INFRASTRUCTURE AND PROJECT FINANCE

SECTOR COMMENT Regulated electric utilities – US

10 July 2019
Proposed California wildfire risk legislation
is credit positive but questions remain
On Monday, the California Senate passed, with the required supermajority, Assembly Bill
1054 (AB 1054), which includes measures to mitigate wildfire risks facing the state's investor-
owned utilities (IOUs). The bill, which has the backing of Governor Gavin Newsom, still
Analyst Contacts
requires a two-thirds supermajority to pass the state Assembly which could happen by July
Natividad Martel, +1.212.553.4561 12 before the legislature's summer recess. This is the deadline set by Newsom for the passage
CFA
VP-Senior Analyst of new wildfire legislation.
natividad.martel@moodys.com
AB 1054 proposes the establishment of a wildfire fund to provide IOUs with an immediate
Jeffrey F. Cassella +1.212.553.1665
source of liquidity to cover future wildfire damage claims and support financial stability
VP-Sr Credit Officer
jeffrey.cassella@moodys.com of IOUs during times of crisis. Implementation of AB 1054 will also require the passage of
Assembly Bill 111 (AB 111) and Senate Bill 111 (SB 111), two identical trailer bills that would
Toby Shea +1.212.553.1779
VP-Sr Credit Officer create new wildfire-related agencies, including the California Catastrophe Response Council,
toby.shea@moodys.com which would appoint and oversee the administrator of the wildfire fund. In addition, the
Michael G. Haggarty +1.212.553.7172 passage of Assembly Bill 110 (AB 110) and Senate Bill 110 (SB 110), also two identical trailer
Associate Managing Director bills, would increase the state’s 2019-20 fiscal budget by $2 billion to implement measures
michael.haggarty@moodys.com related to catastrophic wildfires.
Jim Hempstead +1.212.553.4318
MD-Utilities The proposed creation of a wildfire fund is credit positive for Southern California Edison
james.hempstead@moodys.com Company (SCE, Baa2 negative) and San Diego Gas & Electric Company (SDG&E, Baa1
negative) because it would provide the two utilities with immediate liquidity to cover
CLIENT SERVICES any potential future damages caused by a wildfire ignited by IOU equipment when the
Americas 1-212-553-1653 damages exceed the greater of the utility's insurance coverage or $1 billion annually. Utilities
Asia Pacific 852-3551-3077 would have access to the funds before the California Public Utilities Commission (CPUC)
makes a final determination regarding the recovery of costs. But how much relief the fund
Japan 81-3-5408-4100
provides will depend on which of two options SCE and SDG&E both choose to implement: a
EMEA 44-20-7772-5454
liquidity fund or an insurance-like fund. Under the proposed legislation, Pacific Gas & Electric
Company (PG&E, ratings withdrawn) could also have access to the fund if it meets certain
conditions.

Although the bills do not attempt to reform or eliminate the state's application of inverse
condemnation, we believe that the legislation could substantially improve the IOUs' ability
to recover wildfire-related costs. From a credit perspective, the insurance-like fund option
would be superior to the liquidity-fund option due to 1) its larger size initially; 2) the cap
that it would impose on IOU shareholders' liabilities; and 3) the ability of the CPUC to
apply reasonableness standards similarly applied by Federal Energy Regulatory Commission
(FERC) when determining an IOU’s request for recovery of wildfire-related costs. But the
extent of the benefits of the revised standards will depend on how the revised standards are
 MOODY'S INVESTORS SERVICE INFRASTRUCTURE AND PROJECT FINANCE

implemented. By contrast, the only advantage of the liquidity-fund option is that it would be subject to replenishment through new
charges on ratepayers if the utility is deemed to have acted prudently.

Two options for establishment of wildfire fund

Within 15 days of the enactment of the legislation, SCE and SDG&E would have to both decide whether the wildfire fund should be
established as a liquidity fund or an insurance-like fund. The administrator of the wildfire fund would be responsible for establishing
procedures to reimburse wildfire-related claims within 45 days, if practicable, after it approves any settlement. It will also present
to the appropriate policy committees of the legislature an annual plan of operations that includes projections for the durability and
success of the wildfire fund. The administrator would be appointed and overseen by the California Catastrophe Response Council,
which will consist of nine members, including the governor.

Liquidity fund option

If SCE and SDG&E opt for a liquidity fund, the fund will be initially capitalized by a loan of up to $10.5 billion from the state’s Surplus
Money Investment Fund with an initial transfer of at least $2 billion in the 2019-20 fiscal year. Upon the California Department of
Water Resources' (CA DWR) repayment of its remaining power supply system revenue bonds (CA DWR [Power], Aa1 stable), which is
expected by September 2020, CA DWR would issue new bonds for up to $10.5 billion all at once or in tranches. The proceeds would be
used initially to repay the Surplus Money Investment Fund and, thereafter, to finance the liquidity fund.

