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As wildfire risks mount, Calif. legislators toss utilities a lifeline

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As wildfire risks mount, Calif. legislators toss utilities a lifeline

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Firefighters monitor a backfire while battling the Ranch Fire, part of the Mendocino Complex Fire near Ladoga, Calif.

Source: Associated Press

As firefighters continued to battle the massive Mendocino Complex blaze, the largest wildfire in California's history, state legislators scrambled to come up with a last-minute law that would shield investor-owned electric utilities from billions of dollars in damages that result when electrical equipment ignites brush or trees.

Late on Aug. 31, just before California's 2017-2018 session ended, lawmakers passed Senate Bill 901, which provides limited financial shelter for the state's investor-owned utilities. The bill reduces the likelihood that utilities will be forced into bankruptcy protection as a result of wildfire damages, by requiring the Public Utilities Commission to use a financial stress test when determining the allocation of those costs. Regulators must ensure that utilities can continue to provide adequate service, SB 901 says.

The measure also allows utilities to apply to the PUC for permission to issue securitization bonds to finance wildfire costs, subject to a "reasonableness review" that examines whether utilities did all they could to keep electrical equipment from starting fires. And it creates a five-member Commission on Catastrophic Wildfire Cost and Recovery to recommend options for the legislature and governor by July 1, 2019, to socialize wildfire costs, including creating a fund to assist in paying those costs.

The bill does not, however, change the state's policy of "inverse condemnation"—meaning that utilities and their shareholders could still be on the hook for billions of dollars in wildfire liabilities. The bill “does little to change the perception that the utilities could continue to face sizeable liabilities going forward as the [California Public Utilities Commission] will have broad discretion to determine wildfire liability outcomes," Wells Fargo Securities analysts said in a Sept. 3 report.

In other words, the monetary penalties facing California's major utilities from the rising incidence of catastrophic wildfires could still be devastating. In response to growing wildfire threats and their financial consequences, the state's three major investor-owned electric utilities have lobbied fiercely for relief from inverse condemnation, which makes utilities responsible for all damages from fires that are traced to their electrical equipment, regardless of whether the utility is actually at fault.

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Wildfires are the biggest long-term financial and operational challenge California's utilities face today. As a result of the October 2017 wine country fires, which scorched 245,000 acres in Napa and Sonoma counties and killed 44 people, PG&E Corp. subsidiary Pacific Gas and Electric Co. recorded on its balance sheet a $2.5 billion charge for the quarter ending June 30 as the lower limit of wildfire-related costs it expected to incur. Its total liability, PG&E Corp. said, could exceed $10 billion.

J.P. Morgan Chase estimates that the utility may face more than $17 billion in liabilities from those fires, which is equal to the utility's total revenue in 2017 from its combined electric and gas operations.

"We find ourselves in this climate-driven extreme weather, facing wildfire after wildfire," PG&E Corp. CEO Geisha Williams said in a July 26 earnings call as she pleaded for legislators to rescue utilities from what she called unsustainable utility liability. "And the numbers that we're seeing already in California and in the Western United States is staggering, so this is going to be perennial issue."

Larger and larger

The Mendocino Complex fire in August became the largest wildfire ever recorded in California, burning more land than the previous record-setter, the Thomas fire, which scorched more than 280,000 acres, killed one person and destroyed more than 1,000 structures in Ventura and Santa Barbara counties in late 2017. The cause of the Mendocino fire remains under investigation. To the north, firefighters continued to battle the 230,000-acre Carr fire in Shasta and Trinity counties. Though just over half the size of the Mendocino fire, the Carr fire, sparked by a car with a flat tire scraping across asphalt, has been more deadly, killing at least six people.

Edison International's stock price fell 14% during the Thomas fire, reducing its market capitalization by billions of dollars, and PG&E Corp.'s stock price has fallen by nearly one-third since the wine country fires began. Financial ratings agencies have downgraded the two utilities along with Sempra Energy subsidiary San Diego Gas & Electric Co. because of wildfire risk, undermining their ability to raise capital.

Still, more homes, businesses and utility lines continue to be built further into dry wilderness landscapes. Drought, record high temperatures and bark beetle infestations have turned vast portions of the state into fire hazard zones. When falling trees knock down power lines and ignite parched vegetation, utilities get the blame.

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Wildfires threaten not only the utilities' financial health, but also their ability to meet state greenhouse gas emissions limits established to address climate change, which scientists say is largely responsible for the increasing severity of the fires. Utilities have indicated they may be forced to curtail renewable and energy efficiency efforts, grid modernization, electric vehicle infrastructure support and other programs.

"The current system for allocating and managing the risk of wildfires in California is unsustainable," said Michael Wara of the Steyer-Taylor Center for Energy Policy and Finance at Stanford University during a July 25 legislative committee hearing to consider the problem. Wara said utility ratepayers will have to pay an increased portion of wildfire costs, and so will utility shareholders when regulators deny utilities cost recovery for wildfire-related expenditures.

In July, Gov. Jerry Brown called for the Legislature to direct the courts to adopt a more proportionate liability standard that would balance private loss against the public benefit utilities provide. Providing a framework for judges to use when determining liability for wildfires, a proportionate system would require utilities to compensate fire victims only when the utilities fail to follow prudent safety standards, such as maintaining utility poles and equipment and keeping foliage trimmed a safe distance from power lines. Brown persuaded legislative leaders to launch the bipartisan Wildfire Preparedness and Response Legislative Conference Committee to put forth legislation, including "appropriate wildfire liability," to respond to increasing wildfire danger.

