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Published: March 24, 2025

By Danielle Powers and Mark Karl

Key Takeaways:

• While capacity markets have historically played an important role in supporting grid reliability, their foundational design no longer reflects the realities of today’s power grid. These markets were built around a generation fleet dominated by dispatchable resources, yet the current mix increasingly includes intermittent renewables and resources shaped by policy objectives.
• Some of the core assumptions embedded in capacity market structures, such as the idea that all capacity resources contribute equally to reliability or that investment will consistently respond to price signals, have been called into question. Recent experiences with price volatility, shifting accreditation standards, and out-of-market interventions have raised concerns about whether these markets are sending the right signals to support long-term investment in reliability.
• These challenges have prompted a broader conversation about whether the existing capacity market framework is sufficient on its own, or whether alternative models should be considered. Options such as bilateral contracting, centralized procurement, or new reliability products that reflect the specific attributes needed to operate the grid may offer more tailored solutions for today’s changing landscape.

For decades, capacity markets have played a central role in the design of wholesale power markets in the United States, particularly in regions such as PJM, ISO-New England, and NYISO. These markets were originally established to help ensure grid reliability by securing adequate generation to meet peak demand. However, as resource portfolios evolve, renewable energy grows in prominence, and policy priorities shift, questions have emerged about whether existing capacity market structures remain well-suited to today’s energy landscape. These developments have prompted discussion around whether incremental adjustments are sufficient, or if more substantial reforms may be necessary.

The Origins and Evolution of Capacity Markets

Capacity markets were introduced in the late 1990s and early 2000s as part of deregulation efforts in the energy sector. Their purpose was to address the missing money problem, which is the gap between the revenue that generating resources need to cover their fixed costs and the revenue they actually earn in the energy and reserves markets. Capacity markets were introduced as a solution to this problem, providing an additional stream of revenue to ensure sufficient investment in generation capacity and long-term grid reliability.

The fundamental assumption was that all power plants contributed equally to system reliability, that all megawatts were created equal, and that a simple auction-based market could incentivize investment in new resources as older ones retired.  However, this model was built around a system dominated by traditional, dispatchable power plants—coal, natural gas, and nuclear generators—which provided energy and essential grid services such as voltage control, frequency stability, and inertia. These plants could be counted on to supply power and gird services whenever demand required it.

Another foundational element of capacity market design was that new generation entry would come as a result of a market signal for the needed capacity.  The rapid expansion of renewable resources, along with the policies designed to incent and, in some cases, subsidize these resources, has upended these foundational assumptions. In addition, the price volatility and rule instability that result from constant “tweaking” of the design in an attempt to address shortcomings as they arise makes it difficult to support substantial investment.

Why Capacity Markets No Longer Work

Why are capacity markets increasingly seen as unsustainable in their current form? The reasons are simple: the foundational assumptions on which capacity markets were created no longer hold true.

1. Mismatch Between Capacity Markets and Modern Energy Resources
   The original design of capacity markets assumed that all qualified capacity megawatts were functionally equivalent. This is no longer the case. The modern energy mix includes a growing share of intermittent renewables like wind and solar, which do not always generate electricity when needed. Capacity markets have attempted to adapt through mechanisms like the Effective Load Carrying Capability (ELCC) rating process, performance incentives, and fuel supply requirements, but these changes are incremental fixes that fail to address the full reliability need and fail to address the larger issue: capacity markets are designed for a power grid and a supply resource mix that no longer exists.
2. Distortion from Public Policy Interventions
   The rise of state-level clean energy mandates and direct subsidies for renewables has further complicated capacity markets. Many new renewable projects are entering the market not because of price signals, but because they receive out-of-market financial support to achieve specific policy goals. All else being equal, this artificially suppresses capacity prices, making it even harder for traditional generators to remain viable. As a result, necessary resources are being pushed toward retirement, even when they are still essential for reliability. Capacity markets were never designed to accommodate these policy-driven shifts, and they have proven ineffective at integrating them into the broader reliability framework.
3. Failure to Account for Essential Grid Services
   Traditional power plants provided a “bundle” of reliability attributes beyond just megawatts of capacity. They offered fuel security, , frequency regulation, and fast-ramping capabilities. Although different resource technologies provided different quantities of these attributes, for the most part, they provided the full “bundle.”  New capacity resources, particularly renewables, do not inherently provide all these same services, yet capacity markets still treat them as interchangeable with traditional generators. This has led to reliability gaps, forcing grid operators like PJM to intervene with out-of-market payments to keep critical plants from shutting down. If grid operators must frequently override market outcomes to ensure reliability, it is a clear indication that the market is failing.
4. Increasing Market Volatility and Inefficiencies
   Capacity market prices have become increasingly unstable, fluctuating from near-zero levels in oversupplied years to dramatic spikes when retirements accelerate. The most recent PJM Base Residual Auction saw prices jump nearly tenfold, largely due to resource retirements and new constraints placed on capacity accreditation. Such volatility discourages long-term investment in new generation, as developers cannot count on stable revenue streams. This instability undermines the very purpose of capacity markets, which is to provide financial certainty for generators and ensure long-term resource adequacy.
5. Inability to Adapt to Rapid Changes in Demand
   Since capacity markets were first introduced, electricity demand in the U.S. has grown modestly overall. From the early 2000s to the mid-2010s, total electricity consumption remained relatively flat, influenced by improvements in energy efficiency, a shift toward a more service-based economy, and the decline of energy-intensive manufacturing.  As a result, capacity markets provided sufficient incentive for the construction of new generation resources. However, the demand for electricity from data centers is expected to grow significantly in the coming years due to the rapid expansion of cloud computing, artificial intelligence (AI), cryptocurrency mining, and the electrification of the economy. According to the NERC 2024 Long-Term Reliability Assessment, summer peak demand for the U.S. is expected to grow by 132 GW over the next 10 years, significantly greater than the 80 GW projected in the 2023 assessment. Given the substantial challenges faced in recent years in meeting even modest load growth, it is extremely unlikely the current capacity construct and markets will be capable of delivering the resources needed in time to meet the projected increase.

