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What Does the Stock Market Tell Us about the California Wildfires?

California utilities have lost $20 billion in market value since the wildfires began.

The horrific wildfires in Northern California’s Wine Country in October and then in Southern California in December killed more than 40 people, burned 1.2 million acres, destroyed thousands of buildings, forced hundreds of thousands to evacuate their homes, and led to deadly mudslides.

From the beginning investigators have focused on power lines as a likely cause. And, as more evidence becomes available, it continues to point to power lines. For example, the San Francisco Chronicle now reports that damaged electrical equipment was found at or near the suspected ignition points of four of the biggest wildfires in Northern California.

It will be some time before these investigations have concluded, but it is not too early to begin to assess the stock market fallout. How has the stock market reacted to this news? What does this mean for California electric utilities? For shareholders? For utility customers?

lilacNote: The Lilac Fire burning across a freeway near Bonsall, California on December 9, 2017. Photo taken by Jeff Hall from Cal Fire.

 

PG&E Tumbles

Pacific Gas and Electric (PG&E) has been the hardest hit. Before the wildfires began, PG&E stock was trading near $70 and the company was worth $36 billion. The selloff started shortly after the wildfires began on October 8th and by mid-October PG&E’s stock had tumbled to near $55.

pgeSource: Constructed by Lucas Davis at UC Berkeley.

Then on December 20th, PG&E announced it would suspend its dividend program due to looming potential fire liability, leading to another selloff and stock prices falling to $45. Companies are generally loath to cut dividends because it is perceived by the market to be a very bad signal.

Since October, PG&E’s market value has fallen by $13 billion. This 37% drop reflects potential liability from the more than 50 lawsuits that have been filed against PG&E, representing hundreds of families and businesses who have suffered damages from the wildfires. With the number of lawsuits continuing to grow, PG&E’s total liability could easily exceed the $800 million in liability insurance held by the company.

 

Edison Plummets

Southern California Edison followed a similar pattern. Before the Southern California wildfires, Edison’s stock was at $80 and the company was worth $26 billion. When the wildfires began, Edison’s stock price immediately plunged 16% with shareholders concerned that, like PG&E, the utility would be forced to pay damages. Since then, the stock has continued to slide with several lawsuits alleging that Edison equipment played a role in starting the fires. Overall, Edison’s market capitalization has fallen by $6 billion, almost one-quarter of its total value.

edisonSource: Constructed by Lucas Davis at UC Berkeley.

 

Broader Signal?

Interestingly, one of the worst days for Edison was December 21st, after PG&E announced it was suspending dividends. That day, PG&E stock went down 13%, while Edison stock fell 7%, so a smaller, but still very significant decrease.

I think I understand why PG&E’s stock went down. Companies like PG&E usually try to avoid cutting dividends, so it would make sense for the market to take this announcement as bad news, implying that PG&E’s liability was greater than previous believed.

But why did Edison’s stock go down? They are separate companies, separate wildfires, and separate investigations. Yet the market took PG&E’s announcement as a broader signal. Even San Diego Gas and Electric (Sempra Energy) went down the same day by almost 5%; a single-day loss equal to more than $1 billion. Did shareholders conclude that Edison and Sempra were also likely to cut dividends? Or did the PG&E announcement reveal something deeper about the prospects for all California electric utilities?

A related event got a lot of attention, but had little immediate effect on stock prices.  On November 30th, the California Public Utilities Commission rejected a request from San Diego Gas & Electric to charge customers $379 million to cover costs from a 2007 fire. The decision was interpreted by the media as bad news for utility shareholders, but it had little immediate impact on stock prices. Neither SDG&E (Sempra), nor Edison, nor PG&E experienced any significant decline. Either the decision was already priced into stock prices, or it was deemed unimportant by the market.

 

What about Utility Customers?

In part, the size of the stock market reaction reflects a concern that even if the utilities did nothing wrong, they could be liable for significant damages. This could occur through “inverse condemnation” court cases, a concept that flows from the US and state constitutions and is closely related to eminent domain. Government and public utilities can obtain private property through eminent domain processes in which they compensate owners for the lost use of their property. If a government (or a public utility) damages private property and doesn’t compensate the owner, then the owner can bring an inverse condemnation case.

