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Cinergy Scales Back Gas Trading After Costly Bet in First Half of 2005

Cinergy Corp. said Thursday that its wholesale gas trading operation "just got chopped up" during the first half of this year because it had the wrong market bias -- it was betting that prices would fall or remain flat but instead they rose sharply. That led to a commercial gas division loss of 13 cents per share which contributed to a 14% drop in Cinergy's second quarter net income.

Cinergy reported net income of $51 million, or $0.25 per share, for the quarter compared with net income of $59 million, or $0.32 per share, in 2Q2004. Net income from Cinergy's commercial operations, including gas and power, fell by nearly $28 million to $3.5 million in the second quarter.

CEO James Rogers called it a "major disappointment." He said the company is evaluating what to do with the gas trading division. Cinergy's commercial operations contributed $30 million in earnings before interest and taxes (EBIT) in each of the last two years, but this year the gas operations will not be profitable.

Furthermore, Cinergy's merger partner, Duke Energy, exited energy trading in 2003. It is unclear at this point what impact this negative news will have on the proposed merger, which is expected to be completed in summer 2006.

"While results from our regulated businesses and our other core electric generation activities continue to meet our expectations, we are disappointed with this quarter's results from our commercial gas operations," said Rogers. "Our commercial gas group has consistently contributed to earnings over the last few years, and we're taking the necessary steps to restore their contribution in the future."

Because Cinergy's commercial gas business is not expected to turn a profit in 2005, Cinergy lowered its earnings guidance for the year to $2.50-2.65/share and suspended its preliminary guidance for 2006. The average of analysts earnings estimates for 2005 currently is $2.79/share.

Michael J. Cyrus, formerly executive vice president and CEO of Cinergy's regulated businesses, has been moved back over to head the commercial end of the business, which he ran from 2000 through the first half of 2004. He replaces Foster Duncan who resigned in June. Other personnel changes in the commercial business also have been made. Cinergy said it lost some personnel to competitors during the quarter and let others go in response to the poor performance.

"Our commercial gas group clearly missed our expectations this quarter," said Cyrus. "We're moving quickly to restore the success of this business by making necessary organizational changes, attacking operating costs by consolidating support functions and again executing on our strengths in the physical and financial markets."

Rogers said the company also has curtailed marketing and trading activities and reduced its market position. It expects to maintain a smaller market position "until we restaff," he said. Cinergy was the sixth largest wholesale gas marketing company in North America in the first quarter by sales volume, with 5.86 Bcf/d of physical gas sales, which was a 24% increase from 1Q2004 (see NGI's ranking of Top North American Gas Marketers). In the second quarter, the company sold 5.87 Bcf/d compared to 4.47 Bcf/d in 2Q2004. However, volumes probably will drop in the second half of the year based on its reduced market position.

"For the remainder of the year we will not increase the risk or activity level necessary to try to make up the first half shortfall" in the commercial gas business, said Rogers. He said the company's strategy in marketing and trading has always been a "low risk strategy" and "will not be changed now in an effort to overcome a bad first half. We, however, began to reduce operating costs in consolidating support functions."

Cinergy's net earnings for the second quarter of 2005 were negatively impacted by ($0.04) per share from the recognition of unrealized mark-to-market losses on gas, fuel and power contracts that hedge gas storage and generation assets. These contracts, which were economic hedges, did not meet the accounting requirements to qualify for accrual accounting.

Earnings for the quarter also were reduced by ($0.07) per share for severance payments and certain costs incurred in connection with the proposed $9 billion all-stock merger with Duke Energy which was announced in May (see NGI, July 18, May 16). The merger will create an energy company with $36 billion in market capitalization and 5.4 million retail customers.

Excluding these impacts, adjusted earnings for the second quarter of 2005 were $0.36 per share, compared with $0.43 per share for the second quarter of 2004.

The commercial businesses segment reported adjusted earnings of $0.09 per share in 2Q2005 compared with adjusted earnings of $0.23 per share in the same period of 2004. The segment realized a ($0.13) per share decrease from its gas marketing, trading and origination activities. Increases in fuel costs that are not yet reflected in the prices charged to residential and non-retail customers and increases in operation and maintenance expenses further reduced earnings by a combined ($0.05) per share, Cinergy said. Higher margins realized from generation assets serving Ohio customers and higher margins from portfolio optimization activities partially offset these decreases.

Second quarter adjusted earnings from Cinergy's regulated businesses segment were $0.27 per share in 2005, compared with $0.22 per share from a year earlier. Cinergy's regulated public utilities in Ohio, Indiana, and Kentucky serve 1.5 million electric customers and about 500,000 gas customers. In addition, its Indiana regulated company owns 7,000 megawatts of generation. Cinergy's competitive commercial businesses have 6,300 MW of generating capacity.

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