Role of Virtual Power Plants in Capacity Markets

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Role of Virtual Power Plants in Capacity Markets
Ankur Majumdar, Member, IEEE
International Energy Research Centre
Tyndall National Institute, Cork, Ireland
ankur.majumdar@ierc.ie
Shafi Khadem, Member, IEEE
International Energy Research Centre
Tyndall National Institute, Cork, Ireland
shafi.khadem@ierc.ie
Abstract – The steady increase of renewable penetration has
brought down the price of the wholesale electricity market.
However, due to the intermittent nature of the renewables, the
conventional generations are required to maintain flexibility in
times of scarcity. In order to resolving this reliability problem,
the independent system operator (ISO) plans in advance to
facilitate building new capacity in long-term through capacity
markets. The flexible conventional generations lack incentives to
maintain operation and build new generations due to low
revenue from the energy and ancillary services markets. This
paper proposes an idea to incorporate renewable generations in
the capacity markets within the virtual power plant model as
market units. The proposed idea increases the flexibility of
renewable generation output with and/or without energy storage
systems. Therefore, it will be particularly beneficial for ISO to
increase the renewable capacity in the generation mix.
Keywords – virtual power plant, renewables, capacity markets,
cost of new entry, energy storage system, demand response
I. INTRODUCTION
The modern electricity industry is faced with a trilemma
to provide electricity in a sustainable, secure and affordable
way. In order to achieving this, the EU has set a target of 27%
generation from renewables by 2030 [1]. With the increased
adoption of renewable energy, the wholesale electricity
market price has reduced substantially [2]. However, due to
intermittent nature of renewable resources, the flexibility of
electric power network in times of high peak demand is still
dependent on conventional generations. Therefore, the
flexible conventional generations, such as coal, gas are under-
utilised and faced with a challenge to recover their investment
and operational costs [2],[3]. Furthermore, with the increase
of demand in many countries, this creates an investment risk
in building new generations.
The electricity market operator (EMO) or the independent
system operator (ISO) takes resort of the capacity market
mechanism to solve this long-term resource adequacy
planning problem. There is a need for higher capacity
payments for flexible conventional generations. The advent
of renewables has thus, posed an uncertainty in the continued
revenue stream. Therefore, this asks for a thorough revision
of capacity market structure and remuneration mechanisms
[2]-[5].
Currently, the renewable generations, which receive out-
of-market subsidies such as, feed-in-tariff, contract for
difference (CfD) are mostly not considered in capacity
mechanism in many countries [6]. With the goal of meeting
the 2030 target, it is envisaged that the flexible renewables
with/without storage can participate in the capacity market
and therefore, increase its hosting capacity further.
The renewable generations are predominantly small-scale
and distributed energy resources (DER). In this scenario, the
virtual power plant (VPP) and energy storage systems (ESS)
will play a crucial role. The energy storage through energy
arbitrage and VPPs through higher availability index of
resources will mitigate the intermittency issues [7]. The
energy arbitrage is of particular importance in the context of
dynamic time-of-use (ToU) tariffs. The modern power
network, with VPP and smart grid infrastructure, will impart
a visibility to small players and the opportunity for active
network management.
Capacity/
Forwards/FTR
Day ahead
market
Intraday
market
Ancillary services
(AS)
market
Optimal
Dispatch
Years –
months
T-24
hours
T-1 hour
Mins –
seconds
Real
time
Financial markets
Ex-ante markets
Capacity/
Forwards/
FTR
This creates a motivation for decentralised renewable
resources to participate not only in the energy and ancillary
markets but also in the capacity market. Although there are
some recent research done on VPP control and architecture
[8]-[12], information on VPP participation in capacity market
is not available. The capacity mechanism provides a certainty
in revenues and incentive to invest in renewables and hence,
facilitate integration of cleaner generation technology. Fig. 1
shows the time frames for different types of electricity
markets to enable the continuous cash flow to the generators.
This paper presents the idea of incorporating renewables
in a VPP framework in the capacity market as a capacity
market unit (CMU). The paper is organised as follows.
