Merit order

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 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.

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