DCF Utility Valuation: Still the Gold Standard?
The Utility Sector: A Wall Street Takeover?
Financial players bring credit depth to energy markets, but will they play by the rules?
The center of gravity for energy marketing and trading activity is moving from Houston to Wall Street. Some major financial institutions already have plunged into the market, while others are testing the waters, gearing up to participate in a bigger way. Already their impact is being felt, and it is most definitely welcome.
"Financial players are providing a significant portion of the liquidity in the market-on the order of 30 to 40 percent," says Richard Hunter, managing director with Fitch Ratings in New York.
Financial companies that are trading gas and electricity contracts include commercial banks like ABN Amro, Bank of America, Citigroup, Deutsche Bank, JP Morgan, and UBS; hedge funds, including Citadel Investment Group, DE Shaw & Co., and Susquehanna International Group; and investment banks, like Goldman Sachs, Morgan Stanley, and even Merrill Lynch (which sold off its energy trading organization to Allegheny Energy in 2001 and was sanctioned by the Securities and Exchange Commission for its Enron dealings). According to sources at Merrill, the firm established an oil and gas trading desk in April 2003, and hired several people to conduct trades.
While some firms are taking tentative steps into the energy markets, others are making bigger investments. Goldman Sachs and Morgan Stanley, in particular, are putting money in the ground by acquiring hard assets in fuel and electricity. Most recently, in October 2003, Goldman Sachs agreed to acquire Cogentrix Inc. in a $2.4 billion deal that includes 26 power plants generating 3.3 GW of capacity.
"Our strategy is to have a balance between physical and pure financial activity," says Doug Kimmelman, a partner and managing director with the Goldman Sachs Commodities group in New York. "We believe that owning a modest amount of physical assets will help give us credibility and stability in the marketplace. It will also help to educate us on market dynamics that will benefit our trading activities."
The facilities acquired by the company all sell power under long-term contracts-a sharp contrast to the merchant plant concept (though some excess capacity remains, which Golman says it will sell at wholesale.)
"Merchant plants still face some significant valuation hurdles," Kimmelman says, pointing to the negative spark spreads that have submerged the merchant power industry. "We'd prefer not to take the price risk associated with a merchant plant, and we think we can meet our strategic objectives of building our power marketing and trading business through ownership of contracted assets."
Goldman's strategy won't help the ailing merchant power business, but it does represent a bright spot in the otherwise gloomy wholesale power market. "Buying up contracted plants is just monetizing contracts. But financial players are getting into energy marketing and trading, and that is something to watch," says Peter Rigby, a director with Standard & Poor's. "They have the balance sheets and expertise necessary to succeed."
To the degree these and other well-financed companies enter the energy trading business in a significant way, the market's long, dry spell could be coming to an