Wildfires – Burning
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Current Key Investment Themes JUNE 2021 THOUGHT LEADERSHIP: WILDFIRES – BURNING MORE THA N JUST LANDSCAPES INTRODUCTION Climate change and the risks that go with it have change is happening around us now and is already been front of mind for investors and regulators starting to impact investors’ portfolios. Investors alike for several years. Time and again, we are told not only need to assess the risk of climate change that climate change is a tangible investment risk in the future, but also the current reality of it. that markets will have to grapple with over the In this month’s article, we provide a specific, but coming years and decades, and investors should be very relevant example of how climate change is taking this risk into consideration in portfolio impacting investors’ portfolios today. Wildfire construction decisions. This is reinforced by activity in the state of California has increased guidance from global financial regulators, who are dramatically over the past several decades, with increasingly considering climate change risks as 2020 marking the worst year on record. Over the relevant to their supervisory mandates. course of the year, ferocious wildfires burned But what does climate change risk actually mean to through more than four million acres, more than investors? Climate risk is broadly categorised as quadrupling the annual average from the preceding two distinct risks. The first is physical risk, which five years. California gets most of its annual rainfall involves the damage to land, buildings and throughout its fall and winter. Then, throughout infrastructure caused by climate change, through most of the spring and summer months, the the more frequent and severe weather events such vegetation dries out, essentially turning the as flooding, droughts and storms as well as the landscape into a tinder box. This is not a new chronic impacts of shifting temperature patterns. phenomenon. What is changing is the climate, and The second is transition risk, namely the risks to the hotter and drier weather conditions are leading businesses or assets of the global transition to a to more plentiful and ripe fuel sources. lower-carbon economy. In California, utilities are liable for wildfire damages Climate risks have significant negative implications caused by their equipment, even if not found for economic growth, inflation and investment negligent. In this article, we focus on two returns. It is possible that direct central bank Californian utilities that were deemed responsible intervention may be required in buying up heavily for causing deadly and destructive wildfires in 2017 devalued and stranded assets to protect the and 2018. The financial and reputation impacts financial system in a worst-case climate scenario. were severe, sending their share prices plummeting Climate change has a direct and already visible and one into bankruptcy. Even with a significant implication on the financial stability of insurance regulatory response following the fires, climate companies and banks for example. change has changed the investment case for this sector of the market. We consider this is just one However, much of the conversation around how example of many of how the changing climate is climate risk will affect investors is forward-looking. impacting investments – but investors need to be Investors need to ‘future proof’ their portfolios prepared for this to become the norm. against the risk of climate change. While we agree that this is true, it is important to note that climate 1 THE CALIFORNIAN WILDFIRE LANDSCAPE Since the early 1970s, the extent of California’s Wildfires have become particularly topical in annual wildfires, measured in area burned, has California over recent years due to increases in increased fivefold.1 The trend has primarily been state-wide burned area, underscored by extreme due to an eightfold increase in the forest area wildfire activity in 2017 and 2018, and again in deemed at-risk during the summertime, 2020, resulting in a substantial loss of life and predominantly due to reduced fuel moisture, property. driven by human-induced warming. With increases Chart 1 shows the material increase in the total in evaporative demand, reduced snowpack and number of acres burned by Californian wildfires reduced rainfall through spring and summer, from 2010 through to 2020. wildfire risk is further heightened when combined with hot, dry temperatures during the summertime. Once ignition occurs, winds from the Great Basin, known as the Santa Ana winds in Southern California and the Diablo winds in the north, allow fire to spread at an increased rate. Chart 1: Acres Burned by Wildfire in California 4.5 4.0 3.5 3.0 2.5 2.0 1.5 Acres Acres (millions) 1.0 0.5 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Acreage 5-year rolling average Source: California Department of Forestry