Similar to the current revenue bonds, the new bonds would be secured by non-bypassable bond charges to be collected until January
1, 2036, subject to CPUC’s rulemaking proceeding before year-end 2019. We understand that the new bonds' aggregate annual debt
service will be similar to the amount currently due on the outstanding CA DWR (Power) bonds of about $900 million. The current
charge collected from nearly 12 million retail customers is about 0.5 cents-per-kilowatt-hour.

We understand that if PG&E fails to emerge from Chapter 11 by June 30, 2020, the CA DWR charge would not be imposed on PG&E’s
customers and the total amount collected by the state's ratepayers would be reduced by that amount. The purpose of the deadline
imposed on PG&E is, in part, to incentivize PG&E's emergence from bankruptcy to minimize potential claims from new wildfires that
could affect 2017 and 2018 wildfire claims.

Insurance-like fund option

If SCE and SDG&E both opt for an insurance-like fund, they would make direct contributions to supplement the initial balance of the
wildfire fund created in the same manner as the liquidity fund described above. Under this option, the two IOUs would have to make
an initial contribution equal to 71.4% of their respective share of the fund, with the remaining 28.6% to be contributed in equal annual
installments over a 10-year period. Utilities must have a valid wildfire safety certification from the CPUC and meet other conditions to
be eligible to access the fund.

PG&E can also choose to participate in this fund if SCE and SDG&E choose to create it. To do so, PG&E would be required to notify
the CPUC of its decision to participate within 15 days after the enactment of AB 1054, and obtain approval from the bankruptcy
court to meet the initial contribution requirements within 60 days of enactment. However, if PG&E experiences a wildfire event while
in bankruptcy, the fund shall not pay more than 40% of the allowed claims. The remaining balance of the wildfire claims would be
addressed through the bankruptcy proceeding.

If PG&E elects to participate, the final size of the initial fund could ultimately double to about $21 billion. If PG&E does not participate,
we estimate that the aggregate size of the fund would only be about $9.5 billion. If PG&E chooses to participate in the insurance-like
fund option, AB 1054 estimates that the utility must contribute 64.2% of the total, with SCE and SDG&E required to contribute 31.5%
and 4.3%, respectively. The allocation would be based on the proportion of the IOUs’ total service territory located in high fire-threat
districts as well as the number of miles of transmission and distribution lines in high fire-threat districts, including adjustments for fire-
risk mitigation efforts.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.

2 10 July 2019 Regulated electric utilities – US: Proposed California wildfire risk legislation is credit positive but questions remain
 MOODY'S INVESTORS SERVICE INFRASTRUCTURE AND PROJECT FINANCE

In addition to the potentially larger size of the fund, this option also includes other features that enhance its appeal from a credit
perspective.

Shareholders’ liability capped if the utility is found to have not acted prudently: The liability is capped at the lesser amount of
the wildfire related cost disallowed for recovery by the CPUC or 20% of the IOU’s transmission and distribution equity rate base over
any rolling three-year period. The ability to quantify and limit an IOU’s maximum liability from a wildfire event is critically important to
credit quality. We estimate that the maximum cap would currently be around $2.7 billion for SCE and PG&E and around $800 million
for SDG&E.

However, the shareholders’ liability cap would not apply if one of the following occurs:

» The insurance-like fund is fully depleted. Unlike the liquidity-only option, the insurance-like fund option would not be subject to
replenishment through new charges on ratepayers even if the utility is deemed to have acted prudently.

» The wildfire fund administrator determines that the utility’s actions in connection with the wildfire constituted conscious or willful
disregard of the rights and safety of others.

» The IOU fails to maintain a valid wildfire safety certification. To attain the initial safety certification, a utility would be required to
meet certain conditions that would include 1) having an approved wildfire mitigation plan; 2) being in good standing (for example, if
the IOU agrees to implement the findings of its most recent safety culture assessment); 3) having a board safety committee; and 4)
having a director-level official reporting to the CPUC on safety issues. If a utility satisfies these key conditions, the CPUC executive
director will issue an annual safety certification within 30 days of receiving the IOU’s request. The ability of the IOUs to meet these
conditions quickly will be key to assessing whether the utilities will remain exposed to heightened financial risk during the 2019
wildfire season, a material credit consideration. Additional conditions apply for annual re-certification.

Improved cost recovery standard, including changes to IOU prudency standards: If an IOU has received a valid safety
certification, it would be presumed to have acted reasonably during a wildfire-linked event, and the burden of proof to deny recovery of
wildfire related costs would shift from the IOUs (as is the case under current law) to the intervenors opposing the recovery. Intervenors
would be required to create serious doubt as to the reasonableness of the utility’s conduct. We understand that this revised prudency
standard is in line with the recovery standards applied by FERC.

Under AB 1054, the CPUC would consider wildfire costs to be just and reasonable if the utility’s conduct, as it relates to the wildfire
ignition, was consistent with the actions that a reasonable utility would have undertaken in good faith under similar circumstances
and based on the information available at the relevant point in time. AB 1054 also establishes that reasonable conduct would
encompass a spectrum of possible practices, methods, or acts consistent with a utility system's needs, the interest of ratepayers, and
the requirements of governmental agencies of competent jurisdiction. As was already defined under SB 901, which was enacted in
September 2018, AB 1054 also instructs the CPUC to take into account factors that were beyond the utility’s control (e.g. humidity,
temperature, and winds) when allocating the recovery of wildfire costs in full or in part.

