Maui Fires: A Lesson For Utility Companies?
In July, the big insurance companies raised prices roughly 50% on a worldwide basis, a reaction to the huge claims they had to pay recently. Not many people seemed to have noticed, at first. But insurance companies can’t operate without the backstop and off-loading of risk provided by the reinsurance companies. So expect the price of insurance policies to rise if not being canceled altogether.
In August, deadly wildfires spread over the Hawaiian island of Maui. More than 100 people died. Did the actions or inactions of the local electric company contribute to the disaster? Had it invested enough to protect the grid? Had its operators made the right decisions to de-energize fire spreading transmission lines during the fire? What would internal documents show? Hawaiian Electric’s stock tanked 70% ($3 billion of wealth erased) as analysts opined on how much the company might have to ultimately pay out in damages to fire victims and their next of kin. The County of Maui filed a case against the utility, arguing that it made serious operational errors that contributed to the disaster.
Property damage caused by the fire has been estimated in the $4-6 billion range. One analyst said the total damages to the economy were $14-16 billion. Hawaiian Electric’s enterprise value (the market value of its outstanding stock and bonds) at the end of 2022 was $8 billion but now is only $5 billion. If the courts find the utility responsible for damages, and the insurance carriers resist paying reimbursement, and if the regulators do not permit the utility to pass on the cost of damages to its consumers—a successful lawsuit could wipe out the utility’s shareholders, likely triggering a chapter 11 filing for bankruptcy. A lot of ifs, you could say. From a financial and legal perspective it appears that investors are assuming a California type scenario where wildfire claims ultimately bankrupted Pacific Gas & Electric.
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The Maui suit might set a precedent. Plaintiffs could claim, in future cases after grid failures, that utilities should have planned and prepared better, given that climate related disasters were first predicted two decades ago. And that utility managers should have operated differently considering the new circumstances. They had the information and they had plenty of time to adjust. In other words, they knew. Of course, taking preventive steps would cost money which would require regulatory approval. So what did the regulators know, and is that relevant in a lawsuit for damages? The discovery process in any lawsuit will, no doubt, provide answers to those questions and also indicate whether regulators were too cozy with the utilities or just plain asleep at the switch. Neither alternative should provide much comfort to investors or customers of the utility.
Lawsuits against corporations, accompanied by evidence that the malefactors knew, led on the public, or just lied to them, have resulted in large financial settlements. U.S. tobacco companies several decades ago sponsored TV ads with actors in white coats, claiming that something like seven out of ten physicians recommended brand x cigarettes. The industry set up the Tobacco Institute, as a mouthpiece (smoking doesn’t cause cancer but people who like to smoke may be predisposed to cancer was one of its arguments) and evidence showed that the tobacco companies adjusted the nicotine content in cigarettes to encourage greater addiction. Ultimately, following multiple state lawsuits, the tobacco companies agreed to a $366 billion settlement to cover the damage they did to public health.
More recently, producers of opiates, accused of pushing the drugs and encouraging addiction, agreed to a settlement in excess of $50 billion. Meanwhile, Johnson & Johnson is entangled in a lawsuit over the carcinogenic qualities of talcum powder that could lead to almost $9 billion of payments, while 3M Corporation has agreed to a $10 billion settlement for damages caused by the “forever“ chemicals it manufactured. Similarly, German drug company Bayer, has settled $11 billion worth of suits thus far involving harm caused by an agricultural chemical it manufactured. Our point here is that these settlement numbers are quite large and investors in the shares of Hawaiian Electric do not appear to be over-reacting in driving the stock price lower.
The numerous expected lawsuits targeting Hawaiian Electric may center on what the company did or did not do at the time of the fires—the immediate cause of the disaster. If we were in the fossil fuel business, we would be concerned that the next batch of lawsuits might look different. This time the public might seek compensation for harm due to climate change largely caused by the burning of fossil fuels. Now that the effects of global warming have arrived so dramatically it will be harder to claim with a straight face that the science is in doubt, especially since CO2’s role as a heat trapping gas has been known to science for over a century. Imagine what a group of state attorneys general might do if they thought a huge tobacco industry type settlement was possible. It would mean possibly hundreds of billions of dollars flowing into state coffers after winning such a lawsuit. That’s a powerful incentive to sue. Forget about AI or crypto. Environmental litigation looks like the growth industry of the future.
A while ago, we advocated that oil and gas companies pay out all the cash they can to investors in order to keep it out of the hands of the litigation lawyers who surely will show up, salivating at the possibility of multibillion dollar payouts. (Lawsuits of this type are already proceeding in Europe.) That would mean spending less on drilling and exploration and not making green investments either because even those assets might end up in the hands of the lawyers as well.
We also pointed out that reinvestment in the oil business over the past decade yielded astonishingly bad returns for investors, anyway. Well, last year, the oil companies, according to Bloomberg, returned more money to investors (via stock buybacks and dividends) than they spent on capital expenditures. Oil companies, after all, don’t have to invest. They can draw capital out of the business through a combination of high shareholder payouts (dividends and stock buybacks) and low capital spending. For whatever reason, that’s what they did last year.
Electric utilities, on the other hand, do not have spare cash that they can move out of the reach of litigants. For more than a decade they have had to raise outside capital to meet spending requirements and pay generous dividends. Given that electric utilities are smaller than oil companies, lack free cash flow, and usually serve one locality, they make less tempting targets for litigation. Or so we would have thought. Fewer states have an incentive to go after the utility, there’s less cash to grab, and lower likely damages per lawsuit.
But when the utility’s transmission lines go down causing fires, or the grid is egregiously unprepared for weather conditions, and people incur large economic losses or even die, this question arises: in light of the decade or more of changed circumstances and warnings, should the utility have been better prepared and taken more comprehensive steps than it did? Up until now, most utility outages did not lead to significant penalties for the utility. “Act of God”, the regulators traditionally said and passed all the clean up and rebuild costs on to consumers. At some point, though, some plaintiffs will argue that the utility’s senior managers should have known about fire risk, should have been prepared better, and should have had operational procedures in place to meet the new evolving situation. And pointing to specific managerial steps taken or not taken to cope with specific threats might make an easier case than a global assault based on the causes and consequences of climate change.
Equity investors who bought stock in the wholesome makers of the world’s favorite talcum powder or transparent tape never expected those potentially crippling lawsuits. Certainly, few investors at present think of their local electric company, with its protected regulatory status, as a likely target for lawsuits. They may be wrong.
By Leonard Hyman and William Tilles for Oilprice.com
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