Seeking salvation in a clearing house

Fuente: Financial Times

The current wisdom on Wall Street is that energy companies' electricity trading operations are worth nothing at best. At worst, they are sumps of accounting fraud and lawsuit magnets that represent negative value for shareholders. Even though far more money has been lost on telecommunications stocks and bonds, energy executives are the bad guys of the market.

You might think, from Jeffrey Skilling's bad guy impersonation, that his former colleagues and their industry counterparts have a "public be damned" attitude when it comes to their image. You would be wrong. I spent some time at a gathering of energy traders, and found they were deeply unhappy with the public opprobrium. Some doubted their industry could survive. You can see the reasoning.

Staff cut-backs at the merchant energy companies, particularly in the trading operations, are frequently in the 20 to 30 per cent range.

Senator Dianne Feinstein's bill to reregulate energy derivatives under the Commodities Futures Trading Commission may come up for a vote next month, and its chances of passage are looking good.

In the western states, public power agencies and their political advocates are looking at building new capacity or buying existing plants for their own balance sheets, rather than depending on purchases of power in the merchant electricity market.

But in a contrarian signal, some big banks and investment dealers are looking over the crop of energy traders working their resumés.

Given Wall Street's problems these days with legal exposure to the backwash from the 1990s, it is interesting that some traders are looking at ways they might expand rather than contract their energy exposure. Here is a chance for the energy trading industry to ensure its survival.

The fundamental problem is that rating agencies and the buy side of the credit community are demanding that energy companies sell off assets to reduce leverage, raise cash and get their bonds back to an investment-grade rating.

Since every company but Duke and AEP are subject to these demands, one wonders who will be buying the assets. They can't all take in one another's washing, after all - that was last quarter's game.

Up to now, many of the asset sales that energy companies have undertaken have been to master limited partnerships they have organised. But that is not an infinitely expandable market. Furthermore, it would be a waste of expensive equity capital for all the energy traders to get investment-grade status.

The only reason energy firms need more equity is to ensure that they will be acceptable counterparties for the companies with which they trade. The way around this is to trade through a "clearing house" that either has plenty of equity capital or recourse to the Federal Reserve for liquidity. A clearing house is the seller to all buyers and the buyer for all sellers.

That's how the commodities exchanges work. Their clearing operations are backed by banks which are in turn backed by the Fed. They ensure they are not at risk by demanding original and variation margins appropriate for a particular contract and type of counterparty.

I once worked for a commodities brokerage firm, and I can tell you that the customer base could have been mistaken for the clientele of a smugglers' bar on the Macao waterfront. As such, we double-checked all the information about our customers. Customers of the commodities exchanges have very rarely, if ever, lost money because of counterparty credit problems.

The exchanges in New York and Chicago would be perfectly happy to take over the function of the energy traders. Unfortunately, their contracts are too inflexible to serve the electricity market's purposes. Electricity's price varies too much from one local market to another, transmission charges and capacity can be as significant as the price of gas and power generation and contracts need to be longer term than what is available on an exchange.

The real value from energy trading is in putting together custom-designed "structured" trades. The solution is to combine the best aspects of the over-the-counter dealer markets and the exchanges. A consortium of banks and possibly a large insurer or two could provide the balance sheet and risk management needed to act as a clearing house.

Since they're operating the casino rather than gambling in it, their own capital should be safe. The traders and the local distribution companies would have the assurance that the contracts would be good, and could therefore focus on coming up with the most efficient contract structures.

The availability of the markets as a hedging vehicle would lend stability to borrowing for new electricity generation. The Federal Energy Regulatory Commission and the Commodities Futures Trading Commission could be the overseers and auditors.