The Effect of Renewable Energy On Merit Order
The high demand for electricity during peak demand pushes up the bidding price for electricity, and the relatively inexpensive baseload power supply mix is supplemented by ‘peaking power plants,' which charge a premium for their electricity.
Increasing the supply of renewable energy tends to lower the average price per unit of electricity because wind energy and solar energy have very low marginal costs: they do not have to pay for fuel, and the sole contributor to their marginal cost is operational cost. As a result, their electricity is less costly than that from coal or natural gas, and transmission companies buy from them first. Moreover, solar energy is typically most abundant in the middle of the day, coinciding closely with peak demand, so that it is in the best position to displace coal and natural gas electricity when those sources are charging the highest premium. Solar and wind electricity therefore substantially reduce the amount of highly priced peak electricity that transmission companies need to buy, reducing the overall cost. A study by the Fraunhofer Institute found that this "merit order effect" had allowed solar power to reduce the price of electricity on the German energy exchange by 10% on average, and by as much as 40% in the early afternoon, in 2007; as more solar electricity is fed into the grid, peak prices will come down even further. By 2006, the "merit order effect" meant that the savings in electricity costs to German consumers more than offset for the support payments paid for renewable electricity generation.
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