Reliant Admits Bogus Trades; Stock Plunges
Houston energy company Reliant Resources Inc. admitted Monday that it used phony trades to inflate the company’s revenue by about 10% during the last three years--a disclosure that caused investors to further doubt the health of all energy merchants and raised new questions about the ethics of the industry.
Reliant’s sham deals are the latest practices disclosed by the energy-trading industry amid investigations by federal regulators and Congress into phony accounting and market manipulation. Other major energy-trading companies have acknowledged structuring deals to cut taxes, hide debt and possibly manipulate prices.
Several energy companies, already stung in financial markets last week by investor fears that they might be linked to market manipulation in California of the sort revealed by Enron Corp., lost even more value Monday with Reliant’s admission. The sham trades would amount to nearly $6 billion, based on Reliant’s revenue, though the company did not put a specific dollar value on the matter.
And the admission, coming on top of a disclosure last week of similar trades by Dynegy Inc., raised new questions about whether potential expansion of electricity deregulation and energy trading in the United States would encounter new resistance.
“After last week’s events, the credibility and confidence in the unregulated power sector reached new lows,” said Steven Fleishman, a Merrill Lynch & Co. utility analyst.
Indeed, the stocks of virtually all the major energy traders have dropped sharply in the last year as Enron’s meltdown frightened investors and the economic slowdown hammered profits. Reliant Resources shares have slid 73% from their peak in the last year, and its parent company, Reliant Energy Inc., has seen its shares drop 63% during the same period.
R. Steve Letbetter, chief executive of Reliant Resources, blamed the bogus trades on “some misguided employees” who wanted to improve the company’s standing on industry top 10 lists. He did not identify the managers but said they no longer work for Reliant.
Reliant’s income figures were unaffected by the transactions, known among professionals as “round-trip” trades, Letbetter said. The company is financially strong but is taking a “time out” from most pure trading activities not related to its assets, which include several power plants in California, Letbetter said.
“These transactions are inconsistent with our company philosophy....These types of transaction are no longer occurring at Reliant and will not occur in the future,” Letbetter said in a conference call with analysts. He said the Securities and Exchange Commission, which is conducting an informal investigation of Reliant after a recent earnings restatement, also is looking at the sham energy trades.
In the deals, Reliant sold energy to another company and bought the same amount of energy back for the same price. The practice did not affect the price or availability of power but made Reliant look as if it were trading more power than it really was, Reliant said.
In 2001, for example, Reliant did round-trip trades of 78 million megawatt-hours of electricity and 45 billion cubic feet of natural gas, boosting its trading volumes enough to rank it third among traders that year after Enron and American Electric Power Inc. Without those trades, the company actually ranked fifth, Reliant said.
Such trades accounted for 30 million megawatt-hours in each of the years 1999 and 2000, the company said. In all, revenue for the last three years, which totaled $64.3 billion, was pumped up by about 10%, Reliant said.
On Friday, Reliant abruptly canceled a $500-million private debt placement and disclosed that round-trip trading had occurred, but it did not give details. When asked if the practice is widespread in the industry, Reliant Resources Executive Vice President Joe Bob Perkins in Monday’s conference call said tersely: “It’s possible. I don’t really know.”
Reliant said its primary partner in the bogus trades was CMS Energy Corp. of Dearborn, Mich., but it also did smaller trades with Encana Energy Services, a subsidiary of Encana Corp.; Public Service Co. of Colorado, a unit of Xcel Energy Inc.; and Merchant Energy Group of the Americas.
These developments are only the latest to roil the energy-trading business, which turned sour even before the December bankruptcy filing of Enron, at the time the world’s largest energy trader.
Stocks have been pummeled in recent weeks by suspicions of accounting irregularities at other companies as well as worries that other power sellers might have used techniques to manipulate California’s power market such as those revealed in memos written by Enron lawyers and released by federal regulators last week.
Although Reliant Resources moved quickly to try to soothe investors and regulators, its shares lost 17% of their value Monday, closing at $9.94, and those of Reliant Energy, which hopes to fully spin off Reliant Resources, fell 18% to $17.59; both trade on the New York Stock Exchange.
Other companies hit hard were CMS Energy, down 16.8% to $16.05 a share; Dynegy, down 5.77% to $9.31; and Williams Cos., down 5.7% to $15.55. San Jose-based Calpine Corp. bucked the trend, rising 3.51% to $8.85.
Analysts expressed surprise at the extent of Reliant’s round-trip trades but doubted that they violated any laws except possibly SEC reporting requirements.
“It may not have been very prudent, but I’m not sure it was criminal,” said Jon Kyle Cartwright, an energy analyst with the brokerage firm Raymond James & Associates in St. Petersburg, Fla.
The trades “just raise questions at a time when you don’t want to be raising them,” said Christopher Budzynski of the investment firm Legg Mason Wood Walker. “At this point, the market is pricing at a pretty draconian, worst-case view of these stocks.”
However, the developments raise new questions about the growth potential of energy trading and the future of deregulated markets in the United States, analyst Fleishman said.
“The market has grown skeptical of this sector,” he said. “Up until last week, the momentum toward full deregulation had been picking up again thanks to low wholesale prices and a better political backdrop. But after last week, the tone can best be described as ‘one step forward, two steps back.’”
Reliant is active in the California market and was among the 150 energy companies that the Federal Energy Regulatory Commission asked to state whether they engaged in any of the practices that Enron memos revealed it used to manipulate prices in California.
Reliant acknowledged Monday that it submitted false power schedules at least twice to the state’s grid operator but that it did so one time at the operator’s request, said Reliant Resources general counsel Hugh Rice Kelly. The second incident was minor, he said.
In addition, Reliant at times bought power in the primary market, the California Power Exchange, and sold it at a higher price in the last-minute market run by the California Independent System Operator, he said. It is a legal practice but is among the practices under investigation by the FERC.
Last week, Dynegy said the SEC was investigating a natural gas deal that helped the company cut its tax bill by $80 million. And federal investigators are continuing their probe into whether Enron used questionable trading practices to inflate prices in California.
