Three years after mega-marketers exited the wholesale natural gas market under a cloud of scandal and financial troubles, how well are gas producers able to market their production? For all, counterparty credit risk is the overriding issue in a still-risk-averse market. Even the largest companies have to post letters of credit. From all, much rhetoric is spewed about getting back to basics. Companies that tout asset-driven, physically oriented gas transactions have replaced speculative marketers. Large producers say, in hindsight, it was a mistake to have abrogated gas sales to third-party energy merchants. They welcome getting back into marketing as a core competency. There are fewer middle marketers today. End-users, including utilities, are buying more gas directly from producers. Both sides say they are interested in further developing their business relationships. But producers complain that fewer market participants and lower trading volume at the major gas hubs have resulted in an expanded basis differential-the gap that exists at any time between the cash, or spot, price of gas and the price of the nearest futures contract. Producers lament the lack of wholesale trading volume, which has created liquidity concerns and obscures price transparency, but they say there is less price manipulation, or gamesmanship, than before. Liquidity is generally "adequate." Ben Schlesinger, principal of Benjamin Schlesinger and Associates, a consulting company, says the number of active gas marketers today is 75 to 100, compared with a peak in the 1990s of more than 300. Back then, the same package of gas would be sold three times on the physical markets and about six times on the financial markets. He estimates those turnover ratios have been cut by more than half. Still, Schlesinger says there are too many industrial and commercial customers and local distribution companies (LDCs) for the market to operate efficiently, in the long run, without a middleman. Producers as marketers Three years ago the top 10 gas marketers, based on reported volumes, were nonproducing, independent marketers such as Enron, Dynegy, El Paso et al. Now the list is led by big producers such as BP, Coral Energy (Shell), ConocoPhillips, ExxonMobil and Nexen. BP, which is North America's largest gas marketer and its largest gas producer, markets more than 20 billion cubic feet (Bcf) per day. Other top slots are filled by companies with utility parents such as Sempra, Cinergy and Sequent Energy Marketing (AGL Resources), Tenaska and Oneok. "When you see producers on the list that are selling more gas for others than for themselves, they're acting as marketers, filling a void created by the departure of the mega-marketers," says Scott Kirk, chairman of the gas committee for the Independent Petroleum Association of America (IPAA). He also is vice president of marketing for Burlington Resources, which produced 1.89 Bcf a day in second-quarter 2004. Survivors that already had a marketing presence have gained market share by filling the need for a middleman and by managing logistics, Kirk says. The biggest difference is that the mega-marketers embedded derivatives in their physical contracts, which had an appeal to the small producer. Now the physical and financial transactions are likely to be separated. ConocoPhillips markets about 10.4 Bcf per day in North America, with approximately 20% of that equity production. "ConocoPhillips has grown a foundation of key long-term relationships with both producers and end-users such as large industrials, power generators and local distribution companies," says Tom Mathiasmeier, senior vice president of gas marketing and trading. This business model requires expertise in marketing, trading, storage, risk management, transportation, scheduling and operations. ChevronTexaco previously marketed all of its U.S. gas output through Dynegy, in which it held a minority stake. When Dynegy exited the wholesale gas marketing business, ChevronTexaco sold its interests in Dynegy and now is marketing its own gas production-and aggressively marketing third-party production as well. Apache Corp. is another rapidly growing wholesale gas marketer. Until forming its own gas marketing team a little more than a year ago, the company marketed its U.S. production through a third party. Today, its gas-marketing team, headed by Janine McArdle, markets 1.3- to 1.4 Bcf per day of North American gas, with about 75% from its own production and the balance from production where it is the operator or has some working or royalty interests. Marketing its own gas enables Apache to better manage all physical and financial aspects from the wellhead to the customer, including direct marketing to a broader portfolio of customers, McArdle says. The era of the mega-marketer has been over for some time, but the shakeout is continuing as companies seek their niches, McArdle says. "Recently, we've seen more managers of hedge funds and banks beefing up their physical desks." Physical vs. financial The loss of mega-marketers pretty well pushed the producer into the marketing business for physical gas and brought in the financial institutions to handle the financial plays. Of course, there is a little overlap, but the major producers are mostly sticking to physical sales, says Carol Freedenthal, principal of JofreEnergy Consulting in Houston. Large producers are in a strong position without any other major marketing companies and can dictate their terms to smaller producers needing a market outlet, he says. "Smaller companies have the greatest difficulty for a number of reasons. Size of the stream for sale is a major consideration, and just the number of companies available as aggregators, or sellers, is limited. Many of the smaller producers have banded together to aggregate their production, to make selling easier and share the costs of marketing and trading," Freedenthal says. Ed Kelly, vice president of North American gas and power for Wood Mackenzie Global Consultants, says the demise of the wholesale traders has forced midsize, and even some larger, producers and utilities to be more actively involved in the midstream. Some have been reluctant, others aggressive. "It is not just a matter of necessity," Kelly says. "Positive margins, lack of liquidity, and price transparency resulting in market inefficiency, are enticing many of the producers and utilities that normally would not be disposed to enter this business. Done correctly, the cash opportunity is real and attractive." The claim many companies make that their trading activities are somehow purely "asset-based" should be met with some skepticism, Kelly advises. It's necessary to say transactions are asset-based to convince investors that participation in the trading business