Utility bankruptcy concerns rise as bill comes due for 2017 California fires

California's state motto is "Eureka!" But its energy sector's motto is quickly becoming "Somebody do something!"

The state's grid operator is slowly learning to cope with levels of renewable generation that require unprecedented system flexibility; regulators are studying an onslaught of customer choice nobody has written rules for; and now, California's investor-owned utilities (IOUs) face liability for the state's 2017 wildfires that could bankrupt them.

The state saw five of its 20 most destructive fires between October and December of 2017, capping a year in which the California Department of Forestry and Fire Protection (Cal Fire) recorded 7,117 wildfires. The previous five years averaged 4,835 wildfires per year. The total cost, including fire suppression, insurance and recovery, could be $180 billion, Courthouse News Service reported.

For the fires, California's IOUs face a special kind of liability. Contrary to 48 other states, California courts have interpreted the law on utility liability to mean that utilities must pay all damage costs if utility equipment was involved in a fire, whether the utility was negligent or not.

There is a growing concern that this financial burden could make it difficult for California IOUs to remain solvent. Regulators are asking how to judge the "prudence" of the IOUs' preparations in the "new normal" of extreme weather linked to climate change. While victims' attorneys and insurance companies want IOUs held accountable, legislators and policymakers are wondering if the IOUs are too big to fail.

The concern about the utilities' financial viability has brought forward potential solutions, including ways to reduce their exposure to liability through risk pools and settlements with their insurers and others who contributed to the fire.

Even so, the stakes for Pacific Gas & Electric (PG&E) and Southern California Edison (SCE) are huge, and many say San Diego Gas and Electric (SDG&E) is only one big blaze away.

Fires and bankruptcy

The bankruptcy threat comes out of a September 2017 ruling by the California Public Utilities Commission (CPUC). SDG&E asked the commission for cost recovery on its $379 million liability for 2007 wildfires. The CPUC ruled against SDG&E.

The commission said that because the utility was found negligent under the state's "strict liability" interpretation of the "inverse condemnation" doctrine, its shareholders and not its customers must bear the loss. PG&E and SCE shareholders may now face the same fate under that logic.

California saw significant loss and damage from wildfires last fall and winter.

From October 8 to October 9, 172 wildfires broke out in Northern California. In what Cal Fire called the "Fire Siege," 18 fires "grew into large, fast moving conflagrations," Cal Fire Deputy Director Joe Tyler told the California Public Utilities Commission (CPUC) on January 31. Some 8,920 structures were destroyed and 44 people lost their lives, he added.

On December 4, 122 wildfires broke out in Southern California. In the two week "Santa Ana Fire Siege" that followed, six fires grew into large, fast moving conflagrations as relative humidities of 0% and 1% were recorded, Tyler reported. Some 1,370 structures were destroyed and two lives were lost.

Cal Fire has found PG&E equipment involved in 12 of the Norther Region fires and the utility potentially guilty of negligence and violations in eight. It has not yet released decisions on SCE involvement in the Southern Region fires.

There is speculation from lawmakers and media voices that PG&E faces between $10 billion and $15 billion in liabilities. The utility announced an initial $2.5 billion set-aside in a June 21 Securities and Exchange Commission filing, in anticipation of its potential responsibilities. Early estimates put SCE's costs at nearly $4 billion, but that does not include costs that could reach $250 million for the devastating January mudslides that took 21 lives and were the result of the fires.

"In this election year, legislators have to ask themselves if the consequences of ignoring the problem are potentially worse than stepping up."

Ralph Cavanagh

Senior Attorney and Energy Program Co-Director, NRDC

Stock market activity shows increasing investor concern over potential liabilities.

Until October 2017, the PG&E stock price hovered around $70. Since then, it has plunged to below $40. The utility has suspended its dividend in the face of what amounts to at least a $15 billion loss in market value, according to Bloomberg News.

