Statement of Richard C. Green
Chairman of Aquila, Inc.

Before the Committee on Agriculture, Nutrition, and Forestry
United States Senate
Wednesday July 10, 2002

Thank you, Chairman Harkin and members of the Committee.

As Chairman of Aquila, I appreciate the opportunity to testify on the existing regulatory authority of the Commodity Futures Trading Commission (CFTC) over markets in over-the-counter derivatives, and to look at whether CFTC's authority should be increased in order to prevent fraud and market manipulation. Let me emphasize that I am speaking for Aquila alone today and not for anyone else in our industry.

Aquila is an integrated energy and risk management company based in Kansas City, Missouri with customers and operations across the United States, Canada, Europe, New Zealand and Australia. We own traditional investor owned-utilities in mostly non-urban areas of Missouri, Kansas, Colorado, Nebraska, Iowa, Michigan and Minnesota. We also own and operate generation, transmission, distribution, and gas storage facilities.

Until recently, we were very active in the energy trading business, both in electricity and natural gas. In fact, we were in that business from its inception, rising to be consistently the nation's number two or number three trader in natural gas or electricity. On June 17, we initiated a restructuring that included significant downsizing of our trading operations in both electricity and gas due to the tightening credit and capital requirements for energy traders.

Mr. Chairman, let me start by applauding the Committee for seeking input from the electricity and natural gas trading industry, primarily as it relates to commodities trading and the use of derivatives. I have three main points that I want to make today.

First, it is clear that the Enron collapse has had an enormous impact on shareholders and employees of energy trading companies. Irrespective of a company's track record or its soundness, a crisis of confidence exists, especially from rating agencies and capital markets.

Second, the energy trading derivatives business is complex, but it is a valuable industry for the nation. I need not tell this Committee how valuable derivatives have been for agriculture. Derivatives are no less important to the energy industry. The loss of a substantial portion of energy traders will ultimately have an adverse effect on energy prices as competition diminishes.

The third point that I want to make is that it is critical for bodies, such as this Committee, to work quickly to remove uncertainty from the markets, to make corrective remedies where warranted, and to allow the energy industry to get back to the business of building critically needed infrastructure. This is essential if we are to supply the reliable and competitively priced power necessary to the well being of American consumers and businesses.

Mr. Chairman, the entire energy sector has experienced a state of upheaval since the twin events of the California energy crisis and the Enron bankruptcy. The troubling effects of these events have expanded to affect all energy traders, even those who had nothing to do with either the California market or Enron's inappropriate practices. My company withdrew temporarily, but significantly, from the California market in the fourth quarter of 2000, because we saw signs of instability in that market. As a result, the level of risk to participate was too high. Moreover, we did not engage in the kinds of improper accounting or trading practices for which Enron has become notorious. We played by the rules. Yet we were swept up in the same wave of uncertainty and lack of confidence that has resulted in credit downgrades and investor flight. Consequently, a substantial portion of the trading industry has reduced their trading activities or withdrawn altogether.

The Commodities Future Modernization Act of 2000 was a significant step forward for financial market development in the U.S. Its primary act was to provide legal certainty for the over-the-counter or "off-exchange" derivative markets. Congress provided the legislation necessary to enable companies to actively engage in transactions with derivative products, to manage their price risk, and to provide stability in their business.

Frankly, we at Aquila do not believe that the current Commodities Futures Modernization Act led to the crisis in this industry. We are not sure that one can put the responsibility on thewording of any specific Federal law. We believe that the Act gave ample authority to address fraud and market manipulation. However, we are here to decide whether the current law should be modified, given the current situation. We believe that restoration of public confidence in this industry does require revision in the current law.

The current business climate, not just in energy, is frankly, perilous. The difficulties are both structural and psychological. Starting with the California energy crisis, then Enron, Arthur Anderson, Tyco, Xerox, Qwest, and now WorldCom, the country as a whole has become distrustful about business ethics, financial reporting, accounting practices, and the use of financial instruments such as derivatives. Companies have gone out of their way in annual reports to state that they don't use derivatives. Credit agencies, in response to the Enron collapse, are exercising heightened scrutiny of companies using business practices that were perfectly acceptable only a quarter ago. This heightened scrutiny has led investors to flee investments in companies that operate in complex industries or who use these financial products.

You have a right, and perhaps an obligation, to ask, "Does the activity of these energy traders add value to the market? Do energy derivatives matter?

The answer is "yes". Derivatives have been shown to be a critical factor in investment and growth of the economy.

