The merit-order effect

The strange behavior of electricity prices

Have you ever wondered why electricity prices fluctuate so much throughout the day? Or why they seem to drop significantly when there’s plenty of wind or sun? Maybe you’ve even noticed that prices can sometimes go negative. This all comes down to one fundamental principle: the merit-order effect.

Electricity is traded through several market stages before physical delivery. One of the most important is the day-ahead market, where electricity for the following day is bought and sold one day in advance. In liberalized European markets, it is organized as a blind auction: producers submit supply offers, consumers and retailers submit demand bids, and the intersection of the aggregated supply and demand curves determines the market-clearing price for each delivery period. Accepted orders are settled at the same clearing price, which makes the day-ahead auction a pay-as-clear market