A ranking of top power marketers by first quarter sales volumes shows very little movement among the ranks from the fourth quarter and a continuing increase in volumes, which were up 72% from the first quarter of last year, according to data collected by Energy Performance Review and NGI. However, the picture should change significantly this year as the market begins to shrink, trading counterparties are reduced in number, companies scale back their trading volumes due to closer scrutiny by regulators and the removal of “round-trip” or “wash” trades, and some companies exit the marketing and trading (M&T) business entirely, according to industry experts.

The M&T sector of the industry is in the midst of a major upheaval that has shaken the confidence of trading counterparties, investors, credit rating agencies and regulators. A sharp decline in market liquidity that has resulted from energy trading and accounting scandals that have arisen since the fall of the house of Enron has drastically reduced M&T opportunities. Risk management officials throughout the industry have put multiple counterparties off-limits due to questions about their creditworthiness or reputation. Participation in the market has grown increasingly problematic and the situation is likely to get worse before it gets better.

Several companies, including Dynegy, Williams and El Paso, already have announced trading staff reductions and reduced investments in the business and more companies are likely to follow (see related story). El Paso Corp. announced it will cut back its trading arm 50%, eliminating 300 jobs. Williams plans large cuts from its trading unit. Aquila has announced layoffs but mostly in its utility operations. CMS Energy Corp. and Dynegy said they would reduce their work forces. Dynegy’s reductions will take place in the next two weeks.

Energy industry consultant Benjamin Schlesinger, president of Maryland-based Schlesinger and Associates, noted that through the late 1980s and the entire decade of the 1990s the natural gas marketing and trading business grew rapidly, jumping from a handful of energy marketers to 300 or more, many of whom began trading power when the wholesale power market was opened (see NGI, June 10). Both gas and power trading showed continuous annual volume growth. But now with the fall of Enron, the increased requirements and scrutiny by credit rating agencies and additional wash trading scandals, it appears the industry is entering a new retraction phase.

Constellation Energy Group CEO Mayo Shattuck said last week in a presentation to analysts in New York City that he expects the shakeout in the M&T business to take up to two years and to bring down several more companies in the process. “For those that stay, there is a legitimate role for intermediation in this business that can’t go away,” Shattuck said (see related story). “There are people who need power that have to get it, and people who sell power that need to sell it to somebody and they do not want the risk management responsibilities that exist between those two. [Marketing and trading] is here to stay; we just have to get it right and appropriately regulated, and I think the [regulatory and credit rating] agencies will get it there.”

He said there will be an evolution of industry analysis by the credit ratings agencies, which eventually will break down marketing and trading companies into several categories in which certain trading platforms are evaluated based on their rules and procedures. The ones that will be successful, he said, are those that were built on the “historic Wall Street platforms…that have had 50-60 years of experience running by the rules and procedures and understanding what limits are and the metrics of VAR (value at risk).”

“It’s going to be a difficult year or two, particularly with congressional and regulatory oversight and input into this that may well be a bit of an overreaction.”

Shattuck said Constellation, which sold 86 million MWh in the first quarter, putting it at 11th in the ranking, always has practiced a more conservative marketing and trading method that focuses on structured transactions rather than volume growth. “It’s not about high-volume trading and big market positions; it’s about disciplined analysis and customer relationship management. Our team has proven itself to be very good at it over a period of four years.”

He said Constellation focuses on a portfolio of wholesale load-servicing contracts balanced by owned or controlled generation resources. It focuses particularly on regional markets in which end use, rates and supply have been “fully decoupled;” specifically the Northeast, MidAtlantic and Texas. Shattuck estimates that Constellation has an average load servicing market share in those deregulated areas of about 9%.

“Good companies adapt to market realities, and that’s what we’re doing,” Williams CEO Steve Malcolm said recently. “The credit confidence is gone. There are few counterparties willing to enter into long-term agreements.” Williams is in discussions with several undisclosed parties to explore a partnership covering certain aspects of the M&T business. Absent a partnering relationship in the current environment, the company said new deals will be “limited to those that result in increased cash flow and reduced risk, or are neutral in their effect.”

“Demand is strong for the kind of long-term risk management deals that are Williams’ strength, but the necessary credit confidence is absent throughout this industry segment,” Malcolm said. “While we make progress on building our financial strength to meet the challenges of the new business environment, we will maintain customer relationships through shorter-term deals that are compatible with our cash-flow and portfolio-risk goals.

“While today’s industry conditions are requiring us to scale this business to a size that tracks [current] realities, we will retain the talent, systems and controls to respond once the marketplace stabilizes.”

El Paso CEO Williams Wise said that the market going forward is going to be “vastly different.” There has been an “almost total reversal” during the past six months in the growth in energy trading and the pace of electricity deregulation, agreed El Paso Merchant Energy President Ralph Eads. “We think the opportunities…in the gas business continue to be attractive for us, where we believe we have a leading position. But the power business is somewhat more problematic” due to “uncertainty” in the market, he said. As a result, El Paso is “de-emphasizing” the power trading end of its business. El Paso will cut a total of 300 traders.

“We believe that our trading business has grown into a business that is too large for [the] credit available within the El Paso Corp. balance sheet,” Wise told investors during a recent conference call. “The value that we get in our stock from our earnings out of the trading business is very unquantifiable, and there’s a very good argument with the increasingly large doses of mark-to-market earnings that we are actually getting negative value on our stock as a result of our trading business.” He noted an “important objective” of the company was to limit its mark-to-market earnings to 5% or less of its total earnings stream.

“We’re going to draw a circle around the trading business, and we’re going to limit our call on credit…and our investment in that business,” he said.

All the companies in the M&T business will be undergoing significant changes this year but in the first quarter, the picture retained much of its traditional flavor with large volume increases and continuing overall market growth. American Electric Power retained its top position with 178 million MWh, a 17% jump from 1Q2001. Allegheny reported the largest percentage increase in volumes, a 443% jump to 94 million MWh. CMS Energy’s 315% increase to 15.5 million MWh will have to be questioned for its validity given that the company has admitted that much of its business was made up of wash trades purely designed to inflate volumes and deceive investors. Reliant, which also admitted doing wash trades, reported a 62% jump in volumes, which also should be questioned. The only volume declines on the list were reported by NRG, PNM Resources and FirstEnergy.

Source: Energy Performance Review and company surveys by NGI. For more information on EPR, visit www.energyperformancereview.com. Numbers in ( ) represent rank in the fourth quarter of 2001. *Total excludes 2002 numbers for Constellation, Conoco and Oneok because of missing data for 2001 quarter.

©Copyright 2002 Intelligence Press Inc. Allrights reserved. The preceding news report may not be republishedor redistributed, in whole or in part, in any form, without priorwritten consent of Intelligence Press, Inc.