PG&E – We See Equity Value of $54 in Our Base Case, $63 Upside, $26 Downside As Potential Post-Bankruptcy Outcomes Skew Further to the Upside

Eric Selmon
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Eric Selmon Hugh Wynne

Office: +1-646-843-7200 Office: +1-917-999-8556

Email: eselmon@ssrllc.com Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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April 22, 2019

PG&E – We See Equity Value of $54 in Our Base Case, $63 Upside, $26 Downside

As Potential Post-Bankruptcy Outcomes Skew Further to the Upside

Our worst case scenario, which assumes a third catastrophic fire, a 50% increase in PG&E’s wildfire liabilities, and the consequent municipalization of PG&E’s T&D network, values PG&E at $26 per share, well above its share price of $21 at Thursday’s close. In our base case, which assumes no change to California’s flawed regulatory framework and no recovery of wildfire costs from ratepayers, we value PG&E at $54 per share when it emerges from bankruptcy. In our high case, which assumes California’s regulatory framework is reformed so as to significantly reduce utilities’ wildfire risk, we value the company at $63 per share. Our scenario analyses suggests PG&E offers a very attractive and highly asymmetric set of investment returns, even in the absence of wildfire cost recovery or meaningful regulatory reform (see Exhibits 1, 6, and 7).

The report released by Governor Newsom’s strike force on April 12th confirms our view that California cannot tolerate a recurrence of the catastrophic wildfire damage it has suffered over the last two years, and that the state will act, in tandem with the state’s investor owned utilities, to bring this risk under control. As set out in our report of Feb. 28, Why California Will Engage with the State’s Utilities to Contain Wildfire Risk & Restore Utility Credit, we expect the state to require PG&E to increase and accelerate its investment in wildfire mitigation, and to adopt the best practices implemented by San Diego Gas & Electric to control wildfire risk on its power grid. To ensure that PG&E has access to and will invest the necessary capital, we expect the state to use the power granted it by Senate Bill 901, and possibly legislation to be introduced in the current legislative session, to limit the scale of future, unrecoverable wildfire liabilities of California’s utilities, including PG&E. We are confident now that this analytical framework is fundamentally correct, and have expanded and refined our valuation of PG&E based upon it.

  • The investment case for PG&E rests on the nexus between (i) California’s inability to sustain the cost of recurrent catastrophic wildfires of the magnitude of 2017-2018, (ii) the capital expenditures required to harden California’s power grid and contain wildfire risk, and (ii) the need therefore for PG&E to regain financial stability and access to the capital markets.
  • Governor Newsom’s strike force report confirms our view that California cannot tolerate a recurrence of the catastrophic wildfire damage it has suffered over the last two years, and that the state will act, with the state’s investor owned utilities, to bring this risk under control.
  • We find support for our view in the report’s characterization of California’s wildfire risk as a state-wide threat that has grown worse over time and will likely continue to do so. The report states that:
  • A quarter of the state’s population lives in areas facing very high or extreme fire threat.
  • This threat is worsening: 15 of the 20 most destructive wildfires in the state’s history have occurred since 2000, and ten of the most destructive fires have occurred since 2015.
  • The state’s major study on climate impacts, the Fourth Climate Assessment, projects that California’s wildfire burn area likely will increase by 77 percent by the end of the century.
  • The strike force report states that California’s electric utilities must be part of the solution to this problem and, as we anticipated, contrasts the capital expenditures that this will require with PG&E’s very limited access to the capital markets. In the words of the report:
  • “Hardening the electrical grid is thus a critical component to overall wildfire risk management. Our utilities…must make needed investments to reduce the risk of utility-ignited fires and… must do so now.”
  • “Utilities rely on credit to finance ongoing infrastructure investments, including fire mitigation. As utilities’ credit ratings deteriorate,…these downgrades, and the prospect of additional utility bankruptcy filings, directly impact Californians’ access to safe, reliable and affordable electricity.”
  • Recognizing the importance of strengthening the financial condition of the state’s utilities, the strike force reports recommends several changes to the state’s regulatory structure which, if implemented, would significantly reduce the financial risk to utilities of wildfire damages:
    • Changing the standard for plaintiffs to recover damages from utilities from the current one of strict liability to one requiring the demonstration of utility negligence;
    • Creating a fund to bridge the gap between a utility’s payment of wildfire damages and the CPUC’s determination that the damages may be recovered from ratepayers; and
    • Clarifying the criteria on which the CPUC will determine if wildfire damages may be recovered from ratepayers, reducing uncertainty for utilities and investors.
  • The strike force report makes clear, however, that a financially stable PG&E is not an end in itself, but rather a tool to achieve the larger objective of a safe, reliable and affordable supply of electricity. The corollary is that if a financially stable PG&E does not achieve this objective, the state must explore alternative strategies, including municipalization.
    • The report states that California must “hold utilities accountable for improving safety and preventing wildfires and for damages if their misconduct causes a wildfire.”
    • Specifically with respect to PG&E, the report points out that “PG&E serves 40 percent of California electricity customers and has an egregious safety record. The state must hold PG&E accountable and demand systemic reforms and a commitment to safety.”
    • “Given the long history of safety failures and the critical interests at stake,” the report concludes, “the state can take no options off the table, including municipalization of all or a portion of PG&E’s operations; division of PG&E’s service territories into smaller, regional markets; refocusing PG&E’s operations on transmission and distribution; or reorganization of PG&E as a new company structured to meet its obligations to California.”
  • Our assessment of the range of potential outcomes of PG&E’s bankruptcy is based upon the three considerations raised by the strike force report: the critical importance to California of containing wildfire risk, the key role to be played by the state’s electric utilities in fire hardening the electricity grid, and PG&E’s long history of “mismanagement, misconduct, and failed efforts to improve its safety culture.”
  • Specifically, our valuation scenarios reflect the range of potential responses by PG&E to the challenge of controlling wildfire risk. We outline these scenarios below:
    • Downside case – Our downside case assumes that PG&E fails adequately to fire harden its grid and that its equipment contributes to a third massive fire comparable in scale to those of 2017-2018. In this case, the state or local governments would be more likely to move to municipalize PG&E’s electric grid; San Francisco is already studying this option. Our low case assumes a state takeover of PG&E’s electric transmission and distribution grid with compensation at 1.0x net book value.
    • Status quo case – This case assumes continued PG&E ownership of its current portfolio of electric and gas assets, and assumes no change to California’s flawed regulatory framework for wildfire cost recovery. Critically, however, we assume that PG&E is successful in fire hardening its grid and adopting safety practices such that the number of fires sparked by its grid are reduced to the much lower levels realized by the other utilities in the state. The underlying premise is that PG&E not only undertakes the capital expenditures required to upgrade its grid but also emulates the safety practices adopted by San Diego Gas & Electric following the 2007 wildfires in its service territory. Critical among these is the practice of de-energizing vulnerable circuits in response to weather conditions, such as high winds, that materially aggravate fire risk.
    • Base case – Our base case similarly assumes that there is no change to California’s current regulatory framework for wildfire cost recovery, but that PG&E is successful is successful in bringing the number of fires caused by its grid into line with its Californian peers. Unlike the status quo case, however, our base case assumes that PG&E’s asset portfolio is broken up and sold, both in response to pressure from creditors and shareholders seeking to maximize its value and as well as from a state government and public utilities commission keen to improve the management of these assets. By segregating its gas and power generation assets into separate subsidiaries and selling these assets during bankruptcy, PG&E can insulate these assets from both past and future damage claims arising from fires caused by its electric T&D system – materially enhancing their value. PG&E itself, with its residual electric assets, might then be sold to a utility with a superior management team and a track record of safe operations.
    • Upside case – Like our status quo case, our upside case assumes that PG&E maintains ownership of its current portfolio of electric and gas assets and that PG&E is successful in reducing the number of fires caused by its grid to the level of its Californian peers. Importantly, however, we also assume major changes to California’s regulatory framework so as to significantly reduce utilities’ exposure to wildfire damage claims. These include two reforms recommended by the strike force report: first, the modification of California’s strict liability standard under inverse condemnation to one based on fault, and second, a liquidity pool funded with contributions from the state’s utilities and ratepayers to bridge the gap between utilities’ payment of wildfire damage claims and the recovery of these payments from ratepayers following a CPUC determination of no fault. A third necessary reform, we believe, would be the adoption of clear prudential standards for the operation of the grid which, if complied with by the utility, would constitute prima facie evidence of the absence of negligence and consequently of fault.
  • We have valued PG&E in each of these scenarios using two alternative valuation methodologies: (i) price to book or and (ii) enterprise value to EBITDA (see Exhibits 1, 6 and 7). We estimate PG&E’s value in the first quarter of 2022, assuming a three year bankruptcy process, and therefore apply our P/BV and EV/EBITDA valuation metrics on a backward looking basis to estimated 2021 results. In all cases, our equity valuations are net of our estimate of total outstanding wildfire claims (see Appendix 1) and thus assume no recovery of damages from ratepayers.
    • Critically, our worst case scenario, which assumes a third catastrophic fire, a 50% increase in PG&E’s wildfire liabilities, and the consequent municipalization of PG&E’s T&D network, values PG&E at $26 per share, well above Thursday’s close of $21.
    • In our base case, which assumes no change to California’s flawed regulatory framework and no recovery of wildfire costs from ratepayers, we value PG&E at $54 per share.
    • In our high case, which assumes California’s regulatory framework is reformed so as to significantly reduce utilities’ wildfire risk, we value the company at $63 per share.
  • Based on this scenario analysis, we believe PG&E offers a very attractive and highly asymmetric set of investment returns, even in the absence of wildfire cost recovery or meaningful regulatory reform (see Exhibit 1). Even the partial recovery of PG&E’s historical wildfire losses would offer further meaningful upside (Exhibit 2).

