Hurricanes, Blackouts and Electric Utility Share Prices

Speaker: Seth Blumsack, Energy Policy and Economics Professor at Penn State University

Abstract:
As the climate changes, the frequency and severity of some types of extreme weather events are likely to increase. Stronger and more-frequent extreme weather events can threaten critical infrastructure systems, sometimes with disastrous results. Recent power blackouts related to hurricanes, extreme cold and wildfires have revealed the extent to which utilities and their customers can be affected. Electric utilities are an interesting class of critical infrastructure operators because many are for-profit companies that operate under a unique regulatory structure. Because they are for-profit companies, they are subject to the whims of capital markets and the mood of investors; we might expect (or hope) that investors will penalize utilities with high exposure to climate risks. The finance literature has found mixed evidence to support this hypothesis - natural disasters and extreme weather do not necessarily affect firm market values. Because of the regulatory environment in which utilities operate and critical services that they provide, regulators care about the financial health of utilities and this financial health may be affected by increasing frequency and severity of extreme weather. The present paper focuses on how investors view the value of electric utilities following hurricanes that cause large power blackouts. The theory of utility regulation does not provide a clear hypothesis as to how a large hurricane-induced blackout should affect the value of a utility. Under some circumstances we might expect the market value of an electric utility to decline following a hurricane-induced blackout and in other cases we might actually expect the market value to increase. We use an event study framework to examine the response of utility stock returns to hurricane-induced blackouts. Using a data set of utility share prices and large blackouts reported to the U.S. Department of Energy between 2000 and 2020, we examine (i) how returns to utility shares are affected by hurricane-induced blackouts; (ii) whether investors respond to hurricane forecasts in addition to the actual hurricane event; (iii) whether returns to utilities affected by hurricanes differ from those that are not typically affected by hurricanes; and (iv) whether a utility's regulatory environment affects how investors respond to hurricane-induced blackouts. We find a negative and immediate shock to the abnormal (or excess) returns of utilities that have experienced power blackouts because of hurricanes. These negative shocks tend to persist for several days following the event, and are exacerbated by particularly large blackouts or blackouts that involve long restoration times. We find little evidence of a response in share prices to hurricane forecasts, indicating that investors are not using this information in assessing utility valuations. In comparing the share-price behavior for utilities affected by hurricanes versus those that are not affected by hurricanes, we find that utilities affected by hurricanes see returns to their shares increase relative to utilities unaffected by hurricanes if they operate in a jurisdiction with a favorable regulatory environment. Utility regulation alone cannot stop climate change, but our results suggest that regulators can have a meaningful impact on how the costs of climate risks are allocated.

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