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

Luis E. Gonzales, Koichiro Ito, and Mar Reguant

Key Takeaways:

1. Expansion of renewable energy is one of the most urgent and important challenges for addressing climate change. A decade ago, the principal challenge for decarbonizing the electricity sector was technological: wind and solar technologies were not cost competitive with conventional fossil fuels. Today, the challenge is how to deliver power from renewable-rich areas to the areas where there is the highest demand.
2. The authors develop a simple theoretical model that characterizes the impacts of renewable integration into the market. They then test their theoretical predictions by studying empirical evidence from Chile—one of the very first countries to have tackled this challenge by enhancing electricity market integration.
3. With a better-connected transmission grid, the price of electricity throughout the region becomes more balanced. Prices increase in renewable-rich areas and decrease in the demand centers far from renewables.
4. The grid expansion leads to an increase in renewable generation and decrease in the cost of electricity, replacing higher-cost fossil fuel plants in some cases. Solar generation increased by 51 percent in Chile, indicating that the expansion incentivizes new entries and investment of renewables—a crucial market force to accelerate decarbonization. Further, the cost of electricity declined by 12 to 5 percent.
5. The cost of expanding the grid provides long-run benefits to consumers and investors, with the cost quickly recovered in less than 5.5 years in Chile due to reductions in generation cost and improvements in environmental quality.
6. As nations throughout the world consider the build out of transmission infrastructure to spread the use of renewable energy, the study provides important insights. These insights could be useful, for example, in the United States where the Infrastructure Investment and Jobs Act contains a significant investment in transmission expansion and renewable energy.