The merit order is a way of ranking available sources of energy, especially electrical generation, based on ascending order of price (which may reflect the order of their short-run marginal costs of production) together with amount of energy that will be generated. In a centralized management, the ranking is so that those with the lowest marginal costs are the first ones to be brought online to meet demand, and the plants with the highest marginal costs are the last to be brought on line. Dispatching generation in this way minimizes the cost of production of electricity. Sometimes generating units must be started out of merit order, due to transmission congestion, system reliability or other reasons.
The effect of renewable energy on merit order
The high demand for electricity during peak demand pushes up the bidding price for electricity, and the relatively inexpensive baseload power supply mix is supplemented by 'peaking power plants', which charge a premium for their electricity.
Increasing the supply of renewable energy tends to lower the average price per unit of electricity because wind energy and solar energy have very low marginal costs: they do not have to pay for fuel, and the sole contributors to their marginal cost is operational and maintenance. With cost often reduced by feed-in-tariff revenue, their electricity is as a result, less costly on the spot market than that from coal or natural gas, and transmission companies buy from them first. Moreover, solar energy is typically most abundant in the middle of the day, coinciding closely with peak demand in warm climates, so that it is in the best position to displace coal and natural gas electricity when those sources are charging the highest premium. Solar and wind electricity therefore substantially reduce the amount of highly priced peak electricity that transmission companies need to buy, reducing the overall cost. A study by the Fraunhofer Institute found that this "merit order effect" had allowed solar power to reduce the price of electricity on the German energy exchange by 10% on average, and by as much as 40% in the early afternoon, in 2007; as more solar electricity is fed into the grid, peak prices will come down even further. By 2006, the "merit order effect" meant that the savings in electricity costs to German consumers more than offset for the support payments paid for renewable electricity generation.
A 2013 study estimates the merit order effect of both wind and photovoltaic electricity generation in Germany between the years 2008 and 2012. For each additional GWh of renewables fed into the grid, the price of electricity in the day-ahead market is reduced by 0.11–0.13 ¢/kWh. The total merit order effect of wind and photovoltaics ranges from 0.5 ¢/kWh in 2010 to more than 1.1 ¢/kWh in 2012.
The zero marginal cost of wind energy does not, however, translate, into zero marginal cost of peak load electricity in a competitive open electricity market system as wind supply cannot be dispatched to meet peak demand. The purpose of the merit order was to enable the lowest net cost electricity to be dispatched first thus minimising overall electricity system costs to consumers. Intermittent wind might be able to supply this economic function provided peak wind supply and peak demand coincide both in time and quantity. On the other hand, solar energy tends to be most abundant during peak energy demand in warm climates, maximizing its ability to displace coal and natural gas power.
A study by the Fraunhofer Institute in Karlsruhe, Germany found that windpower saves German consumers €5 billion a year. It is estimated to have lowered prices in European countries with high wind generation by between 3 and 23 €/MWh. On the other hand, renewable energy in Germany increased the price for electricity, consumers there now pay 52.8 €/MWh more only for renewable energy (see German Renewable Energy Sources Act), average price for electricity in Germany now is increased to 26 ¢/kWh. Increasing electrical grid costs for new transmission, market trading and storage associated with wind and solar are not included in the marginal cost of power sources, instead grid costs are combined with source costs at the consumer end.
- William Blyth, Ming Yang, Richard A. Bradley, International Energy Agency (2007). Climate policy uncertainty and investment risk : in support of the G8 plan of action. Paris: OECD Publishing. p. 47. ISBN 9789264030145. Retrieved 24 December 2012.
- Frank Sensfuß; Mario Ragwitz; Massimo Genoese (2007). The Merit-order effect: A detailed analysis of the price effect of renewable electricity generation on spot market prices in Germany. Working Paper Sustainability and Innovation No. S 7/2007 (PDF). Karlsruhe: Fraunhofer Institute for Systems and Innovation Research (Fraunhofer ISI).
- Cludius, Johanna; Hermann, Hauke; Matthes, Felix Chr. (May 2013). The merit order effect of wind and photovoltaic electricity generation in Germany 2008–2012 — CEEM Working Paper 3-2013 (PDF). Sydney, Australia: Centre for Energy and Environmental Markets (CEEM), The University of New South Wales (UNSW). Retrieved 2016-07-27.
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- Sensfuss, Frank; Ragwitz, Mario; Massimo, Genoese (August 2008). "The merit-order effect: A detailed analysis of the price effect of renewable electricity generation on spot market prices in Germany". Energy Policy. 36 (8): 3076–3084. doi:10.1016/j.enpol.2008.03.035.