It is a measure of California’s range of natural dangers that the state’s Wildfire Fund is administered by the California Earthquake Authority. The cost of making a state prone to drought, flood, fire and tremors not merely viable but desirable, and who pays, have been controversial constants all the way back to Los Angeles’ so-called “water wars” a century ago.
Today, as LA contends with fire, the question of liability is as potent as ever.
The stock market quickly digested the awful news and images from LA and promptly wiped 10%, or US$3.1 billion ($4.25 billion), from the value of Edison International, owner of Southern California Edison, the utility serving 15 million customers across a swath of territory including much of Los Angeles County.
That was on Wednesday. By Friday, the wipeout had reached US$4.8 billion. That same day, PG&E, whose Northern California territory is nowhere near LA, dropped by 8%, or more than US$4 billion.
Financially, at least, LA’s fires aren’t contained there. The state’s relatively nascent effort to insure its utilities against enormous losses from wildfires is potentially under threat already, posing a big problem for California’s grid, economy and green aspirations.
In an incident report filed Thursday evening, SCE didn’t indicate any link with its grid, and the Palisades fire isn’t in its service territory. But the Eaton fire around Pasadena, which had expanded to nearly 13,700 acres and destroyed 5,000 structures as of Friday afternoon, is believed to have begun in an area close to the utility’s transmission lines.
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There are also distribution lines nearby, but these were shut off ahead of the reported start of the fire, although a report emerged Friday of some homes in the vicinity possibly still having power at that time.
The ignition point of the smaller Hurst fire, while not in SCE’s territory, is also close to the utility’s transmission lines, and it said late Friday that fire agencies are investigating whether its equipment was involved.
Despite the caveats there, and no firm evidence of SCE’s involvement, the market assumed the worst. That is perhaps forgivable when it comes to California.
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A quirk of the state’s constitution subjects utilities to “inverse condemnation”, whereby they are on the hook for costs related to any wildfire sparked by their equipment, regardless of actual fault. And even the best-maintained wires can come down with a strong enough wind.
Under AB1054, legislation passed in 2019 after PG&E, the state’s largest utility, declared bankruptcy in the face of enormous wildfire-related liabilities, California’s big three investor-owned utilities pay into an insurance pool, the California Wildfire Fund, to help meet such costs.
Utilities can tap the fund to meet costs above US$1 billion that aren’t covered by their own insurance. Moreover, they can obtain safety certification on a regular basis from the state regulator, shifting the presumption of guilt in a disaster and putting the onus on others to prove the utility acted imprudently.
If deemed prudent, the utilities need not reimburse the fund. If deemed imprudent, but safety-certified, they repay an amount capped at 20% of their equity rate base, or the value of their regulated assets less debt. (This protection wouldn’t apply in the case of willful disregard for safety, of course.)
On that basis, SCE would face a maximum reimbursement to the fund of about US$3.9 billion, which, adjusted for tax, works out to about US$3.1 billion — the initial hit to Edison’s market cap. Yet even that assumes two big things: the Eaton fire eventually being attributed to SCE’s equipment plus the utility being found to have acted imprudently.
The continued selloff in Edison’s stock regardless of that, plus PG&E’s slide, suggests investors’ worries extend beyond the specific utility to the fund itself. The fund is due to eventually have US$21 billion in it but had received about US$14.7 billion as of last month.
Mounting estimates of losses from LA’s fires mean that if SCE’s grid is eventually found to be at fault, then while any liability accruing to SCE might be capped, the fund itself could face a multi-billion-dollar hit before it’s even fully capitalised.
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The fund has authorisation to issue several billion dollars worth of bonds to meet any obligations that exceed its liquidity, but repaying these would encumber some of its future revenue.
This matters because the fund is an anchor stabilising California’s utility sector. Recall that, after the wildfires of 2017 and 2018, PG&E plunged from being an A-rated credit to junk within about 12 months, and then entered Chapter 11 for the second time this century.
The Wildfire Fund’s latest annual report cites comments from several credit rating firms on the fund’s importance. Earlier this week, Andy DeVries, an analyst at CreditSights, noted presciently that even though the wildfires are in LA, financial contagion could spread to PG&E, with the risk that a big hit to the fund “could cause the agencies to reassess their views on all CA utilities”.
The stock market would appear to have reassessed its views already.
Just as my Bloomberg Opinion colleague Mark Gongloff has highlighted a potential US$1 trillion hole in US homeowner insurance coverage that is inadequate in the face of accelerating natural disasters, so these fires are casting doubt on California’s new insurance plan having contained the risk to its utilities.
As I wrote here in the aftermath of PG&E’s bankruptcy, much of US infrastructure wasn’t built to withstand climate change, and that extends to the financial arrangements underpinning the built environment.
California’s well-being, and its climate goals aimed at mitigating future natural disasters, rest overwhelmingly on electrification. That means having a power grid that is stable all the way from its pylons down to its balance sheet, allowing investors to regard California’s utilities like any others: as financial safe havens, not volatile bets on weather conditions.