The stock price of SCE parent Edison International, at about $80 per share on December 4, 2017, immediately fell to $70 per share with the Southern California wildfires. Following the January 2018 mudslides, it dropped to around $60 per share, where it remains.

PG&E's potential liability could exceed the utility's $13 billion-plus in 2017 revenues, according to Natural Resources Defense Council (NRDC) Senior Attorney and Energy Program Co-Director Ralph Cavanagh. "What will PG&E do, double its customers' bills?"

SCE's financial burden could also be considerable. In a May 21 filing with state regulators, it reported "an urgent situation regarding securing additional insurance in the wake of the December 2017 wildfires and 2018 Montecito mudslides."

With all their potential liabilities, the bankruptcy threat for utilities looms large.

Inverse condemnation and strict liability

"Under the U.S. Constitution's inverse condemnation doctrine, utilities can be held liable for failure of their infrastructure," NRDC's Cavanagh told Utility Dive. "If they cause harm, they are responsible for making things right."

Unlike most states, however, California precedent imposes "strict liability," Cavanagh said. "Utilities don't have to be found guilty of negligence or any form of unreasonable conduct to be responsible for the cost of wildfires. It is enough to show their equipment contributed to fire damage."

Though the losses to the wildfires are "simply heartbreaking," Cal Fire investigations show "our overall programs met our state's high standards," PG&E wrote in a statement.

"An unprecedented confluence of weather-related conditions" were the "root cause" of the fires, the statement added. The best response to this wildfire devastation is "comprehensive legislative solutions" that include preventing future fires and a reform of strict liability, PG&E argued.

NRDC's Cavanagh agreed. "The legislature can provide guidance to the CPUC on enforcement," he said. "This amount of liability puts the whole principle of rapid and fair compensation at risk because insolvent utilities can't compensate victims."

Legislative steps

California's legislature is working on solutions to the wildfires and to the utilities' liability issues, according to Kip Lipper, the chief energy and environment policy adviser to California Senate President Pro Tem Kevin de León, D. "And there are conversations going on in the executive branch."

"You can accuse the utilities of crying wolf about their need for protection from strict liability, but it could be that the wolf is at the door."

V. John White

Executive Director, Center for Energy Efficiency and Renewable Technology

Two key bills have passed the Senate and await Assembly action. SB 1260 "deals with managing and hardening the landscape to reduce damages and prevent future fires from harming people and property," Lipper said. SB 1088 "deals with the CPUC's role in allocating costs between ratepayers and shareholders."

Governor Jerry Brown's budget also includes a billion dollars for investments to reduce fire risk, he added.

The insolvency threat is "a serious concern that we need to address," Lipper said. "Utilities must face penalties that give them an incentive to invest in preventive measures, but they must remain financially healthy enough to make those investments."

Climate change drivers

CPUC President Michael Picker is also struggling with the wildfire issue's complications, he told Utility Dive. "It is difficult to assign a climate change cause to a specific event, but we are seeing unprecedentedly ferocious heat storms and windstorms during periods of zero soil moisture and zero humidity," he said. "Past standards may not be adequate to judge utility prudence."

The commission may need to reconsider the way costs are allocated if the "new normal" of climate change and extreme weather puts events "outside utilities' influence," Picker added.

Center for Energy Efficiency and Renewable Technologies (CEERT) Executive Director V. John White has been among the leaders in the enactment of California's landmark clean energy and climate policies since the early 1990s.

The state has financed its entire green energy transition largely through the utilities, and without them, reaching the state's renewables and climate goals would be challenging, White told Utility Dive. "There are important questions about the utilities being adequately insured and properly prepared, but it's not a good thing for anybody if the utilities end up in bankruptcy."

Solutions

Policymakers "must work together" on "solutions that go beyond utility practices," PG&E said. It called for improvements in forestry management and building codes, and for making fire insurance more affordable and available.

But it is also "imperative to reform California's unsustainable policies regarding wildfire liability," the company added. Reforms would not absolve utilities from responsibility because victims would still be able to pursue negligence claims in court, and the CPUC could still deny cost recovery to negligent utilities, it noted.

