Thanks a lot, Enron -Energy traders endure credit crunch, investigations and more in the wake of Enron's collapse.
By Mark Gongloff, CNN/Money Staff Writer
May 30, 2002: 2:17 PM EDT
NEW YORK (CNN/Money) - Share prices are falling, executives' heads are rolling, assets are disappearing in fire sales and federal regulators are snooping through the books -- such is the legacy of Enron Corp. for its fellow energy traders.
But don't pull the plug on the sector just yet, analysts say.
"Things will improve, but we have to go through a process of digesting all the fallout from the Enron debacle," said Larry Alberts, vice president and analyst at American Express Financial Advisors. "There are a lot of good companies out there, and a lot of them are positioning themselves for the longer term."
Energy conglomerates such as Enron, Dynegy Inc. (DYN: Research, Estimates), and El Paso Corp. (EP: Research, Estimates) struck gold in the late 1990s by branching out from their traditional roles as natural-gas and energy middle men into marketing and trading energy and related commodities. Revenue and earnings soared through the roof, and stock prices went along with them.
But the party didn't last long, thanks mainly to Enron's mighty fall. That company's famous excesses of aggressive accounting and trading -- which may have been copied, to a lesser degree, by others in the industry -- led to the largest bankruptcy in U.S. corporate history and caused tremendous headaches for its colleagues.
In recent weeks, executives have been excused from Reliant Resources Inc. (RRI: Research, Estimates), CMS Energy Corp. (CMS: Research, Estimates) and Dynegy, while the Securities and Exchange Commission and the Federal Energy Regulatory Commission are investigating allegations that those companies and others participated in "round-trip" trades to pump up their trading volume.
But Enron's longest-lasting legacy has been a credit-rating crunch for the rest of the sector -- the result, some say, of rating agencies such as Moody's and Standard and Poor's trying to wipe egg from their own faces.
"There has been an awful lot of criticism leveled at the rating agencies because they presumably had all the data, were shown all the partnerships being marketed [at Enron], but they had not really connected all the dots," said John Olson, senior vice president and director of research at Houston brokerage Sanders Morris Harris. "As a consequence, they have raised the goal post and moved the end zone."
Tougher standards for credit ratings?
Olson and other analysts believe the rating agencies are applying much tougher standards to energy companies than they did during the brief heyday of the industry, requiring them, basically, to keep an even greater ratio of assets to debt than ever before.
Moody's analysts could not be reached for comment about these claims, but the agency was expected to issue a "white paper" outlining its standards for companies in the industry by Monday.
S&P utilities analyst Jeffrey Wolinsky dismissed the idea that his agency was reacting to the Enron collapse.
"Our method of analysis has not changed, and we're still approaching companies the same way," Wolinsky said.
Nonetheless, El Paso, Williams Cos. (WMB: Research, Estimates), and CMS have in recent days announced sweeping plans to shed assets, issue new stock, and restructure their businesses, largely in an effort to salvage their credit rating.
"We are dealing with a business environment we did not create, but the environment is very real," said Williams spokeswoman Carol Ward. "We have taken quick, decisive actions to be able to continue to operate with investment-grade credit needed for our energy risk-management operations."
But the level of uncertainty about these companies is so high that rating agencies are likely to keep the pressure on them until they see real changes in their balance sheets.
For example, S&P cut its rating on Williams to BBB from BBB+ on Tuesday, allowing the company's debt to remain investment grade -- but just barely -- on the same day Williams announced a plan to raise $3 billion in cash through selling assets and issuing stock.
"Although Williams plans to reduce debt significantly over the next year through a combination of asset sales and equity issuances, the plan is subject to substantial execution risk," S&P analyst Wolinsky wrote when announcing the rating cut.
Liquidity crunch
Analysts have worried that some of the sacrifices the energy trading firms are making to satisfy rating agencies are hurting future earnings by selling valuable assets -- such as Williams' Kern River natural-gas pipeline, sold to Warren Buffett at the bargain-bin price of $960 million -- and cutting back on capital spending.
As a result, many in the industry will likely cut their targets for annual earnings-per-share growth from the heady 15 to 20 percent range of the sector's glory days to the tamer 5 to 10 percent range common in the early 1990s, said Alberts of American Express.
El Paso got the ball rolling Wednesday by slashing its earnings expectations for 2002 and 2003, triggering a 20 percent plunge in its share price. The selling continued Thursday.
But the short-term pain may be necessary for these companies' long-term survival, especially if marketing and trading firms need investment-grade credit ratings to survive, as some in the industry believe.
Lower credit ratings could scare away potential trading partners, according to this view, making the cost of doing business in an already low-profit-margin operation even higher.
"Liquidity is key. You can only extract growth potential from assets if you [survive] long enough to deliver," said Jeff Dietert, vice president and analyst at Houston research firm Simmons & Co. International. Dietert also pointed out that many of these companies have large revolving credit lines coming due in the next few months, providing additional motivation to clean up their balance sheets.
The importance of credit rating is debatable, however, as many companies have been able to keep trading even when slashed to junk-bond status.
Separating wheat from chaff
What may be more critical -- and what raises the most hope among analysts -- is the possibility that these companies will shed their riskier businesses and return to their roots as deliverers of natural gas and power.
"The integrated natural gas and power model was far and away the best energy business model of the 1990s," said Olson of Sanders Morris Harris. "These guys delivered among the best returns in the stock market for five-to-10 years."
The companies best positioned to return to that model quickly appear to be Duke Energy Corp. (DUK: Research, Estimates) and El Paso, many analyst said, since both of them rely less on trading and seem to have healthier balance sheets, helping them avoid some of the short-term pain being suffered by companies such as Williams.
Of course, even the stars in this sector have problems -- Duke and El Paso, for example, face significant exposure to the repercussions of the California energy crisis, which could include the payment of massive fines, according to Robert McCullough, managing partner of Portland, Ore.-based consulting firm McCullough Research.
McCullough and other analysts agree it will take time -- possibly most of this year -- to separate the wheat from the chaff in the industry, a process that will at least be a healthy one for investors and power customers.
"These companies were living on borrowed time. Enron's collapse might have been the best possible thing for the industry because it has forced that recognition," McCullough said. "One can only imagine what would have happened if this had gone on for another five-to-10 years." |