Section II discusses the practices and challenges in the
capacity mechanisms. Section III proposes the idea and
Fig. 1. Electricity market time frames

impact of VPP as a player on the capacity market and the
transition to the integrated single electricity market. Section
IV concludes the paper.
II. CAPACITY MARKETS AND RENEWABLES
Mitigating the resource adequacy problem
Capacity is defined as the ability of a system to provide
energy or ancillary services to satisfy demand in times of
scarcity. The independent system operator (ISO) has the
responsibility to ensure resource/generation adequacy for the
reliability of the network. Given the increase in demand in
many countries, there is an increasing need to invest in new
generations. However, it is a matter of concern whether there
is enough incentive to invest in new generations or search for
alternatives. The most important problem that needs to be
addressed is the resource/generation adequacy problem [13].
A shortage of resources on any given day can result in
blackouts. Most power networks are equipped with spot
market and complementary reserve or ancillary market to
address the short-term adequacy. However, long-term
adequacy is tricky as new generations require time to be built
[14],[15].
Long-term adequacy or reliability is measured in terms of
loss of load expectation (LOLE). In the US markets, LOLE is
generally set to 1 event in 10 years for ensuring sufficient
reliability [16]. In GB and Ireland, the constraint is much
flexible, such as 3 and 8 hours in a year respectively [17],[18].
This creates the motivation to have a long-term electricity
capacity market which will provide solutions to generation
adequacy problem, inefficient pricing and market power in
times of scarcity. The participants in the capacity markets are
– generators, demand response, energy storages and energy
efficiency, interconnectors and renewables [19].
There are different types of capacity mechanisms in place
in different countries as shown in Fig. 2. Some have price
based scheme such as, capacity payment as in Ireland. Others
have volume-based schemes such as, capacity auction in UK,
capacity obligations in France, reliability options in Italy.
Germany however, has a target based mechanism known as
strategic reserves for capacity [21],[22]. The contracted
participants are not allowed to participate in the energy
market and are only activated in case of capacity shortfalls
[23].
Effect of renewable penetration
The European Commission has set target of 27% of
generation from renewables, 27% of energy savings from
business as usual (BaU) and 40% reduction of greenhouse gas
emission by 2030 [1]. Simultaneously, the European
parliament endeavours to achieve a pan-European internal
energy market to facilitate reduction of overall electricity
prices [24],[25].
When the capacity is adequate the market clearing price is
rather low as the generators bid according to their marginal
costs. As a result, the revenue earned from these markets is
not sufficient to cover the variable and fixed costs of
generation. This creates a ‘missing money’ problem.
Due to increasing renewable penetration, they are
gradually displacing conventional generation in bid-based
energy market. The increase in renewable dispatch reduces
the price of electricity in the wholesale market due to low or
zero marginal costs of renewable generations. However, the
inflexible renewables such as, wind, solar increase the price
volatility of the energy market [26]. As a result, conventional
generations are still required for flexibility due to intermittent
nature of renewables output. This increases wear and tear and
thus, maintenance costs of conventional generations.
Moreover, it entails start-up and shut-down costs on the
conventional generations. With the reduced capacity
utilization of conventional generation and increase in
flexibility costs makes the ‘missing money’ problem more
severe.
Moreover, in times of low demand and high renewable
generations, it may happen that the wholesale market is
cleared at a negative price. This creates a further loss of
revenue to the conventional generations. This has happened
quite a few times across Europe and for significant duration
in Germany during Christmas day last year [27].
In times of this transition, it is argued that there is a need
to provide incentives for conventional capacity to not exit the
market rather than incentives for new entry of conventional
Fig. 2. Capacity markets in Europe [20]

generations. Moreover, in order to ensure long-term resource
adequacy the excess generation capacity is still needed [28].
The policy makers will need to play an important role.
