The "extraordinary" surge in 3Q2005 natural gas prices -- up 63% over a year ago -- dramatically impacted margin calls for energy merchants and producers hedging their production; however, most companies either maintained or were able to secure enough of a cushion to withstand the higher prices, according to a report by Standard & Poor's (S&P).
The report, "Third Quarter Energy Price Surge Tests Liquidity Adequacy for USA Energy-Utility," details the strategies of 40 companies in dealing with heightened liquidity needs. It also reviewed how the companies might fare if gas prices were to reach $20/MMBtu or higher, which experts speculate could happen if winter is colder than normal and supply is tight.
Notably, said analyst Jeanny Silva, no ratings actions have been taken as a result of heightened exposure to collateral calls. NRG Energy Inc.'s short-term rating (B-1) was placed on CreditWatch with negative implications, partly on collateral calls but primarily because of its acquisitive strategy. (Calpine Corp., whose stock price collapsed following the ouster of its CEO and CFO in recent days, was not included in the review.)
"In the weeks following Hurricanes Katrina and Rita, many companies saw a dramatic increase in margin calls as commodity prices reached new heights," Silva wrote. "During this period, cash margin held by counterparties increased by more than 100% for some companies."
Several companies reviewed by S&P were forced to "explore ways to increase their available liquidity or decrease their margin requirements," including NRG, Edison Mission Energy, Equitable Resources Inc., El Paso Corp., Public Service Enterprise Group Inc. (PSEG), Constellation Energy Group. Inc., Cinergy Corp. and Reliant Energy Inc. Among other things, the affected companies increased bank lines, renegotiated contracts, reduced exposure to forward sales contracts and other forms of hedging, curbed or offloaded marketing business, issued debt and sold assets, or were "waiting things out."
For the time being at least, Silva said, "bankers' lending appetites remain robust." Companies that experienced material collateral calls but "successfully and quickly" increased bank lines included Dominion, Equitable, Constellation, Cinergy, PSEG and Reliant. Other companies asked counterparties to eliminate contract collateral provisions or extend additional trade credit. "Not surprisingly, the companies who have tended to successfully renegotiate their contracts include companies with 'right-way risk' -- that is, companies whose credit profile is strengthened by a robust commodity price environment."
For instance, Questar Corp. in September worked to eliminate credit support requirements with several counterparties and increase the amount of credit allowed before being required to post collateral. "By the end of October, even though the average forward price of natural gas had declined less than 5%, the amount of cash the company had out on collateral deposits declined to $60.8 million -- a 75% drop."
Dynegy and Reliant reduced their exposure to long-term forward sales and other forms of hedging following the price hikes. Dynegy, for instance, posted only $3 million in additional collateral at the end of the third quarter as compared with 2Q2005. Still others "have opted to take a wait-and-see approach" as gas prices increased. Among them was NRG, whose available liquidity shrank to $600 million as of Sept. 30, 2005 from $1.1 billion as of June 30, 2005. However, many of NRG's contracts are expected to roll-off in the next several months and will be repriced, so the company opted to ride out any additional short-term volatility.
The S&P analyst warned, "there is tremendous concern regarding the potential effect of harsh weather on the price of natural gas over the next several winter months." But Silva said the companies surveyed provided "reassuring" answers on how high the price of gas and power would have to go before their companies exhausted sources of available liquidity.
Of the 40 companies surveyed, 29 reported higher prices would contribute to collateral-related net cash outflows. However, only 10 of the 29 reported "liquidity exhaustion points" below $25/MMBtu. Of these 10 companies, four already are speculative grade, i.e., their vulnerability to another market-stress event is already incorporated in the ratings. Two companies, as affiliates of more creditworthy parents "have the means" to obtain additional liquidity if gas prices suddenly rise again. And four have successfully expanded their bank lines or renegotiated collateral provisions.
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