By Chris Anderson, HQ Energy Services US
To further develop deregulated wholesale energy markets in the 1990s, utility executives first looked to capitalize on market share by using their regulated assets and associated earnings along with intellectual capital-driven marketing and trading machines. For some, trading and marketing wasn’t even a choice but instead a mandate as they tried to create growth vehicles.
Immediately following deregulation, there occurred a period of rising wholesale prices and increased volatility. And those companies that were able to adapt to the new fast-paced, information-intensive marketplace succeeded and were rewarded both with results and by Wall Street. But recent events have cast doubt over energy companies that are highly leveraged and who operate without the security that fixed assets provide. The era of subjective, low risk earnings and reduced scrutiny by regulators has ended.
With the demise of Enron late last year, energy executives and regulators are deeply concerned about this new transitioning period of energy and power trading and what will become of the trading platform that once championed deregulation. The shock waves from the Enron debacle have raised questions about which business model will work in a deregulated environment. Unfortunately, Enron’s behavior is now driving the perception of its peers in the energy industry. Merchant energy companies are working to demonstrate to skeptical regulators, investors, and analysts that they are moving forward to re-instill investor confidence.
Energy merchants have to shore up their balance sheets to appease credit rating agencies, manage the issues of mark-to-market accounting, and simplify their financing vehicles. The attributes of the traditional integrated utilities–slow, methodical, conservative, credit intensive, valuing strong customer relationships–now command more visibility in this new era. Pure marketers find themselves stifled by higher risks, greater credit focus, complex financial agreements, and dependency on volume trading. Business models that are asset-based, with conservative debt structures and sophisticated risk management, are now seen as the preferred choice by the lenders, regulators, and the financial markets whose support is critical to the energy industry.
Integrated energy generators, such as Hydro-Quàƒ©bec (A+ rated S&P), that own and operate assets and have a strong trading, marketing and risk management infrastructure, have a distinct competitive advantage in this new marketplace. These broad-ranging capabilities provide utilities with a significant leadership advantage over integrated merchant energy companies. It’s simply what counterparties, customers and equity markets want right now.
However, utility companies that do not maintain trading, marketing and risk management expertise will likely not survive in the deregulated markets. Within the next three to five years, the key energy traders and marketers who survive will create a bigger marketplace more liquid than ever. In the meantime, the key players remaining must work together to ensure deregulation is successful and that new and existing trading platforms meet the expectations of the marketplace.
The following six points are critical when examining the challenges facing the future of integrated electric utilities and energy trading.
Energy trading within integrated electric utilities
- Innovation–Now that integrated utilities are at the forefront, they must resist the temptation to crawl back into their shell. The pendulum has swung to their advantage and they must move quickly to capitalize on this market opportunity. Utilities should not be so conservative they forget the reward portion of the risk/reward equation.
- Risk management–Companies must understand their risk tolerance and design risk management systems that fit what they’re trying to accomplish. As a company grows and changes, the dynamic of their risk management system parallels their business objectives.
- Adding value–As with any industry, utilities must find the means to add value, or they risk becoming obsolete.
Energy trading (universal principles)
- Portfolio management–Traders must understand the relationships between all energy commodities and the individual characteristics of natural gas, power, coal and oil. Companies must have the skills to adjust risks for best possible returns.
- Integrity–Sound business principles are always one of a company’s greatest assets and are the base upon which to build.
- Credit–The financial markets will make this more critical as time goes on. An integrated utility with high credit rating and low leverage has a distinct competitive advantage.
Determining the integration of utilities and energy marketers in today’s business environment will be difficult. But at the end of the day the efficiency of the marketplace will act as a guide to determine those roles. After all, energy is a physically delivered commodity we use to keep people and businesses moving.
Anderson is President of HQ Energy Services US (HQUS), headquartered in Pittsburgh, Penn. HQUS is a subsidiary of Hydro-Quebec.