Energy marketers involved in “wash” transactions were almost drowned last week with bad news, as investors bailed on their stocks and regulators called for a good soaping of the industry. It was a dreary week overall, but those taking the worst baths included Dynegy Inc., CMS Energy Corp. and Reliant Energy Inc. By the end of the week, at least three top trading executives at two companies had resigned and the weather showed no sign of clearing anytime soon.

The disclosure by several U.S. energy companies of prolific round-trip gas and electricity trading to boost volume — and in some cases revenue — continued to pummel the energy industry, as news of the deals (or those denying any involvement in round-trip transactions) continued to grow. Well known throughout the industry but not publicly disclosed, the transactions that are threatening to undo some companies involve agreements between two parties to buy and sell the same amount of a commodity, in these cases power or gas, at the same price for the sole purpose of boosting quarterly and annual sales volumes.

The week began with disclosures from Reliant Energy Inc., which reported last Monday that it had made 45 Bcf in round-trip gas trades last year and 139 million MWh in power trades over the past three years mainly with three counterparties: CMS Energy Inc., EnCana Energy (formerly PanCanadian), Public Service Company of Colorado and Merchant Energy Company of the Americas.

Reliant Resources Inc., the majority-owned subsidiary of Reliant Energy, admitted that 10% of its trading revenues over the past three years came from round-trip transactions. The company said it had 33 million MWh in round-trip trades in 1999, 31 million MWh in 2000, and 78 million MWh of power and 45 Bcf of gas round-trip trades in 2001. About 20% of all of its trading volumes in 2001 were from these types of transactions. Reliant Resources said it also fired the two employees who orchestrated the deals.

Reliant had cancelled a $500 million bond offering on May 10, a day after news leaked about similar transactions between CMS and Dynegy. “Let me assure you, if…I had known about these transactions there is no way we would have priced those bonds,” CEO Steve Letbetter said during a conference call with analysts. He said once the company found out about the transactions it did the “right thing” by canceling the bond offering.

By Thursday, the first high-level casualties began, with Reliant’s top two trading executives, Joe Bob Perkins and Shahid J. Malik, resigning. Perkins had been COO and president of Reliant Energy’s wholesale group and group president of the wholesale businesses for Reliant Resources. Malik was president of Reliant Energy Services. Perkins, well known throughout the energy community, also was a member of the office of the CEO for Reliant. In a written statement, Letbetter said Perkins and Malik had resigned to “pursue other interests.”

Letbetter named Stephen W. Naeve, formerly executive vice president and CFO, as president and COO of Reliant Resources. He assumes overall responsibility for the operations of Reliant Resources and will be directly responsible for the company’s wholesale group activities. The company will conduct an external search for a new CFO. In the interim, Rex Clevenger, Reliant Resources’ senior vice president of finance, will assume those duties.

In the meantime, though, there is more fallout still to contend with. Reliant told the Securities and Exchange Commission (SEC) that both Reliant Resources and Reliant Energy would delay filing their 10-K quarterly earnings statements for the first quarter until Monday (May 20) so that they could review the trades conducted by the wholesale and marketing business, as well as review Reliant Resources’ accounting practices.

Reliant also faces more than just dissatisfaction with investors: several lawsuits alleging artificial price inflation also were filed against it last week. The lawsuits claim that Reliant Resources issued false and misleading information regarding quarterly and annual financial performance. Specifically, the lawsuits allege that Reliant Resources’ stated and represented revenue in 1999 and 2000 materially was overstated because 10% of such revenue represented purchases and sales with the same counterparty at the same price. The lawsuits also claim the company improperly accounted for certain transactions in its conventional accrual accounts as cash-flow hedges.

Reliant’s Letbetter said the company is planning some changes to its business because of this incident. “We’re calling a ‘time out’ to reassess our mark-to-market activities. In the interim, we will more narrowly focus our trading activities on optimizing the value of our core physical assets. This will entail a reduction in our mark-to-market activities that are not directly tied to our assets.” He said the mark-to-market trading activities being curtailed were expected to contribute 8% of projected total earnings before interest and taxes from trading this year.

Moody’s Investors Service said last week it may cut its ratings on Reliant Resources to junk, following the company’s decision to cancel the bond sale. Moody’s said it may cut Reliant’s “Baa3” senior unsecured issuer rating and its Prime-3 commercial paper rating, affecting about $9 billion of securities. Its review for a possible downgrade will focus on steps taken by management to reduce exposure to trading risk and the impact on liquidity from the cancellation of the bond deal, among other risk factors. Fitch Ratings said the outlook remains negative on Reliant Resources’ ‘BBB’ implied senior unsecured debt rating and ‘F2’ commercial paper program.

Letbetter said he was instituting a company-wide program to better instill core company values in employees. “Those values include integrity, forthrightness and value creation for our shareholders. I am personally embarking on a process to ensure that every employee in this company holds those values dear and performs accordingly.”

But Reliant was not the only company to suffer the sins of disclosure. Dearborn, MI-based CMS Energy, which had been whispered about in purported wash deals with Dynegy days earlier, revealed Wednesday that it had made $4.4 billion in trading revenue in 2000 and 2001 from round-trip transactions. A preliminary internal review found that its Marketing, Services and Trading division, CMS-MST, entered into round-trip power trades between May 2000 and mid-January 2002 that included 79.3 million MWh in 2001 and 29.6 million MWh in 2000. With these trades subtracted, electric trading volumes totaled 31 million MWh in 2001 and 8.3 million MWh in 2000. The company said it found no round-trip gas trades.

All of CMS’ round-trip trades were with Dynegy Power Marketing Inc. and Reliant Energy Services Inc. CMS said they had no effect on the company’s earnings, cash flow or balance sheet for 2001 or 2000. It said it ceased doing these types of trades in January 2002. After the third quarter of 2001, the company changed its accounting treatment so that these trades were no longer included in 2001 revenue and expense.

