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By Peter Maloney
The financial reform bill now being debated in Congress is worrying a lot of bankers, but they are not alone. The energy sector has deep concerns and is matching that with an unprecedented outflow of unanimity and lobbying dollars.
The energy industry is a famously fractious bunch with allegiances that splinter when faced with legislative choices. But they have found common ground in the financial reform bill.
In a recent letter to the Senate leadership, 10 energy industry trade groups - ranging from the American Gas Association and the American Wind Energy Association to the Edison Electric Institute and the Electric Power - argued that "a clear commercial end-user exemption is absolutely critical" to the way they do business.
What they do is hedge their exposure to risk. For instance, an electric power generator that is long coal or natural gas enters into agreements with the likes of Morgan Stanley or Goldman Sachs, which can tailor contracts that can reduce the generator's exposure to fuel price volatility.
The concern within the energy industry is that the financial reform legislation will look at that behavior and paint one and all with the same brush. That, among other things, would force electric utilities and gas distribution companies to move their hedging arrangements to centrally cleared exchanges, which would require the posting of collateral.
Currently many energy companies that use bilateral or OTC hedging arrangements use a variety of alternatives to cash collateral, including letters of credit and liens on assets such as power plants.
Energy industry advocates say that posting the collateral that would be required if they had to move their hedging to exchanges would pose an enormous cost and tie up cash flow that would be better spent on needed capital projects, such as drilling for new sources of natural gas or building needed high-voltage power lines.
According to an industry report, OTC Derivatives Reform: Energy Sector Impacts, the switch from bilateral to exchange-based hedging would cost a competitive power supplier $1 billion to $2 billion in cash margin to counterparties. (The report didn't specify over how long a period that money would be spent.) Regulated utilities say they would incur costs of $300 million to $400 million in cash margin. And independent exploration and production companies say they would have $700 million less cash to invest in natural gas production.
The issue is important enough to the industry that it has ramped up its spending on lobbyists. In the first quarter of 2010, the energy sector spent $131.2 million, outpacing aggregate spending by the finance, insurance and real estate sectors, which spent a combined $124.9 million, according to the Center for Responsive Politics.
What is the energy industry getting for its money?
So far, they have done pretty well. Many industries, including the energy industry, have won commercial end-user exemptions. But they are still not satisfied. They are seeking changes in the language that defines "swap dealer" and "major swap participant."
In short, they don't want to be mistaken for a Goldman Sachs.
But they'd have reason to worry even if they're not mistaken for dealers. Under the most stringent current version of derivatives reform, Goldman and the four others that account for 95 percent of all OTC swaps would have to separately capitalize their derivatives business. Some might choose to exit instead. Either way, the cost of hedging would go up no matter how the end users are classified.
"That is a very real concern," says Dan Dolan of the Electric Power Supply Association, but right now his industry group is more concerned that they are not seen as doing the bidding of the financial sector. That may not be easy, given the dollars both industries are spending.
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