What Is a Capacity Market? – How PJM Auctions Set Prices

Most electricity markets pay power plants for the energy they produce. But a grid also needs plants that sit ready for the hottest afternoon or coldest night of the year, even if they barely run. Somebody has to pay to keep those plants around. In much of the eastern US, that payment comes through an auction, and lately its prices have made headlines. What is a capacity market, and how do PJM's auctions actually set the price?

A capacity market is a system where a grid operator pays power plants, batteries and demand response providers to be available to supply power during future peak periods, separate from payments for the energy they actually produce. In PJM, the largest US grid operator, this happens through the Base Residual Auction, usually held a few years before the delivery year.

Resources offer capacity at a price, PJM sets a demand curve based on its reliability target, and the price where supply meets that curve becomes the clearing price paid to every cleared resource. Since the 2025/2026 auction, PJM capacity prices have risen roughly tenfold, driven largely by forecast data center load growth.

What Is a Capacity Market in Simple Terms?

A capacity market pays for reliability insurance. Energy markets pay for MWh actually delivered. Capacity markets pay for MW that promise to be there when needed, measured as a price per MW per day.

Think of a small peaking gas turbine that runs only during heat waves. It might earn very little from energy sales in a mild year, not enough to cover its fixed costs. Without some other payment, its owner might retire it. Then, during the next heat wave, the grid would be short. Capacity payments give that plant a reason to stay open, and they signal developers when new supply is needed.

Why Do Some Grids Have Capacity Markets and Others Don't?

Grids choose capacity markets when they don't trust energy prices alone to keep enough plants around. Prices in many markets are capped or administratively limited, so plants may not earn enough during scarce hours to cover their costs. Economists call that gap "missing money."

PJM, ISO New England and the New York Independent System Operator run capacity markets. The Midcontinent Independent System Operator (MISO) runs its own Planning Resource Auction. ERCOT in Texas takes the opposite approach, an energy-only market that lets prices spike very high during scarcity and counts on those spikes to pay for new supply. Each design has trade-offs, and both camps can point to stressful moments in the other's history.

How Does a PJM Capacity Auction Work?

A PJM capacity auction works by matching supply offers against a demand curve set by PJM's reliability needs. The process follows these steps:

1. PJM forecasts peak load for the delivery year and sets a reliability requirement that includes a reserve margin.
2. It builds a downward-sloping demand curve, sometimes called the Variable Resource Requirement curve. Higher capacity amounts get lower prices, and shortfalls get higher prices.
3. Generators, batteries, demand response and energy efficiency providers submit offers stating how many MW they can provide and at what price.
4. PJM stacks the offers from cheapest to most expensive and finds where that supply stack crosses the demand curve.
5. Every cleared resource receives the clearing price, though some local zones can clear higher if transmission limits bind.
6. Cleared resources must be available during the delivery year or face penalties.

A toy market makes the mechanics clear. Suppose PJM needs about 1,000 MW in a tiny model market. Offers come in at 400 MW for $50/MW-day, 400 MW for $150/MW-day and 400 MW for $300/MW-day. The first two blocks only reach 800 MW, so the market must dip into the third block. The clearing price is $300/MW-day, and all 1,000 cleared MW get paid $300, including the cheap ones. That single-price design is common in power markets, and it explains why a small shortfall can raise prices so much.

Who Can Sell Into a Capacity Market?

Almost any resource that can help at peak can sell into a capacity market, but not every MW counts the same. Gas, coal and nuclear plants, hydro, wind, solar, batteries, demand response and energy efficiency programs can all participate in PJM, subject to its rules.

The catch is accreditation. PJM credits each resource type for how much it is expected to help during the riskiest hours, using a method called effective load carrying capability (ELCC). A resource with a high rating gets credit for most of its nameplate MW. One that often isn't available during risky hours gets less.

Take an illustrative case: if a 100 MW resource class carries a 40% rating, it can sell about 100 × 0.40 = 40 MW of capacity. Ratings change from auction to auction as PJM updates its studies, and lower ratings for some resources were one reason supply looked tighter in recent auctions.

Demand response sells the promise to reduce load when called. For large, flexible customers, that is the most direct way to earn money from the capacity market instead of only paying into it.

Why Did PJM Capacity Prices Jump?

PJM capacity prices jumped because forecast demand rose quickly while supply stayed flat or shrank. The chart below shows the systemwide clearing prices from four recent auctions.

The price for the 2025/2026 delivery year was more than nine times the year before. According to an analysis by the Institute for Energy Economics and Financial Analysis (IEEFA), PJM's independent market monitor attributed about 63% of that increase, roughly $9.3 billion, to data center load. The 2026/2027 auction then cleared at the $329.17/MW-day price cap.

PJM's December 2025 auction for 2027/2028 cleared at its cap again, $333.44/MW-day, and came up 6,623 MW short of its reliability requirement. PJM said about 5,100 MW of the 5,250 MW in forecast load growth for that year came from data centers. Other factors mattered too, including plant retirements, slower new construction and rule changes in how resources are credited for reliability.

Who Pays for Capacity?

Customers pay for capacity, mostly through their electric bills. Utilities and retail suppliers buy capacity on behalf of the customers they serve, then pass the cost through in rates. Each customer's share depends roughly on its demand during peak periods.

Run the numbers for a hypothetical 100 MW data center, ignoring reserve margin adjustments:

• Daily cost at $329.17/MW-day: 100 MW × $329.17 = $32,917
• Annual cost: $32,917 × 365 = about $12.0 million
• At the 2024/25 price of $28.92: 100 × $28.92 × 365 = about $1.06 million

Same facility, same load, roughly an $11 million difference. For households, IEEFA cited estimated bill increases of about $16 to $21 per month tied to the higher prices, though actual effects vary by utility and state.

What Does a Capacity Market Mean for Data Centers?

For data centers, the capacity market is both a cost and an opportunity. As big, steady loads, they carry a large share of capacity costs wherever those pass through to customers. They are also the main source of forecast load growth, which puts them at the center of the political fight over bills.

The opportunity is flexibility. Demand response can bid into the capacity market, so a data center that can reliably cut its draw at peak may earn capacity revenue instead of only paying for it. Utilities facing these costs are also writing contracts that make big new customers commit to their share. A large load tariff with long terms and minimum charges is one way to keep the risk of overbuilding from landing on everyone else.

Are Capacity Markets Working?

It depends who you ask, and the honest answer is "partly." Supporters say high prices are doing exactly what they should, sending a loud signal that new supply is needed. PJM pointed to new generation offers and uprates responding to higher prices.

Critics say the auctions reward existing plants with windfalls while new plants still face long interconnection queues, so the price signal can't produce supply quickly. Governors in the PJM region pushed for changes, which led to a temporary price cap and floor. Others argue large new loads should bring their own supply rather than lean on the shared market.

Where I land: a capacity market can't fix a queue or a transmission bottleneck. It can only price the shortage those problems create.

A Capacity Market Puts a Price on Being Ready

So, what is a capacity market? It's an auction that pays resources to be ready for peak demand years in advance, with one clearing price set by where supply meets a reliability-based demand curve. In PJM, a fast rise in forecast data center load ran into tight supply, and prices climbed from under $30 to over $330 per MW-day in a few auctions.

For data center developers, that makes capacity costs a real line item and flexibility a real asset. For everyone else, it's a reminder that load growth has a price somebody pays. If you are budgeting a site in PJM, don't plug in last year's capacity price. Ask your utility or retail supplier how capacity costs flow into your rate, run the math at the current auction price and at the cap, and treat any flexibility you can offer as a way to shrink that number.

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