Unfortunately, he wasn’t much help…

Good news though - my vacuum broke last night, so at least now not everything sucks.

Allegro just announced a new enhancement to their product offering, one that moves them ahead of the competition in terms of fully integrating the major electronic exchanges (22 exchanges in total) directly into their system. As they say in their press release…

“This latest enhancement of the ExchangeConnect component provides two-way exchange connectivity (view and capture, bid and offer) to 22 derivatives exchanges, including NYMEX, CME, EUREX, ICE, and the Dubai Mercantile Exchange (…). Allegro users benefit from an automated business process incorporating direct market interaction with derivatives exchanges into a single platform. Traders can see real-time market data, submit or cancel market orders, and pull trades - without duplication of effort.”

Allegro has been working with Trading Technologies International, Inc. to bring that company’s capabilities in aggregating exchange data and ability to execute cross exchange trades from a single screen into Allegro ETRM product. Allegro has embedded that technology in their product, creating a seemless environment where traders can view and interact with the markets directly within their ETRM system, reducing the time and effort in required to view multiple screens, analyze multiple scenarios, and create duplicate entries of transactions. Bottom line, it accelerates the traders interaction with the exchanges and in this business, time is truly money.

This is going to be the next “have to have” capability for ETRM systems. Hats off to Allegro - they’ve really raised the bar in the ETRM market space. You can get more info here.

Don’t forget to get signed up for UtiliPoint’s North American Conference being held in The Woodlands this year. The event will be next week, Oct. 16 & 17. We’ve got a great line-up of speakers, including:

- Barry T. Smitherman, Chairman, Public Utility Commission of Texas
- Jeffrey E. Sterba, Chairman & CEO of PNM Resources, Inc.
- Raymond E. Gogel, Vice President-Customer and Enterprise Solutions and Chief Administrative Officer of Xcel Energy
- Donald P. McConnell, Corporate Senior Vice President and President, Battelle Energy Technology
- Peter Hartley, George & Cynthia Mitchell Professor of Economics, James A. Baker III Institute for Public Policy Rice Scholar Academic Director, Shell Center for Sustainability Rice University
- Michael Murphy, Partner, Pillsbury Gobal Sourcing, Pillsbury Winthrop Shaw Pittman LLP

The theme of this years conference is The Smart Utility and Energy Company. While its not on the offical agenda, your humble blogger is rumored to be involved in some sort of a debate over energy policy…

Click here for more info on the conference.

UBS is the latest victim of the ongoing credit crisis. The company announced earlier today that they are shutting down their softs and energy commodity trading groups, sending several hundred traders and support folks to the unemployment line. This shut down is somewhat ironic in that UBS was the company that came in to sweep up what was left of Enron, and now those last remnants are going by the wayside.

I used the term contagion in the title to this piece purposely (and couldn’t resist the allitteration). What we are seeing is truly a contagion - this market is suffering a viral infection that attacks credit. Not only are we seeing financial traders bailing out, we’ve seen solid companies brought to their knees due to credit linkages to failed financial institutions (like Constellation), and we are now experiencing the impacts in commodity pricing. Crude is being driven lower as many trading shops that have held long positions are being forced to prematurely liquidate those positions due to margin calls brought about by their declining credit worthiness. Several market analysts are now pointing to $50/bbl as being the target if this infection continues to spread. What would a hard dive to $50 do to hedge funds, merchant traders, and even producers?

The upcoming vote for the $700 billion bailout will be telling. Even if it passes, it will take time for the impacts to start to take hold. Sure, Wall Street may react positively as raw emotions and frayed nerves start to settle a bit and cash will start to come back into the markets; however, getting the system up and running will take time and time is not on the side of many of these companies. If the bill fails to pass…who knows. Could the Credit Crisis Contagion become the Andromeda Strain?

