Why Marginal Pricing Still Holds in EU Power Markets

The main reason marginal pricing is likely to remain central to EU power market design is simple:

There is no credible alternative that preserves efficient dispatch, good price signals, and disciplined bidding without creating bigger problems elsewhere.

A power market design that works needs:

• Prices that reflect scarcity: When power is scarce, prices should rise. When supply is abundant, prices should fall. That also includes negative prices when the system has more generation than it can absorb.
• Bids that reflect real costs: The market should encourage participants to bid based on their actual marginal cost, not on guesswork about how to game the pricing rule.
• One price formation process for the whole system: The price should come from the overall balance of supply and demand, not from a restricted part of the market or from an administrative rule.

Most of the proposed alternatives fall short on one or more of these points:

• Fixed prices: Fixed prices remove the market’s role in deciding which plants run and which do not. Once price no longer clears the market, someone else has to do that job. In practice, that means much more direct intervention by the system operator or by regulators.
• Pay as bid: In a pay as bid market, participants are encouraged to bid what they think the market will accept, not what it actually costs them to produce. A generator with a cost of €15/MWh will not naturally bid €15/MWh if it expects the market to accept €60/MWh. The result is more strategic bidding and less cost transparency.
• Average pricing or volume weighted pricing: These approaches do not solve the same problem. If the final price depends on the bids that participants submit, then participants still have an incentive to bid higher in order to lift that final price. So the mechanism still weakens truthful bidding.
• Separate markets by technology: Creating one market for renewables and another for thermal plants may look attractive politically, but it weakens price formation. Electricity prices should reflect the full system balance at a given moment. If you split the market into separate buckets, the resulting prices no longer reflect the real interaction between all supply and all demand.
• Price caps on power: A price cap stops the price from rising beyond a certain level even if scarcity keeps increasing. That means the market can no longer fully express how tight the system really is. If supply and demand still do not match at the cap, the remaining problem has to be managed outside the market.
• Price caps on input fuels: Measures like the Iberian mechanism reduce the fuel cost seen by certain generators. That can limit power prices in the short term, but it also changes the economic signal coming from the fuel market itself. As a long term design, it is hard to sustain without compensation and it distorts the incentives that help ration scarce fuel.

The core issue is straightforward.

A good electricity market needs to do three things at once: send scarcity signals, allocate dispatch efficiently, and give participants a reason to bid in line with real costs.

Marginal pricing still does that better than the alternatives usually proposed against it.

That is why it remains so resilient in EU market design debates.

Julio Quintela Casal