Posted: 2/2002

Trading Desk

Energy Merchants Cease Bandwidth Trading

By Josh Long

The collapse of Enron Corp. last fall apparently put the emerging liquid bandwidth trading market on extended hold.

At the same time the market maker shut down its broadband unit and filed Chapter 11, other U.S. energy merchants ceased trading circuits using the standard Bandwidth Trading Organization (BTO) contract for delivery at common pooling points and have settled forward contracts. Many of these merchants have returned to their core businesses: electricity and natural gas.

“What has ended is the liquidity that the energy companies were trying to provide on certain routes using a standardized BTO contract for delivery at common pooling points,” says Ron Banaszek, a director of brokerage firm TFS Telecom.

Aside from Enron, daily bandwidth traders included Aquila Inc., El Paso Corp. and Reliant Energy Inc. The merchants bought and sold point-to-point long-haul circuits, representing more liquid routes such as from New York to Los Angeles.

Others that provide wholesale services over their own networks, such as Dynegy and Williams Communications Group Inc. had a hand in the market but were not trading daily, sources say.

Dynegy’s director of trading and origination Dane Howell agrees the retreat of the merchants has resulted in a major blow to broadband trading. Dynegy was trading several times a week before Enron’s demise.

Williams, on the other hand, was a less frequent counterparty to the energy merchants’ bandwidth trades.

“Our focus at WCG was never about purely trading with the merchants of Houston,” says Sharon Crow, vice president of bandwidth trading at Williams Communications. “Rather our focus has always been customer and vendor-based given our strategy of structured products and risk-management solutions.

“WCG has not entered into transactions with energy companies for quite some time given their inability to provide the services WCG was requiring in private line capacity and switched services.”

Nonetheless, regular traders agreed last fall to settle all forward contracts, says Neal Daney, an associate broadband trader at wholesale energy marketing firm Aquila, which continues to broker telecom deals and resell metropolitan and long-haul capacity.

“We pretty much agreed to financially settle everything from January 2002 forward and … close the books on all outstanding positions we had,” Daney says.

At its peak, Reliant had only seven bandwidth traders. Reliant made physical trades on long-haul and short-haul city pairs. Many deals were scheduled for delivery in 2002 and 2003, say traders. The energy company, which entered the bandwidth trading market in February 2001, scaled back its bandwidth operations in late October, prior to the Enron fall.

Reliant spokesman Richard Wheatley says the market conditions were not suitable for a variety of reasons.

He says carriers had abundant capacity on their networks and were reluctant to offer firm contracts, which call for liquidated damages if a seller fails to meet his obligations, rather than a traditional best-efforts contract.

A lack of pooling points connecting various networks also impeded trading, he says.

Reliant is one energy company that has decided to get out of the telecom business altogether — at least for now. The Houston-based company has put up for sale Reliant Energy Communica-tions, which offers businesses local and long-distance voice and high-speed data services.

El Paso Corp. was unavailable to comment on its future broadband strategy, although the energy giant still owns a carrier hotel in Chicago and a network in Texas.

What Went Wrong?

Many observers say merchants simply got ahead of themselves. They tried to make money employing risk-management tools, such as call and put options, in a commodity market that they created in their minds.

Perhaps the energy merchants failed to properly articulate how telecom companies could squeeze the most cash out of the assets they owned, say some industry observers.

The oberservers reason: How could operators — both old and new — possibly be expected to view their networks as a commodity after they had just spent billions of dollars to install the greatest fiber and optical gear of the Internet age?

Traditional carriers consistently reminded investors that their networks were unparalleled.

But risk-management advocates say telecommunications providers missed the point. They say bandwidth trading was and still is less about creating a complex financial market and more about utilitarianism — maximizing efficiencies on a network each day through risk-management tools.

“Bandwidth trading has not been about speculative transaction makings,” says Darren Jacobs, a director of TFS Telecom. “It’s about bringing risk-management techniques and cost efficiency to an industry that lacks it presently.”

Although commodity bandwidth trading may have faded, the underlying themes behind it, such as the importance of pooling points to expedite provisioning, are very much alive, says Doug Minster, vice president of business affairs at LighTrade Inc., which owns pooling points around the country.

Minster says executives do not anticipate the end of broadband trading will hurt LighTrade because the company has been marketing itself to a broader group of carriers aside from the merchants seeking to create a liquid market.

Besides, a large number of contracts the energy merchants signed were scheduled for delivery through common pooling points in 2002 and 2003, and it is unknown how many of those

contracts would result in a delivery and, therefore, new business for LighTrade,

he says.

Others agree with Minster that the principles inherent to a bandwidth trading market remain important to telecommunications providers: centralized interconnection points, fast and efficient network access into cities and the management of risks associated with changing prices on routes.

Dynegy, for example, is using a firm contract — calling for liquidated damages if a supplier fails to meet a delivery date or reach a specific performance level — to swap capacity with other credit-worthy carriers, says Dynegy’s Howell.

And what happens when prices start swinging in a direction foreign to most carriers in 2001? Prices have been going only in one direction — down — for a long time although that could change as capacity is absorbed and companies consolidate, says Steve Simonte, vice president of bandwidth desks at Chicago-based Universal Access Inc.

In that scenario, buyers may have a good reason to lock in a price or pay for an option to do so in the future on a certain route.

If prices ebb and start to flow on routes throughout the country and spot markets mature, the byproducts of bandwidth trading — such as options, a standardized contract and a liquidated damages clause — could resurface.

“At this point the volume is quiet but what we are hoping is that as the dust settles post-Enron in the New Year we might see another initiative occur that might bring trading back,” says Jerry Samuels, senior vice president of brokerage operations at RateXchange Corp. which was brokering deals for the energy merchants.