Mexico City Conference - FEBRUARY 16, 2001

----- Forwarded by Mark Taylor/HOU/ECT on 02/16/2001 02:39 PM -----

Ruth Ainslie <RAinslie@isda.org<
02/16/2001 11:46 AM

To: Mark Haedicke <Mark.E.Haedicke@enron.com<, Mark Taylor
<mark.taylor@enron.com<
cc: Pedro Martinez <PMARTINEZ@isda.org<, Stacy Carey <SCAREY@ISDA.ORG<
Subject: Mexico City Conference - FEBRUARY 16, 2001

Here's the article I mentioned. (Also in today's Press Report -
with same copyright caveat!).

This is particularly interesting in light of our conversation on the
May 7-8 Mexico City ISDA Conference we are planning. The agenda is "in
formation". Jose Manuel (Board liaison) and Diane Genova (Chair) of the
Latin American Committee are enthusiastically involved and Pedro is our
staff liaison. We have great support from the Bank of Mexico, NAFINSA,
Mexder (the exchange) and the Mexican Banking Association (all of which will
contribute speakers). We would very much welcome one or more Enron speakers
- particularly from the region. (We contemplate simultaneous
Spanish/English and English/Spanish translation to accommodate and encourage
both English and Spanish speakers). Bob, Diane, Jose Manuel will also be
speakers.

Here's a preview of the still very preliminary (and uncirculated)
Agenda:

DAY 1:

_morning
Intro
Keynote
History and Development of OTC Derivatives
Legal and Regulatory Standards in the Global Derivatives Markets
Risk Mangement in the Derivatives Markets
Overview of ISDA and current Activities

_afternoon
3 Workshops*
I. Comparative analysis: Local Master Agreements and the ISDA
Master Agreement
II. Current Approaches to Risk Management
III. Financial Innovation: Growth and New Products*

DAY 2'

Keynote: Economic Outlook
Panel: OTC Derivatives in Emerging Markets _ Latin American Focus*
Credit and Equity Derivatives
Review of New Bankruptcy Law and Regulatory Developments
OTC Derivatives and Repo Transactions in Mexico
Accounting and Tax Treatment of Derivatives and Repos in Mexico
Synergy between Exchanges and OTC Derivatives in Mexico*

I've put asterisks in several places where Enron would be a terrific
addition. Other areas may also be appropriate. Please let Diane, Pedro or
me know your thoughts. Thak you.

