When The Wall Street Journal reported that Pacific Gas & Electric Co. executives knew years in advance that the power line that sparked California’s deadliest and most destructive wildfire was severely compromised, it was news, but hardly a surprise.
California’s largest power company may have the most checkered history of any utility in America. It is currently in Chapter 11 bankruptcy proceedings for the second time in less than two decades. In May, state officials determined that failure of PG&E equipment caused last November’s Camp Fire. Not only did the Camp Fire destroy the Sierra Nevada town of Paradise and kill 85 people, but it came only a year after several northern California wildfires caused devastation in several communities north of San Francisco in the Napa and Sonoma valleys. Officials determined that PG&E equipment sparked 18 wildfires in 2017. All this was less than a decade since another PG&E-linked fire following a gas main explosion ripped through the Bay Area community of San Bruno.
And let’s not forget the groundwater contamination that all but turned the desert town of Hinkley, near Barstow, into a ghost town, memorialized in the 2000 film “Erin Brockovich.” Or the power shortages that combined with a deeply flawed regulatory regime that pushed PG&E into its first bankruptcy reorganization in 2001.
This brings us to the current summer, which began in earnest in California with an early June heat wave. PG&E, as a protective measure, simply shut off the power in parts of five counties. That decision affected about 16,000 customers.
So there you have it: a power company that customers can’t rely on to keep the lights on and the refrigerators running, whose infrastructure is in some cases more than a century old, supplying electricity to the nation’s biggest state and its undisputed leader in the development of 21st century technology. And the high rates that customers pay for all this are likely to keep getting higher.
Quite a picture, isn’t it?
The Journal article included news that PG&E executives had conceded to a state lawyer that the company faced many urgent projects, all of which needed addressing to prevent system failures. They reportedly likened the situation to a “pig in a python.” But it is worth considering how the python swallowed that pig in the first place.
PG&E is investor-owned but, as a regulated utility in what is one of the bluest of blue states, it is close to government-run. This is not to excuse the company’s well-compensated managers. But it does help to explain how a utility with some staggeringly high power rates – for big residential users, four times as much as I pay in comparably sunny Florida – could not marshal the resources to maintain its grid well enough to deliver electricity without undue risk of setting fire to wide swaths of its service area.
The old saying about Rome not being built in a day also holds true in reverse. A major utility, with billions of dollars of infrastructure, does not fall apart overnight. It takes years of neglect, even when accelerated by mismanagement and misguided public policy.
PG&E might be the poster child for utility industry mismanagement. Yet it is hardly alone, and power companies are not the only miscreants. Just ask anyone who has had to drink the water in Flint, Michigan anytime in the past five years.
In the comfortably air-conditioned offices where accountants and economists earn their daily bread, there are concepts and rules that account for the fact that capital assets generally require ongoing maintenance and eventual replacement. When you build something, whether it is an office building or an electric transmission pylon, you start recording “depreciation expense” to reflect the fact that stuff wears out and eventually needs to be replaced. If you issued bonds to pay for the facility, you might establish a “sinking fund” – essentially a savings account – to ensure you have the money to repay the bonds when they come due. Alternatively, you might just plan to either pay off the bonds with cash from other sources or refinance by issuing new bonds.
Ideally, bonds would always be accompanied by sinking funds and depreciation expense would be matched by reserve funds accumulated out of current earnings to replace the asset when it wears out. Organizations would treat maintenance as an expense regardless of whether it is actually performed or deferred. Unfortunately, in reality accounting rules treat maintenance as an expense only when it is performed. This creates an incentive for managers to dress up their profits by deferring maintenance as long as possible. And depreciation is treated as a non-cash expense, which is disregarded in the popular metric known as EBITDA, or earnings before interest, taxes, depreciation and amortization. Investors tend to focus exclusively on EBITDA, as though those other factors don’t really count.
But out in the real world, they do count. The maintenance PG&E deferred has come back with a vengeance, in the form of liabilities for the devastation of recent fires that the utility cannot repay. This is why it is back in bankruptcy.
It takes a lot of work to build Paradise, but a single spark in the wrong place can wipe it out. That lesson seems to keep getting lost at PG&E.
