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It's been a bad year for energy companies. Energy company CFOs haven't fared all that well, either.
Marie Leone, CFO.com | US
July 3, 2002
Mary Shelley could have written the plot line. An astonishing, bold experiment suddenly goes terribly wrong, ending with an angry mob of citizens chasing a bloodied and confused monster with big clubs and torches.
The scenario is all too familiar for CFOs at energy companies. Afterall, in the wake of the chaos triggered by market deregulation in California -- along with other assorted scandals -- energy company executives have been all but demonized by politicians and media types.
Of course, in many ways, these executives have only themselves to blame for their current public image, which places somewhere between Spiro Agnew and Vlad the Impaler. The continuing horror show in Texas has not helped, that's for sure. The Enron Corp. bankruptcy—triggered by questionable off-balance-sheet deals concocted by then CFO Andrew Fastow—touched off a freefall in power industry stock prices. Indeed, stock prices for traditional utilities dropped 5.1 percent after the scandal in Houston first broke, says utility analyst Paul Fremont of Jefferies & Co. More telling, the market capitalization of pure power generators -- the independent companies that do not own transmission or distribution assets -- sunk by 73.5 percent when Enron unraveled in December.
While the slide in share prices has slowed—the Dow Jones Electric Utilities Index dipped by only 0.66 percent from June 1 to July 1 -- the energy/power company sector continues to be dogged by an endless series of accounting fiascos and scandals. Last month, for instance, shares of Michagan-based CMS Energy fell 6 percent to $12 after the company's management shuttered the "speculative" arm of its energy trading business. The closing followed management's admission that CMS Energy booked $4.4 billion in round-trip trades and inflated its revenue by as much. All told, the company's stock price dropped by more than 50 percent over the past year. In May, CMS Energy's CEO resigned.
Other power providers have not fared any better. In May, Reliant Resources' share price sunk by 20 percent after management acknowledged the company was being investigated by the SEC. Reliant has continued to battle rumors that it too conducted round-trip trades to boost transaction volume. This month, the CEO and CFO at Dynegy Inc., another big energy player located in Texas, resigned amid revelations that like Enron, it's executives used a special-purpose entity, dubbed Project Alpha, to hide debt.
What's all this volatility mean to finance chiefs in the energy sector? For those who still have their jobs, scaring up capital has become a monumentally difficult task. Compounding the problem, says Patric O'Kelley, CFO of industry trade group Edison Electric Institute (EEI), is that most electric company finance chiefs have never had to deal with a cash-crunch before. Many of these executives cut their financial teeth in an industry graced with monopolies and guaranteed returns on capital investments. Now, they face a host of competitors—market mob rule, if you will.
Kelley, who often acts as a sounding board for financial chiefs at more than 100 power companies, says that industry CFOs are working hard to bring back reasonable pricing on debt and equity deals, and rein-in financial covenants that are laden with penalty triggers.
To that end, many power company CFOs are working with the Securities Exchange Commission, the Financial Accounting Standards Board, and the Commodity Futures Trading Commission to refine and standardize disclosure and reporting requirements. The effort is especially important to companies that operate trading businesses, where, among other things, a move from accrual to mark-to-market accounting may be required.
It's a tough agenda, considering that success rides on restoring investor confidence in an industry marred by high-profile scandals, bankruptcies, and credit downgrades. Reminisces O'Kelley: "Utility stocks used to be as good as bonds." Today, he says, it's guilt-by-Enron-association.
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Bad rap or not, CFOs and investor relations teams have little choice but to overcome shareholder mistrust.
It's not always easy. Take the case of Duke Energy. Eighteen months ago, the Charolotte, N.C.-based company raised its earnings growth target, from 10 percent to 15 percent. But in a market where earnings growth regularly topped 30 percent, investors and analysts decried Duke's announcement, lambasting the company's management for being too conservative. Then, last month, the same Duke watchers again complained about the company's steadfast 15 percent prediction—this time because the guidance mark was unusually high.
While the roller-coaster stock performance of the sector can be blamed for much investor ire, it's also indicative of a change in the overall shareholder profile for the industry. "There's been a significant turnover in the investor base of power companies," says Sue Becht, senior vice president of investor relations at Duke Energy. "And that change has brought in many investors that don't understand the sector."
Moreover, educating those investors has gotten more difficult, particularly with the implementation of Regulation Fair Discolsoure and other more strident reporting requirements. As Becht notes, "a data dump of financial information won't help new investors understand the company." As a result, investor education at Duke Energy includes putting financial information—such as complicated hedge accounting rules—into perspective.
That's not the easiest task on the planet. And these days, energy company investors seem to crave as much information as possible. "They are asking for the moon," notes Becht, who says requests for full balance sheets and cash flow statements are now the norm. The difficulty there, she says, is that these financial statements aren't always ready when the company releases earnings.
That means a power company CFO has to exert more pressure on the business units to deliver lower-level financials faster—and then must aggregate and decipher the information for the investing public. Says Jason Makansi, president of power technology consulting firm Pearl Street Inc.: "Understanding an energy company's complex technology and market position may be a piece of cake compared to understanding its balance sheet."
Can energy company CFOs bring investors and analysts back into the fold? Possibly, but it will take some doing.
The financial scandals in the industry have yet to play out fully. Even without those scandals, the electric power business remains littered with snares, pitfalls, and trap doors. To mitigate some of the risks in the business, a small group of industry giants (including Duke, American Electric Power, Constellation Energy, Mirant, and Tractebel) recently formed the Chief Risk Officers Group. The mission of the group is to demystify risk management methodology post-Enron and pre-SEC probes. In practice, that means developing industry standards for risk management metrics, credit practices and disclosure.
It will prove a challenging job. The simple fact is, energy company CFOs have one of the most difficult jobs in finance. Indeed, power pundit Makansi is pretty candid about his assessment of the task that lies ahead for finance chiefs at electric power companies. "They have three strikes against them right from the start, and none of the strikes have to do with Enron."
He's right. The fact is, 90 percent of power companies' business depends on the weather -- and as Makansi notes, power industry CFOs can't count on weather derivatives or insurance products to mitigate that risk completely. Moreover, power company finance chiefs don't have a good means of managing inventory. Says Makansi. "You can't store electricity in large quantities -- yet."
And then, of course, there's the specter of deregulation. "Fifty states are deregulating in 50 different ways," says Makansi flatly. "And the one state that pushed the envelope (California) is looking more like an experiment in socialism than free markets."
Energy company CFOs can expect more ugly mobs.