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PG&E’s descent is a climate alarm bell for corporates

By Jasper Cox
15 Jan 2019

Californian utility firm PG&E’s impending bankruptcy filing, on the back of unprecedented liabilities for wildfire damage in the state, is a warning sign that investors may find it impossible to predict how the climate crisis will threaten companies, both quickly and slowly.

PG&E said on Monday that it was planning tofile for Chapter 11 bankruptcy on or around January 29, a tool allowing US firms to reorganise themselves while continuing their operations.

Potential liabilities from wildfires have crippled the firm. Under California’s inverse condemnation regime, it is liable for fires ignited by its equipment, such as power lines, whether or not its behaviour was negligent. It estimates it could be held liable for more than $30bn based on losses currently documented.

Seven of the top 20 most destructive wildfires on record in the state have occurred in the past 18 months, according to Aon. PG&E may be found liable for the most recent and worst of these, Camp Fire.

The fires appear to be getting worse due to climate change, more houses and worse vegetation control.

The fate of company may now hinge on the support offered by regulators and politicians, financial or otherwise. But they have questioned its corporate governance and safety culture, while an investigation by the California Public Utility Commission could see it converted into a non-profit firm.

Meanwhile, it is not clear what scope PG&E will have to use a legal tool allowing it to pay off liabilities from issuing bonds paid for by or securitised with money from ratepayers.

When assessing firms’ risk to climate change, PG&E’s story is unique. Every type of peril is exceptional in cause and effect, and wildfires are no different. California’s inverse condemnation rule adds a particular twist to this case.

But it does shine a light on the broader topic of how firms should try to report their risks to climate and weather hazards, and how much certainty they can even give.

That much of a surprise?

PG&E’s exposure to fire liabilities was predictable, but unquantifiable. It devoted plenty of ink to discussing the risks of wildfires in its 2016 annual report, before the start of the sequence of events now threatening to topple it.

It warned that liability standards, recent losses recorded from insurance firms and the risk of more fires could hinder its ability to take out enough insurance coverage on the terms it benefitted from at that time.

“If the amount of insurance is insufficient or otherwise unavailable, or if the utility is unable to recover in rates the costs of any uninsured losses, PG&E Corporation’s and the utility’s financial condition, results of operations, or cash flows could be materially affected,” it said.

But investors clearly did not give this too much significance, judging by where its securities were valued at that time and where they are now.

Its share price dropped from the $61 level to the $45 area over 2017 as liability concerns emerged. Then it took another hike down between November 2 and November 16 this year, from $47 to $24, thanks to the latest wildfire activity.

By the end of Monday, its shares were worth just $8.

And its 6.05% March 2034 bond was seen on Tuesday at 528bp over Treasuries, from 113bp at the beginning of last year.

A catastrophe bond the firm used to give it insurance coverage after the 2017 fires also collapsed in value to close to zero.

It is not just investors who were surprised.

“After several years with multiple safety and governance issues, PG&E has been free of any major incidents for the past eighteen months,” Moody’s said in July 2017, the month when the company was upgraded to A3.

The ratings agency now gives PG&E a rating of B2, with potential for downgrade.

Management disconnect

How are other companies faring in reporting risk, and do their efforts even amount to anything?

The European Bank for Reconstruction and Development warned last year that certain industries have a high degree of sensitivity to at least a handful of climate hazards, when considering both weather events and longer-term changes.

This is particularly the case for: vehicle manufacturing; consumer durables and clothing; food, beverages and tobacco; energy; industrial products; materials; and utilities.

But it is very hard to get a grip on the effect of the hazards with any precision.

S&P outlined in a report last June how few companies actually disclose an effect on earnings from weather events. In the financial year 2017, only 15% of S&P 500 companies did.

Among the 18 companies that went as far as to quantify the impact, not just disclose it, the weather events affected earnings by 6%, hardly trifling.

And the way in which firms transmit information is bizarre, further frustrating any attempt to measure the effect of weather events in a more systematic way.

In the financial year 2017, 86% of all disclosures of climate-related impact on earnings came from the CEO or the CFO, S&P found. And 87% of mentions of climate risk factors came from the transcripts of quarterly earning calls, rather than from more formal (and searchable) reporting methods.

It is hard to disagree with Greg Lowe, global head of resilience and sustainability at Aon, when he says that the S&P figures demonstrate “a disconnect between the management of climate risk and a broader risk management strategy”.

Just the start?

Better disclosure is what the Task Force on Climate-related Financial Disclosures (TCFD) calls for. Disclosure is not the aim in itself here, of course. The Task Force hopes disclosure of this kind will put pressure on firms and society more broadly to reduce carbon emissions.

Are investors interested in the effect of weather on earnings? Equity analysts asked the most weather questions of the consumer sector, followed by the industrials sector, according to S&P. It was less of a priority in other areas. But the trend appears to be towards greater interest, whether for ethical or financial reasons.

But however firms disclose the risk, it may be the case that the impact of the climate crisis will be incredibly difficult to predict.

Even if we know extreme events will become more frequent, no-one has devised a model to predict exactly when and where they will strike and how big they will be. Longer-term trends may be easier to calculate, but depend on just how much humans change their behaviour in the coming years.

When it comes to the climate shocking the market, PG&E may be part of a new pattern.

By Jasper Cox
15 Jan 2019