Exhibit 1: What Will PG&E Worth Upon Exiting Bankruptcy?

Scenario Analysis Using Price/Book and EV/EBITDA Methodologies1

Exhibit 2: Upside to Our Average Valuations Assuming Various Levels of Recovery

Of Damage Payments Made by PG&E in Respect of the 2017-2018 Wildfires2

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1. Our valuation methodologies and calculations are presented in detail in Exhibits 6 and 7 below.

2. Assumes the net cost to PG&E of the wildfire damage liabilities arising from the 2017-2018 wildfires is $13.6 billion, after settlements, insurance and taxes (see Appendix 1). This estimate assumes that property damage claims are settled at 60% of face value, as SDG&E did in respect of the 2007 Guejito, Rice and Witch Creek fires. Excludes damage claims arising from the Tubbs fire, where CalFire has found no evidence that PG&E equipment caused the fire.

Source: SNL, FERC Form 1, PG&E SEC and CPUC filings, SSR analysis and estimates.

Exhibit 3: Heat Map: Preferences Among Utilities, IPP and Clean Technology

Source: SSR analysis

Details

The investment case for PG&E rests on the nexus between (i) California’s inability to sustain the economic, social and environmental cost of recurrent catastrophic wildfires of the magnitude of 2017-2018, (ii) the capital expenditures required to harden California’s power grid and contain wildfire risk, and (ii) the need therefore for PG&E to regain financial stability and access to the capital markets.

California’s Utilities Must Be Financially Stable If California Is To Contain Wildfire Risk

The report released by Governor Newsom’s strike force[1] confirms our view that California cannot tolerate a recurrence of the catastrophic wildfire damage it has suffered over the last two years, and that the state will act, in tandem with the state’s investor owned utilities, to bring this risk under control. We find support for our view in the report’s characterization of California’s wildfire risk as a state-wide threat that has grown worse over time and will likely continue to do so. The report states that:

  • A quarter of the state’s population lives in areas facing very high or extreme fire threat.
  • This threat is worsening: 15 of the 20 most destructive wildfires in the state’s history have occurred since 2000, and ten of the most destructive fires have occurred since 2015.
  • The state’s major study on climate impacts, the Fourth Climate Assessment, projects that California’s wildfire burn area likely will increase by 77 percent by the end of the century.

As we anticipated, the strike force report also states that California’s electric utilities must be part of the solution to this problem, and contrasts the capital expenditures that this will require with PG&E’s very limited access to the capital markets. In the words of the report:

  • “Hardening the electrical grid is thus a critical component to overall wildfire risk management. Our utilities…must make needed investments to reduce the risk of utility-ignited fires and… must do so now.”
  • “Utilities rely on credit to finance ongoing infrastructure investments, including fire mitigation. As utilities’ credit ratings deteriorate,…these downgrades, and the prospect of additional utility bankruptcy filings, directly impact Californians’ access to safe, reliable and affordable electricity.”

Recognizing the importance of strengthening the financial condition of the state’s utilities, the strike force reports recommends several changes to the state’s regulatory structure which, if implemented, would significantly reduce the financial risk to utilities of wildfire damages:

  • Changing the standard for plaintiffs to recover damages from utilities from the current one of strict liability to one requiring the demonstration of utility negligence;
  • Creating a fund to bridge the gap between a utility’s payment of wildfire damages and the CPUC’s determination that the damages may be recovered from ratepayers; and
  • Clarifying the criteria on which the CPUC will determine if wildfire damages may be recovered from ratepayers, reducing uncertainty for utilities and investors.