Lack of congestion pricing, transmission capacity and lack of
a proper reserve or ancillary services markets provide
inefficient and insufficient incentives for old and
conventional generations to stay in the market. Capacity
mechanisms across a country will make the countries more
equal. This defeats the purpose of market coupling and the
concept of a pan-European grid and integrated single
electricity market to bring down the overall electricity prices.
Hence, a proper and efficient design of capacity market is
needed to address this challenge.
However, there are many other challenges in
implementing a well-designed capacity market. These are
discussed in the following subsection.
Challenges
1) Lack of demand response: The electricity market is
characterised by supply demand equality, lack of storage,
high concentration ratio and lack of price elasticity of
demand. The inelasticity of demand arises due to lack of
demand flexibility or demand response. Most of the end
customers do not have access to smart meters and as a result
pay a fixed tariff. Hence, in times of scarcity, it is possible
that the market may not clear. However, with the advent of
smart grid and smart meters, the situation is changing. One
may argue that it may be cheaper and faster to install smart
meters and use dynamic pricing than implementing a capacity
market [5]. However, the uptake of real-time meters in
households is rather slow. Moreover, demand response will
not be able to solve the ‘missing money’ problem and the risk
of entry of new generations.
2) Market power in scarcity: The electricity market is
oligopolistic with a high concentration ratio. In times of
scarcity, the market price is high and in an efficient market,
the scarcity revenue should be sufficient to cover the fixed
and variable costs of generations. However, the generators
exercise extreme market power with bid mitigation and this
shoots up the scarcity price further. There are regulatory and
political measures in place, such as, price caps placed at value
of lost load (VoLL), calling on generators in out-of-market
contracts for reserves, to suppress the high scarcity prices
[29]. Hence, due to these market imperfections, there are not
enough price signals for the entry of new generations.
Moreover, price volatility arises due to inelastic and
volatile supply and demand. Although, the long-term
contracts hedge out this volatility to some extent, the
uncertainty is reflected in long-term prices as well. These
coupled with regulatory and political decisions, market power
and tendency to misinform or not inform the competing
generators, pose serious risks to the entry of new generations
[29].
3) Ancillary services market: It is argued that with
ancillary services market there is no requirement for a
separate capacity market [30]. Generators and demands
provide a part of their capacity as spinning or supplemental
reserves in the ancillary services market. These are called on
as reserves in case of demand scarcity or security services in
emergency situations. Although the ancillary services market
provides capacity reserves for short and medium-term, it does
not provide incentives for new entry and thus, the resource
adequacy problem in the long-term. On the other hand, the
reserves market increases the price in the wholesale market
and thus, provides incentives/opportunities for investments.
4) Forward energy-only contracts: Although the
forward contracts hedge against volatility of spot prices and
market power [31], it fails to address the ‘missing money’
problem. As a result, the forward contracts do not provide
enough incentive or price signals for long-term resource
adequacy and thus, the entry of new generations. The long-
term forward contracts may attract resources and bring down
the spot prices which can be detrimental to the incumbent
generations.
ISO demand curve
The demand curve and auction format are designed to
mitigate market power in the capacity market. The
counterparty, ISO or utilities/load serving entities provide
kinked demand curves based on LOLE and forecasted reserve
margin. The capacity market is traded in unforced capacity
(UCAP) rather than in installed capacity (ICAP) to cater in
forced outage rate due to maintenance. The sloped kinked
curve is tendered in such a way that the net cost of new entry
(CONE) of reference technology generator is at target reserve
margin and there are price cap (at 2xCONE) and price floor
(at 0.5xCONE) placed at either side of the target reserve [31].
The sloped demand reduces the price volatility and price cap
and floor prevent the chance of under and over-procurement
respectively. The capacity market influences indirectly the
price of energy and ancillary services market and vice versa.
The net CONE on the demand curve helps to create a linkage
between these markets. The type of demand curve varies from
country to country and depends on target reserve and
reference technology in that country.
