Promoting virtual power plant investments: Energy vs. capacity subsidies

The pilot programs of virtual power plants (VPPs) in China have exhibited great potential to support the coordination and participation of distributed energy resources in electricity market. Energy subsidies (ES) and capacity subsidies (CS) are two commonly used types of policies to promote VPP investments and harness the potential of DERs. This paper investigates the incentive mechanisms and substitutability of ES and CS, and examines the joint effects of responsiveness heterogeneity and cost variability. We develop a dynamic, continuous-time model involving one social welfare-maximizing government and numerous aggregators with heterogeneous responsiveness. The government moves first and announces a specific incentive policy based on ES and CS, after which heterogeneous aggregators dynamically decide whether and when to invest in one unit of VPP project. We find that ES is more appealing to aggregators by directly enhancing investment profitability through greater welfare transfers, whereas CS reduce aggregators' exposure to cost variability and fiscal burdens on governments. ES and CS serve as substitutes in promoting VPP investments, while earlier investment yields higher social welfare only in regions with highly responsive VPP projects and stable costs. These results highlight the need to balance aggregators’ preferences and local fiscal constraints in terms of subsidy scheme choice. ES should be prioritized in those regions with sufficient fiscal capacity and low aggregator engagement, whereas CS should be preferred otherwise. Furthermore, a four-quadrant policy map is provided to guide policymakers in adjusting subsidy settings according to local conditions.