Recently, one of my favorite blogs, Divestor, had a post about the PG&E bankruptcy in California and how this risk is constantly discounted by utility investors.

Essentially, his argument went like this. It turns out that one of the major fires in California this summer was caused by something coming in contact with a PG&E power line. It caused an event hotter than me without a shirt (OOH BABY HE’S STILL GOT IT) and the next thing you know there’s a big-ass fire and houses are being burnt down. And here I am, without marshmallows.

The bastard insurance companies, who just have to blame someone for EVERYTHING, determined PG&E was at fault and are demanding billions in penalties. The company couldn’t afford the payout, so it declared bankruptcy. Which gives me the perfect excuse to use this picture from one of my favorite The Office episodes:

So on the one hand, Divestor has a point, and it doesn’t just apply to power companies either. I own several pipeline companies, and there’s always risk one of those bad boys could go kablammo! TransCanada has nuclear power plants in Ontario, and we all know what can happen if one of those fucks up.

There’s no insuring against these risks, either. It simply costs too much.

If you want to take the pessimist perspective, I have a lot of my capital tied up in these types of risks. Every stock has some sort of risk when you invest in it, but I doubt names like Transcontinental or H&R REIT have the ability to screw up one time and send the stock into bankruptcy protection.

But at the same time I’m not particularly worried about this risk, and I don’t think you should be either. Here’s why, for possibly the first time, I’m disagreeing with Divestor.

Diversification

Let’s take a closer look at the utility portion of my portfolio. I have four power generators that I own, including:

  • Canadian Utilities (TSX:CU)
  • Brookfield Renewable Partners (TSX:BEP.UN)
  • TransAlta Renewables (TSX:RNW)
  • Polaris Infrastructure (TSX:PIF)

Altogether these four stocks represent about 9-10% of my portfolio. Canadian Utilities is by far the largest, with close to a 5% weighting on its own.

Since I’ve diversified my holdings into four different stocks, the worst that can happen is I lose 5% of my portfolio if Canadian Utilities goes to zero. That would be bad. But I’ve already minimized my risk by spreading my utility holdings.

Next is insisting on getting paid dividends. These four stocks combine to offer me more than a 6% yield, and that’s not factoring in my yields on cost (Never factor in yield on cost, by the way. It’s a useless metric.). A 6% yield is no consolation when a stock goes to zero, but at least I’m getting a portion of my money back each year. This also helps mitigate risk.

There’s also a different kind of diversification inside of each of these companies. Canadian Utilities has a lot of operations in Alberta, and so does TransAlta Renewables. But both also have assets outside of Alberta. Brookfield Renewable has assets all over the place. And while Polaris isn’t diversified — it owns one geothermal plant in Nicaragua with plans to build more hydro plants in Peru — there’s no overlap between its operations and my other holdings.

Just how big is this risk, anyway?

I’m just going by memory here, so this list might be woefully incomplete. Still, I think it’s an important exercise.

Just how many utility companies have gone bust from this sort of catastrophic event, anyway?

I can only think of two, at least over the last ten years. There was Tokyo Power in 2011 (which I wrote about on this very blog) after the earthquake/tsunami and then PG&E this year. Note that Tokyo Power didn’t actually go bankrupt, but investors saw a loss of 75% or so, which is close enough to a zero.

If we stretch the definition of a disaster we get a few more names in there. TransAlta (the parent, not Renewables) is in the doghouse because of its dependence on coal. Atlantic Power took on too much debt and was forced to cut its dividend when power prices didn’t cooperate. And so on. There are probably more of these.

But a) those stocks represent a different kind of risk (business execution risk) that doesn’t really apply here. And b) even if one of my stocks falls quite a bit diversification means I’m not screwed.

Besides, there are probably close to a thousand utility stocks around the world, and most just keep on trucking. If one per year screws up and has to declare bankruptcy over it (I think this estimate is still too high, but let’s go with it) then I have a 0.1% chance of disaster. I’d argue probably every stock I could ever invest in has a similar chance of going up in smoke.

So let’s wrap it up

Just diversify and you don’t have to spend much time worrying about this stuff. There’s also the argument that maybe you should sell a utility as soon as it cuts the dividend, a move that would have avoided some of the PG&E pain.

Either way, I’m not losing much sleep over this. The only thing I’m losing sleep over is my damn cat deciding she’d like attention at 6am.

Tell everyone, yo!