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This paper provides insight on the economic inefficiency of the classicalmerit-order dispatch in electricity markets with uncertain supply. For this, weconsider a power system whose operation is driven by a two-stage electricitymarket, with a forward and a real-time market. We analyze two differentclearing mechanisms: a conventional one, whereby the forward and the balancingmarkets are independently cleared following a merit order, and a stochasticone, whereby both market stages are co-optimized with a view to minimizing theexpected aggregate system operating cost. We first derive analytical formulaeto determine the dispatch rule prompted by the co-optimized two-stage marketfor a stylized power system with flexible, inflexible and stochastic powergeneration and infinite transmission capacity. This exercise sheds light on theconditions for the stochastic market-clearing mechanism to break the meritorder. We then introduce and characterize two enhanced variants of theconventional two-stage market that result in either price-consistent orcost-efficient merit-order dispatch solutions, respectively. The first of thesevariants corresponds to a conventional two-stage market that allows for virtualbidding, while the second requires that the stochastic power production becentrally dispatched. Finally, we discuss the practical implications of ouranalytical results and illustrate our conclusions through examples.

On the Inefficiency of the Merit Order in Forward Electricity Markets with Uncertain Supply