Energy Trading Goes On, But Buyers Are Smarter
Saturday, May 27, 2006
When Enron collapsed in 2001, the idea of trading electricity seemed headed for the scrap heap of failed financial innovations.
Enron's victims were everywhere: Residential ratepayers in California were forced to accept crushing prices, some industrial customers in the Pacific Northwest were stranded for a while without any electricity at all, and Enron itself went bankrupt. Just the previous year, it had been hailed in a major business publication for its "flexible culture and track record for innovation" and for having "revolutionized the marketing of natural gas and electricity after deregulation."
But a surprising thing has happened since Enron's demise: The revolution didn't end. Deregulation didn't go away and new marketing and trading techniques are becoming the norm in the once-staid and highly regulated business of electric power.
"The business of energy trading went through a real collapse right after Enron because there was a real loss of confidence in the legitimacy of the companies doing the trading," said Severin Borenstein, a professor at the University of California at Berkeley and director of the university's Energy Institute. "That has gradually reversed over the years. There is a legitimate need for companies to make markets in electricity and to trade power and natural gas. We've seen a resurgence of those markets."
There are differences, of course. Regulators and big industrial customers are slowly getting savvier, and the companies trading electricity are more cautious and financially stable than Enron was. Today the big players are companies like the investment bank Morgan Stanley & Co., energy producer BP PLC, the utility and power generation holding company Constellation Energy Group Inc., and Sempra Energy, which owns two California utilities and which has built up the energy trading operations it bought from insurance giant American International Group Inc. several years ago.
"We are nothing like Enron," Constellation chief executive Mayo A. Shattuck III said in an interview published two years ago. "We have no special-purpose entities, no directional trading, we are not asset-light. We love hard assets."
Borenstein said: "People are more careful. There is not a Wild West economic environment where there are no rules and everybody thinks he can make money, which was the view back in the days of Enron."
Electricity had not been treated like oil, gasoline, pork bellies, sugar or soybeans. It wasn't traded on commodities markets. After securities legislation regarding utilities was adopted in 1935, utilities had their own power generation plants, and state public service commissions determined the profits the utilities could make on their investments, transmission services and fuel sales. Utilities were local, vertically integrated companies, doing everything: buying the fuel, running the generating plant, caring for the transmission lines and billing homeowners and businesses. It wasn't sexy, but it was steady and secure.
In the 1990s, however, many states deregulated their local utilities, freeing them to sell generating plants and seek new market-oriented deals for power. The idea was that companies would become more efficient and that consumers would benefit. A market was created.
The theory didn't match reality, though. Electricity produced in one place couldn't necessarily be delivered someplace else because of grid limitations. Moreover, "You can't store electricity. That's a problem," said Peter C. Fusaro, author of "What Went Wrong at Enron" and chairman of the New York-based consulting firm Global Change Associates Inc. "In all the other commodity markets you have storage. As a result, electricity is a real-time commodity. That means a lot more price volatility."
California regulators, who didn't trust the state's utilities to make the best longer-term deals possible, pressed those companies to buy electricity at spot-market rates. When a crunch came in 2000, half the state's power was priced on the suddenly exorbitant spot market. But with prices capped, utilities couldn't afford to buy enough supplies. "It's just not how you run a market," Fusaro said.
Enron was a big beneficiary because it was dominant, controlling 20 to 30 percent of the nation's electricity market, by some estimates. No single company dominates the market like that today.