The Safety Practices of SDG&E and SCE Are Far Superior to PG&E’s

Critically, wildfires caused by utility power lines are a risk that can be and has been contained, notably in California by San Diego Gas & Electric (SDG&E).  In 2007, SDG&E was the subject of some $3.0 billion in wildfire damage claims due to the role its power lines played in igniting the Guejito, Rice and Witch Creek fires. In the years since the 2007 fires, SDG&E has spent over $1.0 billion to fire harden its grid, replacing 16,000 wood poles with steel poles, selectively insulating power lines, and widening the gaps between wires, with the objective of upgrading its distribution system to withstand 85 mile-an-hour winds. In addition, the utility installed weather stations to track regional wind conditions and now pro-actively de-energizes electrical circuits when wind speeds or other conditions elevate the risk of fire. Following a decade of such network upgrades, SDG&E faced no significant wildfire damage claims in 2017 or 2018 (see Exhibit 4).

Utilities’ exposure to wildfire damage claims, however, is to a significant degree a function of the geography they serve: SDG&E supplies electricity to only 87 communities in high fire risk areas, as against 336 served by SCE and 793 served by PG&E. Nonetheless, other performance metrics also suggest that SDG&E and SCE are much more effective at preventing fires than PG&E. Michael Finch of the Sacramento Bee has compiled data on the number of fires involving utility power lines that were reported by the state’s utilities to the California Public Utility Commission (CPUC) over the four year period from 2014 through 2017. Dividing the number of these fires by each utility’s miles of power lines, we find that PG&E reported 13.3 fires per thousand miles of line over this period, while SDG&E reported 4.3 and SCE 2.9, or 32% and 22%, respectively, the number reported by PG&E (see Exhibit 5).

Exhibit 4: Estimated Damage due to Fires                     Exhibit 5: Fire Incidents Reported to the 

Attributed to Utility Equipment, 2017-18                        CPUC per Thousand Miles of Line, 2014-2017

 

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Source: California Public Utility Commission, California Department of Insurance, company reports. Fire incident data compiled from CPUC sources by Michael Finch II of the Sacramento Bee. SSR Analysis.

The California Public Utilities Commission is pushing the state’s investor owned utilities to do more. In compliance with legislation passed in 2018 by the California legislature and signed by then Gov. Brown (Senate Bill 901),  California’s investor owned utilities have each filed with the CPUC this month their wildfire mitigation plans, backed by proposed capital expenditures of some $4.0 billion in aggregate. In these plans, the utilities undertake to contain wildfire risk by:

(i) fire hardening their electric grids (including replacing wooden power poles with steel or cement ones, insulating power lines, and undergrounding particularly fire prone circuits) and

(ii) adopting operating procedures to ensure the safety of the grid (including de-energizing power lines during periods of high fire risk to prevent these from causing fires, far more aggressive vegetation management, and enhanced system control and data acquisition to monitor the status of the grid as well as evolving wind and weather conditions).

Importantly, the annual capital expenditures proposed by the state’s utilities to achieve these goals are equivalent to approximately one tenth of the property and other damages caused by the 2017-2018 wildfires.

If PG&E Fails to Improve Its Performance, the State May Take It Over

The governor and his staff have limited confidence, however, in PG&E’s ability to fulfill the role required of it in containing wildfire risk. As the strike force report states, “PG&E’s decision to voluntarily seek the protection of a chapter 11 bankruptcy court punctuates more than two decades of mismanagement, misconduct, and failed efforts to improve its safety culture.”

    • “Prior to its filing, PG&E already was on criminal probation, having been convicted of five felony counts for safety violations in connection with the San Bruno gas explosion in 2010. That explosion resulted in eight deaths, approximately 58 injuries and 38 homes destroyed.” The California Public Utility Commission (CPUC) fined PG&E $1.6 billion for its role in the San Bruno explosion. PG&E was also convicted of obstruction of justice as a result of its efforts to foil the regulatory investigation of the same incident.
    • State analyses of the 18 wildfires that broke out in PG&E’s service territory in the fall of 2017 have uncovered evidence PG&E has also mismanaged its electric transmission and distribution grid. With respect to 11 of these 18 fires, the California Department of Forestry and Fire Protection (CalFire) found evidence that PCG had violated state laws for vegetation maintenance and fire prevention. Based on California Department of Insurance data, we estimate that these fires are the source of ~$4.4 billion of claims for damages against PCG.
    • While CalFire has yet to release its report on the 2018 Camp Fire, which killed 85 people and gave rise to ~$19.1 billion in damage claims, PG&E has acknowledged that its equipment likely caused the fire. California has initiated a criminal investigation of PG&E’s role in the fire.

The strike force report concludes that “Given the importance of PG&E to California, the state must work to assure that any resolution of [the bankruptcy] proceeding achieves the near, medium and long-term goals of the state.” In the words of the report:

    • “Given the long history of safety failures and the critical interests at stake, the state can take no options off the table, including municipalization of all or a portion of PG&E’s operations; division of PG&E’s service territories into smaller, regional markets; refocusing PG&E’s operations on transmission and distribution; or reorganization of PG&E as a new company structured to meet its obligations to California.”

Valuation Scenarios

Our assessment of the range of potential outcomes of PG&E’s bankruptcy is based upon these three considerations raised by the strike force report: the critical importance to California of containing wildfire risk, the key role to be played by the state’s electric utilities in fire hardening the electricity grid, and PG&E’s long history of “mismanagement, misconduct, and failed efforts to improve its safety culture.”

Specifically, our valuation scenarios are based on a range of potential responses by PG&E to the challenge of controlling wildfire risk. We outline these scenarios below:

