Wildfire devastation mandates rethinking how electricity providers should be organized
With pathbreaking policies in renewable energy, energy efficiency and electric vehicles, California has been on the leading edge of climate change mitigation policy. Now, with the catastrophic wildfires of the last two years and PG&E’s threatened bankruptcy, the state is unfortunately on the bleeding edge of climate change impact and policies for adapting to it. The state will have to adapt not just physically, but also institutionally, as we figure out how to maintain stable utilities in an environmentally less-stable world.
Electricity lines have been starting fires since the industry began. But two factors have greatly worsened the damage from those fires in the last few decades. Climate change is creating drought and tree deaths that provide more high-potency fuel for the fires, and population migration is putting more people and houses in the so-called “wildland urban interface”, where they are more likely to be in the path of a wildfire. Nationally, the cost of fighting wildfires has more than doubled (adjusted for inflation) over the last 30 years. It is also provoking some difficult discussions about the subsidies to people who live in high-risk areas and want protection from those fires.
When PG&E announced last week its intention to file for Chapter 11 bankruptcy protection on January 29 — citing liabilities from wildfires, possibly due to its own negligence — most media attention focused on the very short run: Is this a rerun of the 2001 electricity crisis? Will the lights, and the power to charge my smart phone, stay on?
The short answer is that this is about as different as a bankruptcy filing can get. In 2001, PG&E was not bringing in enough revenue to pay its day-to-day bills. Wholesale electricity prices had skyrocketed due to a combination of real and artificial shortages, the latter when some larger generators figured out they could increase profits by reducing production. PG&E’s retail prices were frozen, so it was losing money each time it sold a kilowatt-hour of electricity. Once it was clear that PG&E was running out of cash, even some small producers refused to sell, because they didn’t think they were going to get paid. Eventually, that led to rolling blackouts.
Today, the utility is still making money on each unit of electricity it sells, because their regulated retail prices are way above the wholesale cost of electricity. But it is potentially facing some whopper bills from wildfire liability that may eventually (over years, not days) drain the coffers. The bankruptcy judge in a Chapter 11 filing is focused on generating net revenue to pay creditors, so s/he will want to ensure that the company continues to sell electricity, which means making sure that wholesale generators get paid enough to continue supplying.
Still, because the bankruptcy judge’s mandate is to get the creditors paid, s/he has a strong incentive to chip away at any activities of the company that don’t help with that short run goal. In the case of PG&E, that may mean renegotiating renewable energy contracts that were signed a decade ago at prices that are well above the value of that energy today. Similarly, the judge is likely to be less supportive of the many company initiatives targeted at reducing greenhouse gases and climate change. Those initiatives could pay off for Californians and the planet in the longer run, but they use funds in the short run that could go to pay the company’s debts, including liabilities to wildfire victims.
While the bankruptcy is going on (and on, and on… likely for a year or more), state regulators, legislators and the governor will be facing the larger issue it raises for California: in light of growing climate risk and initiatives for climate mitigation, how should our electric utilities be organized? Should they be government agencies, as California has in Sacramento (SMUD), Los Angeles (LADWP) and numerous smaller regions, or should they continue to be investor-owned, as are PG&E, Southern California Edison, and San Diego Gas & Electric, as well as the companies that provide the majority of the electricity in the United States? Should they be as large as PG&E’s vast territory or broken into smaller pieces?
In most of the last century, a utility’s job was pretty straightforward: provide reliable electricity at affordable prices, while meeting a few federal and state environmental regulations. That meant that regulating an investor-owned utility was also less complex. The regulator needed to assure that the company didn’t waste money or provide poor service, but in most cases it could do that with periodic, high-level reviews. The process was slow and predictable, to the point that utilities stocks were considered low-risk investments.
Today, utilities face more risks due to climate change – wildfires, mostly in the Western U.S., as well as increased hurricane and tornado intensity, coastal flooding, and extreme heat waves. But unlike the other threats amplified by climate change, the utility can be part of the cause of a wildfire, and therefore liable for much more of the damage. One mistake in maintaining or monitoring the grid, which used to cause localized fire damage to a few structures, now creates more risk of widespread catastrophic losses.
That requires the formerly-boring tasks of grid upkeep to be a primary focus of utility executives, and a bigger part of the regulator’s oversight responsibility. In other industries where small errors can lead to catastrophic losses, regulation is much more invasive. Think airline safety or nuclear power plant operations. That’s likely where electricity is headed.
Does that mean that the government needs to own the utility? Not necessarily. Airlines are investor-owned while subject to high-intensity safety regulation, though a crash has not generally created the level of liability that would bankrupt a company. Nearly all U.S. nuclear power plants are privately owned, but the Price-Anderson Act protects them from most of the potential liability that a major accident would create.
It’s also not clear that government ownership reduces the risk of catastrophic accidents or makes it easier to compensate the victims. There is, of course, no shortage of stories of horrific errors by government agencies – from the Puerto Rico Electric Power Authority’s botched recovery from Hurricane Maria, to the Flint, Michigan water crisis, to the false alarm of an incoming ballistic missile attack on Hawaii in 2017. Furthermore, any local government would be bankrupted by the liability that PG&E now faces. Ultimately, a government utility would have to be backed by the state of California or the federal government.
“People not Profits” sounds good until you remember that the vast majority of U.S. production occurs in the for-profit sector — including critical functions like food, housing, and pharmaceuticals – for a reason. It has proven to be more cost-effective and innovative in most cases. Electricity may be different because of catastrophic risks, the need for lots of infrastructure and upkeep on others’ private property, or the fact that even investor-owned providers will require expansive safety and economic regulation. But that is not an open and shut case. Many investor-owned utilities and many government-owned utilities have good safety and service records.
Unfortunately, with the wildfires and PG&E’s possible bankruptcy, California will now have to lead in thinking through the best physical and organizational structure for an electric utility in the face of growing risks from climate change. The rest of the world will be watching what California decides. Electric grids are a critical part of transitioning to a low-carbon society, so getting this right is as important as any of the state’s pathbreaking climate mitigation programs.
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Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. He chaired the California Energy Commission's Petroleum Market Advisory Committee from 2015 until its completion in 2017. Currently, he is a member of the Bay Area Air Quality Management District's Advisory Council and a member of the Board of Governors of the California Independent System Operator.