The Merit Order Explained
Competitive electricity markets operate according to a fundamental principle known as the merit order, which determines the sequence in which power plants are dispatched to meet electricity demand. In this framework, generators such as coal, nuclear, wind, and solar plants submit offers to sell electricity, specifying both the quantity they can supply and the price at which they are willing to do so. Collectively, these offers form the market supply curve, commonly referred to as the merit order, in which generation technologies are ranked according to their marginal cost – the cost of producing one additional unit of electricity. As a result, low-cost sources such as renewable energy and nuclear power typically occupy the left-hand side of the supply curve and are dispatched first, while higher-cost technologies, including coal- and gas-fired plants, are only activated when demand increases and cheaper sources are insufficient. Electricity is dispatched in ascending order of marginal cost until total system demand is satisfied, meaning that the final and most expensive unit required to meet demand effectively determines the market-clearing price. This marginal pricing mechanism is a defining feature of wholesale electricity markets across the European Union and is also applicable to Bulgaria, where price formation is primarily based on day-ahead market outcomes.
The merit order directly links generation costs, market structure, and electricity prices. Changes in fuel prices, carbon costs under the EU ETS, or the increasing penetration of renewable energy can shift the merit order and significantly affect price levels. For example, the growing share of renewables with near-zero marginal costs can push more expensive generators out of the market, lowering wholesale prices – a phenomenon often referred to as the “merit order effect”.
However, in real-world electricity systems, the merit order is often subject to various distortions. These may arise from regulatory interventions, long-term contracts, technical constraints (such as “must-run” generation), or market imperfections. As a result, actual price formation may deviate from the theoretically efficient outcome implied by a purely cost-based dispatch.
This analysis focuses on the structure of the merit order in Bulgaria and examines how different generation technologies contribute to price formation, as well as the extent to which observed market outcomes diverge from the theoretical model.
How is the Bulgarian electricity market structured today?
The Bulgarian electricity market is characterized by a hybrid structure, combining both regulated and liberalized segments. While large industrial consumers participate fully in the competitive wholesale market, households have historically been supplied under regulated conditions. Electricity trading in the liberalized segment is primarily conducted through the day-ahead and intraday markets operated by the Independent Bulgarian Energy Exchange (IBEX), where prices are determined competitively based on supply and demand. Since the 2025 reform, the household electricity sector has been organised as a semi-liberalized system: licensed final suppliers such as EVN Bulgaria, Electrohold Bulgaria, and Energo-Pro procure electricity through a diversified portfolio that includes direct participation in wholesale markets (primarily the day-ahead and intraday segments of the IBEX) as well as access to newly developed structured long-term products traded on a dedicated IBEX segment. These products aggregate generation from a state-owned group comprising Kozloduy NPP, TPP Maritsa Iztok 2, and NEK’s hydropower plants, offering electricity at a blended price to the three final suppliers. Households continue to operate within a regulated pricing environment, where final retail tariffs are determined by the Energy and Water Regulatory Commission. Differences between the blended procurement cost and the regulated retail tariff are compensated monthly through the Electricity System Security Fund, which effectively covers the implicit subsidy. Under the previous regulatory model (applicable until 30 June 2025), KEVR allocated mandatory quotas to each major plant: for the 2024–2025 regulatory year, Kozloduy NPP was assigned a quota of approximately 5.43 TWh – roughly 35% of its total annual output – to be sold to NEK at an administratively set price of 65.47 BGN/MWh (respectively 33.47 EUR/MWh) for onward supply to households, with the remaining approximately 65% traded freely on IBEX at prevailing market prices. Under the new model in force from 1 July 2025, mandatory plant-level quotas have been abolished. Instead, Kozloduy NPP, TPP Maritsa Iztok 2, and NEK’s hydropower fleet sell all of their output directly on IBEX – including the volumes destined for households – through a dedicated long-term contract segment. For the 2025–2026 regulatory year, confirmed by KEVR Decision No. Ц-25 of 1 July 2025, the three final suppliers concluded identical contracts covering the entire prognosed household consumption of 13.6 TWh at a uniform price of 189.58 BGN/MWh (or 96.93 EUR/MWh). The difference between this procurement price and the regulated retail tariff (140.03 BGN/MWh, or 71.60 EUR/MWh) – amounting to 674 million BGN (344.61 EUR/MWh) for the full regulatory year – is compensated from the Electricity System Security Fund. Long-term fixed-price contracts with thermal plants are being phased out, and the Security Fund compensation mechanism is intended as a transitional arrangement pending further reform of retail market regulation.
