It looks like the smartest guys in the room were not at Enron but at Sempra Energy. The San Diego–based energy services holding company does what the cowboys from Houston could not do: generate an honest profit. In fact, says CFO Mark Snell, who joined Sempra in 2001, net income from the company's energy-trading unit has done nothing but climb since he's arrived. The company's transformation from sleepy utility to commodity-trading company couldn't have come at a better time. The increased volatility in the energy markets "bodes well for our business," says Snell. In fact, the CFO says the trading mentality permeates all units of the once-staid utility company. For example, Sempra's trading operation was able to identify areas of the country where the demand for natural gas and electricity is growing. To take advantage of the forecast demand, the company plans to spend about $2 billion building new assets — including a 1,663-mile natural-gas pipeline running from the Rocky Mountains to Ohio — to cash in on the country's thirst for energy. These days, says Snell, "most everything we do has a commodity component to it."
Sempra is not a classic utility. Where does the bulk of its net income come from?
Five years ago, two California utilities, SoCal Gas and San Diego Gas and Electric, accounted for nearly 100 percent of our net income. [Today] they're less than 50 percent, even though they're still contributing more than $400 million a year. The rest comes from our trading business, our generation business, ice and storage business, and [eventually] the liquid-natural-gas business. The nonutility driver is clearly our commodities business.
What commodities do you deal in?
We actually are the largest metals trader in the world. We bought our metals business out of Enron's bankruptcy. We also trade oil and some other commodities, but our primary [trading] focusÂ is gas and electricity. [That unit is] much bigger and much more profitable, too. The first year I got here, they made about $100 million. In 2006, the figure topped $500 million.
What accounts for the dramatic uptick?
For one, the market got a lot bigger. All of the energy traders in the United States — Goldman Sachs, Morgan Stanley, Entergy, Koch (which is now part of Merrill Lynch) have grown significantly over the past five or six years. [More important,] we stuck with the business. During the energy crisis in 2002, most utilities that were in this business got out. Some lost a lot of money. Our approach was quite a bit different. The number-one thing — and it is a testament to the management team that predated me — was their recognition that they weren't experts at energy trading. A lot of utilities tried to convert their procurement groups [into] energy-trading groups, with fairly disastrous results. We bought AIG's energy-trading group, which was formerly Drexel's energy-trading group. So a lot of our energy traders have been together since about 1982.
What's the secret of their success?
We didn't change their culture. We kept them on the East Coast headquartered in Stamford, Connecticut, and we've kept them relatively autonomous. We have very strict oversight controls, but we have kept a Wall Street style of trading. If you work for Sempra Commodities and you're a good trader, you get paid as well as or better than if you worked at Goldman Sachs or Morgan Stanley.
Enron tried to do this but had to cheat. What's different here?
There's a marked difference between the Enron style and the Wall Street style [of trading]. And that difference manifests itself in two ways. One, we don't really want to trade in illiquid markets. What we find beneficial is to trade in markets where, if you can pick up the newspaper and know what a commodity is worth, that's a good market. If you've got to make 15 calls and only six people have any idea what you're talking about, that's a bad market. Enron specialized in the latter. [Second, Enron was] big enough to actually make a market in commodities that didn't have ready market value. They were typically doing much longer dated deals. They would sell you gas for delivery 10 years from now, and nobody knows what gas 10 years from now is going to be worth.
How does your trading philosophy differ?
We like to say we're market takers, not market makers. We try to deal in markets that are highly liquid and that we can get in and out of. We are also very customer-oriented. The majority of our business is based on selling commodity products to end users, whether it's electricity to manufacturing facilitiesÂ or metal to fabricators. We're the second- or third-largest gas trader in the United States, but we're the only one in the top five that doesn't have any production. We just have customers, and we go out and procure supplies for those customers.
How does your capital structure mesh the utility business with your trading operation?
The utilities have a regulated capital structure set by the public-utilities commission — 50 percent debt, 50 percent equity. We also have a regulated rate of return on our equity — now about 10 percent. The other [units] have varying capital structures. But generally speaking, we want to keep an above-average investment-grade rating, BBB+. To do that, given the size of our trading business, we have a capital structure that's a little bit more equity-oriented than 50/50.
Do you maintain the BBB+ because of borrowing costs?
Yes, and also because it reduces the margin requirements in our trading business. The better our credit, the lower the margin we have to post for trading.
You also said trading figures into your asset-management decisions. In what way?
One of the ways the trading unit makes money is by looking for inefficiencies in the market. For instance, say gas in a particular part of the country is [selling] for $5 per 1,000 cubic feet (Mcf), but the forward curve indicates that three months from now sellers will be able to get $7 Mcf. That $2 difference is actually what [natural gas] storage is worth. If we see something like that exist for a long period of time, we may work on an asset fix — either build storage [facilities] or a pipeline between two areas. Based on those types of trading differentials, we make asset [investment decisions].