Forget the Climate Change Chatter: Utilities are Storm Ready

and a post-season rally is likely

When Hurricane Idalia hit the Florida Gulf Coast this week, more than 25,000 utility workers from 21 states and the District of Columbia were already in place. Within 24 hours, electricity had been restored to more than half NextEra Energy’s (NYSE: NEE) customers affected by the storm, which strengthened from Category 1 to make landfall as a 3 in a single day. And smart grid technology prevented another 50,000 plus outages.

Within 48 hours, NextEra Energy reported it was fully focused on the hardest hit areas of its Florida-wide service territory, having essentially restored service elsewhere in the state. Harder hit Duke Energy (NYSE: DUK) announced it will restore 95 percent of affected customers by the weekend, despite widespread flooding. And a Citi analyst stated total Idalia damages should generally be covered by insurance.

That’s a solid performance for affected electric utilities in the aftermath of Hurricane Season 2023’s first blow. Meanwhile in northern California, PG&E Corp (NYSE: PCG) made headlines last week when it shut off power to 8,400 homes and businesses north of Sacramento. But it was the first time since 2021 the company has resorted to such measures, a testament to the effectiveness of aggressive hardening of its system against wildfires.

Edison International (NYSE: EIX) in southern California reports it uses outright shutoffs in only 10 percent of prevention cases. And that number is set to drop further this year, as the company completes covered conductor installation on nearly 80 percent of powerlines in fire prone areas.

Bottom line: US electric utilities are proving they’re better prepared than ever to handle the impact of devastating storms on their systems. That means odds are better than ever that service outages will be contained and quickly resolved this year, even if the storms themselves are more severe.

What damages systems do sustain should be covered by insurance and reserves. What isn’t will be paid off in customer rates, the largest amounts through securitization—with companies recovering costs up front by issuing bonds, which are paid off over time as a minor surcharge in rates. And most important, when the work is done and power restored, customers, regulators and politicians will be satisfied with management’s response.

In the past, when a utility has weathered storm season, its share price and investor returns have wound up little affected at the end of the day. That is until the next storm season, when the public will once again focus on affected companies’ ability to get the lights back on.

This time around, we should see meaningful upside.

This month’s events on Maui and several earlier wildfires affecting western states—including Berkshire Hathaway’s (NYSE: BRK/B) PacifiCorp unit—have fueled an emerging narrative in the mainstream media that utilities are ill-prepared for the worsening weather brought by on by climate change.

In fact, Bloomberg Intelligence has noted utilities in the West especially are adopting a “catastrophic wildfire discount.” That includes regulated natural gas utilities as well as electrics and unregulated renewable energy generators like AES Corp (NYSE: AES) and Clearway Energy (NYSE: CWEN).

The Dow Jones Utility Average was already in the red year to date before the Maui fire and lagging well behind the S&P 500. That’s the result of worries about elevated interest rates, concerns about economic growth, lagging share price momentum and the availability of money market funds and short-term CDs yielding 4 to 5 percent.

But on the same day Hawaiian Electric released its potentially exonerating evidence last week, the Wall Street Journal, Fortune and a host of other news organizations published basically the same article the Washington Post had a day earlier. The author(s) implied utilities have done little or nothing to increase preparation for and response efficiency despite worsening storms in recent years. And they alleged through quoted sources that regulators and management alike were either asleep at the switch or were willfully not responding to hold down costs.

Those are some serious charges. If you’ve ever lived through a power outage in your area—I’ll bet you have—it probably sounds at least somewhat believable. And in fact, it’s pretty clear a fair number of investors are buying into it, as utility stocks have come under renewed pressure this month.

That includes utilities out west such as Xcel Energy (NYSE: XEL), accused of a role in several Colorado fires and down nearly -20 percent year-to-date. And it appears to extend to companies in the east coming into hurricane season including Duke and NextEra Energy, which have both greatly underperformed the DJUA this year despite solid operating performance and sticking to guidance.