As a result of this market structure, investment incentives and dispatch patterns in the Bulgarian power system remain shaped by a combination of market prices, regulatory constraints, and system security requirements.
The Bulgarian power system is characterized by a diversified but baseload-heavy generation mix, with a strong reliance on nuclear and coal-fired generation, complemented by a growing share of renewable energy sources. The data highlights several important structural characteristics:
- Nuclear power remains the dominant source, providing around 40% of total generation, ensuring a stable baseload supply
- Coal-fired generation continues to play a significant role, accounting for approximately one-third of total output, supplying mainly the regulated segment of the national energy system
- Renewable energy is expanding, particularly solar photovoltaic generation, which shows a notable increase in the past two years
- Hydropower provides flexibility, although its share remains relatively stable compared to 2024 and dependent on hydrological conditions
Who sets the price – understanding Bulgaria’s merit order
The merit order curve for Bulgaria is constructed by ranking generation technologies according to their estimated marginal costs, defined as the cost of producing one additional unit of electricity. In this framework, nuclear generation, provided by the Kozloduy Nuclear Power Plant, typically forms the low-cost baseload of the system due to its relatively stable and low operating costs compared to fossil-fuel technologies. As a result, nuclear units generally bid at low, non-marginal prices to ensure continuous operation rather than to influence the market-clearing price. In technical terms, nuclear generation is characterised by high fixed costs and very low short-run marginal costs, primarily associated with fuel, while also exhibiting limited operational flexibility due to the technical and economic inefficiency of frequent ramping. Consequently, its economic logic is based on continuous dispatch and long-term cost recovery rather than short-run price optimisation. The relationship between nuclear output and the merit order has, however, been subject to a structural distortion that evolved significantly in 2025. Under the previous model (until June 2025), KEVR allocated mandatory quotas obliging Kozloduy NPP to sell approximately 5.43 TWh – around 35% of its annual output – to NEK at an administratively fixed price of 65.47 BGN/MWh (33.47 EUR/MWh), well below prevailing wholesale prices, while the remaining 65% was sold freely on IBEX. This quantity-based ring-fencing directly removed the cheapest generation from competitive dispatch, raising the wholesale market-clearing price. From 1 July 2025, mandatory plant-level quotas were abolished. Kozloduy NPP now sells its entire output on IBEX, including the share destined for household supply, through the dedicated long-term contract segment. The distortion is therefore no longer quantitative but price-based: the state-owned balancing group (Kozloduy NPP, TPP Maritsa Iztok 2, and NEK hydropower) sells 13.6 TWh of household electricity at a blended contract price of 189.58 BGN/MWh (96.93 EUR/MWh) – approximately 15% below the KEVR-estimated annual market reference price of 220 BGN/MWh (112.48 EUR/MWh) – with the shortfall covered by the Electricity System Security Fund. While nuclear output formally enters the competitive market, the fixed below-market contract price for a large block of its production continues to mute the price signal it would otherwise send, and cross-subsidises the inclusion of uncompetitive coal generation in the same balancing group.
Coal-fired generation, concentrated in facilities such as the Maritsa Iztok Complex, occupies a fundamentally different position in the merit order. Its marginal cost is significantly higher and more volatile, being driven by fuel costs, operational constraints such as ramping limitations and inflexibility, and increasingly by carbon pricing under the EU Emissions Trading System. As a result, coal plants frequently become the marginal units that determine the market-clearing price, particularly during peak demand periods or during episodes of low renewable output, when wind and solar generation are insufficient to meet demand. This makes coal generation a key driver of price spikes and overall wholesale price volatility in the Bulgarian system.
