1. - 1 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
PG&E Case: is the Monopoly sustainable?

2. - 2 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
Conclusion
Shifting from Monopoly to Oligopoly will enable
California Electric sector to become a Free Market
following a two-step approach
Monopoly Oligopoly
Free
Market
SHORT TERM LONG TERM

3. - 3 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
 Who’s PG&E: Market and Industry
 Economic Theory: Natural Monopoly
 Energy Crisis: what went wrong?
 Economic Theory: Regulated Monopoly
 Current Situation: How rates are set
 A New Approach
 Conclusion
Agenda

4. - 4 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
Who’s PG&E: the Market
Pacific Gas and Electric (PG&E) is an investor-owned Utility, the largest energy supplier to Northern California and the
second most expensive company in California
167
154
144137
121
94
PG&ESCEMIDSMUD LADPW
+64%
SDG&E
Monthly Average Residential Electric Bill @ 750 kWh
[January 2015; $ per kWh]
Government-owned Investor-owned

5. - 5 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
The Electric Industry: a Natural Monopoly
Critical mass
 Not enough gains from competition to
cover cost of having two sets of power
distribution lines
 Gaining regulatory
approval to build new
plants is a long and
complicated process
 Achieving brand loyalty
and convincing
consumers to switch
from incumbents is
› costly
› time consuming
 High fixed costs, becoming sunk costs
 High opportunity costs
Infrastructure
Regulations High switching costs
The Power and Utility
Industry has always been a
Natural Monopoly:
 High barriers to entry
 Inelastic demand
 Economies of scale
Natural Monopoly
High barriers
to entry

6. - 6 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
 In an environment free of regulation the Company will naturally tend
to produce quantity (QM) to maximizes its profits, such that:
 Following the demand (D) curve that would mean charging PM to the
customers
 Unfortunately this would mean drastically reducing the quantity
produced by a perfectly competitive market (QC) causing a Loss of
Social Welfare
MC = MR
 Profit maximization
 Increasing market power
 Deadweight Loss: the low
income part of the Public
won’t be able to access high
prices
Monopolist Customers
+ -
PM
P
Q
PC
QCQM
MR
MC
Deadweight Loss
D
Why a Natural Monopoly has to be Regulated?
Profit max
What happens when price caps are set at an arbitrary
level?

7. - 7 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
 Deregulation did
not effectively
allow
competition, as
barriers to
entry still
remained the
same.
 Low Price
Cap led to
more
consumption
when more
conservation
was needed.
 Energy rates
increased to
800 percent
 Bankruptcy of
PG&E
 Blackouts
1996 1998-2000 Thereafter
How does Economic Theory explain what happened?
 Drought and
other problems
put a strain on
the California
energy market
 Enron Corp.
made the
shortage worse
 By shutting
down their
pipelines from
Texas to
California
 Partial
deregulation
allowed them to
set higher
prices
 As high as $ 45
billion was lost
 Taxpayers
bailout PG&E.
Bailout
High Prices and
Blackout
Enron
Manipulation
ShortagePrice CapNatural ForcesDeregulation
 Less supply
and more
demand
created
shortage of
electricity in
California.
California Energy Crisis: what went wrong?
DRIVING FORCES

8. - 8 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
 Regulators are willing to increase social welfare and they set
prices (i.e. rates) at an arbitrary level (P*)
 At this fictional level (P*) the Company can only produce up to its
MC1 (G)
 Yet, at this price demand (Q*) is well above the actual production
(QR). This creates a shortage (i.e. blackouts)
 In the meanwhile, due to increase in input costs, marginal costs
rise (MC2), making economically unsustainable for the Company to
produce quantity QR
 Increased Deadweight Loss from (W) in the Unregulated
Monopoly case to (W + R) in a “poorly regulated Monopoly”
 Unbearable economic situation for the Company, which ultimately
goes bankrupt
PM
P
Q
P*
QR QM
MR
MC1
Deadweight
Loss before
regulation (W)
F
0
Regulated
price
Shortage
Q*
D
WR
G
Deadweight Loss
after “poor” regulation
(W + R)
What happens when rates are arbitrarily set by the regulators?
How does PG&E set the price now?
MC2

9. - 9 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
 The solution adopted by the Regulatory Authority in California (i.e.
CPUC) is to adjust the rates on the basis of a “rate-of-return”
model, at the level by which the quantity produced (Q2) would be
at the point where:
D = ATC
 This is the ideal theoretical
level considered the
constraints:
› The Company is incentivized
at serving as many
customers as possible
› The Company is still
making accounting profits
 For the Natural Monopoly
the allocative efficient
price won’t work
› The price would be set
where
› Yet, in this case
and the Company would lose
money
PROs CONs
+ -
P3 = MC
P3 < ATC
P1
P
Q
P3
Q1 Q2MR
MC
0 Q3
D
ATCP2
F
“Rate-of-return” model: the Theory
Profit max
Increasing Social Welfare
from Unregulated Monopoly situation

10. - 10 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
“Rate-of-return” model: PG&E casePROCESS
Proposal submission
to CPUC
Public hearing
review session
CPUC’s final
decision on rates
 Whenever PG&E needs to make
significant rate changes, it makes a
proposal to the California Public
Utilities Commission (CPUC)
 PG&E’s proposal is then reviewed in a public
hearing with many stakeholder groups,
representing different interests:
› Consumers
› Businesses
› Low-income
› Environmental
› Agricultural
 CPUC makes a decision on what rates are
reasonable
 PG&E changes rates as soon as possible
PROs&CONs
 This new process allows rates to reflect
changes in input prices
 It takes into consideration all different
stakeholders’ interests
PROs CONs
 The monopolist has no real incentives in
being cost-efficient
 The process is time-consuming
 There is a substantial lack of information
symmetry among the parties
+ -

11. - 11 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
Graphene Energy Storages and
Solar Panels
Wireless Electricity
distribution
1. Industry restructuring
Government Intervention in order to advocate
shared infrastructure with new competitors
2. Mature Emerging Innovations
To distribute electricity competing with the
usual distribution infrastructure (shared)
3. Producing and distributing your own
energy
 New technologies
 Energy Democracy: from Consumers to
Prosumers in generating and utilizing
electricity
OLIGOPOLY
FREE MARKET
A New Approach to a Free Market
SHORT TERM
LONG TERM
REGULATED
MONOPOLY

12. - 12 -Hult International Business School – MBA Class 2016 – Golden Gate – Team 8 Mod. A – Economics
Conclusion
Shifting from Monopoly to Oligopoly will enable
California Electric sector to become a Free Market
following a two-step approach
Monopoly Oligopoly
Free
Market
SHORT TERM LONG TERM
GOLDEN GATE TEAM 8:
Ariana Rizzato, Fredy Andrango, Israel Nava, Simone Schmalzbauer,
Shekhar Bharat Singh, Sugar Evelyn Bitongga