The Fourth Wave


Are banks better at trading power than utilities?

Are banks better at trading power than utilities?

Fortnightly Magazine - October 1 2002
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Bank of America's recent request to FERC to be allowed to trade power was yet one more reminder that a whole new class of companies are quietly positioning themselves to dominate what's left of the energy trading space after the departure of traders like Enron and Aquila.

As a result, many energy executives are wondering whether these newcomers will bring greater liquidity, transparency, and discipline to a market that has lacked all three in the last year. Some even quietly hope that the banks might restore a level of credibility and prestige that has been lost amid disclosures of sham trading and market manipulation.

One energy trader describes the current state of energy markets: "There have been significant market impacts. People are behaving differently. There is a lack of liquidity at many locations now. There is declining participation and fewer creditworthy counterparts. But I don't think our process has changed."

The head of energy trading at a Wall Street investment bank I spoke to on a recent trip explained the new phenomenon as a natural evolution of the market:

"You first had the small and large independents-the federated types like a 'Spark Energy' and Enron. Then you had utility affiliates like Cinergy, Aquila, and Duke. Then you had the merchant independents… and now we have Wall Street-the fourth wave."

Furthermore, he believes that neither energy companies nor utilities were ever well-suited to be trading in the first place.

"I won't say that there wasn't any talent out there… [But] I think it is problematic for a business to be engaged in managing the risk of developing, the risk of operating, and price risk at the same time. There are different skill sets involved. I think you are starting to talk about a conglomerate. Conglomerates are a little bit out of style."

In reality, he says, the utilities never had the balance sheets and credit strength to be trading. "It is high time people wrote about this stuff. It is preposterous how the industry was offering credit. Why was everybody shocked that Enron went down? It wasn't a great credit rating."

Furthermore, the banker believes that the conglomerate approach has led many utilities to lose sight of their true business, operating and managing power plants. In fact, it is this confusion over what business utilities were truly in that was reflected in the bizarre descriptions they would sometimes offer about their energy trading activity. Some companies have said in the past that they "trade around the assets" or "optimize the power plants" to describe their business.

"I'm not sure I know what that means," says the seasoned energy veteran, explaining that the industry has done a poor job of defining energy trading. "Trading around the assets doesn't convey immediately what they are doing. I'll never really know what that means."

"That is what you would expect from an organization that has an identity crisis. If you got three or four businesses in the same organization and you ask them what their business is,