In recent years, California experienced a surge in wildfires that have become more frequent and more extreme, a trend attributed to the effects of climate change. In California, electric utilities are liable for damages caused by wildfires started by the company’s equipment under the principle of inverse condemnation, even if the company has not been negligent. The application of inverse condemnation to the large wildfires in 2017 and 2018 resulted in large wildfire related costs to the utilities, with the largest California utility PG&E filing for bankruptcy in early 2019.

NERA was engaged by institutional investors in PG&E to assess the implications of wildfire risk on the cost of equity of PG&E and other California utilities. NERA’s team consisted of Senior Managing Director Richard Hern, Director Zuzana Janeckova, and Senior Consultant Jim Yin. NERA was asked to present an independent report to be submitted to the California Public Utilities Commission (CPUC) as part of PG&E’s application for re-setting prices in 2020.

NERA showed there was substantial evidence from financial markets data that equity and debt investors were pricing additional risks in their valuations of securities issued by California utilities relative to their non-California counterparts, warranting the inclusion of a risk premium in the cost of equity for California utilities. NERA quantified the magnitude of the risk premium using a range of approaches, including a modification to the standard discounted cash flow (DCF) model used in US rate setting, as well as novel approaches that derive a risk premium based on evidence from prices of financial options and debt instruments.

Dr Hern provided oral testimony of NERA’s work at CPUC hearings in San Francisco in September 2019.