  • Downside case – Our downside case assumes that PG&E fails adequately to fire harden its grid and that its equipment contributes to a third massive fire comparable in scale to those of 2017-2018. In this case, the state or individual municipalities could move to municipalize PG&E’s electric grid; San Francisco is already studying this option. Our low case assumes a state takeover of PG&E’s electric transmission and distribution grid with compensation at 1.0x net book value.
  • Status quo case – This case assumes continued PG&E ownership of its current portfolio of electric and gas assets and assumes no change to California’s current regulatory framework for wildfire cost recovery. Critically, however, we assume that PG&E is successful in fire hardening its grid and adopting safety practices such that the number of fires sparked by its grid are reduced to the much lower levels realized by the other utilities in the state. The underlying premise is that PG&E not only undertakes the capital expenditures required to upgrade its grid but also emulates the safety practices adopted by San Diego Gas & Electric following the 2007 wildfires in its service territory (see Appendix 1). Critical among these is the practice of de-energizing vulnerable circuits in response to weather conditions, such as high winds, that materially aggravate fire risk.
  • Base case – Our base case assumes no change to California’s current regulatory framework for wildfire cost recovery but does assume that PG&E’s asset portfolio is broken up and sold, both in response to pressure from creditors and shareholders seeking to maximize its value and as well as from a state government and regulatory commission keen to improve the management of these assets. By segregating its gas and power generation assets into separate subsidiaries and selling these assets during bankruptcy, PG&E can insulate these assets from both past and future damage claims arising from fires caused by its electric T&D system. PG&E itself, with its residual electric assets, might then be sold to a utility with a superior management team and a track record of safe operations.
  • Upside case – Our upside case assumes that PG&E fire hardens its grid and adopts safety practices such that the number of fires sparked by its grid are reduced to the levels of its southern neighbors. It also assumes that PG&E maintains its current portfolio of assets. Importantly, however, we assume an overhaul of California’s regulatory framework so as to mitigate utilities’ exposure to wildfire damage claims. While it is unlikely that California will eliminate inverse condemnation and its principle of strict liability for property damage caused by utility equipment, a series of lesser reforms could significantly reduce utilities’ liability exposure. These include two reforms recommended by the strike force report: first, the modification of California’s strict liability standard under inverse condemnation to one based on fault, and second, a liquidity pool funded with contributions from the state’s utilities and ratepayers to bridge the gap between utilities’ payment of wildfire damage claims and the recovery of these payments from ratepayers following a CPUC determination of no fault. A third necessary reform, we believe, would be the adoption of clear prudential standards for the operation of the grid which, if complied with by the utility, would constitute prima facie evidence of the absence of negligence and consequently of fault. This could be done as part of the report’s recommendation to more clearly define the CPUC criteria for allowing utilities to recover wildfire related expenses from ratepayers.

Valuation Analysis

We have valued PG&E in each of these scenarios using two alternative valuation methodologies: (i) price to book or, more precisely, the ratio of market capitalization to the book value of equity in rate base, and (ii) enterprise value to EBITDA. Importantly, we estimate PG&E’s value in the first quarter of 2022, assuming a three year bankruptcy process, and therefore apply our P/BV and EV/EBITDA valuation metrics on a backward looking basis to estimated 2021 results.

The key assumptions underlying our valuations of PG&E in each of our four scenarios are set out below and tabulated in Exhibits 6 and 7. In all cases, our estimates of PG&E’s value are net of our estimate of total outstanding wildfire claims and thus assume no recovery of damages from ratepayers (see Appendix 1 for an explanation of our estimate of PG&E’s wildfire liabilities).

  • Downside case – In our downside case, we value PG&E at $25 per share based on P/BV and $26 per share based on EV/EBIDA, in both cases net of all estimated wildfire liabilities.
    • As noted above, our downside case assumes a third massive fire comparable in scale to those of 2017-2018 and a consequent state takeover of PG&E’s electric transmission and distribution grid. We assumed that a third fire would increase PG&E’s pre-tax wildfire liabilities and related costs by 50% to $29.0 billion, net of insurance, up from $19.3 billion in our other cases.
    • We have used different sets of assumptions to value PG&E’s various asset sales. Based on the administrative law principle that regulated utilities are to be allowed recovery of their investment in the assets used for the provision of a public service, we have assumed that the state compensates PG&E for the net book value of its electric transmission and distribution assets. Similarly, we assume that PG&E is allowed recovery of the net book value of its investment in the Diablo Canyon nuclear power plant, which is scheduled to be retired in 2025. We have assumed that PG&E’s non-nuclear generation assets are sold to private buyers, and have valued these by reference to the average prices in $/kW of three different sets of comparable transactions, one for each class of power plant (combined cycle gas turbine, pumped storage and conventional hydroelectric). We then subtracted the debt corresponding to these assets in PG&E’s rate base to calculate the value of PG&E’s equity in its generation fleet.
    • PG&E is assumed to retain ownership only of its gas transmission and distribution network. We have chosen NiSource (NI) as a comparable company for this residual portfolio, reflecting not only the predominant contribution of its gas utility operations to its financial results, but also NI’s checkered safety record which, following a series of explosions in Massachusetts, has brought the company under federal criminal investigation.
  • Status quo case – In our status quo case, we value PG&E at $42 per share based on P/BV and $40 per share based on EV/EBITDA, in both cases net of all estimated wildfire liabilities.
    • This case assumes (i) continued PG&E ownership of its current portfolio of electric and gas assets, (ii) no change to California’s current regulatory framework for wildfire cost recovery, and (iii) the successful fire hardening of PG&E’s T&D network such that the number of fires sparked by its grid are reduced to the much lower levels realized by the other utilities in the state.
    • Consequently, we have assumed no increase in our estimate of PG&E’s pre-tax wildfire liabilities ($19.3 billion, net of insurance, for the 2017-2018 fires).
    • In this context, we believe PG&E’s equity in its electric T&D network and its other utility assets could be valued by reference to Edison International (EIX), which shares PG&E’s exposure to wildfire risk, inverse condemnation and CPUC regulation. We therefore apply Edison International’s ratios of price to equity in rate base and EV/EBITDA to all of PG&E’s utility businesses.
  • Base case – In our base case, we value PG&E at $55 per share based on P/BV and $53 per share based on EV/EBITDA, in both cases net of all estimated wildfire liabilities.
    • Our base case assume (i) the break of PG&E and the sale of its component businesses, (ii) no change to California’s current regulatory framework for wildfire cost recovery, and (iii) the successful fire hardening of PG&E’s T&D network such that the number of fires sparked by its grid are reduced to the much lower levels realized by the other utilities in the state.
    • Consequently, we have assumed no increase in our estimate of PG&E’s pre-tax wildfire liabilities ($19.3 billion, net of insurance, for the 2017-2018 fires).
    • As in our downside case, we value PG&E’s unrecovered investment in the soon-to-be-retired Diablo Canyon nuclear power plant at its net book value; its non-nuclear generating assets by reference to the average prices in $/kW of three different sets of comparable transactions, one for each class of power plant; and its gas transmission and distribution business using NiSource as a comparable company.
    • As PG&E’s residual electric assets would remain exposed to wildfire risk, inverse condemnation and CPUC regulation, we value PG&E’s electric transmission and distribution grid by reference to the price to net worth ratio of Edison International (EIX) or, more accurately, Edison’s ratio of market capitalization to equity in rate base.
  • Upside case – In our upside case, we value PG&E at $61 per share based on P/BV and $65 per share based on EV/EBITDA, in both cases net of all estimated wildfire liabilities.
    • This case assumes (i) continued PG&E ownership of its current portfolio of electric and gas assets, (ii) the successful fire hardening of PG&E’s T&D network such that the number of fires sparked by its grid are reduced to the much lower levels realized by the other utilities in the state, and critically (iii) an overhaul of California’s regulatory framework so as to significantly reduce utilities’ exposure to wildfire damage claims.
    • As in our downside case, we value PG&E’s unrecovered investment in the soon-to-be-retired Diablo Canyon nuclear power plant at its net book value; its non-nuclear generating assets by reference to the average prices in $/kW of three different sets of comparable transactions, one for each class of power plant; and its gas transmission and distribution business using NiSource as a comparable company.
    • PG&E’s residual electric assets would remain exposed to wildfire risk, inverse condemnation and CPUC regulation, but would benefit from an assumed overhaul of California’s regulatory framework so as to significantly reduce utilities’ exposure to wildfire damage claims. Thus we value PG&E’s electric transmission and distribution grid at a 15% discount to the median P/BV and EV/EBITDA ratios of the U.S. regulated electric utilities.

