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Reign of the Bond Kings

S&P, Moody's, and Fitch tell why credit issues now rule the energy sector.
Fortnightly Magazine - October 15 2002

AEP, Entergy, or Duke-which could afford to be expanding the merchant energy side, he says. Then you have companies who don't have that substantial amount of physical capacity under lock and key, Hunter says.

"It all comes back to diversification. It's different if merchant energy is the sole business or it is part of the business such as risk management." Hunter believes that companies like Aquila that ramped down their trading business and sold assets may have overdone it. That is why that company is on credit watch, he says, because of their concern about the business that was left.

As to the outlook for growth, Hunter answers by turning the question around and asking how the agencies would have reacted:

"Let me answer this question by going to a parallel universe where the merchant energy traders were sailing happily along and 2002 had not happened as it did and Enron had not gone bankrupt. In addition, there had been no cancellation of new capacity, consumption boomed along."

"Would ratings agencies be upgrading companies because they were showing significant double-digit vast growth in the merchant venue?" asks Hunter.

"No, we wouldn't be. We would be saying OK, we would discount that because we can say that this is the product of a boom. We will go through a leaner period where they won't get that kind of income. The positive benefit of their growing their earnings through merchant trading wasn't going to impress us, and I can't imagine that it would have impressed our two competitors."

So Hunter believes that any conception of growth in the energy industry has to be seen in the larger context of the commodity cycle.

And what if power plant development is necessary to meet new demand in a few years?

The three ratings agencies say they wouldn't stand in the way-but would hold energy companies to post-Enron credit requirements. Diaz explains that many firms funded unregulated assets with the same type of capital structure they used to fund regulated assets.

"If indeed the demand was there, the question is whether there will be equity investors willing to fund either acquisitions or expansion of these assets. To the extent that there are, there would probably be debt investors that are willing to fund their portion. If indeed that happens, there probably would be funding available."

Downgrades: Remorse or Revenge?

Some executives have charged that ratings agencies are getting back at the energy sector for having had their trust broken and their reputation tarnished. Yet that charge earns a quick denial from S&P, Moody's, and Fitch. The agencies have insisted all along that they have remained consistent in their analysis of the energy industry. As noted earlier, a recent report from Merrill Lynch appears to support that claim.

At Moody's, Diaz says he wants the industry to understand that it is the companies that have gotten into the situation. Simply put, they had a lot of debt and their cash flow began to dry up because of changes in the fundamentals of the power market and the trading