Unravelling the market
By Kevin Foster

Wild price swings, September 11, and the implosion of Enron: 2001 was an eventful year for the energy derivatives sector. Who won out?

EPRM’s 2002 energy derivatives rankings show the energy sector in a state of flux following the collapse of Enron Corp. Two months after the Houston energy major declared bankruptcy, a number of its rivals are coming to the fore in each of the markets Enron once dominated: natural gas, electricity and weather. And they all preach the same message: that Enron’s demise, although the key event of the past 12 months, will have no lasting effect on the liquidity of those markets.

A year ago, Enron was the most consistent player in natural gas, electricity and weather. This year’s rankings – one of the first and most comprehensive surveys to be conducted since the firm filed for bankruptcy – show several companies stepping up to fill Enron’s shoes.

In North American natural gas, Houston-based Entergy-Koch Trading wins three out of four categories – the first time it has taken first place in this sector. Jeff Searle, president of Entergy-Koch, says he was pleased with the level of liquidity in the natural gas markets in the first half of 2001. But he says volatility in the second half of the year was down, due in part to the impact of Enron’s problems, but also because trading firms tend to balance out their books at the close of the calendar year.

“Over the last 30 days we have seen levels of liquidity pick up,” he says. “And I expect that in the next two to three months liquidity will return to normal levels.”

Searle attributes Entergy-Koch’s success to its range of coverage in the natural gas markets. The firm trades financial options in all regions of the US, and physical products in the gulf, midwest and northeast regions.

The most successful energy company overall is Houston-based El Paso Corp. Its trading subsidiary, El Paso Merchant Energy, sweeps the board in North American electricity swaps and options, while El Paso Europe, based in London, takes all four first places in UK and Europe natural gas.

Dennis Crum, APB Energy: we have seen across-the-board increases in all products

Brokers going strong

APB Energy consolidates its position as the leading North American electricity broker, taking all six first places in that category. The Louisville, Kentucky-based company also wins first place in North American natural gas basis swaps – the first time it has been placed in any category outside the electricity markets.

Dennis Crum, APB chief executive, says: “The options business remains our core market – we think it is the best way to build growth overall in the power sector. But we have seen across-the-board increases in all products.”

The loss of EnronOnline means voice brokers are now more valuable than ever, he says, because in times of uncertainty customers tend to use voice brokers more. But he adds: “I believe electronic trading platforms bring liquidity to the market-place, and this is good for everyone concerned.” APB’s own electronic platform, True Quote, has seen steadily increasing business throughout 2001, he says.

Michel Everaert, global head of product marketing at broker GFInet in London, also stresses the importance of electronic trading. On January 7, 2002, the company launched its online trading platform in the North American electricity market, adding to its already well established online presence in Europe.

“I don’t think it would have been possible for us to capture as much liquidity and as large a trading share as we have without our online operations,” he says. “Anyone who does not have an [online] screen will not be able to carve out a market leading position.”

But he says GFInet’s voice brokers continue to deliver the most value – a situation he expects to continue.

GFInet takes three out of the four first places in UK and European electricity. Everaert says he would not describe these markets as “mature”, but says they are growing. He says the level of competition is healthy, but adds: “Twelve months ago there were more companies competing on a level basis. Now we are starting to see some segregation between a group of market leaders and the rest.”

Rob Ryneveld, Starsupply: Enron’s fall caused many traders to re-assess their counterparty risk

Oil uncertainty

The crude and products markets, where Enron was a peripheral player, paint a much more familiar picture. Once again, banks Goldman Sachs and Morgan Stanley feature strongly, as they have for the past three years.

Goldman Sachs, with eight outright and three shared first places, is the most successful counterparty in these markets. Morgan Stanley, with six top spots outright and one shared, is given a close run for second place by Bank of America, which has five outright and two shared first places.

2001 was anything but a typical year for the oil markets. The London-based International Petroleum Exchange’s front-month Brent crude oil futures prices swung between a high of $27 a barrel (bbl) immediately following the September 11 attacks to below $18/bbl in mid-November. And the terrorist attacks of September 11 also hit the oil products markets through their impact on the airline sector.

Gary Cohn, managing director and head of commodity derivatives at Goldman Sachs in New York, says: “Many people were very concerned about the effect of September 11 on the jet fuel market. But as it turned out, the reduction in commercial demand was replaced by increased military demand [due to the US and British bombing campaign in Afghanistan].”

Cohn says Goldman Sachs remains one of the leading counterparties because of its commitment to the oil derivatives market. “The commodities markets are a cyclical business – a lot of banks have pulled out over the last three to five years,” he says. “There is competition, but not as many serious players as in the past.”

Goldman Sachs is looking to build its presence in the electricity markets, Cohn says. “We are making a major push in this market,” he says. “In the US, we are building a 100% owned power trading business, and in Europe – where we started trading 18 months ago – we are continuing to grow.” Indeed, this year Goldman Sachs is voted best counterparty in electricity swaps, Europe, for the first time.

New Jersey-based Starsupply is the most successful oil broker, with eleven appearances, including seven first places. Rob Ryneveld, president of Starsupply, says a number of factors affecting the oil product sector came together late in 2001 to create what he calls a “perfect storm”.

He is referring to the impact of September 11 on both jet fuel demand and the wider economy, and the collapse of Enron.

Although the latter did not hit the products market as hard as it did the natural gas and electricity sector, Ryneveld says it caused many traders to re-assess their counterparty risk, which in turn led to a reduction in some trades.

For example, many companies are reluctant to get involved in longer-term deals with expiries in 2004–2005, because of a perceived increase in counterparty risk, he says.

Weathering the storm

This year’s rankings saw a big increase in votes in the two weather derivatives categories. Stamford, Connecticut-based Element Re wins both the swaps and options categories for the first time, and New Jersey-based brokers United Weather repeats its success of 2001 as the top broker.

Lynda Clemmons, president and chief operating officer at Element Re, says: “The weather markets have been increasingly robust over the last 12 months. The demise of Enron certainly had an impact, but I expect almost all the [Enron] traders to land jobs at different companies, and this will also help the market’s growth.” Element Re has already hired one ex-Enron team member, she adds.

Entergy-Koch’s Searle says he feels the weather market moved sideways – or even took a step backwards in terms of liquidity levels in 2001. But he says: “The number of customers continues to grow. We would like the number to grow even further, but we’re not disappointed by the last 12 months.” Entergy-Koch takes second and third place in weather swaps and options respectively.

Element Re’s Clemmons concedes that the range of end-users in the US has not broadened out beyond the energy sector as much as some had hoped. But, she says, this is the exception to an otherwise successful year.

“We have seen increased liquidity, a huge growth in the market outside the US, and an increase in the number of end-users,” she says. “The last 12 months have left everyone in the weather risk industry feeling pretty good.”

Energy derivatives rankings 2002