The merit order refers to the order in which power plants are deployed on the electricity trading market to meet electricity demand. It is intended to ensure the best economic supply of electricity. It is therefore a market model and not a mandatory law for the deployment order of power plants and has been generally applied since the liberalization of the electricity market in 1998.
How is the merit order formed?
On the European Energy Exchange (EEX), power plant operators offer their power plants' electricity production 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 addition or removal of generators, are not taken into account here. This is a frequent criticism of the merit order model.
Similarly, energy suppliers order energy quantities in order to be able to cover their electricity requirements for the following day. The EEX exchange then sorts the offers 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 needed to cover the load and are used accordingly are awarded the contract.
How is the electricity trading price determined?
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.
What does the merit order effect describe?
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.
Influence of the current situation
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.
What influence does battery storage have on the merit order?
Energy storage can lower the average market clearing price in terms of 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 energies, the merit order curve is initially very flat. Since a large part of the load is covered with this amount of energy, the exchange electricity price will be comparably low. In individual cases, there are even negative exchange electricity prices on the market. Thus, if the load increases due to the loading of a storage facility and thus also the demand, the market price increases only 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, because now power plants with expensive marginal costs produce the electricity and ensure a steeper merit order curve. During these times, charged energy storage can create additional supply and displace the marginal power plant, the power plant that sets the price. 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 lowers electricity prices"..