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Gas-Electric Mergers: Money Well Spent?

Fortnightly Magazine - March 1 2000

In a study of the top industry players, Stephenson found that in 1998 the range of physical gross as a percent of revenue was 0.03 percent to 2.19 percent. The average was 1.5 percent for gas and electric combined.

"Last year when we did it based on 1997 data, the average margin was 2 percent," he says. "We have gone from a margin of 2 percent to 1.5 percent. ¼ What this means is that if you sell a dollar revenue wise, you are lucky to make 1.5 cents."

To increase the margins, Stephenson says energy companies have been adding products and services such as risk management services, taking risks for customers, pricing options and offering financing.

Furthermore, Stephenson adds, there is tremendous churning of financial volumes.

"You see as much as 6:1 in natural gas, and in power, it trades as high as 9:1. [For example], if you take 1 million (MM) Btu of physical gas, energy companies are trading as much as 6 MMBtu of financial gas," he says.

Stephenson blames the high churn ratio on the volume focus many energy companies have adopted.

"They do this because the only published metric these companies have to go on are [FT Energy's] Megawatt Daily and McGraw-Hill's Power Markets Week [newsletters]," he says. But Stephenson claims there are problems with this published data because no standard for reporting data exists.

"Some people report on the physical volumes and some people report physical and financial volumes combined," he says. "We have found that they understate from 3 percent [and] overstate by 72 percent."

Every time an energy company makes such a transaction to boost volumes for window-dressing, warns Stephenson, it adds costs or takes speculative positions that could erode margins.

Long-Term Investments?

Maybe You Should Rent

"We believe there [are] going to be some cycles associated with these [electric and natural gas] commodities. Someone in this business has to effectively manage around those cycles, and that is why you will often hear us talking about buying and selling assets," says Duke Energy's Priory.

Priory says he continually must guard against owning power plants where they are not needed and shorting gas in regions where gas is not available at an attractive price. An energy company should be able to continually reposition its assets as market conditions change, he says.

"It is no longer a buy and hold deal. You used to always buy and hold for electric utilities. You would buy your plant [and] forecast the economic cycle for the next 25 years - with the full expectation that you would own that plant for the next 25 years. Then you would play out that cycle. You would win or you would lose based on how well you did against that cycle," he says.

The energy industry, however, has changed in the past four years, says Priory. Instead of the traditional buy and hold deal, he says the business revolves around buy and profit-generation cycles.

"We have to continue to reshuffle our assets and move them around and reposition them not only to