For investor-owned regulated utilities (IOUs) based in high-risk wildfire areas, particularly in the western U.S., the potential for further credit deterioration is a growing reality. If exposure to damaging wildfires continues to spread, ratings on some exposed utilities may come under pressure. Effective risk mitigation strategies, and the availability of regulatory or legislative solutions to limit risk to their balance sheets, could become increasingly important.
Increasingly, S&P Global Ratings' utility analysts view wildfire risk as a material credit consideration for exposed utilities that is difficult to fully contain without comprehensive risk mitigation strategies and regulatory or legislative support. Wildfire risk mitigation, while clearly a credit positive, may not fully address the threats associated with extreme weather events in high wildfire-risk areas. And in this context, insurance against worsening physical climate risks is likely to increase in cost and offer diminishing protection over time.
Why It Matters
Wildfire risks have the potential to shake the foundation of the regulatory compact for IOUs in the most wildfire-exposed parts of the U.S. Our credit opinions on a regulatory jurisdiction are based on the stability of the regulatory framework, encompassing the principles of transparency, predictability, and consistency.
We also incorporate the degree to which the regulatory framework and the legislative environment supports credit quality in its design. Increasingly, wildfires are adding a level of uncertainty to this operating construct due to the lack of clear protections for wildfire-related losses through the regulatory or legislation framework in many states.
What We Think And Why
Climate-related risks including wildfires are now more prominent to IOUs' credit analysis. Transformative change is well under way in the U.S. power sector, and balance sheets are increasingly under pressure to cope with heavy capital investments to both decarbonize and harden the grid. Utilities are also increasingly deploying capital to update the transmission grid to accommodate the rapid increase in new renewable generation and load growth. While all these issues are important to credit quality, we believe that wildfire risks may be the most difficult to manage for the most exposed IOUs due to contingent litigation risks.
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Why wildfires are different from other physical risks--and more problematic from a credit standpoint. The scale of potential liabilities, unpredictable nature of exposures, and frequency of wildfire events has materially increased risk for many utility stakeholders. From a credit standpoint, litigation risk is more problematic than damage to the utilities' infrastructure related to wildfires, as it is difficult to predict or quantify and is heretofore without sufficient mitigation or containment. Wildfire-related litigation payments are typically not recoverable in rates or through other regulatory mechanisms, making them more problematic than physical risk from other climate events. We have already seen how damaging these issues can be for credit quality, once the injured plaintiffs and their lawyers identify cause to file suit against a utility defendant, with significant adverse effects to company value and credit quality.
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Wildfire risk brings with it the potential for large-scale property damage claims and unmanageable non-economic claims that often go well beyond the base-case expectations that we build into our credit analysis. During 2023 and 2024, S&P Global Ratings has downgraded several utilities related to wildfire events including Hawaiian Electric Industries Inc., Xcel Energy Inc., Southwestern Public Service Co., and PacifiCorp. Moreover, in the face of deteriorating wildfire conditions, our analysts are increasingly compelled to address these contingent risks in our ratings.
For many exposed IOUs, we have already adjusted business risk profiles, negatively adjusted rating modifiers to fine-tune our analyses, and raised downgrade and upgrade thresholds to require more financial strength to support ratings. However, our evaluation of prospective exposure is ongoing, and in the face of further climate deterioration and elevated wildfire risk, the existence of financial protections in legislation or utility regulation could become a more important factor in the analysis. Without such protections for utility investors to limit wildfire litigation exposure, more utilities with substantive wildfire exposure are likely to see ratings come under pressure in the years to come.
The Regulatory Compact Is Showing Stress Fractures
Prudently incurred costs and investments associated with the energy transition and modernizing the grid are typically recoverable through rates or regulatory mechanisms to ensure the financial stability of IOUs. While regulatory support varies across jurisdictions, in the U.S., the durability and predictability of the regulatory frameworks are highly supportive of credit quality, often underpinning investment-grade ratings. These factors enable utilities to earn a fair return on invested capital and provide a solid foundation for successfully operating a regulated utility since they deploy significant amounts of capital in long-lived assets to provide essential services to rate payers. In some service territories, wildfires have emerged as a risk that may upset the balance between risks and rewards if not adequately addressed.
