California fire investigators found PG&E power lines at fault for numerous recent wildfires. Read on to learn how this impacts utility investing.

Eric Espeseth, Senior Credit Analyst

Pacific Gas & Electric (PG&E) filed for bankruptcy on January 29th, following fire investigators' findings the utility's electric lines ignited several deadly northern California wildfires. We take a brief look at the factors that led to this decision and consider whether similar implications for other utility companies outside California exist.

PG&E's filing for bankruptcy protection was driven by a combination of two major factors: 1) the potential to be held accountable for billions of dollars in liabilities tied to wildfires caused or aided by the company's electrical equipment, and 2) California's unique application of a legal doctrine known as inverse condemnation.

Following severe drought conditions - which have persisted in much of California going back to 2011 - the state was struck with historic wildfires during 2017 and 2018. Wildfires in northern California during this period burned hundreds of thousands of acres, destroyed thousands of buildings and were responsible for the loss of more than 100 lives. These fires included the 2018 Camp Fire, the most destructive fire in California history.

California state fire investigators have concluded that PG&E's electrical equipment ignited 17 of the wildfires that tore through northern California in 2017. In these instances, downed power lines were typically caused by severe wind storms and falling trees. While the cause of the Camp Fire remains under investigation, state regulators are looking at PG&E equipment's role in the fire. The company has stated it could face up to $30 billion in liabilities tied to wildfires during 2017 and 2018, due to a legal construct called inverse condemnation which allows property owners to seek compensation if a public use causes loss or harm.

While inverse condemnation is not unique, the way California courts apply it to investor-owned utilities is. California case law states that privately-owned utilities can be held strictly liable for damages - in this case wildfire damages - caused by the company's equipment whether or not the company acted negligently. In these situations, the utility typically attempts to recover incurred costs and damages through increased customer rates but there is no guarantee such efforts will be approved by the California Public Utilities Commission (CPUC).

The sheer size and uncertainty over covering these liabilities led to PG&E's decision to file for bankruptcy protection. Wildfire risk and severity has increased throughout California and the possibility CPUC may not allow for cost recovery associated with liabilities due to inverse condemnation has led to heightened investment risks for investor-owned utilities in California, like PG&E. These factors have led our decision to avoid investing in California utilities.

We believe implications for other investor-owned utilities outside of California are fairly limited. While natural disasters pose a risk to utility companies throughout the country, California's combination of environmental factors combined with the application of inverse condemnation presents a unique risk.

Sources

Pacific Gas & Electric, Form 8-K, January 13, 2019

Cal Fire, Top 20 Most Destructive California Wildfires, February 8, 2019

California State Association of Counties, Inverse Condemnation and Utility Liability Fact Sheet, July 10, 2018

San Francisco Chronicle, 12 Northern California Wildfires Sparked by PG&E Power Lines, Investigators Say, June 9, 2018