Enron: The power that was

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Contra Costa Times

WALNUT CREEK, Calif. _ The dramatic fall of Enron Corp., the Houston trading firm that pioneered and profited from increased competition in the electricity and natural gas industries, puts an additional note of discord into California’s troubled experiment in deregulation.

More than anyone, Enron Chief Executive Kenneth Lay is the visionary who believed that markets could displace regulation in the electricity industry. And more than anyplace, California is the laboratory where Lay and others sought to make that vision a reality.

Severin Borenstein, director of the UC Energy Institute, described Enron executives as “very sophisticated players from very early on” in the restructuring debate. “They had a deep understanding of how markets work,” he said.

A casual observer could easily dismiss Enron as a bit player in the energy melodrama that racked this state. The company doesn’t own any major California power plants. It is an important but secondary supplier of natural gas. It abandoned an effort to sell retail electricity to residential customers.

But behind the scenes, Enron took on entrenched utilities to push for opening up the tightly regulated power business. As California took the plunge into restructuring, Enron put up billions of dollars to fund the trading operation that transformed a central tenet of restructuring _ a wholesale power market _ from a theoretical exercise to a practical reality.

After working smoothly at first in California, that wholesale market went haywire last year. The state’s wholesale energy tab nearly quadrupled, from $7.4 billion in 1999 to $27.1 billion in 2000 and $24.2 billion during the first nine months of 2001. Rolling blackouts shook both the business community and the public as a whole, and regulators imposed a 43 percent hike in retail rates.

Then, last summer, the pendulum swung. Power flowed steadily, and wholesale spending on energy fell below $1 billion in September, after topping $6 billion last December.

Enron, which posted solid profits and huge stock gains during the wholesale price runup, saw its fortunes sag as well. That had almost “a Biblical quality,” said Harvey Rosenfield, founder of the Foundation for Taxpayer and Consumer Rights, an advocacy organization. “They reaped the rewards and now they’re paying the price,” he said.

But while Enron‘s fall coincided with the decline in California’s wholesale energy prices, other problems brought it down. Multibillion-dollar investments soured, top executives quit or were fired and the Securities and Exchange Commission launched an investigation into conflicts of interest and murky disclosures associated with some of Enron‘s complex financing arrangements. “The combination of these events has resulted in a complete loss of investor confidence,” Lay said in a conference call Wednesday.

That disaffection was reflected in Enron‘s stock price. At its Friday closing price of $9, shares had lost 90 percent of the value they had at their peak of $90 on Aug. 23, 2000. By comparison, other power sellers with big stakes in California suffered milder declines, including Dynegy, down 11 percent, El Paso Corp., down 20 percent and Calpine, down 44 percent. Shares in one California player, Duke Energy, which owns two large plants in Northern California, actually rose 4 percent during that period.

With its stock price deflated like a dot-com, on Nov. 9 Enron agreed to be acquired by Dynegy, its much smaller Houston rival, in a deal valued at $23 billion including the assumption of debt. Lay, who is not slated to be included in the post-merger executive team at Dynegy, saw his standing as a “visionary” severely shaken. “I could not have ever contemplated the events we as a company and you as a stakeholder have faced over the last few weeks,” Lay said meekly during the conference call.

Lay’s departure is especially troublesome for advocates of electricity restructuring, according to Carol Freedenthal, a Houston energy consultant. “Lay was the leader in what was going on in the development of the energy business,” Freedenthal said. “When the leader falls off his horse and falls on his (backside), you’ve got to say, ‘What’s going on?’ ”

Amidst the technical, economic and political complexity of the energy business, that can be a tough question. Eventually, other advocates of deregulation may prove as effective as Enron and its chief executive. The wholesale energy trade seems likely to keep on expanding, with competitors anxious to grab Enron‘s mantle as the leading broker.

In the meantime, one clear winner has emerged: ChevronTexaco, the giant oil company that is moving its headquarters to San Ramon, Calif. ChevronTexaco already controls 26 percent of the stock and three board seats at Dynegy, which markets ChevronTexaco’s domestic natural gas output. ChevronTexaco, which forked over $2.5 billion to shore up Enron‘s finances, will end up holding the same stake in the leading franchise in the energy trading business.

