{"id":28865,"date":"2026-05-12T10:23:19","date_gmt":"2026-05-12T15:23:19","guid":{"rendered":"https:\/\/blogs.law.columbia.edu\/climatechange\/?p=28865"},"modified":"2026-05-12T10:28:25","modified_gmt":"2026-05-12T15:28:25","slug":"financial-speculation-in-capacity-markets-undermines-the-energy-transition","status":"publish","type":"post","link":"https:\/\/blogs.law.columbia.edu\/climatechange\/2026\/05\/12\/financial-speculation-in-capacity-markets-undermines-the-energy-transition\/","title":{"rendered":"Financial Speculation in Capacity Markets Undermines the Energy Transition"},"content":{"rendered":"

\"\"<\/a>Compounding their significant climate and environmental harms, fossil fuels are also volatile commodities. In 2022, Russia\u2019s invasion of Ukraine disrupted the supply of natural gas, causing prices to spike. More recently, the United States\u2019 war on Iran resulted in the closure of the Strait of Hormuz, one of the most important oil and gas chokepoints in the world, causing an historic international commodity supply shock. Its effects will be felt for years. Coinciding with this energy crisis is the increasing likelihood of extreme and unpredictable weather patterns and events caused by global warming. For example, the potential development of a \u201csuper\u201d El Ni\u00f1o this year could \u201csupercharge extreme weather events and push global temperatures to record heights<\/a>.\u201d<\/p>\n

Energy generators face increasing pressures from these confluent events. Energy supply shocks from geopolitical conflicts expose fossil fuel generators in the United States to financial and operational risk. Moreover, phenomena like El Ni\u00f1o and other extreme weather events threaten<\/a> grid resiliency. Meanwhile, less visible dynamics in the energy market amplify the risks of these current trends. As the economy has become increasingly financialized, and private equity has shifted into energy markets that were traditionally dominated by physical generation entities, a significant rise<\/a> of speculation in capacity markets has led to reduced infrastructure investment. This blog describes the current phenomenon and risks of capacity market speculation, and considers policy options for stakeholders to ensure the electricity grid remains resilient for the climate crisis.<\/p>\n

The Rise of Speculation in Capacity Markets<\/strong><\/h3>\n

To understand the future of energy in a warming world, one must first understand capacity markets. Capacity markets play a significant role in shaping the energy transition in some areas of the country, because they are designed to ensure that energy generators will produce adequate electricity to power the grid. Unlike the typical consumer experience, where a grocery store customer pays for the items they take from the shelf, a capacity market creates a system where consumers pay power plants to be ready to provide energy when demand arises. In this way, capacity markets function more like insurance, where premiums for bulk power are paid to ensure that generators will produce electricity in the future, regardless of extraneous events.<\/p>\n

To accomplish this, grid operators solicit bids from generators within a specific region to make themselves available if called upon in the future, selecting bidders from the lowest to the highest price until the future demand curve is met. Those who \u201cclear\u201d the bid then receive a uniform payment based on the last bid selected, ostensibly providing the financial stability necessary to maintain and invest in physical infrastructure. Figure 1 below shows the basic economic mechanics of capacity markets. Bidders that clear the market are then obligated to provide power if called upon.\"\"<\/a><\/p>\n

One might expect that participation in these markets is limited to owners of physical generating assets\u2014the operator of a natural-gas-fired power plant, a nuclear facility, or a large-scale wind installation, for example. Historically, this was the case, as reliability was secured through forward commitments by those that directly control infrastructure.<\/p>\n

Now, however, capacity markets operate within a far more complex financial environment, where private equity funds, investment vehicles, and holding companies own many generating assets. Indeed, as of 2023, three of the largest generators in the PJM Regional Transmission Operator (RTO) service area were private equity firms<\/a>. Moreover, capacity contracts themselves can be and often are bought, sold, or reallocated through secondary market transactions. Similar to the mortgage-backed securities that precipitated the 2008 crisis, the guarantees to supply energy can be decoupled from asset longevity. This creates a profound tension, as private equity firms\u2019 primary business is portfolio management, not electricity production, meaning that they may optimize for short-term gain at the expense of the system\u2019s long-term reliability.\u00a0As a result, even where a generating asset is sufficient to meet current performance obligations, these owners may have diminished incentives to invest in maintenance and upgrades necessary to ensure reliability over time.<\/p>\n

The Perils of Financialization<\/strong><\/h3>\n

In his February 6, 2026, New York Times<\/em> op-ed, \u201cThe Finance Industry Is a Grift<\/a>,\u201d Oren Cass articulated a key theme of the energy transition: financialization. He defines this as the process of making financial transactions ends unto themselves, often at the expense of the societal benefits that support human flourishing. This \u201crent-seeking behavior\u201d has moved beyond the subprime mortgages and complex credit derivatives of the past and into our energy infrastructure, transforming capacity markets from a hedging function that addresses reliability risk and supports physical commerce into asset platforms dominated by speculative capital.<\/p>\n

