Sam Fletcher
OGJ Senior Writer
DALLAS, Oct. 28 -- Emergence of major integrated oil companies as key players in the merchant energy industry should be a matter of concern to the Federal Energy Regulatory Commission, said Jerry J. Langdon, a former FERC commissioner now employed at El Paso Energy Partners LP, Monday at the annual meeting of the Independent Producers Association of America in Dallas, Tex.
Some majors are combining their equity natural gas with third-party gas in a 2-2.5:1 ratio to mitigate credit risk and match pipeline capacity, Langdon said. The result, he claimed, amounts to an "unregulated branch market" that is "less transparent and less liquid. Fewer players mean more volatility."
Langdon also worries about the growing role of large commercial and investment banks in providing risk management services to independent producers. Bankers, he warned, "know how to charge for their services." In a later response to questions, Langdon added, "When you deal with those who know how to charge fees, buyer beware."
Langdon was part of a panel discussion of the implications to producers of the devastation of the merchant energy business in the wake of the Enron Corp. scandal.
Although the top tier of energy marketers was badly impacted, some big players "such as BP (PLC) and Duke Energy (Corp.) are still hanging on," while "overall volumes haven't changed much," said David Pruner, president of Axiom One LLC, a risk management unit of J.M. Huber Corp. "The industry will survive," he predicted, "but not without a lot of casualties along the way."
However, James M. Donnel, president and CEO of Duke Energy North America warned that natural gas marketers must "restore investor confidence, or we won't be around much longer."
The number of credit downgrades among utility companies has nearly doubled in the last 2 years, Pruner said. "Profits are down across the board," he said.
Langdon noted that several pipeline companies are abandoning the energy marketing business, in part "due to the expense of providing credit support." As a result, he said, the gas market will be less liquid and less transparent, while price volatility will increase.
With the virtual collapse of some of the top energy marketing operations, Pruner said, "More and more people are using (futures contracts) on the New York Mercantile Exchange to hedge (prices on future production), but that's not the right vehicle for everyone." NYMEX was used to hedge against short-term price fluctuations before; "There's just more volume now," he said. Analysis of recent trading activity shows 69% of the open interest contracts are concentrated within the first 12 months of the trading spread, with 90% occurring in the first 24 months.
Many US producers took advantage of high commodity prices in 2000 to hedge forward production, but most "pulled the trigger on the downside" of that price peak, leaving behind some potential profit on the upside, said Pruner.
Currently, he said, "Only about 25% (of anticipated US gas production) is hedged for 2003 because producers are bullish about future rates." Nevertheless, he advised IPAA members to "hedge early and hedge often. The market is so volatile that no one position (for locking in the best potential price) will do it."
Langdon claimed master limited partnerships (MLPs) remain the principle and best source of capital for the midstream sector of the industry. In addition, he said, "It is the ideal surrogate for regulatory oversight." Regulators historically provide investment confidence to capital markets for pipeline infrastructure, and MLPs traditionally give a 9-12% return on equity, he said.
Despite talk of reregulating the natural gas industry, Donnell said, "I don't think you can put that genie back in the bottle." Moreover, he disputes arguments that deregulation has been a failure. "The market is much softer on the demand side," he acknowledged. "The market didn't foresee the highs being so high or the lows being so low. But the companies who best maintain control are the best able to withstand cycles."
He told the independent producers, "All is not lost. Your segment (of the industry) looks very attractive."
Contact Sam Fletcher at [email protected]