In normal times, the structure of the electricity industry is a topic to engage only the most unabashed policy wonk. But when blackouts and skyrocketing prices swept California, attention focused on the once-sleepy power business, and politicians cast as villains Enron and other “out-of-state generators.” While Enron and the others denied that they had engineered the crisis, their arguments were often overshadowed by reports of spectacular profit and sales growth.

As its trading business surged, Enron‘s revenue soared to $100.8 billion in 2000, more than seven times the 1996 total of $13.3 billion. Profits also went up, although not at the same frantic pace. In its filings at the time, Enron said net income went from $568 million in 1996 to $979 million in 2000.

But under scrutiny from investors and regulators, the company cut that result in a confessional restatement issued the day before the Dynegy deal was announced. Net income was cut to $847 million in 2000, and restated down for every year back to 1997.

Other revelations fueled investor skepticism. Lay said the company had piled up too much debt. Chief Operating Officer Greg Whalley said that Enron invested $8 billion in non-core businesses, including a disastrous broadband venture where the return was “dismal.”

Such acknowledgements were striking from leaders of a company never known for its humility. In its heyday, Enron was a master at converting corporate success into political clout. Lay and other Enron employees contributed more than $570,000 to the various campaigns of George W. Bush, making the company the new president’s largest career patron, according to the Center for Public Integrity in Washington. Lay met privately with Vice President Dick Cheney to discuss the energy policy he was drafting on behalf of the administration.

In California and elsewhere, Enron was an early, consistent and powerful advocate for deregulation of an industry dominated by utility companies with exclusive territorial franchises to sell electricity. Regulators set rules that limited utility profits but also helped control risks. Wholesale power markets barely existed, with most trades by utilities exchanging surplus megawatts.

In early 1993, when the state Public Utilities Commission opened the California restructuring debate by publishing a 200-page document dubbed the “Yellow Book,” Enron was one of nine companies that filed a written response within six weeks. It had the clout to take on the state’s skeptical utilities.

“When Enron came knocking at your door, they brought a lot to the door with them,” said William Meyer, a PUC staff member who co-authored the Yellow Book.

As an advocate of wholesale energy competition, Enron backed its words with actions. With more than 1,000 traders ready to buy and sell contracts for future delivery of natural gas and electricity and risk-management securities known as derivatives, Enron helped large electricity suppliers and distributors manage profits and risks. That gave an important boost to the wholesale electricity market, where physical constraints fragment markets, said Ehud Ronn, director of the Energy Finance Center at the University of Texas in Austin. “They provide a market price for all these very many locations.”

Enron lobbied vigorously against attempts to establish a formal energy market structure that would have limited its role as a broker. Enron executives described the company as a neutral broker, raking in a tiny cut of each trade and dependent on a growing volume of transactions to increase revenue and profits. But rivals saw the company, which handles as much as 25 percent of the country’s wholesale energy transactions, positioned to make informed bets on market trends.

Enron‘s sag shouldn’t stifle power markets. While Enron‘s trading volumes dropped, competing brokers ramped up their businesses and took business from Enron. At the InterContinental Exchange, an Atlanta trading platform that power plant operators and investment banks launched last year, electricity and natural gas trading volumes jumped in early November. “Everybody’s kind of licking their chops at the opportunity to take market share,” said a former Enron manager, who spoke on condition that his name not be used.

In the political arena, Enron‘s near-collapse, combined with the California energy debacle, have put the caution flags up in the nationwide race to remake the electricity industry. Lay and the Enron crowd will no longer be there to set the pace.

But restructuring is far from dead. Economists continue to stress the merits of markets. Natural gas producers, energy traders and power plant operators push for new business opportunities. The Bush administration and federal regulators are still signed on. When Dynegy takes over Enron, it will attempt to meld together the two companies’ advocacy efforts, said John Sousa, a Dynegy spokesman.

To be effective, those efforts may need to bury the legacy of Lay and his company. “Enron (became) the real masters of the universe in energy trading,” said Borenstein, the UC energy economist. “They read a little too much of their own press.”

Consumer Watchdog
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