Empowering Enron
While the major US power companies have started to carve out a
position in the deregulating European power market through
acquisition, Enron has followed a different path ? trading.
During 1999, Enron traded more than 250TWh in Europe, more than doubling its 1998 volume. And Enron is also finding new markets to trade in. In December 1999 Enron closed its first trade of broadband fibre-optic capacity in the US ? a monthly contract between New York City and Los Angeles on a Global Crossing network.
But Enron's trading activity will soon be matched by expansion in the generating market. It operates seven power stations throughout Europe and is actively looking to expand this portfolio.
Like the majority of US power companies, Enron is continually looking to maximize shareholder value whilst maintaining growth of operations. Its rating works against it. With a rating of BBB+ from Standard & Poor's and Baa1 from Moody's, it is only just above investment grade.
Paul Chivers, CFO of Enron's European operations says that credit analysis is key: ?Before we enter into any financing, we must make sure that the full implications of our credit rating are understood.?
Enron has developed a very strong ability to analyse credit when it is making trades.
In February, it launched Enroncredit.com, an online credit service. Enron says that ?Enroncredit.com helps businesses evaluate the credit quality of their customers in real time and will allow them to transact in bankruptcy swaps.?
Using Enroncredit.com is free. Its aim is to create greater liquidity in the credit trading market, helping Enron boost its position in the business-to-business e-commerce market.
Enron has a key advantage over other power companies looking to expand in Europe: ?Other power companies do not look at credit markets like we do,? says Chivers.
The advantage is that with complex structured financings involving energy risk, Enron can work out an off-balance sheet solution, whereas other companies may have to keep significant finance and energy risk on balance sheet.
Last year Enron used these principles to finance the purchase from ICI of Etol, an energy services provider based in Teeside, in the north of England.
The total value of the acquisition was $500 million, with the financing co-arranged by Greenwich NatWest and Credit Lyonnais.
?We used a combination of acquisition finance, project finance and structured finance in the deal,? Chivers explains.
?The company had some real estate assets, but the real value was in a number of long-term energy services contracts with high quality petrochemical firms.?
Enron used asset-backed techniques to monetize the portfolio of contracts, to finance the purchase.
But some of the contracts exposed lenders to fluctuations in the cash flow, a risk they were unwilling to take. To counter this, Enron wrapped the deal with a funding derivative, which mitigated this risk through a swap. ?But this did not mean that the banks were taking just Enron risk,? explains Chivers.
The funding derivative mitigated cash flow fluctuations, but not other risk associated with the deal, such as the potential insolvency of one of the obligors.
Through this unique structure both Enron and the banks took on the type of risk that they best understood.
Enron set up its European base in 1989, and it now sees itself as one of the leading pan-European power trading companies.
It is the market leader in Scandinavia, and is looking to be the same throughout continental Europe.
Given that Enron is seeking to have a trading network throughout the whole of Europe, it is unsurprising that it views the development of the euro currency as a positive funding option.
?While the euro capital market is behind the sterling market in terms of credit sophistication, we are continuing to evaluate euro capital market funding possibilities for two power projects,? says Chivers.
One is the 240MW Jertovec plant in Croatia. At one point Enron considered the feasibility of financing it with a euro-denominated project bond. Now it is using a traditional project finance deal, with the European Bank for Reconstruction and Development (EBRD) and Dresdner Kleinwort Benson acting as co-lead arrangers.
The Eu200 million deal will use an A and B loan structure, where the EBRD acts as lender of record for the entire deal, but only keeps a portion of it, selling the remainder to banks. The EBRD acts as a preferred creditor, and its involvement provides comfort to other lenders.
The second project is Arcos de la Frontera, a 1200MW greenfield development in southern Spain. An arranger is expected to be mandated in the coming months.
?We are looking into capital market options for a long-term, euro-denominated, project bond,? says Chivers. However the project cost is $650 million, and there are questions as to whether the euro market is deep or receptive enough for such a financing.
Enron could issue a smaller euro-bond, and top up the rest with dollar-denominated paper, although the financing would then have to incorporate a structured currency swap.
Another option is to launch a euro-denominated bank/bond hybrid, with one tranche in the bank floating market and one tranche in the fixed capital markets. But this might cause inter-creditor complications between two separate senior tranches.
Earlier this year, Enron used the sterling capital markets to securitize an anonymous pool of payment obligations owed to it. The deal, called Yosemite Securities, follows a similar deal launched in the US at the end of last year.
The deal demonstrated how the sterling market is becoming more used to handling complex transactions. ?We were pleased that the UK public debt market had taken a step forward in its analysis of structured credit,? says Chivers.
