To The Moon

California’s Wildfire Bill Turns PCG and EIX Back Into High-Risk Assets

One-line takeaway: Utility stocks may offer protection against the economic cycle, but they are not necessarily protected from wildfire liabilities, regulatory changes or the legal risks of a single state.

The biggest individual stock moves in the U.S. market on Monday did not come from the technology sector, but from traditionally “defensive” stocks.

• PG&E $PG&E Corp(PCG)$ fell 20.1%;

• Edison International $Edison(EIX)$ dropped 23.1%;

• Sempra $Sempra(SRE)$ declined 3.1%.

The trigger was a California wildfire bill. The final version did not include the utility liability protections that investors had expected, nor did it address the long-term funding of California’s Wildfire Fund. (MarketWatch)

1. What Was the Market Expecting?

California Governor Gavin Newsom had previously proposed limiting insurers’ ability to seek reimbursement from utility companies for wildfire losses after compensating residents.

Supporters argued that if insurers were allowed to continue seeking compensation from electric utilities, companies such as PCG and EIX could face enormous and unpredictable liabilities. The ultimate costs could then be passed back to consumers through higher electricity rates, increased financing costs and reduced investment in the power grid.

Opponents argued that the proposal would effectively transfer wildfire liabilities from utility companies and their shareholders to insurers, policyholders and ordinary residents.

After the dispute, the California Legislature did not adopt the most important part of Newsom’s liability relief proposal.

2. What Does SB 492 Address?

SB 492 focuses more heavily on protecting wildfire victims. Its measures include establishing a faster compensation process, restricting certain institutions from trading wildfire claims, and limiting bonuses for utility executives when their companies are responsible for severe wildfire incidents.

However, the bill did not fully answer the two questions that mattered most to investors:

1. It did not significantly reduce utilities’ potential wildfire liabilities;

2. It did not establish a long-term, automatic mechanism for replenishing the Wildfire Fund.

Mizuho said the legislation was more focused on protecting victims but offered no new protections for investors. The firm downgraded PCG, EIX and SRE from “Outperform” to “Neutral.” (S&P Global)

3. Why Do Utility Companies Face Such Significant Risks?

California applies a relatively strict wildfire liability regime.

If an investigation determines that electrical equipment caused a wildfire, a utility company may be required to bear part of the losses even if it has not been proven negligent in the traditional sense.

This means the financial condition of California utility companies depends on several factors at the same time:

• Whether transmission lines start a wildfire;

• Extreme weather and vegetation conditions;

• The scale of insurers’ recovery claims;

• Whether the Wildfire Fund has sufficient capital;

• Whether the state government changes its liability rules.

PG&E filed for bankruptcy in 2019 because of wildfire liabilities. That history has also made the market particularly sensitive to any new potential compensation obligations.

4. Why Is the Wildfire Fund So Important?

California’s Wildfire Fund was originally designed to cover part of the eligible compensation claims, providing utility companies with a financial buffer.

However, the fund is not an unlimited pool of capital.

PG&E previously warned in a regulatory filing that insufficient legislation could leave the company facing long-term financing constraints, greater financing needs and changes to its capital-allocation plans. The company could also reassess the estimated period over which the Wildfire Fund’s assets will be used. (SEC filing)

The market’s concern is that if another major wildfire occurs and the fund lacks a stable replenishment mechanism, losses exceeding the fund’s capacity could return to utility companies’ balance sheets.

5. Why Did PCG and EIX Fall More Than SRE?

Although all three companies are classified as California utility stocks, their risk exposures are different.

$PG&E Corp(PCG)$

Its business is highly concentrated in Northern California. It also has a history of bankruptcy caused by wildfire liabilities, making it particularly sensitive to liability rules and financing costs.

$Edison(EIX)$

Its subsidiary, Southern California Edison, serves Southern California. The company previously confirmed that losses related to the Eaton Fire were probable, although the final range of losses remained difficult to estimate.

$Sempra(SRE)$

Its business structure is more diversified. In addition to its California utility operations, it owns other energy infrastructure assets. As a result, its share-price decline was significantly smaller than those of PCG and EIX.

This also shows that companies carrying the same industry label do not necessarily face the same risks.

6. Can Utility ETFs Still Be Considered Defensive Assets?

$Utilities Select Sector SPDR Fund(XLU)$ and $Vanguard Utilities ETF(VPU)$ still offer relatively stable cash flows, dividends and low sensitivity to the economic cycle. However, this event reminds investors that:

The defensive nature of utility stocks mainly comes from regulated revenue. It does not mean that the sector is free from policy and disaster-related risks.

Compared with holding PCG or EIX individually, utility-sector ETFs can diversify the wildfire risks associated with a single company or state. However, if U.S. Treasury yields continue to rise, the entire utility sector could still come under pressure because of high debt levels and the declining relative appeal of dividends.

The utility sector is therefore affected by two categories of variables:

• Interest rates and bond yields;

• Regional regulation and disaster liabilities.

Tiger’s View

The fact that PCG and EIX lost around 20% in a single day shows that a “low-volatility industry” does not necessarily contain only “low-risk companies.”

For these stocks, I will be watching:

1. Whether Newsom signs SB 492 and pushes for supplementary legislation;

2. The size of California’s Wildfire Fund and its replenishment mechanism;

3. Whether PCG and EIX reduce capital expenditure or adjust their financing plans;

4. Whether analysts continue to lower their credit and earnings expectations;

5. Whether California’s autumn wildfire risk rises further.

The sharp short-term selloff may create a valuation-recovery trade. However, until the liability regime improves, PCG and EIX are closer to event-driven assets than straightforward high-dividend defensive stocks.

Would you consider California utility stocks after the selloff?

A. Buy the dip in PCG or EIX
B. Only consider utility ETFs such as XLU
C. Wait until the wildfire liability rules become clearer
D. Avoid utilities for now in a high-interest-rate environment

Sources: S&P Global | PG&E regulatory filing

This content is provided for market discussion only and does not constitute investment advice.