Trading floors represent ground zero in energy crisis

Michael Liedtke

Monday, March 26, 2001 | 11:16 a.m.

SAN FRANCISCO -- In Houston, it's simply known as "the power corner." Separated by just a few city blocks, four major power wholesalers run Byzantine trading systems that sway energy prices across the nation with minimal oversight from the government.

The Houston trading floors run by Enron Corp., Reliant Energy, Dynegy Inc. and Duke Energy represent ground zero in a power crisis threatening the quality of life in much of the Western United States this summer.

By seizing upon the opportunities created by deregulation and leveraging the Internet, the Houston traders have introduced the ruthlessness of the free market into the once-sedate power industry.

In the process, they have driven two California utilities to the financial brink and electrified the electricity business, just as junk bond traders ignited Wall Street in the 1980s and venture capitalists fueled Silicon Valley in the 1990s.

After raking in billions of dollars for their companies last year, the energy traders are emerging as the first business hotshots of the new millennium.

"They are extremely good at what they do," said Severin Borenstein, director of the University of California at Berkeley's energy institute.

"There are guys on Wall Street that spend all their time doing extremely complex calculations on bond yields and figuring out how to make the most money on the spreads. These traders (at the power companies) are doing the same thing with the energy market."

As they become more sophisticated, the power marketers are moving much of their muscle online, where they are proving more adept at e-business than most of Silicon Valley's fallen Internet companies.

Enron handles much of its trading business on a website launched in November 1999. The company describes Enrononline.com as the world's biggest e-commerce site, based on the completion of 548,000 transactions, totaling $336 billion, with 3,000 customers in 2000.

Following Enron's lead, Duke, Reliant and another major California generator, Mirant Corp., banded together with Wall Street investment banks Goldman Sachs and Dean Witter Morgan Stanley to launch IntercontinentalExchange.com.

The seven-month-old site reported daily trading volumes of 3 million megawatt hours in late February.

San Diego attorney Michael Aguirre believes the power companies are using the password-protected online exchanges to secretly share information and control the power supply to manipulate prices. Aguirre has spent the past six months scrutinizing the trading operations as he pursues a lawsuit alleging that the power generators broke antitrust laws.

"The whole trading thing is just a front that lets them game the market," he said. "They can get away with it because no one (outside the industry) can figure out what they are doing."

Enron says its trading system, particularly the online exchange, has resulted in fairer and more efficient markets. The allegations of market abuse are "just some sour grapes from people who didn't come up with the idea in the first place," Enron spokesman Eric Thode said Friday.

One of the biggest distinctions between the Texas energy traders and the Wall Street securities traders is how they are regulated.

The Securities and Exchange Commission and the Commodities Future Trading Commission oversee the trading of most of the nation's key markets. But the power traders answer to the Federal Energy Regulatory Commission, an agency with little training in the sophisticated financial instruments deployed by these marketers.

The power traders aren't just holding California over a barrel. Other states are paying even higher prices -- a factor that will likely further reduce supplies for California in the months ahead.

In a series of recent deals disclosed to The Associated Press by a major marketer, energy traders charged California $330 to $360 per megawatt hour for July electricity. They fetched $415 per megawatt hour in a key Pacific Northwest market and $495 per megawatt hour in a major Arizona market for contracts covering the same time.

A similar price disparity occurred for August electricity contracts. California paid top price of $395 per megawatt hour while the Pacific Northwest market paid $460 per megawatt hour and the Arizona market paid $535 per megawatt hour.

As the nation's largest power broker, Enron is the kingpin of the energy traders.

Spread through seven floors at Enron's Smith Street headquarters in Houston, the energy specialists among the company's 1,500 traders try to divine where prices are headed, and then swap electricity and natural gas contracts like stocks and bonds.

"You can walk into that trading room and if you didn't already know that you were on Smith Street in Houston, you would swear you were on Wall Street in New York," said Shannon Burchett, chief executive officer of Risk Limited Corp., a Dallas energy consultant.

Although energy is its main business, Enron also trades many other commodities, including paper, lumber, steel and broadband access to the Internet.

Enron's trading strategy remains a mystery even to industry analysts, partly because the company considers its techniques to be proprietary.

Using a team of mathematicians and meteorologists, Enron's traders try to identify places where the company can buy electricity at the cheapest price and then deliver it for a higher price somewhere else. The traders post the prices at which it will buy and sell electricity.

Enron's trading savvy yielded a big payoff last year.

The trading business posted an operating profit of $1.6 billion, up 160 percent from $628 million in 1999. When electricity and natural gas prices soared to record highs in the fourth quarter, Enron's trading profit more than tripled, from $151 million to $538 million.

Without providing specifics, Enron officials said the profits poured in from all over the country, not just California.

"Contrary to what you may hear or read, our success is linked to efficient markets, not higher prices in California, or anywhere else for that matter," Steve Kean, an Enron executive vice president, assured the U.S. Senate during January testimony. "What we are interested in is competitive and well-functioning markets. Our financial success is not built on California's back."

More power companies are trying to emulate Enron's success by investing in elaborate trading floors and aggressively recruiting the brightest MBAs out of graduate schools.

Williams Energy emerged as one of its industry's most profitable companies last year by capitalizing on electricity price swings from its 21,000-square-foot trading floor in Tulsa, Okla. The operation includes a 70-foot wall filled with secret data and two 30-foot data walls breaking out the latest information on energy futures.

Even as its California utility sank deeper into debt with the electricity generators, PG&E Corp. continued to build a 137,000-square-foot trading floor in Rockville, Md., to trade electricity. PG&E's worsening financial woes finally forced the company to delay the expansion late last year.

AES Corp. discovered the increasingly important role that trading floors play in the profit equation last year. The Arlington, Va.-based company owns three California power plants, but said it didn't make any money from them last year because of a contract that turns over the electricity sales to Williams.

The arrangement left AES with an $11 million loss from its California operations last year. Williams doesn't break out its earnings by region, but its energy services division nearly tripled its profit in 2000 to $1.56 billion.

archive