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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


Energy traders and risk managers reengineered their business dealings to manage against unexpected political and financial risks posed by California and Enron in 2001.

The rules of energy market survival changed forever in 2001. California, one of the biggest U.S. energy markets, and Enron, the biggest domestic energy trader, were both humbled by gyrating prices and blackouts in the Golden State, and financial misadventure dethroned the once-crowned king of energy trading.

These twin events sent shockwaves through the very foundation of the energy trading and risk management establishment, which found it was caught ill prepared to handle the financial repercussions of the California crisis and the Enron financial debacle.

"We look at political risks around the world. We look at political risk in South America, Europe, everywhere. Two years ago, we didn't expect California to be the political risk it became," says a still disbelieving Harvey Padewer, Duke Energy's group president, energy services.

"The lesson in California is that it has a big crisis if they don't let market signals work. If they don't allow and encourage power development, they are going to be right back where they were. I think clearly over the long-term the federal government has to understand that price caps really limit market signals," Padewer says.

But while many energy traders and risk managers have since quantified, calculated and curtailed their financial exposures to the California crisis, many are still at a loss to explain what the impact to the industry will be as a result of Enron's financial woes.

On Nov. 28, Dynegy reported that it had terminated its previously announced merger agreement with Enron. The merger was seen as a last-ditch effort to save Enron from its financial troubles.

Surprise disclosures, including the admission it overstated earnings by almost $600 million since 1997 and kept huge debts off its books, led investors to lose faith rapidly in a company valued at almost $80 billion a little more than a year ago, according to Reuters press reports.

In early December, Enron's market value was barely $450 million. A U.S. regulatory probe into its murky off-balance sheet dealings and the unexpected departures of its chief executive in August and its chief financial officer in October helped fuel the fall.

On the day of the Dynegy's merger termination, Standard & Poor's, Moody's Investors Service and Fitch Inc., all downgraded Enron's long-term debt to below investment grade or "junk" status. In Enron's own acknowledgement of the merger termination, the company said that it would temporarily suspend all payments other than those necessary to maintain core operations.

"The industry has reacted well to the potential loss of a market participant over the last several weeks. With superior systems, technology infrastructure and people, Dynegy and its industry are ready to absorb any added volatility in the energy market," said Steve Bergstrom, Dynegy president and COO.

Dynegy said it stopped trading with Enron the morning of Nov. 28, pegging its exposure at $75 million. Other traders said they would deal with Enron on a cash-only basis, a virtual death sentence for a