Why Warren Buffett’s Wrong

Investor worries about electric utility wildfire liability are reaching the realm of the ridiculous.

The Smokehouse Creek Fire has now reportedly consumed at least 1,700 square miles of the Texas Panhandle—claiming at least one life. And with wildfire damages triggering the bankruptcy of California PG&E Corp (NYSE: PCG) in the previous decade—and threatening the solvency of Hawaiian Electric (NYSE: HE) in this one—it’s hardly surprising investors bailed en masse from Xcel Energy (NYSE: XEL) last week.

On Monday, Xcel reportedly became aware a fire was raging “in or near” the service territory of its Southwestern Public Service Company unit. Two days later, the company filed a Form 8-K, stating a law firm “sent a letter on behalf of various property insurance interests.”

The as yet unnamed firm alleged the company had “potential exposure for damages resulting from the Smokehouse Creek Fire.” And it requested a “fallen SPS utility pole” that was “situated within the vicinity of the fire’s potential area of origin be preserved.”

The Xcel news was quickly picked up in the financial media, notably by the ever eager to unsettle investors Wall Street Journal. One big reason: A statement in Berkshire Hathaway (NYSE: BRK) Chairman Warren Buffett’s annual report to shareholders stating: “The regulatory climate in a few states has raised the specter of zero profitability or even bankruptcy” for electric utilities.

Buffett went on to warn of a potentially “confiscatory resolution” of “costs arising from forest fires, whose frequency and intensity have increased.” He also stated “it will be many years until we know the final tally” of Berkshire’s “forest fire losses” so management “can intelligently make decisions about the desirability of future investments in vulnerable western states.” And he said the company “will not knowingly throw good money after bad.”

Those are understandable sentiments, considering a recent court ruling ordered Berkshire’s PacifiCorp unit to pay $5 million in damages to 17 wildfire plaintiffs. While not a large amount in and of itself, it potentially opens the company to as much as $11 billion in claims from a much larger pool of plaintiffs.

It’s undeniable that Buffett’s decision to regionally concentrate his utility holdings in the notoriously dry Rocky Mountain West has come back to haunt him. In fact, the utilities he’s acquired over the past couple decades—particularly PacifiCorp and Nevada Energy—serve customers in the heart of wildfire country.

But is Berkshire really vulnerable? As for the end of 2023, the company was sitting on a $574 billion pile of cash. That’s certainly enough to defend the company in the courts and political arena. And it’s equally clear the states where PacifiCorp operates need its investment to keep the lights on a lot more than Buffett needs his utilities to be profitable.

Anything is possible in the courts. But it seems more likely that these states won’t go to war with Berkshire. Rather, they’ll enact reforms to keep its utilities healthy and willing/able to keep investing—if for no other reason than to utilize the best technology to harden the grid. In fact, you can read Buffett’s letter as a warning to regulators/politicians to get moving on the issue.

That’s what California did when wildfire liability through “inverse condemnation doctrine” forced PG&E into bankruptcy in the previous decade. And the result has been unprecedented investment to harden the state’s grid—by Edison International (NYSE: EIX) and Sempra Energy (NYSE: SRE) as well as PG&E—even while keeping electrification goals on track.

The change of heart didn’t happen soon enough to prevent bankruptcy at PG&E. But that utility is definitely on the road back now, including resuming paying dividends. Edison, meanwhile, has cut its wildfire liability risk by 88 percent since 2017 according to credit rater Moody’s.

Hawaiian Electric (NYSE: HE) still has no official estimate of its potential liability for last year’s deadly Maui wildfire, calculated by some as five times its current market cap. But the state of Hawaii clearly views the utility’s health as critical for meeting its renewable energy targets: Governor Josh Green has established a recovery fund with the condition claimants drop lawsuits against the company. And the legislature is now laying out a recovery plan that includes a large investment in wildfire mitigation.

Investigation of the fire’s causes continues. But the utility has presented evidence power was shut off to the area in question several hours before ignition. And to be found liable, plaintiffs must prove negligence, as Hawaii does not have a doctrine of inverse condemnation like California.

Neither do Texas or Colorado, where Xcel Energy’s equipment is under investigation for being the cause of major wildfires. And the utility’s financial health is also of critical importance to both states, meaning regulators and legislators are motivated to find a solution.

Xcel’s Southwestern Public Service unit, which includes substantial holdings in New Mexico, contributes just 15 percent of total company EBITDA. In the event of a large enough adverse court ruling, management could conceivably put SPS in bankruptcy in lieu of a settlement, and without seriously damaging the parent.

That seems a highly unlikely outcome. But it does translate into effective leverage that regulators and politicians in Texas are no doubt fully aware of.

It’s also worth pointing out that the only entity currently alleging Xcel caused the Smokehouse Creek fire is an “unnamed” law firm—hardly an impartial source. And again, without proof of negligence, there are no real grounds for awarding damages.

Until western states enact real wildfire mitigation policies and plans, utilities operating there are going to trade under at least some presumption of guilt. That means stocks will likely sell for less than comparable utilities, no matter how well they actually perform as businesses.

Trial lawyers are an obvious exception, given they stand to personally collect billions of dollars from successful anti-utility lawsuits. But all other stakeholders in wildfire-prone states have a clear motive to keep utilities healthy and able to invest to harden systems. And at the end of the day, that means risk is likely a lot less than it may now appear.