

Notable recent transactions include EQT’s acquisition of Scale Microgrids. The deal adds to EQT’s portfolio of distributed energy resource providers in the US, which includes Madison Energy Partners. Basalt Infrastructure’s acquisition of AEP Onsite, Arclight’s carve-out of Duke’s C&I solar and fuel cell business, and Brookfield’s acquisition of Standard Solar are other notable examples. The transaction value and multiple attributed to a given pipeline/platform is driven by quality of the operating assets, pipeline, and execution capabilities, with platforms with a strong pipeline and team in place to execute generally trading at a premium.

Obstacles to microgrid development

Challenges facing microgrids and other distributed energy platforms include competitive and evolving markets, high customer acquisition costs and long sales cycles, and delays in development and construction timelines. There is also some degree of market price and performance risk. Here, the quality of a developer’s pipeline – driven by sourcing channels and the scalability of the origination and development process – and end-to-end capabilities across the project lifecycle, often underpinned by in-house software, play a key role in mitigating risk. 

More critically, the evolution of federal and state policy under a new administration will heavily shape customer adoption of microgrids by dictating the pace and profitability of deployments. As a result, there has been much debate about the likelihood of potential increases in tariffs on key project equipment manufactured in China and a potential repeal of investment tax credits or IRA provisions. 

The resulting impact on unit economics from potential increases in tariffs will depend on a developer’s unique mix of technologies, procurement strategy, and ability to pass through cost increases in pricing. Ultimately, higher tariffs on Chinese imports (such as tariffs of over 60% contemplated on battery cells) would make Chinese products more expensive and incentivise US manufacturing in the medium-term. This would normalise prices, with announced plans from Fluence, Canadian Solar, and others to build domestic plants. 

Although a full repeal of the IRA is viewed as unlikely with investment tax credits having endured terms of congressional control from both parties, a repeal would have sweeping implications for the US power grid, increasing retail electricity costs, delaying decarbonisation goals, exacerbating energy supply shortages, and reducing grid reliability. While configurations of microgrids would likely shift towards fewer renewables in the near-term, the underlying drivers of deployment would strengthen, and adaptable developers utilising diverse generation technologies are best positioned to navigate regulatory risks and sustain growth.

The future of microgrids in the US

Microgrids are transforming the energy landscape in the US, offering a pathway to greater resilience, access to power, sustainability, and cost savings relative to unprecedented load growth. While challenges remain, continued technological advancements, supportive policies, and an increasingly educated customer base will continue to drive adoption over the next decade. 

Ultimately, there will be value in scaled players that aggregate flexible DERs, with the future state potentially entailing their use as grid-firming resources through direct capacity agreements with utilities and municipalities, unlocking virtual power plant revenues. Microgrids are set to play a pivotal role in helping the US to confront the dual imperatives of climate change and infrastructure modernisation.