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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.

Fortnightly Magazine - January 15 2003

reporting approach will require companies to retool their trading systems so they can categorize transactions and report the appropriate data separately for the CCRO tables.

“When you break up the portfolio like that, it drives you to focus on each of those categories,” Allott says. “If you break it out you can see how much of earnings is influenced by the proprietary trading book, and you can actually represent the variability of physical facilities—that is, to represent a power plant as a power plant.” Such a view of trading activities should provide significant insight into a company’s risk profile.

And finally, with respect to trading, the CCRO’s recommendations regarding valuation and risk metrics are pertinent. However, they are non-prescriptive enough that any reasonable risk-management process should cover the recommended practices without much trouble. Indeed, the industry seems already to have moved beyond some of what the CCRO is recommending in this area (see “ Where the CCRO Fell Short ”).

One possible reason for the CCRO’s broad-brush approach to valuation and risk metrics is that no universally agreeable set of pricing curves exists as a basis for comparison. “Everyone values things differently. There are no standards, and everyone is left to gun and run, so to speak,” Bell says. “The jury is out on whether the CCRO standards will have enough teeth.”

"Teeth" is precisely what is needed for the CCRO standards—or any standards, for that matter—to become universally accepted and to bring confidence back to the electricity trading market. “We think the CCRO recommendations are a step in the right direction,” says Standard & Poor's analyst Jack Kennedy. “But it would be better if there was some type of independent oversight with respect to the reporting recommendations.”

The CCRO concept, thus far, has been based on voluntary participation, but the standards could evolve into something more binding. One possibility would be for regulatory agencies like FERC or the Securities and Exchange Commission to use the CCRO recommendations as the basis for binding rules. Alternatively, ratings agencies could adapt the standards and implement them as part of a new valuation framework, or the CCRO itself could evolve into a systematic enforcement body. Or perhaps a smaller group of industry leaders might take the next step and become the de-facto benchmark for the rest of the industry.

Until then, the CCRO recommendations serve the purpose of establishing a threshold for the industry. “The industry needs to promulgate a set of minimally acceptable standards. That’s where I think the CRO group has done an excellent job,” says Cohen of PricewaterhouseCoopers. “The key now is to create a tightly integrated risk-management framework that clearly defines risk appetites, acceptable behaviors, and expected results.”

Companies that are unable to meet this challenge, at least in general terms, will not be well positioned to survive in the future electricity trading market, whatever form it takes.

Leaving Limbo

Alongside credit weakness and evolving standards, regulatory uncertainty is the most severe chilling force in the markets today. While FERC has made significant progress, issuing a notice of proposed rulemaking