Wildfires are an escalating risk for electric utilities, particularly in regions with dry climates and dense vegetation, such as California and other parts of the western United States. These natural disasters have become more frequent and severe due to climate change, forest management practices, and population growth in the wildland urban interface. This situation is placing utilities in a precarious position regarding operational stability, regulatory compliance, and financial health. One of the most critical impacts of wildfires on utilities is the deterioration of credit metrics, which can have long-lasting consequences for access to capital and overall financial viability
Operational and Capital Costs
Wildfires can cause extensive damage to utility infrastructure, leading to significant operational and capital expenses. While concerning, the greater worry is the liability associated with wildfires ignited by utility equipment, leading to loss of life and substantial property damages. For example, Pacific Gas and Electric (PG&E) faced over $30 billion in liabilities related to wildfires in California from 2015 to 2018, eventually leading the utility to file for bankruptcy in 2019.
These unanticipated costs can severely strain a utility's balance sheet, increasing debt levels and weakening cash flow. Rating agencies, like Moody’s, Fitch, and S&P Global Ratings, closely monitor these metrics and may downgrade a utility’s credit rating if the company’s financial health deteriorates. As an example, S&P Global Ratings, Industry Credit Outlook stated the following about wildfire impacts:
During 2023 we lowered the ratings on Hawaiian Electric Industries Inc. by multiple notches after the most destructive wildfire in Hawaii's history, with nearly 100 fatalities and about 2,200 structures damaged or destroyed. Also during 2023, an Oregon jury awarded 17 plaintiffs in a 2020 wildfire-related class action lawsuit against PacifiCorp about $5.3 million per plaintiff, which was materially above our base case of about $1 million per structure. The jury also found that a broader absent class affected by the fires could bring claims against the company. Accordingly, we downgraded PacifiCorp by two notches and revised the outlook to negative.
A lower credit rating makes it more expensive for utilities to borrow money, further exacerbating financial stress. Notably an actual fire is not necessary for a downgrade to occur. Rating agencies are scrutinizing utilities’ relative wildfire risk, financial risk, and the efforts underway to minimize those risks.
Main Assumptions About 2024 and Beyond
- Climate change: Climate change is increasing the frequency of extreme and devastating hurricanes, storms, and wildifre, which is heightening credit risks for North America's investor-owned utilities
- Record capital spending: While the industry's robust capital spending is necessary for prudent investsments in safety, reliability, and energy transition, it is directly leading to high cash flow deficits. If these deficits are not funded with debt and equity in a balanced manner, credit quality will likely weaken.
- Management of regulatory risk: Given the signficant captial spending, effective management of regulatory risk is important for the industry's credit quality. This includes constructive rate case orders, minimizing regulatory lag, earning its authorized return on equity, and managing the customer bill impact.
Insurance Costs and Availability
Insurance plays a critical role in responding to wildfire risks for both utilities and property owners, but as wildfires become more frequent and severe, insurers are reassessing their exposure to these events. Utilities may find it increasingly difficult or expensive to obtain sufficient insurance coverage, which can leave them exposed to significant financial risks. Additionally, higher insurance premiums add to operating costs, negatively impacting profitability and cash flow.
If insurance is unavailable or unaffordable, utilities may need to self-insure, setting aside reserves to cover potential losses. This approach can tie up capital that could otherwise be used for operational improvements (e.g. as resilience investments) or growth initiatives, leading to a decline in key credit metrics such as return on equity and debt coverage ratios.
Regulatory and Political Risks
Regulators increasingly require utilities to implement wildfire mitigation measures, such as vegetation management, equipment upgrades, and public safety power shutoffs (PSPS). While these measures are necessary to prevent future wildfires, they come with substantial costs and customer impacts. Some states may seek to enforce mandatory compliance with wildfire resilience measures. Utilities may seek to recover these costs through rate increases, but regulators may be hesitant to approve significant hikes, especially in regions where customers are already facing high electricity bills.
Building an Effective Wildfire Mitigation Plan
Given the severe financial risks associated with wildfires, utilities must prioritize the development and implementation of comprehensive wildfire mitigation plans. According to the S&P Global Ratings, Industry Credit Outlook:
We expect IOUs—especially those in the western U.S.—will develop detailed wildfire mitigation plans that reduce damages, minimize litigation risk, and expand capabilities for cost recovery. While it may take considerable time and investments for the industry to fully implement these strategies, the solutions are largely predicated on already-developed and in-use technologies.
A well-designed and executed plan not only reduces the risk of wildfires, but also helps protect the utility’s credit metrics by minimizing the financial fallout of these events. In California, utilities were battered with credit downgrades, following several utility ignited conflagrations, however, after substantial efforts CA utilities are now seeing credit upgrades due to their efforts to reduce wildfire risk. These efforts included strict wildfire mitigation plan (WMP) requirements, wildfire resilience investments, mandated independent evaluations of WMPs, and, eventually, the establishment of a state wildfire liability fund. This is in contrast to utilities receiving fire-related downgrades in other Western states that have more recently been developing WMPs and the regulatory structures to approve resilience investments.
If the utility is operating in an area with substantial fire risk, a WMP should be generated. At a
minimum, utilities need their WMP to include the following actions:
- Conduct a risk assessment to identify the highest risk circuits, lines, and communities.
- Assign proper roles and responsibilities to implement the plan.
- Deploy situational awareness tools to monitor real-time weather and operating conditions.
- Employ operational changes like increasing relay trip sensitivity to reduce the likelihood of utility ignitions, review inspection and vegetation management practices, and, in extreme conditions employ pre-emptive de-energization of power lines (commonly called public safety power shutoffs or “PSPS”).
- As appropriate, deploy grid hardening measures that reduce the likelihood of ignition and increase system resilience such as covered conductor, steel power poles, and non-expulsive fuses.
WMPs are essential for at risk utilities to safeguard their financial position. A well-constructed, comprehensive WMP is primarily driven by the need to substantially reduce ignitions that can become wildfires, but the impact to the ability to attract capital and the cost of capital must be considered. In order to establish whether a WMP is effective, a third-party independent evaluation should be considered. Such an independent evaluation can help the utility and its insurers, credit rating agencies, and regulators determine whether utilities are protecting communities, customers, and investors.
Conclusion
Wildfires pose a serious threat to electric utilities, not only in terms of operational risk but also through the potential deterioration of credit metrics and investor sentiment. Utilities that fail to proactively manage these risks may face significant financial consequences, including higher borrowing costs, reduced access to capital, and even bankruptcy. By seeking an independent evaluation of WMPs insurers, rating agencies, and regulators can better understand the risk environment in which a utility operates and utilities can better protect infrastructure, reduce the likelihood of wildfires, and safeguard their financial health.
