How it works
The system operator first works out how much firm capacity it needs to cover peak demand with a reserve margin, for a delivery year that may be up to three years away. It then runs an auction. Generators, storage and demand response offer capacity in MW at a price, and the auction clears where their offers meet a demand curve set by the operator. Cleared resources are paid the clearing price, often quoted in $/MW-day or $/kW-year.
Each resource can offer only its accredited capacity, which is lower than nameplate for plants that may not be running at peak. Solar, wind and short-duration storage are derated according to how much they contribute in the hours of highest risk. In return for payment, a cleared resource must be available when called during system stress. If it fails to perform, it pays a penalty that can wipe out much of its capacity income.
Why it matters
Capacity payments are a revenue line separate from energy, and they often make a battery or peaking plant financeable. They are set years ahead, which gives lenders a fixed income stream to lend against. For storage, accreditation rules decide how much of a battery's MW earns, so duration is chosen partly against them. For large buyers, capacity costs flow into bills as a charge tied to their demand at peak.
A worked example
A 100 MW, 4-hour battery is accredited at 80% of nameplate, so it offers 80 MW. The auction clears at $150/MW-day for the delivery year. Annual revenue is 80 × $150 × 365 = $4,380,000. A 2-hour battery of the same power, accredited at 50%, offers 50 MW and earns 50 × $150 × 365 = $2,737,500. The extra two hours of duration are worth about $1.6 million a year in capacity payments alone.
Illustrative figures.
Across markets
In the US, PJM, ISO New England, New York and MISO run capacity markets, each with its own auction timing and accreditation rules, while ERCOT is energy-only. Great Britain, Italy, Poland and Ireland, among others in Europe, run capacity mechanisms under state-aid approval. India has no capacity market of this kind. Utilities pay a fixed capacity charge to contracted thermal plants under long-term PPAs, and resource adequacy is planned by the utilities and regulators.