The decision last week by a Financial Accounting Standards Board (FASB) task force to revoke a prior ruling that allowed the use of controversial mark-to-market accounting for energy-related contracts won’t result in as “big a hit” on the industry as some might think, said FERC’s chief accountant. Companies already sharply reduced the value of their contracts in response to the downturn in the market over the past year, he noted.
The change in how energy sales and purchase contracts will be valued in the future “will affect different companies differently,” with utilities likely to see little effects, while the already-troubled energy traders could face more write-downs as a result of the task force’s action, noted John Delaware, who is also deputy executive director at the Commission. “This is not a broad brush type of thing.”
Analyst John Olson of Sanders Morris and Mundy agreed, noting that some companies “may have small exposure,” while others with power plant tolling agreements and natural gas storage/transportation contracts could see “some hits taken to their comprehensive income line” and adjustments to write-downs. But, he conceded, “nobody is really sure yet” what the ultimate impact will be on the industry.
For Merrill Lynch analyst Steven Fleishman, “The immediate risks to companies using [mark-to-market] could include revisions to earnings outlooks (most likely downward) and the possibility of write-downs hitting the balance sheet. The good news is that this will have no cash impact.”
Mark-to-market accounting, which many believe led to the collapse of Enron Corp., allowed energy companies to book income from their long-term energy contracts years in advance of actually receiving the income and allowed them to adjust the value of their contracts annually to reflect changes in the market. FASB’s Emerging Issues Task Force, which examines new accounting trends, moved last week to replace mark-to-market with the more conservative accrual accounting method, which would prevent advance booking of income, and would put the value of a contract at whatever it was when the contract was settled.
Mark-to-market accounting or the practice of booking, for instance, proceeds expected from a 20-year contract in the year the contract was signed, left a lot of leeway for companies to predict what their product would be worth in the out years.
The accounting change would affect all energy commodity/capacity purchase or sales contracts that settle physically, such as power plant tolling agreements, and gas storage and transportation contracts. It immediately would apply to all transactions entered into after Oct. 25, while existing arrangements would revert to accrual accounting in the first reporting period following Dec. 15 of this year, according to a Merrill Lynch “Weekly Industry Update.” Derivative instruments, such as pure price swaps, options and collars, would continue to be subject to mark-to-market accounting.
Delaware believes energy companies abused the mark-to-marketing accounting method. “A lot of the energy companies, particularly Enron, used it to manipulate their earnings.” In fact, Delaware noted, “I wouldn’t be surprised [to learn that] Enron wouldn’t have been able to do some of the things [it] did if it didn’t have mark-to-market accounting.”
Constellation Energy, seeing the trend early, said it began moving away from mark-to-market to the accrual method in the second quarter and expects that completing the exercise will have “little impact” on its earnings. The company expects to take between a 20 to 40 cent hit with the changeover, but could not pin it down further since many transactions include both physical and financial elements and those will have to be separated one by one.
“This [accounting] pronouncement is only a few days old, but we’ve got some sense of what the consequences could be,” said Entergy CFO John Wilder. There are a “number of variables that you can’t interpret yet. Variables like the hedges that you have put on your inventory to protect your inventory positions. Will those or won’t those be able to be mark-to-market?” he asked.
“We would expect, when you analyze the length of our book — particularly with our inventory which is the majority of our issue — that we would have a one-time charge that would not be material as it relates to the partner capital in EK [Entergy-Koch], which is critical.” EK is the energy marketing and trading joint venture of Entergy and Koch Industries. “We don’t believe that there will be a substantial enough book impairment with that one-time charge to cause any credit issues,” said Wilder.
“Our goal would be to get this thing behind us. It’s not going to be a big deal to us. It’s noncash. It’s not going to hurt our creditworthiness or EK’s creditworthiness and we’ll follow all the accounting rules as the governing bodies pronounce them.”
FERC’s Delaware anticipates there might be some adjustments made to corporate earnings during the transition from mark-to-market to accrual accounting, and these will be reflected in companies’ first-quarter 2003 filings with the Securities and Exchange Commission.
“I think it’s time” for an industry-wide switch to accrual accounting, Delaware told NGI. He noted the 1998 FASB ruling, which granted energy companies an exception to use mark-to-market, was the result of heavy lobbying by Enron, and “probably wasn’t a good idea.” That exception “has sent a lot of confusing signals” on the value of contracts. The move to the accrual method is “going to give [us] more reliable accounting information on what’s happening on these contracts,” he said.
Â©Copyright 2002 Intelligence Press Inc. All rights reserved. The preceding news report may not be republished or redistributed, in whole or in part, in any form, without prior written consent of Intelligence Press, Inc.
© 2021 Natural Gas Intelligence. All rights reserved.
ISSN © 1532-1231 | ISSN © 2577-9877 |