The 2020 California wildfire season was one of the more destructive wildfire seasons on record with more than 4 million acres burned and 10,000 structures damaged or destroyed. A relatively small percentage of the destruction was directly attributable to California's investor-owned utilities (IOU) or public power utilities (POU) as opposed to the previous few years, and we believe this is in part a reflection of the efficacy of the utilities' updated wildfire mitigation plans. While timing varies, we expect it will take upwards of three to five years for all utilities to fully implement their wildfire mitigation strategies. In the meantime, risks associated with catastrophic wildfires continue to weigh to varying degrees on our ratings on California's IOUs and POUs, which remain exposed to onerous liability claims under the state's inverse condemnation doctrine--whereby a California utility can be financially responsible for a wildfire if its facilities were a contributing cause of a wildfire, irrespective of negligence. While we view Assembly Bill (AB) 1054 that established an approximate $21 billion wildfire fund as supportive of the IOUs' credit quality and most POUs, which cannot access the wildfire fund, are not highly susceptible to wildfires due to their urban service territories, undergrounding of power lines, or having power lines that run through areas with scant vegetation, we view wind-driven events as a key contributor to utility-caused wildfires. High wind conditions can spark a wildfire if trees and limbs come into contact with power lines or cause electrical lines to fall onto combustible material (dry brush and trees). California's environment has been more prone to catastrophic wildfires as evidenced by 13 of the 20 most destructive wildfire having occurred since 2017, some of which were attributable to electric utility infrastructure.

In advance of this year's wildfire season, S&P Global Ratings reviewed the 2020 wildfire season empirical data with many industry stakeholders. This FAQ updates our wildfire assumptions and analysis, answering investors' frequently asked questions.

Frequently Asked Questions

What did S&P Global Ratings learn from the 2020 wildfire season?

Based on our analysis of the 2020 wildfire season, the following represents are our key takeaways and updated views:

• California's environment remains highly prone to catastrophic wildfires, continuing to pressure utility credit quality.
• We believe the use of public safety power shutoff (PSPS) in addition to the deployment of advanced technologies and system hardening, such as undergrounding or cover conductors, are becoming effective tools for California's utilities to more predictably avert causing a catastrophic wildfire, which we view as supportive of credit quality.
• California's utilities demonstrated improved operational performance during the 2020 wildfire season that we believe could indicate a gradual and sustained operational improvement, which would be supportive of credit quality.
• For the purpose of clarifying an IOU's downgrade threshold reflecting potentially higher business risk, we are defining catastrophic wildfires as those caused by a single utility, during a wildfire season, and totaling more than $4 billion in wildfire claims. Furthermore, because this information is typically not available in real time, we intend to use about 4,000 structures damaged or destroyed as a proxy for the $4 billion in wildfire claims.
• We rate California's POUs higher than the IOUs because the POUs generally operate in urban areas assessed as low fire risk zones and the POUs do not need regulatory approval to raise rates or to issue debt.
• We rate San Diego Gas & Electric Co. (SDG&E) higher than its IOU peers because it has a long track record of proactively avoiding catastrophic wildfires. We view SDG&E as having a lower wildfire risk exposure than its IOU peers, and we believe that it is unlikely that SDG&E will require the use of the wildfire fund.
• We believe California remains committed and very supportive of wildfire suppression and prevention. Over the past five years the budget for the California Department of Forestry and Fire Protection (CAL FIRE) has increased to about $3 billion from about $2 billion.

How does California's current environmental conditions compare to those at the start of the 2020 wildfire season?

Today, in advance of the 2021 wildfire season, it appears that California, for the second consecutive year, will receive below-average rainfall, indicative of drier-than-normal conditions. We believe that these dry conditions increase the susceptibility that a smaller wildfire may grow into a catastrophic wildfire. We view high wind conditions combined with combustible fuel as the primary catalysts for wildfires attributable to utility equipment because high winds can push trees and broken limbs into power lines, and they can also dislodge energized wires. High winds have even propelled tree limbs from outside the mandated clearance surrounding power lines into power lines, sparking wildfires. Drier-than-normal vegetation conditions can exacerbate the potential for wildfires developing into catastrophic conflagrations.

