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The Dynamic Impact of Market Integration: Evidence from Renewable Energy Expansion in Chile (WP-22-21)

Luis E. Gonzales, Koichiro Ito, and Mar Reguant

Effective and economical expansion of renewable energy is one of the most urgent and important challenges of addressing climate change. However, many countries are facing a problem because existing network infrastructures (i.e., transmission networks) were not originally built to accommodate renewables, which creates disconnections between demand centers and renewable supply. In this paper, the researchers study the static and dynamic impacts of market integration on renewable energy expansion. Their theory highlights that statically, market integration improves allocative efficiency by gains from trade, and dynamically, it incentivizes new entry of renewable power plants. Using two recent grid expansions in the Chilean electricity market, they empirically test their theoretical predictions and show that commonly used event study estimation underestimates the dynamic benefits if renewable investments occur in anticipation of market integration. The authors build a structural model of power plant entry and show how to correct for such bias. They find that market integration resulted in price convergence across regions, increases in renewable generation, and decreases in generation cost and pollution emissions. Furthermore, a substantial amount of renewable entry would not have occurred in the absence of market integration. They show that ignoring this dynamic effect would substantially understate the benefits of transmission investments.

Luis E. Gonzales, Pontificia Universidad Católica de Chile, Centro Latinoamericano de Políticas Económicas y Sociales

Koichiro Ito, Associate Professor, Harris School of Public Policy, University of Chicago

Mar Reguant, Associate Professor of Economics and IPR Associate, Northwestern University

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