The post-Enron Corp. energy industry erosion of financial sector confidence will only be reversed by companies and the overall industry developing more standardized contracts and greater disclosure, according to speakers at a day-long Standard & Poor’s “Power and Energy Credit Conference” Wednesday in New York City. The rating agency’s speakers also said their ratings work will continue to be done on a company-by-company basis, so individual companies do not have to be tainted by the current industry torpor.

Noting that it is up to the industry — not regulators — to address investors’ lack of confidence in energy firms today, John C. S. Anderson, John Hancock Life Insurance Co.’s bond and corporate finance group director, said that “everyone knows what is needed; now it is a matter of implementing it.” In response to a specific question, Anderson and other speakers acknowledged that current problems stem from more than just the need for improved disclosure, but also from the lenders “enforcing basic credit standards” again among the companies to which they lend money.

Michael L. Smith, Mirant Corp.’s vice president for global risk control, said his company and 14 other energy firms’ risk management executives have formed an industry-wide “committee of risk control officers” to develop standardized contracts and the possibility of industry-wide, multi-level clearinghouse functions with the goal of reducing collateral requirements in energy trading. The group of executives is working with an Edison Electric Institute (EEI) initiative regarding the development of a standardized contract.

Smith said Mirant’s trading business separates “operations risks” (plants going down) from the people/program-driven “operating risks,” which he said is where the industry has lost a lot of confidence. “Operating risk is the area that needs to get more attention by everyone in this room (financial community participants),” he said. “We describe it as when an entity does not have coherent policies, does not have segregation of duties, and does not have clear accountabilities and performance expectations, particularly for their risk management activities. It is illustrated by companies that have been profiled as doing transactions that have had no economic benefit (so-called “wash trades”).

“That is an operating risk violation, and I think where we as an industry can regain confidence is by putting more attention on operating risk. Everyone always starts with measurements and how you look at counterparty credit, but they never ask what sort of performance expectations have been set up for your traders, or what your book structure is.”

Smith and Anderson took part in a panel discussion among “borrowers and lenders” in the industry, moderated by an S&P managing director, William Chew, who also provided an opening summary of recent changes in the energy industry. Some of his other S&P colleagues gave overviews of the merchant energy companies and public sector energy providers, respectively.

Suzanne Smith, an S&P director, said her rating agency is “refining” the way it evaluates energy merchant companies, changing its “analytical framework where we feel it is necessary to adjust to current market conditions.” Smith emphasized that S&P will augment its assessment of market and credit risk, enhance the analysis of liquidity and further scrutinize components of capital, and revise the way the analysis of an energy trading business is incorporated into the consolidated rating of a parent, along with requiring more disclosure as the industry itself indicates it is going to provide.

Smith cited 17 large “energy merchants,” which she segmented into three categories: (1) independent power producers (Mirant, Calpine, NRG, AES, Edison Mission and PG&E’s National Energy Group), (2) natural gas companies (Williams, El Paso, Duke and Dynegy), and (3) regulated electrics (AEP, Aquila, Sempra, Exelon, Dominion, TXU, Constellation, and Reliant Resources). S&P currently has only four of the companies rated in the “A” level (A+, A or A-).

In the last several years, these companies have gotten more heavily into energy marketing/trading, meaning they are now more exposed to competitive power risks. “The vast majority of trading that is done is done in connection with support from parent companies, and the relationship of the trading business to the overall parent company is an important element of the total picture,” Smith said.

Standard & Poor’s has always looked at the potential loss of trading income, but now it will request and review market position reports and conduct stress and scenario analyses on market portfolios, among other changes.

“We believe that it is vital for borrowers to rebuild investor confidence,” Smith said. “Rebuilding credit by improving the market’s understanding of credit is one of the best steps individual companies can make.”

A report on S&P’s updated approach, “Updated Approach For Rating U.S. Energy Trading and Marketing Firms,” is available on RatingsDirect, Standard & Poor’s web-based credit analysis system.

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