A new giant is set to emerge from a venture of New Orleans-basedEntergy Corp. and privately held Koch Industries Inc. Entergy-KochLP will be a North American and European powerhouse in electricityand gas, gas transmission and weather derivatives and will be owned50% by each of its partners. A big focus of the venture will beweather derivatives, of which Koch is a pioneer.

Entergy expects the venture to transform it from a utility withhigh exposure to price risk into an asset-rich risk management andtrading machine. “We were not looking to incrementally step outwith more of the same skills, talent or culture we already have,”Entergy CEO J. Wayne Leonard told analysts during a conferencecall. “If we were going to have a partner, it should be someone whocan help create fundamental change in the way we think about themarket and customer needs, a partner who can help take the physicalassets, skills and knowledge we possess and leverage that withcomplementary skills and assets…..”

Wholly owned subsidiaries will be set up for the variousbusinesses, including a pipeline company that will operate thesystem known as Koch Gateway. Entergy-Koch is expected by itspartners to be among the nation’s top ten energy commodity tradersin terms of combined volumes of electricity and gas. The newcompany will have assets of approximately $1 billion, including the10,000-mile Koch Gateway Pipeline, one of the largest gastransmission systems in the Gulf South, and the Bistineau gasstorage facility.

The new company will be the first venture between Koch andEntergy, the third-largest U.S. generator of electric power andowner of the nation’s largest gas-fired generating fleet.Entergy-Koch, which will have its asset base in the Gulf South anda trading presence in North America and Europe. “The deal looksexcellent and worth waiting for, I might add,” Morgan Stanleyanalyst Kit Konolige enthused to Entergy executives duringyesterday’s conference call. Edward Tirello, an analyst withDeutsche Banc Alex. Brown, said his firm has had a “buy” rating onEntergy for about a year and a half. “It’s only looking better.”

In addition to Koch Gateway Pipeline, Koch Industries will alsocontribute the capabilities of Koch Energy Trading, which marketsand trades gas, power and weather derivatives. Entergy willcontribute its power marketing and trading businesses —consisting of Entergy Power Marketing Corp. in the United States,and Entergy Trading and Marketing in Europe — and also cash.Entergy estimates the cash contribution to be $350 million, $150million of which would be funded with equity and $200 million withdebt.

“The complementary strengths being contributed by Entergy andKoch — in natural gas and in the marketing and trading of powerand other energy commodities — bring a unique set of resources tothe new company,” Leonard said. “Entergy-Koch will have the assetsand the scale to compete and grow. It will trade volumes in excessof 100 million MWh of electricity annually and 5 Bcf of gas daily -a scale that is generally recognized as necessary for ongoingprofitability. For Entergy, the new company will not onlycontribute to our earnings growth on its own but will offerrisk-management tools to our existing businesses.”

In March Entergy confirmed it was involved in talks regarding apossible joint venture between its wholesale electricity tradingunit, Entergy Wholesale Operations, and another company (see NGIMarch 27). In December Entergy unveiled a five-year, $9.8 billioncapital investment plan. “The next five years will find Entergythrough its transition period and well into competition in most, ifnot all of our service territory,” Leonard said at the time.

Leonard last week told analysts the venture “…will transformEntergy from a company viewed by some of you as struggling tomanage the price risk that goes with being the third largest powerproducer in the country, having 32 combustion turbines on order,and being the nation’s largest natural gas purchaser into alegitimate market-maker with an interest in substantial assets inboth power and natural gas, a skill level equal to anyone in theindustry, and information systems that are in many wayssubstantially ahead of anyone we are aware of in the industry. Ourpeople, having traded most shops in Houston, including at Enron,and on Wall Street, will tell you that Koch’s information systemsprovide a substantial competitive advantage to anyone they areaware of.”

Entergy-Koch will benefit from Koch Energy Trading’s leadingposition in energy commodities markets, including weatherderivatives, and from Koch Energy Trading’s highly disciplinedcommodity trading controls, policies, procedures, systems andinfrastructure. The new company will also benefit from Entergy’scapabilities in domestic and international power marketing andtrading. Entergy-Koch will be able to provide customers a broadrange of commodity sources and options, including gas, oil, coaland power, weather derivatives and additional risk managementtools.

The company also will market the power of and provide riskmanagement and trading services for Entergy’s existing and futuremerchant plants. Entergy will retain its growing merchantgeneration fleet, enabling it to establish a singular focus ondeveloping profitable merchant plants while benefiting from itsrelationship with Entergy-Koch’s skilled trading and riskmanagement team. Entergy Corp. is expecting the venture tocontribute 25 to 30 cents per share to its earnings in its firstfull year of operation.

Koch Energy Trading is a market leader in weather derivatives,currently accounting for about 30% of such trades. Leonard saidEntergy initially wanted no part of the weather derivativesbusiness, and Koch wasn’t willing to give any of it up. However,now it is one of the most exciting components of the deal, he said.”Weather derivatives are currently estimated to be a $3 to $5billion market that Koch is just beginning to scratch the surfaceof all the potential applications that these products offer.”

While the word “derivative” is still considered pejorative insome circles, Entergy is one of many who are overcoming theirapprehensions. “I think the word derivatives scared them,” saidKyle Vann, currently senior vice president of Koch Industries andthe head of Entergy-Koch. “I think from our standpoint there are acouple issues that changed. One, they saw how profitable thebusiness could be. Koch initially wanted to keep it in KochIndustries, but I think the weather derivatives group was mostsuited to be with the gas and power area…”

Through the deal with Entergy, Koch gets a physical fit with thecompany through Koch Gateway Pipeline, which serves many ofEntergy’s gas-fired generating facilities. Once the venture is upand running, initial focus will be on strengthening gas supply forboth parent companies and growing a national presence in gasthrough the storage and marketing businesses, Vann said. Theventure will provide storage management to LDCs. Power projectdevelopment also will be a priority. And Vann said a big focus willbe placed on cross-commodity trading, embedding weather derivativesmore and more into other commodities to lower the risk in both.Finally, moving the weather and other trading businesses to Europeis a goal. Entergy Marketing and Trading in London is trading gasand power there now, and the venture will become the entity thatmanages those operations.

The venture will be headquartered in Houston. Formation of thenew company is subject to completion of some final documentation,and the venture will require board approvals. Approval also isneeded from the Federal Energy Regulatory Commission and theSecurities and Exchange Commission. The approval process isexpected to take six to nine months.

Joe Fisher, Houston

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