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Collateral Damage

Credit ratings agencies put the squeeze on merchant power.

Fortnightly Magazine - July 15 2002

diversified by asset class, customer and geography," the Moody's report says.

Moody's cites investment banks like UBS Warburg and joint ventures like Entergy-Koch as examples of the types of companies it wants trading energy.

But banks have been fickle on energy trading in the past. In the last five years, J.P. Morgan and Merrill Lynch closed or sold their energy trading businesses. Credit Suisse First Boston, it was reported recently, backed away from plans to trade energy in Europe. Even GE Capital took a passive investment in the now infamous Power Company of America (PCA) as an entry to understanding the business, but turned tail when PCA lost $200 million during the 1998 Midwest price spikes.

Certainly, one might be optimistic about recent entrants such as UBS Warburg and Barclays, but who is to say they may not head to the exits in a New York minute, especially as UBS' investment is said to be not nearly as profitable as it was under Enron.

Morgan Stanley and Goldman Sachs have been consistent energy merchant players over the years, but the banking sector and less than a handful of diversified energy conglomerates does not a market make.

Furthermore, Entergy-Koch style tie-ups (as Moody's suggests) are great when they work, but artificially forcing the industry into greater consolidation could lead to less liquidity in markets, and more opportunities for market power abuse. The top five energy merchants make up the bulk of participation in energy trading. Cut the number of firms in half through partnerships or mergers, and you are suddenly looking at an oligopoly situation in which the idea of competition in wholesale markets is a fantasy.

Should ratings agencies have the power to dictate the strategy of companies (especially if it is inconsistent), and in doing so, dictate the size and competitiveness of wholesale markets, the liquidity of markets, and therefore potentially impede just and reasonable prices due to a lack of competition? I thought that was the job of an independent government agency-entrusted to set universal standards.

FERC: Dropping the Ball?

It seems a bit ironic that an agency that has spent so much time developing a standard market design (SMD) may not have enough players in the market next year to participate. In other words, the Federal Energy Regulatory Commission may have lost sight of the bedrock fact that you can't have a market without market players.

Many say FERC has done wonders in forwarding the cause of defining competitive markets, but has dropped the ball on defining and monitoring the role of energy merchant players, and because of this, other non-governmental agencies are eating FERC's lunch.

In fact, a recent General Accounting Office report concluded that FERC lacked the insight and resources to monitor effectively the wholesale electricity markets it is trying to create. Furthermore, the report found that FERC has been "attempting to implement a regulatory and oversight approach ... with an outdated legislative framework and using authorities that may not be adequate for today's competitive markets." Chairman Wood largely agreed with the report's conclusions.

Some say what