According to the committee's co-chairman, Sen. Bill Dodd, D-Napa, the panel stopped considering changes to the liability standard in the summer session because there was not enough support among the panel's 10 members to address the matter.

During an Aug. 9 committee hearing, Independent Energy Producers Association CEO Jan Smutny-Jones pleaded with lawmakers to provide legislative guidance to the courts so utilities can manage wildfire costs. If the utilities go bankrupt, the state's renewable energy and carbon reduction goals cannot be met. "Bankruptcy judges as referees do not care about the policies, with all due respect, that the legislature put forward," Smutny-Jones said. "Their job is to the creditors."

The politics of risk

California utilities face enormous wildfire damage claims because the state constitution says that private property may be taken or damaged for a public use only when just compensation has first been paid to the owner. Interpreting that right, courts have established the legal doctrine of inverse condemnation, which makes utilities strictly liable for all damages that result when their utility equipment causes fires.

Even as utilities sought a legislative solution, Pacific Gas and Electric on June 18 appealed a lower court ruling on inverse condemnation to the California Supreme Court. The utility's petition asks the high court to review whether investor-owned utilities are subject to strict liability even though the California Public Utilities Commission has declined to guarantee that it will allow the companies to spread the costs of damages to electric customers. SoCalEd and SDG&E on June 22 asked the court for permission to file in support of Pacific Gas and Electric's appeal. As of Sept. 4, the high court had not yet acted on the appeal.

Grappling with the wildfire liability issue, lawmakers faced pressure from dozens of interest groups, including thousands of wildfire victims who draw considerable sympathy as they attempt to recover from burned-out homes and destroyed businesses. As the utilities are publicly vilified, ratepayer advocates rise in opposition to letting them off the hook or giving them bailouts. Although the governor has proposed reducing utilities' fire liabilities, Brown is term-limited and the November elections will determine his successor. All 80 seats in the California State Assembly, as well as 20 of the Senate's 40 seats, are up for election. How the liability issue will play out in the next legislative session, which begins in December, is anyone's guess.

SB 901 hands utilities a powerful financial tool in the form of securitization, which will allow utilities to issue bonds backed by dedicated charges on customers' bills to defray wildfire costs without going bankrupt. The measure faced heavy resistance, especially from ratepayer groups such as The Utility Reform Network, which considers the bonds a bailout for utilities that fail to meet wildfire safety requirements. If a system for securitized bonds is put in place, the Public Utilities Commission's review would be required to authorize bonds only for past expenditures the regulators deem prudent or subject to ratepayer refunds, Height Capital Markets analyst Clayton Allen wrote on Aug. 17.

Any legislation or regulatory action that appears to let utilities off the hook will face fierce opposition, whoever occupies the capitol in Sacramento. During the Aug. 9 hearing Dodd, whose district was scorched by October 2017 wildfires in Napa and Sonoma counties, said fire investigators have forwarded 11 cases to district attorneys because they found evidence of criminal violations, mainly for failure to maintain minimum tree clearances involving from Pacific Gas and Electric's utility equipment. "Frankly, PG&E violated our trust and must be held accountable," he said.

Assembly Member Jim Wood, D-Santa Rosa, who is on the committee and whose district was also burned in the wildfires, told the panel that hundreds of lawsuits have been filed against Pacific Gas and Electric as homeowners attempt to put their lives back together. "Those lawsuits must be allowed to proceed and I will not support any solution that would prevent anyone from having their day in court," Wood said.

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Insurance coverage is limited

While legislators wrangled up to the last day of the session, utilities scrambled to obtain insurance coverage to cover future liabilities. But the market will not be able to provide insurance for utilities at any price if current wildfire trends continue, according to insurance executives.

The potential exposure from the 2017 Northern California fires of $15 billion would exceed all insurance capacity available in the California market, said reinsurer Aon's U.S. Power Casualty Team Leader Christine Palomba. Insurance companies that are still willing to write policies are reducing their coverage and raising prices because the likelihood of losses is so high. PG&E Corp. reported that its utility has liability insurance of about $840 million from various insurers for third-party liability attributable to the October 2017 wildfires, far short of the billions of dollars the utility could be liable for.

Insurers, who write policies based on spreading risk of loss among policyholders, will not write policies if they know large claims are inevitable. With California wildfires, Palomba said, "there is no spread of risk because of inverse condemnation," she concluded.

Simply removing strict liability from utilities, without other public policy changes, could increase premiums for personal property owners, said William Dubinsky, managing director of insurance-linked securities at Willis Towers Watson Securities. To counter this, the state could help insurers fund catastrophic wildfire losses through a program similar to the California Earthquake Authority, a nonprofit public/private partnership, Dubinsky said.

A shortage of capital is not the problem; plenty of reinsurance capacity, backed by insurance-linked securities, exists to step in directly or in partnership with insurers to expand coverage. Clarifying policies about who pays and who is liable is critical, Dubinsky said, and it will take the insurance industry at least a few years to adjust its modeling and pricing to build up the insurance market for wildfire coverage.

Meanwhile, fires worsen and firefighters continue to pay the ultimate price. A Utah firefighter died Aug. 13 as a result of injuries suffered battling the Mendocino Complex fire, a few weeks after two firefighters died battling the Ferguson fire in Yosemite National Park. As of Sept. 4, the Mendocino Complex fire had raged for 40 days, consuming nearly 460,000 acres.