Capacity Markets Regulation: Detailed Explanation with Case Laws

1. Introduction

A capacity market is a mechanism through which electricity generators and other eligible resources are compensated not merely for the electricity they actually produce, but also for maintaining available generation capacity that can be called upon when required.

The concept is different from an ordinary electricity market. In an energy market, the principal commodity is electricity measured in units such as MWh. In a capacity market, the focus is on availability and adequacy of capacity, generally measured in MW.

In India, capacity-market regulation is an evolving area. The Central Electricity Regulatory Commission (CERC) issued a Staff Paper on “Capacity Market for Electricity in India” in 2026, showing that the subject is currently under active regulatory consideration rather than being a fully established standalone national capacity-market regime.

2. Meaning and Purpose of Capacity Markets

Electricity must be supplied continuously because large-scale storage is still limited compared with total system requirements. Therefore, a power system needs sufficient generation capacity to meet demand during periods of peak consumption, unexpected outages and other system contingencies.

A capacity market attempts to solve this problem by creating a financial incentive for generators to remain available.

For example, if a generating company has a 500 MW plant, an energy market primarily rewards the electricity actually generated. A capacity mechanism may additionally compensate the generator for keeping an agreed amount of capacity available for the system.

The principal objectives are:

Ensuring resource adequacy.

Maintaining sufficient reserve capacity.

Encouraging investment in new generating capacity.

Reducing the possibility of electricity shortages.

Providing predictable revenue for capacity providers.

Supporting reliability of the electricity grid.

3. Capacity Market and Energy Market: Difference

The distinction between the two markets is important.

An energy market answers the question: How much electricity is produced and supplied?

A capacity market answers the question: How much dependable capacity will be available when the system needs it?

Therefore, capacity payments are generally associated with availability, reliability and adequacy, whereas energy payments are associated with actual electricity supplied.

Indian electricity regulation already contains concepts such as capacity charges within tariff structures. However, capacity charges under regulated tariffs should not automatically be treated as equivalent to a fully developed competitive capacity market.

4. Legal Framework in India

The primary legislation is the Electricity Act, 2003.

Section 61 lays down principles governing tariff regulations, including efficiency, competition, economic use of resources, investment and consumer interests. Section 66 requires the appropriate Commission to endeavour to promote the development of a market, including trading, in electricity.

CERC exercises important regulatory functions under Sections 76, 79 and 178 of the Electricity Act.

The CERC Power Market Regulations, 2021 are particularly relevant. These regulations expressly contemplate different electricity-market contracts and include “Capacity Contracts” among contracts that may be approved by the Commission.

Thus, Indian regulation already provides a legal foundation for capacity-related market instruments, while the broader design of a capacity market remains under development.

5. Role of CERC

CERC has a central role in developing electricity markets in India. Its statutory mission includes promoting competition, efficiency and economy in bulk power markets, improving supply quality, promoting investment and facilitating the development of power markets.

The 2026 Staff Paper on Capacity Market for Electricity in India is significant because it indicates that the regulator is examining how a capacity mechanism could operate within India's electricity system. Issues likely to arise include:

determining the required capacity;

eligibility of capacity resources;

capacity obligations;

procurement mechanisms;

capacity pricing;

performance requirements;

penalties for non-availability;

treatment of renewable energy and storage;

interaction with existing power markets.

6. Case Law: PTC India Ltd. v. CERC

A foundational judgment is PTC India Ltd. v. Central Electricity Regulatory Commission, (2010) 4 SCC 603.

The Supreme Court recognised the legislative character of regulations made by CERC under the Electricity Act. Regulations made under Section 178 constitute subordinate legislation and can affect existing contractual arrangements between regulated entities.

This principle is highly relevant to capacity-market regulation. If CERC establishes binding capacity-market rules within its statutory authority, market participants cannot simply rely upon contractual arrangements inconsistent with those regulations.

7. Case Law: Energy Watchdog v. CERC

In Energy Watchdog v. Central Electricity Regulatory Commission, (2017) 14 SCC 80, the Supreme Court considered the regulatory framework governing electricity tariffs and power-purchase agreements.

The case is important because it demonstrates that electricity regulation must operate within the statutory framework of the Electricity Act and applicable regulatory instruments. The Court's reasoning is relevant to capacity markets because capacity procurement, availability obligations and payments must similarly be structured within statutory and regulatory authority.

8. Case Law: Gujarat Urja Vikas Nigam Ltd. v. Solar Semiconductor Power Co.

In Gujarat Urja Vikas Nigam Ltd. v. Solar Semiconductor Power Co. (India) Pvt. Ltd., (2017) 16 SCC 498, the Supreme Court emphasised that a regulatory commission is a creature of statute and cannot assume powers that have not been conferred upon it.

The principle is particularly important for capacity-market design. CERC or any other regulatory authority must identify clear statutory authority for imposing capacity obligations, financial penalties or market-access conditions. Regulatory convenience alone cannot create substantive jurisdiction.

9. Case Law: Haryana Power Purchase Centre v. Sasan Power Ltd.

In Haryana Power Purchase Centre v. Sasan Power Ltd., (2024) 1 SCC 247, the Supreme Court reaffirmed the importance of regulatory regulations in the electricity sector. Subsequent Supreme Court decisions have relied on PTC India and related cases to explain that valid CERC regulations can override inconsistent contractual arrangements.

This principle would become significant if capacity-market regulations affect existing PPAs or capacity commitments.

10. Regulatory Challenges

Capacity-market regulation presents several challenges in India.

First, India has a rapidly expanding renewable-energy sector, particularly solar and wind, whose output is variable. A future capacity mechanism must therefore determine how renewable resources, batteries, pumped-storage projects and conventional generators contribute to dependable capacity.

Second, there is a risk of over-procurement. If regulators procure excessive capacity, consumers may bear unnecessary costs.

Third, capacity markets can create complicated interactions with existing PPAs, regulated tariffs, power exchanges, ancillary services and real-time electricity markets.

Fourth, market design must prevent generators from receiving capacity payments without actually providing the promised availability.

11. Conclusion

Capacity-market regulation seeks to ensure that an electricity system has adequate dependable resources available when consumers need them. It complements, rather than simply replaces, the energy market.

In India, the legal and regulatory framework is still evolving. The CERC Power Market Regulations already recognise capacity contracts as a possible category of market contracts, while the Commission's 2026 Staff Paper demonstrates active consideration of a broader capacity-market framework.

The Supreme Court's decisions in PTC India, Energy Watchdog, Gujarat Urja Vikas Nigam and related electricity cases establish important principles for any future regime: regulatory authorities must act within statutory powers, valid regulations have binding legal force, and electricity-sector contracts must operate consistently with the regulatory framework.

Accordingly, the future of capacity markets in India will depend upon achieving a careful balance between grid reliability, investment incentives, competitive market design and consumer protection.