Posted by Larry M. Elkin, CPA, CFP®
photo by Wikimedia Commons user LPS.1
When The Wall Street Journal reported that Pacific Gas & Electric Co. executives knew years in advance that the power line that sparked California’s deadliest and most destructive wildfire was severely compromised, it was news, but hardly a surprise.
California’s largest power company may have the most checkered history of any utility in America. It is currently in Chapter 11 bankruptcy proceedings for the second time in less than two decades. In May, state officials determined that failure of PG&E equipment caused last November’s Camp Fire. Not only did the Camp Fire destroy the Sierra Nevada town of Paradise and kill 85 people, but it came only a year after several northern California wildfires caused devastation in several communities north of San Francisco in the Napa and Sonoma valleys. Officials determined that PG&E equipment sparked 18 wildfires in 2017. All this was less than a decade since another PG&E-linked fire following a gas main explosion ripped through the Bay Area community of San Bruno.
And let’s not forget the groundwater contamination that all but turned the desert town of Hinkley, near Barstow, into a ghost town, memorialized in the 2000 film “Erin Brockovich.” Or the power shortages that combined with a deeply flawed regulatory regime that pushed PG&E into its first bankruptcy reorganization in 2001.
This brings us to the current summer, which began in earnest in California with an early June heat wave. PG&E, as a protective measure, simply shut off the power in parts of five counties. That decision affected about 16,000 customers.
So there you have it: a power company that customers can’t rely on to keep the lights on and the refrigerators running, whose infrastructure is in some cases more than a century old, supplying electricity to the nation’s biggest state and its undisputed leader in the development of 21st century technology. And the high rates that customers pay for all this are likely to keep getting higher.
Quite a picture, isn’t it?
The Journal article included news that PG&E executives had conceded to a state lawyer that the company faced many urgent projects, all of which needed addressing to prevent system failures. They reportedly likened the situation to a “pig in a python.” But it is worth considering how the python swallowed that pig in the first place.
PG&E is investor-owned but, as a regulated utility in what is one of the bluest of blue states, it is close to government-run. This is not to excuse the company’s well-compensated managers. But it does help to explain how a utility with some staggeringly high power rates – for big residential users, four times as much as I pay in comparably sunny Florida – could not marshal the resources to maintain its grid well enough to deliver electricity without undue risk of setting fire to wide swaths of its service area.
The old saying about Rome not being built in a day also holds true in reverse. A major utility, with billions of dollars of infrastructure, does not fall apart overnight. It takes years of neglect, even when accelerated by mismanagement and misguided public policy.
PG&E might be the poster child for utility industry mismanagement. Yet it is hardly alone, and power companies are not the only miscreants. Just ask anyone who has had to drink the water in Flint, Michigan anytime in the past five years.
In the comfortably air-conditioned offices where accountants and economists earn their daily bread, there are concepts and rules that account for the fact that capital assets generally require ongoing maintenance and eventual replacement. When you build something, whether it is an office building or an electric transmission pylon, you start recording “depreciation expense” to reflect the fact that stuff wears out and eventually needs to be replaced. If you issued bonds to pay for the facility, you might establish a “sinking fund” – essentially a savings account – to ensure you have the money to repay the bonds when they come due. Alternatively, you might just plan to either pay off the bonds with cash from other sources or refinance by issuing new bonds.
Ideally, bonds would always be accompanied by sinking funds and depreciation expense would be matched by reserve funds accumulated out of current earnings to replace the asset when it wears out. Organizations would treat maintenance as an expense regardless of whether it is actually performed or deferred. Unfortunately, in reality accounting rules treat maintenance as an expense only when it is performed. This creates an incentive for managers to dress up their profits by deferring maintenance as long as possible. And depreciation is treated as a non-cash expense, which is disregarded in the popular metric known as EBITDA, or earnings before interest, taxes, depreciation and amortization. Investors tend to focus exclusively on EBITDA, as though those other factors don’t really count.
But out in the real world, they do count. The maintenance PG&E deferred has come back with a vengeance, in the form of liabilities for the devastation of recent fires that the utility cannot repay. This is why it is back in bankruptcy.
It takes a lot of work to build Paradise, but a single spark in the wrong place can wipe it out. That lesson seems to keep getting lost at PG&E.
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