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So-called 'round-trip trades' and what FERC should do about it.

Historically, the energy industry, for sound or unsound reasons, has placed a lot of weight on the level of company trade volume relative to its peers. If there were any doubt, you need only look at the recent equity performance of Dynegy and Reliant Resources after recent disclosures of round-trip trades that inflated trade volume. Round-trip trading is the practice of executing mirror-image transactions, in which two companies enter into a trade at the same price, quantity amount, and delivery point.

Although such transactions boost volume and revenue, there is no material impact on either company's reported net income. Following the initial May "round-trip" trading disclosures by Dynegy and Reliant, each company's stock price dropped by more than 40 percent, representing billions in lost market capitalization.

In fact, Reliant last month also acknowledged that round-trip trades boosted stated volume and revenue.

Given this, why has trade volume historically been one of the key measurements used when evaluating an energy-trading firm's financial health? The main reason is that as this sector has rapidly developed there has been a tendency to gravitate to a single industry rankings benchmark that could be consistently applied to individual companies as well as to peer group performance.

In fact, published industry rankings based on volume traded have been used to determine market dominance, validate growth strategy, evaluate a potential merger candidate, or to determine whether to extend credit to counterparts.

Power trading companies that make the cut on the top-10 ranking list essentially have won the right to brag ... or have they?

Actually, as measured in total megawatt hours sold (MWh) for 2001, the top-10 trading entities represent about 55 percent of overall traded market volume. Companies that are able to make it on this list have, what is affectionately referred to in the industry as, "bragawatt" rights.

For example, total U.S. power trading volume in 2001, as measured in MWh, was approximately 6.7 billion. Of this total volume, the top-10 energy traders represent approximately 3.7 billion MWh and the top-five largest energy-trading firms traded approximately 2.6 billion MWh. Examples of top-tier companies, which have previously made it on both the power and gas trading league tables, include Enron, AEP, Dynegy, Duke Energy, Mirant, El Paso, Aquila, and Reliant.

The formula to break into these rankings has been quite simple; trade lots of volume and make sure you submit the quarterly sales numbers directly to FERC and to publications that provide industry rankings.

In energy trading, how widespread is the practice of entering into non-economic trades for the sole purpose of inflating trade volume? Some experts have estimated that such non-economic trades could make up 10 to 15 percent of the total trade volume conducted by the top-10. If we were to take the total volume of MWh traded by the top-10 in 2001 and adjust it to reflect round-trip trades, this estimate would represent as much as 600 million MWh. Assuming these related power transactions represent a mean price of $50, the estimated amount of