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Price Spike Roulette: Can Utilities Play By Wall Street's Rules?

Fortnightly Magazine - October 15 1999

operating income of $600 million, a 64 percent increase. Furthermore, in one year's time, J.P. Morgan's stock price jumped from around $97 in 1998 to near $129 in early September, a show of shareholder confidence, analysts say.

"For our core activities, the crisis was one of the most stringent market tests ever. We learned many tactical lessons, but fundamentally our risk management processes and operational support areas performed well," says Douglas A. Warner III, chairman and chief executive officer of J.P. Morgan, in annual report materials.

Could a utility like Cinergy make such a fast turnaround?

Merrill Lynch thinks not. "We are able to conclude that Cinergy remains at risk for another heat-driven supply and price spike, that mitigation measures will be taken and those will cost money. How much risk and how much cost are hard to quantify," according to the analyst report.

At least some bond analysts disagree with the stock analysts. "Moody's believes Cinergy's July failures and losses to be a legacy of Cinergy's previous power trading strategy and not reflective of Cinergy's supply and power marketing strategy going forward. ¼ Moody's expects Cinergy to be able to meet its obligations during high-demand periods in future years," says Andy Jacobyansky of Moody's Investors Service. Moody's did not change Cinergy's "stable" ratings outlook and has removed the company from review, he added. A "stable" ratings outlook, as opposed to a "negative" or "positive" outlook, indicates Moody's determination that barring unforeseen events, the ratings will remain stable for 18 to 24 months.

Nevertheless, bond rating agency Standard & Poor's on Sept. 16 was not swayed by Moody's confidence, assigning Cinergy a "negative" outlook. According to S&P press materials, "Standard & Poor's is concerned by Cinergy's decision at the beginning of 1999 to cover its potential exposure of 5 percent on full requirement contracts with hourly sales rather than purchase options. This indicates that Cinergy's risk appetite may be greater than previously judged and is not fully captured in the consolidated business profile."

However, a bond analyst says the business community does not recognize as significant a difference of one notch or level among ratings agencies. In the case of Cinergy, he says, the S&P review is not viewed as significantly different from the Moody's review of the company because the ratings outlook is only one level of difference.

UtiliCorp's Payne explains why Wall Street and Main Street view utilities and investment banks differently when it comes to risk.

"Investment banks are seen as the professionals when it comes to managing risk. Those who invest in investment banks know what they are getting into. The person who invests in Cinergy does not want earnings volatility. Shareholders still see electric utilities as the stable, low-risk investment for widows and orphans."

Management:

Blinded by the Duty to Serve

Some executives say that utilities like Cinergy will be at risk of default no matter how much risk management is practiced because of their adherence to the traditional utility "obligation to serve." That view is growing among financial experts.

"Between its core utility requirements [obligation to