New energy trading rules coming fast and furious

In the years since the financial crisis hit, energy prices have climbed and volatility has returned to energy markets – at least when it comes to crude oil. Natural gas has been relatively stable and prices low.

Volatility is nothing new to the industry, but the financial crisis has changed the way energy companies assess risks in energy trading, according to a panel discussion at KPMG’s  Global Energy Institute event at the InterContinental Hotel in Houston.

Companies have started to focus more on the creditworthiness not just of their counterparties in trades but of the industry sector that those parties are in, said Terry Nutt, the controller for Luminant Energy, a Dallas-based power plant operator.

“So you step back from the individual counterparty and look at what can go wrong in the whole sector, with suppliers, with the pipeline, etc.,” Nutt said.

Since the financial crisis energy clients have also started to model more low probability/high impact events and reported on this, said Julie Luecht, a principal with KPMG.

“Are they then doing anything about it? No,” Luecht said. “But information is powerful.”

The passage of the Dodd-Frank Act in July 2010 was largely aimed at the financial services and banking industry, but there are parts of it that will have major effects on energy trading. In particular is a section aimed at changes in how derivatives – financial instruments in which the value is based on the value of another item – are defined.

The law is supposed to either go into effect 360 days after it was passed – July 16, 2011 – or 60 days after the final rule related to the bill is published. The pace of new rules that are coming out of the law has most of the panelists expecting it will be much later.

Typically industry gets several months to review and comment on proposed accounting changes, said Nutt.

For example, new Financial Accounting Standards Board rules may involve a 150-page exposure draft document that industry has 60 to 90 days to review and comment on.

But the pace of rules being issues by CFTC and SEC to implement Dodd-Frank has led to the release of as many as 50 new rules that are anywhere from 25- to 350-pages long, with a 30 to 45 day review period.

“The velocity at which the new rules are coming is a big concern,” Nutt said.

Several addendums to the Commodity Futures Act that were designed to deal with swap trading,  in which parties enter into a deal to exchange two flows of cash as a way to manage risk,  go away automatically one year after the bill was passed.

“But what exactly will happen come Monday, July 18 is difficult to get an attorney to tell you,” said Jim Allison, Regional Risk Manager for ConocoPhillips.

It seems unlikely the CFTC will begin taking enforcement actions against swap trades, particularly since the new rules won’t be in place, the panelist said.

But there may be a challenge in which counterparties who find the swap deal didn’t go to their advantage may claim it’s invalid because it is no longer covered by the law.

“The closest you get to clarity is lawyers telling you ‘with your regular counterparties it’s probably safe, but with new counterparties it might not be,’ ” Allison said. “That not the ringing endorsement a risk manager likes to hear from a lawyer.”