By Thursday afternoon, there was another casualty, with the resignation of Tamela Pallas, CEO of CMS-MST. Pallas was responsible for the organization during the period in which the recently publicized ’round trip’ electricity trading activity occurred, the company said in a written statement. She “expressed regret over the controversy that has resulted from this trading activity, and her belief that it was in the best interest of CMS Energy for her to step down,” according to the company.

“These round-trip trades are not consistent with the company’s values and high standards of integrity,” said CMS Energy Chairman William T. McCormick Jr. “The company is committed to ensuring that such practices are never repeated.”

David B. Geyer, vice president and chief risk officer of CMS Enterprises, has been named interim president of CMS-MST. “David is a very capable and experienced manager who I am confident will provide solid leadership for CMS-MST,” said McCormick. CMS also reiterated that it was cooperating with an informal inquiry by the SEC and was also cooperating with the Commodity Futures Trading Commission, which has requested that the company furnish information on the “same general subject.”

On Thursday, Moody’s revised the ratings outlook for CMS to “stable” from “positive,” with a credit rating on its senior unsecured notes at Ba3. The revision, said Moody’s, affects $15 billion worth of debt, and was predicated by the CMS-MST news.

“While the contribution from CMS-MST to CMS Energy’s operating net income is expected to be less than 15% in 2002, event risks associated with an ongoing Securities and Exchange Commission investigation and the increased risk associated with potential litigation make it highly improbable that an upgrade in the company’s rating will occur in light of these current circumstances,” Moody’s said. “It is Moody’s intention to reevaluate the company’s rating outlook when the current situation clarifies itself.”

In response to those companies admitting they had engaged in round-trip trades, other energy companies went on the offensive, reporting when they had not engaged in the wash deals.

Constellation Energy Group stated Wednesday that it has not engaged in trades designed to inflate volumes or revenues and noted that “achieving high trading volumes is not a business objective.” In addition, the company said it had always reported trading revenue on a net rather than a gross basis and therefore could not inflate revenues through matched offsetting transactions.

“We feel it’s important to clearly state that Constellation Energy Group has not engaged in transactions that are designed to inflate energy trading volumes or revenues,” said CFO Follin Smith. “All our trading activity has been done for legitimate business purposes.

“We are confident about our financial future as an energy company with a strong balance sheet and a balanced portfolio of regulated and nonregulated businesses that should provide solid cash flow and dependable earnings,” Smith added.

Aquila and NRG Energy also denied engaging in round-trip deals to inflate volumes. NRG said its “initial” review showed no instances of trading transactions involving simultaneous purchases and sales with the same counterparty at the same price.

Duke Energy and Mirant also confirmed that none of their energy trades were done to inflate revenues or trading volumes.

“This type of activity is not tolerated, nor will it ever be tolerated, at Mirant. Our trades are conducted to serve our customers, to balance our portfolio, to manage risk and achieve business purposes,” said Mirant CEO Marce Fuller.

Jim Donnell, CEO of Duke Energy North America, said Duke’s trading operation is “measured on and fully focused on profitability and value creation. We engage in trading for three purposes — to serve customers’ needs, to profitably grow our business and to optimize the value of our energy assets. All of our business activities are done with the express goal of generating earnings.”

Duke said it analyzed its trades for the three-year period from 1999 through 2001 to identify those trades which may have some of the characteristics of sell/buy-back trades. Identified trades accounted for less than 1% of the company’s trading and marketing revenues. None of these trades were entered into to increase volume, the company said.

Still, the energy community — sham trades or not — has only begun what appears to be a long journey of investigation and revelations. Now that the Federal Energy Regulatory Commission has launched an investigation into practices used to sell power in California, more companies are expected to announce internal reviews of practices in all areas of their energy trading units.

Last week, Reliant Resources was the first energy supplier to publicly admit that it engaged in some of the same practices used by Enron to sell power into California markets, but it contends the actions were entirely legal.

The practices “involved no conduct in violation of applicable law, regulations or tariff provisions,” said Hugh Rice Kelly, Reliant’s senior vice president and general counsel, during a web-cast conference with financial analysts Monday. “Based on our review to date, we expect our answers to FERC will be that we did not engage in eight of the 10 practices.”

As for the other two practices, Reliant purchased low-cost, capped power from the California Power Exchange (Cal-PX) and sold it at higher prices, said Kelly, adding that “we had no policy against buying low and selling high when it was lawful to do so.”

While Reliant generally did not sell into the California energy market by overscheduling load, as Enron apparently did, there were “two minor exceptions,” according to Kelly. “The first [exception] was set up in cooperation with the California Independent System Operator in which the California PX acted as our scheduling coordinator. The second was a minor activity accounting for less than 1% of our revenues in California. We should add that this particular practice also demonstrably benefited both consumer prices in California and system stability.” Reliant said it would withhold further statements about its use of Enron-like trading practices in California and other western markets until later this month.

Reliant’s comments came less than a week after FERC staff ordered more than 150 energy suppliers to furnish information on whether they engaged in Enron-like trading practices during the height of the California energy crisis in 2000-2001 (see NGI, May 13). The agency asked the power suppliers to western markets to “admit or deny” under sworn oath that they unfairly gamed the market. Their responses are due at the Commission by May 22.

FERC directed the suppliers to base their responses on the now-infamous Enron memos that appeared to provide a blueprint for manipulating trading in California and other western markets. The three memos, which were released by the Commission, described in detail a number of colorfully named strategies — inc-ing load, Fat Boy, Death Star and Ricocheting — that were employed by Enron (see related story).

©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.