Exhibit 6: Estimated Value of PG&E Equity in 2022 – Sum of the Parts Valuation Based Upon Multiplying PG&E’s Equity in Rate by Segment by the Ratio of Price to Equity in Rate Base of Comparable Companies1

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1. Our price to book valuation multiplies (i) PG&E’s equity in 2021 rate base by business segment by (ii) comparable companies’ ratio of market capitalization to equity in rate base. We forecast 2021 rate base by assuming 7% compound annual rate base growth (the low end of PG&E’s guidance) off of a 2019 base of $40.5 billion in rate base and $1.8 billion in CWIP. PG&E is allowed to earn an equity return on both rate base and CWIP.

2. In scenarios 1, 2 and 4, we have valued PG&E’s nuclear generation asset (the Diablo Canyon nuclear power plant) based upon its net book value, as the plant is scheduled to be retired from service in 2025. In scenario 4, in which PG&E’s electric T&D assets are municipalized, we assume compensation to PG&E at 1.0x net book value.

Source: SNL, FERC Form 1, PG&E SEC and CPUC filings, SSR analysis and estimates.

Exhibit 7: Estimated Value of PG&E Equity in 2022 – Sum of the Parts Valuation Based Upon Multiplying PG&E’s EBITDA by Segment by the Ratio of EV to EBITDA of Comparable Companies1

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1. Our EV/EBITDA analysis is based upon the 2021 consensus estimate for PG&E’s EBITDA of $7.1 billion, which we allocate among the segments based upon the segment breakdown of EBITDA in 2018. In scenario 4, in which PG&E’s electric T&D assets are municipalized, we assume compensation to PG&E at 1.0x net book value.

Source: SNL, FERC Form 1, PG&E SEC and CPUC filings, SSR analysis and estimates.

Upside from the Recovery of Wildfire Losses

A very conservative aspect of the above valuation analysis is that in all cases it assumes that PG&E (i) was negligent in causing the Camp fire and all of the 2017 fires excluding Tubbs and (ii) is allowed no recovery whatsoever of its wildfire liabilities. In light of Senate Bill 901, we believe these to be unrealistically conservative assumptions. (A summary of the key provisions of Senate Bill 901 is presented in Appendix 3.)

In Exhibit 8, we present the potential upside to our valuation of PG&E were the utility allowed to recover a portion of these damage payments. Under California’s utility regulatory framework, as modified by Senate Bill 901, this would correspond to a scenario where:

  • PG&E was found to have acted prudently in the management of its electric grid and, because the utility’s negligence did not contribute to the wildfires that caused the damages, PG&E is allowed to seek recovery from the CPUC of its wildfire losses;
  • PG&E negligence contributed to the fires, but other factors (such as drought and high winds, or violations of municipal building or vegetation management codes) contributed as well, causing the CPUC to allow PG&E recovery of some portion of the losses (although under Senate Bill 901 this only applies to fires in 2019 or later, the CPUC may have authority under existing regulations to apply the same standards for recovery to the 2017 and 2018 fires and could choose to do so); or
  • PG&E’s negligence caused the losses but the utility’s unrecoverable losses exceed “the maximum amount the corporation can pay without harming ratepayers or materially impacting its ability to provide adequate and safe service,” in which case the CPUC has the authority under Senate Bill 901 to cap PG&E’s unrecovered losses for 2017.

For every 10% of PG&E’s maximum potential wildfire liability that PG&E is allowed to recover, the utility’s after-tax, after-insurance cost is reduced by $1.5 billion in our high and mid cases, equivalent to almost 14% of PG&E’s current market cap of $11.1 billion. In our low case, with its assumption of a 50% increase in PG&E’s wildfire liability, 10% recovery reduces the utility’s unrecoverable costs by $2.3 billion, or almost 21% of PG&E’s current market cap. We note that these potential upsides are not improbable; in our high and mid cases, for example, a 10% reduction in PG&E’s wildfire liability might occur if PG&E were found not to be responsible for the 2017 Atlas fire, for which we estimate that property and other damages will total $2.7 billion, but in respect of which the company has not felt compelled to book reserves in accordance with GAAP.

Exhibit 8: Upside to Our Average Valuations Assuming Various Levels of Recovery of Damage Payments Made by PG&E in Respect of the 2017-2018 Wildfires1

_____________________________________________________________________________

1. Assumes the net cost to PG&E of the wildfire damage liabilities arising from the 2017-2018 wildfires is $14.2 billion, after settlements, insurance and taxes (see Appendix 1). This estimate assumes that property damage claims are settled at 60% of face value, as SDG&E did in respect of the 2007 Guejito, Rice and Witch Creek fires. Excludes damage claims arising from the Tubbs fire, where CalFire has found no evidence that PG&E equipment caused the fire.

Source: California Department of Insurance, company reports, SSR analysis and estimates

Conclusion

Based on our scenario analysis, we believe PG&E offers a very attractive and highly asymmetric set of investment returns, even in the absence of wildfire cost recovery or meaningful regulatory reform (see the right hand column of Exhibit 9). Even partial loss recovery offers further meaningful upside (see Exhibit 8).

Exhibit 9: What Will PG&E Worth Upon Exiting Bankruptcy?

Scenario Analysis Using Sum of the Parts and EV/EBITDA Methodologies1

_____________________________________________________________________________

1. Our valuation methodologies and calculations are presented in detail in Exhibits 6 and 7 above.

Source: SNL, FERC Form 1, PG&E SEC and CPUC filings, SSR analysis and estimates.

Appendix 1: Methodology for the Estimation of Wildfire Liabilities

  • The losses that PCG may incur as a result of the 2017-2018 California wildfires can be categorized as follows:
    • penalties, including fines and unrecoverable capital expenditures, imposed by the California Public Utility Commission (CPUC);
    • third party liability claims for deaths, injuries, property damage and consequential damage (e.g., loss of wages or profit);[2]
    • punitive damages, either awarded by the courts or implicit in settlements negotiated by the utilities with victims of the fires;[3] and
    • legal costs for the litigation and CPUC proceedings.

