Power Trade Slump May Hit Consumers
When Western electricity traders gathered in Ojai in June for their industry group’s annual meeting, the masters-of-the-universe attitude was gone.
Traders, who in the age of Enron Corp. seemed to rule the energy world, complained they were spending more time defending against market-manipulation lawsuits and investigations than they were buying and selling electrons. “It was pretty glum,” acknowledged Gary Ackerman, executive director of the Western Power Trading Forum, the Menlo Park, Calif.-based trade group.
Since then, the energy trading sector has staggered through a summer of financial disaster that has badly shaken the business.
The year has brought accusations of questionable accounting and trading practices, stubbornly low electricity prices, deep losses, abrupt executive departures and widespread layoffs as companies scaled back or abandoned electricity trading. Energy merchants are mounting the equivalent of a giant yard sale of energy assets and have postponed or canceled the construction of scores of power plants.
The pain has been severe for the companies, their employees and shareholders. But there are even wider implications from the meltdown, including potential electricity shortages and a lack of good energy deals for big industrial users and others, which could eventually mean higher costs for consumers.
The trading of energy products might seem to be an esoteric enterprise far removed from the daily business of flicking light switches. However, energy trading firms also build power plants. With the companies in such sorry financial shape, they are pulling the plug on plant-building programs and eliminating projects capable of generating 86,000 megawatts of electricity nationwide. During the last two years, projects that could generate an additional 90,000 megawatts have been put on hold, according to Platts, an energy research company. (One megawatt can power about 750 homes.)
More of the canceled or postponed power plants were in California than any other state, Platts said, with total potential production capacity at about 19,000 mega-watts. Calpine Corp. of San Jose was most aggressive in the nationwide pullback, followed by Duke Energy Corp. of Charlotte, N.C.
“Clearly the boom is over and we’re in a bust,” said Brian Jordan, director of North American electricity markets at Platts. “When the bust becomes so severe and a lot of plants are being killed or postponed, that suggests that the next boom-bust cycle will be even more severe.”
California’s Supply
Although the nation as a whole will have more electricity than it needs until 2006, California may begin experiencing power shortages after 2003, said Christopher Ellinghaus, energy analyst with Williams Capital Group, a New York investment bank, who recently completed a market-by-market study of electricity supply.
The California Energy Commission on Wednesday licensed a 600-megawatt power plant in Hayward, which Calpine is scheduled to begin building early next year for operation in 2005. But a Calpine spokesman said Thursday that the company won’t build the $400-million plant unless it can sign long-term power contracts for the juice electricity the facility would produce.
The California Energy Commission, however, is not ready to send up warning flares, despite the cancellation or postponement of several power plants. Some of the proposals were not all that serious anyway, said Claudia Chandler, assistant executive director of the commission. “It’s not the market that people thought it was when everyone thought they could make a bazillion dollars in power plant development. Now we’re seeing the real developers.”
“Power plants are being built,” Chandler said, adding 2,766 megawatts in the year ended July 31 with 3,643 megawatts to be added in the next fiscal year. “We are OK through the end of 2004, though we are watchful of 2005.”
At the same time, power trading has shriveled. Platts estimates that trading in some key daily and forward electricity markets has fallen as much as 70% from a year ago. This may not make much of a difference to California power users, forbidden by law from seeking the best deal for electricity on the open market, at least for now. But some market-watchers say the declining number of energy merchants also has affected the sale of natural gas, which was deregulated in the ‘80s.
As a result, some large customers have a harder time getting energy contracts signed with energy middlemen, or at least on the terms they would like, consultants say. And with a slowdown in the trading of energy derivatives, which are contracts based on the future price of a commodity, big energy users are having trouble hedging against large price movements.
Higher Energy Costs
Large industrial and commercial customers usually secure their own supply of natural gas, but residential and small-business customers are served by utilities such as Southern California Gas Co., a unit of Sempra Energy. Higher energy costs for large industrial and commercial users can be expected to eventually reach the consumer through higher prices or fewer jobs, if corporate profits suffer.
