How the electricity price is determined

The energy market is in flux as never before. An unexpected power plant failure, or just a weekend with abundant wind and solar power, can lead to sharp price fluctuations within hours, with peaks or troughs, sometimes even below zero.

For many companies, this is often a source of uncertainty: why does the market price vary so much? Although the market is dynamic, it relies on specific mechanisms. By understanding these mechanisms, you can predict price fluctuations more strategically.

The merit order: a key principle

One of the fundamental principles for understanding power prices is the merit order. But what does it mean?

The merit order principle determines how electricity prices are set in the market. It describes the order in which different generating plants are deployed to meet demand. The decisive criterion is the marginal cost: the extra cost to produce one more kilowatt-hour.

The deployment order usually looks like this:

• Wind and solar power: virtually no marginal cost because wind and solar are free.

• Nuclear power plants: low marginal cost, but higher fixed costs.

• Gas, oil and coal plants: higher marginal costs, depending on fuel prices and the CO2 price.

The cheapest sources are used first to meet electricity demand. Only when demand rises further do more expensive power plants come into the picture, and the electricity price is ultimately determined by the most expensive plant still needed to meet total demand.

The merit order principle in practice

• Lots of wind production: gas plants are used less, which usually leads to a lower market price.
• Negative prices:in some situations, electricity supply exceeds demand. This happens especially when there is a lot of wind or sun in combination with low electricity demand, for example at night or on weekends. In such cases, hourly prices can drop below zero. Negative prices arise because not all power plants can be shut down flexibly and because options for storage or export are limited. To avoid additional costs or technical problems, producers in these situations are willing to offer power at negative prices.
• Little sun and wind, high demand: gas or even oil power plants have to step in more often. In such situations, the daily market price for power rises.

The merit order therefore explains why prices can move sharply depending on weather conditions, demand and power plant availability.

What does this mean for your business?

By understanding these mechanisms, you can better assess market fluctuations and avoid unpleasant surprises, allowing you to better anticipate risks and opportunities.

Some examples:

• Are gas prices rising? Then electricity prices often rise along with them.

• Is a lot of wind predicted? Then the daily market price for electricity may drop.

• Are there outages or maintenance at nuclear power plants? Then the deployment order may change.

By monitoring these factors, you can plan energy costs smarter, reduce risks and choose an appropriate purchasing strategy in a more targeted way. That not only provides peace of mind, but also a strategic advantage.