We explain below how we estimate the range of potential losses in each of these categories.

Exhibit 10: SSR Estimate of PG&E’s 2017-2018 Wildfire Costs

___________________________________

Source: California Department of Insurance, California Department of Forestry and Fire Protection, PG&E reports, SSR estimates and analysis

  • CPUC Penalties. Historically, the CPUC has levied relatively modest penalties on the state’s electric utilities for regulatory violations contributing to brush fires.
    • In September, 2015, the Butte Fire in Amador County burned 71,000 acres, destroyed 549 homes and killed two people. The CPUC found that PCG’s negligence in pruning trees nears its lines had contributed to the fire and fined the utility $8.3 million.
    • In 2013, Southern California Edison (SCE) agreed with the CPUC to a $37 million settlement in connection with the 2007 Malibu Canyon fire, paying a $20 million fine to the State of California and absorbing $17 million in costs to assess the safety of utility poles. SCE admitted having overloaded its power poles in violation of CPUC rules and having withheld pertinent information from the CPUC.
    • In 2010, San Diego Gas & Electric (SDG&E) agreed to pay $21 million to settle allegations that its mismanagement led to the 2007 Guejito, Rice and Witch Creek fires and that SDG&E hampered investigators. SDG&E paid $14.35 million in fines to the State of California and absorbed $6.75 million in costs incurred as a result of the 2007 fires.
    • In 1994, PCG was found guilty of 739 counts of negligence in connection with a fire in the Sierra foothills that destroyed twelve homes.  PCG was fined $30 million by state regulators, or the equivalent of ~$50 million in 2018 dollars.
    • To be conservative, we have used the largest of these historical penalties, that levied in the Sierra foothills fire, as the basis for our estimate of CPUC penalties in respect of the 2017-2018 California wildfires.
  • Third Party Liability. PCG face the risk of liability for property damages under the principle of inverse condemnation, and the risk of liability for property damages plus personal injury, pain and suffering and incidental damages under the principle of tort liability.
    • Inverse condemnation. Inverse condemnation is based upon the fifth amendment of the U.S. constitution, which stipulates that private property may not be taken for public use without just compensation. Under California state law, inverse condemnation, a principle that requires compensation for damage to property caused by government property, has been extended based on the state constitution to cover investor owned utilities operating under state regulation. The principle stipulates that a utility must compensate property owners for damage to their property caused by a utility’s assets, whether or not the utility was negligent in the operation or maintenance of those assets. If the utility was not negligent in causing the damage, the CPUC should allow recovery of the damages from ratepayers. The principle of inverse condemnation does not extend to third party liability claims for death, injury, and consequential damages (e.g., loss of wages or profits); these must be pursued under the principle of tort liability.[4]
    • Tort liability. Third party liability claims for property damage could also be brought against PCG under the principle of tort liability in suits filed in state courts. Under the principle of tort liability. Plaintiffs may also seek compensation for death, injury, and consequential damages (e.g., loss of wages or profits). Under the principle of tort liability, however, the utility would be liable for property and other damages if the plaintiff could prove that the damages suffered were caused by the utility’s negligence. Plaintiffs can, and have, filed claims for both inverse condemnation and negligence at the same time, collecting the greater of the two liabilities they can prove in court.
      • Negligence. Whether a utility has been negligent in the operation or maintenance of its assets is of far greater consequence than whether a claim is pursued under the principle of inverse condemnation or tort liability. A finding of negligence is what determines if the utility suffers an economic loss or not. If a utility is not found to have been negligent, then, under the principle of inverse condemnation, it is to be allowed to recover from ratepayers any damages paid, implying minimal economic loss; under the principle of tort liability, it would not be liable for damages in the first place and thus, similarly, would suffer no loss. Conversely, if a utility is found to have been negligent, under CPUC rules, no recovery is allowed from ratepayers (regardless of whether the damage was awarded under the principle of inverse condemnation or of tort liability), implying that shareholders must absorb the cost of any damages paid.
    • Consequences. If a utility’s assets are found to be the cause of a fire, and it is determined that the negligence of the utility in maintaining or operating its equipment caused the fire, then the utility will be liable for all damage resulting from the fire, including property, death, injury, pain and suffering and consequential damages such as the loss of wages or profits.
  • Punitive Damages. We view the odds of an award of punitive damages to be very low and have excluded it from our analysis of potential impacts. In punitive damages cases, the burden of proof is on the plaintiff, who must demonstrate that the defendant engaged in “willful misconduct,” a higher legal standard of negligence which has generally been defined as a conscious disregard of probable harm. Given the absence to date of any physical evidence suggesting such egregious misconduct by the utilities, and their significantly increased focus on vegetation management and fire prevention as California’s drought worsened over the last several years, proving conscious disregard of probable harm will be a challenge for plaintiffs.
  • Estimating the Scale of Potential Losses. It is too early to know the full scale of damage caused by the 2017-2018 California wildfires. It is possible to estimate the scale of damage, however, by reference the damage caused by past fires, such as the 2007 Witch/Rice fires, the 2015 Butte fire and the fires in Northern California in October 2017.
    • Property Damage. Based on the insurance claims brought in connection with past fires, and the number of structures destroyed by these fires, it is possible to arrive at an estimated ratio of insured damage per structure, which we use as a proxy for property damage.[5] Adjusting for inflation, we found that the highest value of insurance claims per structure destroyed was registered in connection with 2017 northern California fires. Dividing the $9.4 billion in property damage claims arising from these fires across the ~8,600 structures destroyed results in a ratio of ~$1.2 million per structure destroyed in 2017. For the 2018 Camp fire the insured damage totaled $8.4 billion, but that was across ~18,800 structures, resulting in a much lower damage per structure of ~$0.45 million. To estimate the total property damage caused by the 2017-2018 California wildfires, we have multiplied the 2017 ratio of $1.2 million in property damage per structure destroyed by the total number of structures destroyed in the Nuns, Atlas and Redwood Valley fires (~$2.4 billion) and we added the $8.4 billion of insured damage for the Camp fire.
    • Other Third Party Liabilities. PCG will likely also face other third party liabilities, including claims for damages arising from death and personal injury, consequential damages, such a loss of wages or profit, damage to governmental property, and firefighting costs. In the Witch/Rice fire, San Diego Gas & Electric (SDG&E) recorded total costs of $1.3 billion for all third party claims excluding insured claims. Calculated per structure destroyed, and adjusted for inflation since 2007, the losses from the Witch/Rice fire work out to ~$850,000 per structure. For the 2017 wildfires, again, we have multiplied this ratio in other third party liabilities per structure destroyed by the total number of structures destroyed in each wildfire to estimate the total cost of these claims to PCG. For the Camp wildfire, given the poorer economic conditions of the area compared to the previous fires, we reduce the non-property damages by one third to ~$570,000 per structure[6] and multiplied it by the number of structures destroyed.
    • CPUC Penalties. Reflecting the penalty imposed on PCG by the CPUC for the Sierra foothills fire of 1994 — the largest penalty imposed by the Commission over the last 25 years in respect of a brush fire – we assume that PCG will each face $50 million in CPUC fines and penalties for each major fire in their service territories, or a total of $100 million each across 2017-2018.
    • Legal Fees. We estimated the legal fees for the bankruptcy filing and the wildfire claims litigation within the bankruptcy filing separately. Based on the legal costs incurred by PCG in connection with the San Bruno gas pipeline explosion, we estimate that PCG will incur $300 million in legal costs in connection with the claims arising from each of the 2017 and 2018 northern California wildfires, for a total of $600 million. We added an additional $600 million reflecting the legal fees for Energy Future Holdings bankruptcy.
  • The Offsets: Insurance and Taxes. PCG had $2.2 billion of third party liability insurance available to them to cover losses from the 2017-2018 wildfires. Importantly, payments of third party liability claims in excess of these amounts are tax deductible, as are legal expense. CPUC penalties, however, are not. We have assumed, therefore, that both PCG can deduct their legal costs and payments of third party liability claims, net of insurance proceeds, from their taxable income in the calculation of their federal income taxes.