Impact of market coupling
With the concept of pan European internal energy market
(IEM), the market coupling will reduce the overall price of
electricity [24],[25]. However, different capacity mechanisms
across Europe risk distorting market coupling in the pan
European internal energy market (IEM). Market coupling
may result in double capacity payments to generators in
markets of higher payments compared to that in energy only
markets or lower payments. Furthermore, lack of
harmonisation in capacity mechanisms across Europe will
shift the capacity towards the market with higher payments
[32]. Therefore, a coordinated market-based capacity
mechanism across Europe should be considered to encourage
competition in different generation technologies. To facilitate
this single platform for cross-border capacity, capacity
providers from neighbouring markets and interconnectors
through implicit auctions must be able to partake in the
market. Smart grid technologies such as, dynamic line ratings
(DLR) and financial instruments such as, financial
transmission rights (FTR) will expedite this process, which is,
currently limited by interconnector capacity constraints.
Moreover, the participation of energy storage, demand
response and energy efficiency will boost flexibility in the
capacity mix.
A properly designed capacity market will solve the long-
term reliability problem and reduce the market imperfections,
risks and market power. These need to be backed up by
efficient political and regulatory decisions in relation to

capacity market design. This will facilitate the efficient mix
of resources in the generation portfolio.
III. VIRTUAL POWER PLANTS AS CMU
A. VPPs as aggregators
Modern networks are gradually moving from a centralised
generation to a more decentralised and local generation [33].
However, the DERs are installed with a ‘fit and forget’
approach. As a result, the individual DERs lack
representation and visibility in the system. Without active
management there will be an increase in reinforcement and
operation costs of the distribution network [34],[35]. With the
growing pressure to increase DER and renewables, there is an
increasing need of proper active management of these
decentralised resources rather than a passive approach
[36],[37]. In the long-term, if the renewable generations have
to replace the conventional generations, they need to
participate in the energy market and network management.
This will enable them to provide the system ancillary
services, controllability and capacity.
In this scenario, the role of virtual power plants (VPP) is
crucial. A VPP is a flexible portfolio of DERs, which includes
generations, energy storages, flexible demands (consumers)
and mixture of both (prosumers). It aggregates the capacities
of not only different types of DERs, renewables such as,
wind, solar and non-renewables such as, combined heat and
power, but also energy storages, flexible and controllable
demands. This facilitates the DERs and consumers/prosumers
to participate in the wholesale market, bi-lateral contracts and
provide transmission system services, such as, frequency
response, voltage response, reserves, security and energy and
power balancing. The VPP is characterised by scheduled
output, reserves, ramp rates, reactive power limits, voltage
regulation from the perspective of conventional generators.
Additionally, it is characterised by price demand elasticity
from the perspective of controllable demands. The advent of
smart grid and smart meters, through internet of things (IoT)
enables optimal dispatch of generation, demand and storages
in a unified and secure web-connected system [8], [33].
Inflexible renewables such as, wind and solar, have a
significant share in the DER portfolio. The uncertainty or
intermittency of output creates volatility issues in price and
system services. However, the VPP incorporates the benefits
of diversity of resources and increased capacity through
aggregation. This reduces the risk of missing the contract
position as the probability of losing all DER units is rather
low.
Besides, the energy storage systems (ESSs), such as,
battery, fuel cells, super- and ultra-capacitors, pumped hydro,
super magnetic storage, electric vehicles (EV), thermal
storage will be particularly beneficial for system operation
and ancillary services. ESSs facilitate the intermittent
renewable generations to be more flexible by storing energy
at times of high renewable generation when the price is low
and providing that stored energy to the demand locally or to
the grid for ancillary services when prices are high. This is
called energy arbitrage and will make the system ready for
dynamic pricing tariff mechanisms.
The VPP will hence, facilitate the small-scale
consumers/prosumers and DERs to participate in the energy
and ancillary services market and also in system management
which would not be possible without it. This creates a
motivation for VPPs to participate in the capacity markets
too. Although, there is no current policy for VPPs to be part
of the capacity auctions, the growing research and various
applications of VPP will enforce a change. The VPPs will bid
for capacity (a large portion in the portfolio are renewables)
in the capacity market and thus, in the long run, increase the
renewable generation portfolio in the capacity. Fig. 3 shows
a basic schematic of a VPP architecture for capacity markets.
