Energy Trading: Out of Power?

For years, electricity trading has been described as the future of the power business. Now companies can't get out of it quickly enough.

Any business in which the now-fallen Enron Corp. was considered a trailblazer would seem likely to be suffering tough times at the moment. But recently a wave of developments has raised serious questions about the direction of the entire power-trading industry.

Consider this:

In recent weeks, major energy traders like El Paso and Williams have announced they are cutting their trading operations dramatically.

The government is looking into allegations of price-fixing stemming from California's power crisis.

Some firms, including Dynegy and Reliant, have acknowledged swapping quantities of electricity with each other to boost revenues.

And many states pondering electricity deregulation — a crucial aid in helping the trading business grow — have dropped the idea.

On top of all that, stricter government regulation of energy trading is on the way. The General Accounting Office, the federal government's watchdog office, issued a sharp report Wednesday calling for the Federal Energy Regulatory Commission to monitor the business more closely and further regulate a business once thought to represent the cutting edge of the free-market system.

"The industry is hemorrhaging right now," says Jim Walker, an analyst at Forrester Research in Cambridge, Mass.

A Commodity Like Any Other

It's all a far cry from the vision described by former power company executives like Kenneth Lay, the ex-Enron CEO, who told Congress in 1996 that deregulating the electricity business would "bring it into the modern age, and give American consumers the equivalent of one of the largest tax cuts in history."

Energy trading, while complicated in its details, operates via the same principles as other types of older commodities trading, from wheat to gold or oil. Companies like Enron — the industry pioneer in the United States — would try to anticipate fluctuations of the energy supply and demand around the country and trade quantities of power accordingly.

For instance, if Enron anticipated power shortages in Oklahoma, it could arrange to sell electricity to the local utilities in the future at a fixed price. Enron would then find a power producer elsewhere in the country with excess capacity, buy a contract guaranteeing the required amount of electricity, and have it shipped to Oklahoma.

Proponents of the concept, like Lay, argued prices would be lowered due to industry competition, and lobbied Congress vigorously to ease restrictions on shipping electricity around the country.

The Ups and Downs of Trading

The energy-trading business, however, has turned out to be as difficult as any other trading business when it comes to generating steady returns — like investment banks, for instance, which can see large year-to-year fluctuations in their trading profits (or losses).

That's not what the energy traders used to claim: Enron, for one, maintained its soaring revenues in recent years were mostly due to increases in the trading business.

Since Enron's fall, however, it has become clear that a substantial chunk of industry revenues were based on so-called mark-to-market accounting, in which future contracts are counted as current revenues. While this is not uncommon, analysts and investors have become wary of companies that heavily engage in this practice.

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