CMS Energy Corp. has thrown out its speculative energy trading business and with it, cut 50 energy traders, about 25% of the workforce, in a plan designed to clean the balance sheet and improve cash flow. The Dearborn, MI-based company also revised its earnings outlook for 2002, and is selling more assets as it continues a “back-to-basics” program centered around its regulated assets in North America.

In line with recent announcements by El Paso Corp., Dynegy Corp., Williams Cos. and Aquila Inc., CMS’s energy unit, Marketing, Services and Trading (CMS-MST) will stop all of its speculative energy trading, and cut a quarter of its 200 trading unit jobs. CMS Corp. CEO Kenneth Whipple noted that CMS-MST “will have less of an emphasis on trading,” with its business used to support the company’s “asset optimization and risk management.”

In a frank discussion that lasted nearly five hours last Wednesday, the revamped executive team took their time during an investors’ seminar to explain how each of the CMS units are faring — in the face of a severe drop in earnings, and the ongoing and growing investigations by the Securities and Exchange Commission, the Federal Energy Regulatory Commission and the Commodities Futures Trading Commission.

“The whole segment [of the energy trading industry] is under attack right now,” said COO David Joos. “The restoration of investor confidence and repositioning the company is a high priority of ours. We are obviously focused on reducing volatility, and we will place a continuing high priority on that.”

CMS, which had decided this year to shift its business focus on North America, is “probably not going as quickly” as the company wanted to — all because of current market conditions, said Joos. In the long-term, CMS wants to strengthen its electric and gas utilities, which he called one of the strongest franchises in the United States, and return to its regulated utility roots — “that is the core of our business and it makes sense to grow it.”

Along with building its customer base on the wholesale side, Joos said the company’s leading liquefied natural gas (LNG) franchise, CMS Trunkline LNG in Lake Charles, LA, has become “a lot more attractive in last two years,” and CMS wants to expand that market as well. CMS is awaiting approval by FERC to expand the Lake Charles facility, which he predicted would go forward eventually, despite current security concerns.

What will also help the company going forward, said David Geyer, CEO of CMS-MST, is that all of the company’s problems now are out in the open. “This wasn’t the tip of the iceberg; it was the whole iceberg.”

With the trading pullback, CMS-MST should be able to close only on about $25 million in transactions this year, out of $280 million in new business it is working on, Geyer said. Customers have not gone away, but they have put a lot of business on hold, waiting to see how the various investigations play out. “Our customers are working with us,” he said, pointing out that they don’t have a lot of choices since many of CMS’s major competitors have scaled back operations as part of the industry restructuring.

“This isn’t just CMS; it’s an industry problem,” Geyer said. “Clearly the industry has changed almost overnight for all industry players…for everyone in this energy business. Liquidity is completely out of market…nobody is trading on large scale until this story plays out.”

He listed trading peers Aquila, Reliant, Williams and El Paso as dropping out of the competition for CMS customers, and predicted it would be 18 months to two years before they would be back in force. “Our only real competitors right now are AEP and Cinergy. Nobody is trading on any large scale until this story plays out.” Winding up its speculative trades has reduced CMS’s exposure to market volatility “to about zero now.”

Geyer said the trading arm’s method of structuring deals has changed because of the credit crunch. Previously, the trading unit could stand between the customer and supplier on large deals, taking in millions in payments from the customer and paying out millions to the supplier. Because its credit quality has deteriorated, deals have become more complex. Both sides of a deal have to be structured separately, with payments going through an escrow-type account, so if anything happens to the company, the deal doesn’t have to come unwound.

“Customers have been supportive and the suppliers are anxious to keep this type of business going, even in this economy, because they’re getting jammed a little bit like we are; there are not the people out there that there used to be to do business with,” Geyer said.

While the company is eliminating speculative trading as a business line, it is not eliminating trading as a part of its regular function of sales of product. It will continue contract origination for its customer base and building its asset base, optimizing results every day, Whipple said. CMS-MST will take “a more conservative stance,” in trading, with transaction volume limits and large transactions subject to executive review.

CFO Alan Wright, explaining how the large number of phony “wash” trades occurred, said CMS has had a strict monitoring system for its risk trading, but the trades were straight transactions that did not come under the monitoring system. The company’s financial statements are being redone to reflect the company’s actual earnings from 2000 and 2001, which will eliminate all of the round-trip transactions.

Whipple also talked about the CMS’s special committee of the board of directors, which is investigating the company’s round-trip transactions, hiring law firm Winston & Strawn to help with the probe. The special committee is led by Kenneth L. Way, chairman of Lear Corp. Way said the investigation will be conducted “expeditiously,” and should complete its work and report to the board within 60 to 90 days, and Whipple added that after the company has reviewed the findings, the results will be released.

CMS now has in place specific prohibitions against round-trip trades, Whipple said, or “any trades not supporting defined business objectives.” The company also has established transaction volume limits. Transactions in excess of defined limits require pre-approval by CMS-MST’s president and chief risk officer, he said.

To build up liquidity, CMS will sell CMS-MST’s energy performance contracting subsidiary, CMS Viron, as well as CMS Trunkline’s one-third ownership interest in Centennial Pipeline LLP, an interstate refined petroleum products pipeline. These asset sales will contribute to the company’s $2.9 billion asset optimization program, of which $2.4 billion has been completed to date, the company said. In May, CMS placed its oil and gas exploration and production business on the block.

The only drawback with the asset sales, explained COO David Joos is that the market is flooded right now in assets that have been put on the block by other energy companies. Sales are going slower than the company had anticipated, but he said CMS “is looking for ways to meet our targets and improve the balance sheet.”

CMS is following “a back to basics strategy,” focusing on North America, and its core oil and gas, pipeline and distributor operations, Whipple said, but there are no plans to sell its “very valuable” Panhandle pipelines or LNG operations.

The 2002 net operating earnings forecast, hit by a reduction in energy trading, has been cut as well, with a forecast of approximately $1.50 to $1.55 per share, down from a previous estimate of $2 to $2.05 a share. Analysts in a survey by Thomson Financial/First Call have an estimate of $1.68 a share. In 2001, the company earned $185 million, or $1.41 a share, excluding items. The new forecast includes the impact of Argentinean crisis, but excludes asset sales, discontinued operations, and restructuring charges.

“These actions will make our energy marketing business more predictable, reduce outstanding credit requirements, improve cash flow, and re-establish our emphasis on serving customers and pursuing customer power and natural gas supply contracts,” said Whipple. The additional sales are necessary since there appears to be no market currently for its operations in financially-troubled Argentina, which it had earlier designated for sale, company officials said in the webcast.

CMS in May restated its 2000 and 2001 earnings to eliminate over $5 billion in revenue and expenses from round-trip trades, involving arrangements for simultaneous trades of the same volumes at the same price. Chairman William McCormick’s resignation followed on the earlier resignation of Tamela Pallas, CEO of CMS-MST (see NGI, May 27).

The company also announced last Wednesday that Rodger A. Kershner, senior vice president, general counsel and corporate secretary, had resigned to pursue other opportunities. Kerschner was replaced by former CMS executive S. Kinnie Smith Jr., who is expected to be elected to the board of directors this month.

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