If you have read the news in the last few weeks, you’ll know that PG&E (a massive utility company that provides power to Californians) has indicated its intent to file for bankruptcy (technically, it had to give 15 days’ notice that it will file for bankruptcy).
The reason is that when a forest fire occurs due to a power line falling or equipment malfunctioning, it’s the utility company that is liable. Therefore, PG&E has a massive liability because it allegedly caused the recent forest fires in California, leading to the loss of life and property.
The motivation of PG&E’s decision to file is likely due to an uncertainty about how big that liability is. What’s interesting is that analysts and shareholders disagree about the magnitude of the liability — estimates range from a few billion up to $30 billion. This is the difference between a financial hiccup (I use that term loosely) or insolvency.
But one of the ideas we haven’t really seen is that securitization could be the answer.
Here’s how it would work in a few bullets, and below is more detail:
The utility company raises prices to consumers to cover its costs and liabilities.
Because it’s a regulated monopoly, the consumers (people of California) have to pay this extra amount.
Since there are so many of these consumers, and the extra amounts are mandatory, the cashflows essentially look the same as any other annuity stream, and PG&E could take those future cashflows, put them into a new legal entity, and securitize the cashflows to save itself.
What’s really interesting about all of this: while it may seem that PG&E could get away lucky, doing this ultimately saves money for the consumer relative to other options.
How it Works:
Utility tariff securitizations (a.k.a. rate reduction bonds or stranded cost securitizations) are financings secured by small charges that show up on customers’ electricity bills. These charges go to pay for a wide variety of expenses, from storm clean-up costs, to utility equipment, to environmental and other costs. Utilities that have issued them include Centerpoint and Entergy in Texas, CLECO in Louisiana, Potomac Edison in West Virginia, and Florida Power & Light.
The way these securitizations work is conceptually simple, but requires governmental coordination:
The state’s public utility commission approves the costs to be financed, and issues an order mandating that the utility’s customers be charged an extra fee on their bills (e.g., the “utility tariff”). For the average customer, these tariffs are typically just a couple dollars per month.
The utility tariffs have a special feature called a “true-up” — which provides that if for whatever reason the approved tariffs are insufficient to pay for the costs, the tariffs simply ratchet up.
The utility company then issues securitization bonds secured by the tariffs.These securitization bonds are rated “AAA” because they are virtually bullet-proof: (i) they have irrevocable legislation protecting the underlying utility tariffs forever, and (ii) they have a true-up mechanism that provides for an uncapped source of repayment from utility customers.
In case this seems unfair to utility customers, here’s a quick reminder about the economics of utilities. A utility is a regulated monopoly and, therefore, its profit margin is regulated by the state: they are only allowed to make a set margin, say 8–10%. This means the cost of your electricity bill is literally the sum of the utility’s own costs plus the state-approved margin. So, if a utility bears extra costs — like storm clean-up costs — they will be passed along to customers.
However, a utility tariff, and a securitization thereof, actually saves people money — because securitization bonds are issued at 4–5% yield, which is lower than the 8–10% approved profit-margin if a utility were simply to pass them along under its normal pricing regime.
Utility-tariff securitization technology could be used by PG&E: rather than file for bankruptcy, it could securitize its liability. It could issue bonds to cover the known costs at this point in time, and then utilize the magic of the “true-up” to increase the tariff to customers over time if the liability continues to increase.
This removes the uncertainty of paying for its liability, and precludes the potential that it filed for bankruptcy pre-maturely because it doesn’t know the true cost of its liabilities. This delivers a fair and elegant solution to Californians: they all pay for the liability evenly. This is more just than the alternative: a bankruptcy process that adversely affects those citizens who actually suffered losses, and whose claims are limited or minimized by the bankruptcy.
Commentaires