There are some who would say that that the energy sector could stand to adopt one last Enron-like practice.

The energy merchants whose shares rose, plunged and are now rising again could employ Enron's old "survival of the fittest" strategy to shake out weak competitors, so that the strong can move on. And the Enron case could in turn leave the sector with a final lesson that actually brings less harm than good.

It's "all about corporate revitalization -- eliminating wealth-destroying practices and freeing up resources for higher-valued uses," economic consultant David Haarmeyer recently wrote in the New Power Executive. "This is certainly what the energy industry requires."

But instead, many energy merchants are hooked up to life-support systems that, some say, simply drain precious capital while delaying inevitable doom. In recent months, many struggling merchants -- including AES ( AES), Allegheny ( AYE), Aquila ( ILA), Dynegy ( DYN) and Reliant ( RRI) -- have convinced lenders to float them billions more so they can weather the bad times and rebuild for the good times they hope will return. With immediate liquidity pressures lifted, the companies' stocks have soared to post some of the most spectacular gains in the market. But underneath those strong, new stock prices, critics say, are the same weak companies that first dragged the shares down.

"The refinancing transactions push out the maturities with more medium-term debt, without addressing the underlying fundamental credit issues," Standard & Poor's recently observed.

Industry critic Karl Miller is more succinct.

"Hope is not a strategy," said Miller, a former industry executive who now leads an energy-related acquisition firm. "And there's a lot of hoping going on in this industry right now."

Making a Mess

In an empirical study of financially distressed companies published by New Power Executive, Haarmeyer cast some light on what could happen to junk-rated companies now attempting to restructure in the merchant energy sector. He emphasized that restructuring is a "messy process," involving multiple players with differing views, that sometimes can be cleaned up only in bankruptcy court.

In the past, Haarmeyer says, junk-rated companies have cut their assets by 20% -- and their capital expenditures by a whopping two-thirds -- to successfully dodge bankruptcy. Nevertheless, he said, empirical studies show that more than half of the companies still wind up restructuring in court. While bankruptcy does trigger some positive changes -- namely new management, directors and compensation policies -- it also costs more, and leaves companies far less profitable, than private restructurings. And of course, when companies enter Chapter 11, shareholders are left with nothing.

Haarmeyer stops short of predicting who will fail in the merchant energy sector. In general, he says that companies with heavily encumbered assets -- particularly in the glutted power sector -- appear to face the most risk. But he does point to Calpine ( CPN) as a possible example.

"Calpine's still out there constructing new power plants, taking on more debt and deepening the mess the sector is in," Haarmeyer said. "Should Calpine slip into distress, it would be forced by creditors to make real structural changes in its business -- and this would likely benefit both it and the broader industry."

Cape Hope

The hope Miller spoke of has clearly spilled over to the industry's shareholders, who've pushed some battered stocks to extraordinary gains this year. Take Dynegy and Williams ( WMB), for example. The two companies, scrambling to escape bankruptcy just last summer, have rocketed to become top performers in the now-sizzling merchant energy sector. Following a huge run in recent months, Dynegy now trades at roughly 25 times this year's projected earnings. Meanwhile, Williams' price-to-earnings ratio has thundered past 50.

Given those prices -- and the companies behind them -- veteran energy analyst John Olson wouldn't touch either stock right now.

"Their dividends have disappeared, and their balance sheets are still highly leveraged," said Olson, an analyst at Sanders Morris Harris. "Clearly, the market is already discounting a much brighter future for these companies."

Granted, both stocks look cheap compared to their old record highs. But the companies don't even resemble the giants that once sported those expensive price tags. Dynegy has abandoned its primary business of energy trading. Williams has also scaled back trading -- once a powerful engine for growth -- while shedding some prize assets in its core pipeline business just to stay afloat.

Some investors, admittedly happy to see trading go, mourn the huge dent in Williams' core natural gas operations. No longer does Williams rank as the second-largest pipeline company in the nation.

"That's a statistic the company used to state proudly," recalls Jake Dollarhide, an executive at Fredric E. Russell Investment Management, a Tulsa firm that currently has no stake in Williams. "They don't use it anymore."

Following two big pipeline sales -- including one to Berkshire Hathaway's MidAmerican Energy -- Williams estimates that it now ranks as, perhaps, the fifth-largest pipeline operator in the country. But it continues to stress its prominence, saying that it still delivers 12% of America's natural gas and serves core markets like New York and Seattle.

Ultimately, Olson believes that Williams -- and even Dynegy -- can survive. But he's focused on something outside fundamentals right now.
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"Probably the single biggest liquidity argument merchants have going for them is that the banks absolutely, categorically do not want another Enron," Olson said. "They don't want 48 law firms bleeding a company for $30 million a month."

Today, bankruptcy attorneys seem to be the primary tenants at the big Enron tower once filled with employees, Olson said. But even that tower looks crowded when compared to the fancier one next door.

"The new tower where former CEO Ken Lay and former CFO Jeff Skilling had the huge offices with the long, flowing staircases? That building -- the height of pretension -- is totally unoccupied," Olson said.

A Toast to Turmoil

Because they've already slid -- and from lower pedestals -- perhaps no energy merchant can crash quite like Enron did. But falling into bankruptcy still hurts. So most companies, content to ride the trading boom a few years ago, are now willing to make huge sacrifices in order to survive.

Convinced that the industry needs a fundamental overhaul, Haarmeyer actually views financial distress and the resulting restructurings as critical, positive steps towards recovery. Hence, he's somewhat upbeat about the eventual outcome of the industry's current turmoil.

"I'm a great believer in incentives," Haarmeyer said. "Financial distress puts companies under an incredible burden to change what are often value-destroying strategies and practices."

"And only when they are under the gun," he concluded, "will many companies change."