We also believe that the duration of the wildfire season may be increasing. During the 2020 wildfire season, the first PSPS event occurred in May 2020 and the final PSPS event occurred in January 2021, indicating that wildfire season can be as long as nine months. A PSPS event is when a utility proactively deenergizes power lines in areas facing elevated wildfire conditions. Furthermore, for the 2021 wildfire season, Southern California Edison Co. (Edison) already experienced a PSPS event as early as April 2021. We believe a longer wildfire season increases risk because there is more of an opportunity for a utility to cause a catastrophic wildfire.

Similarly, at the start of the 2020 wildfire season, California faced below-average rainfall and drier-than-normal conditions, appearing to increase wildfire-related risks for its utilities. At the beginning of the 2020 wildfire season there was already unprecedented wildfire activity throughout California. Although the 2020 wildfires were principally attributable to lightning strikes, we viewed the wind and vegetation conditions as indicative of a worsening environment, in addition to frequent droughts, which we believed could potentially lead to more frequent and severe wildfires. As a result, in September 2020, we revised the outlooks for PG&E, its operating subsidiary Pacific Gas & Electric (Pac Gas), Edison International, its operating subsidiary Edison, and SDG&E to negative from stable.

What may explain why California's utilities did not cause a catastrophic wildfire in 2020, despite rising environmental risks?

During the 2020 fire season, we observed that IOUs and POUs effectively used public safety power shutoffs (PSPS) to mitigate the fire risks that high wind conditions can create. When high wind conditions were forecast during the 2019 and 2020 wildfire seasons, California's IOUs and most of the state's POUs implemented PSPS to avert causing a catastrophic wildfire. The California Public Utilities Commission (CPUC) initially authorized the use of PSPS in 2012 and has continued to periodically revise and enhance its guidelines to improve its effectiveness. The most recent update was in June 2020. Following our analysis of the 2020 wildfire season, we believe that the prudent use of the PSPS tool, continued development and deployment of weather forecasting technologies, and enhanced system hardening could potentially lead to a significant reduction of utility-induced wildfires.

Chart 1

In 2020, the IOUs had 22 PSPS events compared to 23 in 2019 and just 8 in 2018. We believe the use of PSPS tool could potentially be extremely effective for the California IOUs to more predictably avert causing a catastrophic wildfire, despite the rising environmental risks.

What was S&P Global Ratings' assessment of the operational performance of IOUs during the 2020 wildfire season?

Despite our view of potentially challenging environmental conditions prior to and at the start of the 2020 wildfire season, none of the IOUs were responsible for a catastrophic wildfire. As such, we believe California's IOUs demonstrated operational improvement during the 2020 wildfire season (in line with the 2019 wildfire season) and especially when compared to 2017 and 2018 operational performance.

While none of the IOUs caused a catastrophic wildfire during 2020, Pac Gas and Edison may be held responsible for smaller wildfires. CAL FIRE determined that the 2020 Zogg Fire was caused by a pine tree contacting electrical distribution lines owned and operated by Pac Gas. The Zogg fire damaged or destroyed 231 structures and had 4 fatalities. Additionally, while the 2020 Bobcat fire is still under investigation by the United States Forest Services (USFS), Edison reported that a camera in the vicinity captured the initial stages of a fire with the first observed smoke approximately six minutes before an Edison circuit in the area experienced an anomaly.

We believe the operational improvement of IOUs is likely related to their effective use of the PSPS tool. Furthermore, because of the increased use of advanced technologies, the utilities have improved and are continuing to strengthen their analytics to identify when and where a fire is more likely to begin. Secondly, we believe California remains committed and very supportive of wildfire suppression and prevention. Over the last five years the CAL FIRE's budget has increased to about $3 billion from about $2 billion. Also, over the past several years, in our view, the communication between the various California agencies and the utilities has also improved. This benefits the advance staging of resources often resulting in faster response times to quickly extinguish a wildfire.