Appendix 2: Comparable Transactions Valuation of PG&E’s Generating Fleet

First. we have valued PG&E’s 1,203 MW of CCGT capacity at $574/kW, by reference to the $300 million price paid by Avenue Capital in November 2018 for AltaGas’ three gas fired power plants, totaling 523 MW of operating capacity (330 MW CCGT, 193 MW GT) in California’s San Joaquin and Kings counties. All three plants are in PG&E’s service territory and have PPAs with the utility through 2022. (We believe the AltaGas sale to be a conservative benchmark by which to value PG&E’s CCGT capacity, given the relatively high proportion of open cycle gas turbine capacity (37%) in AltaGas’ Californian fleet.)

Second, we have valued PG&E’s 1,212 MW of pumped storage capacity at $790/KW by reference to the average price set in two recent sales of pumped storage facilities. The first of these was the sale by Engie Group to PSP Investments in November 2016 of 1,168 MW of pumped storage capacity and 232 MW of conventional hydroelectric capacity in Massachusetts and Connecticut (like California, states where gas fired generators tend to be the price setting units) for a price of $1.2 billion, or $857/kW. The second was the sale by Allegheny Energy to LS Power in July 2018 of 421 MW of capacity at the Bath County, Virginia pumped storage facility, plus 881 MW of open cycle gas turbine capacity. If we value the open cycle gas turbine capacity (generously, in our view) at $592/kW, by reference to three sales of CCGT capacity that also closed in the second half of 2018, the implied valuation of the pumped storage capacity is $722/kW.

Third, we have valued PG&E’s 2,685 MW of conventional hydroelectric capacity at $1,623/kW, reflecting the average of two sales of comparable fleets of hydroelectric assets. The first of these was the sale by PPL to NorthWest Energy in November 2014 of 633 MW of capacity at 11 hydroelectric plants in Montana for $900 million, or $1,422/kW. The second was the sale by TransCanada to ArcLight Capital in April 2017 of 584 MW of capacity at 13 hydroelectric facilities in Vermont, New Hampshire and Massachusetts for $1.065 billion, or $1,824/kW.

