The market design for wholesale electricity markets is broken. It doesn’t make any sense and needs to be changed.
With this post, I want to call attention to the relation of the “merit order” market design to antitrust law.
“Merit order” means that the most expensive generator in the market sets the price for everybody. “Most expensive” means “highest marginal cost”.
I have discussed this already with my post titled “The Weird World of Electricity Pricing” last November. Using an example from that post, here again is the basic idea of the “merit order” market:
Solar park A bids for 0.1 cents per kWh, since they have basically no marginal cost (the fuel is free). Gas turbine owner B bids for 5.3 cents per kWh, to reflect high gas prices. Assuming that B is the highest bid, everybody (including A) gets paid 5.3 cents.
Why is that not setting the price for solar energy at an artificial level, which is the definition for “market manipulation” under Regulation 1227/2011 on wholesale energy market integrity and transparency? The price for the solar energy is fixed disregarding completely what A has bid.
Market participants under a merit order market are supposed to pay their fixed costs with the difference between the merit order price and their bid. But those fixed costs are not related in any way to that difference. They could be higher, as with solar right now, or lower, as with coal or nuclear plants already paid for.
In the latter case, the generators get an extra windfall profit from this market design. It is exactly this kind of windfall profit from fixing prices at an artificially high level that usually is frowned upon by antitrust law. Why is there any reason to allow for an exception with the merit order market design? And why do all the people worried about price hikes coming from renewable energy don’t discuss this basic market design flaw, leading to ripping off consumers by the tune of billions?
Just to be clear, I think that the merit order market design needs to go anyway. It doesn’t make sense. But the fact that it is just about the opposite of what is happening under antitrust law in every other market is just one more reason to think about alternatives.
Imagine enterprises on any other market setting their prices uniformly based on the highest cost of any market participant. That would be a clear case of antitrust violation. I recall that the EU Commission has fined producers of power transformers EUR 67.6 million for a much less serious form of cartel.