What Comes Next? Alternatives to Capacity Markets

To borrow a phrase from FERC Chair Mark Christie, “we have a rendezvous with reality”.  It is time to move beyond incremental adjustments to capacity markets and begin exploring alternative approaches to ensuring grid reliability. We can’t afford to continue to put reliability at risk when “baseload” retirements are happening faster than dispatchable generation can be added.  As Chair Christie recently stated in comments made at CERAWeek when stressing the need for dispatchable resources to maintain grid reliability, “we’re simply not ready to run a grid where we don’t have dispatchable resources”.  How can the current capacity market design incent dispatchable gas-fired resources critical to ensuring reliability when these resources might operate for a handful of peak hours during the year?

There are market designs, such as those used in MISO and ERCOT, that provide useful models. MISO relies on load-serving entities (LSEs) to demonstrate sufficient resource adequacy through bilateral contracts and self-supply options. ERCOT operates an “energy-only” market, where real-time prices reflect scarcity conditions and encourage investment in new capacity when needed.

Another viable approach is the creation of a centralized procurement agency—such as a state or regional power authority—that would oversee long-term reliability contracts. It is important to recognize that the creation of such an agency need not represent the abandonment of wholesale electricity markets. Certainly, the energy and reserves markets need not change, and can continue to provide the same efficiency benefits they do today.

The power authority need not own or operate supply resources either. Such an entity could competitively procure the right mix of resources on a contract basis from independent owners and operators to balance dispatchability, fuel security, reliability, affordability, and policy goals, rather than relying on an outdated market mechanism that no longer serves its intended purpose. The procurement process could also allow for self-supply by load serving entities, utilities, or municipal systems and would provide a more stable revenue stream to facilitate lower cost financing.

Conclusion

The electricity system is undergoing a fundamental transformation, and capacity markets are failing to keep pace. Designed for a different era, they no longer align with the realities of modern energy markets, technological advancements, and policy objectives. Instead of continuing to modify an outdated system, policymakers and grid operators should move toward market structures that better reflect today’s energy needs. Whether through direct procurement, LSE-led resource planning, or new reliability products that disaggregate the attributes currently assumed in the current capacity product, the time has come to move beyond capacity markets and embrace a model that ensures a reliable, cost-effective, and sustainable energy future.

Links to Cited Sources:

2024 Long-Term Reliability Assessment. North American Electric Reliability Corporation

“US Grid Must Embrace Natural Gas in ‘Rendezvous with Reality’: FERC Chair.” Upstreamonline.com

 

All views expressed by the authors are solely the authors’ current views and do not reflect the views of Concentric Energy Advisors, Inc., its affiliates, subsidiaries, related companies, or clients. The authors’ views are based upon information the authors consider reliable at the time of publication. However, neither Concentric Energy Advisors, Inc., nor its affiliates, subsidiaries, and related companies warrant the information’s completeness or accuracy, and it should not be relied upon as such.