The domestic energy trading market, which shrank considerably following the collapse of Enron Corp., is on the upswing, according to a new report issued by a Boston, MA-based research and consulting firm.

The U.S. energy market sunk to $1.3 trillion in 2002 from $1.8 trillion the prior year in the wake of Enron’s bankruptcy and the exodus of major traders that had been perceived to be investment-grade companies, but it is expected to rebound to $1.7 billion in 2006, said Celent Communications in its 50-plus page report on the trading industry.

However, the market players are decidedly different now, it said. “Some banks have picked up where the failed energy merchants left off, providing liquidity in the gas and power markets, especially on the longer end of the curve.” Morgan Stanley and Goldman Sachs, the two dominant players among banks, are providing structured risk-management products and participating in a number of asset swaps, according to the Celent report.

“A number of other banks have recently opened trading desks [as well]. Hedge funds are also providing a substantial amount of liquidity, particularly in the oil and natural gas financial markets,” it noted.

Celent said the recent recovery has been spurred in part by the innovative market developments in clearing — specifically, the Nymex ClearPort platform. “Improved clearing mechanisms should continue to facilitate growth by eliminating counterparty credit risk, as will improved pricing transparency. Counterparty credit risk has been a major impediment to growth since the collapse of the energy merchants.”

Currently, Celent estimates that about 17% of the energy trading market is electronic, with short-term natural gas contracts being the most heavily traded electronically. It projects that electronic trading will account for 29% of the market by 2008.

“The U.S. energy trading industry is finally starting to recover from the scandal it will forever be associated with and is poised to grow substantially in the years to come,” Celent said. The trading sector today is far more healthy than it was a few years ago, the research firm believes.

“Industry participants are paying far more attention to counterparty credit risk, though a fundamental misconception about the exact nature of credit risk still exists. Price transparency has improved. Risk managers such as banks and speculators such as hedge funds have become increasingly prominent, providing desperately needed liquidity, trading acumen and better knowledge of risk to the market.”

But while banks have become increasingly involved in the market since the energy trading sector’s meltdown in 2001-2002, Celent said that many have done so in the past, only to later either reduce their participation or exit the market entirely. “Were a number of banks to do so again, the industry would have a liquidity crunch on its hands,” it cautioned.

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