Banc of America analysts Tuesday admitted they had “misjudged the snowball effect of Enron’s collapse,” and dropped the ratings of 11 energy wholesalers they cover. Other analysts followed with their own downgrades, all noting that the liquidity for many of the formerly well-heeled traders was quickly evaporating.

In a research report titled, “Clearing the Decks,” Banc of America dropped Sempra Energy to “market performer” from “strong buy,” and lowered the ratings of Allegheny Energy, Duke Energy, El Paso Corp., Williams Cos., Mirant Corp., American Electric Power, CMS Energy Corp., Williams and Xcel Energy to “market performer” from “buy.” Reliant Resources Inc. was downgraded to “underperform” from “buy.” (They included Alliant, but noted that it was not actually a wholesaler that fit into the sector.)

“While we regret making this call after so much devastation in the sector, we are downgrading several names with exposure to energy wholesale activities, given our view that risk continues to rise as most recently and vividly illustrated by Williams,” noted analysts William Maze and Shelby Tucker. Williams lost 61% of its value Monday after it warned it would post a second quarter loss because of the decline in marketing and trading (see Daily GPI, July 23), and its credit was cut to “junk” by Standard & Poor’s on Tuesday (see related story).

“We are not comfortable with the fact that Williams will be flying without a facility,” said the analysts, noting that Williams has to refinance a $2.2 billion bank facility that matured Monday. “Dynegy, Duke and El Paso have also provided negative headlines over the past week,” they said. “Although these issues are company specific, they were all brought on by…Enron’s collapse. Although we downgraded the sector at year-end, we did not go far enough, as we misjudged these risks, which continue to rise.”

Dynegy on Tuesday added its name to a list of energy merchants actively pursuing a partner for its trading activities (see related story). Williams had already said it needed a partner, and Calpine and Mirant also have said they could resolve the lingering credit problems with a credit-worthy financial institution. However, the chances any deals could be struck following months of disappointing news may be slim. Maze and Tucker said that “several types of risks continue to plague the group, including that wholesale energy operations will likely remain a radioactive cloud over these names for some time.”

Political risks are expected to increase on the group, as November elections approach, said the analysts, and the sector’s ties to “the President, Enron and California make it a favorite political football. Furthermore, the Enron trial is likely to start late summer, which should add more fuel to the fire, and allow politicians to use corporate greed as a political theme.” The likelihood is “great,” that some of the “Enron dirt will be wiped on other wholesale players.”

Noting that the investigative risks were already high, the Banc of America analysts said they were notched even higher with the “recent subpoenas doled out by the U.S. Attorney’s office” (in Houston). Although they said they “believe there is little chance of wrongdoings…the probability of finding something questionable increases,” the longer the investigations continue.

California’s risks also are a continuing, though smaller, problem for the wholesalers, especially politically. If the state experiences any blackouts or brownouts, the group can expect more scrutiny from California, said the analysts.

Meanwhile, credit risk “remains high with no end in sight. This circular logic has caused illiquidity in the energy trading markets, which has limited profit potential, thus further impairing credit quality.” More asset/goodwill write-downs also may occur, they said, and the mandate for CEOs to sign off on financial statements “could place pressure on reported earnings, particularly since this sector was the epicenter for these concerns.”

Spark spreads, said Banc of America, remain at “lackluster” levels, and the “visibility to earnings” in 2003 and 2004 “is limited as most spark spread hedges roll off. Moreover, it is increasingly unclear as to the viability of the overall merchant model,” said analysts.

What the analysts will look for in terms of a recovery within the wholesale sector include the following:

First to recover once the “wholesale cloud” dissipates likely will be Duke, El Paso, AEP and Sempra, said Maze and Tucker, because of their strong financial positions and “grounding in quality regulated assets.”

Meanwhile, Salomon Smith Barney analyst Raymond Niles followed with his report on the sector Tuesday, and downgraded Calpine, AES and Dynegy to “underperform” from “neutral,” citing deteriorating corporate and industry fundamentals in the power and natural gas industry.

In a research note, Niles said the weak commodity prices are continuing to reduce corporate margins. He also noted further evidence of weakening credit quality in the industry after S&P downgraded Dynegy, and pointed to Williams’ “apparent inability to rollover a credit line due July 24.”

As far as individual companies, Credit Suisse First Boston analyst Curt Launer cut Williams’ rating to “hold” from “strong buy.” Launer put a 12-month target for the company at $6. Meanwhile, UBS Warburg’s James Yannello predicted a further near-term drop for Dynegy, and said he hopes to see equity investor ChevronTexaco, which owns about 27% of the company, step in “soon” to improve the company’s liquidity. ChevronTexaco has so far not commented on Dynegy’s current news. Said Yannello, “Dynegy shares could come under further pressure if customers substantially hesitate doing business with it,” and said any “negative findings” from federal investigations would hurt it.

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