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 merit order in the British electricity market
The merit order was the method used in the electricity market of Great Britain when electrical power generation was the responsibility of a single integrated utility (the CEGB). After privatisation of the sector this was replaced by a more complex bidding system, the electricity pool, in 1990.
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 contributor to their marginal cost is operational cost. As a result, their electricity, this costs fully covered by the FIT revenue, is, on the spot market, less costly 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, 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.
The effect of intermittency on merit order
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, 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 5bn euros a year. It is estimated to have lowered prices in European countries with high wind generation by between 3 and 23 euros per megawatt hour. 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 Act), average price for electricity in Germany now is increased to 26 €ct./KWh.
- 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).
- Helm, Dieter; Powell, Andrew (1992). "Pool Prices, Contracts and Regulation in the British Electricity Supply Industry". Fiscal Studies 13 (1): 89–105. doi:10.1111/j.1475-5890.1992.tb00501.x.
- Sensfuss, Frank; Ragwitz, Mario (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 ( August)): 3076–3084. doi:10.1016/j.enpol.2008.03.035.