Pacific Gas & Electric’s wildfire-liability-driven bankruptcy reorganization has been playing out in the political arena this week. The utility’s plan for a new CEO and a revamped board of directors has come under fire from California Gov. Gavin Newsom and state lawmakers, who say it favors the interests of PG&E investors over its customers, state clean energy policies, and most importantly, improving wildfire safety.  

But despite the fractious and challenging politics, California will likely need to undertake significant legal and regulatory reforms to solve the problem that brought PG&E to insolvency, and could threaten the state’s other investor-owned utilities — reducing their exposure to covering the costs of California’s increasingly frequent and devastating wildfires.  

That’s the challenge laid out in a Wednesday note from credit ratings agency Moody’s, due to the state’s unusual “inverse condemnation” standard, which holds utilities liable for damages from wildfires and other disasters caused by their equipment even if they weren’t at fault or negligent. At present, the most likely option appears to be some kind of wildfire emergency insurance fund, Moody’s wrote — perhaps like the one being developed by California lawmakers, or perhaps like the one that PG&E and three hedge funds are working on behind the scenes, as Bloomberg reported last week. 

Credit downgrades for California utilities

Inverse condemnation “effectively turns the state's investor-owned and publicly owned electric utilities into an insurance backstop” for wildfire damages, “without the certainty of cost recovery or authorized capitalization and rate of return to account for the higher risk,” Moody’s wrote. This unique situation has been the primary driver of PG&E’s bankruptcy, leading ratings agency to downgrade its credit to near-junk status and making it impossible for the utility to continue to borrow money. 

It’s also led credit ratings agencies including Moody’s, Standard & Poor’s and Fitch to downgrade fellow investor-owned utility Southern California Edison, and to advise state lawmakers that, absent some form of relief, they’ll be forced to continue to view “wildfire-related damages as an increasing risk that has weakened our overall assessment of the credit supportiveness of the California legislative and regulatory framework.” 

But an attempt to undo inverse condemnation already failed once as part of last year’s wildfire legislative package SB 901, and the politics have only grown worse since PG&E’s bankruptcy filing. As Moody’s noted, getting the two-thirds vote in both the Assembly and the Senate, as well as majority approval by voters, in order to amend the state’s constitution to alter the doctrine, is considered impossible today. 

Also politically challenging would be any form of “safe harbor” legislation that would “ensure the automatic recovery of wildfire-related costs” for utilities, “as long as utilities operate according to wildfire mitigation plans that have been preapproved by regulators,” Moody’s noted. PG&E and the state’s other investor-owned utilities are already under intense scrutiny as they detail their wildfire mitigation plans for this year’s fire season, and PG&E’s fire prevention efforts in particular have been complicated by its bankruptcy, as well as the oversight of the federal judge overseeing its criminal probation for its role in the 2010 San Bruno gas pipeline explosion. 

Catastrophe fund seen as most likely outcome

That means that some kind of “state catastrophe fund” appears to be the reform that is “most likely to happen” in the near term, Moody’s wrote. An independent fund could provide an “immediate source of liquidity for utilities addressing wildfire claims and allow for financial stability during times of crises,” which is the primary concern of ratings agencies and investors. But it would do so while avoiding the more politically unpopular avenue of reforming inverse condemnation or otherwise limiting utilities’ liability for wildfires, which could leave the insurance industry, utility ratepayers, or the state at large on the hook for the additional costs. 

Moody’s note cited “a couple of catastrophe fund options currently on the table,” the most prominent being AB 235, which was introduced by Assemblyman Chad Mayes last year but didn’t make it into the SB 901. While the details of the bill are still being negotiated, AB 235 proposes a California Wildfire Catastrophe Fund Authority that would be funded by investor-owned and public electric utilities, and use these contributions, along with bonds secured by them, to cover future wildfire costs incurred by the utilities. 

Of course, someone will have to pay for wildfire damages, meaning that “the extent of the relief would depend on the size of the fund and how it would address wildfire-related costs,” Moody’s wrote. “Depending on how the fund will be financed, the burden could ultimately be felt by utility customers.” In particular, AB 235 envisions that the fund and state regulators would “determine how to apportion the affected utility's annual contribution to the fund between the utility's customers and shareholders” — passed on to customers or borne by the corporation, in other words – “based on the degree to which the utility was determined by state regulators to have acted imprudently.” 

No easy solution

While the Moody’s note doesn’t mention it, another version of a wildfire catastrophe recovery fund emerged last week, according to a report from Bloomberg citing unnamed sources with knowledge of PG&E’s bankruptcy. According to the report, PG&E and three hedge funds with significant ownership stakes in it — Pacific Investment Management Co., Elliott Management Corp. and Davidson Kempner Capital Management — have outlined a plan that they believe could bring the utility out of bankruptcy by next year, largely by relying on two sets of funds to cover wildfire costs.

Past wildfires would be funded by a trust of $14 billion, with PG&E providing $13 billion and the state the remaining billion. For future fires, the plan proposes $13 billion, of which $4.5 billion would come from PG&E and the rest from California’s other utilities, bonds and other state funding, according to Bloomberg. PG&E and its partners declined to comment publicly on the plan, leaving it unclear whether or not it has been shared with other parties, such as California lawmakers working on AB 235 or other forms of legislative relief, or the Commission on Catastrophic Wildfire Cost and Recovery created last year, which is set to report recommendations to Gov. Newsom before July. 

Wildfire victims suing PG&E, ranging from individuals to cities and counties, may take issue with the plan’s assumption that $14 billion will suffice to make whole past wildfire victims, given that the damages for last year’s Camp Fire alone, the state’s most deadly, have already exceeded that figure. But as Bloomberg noted in an analysis of the plan, parties to PG&E’s bankruptcy are balancing other sub-optimal outcomes, such as struggling through years of bankruptcy for what could end up being a similarly poor payout on their claims.

Despite the political challenges of designing a catastrophe fund to cover utility wildfire costs, Moody’s sees it as preferable to the primary tool provided by last year’s SB 901: securitization, or allowing utilities to issue bonds to cover the costs of past wildfires. While utilities often use securitization to recover unpredicted or stranded costs in a positive way, “excessive use of this tool can have negative consequences” – most obviously by jacking up customers’ bills, but also by limiting its ability to raise rates or issue debt for other, more useful, reasons. And with California’s wildfires expected to become more dangerous and common due to climate change, those costs are likely go up, not decrease, over the long term. 


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