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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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Texas Wildfires Underscore Increasing Risk for Utilities

  • Warren Buffett’s fretted, in his annual report, that wildfires threatened his electric utility investments.
  • the Smokehouse fire in the Texas Panhandle has burned over a million acres of brush and timber in the heart of cattle country.
  • Business and financial risks in the utility industry seem to be rising dramatically due to climate change.

Warren Buffett fretted, in his annual report, that wildfires threatened his electric utility investments. He specifically cited the stock price carnage experienced by two US utilities, Pacific Gas & Electric and Hawaiian Electric, as the basis for his concern. Barely a week later,  the Smokehouse fire in the Texas Panhandle has burned over a million acres of brush and timber in the heart of cattle country. This time it is Minneapolis-based Xcel Energy and its utility subsidiary, Southwestern Public Service that is at risk. The company filed an 8-k with the US Securities and Exchange Commission on February 29 stating that a lawsuit had been filed in Texas blaming the utility's inadequate pole maintenance practices as being the cause of the wildfires. Shares of Xcel Energy have declined about 20% in response thus far.  The legal firm representing the aggrieved homeowner outside of Amarillo previously secured the $13.5 billion wildfire-related settlement against PG&E. The financial stakes here are not small.

Will Xcel ultimately be driven into bankruptcy by overwhelming legal claims resulting from wildfires? Frankly, at this point we have no idea. But we can make a few observations about changing business and financial risks in the utility industry which seem to be rising dramatically due to climate change. First, there are still three main pieces of our electric grid—generation, transmission, and distribution. For investor-owned utilities, the generation business has been partially deregulated and faces increasing competition from renewables. But the regulated transmission and distribution businesses, still monopolies, have been regarded as relatively low risk, relatively decent return business. A kind of financial rock. And this spurred a wave of corporate mergers producing the likes of Xcel Energy with regional headquarters in Minneapolis, Denver, and Amarillo. But if proximity to forests and brush is the new source of bankruptcy risk, then every single non urban utility in the US is at some elevated risk. Fairly soon the rating agencies may have to weigh in on this as well. These wildfire-lawsuit sagas are the new normal for the industry that the Xcel exposure in the Texas Panhandle merely underscores. The only question is how many wildfires and bankruptcy-threatening lawsuits have to happen before the industry revalues, presumably lower. Related: How To Profit From Europe’s $800 Billion Energy Crisis

Mr Buffett probably saw it clearly and that’s why he wrote somewhat obliquely about the looming threat of government ownership of the utility, which is the norm in his home state of Nebraska. Perhaps he sees this as the inevitable future for investor-owned utilities. We believe he was writing unhappily about his own electric utilities as an insurance problem that even he couldn’t solve and was now stuck with. What we believe he was suggesting is that the wildfire-litigation-bankruptcy route inevitably leads to public ownership once there is no privately held corporation left to bankrupt. The best we can say is it’s a very unstable business model.  And this heightened risk exposure now has to be viewed as nationwide.

All we can conclude at this point, regardless of whether or not Xcel Energy’s shares continue to succumb to potential wildfire liabilities, is that the risk profile of the regulated utility T&D businesses has increased dramatically. In other businesses, this typically means higher financial returns to offset higher business risks. But it might be different this time for utilities. Why? Because, as Mr. Buffett pointed out in his recent shareholder letter, extreme situations in the past have led to alternatives like public ownership.

By Leonard Hyman and William Tilles for Oilprice.com

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