THE END OF THE MERCHANT POWER RACKETS?
Hi JP,
I thought this article on Apache's battles with the energy merchants to be indicative of big changes afoot. -RGD
thestreet.com
Potential Partners Shun Energy Traders
By Melissa Davis
Staff Reporter
06/14/2002 07:31 AM EDT
Houston-based Apache (APA:NYSE - news - commentary - research - analysis)
can't think of a worse idea than hooking up with a neighbor like Dynegy
(DYN:NYSE - news - commentary - research - analysis) to pursue a future in
energy trading.
Never mind that Apache rid itself of a large stake in Dynegy's predecessor a
decade ago, and that the top brass at the two companies have remained on frosty
terms for years. Ignore the fact that Apache is suing Dynegy over disputed natural
gas transactions in New Mexico.
No, it's nothing personal. Apache simply wouldn't
entertain a partnership with any merchant energy
company, an executive there says -- and he
doubts that other big players would do so, either.
Though Apache's just one company, its comments
highlight the increasing peril for merchant energy
stocks as these onetime highfliers search
desperately for fresh capital to revive a faltering
business.
Indeed, with regulators probing all aspects of
energy trading and credit rating agencies openly
questioning the viability of the businesses, few observers see a light at the end of a
tunnel that has led these stocks lower by 40% and more over the last year. Now,
with credit lines coming up for renewal and the market awash in assets for sale,
the sector may face an even more brutal selloff before anyone takes serious
interest in these companies.
Fundamentally Unsound
To people like Apache's Tony Lentini, it all comes down to the trading industry's
fractured fundamentals. Things like roundtrip trades -- deals that boosted
transaction volume and revenue but had no actual economic value -- point to a void
at the core of the industry that no amount of cheap capital can fill, he says.
"When you look at the stuff these guys allegedly had to pull in order to create what
appeared to be a viable business -- adding phony trades to pump up volume,
creating revenue out of thin air -- you've got to wonder about the business model,"
says Lentini, vice president of public and international affairs at Apache. "If you've
got to resort to chicanery to run a business, then something must be wrong."
To be sure, there is no indication that the energy traders that engaged in roundtrip
trades did anything illegal. The companies generally maintain that their business
and accounting practices are legitimate and say they are cooperating with various
government probes of trading activity. Dynegy didn't immediately return calls
seeking comments.
But the inquiries by the Securities and Exchange Commission and Federal
Energy Trading Commission have only heightened investor anxiety in a sector
that was once just as hot as the tech and telecom sectors in the late 1990s.
Today, a number of merchant energy companies are hanging the equivalent of "for
sale" signs on their trading units, but they have yet to snag significant business
partners -- let alone buyers.
No Dairy Queen
Indeed, the well appears to be bone dry for would-be energy-trading partners. To
cite one example, after Williams (WMB:NYSE - news - commentary - research -
analysis) assured investors Monday that its phone started ringing soon after it
began shopping for a partner, the Tulsa company failed to as much as hint at who
might be on the other end of the line.
Analysts participating in a Monday morning conference call -- the second in as
many weeks -- raised their own hopeful possibility. They asked if Berkshire
Hathaway (BRK.A:NYSE - news - commentary - research - analysis), led by
billionaire value investor Warren Buffett, might be a future partner. Berkshire
Hathaway, after all, recently forged a relationship with Williams by investing in
Williams' preferred stock, buying a prize pipeline and negotiating on a joint utility
transaction in Nevada.
Still, after reviewing that involvement, Williams stopped well short of suggesting
that Berkshire Hathaway might become a bona fide trading partner.
"This suggests to me an improving relationship," said Williams Chief Executive
Steve Malcolm. But "whether we do anything with them in the future, I can't say."
Berkshire Hathaway didn't return phone calls. And one Tulsa money manager
downplayed the chances of such a partnership.
"Warren Buffett loves Williams' pipelines," said Fredric E. Russell, whose firm
owns Williams' stock. But drawing a contrast with the company's complex,
hard-to-explain trading operation, Russell added, "He's interested in buying assets
he understands."
Paper Profits
At least on paper, the business can look enormously profitable. Last year, Dynegy
attributed $1.26 billion -- or 82% of its total profits -- to energy trading. At Williams,
just over half of the company's $2.4 billion in reported profits (before extraordinary
charges) came from trading. Similarly, both Reliant (REI:NYSE - news -
commentary - research - analysis) and El Paso (EP:NYSE - news - commentary -
research - analysis) credited trading for nearly half of their companies' profits.
But a recent credit crunch has crippled the industry's ability to reel in the long-term
energy contracts that, through mysterious mark-to-market accounting, pumped up
profits so nicely. Stripped of that power, Williams is suddenly projecting
second-quarter per-share earnings in the low 20-cent range, or about half what it
predicted before its access to capital -- so critical to long-term deals -- dried up.
Despite that revision, Prudential applauded the improved "quality" of Williams'
earnings. Absent long-term contracts, Williams is still expecting $500 million in
cash earnings -- the kind you can actually scoop off the books and pour into the
bank -- for 2002.
Cash Certainty
The deep cut comes to what Williams has coined "cash-certain" earnings, a figure
questioned by some for its dependence on elaborate models and accounting
practices that can be riddled with assumptions.
"There's cash, and there's prediction of cash -- but there's no such thing as 'cash
certain,'" Russell said. "I don't think energy traders should be inventing new
phrases for the English language. We have perfectly good phrases already."
In an extensive report last month, Moody's criticized the lack of clarity in financial
reporting throughout the merchant energy business. The ratings agency called for a
massive overhall of the entire sector, strongly suggesting that energy traders seek
out creditworthy partners both inside and outside the industry.
With its power to withhold investment-grade ratings -- considered crucial in the
capital-intensive energy trading business -- Moody's caught the full attention of its
target audience.
Craig Goodman, president of the National Energy Marketers Association, called
the Moody's report "very well written but also very frightening." He said his
organization's primary mission is to restore American confidence in the energy
trading sector so that the country can move forward and realize the benefits of
deregulated energy markets.
Goodman described Williams and its peers as "great companies that are under
siege," saying their survival is critical to the country.
But Apache, an exploration company and longtime critic of energy trading,
responded to the association's claims with ridicule.
"The country operated fine for years before there ever was an Enron," Lentini said.
"Consider the source. This is an organization representing companies that don't
want to go down." |
