New Merit Order Ideas

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Originally published on Lenz Blog.

I have written extensively about the fact that the market order for electricity in Germany is broken. A search with the term “merit order” brings up those posts.

These questions are complicated. With this post, I will try to make a very simple point:

“Merit” should not be based simply on price.

Even right now, that is true in part. The German Law on Priority for Renewable Energy says in Article 8 that electricity from renewable sources needs to be bought with priority, irrespective of price.

That is a very simple order with only two elements. Renewable beats everything else.

But one could very well imagine a more detailed merit order. I will show one example right now. It shows my personal ranking. Other people may have different ideas. But showing my idea will make the concept clear.

I’ll do so in two steps. The first step shows a very rough order. In a second step, I will go into more detail.

1. Rough Merit Order

I agree with the present legislation that renewable energy from all sources gets priority over everything else.

On second place comes nuclear. I don’t think that the dangers from radiation caused by nuclear accidents are as severe as the dangers caused from firing fossil fuel. Obviously, a lot of people will disagree with that. And anyway, nuclear in Germany will be phased out over the next decade, so this entry in the order will disappear completely eventually.

And fossil fuel (all sources) has no merit at all, so it deserves a place firmly at the bottom of the scale.

2. More Detailed Merit Order

There are a lot of renewable options. How should one decide on their relative merits?

I am not very sure about this right now. But the big picture is that the transition to renewable energy needs to process as fast as possible. To achieve that, the most important thing is to get prices down for technologies that are still more expensive than others.

For example, onshore wind is already very successful in Germany, but offshore wind development is still behind schedule and still much more expensive than onshore wind.

Therefore, offshore wind should get priority over onshore wind. All things equal, that will help offshore wind get to scale faster.

Note that this leads to higher average prices now, since it gives priority to the technology with higher costs. But it leads to a faster transition in the long term and therefore to saving more fossil fuel costs faster in the future.

For example, solar is still more expensive than onshore wind and will stay so for another couple of years before it becomes the cheapest option. Therefore, solar should get priority over onshore wind right now.

Firing fossil fuel has no merit at all. But the damage to the climate is different for gas, hard coal and lignite. It is also different depending on whether it is cogeneration (using the heat for other useful purposes like heating buildings or water) or not. The way to decide this would be to calculate the CO2 emissions per unit of useful energy, and put the worst alternatives at the very bottom of the list.

3. Prices

Once a policy decision has been made on a detailed merit order, the question is left who gets paid how much. The present way of dealing with this is broken. It makes it impossible to operate fossil fuel plants with a decent profit. That’s a problem since fossil fuel plants will still be needed for a couple of decades as backup. And it’s also a problem since in the future people will make coal and gas from renewable sources. There’s nothing wrong with firing gas if you make it from excess wind power in the first place. There is no problem with firing coal if you make the coal from present day biomass, as opposed to fire fossil reserves.

This post is not the place to discuss that in detail. But I think that the system needs to make sure that everybody gets paid a fair price that is enough to cover costs and a fair profit. The way to do this would be to have everybody bid based on the sum of their fixed and marginal cost, and pay everybody who gets to sell under the new merit order based on these bids. More on that here.