No business is assured of going on forever
The recent fate of US utility PG&E shows, once again, that just because people believe an event has an extremely low probability of occurring, that does not mean the odds are zero or can be ignored
The last few decades have seen the perception gain ground in markets that a combination of cash generation and state backing makes utility companies pretty much shockproof as income-yielding investments.
The fate of Pacific Gas & Electric (PG&E), which last week filed for bankruptcy protection in the US, should serve as a stark reminder no business is assured of going on forever.
The first climate change bankruptcy
Now being hailed as ‘the first climate change bankruptcy’, PG&E is estimated to be facing some $30bn (£23bn) of potential legal liabilities relating to the wildfires that ravaged much of its home state of California last year.
That figure is close to the $31bn market capitalisation the business boasted at the end of 2016 – and some 10 times the $3bn-odd market capitalisation ascribed to PG&E by the middle of last month.
While the cause of the fires remains under investigation, suspicion has fallen on PG&E after it disclosed a high-voltage powerline was damaged and dislodged from a tower in the area some 15 minutes before the first fire was reported.
The company now faces dozens of lawsuits from residents and insurers – and Californian law makes utilities responsible for any fire started by their equipment, even if no negligence is proved.
This time last year, PG&E would largely have been viewed as as much of a going concern as any other utility.
Markets have grown increasingly comfortable with utilities over recent decades as a result of revenues that are largely underwritten by state and federal regulators.
A false sense of security
It would be wrong to suggest utilities never go bankrupt – indeed PG&E filed for bankruptcy itself in 2001 as California was hit by rising wholesale power prices and rolling black-outs – but instances are rare and this may induce a false sense of security.
Extrapolating the future from the recent past – or ‘anchoring’, as it is known in behavioural finance – is a common enough failing among investors and it was perhaps the California connection that prompted me to recall how value investor Mohnish Pabrai addressed the subject, back in 2004, in a piece entitled The Yellowstone Factor.
“Yellowstone National Park is volcanic in nature, yet not one cone or caldera is visible,” he wrote. “In the 1960s, this mystery was finally solved: the entire park – 2.2 million acres – is the caldera. It is the largest active super-volcano on Earth. Yellowstone started erupting about 17 million years ago, and it has a cycle of erupting roughly every 600,000 years.”
Which might lead you to wonder – when did the last eruption occur?
It was 630,000 years ago, notes Pabrai –meaning we are “ about 30,000 years past due on the next big one” – and he goes on to observe: “Yellowstone represents just one of the many ugly outlying events that have an extremely low probability of occurring, but that does not mean that the odds are zero or that they can be ignored.
“Even the most seemingly resilient businesses, by their very nature, are very fragile temporary creations — and it would take a lot less than Yellowstone’s eruption to wipe them out. The Yellowstone Factor alone implies that there isn’t a single business on the planet whose future is assured.”
The fate of PG&E should have brought the point home to markets – at least until such time as they have to relearn it all over again.
Juan Torres Rodriguez
Fund Manager, Equity Value
I joined Schroders in January 2017 as a member of the Global Value Investment team. Prior to joining Schroders I worked for the Global Emerging Markets value and income funds at Pictet Asset Management with responsibility over different sectors, among those Consumer, Telecoms and Utilities. Before joining Pictet I was a member of the Customs Solution Group at HOLT Credit Suisse.
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