The revelations last week that Aquila Inc. will soon shutter its merchant services unit and that Dynegy Inc. stopped its online trading business were not nearly as surprising as one industry veteran had expected. Referring to this time as “the Great Shakeout,” energy consultant Ben Schlesinger said a year from now, “those who don’t want to be in this business won’t be in it, and those who are good and really want to be in this business, will be.”

That choice has become very difficult for many merchant energy companies that have grown up out of traditional utility operations. It’s a choice that will lead to a lot fewer companies next year, and those that remain will see significant changes in the way they conduct everyday business, especially if their energy trading divisions remain in house. “Individual traders are good at it. Traditional utility management usually isn’t,” Schlesinger told NGI Thursday.

“In more instances, where traditional management came up through the ranks, they have woken up to find they are now managing an awesomely complex trading operation that they may not even want or fully understand. They see their brethren executives cut down, and they see how easily they can find themselves in the same situation,” Schlesinger said. “A lot of them are probably deciding this isn’t worth it,” he said of the fast money-making trading operations, “and they want to return to the more traditional path of growth.”

Although energy trading is a necessary function, Schlesinger said that some companies may begin to consider only physical trades and to cut down or eliminate a lot of financial and online trading, despite its ease. “I think it does provide a lot of plusses, but some may decide that the efficiencies of online trading are unnecessary.”

Marketer sales volumes were already forecast to be down this year, but Schlesinger predicts they will be much lower than anyone suspects. As far as the slash and burn going on in the energy trading sector, he also said he was not too surprised even with announcements that some companies, like Aquila, will stop their energy trading business altogether.

“I’m not as surprised by Aquila as I should have been,” he said. “It is a really fine company, but it is run by traditional utility management, and like other companies in the same situation, some of the trading structures have become awfully Byzantine in the last couple of years. Traditional management probably had it up to ‘here’ with it,” Schlesinger added.

A lot of introspection is going on in the energy industry right now, he said, both in the way trading is organized and the role it’s going to play in the future. A trading function is needed, but “many are nested or are part of energy utility companies that have traditionally been run on a stable basis, with the focus on the customer and shareholder needs, who are used to living in a world of regulations.” In this way, energy trading is quite different from what the engineers and the accountants learned as they entered the business 20 years ago.

“Managers came up through the energy chain at utilities and have traditionally been run by Main Street — engineers, lawyers, accountants. They don’t have trading backgrounds, per se. Energy trading is run by Wall Street,” Schlesinger noted. “It’s a completely different world. And now they are seeing their fellow executives and what’s happening to them. They want out.”

Schlesinger imagines that a lot of the energy executives “never really fell in love with trading… It’s not easy for an engineer to communicate with a trader.” And these executives are finding that their traditional management methods also are not working in the trading-focused organizations.

“These ’round-trip’ transactions and things, these are things that the executives may not understand. I can see a utility executive asking himself, ‘why do I need this…there’s a real risk for me.’ And even though there is tremendous growth; they are lucrative operations. Maybe they want to slow down. I mean, we’re not growing as an industry now, and maybe it’s time to rein in the trading operations.”

Asked to speculate about what energy trading will become, Schlesinger said, “That’s the $64,000 question.” There is a “shift taking place,” he said, “and we’re going to see more structure, more management involvement on the risk side. It’s a real shift. It’s not an activity that should disappear, but it’s way beyond physical trades now, and we’ve moved toward more complex transactions.” Those types of risks for individual companies may disappear, or be merged with other companies, or they could be shifted to separate entities.

“There is an expectation that they will see more value building power plants and be less prone to build their trading functions,” Schlesinger said. “We’re moving back to the mid-’90s, just before there was this shift to managing risks, and we’ll see more of that, more traditional growth. The way this industry has always grown is through creativity and brain power. Adding value is the result of brain power, and we should start to grow again.”

However, Schlesinger predicts “far more regulations” on three fronts: management, industry and government.

“The primary form of regulation is going to be through disclosure,” said Schlesinger. “Without setting a lot of rules for what we can do and what we can’t do, information is really very powerful. Seventeen years ago, there was full disclosure of physical transactions to the Federal Energy Regulatory Commission. That may be necessary again. California would have been a lot less likely if there had been disclosure, and if not less likely, a lot easier to deal with.” Industry standards also are expected to be put into place, and management systems will be set up to ensure more oversight of what the trading arm is doing.

When disclosure on the natural gas side stopped, Schlesinger noted that it helped the industry to grow. However, the trust factor started to disappear also. “Trust has really got to be there, and you get that from disclosure.” He noted that the New York Mercantile Exchange has grown, and continues to grow, and it requires full disclosure on all of its trades. “This really is a time of change, and it is so necessary.”

In the meantime, other online exchanges, especially neutral platforms, could see more business, including industry leader IntercontinentalExchange (ICE), TradeSpark LLP and UBS Warburg’s UBSWenergy.com, formerly EnronOnline. However, the current credit crisis in the industry probably will limit all types of trading in the short-term.

ICE, based in Atlanta with offices across North America and in London, is owned by nearly 100 global energy and metals traders, brokers and bankers, including many of the major oil and gas companies such as BP and Royal Dutch/Shell. It has had strong growth since Enron collapsed last year. UBS Warburg Energy, which took over EnronOnline in February, would not comment on the current situation Thursday.

TradeSpark, based in the United States, had seen an upswing in business earlier in the year. On Thursday, former New York City-based TradeSpark officially made its headquarters in downtown Houston. After losing 38 of its 41 New York-based employees on Sept. 11, 2001, the company decided to centralize its operations and refocus its activities in the Texas energy capital. TradeSpark’s neutral marketplace trades physical and financial energy products. TradeSpark is a unique partnership formed by eSpeed, an electronic marketplace engine for business-to-business e-commerce; Cantor Fitzgerald, one of the world’s leading voice brokerages; and six U.S. energy producers/distributors, including Coral Energy, Dominion, Dynegy, Entergy-Koch Trading LP, TXU Energy Trading and Williams Energy Marketing and Trading Co.

Another online broker also is making inroads and may pick up the overseas online business that some of the U.S. platforms like Dynegy’s are leaving behind. On June 13, APB Energy Europe launched its online trading platform, True Quote, in the Dutch market. Product offerings include electricity, natural gas, coal and other energy-related products. APB Energy, a subsidiary of APB Financial LLC, is a full service over-the-counter commodities brokerage. Headquartered in Louisville, KY, the company has offices in Houston, North Carolina, Norway and Amsterdam.

“We see this as an excellent beginning to strengthen and improve our services by offering hybrid brokering in the European power market,” said Karl-Ove Tvedt, managing director.

In a report set to be released this week on the merchant energy sector, Prudential Securities analysts called energy trading “still a viable business,” but noted that “recovery is unlikely until regulators, politicians, credit rating agencies and shareholders gain a better understanding of the trading business.”

A veteran consultant said, “We are sensing that the ‘new’ trading environment will resemble that of the early 1990s, characterized by buying and selling arrangements under shorter-term durations before the excessive use of structured deals, long-dated books, and complex financial transactions.”

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