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The Utility Sector: A Wall Street Takeover?

Financial players bring credit depth to energy markets, but will they play by the rules?
Fortnightly Magazine - January 2004

necessarily willing participants, however. Specifically, some banks are taking possession of merchant power plants when their original owners default on senior debt obligations. In the past year, Exelon, NRG Energy, and PG&E's National Energy Group together surrendered nearly 10 GW of generating capacity to lenders BNP Paribas, SocGen, Citibank, and ABN Amro. More such defaults are likely to follow in the next year, through loan write-downs and bankruptcy proceedings.

Given the current depressed market for merchant assets, banks seem likely to hold on to such facilities until such time as they can liquidate them in a more favorable market. Some banks are trying to negotiate long-term power sales contracts, but that will prove difficult for merchant plants facing a negative spark spread. How banks will manage such plants in the meantime remains to be seen.

"The previous owners might have been in the business for cash, but the banks could take a more sophisticated view," Hunter says. "Their balance sheets give them the flexibility, for example, to take plants off line if they think it will lead to better prices in the market for their overall portfolios." That is what happened in the United Kingdom and Spain, Hunter explains, when better-financed buyers acquired power plants but then faced a negative spark spread.

The degree to which a plant owner could employ such a strategy in this country, however, is another question. In issuing its market behavior rules in November, the Federal Energy Regulatory Commission (FERC) said that causing or attempting to cause an "artificial shortage by physically withholding sufficient and otherwise available power from the market for the purpose of raising the sales price obtainable by other units participating in the market" would be considered forbidden market manipulation.

Legal Limbo

In some sense FERC's market-manipulation rule is unfortunate, because it may discourage speculators from trading around price imbalances-a basic function in an efficient, liquid market. Listen to Sharon Brown-Hruska, a commissioner with the Commodities Futures Trading Commission (CFTC):

"In our effort to squelch manipulative behavior, we may end up unwittingly nurturing it by encouraging noncompetitive, illiquid markets," she said in an address given in October. "The true enemy of manipulation is competition and liquid markets."

Not only does overly broad regulation discourage competition. The mere prospect a federal agency bringing charges of market manipulation can add uncertainty to the already frail wholesale power business.

"A FERC investigation can go on for weeks and months. The impact on ratings can be more significant than the penalties might be, because it creates uncertainty," Hunter says. "That gives us cause for concern."

Uncertainty, of course, is the enemy that risk managers are always struggling to defeat. So the banks and financial houses must learn to navigate the industry's shifting regulatory landscape, along with everyone else. Several key features of this landscape remain in flux as the new year begins:

  • Little Experience. FERC's market behavior rules are brand new, and have yet to be tested in either the real world or the courts. The commission waded through comments from more than 60 companies during the review