North America’s damaged energy trading industry appears to be on the mend at mid-year 2004, as industry players old and new realize the fundamental need for risk management. Some of the names that figured prominently three years ago as the merchant sector began to collapse still remain in NGI‘s Top 20 North American Gas Marketer Ranking. However, some shakeout continues as new players with substantial financial wherewithal step forward.
The energy merchant industry, slowly rebuilding, is now going through some growing pains, but it appears healthier and more transparent than it was in the late 1990s, when Enron Corp. dominated the landscape. The current players have taken what happened to the industry and made it an “object lesson in the importance of creditworthiness in financial markets,” according to Adam Josephson of Celent Communications.
Boston-based Celent, an independent, privately owned research firm, published a report in August on the state of the U.S. energy trading industry, which was authored by Josephson. He examined the revolution of the industry from its inception and collapse to its rebirth, and he now sees the sector nearly as strong as it was in 2001. The U.S. energy merchant industry dropped from an estimated $1.8 trillion in 2001 to about $1.3 trillion in 2002. By 2006, Josephson said it will approach $1.7 trillion, led by the emergence of financial institutions.
“As the U.S. energy trading market matures, banks and hedge funds should help drive solid, steady growth in the years go come,” said Samuelson. “Market participants are becoming increasingly comfortable using risk management tools, which are becoming ever more important in managing price risk.”
Ken Silverstein, director of Energy Industry Analysis for UtiliPoint International Inc., agrees that the energy merchant industry has taken a “dramatic” turn since the big players departed the scene. “Those with deep pockets and investment grade ratings have stepped up,” he said, and credit concerns have been eased while liquidity has increased.
It is still early to determine the impact of the banks and financial institutions on the amount of wholesale natural gas volumes sold in North America. Many are only beginning to set up trading desks and offices to deal with the new and expanded business, but it’s clear from looking at the gas volumes that new players are entering the market.
In the second quarter, London-based BP plc continued to dominate the landscape, reporting 21.8 Bcf/d of gas sold in the United States and Canada. The top 10 list includes the usual players of the past few quarters, ConocoPhillips, Coral Energy (Shell’s marketing arm), Sempra, Cinergy and Entergy-Koch. However, expect those top names to shift somewhat in the coming quarter: Entergy-Koch’s energy trading business has been bought by Merrill Lynch, a strong indication that the financial institutions view the merchant sector as profitable.
The entry by financial institutions such as Merrill “could potentially be a profitable one in the $400 billion a year electricity and natural gas industry,” said Silverstein. “The banks are looking to make up for reduced trading revenues in their equity and bond businesses and the power sector does appear ready to accommodate a growing economy. Moreover, volatility in the oil and natural gas businesses provides for even better opportunities. Barclays, Citibank, Deutsche Bank, Goldman Sachs and Morgan Stanley are among those that are working to diversify their commodities positions and to sell electricity products to their institutional and industrial clients.”
Silverstein noted that the Merrill Lynch announcement “could exceed any expectations from deals completed in the past” because “unlike other previous energy traders with utility roots, Entergy-Koch has remained powerful. When it formed in 2001, it had assets of $851 million. Now, with its nearly 700-person operations located in the United States and in Great Britain, it is worth $1.18 billion.”
Peter Fusaro, chairman of Global Change Associates, agrees. He said the Merrill deal is “a significant indicator of the next wave in energy trading causing the rapid ‘financialization’ of energy markets with the participation of financial players with the balance sheet to put more capital at risk.”
This is the second energy trading unit for Merrill. It sold the energy merchant unit in 2001 for $490 million to Allegheny Energy after huge losses and lingering lawsuits. This time, Merrill won’t only rely on natural gas. If the Entergy-Koch transaction is approved by regulators, Merrill officials indicate they want to expand the merchant unit to offer oil and coal contracts.
David Hendler and Richard Hofmann, financial analysts with CreditSights, said Merrill is stressing that the Entergy-Koch transaction “should catapult it into the top three energy traders on the Street as activity in various markets (oil, coal, etc.) remains a key growth focus going forward.”
Goldman Sachs made its push into energy trading with its purchase of Cogentrix’s generation assets. The transaction added 26 generators and about 3,300 MW to Goldman’s power portfolio, which now totals about 4,300 MW. Most of Cogentrix’s output was sold under long-term contracts to investment trade utilities.
However, while there are opportunities, “success is not a given,” said Silverstein. “Consider American Electric Power and Duke Energy, which pulled out of speculative trading. They have focused instead on the spot market, selling the excess power they generate to those entities that must ‘balance’ their load requirements. Just ask UBS Warburg, which bought Enron’s trading desk: It’s laid off at least one-quarter of the 600 traders that it inherited, all because of weak natural gas and electricity trading volumes.”
However, some energy consultants see the energy merchant field growing in different — but stronger — directions. Silverstein noted that more than 200 hedge funds, which are privately organized and administered by investment professionals, are trading energy commodities, or financial instruments that include derivatives. The void, he said, could potentially be profitable in the $400 billion a year electricity and gas industry.
“The next wave of energy trading has now begun with hedge funds entering the energy markets,” said Fusaro. “Their importance cannot be understated as both liquidity providers and price influencing factors.”
* Total excludes Louis Dreyfus because a numberfor 2003 was not available.
Source: Quarterly financial reports with theSecurities and Exchange Commission, or if necessary, statements signedby company officials and provided to NGI.
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