Despite recent earnings and regulatory setbacks focused on its energy trading operations, PG&E Corp.’s National Energy Group (NEG) has no intention of discontinuing its trading operations even with last Thursday’s announcement of cutbacks totaling $40 million annually in its merchant energy businesses. Trading is profitable and contributing to PG&E NEG’s positive cash flow, company officials indicated.

A few days before the downsizing announcement, which started with eliminating 11 of 50 senior executive positions, PG&E earlier in the month reported in a quarterly Securities and Exchange Commission filing that its trading unit participated in at least 44 questionable deals between the start of 2000 and the end of May this year. All but four of the transactions were initiated by traders other than PG&E, and the company said none of the trades were necessarily intended to inflate revenues.

Less than a week later, the Besthesda, MD-based merchant energy operator, NEG, announced it was immediately launching the first of a two-phase effort to cut back operations by $40 million annually through a reorganization into functional units and layoffs, beginning with a 22% drop in its top executives.

As a result of the last three months of internal review and recent negative second quarter results and credit-rating downgrades, PG&E NEG’s Bethesda spokesperson said all aspects of the business are being examined for potential cost savings, but there are no percentage targets for cutting the national units more than 2,200 employees concentrated in Portland, Boston and Houston in addition to the Washington, DC, area headquarters.

The energy trading operation and interstate natural gas pipeline operations in the Pacific Northwest are likely to be the least impacted. PG&E substantially consolidated and reduced the size of its trading unit when it moved from Houston to Bethesda two years ago, the NEG spokesperson said.

“We have made a decision that trading most definitely will not be eliminated,” the spokesperson said. “We are already operating with a substantially lower number of people than most major trading units. In fact, some of the top firms making cuts lately have surviving organizations that still substantially larger than our operation in terms of the remaining people. Our trading operation is a very important part of our business. It helps define the markets from the outset of our merchant plants, and it helps create value.

“We’re going to take a look at the entire company and go from division-to-division, department-to-department and level-to-level to see the best way the financial targets can be achieved by realigning the company to fit the current strategy,” the Bethesda spokesperson said. “There are no targets in terms of numbers of people at this time.”

The recently depressed wholesale electricity prices were cited as a trigger for the six-cent/share loss in its nonutility National Energy Group (NEG) operations in the second quarter, leading to a ratings downgrade below investment grade by Standard & Poor’s, which in turn has caused financial uncertainty for NEG because a lot of its debt financing is tied to rating triggers that kick-in when they dip below investment grade.

“Conditions in the national energy markets will constrain PG&E NEG’s near-term profitability and growth,” said the company’s latest quarterly SEC filing released last Friday. “The excess supply conditions reduce operating margins for electric generators and lower price volatility for energy products, potentially reducing profits from energy trading activities.”

In response to the liquidity problems, NEG indicated in the SEC filing that it is abandoning some of its development projects, including the associated turbine and equipment orders, because the “market viability of these projects is uncertain.” It is looking for potential buyers or partners in pursuing the projects, and has launched a further administrative, general and operating cost reduction program to slice a minimum of $40 million from its annual expenses.

In the midst of the depressed markets and financial uncertainty in the energy sector, the federal investigations of trading activities are further complicating matters for PG&E and the entire industry, the company acknowledged in its SEC filing. In response to the request for data from the Federal Energy Regulatory Commission earlier this year, PG&E found 12 questionable trades, but it acknowledged in this recent SEC filing that another 32 trades fitting FERC’s criteria for so-called “wash trades” occurred over the almost-2-1/2-year period.

“These instances had no material effect on PG&E NEG’s reported revenues or financial results,” the SEC filing stated. “Revenues associated with these instances represent approximately 0.14 % of NEG’s revenues during the same period.”

The new organization will abandon the current geographical structure with four functions: (a) interstate natural gas pipelines; (b) merchant power plants and energy trading; (c) so-called “IPP” power plants tied mostly to long-term utility contracts; and (d) external/regulatory affairs. In addition, the normal business functions of accounting, human resources, etc., will be maintained as part of the headquarters staff.

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