Merit Order

Merit Order

Merit order is a ranking system used to determine the order in which different sources of electricity should be used to meet demand. It is based on the marginal cost of each source, with the lowest-cost sources used first. This system optimizes using different power plants and resources while maintaining a fair market environment for participating generators.

Energy Exchange Pricing

But first things first. We need to briefly explain how power exchange pricing works to understand merit order.

The electricity market behaves like any other market - based on supply and demand. When electricity demand exceeds supply, the price of the power exchanges rises and vice versa. Customers' electricity demand is constantly evaluated against the lowest prices provided by individual power plants.

Power plants only produce electricity when it is profitable, i.e., when the selling price per unit of electricity is higher than the cost of production. And because production costs vary from plant to plant, different plants set different minimum prices at which they are willing to sell electricity on the exchange. Take a coal-fired power station, for example. It has to pay for fuel and emission allowances compared to a solar plant, so it will sell at a higher minimum price on the market.

Learn more about how power plants set their electricity prices and how electricity prices are set in general

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Price is not the only thing differentiating power plants - we also need to look at the maximum capacity they can provide. The market has to decide for each hour of the day which power plants will run to meet the electricity demand while considering all these factors.

How Does the Market Decide Which Plants to Run?

The merit order is the principle that governs how we prioritize which generators we use to supply electricity to the grid. The merit order means that the generators that produce electricity at the lowest cost are used first. The generators that are more expensive to run are only brought online when the electricity demand cannot be met by the cheaper generators. Besides the price, the market has to consider the ability of power plants to produce electricity within a given time frame as well when deciding which power plants to choose.

Think of it like a queue of generators, with the cheapest at the front and the most expensive at the back. As long as the electricity demand can be met by the generators at the front of the queue, the more costly generators will remain idle.

The 'market clearing price' is the lowest bid accepted in an auction to buy electricity. The plant with the highest marginal cost sets the market price for all plants. This pricing mechanism is known in the energy industry as 'uniform pricing' because all power plants receive the same price for their electricity, even if they have offered different prices.

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