To be sure, stakes are high when a utility’s service territory really gets walloped by a storm. And as the magnitude of storms has seemed to worsen—from hurricanes in the East and wildfires in the West to tornados and ice storms in the South and Midwest—companies with responses and/or preparedness found to be lacking face increasingly dire consequences.

Those include massive litigation. The story of Maui’s deadly wildfire earlier this month continues to unfold. Since my Substack article last week, Hawaiian Electric (NYSE: HE) has suspended its dividend and drawn down credit lines in expectation of a lengthy legal defense.

Management also presented evidence in a filing with the SEC indicating its power lines did not ignite the fire that destroyed the town of Lahaina, which killed over 100 people. That news has since sparked a nearly 50 percent rally in the stock, which had fallen as low as $9.06 per share from an average 52-week price in the high 30s.

Nonetheless, the swarm of outside trial lawyers that had descended on the state shows little sign of dispersing anytime soon. Mainly, with a little less than $4 billion in annual revenue including its banking unit, Hawaiian Electric isn’t a large company as utilities go. But the prospect of grabbing a sizeable chunk of the estimated $5.5 billion in damages plus more for pain and suffering is too enticing to give up on easily.

PG&E Corp (NYSE: PCG) wound up paying out close to $23 billion to settle wildfire cases from the previous decade. And California utility units Edison International (NYSE: EIX) and Sempra Energy (NYSE: SRE) have laid out several billion as well under the state’s “inverse condemnation doctrine,” which holds companies responsible for damages from any events involving their equipment even if they’ve followed best practices.

Most utilities including Hawaiian Electric can take comfort in the fact that their states don’t have inverse condemnation or as with Hawaii have never applied them to utilities. But where utility equipment is implicated in igniting wildfires, companies can expect to face a wave of litigation. And that’s in addition to the cost of restoration efforts, which regulators will be reluctant to pass along to customers.

Given all that, it’s no great surprise investors are concerned this storm season with potential liability for utilities. And I’m not here to debate the severity of climate change—or whether the fault for most storm damage is ever more catastrophic weather or an unprecedented number of people building in vulnerable areas. Certainly, damages from storms have continued to rise in the US in recent years. And consequences for utilities perceived as coming up short in the face of them are obviously worsening.

But the argument utilities are sitting ducks to the weather does ignore the fact storm response has greatly improved in recent years. And given that progress, investors’ current worries about climate change impacts on power grids—fanned by mainstream media hype—look increasingly overblown and out of step with reality.

In California, for example, utilities are not only hardening the grid with stronger power poles, accelerated installation of covered conductor wire and undergrounding of power lines with regulators’ support. They’re utilitizing new technologies such as drones, data science and now artificial intelligence to identify potential ignition points, preventing wildfires before they start. That’s how Edison has reduced the number of destroyed structures and acres burned by 98 percent and 92 percent respectively in just five years. And it’s why credit rater Moody’s calculates fire damage risk is now 85 percent lower since 2017-18.

Yes this storm season has a ways to run. Though Warren Buffett’s Berkshire Hathaway has apparently made a big bet on a mild one, no one should discount the possibility some areas will be hit hard. And even should utilities acquit themselves well this year, it would be foolish to expect recognition in the mainstream media, which by then will be onto the next attention grabbing issue.

Nonetheless, if utilities continue to perform as Duke and NextEra have in the wake of Hurricane Idalia, it is likely at least some of the current storm discount will disappear. That means share prices will push higher as multiplier, even if the economy slips into recession and the stock market’s high flying tech stocks sell off.

That’s what I increasingly expect to see, if for no other reason than so much weather worry has been priced into the sector.

Hawaiian Electric appears to have a pretty good case that its power lines did not ignite the Maui fires. That will make it difficult to sue successfully. But given its massive restoration costs, the company’s stock is Hawaiian Electric is still for very patient speculators only.

But electric utility stocks are now trading at sizeable discounts. And in a stock market looking increasingly stretched and vulnerable to higher for longer inflation and recession risk, they offer a solid value proposition of high yield, safety and upside once storm season comes to a close—as it always does.