Best regards, Ruth

< MANAGING NATURE WITH MARKET MEANS
< Latin Finance - February 16, 2001
< By Maria O'Brien
<
< Unpredictable weather and deregulation of Latin America's electricity
< industry have serious implications for power companies in the region. They
< must simultaneously manage the risks associated with nature as well as
< those inherent in a free market.
<
< In Argentina, Brazil and Chile, where power comes mainly from
< hydroelectric dams, the industry is vulnerable to fluctuations in
< rainfall. Meanwhile, privatization and deregulation of the electricity
< market in these countries will require generators and distributors to
< manage shortfalls and excesses in power more efficiently, a function
< financial markets are already fulfilling in the US and Europe. The use of
< financial hedges to mitigate risk is a trend companies and regulators in
< Latin America want to encourage.
<
< Mitigating weather risk is not an abstract problem for the Latin markets.
< In 1998, power generation in Chile nearly ground to a halt when droughts
< caused power cuts at hydroelectric generators. One of the most affected,
< Chile's Pullinque 49 megawatt hydroelectric dam, was forced to halt
< production when river water levels dropped drastically Scudder Kemper
< Investments and Energia Global International, who were investors in the
< project, rescued
< the plant in a $52 million deal.
<
< John Northrop, of Scudder's Latin American power group, says the company
< did not consider hedging against weather risk prior to the drought in
< 1998, since financial cover was written into the generator's 30-year power
< purchase agreement with Endesa, Chile's main power company and largest
< hydroelectric investor. Under a unique agreement between Endesa and the
< generator, Endesa had to buy power from Pullinque, but the plant was not
< required to supply power to Endesa. Unlike other hydroelectric plants in
< the region, Pullinque wasn't forced to purchase expensive natural gas
< power in the spot market to keep the plant running at a loss.
<
< During the drought, Endesa was unable to buy adequate hydroelectric output
< and had to rely on older, inefficient fossil fuel power plants to
< supplement hydroelectric production. Since then, Chile has begun importing
< natural gas power through the $325 million GasAndes pipeline from Mendoza
< in Argentina.
<
< Power companies in Brazil currently rely on assured power arrangements in
< which generators cover one another for shortfalls in energy. ma
< deregulated market, they will be able to buy and sell power as needed.
<
< The rising number of natural gas-fired merchant power projects, which sell
< all their power to the spot market when demand is high, shows how
< profitable this business can be. According to Capital DATA's global
< project finance database, financing for $4.5 billion worth of merchant
< power projects in Latin America is complete to date, with $10.2 billion in
< the pipeline. Argentina already has five operating merchant power plants
< supplying power to the spot market. Brazil is preparing itself for
< deregulation in 2003 with the launch of a thermoelectric power generation
< program that will build 49 new plants by 2003.
<
< US energy companies such as AES, Enron and Duke Energy are lining up to
< snap up distribution and generation companies in government
< privatizations. In Brazil alone, auctions of Cesp, the S?o Paulo
< generator, and Eletrobras, the federally owned generator, are expected
< this year.
<
< Following the lead of US energy companies, providers of risk management
< products are looking to get involved. One innovative risk management
< financing structure-for a power plant in Cartegena, Colombia-has been
< completed in the region and insurers, re-insurers and even investment
< banks are incorporating risk management into debt products in case another
< drought stifles hydroelectric power and injects price volatility into the
< spot market.
<
< Setting a Standard
< The Termocandelaria 314 megawatt 'peaking' gas-fired merchant power plant
< in Cartegena sells thermal power to Colombia's spot market. Colombia
< derives 70% of its power from hydroelectricity as a merchant power plant
< selling all its power to the spot market, Termocandelaria is 100% exposed
< to revenue risks.
<
< The sponsor, KMR Power Corp., originally planned to raise financing in
< 1998 with a high-yield debt issue in New York's 144A bond markets. When
< the bond market shut its doors to emerging market borrowers following the
< Russian crisis, the company was forced to look for an alternative
< financing scheme. KMR Power secured an agreement with Centre Solutions, a
< risk management unit of Zurich Financial Services, to guarantee an $85
< million subordinated loan structured to absorb power price volatility
< risks.
<
< Stefan Marti, vice president at the Centre Group in New York, says the
< insurance company determined KMR's debt repayments based on a seven-year
< projected rainfall profile. Termocandelaria scheduled repayments for
< periods when there was little rainfall and therefore increased demand for
< natural gas power in the spot market. Double A- rated Centre Solutions
< guaranteed to meet payments if revenues dipped. Marti says there were
< periods when Centre would make payments and recover them later.
<
< Once KMR Power secured this insurance, Bank of America agreed to syndicate
< a $90 million, five-year senior loan. Centre also took a $35 million chunk
< of the senior debt and five local banks joined the syndicate.
<
< Centre's participation was a landmark because until 1998, insurance was
< designed to cover catastrophic events and not to manage fluctuations in
< weather patterns. That year, MG Risk Finance, a division of the insurance
< company American International Group, developed its snow, temperature and
< rain management product to protect revenues that were adversely affected
< by unfavorable weather. MG provided insurance for an excess or shortfall
< in precipitation, extreme temperatures or any other weather event as
< measured by an independent weather source.
<
< Since the inception in the US of the weather risk management industry in
