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Energy Trading & Marketing: The Evolution of the Deal

Energy traders and risk managers reengineered their business dealings to manage against unexpected political and financial risks posed by California and Enron in 2001.
Fortnightly Magazine - January 1 2002

people forget about is that contracts have to be unilateral in case the tables are turned, Maddox says. "That is oftentimes what haunts you. If you are high investment grade at one point in time and the next thing you know you are junk, your own language will eat you alive.

"[Furthermore], what surprises people is the amount of cash that it can draw out of an organization. I know that Enron [had] to be feeling [the] pain. Certainly, we went through our period where we tried to keep up with those things. But counterparts were very good to work with us and we managed through it," he says.

Maddox says his success at restoring investor and counterpart confidence could be attributed to doing one very critical thing: living up to the letter of the law in all his contracts with counterparts.

"The first thing we had to do is we absolutely lived to the letter of the law in all of our contracts. We did not want anybody to use the case that we had defaulted on a performance event or payment event, or anything like that. That gave our counterparts the confidence that [we're] going to perform no matter what under our contracts."

The other thing Maddox did was to make sure that the credit department's independence remained strong when enforcing its requirements on the trading organization.

"Particularly in energy, there seems to be a lot of strong personal relationships out there and often times that clouds the best judgment while people try to manage their credit issues. But it is nothing personal. You have to make sure you protect your shareholders and protect your company by having sound credit requirements. We have very formal requirements through our risk management policy that we have to produce."

Furthermore, Maddox says that during a credit crisis a company wants to have many different types of collateral facilities at its immediate disposal so the company can respond to the event.

"The perception creates the reality. There are events in the market that will make it look like you are a worse credit call than you are. People get concerned about your ability to be able to handle your market calls. Often times, the only way to deal with market calls if you have big positions on, and high volatility, is to either liquidate those positions or to post cash, or letters of credit."

Finally, Maddox believes that the company's asset-based strategy helped it through its darkest hour. "A strong balance sheet, whether you are regulated or non-regulated business, is absolutely necessary to be in the energy business."

—R.S.

Yet some feel Enron will never be able to be completely replaced-since the company took risks that most others were unwilling to take-which has precipitated the current liquidity crisis.

David Shimko, a principal consultant for Risk Capital Management, a boutique risk consultancy, and a finance professor at the Harvard Business School, explains, "There are two kinds of liquidity crisis [that developed] with Enron. One is that a lot more people are trying to be more