Energy companies have largely had a “good” crisis.
As banks, manufacturing firms and more recently entire governments have faced defaults and even collapse, established players across the energy sector have shown their mettle and continued to rack up profits. Oil and gas firms benefited from entering 2008 with high oil prices that have only dipped intermittently since, while the power sector implemented crisis-management lessons learned ten years ago in the scorched-earth aftermath of Enron’s collapse.
With the exception of a recent spate of bankruptcies among start-up firms in the solar sector, and the sustained drag on power company earnings from low manufacturing demand, many energy companies have sustained few damaging blows over the last few years since the crisis began in 2007-2008.
But as the impacts of the financial crisis continue to proliferate in political and regulatory spheres as well as across the broader economy, the energy sector may begin to face many of the same challenges as firms in other sectors adjusting to the “new normal.”
Danger Of The Familiar
Internationally-hailed economists Robert Merton and Myron Scholes have spent much of the past few years evaluating the causes and effects of the financial crisis, and brought a number of their conclusions about the present state of the business world to a session on the global economic outlook at this week’s CME Global Financial Leadership Conference in Florida.
Management of all firms has “a tendency to treat that which is familiar as less risky than that which is new,” Merton said at the conference, which lies at the root of a widespread distaste for evaluating, analyzing and pricing risk. Companies prefer to focus on what they do well rather than on potential problems and beliefs built by managers on past data can be wrong, Scholes agreed.
Pick And Mix Problems
Setting the stage for continued turmoil in financial markets that hinder companies’ access to capital and limit demand growth among consumers, the two economists sketched out a series of threats to companies.
Government intervention, disbelief in existing accounting systems, misunderstood feedback loops created by inherent government guarantees as well as complexity, correlation and “connectiveness” in an increasingly globalized operating environment for all companies are hindering growth and a return to confidence, Merton said.
Hedge Against The Noise
Companies have traditionally used financial instruments to hedge their risk exposure, with the energy sector relying on trades in the futures markets like those operated by CME Group as their product of choice. While hedging in the energy and commodities markets was not as decimated by the financial crisis as trading in financial products or mortgages, the business will be equally impacted by the onset of legislation designed to limit, control or increase transparency in hedging.
Years after the initial proposals, large portions of the Dodd-Frank legislation on derivatives trading are coming into effect as regulators finish writing the rules that actually impact market activities. The industry is largely braced for the changes, many of which are broadly held to be likely to limit participation in markets along traditional lines but not result in the evaporation of the markets completely. Among other moves, more energy companies and those trading on energy price moves may increases rely on exchange-traded contracts rather than bilateral company-to-company derivative bets that could inadvertently violate the new rules.
But the death of derivatives has been greatly exaggerated, both Merton and Scholes said at the CME event. “No financial institution, including the central banks, could operate without derivatives,” Merton pointed out.
The complexity of the new rules is a major stumbling block to companies’ being able to follow them while still remaining true to the letter of the law, both economists said. Even now Scholes said he had not read the entirety of the Dodd-Frank bill, while Merton had read only the already-lengthy summary of the legislation.
Both economists had trouble finding many positive impacts from the Dodd-Frank legislation, but Merton said he supported the newly-created Office of Financial Research to be housed within the US Treasury. The central repository for financial research in the government could help boost transparency with its subpoena power, he said.