“It’s becoming much more difficult to get deals done,” said one consultant, who wished to remain anonymous to avoid annoying his clients. “Until late last year you could do a one-or two-year deal over the phone very quickly and you could have multiple parties within fractions of a cent of each other. You knew you were getting a decent price.”
Los Angeles County went shopping for natural gas 2 1/2 years ago and found nearly 20 companies vying for the contract to supply the county’s many facilities. When the county went back to the market in June, only two firms were willing to offer the kind of fixed-rate contract that the county sought to shield against the gas price spikes of two winters ago, said county energy manager Howard Choy.
“There was no real competition, nobody having those portfolios where they can mix and match to create savings,” Choy said. Instead, the county got a fixed price based on the published cost of producing gas plus transportation. “If somebody is really trying to stick it to us, we know it, but at the same time, we’re not getting any great deal,” he said. Still, compared with the extraordinarily high prices paid in the winter of 2000-2001, “we look like geniuses,” Choy quipped.
Southern California Gas spokeswoman Denise King said energy trading problems have not hindered the utility’s ability to buy natural gas for its customers.
A Blow to Deregulation
The trading industry’s struggle was a blow to the deregulation movement and competition’s promise of lower prices and more consumer choice--now an impossible sell in California. Several states that considering opening their utilities to competition have slammed on the brakes, but federal energy regulators recently signaled a plan to open electricity markets and transmission nationwide.
“There’s been a loss of momentum,” said Ken Malloy, chief executive of the Center for the Advancement of Energy Markets, a pro-competition think tank. About 10 states remain committed to energy industry restructuring and 15 others had been considering opening their monopoly utilities to outside competition but are now “frozen in place,” he said.
Mark Cooper, energy analyst at the Consumer Federation of America, considers that good news. “It proves something very important: There are certain public values embedded in electricity and telecommunications and other utilities that are not well-suited to the market mentality that these traders thrived on,” Cooper said.
The fast-growing, largely unregulated businesses of energy trading and power generation and the high electricity prices that fed them seemed like a party that would never end. Now that it has, these same companies are scrambling to look like traditional utilities again to regain Wall Street’s favor.
“It is quite interesting how poorly the financial community understood this business,” said Lawrence J. Makovich, a senior electricity consultant at Cambridge Energy Research Associates. “The market was rewarding trading and merchant power in spite of some clear evidence that there were big problems here.”
Trader woes began with a collapse in electricity prices last year that was exacerbated by the economic malaise after Sept. 11. Then followed a fast-spreading contagion in the industry known as Enronitis: The disintegration late last year of the world’s largest energy trader drained confidence in the energy trading business and sucked liquidity from the energy market, which operates on an enormous amount of cash and short-term credit.
Wall Street credit raters re-evaluated the industry and methodically slashed the debt rating of most market players deep into “junk” territory. Hard hit were the major power sellers, including AES Corp., Duke Energy Corp., Dynegy Inc., Mirant Corp., Reliant Energy Inc. and Williams Cos. Other traders also have been hurt, such as Calpine, which won much praise from Gov. Gray Davis for building some key power plants in the state.
When will this sector improve?
Some Wall Street analysts figure the trading business has been through the worst but will limp along for a year or more with the possibility of a few major corporate wipeouts to come. Others warn of more weakness ahead among energy trading companies that already have lost more than $200 billion of market value.
“Few doubt that one or more energy merchant companies may soon file for bankruptcy,” Standard & Poor’s analyst Peter Rigby wrote in a recent report.
The business that survives will look different with new players, new business models and new regulations. Bank of America Corp., for instance, plans to beef up its power-trading operations as are other financial institutions.
“I think we’ve hit the bottom in terms of trading volume and the credit crunch that has caused many people to abandon power trading or to cut back severely,” said Ackerman of the power trading industry group.
“Enron is gone,” he said. “What will replace it will be more sophisticated trading with more open rules and more open reporting.”
