Financial Speculation in Capacity Markets Undermines the Energy Transition – Image for illustrative purposes only (Image credits: Pexels)
Energy generators across parts of the United States now operate under mounting strain from sudden supply disruptions and intensifying weather extremes. Geopolitical events have driven sharp swings in fuel prices, while climate-driven patterns such as a potential super El Niño threaten to push temperatures and storm activity higher. At the same time, a quieter shift has taken hold inside the markets designed to keep the lights on: financial players have moved into capacity contracts once held mainly by operators of physical power plants.
How Capacity Markets Are Supposed to Work
Capacity markets exist to secure future electricity supply by paying generators to stand ready. Grid operators run auctions in which plants bid to make themselves available during periods of high demand. The lowest bids clear first, and every successful participant receives the same clearing price. This structure is meant to give owners steady revenue that supports maintenance and new investment, functioning much like an insurance premium paid in advance.
Historically, only owners of actual generating assets participated. A natural-gas plant, a nuclear station, or a wind farm would commit its own equipment and receive payment in return for the promise to deliver when called. The system rewarded physical reliability because the same companies that owned the hardware also bore the long-term costs of keeping it in working order.
Private Equity Enters and Changes the Incentives
Ownership patterns have changed rapidly. By 2023, private equity firms ranked among the largest generators in the PJM region, one of the country’s biggest wholesale markets. Capacity obligations themselves now trade on secondary markets, allowing contracts to be bought and sold separately from the underlying plants. The result is a growing separation between the financial claim on future revenue and the physical condition of the equipment that must deliver it.
Portfolio managers focus on short-term returns and debt service. When an asset clears the auction, its new owner may see little reason to fund upgrades that pay off only years later. Maintenance can be deferred, weatherization postponed, and reinvestment limited, even while the contract continues to generate payments. This dynamic turns a reliability tool into a vehicle for extraction rather than long-term stewardship.
Recent Storms Reveal the Practical Costs
Winter Storm Elliot in 2022 exposed the gap between financial promises and physical performance. In the PJM footprint, nearly one-quarter of committed capacity failed to deliver during peak stress. Several of the worst-performing units belonged to private equity portfolios, including gas-fired plants acquired by ArcLight Capital the previous year. The operator later faced roughly $100 million in penalties.
Investigations by federal regulators pointed to freezing equipment and mechanical failures as primary causes. While direct causation is difficult to prove in every case, the episode illustrated how leveraged owners may lack both the capital and the incentive to harden assets against extreme conditions. When multiple portfolios face simultaneous shortfalls, the fines can push firms toward insolvency, raising the prospect of broader credit disruptions for other infrastructure projects.
These events coincide with wider price volatility. The 2022 natural-gas shock from the Ukraine conflict and the more recent closure of the Strait of Hormuz have already lifted fuel costs. Layered on top is the growing frequency of climate-driven extremes that can disable generation and transmission at the same moment. A system built around short-term trading leaves fewer resources available for the sustained investments needed to withstand such overlapping shocks.
Regulatory Rules Lag Behind Market Reality
Current oversight still rests on the Federal Power Act’s requirement that rates remain just and reasonable. That standard was written for vertically integrated utilities, not for portfolios of capacity contracts traded like securities. As a result, regulators have limited visibility into ownership chains and secondary-market activity, and they lack clear authority to require performance upgrades tied to climate resilience.
Scholars describe this mismatch as a “legal mid-transition,” in which rules designed for an earlier era fail to address the incentives now driving behavior. Without updated standards, speculative bidding can suppress prices in the short run while leaving the physical grid less prepared for the next heat wave or freeze.
Options for Realigning Incentives
Stakeholders have several concrete avenues to reduce these risks. One path involves reinterpreting existing “just and reasonable” standards to account for speculative ownership and its effect on long-term reliability. A second approach would redesign auctions so that payments depend on actual performance during stressed periods, similar to the pay-for-performance rules already in place in New England since 2018.
A third route recognizes that a future grid dominated by solar, wind, and storage will need different signals. Instead of paying for nameplate capacity that may not be available at night or during calm periods, markets could compensate resources based on their ability to deliver energy when it is most needed. PJM has already begun exploring scarcity- and performance-based frameworks in response to rapid load growth from data centers.
Finally, enforcement can be strengthened. Higher penalty ranges for underperformance during emergencies would raise the cost of deferred maintenance and encourage owners to treat reliability as a core business requirement rather than an optional expense.
Each of these steps would shift the balance from short-term financial extraction back toward the physical resilience the grid requires. Without such adjustments, capacity markets risk becoming another layer of leverage that amplifies rather than cushions the shocks already arriving from geopolitics and a changing climate.
