The merit order is the order in which power plants are deployed on the electricity trading market to cover electricity demand. It is intended to ensure the most economical power supply. It is therefore a market model and not a mandatory law on the order in which power plants are deployed and has been generally applied since the liberalization of the electricity market in 1998.
Power plant operators offer the electricity production of their power plants on the European Energy Exchange (EEX) for the next day at the respective marginal costs, i.e. the costs required to generate the megawatt hour. However, long-term costs, such as the expansion or reduction of generators, are not taken into account. This is a frequent point of criticism of the merit order model.
Similarly, energy suppliers order energy volumes to cover their electricity requirements for the following day. The EEX exchange then sorts the bids from the generating power plants in ascending order. This results in the merit order curve. Starting with the cheapest generator, all other power plants that are required to cover the load and are used accordingly are awarded the contract.
The merit order, meaning the deployment sequence of the generating power plants, and the energy demand can be used to determine the so-called market clearing price. This is determined by the most expensive power plant that receives a surcharge. In other words, the most expensive power plant that is used to meet demand. This power plant is also called the marginal power plant. Consequently, the market clearing price is the exchange price and is paid for all power plants used. The generators with particularly low marginal costs can accordingly achieve very high profits.
The expansion of renewables ensures permanently falling electricity production costs and thus a shift in the order of power plants. The marginal costs of renewables are virtually zero, since solar and wind energy are available free of charge. They are gradually displacing conventional power plants to the back of the merit order. This phenomenon, the displacement of the more expensive power plants, is also known as the merit order effect and ensures that expensive peak load power plants are used less frequently as price-determining power plants.
In the past, gas-fired power plants were the most expensive power plants with the highest marginal costs. Most of the gas used to generate electricity came from Russian production. As a result of the war situation in Ukraine and the political consequences, the price of gas rose sharply, as is well known. As a result, the marginal costs of gas-fired power plants have also risen extremely. Since then, the corresponding merit order curve shows exponential characteristics. If these power plants are used to meet demand, the market clearing price is correspondingly high.
Energy storage systems can reduce the average market clearing price with regard to the exchange electricity price. But how does this work? After all, no electrical energy is generated, but the feed-in is merely shifted in time.
At times of high feed-in of renewable energy, the merit order curve is initially very flat. As a large part of the load is covered with this amount of energy, the electricity exchange price will be comparably low. In individual cases, there are even negative exchange electricity prices on the market. Therefore, if the load increases due to the loading of a storage facility and thus also the demand, the market price only increases slightly due to the flat merit order curve.
However, if the energy supply is low in windless and dark periods due to the resulting low feed-in of renewable energies, the exchange electricity price rises sharply, as power plants with expensive marginal costs now produce the electricity and ensure a steeper merit order curve. At these times, charged energy storage systems can create additional supply and displace the marginal power plant, the price-determining power plant. In this way, a price-dampening effect can be achieved by shifting the feed-in. This can also be read in detail in our blog article "Why battery storage systems reduce electricity prices" .
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