Except in extreme scenarios, rising wildfire risks are manageable for California's publicly owned electric utilities, Moody's Investors Service said in a recent report.
In the May 27 report, the rating agency said that the physical risks of wildfires in California are projected to rise because of climate change. “Wildfires' increasing frequency and intensity combined with the state’s historical application of inverse condemnation increases the financial risk to utilities,” it said.
Under California's unique method of applying inverse condemnation, an electric utility is held strictly liable for property damages and legal fees if the utility's facilities are found to have caused a fire, even if the utility was following all safety rules and wasn’t found to be at fault.
But Moody’s said that evolving judicial guidance on what is required to prove an inverse condemnation claim coupled with legislative action to help protect the state's investor-owned utilities (IOUs) from the financial effect of future wildfire risks are positive actions for California's publicly owned utilities (POUs).
The rating agency noted that most POUs have experienced zero wildfire-related claims or settlements, “demonstrating their historically lower exposure and ability to rapidly respond to any wildfire threats in their smaller service territories, effectively limiting the fire's spread and damage.”
California POUs have notably smaller and more urban service territories compared to the large IOUs in the state, the report noted. Because of the scale difference, California POUs have materially less of their service territories located in Tier 3 (extreme) and Tier 2 (elevated) exposed areas as designated by the California Public Utilities Commission’s Fire-Threat Map.
Wildfire stress tests
Moody’s said that wildfire stress tests show POUs' resiliency to large wildfire settlements, but very small POUs have material exposure to smaller settlement amounts.
The rating agency’s wildfire scenario analysis stress tests POUs' financial resilience to $50 million up to $5 billion of wildfire settlement payments. Wildfire settlements are typically less than the initial wildfire claims, so the settlement implicitly accounts for much larger claims or destruction, the report said.
“The wide range of settlement amounts reflects the wide range of exposure and difference in scale of the California POUs with moderate or elevated wildfire risk exposure. The larger POUs can absorb sizeable wildfire settlements up to several billion dollars.”
However, a very small POU would experience material credit stress if it had to pay for a wildfire settlement as low as $100 million, which would more than triple its current amount of direct debt outstanding.
“Our wildfire stress tests consider settlement amounts that are multiples of historical experience to incorporate several hard to quantify risks. These risks include the projected increase in wildfire risk in the state, the potential for an asset financed through a joint action agency (JAA) to cause damage that the JAA participant will be responsible for and the potential for a POU asset caused wildfire to spread beyond the POU's service territory and cause much greater destruction and harm,” Moody’s said.
The stress test results detailed in the report depend on the utility's scale, level of insurance coverage, liquidity and current leverage profile. Most POUs maintain strong levels of liquidity and insurance coverage, Moody’s noted.
Meanwhile, the rating agency pointed out that several publicly owned utilities have a city owner or related parent government.
“Utilities with city owners can benefit from the city's support in times of crisis and vice versa, if needed. The city's support can be demonstrated by supporting credit friendly financial policies and needed rate adjustments to ensure the utility remains financially sound. Since POUs have local control of customer rates, they can choose their financial policy targets and adjust rates to meet them,” the report said.
However, not all cities have the financial ability to provide material support to a utility as California local governments have their own credit pressures related to large unfunded long-term pension and other post-employment benefit obligations. Yet, they also tend to have large tax bases, Moody’s noted.
In addition, the rating agency said that while there has been no direct legislative action to support POUs in the state like the IOUs, “we would expect the state to provide some level of legislative support in case of a dire emergency. Showing a willingness to step in to help the IOUs in a time of crisis bodes well for POUs.”
Moody’s also noted that the Federal Emergency Management Agency's (FEMA) public assistance program provides grant funds to POUs to reimburse them for some of their costs incurred to respond and recover from a natural disaster.
“The amount and timeliness of FEMA support is not predictable enough for municipalities to rely on it as a first source of liquidity and insurance protection against natural disasters like wildfires. Yet, in catastrophic situations, FEMA support proves invaluable to the recovery of hard hit communities and their locally publicly owned utilities,” the report said.
“While POUs tend to serve more urban areas, not all do, and we take wildfire mitigation very seriously,” said Barry Moline, executive director, California Municipal Utilities Association. “We’re not standing still or waiting for a legislative fix. We’ve developed and are implementing detailed plans to minimize the possibility of igniting a wildfire.”