Utilities’ Right to Recover Operating Costs Through Rates
All electric utility regulation relies upon the Regulatory Compact. The Regulatory Compact is a contract between the utilities and the state. The utilities promise to provide reliable service to customers. And the state promises to approve just and reasonable rates for the utility’s services.
Using the state-approved just and reasonable rates utilities are able to recover their cost of providing service, including a reasonable return on its investment. But what happens when a utility incurs extraordinary costs? Are those costs included in the just and reasonable rates? Or are they excluded from rates and borne by the utility shareholders?
PG&E’s Liability for Fire-Related Damages
That brings us to Pacific Gas & Electric Company (PG&E) and the California wildfires. In recent years PG&E’s equipent has caused California’s most devastating wildfires. The 2018 Camp Fire alone killed 86 people and destroyed 14,000 homes.
Under the usual laws of negligence PG&E would be liable for fire-related damages only if it failed to act reasonably under the circumstances. In other words, PG&E would be liable if it were negligent. However, in California, the usual laws of negligence do not apply. Under California law, if PG&E’s equipment caused the fires it is liable for all fire-related damages whether or not it was negligent.
PG&E’s Ability to Recover Fire-Related Damages Through Rates
Although California law holds PG&E liable for all of the fire-related damages, it may be able to recoup all or some of those damages through its rates. The California Public Service Commission (CPUC) will decide whether PG&E can recover those damages through rates.
If the CPUC finds that PG&E operated its system prudently PG&E can include the damages in its rates. However, if the CPUC finds that PG&E’s negligence led to the fire-related damages, it will disallow the recovery of those costs. The CPUC followed this process when it disallowed San Diego Gas & Electric’s request to recoup $379 million of fire-related damages from a 2007 fire.
PG&E, therefore, faces a two-step process. First, PG&E will be liable, under California law, for all 2017 and 2018 fire-related damages caused by its equipment. Second, PG&E can only recover those costs from ratepayers if the CPUC determines that it operated its system prudently.
PG&E’s Potential Liability From the 2017 and 2018 Fires
PG&E believes that it will be subject to $30 billion in claims for damages arising from the the 2017 and 2018 fires. After its 2007 fire San Diego Gas & Electric (SDG&E) implemented new state of the art fire response procedures. For example, SDG&E now keeps extensive data on every pole in its system; it uses 177 stations to monitor temperature, humidity service and wind speed; it records video from 100 strategically placed cameras in its service territory; it uses satellite data to track where grass is dry; and it shuts down portions of its system when fires are imminent.
Unlike SDG&E, PG&E had not implemented any of those mitigation procedures before the 2017 and 2018 fires. There is, therefore, good reason to suspect that PG&E’s negligence was, at least partly at fault for the fire-related damages. (It should be noted that PG&E is now implementing some of the procedures implemented by San Diego Gas & Electric.)
PG&E’s Possible Breach of the Regulatory Compact
If PG&E cannot recoup all of the fire-related damages through its rates it will have less funds available to pay ongoing operating expenses, to pay down debt and to issue dividends to shareholders. PG&E could ultimately be unable to financially operate its system. If it were unable to operate its system it could be argued that PG&E breached its promise to provide service under the Regulatory Compact and that it should no longer be permitted to operate as a state approved utility.
This would not be the first time that a major utility lost its operating franchise due to a breach of its promise under the Regulatory Compact. In 1998, after many years of poor service and increasing rates, the Long Island Lighting Company (LILCO) lost its franchise to operate. In that case the State of New York created a state agency, the Long Island Power Authority, to purchase LILCO’s facilities and to take responsibility for service in LILCO’s former service territory.
This is the fate for PG&E recently proposed by San Jose’s mayor, Sam Liccardo. In October, 2019, in anticipation of potential wildfires, PG&E shut down portions of its system temporarily cutting off service to hundreds of thousands of customers. Reflecting the frustration of many PG&E customers, Mr. Liccardo suggested that municipalities and counties in the State of California should jointly purchase the PG&E system and turn it into a customer owned utility. If Mr. Liccado’s suggestion gains any traction PG&E’s fate will probably be decided by the CPUC.
PG&E’s Attempt to Stay Solvent
But, for the time being, PG&E has said that its system is not for sale. In addition, it is doing everything that it can to maintain a sound financial footing. In January, 2019, PG&E filed for bankruptcy. Within the bankruptcy process PG&E has already reached financial settlements for fire-related damages with numerous governmental agencies and insurance companies. It has not yet resolved claims with the many individuals who suffered damages. Presumably, PG&E hopes to emerge from bankruptcy as a solvent company able to continue to operate its business.
However, absent some relief from the California State Assembly, PG&E will still be facing considerable challenges after it emerges from bankruptcy. For example, it would still have to face liability for all future fire-related damages caused by its equipment. And the CPUC could still prevent PG&E from recouping those costs if it found that PG&E was negligent. In addition financial institutions are saying that, because of the risks of operating a utility in California, they will have to charge PG&E high interest rates.
There are many legal, financial and regulatory issues that have to be resolved here. And in 2018 and, again in 2019, the California State Assembly decided to take action. It decided to first focus on the most important issue – ensuring that PG&E and the rest of the utilities in California are financially viable companies capable of taking the actions necessary to reduce damages from wildfires.
On September 21, 2018, Governor Brown signed SB 901 into law. SB 901 addresses the above issues as follows:
- For fires occurring after December 31, 2018 the CPUC will use a new reasonableness standard to determine whether utilities can include fire-related damages in rates. Instead of relying solely upon whether the utility acted reasonably under the circumstances the CPUC will be required to consider the specific wildfire related circumstances. It is believed that this new standard will make it harder for the CPUC to keep fire-related damages out of rates.
- For fires occurring in 2017 the CPUC will conduct a “financial stress test” for each utility to determine the maximum amount of fire-related damages that they can absorb without incurring financial harm. It is believed that this provision will result in the CPUC allowing fire-related damages in rates which it would have otherwise disallowed under the existing reasonableness standard.
SB 901 does not address fire-related damages from fires that occurred in 2018. It is likely, however, that the State Assembly will revisit this issue in the next session.
SB 901 also imposes new fire mitigation procedures and requirements on the utilities.
On July 12, 2019, Governor Newsom signed AB 1054 into law. AB 1054 creates a fund of as much as $21 billion that the utilities can use to pay for fire-related damages. The utilities and their ratepayers will initially contribute equally to the fund. The ratepayer portion will be financed through a $2.50 per month surcharge on bills paid over a number of years.
The fund enables the utilities to pay for fire-related damages without waiting for CPUC approval for rate increases. If the CPUC determines that a utility is responsible for fire-related damages it will replenish the fund for the amounts used. If the CPUC determines that a utility is not responsible then ratepayers will replenish the fund through additional or extended surcharges.
Like SB 901, AB 1054 imposes additional fire mitigation procedures and requirements on the utilities.
I. David Rosenstein worked as a consulting engineer and attorney in the electric industry for 40 years. At various times during his career he worked for utility customers, Rural Electric Cooperatives, traditional investor owned regulated utilities and deregulated power generation companies. Each of his posts in this blog describes a different aspect of the past, present or future of the electric industry.