Energy Trading: Electronic Trading Platforms Flourish Despite Enron’s Collapse
At the moment, with every day bringing forth damaging new revelations, Enron’s legacy appears to be limited to shady finances and crooked accounting. But as time goes by, a different, more positive perspective could well emerge. Whatever chicanery Enron’s executives and accountants may have committed should not obscure the company’s pioneering role in developing online markets for commodities and derivatives trading.
Enron, of course, did not invent business-to-business trading in the energy sector. But through EnronOnline it did play a big role in moving gas and power trading to the Internet and showing how successful this business could be. It also made markets in a wide variety of products far beyond its core energy businesses, a move that may have weakened the company and contributed to its collapse. That lesson is not being lost on other energy companies, as they draw on both the innovations and excesses of Enron to chart the future course of gas and power trading.
The deregulation of the U.S. oil, gas, and electricity markets in the 1980s and 1990s created a complex competitive landscape. It galvanized an explosion of trading among a mosaic of generation, marketing, and distribution companies in the scramble to acquire supply, meet demand, hedge and speculate on prices, and maximize return on assets. Industry experts say that every barrel of oil is traded 10 times before it arrives in port, and every cubic foot of natural gas four to five times before it is consumed. To this day, much of this trading is carried on bilaterally between companies with long-standing relationships. Still other trading is done through brokers over the phone or in the pits of Chicago, New York, and London commodities exchanges.
The advent of the Internet brought the ideas of B2B e-commerce to the energy and power industries as it did to other sectors of the economy. Enron, acting as a counterparty to each electronic transaction in which it engaged, automated a one-to-many trading model with real-time pricing and electronic transactions. As Enron’s credit unraveled and even before its ultimate collapse, however, power and gas traders began diverting large volumes of trading to other platforms in order to diversify their credit risk.
That the traders anticipated the consequences of Enron’s credit downgrades is proven by the fact that the marketplace recorded nary a blip in the wake of Enron’s collapse. In fact, the fallen giant’s market share was absorbed rather efficiently, considering Enron’s 25 to 70 percent share of trading in some products.
Trading desks at leading energy companies experienced a noticeable increase in activity. “We saw a pickup in volume as parties came to us saying, ‘With Enron gone, would you please help us get through the winter?’” recounted Steve Malcolm, CEO of the Williams Companies, a Tulsa-based energy concern. “These are short-term relationships which we hope to expand into long-term ones.”
Credit Risk Takes Its Toll
Energy companies with less than investment grade credit ratings realized that they would have a tough go grabbing the most desirable, long-term deals. Mirant Corporation, an Atlanta-based company and the largest exporter of Canadian natural gas to the United States, was recently placed on credit watch by reporting agencies. The company’s reaction was to promulgate a liquidity plan that called for slashing non-core assets and canceling questionable projects.
“We cut everything until we were able to live with our position for the plan period,” said Ray Hill, Mirant’s CFO. “Instead of deferring decisions on new plants, we canceled them. As long as our debt is not investment grade, we will have a hard time with longer dated contracts, and we need to find a way to fix that.” Hill believes that many entities will have the opportunity to soak up some of Enron’s market share.
For Kevin Smith, product manager for North American energy at GFI Group, Inc., a New York-based commodities broker, the Enron collapse has “reshuffled the competitive landscape. It lets us get in and be more aggressive in the marketplace,” he said. “Brokers don’t have to walk as tight a line.”
GFI, which has seen its voice brokerage business increase since the Enron collapse, also introduced in early January an online marketplace for electricity in the Canadian province of Alberta, through its online markets division, GFInet. That venture represents the kind of multi-party, many-to-many exchange that has come into favor since Enron’s demise. These would-be NASDAQs for energy products allow traders to diversify their credit risk by trading with multiple parties. Some traders also feel that a multilateral exchange provides better pricing.
“On EnronOnline, you saw Enron’s prices exclusively, which may or may not have been the best prices at the time,” said Robert McGaughey, regional vice president for trading at Edison Mission Marketing and Trading Inc., a Boston-based power producer and trader. “On a many-to-many exchange, you see the best prices of many market participants, which should allow you to see smaller bid-ask spreads and theoretically better prices.”
