How to manage risk for your virtual power plant

02-08-24

The Navitasoft VPP blueprint - Part #6

Virtual Power Plants (VPPs) take center stage on the way to a more sustainable and renewable energy world with a predicted growth that is nothing short of incredible. A report by Grand View Research provides a detailed forecast, estimating the global VPP market size at $4.13 billion in 2023, with expectations to grow to $16.65 billion by 2030, which means a compound annual growth rate (CAGR) of 22.0%. Naturally, such an outlook makes VPPs one of the hottest topics in the industry right now, and surely one of the most exciting talking points at this year’s E-world.

And it is indeed an exciting technology: By harnessing the power of advanced software and communication, VPPs can optimize the production and distribution of electricity from various sources, including wind, solar, and battery storage, to meet demand in real-time. But new tech requires new methodologies in just about every aspect, be it forecasting, trading strategies, optimization, integration and reporting; but also risk managers for energy are called onto the scene. Risk management for VPPs, which is today’s part of our big-picture VPP Blueprint series, introduces a whole new set of challenges and considerations distinct from traditional energy trading.

VPP vs. traditional risks

In traditional energy trading, risks are predominantly centered around volatile market prices and the potential for counterparty default. These challenges are well-understood, and management strategies have been established. However, VPPs introduce a different risk profile. The variability of renewable energy output and the real-time balancing of supply and demand across a distributed network of assets introduces a layer of complexity unseen in conventional trading scenarios. Furthermore, the increased use of algorithms and AI in decision-making processes obscures the rationale behind specific trades, making it difficult to assess why certain decisions were made or not made. This opacity challenges traditional risk management frameworks and requires new approaches to ensure transparency and accountability in VPP operations.

Let’s first take a look at the respective risk factors that need to be considered when successfully operating a VPP:

Engineering and complexity risks

The integration of various energy assets into a single operational framework is at the heart of VPP functionality but also introduces significant engineering risks. The setup phase is fraught with financial risk as investments are made to connect and synchronize disparate assets. This phase is characterized by uncertainty around technological compatibility, regulatory compliance, and the seamless integration of assets into the central control system.

Once operational, VPPs face ongoing risks related to asset performance and reliability. Connection breakdowns, delayed or incorrect responses to control signals, and the failure to meet predicted energy outputs can all undermine the effectiveness of a VPP. Managing these risks requires robust engineering solutions, including redundancies, real-time monitoring, and adaptive control algorithms designed to accommodate the unpredictable nature of renewable energy sources.

Psychological risks

For many in the energy sector, VPPs represent a significant departure from traditional operation and management practices. The integration of assets into a centrally controlled environment can be seen as a loss of control over individual assets, leading to resistance within organizations. This psychological aspect is compounded by the multidisciplinary nature of VPPs, which require collaboration across departments and specializations. Overcoming these challenges requires effective change management, clear communication of the benefits of VPPs, and strategies to involve stakeholders in the transition process.

Financial risks

The initial investment and uncertainty about future revenues and regulatory changes pose significant risks in the early stages. However, once operational, VPPs can mitigate some financial risks inherent in traditional trading through more granular control over assets and the ability to respond swiftly to market signals. Nevertheless, the financial viability of VPPs remains sensitive to market dynamics, regulatory shifts, and the evolving landscape of energy demand and supply.

Regulatory risks

VPPs operate within a complex regulatory environment that is still adapting to the rise of decentralized energy resources. Regulation changes can profoundly affect VPP operations, from altering the economic setup to imposing new technical requirements. Taking these risks into account requires a proactive approach to regulatory engagement, including participation in policy development processes and flexible business models capable of adapting to new regulatory regimes.

Risk management strategies

Taking all these risk factors into account by having effective risk management in place within Virtual Power Plants (VPPs) is a must for optimizing performance, ensuring financial viability, and maintaining compliance with regulatory standards. The following are the most critical aspects that need to be covered by a proper risk management strategy to mitigate the unique risk profiles of VPP operations.

Position management and trade execution

Significantly, as the volatility of energy markets is increasing continuously, managing the position of a VPP is the foundation for success. This involves monitoring the energy market, predicting price movements, and adjusting the VPP's position to minimize risk and maximize returns. Effective position management strategies include forecasting tools to anticipate market trends, real-time analytics to change positions quickly, and diversification of energy sources to spread risk.

Efficient trade execution requires the integration of advanced trading platforms that can automate the buying and selling energy based on predefined criteria and real-time market conditions. These platforms must be capable of high-speed transaction processing to capitalize on fleeting market opportunities. Moreover, ensuring secure and reliable communication channels between the VPP control center and the market will prevent delays or errors in trade execution.

Trade capture modules

Trade capture is a vital component in risk management for VPPs. It involves accurately recording trade details, including the type of energy traded, volume, price, and transaction time. This information is the foundation for:

Compliance and Reporting: Ensuring that all trades are recorded accurately is essential for regulatory compliance. Trade capture systems facilitate the generation of reports needed for regulatory bodies, auditors, and internal stakeholders.
Performance Analysis: By capturing every trade, VPP operators can analyze the effectiveness of their trading strategies, identify areas for improvement, and refine their approaches based on empirical data.
Financial Management: Accurate trade capture is essential for financial reporting, risk assessment, and the management of cash flows. It provides a detailed record of the financial transactions associated with VPP operations, enabling better forecasting and budgeting.

