Rooting out rodents isn’t always easy. Ask Rentokil. They say if you see one in your house you can guarantee it is not alone. Right now the various US regulating bodies must feel like the Rentokil of the US power industry; or the modern day Pied Piper.
As the Enron saga continues to unfold, it seems they were not not the only ones involved in dubious dealings. The latest part of the saga has seen me learn a new term – “round trip” trades. This is a transaction involving simultaneous sales and purchases with the same counterparty at the same price, as a way of increasing trading volumes. Experts in the business are already familiar with the term with one energy risk management consultant saying: “…every single trading company does it, and while they are probably not illegal they are certainly not ethical.”
So far, Dynegy, CMS Energy and Reliant Resources have all admitted round trip trading practices. As these companies and their practices come under scrutiny, credit agencies have reacted. In May Standard & Poor’s put Dynegy and its subsidiaries on CreditWatch with negative implications after the announcement of a formal SEC investigation. Such downgrades have not been just limited to the guilty. Mirant, which has made it clear that it has not engaged in any transactions for the purpose of artificially enhancing its trading volumes or revenues, was downgraded in December last year.
With many of these companies operating globally, many of us across the Atlantic are wondering what will be the wider impact of these investigations and downgrades. Certainly, there has been talk that rating agencies are perhaps over-reacting to the Enron-triggered revelations.
Anthony Flintoff, director of infrastructure finance rating at Standard & Poor’s countered: “We’ve always looked closely at the trading activities of utilities. However it’s perhaps becoming more important as the markets deregulate and competition increases. One difference in Europe is that trading tends to be just one part of the utility’s business, unlike some of the trading-only companies in the US.
“The trend in Europe and around the world is for rating downgrades to exceed upgrades. In the energy sector, this is largely because of liberalization and competition which makes markets riskier. So companies more involved in the competitive side of energy are more likely to face credit pressures than regulated utilities that are not subject to these changing market conditions.”
Simon Harrington, senior vice president responsible for portfolio management and energy trading at TXU, commented: “We have been operating a prudent credit risk strategy for many years and had a mitigation strategy in place to manage our position against Enron well before the Enron issue. This has borne us well with the credit rating agencies.”
For trading companies, being investment grade is very important since their counterparties require high levels of collateral or cash to be put up to guarantee trades if the trader is not investment grade. Harrington explained the possible market implications: “There will not be a general rise in electricity and gas prices since the fundamentals of supply and demand haven’t changed. However, people’s appetites to have risk with these companies reduces. Taken to the limit this ends up with reduced liquidity in the [energy] marketplace, i.e. less counterparties and less trading. Less liquidity in the trading market means probably less transparent prices and possibly greater price volatility.”
So what’s next for the embattled and downgraded energy company? Flintoff noted: “If it is operating in a market which is ‘risky’ due to liberalization, there is not a lot it can do. But it may need a more conservative capital structure to compensate for some of those risks. It may need the parent to inject equity to reduce debt.” Certainly we have seen many energy companies selling off assets to reduce debt.
Harrington, while stating that TXU has never been just a trader, believes there is still a market for pure trading players. “Efficient markets need them but those companies which are purely exposed to energy trading – particularly those in Europe with American parents – will be feeling pretty isolated and wondering if it’s time to go home.”
So it seems that for the scurrying US energy trader, the music is slowing and it may be soon time to pay the Piper.