Utilities also have a limited defense against insolvency by recovering costs from other parties, Stanford Law Professor Michael Wara told Utility Dive.

"Utilities must face penalties that give them an incentive to invest in preventive measures, but they must remain financially healthy enough to make those investments."

Kip Lipper

Chief energy and environment policy adviser to California Senate President Pro Tem Kevin de León

Along those lines, a May 21 Morgan Stanley analysis estimated PG&E's eventual liability could be reduced to $3.75 billion, after settlements with insurers and those who contributed to the fires. SDG&E brought its liability for the 2007 fires down from $4 billion to $379 million through this limited defense.

But "there is no assurance that utilities can use this defense to recover costs that would mitigate their gross losses," NRDC's Cavanagh said.

It is vital for lawmakers to revise the strict liability interpretation of the inverse condemnation doctrine, he argued. It would only protect utilities if they are not negligent, he stressed. "SB 1088 would clarify what negligence means, and if a utility was found to have been negligent, the CPUC would deny cost recovery."

A statutory revision of inverse condemnation would certainly be challenged legally, Stanford's Wara responded. Although that would prolong uncertainty, "the revision would likely stand if it clarified the issue."

White, Cavanagh and others are also talking about a fund, similar to those created to address Florida hurricanes and California earthquakes. A publicly funded risk pool would cover wildfire damages if utilities were found to be not negligent.

With an established negligence standard and new liability rules that balance utility incentives and penalties, a risk pool could assure that victims were paid promptly and costs would be spread fairly, Cavanagh said.

But attempting to restructure liability is a Rubik's cube of political complexity, Lipper said. It requires balancing law and policy.

The politics

The legislature could act to restructure liability, but there is significant political opposition. Some call the idea "bailling out" utilities.

A June 11 San Francisco Chronicle editorial was unforgiving: "PG&E doesn't deserve a bailout," it headlined. The state's IOUs are "working to deflect blame to climate change, extreme weather and other external forces" and lobbying for protections "regardless of wrongdoing," it asserted. The Chronicle called on lawmakers "to protect the public from PG&E instead of rushing to rescue the company from itself."

"The utilities' equipment caused the fires," according to The Rebuild with Resilience Coalition of insurance companies. "Legislators should protect Californians' pocketbooks and prioritize public safety over private profits for the IOUs by ensuring the IOUs are held accountable," the group said in a June 12 statement.

Another group, Up from the Ashes, is a "coalition of victims against utility abuse," and is "funded by law firms suing PG&E," according to the Chronicle. Its rallying cry is "Hold PG&E accountable."

These efforts explain why state senators do not want to be seen bailing out utilities, Lipper said. "But this is not a black or white issue," he said.

California's labor unions are allied with the IOUs, Lipper said. "They are very concerned about the impacts of jobs, pensions, and the financial health of utilities that employ tens of thousands of workers."

What is needed is "a series of actions" that "prevent fires but also keep the utilities creditworthy," he said.

Avoiding bankruptcies

Cavanagh stressed that changing the interpretation of the inverse condemnation doctrine is "not about bailing out PG&E." Negligent utilities will still be accountable, he said. But utilities that meet the standards set by lawmakers and regulators will not face bankruptcy.

"In this election year, legislators have to ask themselves if the consequences of ignoring the problem are potentially worse than stepping up," Cavanagh said.

"This could be seen as bailing out utilities and, in an election year, that is a hard call for lawmakers," CEERT's White acknowledged. There is talk of a "mega-deal" that could come near the August 31 end of the current legislative session that would resolve the wildfire issue and other energy sector initiatives.

"People who had devastating losses may want to stick it to PG&E, but this is not just the utilities' problem, it is everybody's problem," White said. "You can accuse the utilities of crying wolf about their need for protection from strict liability, but it could be that the wolf is at the door."