“Nord pool does not establish the price for electricity, something that end-consumers and even market participants think we do,” says Kristiane. 

The Senior Expert in Nord Pool Consulting and previous Trading Adviser sheds light on the price creation process that empower stakeholders to navigate the energy landscape with clarity. 

“Nord Pool is a power exchange platform where market participants submit their bids and offers. As one of several Nominated Electricity Market Operators (NEMOs), Nord Pool collaborates with other power exchanges through a common implicit auction system.” 

While cross-border transmission capacities are vital for exchanging offers and standardised rules and procedures ensure consistent market results, the merit order effect plays a crucial role in determining electricity prices and to ensure that demand is always met in the cheapest possible manner.

How the merit order ensures the lowest price possible 

Imagine a lineup of power plants, each waiting to contribute electricity to the market. These plants are ordered based on their production costs. 

The cheapest power station, usually renewable, supplies electricity first, followed by progressively more expensive ones. As demand increases, additional power stations are brought online, and their costs influence the overall price. 

“The last power station needed to meet demand sets the market-clearing price – the price at which all electricity is sold,” Kristiane elaborates. 

“So, the merit order determines the sequence of power station dispatch and ultimately shapes the market price. This way of achieving the daily power price allows the utilisation of resources as efficiently as possible.” 

Impact of renewable energy on merit order and price formation 

Increased production from renewable sources like solar and wind significantly impacts the merit order and price formation. These technologies typically have very low marginal costs, allowing them to supply electricity at a lower price compared to coal, gas, nuclear, and even hydropower. 

“Consequently, they are often at the top of the merit order, pushing down prices. As renewables become more prevalent, they set the price more frequently, benefiting consumers,” Kristiane explains. 

As more solar and wind energy is included in the merit order graph, the overall supply curve shifts, enabling the provision of more electricity at a lower price. This shift in the merit order can also squeeze out more expensive technologies. “With sufficient supply from lower-cost renewable sources, higher-cost technologies become less competitive and are used less frequently,” Kristiane adds. 

Comparing gas and renewables in the merit order 

Gas-fired power plants face higher operational costs compared to renewable energy sources. The marginal price, based on the operational cost of producing a unit of electricity, plays a crucial role in this competitiveness. 

“A gas power plant needs gas to run and is therefore dependent on the gas price. When the CO2 price is high, it becomes more expensive to produce a megawatt from gas than from solar and wind,” Kristiane explains. 

This dependency on gas prices and CO2 costs makes gas-fired power plants less competitive in the merit order compared to renewables, which have lower marginal costs. As a result, renewables are dispatched first, pushing gas-fired plants further down the merit order. If there is not enough energy from renewables available in the system, gas is next in line, and the price for gas will then determine the spot prices. 

The curve orders 

Essentially, curve orders harmonise the supply and demand across Europe’s electricity market. Nord Pool acts as a conductor, ensuring reliability, transparency, and progress across borders. 

Curve orders are defined as product orders where a volume is specified for each price step. Post gate closure, Nord Pool constructs two pivotal curves: one for supply and one for demand. The supply curve, derived from sell orders, illustrates the available supply at various prices. Kristiane explains; 

“We compile all the orders to determine the volume each participant is willing to sell at different prices. Starting from the technical minimum price of -500 euros, we aggregate the volume for each subsequent price step until we reach the maximum price of 4000 euros, forming a slightly upward-sloping curve.”  

Similarly, the demand curve, based on buy orders, represents the desired quantity of electricity at different price levels.  

“We apply the same method to the demand curves, assessing the demand at each price step from -500 euros to 4000 euros. The intersection of these curves determines the market price and volume,” Kristiane elaborates. 

This process underscores the importance of curve orders in defining volumes per price step, essential for comprehending market dynamics at Nord Pool 

Block Orders  

"We also have more complex orders, like block orders”, Kristiane states.  

These orders specify a volume and price over a consecutive number of hours, integrating these blocks into the merit and pricing mechanism. Kristiane explains that the process begins with using curve orders to establish the merit order. The “branch and bound” technique is then applied, where each block is placed into the supply and demand curves to observe how the intersection between supply and demand shifts. This helps determine if a different price and volume result from each block. 

Each block order is tested individually.  

“We take that block order out and put the next block order in. This iterative process helps identify which block orders provide a better socio-economic price and a more accurate market price. Block orders that significantly affect the price or are priced too high are excluded,” Kristiane says and acknowledges the intricate nature of this process. 

Market Clearing Price 

Returning to the basics, Kristiane explains that the merit order results in a pay-as-cleared solution. Buy orders with prices equal to or greater than the market clearing price are accepted, while sell orders with prices equal to or lower than the market clearing price are accepted. Even if some volumes are offered at -500 Euros, and the market price is 78 Euros, those megawatts are cleared at 78 Euros, not -500. 

This process ensures transparency and fairness for all market participants. 

“So, if you place the bid for 75 Euros, and the clearing price is 78, you will be accepted. But the bid that was 95 euros, it will not be accepted,” Kristiane elaborates. 

Once market results are confirmed, accepted buy and sell orders become binding transactions. These transactions are then cleared and settled by the clearing service providers.  

The market clearing price, determined hourly for each bidding zone based on consumption, production, and transmission capacity, is crucial for spot trades and directly impacts the electricity bills of end-users. 

  

Understanding the merit order effect is essential for policymakers, investors, and consumers alike. It not only shapes electricity prices but also influences investment decisions and drives the transition toward cleaner energy sources.