Oil/gas firms take lead among new breed of energy megamarketers

Barbara Saunders
Staff Writer

Traders coordinate gas and electricity deals from the same trading room, a sign of the evolving new breed of energy megamarketers. Photo by Drew Donovan, courtesy Enron Corp.

Companies in the U.S. oil and natural gas industry are stepping up efforts to make the most of policy reforms opening the electricity market to competition.

They're among the strongest players in a new breed of energy megamarketers that's evolving in response to continuing power deregulation. Such companies are capable of simultaneously buying and selling electricity-along with natural gas and other energy fuels.

Unregulated affiliates of electric utilities, trading houses, and commodity brokers also are in the lineup.

Under a process administered by the Federal Energy Regulatory Commission, companies can apply for power marketer certification, which enables them to buy and sell electricity for wholesale transactions at market-based rates.

Power marketers can sell utility-generated power outside the utility's service area at unregulated rates; they also can package power supplies from non-utility generators (NUGs) for wholesale transactions

The larger concerns are combining their ability to market power with established marketing operations for natural gas, crude oil, and other fuels to create integrated one-stop energy "shops."

Cropping up as an outgrowth of integrated energy marketing are opportunities for interchangeable fuel-power transactions. For instance, if a utility needs peaking power, it can sell gas to a marketer in exchange for power that's cheaper than what the utility could generate internally (OGJ, Oct. 24, 1994, p. 21). It's opportunities like this that have attracted gas concerns, in particular, to the power marketing business.

Analysts say the U.S. electricity market alone yields annual revenues of about $200 billion. Add natural gas to the equation, and the total comes to about $300 billion, according to an estimate by Enron Corp.

Put another way, that translates to an industry roughly triple the size of local and long-distance telecommunications. That's why firms are rushing to qualify as power marketers.

Deregulation background

Until just a few years ago, the sale of electricity was rigidly controlled. Then Congress, with passage of the Energy Policy Act of 1992 (Epact), relaxed some of the restrictions on the market. Essentially, Epact created a new category of Exempt Wholesale Generators (EWGs) able to compete more freely and sell electricity for less.

By lifting restrictions on utility ownership of EWGs, utility affiliates could compete on more even terms with non-utilities in building or acquiring generation facilities that sell only wholesale power.

NUGs were also freed from some of the restrictions on power sales to utilities, but for some cogenerators, it has meant that they got less for power they sold to utilities than they had under previous law.

Another key provision of Epact guaranteed the right to access to transmission lines for electricity not owned by utilities-known as wheeling-but only for wholesale transactions. This is an important distinction, because wholesale transactions account for about two thirds of all electricity sales.

Seeing the potential in the new law, companies of all kinds-gas marketers, utility affiliates, commodity brokers, and even investment banks-went to FERC for certification as power marketers. This certificate allows the holder to buy and sell electricity at market-based prices or whatever two parties to a deal agree is fair.

Not everyone has the size or savvy to play the unfolding power market. At first, the firms seeking power marketing status didn't exactly rush to FERC's door. As of mid-1994, FERC had issued only about 50 of the certificates, but every year since, the number has doubled.

The great majority of firms that have federal approval to buy and sell wholesale power aren't even active.

As of June 1996, FERC had issued 192 certificates to concerns seeking to buy and sell power at unregulated, market-based prices and had another 28 applications pending.

Of the approved power marketing concerns, only 55 reported any transactions during first half 1996, and 10 accounted for nearly 80% of all sales.

Gas marketers in forefront

"The predominant origin of power marketers right now is from a gas marketing background," says Gary Simon, senior director of electric power for Cambridge Energy Research Associates, Cambridge, Mass.

Knowledge of deregulated markets gives gas marketers a leg up on the process. On the other hand, "affiliates of utilities know how the electricity system works. Each of them has something to learn."

Longtime players in the oil and gas industry hold a commanding position in the ranks of power marketers. Units of Enron Corp., Consolidated Natural Gas Co., NGC Corp., and Koch Industries Inc. rank among the top 10 active power marketers and accounted for 47% of all power marketing transactions in the first half, according to a survey of FERC filings by Power Markets Week.

