Research / BFI Working PaperMay 19, 2022

The Dynamic Impact of Market Integration: Evidence from Renewable Energy Expansion in Chile

Luis E. Gonzales, Koichiro Ito, Mar Reguant

We study the static and dynamic impacts of market integration on renewable energy expansion. Our 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, we empirically test our theoretical predictions and show that commonly-used event study estimation underestimates the dynamic benefits if renewable investments occur in anticipation of market integration. We build a structural model of power plant entry and show how to correct for such bias. We 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. We show that ignoring this dynamic effect would substantially understate the benefits of transmission investments.

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