Utilization and revenue splitting

Given that VPP assets are often not owned by the VPP operator but by third parties, transparent and fair mechanisms for asset utilization and revenue splitting are essential. This requires:

Transparent Optimization Algorithms: Algorithms that prioritize the dispatch of assets based on efficiency, cost, and other relevant factors must be transparent to all stakeholders. This transparency helps build trust with asset owners and ensures that assets are utilized optimally.
Fair Revenue Distribution Models: The financial benefits derived from the operation of VPPs must be distributed equitably among asset owners. This involves developing clear contracts and revenue-sharing agreements that reflect the value contributed by each asset to the VPP.
Reporting and Communication: Regular and detailed reporting to asset owners about the performance of their assets and the revenues generated is crucial. This not only aids in maintaining a positive relationship with asset owners but also helps in optimizing asset performance within the VPP.

Secure communication

According to a report by Cybersecurity Ventures, cybercrime damages are expected to cost the world $6 trillion annually by 2021, up from $3 trillion in 2015. This is especially relevant for the reliability of VPPs, as they heavily depend on the secure and uninterrupted flow of information between the control center and the distributed assets. Implementing robust cybersecurity measures to protect against hacking, data breaches, and other cyber threats is therefore critical. Additionally, redundancy in communication channels can help minimize the risk of connection breakdowns, ensuring that control signals and market orders are always transmitted effectively.

Changes in regulations

VPPs operate in a dynamic regulatory environment that can significantly impact their operation and profitability. Staying abreast of regulatory changes, engaging with policymakers, and participating in industry associations can help VPP operators anticipate and adapt to changes in the regulatory landscape.

A proactive approach allows VPP operators to adjust their strategies in advance, ensuring continued compliance and minimizing the impact of regulatory shifts on operations. It also positions them to influence the development of regulations in ways that support the growth and integration of VPPs into the energy market.

Intraday trading and the role of technology and data

Nowadays, VPPs can’t be profitable without being connected to Intraday trading markets, as they allow them to capitalize on short-term fluctuations in energy prices and demand. A trading strategy for managing the variable output of renewable energy sources and aligning it with market demand is a prerequisite to maximizing profitability and efficiency.

This is why a typical VPP employs sophisticated algorithms for intraday trading, which analyze market data, predict price movements, and automatically execute trades to optimize the energy portfolio. To make informed trading decisions, these algorithms consider various factors, including weather forecasts, demand predictions, and energy supply from renewable sources.

The main challenges in intraday trading for VPPs include the unpredictability of renewable energy outputs and rapid changes in market prices. Solutions involve developing more accurate forecasting models, such as Monte Carlo simulations and ARMA models, which assess and mitigate the impact of uncertainty in energy production and market prices.

High-quality, real-time data enables better asset monitoring, control, and optimization, facilitating informed decision-making and improved risk management. Improving data collection and analysis include enhancing sensor technology and communication infrastructure while adopting data standards.

VPP risk in brief

As we saw, managing risks in VPPs encompasses a broad spectrum of strategies, which is why the success of VPPs depends on their ability to adapt to rapidly changing market conditions, future technological advancements, and policy shifts. These are our lessons for anyone considering starting a VPP:

First, lay importance on the effective management of risks - from operational and financial to regulatory and technological. Here, strategies such as advanced predictive modeling, efficient trade execution, and proactive regulatory engagement must be applied.
Also, find a way to make the advancement and integration of technologies act in your favor: AI, machine learning, and real-time data analytics - modern methods for processing data will enable you to deal with the uncertainties inherent in VPP operations by assisting you with accurate forecasting and improved decision-making processes
Finally, the evolving regulatory landscape presents both challenges and opportunities for VPPs. A proactive approach is required here, with VPP operators participating in policy discussions and advocating for regulations supporting the growth and integration of renewable energy resources.

Future outlook

Looking ahead, the technological capabilities of VPPs will continue to advance, and the push for renewable energy will grow even more vital, so there is potential for VPPs to play a massive role in the energy ecosystem. Key trends to watch out for include:

As the cost of renewable energy technologies continues to decrease and their efficiency improves, integrating these sources into VPPs will likely accelerate, further enhancing the sustainability and resilience of the energy grid.
Developing more efficient and cost-effective energy storage solutions will address one of the significant challenges facing VPPs - the variability of renewable energy production. This will enable a more consistent and reliable energy supply, even without real-time production.
The future growth of VPPs will be significantly influenced by policy decisions and market incentives that support decentralized energy resources and encourage the participation of a broader range of assets and technologies in VPPs.
The complex nature of VPP operations requires collaboration among various stakeholders, including technology providers, energy producers, regulatory bodies, and consumers. Here, building solid partnerships and fostering a culture of innovation will help to overcome challenges and realize the full potential of VPPs.

Stay tuned for more

Managing risks is one thing, but how do VPPs synchronize when individual devices go rogue? The next part of our series on our Blueprint for VPPs pulls back the curtains on the complex distributed control systems that coordinate diverse energy assets in real time. Together, we'll explore the challenges of centrally dispatching portfolios for frequency regulation services, where on-site monitoring and instant response are essential.