Market integration in the Chilean electricity sector led to price convergence, increased renewable generation, and reduced costs and emissions. Importantly, most of the benefits came from new investment, emphasizing the need to take dynamic effects into account.
The expansion of renewable energy faces challenges in numerous locations due to outdated grids designed for conventional power plants built near high-demand centers. Renewable energy plants require distinct infrastructure, as they need to be situated far from demand centers, given the nature of sources like wind and solar. The absence of market integration between renewable-rich areas and demand centers results in excess generation -leading to curtailment- and low local market prices, discouraging new investments. This poses a significant obstacle for countries prioritizing renewable energy expansion and hinders decarbonization efforts.
This paper explores the impact of market integration on renewable expansion and allocative efficiency in wholesale electricity markets through theoretical and empirical analyses. The theoretical model, considering market integration with and without investment effects, reveals that the conventional gains from trade apply when investment is held constant. However, anticipating market integration prompts producers to invest in new capacity, altering the supply curve (Figure 1). Building on this insight, the authors empirically quantify these theoretical predictions by exploiting two significant changes in the Chilean electricity market. The historical separation of Sistema Interconectado Norte Grande (SING) and Sistema Interconectado Central (SIC) until 2017 hindered renewable energy expansion, prompting the Chilean government to complete a new interconnection between Atacama and Antofagasta in November 2017 and reinforce the transmission line between Atacama and Santiago in June 2019.
Figure 1: Impacts of Market Integration on Solar Expansion
The paper conducts a descriptive analysis of market integration outcomes. Before the interconnection, Atacama exhibited near-zero prices due to zero-marginal-cost solar generation. Following the interconnection, prices became positive, and the gap between Atacama and Antofagasta disappeared, a pattern that was repeated between Santiago and Atacama after the 2019 reinforcement. The authors estimate that the interconnection and reinforcement reduced the generation cost by 2.42 and 0.96 USD/MWh for hour 12 and by 2.07 and 0.62 USD/MWh for all hours.
Moreover, the paper explores the entry of solar plants, finding suggestive evidence that energy producers anticipate market integration, leading to new investments despite near-zero prices. These results highlight the importance of investment effects in understanding the value of transmission expansion.
The study establishes a robust two-part structural model to assess how market integration and investment effects influence solar plant entry. This model comprises a weekly economic dispatch model and an investment model. Together, these models determine the equilibrium entry of solar plants and simulate the consequences of a transmission expansion project. For that, they compare the Actual scenario, with two possible counterfactuals: one without market integration but holding solar investment fixed, and the other by computing the equilibrium level of investment had the line not been built.
Figure 2: Impacts of Market Integration on Solar Expansion
As shown in Figure 2, the actual scenario, aligned with observed data, demonstrates a notable post-interconnection price increase in Atacama to around 50 USD/MWh, as this region can now export solar power to other regions. In contrast, a counterfactual scenario without market integration but actual investment predicts sustained zero prices because some solar production still cannot be exported to other regions. Accounting for reduced solar investment due to the absence of transmission, equilibrium solar capacities are a small proportion of the actual scenario, leading to higher prices. Increased solar generation in the actual scenario emphasizes the impact of market integration.
The paper concludes that prices align with theoretical predictions and emphasizes the need to consider investment effects for a comprehensive understanding of outcomes. With this investment effect, results suggest that the full impact of market integration on solar generation was a 178% increase in solar generation, as opposed to the 10% increase if we ignore the investment effect. Finally, the authors conduct a cost-benefit analysis taking into account the cost of transmission expansion, which can be recovered by 7.2 once investment effects are taken into account.
