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Utility Valuation: Shedding Light on the Black Box

Experts debate how energy companies should be valued in the wake of electric restructuring and Enron.
Fortnightly Magazine - April 15 2002

the past year since close (). The findings showed that the mergers that were strictly vertically integrated utilities matching up with one another for the purposes of obtaining scale have not been very effective from the market's perspective.

Ciolek says the lessons of Enron and California were that it is very difficult to be a pure play merchant. Going forward, he believes there still might be some companies that want to brave the pure play business model.

But it is a high-risk business with boom-bust commodity driven cycles, which would expose those entities to a great deal of risk, he says. The corollary would be an upstream oil company. When oil prices are going up, things are like gangbusters, but when power prices drop they bear the brunt of it.

Certainly, energy merchants like Calpine and Mirant could benefit from a pairing with an oil major because of its strong balance sheet. Bodington also agrees with this idea. He says that if he had to choose between the diversified utility model or a merchant developer owned by an oil major, he would choose the oil major as the ideal corporate structure.

Take, for instance, Shell trading. Here we have a company that is not involved in vertically integrated utility operations but is a very big trader and they have a AAA credit rating, he says.

"If you want to be a trader, you have to have a AAA credit rating. If it is supported by a vertically integrated utility, great, but if it is supported by a global energy business that involves oil that is fine too. I don't see any reason that trading needs to be restricted to somebody supported by a vertically integrated utility. I think what you have to do if you want to be an effective trader is of course know what you are doing and have a good credit rating, and how you get that is really not very important. You can do that by owning a utility or the Shell model.

"I would have Shell at the top of the list. One of the good reasons for deregulation is that the industry was moribund and had ossified and badly needed to become more aggressive and more dynamic. In a corporate structure where there are subsidiaries that do different things, the approach of having one unrelated businesses has been largely discredited. The approach that involves businesses that can take advantage of each other's skills is proven," says Bodington.

He says the trading organization benefits more from an entrepreneurial culture involved in all kinds of risk management activities than from a highly regulated culture. "I think the skills and the mindset of the entire Shell organization are better suited to supporting a trading company than those of a Duke-like entity."

Trading companies can be very useful and don't need to have hard iron or assets, he says. What any trading organization has to have is a focus on risk management, whether you manage risks through owning iron or power plants or manage risks through financial instruments really don't