California Utilities crosses a big hurdle

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Of all indications, 2020 was the worst wildfire season in California history. And the state is not alone in its misery, as an unprecedented combination of gusty winds and dry conditions has also inflicted record damage in the western and Rocky Mountain states.

As Americans, our hearts go out to the victims of these extreme weather events, coupled with record hurricane activity this year on the US Gulf Coast. And damage to human health, property and economic activity is still being accounted for.

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Mid-South Utility Entergy
ETR
Corp
(ETR) recently estimated a range of $ 220 million to $ 250 million for system repairs following Hurricane Zeta alone. This projection does not include potential damage to a power line in southeast Louisiana, which management “could be significant.”

Regulators have always allowed utilities to recover the costs of storm damage in addition to insurance claims. And that should be the case for Entergy this year.

Typically, companies defer these expenses until they can be passed on to customers through a regular pricing process. During years of high damage, many states allow “securitization,” bundling the costs into a bond that has been paid over a period of several years. This spreads the impact on customer rates. And it allows the utility to offset the expense with other cost control measures, and without drastically reducing profits.

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Most states, including California, also allow the securitization of forest fire damage costs. What continues to differentiate the state is the doctrine of “reverse condemnation” enshrined in its constitution. IC holds utilities liable for damage resulting from wildfires in which their equipment plays a role, even if the company follows best practices.

IC was enacted to increase accountability, providing a powerful incentive for electric utilities to keep their high voltage transmission lines and distribution cables in pristine condition. But that has become an impossible norm in recent years, as Californian summers have grown drier and autumns windier – with the result that wildfires have proliferated on an unprecedented scale.

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PG&E Corp’s The bankruptcy filing (PCG) in early 2019 was the result of damage claims from forest fires in 2017-18, which she just couldn’t afford to pay. And the company’s move also triggered a crisis of confidence for other state utilities, with credit ratings down and stock prices plummeting.

The saving grace for California’s electric utilities is that they desperately need good financial health for the state to meet its aggressive decarbonization goals. The needs include hundreds of billions of dollars in projected spending on power grids to toughen them against increasingly severe weather conditions, as well as to enable rapid construction of solar power and expansion of electric vehicle fleets.

Utilities with unwanted bond ratings are unable to fund this scale of investment. And with all due respect to defenders of public power, state and local municipal entities that depend exclusively on debt issuance would not either.

Former California Governor Jerry Brown acknowledged the state’s co-dependence on utilities when he urged IC easing and securitization. The same goes for current Governor Gavin Newsom, who pushed AB 1054 to establish the Utilities Forest Fire Insurance Fund, despite extreme public pressure to punish PG&E for his role in the camp fire. deadly of 2018.

Support from the California government helped PG&E come out of bankruptcy in June this year, the deadline to join the Wildfire fund. That left three big questions for California electric utilities as the wildfire season approached, which began a few weeks later:

• Would the storms of 2020 be as damaging as those of recent years?

• Would public service spending efforts to strengthen systems and improve response make a difference?

• Would the state’s new Wildland Fire Insurance Fund, combined with a handful of rule changes, prevent utilities from meeting their responsibilities?

As it turned out, the wildfire season turned out to be a lot worse than most anyone imagined. A series of severe lightning storms at the start only worsened with around 14 major fires eventually being recorded. In late October, the governor noted that 42 separate fires broke out in 24 hours, adding to more than 4.2 million acres already burned in the state.

Surprisingly, however, California utilities are increasingly likely to escape this year without significant new liability, as they largely did in 2019. Investigations are still ongoing, including a fire in Southern California which may have involved a Edison
EIX
International
(EIX) power line. And Edison and PG&E still have unfinished business with victims of the 2017-18 fires.

But at this point, utility-managed outages and increased power grid spending appear to be having a positive impact on reducing the potential causes of California wildfires. Edison, for example, will install “covered conductors” on 1,000 of the 6,000 miles of targeted power lines by the end of this year, with an additional 1,000 miles by the 2021 wildfire season.

PG&E has completed 470 miles of its goal of 7,100 miles over 12 years, with 365 more on track by the next wildfire season. And new CEO Patricia Poppe will only speed up the process, as a former engineer with five years of experience increasing efficiency, safety and profitability at Michigan Utility. CMS
CMS
Energy
(CMS).

As for the Forest Fire Insurance Fund itself, the decrease in potential liability over the past two years means that it is unlikely to be tested before the next wildfire season. This seemed to be the conclusion of the credit rating agencies who discussed the California situation at 55e Edison Electric Institute Annual Financial Conference, which took place virtually last week.

I outline my key takeaways and recommendations for post-conference actions in a special “Fresh Perspectives from EEI 2020” report, including updated advice on 30 companies based on what I learned there.

For California Electric Utilities Edison, PG&E and Sempra Energy
SRE
(SRE), most importantly, they overcome their biggest hurdle to reward investors with big capital gains in the years to come, as they invest profitably in the state’s rapid energy transition. This makes all three stocks pretty cheap now.

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