An additional credit benefit of improved 2020 operational performance among California IOUs is that every year without catastrophic wildfires preserves the wildfire fund for future years and allows the utilities to continue to focus on their wildfire mitigation efforts without having to exhaust resources on restoration. Under our base case, we assume that it will likely take upwards of three to five years for all utilities to fully implement their wildfire mitigation strategies, which includes the integration of technology, software, and system hardening.

What was S&P Global Ratings' view of the operational performance of the POUs during the 2020 wildfire season, including their use of the PSPS tool?

We believe that none of the 2020 wildfires were attributed to POU assets. During 2020, POUs continued to refine their respective wildfire mitigation plans and were able to avoid causing wildfires during another dry and hot season with several wind events. From a safety standpoint, we view PSPS as a key tool for reducing wildfire risks. At the same time, we understand that the decision to de-energize lines can sometimes be difficult from a political or reliability standpoint.

In our analysis of wildfire mitigation plans and from discussions with POUs, we found that just five of the 22 POUs we rate do not or are unlikely to de-energize power lines during threatening conditions. Four of these POUs cite their lack of material exposure as the basis for this policy. We recognize that de-energizing could pose significant health (e.g., those who rely on powered medical equipment) and safety (e.g., traffic accidents due to nonfunctioning street signals) risks. Nevertheless, in our view, the utilities that maintain the most comprehensive and flexible menu of fire mitigation options will be best positioned to manage financial risks. Although the Los Angeles Department of Water and Power (LADWP) will use PSPS, the utility's threshold for deenergizing is higher than that of other California utilities, and we believe this elevates LADWP's risk profile given their wildfire exposures.

What are some of the technologies both California IOUs and POUs are using to prevent or mitigate devastating wildfires?

POUs, and especially the IOUs, have made significant advances in the use of technologies and other tools to prevent wildfires or identify them early on to avoid more severe wildfires. In our view, while the IOUs have a greater level of wildfire exposure given their larger footprints, they are also relatively more advanced in their preparations. Nonetheless, public and private utilities coordinate and collaborate with many of the same state agencies and there is ongoing dialogue among all parties where ideas, information, and technologies are shared.

We've listed many of the technologies and tools currently in use by both IOUs and POUs in the state (see table).

S&P Global Ratings has previously stated that it would downgrade an IOU that increases business risk such as causing catastrophic wildfires. How does it define the relative size of catastrophic wildfires?

We are defining "catastrophic wildfire" as $4 billion in total wildfire claims caused by a utility during a single wildfire season. We expect that the cause of a wildfire would be either independently determined through a California agency such as CAL FIRE or publicly acknowledged by a utility. Because wildfire claim information is typically not available during a fluid wildfire season, we intend to use about 4,000 structures damaged or destroyed as a proxy for the $4 billion in wildfire claims. As a point of reference, in the history of California wildfires there have only been two individual wildfires that damaged or destroyed more than 4,000 structures: the 2018 Camp fire (18,804 structures and 85 fatalities) and the 2017 Tubbs fire (5,643 structures and 22 fatalities, which was not caused by an IOU or by a POU). Furthermore, only during the 2018 wildfire season did a single IOU damage or destroy more than 4,000 structures and a single POU has never damaged or destroyed more than 4,000 structures.

Chart 2

Does S&P Global Ratings view AB 1054 as supportive of the IOUs' credit quality?

We view AB 1054 as generally supportive of the IOUs' credit quality. AB 1054 created a vehicle for tempering California IOUs' financial exposure to wildfire liability, which can be pronounced under California's interpretation of the legal doctrine of inverse condemnation. Under AB 1054, the state established an approximate $21 billion wildfire fund, which is funded by electric ratepayers and California's IOUs. In addition, AB 1054 allows IOUs to have a predetermined cap that limits liability and provides for a revised standard for determining a utility's reasonable conduct that places the initial burden of proof on the intervenor. We expect these measures will enhance the IOUs' regulatory construct and reduce liability exposure related to wildfires and California's interpretation of the legal doctrine of inverse condemnation.