Enron alone holds a 32.7% share of the reported volumes, with sales of 21.4 billion kw-hr during the first half.

Gas and oil companies are getting competition from other fuel producers and marketers in this burgeoning new market.

Coal interests are jumping on the multicommodity bandwagon as well. Peabody Coalsales Co. formed a new marketing unit and applied to FERC for power marketing status.

"We look at this as an important adjunct to our principal business of mining and marketing coal," said David Turnbull, vice-president of energy trading for the new unit, Powertrade Inc. "It's one more service we can offer our customers, and it allows us to tailor coal supply arrangements to meet a broader range of utility needs."

Power marketing in perspective

Overall, power marketing is picking up at a rapid pace.

The combined sales of power marketers in the first half totaled 65.5 billion kw-hr, outpacing sales of 28 billion kw-hr during all of 1995.

Still, that's only about 1.4% of all wholesale electric sales, which stood at about 1.9 trillion kw-hr last year.

The potential wholesale market alone is valued at about $90 billion, according to Ellen Lapson, senior director of Fitch Investor Service.

About 40-50% of that market could open up the next 3-5 years, as utility supply contracts with other utilities and NUGs expire.

But larger potential is down the road, as the $110 billion retail market opens to competition. Most industry analysts agree it's only a matter of time before that happens.

Right now, FERC lacks authority to order retail wheeling of power, and the issue is in the hands of the states.

Some states are also considering allowing the gas market to open to competition at the retail level.

This could result in revenues from a combined gas-electricity retail market of up to $300 billion, roughly triple the size of local and long-distance telecommunications markets, according to an Enron projection.

Convergence of gas and electricity "has brought a lot of discipline to the market," says Paula Rosput, president of PanEnergy Power Services. "Gas and electricity prices used to be all over the place. Now, they're almost working in lockstep."

Growing pains

Still, the fledgling power market is not without growing pains.

"We don't see a lot of liquidity in the market. It's in the very early stages of getting liquid, and only in the west...It's not a market where you can protect yourself financially, so you have to cover yourself physically. There's very little term activity going on."

One exception, she noted, is industrial customers coming off the Bonneville Power Administration system. There's a great deal of competition for these "essentially retail" customers.

There's also competition to develop a full array of customer services, including load balancing, scheduling support, information system development, and risk management.

"We're trying new services and types of contracts," said Ken Rice, managing director of Enron Capital & Trade Resources, Enron's merchant arm. "We have a custom contract tied to other commodities with producers. Electricity floats with aluminum prices."

In a sign of the times, Enron-along with most other large marketers-has merged once-separate trading operations into a single large room.

"We have one gas and electric trading floor broken down by region," Rice said. "We've gotten our traders so they can communicate on a real-time basis."

Right now, most of the power market trades are in the physical market, counterparty-to-counterparty, said Rod Husk, vice-president of Koch Energy Services Inc.

"Utilities are reluctant to be seen as speculating. The short term nature of today's deals are a function of regulatory uncertainty."

Policy changes

Earlier this year, FERC crossed an important threshold en route to power deregulation by approving Order 888, providing open access to transmission systems for wholesale transactions.

FERC's rule also supports, but stops short of requiring, efforts by utilities to transfer management of power dispatch on transmission systems in a given region to an Independent System Operator.

In addition, Order 888 allows utilities to recover stranded costs of prior investments in generating facilities, as long as these costs were "prudently incurred."

Estimates of stranded costs range from $100 billion to $300 billion, but the portion of these costs that fall within FERC's jurisdiction is a gray area. It's an issue that FERC plans to decide on a case-by-case basis, and one that states will be grappling with, too.

Some 40 states are addressing the concept of retail wheeling, with most still in the early stages of launching inquiries or spelling out generic guidelines. One exception is California, which begins implementing a full-fledged program next year that will lead to retail competition by 2001.

