Trading Desk - Here Come the Utilities

Posted: 05/2001

Trading Desk

Here Come the Utilities
By Bruce Christian

The accelerating pace of energy companies’ entry into the wholesale
telecommunications market seems destined to have a major impact on bandwidth
trading and, conceivably, the way the telecom industry is ultimately structured.

Utilities of every description from the natural gas, oil and electrical power
sectors are coming to recognize that, with deregulation and commoditization of
their core products, their business models are a natural fit for the way the
bandwidth wholesale business is evolving. Add to that the synergies associated
with possession of major rights of way, and it’s easy to see why the utility
pursuit of opportunities in telecom is turning into a stampede.

According to figures provided by the United Telecom Council (www.utc.org),
a global trade association for utilities, pipelines and other critical
infrastructure companies, there were 79 investor-owned utilities offering
wholesale, local dial tone, long distance, cell, paging, Internet access, or
data or wholesale as of July 15, 2000. The number of public utilities with
telecom activities was 95.

During February’s Competitive Telecommunication Association (CompTel, www.comptel.org)
conference, the number of utility companies on the exhibit floor had more than
doubled from the February 2000 show.

And Yankee Group (www.yankeegroup.com)
energy communications analyst Elizabeth Moore, speaking in March at the UTC
Telecom Summit, said, "Telecom strategies are compelling diversification
strategies for utilities, because they help strengthen existing customer
relationships, monetize existing network assets, enter high-growth telecom
markets with significant price-earnings multiples and gain operating experience
in competitive markets."

She says the assets utilities have and the qualities that increase their
potential for success are:

The companies that have been in the space for a while are seeing success and
similarities.

"Trading bandwidth is almost exactly the same [as trading gas and
electricity]," says Kenneth Rice, CEO of Enron Broadband Services (www.enron.net).
Enron was among the first utilities to recognize the potential value of telecom.
"In essence, the commercial proposition is exactly the same, although it’s
a different commodity with different physical characteristics."

With utilities moving quickly into the telecom space and trading their
bandwidth, it’s only natural to wonder whether the primary service
"telephone company" may ultimately be a one-stop shop utility where
consumers would get all their natural gas, electricity and communication
services.

"You can certainly see that this is the direction it is going,"
says Chris Lemmer, executive director of bandwidth trading and risk management
for Williams Communications (www.williamscommunications.com).
"That seems to be the way the evolution is taking us."

He cited the recent entry into the space of El Paso Global Networks Co. (www.elpasoglobalnetworks.com),
Dynegy Inc. (www.dynegy. com), Aquila Inc. (www.aguilaenergy.com)
and Dominion (www.dom.com) as examples.

Williams probably was the first major utility company to enter the telecom
space. In 1985, under the guidance of Roy Wilkens, now with reseller McLeodUSA
Inc. (www.mcleodusa.com), Williams began
to run fiber optic cable through its decommissioned pipelines. This led to the
founding of Williams Telecommunications Co. (WilTel), which became the nation’s
fourth-largest long-distance network. WilTel was sold to LDDS
Communications/WorldCom Inc. (now WorldCom Inc., www.worldcom.com)
in 1995. And as soon as the three-year noncompete agreement with WorldCom had
expired, Williams was right back at it. It completed a 33,000-mile fiber optic
network stretching from coast to coast last December.

Williams, a facilities-based wholesaler, established its own trading platform
last March, but Lemmer is unsure whether bandwidth can be considered a commodity
at the same level of energy-related products.

"I think when we looked at trading, the whole concept of buy low, sell
high, at least in this marketplace, we don’t have a fungible product yet,"
Lemmer says.

Even so, he agrees that eventually everyone will consider bandwidth a trading
commodity. That’s why Williams, like many of the energy companies, has become
active in the Bandwidth Trading Organization (BTO), formed last year to draft a
master trading agreement.

Lemmer says Williams is not pleased with the trading agreement that was
posted last December on the CompTel website, which he says did not solve some
issues.

"We were extremely close, but as it was being completed, the group began
talking about governance of the group [BTO], and the talks began to break down.
The document was not finished. The document that was put on the website really
was Enron’s."

Lemmer says that document fails to resolve QoS standards and compensation for
nondelivery, which is why Williams continued to work on the agreement, and it
has posted its own version on CompTel’s website.

Lemmer says the main difference between the two is that the Williams’ version
uses firmer language in making buyers and sellers responsible for nondelivery,
while the Enron proposal concentrates too much on errored bits per seconds or
unavailable seconds, which he says is no longer pertinent.

But Rice believes the Enron model works just fine, adding that since it was
posted, more than 500 trades have been made using it as the base contract.

The Enron trading model, which is patterned after its trading of natural gas,
allows the company to be either the buyer or the seller in each transaction.

"This way you know you are transacting with Enron," Rice says.
"The terms and conditions of that delivery are negotiated with Enron, and
we are actually taking the risk position. We will buy that circuit or sell that
circuit, and we will price it at a price based on the ability of the buyer to
meet the credit requirements. We are the ones who are intermediating the risk
differential between the two parties, and we look at that as a value-added
service."