Renewable energy sources such as wind and solar exhibit near-zero marginal costs, as they require no fuel and incur only minimal variable operating expenses. Consequently, they typically submit very low or near-zero price offers and, when available in sufficient quantities, displace more expensive generation technologies in the dispatch order. This effect exerts downward pressure on wholesale electricity prices and can significantly reduce the need for fossil-fuel-based generation during periods of high renewable output. However, due to their inherent variability and dependence on weather conditions, high renewable penetration can also contribute to occasional periods of oversupply, which may lead to very low or even negative prices, particularly during periods of low demand combined with high solar generation.
Hydropower occupies an intermediate and highly flexible position within the merit order. Its bidding behaviour is not determined solely by immediate operating costs but also by opportunity costs related to water storage, as reservoir levels must be managed across time. Accordingly, hydro plants adjust their offers dynamically based on expected future market conditions, reservoir management strategy, and system balancing needs. This makes hydropower a critical flexibility resource that helps smooth intraday fluctuations in both supply and price, while also exerting stabilising effects during moderate demand conditions.
In addition, cross-border electricity flows and import–export dynamics can temporarily shift the marginal price-setting technology, depending on regional price differentials and transmission constraints. This introduces an additional layer of variability into Bulgaria’s price formation process.
The emergence of battery energy storage systems in the last couple of months has introduced a new structural element into the merit order, increasingly visible in the Bulgarian Electricity System Operator (ESO) data through indicators such as “ESS – charging”, which represents periods of storage charging. During these periods, batteries act as demand-side participants, absorbing electricity when prices are low – typically during high renewable output or low consumption hours – thereby increasing demand and supporting price floors. Conversely, during discharge periods, they function as supply-side resources, releasing electricity during peak demand or scarcity conditions. This reduces reliance on high-cost marginal generation such as coal or gas and contributes to moderating price spikes. Overall, the growing presence of battery storage is reshaping the Bulgarian merit order by introducing a temporal shifting mechanism, increasing intraday price volatility in a structured manner, reducing renewable curtailment, and gradually weakening the dominance of thermal generation in price setting, while simultaneously improving the efficiency of energy allocation across time.
The first panel presents installed generation capacity by technology type against average system load for 2025, highlighting that in purely static terms, low-marginal-cost technologies such as solar appear sufficient to cover average demand. However, this representation does not account for temporal variability in renewable generation.
The second panel depicts an actual system snapshot for 11 May 2025 at 19:00, when total load reached 3,735 MW. At this hour, solar and wind generation were relatively limited (568 MW combined), while demand was met through a combination of hydro, nuclear baseload generation, coal, and gas-fired generation.
The merit order effect is clear: despite the large installed capacity of low-marginal-cost renewable technologies, system dispatch in real time continues to rely on higher-marginal-cost flexible generation when renewable output is constrained. As a result, marginal fossil-fuel units are likely to have determined the market-clearing price, which at that time was 153.3 EUR/MWh.
The marginal costs are indicative and reflect fuel prices, CO₂ costs, and variable and fixed operations and maintenance (O&M), as well as opportunity costs. It should also be noted that the constructed merit order represents a simplified approximation of real market conditions. In practice, actual dispatch decisions may deviate from strict marginal cost ordering due to technical constraints, regulatory interventions, and the presence of long-term contracts. In particular, CHP plants may operate based on heat demand rather than electricity market signals, and certain generation volumes are allocated to the regulated market segment. As a result, the observed market outcomes may not fully reflect the theoretical merit order.
Data source: ESO
Why the Merit Order Doesn’t Fully Work: Key Market Distortions in Bulgaria
Despite the theoretical efficiency of the merit-order framework, distortions may arise when the ranking of power plants by variable operating costs no longer reflects true economic costs. In such cases, price signals become misaligned, leading to inefficient dispatch outcomes and suboptimal investment incentives.
