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State of Energy Trading


State of Energy Trading & Markets After Enron EIM Conference Tarpon Springs, Florida February 24, 2003 Peter Fusaro Global Change Associates New York, New York – PowerPoint PPT presentation

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Title: State of Energy Trading

State of Energy Trading Markets After EnronEIM
Conference Tarpon Springs, FloridaFebruary 24,
  • Peter Fusaro
  • Global Change Associates
  • New York, New York
  • 212-333-4979

GCA Products Services
  • Books
  • New York Times bestseller What Went Wrong at
    Enron (John Wiley, July 2002)
  • Energy Convergence (John Wiley, May 2002)
  • Energy DerivativesTrading Emerging Markets
  • Energy Risk Management (McGraw-Hill, 1998)
  • Customized consulting for energy financial
    service companies in energy environmental risk
    management advisory, competitive intelligence and
    business strategy

Energy Market Changes
  • Evolution of Energy Trading
  • Overview of energy trading
  • Energy futures and OTC trading
  • New market developments and instruments such as
    weather and emissions
  • The Enron disasters impact on markets
  • Whats to come

Evolution of Energy Trading
  • Historically high price volatilities for oil, gas
    and electricity
  • More volatility coming
  • Risk shifting not elimination no silver bullet
  • More futures contracts failing
  • OTC markets in crisis
  • Electronic trading price discovery

Historical Overview of Energy Trading
  • Need for viable cash markets
  • crude oil
  • heating oil
  • gasoline
  • propane
  • fuel oil and bunkers
  • natural gas
  • coal
  • electricity

Historical Overview of Energy Trading
  • Exchange-traded Futures Contacts
  • Transparency, clearing, and performance
  • Crude oil (Headline contracts)
  • Gasoline
  • Propane
  • Home heating oil
  • Natural gas (Benchmarks created)
  • Electricity
  • Coal

Historical Overview of Energy Trading
  • The Over-the-Counter Markets
  • Flexibility customization
  • Longer-term
  • No regulation, more risk
  • Forward Contracts
  • Price Swaps
  • OTC options
  • Current market collapse

Historical Overview of Energy Trading
  • Multicommodity Trading Takes Off
  • Oil Petroleum Products
  • Natural Gas
  • Electric Power
  • Emissions
  • Weather
  • Shipping
  • LNG
  • Coal

Energy is a Risky Business
  • The Risks
  • Price
  • Fuel
  • Operational
  • Regulatory
  • Liquidity
  • Credit

Why These Tools Emerged
  • Oil, gas, power and emissions are now
  • Unprecedented price volatility
  • Coal becoming a commodity
  • Securitizes future sales and receivables
  • Energy price risk management becomes a fiduciary
    responsibility of energy companies

Why These Tools are Emerging
  • Deregulation, privatization and risk of
    competitive markets
  • Conservative industry on the brink of fundamental
  • Financial leverage is now more important
  • More risk endemic in a market economy but more
    risk mitigation techniques now exist

Evolution of Power Trading
  • Energy Policy Act of 1992
  • Long-term contracts die (10 to 20 years)
  • No building except IPP
  • Spot markets are created
  • Price discovery commences
  • NYMEX others fail at creating futures
  • Financial instruments for power fail
  • Market breaks down in 2002

Evolution of Power Trading
  • Advantages of Merchant Power
  • Wholesale trading essential in deregulated
  • No retail load nor obligation to serve
  • Act like a trader
  • Greater arbitrage opportunities
  • Can turn off equipment
  • More flexibility
  • Cash flow becomes king

Evolution of Power Trading
  • Disadvantages of Merchant Power
  • No retail load (i.e. no cash flow)
  • Incumbent retail clients can be served and
    maintain cash flow
  • Market collapse oversupply
  • Weather still the key variable
  • Too much financial leverage (debt)

Why is this Happening Now?
  • Greed and incompetence have to lead to market
  • Wrong incentives in place for traders
  • Quarterly profits and quarterly bonuses
  • Senior management knew no rogue traders
  • Need for oversight both internally and externally
  • Replication of financial template throughout the
    energy complex not just Enron