In getting its telecom network up, Rice says Enron teamed with some
"pretty good partners" to help it solve any technical challenges.
Among those are Lucent Technologies Inc. (www.lucent.com)
and Sycamore Networks Inc. (www.sycamorenet.com).

"Our biggest challenge in telecom, as it is in gas and electricity, is
educating potential customers and counter parties, and developing the team to do
it," Rice says.

"It takes a blend of skills," he continues. "You obviously
need people with the background and the contacts in the industry so you can get
in doors. You’ve got to have experienced people who know what they are doing in
the business. But possibly the biggest challenge has been integrating a couple
of different cultures into the same organization.

Enron began blending telecom and its utility divisions shortly after it
bought Portland General Electric Co. (www.portlandgeneral.com)
in 1996. That power company already had begun to lay fiber, so Enron, which
began 15 years earlier as a natural gas supplier, took a hard look at
telecommunications and liked the fin-ancial projections.

Perhaps Enron’s and Williams’ successes are what caused other utilities to
look at telecom. Or perhaps it was simply the natural realization that they
could squeeze dollars from their assets, such as rights of way.

Two utilities that have been looking at the telecom market for several years,
but only publicly entered the fray during the past year, are Dynegy, with its
Dynegy Global Communications, and El Paso Energy Corp. (www.elpaso.com),
with its El Paso Global Networks.

Marian Davenport, vice president of Dynegy Global Communications and Dynegy
Inc., says the move "was sort of a natural follow on to the other things we
had worked on for so long."

She says, "We looked at [the telecom market]–how fast it was
growing–and saw that revenue projections were greater than for gas and
power."

Dynegy made its move late last summer when it acquired Denver-based Extant
Inc. In late February, it added Europe-based iaxis.

"I think from a timing point of view, we acquired them at good prices,
and we feel like we are now in a very, very good position compared to our
competitors," says Davenport. "We haven’t overextended
ourselves."

Dynegy has adopted a wholesale model, which, according to Davenport, will be
operated much as its power side has been. "We hope we can build on the back
and mid-office we already have," she says.

And she is confident that, as market liquidity develops, trading bandwidth
will develop into a major revenue generator.

"Remember, it wasn’t that long ago that we weren’t trading power,"
she says. "People speculated that it would be too difficult."

She adds that it’s likely that Dynegy will run its own trading platform, but
that it also will be involved with some neutral exchanges as well.

"Commodity delivery is a skill that sets us aside," Davenport says.
"One of the things that is particularly important to us is provisioning
time. One of our goals is to be a leader in [making] broadband on demand a
reality, and we think we have the systems to put that in place."

During the CompTel conference, El Paso Global Networks was one of the most
visible companies. It had a large booth on the tradeshow floor, was a sponsor of
a major event and had signs posted everywhere. This was only six months after
the company was "not ready" to discuss its telecom plans.

Truth be told, however, El Paso has been looking at the telecom space for
nearly three years.

The company’s vice president of trading and risk management, Chris Noon, says
El Paso is "a trading company with some pretty good assets," one of
which is a large natural gas pipeline–and the easements that come along with
it.

According to Noon, El Paso Energy began to explore how it could "monetize
or get more value" in the pipeline easements.

He recalls that when Enron announced it wanted to commoditize bandwidth, El
Paso thought it was an interesting idea.

However, it only explored the concept marginally. But when the equity market
opened, El Paso’s interest increased.

"We looked at some of the other companies out there, and believed we
could do a better job with these assets we have," Noon says.

El Paso committed itself to the telecom market before the economic downturn
began last March. But that makes no difference, according to Noon.

"To me, we have entered at the most optimal time," Noon says.
"We come in and we can try to help the market commoditize in one way, and
we can evaluate the downturns in the market.

He adds that because the company owns its easements, it can spend money to
buy assets from "distressed" companies. But he really sees El Paso
becoming successful in telecom if it "can further the efforts of
commoditization."

He explains that if bandwidth becomes a liquid market, the company can manage
its risks by making better decisions.

"But even if the commoditized market doesn’t work, we still would get
into the business," Noon says. "I’m pretty bullish on its
future."

Like Davenport, Noon recalls the naysayers who never believed energy could be
a commodity.

"There were a lot of roadblocks in the early days of the power
market," Noon recalls. "People would say ‘You can’t commoditize this.
It can’t be stored.’ Well, it’s a pretty robust market today, and I think it
will be the same with bandwidth."

In fact, Noon says he’s impressed with the evolution of the bandwidth trading
market, saying it is moving much faster than the energy market did.

"That companies agreed this early in the game that [for them to] propose
and draft a standard agreement is a huge step," Noon says. "In
electricity, there isn’t a standard agreement, so this is a huge move.

"You have some sophisticated players that have entered the market.
Included are players making markets, like ourselves, on a variety of different
routes."

"But this still is an immature market," Noon says. "It has a
level of sophistication, because you have companies emerging with tremendous
risk-management skills."

Noon doesn’t see the end of the traditional telephone company, however.
That’s because he believes the utilities, such as El Paso Global, will remain in
the wholesale business.

"We don’t care to find ourselves dealing with the retail customer,"
Noon says. "The traditional companies have a lot of momentum, but they will
have to make some changes. If they continue to operate under the old business
model, their success is limited."