Is the Regulatory Compact Underpinning California’s Electric Grid At Risk?

The U.S. National Academy of Engineering has named construction of the vast U.S. electric power grid the 20th century’s most important achievement. From huge hydroelectric projects and massive generation facilities capable of powering large cities, to transmission lines climbing over mountain ranges and individualized distribution lines delivering electricity to nearly every single American household and factory floor, the grid epitomizes the promise of creative cooperation of people and organizations with different interests over decades. It is unlikely to have succeeded if not for a “regulatory compact” that today is unfortunately at risk.

The relationship, this regulatory compact, between regulators and utilities is an agreement whereby government grants exclusive service territories, a local monopoly, while managing rates in a manner that provides an opportunity for a reasonable return on investment. In exchange, utilities submit their operations to full review and regulation. While this is not a single signed contract, it is the rule of the road between regulator and utility, and importantly, for the investment community which serves as the source of capital to finance this vast undertaking. The investment community is of course quite diverse, ranging from Wall Street heavy hitters to schoolteachers and public service retirees who collect a pension. The latter depend on the regular payment of dividends and stability of stock price, long and historically the hallmark of utility stock.

Today, as California embarks on an ambitious program to replace traditional generation with renewables, and replace essentially all fuel consumption with electricity, they will need the active involvement of the investment community. The cost of this transition is in excess of $3 trillion with perhaps 60% representing transmission and requisite storage to manage the renewables’ intermittency of output. The regulatory compact will need to be strengthened, not weakened, if this effort has any chance, but the recent actions of Pacific Gas and Electric (PG&E) are working counter to this effort.

The dominant utility in northern California, PG&E is responsible for the majority of transmission and distribution in the area and maintains a virtual monopoly over such. But while it is still subject to regulation, PG&E’s behavior and corporate decisions coupled with deficient oversight by the California Public Utilities Commission (PUC) led to a series of devastating wildfires in the late 2010s that destroyed more than 23,000 homes and businesses, killed more than 100 people, and sent the company into Chapter 11 bankruptcy.

Yet while PG&E has paid more than $25.5 billion in restitution to communities affected by wildfires and to the utility’s hedge fund creditors – largely using ratepayer taxes from the California Wildfire Fund – the company and its leadership have done nothing to compensate equity investors who were harmed by the negligent activity of management. Public pension funds, including those representing first responders and schoolteachers were some of those heavily affected by this failure and have been denied relief in PG&E’s Bankruptcy by this serious oversight. 

As a result, a lawsuit seeking compensation has been filed that among other things asserts that the company’s executives and directors failed to update critically failing infrastructure which led to the wildfires and shareholder losses, and that the company was not transparent and was not engaging in proper reporting and keeping investors properly informed about ongoing operational risks. The fact of the matter is when these public pension funds invested in PG&E a contract was entered into where public pensions investing in PG&E expecting a reasonable rate of return that may have lagged the broader market but would be stable and predictable. Negligence that led to wildfires violated this contract and has left these investors with heavy losses and should not be allowed to stand. 

Holding leaders at PG&E, as well as the PUC, to account for the actions that led to these failures will also be critical to ensure such incidents don’t happen again and to ensure that California can continue to move its power grid forward with access to investor capital under favorable terms. The green transition that the PUC and many leaders in Sacramento are pushing will take money from outside investors as taxpayers can’t foot the bill alone. But if these investors are not compensated for their losses due to negligence it will be increasingly difficult in the future to secure outside funding. The alternative could be the continued ageing and degradation of our critical grid or paying extra for our transition to a ‘clean grid.’

Taking all of this into account, California’s policy makers must make sure PG&E and the PUC are acting in a responsible manner and that all parties affected by this failure of leadership receive restitution. Not only will it help them achieve their objectives of incorporating more renewable energy into the grid, but it is also the right thing to do to ensure that first responders are taken care of in retirement through financially sound pension funds.