William Hoffman, The Dallas Business Journal
DALLAS, May 24, 2004 — Rules encouraging independent retail providers to jump into Texas’s recently deregulated electricity markets have attracted some players that are severely undercapitalized and susceptible to bankruptcy, two energy experts contend.
Independent providers, or REPs, dispute the contention by John D. Baumgartner, a director at Houston investment banking firm Chiron Financial Group Inc., and Diana Woodman, an attorney at Thompson & Knight L.L.P., also in Houston.
The two made the argument in a May 10 article in the Texas Lawyer newspaper headlined, “R.I.P. REP? Loose Capitalization Requirements Could Mean More Bankruptcies.”
“I think a better headline would have been, ‘Market manipulation could mean more bankruptcies’,” said Darwin Lau, COO of Allen-based Texas Commercial Energy L.L.C., whose pending lawsuit claims the company’s 2003 bankruptcy was provoked by incumbent utilities and energy traders.
Baumgartner and Woodman didn’t specify which independent REPs they consider undercapitalized. But their comments were set against a backdop of continuing turmoil in the state’s retail electric markets.
Those markets were deregulated on Jan. 1, 2002, and since have been crowded with more than 70 new retailers ranging from affiliated giants such as Oncor Electric Delivery, recently renamed TXU Electric Delivery, to entrepreneurial startups including TCE and Cirro Energy.
Signs of the turmoil include a 3.4% rate hike May 13 by retailer TXU Energy; the ongoing saga of TCE’s recovery from Chapter 11 bankruptcy; questions about Gexa Corp. in Houston, which missed 2003 annual and first-quarter 2004 filing deadlines mandated by the Securities and Exchange Commission; and a hearing this week that could decide the fate of TCE’s lawsuit.
While observers generally agree that deregulation in Texas has gone more smoothly than in other states — thousands of businesses and individuals have left the old monopoly utilities to seek savings from competitive retailers — most industry participants also believe a reduction in the number of retailers is inevitable.
The capital requirements for REPs licensed by the Electric Reliability Council of Texas Inc. to do business in Texas are “every bit as volatile as the supply market,” Baumgartner said in an interview with the Dallas Business Journal. “To the extent that these REPs don’t have access to credit, I think there could be a shakeout.”
“Our position is, yeah, credit is king,” countered Tim Rogers, CEO of Cirro Energy in Plano. “I think Ercot (which maintains the state’s deregulated electric power grid) has corrected any credit imbalance,” he added, in the wake of TCE’s bankruptcy filing in March 2003.
“I think all these REPs understand what they’re getting into, and Ercot is managing things fairly conservatively.”
In their article, Baumgartner and Woodman argued that “minimal margins REPs realize on energy sales are not sufficient to enable these firms to generate the cash necessary to properly capitalize and hedge themselves against pricing risks.”
Baumgartner said Gexa’s (OTC: GEXCE) gross profit margins ranged from 10% to 14% in summer 2003, according to the public company’s filings. But the margin has been shaved to 4% to 7% now, he said, largely as a result of rising natural-gas prices.
Rising gas prices have reduced REPs’ ability to adapt to further sudden spikes in costs, he said, and contributed to TCE’s bankruptcy filing.
Lau disputed that. Rather, he said, price spikes during the February 2003 ice storm increased TCE’s collateral requirement for credit standing in Ercot six-fold in one night, just days before an anticipated infusion of capital to the company.
Unlevel playing field
Terry Hadley, a spokesman for the Public Utility Commission of Texas in Austin, explained that start-up REPs must post $100,000 in cash as collateral, show $50 million of net worth or establish an investment-grade credit rating before doing retail business in the state. After that, collateral requirements are calculated using a number of formulas.
“The rule is designed to encourage entry by potential retail providers and promote a vibrant market,” Hadley said, “yet (also) provide enough assurances that these companies are capable of providing reliable service in the competitive market.”
Hadley said concerns about REPs’ creditworthiness were addressed in reforms adopted by Ercot after the TCE bankruptcy, including requiring more REPs to post more collateral as revenues grow and strictly limiting the amount of power REPs can buy on volatile spot markets.
Lau said TCE has ample backing — including a $25 million line of credit from Magnus Energy Marketing L.L.C. in Addison — but that independent REPs such as his are on an unlevel playing field with their affiliated REP competitors.
Affiliated REPs such as TXU Energy get a “free ride,” Lau said, due to their affiliation with incumbent utilities such as TXU Corp. and the physical assets they possess. Independent REPs such as TCE have few or no physical assets aside from computers and office furniture.
Carolyn Pengidore, president and CEO of energy consulting firm Comperio Energy Inc. in Dallas, said, “I’m not alarmed by what I see” in retail markets. “The majority of REPs I talk to — the vast majority — will not take on a customer unless they can hedge that price risk.”
Pengidore said that, as a result, smaller REPs with fewer credit resources may grow more slowly and even turn away customers with power needs in excess of the REP’s capacity to deliver.
“Generally, there are still more REPs coming into this market,” Pengidore said, noting the recent entry of Direct Energy, a unit of Toronto, Canada’s $4 billion Centrica North America. “There will be consolidation over time, but I don’t expect it to be a big, event-driven consolidation.”