While we view this legislation as evidence of California's support for its IOUs' credit quality and we expect that the measures within AB 1054 will protect credit quality over the medium term, longer-term risks exist. Such risks include the lack of an automatic replenishing mechanism and the possibility of depleting the wildfire fund whenever there is a wildfire caused by an IOU. If the fund becomes fully depleted, the IOUs loses the credit benefit of using the wildfire fund as a source of liquidity and more importantly loses the credit protection of the liability cap. Another longer-term risk is the uncertainty as to how the CPUC, which is responsible for implementing much of the new law, will interpret AB 1054. If the CPUC does not implement AB 1054 in a credit-supportive manner then much of the law's credit-supportive elements related to the revised standards of a utility's reasonable conduct could be negligible.

What are the credit-supportive factors that compensate POUs for their inability to access the financial protections of AB 1054?

AB 1054's financial protections do not extend to POUs. Nevertheless, in our view, most POUs are not highly susceptible to wildfires and related liability claims due to their urban service territories, undergrounding of power lines, or because the pathways of their high voltage power lines run through areas with scant vegetation. Their transmission and distribution lines are principally within smaller, urban service territories in low fire threat areas, which we believe are less prone to power lines sparking catastrophic wildfires. With small geographic footprints, POU local fire departments' response time is generally short, which can limit the ultimate size and destruction of the wildfires. Also, the transmission and distribution lines of the primarily urban POUs we rate typically are within areas the CPUC assesses as low fire risk zones. In terms of preparedness, our research indicates that the various POUs that have meaningful wildfire risk also practice sound vegetation management and almost all are willing and able to use PSPS to de-energize power lines to address threatening wildfire conditions.

Furthermore, the state's POUs do not need regulatory approval to raise rates or issue debt to fund claims to the extent they are liable for wildfire-related liabilities resulting from the application of inverse condemnation. This ability to set rates without the constraints of California's regulatory framework and to issue debt as needed supports our view that, within limits, POUs are in a good position to address wildfire-related liabilities including recovering from ratepayers amounts paid as judgments. It is these credit-supportive factors that we believe offset a POU's inability to benefit from the credit protections of AB 1054.

Despite the credit-supportive conditions for POUs, prior to the 2020 wildfire season, S&P Global Ratings lowered the ratings on a few POUs based on our analysis of wildfire risks, service territory topography, and performance in prior wildfire seasons. The affected ratings included:

• Glendale Water & Power--Electric System; lowered to A+/Stable from AA-/Negative on April 28, 2020
• Los Angeles Department of Water and Power (LADWP)--Power System; lowered to AA-/Negative from AA/CreditWatch Negative on March 3, 2020
• Trinity Public Utility District; lowered to A-/Negative from AA-/CreditWatch Negative on May 8, 2019 (and subsequently lowered to BBB+/Stable on Nov. 25, 2020)

We lowered our rating on Glendale due to a significant number of customers located in high wildfire risk areas. We lowered the rating on LADWP to reflect our view of the utility's wildfire risks, including a history of utility-related fires and its high threshold for deenergizing lines in the face of threatening wind conditions. Our rating action on Trinity Public Utility District in Northern California reflected a determination that utility infrastructure sparked a wildfire and the damage assessment exceeded the utility's balance sheet liquidity and insurance coverage.

Given S&P Global Ratings' view of IOUs' operational performance during the 2020 wildfire season, why did it only revise its outlook on SDG&E to stable from negative, while maintaining the negative outlooks on both Edison and Pac Gas?

We have consistently assessed SDG&E's operations as better than peers. This incorporates SDG&E's state-of-the-art, self-developed, technology with a demonstrated ability to predict the likelihood of a catastrophic wildfire. The company is viewed as a global leader in wildfire prevention and over the past decade wildfires within its service territory have either been insignificant or the utility has not been determined to have been the cause of these wildfires. Based on its track record, we believe it is unlikely that SDG&E would require the use of the wildfire fund. This contrasts to our view of both Edison and Pac Gas. Despite their improved performance, they experienced wildfires in 2019 and 2020 that could be attributable to the utility. As such, we continue to expect that both Edison and Pac Gas may, at some point, require the access of the wildfire fund and view them as having a higher operating risk than SDG&E.