UtiliPoint IssueAlert
Patrick Reames

Energy Trading and Risk Management (ETRM) software providers have been enjoying considerable success over the last several years. With a market buoyed by higher commodity prices, high levels of volatility, new regulation and reporting requirements, and new market entrants, software vendors have been making some serious hay. These companies have been seeing new records for unit sales and revenues and have struggled to keep up with demand. However, at UtiliPoint, we’ve been projecting that the rapid market expansion, while not necessarily ending, would be slackening as there is only so much growth that’s sustainable over the long term in a market of this type. In our recently released 2008 North American ETRM Market Analysis and Sizing Report, we’ve forecast that slowing, projecting market growth this year to be substantially down from the double digit growth rates of 2006 and 2007. Our forecast has been based upon a number of dampening forces which started emerging in energy commodity markets in the first quarter and have reached a crescendo within the last week. These forces are now hammering many in the energy commodity markets and have started, and will continue, to impact sales of software products servicing those markets.

The Financial Services Crisis is Being Felt in the Physical Energy Markets

The dollar magnitude of the transactions in the energy commodity markets demand that players have ready access to credit, and by extension, a solid balance sheet. Credit is the oxygen that keeps this market alive. Consider a common sized transaction for natural gas: 10,000mmbtu/day for a month. At current market prices, that transaction is worth around $2.25 million. Small trading shops may be buying and selling up to a half of a BCF of gas per day, meaning their exposures will be north of $100million prior to the end of the month settlements. Mid-sized traders, those up to 1 BCF/day, will have exposures measured in the hundreds of millions of dollars, with the largest companies, those trading several BCF/day, having multiples of that. This is not a “cash on the barrelhead” business. These trading companies rely on ready access to quality credit reserves to provide assurance to their trading partners that they can meet their obligations despite any negative market developments. If market players start to doubt the credit worthiness of one of their trading partners, they will stop selling to that company in order to reduce their exposures, leaving that suspect company dead in the water and unable to meet their obligations to the companies they’ve sold product to.

Last week saw the crash of Constellation Energy for this very reason. Despite the fact that Constellation’s energy trading group was successful, generating up to 80% of the parent’s revenues, the markets were increasing uncomfortable with the quality of the firm’s credit due to the failure of Lehman Bros. (who held a less than 6% stake in the company) and the suspect nature of a few banks who were proving relatively modest credit lines to the company. As a result of credit downgrades associated with Lehman’s demise and the questionable credit lines, many of Constellation’s trading partners started to pull back and the company’s stock plunged 45% in a single day. Ultimately Constellation was salvaged via a fire sale to MidAmerican Energy at $26.50/share, less than half its price just 10 days ago.

When Enron collapsed over the period of a few days in Oct. 2000, most companies couldn’t react in time to shield themselves from losses - they had already sold significant volumes to Enron based on credit ratings that were ill-informed and ultimately far too optimistic. These companies, unable to recoup their losses, took significant bad debt write-offs, contributing to the demise of many them. It was only after banking and financial services firms stepped up and into the market did any semblance of confidence return. Not only did these financials enter the markets directly through acquisition of existing trading companies or expansion of their own subsidiary commodity trading groups, they also extended and backed credit lines for other players. The recovery of the energy markets, catalyzed by the entrance of the financial companies, brought the ETRM solutions market out of the doldrums and fueled significant market growth for a number of the larger vendors.

With the market taking several years to emerge from the damage caused by Enron, credit managers have, for good reason, increased their diligence, and in some cases have become hypersensitive when it comes to counter party credit exposures. However, until recently, if a counterparty had one or more solid lines of credit from one of the major banks or financial services companies, credit managers were pretty comfortable with the source and were more willing to extend credit. The source of the credit helped assure them that the transactions were adequately backstopped in case something bad happened.
However, the sub-prime lending crisis has changed all that. With 3 of the 5 largest financial services companies imploding and with major banks, like IndyMac, going under, there are few if any golden backstops these days. Credit managers are seeing the quality of their counterparties’ credit being impacted as firms such as Bear Sterns, Lehman Brothers and Merrill Lynch have either gone under or have had to be rescued by larger entities.

Even for those energy trading companies that have been able to maintain sold credit, those credit lines are being exhausted more quickly as commodity prices have taken off. Simply put - a doubling of the price of a commodity will double the credit exposure for a same sized transaction. Credit has become a limiting factor for growth for many companies as commodity prices have continued their steady rise over the last 24 months.