Virtual Power Plant
TSO DSO
Active
consumers
Prosumers
Suppliers
Renewables
Small-scale
DERs
Capacity
markets
Wholesale
and AS
markets
Energy
storage
ESCos
B. Current VPP practice
The increase in renewable generation, demand response
functions and energy efficiency initiatives are driving the
market of virtual power plant forward. It is expected that the
global VPP market will hit a value of $5.5 billion by 2023
[38]. The current major players in the market are ABB Ltd.,
EnerNoc Inc., Schneider Electric SE, Enbala Power
Networks, AutoGrid Systems Inc., Sunverge Energy Inc.,
AGL Energy Limited, ENGIE Storage Services NA LLC and
Siemens AG. Besides, RWE in Germany started a VPP in
2012, Stem Inc. in USA, and Flexitricity and Veolia have a
large market share in UK and Ireland.
There are a few of the most significant projects in Europe
that deals with DER implementation in a VPP model. In the
Ecogrid Project talked about the concept of distributed energy
market and allowing the end-customers to participate in the
energy market and the ISO to better manage the network [39].
The novel thing about Edison project was to incorporate
electric vehicles as a part of VPP and providing balancing
services as balance responsible party [40],[41]. The Knowers
project, however, spreads the reserve capability across the
VPP rather than on unpredictable CHP. This is managed
through supervision by distributed energy management
system [42]. Moreover, the smart heat pumps through VPP
can assist the balance of supply and demand. The idea is
considered in Germany, Netherlands, Switzerland and
Denmark [43].The Fenix project proposed two types of VPP,
commercial and technical for the integration of varied types
of DERs and moving away from the traditional network
management [44]. It implements a pilot VPP in the two
networks in the UK and Spain. It develops the concept of
commercial and technical VPP and how they can provide
network management, ancillary and reserve services. A
project under the EU FP 5 developed and tested the fuel cells
as DERs in VPP model and how it delivers electricity to the
network by a central control system [45]. However, none of
the commercial and research projects talked about the
possibility of employing DERs as a VPP entity in the capacity
market. The on-going project Storenet in Ireland concerning
Fig. 3. A VPP architecture for capacity markets

a reputed research centre IERC with an industry consortium
of ESB Networks (DSO), Solo Energy (aggregator) and
Electric Ireland (supplier) is developing a VPP framework
with distributed energy storage and PV in low voltage
residential network [46]. It will facilitate the small-scale
prosumers to participate in the energy market through a
trading platform FlexiGrid. It aims to develop the platform to
facilitate the small-scale DERs in a VPP entity to participate
in the capacity mechanism as well.
C. Mitigating the capacity market challenges
The VPP incorporates a mixed bag of small-scale assets
such as, DERs (mostly renewables), CHPs, energy storage,
active demand response, electric vehicles, and energy
efficiency services. The VPP with the help of
distributed/centralised control system reduce costs of
operation and network losses through better energy
management. The commercial VPP as a single entity
participates in capacity market and improves the quantity of
clean power supply. The VPPs will compete with other
conventional generations in a merit order manner for
capacity. The ESS will facilitate the VPP to participate in the
flexibility and reserve services in the ancillary market.
Therefore, the VPPs across the network through IoT enable
active demand response and reduce the chance of energy
market price to go too high and thus, reduce market
inefficiency and market power. Furthermore, it mitigates the
risks of price volatility through its higher availability index.
With the increase in overall flexibility with non-
dispatchable renewable generations in a VPP model, there
will be less or no dependence on conventional generations for
flexibility. This needs to be backed up by a proper reserve or
ancillary services market in order to provide more reserve
payments to flexible conventional but under-utilised
generations. The ancillary services with adequate flexibility
products will reduce the effect on the wholesale market price.
