The PG&E Bankruptcy: Five Questions
Earlier this week, on Tuesday January 29, Pacific Gas and Electric Corporation (generally known as PG&E) filed for bankruptcy in the Northern District Court of California. Headline news in all the financial press.
PG&E, which serves northern California, has the largest number of customers of any utility in the United States. The filing noted that PG&E had assets of $71 billion, against liabilities of $51 billion, but was facing an estimated up to $30 billion in further liabilities as a result of the major wildfires which have swept through California in the past two years. That number could wind up significantly higher, as PG&E faces possible liabilities in as many as 17 of California’s 21 wildfires from 2017, and an unknown number from 2018 wildfires which caused more losses in lives and property. Insurance cover? About $2 billion. Its stock has lost over $20 billion in value in the last three months.
This is the first bankruptcy of a major utility to be linked to climate change; indeed, it may be the first major corporate climate change-driven bankruptcy across all industries. While it is too early to tell how the bankruptcy will proceed, it is clear there will be major implications. And many warnings and lessons for utilities around the world. In this post, Infrastructure Ideas will look at five big questions arising from this event.
1. Will post-Chapter 11 life return to normal for PG&E? No.
The utility’s reorganization process under Chapter 11 bankruptcy will be complicated. Compensation for those affected by wildfires, estimated at $30 billion, could wind up substantially higher. Electricity rates were already raised in 2017 – to between 11.9 and 29.8 cents per kilowatt hour – in order to address liabilities from wildfires in earlier years, and there seems to be limited room for yet higher tariffs at a time of widespread condemnation of the utility’s performance. The Company is seeking to be released from paying renewable energy providers rates earlier negotiated under Power Purchase Agreements (PPAs): federal regulators ruled against the request, and PG&E is appealing in court. Such a release would complicate operations for wind and solar generators selling power to PG&E, and have widespread ramifications across many geographies. And some California legislators are taking the position that a large, integrated utility like PG&E no longer is appropriate for an age of more decentralized renewable energy production, that its gas and power businesses should be separated and the company split into a number of smaller, more localized utilities.
Whichever outcomes fall out of the bankruptcy and reorganization, one thing is clear. Life for PG&E will never be the same. It was already faced with complex challenges as a buyer of electricity, with on the one hand regulators mandating it to buy a growing share of intermittent renewable energy, and with wind and solar generators on the other hand constituting a much more varied electricity supply base, and with challenges as a buyer and seller of natural gas, where traditional long-term purchase contracts are increasingly a concern in the face of future uncertainty over fossil fuels. Now it also faces a future where the trigger events for its current bankruptcy are expected, unfortunately, to be ever more frequent. As The Economist pointed out in its coverage, with climate warming and extreme events such as severe droughts becoming more common, wildfire costs look set to be the norm in the western US, and many other geographies as well. So what is clear about PG&E’s future is – it’s not PG&E’s past: it is not the life of a stable, low-risk utility with predictable (and easily managed) problems. Rather, PG&E’s future is one of more erratic price risks, greater uncertainty about policy mandates, and recurring uninsurable risks.
2. Will other utilities face similar risks to PG&E? No. And yes.
One aspect of PG&E’s bankruptcy is relatively unique. Its exposure to wildfire-related liabilities is far greater than most utilities, in that its jurisdiction, California, is one of only two US states with strict fire liability for utilities (Alabama is the other). Investors in Southern California Edison may be nervous about a similar scenario, but the other 99% of utilities may well look at this, shrug their shoulders and say “well, good thing we’re not in California.”
Yet in the broader sense, yes, other utilities will face similar risks. As a specific case, PG&E was overwhelmed by rapid climatic changes as a prolonged drought dried out much of the state and decimated forests, dramatically increasing the risk of fire. While California’s legal environment is unique, the risk of wildfires is far from limited to the state – most scenarios show widespread higher wildfire risk across many geographies as global warming continues. Growing populations mean, virtually everywhere, that fire-prone areas are closer and closer to more homesteads than before. That in turn means ever larger wildfire costs, in terms of losses of lives and property. Many of those wildfires are caused, or exacerbated by power lines, as we’ve observed in Northern California – where as mentioned already PG&E is being charged with liability in 17 of 21 of the 2017 wildfires in its area. The situation faced by many utilities will be that people in their area will incur large losses due to wildfire, and utilities will always be “the deep pockets” from which people will seek to recover those losses – well beyond what can be insured.
Wildfires are of course not the only climate-related issue facing PG&E, or other utilities. Policy mandates and the deterioration of the coal market are forcing many to overhaul their energy sourcing. The growing share of wind and solar power in their purchasing initially raised costs; now the purchase costs of renewables are dropping rapidly, but a growing share of intermittent power brings greater technical challenges. Hydropower resources are becoming more unpredictable. And the risks of policy discontinuities in the energy sector are highly likely to rise as emission reductions miss their targets and global temperatures rise. For now, none of those risks have the same existential magnitude as exposure to wildfire-caused losses, but that may change. For utilities in general, as for PG&E, the future is surely much less stable than the past.
3. Should PG&E investors be upset at PG&E management? Yes
Lawyers will argue at length about the extent of PG&E’s responsibility for the California fires. Management will naturally claim these as “acts of God” beyond its responsibility. But investors who are part of the $20 billion plus reduction in market value which accompanied the bankruptcy filing are upset at management, and rightfully so. PG&E’s handling of fire risk has been very unimpressive. Leaving aside the technical aspects, and how much more it could have cleared rights of way, or better monitored the early onset of fires, or more quickly cut power to lines in affected areas, PG&E completely failed to manage the non-technical side of its new risk.
The new reality for utilities, as demonstrated in this case with PG&E, is a much more unstable and unpredictable risk environment. In such an environment, a “traditional” large utility attitude – being insular and assigning no value to relationships with consumers and most constituents – is completely exposed to blame – and the risk of financial liability – from the unexpected. By contrast a utility which invests in relationship management, and is seen as a “partner” rather than an adversary by consumers and local populations, can expect better treatment in both the court of public opinion and the court of assigning unforeseen costs. PG&E was the former, and investors are right to be upset that it failed to become more of the latter. Asking the bankruptcy court to allow $130 million in management bonuses is the perfect illustration.
4. Should non-PG&E utility investors be concerned about this bankruptcy? Yes.
As noted above, the specifics of responsibility assignment for wildfire costs is unique to PG&E’s context. But many utilities face similar future unpredictability in costs, revenues and policy risks. The costs of extreme weather events – hurricanes, flooding, and wildfires – are more often beyond the scope which insurance will cover. Few or no utilities will go through an identical bankruptcy to PG&E’s, but many will face large-magnitude uncertainties completely different than their historical risk profiles. New climate related risks should concern all utility investors.
As a Bloomberg headline framed it, “PG&E shows utility stocks aren’t boring anymore”.
5. Should wind and solar companies be concerned by the PG&E situation? Yes.
Like investors, wind and solar companies also have a big stake in the stability of utilities, in this case as their source of revenue. PG&E has already asked the bankruptcy court to reject a ruling by regulators that would force them to keep honoring renewable energy supply contracts. Whether the court sides with PG&E or not, wind and solar providers are facing a reality that their main buyers are themselves increasingly unstable, and so that their own revenue streams are at greater risk. This risk could be existential – in hopefully rare cases – but at a minimum is likely to make it yet more difficult for YieldCos and similar financing structures used by renewable companies.
The climate change pain of utilities will be shared. PG&E’s bankruptcy is a first act. There will be more. But Bloomberg has it right: at least the electricity business can no longer be called boring.