With credit being impacted by the ongoing financial market crisis and higher commodity prices, the oxygen is clearly being sucked out of this market and ETRM system providers are starting to feel the impact.

Budgets have Absorbed Higher Prices

Producers have always been a steady market for ETRM vendors, making up 10 to 20 percent or more of the system sales in any given year. With the run-up in commodity prices, many energy producers generated profits beyond their budgetary projections. This unexpected influx of cash enabled many to upgrade their systems earlier than they may have otherwise; improving their transaction management capabilities at a time they needed it the most.

Unfortunately, this accelerated replacement cycle in the producer space will create some hangovers for vendors. As UtiliPoint’s research shows that the normal replacement cycle for these systems averages 5 to 6 years, pulling many of these future deals forward will take some license sales opportunities out of the market for the next couple of years. For many of the energy companies that had stayed with their legacy systems through the period of rapidly escalating prices, the recent slump in commodity prices has them rethinking near-term system purchase plans. With budgets developed last year during the upswing in the market, the recent sell-offs in commodities are forcing a number of companies to re-examine and potentially delay planned expenditures for IT infrastructure.

Some Positives

Despite many troubling developments in the market, there are some positive trends that should provide opportunity for ETRM system providers.

With crude having traded close to $150/bbl recently and still hovering around $100/bbl, industrial scale consumers of crude-based products continue to adopt aggressive price hedging strategies. UtiliPoint is anticipating that these industrial-scale consumers, including transportation companies, railroads, and airlines, will continue to seek out ETRM system capabilities to better manage their energy purchases and hedging strategies.

We also expect to see continued growth in the market for systems servicing non-energy buyers, such as agricultural product producers and traders. This market has been emerging for the last 18 months and should continue to drive new sales for the vendors that have capabilities in the space.

An additional bright spot in the market is the widening acceptance of ASP or “Software as a Service” (SaaS) solutions. These solutions, delivered over the web, have been selling well in the last couple of year as they enable smaller market participants, such as municipals, to acquire ETRM capabilities at a lower price and with less implementation effort. Given their appeal to the lower tiers of the market (a segment likely to be lest affected by the credit crisis), we believe the ASP/SaaS software vendors will continue to see success and enjoy good market growth.

Some Vendors More Impacted than Others

2006 and 2007 saw solid growth for most of the solutions providers - the rising tide lifting all boats. 2008 and 2009 don’t appear to offer the same widespread opportunities - there will be winners, but there will be more losers than in past years. Vendors that have been successful in the industrial, fuels, and non-energy markets (such as Solarc, Triple Point and Allegro) should continue to see success. Additionally, companies like OATI, OilSpace and others that can service the ASP/SaaS markets will also continue to sell products. Still, there is little doubt that all vendors will feel the impact of the turmoil in the markets, although some much more than others.

Mid-American Energy just announced that they will acquire Constellation Energy for $26.50/share. Constellation, which had traded at almost $108/share in January of this year, had been seeking a life-line for several days as its credit was being downgraded. This is a company that had revenues of around $8 billion in wholesale power trading in just the first half of this year, yet because of the banking crisis, was perceived by the market to be at risk because they were so large and appeared to be dependent on multiple lines of credit from various banks that are either wobbly or are going under.

Again, keep in mind that Constellation was a strong company. Its trading business was fundamentally solid and they were making money. Yet, because they were so large and relied on various lines of credit to support their operations, just like most every large business in this country, the perception developed that they were at risk. And, when it comes to credit exposure in this market of hypersensitive nerves and sweaty palms, perception is everything. If your counter parties think you’re at risk (even if you’re not), you’re going to have a hard time maintaining your business. These trading partners will pull back and want to limit their exposure to you. You become a trading leper and you can’t stay in business. Perception of risk will always create risk - it is truely a self-fulfilling prophecy.

With the failure of Lehman Bros., their energy trading group, Eagle Energy, is facing its own meltdown. Eagle, which was bought by Lehman in 2007, is being pounded by the fallout of having their credit tied to that of Lehman. Those that are selling gas to Eagle are canceling deals and those that are buying are left looking for other sources.

