Advancements in next-generation energy technologies can make for a confusing landscape where it can be difficult to distinguish valid potential from overblown hype. But given the fact that wind and solar are now cost-competitive with fossil fuels, and energy storage costs are coming down dramatically, it's reasonable to forecast that the current series of innovations will upend the energy industry as we know it.

One such innovation is the virtual power plant, which ties hundreds or thousands of small energy-storage systems together and allows them to behave like a power plant for the grid. If deployed effectively, the concept could save the grid operators money, make homeowners money, and create a massive new market for companies like Tesla (NASDAQ:TSLA). And the market for virtual power plants may finally be opening up.

The virtual power plant Elon Musk is building in Australia

The most notable example of a virtual power plant was just announced in Australia. South Australia Premier Jay Weatherill's press release announcing the plan said this:

Beginning with a trial of 1100 Housing SA properties, a 5kW solar panel system and 13.5kWh Tesla Powerwall 2 battery will be installed at no charge to the household and financed through the sale of electricity. Following the trial, which has now commenced, systems are set to be installed at a further 24,000 Housing Trust properties, and then a similar deal offered to all South Australian households, with a plan for at least 50,000 households to participate over the next four years.

In theory, the cost-effectiveness of energy storage is so strong that batteries can be installed for free, as long as the utility gets control of the devices for charging and discharging. If all 50,000 energy storage systems are installed, they could supply a total of 250 MW of power, similar to the output of a small natural-gas power plant.

A model for the future

Virtual power plants aren't a new idea for advanced energy companies, but a 250 MW virtual power plant takes the concept to a new level. Stem Inc. completed a 1 MW energy storage virtual power plant in Hawaii early in 2017 using commercial energy storage installations. SunPower (NASDAQ:SPWR) is running a virtual power plant pilot with Con Edison (NYSE:ED) in New York using 300 energy storage systems in homes. And Sonnen is building a 2,900-home virtual power plant in Arizona.

What each of these companies has in common is that they're trying to build a network of connected energy-storage systems. How exactly that will work is another story.

Regulations are everything for virtual power plants

At the moment, the rules and regulations of utilities are blocking the wider adoption of virtual power plants. If a virtual power plant operator doesn't have a mechanism for bidding its capacity into the market, it can't be compensated. And there are few jurisdictions today where the market will allow for virtual power plants to be paid appropriately.

But that's changing as states like California adopt time-of-use pricing and regulators demand that utilities open up their market to new energy concepts like demand response or energy storage. More states will follow in the U.S., and international markets will likely open as well, particularly those with high renewable-energy adoption rates.

Virtual power plants will be a key to the renewable energy future

Where these innovations get interesting is at the point where you combine a rooftop solar system with local energy storage that's embedded in a virtual power plant. In that situation, homeowners can produce their own electricity while adding valuable services to the grid. As a bonus, they even have backup power in case of an outage.

Putting power plant assets in the hands of homeowners or businesses would be a huge shift in the energy industry. But if virtual power plants continue to grow in size and capability, we could see them start to replace traditional power plants very soon.