In the investor-owned utility sector, authorized returns on equity (ROEs) averaged about 9.5% in 2024. While these return levels are consistent with the sector's historical precedent, management teams in some parts of the U.S. must grapple with more severe physical risk and the risks of wildfire-related litigation. In a scenario where wildfire risk continues to increase and the utility lacks adequate mechanisms to recover related costs, we think that the traditional regulatory model and typical returns may not be sufficiently attractive to motivate utility management teams to deploy large-scale capital. Lower capital invested over time would likely limit or delay necessary infrastructure upgrades leading to higher operating risks and less-efficient operations.
Bondholders lend capital to utilities over lengthy periods to fund the development of long-lived assets. Investors in utilities operating in any jurisdiction also need to understand how the regulatory and legal framework enables the utility to recover its costs, manage its liabilities, and maintain financial health necessary to ensure the return of invested capital over an extended period. These same considerations are also integral to the decision-making of utility management teams as they decide how much risk is acceptable to shareholders when deploying long-term capital. In the current environment of rapid energy transition and record capital spending, these issues are more important than ever. Evolving wildfire risks, which can manifest themselves without much warning, can present a challenge that traditional regulatory mechanisms or existing legislation may not clearly address.
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Utilities are highly dependent on external funding sources. Thus the cost of capital has important implications for the utilities' financial strength and the rates charged to customers. Access to low-cost capital enables the utility to fund investments necessary to expand the rate base and achieve earnings growth. In this model, maintaining investment-grade ratings is supportive of credit quality since this allows for readily accessible low-cost debt financing and promotes stability. Based on recent S&P Global Research & Data stats, the median investment-grade credit spread is about 100 basis points over treasuries lower compared to the same maturities for high speculative-grade issuers (see chart below).
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This disparity in credit spreads is consistent over all maturities and over time, with wider disparities during times of financial market distress and uncertainty. Maintaining a lower cost of capital is a key consideration for running a healthy utility as borrowing costs can be more contained thereby helping to limit rate pressures for customers. Given the large balance sheets and the amount of debt carried by many IOUs, the stakes of preserving credit quality are key to all stakeholders. Credit stability is also associated with stable operating results, manageable debt, and the predictable growth necessary to entice investors to support the utility with additional equity capital over time. In this way, supportive regulation, low-cost capital, and access to equity financing enable the utility to achieve the regulator's primary objectives of keeping electricity rates low for customers and reliability of power supply steady.
Even Strong Wildfire Mitigation May Not Be Enough To Reduce Litigation Risk
For the IOUs most exposed to material wildfire risks, comprehensive mitigation and effective wildfire management plans are clearly important to managing wildfire risks. Still, if wildfire risks continue to expand under a deteriorating climate scenario, long-range legislative or regulatory risk-absorbing solutions, including insurance, wildfire funds or regulatory mechanisms, could help to stabilize credit quality. S&P Global Sustainable1's moderate-to-high emissions (a slow transition to lower carbon) scenario projects a global temperature increase of 2.1C by 2050 supporting an expectation of persistent drought and wildfire risks for much of the western U.S. (see map below).
We assume wildfire litigation could continue to remain high and move further east. Because utilities operate under potentially hazardous conditions that include safety as well as environmental risks, they have always been susceptible to some litigation. However, in recent years, as climate change contributes to more frequent and severe wildfires, as well as possible lengthening of the wildfire season, litigation and class action civil lawsuits have become a broader issue with numerous legal actions now pending against investor-owned utilities. Currently, plaintiffs have pending civil lawsuits against eight investor-owned utilities because of wildfires.
Higher standards of negligence improve, but do not eliminate, litigation risks. The negligence laws for most Western U.S. states require that the plaintiff demonstrates that the defendant is at fault for acting in a deficient manner or for breaching the duty of care. States' standards of negligence differ, and these standards are important to understand risk exposure. Even in states with higher standards of negligence to bring a successful lawsuit, we believe that utilities could still face risks of adverse rulings in a jury trial, given the operational judgments necessary to manage dynamic wildfire risks.
In California, IOUs are held to a higher level of accountability through the state's interpretation of inverse condemnation doctrine--whereby a California utility can be financially responsible for a wildfire if its facilities were a contributing cause of a wildfire, irrespective of negligence. While we assess this interpretation as not credit supportive, to date California remains the only Western U.S. state that supports this interpretation for utilities.
