How renewable production depresses electricity prices: Evidence from the German market

The urgency of climate change has led several countries to develop renewable energy in order to reduce CO2 emissions, through the means of various subsidies. In the electricity sector, one drawback of such policies is the negative impact on electricity prices, known as the merit-order effect. This paper aims at assessing how intermittent renewable production depresses electricity prices in Germany, which has experienced a significant increase of its renewable capacity over the last two decades. To do so, we use a two-regime Markov switching model, that enables to disentangle the impact of wind and solar generation, depending on the price being high or low. We find as expected that renewable production induces a negative marginal effect, which is stronger in regimes of relatively high prices. In addition, we show that both wind and solar productions have a significant impact on the distribution of prices, and in particular on the frequency and expected duration of each regime. This has implications in terms of market design, security of supply, and support mechanisms for renewables. •Renewable production depresses electricity prices (merit-order effect).•The merit-order effect is more important during high-price periods.•Renewable production also induces more frequent and longer episodes of low prices.•The profitability of all producing units and security of supply are put at risk.•Policy implications include market design and support mechanisms.