As the myriad of regulatory issues continues to be resolved, a Standard & Poor’s (S&P) natural gas analyst predicted Wednesday increasingly positive interest from creditors and investors toward energy merchants.

In a 48-page report, “Industry Survey on Natural Gas,” released on Wednesday, Craig Shere, an equity analyst for S&P, detailed several implications from the “seemingly negative” show cause orders issued by the Federal Energy Regulatory Commission staff in March.

“Despite its allegations of wrongdoing and its negative tone, the FERC report heralds an improving outlook for beleaguered energy merchants,” said Shere. “Given the involvement of most energy merchants in both the electric and natural gas markets, a resolution of this power regulatory uncertainty is important for the natural gas industry. The connection is made even stronger when one considers that the overwhelming majority of new power plants in the United States are both natural gas-fired and owned by unregulated energy merchants.”

S&P believes California’s demand for refunds of close to $9 billion for market manipulation “would be hard to justify,” however, now that the refund exposures have been defined, “we believe that creditors and investors will be more likely to look favorably on the energy merchant group.”

Since early April 2003, Shere noted that the findings of market manipulation “have had limited implications for energy merchants,” and FERC has yet to decide whether to approve its staff’s recommendations to seek disgorgement of profits from companies’ alleged violations.

In his review of energy merchant refinancings, asset sales and management changes, Shere’s review notes that some of the greatest risk exposures for the industry developed from the lack of energy trading structures and institutions. “As a fast growing, nascent industry energy trading was like a Wild West frontier town,” he wrote. “In this developing world, good guys thought they could survive on the quality of an honest man’s word, and bad buys thought they could take advantage of lawlessness. Both were wrong.” But the analyst found that industry participants and regulators are moving to develop structures to resolve unforeseen credit risks and to “foil efforts” to manipulate the system.

Among other things, S&P noted that many companies have responded to concerns about possible index price manipulation by moving data reporting from the trading desks to the risk management offices. Still, other issues remain, including mercury emission rules that will affect power plants and FERC’s proposed Standard Market Design.

S&P also expects merger activity among natural gas companies, including intra-industry and gas/electric mergers, eventually will return. “Consolidation will be driven by a growing need for natural gas to supply power plants, the increased scale required to manage volatile natural gas prices and rising credit requirements for all operations (regarding diversification, size, liquidity and proportion of equity funding to debt.”

For more information on the S&P report, visit the web site at www.standardandpoors.com.

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