Claiming it is more economic reality than wishful thinking, a disparate set of energy industry stakeholders expressed optimism last week that the energy trading sector will rebound. They predicted that order will be restored and credibility will slowly return even with more legal shocks like the former Enron trader’s guilty plea to federal authorities earlier this month. Trading is too essential to the operation of the nation’s energy system, particularly electricity, a variety of industry sources in the West and the East said in interviews with NGI.

As a backdrop, a number of organizations, including the Edison Electric Institute (EEI), Electric Power Supply Association (EPSA) and a new national ad hoc group, the “Committee of Chief Risk Officers,” have launched complementary efforts to facilitate restoring order and credibility.

“These are part of various efforts under way by a variety of industry organizations,” said Mark Stultz, spokesman for Washington, DC-based EPSA. “Each are focusing on a niche, which when put together will hopefully help restore investor and shareholder and market confidence. It is not something that will happen overnight. It will have to be a constant process moving forward.”

The new interest among financial community players, such as the Bank of America, which are applying to the Federal Energy Regulatory Commission to get involved in energy trading should help “show some confidence” in this sector, said Stultz, noting that in the long run that should be a boost for the role of competitive markets in the industry.

In the wake of former Enron trading director Timothy Belden’s guilty plea this month, EPSA, the Western Power Trading Forum (WPTF), EEI and others participated in a recent conference call to talk about two principal areas: (1) an EPSA “code of conduct” hammered out last summer, and (2) proposed new approaches for price survey reporting requirements, according to Gary Ackerman, executive director of the San Jose, CA-based WPTF.

“Without reservation, there was a strong feeling that what is needed is that reporters (price index survey people, such as those at NGI) not talk to traders, but instead get their information from the back-office people who have the actual data,” said Ackerman. He noted traders were recently fired for allegedly giving false price information to at least one of the national trade publications. “I didn’t know the ethics discussion fed into the reporting, but apparently it does. This topic covered the bulk or about 70% of our discussions.”

Separately, EEI, which held its annual financial forum last week, is taking the lead in creating a master netting agreement that can help with the collateral requirements for energy trading (see related story) which remains absolutely essential for its members that for the most part are utilities and the independent power producers. Generators have to trade to operate their system with the grid, all of the stakeholders interviewed last week agreed.

“I can almost categorically state that the market will sort itself out,” said Sam Van Vactor, of Portland, OR-based Economic Insight, the publisher of Energy Market Report. “The reason is that it has to. We’re not going to stop trading. It is a physical necessity; the nation’s electrical system can’t work without trading. And it is inevitable once the set of problems now facing it are ironed out that other traders will come back into the market that are better financed and hopefully more sober in terms of their procedures.”

The risk officers’ committee, representing about two-dozen major energy companies, including Duke, Mirant, AEP, Exelon, FPL and others, has established a web site (www.ccro.org) and developed a series of “white papers” that will be made available beginning Nov. 15. The papers cover (a) governance, (b) valuation and risk, (c) credit risk management, and (d) disclosure. The committee recognizes that among the energy trading community the approaches to these four areas have varied widely, and it is attempting to establish some bottom line standards.

How much time it is going to take to get the desired restoration of order and credibility varies among the stakeholders interviewed. Van Vactor thinks it will happen relatively quickly — within the next six months; other like Stultz and Ackerman are more cautious. In the meantime, the generators having to trade around their portfolios face the sobering reality that it costs them and their customers more because there isn’t the liquidity needed to drive down prices.

“The untold story [in the energy trade meltdown] is the huge liquidity drop, which needs to be translated into common language,” said Fred Pickel, a West Coast-based vice president with Tabors Caramanis & Associates, a Cambridge, MA-based energy consulting firm. “This liquidity drop has meant bigger bid/ask spreads — and no availability of more structured deals. What does it mean? Higher transaction costs and fewer choices for gas and power retail customers who can still buy directly, and higher transaction costs for utilities buying as merchants for their end-users.”

Along with the concerted efforts by the various organizations to right the trading ship, Van Vactor and others pointed out some of financial and market realities in play, such as the always relatively “thin” electricity markets (compared to natural gas) and the factor that today’s firms with the financial backing and expertise don’t necessarily have “the stomach,” as Van Vactor calls it, for the financial trading, which is more discretionary, as opposed to the physical trading that is more essential to the industry players.

“Power markets as commonly defined only cover a small fraction of power, unlike for the natural gas industry, and the physics of electricity require that they be regionalized,” said Robert Michaels, a Caramanis consultant and economic professor at California State University, Fullerton. “FERC’s standard market design (SMD) is…a step forward, but not as big a step as many are making it out to be. It will be really interesting to see what sort of products and practices get invented as banks and similar institutions take over a bigger fraction of the trading.

“All the customers and all the uncertainties of electricity are still there, just waiting to be dealt with.”

Overall, the optimistic comments about trading come from organizations and individuals who remain committed to fostering more dependence on market-based, as opposed to regulatory-imposed, energy industry solutions. EPSA has commissioned independent consultants’ studies by BostonPacific (www.bostonpacific.com/powerprices) that verify real dollar energy price declines since the mid-1980s due to competition, and the association remains convinced that albeit at a slower pace, on a national basis, the U.S. will continue to open up energy markets, and trading will play an important role.

“I think the best thing to restore credibility is to let the market work for a bit,” said Van Vactor. “The market fortunately is in a surplus in the West right now, and we’re also in a shoulder season. So I wouldn’t anticipate a lot of problems like we had in 2000 and 2001. That should make for a little more orderly process.”

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