California’s combination of increasingly dangerous wildfires and utility liability legal doctrine has already pushed its biggest investor-owned utility, Pacific Gas & Electric, into bankruptcy. 

What policy changes could prevent the next big wildfire caused by a utility power line to force the state’s remaining investor-owned utilities, Southern California Edison and San Diego Gas & Electric, into a similarly untenable financial situation?  

California lawmakers have spent much of this year grappling with a host of costly, complicated and potentially unpopular policy answers to this question. But as we’ve noted in previous coverage, the option most favored by utilities and their creditors and investors remains politically improbable: namely, replacing the state’s "inverse condemnation" doctrine, which holds utilities liable for damages from fires caused by their equipment, whether or not they’re negligent or at fault, with a more common “fault-based” standard. 

Last week, the California Commission on Catastrophic Wildfire Cost and Recovery released a draft report that also put inverse-condemnation reform as its top choice for managing the risk of wildfires driving utilities into bankruptcy. The commission, created by last year’s wildfire legislation SB 901 and with members appointed by Gov. Gavin Newsom and the state’s Senate and Assembly leadership, noted that the current system “imperils the viability of the state’s utilities, customers’ access to affordable energy and clean water, and the state’s climate and clean energy goals; it also does not equitably socialize the costs of utility-caused wildfires.”

But, much like a similar report from a Newsom-appointed “strike force” in April, the report also laid out a series of alternative options.

Chief among them is creating “a large and broadly sourced Wildfire Victims Fund, to more quickly and equitably socialize wildfire costs, and maintain the heath of the state’s utilities.”

Of course, raising the billions of dollars needed to capitalize this fund will be challenging, particularly with PG&E in bankruptcy, and will have to be managed to ensure that it doesn’t discourage utilities from investing more in safety, the report noted. 

Gov. Newsom, Senate President Pro Tempore Toni Atkins and Speaker of the Assembly Anthony Rendon declined to endorse inverse-condemnation reform in their response to last week’s commission draft report — at least, not as a first resort. “We are committed to continuing the exploration of the impact of strict liability on the costs to ratepayers, on wildfire victims and on the solvency of our utilities. If the trend of massive, catastrophic wildfires persists, we may need to pursue additional changes,” they wrote. 

Undoing California’s inverse condemnation doctrine is highly unpopular with the insurers and attorneys representing victims of the devastating wildfires of 2017 and 2018, including last year’s Camp Fire, the state’s deadliest to date, which was caused by a PG&E transmission line. But the public defense of the doctrine has largely focused on holding utilities like PG&E responsible for years of lax safety management, rather than on the fact that it provides insurers and attorneys a clear financial target for recovering losses. 

For this year’s legislative session, however, Newsom and the state’s legislative leaders laid out a more restrained agenda — to allow "bridge financing" for utilities facing wildfire damage claims, and "to allow cost recovery for electricity providers who act responsibly and in the public’s best interest. These actions will include insisting on a culture of safety for utilities and on affordability for ratepayers.”

Moody's highlights utility liability limits as potential solution

Credit ratings agency Moody’s highlighted these political realities in a Wednesday note, writing that “it is apparent to us that lawmakers are not actively considering reforming the inverse condemnation law” in this year’s legislative session, even though that would represent the most “credit-positive” option provided by the commission’s draft report.

Moody’s also suggested that utility-proposed changes to the “prudent manager standard” — the rules by which state regulators determine if utilities prudently managed their systems before they can recover liability costs — are unlikely this year.  

Given these realities, Moody’s centered on one particular option in the commission's report, known as Cost Recovery Option 3, as “critically important for maintaining the credit quality” of SCE and SDG&E. This option, as laid out in the draft report, calls for allowing utilities to be forced to pay damages for wildfires, but only “up to the point it harms ratepayers or impacts service” — for example, by driving the utility in question into bankruptcy. 

This concept has already been put forth in SB 901, in its mandate to the California Public Utilities Commission (CPUC) to create a “stress test” methodology for utilities facing future wildfire damages under the inverse condemnation doctrine. But Moody’s and other ratings agencies have pointed out that this CPUC proceeding doesn’t provide California utility investors or creditors with very much certainty, given that it’s still in progress and hasn’t yet indicated how it will accomplish its mandate. 

But Moody’s noted that Cost Recovery Option 3 from last week’s draft report “suggests that utility liabilities can be limited through a stress test or an amount calculated from a percentage of the market capitalization prior to the wildfire event, if the utility makes a substantial upfront contribution to a wildfire victims fund.”

This second approach “will likely be easier to calculate and its implications more transparent to investors, thus more credit friendly.” 

As for a fund to cover catastrophic wildfire losses, Moody's cited it as both credit-positive and the most likely to happen among the recommendations in the draft report. But it added that "the extent of the relief would depend on the size of the fund, the mechanism to access the fund, and increased assurances of the ability of utilities to recover wildfire-related costs."