A much smaller energy merchant sector now operates in a “hybrid” state with ambiguous rules and may remain only a minor part of the energy industry well into the future, a panel of energy risk management analysts said Thursday.

“Eleven years ago when I started working in trading and risk management, we had a vision of a great future,” said Vincent Kaminski, senior vice president of commercial analytics for Reliant Resources Inc. Kaminski, speaking at Hart’s Energy Markets executive forum on “Trading and Risk: Profit and Protection” in Houston, said, “We expected to have very liquid, long-term markets resembling Wall Street firms…but we know now that the great vision didn’t materialize.”

Kaminski, whose resume includes managing analytical research for Citadel Investment Group LLP and Enron Corp., said he now believes that “energy trading problems are here for the long term.”

The loss of 12,000 to 15,000 jobs in the energy trading sector “will not be reversed in our professional lifetime. If they fired a cannon down Smith Street today, it would not hit a single energy trader.” Houston’s Smith Street had once been the address not only of Enron but many other former energy merchants.

Kaminski noted that it will take a “long time” to modify the business systems that had been put in place by companies with merchant units. “They fall into a trap. They have tried to use the same financial models used by other industries, and they thought it would work in the energy industry. And it didn’t.”

Bradford T. Nordholm, CEO of Tyr Energy LLC, a start-up company run mostly by former Aquila Inc. executives, noted that “a lot of assets are for sale” but those willing to take the risk are mostly private equity firms.

“The critical issue is certainty,” said Nordholm. Those needing to sell assets will be in a “tenuous position for two to three years.” He said that many investors are looking for a 26% return on their equity, but assets for sale have a lot of “significant risks.”

Kaminski noted that most former energy merchants have moved to trading around their assets. “In my view, one should start with assets to make statements about optionality and not with an option model to make statements about assets.” The business model has to recognize physical assets, and “recognize many constraints. It’s difficult to optimize within a model.” However, asset-based companies still face a “huge risk of credit, which is not going away,” said Kaminski. And credit risk management creates “excessive needs for working capital.”

Long-term contracts also are posing dangers, he noted. “You can lock in prices that are too low or too high, which creates the potential for future defaults and semi-defaults, and there is the inability to mange long-term fuel price risk.” Kaminski also expects to see more companies attempt to cancel their contracts, which will continue to cause problems into the future.

Zimin Lu, vice president of Tractebel’s research and analysis, agreed it is a “tough time” for merchants, with more challenges ahead. However, Lu said there are “reasons for hope.” Tractebel, which is making more inroads into North America through liquefied natural gas and power plants, uses an integrated business model which doesn’t rely on one part of its business to do well; rather, it uses all of them together so that the weaker businesses are strengthened by the stronger ones.

“Stand-alone energy merchants are threatened by shifts in the market,” said Lu. “We’re not in a great period as a merchant right now, but if we can capture the upside, we’ll be fine.” As in nature, he said, “only the strong will survive. The non-integrated players will struggle as they can no longer balance their business and hedge physically or financially their positions at low cost.”

However, Lu noted that “demand will continue to grow, which will absorb capacity over time, and the cycle will rebound.” Across the value chain, he added, “companies with solid credit and balanced aspirations will find opportunities.”

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