The European Market Paradox: Why Expensive Natural Gas Still Sets Electricity Prices

In recent years, Europe has been undergoing an energy revolution. The share of electricity generated from cheap renewables—solar and wind—is reaching historic highs. Yet, consumers still face high electricity bills that closely mirror the price of natural gas on global commodity exchanges. How is it possible that cheap green energy hasn't lowered bills for everyone? The answer lies in a market pricing mechanism called the Merit Order (sorting generation sources by marginal cost).

How Does the Merit Order Work?

The European wholesale electricity market operates on a uniform pricing principle for the grid in any given hour (the pay-as-cleared model). All available power plants submit bids with their generation costs to the market. The market clearing engine then sorts these bids from the cheapest with the lowest operating costs (marginal costs) to the most expensive.

The typical dispatch order is as follows:

1. Renewables (solar, wind, hydro): Operating costs are near zero (the fuel is free).
2. Nuclear power plants: Low fuel costs and steady, baseload generation.
3. Coal power plants: Higher costs due to fuel prices and carbon allowances (EUA).
4. Gas-fired power plants: High operating costs driven by gas fuel prices and carbon allowances.

The market accepts bids starting from the cheapest sources until the total grid demand for that specific hour is met. However, the key rule is: The clearing price for all dispatched generators is set by the most expensive power plant required to meet the demand. This final power plant is known as the marginal or clearing unit.

Why Do We Pay the Price of Gas?

During sunny and windy days with low electricity demand, renewables and nuclear power can cover the entire load. During these hours, wholesale electricity prices on the exchange crash to zero or even drop into negative territory.

But when evening falls, the sun sets, the wind dies down, and people return home (the evening peak), grid demand spikes. The cheap sources are no longer sufficient. The grid operator must dispatch coal and eventually gas-fired power plants, which can ramp up very quickly to supply the missing megawatts.

At that moment, the gas-fired plant becomes the marginal unit. Because gas and carbon allowances are expensive, the gas plant might offer its power at €150/MWh. Under the Merit Order rule, this clearing price of €150/MWh is paid to **all** active generators—even those producing power cheaply from nuclear or solar.

The Path to Cheaper Electricity: Storage and Flexibility

The Merit Order system was designed to incentivize the construction of the cheapest generation sources (since they capture the largest profit margin when prices are set by expensive gas). However, to break free from our dependence on expensive gas, we must address energy storage.

If we deploy enough battery storage and pumped-storage hydro, we can save excess cheap electricity from midday for the evening peak. In this scenario, we won't need to fire up a gas plant in the evening; instead, we will discharge batteries. The marginal unit setting the price will then be a cheaper battery or a wind farm, and market prices will fall significantly.

Want to track in real-time which sources (nuclear, coal, gas, renewables) are currently covering demand and how spot prices are moving? Open our interactive EnergyDataDesk App.