Secondly, AB 1054 generally determined the wildfire fund allocation based on land area and miles of transmission and distribution lines within a high fire threat district. It was on this basis that the fund was allocated at about 64% for Pac Gas, about 32% for Edison, and about 4% for SDG&E. In our view, the smaller contribution assigned to SDG&E is an indicator of its considerably lower wildfire risks relative to its IOU peers.

Are there additional credit risks for Edison?

Edison continues to face additional credit risks including financial measures with minimal cushion from its downgrade threshold, climate change risks, recent wildfires within its service territory, and some potential dependency on the operational performance of Pac Gas.

Edison has been operating with financial measures that are indicative of minimal financial cushion from its downgrade threshold. The company's funds from operations (FFO) to debt for both 2019 and 2020 was 15.1%. These results are only minimally above the company's downgrade threshold of FFO to debt of 15%. A key assumption for the company's forward-looking financial measures is the outcome of its 2021 general rate case. The company's revised filing includes an approximate $1.2 billion revenue increase in 2021 and increases of about $460 million and $530 million in 2022 and 2023, respectively. We expect a commission's order before year-end 2021.

Another risk for all utilities is the rising environmental risks and the appearance that the climate conditions may be worsening. California for the second consecutive year appears to have received below-average rainfall, indicative of drier-than-normal conditions. These dry conditions increase the susceptibility that a smaller wildfire can grow into a catastrophic one. Furthermore, it appears that the duration of the wildfire season may be increasing. During the 2020 wildfire season, Edison had a PSPS event as early as May 2020 and had its last PSPS event as late as January 2021. Furthermore, for the 2021 wildfire season, Edison already experienced its first PSPS event in April 2021. We believe a longer wildfire season increases risk because there is more of an opportunity for a utility to cause a catastrophic wildfire.

Edison also remains susceptible to wildfire risks. While the 2019 Saddle Ridge and 2020 Bobcat wildfires are still under investigation and were not catastrophic, these wildfires represent continued wildfire risks that remain present within Edison's service territory.

Because our base case assumes that at some point Edison and Pac Gas may require access to the wildfire fund, Edison's credit quality to some extent is dependent on the operational performance of Pac Gas.

What further credit risks are affecting Pac Gas?

Similar to Edison, Pac Gas is experiencing a longer wildfire season, below-average dry conditions, and financial measures with only minimal financial cushion. Pac Gas also experienced wildfires in 2019 and 2020 that may have been caused by the utility. In addition, over the last several months there were several singular events that we believe could potentially increase credit risks. These include:

• Timing of Pac Gas' safety certification;
• Enhanced Oversight and Enforcement Process (EOEP); and
• Criminal charges

The wildfire safety division approved both SDG&E and Edison's most recent safety certification in about 90 days and approved Pac Gas' safety certification in about 170 days. In our view, the extra time taken to review and approve Pac Gas' application indicates the seriousness of the approval process and that the approval process is clearly not automatic. This is critical because there are negative credit ramifications should a utility not receive its safety certification. This includes the inaccessibility of the liability cap, which limits the amount of liability that a utility could be required to bear for a catastrophic wildfire and that the initial burden of proof, in a prudency proceeding, would shift from the intervenor to the utility. Should Pac Gas be denied approval of its safety certification, we believe it would be negative for its credit quality, likely resulting in a downgrade.

A second risk for Pac Gas is the EOEP. On April 15, 2021, the CPUC placed Pac Gas in step 1 of the EOEP. As a result, the utility will be subject to additional reporting requirements, monitoring, and oversight by the CPUC. The CPUC stated that it believes that Pac Gas made insufficient progress toward approved safety or risk-driven investments related to its enhanced vegetation management work in 2020. While we believe the utility is taking the appropriate corrective action and our ratings contemplate that Pac Gas will likely fix the weaknesses identified, we believe this incident is another example of potentially higher reputation risk for the company that could possibly lead to a weakening of its management of regulatory risk.