Appendix 3: A Summary of the Provisions of Senate Bill 901

  • To frame the implications of Senate Bill 901, it is first helpful to summarize what the bill will not change:
    • The bill would not do away with California’s unique legal principle of applying inverse condemnation to privately owned utilities. Utilities will continue to be subject to strict liability for damages caused to third parties by utility assets or operations, relieving the injured party of any obligation to prove negligence or fault on the part of the utility.
    • Utilities seeking to recover from ratepayers the cost of damages paid to third parties will remain obligated to demonstrate to the California Public Utilities Commission (CPUC) that their actions were prudent, and that the damages did not arise due to negligence of the utility.
    • The bill would not protect California’s utilities against tort claims brought in state courts. In such cases, however, the burden of proof falls on the plaintiff, who must demonstrate that the damages were caused by the utility’s negligence.
    • The bill does not change the current law at all for non-catastrophic wildfires. What qualifies as catastrophic is not specifically defined in the bill, but it is clear from the legislative discussions that fires of a similar magnitude to the October 2017 southern California wildfires and Thomas fire in southern California would be considered catastrophic.
  • Within this ongoing framework, however, S.B. 901 would materially strengthen the position of California’s utilities in securing recovery from ratepayers of catastrophic wildfire-related expenses, reduce the cost to ratepayers of such recovery, and, for the 2017 wildfires, limit utilities’ financial exposure to unrecovered penalties and expenses.
  • First, for the 2017 wildfires, while the bill does not change the current standard of review for the recovery of costs from ratepayers, S.B. 901 would set a cap on how large a utility’s unrecoverable costs can be. Unrecoverable costs would be capped at an amount equal to “the maximum amount the corporation can pay without harming ratepayers or materially impacting its ability to provide adequate and safe service.” This amount is to be determined by the CPUC, although it is unclear how the determination is to be made.
    • This is most relevant and positive for PG&E, as the maximum potential liability for EIX for the Thomas fire likely is well below any potential limit the CPUC may set.
    • Therefore, if S.B. 901 is passed, the key controversy around PG&E will become the level at which the cap on unrecoverable 2017 wildfire expenses will be set and the timing for such a determination.
      • It can be argued that ratepayers are already being harmed because the cost of equity for PG&E is now significantly higher than its peers.
        • In 2012, Overland report, commissioned by the CPUC for the San Bruno gas explosion proceedings, determined the maximum equity PG&E could raise at that time without significant affecting its cost of capital (which would harm ratepayers) was $2.25 billion.
        • Based on that report and statements in the hearings, we believe the cap will likely be well below PG&E’s maximum potential liability of ~$15 billion.
      • On the other hand it can be argued that PG&E’s stock is already pricing in enough equity issuance to cover $15 billion in damages with no apparent impact on electric service.
    • The bill only authorizes the CPUC to determine this limit as part of a proceeding to recover costs from the 2017 fires, meaning the limit could remain unknown for an extended period of time. A strategy that could help reduce the uncertainty for investors would be for PG&E to file for recovery of even a small portion of costs as soon as practical to force a determination of the cap by the CPUC.
  • Second, for catastrophic wildfires ignited in 2019 and afterwards, the bill requires the CPUC to allow utilities to recover wildfire-related costs and expenses, including damages paid by utilities to third parties in compensation for their losses, “if the costs and expenses are just and reasonable.” In addition, the bill requires the Commission, “in evaluating the reasonableness of the costs and expenses” to consider exculpating factors, such as:
    • The extent to which the costs and expenses were in part caused by circumstances beyond the utility’s control;
    • Whether extreme climate conditions, including humidity, temperature or winds, contributed to the fire’s ignition or exacerbated the extent of the damages;
    • The utility’s compliance with regulations, laws, commission orders and its own wildfire mitigation plans, as well as the utility’s past record of compliance; and
    • Any statutory, regulatory or ordinance violations by parties other than the utility that contributed to the extent of the damages.
  • Third, if the Commission, having considered these exculpating factors, finds any of the costs and expenses incurred by the utility to be reasonable, the Commission may allow recovery of a portion these costs even while denying recovery of the remainder. Therefore, the Commission’s determination of fault is thus no longer a binary, all-or-nothing decision, where any finding of negligence would deny the utility recovery of all its wildfire-related expenses for each event. Rather, the Commission is (i) instructed to make a balanced assessment of the utility’s responsibility for the wildfire and the damage it caused, and (ii) is permitted to allocate the wildfire-related expenses of the utility to ratepayers or shareholders in a manner that reflects the relative prudence or negligence or the utility’s actions.
    • It is important in this respect that the bill provides more detailed guidance to utilities as to the preparation of their annual fire mitigation plans, requires that these plans be reviewed by an independent evaluator and, finally, requires the CPUC to approve the utilities’ plans. These provisions should help utilities to demonstrate the prudence of their fire prevention measures and thus improve the odds of recovery from the CPUC of future fire costs.
  • Finally, if the Commission finds “some or all” of the costs and expenses related to a catastrophic wildfire to have been reasonably incurred by the utility, the utility may apply to the Commission for “a financing order to authorize these costs and expenses to be recovered through fixed recovery charges.” These fixed recovery charges can be assigned in turn to lenders through a securitization, allowing the utility to raise the funds required to defray these costs and expenses in the capital market.
    • The CPUC is required to respond to the utility’s application within 180 days, and to authorize the securitization if its proposed terms are just and reasonable, consistent with the public interest and capable of reducing “to the maximum degree possible” the present value of ratepayers’ future payments to the utility.
    • Historically, California and other states have excluded the proceeds of such securitizations from the calculation of a utility’s total capital, thus avoiding any required increased in the utility’s common equity. The result is that the cost to ratepayers of the capital raised reflects the interest rate on the securitization alone, which tends to be low given the collateralized nature of the obligation, and not the weighted average cost of capital to the utility, which is based on an equity ratio of close to 50% and thus is materially higher.
    • As noted above, any costs from the 2017 wildfires allowed for recovery or exceeding the financial impact cap set by the CPUC can also be securitized under this provision.
    • The one glaring fault with the bill is that any catastrophic fires in 2018 are not addressed at all. While no fires this year have yet been attributed to utilities, there are still several months remaining in the year.
    • Two other provisions of S.B. 901, although they will not have an immediate impact, could in the long run materially reduce the financial risk to California utilities of future wildfires.
  • First, the bill establishes an expert commission to determine how California should allocate the costs of catastrophic wildfires associated with utility infrastructure, and charges the commission to submit its recommendations by July 1, 2019. Specifically, the bill would require the commission “to examine issues related to catastrophic wildfires associated with utility infrastructure” and to make “recommendations as to changes to law that would ensure equitable distribution of costs among the affected parties.” The implication of this provision is that the legislature is seeking a permanent mechanism to ensure that wildfire-related costs are not borne exclusively by utility shareholders but rather are borne at least in part by commercial or government insurers, utility ratepayers or state taxpayers.
  • Second, the bill would require the state forestry board to adopt regulations implementing minimum fire safety standards applicable to lands designated as very high fire hazard severity zones, and would require the regulations to apply to the perimeters and access to all residential, commercial and industrial building construction within such zones after July 1, 2021. The provision could help to address the growing risk to utilities caused by expansion of settlements in areas of high wildfire risk.
  • Other provisions of S.B. 901 are far less material in their impact on the valuation of California’s utilities, but will nonetheless be of interest to investors. These include:
  • A prohibition on utilities recovering from ratepayers the compensation of their corporate officers.
  • A prohibition on electric utilities recovering from ratepayers the cost of penalties or fines (a similar ban was imposed on gas utilities following the San Bruno gas pipeline explosion).
  • A requirement that utilities conduct a safety culture review every five years.
  • A push to minimize outside contractors for fire prevention, mitigation and defense, favoring utility employees instead.
  • Certain limits imposed on companies acquiring California utilities, in particular limits on firing employees or reducing their compensation in the first 180 days following an acquisition.

©2019, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

  1. Wildfires and Climate Change: California’s Energy Future, Governor Newsom’s strike force, April 12, 2019. 
  2. Third party liability claims for property damage could be brought against PG&E under (i) California’s principle of inverse condemnation, which stipulates that a utility must compensate property owners for damage to their property caused by a utility’s assets, whether or not the utility was negligent in the operation or maintenance of those assets, or (ii) under the principle of tort liability in suits filed in state courts, in which case the utility would be liable for damages only if the plaintiff could prove that the damages suffered were caused by the utility’s negligence. The principle of inverse condemnation does not extend to third party liability claims for death, injury, and consequential damages (e.g., loss of wages or profits); these must be pursued under the principle of tort liability, requiring the plaintiff to prove negligence. 
  3. The principle of inverse condemnation does not extend to punitive damages; these must be pursued under the principle of tort liability. In punitive damages cases, the burden of proof is on the plaintiff, who must demonstrate that the defendant engaged in “willful misconduct,” a higher legal standard of negligence which has generally been defined as a conscious disregard of probable harm. 
  4. For a much more thorough discussion of inverse condemnation and the risk it poses for utilities, please see our note from December 5, 2017 CPUC Ruling Denying SRE Recovery of Forest Fire Costs Does Not Increase the Risks for California Utilities
  5. We used the insurance claims as an estimate of total property damage. While there are uninsured property damages, the vast majority of structures destroyed in the past fires were insured. Furthermore, the insurance claims include non-property damages, such as business interruption and the cost of replacement housing. We assuming the non-property portion of the insured damages is similar in size to the value of the uninsured property. 
  6. We did not reduce the non-property damages in line with the lower value of the property damages per structure because much of the non-property damage, such as injury, death and pain and suffering, is not related to the regional economic differences. 
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