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Are California Utilities At Risk of a Ratings Downgrade Due To Wildfires?

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Problems at Pacific Gas & Electric could end up affecting the ability of utility companies to source capital from public markets. According to Gabe Crosberg, S&P Global Ratings Director, PG&E’s recent bankruptcy filings and problems has led the ratings firm to reconsider the risk status it assigns to California utilities. Specifically, the firm may downgrade California-based utilities from their investment grade status due to the risk of wildfires. Along with Moody’s, S&P’s ratings are the two most important metrics used by investors and a downgrade generally results in limited access to capital markets.   

In a post with a dramatic headline on Utility Dive, Crosberg identified three distinct areas of rising risks for California utilities: dampened investor confidence, weakened resilience to recover from future wildfires, and ratings risks. 

Out of these, ratings risks are the most critical in spiraling utility stocks down the credit rabbit hole. Crosberg writes that the camp fire last November has already led the company to reassess ratings for California-based utilities at S&P. In January this year, the S&P team downgraded Edison International and Southern California Edison to a BBB rating. The firm’s assessment of San Diego Gas & Electric Co. also fell to BBB+.

All three companies are now at the edge of investment grade rating. A further downgrade from S&P would push them into speculative grade territory, which consists of securities with high yields and risks. Such securities generally attract speculative investors, who are unreliable and invest only for the short-term.

Crosberg’s column should set off alarm bells ringing for investors in utility stocks. Before they hit the panic button, however, investors might be wise to consider answers to a couple of questions.

The first one is the effect that a change in ratings might have on the sector’s performance in the long term. While PG&E comprises a significant share of the utility sector’s valuation in the markets, its stock performance does not necessarily translate into a downturn for other utility stocks. Recent performance statistics are proof of the disconnect. Even as PG&E’s share price is getting hammered, the utility sector is doing just fine, even thriving, as a matter of fact. It is close to an all-time high and gained 0.4% in the last week. Utility stocks are up by 13% this year and have outperformed the S&P 500.

Even during the turbulence at the end of last year, when PG&E’s bankruptcy filing made front page headlines, the S&P 500 utility sector was ranked second in terms of gains for 2018 through November 26. Some investors in PG&E’s price are also looking at the decline in its stock price as an opportunity to buy low. Therefore, a ratings downgrade for California-based utilities from S&P may not have a ripple effect on other utility stocks.   

The second question is more fundamental and relates to the cause of the downgrade. In his note, Crosberg raises the spectre of “inverse condemnation” in which a utility could be held liable for fires caused in its territory. Analysts at S&P have called for regulatory reform in California in order to mitigate this risk.

But the problem with their assessment is that it does not align with that of regulators. According to J.K. Sandoval, former commissioner at the California Public Utilities Commission, damaged utility poles, that have either been neglected in upkeep or are straining under the weight of carrying high voltages, are the main cause of fires in the state. “..the CPUC’s enforcement process remains hampered by antiquated information systems, spotty reporting of rule violations, limited enforcement resources, aging infrastructure designs and resources, and a system that tolerates rule violations that persist for years,” he wrote in a post for Santa Clara University’s School of Law, where is professor.

Among his recommendations to overcome these problems is modernizing infrastructure through use of smart poles and sensors. Regulatory reform can only go so far in containing the financial damages caused by wildfires. Eventually, it is up to the utilities themselves to lessen its effect on their bottom line. Further south, SD G&E is already undertaking efforts to improve its infrastructure.

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Thank Rakesh for the Post!

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