A third more recent risk for Pac Gas is the Sonoma County District Attorney's Office filing criminal charges against the utility in connection with the 2019 Kincade fire. The company disagrees with these charges and believes it will likely take several years to fully resolve. In the meantime, we believe that these charges are yet another example of potentially higher reputation risk for the company that could possibly lead to a weakening of its management of regulatory risk.

Pac Gas appears to be moving forward with $7.5 billion of securitization. Does S&P Global Ratings view that as supportive of credit quality?

We view the CPUC's initial approval of the securitization of $7.5 billion of wildfire-related costs as mostly credit neutral. The bond proceeds will generally be used to reduce debt incurred due to the payment of wildfire claims associated with the 2017 Northern California wildfires, which we view as credit supportive. Typically securitization contains an irrevocable, non-bypassable charge with periodic true-ups, and an absolute transfer and first-priority security interest in transition property. We often deconsolidate such debt, resulting in stronger credit measures and better credit quality. However, in this situation, the securitization is designed to be rate neutral and the company will be reducing its future cash flows (from net operating losses) to fund an equivalent customer credit to avoid a material increase to the customer bill. In our FFO to debt calculation, while we expect some modest improvement in the near term, over the longer term, the customer credit or loss of cash flow mostly offsets our deconsolidation of securitized debt.

What will it take for S&P Global Ratings to affirm its ratings on parents Edison International and PG&E and revise outlooks on both to stable from negative?

Our forward view of both company's financial measures would have to consistently be above their downgrade threshold without any increase to business risk. The downgrade threshold for Edison International is 15% and the downgrade threshold for PG&E is 13%. Key developments include credit-supportive rate case outcomes, utilities' avoidance of being the cause of a catastrophic wildfire, effective management of regulatory risk, and our assessment that the wildfire fund will last for the longer term.

Moving forward, what wildfire-related factors could lead to downgrades for California POUs?

Our analysis indicates that a majority of the state's POUs do not face significant risks in terms of utility-cased wildfires. But, for those that do, the following factors could lead to lower ratings:

• Failure to maintain appropriate levels of liquidity given wildfire risks.
• An inability to obtain wildfire liability insurance.
• Utility-caused wildfire, whether or not it leads to significant liability claims.
• Significantly worsening drought and climate change.
• Increase in the number of customers or miles of power lines located in high wildfire threat areas.
• Wildfire mitigation practices and policies that we believe have weakened relative to peers, including vegetation management and use of existing and emerging technologies.
• Changes in policies that erode the use de-energization or blocking of automatic reclosers.
• Inadequate fire suppression, including slow response times.
• Increases in other operating risks that could consume or require the liquidity that is in place to offset wildfire risks, such as exposure to volatile wholesale sales, high variable rate exposure, or a heavily concentrated or industrial customer base.

Are there conditions where certain utilities could be upgraded, even those facing meaningful wildfire risks?

For IOUs and POUs, because we view the likelihood of a change to California's interpretation of inverse condemnation as remote, and favorable climate change patterns are also unlikely to emerge for a state with a long history of drought conditions, we are unlikely to raise ratings for utilities with meaningful wildfire-related risks in the near term. Over the longer term, higher ratings could occur if further credit-supportive legislation is passed that provides for additional credit enhancements such as an automatic replenishing mechanism for the wildfire fund. Also, higher ratings for the IOUs could be contemplated if they develop a track record of proactively avoiding being the cause of wildfires, increasing the likelihood that the IOUs would not need to rely on the wildfire fund, and their financial measures are consistently above the upgrade threshold. For POUs, in certain cases, higher ratings could be considered subject to our level of comfort with a utility's increased levels of liquidity versus its risk profile, a clean recent track record of not causing wildfires, or significant advancement in wildfire mitigation (including use of technology).