Utilities could try to argue that the damages they pay through inverse condemnation should be passed along to customers as part of the broader costs of providing electric service. But will utilities actually be able to pass along these costs? The market does not expect 100% of these costs to be passed on to ratepayers; otherwise you wouldn’t see these large stock market impacts. But there may well be rate increases. California legislators are introducing legislation that would prohibit the CPUC from pushing fire liabilities onto rates, but it is too soon to know what will happen with this legislation. The damages from the wildfires are very large. The Tubbs Fire and Thomas fires were the most destructive and largest fires in California history, respectively. So there is more than enough pain to go around.

santarosa.pngNote: The devastation in Santa Rosa California on October 11, 2017. Image licensed under creative commons.

 

Who Should Pay?

Many questions remain. Who should pay for wildfire damages? How do we incentivize utilities to reduce wildfire risk? How much risk should be borne by shareholders? By utility customers? What is fair?

A central tenet of law and economics is that agents should bear the costs of their actions. Utilities are constantly making investments in fire prevention and you want utilities to make these decisions efficiently, “internalizing” the potential damages from action and inaction. So you want shareholders to be liable, to have significant “skin in the game” so that their companies will take the right actions to reduce wildfire risk.

But at the same time, you also don’t want to make utilities responsible for all wildfire damages, regardless of whether the companies acted negligently. This would raise the cost of capital for utilities, making it hard for them to finance basic operations. Put simply, if you make it unattractive enough to be in the utility business, nobody will want to do it.

This is not just about power lines. With climate change average temperatures keep climbing, and the summer of 2017 was much warmer and dryer than usual. And California’s population keeps growing, with more and more people living in fire-prone parts of the state. The devastating California wildfires of 2017 raise many very difficult questions that we are going to be asking for a long time.

Lucas Davis View All

Lucas Davis is an Associate Professor of Economic Analysis and Policy at the Haas School of Business at the University of California, Berkeley. His research focuses on energy and environmental markets, and in particular, on electricity and natural gas regulation, pricing in competitive and non-competitive markets, and the economic and business impacts of environmental policy.

13 thoughts on “What Does the Stock Market Tell Us about the California Wildfires? Leave a comment

  1. There are two elements of liability, one specifically for PG&E, and the other for all 3. For PG&E, its failure to turn off line reclosers during the fall fire season is clearly a poor management decision. Local rural reliability already is relatively poor in PG&E’s rural service territory, so any service losses probably would be quite incremental. PG&E’s excuse for not doing so was off the mark unless PG&E is already providing 99.999999% reliability to those affected customers, which it has not been doing.

    For the 3 IOUs as a group, they were very slow to join efforts to reduce greenhouse gas emissions and have been resistant to stronger efforts. They also have not done much to recruit other utilities around the nation to match California’s efforts. Given that electricity has been a large plurality of GHG emissions for the state, the utilities bear the lion’s share of the responsibilities for those emissions. Not pursuing GHG reductions aggressively for a long time may have been a management decision, but it had inherent risks and now those are coming to roost. As with any corporation, shareholders should bear the outcomes of the risks they choose. And in this case, one of them is climate change-driven wildfires.

  2. I agree with Paul. The fires themselves were caused and made worse by very high winds. Perhaps God should be sued for causing the winds. God doesn’t have deep pockets. The concept of having the deep pockets pay all of the damages is a concept that came out of California and the lawyers of our fair state. This will become a class action suit where the people who lost everything in the fire will get very little, the lawyers will get rich and the utilities could go bankrupt. California as a state will reap what it has sewn. The shareholders, the rate payers and perhaps the tax payer will likely get screwed. Rural areas will be hurt the most.

  3. “Who should pay” is probably going to turn out to be the interesting question. It isn’t just a question of finding a deep since really there are two: the utility (shareholders) and ratepayers or taxpayers (depending on what group is considered responsible for the actions of the regulators). If the utility cut corners to pocket its approved revenue for maintenance or tree trimming, it should pay; if the utility requested more budget that would have allowed for practices that could have prevented it and did not receive, it should not pay; and what if the utility did not so request but based on “best practices” (whatever those are) should have?
    I saw articles saying PG&E could be responsible for not deactivating reclosers like SCE; was that a reasonable choice (in which case maybe SCE is insufficiently reliable) or is deactivation a best practice?
    Any choice of maintenance budget or practice creates some probability of failure or disaster. Was that probability correctly chosen and do those events fit in that range of “reasonable risk”?
    If Chris Marnay is right and the problem is CO2 how do you apportion blame and cost if you can only reach Californians? The utilities seem to have been pushing pretty hard to go renewable and even if climate change were 80% responsible for the fire damage we could probably only reach the parties responsible for the other 20%
    But I don’t think these questions are that “interesting” to people who lost their houses, possessions or loved ones and it is those people who have the most heartfelt need to assign blame.

