Power finance in a new normal for wildfires

January 2025  |  SPECIAL REPORT: ENERGY & UTILITIES

Financier Worldwide Magazine

January 2025 Issue

The past 10 years have seen a tremendous uptick in the number and scale of wildfires affecting electric utility companies in the US. Pacific Gas and Electric Company filed for bankruptcy protection on 29 January 2019 after a series of California wildfires.

The company had disclosed earlier that month that it faced about 750 complaints on behalf of at least 5600 fire victims alleging damages caused by PG&E equipment, and estimated that its fire-related liabilities could ultimately exceed $30bn.

PacifiCorp, a subsidiary of Berkshire Hathaway Energy, has been the subject of a number of lawsuits in connection with various wildfires in western US states that occurred between 2020-22. Claims against PacifiCorp total at least $46bn following recent lawsuits in Oregon.

A deadly August 2023 wildfire in Maui destroyed the town of Lahaina. Since the fire, Hawaiian Electric Industries, Inc. has become the target of a number of suits brought by both the County of Maui and individual plaintiffs. Hawaiian Electric announced on 2 August 2024 that Hawaiian Electric and its subsidiary, Hawaiian Electric Company, Inc., and certain other parties including the state of Hawaii and the county of Maui, have reached an agreement in principle to settle all tort claims related to the August 2023 wildfires.

The defendants would collectively pay over $4bn to resolve all tort claims arising from the 8 August 2023 wildfires on Maui. Hawaiian Electric and Hawaiian Electric Company’s contribution is a total of $1.99bn (pre-tax) to be paid in four instalments.

In February and March of 2024, the largest wildfire in Texas history, the Smokehouse Creek Fire, burned more than 1 million acres in the Texas Panhandle. The fire occurred in or near the service territory of Southwestern Public Service Company, a subsidiary of Xcel Energy Inc. Xcel Energy Inc. also faces a lawsuit in Colorado where the Marshall Fire, ignited in Boulder County, Colorado, burned over 6000 acres in December 2021.

The effects of climate change are likely to continue to put stress on the financial condition of investor-owned utilities in the US. For example, from 2005 to 2017, S&P downgraded two North American investor-owned utilities due to physical risks from climate change.

From 2018 to 2023, S&P downgraded 19 investor-owned utilities due to such risks. Increased wildfire risk has contributed to nearly 100 utility company credit downgrades since 2020, according to a recent report by Charles River Associates.

Considerations for a rate regulated utility

Electric utility companies are often required by state public utility commissions (PUCs) to implement certain policies that mitigate the risk of wildfires (or their spread). These policies include vegetation management, maintenance of power lines, burying powerlines and power shutoff plans (sometimes referred to as ‘public safety power shutoff’).

PUCs usually set the terms and conditions of a utility’s business and, as such, have authority over many of the utility’s projects and the utility’s requests for consumer rate increases. This includes the PUC’s review and approval of the mitigation efforts.

When a wildfire occurs, PUCs may in some circumstances limit a utility’s ability to recover costs associated with a wildfire through customer rates. For example, in 2017 San Diego Gas & Electric was not allowed to recover $379m of costs resulting from 2007 wildfires. The California PUC determined that San Diego Gas & Electric had failed to “reasonably manage and operate its facilities” prior to the fires. The California PUC used a ‘prudent manager’ standard to reach its conclusion.

In extreme scenarios, wildfire liabilities may become existential for the utility and any parent company. In the case of PG&E, one factor contributing to the company’s bankruptcy was California’s interpretation of ‘inverse condemnation’. Inverse condemnation is a legal concept that entitles private property owners to just compensation if their property is damaged by a ‘public use’.

Unlike most states, California’s courts have applied the inverse condemnation doctrine as a strict liability rule, imposing liability regardless of any considerations of the fault on the part of the public actor. Furthermore, California courts have not restricted application of the remedy to the actions of public actors and have instead allowed recovery in the case of certain private entities who damage property in their provision of public services. Specifically, California appellate courts have held that inverse condemnation is validly applied to privately-owned utilities when electric equipment sparks a wildfire.

Potential effects on secured debt under a utility mortgage indenture

Under a typical utility mortgage, one method the issuer may choose to issue mortgage bonds from time to time is on the basis of ‘property additions’. If the issuer uses ‘property additions’, then the issuer is able to issue mortgage bonds in an amount equal to some set percentage of unfunded ‘property additions’ (after adjustments to offset retirements) – this percentage enumerated in the mortgage is referred to as the ‘bonding ratio’.

One trend we have seen over the past several decades is an increase in the bonding ratio under the typical utility mortgage, whether as the result of an amendment to an existing mortgage indenture or as a term of a new mortgage.

Despite the trend in greater bonding ratios, it is unlikely that holders of utility mortgage bonds would be precluded from recovery either as a result of the wildfire destroying certain of the issuer’s properties or as a result of a bankruptcy. Furthermore, many modern mortgages include extensive provisions detailing the insurance coverage that must be maintained as well as detailing how any such amounts will be paid by the mortgage trustee to the company.

In the case of bankruptcy, assuming the collateral subject to the mortgage is sufficient to pay first mortgage bondholders in full (and there are no junior secured creditors), the excess collateral would then go to unsecured creditors in accordance with the priority waterfall established by the bankruptcy code.

Recent wildfire disclosure and diligence developments

Over the past several years, there has been renewed focus by utility issuers on disclosures with respect to wildfire risk and risk management. One obvious theme from a review of recent disclosures is that the list of issuers which have most commonly disclosed this risk is skewed toward the western US.

