In an extensive report entitled, Energy and Investing, the Cornell Capital group examined the investment implications of what we referred to as the great transformation from reliance on fossil fuels to using primarily renewable sources of energy. One of the key items we analyzed was political risk. As people become progressively more dependent on electricity, the ultimate useful energy derived from renewable sources, its pricing and distribution will become increasing important. That will make electricity pricing a paramount political issue and make political risk related to that pricing a central consideration for investors. The experience of equity investors in PG&E offers an a precursor of the types of risks investors are likely to face in future energy investments.
Historically, investment in utility stocks has been considered to be “low risk.” The reason is that electricity rates are set at a level that allows the utility to earn a fair rate of return on its capital investments in infrastructure referred to as the rate base. More specifically, the electricity rates to consumers are set so that the utility’s revenue exceeds its allowed costs by an amount which equals the fair rate of return times the rate base. It sounds like low risk, but there is a catch. The allowed costs are politically determined and may not be include all the costs a utility has to pay. The stock price of PGE, plotted below, demonstrates how the political risk associated with allowed costs turned out to be devastating for investors. For complex regulatory reasons, too intricate to explain here, it is likely that many of the expenses PG&E faces associated with California wildfires in the fall of 2017 and the summer of 2018 will not be included in allowed costs. The impact of this risk is clear in the stock price chart. There is a sharp drop in the summer of 2017 and an even larger collapse in summer of 2018. Ultimately, the situation became so dire that PG&E filed for bankruptcy on January 19, 2019. At that time, the stock price was $7.23 a drop of almost 90% from a starting point of $70.64 prior to the first major wildfire.
PG&E is just the tip of the political iceberg. It is hard to say much about the “green new deal” because it is so poorly defined at this juncture. Nonetheless, two points can be made. First, it vastly underestimates the costs and the difficulties of the great transformation. The transformation may be necessary, and in the long run, should be beneficial, but it will not be easy or cheap. Second, and more related to this post, it is further evidence that returns on energy related investments are going to be greatly influenced by politics in the years ahead.