“The Value of Infrastructure and Market Integration: Evidence from Renewable Expansion in Chile”
Luis Gonzales (Pontificia Universidad Catolica de Chile), Koichiro Ito* (University of Chicago), and Mar Reguant (Northwestern University)
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. We begin with a simple theoretical model that highlights why market integration plays a key role in renewable expansion in static and dynamic ways. Statically, market integration improves allocative efficiency by gains from trade. Dynamically, it incentivizes new entries of renewables plants. To quantify these theoretical predictions, we build a structural model of power plant entries and apply it to a recent change of market integration in the Chilean electricity market—two fully separated markets were integrated into one market in 2017. We find that market integration resulted in price convergence across regions, increases in renewable generation, and decreases in overall generation cost due to gains from trade. Furthermore, our counterfactual simulations quantify that substantial amount of renewable entries would not have occurred in the absence of market integration. We show that ignoring this dynamic effect would significantly understate the benefits of market integration, including its impacts on allocative efficiency and renewable expansion.