While wildfire risk factors are common in utility 10-Ks, deal participants should consider whether specific disclosure around rating agency action in response to such wildfire risk is warranted. In the past 12 months, such disclosure has become very common in prospectus supplements for several issuers that have accessed the capital markets.

Furthermore, wildfire risk and risk management, including insurance coverage, has become a more frequent topic on transaction due diligence calls. These questions typically cover exposure to wildfire risk in the utility’s service territory and wildfire mitigation plans in response to such risks, and associated insurance policies, current availability and coverage limits.

Disclosing wildfire risks when contemplating an offering

Prior to accessing capital markets, deal participants should ensure that the disclosure package includes relevant wildfire risk factors. In general, such disclosure would include risk factors relating to the impact of climate change, risks inherent in the operations of transmission and distribution assets, risks relating to litigation and adverse regulatory decisions, risks relating to insurance coverage and related limits, and rating agency risks in response to wildfire scenarios.

Preparing disclosure to address wildfire risk is a relatively straightforward exercise prior to an offering. A particularly bad time to have a wildfire, though, is when the issuer has priced a securities offering and has yet to close. We are aware of at least one instance over the past several years when this exact scenario has occurred.

Cost-recovery: wildfire funds and securitisation for wildfire costs and wildfire mitigation

In a November 2023 S&P report, S&P opined that “we believe it’s important for the [investor-owned utility] industry to significantly increase and broaden recovery capabilities. This includes implementing storm reserves, increasing commercial insurance levels, incorporating self-insurance, participating in a special wildfire fund, and securitization”.

In July 2019, a special wildfire fund for investor-owned utilities was established in California under Assembly Bill 1054. The law provides for the establishment of a statewide fund that will be available for eligible electric utility companies to pay eligible claims for liabilities arising from wildfires occurring after 12 July 2019 that are caused by the applicable electric utility company’s equipment. Each of California’s large electric investor-owned utilities has elected to participate in the wildfire fund.

Electric utility companies that draw from the wildfire fund will only be required to reimburse amounts that are determined by the California Public Service Commission (CPUC) in a proceeding for cost recovery not to be just and reasonable, after applying the prudency standard in AB 1054 and after allocating costs and expenses for cost recovery based on relevant factors both within and outside of a utility’s control, subject to a disallowance cap equal to 20 percent of the utility’s transmission and distribution equity rate base.

The wildfire fund and disallowance cap will be terminated when the amounts therein are exhausted. The wildfire fund will be capitalised with $10.5bn of proceeds of bonds supported by a 15-year extension of certain charges to customers, $7.5bn in initial contributions from California’s three large electric utilities and $300m in annual contributions paid by the participating electric utilities for a 10-year period.

Securitisation has also played an increasing role in wildfire mitigation efforts and cost recovery. Since 2021, Southern California Edison Company has issued several secured recovery bonds for the purposes of wildfire mitigation and wildfire related capital expenditures. SCE Recovery Funding LLC is a bankruptcy remote, wholly owned special purpose subsidiary, consolidated by Southern California Edison. SCE Recovery Funding LLC has issued a total of $1.6bn of securitised bonds.

The proceeds were used to acquire Southern California Edison’s right, title and interest in and to non-bypassable rates and other charges to be collected from certain existing and future customers in Southern California Edison’s service territory, associated with ‘excluded capital expenditures’ under AB 1054. Under AB 1054, approximately $1.6bn of spending by Southern California Edison on wildfire risk mitigation capital expenditures made after 1 August 2019 cannot be included in the equity portion of Southern California Edison’s rate base.

The CPUC voted in 2021 to approve a financing order giving Pacific Gas and Electric Co. authority to use securitisation to finance $7.5bn in costs related to wildfires caused by its power lines in 2017. The securitisation paved the way for PG&E to retire about $6bn in debt and accelerate final payments to victims of the wildfires. The securitisations were effected pursuant to Senate Bill 901, one of the two state securitisation laws passed during PG&E’s bankruptcy that set the terms of ratepayer bond issuances covering utility wildfire costs.

Pursuant to three separate financing orders issued under Assembly Bill 1054, Pacific Gas and Electric sold its right to receive revenues from the non-bypassable wildfire hardening fixed recovery charges to PG&E Recovery Funding LLC. On 12 November 2021, PG&E Recovery Funding LLC issued approximately $860m of senior secured recovery bonds.

On 30 November 2022, PG&E Recovery Funding LLC issued approximately $983m of Series 2022-A senior secured recovery bonds. On 1 August 2024, PG&E Recovery Funding LLC issued approximately $1.42bn of Series 2024-A senior secured recovery bonds.

Final remarks

Wildfire liabilities have cast a new light on a historically safe investment – the rate regulated electric utility company. As the landscape has changed, issuers are well-advised to monitor developments in the industry, including with respect to disclosure, due diligence, mitigation efforts and when wildfires do occur, cost recovery.

 

Michael Fitzpatrick, Peter O’Brien and Steven Friend are partners at Hunton. Mr Fitzpatrick can be contacted on +1 (212) 309 1071 or by email: mfitzpatrick@hunton.com. Mr O’Brien can be contacted on +1 (212) 309 1024 or by email: pobrien@hunton.com. Mr Friend can be contacted on +1 (212) 309 1065 or by email: sfriend@hunton.com.

© Financier Worldwide

BY

Michael Fitzpatrick, Peter O’Brien and Steven Friend

Hunton

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