Ratings agencies weigh in on utilities after passage of California wildfire legislation

Wall Street took a generally positive, but wait-and-see stance on California’s investor-owned utilities (IOU) as the energy companies entered a new phase in their relationship with the state’s increasingly destructive wildfires.

The major bond ratings services held off on any downgrades to credit ratings this week as the California Public Utilities Commission (CPUC) launched a series of public hearings on a rate request from Pacific Gas & Electric Co., which is digging itself out after being pushed into bankruptcy by billions of dollars in liabilities caused by a series of deadly and destructive wildfires linked to its power lines and equipment.

The first in the two-week series of public hearings on PG&E’s request opened July 17 in sweltering Stockton as the state digested the passage of Assembly Bill 1054, a sprawling new strategy aimed at shoring up the state’s three IOUs, and at the same time requiring them to pony up for extensive upgrades to their transmission systems to help prevent future fires. A major impetus for the legislation was to assure that the bond ratings for the IOUs would not be downgraded and enable the companies to meet their liability obligations and at the same time pay for the necessary fire-prevention improvements.

AB 1054, signed into law on July 12, creates an insurance fund to cushion utilities from potential wildfire exposure while the state works on measures to reduce the severity and frequency of destructive wildfires. In addition, the legislation shifts the burden of proof to a more reasonable standard, provides a wildfire safety certification process, caps potential utility financial exposure in the event that a utility is found to be imprudent and requires $5 billion of investment in wildfire remediation by the IOUs, as summarized in a Fitch Ratings report.

S&P Global Ratings said on July 16 in a comment about the state’s public power utilities that it “positively” viewed the legislation’s requirements for utilities’ fire hardening and fire mitigation plans. “We continue to observe and assess the success of fire mitigation in changing climate environments,” the S&P note said. “Good asset stewardship cannot eliminate wildfire or climate-related risks, but we believe this planning materially lessens the risk, which the ratings reflect.”

Prior to the CPUC hearing, PG&E put out a statement declaring that its new fire-prevention campaign was off to a running start. The utility said that as of June 22, its crews had inspected more than 90 percent of approximately 50,000 transmission structures in high-risk areas, including all 222 substations. At the same time, chainsaws have been roaring and would continue to through the remainder of the year. “The 2019 forecast is to prune or remove approximately 375,000 trees along approximately 2,500 miles of distribution lines,” PG&E said. “More than 50 percent of the line miles have been inspected so far with 20 percent cleared.”

In addition, PG&E said it had deployed enhanced weather monitoring stations and cameras to monitor its remote infrastructures. It also has a squadron of seven aircraft flying daily patrols over the power lines to look for potential problems through Oct. 31 when cooler, wetter weather is supposed to start settling in.

S&P cautioned, however, that fires could certainly break out anywhere in any of California’s service territories and that the risk of a disaster was not limited to areas designated as high-risk. “Our credit analysis includes a comprehensive evaluation of the geographic factors that might contribute to exposure as well as each utility’s infrastructure management to mitigate this risk,” the report said, adding that financial developments would also play a significant role in future ratings moves, in particular rates, as were discussed in Stockton as they pertained to PG&E.

Favored Options
California’s other two IOUs were not being ignored by the financial community as July heated up across the Golden State.
Moody’s Investors Service had its eye on Southern California, reaffirming investment-grade ratings for both Southern California Edison (SCE) and its parent company, Edison International, along with San Diego Gas & Electric Co. (SDG&E) Moreover, Moody’s maintained a negative outlook for the companies. Fitch also affirmed SCE and SDG&E’s ratings, but while it left SCE’s rating with a negative outlook, it revised the ratings outlook on SDG&E to stable from negative.

Moody’s explained the potential credit ramifications regarding the different choices set out by AB 1054 that would allow the IOUs to reduce financial exposure to wildfires. The bill provides the IOUs with two options to participate in the state’s new wildfire fund: a $21 billion insurance fund option, which would require them to make certain upfront cash contributions, or a $10.5 billion liquidity fund option.

Moody’s said in a statement that it favored the insurance fund option because it “provides a much higher level of risk reduction.”

“The insurance fund option is more supportive of SCE’s credit profile than the liquidity fund option by a wide margin,” said Toby Shea, senior credit officer at Moody’s. “However, the negative outlook reflects the existing uncertainty as to which option will be chosen.”

Fitch, in its report on SDG&E, said, “The enactment of A.B 1054 and anticipated creation of a $21 billion wildfire insurance fund under the law is a major credit positive.”

The three IOUs have approximately two weeks from the time the law was enacted to decide whether they select the insurance fund option, Moody’s said.

The legislation authorizes the California Department of Water Resources (DWR) to issue up to $10.5 billion in bonds
backed by ratepayer charges. If IOUs choose the insurance fund option the CPUC is obligated to collect from ratepayers $900 million per year for 15 years, which can be used to directly capitalize the wildfire fund, or to pay debt service on DWR bonds issued to capitalize the fund, according to S&P.

Warming Warning
Either way, California’s utilities will have to choose wisely when it comes to joining the AB 1054 fund because it does not appear the threat of wildfires will be going away any time soon. A study published July 15 in the journal “Earth’s Future” warned that climate change had driven a “five‐fold increase in annual burned area” in California between 1972 and 2018. The jump was blamed on overall drier and hotter conditions that accelerated the drying of fuels in the summer months and set the stage for more major fires in the fall.

“Background warming and consequent fuel drying is increasingly enhancing the potential for large fall wildfires,” the study said. “Among the many processes important to California’s diverse fire regimes, warming‐driven fuel drying is the clearest link between anthropogenic climate change and increased California wildfire activity to date.”

California’s fire season has become a year-round event with a total of 2,724 fires so far this year scorching more than 25,000 acres, according to CAL-Fire.