Why is This Happening Now?
  • Financial leverage became paramount
  • Hiding debt became the game
  • Lying became endemic
  • Perversion of financial engineering
  • The energy companies, banks, accountants, lawyers
    and regulators are all to blame
  • Government asleep at the wheel

Not Just Enron
  • Major energy market makers in gas, electric and
    bandwidth failed
  • More off balance sheet financing schemes to be
    further exposed
  • Arthur Andersen auditors replaced with rigorous
    scrutiny of MTM and other deals
  • More red ink to be disclosed in next 2 quarters
  • Market bottom coming

Rebuilding the Market
  • May take rest of the decade
  • NYMEX wins by doing nothing oil and gas futures
    work, are regulated, and business as usual. OTC
    Clearing is a great success!
  • ICE in trouble, salvation is IPE
  • Liquidity crisis brewing 90 billion needed to
    shore up balance sheets
  • Potential power shortages in some areas of the US
    in the future

Rebuilding the Market
  • New gas-fired combined cycle turbines are not
    dual fuel capable (a new risk)
  • Loss of generation build out
  • Environmental compliance could be overridden by
    power shortages
  • Load growth still going up
  • Guess what the digital economy uses power

State of Electricity Markets
  • The dispatch queue nuclear, hydro coal with
    gas for peaking
  • Microturbines as peakers
  • Distributed gen cant get off the ground
  • Reserve margins are not a bad thing i.e. peak vs.
    off peak
  • Spark spreads now under water
  • Conventional wisdom in unconventional times does
    not work

The State of Financial Electricity
  • Too much price volatility 1998, 1998, 2000, 2001
  • 2002 Collapse of financial trading
  • Result real-time hourly market and next day
  • Relaunch of electricity futures by NYMEX
  • NYISO and PJM West
  • ISO indexes and ICE
  • Mark to model

The State of Electricity Markets
  • Little speculation
  • Supply balancing
  • Short-term oriented
  • Destruction of forward price curve
  • Price volatility continues (real-time commodity)
  • At least 2 more years to rebuild trading
  • Electricity becomes a strategic commodity just
    like oil i.e. it will never be fully deregulated

Electronic Trading and the OTC Markets (Setback
  • Over 60 Internet energy platforms have failed
  • Over hyped and just starting to be used
  • The Internet is just one more marketing channel
    and information tool
  • Consumers are slow to change behavior

Whats left of Electronic Energy Trading and
  • Automated Power Exchange
  • Natural Gas Exchange (NGX)
  • Intercontinental Exchange (ICE)
  • TradeSpark
  • Wheres the EnronOnline business?

Whats To Come?
  • Supply balancing rather than speculative trading
  • Less trade volumes for gas as well
  • Weather derivatives not a fungible commodity,
    really a reinsurance product
  • Movement to new markets
  • Green trading markets are real, government
    mandated and protected

Whats To Come?
  • Heavy heavy regulatory intervention in markets
  • FERC Standard Market Design is California all
    over again (economists and engineers cant make
  • Launch is September 2004
  • Traders are much smarter than government
  • More and honest financial disclosure necessary
  • Wall Street Banks are not energy companies and
    cant replace the loss of liquidity

The Government Reaction
  • Investigations
  • FERCs SMD (Sept 2004) and RTOs
  • State Commissions focused on wrong ball
  • CFTC is six months to a year behind markets
  • Overregulation is imminent
  • This will not produce one MW of power or one
    molecule of gas
  • No federal energy policy except bones to ethanol
    and coal lobbies

Environmental Market Evolution
  • Biggest financial challenge of energy industry
  • The Beginning Today
  • Opaque prices
  • Little trading and poor liquidity
  • Few participants
  • Wide arbitrage opportunities and fat margins
  • Tremendous inefficiency
  • Regulatory uncertainty
  • Cross commodity plays with weather and coal

The Next Market Environmental Trading
  • Environmental markets emerge (1995)
  • SO2 (volatility and options)
  • NOX in 1999
  • CO2 (100 trades and growing globally)
  • Bush moves on GHG are confusing
  • In North America, we make markets

