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Bursting The Bubble

Merchants' trading volumes and revenue are still too inflated.

Fortnightly Magazine - June 1 2002

percent and 40 percent, respectively, for their fair-value based on models and allowed a premium for El Paso due to its 91 percent of fair value based on active quotes.

The assignments were based on CSFB's opinion that the "most risky fair-value basis is mark-to-model, because of the subjectivity, and the most secure is prices based on active quotes in futures markets."

Also, the I-bank prefers to see relatively low-less than 20 percent-of EBIT derived from trading, because it is the most volatile.

But while high power clients of CSFB may glean new insights into the financial health of energy traders from highly intelligent equity research analysts, much of Main Street continues to be in the dark, preferring not to invest in anything that appears to be Enron-like.

Naturally, there is talk that the Emerging Issues Task Force (EITF) of FASB is looking again into whether to force energy companies to report their energy contract revenues on a net basis, rather than gross.

Meanwhile, like most industry watchers, I like to see the industry do well and get all the accolades it deserves. But I'd rather see those accolades bestowed on those who made it by reporting net.

Of course, that would mean that not everybody would make the Fortune 500 that made it in previous years using gross reporting. But isn't that the point? It should be a rating of all industries held to the same reporting standard.

Furthermore, energy companies might learn from some of the troubles Dynegy, Reliant and CMS Energy are experiencing from inflating their trading volumes.

Energy Trading Volumes: The Industry Joke that Became an SEC Investigation

Every quarter the energy trade press index newsletters have long published volume rankings to establish the so-called best-of-the-best in energy trading and marketing.

But when I have investigated this issue in the past, I have found that those very energy traders don't put much stock in it-as these marketers have readily admitted that volumes tell little as to the profitability of the trading concern.

And some marketers privately have admitted to inflating their volumes purposely to get a top ranking.

Even as traders publicly shrug off the volume rankings' significance, one finds those ranked highest promoting the fact in marketing material or on the trade floor to potential investors and clients. Even investment bankers that I know use those rankings in pitch books and presentations to potential clients.

That is probably why what has been a long-standing joke inside the industry is no laughing matter to a Securities and Exchange Commission wanting to protect investors from being duped-and already suspicious of power marketer accounting practices.

For example, U.S. financial regulators in mid-May put the microscope on electric-power trades by Dynegy that canceled each other out but appear to have boosted the energy company's trading volumes.

Dynegy's trades with a unit of CMS Energy were valued internally at a combined $1.7 billion and would have accounted for 13 percent of the total fourth-quarter value traded on Dynegydirect, according to the Wall Street Journal.

Experts generally agree that the prevalent reason is