Similarly, legislation that limits damages is credit positive, but IOUs could still be exposed to large damages given the high number of potential plaintiffs in some wildfire events. For most civil lawsuits, if the defendant is found liable, jurors may assess for economic, non-economic, and punitive damages. Economic damages are the reimbursement of actual monetary losses, while non-economic damages are more subjective and can sometimes include emotional distress, medical expenses, and lost wages. Punitive damages are a penalty to deter further intentional or reckless behavior.
The maximum amounts for non-economic and punitive damages are sometimes capped by state statutes, and we view these caps as supportive of credit quality, limiting the total potential damages. For example, in Colorado, non-economic damages are capped at about $642,180 per plaintiff and punitive damages are limited to 1x total damages; however, both caps can be increased under various circumstances.
Oregon also established caps to limit non-economic damages in a civil action for property damage caused by a wildfire, with the recoverable damages limited to the amount of economic and property damages if the wildfire did not occur as the result of recklessness, gross negligence, willfulness, or malice. The cap is twice the amount of economic and property damages if the wildfire occurred as the result of recklessness, gross negligence, willfulness, or malice. However, the interpretation of the law allowed jurors in a class action wildfire lawsuit against PacifiCorp in Oregon to assess economic damages at about $4 million for 17 plaintiffs but added substantial non-economic and punitive damages of about $68 million and $18 million, respectively. This increased total awarded damages to about $90 million or about $5.3 million per plaintiff.
Similarly, Utah Senate Bill (SB) 224 clarified limitations of liability if an electric utility has an approved wildland fire protection plan in place and the commission determines that the utility complies with this plan. These caps were set at $450,000 for non-economic damages for parties with a physical injury, $100,000 for other non-economic damages. Caps do not apply for wrongful death claims.
We view legislation limiting non-economic damages as favorable for credit quality, but these laws will need to be tested over time and are subject to the potential interpretation of courts and jury verdicts on a case-by-case basis.
Effective regulatory mechanisms that allow for the timely recovery of wildfire-related cost recovery can be an important part of a comprehensive wildfire mitigation strategy. In March 2024, the California Public Utility Commission (CPUC) adopted a resolution following the passage of Senate Bill 884 in 2023 that authorizes electric utilities serving 250,000 or more customers within the state to participate in an expedited utility undergrounding program. Participating utilities must submit a 10-year distribution infrastructure undergrounding plan to the Office of Energy Infrastructure Safety (OEIS). Upon OEIS approval, the utilities may seek cost recovery from CPUC, subject to several provisions, including utilities not exceeding approved cost caps for each specific year during the plan, ongoing progress report filings with both the OEIS and the CPUC, and use of an independent monitor to assess utilities' compliance for each year the undergrounding plan is in effect. Overall, we believe the resolution indicates California's proactiveness toward addressing wildfire risk, which is supportive of credit quality.
Expanded availability of securitizations could help to reduce debt related to wildfire exposures. Securitization allows for the issuance of debt secured by a non-by-passable charge to the customer's bill, allowing the utility to fully recover its costs at a lower interest rate for customers. Utilities with regulatory approval can securitize costs associated with the fallout from weather-related incidents, energy transition, commodity prices, or other events. Because the debt is secured by the high likelihood of customers paying their bills, the associated interest costs are typically lower. We often deconsolidate such debt, resulting in stronger IOU credit measures and view securitization as supportive of credit quality. California Assembly Bill (AB) 1054 provides an example of how this works in the context of wildfire mitigation, by allowing the electric utilities to recover reasonable costs and expenses related to a catastrophic wildfire including fire risk mitigation capital expenditures.
On Aug. 29, 2024, Edison International (Edison) subsidiary Southern California Edison Co. (SCE) reached a settlement agreement related to the 2017/2018 Thomas Fire, Koenigstein Fire, and Montecito Mudslides (TKM). If the California Public Utilities Commission (CPUC) approves this, SCE will be authorized to recover 60%, or approximately $1.6 billion of approximately $2.7 billion of losses, including approximately $1.3 billion of uninsured claims, and about $300 million of legal and financing costs paid as of May 31, 2024, and a portion of losses paid after May 31, 2024. If approved, SCE may issue securitization bonds to recover such amounts. Should the CPUC approve the TKM settlement, it potentially signals a precedent for the recovery of prudent third-party wildfire claims to be recovered from ratepayers, which could lead us to a more favorable view of California's regulatory construct.
