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Stabilizing Utilities in an Unstable Climate

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.

pgebankruptcyfig3Electricity 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.

pgebankruptcyfig5When 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.

pgebankruptcyfig2Today, 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.

pgebankruptcyfig6Today, 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.

I’m still tweeting energy news stories/research/blogs most days @BorensteinS

Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas

Suggested citation: Borenstein, Severin. “Stabilizing Utilities in an Unstable Climate.” Energy Institute Blog, UC Berkeley, January 22, 2019, https://energyathaas.wordpress.com/2019/01/22/stabilizing-utilities-in-an-unstable-climate/

Severin Borenstein View All

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.

22 thoughts on “Stabilizing Utilities in an Unstable Climate Leave a comment

  1. As someone who doesn’t live in California, I’m hesitant to jump into this, but isn’t one of the challenges figuring out who is going to capitalize PG&E coming out of the bankruptcy? Utility stocks have been a traditional low risk, low return investment, but from an outside perspective, PG&E looks like a low return, potentially very high risk investment. Also, at least according to press reports, under California law the company is liable for any wildfire initiated by their equipment, whether the result of negligence or not; i.e., a liability that you may not be able to eliminate with better management. Not for my IRA, thanks.

    If investors aren’t willing to bite, perhaps the state could establish a re-insurance fund to cover catastrophic fire losses. It would be funded through a tariff on power, with higher tariffs for those living in areas with higher fire risks. Like any insurer, the fund would also audit the activities of the insured (PG&E or its remaining pieces) to make sure they are minimizing risks.

    • Essentially you ask for government backstop, why not have government owned operation of the grid? Streets aren’t largely owned by companies either! If the grod would be open, cheaper alternative renewable energy could access it much easier.

  2. An aside about the 2001 bankruptcy: “Wholesale electricity prices had skyrocketed due to a combination of real and artificial shortages,” Twice on two different teams, I modeled how the prices were manipulated solely through artificial shortages. The first time was in May 2000 for the CPUC as part of the hydropower divestiture PRIOR to the actual first price spike in late May. In that case, we found that under normal conditions, an owner with as little as 1,500 MW could profitably increase market prices for several thousand hours a year. (And Southern Company had already discovered this in 1999.) The second time was in the “withholding” model created for the California Parties in the FERC Energy Crisis Proceedings. The attempt by the merchant plant operators divert attention to other “causes” of shortages in fact were trivial influences on the magnitudes of the price increases. Let’s be clear that entire crisis was an internal creation (by multiple decisions) of the system with little to no external influences.

  3. PG&E going bankrupt over climate change is too convenient for an excuse or even explanation. What is the climate doing to PG&E???
    Let’s break it down: PG&E makes money from selling written off assets (ie electricity from conventional power plants. It does not make money from transmission, where they have a shady record (see San Bruno, Paradise Fire, Santa Rosa Fire), and it does not make money from purchasing mandated renewable energy and selling it at mixed rate to users. None of this involves climate change in the first order.
    The issue of climate change shows up in that production is now mandated to be carbon-free (SB100 – makes no scientific sense but stay with me) and that neglected, sub-standard transmission sparks fire or blows up. The latter is a matter of cheap maintenance against better knowledge. This is why PG&E was faulted after the San Bruno fire and this is why they should not run transmissions above ground. Guess what, after the 1991 Berkeley Hills fire no transmissions are above ground there. Why is that not a proper practice everywhere?
    What should happen during the bankruptcy is that PG&E should loose the transmission and merely be a producer, forced under AB32 to reduce green house gases and acquire renewable power to do so, while taking combined cycle plants of grid. At the same time, this would get them out of their anti-renewable power slot in regulating who gets to access the power and gas grid, which is the major impediment to more wind, solar, and biogas. All those sources are available, but reduce PG&E’s profit from selling from fossil fuel, and hence they try everything in the book of limiting independent distributed power generation, ie by imposing ridiculous interconnection fees. Interconnection fees that are used to upgrade the grid, that they have for many years neglected because it is an expense.
    Get PG&E out of transmission, open for renewable power and charge them with adjusting their RPS. Run the transmission and distribution grid underground so their are no arcs. This is standard in developed countries, why not in forward thinking California? Wire poles are from the gold rush time!

    • PG&E now makes most of its money for shareholders from return on and of investment on transmission and distribution infrastructure. It makes much less off its hydropower, nuclear and gas-fired generation assets. (It owns almost no other renewable generation.)

      A recent estimate put the cost of undergrounding PG&E’s rural system at $87 billion. That would translate into a 75% rate increase. We need to be looking for other altenatives.

      • You essentially say they have been “making money” by not maintaining the grid transmission in a prudent manner. Specifically the San Bruno blow up is testament to that. Maybe the cost is 87 bn, maybe that is the cost that is necessary to protect the state from arc fires. The cost of the Santa Rosa fire is 1.3bn plus, San Bruno was judged criminal negligence, obstruction of justice and gross miss management, Camp Fire is pegged at 13-16bn plus. The cost of climate change is estimated at annually 360bn and above.
        So yeah, alternatives would be great, like alternatives to climate change, and oblivious management. What would those be??? A second earth? Mowing down all forests? Suck it up baby, tighten the belt: delayed maintenance is coming home to roost.

        • I absolutely agree that we need to act to reduce fire risk. However, it may not involve “fixing” the distribution system–rather it may be to largely eliminate it by investing in distributed energy resources and microgrids. For dwellings in the wildlands, this is almost certainly a less costly solution. But I’ll say about that soon at https://mcubedecon.com/.

          • The arc fires are caused by local distribution grids, they will not disappear with microgrids or decentral generation. Generation and distribution are two different things.

          • The arcs generally occurred in remote locations without monitoring, and on overhead lines.The Camp Fire was started on a transmission voltage line that might have been shut down if local load can be readily shed. Microgrids can be undergrounded more cost effectively, and individual dwellings can be islanded under windy or other adverse conditions.

          • Why can a microgrid be undergrounded more cost effective?
            Why can PG&E not install the same switch gear to island?

          • A microgrid only needs to underground a small segment of the distribution grid. The remaining overhead system can be deenergized when conditions are unfavorable for fire. And eventually, the entire distribution grid in remote areas could be decommissioned. This is all less expensive than complete undergrounding.

          • So it is only cheaper for the transmission part you don’t underground. Which PG&E could already do, but wasn’t in Paradise.

          • It’s the transmission and the much of the distribution grid that wouldn’t be undergrounded, which the majority of the mileage. Again, the estimate is about one to $1.5 million per mile to underground, and that would result in a near doubling of rates.

          • Your savings are entirely based upon not undergrounding everything and not intrinsic to having a microgrid or distributed generation. These are savings independent of who does it.

          • The microgrids and DER are necessary for providing system resilience so that the overhead lines can be deenergized in the specified circumstances rather than undergrounding. And eventually, even the distribution lines can be decommissioned entirely in the most remote locations, which will save replacement and maintenance costs.

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