Banks See Big Chance In Trading Electricity
Sydney Morning Herald
Saturday October 5, 2002
If power stations can't sell output, the money men are preparing to do it for them, writes Brian Robins.
In the wash-up to the Enron collapse, Australian banks are moving in on the most volatile, high risk market imaginable electricity trading.
It has gone unnoticed, but Westpac has bought the local Enron trading team significantly boosting its profile in the wholesale electricity market.
In its wake, Commonwealth Bank is preparing to follow suit.
Houston-based Enron may have gone belly-up, mired in allegations of fraud and market rigging, but locally it was solidly profitable, boasting a gross profit (earnings before interest, tax, depreciation and amortisation) of around $5.5 million in 2000, surging to $18 million in the first nine months of 2001.
With the collapse of its US parent, the local operations are being wound up, although litigation launched by Integral Energy has delayed progress until at least year-end.
Huge surges in wholesale electricity prices on the back of output problems and weather shifts bankrupted California's electricity industry in 2000, and controversy has centred on the role of aggressive electricity traders such as Enron.
Price spikes in the wholesale electricity market are common and can expose buyers of electricity to huge losses. In the past week alone, spot prices in NSW whipsawed at one stage to over $1700 a megawatt hour 20 times the peak for any other state. (The nearest was $86 in Queensland.) The average price in the wholesale market is around $30 a megawatt hour.
Usually, that exposure is covered by hedging agreements between generators such as Macquarie Generation and Delta Electricity, and electricity retailers such as EnergyAustralia and Integral Energy.
But in light of plans by the Carr Government for a further restructuring of the power industry, the Westpac move has much greater significance. Late last year, the Government signalled that it wanted to stop the state-owned electricity generators and power retailers trading in the electricity market.
Ongoing pressure from the NSW Government for higher earnings saw power companies turn increasingly to electricity trading to lift earnings, in the process raising their risk profile. The Government wants them out of the trading area to avoid the possibility of big losses such as those registered in the past by Integral Energy and Pacific Power, though details have not been made public. Pacific Power was effectively bankrupted and has since been carved up.
Blocked by the electorate from privatising the power industry, the NSW Government has done the next best thing: it has pulled as much money out of the sector as it could more than $3 billion in 2000-01 alone while piling debt onto their balance sheets.
Apart from selling the utilities which it cannot do the next best thing is to auction the output under long-term contracts, which appears to be the strategy behind stopping the utilities from trading electricity.
NSW appears to be following the lead of Canada's Alberta State Government, which raised an initial $C2 billion in 2000 and a further $C1 billion in 2001 by selling off rights to the electricity output of its power utilities.
Subsequently the wheels fell off, with a surge in power prices in Alberta, until then among the lowest in the world at $C14.50 a megawatt hour. This was due to difficulties in California and soaring natural gas prices in North America, although power prices have subsided.
Nearly all the State Government's profit went back to consumers via big rebates, quelling criticism of the move.
The Carr Government's proposal has yet to progress, and is now on the back burner, with state elections in March. Some say that the proposal has been shelved, others that Frontier Economics, the adviser to the Government on the planned move, is still tinkering with it.
Within the industry, there has been considerable debate on the issue, although counter-proposals have yet to emerge.
And this is where the Westpac decision to buy the Enron team, and beef up its power expertise, is more than an idle strategy.
Among electricity traders, taking the state-owned power industry out of trading is expected to lead to auctioning off their output under long-term contracts, as Alberta has done. And apart from the banks, what financial institutions have the balance sheet and wherewithal to take it on?
Westpac argues that access to wholesale electricity markets simply rounds out the suite of risk management products it can offer clients. Its move has triggered an immediate response from the Commonwealth Bank, which is soon to begin assessing whether it should follow suit. Banks such as NAB and ANZ are not interested at this stage. Neither is active in trading in the wholesale electricity market.
The NSW Government isn't talking about its game plan, but if it wants to know what happened in Alberta, perhaps it could send someone down to No 1 Martin Place, since Macquarie Bank has been advising Alberta on the deregulation process.
In fact, Macquarie liked the privatisation process so much that it took a 15 per cent stake in the AltaLink consortium which bought the power transmission business of one of Alberta's local power companies in mid-2001.
And a direct stake in the industry can be vital for traders.
Earlier this year, SG Australia took a five-year output purchase agreement over a small power station in South Australia, giving it direct exposure to the power generation market. It hopes to profit from surging mid-summer power demand and prices in South Australia and Victoria. A cool summer last year derailed its hopes to make money out of it this year, but prospects for the summer ahead look enticing.
For power traders, despite concerns that the Enron collapse and the move by Edgecap (now owned by AGL) to pull out of the market would see electricity trading collapse, the past six weeks have seen the most active trading since the market opened up in 1999. A number of factors have been cited, such as the launch of a new electricity futures contract (with another to come mid-month on the ASX) through to full market deregulation in South Australia from the start of the new year.
Offshore, Bank of America is to enter the US electricity market, following on from UBS Warburg's purchase earlier of the Enron online trading platform. Similarly, Goldman Sachs, Barclays Bank and the like are all active in the field.
The move by banks into electricity trading has all the hallmarks of what happened in the wash-up to the junk bond boom of the early 1990s.
That bubble, which inspired novels and Hollywood movies, saw the collapse of Drexel Burnham Lambert, the investment bank at the centre of the junk bond party, and the jailing of Michael Milken, the originator of the market.
And just as is happening now with electricity trading, banks moved into trading junk bonds and effectively made them respectable.
Just as Drexel Burnham Lambert help open up access to America's credit markets for much of corporate America, so too has Enron revolutionised energy markets.
Enron scored key start-up funding from Drexel Burnham Lambert. Links were so close that ex-convict Milken was spotted on the Enron trading floor the first week he was out of prison.
© 2002 Sydney Morning Herald