California And Utah Wildfire Funds Add Credit Support
California Assembly Bill 1054
Combined with the other wildfire management mitigants, California's wildfire fund sets a credit-supportive precedent for reducing statewide wildfire risks to IOUs. In 2020, a special wildfire fund was established by the state government under AB1054 to decrease risks for its IOUs. We view the wildfire fund as supportive of credit quality. The wildfire fund will reach $21 billion once fully funded, of which the largest IOUs (Pacific Gas & Electric Co., Southern California Edison Co., and SDG&E) funded $9 billion over the 2019-2023 period. The $21 billion fund is designed to be funded equally by the IOUs' ratepayers through wildfire non-by-passable charges to customer bills, and by contributions from the participating utilities. As of June 30, 2024, total assets within the wildfire fund total $12.25 billion.
The fund is only available for participating California IOUs after its eligible wildfire claims exceed $1 billion in any coverage year. To tap the fund, the utilities must receive safety certification issued by the state, demonstrating that they are implementing required wildfire mitigation measures. After receiving safety certification, a utility company can then recover certain costs and expenses arising from wildfires if the CPUC determines the fire was caused by the utility's equipment, the damages are not covered by insurance, and the utility acted responsibly and its conduct was just and reasonable.
Since its inception, the fund had not been tapped until recently; on Sept. 27, 2024, PacGas received its first reimbursement from the wildfire fund related to the 2021 Dixie Fire. The Dixie Fire, which destroyed over 1,300 structures, has an estimated $1.6 billion in wildfire claims. Since these claims exceed $1 billion, PG&E recorded a $600 million Wildfire Fund receivable in 2024 with expectations for the utility to draw on the fund. We view PG&E's access to fund reimbursement as supportive of credit quality, as it demonstrates the efficacy of a state wildfire fund.
Utah senate bill (SB) 224
Utah's wildfire fund offers a second tangible example of a statewide solution to support utilities that are exposed to litigation risks from wildfires. We view the passage of SB 224 in March 2024 as a strong example of legislation supporting utility credit quality. The legislation creates a dedicated wildfire fund, that if executed well, may prove a viable path forward for reducing some of the litigation risk utilities operating in wildfire-prone states face.
SB 224 established a fund for large-scale electric utilities in the state to help pay claims arising from a fire caused by the utility. The fund will be funded by a Utah commission-approved surcharge that the utility may charge its customers for a set period, plus investment income earned on fund assets.
The surcharge will be included on customer bills provided that the surcharge does not result in an increase over current rates of more than 4.95% and for an average residential customer more than $3.70 a month. The Utah fire fund will terminate collections on the earliest of 10 years from its May 1, 2024, effective date or the date on which the assets in the fund reach an amount equal to 50% of the Utah utility's revenue requirement.
The utility can access the fund regardless of whether it is deemed negligent but must pay a $10 million deductible. The fund is accessible after applicable insurance coverage, including self-insurance. The fund allows injured plaintiffs to recover economic losses to compensate for damage to property and non-economic losses to compensate for pain, suffering, and inconvenience. The amount of non-economic damages covered is limited to $100,000 for a person who is not physically injured as a result of the fire, or $450,000 for a person who is physically injured as a result of the fire.
While the Utah fund is only the second state-level fund created for utility wildfire exposure, it offers a partial mitigant to wildfire risk at the state level.
Given Increasing Wildfire Risk, Some IOUs May Find It Harder To Maintain Credit Quality
IOUs rely on a stable and predictable regulatory and legislative risk environment to provide investors with the impetus to invest in these businesses for a fair return. With the benefit of capital access and a predictable risk environment, management teams stand ready to deploy significant amounts of capital in pursuit of improving operations and to seek growth and profits. We believe that wildfire risk, if not addressed through comprehensive risk management, could begin to upset these relationships.
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Capital spending has reached record levels in recent years. This highlights the increasing pressure on utilities to deliver safe and reliable energy, manage the energy transition, and harden their assets against physical risks. Our ratings on IOUs are on a downward trajectory because of increasing cash flow deficits and higher reliance on debt financing. We believe that the negative trends could accelerate without strong management and tangible solutions to limit financial exposure to wildfires and litigation.
Related Research
This report does not constitute a rating action.
| Primary Credit Analyst: | Kyle M Loughlin, New York + 1 (212) 438 7804; kyle.loughlin@spglobal.com |
| Secondary Contact: | Daria Babitsch, New York 917-574-4573; daria.babitsch1@spglobal.com |
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