Market Mechanisms
How electricity prices are determined through supply and demand matching in European markets.
The European electricity market operates across multiple timeframes, each serving a specific purpose. From long-term capacity planning to real-time balancing, these markets work together to ensure reliable, efficient electricity supply.
Forward Markets
Years to months ahead. Futures and options for long-term hedging and price discovery.
Example: A utility buys 100 MW baseload for 2025 at €60/MWh
Spot Markets
Day-ahead and intraday. Where most physical electricity is traded and prices are set.
Example: SDAC clears at 12:00 for next day delivery
Balancing Markets
Real-time. TSOs activate reserves to maintain grid frequency at 50 Hz.
Example: aFRR activated when frequency drops to 49.9 Hz
The Merit Order is a ranking of available power generation sources based on their ascending marginal costs of production. Generators are dispatched from cheapest to most expensive until demand is met. The market clears at the intersection of supply and demand, setting a uniform Marginal Price for all participants.
Typical Merit Order (by marginal cost):
Merit Order Effect
Generators are ranked by their marginal cost (cheapest first). Renewables (Wind/Solar) have near-zero marginal cost, so they come first.
Marginal Pricing
The market price is set by the last generator needed to meet demand. All generators get paid this same clearing price.
Price Setting
If demand is low, cheap renewables might set the price. If demand is high, expensive gas or coal plants set the price for everyone.
Marginal pricing (Pay-as-Clear) incentivizes generators to bid their true costs. It ensures the most efficient dispatch of resources and provides investment signals for new capacity.
Efficiency: Cheapest generation runs first, minimizing total system cost
Transparency: Single clearing price reflects scarcity
Investment Signal: High prices during scarcity attract new capacity
When wind and solar are abundant, they push expensive gas plants out of the merit order, lowering the marginal price dramatically—sometimes to zero or negative.
Sunny/Windy Day: Price = €10/MWh (solar sets the price)
Calm Night: Price = €100/MWh (gas sets the price)
Result: High price volatility, need for storage and flexibility
Scenario 1: Windy Day
Wind generation: 45 GW (60% of demand). Gas plants offline.
Clearing Price: €15/MWh
Marginal unit: Lignite coal plant
Scenario 2: Calm Evening
Wind generation: 5 GW (7% of demand). All gas plants running.
Clearing Price: €180/MWh
Marginal unit: Gas peaker plant