The rapid expansion of hyperscale data centers to support artificial intelligence, cloud computing, and big data analytics has fundamentally altered electricity demand patterns across various regions in the United States. In response to rising peak loads and concerns about grid reliability during extreme weather and supply disruptions, numerous developers have adopted a co-location model, linking large IT campuses directly with on-site generation assets. Although this arrangement presents appealing benefits—including a dedicated power supply, reduced exposure to transmission congestion, and potential for improved resiliency—it also obscures the established lines of cost causation and market participation. If a generator solely supplies its neighboring data center, should it still bear the costs of network upgrades, capacity obligations, and ancillary services that traditional grid customers have historically shouldered? On February 20, 2025, the Federal Energy Regulatory Commission issued a show-cause order under Section 206 of the Federal Power Act, requiring PJM Interconnection and its transmission owners to demonstrate that their tariffs appropriately govern co-located facilities or to propose specific reforms. Although focused on PJM, the largest ISO by load, the outcome of this proceeding is expected to influence tariff design and cost-allocation principles across all organized markets.
The Emergence of Co-Located Data Centers
Over the past decade, certain corridors—most notably Northern Virginia’s “Data Center Alley”—have experienced explosive growth in server farms consuming hundreds of megawatts each. As developers pursued increasingly larger load footprints, traditional transmission networks began displaying capacity constraints, especially during peak periods. In this context, co-location emerged as an innovative approach: by situating a data center next to an existing power plant—whether a natural gas combined-cycle facility, a combustion turbine, or even a nuclear station—operators can access dedicated behind-the-meter generation. This design can shield data centers from congestion charges on transmission lines and lessen reliance on the broader grid during emergencies. Several high-profile proposals arose, including plans to pair a hyperscale data campus with a nuclear reactor in Pennsylvania. Proponents argued that such arrangements would provide carbon-free, reliable electricity at stable prices while creating new revenue streams for generation owners. However, opponents expressed concerns that if the paired load were effectively removed from the tariffed network service framework, the fixed costs of grid maintenance and expansion would be distributed among a smaller base of remaining customers, potentially leading to higher rates for all other users. Without clear tariff rules, these bespoke deals risked undermining cost-causation norms and eroding system visibility.
Legal Underpinnings of FERC’s Section 206 Show-Cause
FERC’s intervention relies on Section 206 of the Federal Power Act, which grants the Commission the authority to investigate and remedy any rate, charge, or tariff provision it deems unjust, unreasonable, or unduly discriminatory. In contrast to changes initiated by PJM under Section 205, a Section 206 proceeding requires the existing tariff to show its reasonableness. FERC’s February 20 order consolidated complaints, technical conference findings, and stakeholder concerns regarding co-location into Docket EL25-49-000. The Commission determined that PJM’s Open Access Transmission Tariff and related agreements “do not appear to sufficiently address the rates, terms, and conditions of service applicable to co-location arrangements,” a deficiency that could result in unjust or unreasonably discriminatory outcomes. By issuing a show-cause directive, FERC mandated that PJM and its transmission owners justify the status quo or propose targeted tariff amendments within 30 days, under the threat of Commission-imposed revisions and refund obligations dating back to November 2024.
The Complexity of Co-Location Configurations
At the heart of the inquiry lies the multifaceted nature of co-location itself. FERC and PJM distinguish between fully isolated configurations—where the data center draws exclusively from its paired generator under normal operations—and networked arrangements in which the co-located load remains a formal network customer, drawing supplemental power from the grid as needed. Fully isolated models offer maximum autonomy but raise operational risks: if the on-site generator trips, the data center must transition to grid supply, potentially without sufficient notice or reservation, creating sudden load swings that can destabilize local voltages. Networked models mitigate these reliability concerns by maintaining the data center’s visibility in system load forecasts and market dispatch, but they may dilute some economic advantages of behind-the-meter generation. Each variation implicates distinct interconnection study requirements, dispatch protocols, and cost responsibilities. Without explicit tariff definitions, both PJM and project proponents have relied on informal guidance and bilateral agreements, leaving significant ambiguity around who pays for network reinforcements, capacity reliability, and ancillary services.
PJM’s Tariff Deficiencies and the Path to Reform
Before FERC’s show-cause order, PJM’s tariff had no dedicated provisions for co-location. Its existing rules envisioned two distinct roles: generators interconnecting to sell wholesale power and loads taking network transmission service. Hybrid sites did not align neatly with either category. Stakeholders had debated the issue in PJM committees since 2022, but reaching a consensus proved elusive. In early 2024, PJM issued nonbinding guidance suggesting that co-located loads be treated as network customers whenever feasible, reinforcing the idea that even physically adjacent loads should pay standard transmission rates and capacity charges. However, this guidance lacked enforceability, and project-specific exceptions continued to persist. FERC’s order explicitly highlighted gaps in transmission service definitions, interconnection study processes, and ancillary-service obligations for these facilities. It emphasized the need for uniform tariff language to assign responsibilities for cost causation, reliability, and market participation.