Theoretically, the presumption of reasonableness after attaining the safety certification could mitigate some of the strict liability risk
that is inherently assumed by the IOU under inverse condemnation, an improvement compared to the utilities’ current situation.
However, AB 1054 also states that the IOU will have the burden of dispelling any serious doubt raised as to the reasonableness of
its conduct that a party may assert, which creates some uncertainty around the application of the new requirements, and the IOU’s
ultimate ability to recover wildfire related costs.

Settlements of subrogation claims are subject to the fund administrator’s approval: Under AB 1054, the fund administrator
may approve the utility’s settlement of subrogation claims (i.e., insured claims) when the settled payout ratio exceeds 40% of the
total asserted claim if it also includes a full release of the balance of the asserted claim. The absence of a clear legal limit to a utility’s
exposure to subrogation claims, as it is currently the case, is less credit supportive.

We understand that these claims typically account for at least 60%-70% of the total settled claims (which include insured and
uninsured claims), and that they are ultimately settled at about 40%-50% of their asserted values. The possibility of gaining quick

3 10 July 2019 Regulated electric utilities – US: Proposed California wildfire risk legislation is credit positive but questions remain
 MOODY'S INVESTORS SERVICE INFRASTRUCTURE AND PROJECT FINANCE

access to the liquidity provided under the insurance-like fund could incentivize insurance companies to consider settling their
subrogation claims at similar payout ratios.

The Wildfire Fund Durability Analysis prepared for the governor's office by Filsinger Energy Partners estimates that there is a high
probability that the insurance-like fund option will be enough to cover gross claims (i.e., before assumed 45% settled claims payout
ratio, insurance coverage, etc.) that average $8.5 billion a year for 10 years. This, in turn, could provide the California Legislature with
time to assess the effectiveness of the new legislation and to consider whether the more comprehensive initiatives to reduce wildfire-
related risks are successful, particularly in the service territories of PG&E and SCE, which have pursued less aggressive fire prevention
measures than SDG&E in the past.

4 10 July 2019 Regulated electric utilities – US: Proposed California wildfire risk legislation is credit positive but questions remain
 MOODY'S INVESTORS SERVICE INFRASTRUCTURE AND PROJECT FINANCE

Moody’s related publications

Sector Comments

» Electric utilities – US: Limiting utility liabilities looms large after release of SB 901 Commission draft report, June 2019

» Regulated electric utilities – US: California wildfire strike force report is credit positive, but details are still pending, April 2019

» P&C Insurance - US: PG&E's bankruptcy likely to lower lawsuit recoveries and generate liability losses, January 2019

» Power Generation Projects and Power Companies - US: PG&E bankruptcy contagion impacts selected commodity suppliers, January
2019

» P&C Insurance - US: PG&E bankruptcy announcement credit negative for US P&C insurers, January 2019

» Insurance - US: P&C insurers face large losses from devastating California wildfires, November 2018

» Cross-Sector California wildfires could create material contingent liabilities and credit challenges, December 2017

Sector In-Depth

» Electric and Gas Utilities - US: California utilities struggle with inverse condemnation exposure, April 2019

» Public power utilities - US: FAQ: California public power utilities are not immune to wildfire risks, April 2019

» Electric Utilities - US: Potential remedies to reduce California fire risk face competing interests, April 2019

» Infrastructure & Project Finance - US: PG&E PPA contracts: To reject or not reject, April 2019

» Regulated Utilities and Power - US: PG&E bankruptcy highlights environmental, social and governance risks in California, February
2019

» Regulated Electric and Gas Utilities - US: Climate-related disclosures by four major utilities vary in both depth and scope, December
2018

» Regulated utilities - US: Utility cost recovery through securitization is credit positive, July 2018

» Regulated Electric and Gas Utilities and Networks - Global: Prudent regulation key to mitigating risk, capturing opportunities of
decarbonization, November 2017

Issuer In-Depth

» Atlantica Yield plc: PG&E exposure via Mojave project is credit negative but mitigating factors will limit impact, May 2019

Credit Opinions

» San Diego Gas & Electric Company: Update following downgrade to Baa1 negative, March 2019

» Southern California Edison Company: Update following downgrade to Baa2 negative, March 2019

» PG&E Corporation: Update following rating downgrade, January 2019

Outlook

» Regulated utilities - US: 2019 outlook negative amid growing debt and stagnant cash flow, November 2018

5 10 July 2019 Regulated electric utilities – US: Proposed California wildfire risk legislation is credit positive but questions remain
 MOODY'S INVESTORS SERVICE INFRASTRUCTURE AND PROJECT FINANCE

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6 10 July 2019 Regulated electric utilities – US: Proposed California wildfire risk legislation is credit positive but questions remain