“In addition, your transactions take place with multiple counterparties, which diversifies your credit risk,” McGaughey continued. “In the future, companies probably will be less willing to concentrate their credit risk with one counterparty, as they did by using EnronOnline extensively.”
ICE Surges Ahead
It is no surprise, then, that several established online exchanges saw a boom in business toward the end of last year, just as the Enron scandal was unfolding. The Atlanta-based IntercontinentalExchange (ICE) saw system-wide trading volumes grow by 30 percent between mid-December and mid-January. ICE also reported strong trading growth in energy, with volumes of North American power up 51 percent in January 2002 over December 2001; trading in North American gas up 37 percent in the same period; European gas, up 32 percent; and oil, up 10 percent.
ICE, which was launched in May 2000, boasts 8,500 users worldwide who trade 600 commodity and derivative contract types, including crude oil and refined products, natural gas, power, precious metals, weather derivatives, and emissions allowances. ICE’s founding partners include BP Amoco, Deutsche Bank, Goldman Sachs, Morgan Stanley, Royal Dutch/Shell Group, Société Generale, Totalfina Elf Group, and Continental Power Exchange. Several additional partners came on board in November 2000, including American Electric Power, Aquila Energy, Duke Energy, El Paso Energy, Mirant and Reliant Energy.
ICE’s success points to another aspect of the boom in the electronic trading of energy products—the convergence between online trading platforms and traditional futures exchanges. In July 2001, ICE completed the acquisition of the London-based futures market International Petroleum Exchange and is preparing to move IPE’s line of futures products to its platform some time this year.
IPE futures are cleared through the London Clearing House, and ICE last year reached an agreement with LCH to offer clearing of certain ICE products, starting with crude oil swaps and natural gas swaps. One futures commission merchant, Cargill Investor Services, has signed up to participate in the clearing arrangement, and others are in the testing phase. While ICE set the arrangement with LCH in motion well before Enron’s collapse, the increased awareness of credit risk has heightened interest in the protection against default that clearing provides.
TradeSpark is another neutral and anonymous energy trading system that has benefited from the Enron debacle. Despite suffering a tremendous blow on September 11, when the collapse of the World Trade Center buildings destroyed the headquarters of its parent company Cantor Fitzgerald, caused a catastrophic loss of life, and took the platform offline for 10 days, TradeSpark reported a double-digit increase in the volume of trading conducted on its exchange. The total transaction volume in the fourth quarter of 2001 increased 81 percent as compared to the same period the year before, while the number of electronic trades rose by a stunning 295 percent.
TradeSpark, which began live trading in October 2000, also reported that the number of users and logins increased significantly in the fourth quarter of 2001, with a total of 231 companies and more than 3,500 users participating in the marketplace. TradeSpark’s investors include five major power companies—Coral Energy, Dominion, Entergy-Koch LP, TXU Energy Trading, and Williams Energy Marketing and Trading Company. Dynegy, the Houston-based company that sought to acquire Enron before the latter’s improprieties came to light, also is a major user of the TradeSpark platform.
NYMEX Broadens Appeal
The New York Mercantile Exchange, which has been trading energy futures since the 1970s, has seen an increase in trading activity since EnronOnline went dark, primarily in its natural gas futures and options on futures. Both contracts had a record amount of turnover in November, and trading has continued to be very strong into the new year.
NYMEX, which conducts most of its trading through the traditional “open outcry” method, last fall listed a natural gas swaps contract on its electronic trading system, known as ACCESS. The exchange also has extended its EFS facility (exchange of futures for swaps) to include natural gas futures, and is trying to make it easier for large traders to use its products.
NYMEX’s efforts to enter the electricity market, however, have been completely unsuccessful. The exchange listed electricity futures back in 1996, but trading faded to zero last year and the exchange recently delisted the contracts. Trading never took off because the contracts were too large and too rigid, said one industry expert. Others said the problem was that the main players in the electricity business threw their weight behind the electronic exchanges that began sprouting in the late 1990s. NYMEX officials say they plan to come back to the market with “reconfigured” electricity contracts more suited to the industry’s needs. No timeframe has been set for that initiative.
