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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

trading outfit that has $16.86 billion in debt and other obligations-and less than $2 billion in cash on hand, according to Reuters press reports.

Operations were also suspended indefinitely at Enron's once highly lucrative online trading system, EnronOnline. The unit accounted for up to 90 percent of Enron's earnings, and was considered the jewel of the trading franchise that Dynegy coveted most.

Enron filed to reorganize under Chapter 11 bankruptcy protection on Dec. 2, in one of the largest U.S. corporate bankruptcies ever. Enron also sued rival Dynegy for $10 billion, claiming the fellow Houston-based company had no grounds to scuttle a proposed buyout, according to a press statement.

"I think overall ... that liquidity has tightened up considerably. Whenever you have a major player, whether its PG&E or Enron, and you remove a participant you have fewer counterparts to deal with. If you look at the top 10 or top 6 trading companies, that represents about 80 percent of liquidity in the trading market. It makes it a little bit more challenging to do transactions. Sometimes it will cause a little lack of depth in liquidity in long-term transactions," said Lyn Maddox, president and COO of PG&E's National Energy Group, Trading.

As a result, some say that Enron should be likened to Long Term Capital Management. In September 1998, the Federal Reserve (Fed) organized a rescue of Long-Term Capital Management, a very large and prominent hedge fund on the brink of failure. The Fed intervened because it was concerned about possible consequences for world financial markets if it allowed the fund to fail.

According to one source, the Fed, as well as other energy traders, had been investigating whether an Enron failure would have dire consequences to world energy markets and the U.S. economy. The domestic implications could be substantial, some say, as Enron has represented approximately 25 percent of the U.S. energy market.

"I don't think this is a Long-Term Capital situation. The counterparts of Enron have had time to reduce their exposure to Enron and to begin trading with other counterparts. We ourselves have worked down our exposure. If everyone has done the rational thing, this should not be an issue," says Padewer.

PG&E's Bankruptcy:
A Power Trader's Trial by Fire

Lyn Maddox, the head of PGE's energy trading subsidiary, has seen the worst of it. He's had to maintain a trading business as his company's utility slipped into bankruptcy in 2001-one of largest in U.S. history-as a result of the California crisis. Maddox says he has learned some very valuable lessons from the event-lessons that many in the industry are only beginning to learn as a result of Enron's misadventure.

"I can tell you from experience when you have a bankruptcy event ... as Enron ... as with our utility affiliate Pacific Gas & Electric ... you'll find that some of the credit provisions you have in your trading contracts where you were once a healthy investment grade company and now considered junk is a very challenging event," he says.

One thing that always happens in credit that