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Energy trading was once a little-known, mythical enterprise that took place on the top-secret trading floors of large, indestructible energy companies. The general public had no idea what energy trading was really all about, and the few available glimpses into that world only left the curious bystander with images of young, highly paid business execs sitting in front of rows and rows of flat-screen monitors and plasma televisions. Stock prices were high, annual bonuses were even higher, and ignorance was bliss. But thanks to the well-publicized failures of several energy-trading companies, as well as the ensuing scandals and suits, the honeymoon is over for energy trading. Investors now seem to understand what this business is all about, and they are not so sure that they like it anymore. To many observers, energy trading looks and sounds like nothing more than high-stakes poker. And, based on some of the facts revealed in the many investigations, it appears that some of the participants certainly behaved more like gamblers than professionals. Perhaps it should come as no surprise that energy trading became so big, so fast, only to crash and burn even faster. In its current form, the industry is still relatively new. Companies have traded energy products for decades, but the new breed of trading — in which energy is like any other commodity — has been around for less than 10 years. The practice of exchanging energy with other energy companies changed almost overnight from a risk management function performed out of necessity to a potentially speculative enterprise expected to generate profits. The learning curve was steep, and there was not really time to stop and think about all the risks. Before lawyers for energy companies really could catch up with this new business, traders were entering into transactions worth millions of dollars, with terms from one hour to more than a year, in cryptic telephone conversations that would last less than a minute. Imagine the horror and the gut-wrenching feeling that the early energy trading lawyers must have experienced when first confronted with this new type of transaction. Are these oral contracts enforceable? Does the Uniform Commercial Code apply? What are all the terms and conditions of sale? This new business had risk written all over it. Fortunately, the lawyers for energy companies figured out early on that they would need to develop master trading agreements to manage the many risks associated with entering into these fast-moving commodity contracts. The master agreements established a clear framework by which two companies could agree to enter into oral transactions on an ongoing basis. In addition, the agreements often would include language addressing other issues, such as warranties, transfer of title, payment provisions, dispute resolution procedures and termination of the trades. The goal for energy-trading lawyers was simple: Manage as much risk as possible without slowing down the trading activity. Get a contract in place quickly. The trading already was happening, so any contract would be better than no contract. TAKE RESPONSIBILITY Although energy-trading lawyers seemed to be on the right track with their master agreements, the early forms were custom bilateral trading agreements. Each energy-trading company had its own form, so when it came time to sign an agreement with a new trading partner, the negotiation process was painful and time-consuming. The longer it took to establish a contract with a new trading party, the more exposure to risk a company would have. Over time, it became obvious that this practice of negotiating individual, custom agreements with every other energy trader was not practical or efficient — especially since the energy trading companies generally were trading energy with each other. Energy-trading lawyers learned quickly that it was in their mutual best interests to unite to develop industry-standard master trading agreements. With the master agreement developed by the International Swaps and Derivatives Association (www.isda.org) as a model, several industry groups formed around common interests to develop standard contracts. For example, the North American Energy Standards Board (www.naesb.org) – previously known as the Gas Industry Standards Board — developed a base contract for sale and purchase of natural gas. For the trading of electric energy, groups of industry attorneys developed several standard contracts, including the Edison Electric Institute’s (www.eei.org) master power purchase and sale agreement, the Western Systems Power Pool (www.wspp.org) agreement, and the ERCOT (www.ercot.com) wholesale electricity enabling agreement. The Emissions Marketing Association (www.emissions.org) developed a master agreement for the purchase and sale of emissions products. Collaborative efforts of lawyers representing energy companies, trade groups, consumers and government agencies — often with many different and competing interests — created these industry-standard master agreements. In some cases, the lawyers, trade groups, consumers and government agencies debated the contracts as they went through lengthy drafting, review and comment periods, followed by public sessions. Disagreements certainly existed, but in the end, each group did its best to create a consensus agreement that was acceptable to nearly all the participants. And, even after the initial development of the agreements, most of the groups remain intact to review and update the agreements as necessary to reflect changes in the market and based on what worked and what didn’t when using the agreements in day-to-day practice. As a result of these cooperative efforts, energy-trading lawyers significantly streamlined the process of entering into master agreements with new trading partners. In many cases, the parties can agree upon which form to use as a base, and they can work quickly through any minor modifications or additions to the standard agreement. Contract-language disputes now are more likely to be over commercial terms rather than purely legal matters. Often, the lawyers on either side know each other on a first-name basis from working together on the drafting of the master agreements. Lawyers completed contracts sooner, manage (but not eliminate) risk, and focus on issues that are more important, making clients happier. The industry-standard master trading agreements certainly helped energy-trading companies better manage the many risks associated with their ever-changing new industry. However, even the best contracts could not have saved the industry from its recent chaos. Lawyers and contracts only can do so much. At the end of the day, energy-traders must take responsibility for, and defend, their own actions. Buddy Broussard is an associate with the corporate and securities and energy practice groups of Winstead Sechrest & Minick in The Woodlands, Texas. If you are interested in submitting an article to law.com, please click here for our submission guidelines.

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