California “Exceptionalism” and Other Tragedies

 

I began to write last week intending to write about what the California Public Utilities Commission (CPUC) needs to do to ensure that the market is procuring sufficient “resource adequacy” (RA) capacity to ensure system reliability. However, the unfolding wild fire disaster made such commentary seem trivial at this point. There will be time to deal with the importance of RA and a recent FERC decision of dubious logic about the RA market, but not this week.

It is hard to fathom all the suffering and anguish caused by the most recent wild fires in California. Every day seems to bring some new stunning news item about the blazes. The number of confirmed deaths; the number of “unaccounted for,” the Beijing-like air quality in places like San Francisco and Sacramento; the incredible economic toll.

I can offer no wisdom on the extraordinary human tragedy that has unfolded this past week in California. However, I can speak to some of the economic toll. I offer my perspective on the way in which California legally assesses liability – unique in the entire US – and the resulting economic damage done to captive ratepayers and companies that must do business with California utilities.

“Inverse condemnation” stipulates that an entity with assets that may have contributed to a disaster like the wildfires – even if not found to have been operated negligently – is subject to almost limitless liability. This liability doctrine is so unique that it has been the subject of bewilderment in recent news reporting.  It took on-air analysts with news venues such as Bloomberg TV and Radio and CNBC several minutes to convey the concept, and on-air hosts could be heard incredulously asking if this is truly the way California assigns liability.  Indeed.

The legislature, with Governor Brown’s backing, recently tried to modernize these liability laws in California and make them better align with what the rest of the country does. Insurance companies, naturally, have not been in favor of such a commonsense solution as it removes significant risk to their books. No doubt, they contributed to the outrage commentary that the utilities were being let off the hook. This assertion was outrageous (one must use this term in California as it is a common currency of political debate in the Golden State) by virtue of the fact that, absent inverse condemnation, the utilities are still be liable if they are found to have been “negligent.”

Regrettably, the legislature did not have the wherewithal to ignore the cries of outrage and enact change that might help a large-scale utility business. I have developed a theory that the California political milieu loathes any policy supporting big business – unless it’s “tech.” But I digress… Instead, the legislature has allowed the utilities to issue bonds to cover costs related to wildfires under inverse condemnation. In other words, the government has tacitly encouraged utilities to take on more debt, which customers will ultimately pay. Of course, since they are still open to potentially limitless liability, the companies could find themselves in the untenable situation of taking on vast and accruing debt.

The levels of liability that are being discussed in relation to the most recent fires would almost certainly overwhelm any debt or credit vehicle that a California utility might have available. Worse, the perception in the credit markets and among those with whom the utilities do business could lead to onerous demands for cash and collateral.  That would result in an increase in the cost of doing business that would flow throughout the energy sector in the West. All for what?

California is the largest energy sink in the Western US. At peak hours, many companies throughout the West do business with the California utilities. If the perceived risk of doing business with a California utility were seen as high – due to open-ended obligations of liability or debt – then counter-parties would demand more “insurance” against a possible default in the form of cash or other fungible collateral. These costs would be passed on to customers and could even affect perceptions of the creditworthiness of those doing business with the utilities. Such credit ripple effects can create cascading events in stock prices and unrelated money markets. The bottom line is that this is a dangerous place for the utilities and for the energy sector in the West generally.

California often revels in the belief that it is special, unique, an “exception.” It is, as anyone who lives or visits there can attest, a place blessed by unparalleled beauty and often glorious climate. It has many great centers of innovation and entrepreneurship. More recently, however, it has been “exceptional” for reasons that are not so enviable: high taxes, high cost of living, and a political environment that has become “anti-business.”

Like many of us, my optimism has given way to cynical disbelief that our legislative bodies can work collaboratively and make tough choices. And in California, my optimism that the legislature can deal with any difficult situation such as the wildfires is beyond low. The departure of Governor Brown – not exactly my political soulmate but certainly the “adult in the room” of California politics – does not bode well for solutions that require tough choices. Here’s to hoping the new legislative session kicks off the New Year by surprising me and changing the liability rules so that a company in California can be assessed in a manner similar to the rest of the country. It would be good for California in the long-run as well as California’s neighbors.

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