The Investment Effects of Market Integration: Evidence From Renewable Energy Expansion in Chile

Abstract

We study the investment effects of market integration on renewable energy expansion. Our theory highlights that market integration not only improves allocative efficiency by gains from trade but also incentivizes new investment in renewable power plants. To test our theoretical predictions, we examine how recent grid expansions in the Chilean electricity market changed electricity production, wholesale prices, generation costs, and renewable investments. We then build a structural model of power plant entry to quantify the impact of market integration with and without the investment effects. We find that the market integration in Chile increased solar generation by around 180%, saved generation costs by 8%, and reduced carbon emissions by 5%. A substantial amount of renewable entry would not have occurred in the absence of market integration. Our findings suggest that ignoring these investment effects would substantially understate the benefits of market integration and its important role in expanding renewable energy.