Scandal May Open New Doors in Energy

Amid daily revelations of possible dishonesty and apparent foolishness in energy trading, what is really going on is a great shakeout that will lead to bargain electricity prices for the next few years.

In the boom that ended last year, many firms in the nationwide electricity industry--including Enron Corp.--fostered the illusion that they could increase sales and profits 20% to 30% a year, even though electricity usage advanced only by 2% to 3% a year.

Now Enron is in Chapter 11, and other companies are dropping out of energy trading or trying to sell assets and shares to pay their debts.

Opportunity may be the next phase as newcomers enter the business. Oil and gas companies may step into electricity because they have the deep pockets needed for owning generating plants and marketing their output. ChevronTexaco Corp. is backing Dynegy Inc.; BP is rumored to be looking at a relationship with Calpine Corp.

Wall Street firms may see opportunity in trading electricity once current outcries and investigations of shady practices pass. UBS Warburg purchased Enron’s trading business. The New York Mercantile Exchange’s energy-trading operation, which includes credit guarantees and federal regulation, is gaining participants.

Ailing companies such as PG&E; Corp., whose utility unit is under bankruptcy protection, and Edison International probably will make a comeback in the next few years.

But in the present turmoil, such a peaceful, rational future is not easy to foresee. Instead, credit-rating firms are forcing Calpine, Williams Cos., Dynegy and others to sell assets in a soft market and sell stock when their share prices are in the basement.

Other companies with stronger finances--Constellation Energy Group Inc., American Electric Power Co., Sempra Energy, Exelon Corp. and others--are carrying on trading as part of their main electricity business in an evolving time for the industry.

This is an ideal time for electricity buyers to make long-term contracts--and for the state of California to renegotiate the expensive deals it signed under duress more than a year ago.

But investors and everyone with a stake in the future of the $300-billion electricity industry should understand how this situation came to be. Electric utilities, which have traded power with neighboring utilities for decades, were enabled by the federal Energy Supply Act of 1992 to move power to industrial users nationwide, using improved transmission grids.

Electricity-trading markets grew up to facilitate such power sales and energy moved around the country more efficiently. But it should be noted that the new system did not increase demand for power or add to total supply. Even so, Enron and other companies made energy trading sound like a growth industry.

Many firms seemed to get very large--Enron grew to more than $40 billion in sales, for example. But that was only because they took the ostensible value of everything they traded into their annual accounts--a contract for millions of dollars over 10 years would be recorded as a single year’s sales.

Some firms engaged in exchanges of the same amount of energy at the same price--so-called wash sales--just to swell their trading volumes and make them look like players.

Credit was abundant from lenders and bond markets that accorded risk-bearing, unregulated companies the credit status of traditional regulated utilities.

But illusions ended with Enron’s collapse last fall and demand in recent weeks from credit-rating firms that energy traders bolster their balance sheets. El Paso Corp. and Reliant Resources Inc. are retreating from the trading business because it demands too much capital.

Moody’s Investors Service, a credit-rating firm, issued a white paper last week saying, in effect, that energy trading may not be investment creditworthy unless it is attached to a “more stable core business.”

However, the original reason for energy trading--to facilitate power sales and efficient supply--remain.

“We customize energy supply for industrial customers, delivering electricity or natural gas to chemical plants or fertilizer makers on a schedule and with pricing flexibility that suits their production plans,” explains David Messer, president of Sempra Energy Trading, the Stamford, Conn.-based wholesale trading division of Sempra, the San Diego-based holding company for San Diego Gas & Electric and Southern California Gas.

Sempra has a solid A2 investment-grade credit rating to support its wholesale business, which is in Europe, Latin America and Asia as well as the U.S.

Other companies with well-backed energy trading include Constellation Energy Group Inc., a company combining the Baltimore Gas & Electric utility with a merchant energy marketer and trader that was created by investment firm Goldman Sachs.

American Electric Power, a Columbus, Ohio-based utility, sells electricity wholesale in the Southwest and elsewhere. AEP is separating its regulated and unregulated business because tensions arise between employees and managers in the two types of operations.

The unregulated business emphasizes marketing and profit, with incentive pay for higher sales; the traditional regulated utility stresses reliability of power supply and puts a premium on employees who think first of customer service.

In the aftermath of the Enron debacle, investors probably will favor traditional utility companies, which pay dividends rather than chase after promises of growth, says analyst Brian Youngberg of Edward Jones & Co. He cites the example of Southern Co., an Atlanta-based utility that got out of trading by spinning off its Mirant Corp. division to shareholders.

Companies such as Williams, which has pipelines, refineries and oil and gas production as well as energy trading, and Aquila Inc., a Kansas City, Mo.-based utility firm, are trying to improve their balance sheets so they can remain in trading.

San Jose-based Calpine is negotiating alliances with large companies, says analyst Michael Worms of the Gerard Klauer Mattison investment firm. BP issued a statement last week saying that it is not preparing to acquire Calpine, after market rumors in London and New York suggested it was.

“The energy industry is evolving,” says Edward Muller, an investor in energy ventures and former president of Irvine-based Edison Mission Energy. “Ultimately, electricity will become like oil and gas and other commodity businesses, with specialized firms and big major players. Trading, with some rules imposed, will be an ordinary part of the business.”

With numerous power plants built in recent years, the availability of electricity looks ample for this summer and next, although transmission lines will continue to need reinforcement and expansion, says analyst Steven Fleishman of Merrill Lynch.

That promises stability in the electricity markets in California and other Western states, a good time to work out intelligent energy policies.

James Flanigan can be reached at jim.flanigan@latimes.com.