A classification of Christoph Gardlo, COO of ESFORIN:
The merit order system is regularly the subject of criticism. Ever since the 2022 energy crisis, at the very latest, the question has been raised time and again: Is a market design in which a relatively small share of expensive gas-fired power plants determines the electricity price for everyone still appropriate today? Or does this very principle prevent an even more efficient and cost-effective electricity market?
The discussion is understandable. High electricity prices are a burden on both industry and consumers. At the same time, the energy transition is fundamentally changing the structure of our electricity system. Renewable energy sources are increasingly dominating generation, battery storage is growing rapidly, and flexibility is becoming ever more important. Nevertheless, I believe it is a mistake to make the merit order the scapegoat. Anyone who wants to understand the causes of high electricity prices must look deeper.
What exactly is the merit order?
At its core, the merit order is nothing more than a market-based principle. Power plants are ranked according to their short-term generation costs. The cheapest generators—such as wind and solar plants—feed power into the grid first, followed by more expensive power plants. The last power plant still needed determines the market price for all of them.
This process is neither complicated nor specific to the electricity market. It is based on the fundamental economic principle of supply and demand. Similar mechanisms can be found in virtually all commodity and energy markets worldwide. This is precisely why the merit order has proven its worth over decades. It ensures the efficient allocation of resources and creates incentives for investment in new generation capacity.
The real problem does not lie in the market design
The debate is often reduced to the argument that gas-fired power plants determine the price of electricity and that electricity prices are therefore too high. However, this view falls short. For one thing, gas-fired power plants do not set the price every hour by any means. During many hours, it is coal-fired power plants that set the price; in extreme situations, it is even oil-fired power plants or imports from neighboring countries. Furthermore, while gas accounts for only a relatively small share of Germany’s electricity mix, it plays a crucial role in ensuring the system’s security of supply and flexibility.
The key issue is rather the composition of the overall generation mix. Countries such as France, Spain, and the Nordic nations have lower electricity prices, not because they use a different pricing mechanism, but because their generation structure is different. Nuclear power, hydropower, and a high share of renewable energy sources lower average production costs in those countries. The cause of high electricity prices therefore lies less in market mechanisms than in the structure of the system itself.
Why Interventions in the Merit Order Can Be Problematic
Alternatives are discussed time and again. These include caps on gas prices, government-set reference prices, or so-called “pay-as-bid” systems. What sounds attractive at first glance often creates new problems. Experience shows: Interventions in price formation do not eliminate costs; they merely shift them. Anyone who artificially lowers the wholesale price must finance the resulting shortfall elsewhere—for example, through surcharges, taxes, or grid fees. The actual costs of electricity generation do not disappear; they simply become less transparent.
Furthermore, a harmonized European electricity market depends on uniform rules. If individual countries begin to introduce their own pricing mechanisms, this could lead to market distortions, inefficiencies, and reduced investment certainty.
The energy transition needs more flexibility, not less of a market
The real challenge in the coming years is not “merit order or no merit order.” Rather, the crucial question is how we can organize an increasingly renewable power system in a stable and efficient manner. Flexibility plays a central role here:
- Battery Storage
- Demand-Side Management
- smart grids
- Smart Meter
- Bidirectional charging of electric vehicles
- Cross-sector use of electricity, heat, and mobility
Battery storage, in particular, is currently advancing at an enormous pace. It can help smooth out price spikes, store excess renewable energy, and significantly increase flexibility in the energy system. At the same time, however, the challenge of prolonged periods of low wind and solar output remains. Additional hedging mechanisms will continue to be needed in the future for periods lasting several days or even several weeks with low wind and solar production.
That is precisely why the discussion in the future will focus less on individual technologies and more on the optimal combination of various flexibility options.
Why Energy Security Still Comes at a Price
One aspect of the debate that is often overlooked concerns the financing of backup capacity. In an electricity system with a high share of renewable energy, flexible power plants are operating less and less frequently. At the same time, they must be available at all times. This leads to the so-called “missing money problem”: Power plants are needed to ensure supply security, but often do not generate enough revenue through the electricity market alone to be economically viable.
That is why capacity markets, Contracts for Difference (CfDs), and other investment mechanisms are gaining importance. They do not replace the merit order, but rather complement it in cases where market prices alone no longer provide sufficient incentives for investments in security of supply.
Conclusion: The merit order is not the problem
The discussion about merit order is important because it touches on key issues related to the energy transition. However, it often distracts from the actual challenges. Merit order continues to ensure efficient price formation and a transparent allocation of generation capacity. High electricity prices do not result primarily from the market design, but rather from the structural conditions of our energy system: the generation mix, grid expansion, the availability of flexibility options, and the policy decisions made in recent years.
Anyone who wants to lower electricity prices permanently should therefore not change the pricing mechanism, but rather address the root causes:
- Faster network and infrastructure development
- Expansion of Battery Storage
- greater load flexibility
- Digitalization of the Energy Sector
- Technology-neutral investments in guaranteed performance
The energy transition requires more market integration, more flexibility, and more investment—not less merit order. After all, the bottom line is this: An efficient electricity market is not created by eliminating price signals, but by establishing the right framework conditions to allow those signals to take effect.
