[BETA] Fortnightly

Have they gone too far? Have ratings agencies become overzealous in their efforts to rein in energy merchants? Many in the industry are coming to that belief after Aquila, one of the industry's most respected companies and leaders, announced it would exit the merchant energy trading sector in late July. It said it could no longer meet the credit requirements imposed by ratings agencies to maintain that business.

It is one thing, and right, to demand more transparency and disclosure from energy merchants after the Enron debacle-to insist on standard rules that protect energy consumers and investors alike from another Enron, and insure that energy merchants have enough capital to carry the risks that they take.

But it is altogether different for ratings agencies to dictate terms that some say are unfair and applied inconsistently. Such terms could destabilize wholesale energy markets by eliminating the able players, like Aquila. They could undermine FERC's initiatives to establish competitive markets, while killing off future investment in infrastructure at the same time.

In Prudential Financial's June 20 report, analyst Carol Coale says, "more than we can ever remember, the [ratings] agencies are dictating the short-term and now long-term strategies of many energy companies." She also criticizes Standard & Poor's and Moody's for recent reports on revised criteria by which energy traders will be rated, saying, "the two agencies do not appear to have a unified, coherent set of goals for the traders to achieve."

In its June 11 report on energy merchants, S&P waffles by stating that it requires an amount equal to about 25 percent of the sum of the market, operational, credit risk, plus all other identified capital requirements, to be in liquid assets. In the very next sentence, S&P says it will also evaluate, case-by-case, whether a higher amount is needed based on the trading company, its trading strategy, and its volume transactions particularly, in order to maintain investment-grade ratings.

Meanwhile, Coale sees problems with setting a target for a 50/50 debt/equity capital structure. Apart from forcing up the cost of capital, she feels that a 50/50 ratio could make the financing of future infrastructure more expensive. That could lead management to scrap certain projects that would have been considered viable under a more leveraged capital structure.

Not to mention that in an effort to shore up their balance sheets, companies would find they were forced to sell income-producing assets, or cut back energy trading activities in many cases, she adds. Of course, Moody's makes no bones about its warning that energy merchants with significant trading operations will be downgraded to junk status unless these activities are downsized, combined in a joint venture, or spun off into separate entities.

Wanted: Banking Experience

In its May report on energy merchants, Moody's said it expects there will be a consolidation of industry participants into a smaller number of well-capitalized companies with diverse asset bases and strong liquidity profiles.

"This includes the participation of financial institutions with solid credit ratings and trading operations that are broadly