Under a hedging regime, physical owners manage the risks of production to ensure long-term stability. In an extraction regime, financial institutions trade capacity obligations as profitable assets, seeking to maximize short-term dividends rather than investing in the physical resilience of the grid. This shift from hedging to extraction is particularly risky as climate change generates more extreme weather events, leading to supply side grid disruptions. And the recent increases in oil and gas prices, driven by military actions in the Middle East and the closure of the Strait of Hormuz, has further exposed the fragility of a system that prioritizes short-term market dynamics over the diversified, resilient infrastructure required for a true transition.<\/p>\n

Troubling parallels to the financial crisis of 2008 are emerging<\/a>, notably overleverage and a lack of transparency with respect to ownership structures and secondary market transactions. Just as subprime mortgages were bundled into complex instruments that obscured their underlying risk profiles, energy obligations can now be traded as speculative assets with diminished regard for the physical condition of the plants they represent (assuming sufficient reliability). For example, in PJM during 2022\u2019s Winter Storm Elliot, the private equity firm ArcLight\u2019s gas-fired power plants, purchased in 2021, \u201cdid not perform up to expectations,\u201d<\/a> resulting in about $100 million in fines<\/a>. In fact, almost 25% of PJM capacity failed<\/a>, and many of the worst performers were private-equity owned generators. The resulting fines pushed firms to the financial brink. A post-mortem of Winter Storm Elliot, published by FERC and NERC<\/a>, found that freezing and mechanical\/electrical failures contributed most to generation outages. Though it is difficult to establish causality, one explanation for underperformance during Elliot is that speculative investment contributed to the diminished performance capabilities of generation assets. If these energy portfolios are heavily leveraged with debt, their collapse could trigger a contagion, where the failure of a private equity energy portfolio freezes credit for other critical infrastructure projects. This type of systemic risk, where interconnected financial players lack the proper incentives to \u201charden\u201d their assets against extreme weather, means that a single weather crisis could trigger not just a regional blackout, but broader economic shocks.<\/p>\n

Governance Gaps Amplify Risk<\/strong><\/h3>\n

These risks are compounded by inadequate regulation. While financial players treat power plants like stocks in a portfolio, the governing laws remain adapted to historical norms of physical utilities, not speculative capital. Specifically, the institutional and regulatory framework remains tethered to the Federal Power Act\u2019s longstanding standard of \u201cjust and reasonable\u201d wholesale rates, even though the structure of capacity markets has fundamentally changed, and the economic landscape increasingly resembles a speculative market layered atop critical infrastructure.<\/p>\n

This situation is part of the \u201clegal mid-transition,\u201d as described<\/a> by scholar Alison Gocke, who highlights how, in the energy transition, the law often lags structural change, producing governance gaps and misaligned incentives. Unfortunately, as regulatory frameworks lag behind the rapid transformation of capacity markets, governance gaps have emerged that invite exploitation just as the climate crisis demands long-term physical resilience and transformation of our energy sources. This disconnect highlights a fundamental misalignment between the high-speed imperatives of finance and the physical realities of building a decarbonized grid.<\/p>\n

Market Distortion and the Erosion of Decarbonization Goals<\/strong><\/h3>\n

The central grift of financialization in the energy sector is the illusion of efficiency, driven by incentives toward short-termism. One danger is that capacity markets now signal reliability when the generating assets are managed for short-term yield instead of long-term decarbonization. Speculative owners may bid aggressively to clear the market and secure capacity revenues, even where long-term operation or reinvestment in the asset is uncertain. This speculative bidding may contribute to price suppression and volatility, which can weaken the market signals necessary to attract capital to build clean energy infrastructure.<\/p>\n

The current model also creates a perverse incentive to maintain old, dirtier plants, because they are cheaper to bid into auction than the capital-intensive projects required for a transition. By prioritizing short-term dividends over long-term investments, like weatherization and grid hardening, owners leave the physical grid vulnerable to the very climate disasters they are helping to accelerate. As seen with the catastrophic wildfire liabilities that crippled<\/a> PG&E, financial owners do not naturally have the proper profitability incentives to manage energy assets for the communities they serve. A legal contract to produce energy is useless if the physical plant is underwater or on fire, yet the markets continue to treat these contracts as high-quality assets.<\/p>\n