Anticipated Tariff Revisions and Market Impacts
PJM’s compliance filings are anticipated to propose a structured menu of service options for co-located facilities, each linked to defined cost and reliability obligations. One probable outcome is the codification of distinct service categories, ranging from full network integration to limited backup transmission reservation, with corresponding rate schedules. Tariff reforms may require the registration of co-located loads as network customers, real-time telemetry for both generation and load and participation in capacity auctions if the paired generator significantly impacts resource adequacy. Emergency back-stop provisions could necessitate that co-located sites curtail load or switch to predefined service levels during system stress events. These changes will reverberate through market clearing prices, transmission planning assumptions, and the levelized cost calculations of co-location projects. Early analysis suggests that incorporating transparent cost allocations and reliability requirements could increase the effective cost of behind-the-meter arrangements by up to ten percent, thereby narrowing the economic incentive but enhancing system integrity.
Implications Beyond PJM for ISO/RTO Tariffs
Although the show-cause order initially targets PJM, FERC’s findings are significant for all interstate wholesale markets. Other ISOs, including those in New England, New York, the Midwest, and California, are facing similar proposals—battery-infused electric vehicle hubs and AI centers seeking tailored generator partnerships. Regions lacking explicit co-location rules confront the possibility of reactive show-cause directives or litigation once major projects arise. By establishing clear definitions, cost-allocation safeguards, and operational protocols in PJM, FERC is creating a model for other RTOs to adopt voluntarily. Furthermore, the Commission may issue broader policy guidance or a rulemaking extending essential principles—such as mandatory cost contributions for standby service—to all FERC-jurisdictional tariffs. This uniformity would help maintain equitable cost-sharing and reliability planning as diverse private-sector innovations develop across the grid.
Strategic Considerations for Industry Stakeholders
Data center developers and generation owners now face both opportunities and constraints. Regulatory clarity reduces project development risk, enabling stakeholders to negotiate co-location agreements with clear cost parameters and reliability expectations. However, the prospect of paying explicit transmission reservation fees, capacity charges, and ancillary service obligations diminishes some of the cost savings that initially made co-location appealing. To navigate this landscape, many developers are pursuing negotiated rate filings under Section 205 while participating in PJM’s stakeholder process to shape tariff language. Hybrid commercial structures have emerged where a generator commits a portion of its capacity to the grid and reserves the rest for local load, striking a balance between market integration and on-site supply. Legal teams and market analysts are stress-testing these models against PJM’s load forecasts and capacity auctions to quantify potential cost impacts and secure competitive financing terms.
From a financial perspective, lenders and investors require stable, predictable regulatory frameworks before underwriting long-term debt. The uncertainty surrounding retrospective cost assignments—or potential refund obligations dating back to late 2024—adds risk premiums to capital costs. Clarity on co-location tariffs will enable more accurate project underwriting, enhance bankability, and facilitate innovative power purchase and standby service contracts tailored to the needs of data centers. Generators, particularly merchant nuclear and gas facilities under economic pressure, may view co-location as a revenue lifeline if structured fairly. Transparent tariff rules will determine whether such partnerships can significantly extend plant operating lives and support grid decarbonization goals.
The Road Ahead: Timeline and Milestones
Under FERC’s procedural schedule, PJM and its transmission owners filed initial responses by late March 2025, outlining either defenses for the existing tariff or proposed revisions. Stakeholders then submitted comments in late April, discussing the merits of competing models. FERC indicated its intention to issue a further order by mid-2025, potentially approving interim measures or directing a formal Section 205 filing for proposed tariff amendments. Meanwhile, PJM’s technical teams are conducting detailed studies to quantify the system impacts of various co-location configurations, ranging from flow analyses to resource adequacy modeling. These technical insights will inform the final tariff design, ensuring that obligations for registration, telemetry, and reliability are based on operational realities. A finalized tariff, likely to take effect by late 2025 or early 2026, will usher in a new era in which co-located generator-load pairings coexist within a transparent, equitable market framework.
Conclusion
FERC’s 2025 show-cause inquiry into co-location in PJM marks a critical turning point in the evolution of electricity markets. By requiring explicit tariff rules for data center–generator pairings, the Commission underscores the ongoing importance of cost causation and system visibility, even as the grid adapts to new load-integration models. The upcoming PJM reforms—defining service categories, clarifying cost responsibilities, and enforcing operational coordination—will serve as a blueprint for other ISO/RTOs and utilities nationwide. For datacenter developers, generation owners, and grid planners, this proceeding provides regulatory certainty and a pathway to innovate responsibly. As the energy transition accelerates and AI-driven loads continue to reshape demand patterns, establishing fair and transparent co-location frameworks will be vital to maintaining a reliable, efficient, and equitable power system.
