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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

1988 Basel Accords set bank capital standards for market risk (the risk that a bank's value may be adversely affected by price movements in financial markets).

"Fundamentally I don't think the government ought to restrict innovation and progress and fundamentally all these systems are the next generation of communication," he says, adding that while the speed of transaction and the cost of transaction comes down, the issue of counterpart credit is the same.

"The notion of the government regulating the way that government extends credit to another counterpart, or the way in which lending is performed, is something the government has seen fit not to do and would not be appropriate," he says.

Furthermore, he explains, in a clearing structure (which ICE has proposed) where you have mutualization of risk among a variety of parties, there is no meaningful capital obligation imposed by the CFTC.

In addition, anyone who trades with anyone else ought to be comfortable with the credit of its counterpart. "Where is the federal government providing value in that discussion? I don't think it does," he says.

He explains there are a lot of reasons why banks have to have capital requirements associated with their business because of the functions they perform and the central role they have in the U.S. economy.

"General Motors does not have a capital requirement. Dupont does not have a capital requirement. So, what is the value added of imposing that? It basically means that you are restricting the freewheeling, free enterprise economy for reasons that cannot be justified. If you decide to do business with another company, you take the risk of that company's default. That has always been true. That is inherent in any contractual relationship. The notion that the federal government is there to protect the company or to protect you, or to protect the safety and soundness of that deal that you have done, that layers into the equation a cost."

Raisler concludes that the fact that the commodity is highly volatile only emphasizes the need for state-of-the-art risk management, or a lot of capital. "I don't think that there is anything that distinguishes trading in one volatile commodity versus another commodity."

Paper or Physical? Energy Markets Get More Physical

In the wake of the Enron situation, energy traders and risk managers say they prefer pure power, rather than a check, to back a deal.

"I think a lot of players don't want the bank and a lot of non-physical players getting into this business. It is not in their interest to divorce physical from financial. It helps to erode their competitive advantage. Going back to Enron as an organization that pushed things in the direction of paper or financial deals. As a result, there is a push back from that. There is a natural regrouping," Shimko says.

"What we have learned is that you can't use paper to manage your risks. A classic example is when the Olympic Committee was looking for power suppliers for Atlanta, they had two bids to consider. A bid from Southern Co, the incumbent,