By utilizing futures, options, and swaps, Aquila and companies like it, are able to take price risk from someone who doesn't want it and distribute it to someone who will accept it. The use and value of derivatives in the energy industry is no different than the more "mature" industries like agriculture and banking. And, Mr. Chairman, this Committee is quite familiar with the importance of derivatives for agriculture.

Here is an energy industry specific example: Aquila has customized a derivative product called Guaranteed Bill for the customers of a midwestern regulated utility. Guaranteed Bill is marketed to residential customers by the local regulated utility. The service offers customers a fixed monthly bill for natural gas. It is designed to put the retail customer in control by allowing the customer to "fix" energy costs.

Historically, a customer trying to control costs was limited to a level payment plan that offers no insulation from weather or commodity price fluctuations, but only averages the monthly payments with a "true-up" over the course of the agreement. With Guaranteed Bill, there is no end-of-agreement "settle-up" payment due at the termination of the agreement. Aquila provides the utility with a weather hedge and a fixed commodity price allowing the utility to provide its customers with true price certainty.

Another example of the benefits of a customized derivative is our contract with the Sacramento municipal utility which provides them power or cash to purchase power when there is insufficient rainfall for their hydroelectric generation to operate. This allows the Sacramento utility to protect its customers from rate increases to cover the cost of purchasing last minute power at high prices on the open market during periods of drought.

From an infrastructure perspective, the PJM Regional Transmission Organization, which operates in the Pennsylvania, New Jersey and Maryland areas--has received stakeholder approval of market changes that will boost the use of hedging instruments to manage the risk of congestion. PJM is arguable the most effective RTO in operation today.

By utilizing these risk-mitigating products, companies are able to precisely manage risk based on the business conditions they face and then to pass that savings on to their customers.

Chairman Greenspan in April of this year spoke to the Institute of International Finance. He stated, "The performance of these increasingly complex financial instruments, especially over the past couple of stressful years, has been noteworthy. These financial products have contributed importantly to the development of a far more flexible and efficient financial system--both domestically and internationally--than we had just twenty or thirty years ago."

While Chairman Greenspan was speaking primarily of financial derivatives related to interest rates, the same can be said for the use of these instruments in the energy markets. These instruments operate in the same way. One hedges price risk in interest rates or corn, another in natural gas. In one industry, this is rewarded. It should not be penalized in another.

That is why I believe that the current state of affairs in energy trading and the lack of understanding regarding energy derivatives is temporary. Let me say again, energy traders are simply too essential for competitive pricing, and derivatives are too valuable for risk reduction, not to be utilized again.

Primarily to restore confidence in this industry, this Committee must work quickly to put remedies and safeguards in place, where necessary.

Mr. Chairman, we at Aquila especially appreciate Senator Feinstein's willingness to listen to industry concerns throughout this process. We are certainly supportive of the principles of S. 1951 that create greater access to information for review and oversight by the appropriate governmental agencies. These principles are critical towards restoring public trust. Based on the latest version of her bill we are pleased to say that we can now support her legislation. These proposed changes in current law will:

(1) increase transparency through better and more detailed reporting of transaction data;

(2) give the appropriate regulatory agencies abundant and unambiguous authority to investigate anti-fraud and anti-manipulation tactics that have been so critical in destroying investor confidence; and

(3) require for bi-lateral dealer markets the use of Value-at-Risk models, or in very limited circumstances and where the Commission determines the risk demands it, the application of minimum capital requirements.

It is important for all corporate citizens to support these provisions. It is through more openness and accountability that we can we start the task of rebuilding America's confidence in the energy trading industry.

Nevertheless, this proposed legislation will only speak to the CFTC's authority over financial transactions in energy. It is also important that issues regarding restructuring, capitalization, generation, transmission and standard market designed are fast-tracked and addressed in a similarly aggressive and direct manner as the derivative legislation.

In testimony before another Senate Committee, Aquila has urged the Congress to reaffirm FERC's authority to:

Move forward on broad, regional transmission organizations (RTOs) to provide for more transparency.

Adopt standardized interconnection rules to allow clear and timely access to the power grid for new generation supply.

In summary, the Enron debacle has led rating agencies to lose confidence in the energy trading industry for the time being. Yet energy trading and energy derivatives remain valuable tools for our economy, just as their agricultural counterparts are essential to that sector. This Committee and others in the Congress can help restore confidence through revisions and improvements in existing law. I am very pleased to work with Congress in whatever way Aquila can be helpful to restore that confidence.

Thank you for the opportunity to appear before the Committee and to testify on these important issues. I am happy to try to answer any questions you may have.