By this summer, at least two more energy trading companies — more likely asset-light instead of asset-heavy — may be forced to file for bankruptcy, which will offer opportunities for other companies, and perhaps even an opening for new trading players, a panel of energy executives forecast last Tuesday. Speaking at the UBS Warburg Global Energy & Utilities Conference in New York City, the panel agreed that companies most likely to succeed will be the multi-dimensional players, with balanced portfolios that operate in both high or low volatility markets.
Lyn Maddox, COO of energy trading for PG&E National Energy Group, said the taint of the Enron Corp. scandal could lead to the “risk of a domino effect” in the coming months as Enron’s problems affect other companies. “Finding capital available will be real painful.”
Another panelist, V.J. Horgan, president of TXU Energy Trading, said, “I hate to forecast there will be bankruptcies in the energy business, but trading is more at risk as are the cash flows in this business. These are the events that would catapult a company into distress and into bankruptcy. Those that have seen the pressures brought about in Enron’s demise will reassess…some companies may get out of some aspects [of the business].”
However, while some players may be forced out or bought out, the marketplace is growing, and at least one company, Germany’s RWE Trading GmbH, wants to be a part of that growth. RWE plans to debut a U.S.-based trading platform in March, said Stefan Judisch, managing director. Judisch, who said his company plans to take advantage of distressed companies as it grows its U.S. marketplace, also predicted energy company bankruptcies before the end of this year, but “what happens in the United States…depends very much on how this summer goes.”
“If we have a volatized summer,” Judisch said the companies wobbling from credit problems may escape bankruptcy. “Otherwise, I see two or three bankruptcies. I think two are on the verge of bankruptcy. The cycles stopped very abruptly, and the adjustment was difficult to make.” Those companies, which he did not elaborate on, are “leveraged up to their eyeballs and are now being penalized for it.”
Judisch also offered some insight into his former employer, UBS AB, whose subsidiary UBS Warburg Energy has bought Enron’s wholesale and marketing unit. The Swiss-based banker, which holds an AA+ credit rating, will “lead with its balance sheet…not with marketing.”
Though somewhat puzzled that UBS would even consider buying Enron assets, Judisch predicted the new trader will be “successful,” but he added he does not think the banking institution will become a permanent fixture on the U.S. energy trading scene. “They bought EnronOnline for market making…This business is very capital intensive,” and he said he did not think banks would want to remain too long in the trading arena.
Dynegy Inc.’s Louis Dorey, president of marketing and origination, said last year was “traumatic in a lot of ways,” with the first half of 2001 “pretty rough,” and then downhill after that. However, he and other panel members dismissed the attention captured by the bankruptcy of Enron, stating, “Enron is just a company. It’s unfortunate that it’s taking up so much of the news. Dynegy did not rely on Enron.”
Dorey admitted, however, that Enron’s departure has added value in more ways than one to Dynegy’s reputation. “In terms of brand, everyone knows who we are now,” Dorey said, following the failed attempt at a merger with Enron last year. “The good news is, everyone wants to do business with us.”
There are “huge opportunities for customers in Texas and throughout the Northeast,” said Dorey, and if the economy picks up later this year, it will “make the fundamentals” stronger. “The red count is starting to go down,” he said, proving that the “market really does work.” Dorey added, “It’s all about the customer at the end of the day. In terms of who’s going to win, there’s going to be winners and losers,” but he also predicted the marketplace will go through an intense shakeout in the next 24 months.
Horgan agreed that the opportunities to expand the customer base are especially strong. Noting that TXU Energy was “well suited in this environment with companies in distress,” she said the company’s main objective is to be patient and wait for the right opportunities. Now centered in the newly deregulated Texas marketplace, Horgan said TXU Energy sees “opportunities in the Northeast and the Midwest” on the radar screen, and said there are big plans to “expand our opportunities beyond Texas.” For 2002, TXU Energy has a “brand new portfolio” as it slipped into the deregulated marketplace.
“All eyes are on Texas right now [as] the deregulation model,” Horgan said. However, while most of its trading business is centered in Texas, TXU Energy now plans to “defend its base and deploy systems to extend the model to other market areas.” TXU Energy sees “tremendous opportunities in other companies’ distress. There are a lot of assets in the marketplace” that will be for sale, and “our challenge is one of patience, not just doing something for the sake of doing something.”
PG&E’s Maddox said the California bankruptcy experience forced his unit to “stare death in the face…we were hammered in ’01.” However, as “painful” and “challenging” a year as 2001 was, Maddox noted that important lessons were learned for his company as well as Enron’s. “When you are faced with different types of credit challenges, you learn that when the liquidity runs out, it can be fatal.”
Because PG&E National Energy Group’s energy trading unit is not the same company as Pacific Gas & Electric Co., it has “separate debt and separate balance sheets,” said Maddox. “We are unregulated and we were able to survive the liquidity run.” He said his unit also has learned the “importance of investment grade ratings” following the volatility in the marketplace last year, and said it is a lesson that other companies should also learn. “It’s important for the entire industry,” he said.
To “win,” said Maddox, energy traders need to have a balanced debt level. “Portfolio diversity will be key,” he said. “It is critical to the mitigation of risk. Diversity is going to be critical in the design of the portfolio,” so that companies can be more flexible when the marketplace is as volatile as it was last year.
“Risk management competencies are absolutely critical” too, Maddox noted. He also echoed other panelists regarding the importance of customers, noting that their “satisfaction is an important part of fundamental hedging.”
In the face of ratings scrutiny by the credit agencies, Maddox said agencies will be looking at the current debt levels carried by companies and their short-term cash flow. “Those companies that overrated the potential for new capacity…those overloaded on debt are now revisiting all of that.” He said that PG&E has been working with Standard & Poor’s to “educate them on the numbers,” which he said has led to a “healthy discussion.”
The credit rating agencies, said Maddox, are under “a lot of pressure for not downgrading” some entities sooner, and with the “recent events, they will pay more attention to early indicators and spreads, bonds, debt.” In the end, however, the “quality of the ratings will improve,” and there will no longer be a “knee jerk” reaction to take action quickly.
Said Dorey, “Part of what’s gone on has been justified, part of it has been knee jerk. I’m not sure there’s going to be another wave of downgrades, but initial scrutiny has stepped up.” To the extent that companies affected “can react, they will react. This is a healthy thing going forward…providing additional visibility that we need.” He said in the next six to 12 months, there will be a “better understanding” of what energy traders do. “What’s going on is a healthy thing. We will be a stronger industry.”
Judisch reminded the audience that Enron’s problems did not come from its trading unit. “They came from over leveraging and over-stretching on the credit side. Enron had a lot of problems investing [in things] at the wrong time.” However, he said, Enron’s collapse was “not about trading.”
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