The Next Market Environmental Trading
  • GHG is ready to roll
  • Energy agricultural industries are heavily
    impacted and have liabilities
  • CO2 trades already starting at state level and
    will be grandfathered in
  • Renewable portfolio standards in 14 states
    started in Texas last year
  • Negawatt market under development

The Next Market Environmental Trading
  • Green Trading markets may be 3 trillion market
    opportunity globally compared to 5 billion in
    SO2 and NOX trading today
  • A North American Market, European and Asian
  • Carbon is a fungible commodity just like oil, and
    therefore a global market is emerging with cross
    border opportunities

Bundling All the Risks The Future of Carbon
  • John Hancock Natural Resource Trade in Australia
  • Reforestation Play
  • Water Play
  • Renewable Energy Play
  • Carbon Play
  • Real Estate Play
  • Backed by Zurich Re

Visions of the Future Post Enron
  • The Emerging Trading World
  • Energy hedging still in its infancy 25 years
    after first futures contract
  • Application of financial engineering to
    environmental structured and project finance
  • Globalization will accelerate trading solution
    (Rest of the world is hot about energy trading
    and risk management)

Visions of the Future Post Enron
  • Enrons loss mostly confined to gas and
  • Loss of market maker and risk taker in gas and
    power (25-30 of gas markets) more significant
  • Largest gas power market maker and others gone
  • Set back for energy hedging for at least two
    years for gas and power

Visions of the Future Post Enron
  • More physical vs. financial trading especially
    for power devolving
  • Opportunities in coal, emissions, and oil trading
  • Loss of EnronOnline
  • Loss of aggressive deregulation advocate

Visions of the Future Post Enron
  • Deregulation politicized and dead (i.e. Gray
    Davis in California)
  • More regulation coming in energy and financial
  • Dont meet more laws, need proper enforcement
  • More financial disclosure
  • Markets work, Enron didnt

Visions of the Future Post Enron
  • Debunking of all Enron/McKinsey propaganda
  • Asset light
  • Disintegration of energy industry
  • Telecommunications bigger than energy
  • Virtual utility
  • Etc., Etc. Etc Common sense is important!

Visions of the Future Post Enron
  • The loss of responsibility in the energy patch
  • Phantom trading
  • Sleeving
  • Market manipulation
  • Bonuses not tied to real financial performance
  • Traders are too young, arrogant and stupid to
    have this much responsibility
  • Risk controls are preeminent market-to-market
    windows based straight through processing
  • Volatilities are growing

Visions of the Future Post Enron
  • More volatility coming due to cancellation of
  • Companies in trouble AES, Calpine, Dynegy, CMS,
    Panda, Mirant, Williams, Reliant, Aquila and
    others to join the list
  • Movement back to coal due to increased gas
    production and deliverability problems
  • Create more emissions activity
  • More consolidation Bigger Globalized Utilities
    and Big Oil Waiting in the Wings

Visions of the Future Post Enron
  • Heavy handed government regulation and
    investigation underway
  • Strangulation of markets in the near-term
  • FERC and SEC will lead the charge
  • Only the Fed can protect the financial markets
  • Death of the financial electricity market is not
  • Liquidity crisis brewing migration of OTC gas to
    NYMEX accounts for doubling of volumes in past
    year and now NYMEX has OTC Clearing

Visions of the Future Post Enron
  • Accelerating energy market consolidation
  • Wellhead to wires Big oil learns the power
    business slowly
  • European and to a lesser extent Japanese Korean
    utilities enter the US market
  • Fewer global players with mega portfolios of
    generation assets (70,000 -100,000 MW)
  • Energy will always be an asset heavy business

Visions of the Future Post Enron
  • More volatilities coming and more cross commodity
  • emissions and coal
  • emissions and weather
  • coal and other fuels

Visions of the Future Post Enron
  • The markets will be rebuilt
  • Talent will migrate from energy trading to
    environmental trading
  • Financial controls will be better
  • Less liquidity in all markets now
  • Accelerated consolidation and globalization
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