Enron’s woes weigh on weather market

While its executives desperately try to save something from Enron’s collapse, weather dealers are already anticipating a market without one of its giants. Emily Saunderson and Mark Nicholls report

Six months ago, trading giant Enron seemed invincible. But its collapse in November has sent shockwaves through markets as diverse as crude oil, credit derivatives and bandwidth capacity. In weather derivatives and US emissions permits markets – in both of which it was a pioneer and leading player – Enron’s trading partners are anxiously awaiting the outcome of its management’s desperate attempts to restructure the firm.

There is little doubt that the potentially terminal crisis at Enron will cause short-term market disruption – not least as its counterparties write off credit exposures to the firm. But most market participants are confident that the medium-term ramifications for the weather market will be less severe. They are hopeful that other trading houses and banks will step into any breach left by Enron, and that its weather specialists will go on to staff new and existing weather desks.

As of 5 December, the future of the firm was clouded in uncertainty. Even as it sought financing to restructure its operations, it had not yet been decided if its weather trading operations would be classified as a core business, and therefore part of any potential restructuring, a company spokesman said.

On the same day, Mark Tawney, head of weather risk management in Houston, said that 36 of the 48-strong weather group had been laid off, leaving skeleton teams in Houston and London. The Nordic weather desk – which doesn’t fall under Tawney’s ambit – remains fully staffed, but Bjarne Schieldrop, its head, declined to speculate on his team’s future.

However, Tawney added that, while the weather desk has stopped posting prices on EnronOnline, the firm’s internet-based trading platform, it was working to preserve the value of its portfolio – and its franchise. “We’re looking at what we can do to trade around our portfolio, and we’re keeping in touch with the market,” he said.

The immediate concerns for counterparties are their credit exposures to the stricken giant. Dealers say it is too early to quantify their weather positions. But most counterparties say they are assessing their total exposures to Enron, and netting off positions where they owe money to the company against those that would see Enron paying them.

Some credit problems may have been averted. Traders in Europe and the US say a number of firms had been trying to reduce their weather exposure to Enron since October when the firm’s debt and balance sheet problems started to emerge and the credit rating downgrades began.

“Many weather traders are in limbo at the moment because they do not know whether their deals with Enron will stand, or how far down the list of creditors they are in the administration process. You cannot trade on a book unless you know what your positions are,” says Olivia Goldsmith,weather broker at GFI in London. If everyone is told their trades with Enron will be broken, there will be a flurry of activity in the weather market as firms try to re-establish their winter portfolios, she adds.

In early December, US weather brokers said clients were beginning to make enquiries about repositioning portfolios on the assumption that outstanding contracts with Enron would not be honoured. Indeed, on 4 December, one dealer reported seeing 19 trades – far more than normal – go through the market, although he added that some of this business may be a result of a considerably warmer November than forecasts predicted.

This warm weather may, however, cause a more serious credit issue: those end-users that turned to Enron for protection against a warm winter will have seen their protection evaporate, losing both their premium and the likelihood of a substantial payout, exactly at the time they need it. Such an experience could easily discourage first time end-users from returning to the market.

For all the uncertainty, however, weather derivatives traders are looking on the bright side. They point out that most of Enron’s weather trading teams in the US and Europe will probably end up trading weather for other firms, and that demand for weather hedging will not go away just because Enron cuts its operations.

And they add that – in the US at least – Enron is no longer indispensible to the weather market, as other trading houses have joined the market, or expanded their activities. “Enron was great at creating markets, and together with Koch [Energy Trading] and [reinsurance giant] Swiss Re it really founded weather derivatives trading. But the start of the market, in the US at least, is ancient history. Once a market has momentum, you don’t have to rely on the seeds anymore,” says a New York-based trader.

