Trading down: Once the darlings of Wall Street, energy merchants face a low-key future after wave of scandal and scrutiny
chron.com
By LAURA GOLDBERG Houston Chronicle
In some ways, an MBA sitting in front of a computer replaced the grizzled roughneck in recent years as the icon of Houston's energy industry.
Across the city, hundreds of young professionals were drawn to massive trading floors at companies such as Enron Corp., Dynegy, Reliant Resources or Duke Energy Corp. They bought and sold electricity and natural gas, or managed complex financial contracts.
Though some of these energy merchants had long dealt in natural gas, the promise of big profits in the nascent wholesale power business made them favorites on Wall Street and, collectively, a staple of the city's new energy economy.
Today, the industry is under siege and faces the daunting task of rebuilding its credibility with investors in the wake of financial restatements, disclosure of dubious trading practices and plunging stock prices.
At the same time, Wall Street's rating agencies are imposing higher standards as they pore over the companies' financial statements and business plans. Those that fail to earn strong credit ratings will see business costs rise, clients flee and stock prices fall further.
Finally, the industry must wrestle with the political legacy of the California energy crisis and the regulatory changes that may come with it.
"The current circumstances raise some difficult issues about whether this market is going to be allowed to mature or whether it's going to be put out of its misery," said Jim Hoecker, who until early 2001 was chairman of the Federal Energy Regulatory Commission. "My gut is that five or 10 years from now, we'll look at this as a sad interlude but one we profited from by learning the right kind of lessons."
Most observers believe there are still profits to be made in trading, selling and producing electricity in a marketplace where the government doesn't set prices, even with the additional regulation that's likely to follow.
But the bottom line for these companies isn't likely to be as fat as hoped several years ago, and some companies may not make it through the turbulence.
"It was clearly overhyped," said Matt Wright, who manages the First Investors Utilities Income Fund, which owns shares in several merchant companies. "When the music stops, people start thinking about the worst-case scenario. ... The reality lies somewhere in between the hype and where we are today."
Underlying the industry's woes -- and some in the industry say the root of all its troubles -- is Enron, the company that in a few months went from industry pioneer and market leader to the biggest business failure in history.
Enron's relentless promotion machine sold, and many would say oversold, the concept of electricity trading with great success.
In a dot-com-ish frenzy, Wall Street jumped aboard, showering money on trading and generating companies, some of which steadily piled up debt. It was easy to overlook the fact that demand for electricity is cyclical, rising and falling with the weather and the economy.
"People got capital who should not have gotten capital," said Stephen Naeve, the newly installed president of Reliant Resources, a publicly traded arm of parent Reliant Energy.
"The question is: Does the business model really work?" said Jim Chanos, president of Kynikos Associates, a New York hedge fund. "My vote is that it doesn't."
Chanos has doubted for some time that energy trading is a business worth investing in. He has made money selling Enron short, betting its share price would fall, and has short positions in shares of other traders.
By his calculations, returns on capital in the business are low -- in fact, lower than the average rates for corporate America.
While many still believe the industry has a future over the long term, its credibility with Wall Street is in a shambles. In the wake of Enron's apparent smoke-and-mirrors accounting, investors are taking a hard look at the whole industry, and what they're seeing are weak balance sheets, bogus trades and hard-to-understand accounting practices.
Stock prices for a group of nine traders and generators are down by an average of 67 percent from a year ago.
Financial restatements by several of the companies have made it worse.
Dynegy plans to change last year's accounting for a natural-gas deal known as Project Alpha, while Reliant Resources restated two quarters' worth of 2001 earnings because of an error in the way it reported some natural-gas and power purchases. Both actions are under review by the Securities and Exchange Commission.
The latest problem to slap the industry is the "wash trade" -- a transaction in which a company buys and sells an equal amount of power or other commodities at the same time. No money is made or lost, but the deals can create the appearance of higher trading volumes and revenues -- what some in the electricity trading business call "bragawatts."
As pressure grew on companies to increase their trading activity, these wash trades apparently became a common practice.
"The energy industry has tended to be a very herd-oriented industry," said Amy Jaffe, senior energy adviser at Rice University's James A. Baker III Institute for Public Policy.
Among those that have disclosed the use of wash trades are Dynegy, CMS Energy Corp., Reliant Resources and Duke. Dynegy said it did so at CMS' request and to test its own systems, while Duke said its trades weren't about volumes, but to verify prices.
At Reliant, officials said misguided traders did them to inflate volumes. The traders are gone, and two top company executives resigned following the disclosures.
There is concern that wash trades may have worked to give investors a false sense of the size of the overall electricity marketplace.
The SEC has begun looking into such practices, and Wednesday the FERC began investigating whether wash trades worked to inflate power prices in California.
The role of energy merchants in California's power crisis in 2000 and 2001 represents another key source of concern for investors. Companies face the possibility of refunds or damages related to their activity there, and consumer outrage, combined with an election year, has made the state a flash point for new regulation of the industry.
California Gov. Gray Davis, who led the charge against Enron and other Houston companies, is up for re-election this year, while the Bush administration, seeking to distance itself from Enron, could end up taking a harder line than it otherwise might.
"I don't trust politicians with my investments," said Wright, the fund manager. |
