The current decline in market liquidity is an unfortunate but inevitable consequence of the energy trading and accounting scandals that have arisen since the fall of the house of Enron. Sources in all market areas report seeing a gradual shrinking of liquidity as their risk management officials put various counterparties off-limits due to questions about their creditworthiness or reputation.

A Gulf Coast marketer offered a concise analysis of how the market is growing increasingly problematic: “Finding healthy [trading] counterparties is a daily task these days. Those that still have good credit use it up rapidly at these $3-plus prices.” It really is a shrinking market, he added, and that’s starting to show up in liquidity tightness for many people. “If it’s up to the [credit] ratings agencies, it will be a long time before the industry recovers. Moody’s [Investor Services] was telling us this in their white paper (see NGI, June 3): Who you resell to now is a direct mirror of how you are rated yourself.”

In announcing an online gas auction to supply several major industrial end-users (see related story), energy management firm Kimball Resources Inc. noted that industrial consumers have become very leery of the energy business recently. “They are asking me a lot more questions about suppliers than ever before. They want more and more details about transactions than they have in the past,” said Brandon S. Hayes, president and owner of Kimball.

More pointedly, Hayes added, “Credit managers have taken over the business. They’re scrutinizing every transaction. The companies are letting the marketers go and hiring more credit managers. It used to be the marketers were the dealmakers,” but now credit issues rule, and “there are not as many deals being done.”

An East Coast utility buyer noted that in doing business on online platforms like IntercontinentalExchange (ICE), determining the suitability of a potential trading counterparty is almost mechanical. “You can open up filters to someone, but they have to open you up in return. Your risk people have already determined who’s OK and who’s not. If you agree with each other, it comes up as white on the ICE screen; if not, red. I’m seeing a lot more red than before.”

As liquidity dries up, it’s going to weed out some of the middlemen, the utility buyer continued. “Obviously the pure producers have the hard assets, and you don’t see them involved in the scandals. Some of the smaller ones didn’t have the resources to locate potential buyers, and that was where the middle marketers and brokers arose. I think we’ll end up with two or three very big marketers, but they will be backed by assets.” He also anticipates an increase in direct producer to utility/end-user trading.

A Canadian producer agreed: “Obviously there are not as many players now as [there were] a couple of months ago. We’ve been going directly to end-users more than we used to. You should always be out looking for new markets anyway, and this [liquidity cutback] is just forcing the issue.”

In line with that, not everyone sees the current turmoil as totally negative. According to Tom Saal of Miami-based Pioneer Futures, “What we are seeing is the market belching out its inefficiencies. With technology and the Internet what they are now, there is no longer the need for these mega-marketers. Going forward, producers will take a increased role in marketing their own gas. Additionally, there should emerge more mid-sized, regional boutique-style marketers that will serve customers as small as hospitals and as large as small manufacturers.”

A Gulf Coast producer perceives the liquidity crunch not so much as the result of trading scandals “as it is the credit analysts hammering investment ratings,” although he acknowledged that the analysts’ critiques were based at least partially on news of sham trading. He pointed to evidence of tighter liquidity: “On ICE you see deals being done at a penny off the best bid because they can’t find suitable counterparties, especially toward the end of trading.” The scandals have centered largely on the merchant companies, the producer observed. “We’ve seen a reduction in creditworthy parties, but haven’t had anybody turn us off.” But all energy people are going to be paying the price down the road, he said, adding, “Actually, we’re already starting to pay a price.”

Veteran energy consultant Charlie Neill with Charles River Associates agrees, saying the ongoing investigations are “gutting the competition and effectively raising the price of the commodities.” But, he added, “Margins for the survivors will increase.”

Another industry observer predicted the large merchant marketers will not find the scaled-down business as attractive and will devote less resources to it in the future. They also are likely to add on higher margins to support trading operations.

A marketer thinks credit inquiries can have psychological results. “We have had traders that aren’t concerned about our credit but asked to check it anyway,” he said. “But just asking can make traders hesitant because it is an additional risk. It should also have the effect of raising margins, as fewer sellers would be competing for buyers. We haven’t seen it yet, but we should. On each consecutive sale you make less money, because you do your most lucrative deals first and work your way down. As you get down to where you are nearly breaking even, you would be less likely to deal with someone who wants to check your credit, given the additional risk. You should, in theory, raise margins and also raise prices — not a whole bunch, but a penny or so.”

A risk manager with a utility company added these comments: “For these mega-marketers — some of whom have seen their market capitalization decrease from $4 billion to less than $2 billion in a couple of weeks — it is safe to say that credit concerns and their exposure to risk is now paramount. Their focus now needs to be on keeping their risk profile in check and keeping their credit rating through these tough times. And it’s not going to get any easier for them to manage risk.”

NGI recently encountered a further sign of the measures that some companies are taking to protect themselves against new scandal. An editor, calling a marketer to whom he had talked many times before, heard this for the first time: Even before the phone started ringing, a recording came on and said, “Your call will be recorded.”

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