June 21, 2019 – Catastrophic Wildfires Caused by Utilities Increase Costs for Utility Ratepayers. Recent catastrophic wildfires caused by utilities in California have caused tens of billions of dollars in property damage. Under current legal standards, these damages will directly lead to increased costs for utilities, which could be passed on to ratepayers. Moreover, the recognition of increased potential costs associated with wildfire risks has affected the credit markets, contributing to one investor owned utility (Pacific Gas and Electric) declaring bankruptcy, as well as credit downgrades for other utilities. These credit effects will make it more difficult and expensive for utilities to secure financing for capital investments, which will also increase costs for ratepayers, as well as potentially affect other policy goals. The goal of this report is to be a resource for policymakers and the public seeking to better understand the complicated issues surrounding utilities and the costs associated with wildfire risks.
Recent Government Reports Identify Potential Changes to Allocating Costs. Specifically, we describe and assess four options that were identified by both the Governor’s Strike Force and the Commission on Catastrophic Wildfire Cost and Recovery:
- Changing the prudent manager standard used by the California Public Utilities Commission (CPUC) to determine whether the utilities will be allowed to pass costs on to ratepayers in the form of higher electricity rates.
- Changing the strict liability legal standard—which makes utilities pay for property damages from fires started by their equipment, regardless of whether they were negligent—to a negligence standard.
- Establishing a liquidity‑only fund to pay wildfire claims before CPUC determines whether the utility can pass costs to ratepayers.
- Establishing a broader wildfire fund—funded by shareholders, ratepayers, property owners, and/or state taxpayers—to pay wildfire claims.
Summary of LAO Assessment. The effects of each option depend heavily on key implementation details. However, for each option, we qualitatively assess how the change could qualitatively affect three key policy criteria.
- Fair Distribution of Financial Costs and Risks Among Different Groups. Most of the changes would shift how future costs associated with utility‑caused wildfires are paid among different groups. For example, changing the prudent manager standard would shift future risks from utility shareholders to ratepayers. Other changes—specifically, changing strict liability and establishing a wildfire fund—would likely result in a broader shift in risk between shareholders, ratepayers, insurers, and property owners.
- Incentives for Different Groups to Reduce Overall Wildfire Risk. Changes that increase potential wildfire‑related costs for insurers and property owners could encourage them to take additional actions to reduce future risk, such as through increased implementation of home hardening and defensible space. On the other hand, changes that reduce financial risk for utilities (shareholders or ratepayers) could reduce utilities’ financial incentives to take actions to reduce wildfire. However, the ultimate impact on wildfire risk reduction activities would depend, in large part, on other state actions intended to promote greater risk mitigation activities, including oversight of utility mitigation activities and property insurance market reforms.
- Ability to Raise Capital for Utility Expenses and Reduce Ratepayer Financing Costs. By reducing the perceived riskiness of utilities, all of the changes have the potential to improve utilities’ ability to raise capital for paying wildfire claims, as well as potentially for other expenses such as to implement wildfire safety and carbon emission reduction activities. The changes could also reduce ratepayer costs related to raising this capital by lowering bond interest rates and shareholder returns on equity. The magnitude of these effects are unclear and depend, in part, on how the changes affect investors’ perception of utility financial risk.
This report is available using the following link: https://lao.ca.gov/Publications/Report/4079