and Fire Protection 1 Advancing Earth and Space Science, 2019, https://www.agu.org/ 2 Wildfires – Burning More Than Just Landscapes The 2017 and 2018CALIFORNIAN Fire Seasons WILDFIRES In 2017, over 1.5 million acres were burned due to same year, approximately two million acres burned wildfire, materiallyBACKGROUND higher than the five-year due to wildfire, breaking state records in place at average.2 In early 2018, the California Department the time.3 Table 1 summarises the most notable of Forestry and Fire Protection (Cal Fire) issued fires in 2017 and 2018. Meanwhile, Chart 2 shows the statement ‘climate change has rendered the term total wildfire losses, including insured losses, in the “fire season” obsolete, as wildfires now burn on a year- US between 2010 and 2019. Data was not round basis across California’. By the end of that available for the 2020 season at the time of writing. Table 1: Notable California Wildfires, 2017 - 2018 Event Location Area Burned Structures Fatalities Insurance Note(a) (Acres) Damaged Loss Est. (US$ billions) Tubbs Fire Sonoma County 37,000 5,600 22 8.7 Second costliest in US history Atlas Fire Napa County 52,000 120 6 3.0 Fifth costliest in US 2017 history Thomas Fire Ventura County 282,000 1,063 1 2.3 Sixth costliest in US history Camp Fire Butte County 153,000 18,800 85 10.0 Most destructive and deadly on CA record Mendocino Fire Various counties 459,000 280 1 0.3 Largest area burned on CA record 2018 Carr Fire Shasta County 230,000 1,614 8 1.3 Tenth costliest in US history Woolsey Fire Ventura County 97,000 1,634 3 4.2 Third costliest in US history (a) Ranking statistics are as at time of event. Source: Insurance Information Institute, National Interagency Fire Centre Chart 2: Wildfire Losses in the United States, 2010-2019 (US$ Millions)(a) (a) Figures adjusted for inflation. Source: Munich RE 2 California Department of Forestry and Fire Protection, 2020 3 California Department of Forestry and Fire Protection, 2018 3 Wildfires – Burning More Than Just Landscapes The 2020 Fire Season campfires left unattended, the burning of debris, downed power lines, negligently discarded California residents were again devastated by new cigarettes and intentional acts of arson. The record-setting wildfire activity in 2020, with remaining 10% are started by lightning or lava.5 4.2 million acres burning across 9,917 events, Interestingly, in Australia, it is estimated that resulting in 33 fatalities and 10,488 structures being lightning is responsible for about half of all bushfire destroyed.4 By comparison, from 2015 to 2019, ignitions, with humans (both accidental and the average annual number of acres burned was deliberate) responsible for the remainder.6 1.1 million. This chalked up another bleak record, with the 2020 wildfire season going doing as the It has been proven that electricity transmission worst in the state’s history in terms of area lines played a role in past wildfires, typically as a burned. This was largely due to the expansive result of high winds, causing transmission lines to August Complex in the northern part of the state, touch, contact surrounding trees or fail completely which alone burned more than one million acres and become disjointed from latticing. In and became the state’s first ‘gigafire’, being a blaze circumstances when the surrounding vegetation is that burns at least a million acres of land, in tinder dry, the transmission lines can ignite the modern history. brush. Wildfire Causes Figure 1 shows an example of the equipment which suffered damage due to winds, sparking the It is estimated that around 90% of wildfires in the fire. United States are human caused, including through Figure 1: Powerline Transmission Latticing Source: Cal Fire 4 California Department of Forestry and Fire Protection, 2021 5 US Department of Interior, 2018 6 Geoscience Australia, https://www.ga.gov.au/scientific-topics/community-safety/bushfire 4 Wildfires – Burning More Than Just Landscapes Unique Californian Legal Context Unlike all other US states, in California, electric Once utility equipment is found to be the cause of utilities, including investor-owned utilities (IOUs) fire damage, and the IOU’s liability is established by listed on the US stock exchange, are liable for the courts, it is then up to the Californian wildfire damages caused by their equipment, even regulator, the California Public Utility Commission if not found negligent.7 This is referred to as (CPUC), to determine how much of the liability ‘inverse condemnation’ under a ‘strict liability’ the IOU can recoup through future rate increases. regime. The courts’ classification of IOUs as effective Property owners can seek compensation from the government agencies allows inverse condemnation IOU for any damage if their equipment caused the to be applied, on the basis that the IOU has the fire. In legal terms, the property owner can bring ability to recoup the costs.