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Energy Trading: Down But Not Out
The speculative electricity trading industry has a bad case of rigor mortis, but current efforts might breathe new life into the practice.
words, life goes on—just in a different form. (See Table 1, “Maturing Markets.”)
Without speculative trading, however, liquidity and price discovery have suffered, and this has, at best, crippled the market. “It used to be with gas and electricity you could get forward prices four or five years in the future,” says Kevin Howell, president of Dominion Energy Clearinghouse. “But the liquidity has disappeared along with the big wholesale counterparties.”
The result is a lack of price transparency. Most of the trading volume is occurring on an over-the-counter (OTC) basis, and as a result forecasting and hedging have become more difficult. Adding insult to injury, many of the counterparties that remain in the market have suffered serious financial trauma and are no longer creditworthy. This further complicates hedging efforts.
“Creditworthiness of counterparties has probably been a bigger issue for us than anything else,” says Dan Verbanec, a senior vice president with WPS Energy Services, the trading affiliate of Wisconsin Public Service. “We do structured deals with utilities or end users, then go to the market and hedge it off. Today, the ‘hedging it off’ part is where the problems come in. We’ve become more careful and disciplined as we create products for our customers.”
Many continue to hold out hope that major players—possibly financial institutions—may bring some liquidity back into the market. But for the moment, the signs look bleak. In November 2002, UBS Warburg announced that it would eliminate the former Enron Online trading operation in Houston, and that only 90 of the 380 employees would be offered positions at the firm’s Stamford, Conn., offices.
The fact that UBS is retaining part of the former operation might be seen as a bright spot, albeit a minor one. “UBS sees a future in energy trading, but its operations have to be sized to the opportunities that currently exist in the market,” says Jennifer Walker, a spokesperson for UBS Warburg Energy. Contrary to popular conception, UBS was not involved in energy trading before it acquired Enron Online. “We were essentially a startup in February 2002,” Walker says. “UBS didn’t inherit any of Enron’s trading book or positions.”
Nevertheless, on balance the contraction of UBS Warburg Energy signals continued hesitancy among the banking community to commit major resources to the electricity market. Bank of America, which won FERC approval in late October to become an electricity trader, has yet to begin promoting those services. And rumors of other institutions entering the market have remained just that—rumors. Incumbent financial players that remain in the market are sticking to providing hedging structures for clients.
“Morgan Stanley has been in this market for a long time,” says John Woodley, a Morgan Stanley trader. “We haven’t pursued speculative trading. But the basic need for price-risk management services, the service we provide in our trading function, will get more important, not less important.”
While this function is important, it does nothing for volume and liquidity. “What firms like Morgan Stanley do is complicated one-off transactions that span three to five years,” Williams says. “Sophisticated sellers of these products will