The US natural gas and wholesale power trading sector, along with the power-generating sector, is presently facing a period of "extreme stress," according to Richard Hunter, managing director, global power group, for New York-based Fitch Ratings.
And the energy trading sector's response to this stress is affecting the scope of activity within the energy commodities markets.
Factors contributing to this strain have been industry's desire to reduce its exposure to energy trading operations, continuing regulatory investigations into financial reporting practices, and an onslaught of litigation, Hunter said at a Fitch-hosted teleconference late last month. At the same time, energy traders are reassessing their portfolios for possible asset sales to raise cash flow and lower debt profiles. These factors, he said, have all played their part in creating a negative outlook for the sector.
Meanwhile, analysts continue to downgrade companies involved in energy trading and power-generation. Fitch, which tracks downgrade-to-upgrade ratios, said that among all US corporations in Fitch's universe of companies-including financial institutions-the downgrade-to-upgrade ratio was 4:1 for the first half of 2002. Removing financial corporations, Hunter said that the ratio changes to "a rather heady 14 downgrades to 1 upgrade" for the same period. During the first 6 months of this year, the ratio within the global power group's universe of companies is 18:1, vs. a ratio of 6:1 for the first half of 2001.
For the first half of this year, Fitch estimated that total defaults among corporations worldwide amounted to $50 billion, Hunter said. "That compares to a record year of 2001 with $78 billion (in defaults) for the whole year, which itself beat the prior record year of 2000 with some $28 billion." Hunter said that defaults worldwide typically run well below $10 billion/year.
Risk exposure
Gas and power marketers and traders wanting to minimize their risk exposure are shying away from trading operations and concentrating efforts on firming up their physical assets. Such moves are amounting to fewer counterparties to trade with, which in turn is resulting in less trading activity and less volatility in the market, said Ellen Lapson, Fitch global power group analyst. But these same energy marketers and traders are currently in the best position to deal with any systemic risk, such as being exposed to a counterparty that defaults on a contract, Lapson noted. "I'm confident that the marketers and traders have been reducing their exposure to those of their counterparties that they lack confindence in," Lapson said.
Companies more at risk, Lapson explained, are those that don't have the benefit of being able to offset their positions and those that do not have the same kind of protection against the "automatic stay" in bankruptcy. An example would be an independent power producer or utility that has a contract with a marketer, Lapson said. "If the marketer defaults, that contract may be deemed to be a normal commercial contract and therefore subject to the automatic stay," thus resulting in the counterparty being subject to the risk of having to cancel the contract, which in many cases can result in fairly large exposures, she said.
"We have seen that the marketers and traders have a significant benefit in their ability to terminate exposures through their trading contracts, which is not shared by normal commercial contracts-which are subject to the automatic stay," Lapson said. While tracking the events of the downfall of Houston-based Enron Corp., Lapson said she noticed that while marketing and trading counterparties were able to exercise remedies of termination for contracts, a utility or a power generator that had a normal commercial contract was "sort of stuck holding the bag."
"Because a supply contract would probably be deemed to be an executory contract, the marketer could terminate the contract if the marketer is 'out of the money' and the utility is 'in the money,' Lapson said, adding that this situation would leave the utility exposed. "On the other hand, if the marketer is 'in the money,' and it declares bankruptcy, and the utility is 'out of the money'-meaning that the utility could go out in the market and get new supply at a lower cost-the automatic stay in bankruptcy would probably prevent the utility from terminating (the contract) even though it is at a significant risk," she explained.