The deal used a credit derivative agreement with Citibank to ensure that regardless of the quality of the assets, the risk would always remain at BBB+, Enron's senior unsecured debt rating.
?There are two key elements to the transaction,? explains Chivers. ?First, investors are buying synthetic Enron risk. Second, it was a very cheap way for investors to buy that risk.? The deal priced at 248bp over the December 2006 Gilt.
For confidentiality reasons, Enron cannot reveal the specific asset classes in the pool. The contracts are those that Enron attaches some risk to and has decided to hedge.
Before this transaction, Enron has been a frequent issuer of privately placed structured deals. ?We have used these deals to manage Enron's short-term credit exposure,? Chivers says.
?Enron has been one of the few corporates to buy credit protection in the derivatives market, but we found it to be an inefficient way to hedge our corporate credit exposure.?
This is because credit protection is geared around bond default in the financial markets, but in Enron's view, bankruptcy of the obligor would be a more liquid benchmark.
Instead of buying credit protection, it is cheaper to structure a credit derivative on the contract, and sell it privately. The deal must be sold privately to ensure that the obligor, or any other party, does not know that Enron has hedged the original trade.
Enron has been using the private placement market in Europe for around four years, although the depth of the US market means that any deals rated less than BB have had to be issued in dollars.
With the success of Yosemite, Enron's dependence on private placements is reduced and more publicly placed sterling deals are expected.
Enron believes that its credit analysis skills gives it an advantage as it can structure complex off-balance sheet financings.
But one financier from a rival power company turns this on its head.
?Enron has to have a vast amount of off-balance sheet financing, because it cannot get a high rating, due to its role as a servicer,? the financier says.
Nevertheless, Enron's increased trading with power and telecom companies does not mean increased risk exposure.
On March 23 Moody's upgraded Enron Corporation to Baa1, bringing it in line with the Standard & Poor's rating.
Moody's explained that the decision ?reflects Enron's rising earnings potential primarily as a result of its strong market position in the wholesale North American energy market, and its improving financial flexibility over the medium-term due to its planned sale of Portland General Electric.?
The rating followed an exhaustive analysis of Enron's off-balance sheet activities.
And this off-balance sheet activity is certain to increase ? as Enron finds new markets to trade in and new projects to finance.
During 1999, Enron traded more than 250TWh in Europe, more than doubling its 1998 volume. And Enron is also finding new markets to trade in. In December 1999 Enron closed its first trade of broadband fibre-optic capacity in the US ? a monthly contract between New York City and Los Angeles on a Global Crossing network.
But Enron's trading activity will soon be matched by expansion in the generating market. It operates seven power stations throughout Europe and is actively looking to expand this portfolio.
Like the majority of US power companies, Enron is continually looking to maximize shareholder value whilst maintaining growth of operations. Its rating works against it. With a rating of BBB+ from Standard & Poor's and Baa1 from Moody's, it is only just above investment grade.
Paul Chivers, CFO of Enron's European operations says that credit analysis is key: ?Before we enter into any financing, we must make sure that the full implications of our credit rating are understood.?
Enron has developed a very strong ability to analyse credit when it is making trades.
In February, it launched Enroncredit.com, an online credit service. Enron says that ?Enroncredit.com helps businesses evaluate the credit quality of their customers in real time and will allow them to transact in bankruptcy swaps.?
Using Enroncredit.com is free. Its aim is to create greater liquidity in the credit trading market, helping Enron boost its position in the business-to-business e-commerce market.
Enron has a key advantage over other power companies looking to expand in Europe: ?Other power companies do not look at credit markets like we do,? says Chivers.
The advantage is that with complex structured financings involving energy risk, Enron can work out an off-balance sheet solution, whereas other companies may have to keep significant finance and energy risk on balance sheet.
Last year Enron used these principles to finance the purchase from ICI of Etol, an energy services provider based in Teeside, in the north of England.
The total value of the acquisition was $500 million, with the financing co-arranged by Greenwich NatWest and Credit Lyonnais.
?We used a combination of acquisition finance, project finance and structured finance in the deal,? Chivers explains.
?The company had some real estate assets, but the real value was in a number of long-term energy services contracts with high quality petrochemical firms.?
Enron used asset-backed techniques to monetize the portfolio of contracts, to finance the purchase.
But some of the contracts exposed lenders to fluctuations in the cash flow, a risk they were unwilling to take. To counter this, Enron wrapped the deal with a funding derivative, which mitigated this risk through a swap. ?But this did not mean that the banks were taking just Enron risk,? explains Chivers.
