In the summer of 1998, the US power trading equivalents of little kids’ lemonade stands were overturned and smashed by some very nasty bullies. The wondrous growth market of energy juggling, where volumes doubled every year and new names heaped humiliation on yesterday’s energy giants, was simply pulverised in a week’s frenzied Midwest heat wave trading. The result was the withdrawal or bankruptcy of ranks of trading amateurs without real assets behind them. These unfortunates were disparagingly dismissed by the big boys as “have phone and fax, will trade” losers.
But what about “have utility, will trade even more”? Ohio utility Cinergy’s own very sizeable lemonade stand has been smashed this summer, and many wonder whether it is worth putting it back together again. After last year’s Midwest ruckus, the harsh and uncharitable (read Wall Street) see any major trading mishap in the region as simply unacceptable.
All the more so when the mistake seems so basic. On a hot July 30, Cinergy was running a short position. As demand soared, it was not able to meet all its delivery commitments with its own plants or power imported from other regions, and so defaulted on contracts with eight traders, including top US players. How could Cinergy have put its credibility at stake in this way? Weren’t unplanned outages and transmission constraints, plus hot weather, the straightforward and predictable causes of the summer 1998 crisis? Why was the group apparently so confident that the summer of 1999 would be different?
The damages totalled $73 million. Cinergy lost $57 million after tax attempting to cover its short position while prices soared, and anticipates another $16 million after tax in damage claims. This is not the first setback in trading: in the second quarter of 1998, Cinergy set aside a $61 million provision to cover credit quality issues and a reassessment of the risks of the mismatch between its long term delivery contracts and its own production assets. When these losses are set against the meagre single digit margins “successful” players secure in trading, it is easy to wonder how long it will take for Cinergy shareholders to run out of patience. Currently hovering just under $30, their shares are stuck where they were two years ago.
Analysts have been soothed with a “fix it or sell it” promise, which should be fulfilled by November. Fixing trading may be worth it, since Cinergy is a big player. Power trading (“sales for resale”) volumes in the first half of 1999 were reduced to 21.4 TWh from 38.1 TWh in the same period last year. But on stable second half volumes Cinergy should still have a good chance of a place in the lower ranks of the 1999 top twenty US power traders by volume. In revenue terms, power trading contributed $551 million in the first half, or just over a fifth of total Cinergy revenues of $2 678 million. The gas trading business is no minnow either.
But scale is no guarantee of performance in a crowded and volatile commodity market. If Cinergy’s trading teams can’t deliver, the best fix for their rapid build-up may still be equally rapid retreat. Who ever made good money out of lemonade stands anyway? Boringly stable paper delivery rounds are much more rewarding in the end.
