Regulatory Research Associates, a group within S&P Global Market Intelligence, is maintaining its assessment of the energy utility regulatory construct in California following passage of legislation to create an up to $21 billion insurance fund to support utilities against wildfire liabilities.
Legislators, however, did not address the state's inverse condemnation doctrine, which exposes all of the California utilities to liabilities from wildfires, regardless of whether they were negligent, as long as their equipment was involved in the incident. Gov. Gavin Newsom's commission that was looking at wildfire cost recovery by utilities in late May recommended that the state replace the strict liability standard of inverse condemnation for utilities with a fault-based standard.
This inverse condemnation legal standard and billions of dollars in associated potential liabilities related to 2017 and 2018 Northern California wildfires led PG&E Corp. and utility Pacific Gas and Electric Co., or PG&E, to file for bankruptcy court protection Jan. 29.
The state Assembly voted 63-8 on July 11 to pass Assembly Bill 1054, the centerpiece of Newsom's $24 billion proposal to stabilize California's investor-owned utilities and protect ratepayers from the costs of catastrophic fires linked to climate change and electrical infrastructure. Citing concern over potential credit-rating downgrades for California utilities, Newsom set an ambitious goal for the Legislature to pass the bill by July 12, when lawmakers break for summer recess. The legislation passed the Senate on July 8. It now awaits Newsom's signature.
The bill would require PG&E to emerge from bankruptcy by June 30, 2020, if it wishes to participate in the fund. PG&E must also settle past wildfire claims that could exceed $30 billion.
The bill provides two options for the wildfire fund. One would create a $10.5 billion liquidity fund that would serve as a line of credit that utilities can tap to pay for wildfire claims and funded with state bonds. After the fund is drawn down to pay for fire damages, the fund would be reimbursed by ratepayers if costs were deemed prudent and by shareholders if not. The other would be a larger wildfire insurance fund backed by $10.5 billion in state bonds and another $10.5 billion in shareholder contributions from utilities. Utilities would have to agree to funding this larger fund.
A utility would be required to obtain safety certification to access the fund. To receive the certification, the companies would be required to tie executive compensation to safety performance, create a safety committee on its board of directors and implement wildfire mitigation plans.
In addition, the bill calls for the utilities to invest $5 billion in wildfire mitigation efforts without the opportunity to earn a return, or profit, on such investments. It also creates a new Wildfire Safety Advisory Board whose members would be appointed by the governor and Legislature to advise the California Public Utilities Commission.
Stress testing for rate-based cost recovery
The insurance fund would cover wildfire claims after the effectiveness of the legislation, hence utilities would have to pay claims for 2017 and 2018 wildfires to access the fund. How much of the costs of the 2017 and 2018 wildfires would be borne by ratepayers versus shareholders is a matter of deliberation by the PUC.
The PUC on June 27 adopted a stress test methodology for determining the amount of expenses that utilities and their shareholders must absorb before recovering costs related to 2017 wildfires. The primary driver of the stress test model is determining how much additional debt a utility can bear and maintain a minimum investment-grade credit rating from Moody's and S&P Global Ratings. An investment-grade credit rating is seen as a predictable indicator of a utility's ability to access capital markets on reasonable and acceptable terms.
Eventually, the PUC will need to determine the maximum amount utilities can pay without harming ratepayers while also maintaining safe and reliable service. Financially viable utilities are seen as more capable of meeting California's aggressive green-energy and low-carbon policy goals. The proceeding will not address any particular fire event or determine the amount of liabilities a utility will be responsible for; it only will set the criteria and methodology to be applied in future utility requests for wildfire cost recovery.
The stress test proceeding is closely aligned with several other proceedings the PUC has on its plate that could impact wildfire costs for utilities. Notably, PG&E in December 2018 filed its 2020 general rate case application requesting an increase in electric generation and distribution base rates of nearly $1 billion. More than half the total requested increase is directly related to wildfire prevention. Additionally, the state's electric utilities recently tendered cost-of-capital filings that request return on equity premiums to compensate them for increased wildfire risks. In its filing, PG&E requested a boost in its authorized return on equity to 16% and a revenue increase of about $844 million from present rates for its electric generation and distribution operations. Combined, the general rate case and cost-of-capital proceeding request a total revenue increase of close to $1.8 billion for PG&E's electric utility.
Regulators are considering whether PG&E Corp. should be broken up and its operating subsidiary split between separate natural gas and power companies. Additionally, the PUC recently opened an investigation into PG&E's maintenance and operations practices with respect to the electric facilities' role in igniting wildfires in its service territory in October 2017, which could result in substantial fines.
California's two other major investor-owned utilities, Edison International's Southern California Edison Co. and Sempra Energy's San Diego Gas & Electric Co., have 15 days after the effectiveness of the new legislation to decide whether the fund will be a liquidity fund or an insurance fund.
Assessment of regulatory framework in California
RRA had reduced its regulatory ranking of California energy regulation to Average/1 from Above Average/3 in January, just ahead of the expected PG&E bankruptcy filing. Prior to that, the state's utility regulatory environment had improved steadily in the roughly two decades since the California energy crisis caused PG&E to tender its previous bankruptcy filing. As a result of that situation, California was viewed as restrictive from an investor viewpoint and was accorded a Below Average/1 ranking by RRA in 2001, the year of the bankruptcy filing.
While the wildfire legislation mitigates some of the future wildfire risk, the failure to address the inverse condemnation doctrine and move away from a strict liability standard continues to pose higher-than-average risks for investors in all of the state's utilities. In addition, the bill does not provide current support for PG&E's ultimate emergence from bankruptcy, nor does it address previously incurred liabilities that are subject to pending litigation.
Nevertheless, other relatively constructive paradigms, including the cost-of-capital adjustment framework, use of electric and gas decoupling mechanisms, and performance-based ratemaking provisions, in RRA's view, support a continued Average/1 ranking for the state.
Overview of RRA rankings process for energy utilities
RRA maintains three principal rating categories, Above Average, Average and Below Average. An Above Average designation indicates that, in RRA's view, the regulatory climate in the jurisdiction is relatively more constructive, representing lower risk for investors that hold or are considering acquiring the securities issued by the utilities operating in that jurisdiction. At the opposite end of the spectrum, a Below Average ranking would indicate a less constructive, higher-risk regulatory climate from an investor viewpoint.
A rating in the Average category would imply a relatively balanced approach on the part of the governor, the Legislature, the courts and the commission when it comes to adopting policies that impact investor and consumer interests.
Within the three principal rating categories, the designations 1, 2 and 3 indicate relative position, with a 1 implying a more constructive relative ranking within the category, a 2 indicating a midrange ranking within the category and a 3 indicating a less constructive ranking within the category.
RRA attempts to maintain a "normal distribution" of the rankings, with the majority of the states classified in one of the three Average-range categories. The remaining states are split relatively evenly between the Above Average and Below Average classifications, as seen in the accompanying chart that depicts the current distribution of the rankings. For additional detail on RRA's rankings process, refer to the most recent Quarterly State Regulatory Evaluations report.
Regulatory Research Associates is a group within S&P Global Market Intelligence.
Article was amended at 12: 30 p.m. July 21, 2019 to clarify the reimbursement process of the liquidity and insurance funds.
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.