“It would have been a different story 18 months ago,” says Lynda Clemmons, president of Element Re, the Connecticut-based weather trading arm of reinsurance firm XL Capital, “but there are a lot more players in the market now.” Around 30 companies look at weather derivatives prices in the US every day, and of those, 12 to 15 are trading actively, says one New York-based weather trader.

Also, some dealers say that the decline of the firm’s web-based trading system, EnronOnline,may even be a positive development if it encourages more trade in weather contracts listed the Chicago Mercantile Exchange, the London International Financial Futures and Options Exchange and the Intercontinental Exchange in Atlanta.

“If trade moves from EnronOnline on to genuine derivatives exchanges, that can only be a good thing for the weather derivatives industry,” says one US-based weather trader. The problem with EnronOnline was that Enron was the counterparty to every deal, so if you did not want to deal with Enron, you could not use the market, he adds.

EnronOnline did, however, offer one of the few sources of transparency in the weather derivatives market. “A lot of traders looked at EnronOnline daily just to see where the market was, even if they weren’t trading on the system,” says another US-based trader.

But the fact remains that Enron was one of the largest weather trading and market making houses in the world and its absence from the market or, if it manages to survive in some form, its reduced market presence, will certainly diminish liquidity and perhaps even increase prices for weather hedges for the coming season, if not longer.

Enron’s difficulties, however, have had little impact on the weather market for the current winter season, which runs from November to March. “It was difficult to say how Enron’s problems had affected the US market by the end of November because a large number of the trades for winter 2001 were finished by August/September time and Enron has had a low profile in the market since then,” says Mike Scharfenberger, a weather broker at Houston-based firm Boldwater.

There has been some short-term trading as firms adjust their hedges according to new forecasts, but it is not unusual for Enron to keep a low trading profile at this time of year: it tends to set up its seasonal weather trades early and come back into the market once in a season to adjust its portfolio.

But the picture may not be so rosy in Europe. Many market players had attributed the increase in volumes over the last six months largely to Enron and its competitor, Entergy-Koch, “kicking trades between themselves.”

“Enron was active in the European weather markets until counterparties started to have trouble with their credit quality,” comments one London-based trader. “The banks pulled out first, in early October,” he adds. Enron’s absence has certainly reduced the depth of the European market, he adds.

Although the weather market has lost one of its major trading houses, the collapse of Enron gives other firms the chance to hire well-qualified weather specialists, some of whom may bring clients with them. “The headhunters are beating their drums,” notes one trader. Brokers say there are at least two firms looking to hire weather teams in the US and Europe en masse, although they decline to give further details.

Indeed, even Enron’s Tawney notes that the dispersal of his team will help develop the weather derivatives market.“There are several firms looking to get into the business, who had been constrained by the lack of skilled staff: there are now at least 36 people around to staff new and existing groups,” he says.

“Whatever happens here, I’m confident we’ll all fall on our feet,” he adds. “Nothing will disappear from the weather market because the essence of a business is the people in it and they will turn up elsewhere,” agrees Clemmons, herself an ex-Enron trader. “The weather market will naturally miss Enron because it was a major trading house, but it might not have as much effect as many people fear,” she adds.

Enron had invested in the development of the weather derivatives markets on many different levels, from straightforward trading, to making markets in weather contracts on EnronOnline, and advertising the benefits of weather hedging to corporates on US business television. But most traders in the US, at least, say there is nothing unique about Enron’s approach.

The company certainly did plenty to encourage more weather derivatives end-users, they say. But there are more banks involved in the market now, with access to a broader range of potential end-users than any energy trading firm, so they will be able to encourage more business than Enron ever could, says one European weather trader. Recent banking entrants to the weather markets include Goldman Sachs, Dresdner Kleinwort Wasserstein, Deutsche Bank and Italy’s IntesaBCI.

In the short term, then, it is inevitable that the weather markets – in common with most energy markets – will see considerable disruption following Enron’s collapse. But most weather dealers are optimistic that the dispersal of talent from Enron’s weather desk will help to further seed the market.