Diverging Regulatory Options to Align Incentives<\/strong><\/h3>\n

These flaws raise fundamental governance questions: when reliability is secured through instruments embedded in financial portfolios, what is the role of capacity markets in steering the energy transition? And what, if any, regulatory adaptations are necessary to align market design with decarbonization objectives? Further, as climate change continues to generate more extreme weather events, threatening grid resilience, are financial promises sufficient to keep the grid stable, or are new regulations necessary to govern the financialization of critical infrastructure? And how should a new regulatory environment address the systemic risk caused by the involvement of interconnected financial players, to avoid compounding effects triggering a broader economic shock? Though we\u2019ve focused on these issues in the PJM context, they may be relevant to other markets as well.<\/p>\n

There are several pathways that stakeholders can work toward to address the governance gaps created by the shift toward speculation in the capacity markets. One approach would be to update existing regulations to meet the current structure of the energy market. This would require a significant reinterpretation of the \u201cjust and reasonable\u201d rules to account for speculative behavior and market distortion. This may not be a viable path under the current regulatory landscape, but if capacity markets experience additional and widespread failure of generating infrastructure as speculative investment persists, the outlook may change.<\/p>\n

The second, more transformative path would be to redesign capacity markets to more closely link generator performance during stressed conditions. Under this theory, generators aren\u2019t paid merely for being available, sharpening incentives for investment in reliability. For example, the New England Independent System Operator (ISO) introduced a \u201cpay-for-performance\u201d framework<\/a> in 2018 that connects capacity payments to actual asset performance. This shift would force owners to prove that their assets can handle the climate transition \u2014 a requirement that parallels the prudential regulation and rigorous scenario analysis currently undertaken by many traditional financial institutions. Such a redesign would align financial incentives with the physical realities of decarbonization, ensuring that \u201creliability\u201d is more than just a line item on a hedge fund\u2019s balance sheet.<\/p>\n

Notably, traditional capacity markets may become less important for a future grid run on solar, wind, and battery storage. These resources do not produce energy on demand in the same way fossil generators do; their energy production is variable. Looking ahead to a clean energy grid, then, the vulnerability shifts from capacity at peak demand, to capacity during periods of higher demand but lower levels of electricity production (e.g., the nighttime hours with respect to solar). One approach to reconceptualizing energy markets supported by renewables is to switch away from \u201creserve margins <\/em>and towards a notion of resource availability<\/em>.<\/a>\u201d This approach recognizes that the limitation for this future grid is not the overall amount of capacity, but how much electricity can be produced at a given time to meet demand. It may also offer an exit from the structural corruption of our energy markets. PJM is already under pressure to adapt its market design to changing conditions, including rapid demand growth driven by data centers, and is considering a pathway that could help shift the region toward a scarcity- and performance-based framework that compensates resources based on their availability and delivery during periods of system stress. Indeed, in a recent white paper<\/a>, the RTO acknowledged the \u201cmissing money\u201d problem created by recent price caps that contributes to underinvestment in new generation, and queried whether the capacity market \u201cshould be the centralizing organizing instrument at all[.]\u201d<\/p>\n

Alternatively, a solution might come from the enforcement side of the regulatory equation. Fines for generation underperformance, like those assessed after Winter Storm Elliot, are meant to ensure that asset operators continue to generate units in good condition. But fines may not be high enough to adequately deter future underperformance, suggesting that regulators might consider penalty policies with higher ranges. In short, rethinking enforcement mechanisms for underperformance may be another path to address regulatory gaps.<\/p>\n

Conclusion<\/strong><\/h3>\n

The current financialization of energy infrastructure is a systemic risk that threatens to undermine both economic stability and climate resiliency planning. Reforms are necessary to ensure finance serves its proper purpose: not as a profit center in and of itself, but as support for the physical infrastructure and long-term capital investments that make human flourishing possible.<\/p>\n

<\/div>","protected":false},"excerpt":{"rendered":"

Compounding their significant climate and environmental harms, fossil fuels are also volatile commodities. In 2022, Russia\u2019s invasion of Ukraine disrupted the supply of natural gas, causing prices to spike. More recently, the United States\u2019 war on Iran resulted in the closure of the Strait of Hormuz, one of the most important oil and gas chokepoints […]<\/p>\n","protected":false},"author":2562,"featured_media":28871,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"footnotes":""},"categories":[69219,69134],"tags":[],"class_list":{"0":"post-28865","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-energy-resilience-1","8":"category-financial-regulation","9":"czr-hentry"},"yoast_head":"\nFinancial Speculation in Capacity Markets Undermines the Energy Transition - Climate Law Blog<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/blogs.law.columbia.edu\/climatechange\/2026\/05\/12\/financial-speculation-in-capacity-markets-undermines-the-energy-transition\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Financial Speculation in Capacity Markets Undermines the Energy Transition - Climate Law Blog\" \/>\n<meta property=\"og:description\" content=\"Compounding their significant climate and environmental harms, fossil fuels are also volatile commodities. 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