Therefore, to have an efficient incentive to build new
capacity or to recover the ‘missing money’ problem for
existing or retrofitted capacity, the presence of a capacity
market is necessary. The renewables and ESSs in a VPP
scenario will facilitate this process and alleviate the ‘missing
money’ problem and the challenges of a capacity market,
discussed in Section II.
D. VPP in I-SEM and IEM
With a vision of a coordinated market-based capacity
auction across Europe, the capacity market and market
coupling will co-exist. Furthermore, the locational pricing
mechanism will provide appropriate signals of where to build
new renewable capacity in the network. The new technologies
such as, DLR and financial instruments such as, FTR will
facilitate the process of integration of markets and thus,
reduce the probability of market splitting.
Since the focus of future generations should be on
renewables, the emission of greenhouse gases can be
restricted by putting an upper cap on carbon emissions [47].
Thus, only the conventional generations with emissions less
than a limit are allowed to participate in capacity markets.
This give incentive for conventional generation to reform
their technologies and hence, stay in the market.
Although the renewables are part of the generation
portfolio, in many countries, the renewable generations which
receive out-of-market subsidies are not allowed to participate
in the capacity market auctions. In the single electricity
market (SEM) in Ireland, only the flexible renewables can
take part in the capacity market. In order to achieve the
European Commission target, it is imperative for renewables
to participate in the capacity market. As Ireland plans to move
from SEM towards an integrated single electricity market (I-
SEM) to facilitate free flow of energy across borders, there is
a provision for inflexible renewables to participate in capacity
auctions as well [19],[48]. The current capacity payments
mechanism will give way to a competitive market based
capacity remuneration mechanism (CRM). VPPs may serve
as a capacity market unit (CMU) of prosumers with less than
de minimis threshold of 10MW mentioned in the capacity
market code [49]. This will give a voice to the small-scale
prosumers and DERs in the capacity mechanism. The ability
of VPPs to participate in the capacity market will have long-
term impacts on the electricity industry. The VPPs with ESSs
will provide flexibility so that, we are not obliged to depend
on conventional generations during high demand. Given the
diversity of generations in the VPP portfolio, the probability
of unavailability of all generations at the same time is rather
low. As a result, even without storage, the VPP output is
relatively flexible. Moreover, the VPPs will increase the
reliability of the network and clean energy capacity in the
generation portfolio. This will create more certainty in the
growth of renewable energy and reduce the wholesale energy
price.
E. Impact of research findings on stakeholders
The concept of employing small-scale renewables and
DERs in VPP in the capacity market is beneficial for different
stakeholders such as, generation providers and suppliers,
DER owners, DSO and TSO, policy makers, regulators and
aggregators. These are summarised as:
 Increases the clean energy capacity in the generation
portfolio
 Reduces the electricity price
 Improves the visibility of small-scale resources,
prosumers and consumers
 Provides flexibility – so, ISO does not have to depend
on conventional generations during high peak demand
 Improves network management, transition of DNO to
DSO and therefore, better coordination between TSO
and DSO
 Increases reliability of the system
 Reduces price volatility and financial and commercial
risks
 Does not hamper market coupling
 Facilitates a cleaner pan-European grid and integrated
SEM.
IV. CONCLUSIONS
Due to the non-dispatchable nature of renewables, the
flexible conventional generations require higher flexibility
such as, ramp rates, lower minimum up and down times than
before. To prevent energy prices to shoot up during scarcity
events and to ensure reliability, the market operator resorts to
capacity markets. However, these market-based capacity
mechanisms can be extended to renewable generations as
well.
This paper presents and discusses a method to include the
renewable generations in the capacity market auction. The
capability of energy storage to provide flexibility to variable

renewable sources will allow the renewables to partake in
flexibility services during scarcity. The incorporation of
renewables in the virtual power plant framework promotes
the decentralised technologies a visibility in the capacity
market. This will assist the system operator and regulator to
increase the hosting capacity of low-carbon generations. The
VPP with its DERs, energy storage, demand response, energy
efficiency portfolio, together with a coordinated market-
based capacity mechanism (through implicit auction of
interconnectors) will not distort the pan European market
coupling.
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