< 1997, and the creation of tradable financial instruments, approximately
< 5,000 weather derivative trades worth more than
< $5 billion have been completed.
<
< Enron was the first energy company in the US to develop weather risk
< management products. With $1.5 billion invested in hydroelectric projects
< in Latin America, the Houston-based energy conglomerate is convinced the
< potential for weather derivatives exists in that market.
<
< 'The appeal of a weather derivative" says Valter Stoiani, a marketing
< executive in Enron's global risk management group, "is that unlike
< insurance-which is designed to compensate for catastrophe and requires the
< buyer to submit a claim and demonstrate an actual loss- a derivative does
< not require proof of loss. Instead, settlement is based only on the
< performance of the index against a strike level with no up-front cost."
< Stoiani says that unlike insurance, transactions can be structured in many
< different ways. In one of the more popular forms, there is no up-front
< premium but the buyer is still able to exchange its variable exposure for
< a fixed exposure. The buyer receives financial compensation in the event
< of adverse conditions, but pays out in favorable weather.
<
< "The concept of a flexible and inexpensive derivative is appealing but
< difficult to implement in Latin America at the moment," says Stoiani,
< because the market lacks fundamental elements.
< Mark Tawney director of Enron's worldwide trading operations, agrees,
< adding that "the biggest problem for hedging weather risk in Latin America
< is the difficulty in assembling enough quality data."
<
< Unlike the National Weather Center in the US, there is typically no
< central pool of historic data in electronic form in Latin American
< countries. The quality of the data differs from country to country and in
< some countries there is little information available.
<
< Marti says Centre Solutions required 20 to 30 years of weather data to
< structure Termocandelaria's subordinated loan and "unlike other countries
< in Latin America Colombia's data is quite good." Stoiani says that without
< 30 to 50 years worth of meteorological information, "there is no
< foundation for a weather index as a benchmark for structuring weather
< derivatives."
<
< Jeff Kabel, director of trading and origination for Enron Argentina, says
< the company is working hard to educate local energy companies on the
< potential of weather derivatives "as a tool to manage cash flow exposure."
< But the lack of liquidity in the power trading markets is also a problem.
< Even in Argentina, with an active wholesale market since 1998, there is
< still relatively low liquidity.
<
< In Chile, the state energy commission still regulates prices for retail
< clients. In Brazil, Mitsumori Sodeyama, president of the country's power
< exchange administrator, ASMAE, does not expect liquidity to pick up until
< the market is fully liberalized in 2006, since the wholesale electricity
< market was just introduced in late 2000.
<
< The Brazilian electricity regulatory agency, known as Aneel, is
< encouraging investment in hydroelectricity and has invited bids for 31
< hydroelectric generation plants totaling $12.2 billion. John Foster,
< senior vice president of Latin America for InterGen, an international
< power company jointly owned by Bechtel Enterprises and Shell Generating,
< doesn't think this is part of any long-term plan to exploit Brazil's
< hydroelectric potential. He says, "There has been massive under-investment
< in Brazil in the last 10 years and with demand still growing, they are
< trying to build anything they can, period."
<
< However, Aneel is offering incentives to private investors in
< hydroelectricity and awarding concessions for the independent production
< of electricity to be freely traded in the wholesale market. Small
< hydroelectric plants with up to 30 megawatts of capacity are entitled to
< discounts of over 50% in fees for using transmission and distribution
< systems and can trade electricity at no cost with consumers of loads of
< 500 kilowatts or more.
<
< Sodeyama "absolutely expects a secondary market as the energy market
< evolves to a more mature situation." He estimates that Brazil's energy
< profile will reduce hydroelectricity to 80% of total energy investment
< from 92% in the next 10 years and increase its investment in natural gas
< from to 17.5%. from 5.5%. As private investors need to manage their hydro
< and thermal assets, "this means potential for risk management products,"
< Sodeyami says.
<
< Enron's Stoiani agrees that "a couple of years down the road the market
< will pick up, "and as competition increases, he sees "growing interest
< from counterparties looking for effective ways to hedge their exposure to
< weather, as well as additional interest from speculators." With the growth
< in liquidity, Stoiani foresees opportunities for arbitrage and
< cross-commodity trading. He says "a hydroelectric plant with no natural
< gas-fired back-up plant could purchase a derivative paying out gas units
< in times of low precipitation."
<
< The Centre Group's Marti says his company is writing weather-related
< insurance risk for both hydro and thermal power in South America for local
< and foreign power companies. "It provides an interesting profile for
< smaller sponsors of power projects, who may have equity capital
< constraints," he says.
<
< Foster agrees and says that as the deregulated electricity markets mature
< and more efficient, less-expensive products emerge, investors will need
< some long-term hedge, either a portfolio of diversified assets or these
< financial products.
<
< In the long term, Enron's Tawney predicts that the growing needs of the
< energy sector in Latin America coupled with the deregulation of the power
< market will mean "the energy industry will be both the first and the
< largest" buyer of weather derivatives.
<
<
< THE ISDA PRESS REPORT IS PREPARED FOR THE LIMITED USE OF ISDA STAFF,
< ISDA'S BOARD OF DIRECTORS AND SPECIFIED CONSULTANTS TO ISDA. THIS PRESS
< REPORT IS NOT FOR DISTRIBUTION (EITHER WITHIN OR WITHOUT AN ORGANIZATION),
< AND ISDA IS NOT RESPONSIBLE FOR ANY USE TO WHICH THESE MATERIALS MAY BE
< PUT.
<
<