Climate Burning Utility Business Models

Good catch by Texas energy analyst Doug Lewin.

Berkshire Hathaway 2023 Annual Report:

Our second and even more severe earnings disappointment last year occurred at BHE. Most of its large electric-utility businesses, as well as its extensive gas pipelines, performed about as expected. But the regulatory climate in a few states has raised the specter of zero profitability or even bankruptcy (an actual outcome at California’s largest utility and a current threat in Hawaii). In such jurisdictions, it is difficult to project both earnings and asset values in what was once regarded as among the most stable industries in America.

For more than a century, electric utilities raised huge sums to finance their growth through a state-by-state promise of a fixed return on equity (sometimes with a small bonus for superior performance). With this approach, massive investments were made for capacity that would likely be required a few years down the road. That forward-looking regulation reflected the reality that utilities build generating and transmission assets that often take many years to construct. BHE’s extensive multi-state transmission project in the West was initiated in 2006 and remains some years from completion. Eventually, it will serve 10 states comprising 30% of the acreage in the continental United States.

With this model employed by both private and public-power systems, the lights stayed on, even if population growth or industrial demand exceeded expectations. The “margin of safety” approach seemed sensible to regulators, investors and the public. Now, the fixed-but-satisfactory- return pact has been broken in a few states, and investors are becoming apprehensive that such ruptures may spread. Climate change adds to their worries. Underground transmission may be required but who, a few decades ago, wanted to pay the staggering costs for such construction?

At Berkshire, we have made a best estimate for the amount of losses that have occurred. These costs arose from forest fires, whose frequency and intensity have increased – and will likely continue to increase – if convective storms become more frequent.

Doug Lewin – Texas Energy and Power Newsletter (email):

Here’s what happened to Hawaiian Electric Industries’ share price after last year’s devastating fires on Maui:

With the Smokehouse Creek fire still raging and only barely contained, Xcel is facing the possibility of a similar future. Last week, the company filed a report with the Securities and Exchange Commission (SEC) that said “insurance interests” told the company it faces “potential exposure for damages” from the fire; the company has been asked to preserve a downed utility pole “within the vicinity of the fire’s potential area of origin,” per the SEC filing.

Following the filing, Xcel’s stock dropped nearly 20%.

The situation is so risky, Buffett even wondered in his letter whether there will be a “confiscatory resolution to our present problems” and if “certain utilities might no longer attract the savings of American citizens and will be forced to adopt the public-power model.” 

That’s not idle speculation. Today’s investor-owned utilities obviously don’t want a “confiscatory resolution” in which a governmental entity would partly or entirely take over their operations. 

But if Buffett is raising the possibility, they ought to take it seriously. 

In this case, taking it seriously means taking real, meaningful actions — in the very short term — to adapt to climate change and keep it from getting worse. It means, among other things, lowering emissions, managing vegetation and preparing for disasters better, and helping customers to be more resilient with onsite solar power generation, storage, and reducing energy waste (which also lowers emissions).

That’s a lot, and all of it is necessary. If they do it, utilities can protect themselves and protect the current system. 

If they don’t, it’s becoming increasingly likely they won’t make it.

Climate change is real, and it’s changing our world in ways we are only beginning to comprehend.