As the wholesale energy sector is rebuilt in the coming years, more financial institutions and more oil and gas producers are expected to lead the way, armed with strong balance sheets and investor goodwill. However, the new players will still need the expertise of energy merchants, and more partnerships are likely, experts believe.

At the week-long CERAWeek 2003 conference sponsored by Cambridge Energy Research Associates, energy leaders were clear about what’s ahead for wholesale marketing and trading. “Assets matter,” said David A. Sobotka, president of Entergy-Koch LP. However, Sobotka and his colleagues also believe that physical assets have to be backed up with financial strength, compliance and controls discipline, quality customers and quality partnerships, as well as fundamental analytical strengths.

Expected regulation within the industry “will change the way the market operates, without a doubt,” Sobotka said, adding that Entergy-Koch also believes that there will be continued high market volatility, driven more by natural gas than power. “We’re bullish on the long-term prospects for fuel,” he said, but like most other energy executives at CERAWeek, it will be a long-term proposition.

As the market rises again from the ashes, Sobotka noted that there will be much more transparency in financial data, and said he expects more disclosure than ever before. However, he does not believe regulations alone will enable the market to recover. Among other things, over-the-counter clearinghouses will be a “hugely important element of the future. Clearinghouses, whether under the guise of Nymex or whatever, will give people access to the markets again. They will not exclude anybody and there will be a better advantage.”

Tighter credit markets also are expected to continue, the Entergy-Koch executive believes. “It will continue to be exceedingly difficult to raise capital in any form.” Some consolidation may occur, but he believes that the more likely outcome will be the emergence of new entrants with “big balance sheets.”

Said Sobotka, “the energy players will be relatively disadvantaged to financial players, but winners will emerge. Financial institutions will become very active participants in the market.” However, the new participants still will require the expertise of the energy leaders, making it more likely that partnerships will emerge between banking institutions and energy merchants. “In any case, the energy markets have a very healthy future,” he said. “We believe in it and we will continue to invest in it.”

In his overview of what has become of the formerly strong energy merchants, Vincent J. Kaminski, managing director of Citadel Investment Group, said their move to proprietary trading only “cannot be a solution for the entire industry.” Kaminski said, “there is nothing wrong with proprietary trading, as long as it is properly disclosed to investors and traders.” However, “sooner or later, you run out of a way of making profits.”

Wholesale trading “can thrive in the long run only if the end users have confidence in the market,” Kaminski said. “Energy marketing has to be supported by strong balance sheets,” or otherwise, a business has “cashless prosperity,” like Enron Corp.’s demise revealed. “Industry has to recognize that many challenges come from risk, but the problems in the industry did not come from overnight exposures…they came from the collapse of the spark spreads.”

Going forward, wholesale merchants will have to be “focused on the long-term risks of the contract,” Kaminski said. “The industry will recover, but it will be much different than before.” Like Sobotka, Kaminski believes financial institutions will enter the business.

However, he also believes that “some oil companies” with strong balance sheets also are likely to participate. “Whoever they are, they will have strong balance sheets and strong physical assets. They will have new ways of managing credit risk.”

Anthony Gordon, president of AIG Energy, said it was “up to us…to get the industry on the right track.” Although it has been compared to other types of businesses, Gordon noted that the “reality is, energy is quite different.” He said the energy business “has a unique set of risks that must be managed. There is plenty of volatility to be managed and risks to be spread.”

AIG analysts believe that energy risk management requires a “regional physical presence,” said Gordon, “with a tremendous amount of communication.” He said that the “timing is right to enter the markets,” with “robust opportunities for companies with capital and strong credit.”

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