Issue #7
March 2002
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Energy Markets Post-Enron by David Katz The Enron bankruptcy and the fallout that ensued have had a major impact on several areas of our economy, not least on banking and the accounting profession, as well as on the share prices of other companies with "creative" debt structures. Remarkably, the area that appears to have been rocked relatively little is the energy markets.
Enron was, of course, a major player in these markets, and provided a reference price for other firms seeking to value their energy positions. Despite this, and despite the huge number of energy contracts held by Enron, the energy industry "hardly noticed" Enron's demise, according to the speakers at a workshop entitled "Energy Markets Post-Enron", at this month's Futures Industry Association's Boca Raton conference. Prices remained stable, the market experienced no real increase in volatility, and market liquidity was unaffected.
What accounts for this stability under adverse conditions? Two main factors were cited by the workshop panelists, both factors being spinoffs of the Commodity Futures Modernization Act (CFMA), passed by Congress in 2000.
One factor was that the Enron energy contracts were not subject to bankruptcy. Normally, when a company declares bankruptcy, all of its outstanding assets and liabilities are frozen subject to disposition by bankruptcy court. In the case of energy contracts, this would have meant that these contracts would have been in limbo for an extended period of time, creating turmoil in the market, and offsetting contracts (where the same company had both purchase and sale contracts with Enron, usually settled by netting them out) might have been subject to "cherry picking", whereby the contracts in which Enron was owed money would have been vigorously pursued for collection, while the contracts on which Enron owed money would have been placed in the general pool of creditors. Fortunately for market stability, however, a section of the CFMA exempts energy contracts from bankruptcy protection, allowing the Enron contracts to be netted and settled in a normal fashion, greatly reducing the impact of the Enron collapse.
Another factor was the authorization of alternative over-the-counter energy marketplaces that the CFMA encouraged and enabled. These new markets and market-makers, both electronic and "voice", played a large part in absorbing the trading volumes and credit risk put into play by Enron's collapse, while more traditional exchanges, like New York's Mercantile Exchange, provided liquidity and a haven for a flight to credit quality. Even before bankruptcy was declared, much of the Enron risk had been dispersed using these markets and other mechanisms by firms who realized that the degree of exposure represented by Enron was imprudent for them to maintain. As a result, many companies will be taking hits that are survivable, instead of a few companies receiving fatal blows.
All this is not to say that the energy industry was completely unaffected, or that no regulatory or organizational changes are needed. Legislation is being considered that would create greater market transparency by mandating improved record-keeping by market participants, and regulation of OTC (over-the-counter, or physicals market) exchanges and facilitators.
Similarly, OTC clearing and netting, long resisted by the industry because of cost, is being encouraged by the credit-rating agencies and by the heightened desire of industry players to reduce credit risk. This will result in a safer, more fluid market.
Certainly the changes put into place by the CFMA helped mitigate Enron's damage to the industry and to the country as a whole. Did the loosening of regulations that this Act brought with it also encourage Enron's excesses? The workshop panelists think not, claiming that regulatory oversight of Enron's on-line trading platform was the same before the passage of the Commodity Futures Modernization Act as after, and that most of Enron's abuses were outside the purview of that law.
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