Merchants' trading volumes and revenue are still too inflated.
Richard Stavros is Executive Editor for Public Utilities Fortnightly.
Merchant energy trading and marketing certainly has represented a valuable earnings growth vehicle to many utilities. That much is certain. But in the post-Enron world, many continue to question the legitimacy of the practice of inflating revenues through the trading business to bolster the company's financial picture. At least that's the view of the Petroleum Finance Company (PFC), which recently conducted a study called "Distorting Reality? Inflated Sales of Energy Traders."
A major concern of the PFC is that energy merchants do not follow uniformly stringent reporting standards for what they report as revenue for traded energy-booking the total value of the transaction as revenue, not just the net income of the transaction as investment banks do.
Of course, energy companies use what is now well known as mark-to-market accounting, which has the Financial Accounting Standards Board's (FASB's) blessing and comes into play at the end of each quarter.
That's the time when companies typically have their outstanding energy-related contracts on their balance sheets, either as assets or liabilities. CFOs then estimate the fair value of the contracts, based in part on their forecasts for market conditions. These quarterly changes in non-cash values subsequently show up on income statements.
Apparently, corporate managers have wide discretion in how they can interpret this rule, which has been one of the main sources of criticism of the approach.
In fact, FASB debated this technique for the past three years but ultimately decided to leave the interpretation to the individual companies, and so they have.
Many companies wanting to appear more transparent and more forthcoming than Enron have modified (only slightly) the way they report their mark-to-market earnings.