Markets, Liquidity Concerns Roil Industry
Baltimore Gas & Electric's Parent in Active Talks With Potential Partners

By Steven Mufson
Washington Post Staff Writer
Thursday, September 18, 2008

Market turbulence continued to ripple through the energy industry yesterday.

Constellation Energy Group, parent of Maryland's biggest utility, was said by a key analyst to be at an "advanced stage" in talks to sell part or all of the company after it came under pressure to boost liquidity for its energy-trading business.

Ethanol giant VeraSun lost three-quarters of its already deeply depressed stock value after saying it would lose up to $103 million in the third quarter because it made bad hedging bets on corn.

And leading oil price bull Goldman Sachs slashed its forecasts for the next few months. Less than one month after it reiterated a target of $149 a barrel by yearend, Goldman Sachs said the financial crisis and global economic slowdown could push prices down to $75.

Constellation Energy, one of the country's top generators of electricity and the parent of Baltimore Gas & Electric, is facing a crisis of confidence over the liquidity needs of its trading arm, which until this year was a profitable and rapidly growing business. The company issued a statement saying it was in "active discussions with potential strategic partners" and had retained advisers from Morgan Stanley and UBS.

Standard & Poor's issued a report saying, "These strategic options include an outright sale of Constellation, which management has informed us is at an advanced stage." Maryland Gov. Martin O'Malley's office later said that state regulators would have to approve a sale if it included BGE.

Constellation's stock has lost half its value in the past two days and 70 percent of its value since July 31. Its market capitalization yesterday was $5.5 billion.

Constellation officials did not return calls for comment.

In early August, Constellation disclosed that if its credit rating were downgraded, the company would need $3.3 billion in collateral. That was about $1 billion more than it had previously said would be needed. While the revision had no immediate financial impact, it damaged investor and lender confidence.

"It was seen more as a lapse in risk management," said Aneesh Prabhu, an analyst at S&P, which lowered its credit rating for Constellation to "BBB" on Aug. 13.

He said crumbling confidence had prompted a small number of counterparties on London's ICE exchange to already cut off business with Constellation. Though they were not significant in amount, Prabhu said "once it starts, it can certainly snowball."

Analysts said there were concerns that a $2 billion credit line that Constellation had negotiated but not closed with Royal Bank of Scotland and Union Bank of Switzerland would fall through. But Constellation said yesterday that the credit line was intact. S&P's report said the rating agency had separately contacted the banks, which said they would provide the credit even if an effort to syndicate the loan to other institutions failed, a much greater possibility in the current financial climate.

Constellation recently said it hoped to raise $1 billion through asset sales, but that now appears to be too little, too late. "You are in a challenging market for asset sales needed to shore up liquidity," Prabhu said.

Whatever happens, the crisis at Constellation is likely to revive the debate over deregulation of utilities, which helped expand energy trading by utility-holding companies and investment banks.

For every trade, a firm is required to hold a certain amount of collateral. And most of the biggest electricity and energy trading firms are investment banks.

Earlier this year, Sempra Energy, a California-based utility, sold half its trading business to Royal Bank of Scotland, which now provides the liquidity or access to cash that is needed.

"These are businesses that on occasion, because of high energy prices or problems in the credit market, can require a lot of liquidity," said Mark A. Snell, chief financial officer at Sempra. "Sometimes that can overwhelm a company that doesn't have access to liquidity like a bank does. Once these companies reach a certain size, it helps to have a relationship with a financial institution and preferably one with access to the Fed window."

Constellation is one of the biggest utility-trading firms. Yesterday it disclosed that it is owed about $6 billion by counterparties to trades. Seeking to calm fears that it might not be able to collect from troubled financial firms, Constellation said that financial institutions accounted for only $120 million of that total and that no single financial firm owed it more than $28 million.

Meanwhile, VeraSun, which uses corn as feedstock for the 355 million gallons of ethanol it makes every quarter, said in a Securities and Exchange Commission filing that it had locked in corn purchases after rising demand, market conditions and Midwest floods had driven the price to $8 a bushel in July. Prices fell to $5 by mid-August.

Earlier, VeraSun had bet on falling corn prices, but after watching prices rise from $6 in late May, it abandoned that position at just the wrong time. It said it expected a third-quarter loss of $63 million to $103 million as a result.

Other companies made bad bets on commodities. United Airlines said yesterday that it was on track to lose $544 million on fuel hedges this quarter. That included $72 million in realized losses and $472 million more in unrealized losses.

Meanwhile, Goldman Sachs lowered its 2009 average oil price forecast to $123 a barrel from $148 a barrel. "We will stand by our bullish view on oil but just think it will now take longer to get to our previous price targets,'' Goldman analysts, led by Jeffrey Currie, wrote in a Tuesday report. "The supply side of the market still remains severely constrained.''

But the firm hedged by warning that economic weakness could temporarily drive prices down further than they have fallen already.

Yesterday, oil prices rebounded by $6 a barrel, to $97.16.

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