New Hampshire, New York, Massachussetts, and Illinois also have launched small-scale, experimental retail programs this year, as part of larger restructuring efforts. Similar retail-level pilots are being implemented in the natural gas distribution sector as well.

Many see the programs as an important gauge as to how consumers respond to a choice in electric providers. Electricity already is being offered in New Hampshire under brand names, with slogans and commercial pitches.

These experimental programs could be like "matchsticks on dry timber" in igniting demand from industrial customers for the freedom to choose suppliers, predicts Roger W. Hale, chairman and CEO of LG&E Energy Corp. The utility's affiliated marketing arm has the second larger power marketing volumes, after Enron.

Megamarketers realign

Eager to position themselves for a bigger piece of the action, potential megamarketers originating in the natural gas industry this year launched a series of mergers and strategic partnerships.

Enron in July announced plans to merge with the Oregon-based electric utility Portland General Corp. in a $2.1 billion stock transaction.

The merger aligns Enron with a low-cost power producer well-positioned to serve the California market.

"It gives us control over generating assets within close proximity to the California-Oregon border trading point," said Enron's Rice. "It gives us flexibility to make more reliable deliveries." It also gives Enron access to Portland General's 675,000 retail customers in Northwest Oregon.

August brought the close of a merger of NGC Corp. with units of Chevron Corp. (OGJ, Sept. 9, p. 39).

"We had in mind a merger partner to take the whole concept of the energy store to another level," said C.L. (Chuck) Watson, NGC's chairman and chief executive officer.

As part of the deal, NGC will market virtually all of Chevron's North American production of gas, natural gas liquids, and electricity.

The venture boosts NGC into the top slot as a gas marketer, with volumes of more than 10 bcfd, and should enhance its position as a power marketer.

PanEnergy Corp. and Mobil Corp. affiliates also joined forces in launching new marketing units in Canada and the U.S., with combined marketed gas volumes of about 7 bcfd and more than 458,000 kw-hr of electricity (OGJ, Aug. 12, Newsletter). The new company is looking ahead to developing retail gas markets and plans to use Mobil's logo for brand name identity.

Meanwhile, some U.S. and Canadian gas marketers are forming partnerships to expand their reach. Houston-based Coastal Corp. and Westcoast Energy Inc., Vancouver, B.C., are reported to be close to merging their natural gas divisions. The merger would create the fourth-largest gas marketing operation in North America, with control of about 6.7 bcfd. In addition to marketing gas, Coastal is active in the power market, with first half sales volumes of about 8.4 million kw-hr.

Also joining forces are Coral Energy LP, Houston, and Shell Canada Ltd. Under a new agreement, Coral will market Shell Canada's gas. The combination will boost Coral's marketed gas production to nearly 6 bcfd. "We are refocusing our natural gas marketing efforts so we can be more responsive to our customers' needs," said Shell Canada's Senior Vice Pres. Neil McKim. "Our customers will gain value-added services, such as financial options and expanded North American supply."

Some electric utilities have been out shopping recently for a stronger presence in the gas market, as well. Houston Power & Lighting Co. is acquiring large-volume gas marketer NorAm Energy Corp. Inc. for $2.4 billion in stock, and Texas Utilities is purchasing Enserch Corp., Dallas.

Looking to the future, analysts expect both asset acquisitions and partnerships to continue. Companies looking to play in the power market not only will buy generation but lease it, predicts CERA's Simon.

"Owning some physical (power) production assets makes a lot of sense," said William Grealis, president of the energy services unit of Cinergy Corp., parent company of Cincinnati Gas & Electric Co.

"You have to understand generation and moving power to the market. It's going to get more difficult to get into the electric business without owning some transmission assets. There will also be more utilities merging with the marketing arms of gas companies."

But Grealis cautioned, "I'm not sure everyone believes you can do both wholesale and retail...I'm not sure people fully understand what the cost considerations are nationally. On the retail side, it means aggregating millions of accounts."

Another open question, Grealis offered: "Is the ultimate aggregator someone who can do it on the Internet? Can you control access to the customer by having direct access to the house? People say the technology is there. Nobody's combined it all."