For a while, Tenaska Energy was facing a similar fate, as their trading arm, Tenaska Marketing Ventures (TMV) is backed by failing insurance giant American International Group (AIG), who picked up 50% of the gas trader/marketer last year. Fortunately for Tenaska, and those that do business with the company, the Feds stepped-in to save AIG, advancing about $85 billion in loans to keep the global company from going belly-up.

Also this week, Bank of America agreed to bail out Merrill Lynch, taking over their business in a $50 billion stock transaction. In the process, BofA gets Merrill’s energy trading group, formally known as Entergy-Koch. Interestingly enough, BofA has already taken a bath in energy trading, having lost a bunch of money on wrong sided hedges in crude and jet fuel, and most recently, with the collapse of Tulsa based SemGroup LP, a company that lost $3.2 billion due to poor decision making in the energy futures markets and was heavy into BofA for commercial credit.

Don’t think for a second this is the end of the turmoil in the energy markets brought about by the movement of financial services companies into energy commodity trading. It’s not that these companies don’t know what they are doing when it comes to energy trading (in fact, some of the most profitable divisions for a few of them have been their energy trading operations). The problem is that these companies have brought an entirely new counter party credit risk profile with them. These financial companies have staked huge positions in both the physical and financial energy commodity space, the “traditional” traders that do business with them now have to contend with events that have nothing to do with energy market fundamentals when calculating risk exposures. They now have to deal with issues related to junk mortgages, bond trading, and exposures of insurance companies to storm losses. Financial services and hedge funds carry with them an entirely new load of baggage that, prior to the last couple of years, most credit managers never really had to consider.

OPEC declared yesterday that crude prices were too low and that they were going to cut production to ensure that their various despotic leaders could continue to exercise their favorite hobbies of driving Bentley’s and oppressing their citizens. Their flawed logic maintains that cutting production would drive up prices and produce more revenue - this despite the fact that prices have fallen in large part due to increasing inventories driven up by a decline in consumption as folks drive less and global economies start to slow down. Pushing crude prices up will only exacerbate their demand side problem.

Setting that aside, most analysts don’t believe it the cuts will ever materialize given the fact that the largest players we’re talking about here include countries like Venezuela and Iran. OPEC has become less a cartel and more a group of clowns sitting around playing liars poker, each trying to convince the others that they are cutting all the production they can and that everyone else needs to take a larger share of the cuts.

The Saudis are the only ones showing real business acumen. They have declared that they are not going along with what would have been an otherwise unanimous decision. In announcing that Saudi Arabia will meet the market's demand. We will see what the market requires and we will not leave a customer without oil, the Saudi’s not only look like the good guys, they are also helping to limit damage to global economies and ensuring that our heroin-like addiction continues - they’re the street corner pusher with the heart of gold. They’re showing that they are clearly the brains behind the operation.

The markets are clearly unimpressed with the Saudi-less OPEC bluster, as crude is trading lower this morning and nearing the $100/bbl mark.

For the socially backward and politically aggressive third world countries that make up the bulk of OPEC membership, declining revenues equal social unrest and a threat to their leaders’ continued existence. These guys can’t afford a decline in cash flow. While siphoning off huge amounts of cash to fill bank accounts in Geneva, these leaders are spending beyond their meaning on military equipment that their undereducated armed forces can’t even maintain, while doling out just enough money to keep their citizens complacent despite the economic disasters brought on by failed socialist economic policies. It’s clearly quite possible that Hugo Chavez may ultimately find that for him, crude oil really is the devil’s excrement.

Triple Point announced this week that they have signed Sheetz, Inc., “one of the largest gas and convenience store operators in the US with $3.8 billion dollars in annual revenue”. Sheetz bought Triple Point’s Commodity XL for Oil to manage their wholesale gasoline procurement, hedging programs and supply chain logistics. In addition to Commodity XL for Oil, they also picked up the PhysOps ‘Visual Cockpit’ to manage logistical operations, including ships, barges, trucks, railcars and pipelines.