One-To-Many Continues to Thrive
While many pick ICE as the big post-Enron winner, it is probably too early to handicap that race. ICE and TradeSpark are themselves survivors of the dotcom bust, before which at least eight B2B exchanges vied for the attention of energy traders.
“In the interest of liquidity and transparency, it would be ideal if the industry settled on one favorite platform,” says Edison Mission’s Robert McGaughey. “But what will probably happen is that the various platforms will compete for liquidity and their use will likely be cyclical.”
McGaughey’s comments illustrate that traders perceive advantages to operating on a diversity of trading platforms, at least for now. Thus, the increasing strength of the multi-party platforms likely does not spell the demise of other trading venues.
For example, Dynegy operates a heavily used online trading portal called Dynegydirect, which like EnronOnline works on the one-to-many model. Dynegydirect offers trading in over 750 products, including broadband networking, and reported significant increases in trading volume after October 1. The number of customers accessing the portal has doubled, the company said, and the number of customers executing agreements increased by 20 percent. Dynegydirect recorded $13 billion in notional transactions in the fourth quarter, bringing its total for the year to nearly $43 billion.
Meanwhile, Enron’s former energy trading platform has been acquired by UBS Warburg, the investment banking division of the Swiss bank UBS, and trading resumed on February 11 at the rechristened UBSWenergy.com. The transition in the management of Enron’s gas and power trading operations from energy giant/trading player to banking institution is an interesting one, especially since this is UBS Warburg’s first foray into the energy trading business.
“This is new for UBS Warburg,” noted company spokesperson Jennifer Walker, “but it is in line with our plans to expand our presence in North America.” UBSWenergy, she added, is being operated by former Enron managers and traders, some 625 former Enron employees in total. Reportedly they include Greg Whalley, a senior Enron executive who was instrumental in building the company’s trading operation.
UBS Warburg did not inherit any of Enron’s trading positions as part of the deal, but like Enron Online, it will be operating a one-to-many portal, taking one side of each transaction. UBS Warburg is ramping up trading slowly, starting first with financial products and adding physical products only later on.
“My view is that UBS Warburg will be a much smaller organization than EnronOnline in terms of total trades,” said James Walker, a research director at Boston’s Forrester Research. “I don’t think UBS Warburg will take the same types of capital risk. It will be more conservative and it will struggle to find a niche.”
Still, with its AA credit rating, UBS Warburg is likely to attract its fair share of counterparties, including Edison Mission’s Robert McGaughey, who said he’d “love” to trade with UBSWenergy once it gets off the ground.
Back to Basics
For energy companies as well, credit management considerations dictate that conservatism is likely to be the order of the day. “Enron was building markets in all types of products,” said Forrester’s Walker. “I think that companies will focus on what they know and on risk that they understand.”
That sentiment was repeated by energy company executives. “We trade only energy commodities and we trade around our assets,” said Williams CEO Steve Malcolm.
“We aim to extract value out of our portfolio of assets and to offer structured risk management products to our customers,” asserted Richard Sherrill, executive vice president and COO of Charlotte’s Duke Energy North America.
The same back-to-basics theme was also echoed by Dynegy President and COO Steve Bergstrom, who accused Enron of becoming enamored of trading for its own sake. “Enron was a pure financial play,” he said. “They lost touch with their customers and forgot that they were producing and consuming physical products, and not just engaging in screen trades. Trading is not the be-all and end-all.”
Considering the fact that Dynegy was trying to take over Enron just a few short months ago, Bergstrom’s is the voice of the survivor who has developed a renewed appreciation for his company’s core products and services after almost getting severely burned. The same considerations do not apply, however, to those developing and advocating many-to-many exchanges for energy products and derivatives. For them, the exchange is an end in itself, a tool to provide the liquidity and marketplace efficiency that comes with attracting a multitude of buyers and sellers to one forum.
“The market is realizing what we knew all along, that ours is the better model,” said David Goone, senior vice president of IntercontinentalExchange, commenting on ICE’s recent successes. “The many-to-many model has the benefits of a true marketplace where many buyers and sellers come together. Ultimately, the market will decide the long-term model.”
Peter Buxbaum is an independent business journalist based in New Jersey. |