The Bulgarian electricity market exhibits several institutional and regulatory distortions that modify price formation and weaken the pure marginal-cost logic of dispatch. One of the most important historical distortions is the use of feed-in tariffs (FITs) for renewable energy sources. These schemes guaranteed fixed, above-market prices for electricity generated from wind, solar, biomass, and small hydropower installations, with contract durations typically ranging from 12 to 20 years depending on the technology. While this mechanism played a key role in accelerating early renewable deployment, it has been largely phased out for new installations and replaced by market-based premium schemes. Nevertheless, existing contracts continue to affect market outcomes until their expiration, meaning that a portion of renewable generation remains partially insulated from market signals and merit-order competition.
A second major distortion arises from the continued regulation of household electricity prices. In Bulgaria, residential consumers remain on a regulated tariff system, where prices are set administratively by the Energy and Water Regulatory Commission rather than being fully determined by wholesale market outcomes. The mechanism governing household supply underwent a significant structural change as of 1 July 2025. Under the previous model, the National Electric Company (NEK) acted as the public supplier, assembling a regulated energy mix from mandated quotas of each major plant and reselling it to the three final suppliers (Electrohold, EVN Bulgaria, and Energo-Pro) at an administratively blended price. Since 1 July 2025, NEK no longer fulfils this function: instead, Kozloduy NPP, TPP Maritsa Iztok 2, and NEK’s hydropower fleet operate as a coordinated balancing group and sell electricity to the three final suppliers through a dedicated long-term contract segment on the IBEX. For the 2025–2026 regulatory year, all three suppliers concluded identical contracts at 189.58 BGN/MWh (96.93 EUR/MWh), with a combined value of approximately 2.86 billion BGN (1.46 billion EUR). The difference between this blended procurement price and the regulated retail tariff is compensated monthly from the Electricity System Security Fund, maintaining administrative control over the effective price paid by households. The structural consequence for the merit order is two-fold. First, Kozloduy NPP’s output – while formally now sold entirely on IBEX – is subject to a price-based distortion: the state balancing group contracts 13.6 TWh of household electricity at 189.58 BGN/MWh (96.93 EUR/MWh), approximately 15% below the KEVR reference market price of 220 BGN/MWh (112.48 EUR/MWh), with the gap financed by the Electricity System Security Fund. The nuclear plant effectively cross-subsidises household tariffs rather than maximising market revenue. Second, TPP Maritsa Iztok 2 – a coal-fired plant whose electricity cannot compete on the open market – is kept commercially viable through its inclusion in the state balancing group supplying the household segment, effectively providing a structural subsidy financed through the Security Fund. This creates a hybrid market structure in which wholesale competition coexists with regulated retail pricing and cross-subsidisation among state-owned generators, reducing overall allocative efficiency and partially insulating price signals from underlying generation costs.
An additional set of distortions arises from the structural characteristics of the Bulgarian power sector, particularly the significant role of state ownership and market concentration. A large share of electricity generation is controlled by state-owned entities within the Bulgarian Energy Holding group, including key producers such as the Kozloduy NPP and the National Electric Company (which manages a significant share of hydropower capacity). This concentration can limit effective competition on the supply side and reduce market liquidity, particularly in forward and long-term segments.
A further source of distortion stems from network limitations and cross-border congestion. Bulgaria is integrated into the Southeast European electricity system, where cross-border flows with countries such as Romania, Greece, Turkey, and North Macedonia influence domestic price formation. As a result, the marginal unit determining prices in Bulgaria is not always the lowest-cost generator available at the regional level. This can lead to price divergence and inefficiencies, particularly during periods of congestion.
In addition, the increasing share of intermittent renewable generation places growing pressure on transmission infrastructure. According to the latest ten-year development outlook of the system operator, geographically concentrated renewable production can lead to network constraints, curtailment, and distortions in flexibility and balancing markets. Under such conditions, market prices may fail to reflect the true system cost of balancing supply and demand, further weakening the efficiency of the merit-order mechanism.
Author: PhD Candidate Lyubimka Georgieva