POWER January 2020 - 17

LEGAL & REGULATORY
Structural Effects of
Climate Change on the
Utility Business
William Friedman
D
evelopers and other sellers of electricity have traditionally
viewed utilities as creditworthy counterparties. Utilities
are longstanding institutions that provide a public
service and receive a regulated rate of return.
Climate change, and the resulting legal and regulatory responses,
however, are beginning to change the core business
model of utilities. These changes have the potential to affect
the structure of the wholesale electricity market and drastically
impact sellers, particularly renewable generation developers.
Increased Risk, Increased Costs
A prominent effect of climate change over the past two years
has been the increased frequency and severity of wildfires in
California. Fires caused by utility equipment represent a massive
liability for utilities, and this is amplified by California's inverse
condemnation law, which holds a utility strictly liable for
property damage and legal fees if its facilities are the substantial
cause of a fire, regardless of fault.
Citing the risk of wildfire liability, Southern California Edison
(SCE) filed with the Federal Energy Regulatory Commission
(FERC) in April to increase its transmission rates. In particular,
SCE proposed to increase its return on equity (ROE) dramatically
from 11.12% to 17.62%. To support the proposed 650-point
adder, SCE argued that, due to wildfire liability, credit rating
agencies downgraded SCE, warned of further downgrades,
and dampened investor confidence. SCE eventually settled for
a 12.47% ROE, still a sizable increase.
Pacific Gas & Electric (PG&E), another California utility, also
has sought an increase in ROE related to wildfires. Ultimately,
PG&E's and SCE's increased ROEs will be reflected in higher
transmission charges.
Risk of Cancellation
Climate change-related wildfires were a significant factor in
PG&E's decision to file for bankruptcy in early 2019. The bankruptcy
triggered a still-unsettled legal battle over the ease with
which a utility may reject wholesale power purchase agreements
(PPAs) in its bankruptcy proceedings.
Normally, a company in bankruptcy is permitted to reject
contracts under the deferential " business judgment " standard
of the Bankruptcy Code, but FERC has asserted concurrent jurisdiction
with the bankruptcy courts to prevent the rejection
of wholesale PPAs, unless it finds that such rejection meets
the higher " public interest " standard of the Federal Power Act.
PG&E has not yet rejected any PPAs, but the ongoing litigation
poses real risks for electricity suppliers, who support
FERC's efforts to limit PPA rejections. If FERC ultimately loses
this legal battle, it increases the risk that PG&E or other
utilities in future bankruptcies will cancel PPAs, thereby exposing
sellers.
January 2020 | POWER
Regulatory Uncertainty
The threat of climate change is also causing state regulatory authorities
to change their market structures. For example, New
York is implementing its " Reforming the Energy Vision " (REV)
initiative, aimed at meeting the state's clean energy goals. As
part of the REV, New York is reforming the fundamental business
structure of utilities.
Utilities will be encouraged to emphasize creation of opportunities
for distributed energy resources (DERs), and move
away from the traditional model of relying on load growth and
capital improvements to earn a return on investment. New York
also will require utilities to use new rate structures, such as
the " value of distributed energy resources. " Because these
structures are in development, the prevailing rates sellers can
expect for power going forward are uncertain.
Both the environmental effects of climate change and the
regulatory responses pose challenges for generation developers
and other electricity sellers. Utilities like SCE and PG&E are
attempting to pass on their risks to sellers in the form of increased
transmission charges. Increased costs combined with
falling wholesale electricity prices, particularly for renewables,
squeeze the economics for generation developers.
Additionally, as prices fall for renewable energy, utilities are
less willing to enter into long-term PPAs with renewable generators
because the agreements are likely to be uneconomic in
the later years of the contracts. The current debate over whether
utilities may reject PPAs in bankruptcy further exacerbates
concerns over the stability of long-term deals.
Utilities like PG&E may seek to reject above-market longterm
contracts in bankruptcy proceedings. Rejection of, or
refusal to enter into, long-term PPAs threatens a stable revenue
stream that developers and investors rely on to finance
new projects.
The challenges of finding revenue stability and a creditworthy
buyer are multiplied when the regulatory paradigm is in
flux, as in New York. The state's changing utility model creates
uncertainty as to how existing contracts will be treated and
whether the sales will be at market prices. Additionally, while
regulators work on calculating rates like the value of DERs, developers
must ponder how their resources will be priced.
As these concerns illustrate, climate change is affecting the
business and regulatory structures familiar to wholesale sellers.
Many unforeseeable consequences remain, such as what
happens should Congress pass a carbon tax or implements
some form of Green New Deal. Developers would be prudent
to stay abreast of the changing legal and regulatory landscape,
and structure their businesses to minimize the risks posed by
the increasingly insecure utility model. ■
-William Friedman is an associate in Davis Wright Tremaine's
Washington, D.C., office, focusing on regulatory, compliance,
and transactional issues in the energy sector.
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POWER January 2020

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