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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

work for their business model is high gas prices and low power prices and overcapacity. There is a lot more focus on business strategy. Where does that company fit? Are they asset light or asset heavy? The talent that is being hired on the credit side is getting much more sophisticated. You are seeing more former banker types that are not only familiar with good credit, but more importantly bad credits that haven't worked out. They know what it is like to make a loan and have it go south. A lot of the credit officers in the power industry are brand new and they haven't worked through a situation like that."

As a result of Enron's now famous losses from its off-balance sheet transactions-which when reported, caused an investor backlash and reversed the company's fortunes-risk managers are now concentrating their attention on these sort of off-balance sheet deals by other counterparts, Williams says.

"A perfect example is, two weeks ago El Paso went to the market and said, 'Hey, we don't have very many off-balance sheet transactions, but this is what we do have.' They are very transparent to Wall Street. They said, 'Hey look at us,' " Williams says.

Furthermore, questions of what percentage of earnings are being generated as steel in the ground versus trading operations, which are a less predictable revenue stream, are being asked. "That is an important question. That is the question that wasn't being asked just six months ago," he says.

"With Enron, the majority of their revenues came from trading operations. Take a shop like Reliant, and a much smaller percentage comes from trading operations and the rest come from owning steel in the ground. Look at Calpine. How much of its revenue is trading related versus steel in the ground? [It has] a lot of projections of phantom plants that they are going to be putting up in the next 3 to 5 years. But clearly trading revenue is a very small percentage of their overall revenue. The quality of their revenues as it relates to trading revenue is less in question."

Brett Humphreys, a principal consultant at Risk Capital Management, explains that an outgrowth of the Enron credit issue is that good credit risk managers are not simply taking the ratings from the ratings agencies for granted. "They are doing their internal analysis. They are looking at the financial statements. They are looking at the company and saying, 'Is there anything that I should be concerned about?'" he says.

"The problem that many of these companies face is that Enron was the only counterpart. You had a choice: You could not trade, not get into or out of these positions, or take on more credit risk with Enron. If you could negotiate deals with Enron to give yourself some collateral or credit protection, that was great. But, a lot of companies didn't."

Diversification: Is It the Key?

The Enron debacle made one thing quite clear: the power industry had too much exposure to one counterpart-Enron. Going forward, the industry is taking steps