is limited and disciplined, but the reality of day-to-day trading is such, limits are difficult, if not impossible, to maintain. Sequent Energy Marketing is an example of how the marketing arm of a utility holding company has reached out to producers, including small producers. Sequent, the non-regulated marketing arm of AGL Resources, markets about 2 Bcf a day. AGL Resources is also the parent of Atlanta Gas Light. Patrick Strange, vice president of natural gas trading and marketing, says Sequent's strategy is simple: "We strive to provide a value-added service to the producers we buy from. Clearly we filled some of the void and space that was created by the mega-marketer departure. However, our entry into the producer services/aggregator business was to buy our natural gas requirements from the folks that actually produce the stuff. "We value small volumes as well as large because we want to be in business with companies as they grow and prosper." Independents go it alone Swift Energy, Magnum Hunter Resources and Latigo Petroleum are examples of independent producers that market their own production and some production where they are operators, or at least have interests. They don't market third-party gas. "The removal of the manipulations factor and price gamesmanship has brought some level of comfort to the producers that they are receiving the true market price," says Kevin Williams, manager of gas marketing for Magnum Hunter. The company produces about 120 million cubic feet a day sold at spot and 50 million a day sold on longer-term contracts. "This has forced producers to learn more about the benefits of having marketing in-house vs. leaving that function to an unrelated entity, thereby limiting your control of the product," Williams says. "A producer takes 100% of the risk in drilling and bringing a well to market. To then give all that away to another entity for marketing is to discount the potential return on your investment." Tulsa-based Latigo, which sells 100% of its production at the wellhead, primarily to large gathering aggregators, is concerned with the continued basis expansion, particularly in the Midcontinent, which it believes is partially the result of less market liquidity. Latigo is pleased, however, says Dan Schooley, marketing manager, with the liquidity it sees in the financial or hedging markets. The larger institutions and banks have become adroit in providing these products to producers, he adds. "While we would generally agree that the industry has returned to the basics, the volume of transactions and the attendant liquidity at many of the trading points around the country has significantly decreased," Schooley says. "This, in our opinion, has contributed to the explosion of basis at many of these points and over time is of greater concern to Latigo than the speculation and gamesmanship we experienced three years ago." Swift Energy markets its own 12- to 14 Bcf per year of domestic gas production and production from wells where it is the operator. Steve Schmitt, director of energy marketing, says Swift only handles risk-management issues with institutions in which it has an existing bank relationship, whereas in the heyday of mega-marketers it would enter risk-management transactions with gas marketers. Even back then, Burlington Resources marketed its own gas. Unlike some of its peers, the company has not gotten into marketing third-party gas. It urges partners in shared production to market their own gas, to avoid any perceptions of operational or transportation conflicts, Kirk says. Burlington always kept the physical and financial transactions separate, he adds. Price volatility Norman Young, vice president and senior trader of RJO/Coquest, an energy-oriented derivatives marketing/trading firm, says price volatility has increased. "Without the energy merchants, the market is much more vulnerable to well-financed speculators (funds) and locals. Previously, we had large, commercial trading shops selling in upward price moves and buying the dips, thus serving to maintain a healthy trading range. We now see enormous price moves based on 'headline trading' and psychological factors. "The market can be manipulated more easily by speculators now, but the commercial traders are less controlling." In March 2004, Coquest started operations in a joint venture with R.J. O'Brien, based in Chicago, one of the oldest and largest independent Futures Commission Merchants and brokerage firms in the industry. The joint venture introduces over-the-counter energy risk-management products and services to Coquest's customers, as well as RJO's commercial energy customers in North and South America. It has formed alliances with gas marketers, which affords the opportunity to participate in marketing physical gas without the significant financial and intellectual capital investment needed to efficiently run a full-service marketing company, Young says. Major producers are "perfectly situated" to step into space created by the exodus of the large energy merchants, to take on the performance obligation of delivering a secure supply, says Jim Wales, executive vice president of Crosstex Energy Services in Dallas, a midstream company that operates gathering, pipeline, treating and processing assets. ONEOK'S CHANGES Reflecting a change in strategy, Oneok Energy Marketing and Trading has changed its name to Oneok Energy Services Co. The change reflects the more cautious attitude that prevails today in the natural gas world generally. "The review of our business led us to refocus our emphasis on the physical purchase and sale of natural gas, primarily during periods of peak demand," says Chris Skoog, president of Oneok Energy Services. "We want to grow our wholesale and retail marketing businesses while de-emphasizing both gas-options trading and unhedged pipeline arbitrage. While trading activity will continue to be a part of what we do, we expect it to be a smaller portion of our operating income." COMING BACK These days, everyone wants into the commodity game as they watch oil and gas prices soar. This year a number of high-profile U.S. and European banks have announced they were entering, or reentering, the commodity trading and risk management business with an eye to oil, gas and power derivatives. These companies will use their creditworthiness and size to offer risk-management and trading services to corporate clients such as producers, end-users, hedge funds and large investors. These include ABN Amro, Dresdner Kleinwort Wasserstein, Barclays Capital, Credit Suisse First Boston (which has an alliance with TXU, the Dallas utility) and Merrill Lynch, which just acquired the energy trading operations of Entergy-Koch in Houston.

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