The funding derivative mitigated cash flow fluctuations, but not other risk associated with the deal, such as the potential insolvency of one of the obligors.
Through this unique structure both Enron and the banks took on the type of risk that they best understood.
Enron set up its European base in 1989, and it now sees itself as one of the leading pan-European power trading companies.
It is the market leader in Scandinavia, and is looking to be the same throughout continental Europe.
Given that Enron is seeking to have a trading network throughout the whole of Europe, it is unsurprising that it views the development of the euro currency as a positive funding option.
?While the euro capital market is behind the sterling market in terms of credit sophistication, we are continuing to evaluate euro capital market funding possibilities for two power projects,? says Chivers.
One is the 240MW Jertovec plant in Croatia. At one point Enron considered the feasibility of financing it with a euro-denominated project bond. Now it is using a traditional project finance deal, with the European Bank for Reconstruction and Development (EBRD) and Dresdner Kleinwort Benson acting as co-lead arrangers.
The Eu200 million deal will use an A and B loan structure, where the EBRD acts as lender of record for the entire deal, but only keeps a portion of it, selling the remainder to banks. The EBRD acts as a preferred creditor, and its involvement provides comfort to other lenders.
The second project is Arcos de la Frontera, a 1200MW greenfield development in southern Spain. An arranger is expected to be mandated in the coming months.
?We are looking into capital market options for a long-term, euro-denominated, project bond,? says Chivers. However the project cost is $650 million, and there are questions as to whether the euro market is deep or receptive enough for such a financing.
Enron could issue a smaller euro-bond, and top up the rest with dollar-denominated paper, although the financing would then have to incorporate a structured currency swap.
Another option is to launch a euro-denominated bank/bond hybrid, with one tranche in the bank floating market and one tranche in the fixed capital markets. But this might cause inter-creditor complications between two separate senior tranches.
Earlier this year, Enron used the sterling capital markets to securitize an anonymous pool of payment obligations owed to it. The deal, called Yosemite Securities, follows a similar deal launched in the US at the end of last year.
The deal demonstrated how the sterling market is becoming more used to handling complex transactions. ?We were pleased that the UK public debt market had taken a step forward in its analysis of structured credit,? says Chivers.
The deal used a credit derivative agreement with Citibank to ensure that regardless of the quality of the assets, the risk would always remain at BBB+, Enron's senior unsecured debt rating.
?There are two key elements to the transaction,? explains Chivers. ?First, investors are buying synthetic Enron risk. Second, it was a very cheap way for investors to buy that risk.? The deal priced at 248bp over the December 2006 Gilt.
For confidentiality reasons, Enron cannot reveal the specific asset classes in the pool. The contracts are those that Enron attaches some risk to and has decided to hedge.
Before this transaction, Enron has been a frequent issuer of privately placed structured deals. ?We have used these deals to manage Enron's short-term credit exposure,? Chivers says.
?Enron has been one of the few corporates to buy credit protection in the derivatives market, but we found it to be an inefficient way to hedge our corporate credit exposure.?
This is because credit protection is geared around bond default in the financial markets, but in Enron's view, bankruptcy of the obligor would be a more liquid benchmark.
Instead of buying credit protection, it is cheaper to structure a credit derivative on the contract, and sell it privately. The deal must be sold privately to ensure that the obligor, or any other party, does not know that Enron has hedged the original trade.
Enron has been using the private placement market in Europe for around four years, although the depth of the US market means that any deals rated less than BB have had to be issued in dollars.
With the success of Yosemite, Enron's dependence on private placements is reduced and more publicly placed sterling deals are expected.
Enron believes that its credit analysis skills gives it an advantage as it can structure complex off-balance sheet financings.
But one financier from a rival power company turns this on its head.
?Enron has to have a vast amount of off-balance sheet financing, because it cannot get a high rating, due to its role as a servicer,? the financier says.
Nevertheless, Enron's increased trading with power and telecom companies does not mean increased risk exposure.
On March 23 Moody's upgraded Enron Corporation to Baa1, bringing it in line with the Standard & Poor's rating.
Moody's explained that the decision ?reflects Enron's rising earnings potential primarily as a result of its strong market position in the wholesale North American energy market, and its improving financial flexibility over the medium-term due to its planned sale of Portland General Electric.?
The rating followed an exhaustive analysis of Enron's off-balance sheet activities.
And this off-balance sheet activity is certain to increase ? as Enron finds new markets to trade in and new projects to finance.
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