    • Jonathan, though “utilities seem to have been pushing pretty hard to go renewable” may be the message, it’s a joke.

      Since 2013 both PG&E and Edison have been pushing pretty hard to bury nuclear and burn natural gas, with the blessing of Jerry Brown’s Methane Mafia (his sister Kathleen sat on the board of Sempra Energy, the biggest purveyor of methane in the state).

      2013 was the year San Onofre was shut down, and 97% of its clean electricity was replaced with gas-fired generation. Approved by the Brown-appointed Public Utilities Commission, the shutdown was justifed by claiming 20%+ of San Onofre’s generation would be replaced with “efficiency”, “storage”, “demand response”, and other imaginary sources of energy. That resulted in some equally-imaginary reductions in carbon emissions, with the state’s CO2 output skyrocketing 36%.

      Since then there have been minor reductions in emissions, primarily by outsourcing CA emissions to southwestern states (CA now imports 33% of its electricity). Meanwhile, the state is not remotely close to meeting its 2020 climate goals, nor any after that. But Brown will have retired from politics by that time, so coming up with an alibi will be Gavin Newsom’s job.

  4. Bob, yes burning carbon fuels anytime anywhere produces CO2. We’re typically responsible for combustion whenever we drive our cars, heat, cool, or light our homes, fly away on vacation, or indeed, buy almost anything produced with energy and delivered to us. It’s a great idea that we be held liable for the consequences on these choices, preferably in the form of a broadly based carbon tax.

  5. Lucas, Edison stock plummeted in December because the company’s equipment was suspected of being partly responsible for the fires:

    “Southern California Edison reported last week that authorities are investigating the utility’s equipment as a possible source of the Thomas fire. “The causes of the wildfires are being investigated by Cal Fire, other fire agencies and the California Public Utilities Commission,” SoCal Edison said in the press release.“
    https://www.greentechmedia.com/articles/read/california-wildfires-spark-utility-investigations-and-new-regulations

    To the credit of CPUC are new regulations, approved in December, increasing inspections and brush clearances.
    http://docs.cpuc.ca.gov/PublishedDocs/Published/G000/M200/K638/200638039.PDF

    Assigning liability will be a challenge for years to come, considering both the responsibility of utilities in combination with the value of their continuing service to the California economy and public. No doubt liability for the underlying cause of extensive damage from the fires – climate change – will be ignored or assigned to “natural causes”, as California continues its CPUC-approved transition from clean nuclear energy to burning methane. Though the practice injects millions of tons of Mesozoic carbon into our modern atmosphere, oil companies continue to promote methane as “natural gas”.

  6. This was a weather induced phenomenon.To hold utilities responsible for these fires, acts of God, acts of nature, is gonna bite California big time. This could be the final nail in the coffin of a dying , anti business state.

  7. Our terrifying recent northern California fire experiences, together with similar ones in Australia, Chile, and Portugal, are just further contributors to the megagrid death spiral. As in other disasters, hurricanes, floods, earthquakes, heatwaves, etc., we worry about the poor performance of the megagrid during the events and their aftermath. The case of fires disturbs more because power infrastructure sometimes causes or contributes to the disaster. The economics of delivering electricity to remote locations from distant sources is questionable to begin with. Add that power lines may be creating some serious hazards and rethinking energy supply becomes imperative. Locally controlled microgrids will soon drive traditional discos further and further into financial dispair.

    • Chris, when the purveyors of “locally-controlled microgrids” burn methane to accomodate their electricity needs when renewables can’t, wouldn’t the locally-uncontrolled CO2 they release render them liable for damage from wildfires and other effects of climate change? Or is the plan to capture all of that extra carbon in bubbles?

  8. How do you think the risk from wildfires will impact the utilities insurance coverage? Traditionally the utilities have carried insurance for some risks, self-insured (with a reserve fund) for some risks and gone uninsured (without a reserve fund) for some risks. If the CPUC holds the utilities shareholders responsible for wildfire risks above insurance, doesn’t that provide an incentive for the utilities to carry more insurance. And wouldn’t the cost of that insurance will be rolled into rates as a cost of doing business.

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