Fixed Income Market Watch News

How To Start Fires and Force Customers To Pay For Them

Reuters released another market bomb this morning. PG&E (PCG*) is getting closer to filing for bankruptcy protection. In case you hadn’t heard, PG&E is the company largely to blame for California’s Camp wildfire in 2018 …and the wildfires in 2017. It all because of sparking, under-maintained utility lines. We’ll also throw out there that they’ve also been found guilty of causing disasters in 2010, 1997, and 1994 to name a few. California is already one big tinderbox when it doesn’t rain and that does certainly cause a problem. But a fairly simple issue to address is when a utility company has a long track record of not trimming back growth from their lines. Multiple years in a row citizens have reported seeing their utility lines throwing off sparks hours before the fires started. In the past, the company has gotten away with tap on the nose and a multi-million dollar fine. Reason? They supply power to almost half of California.

California isn’t a right to choose state. Depending on where you live, you pretty much have to go with the one company that supplies power to your area. So it’s pretty easy to understand the big, black pickle that arises for the state when things like burning city-sized chunks of land and killing people happen. You can’t just shut down the only company that provides power to your citizens. Even if you you’re considering charging the company with murder and manslaughter.

The company was already on the line financially for it’s involvement in the 2017 wildfires, and with the new liabilities added in they’re looking at about $30 billion in total. The problem is that, as of today, the company is only valued at about $9.83 billion (shares dropped 22.34% today). They already maxed out their credit back in November. They also used another new lifeline last year; bonds they were allowed to issue because of a new Governor endorsed bill. Then in December, they requested that the state allow them to pass on a rate hike to their customers to the tune of $2 billion dollars.

The next logical step is bankruptcy, which they say they are “trying to avoid”. Filing for bankruptcy will allow them to evaluate their options while being shielded from liabilities. One option being considered is selling off their gas business to help finance paying off death and injury charges. The other is to issue more of those bonds used in 2017.

For the new guys, a bond is basically an IOU with interest. If you need money for a project, you borrow the money from investors by selling bonds and pay interest on the loan until you can give the entire amount back. In 2017, as an emergency measure, the governor of California signed a bill saying that PG&E could issue bonds (financed by customers) to allow the company to secure money to pay off their liabilities. Obviously, the state couldn’t allow the company to just go under. Signing this bill was viewed as a way to settle the matter for good. We know this because the bill didn’t say anything about allowing them to issue bonds in 2018 or going forward. But that’s exactly what PG&E was hoping to get approval for when they asked for the customer rate hike back in December (decision still pending)

The 2017 bonds were a pretty nice little proposition for investors. They get to invest in a bond where the only real risk is if citizens decide they don’t need to have their electricity turned on anymore. PG&E gets the loan, and the investors get the interest paid from surcharges levied on customers that can’t use any other company. As of today, with liabilities stacking and bankruptcy looming, the bonds outstanding are all over the place in value from the low 70’s to low 90’s. All bonds traded today are at least 8% below par value (which means they’re selling at a discount). Bond investor’s (which some view as the “smart money”) don’t seem to know what to expect. This is getting into fairly unprecedented territory.

With stock shareholders (PCG), their sentiment is a bit more obvious. The stock tanked over 22% today when the news was released. However, we’ve already seen once in the last few months what happens when the state even talks about stepping in to help these guys out. From November 8th to November 15th, 2018 the stock crashed from $48.80 to $17.26 as news about liabilities kept rolling in and people found out that the company’s credit was maxed out. Then, after market close on November 15th, Michael Picker (the head of the California Public Utilities Commission) reportedly said he “could not imagine letting PG&E go bankrupt as it faces billions of dollars in potential liability from the wildfires ravaging California.” The stock surged 37.5% overnight.

Utility companies, like PG&E are historically a great “defensive” play. Meaning that when the markets get shaky, people switch to stocks that they think can weather the storm and aren’t as susceptible to a crash. The protection offered from utility stocks is two fold: 1. Nobody will ever stop needing water and electricity. 2. They usually pay pretty high dividends (PCG paid dividends as late as October 2017) With a company like PG&E, the protection is even greater since they’re the only utility available in most of the areas they serve. “Sales” are essentially guaranteed. That explains why even after the fallout of 2017, hedge funds and institutions still held an enormous amount of shares of the utility company. In the third quarter of 2018 alone, Seth Klarman (a market deity) of Baupost Group loaded up on almost 14.5 million shares. After the November stock crash, some companies even decided to go even bigger or go broke. In a December letter to shareholders, BlueMountain Capital Management ($21 billion AUM) included a chart predicting insured losses for the two fires to be $11.7 billion total. They also wrote that the likelihood of back-to-back years of fires of Camp and Tubbs’ magnitude “was approximately 1 in 150.”

Our lesson is this…

You may see opportunity in these events to make money on things going up or down, but you don’t have to have money to be informed.  Right now, millions of Californians are footing the bill for a company that has habitually proven themselves to be irresponsible. Not only are customers paying the company, they’re paying investors interest for the negligence of their only electricity provider. You may agree or disagree with how the state is handling this issue, but when we say that learning this stuff can change how you vote this is exactly what we’re talking about.

According to the 9/30/18 13-F filings, the number of PCG shares owned by hedge funds went up 40.94% in the quarter between June and September 2018. The number of hedge funds that owned PCG shares went from 20 to 87. The Camp fire started November 8, 2018. There were 86 fatalities and over 18,804 structures destroyed.

Further Reading:

Exclusive: California utility PG&E explores bankruptcy filing – sources (Reuters)

PG&E stock tumbles 21% on bankruptcy concerns (CNN)

PG&E shares tumble after bankruptcy reports (FT)

After California fires, PG&E proposes raising electricity bills to bolster precautions (CNN)

PG&E Power Line Near California Wildfire Had Damage (WSJ)

Insurance companies sue PG&E over California wildfire damages (MW)

Blue Mountain has doubled down on PG&E since the wildfires (BI Prime)

Gov. Jerry Brown signs wildfire safety bill slammed as PG&E bailout (Mercury News)

*PCG is the stock symbol for PG&E
**Apx. 16 million customers vs California population of 39.54 million in 2017