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The 'Marginal Power Plant' Principle – Key to Price Formation on the Wholesale Market in Germany


The ‘Marginal Power Plant’ Principle – Key to Price Formation on the Wholesale Market in Germany (bar/line chart)

 

  • Daily demand on the European Energy Exchange (EEX) is met by a large number of electricity products based on a variety of energy sources. Every type of power plant (nuclear, gas, coal, etc.) has marginal costs in terms of usage.
  • Marginal costs are primarily determined by the “variable cost” of fuel (incl. CO2) and operating assets - costs that are incurred when the power station is up and running and must at least be earned back.
  • On the EEX, power plant capacity is drawn upon, starting from the lowest-cost option, until the demand is met.
  • The offer price of the last power station needed to satisfy this demand (“marginal power plant”) determines the market price for all the other power stations.
  • Power prices are thus the result of the point at which supply and demand intersect. Therefore, to cover high demand, a gas-fired power plant with relatively high marginal costs would tend to determine prices, whereas to cover low demand, a more affordable coal-fired power station would be preferable.

 

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