At least two energy traders, long stuck in the shadows of high-octane growth stories like
, are at last having their own day in the sun.
, a quiet little partnership half-owned by
, scored unexpected fame during the escalating industry chaos of a month ago. The reason? Moody's, in an otherwise scathing report about the merchant energy sector, actually had something nice to say about the company.
"We were just mentioned in two sentences on page 10," said Entergy-Koch Chief Executive Kyle Vann. "But it's really given us some attention."
Before the industry meltdown, Entergy-Koch was a relatively obscure trading company plugging along in a Houston building about 10 minutes down the road from Enron. But despite their proximity, the two companies embraced business philosophies that flung them worlds apart.
The same might be said about a couple of energy merchants in Tulsa, Okla. Now under assault from multiple fronts, one-time highflier
has found its financial position -- and its stock price -- in shambles. But
, a modest energy trader by comparison, would be hard pressed to remember better times.
"During the first quarter, we ranked 23rd in volume for energy marketing and trading," said Chris Skoog, president of ONEOK Energy Marketing & Trading. "But we produced more cash income than any other marketing and trading business.
"That's cash earnings -- none of that funny money. When cash is in the register, you know you've really earned it."
The market has smiled on Entergy and ONEOK alike, keeping their stock prices near record highs and rewarding them with price-to-earnings multiples that are several times greater than the mid-single digits now rampant throughout the industry. So what, exactly, have these companies done so right in an industry gone so wrong?¿
Frugal to the Core
Long before Enron got in trouble, Entergy and Koch were negotiating a partnership that, in hindsight, would make them look visionary if not downright brilliant.
At the time, the companies just seemed unfashionably cautious. Entergy was a New Orleans-based utility that had already tried, but largely failed, to expand into the red-hot energy trading sector. Koch, a private Houston company, had a savvy trading operation but -- unlike Enron at least -- felt a pressing need to back that business with power assets that it lacked.
As the millennium drew toward a close, the two companies began independent hunts for partners and wound up on one another's doorsteps.
"It just made sense," Vann said. "It looked like the best fit."
They struck a deal. Entergy pitched in some hard power assets and $414 million. Koch offered up a pipeline and its trading expertise. The result was Entergy-Koch, a well-capitalized partnership launched in early 2001 and still highly creditworthy to this day.
"We were in a market with very big balance sheets -- or at least they were very big at one point," Vann said. "In order for us to be successful, we felt it was important to have a strong credit rating."
The ratings agencies were impressed with Entergy-Koch's stable flow of earnings from power assets, and they rewarded the company with high investment-grade ratings. But those ratings -- A from Standard and Poor's and A3 from Moody's -- remain intact today at least partly because of Entergy-Koch's restraint.
While other energy merchants borrowed heavily to grow trading operations and build power plants -- enticed by skyrocketing profits and demand -- Entergy-Koch stuck to its frugal business philosophy. Koch, in particular, knew all too well the dives that often follow peaks in unregulated markets. The company had seen the cycles, leaving a glut of drilling rigs and refineries, in the energy sector already.
So it felt little temptation to follow its larger peers to the bank in search of financing.
"We saw companies getting heavily invested in trading and power generation, which are pretty risky structures," Vann said. "And we had a somewhat buried sentiment that these projects were being added at a rate way beyond what was needed."
In less than a year, the sudden energy trading boom went bust -- as, it seems, all energy booms eventually do. The same energy merchants that waltzed through long-term financing deals last summer are now struggling to renew standard revolving credit lines. And they're selling, not buying, assets to regain financial stability and escape potentially devastating credit downgrades.
Pushed by Moody's, they're also seeking creditworthy partners in an attempt to salvage the trading operations that fueled their explosive growth. And they're making Entergy-Koch -- a joint venture forged before the rush -- look almost psychic.
Vann chalks up the company's good fortune to frugality and a little luck.
"Our strategy hasn't changed. Our strategy," he said, "has just been vindicated."
Running a Different Race
ONEOK is basking in some vindication of its own.
As other energy traders scramble to distance themselves from Enron, ONEOK is smoothly going about its business. Nobody's questioning the company's power trades in California because, quite simply, it didn't make any. Its only power asset is a peaking generator in a suburb of Oklahoma City. After spending nearly a century in the natural gas business -- and becoming a master trader of that commodity -- ONEOK saw little reason to detour from its roots in pursuit of the electricity-trading frenzy.
"If you want to run in the same race with everyone else, your chances of winning aren't very good," Skoog said.
As it turns out, the race was an obstacle course. And now ONEOK's peers are struggling to clear the hurdles. They're cleaning up their accounting, pushed by ratings agencies to return to a simpler bookkeeping style that ONEOK never abandoned. But still, their past reliance on mark-to-market accounting -- which allowed the instant booking of future profits -- could cost them dearly, Skoog said.
Some companies have already rewarded traders with generous bonuses based on long-term deals that may or may not reach full fruition, he said.
"If you've been paying in excess of $150 million to $250 million in bonuses, and you don't have any cash yet to show for those deals, what's that going to do to your books?" Skoog asked.
"I think a lot of companies are going to take a lot of one-time losses because of this."
ONEOK won't be among them, he said. The company has always favored a "team incentive plan" over bonuses for individual deals. And it engages in short-term contracts that require no mark-to-market guesswork or wizardry.
"A long-term deal for us is really a one-year transaction," Skoog said. "As opposed to numbers, we're trading what we physically understand."
Up for the Count?
One Houston analyst -- known for his criticism of Enron and the industry's aggressive accounting practices as a whole -- applauded ONEOK's differences.
"They're probably one of the most successful traders in the business," said John Olson of Sanders Morris Harris. "And they're probably the best example of a company that's succeeded without any of the artificial life support provided by mark-to-market accounting."
Olson has owned ONEOK's stock for 16 years. He's also a long-term investor in
( EP). He likes Duke's solid investment-grade rating and the steady stream of profits from its regulated pipelines and power generation assets. He likes El Paso, at least in part, because of its willingness to slash its trading operations before things went too far south.
But Olson is most enthused about El Paso's position as the largest pipeline operator and fifth-largest gas producer in the country. He feels the combination leaves El Paso perfectly poised for future growth in the industry. For now, he said, El Paso's pipeline and exploration-and-production assets already generate 80% of the company's earnings -- and, by themselves, are worth $30 a share.
"The rest, you get for free," he said.
Olson also sees some hope for a couple of downtrodden energy merchants that he doesn't own.
"I'm reasonably confident that Williams and
will survive in some downsized manner," he said.
Moreover, he said, the industry itself is a survivor. Both ONEOK and Entergy-Koch agreed.
"These aren't great times to be trading," Vann admitted. "People are cashing in their chips and getting out of the game. But new people will come in to buy those chips.
"And this market will correct."