The Clever Young Men of Enron
by Charles H. Featherstone
by Charles H. Featherstone
The verdict is in, and former Enron executive Ken Lay is guilty and faces the possibility of life in prison.
I'm not sure what's worse: the fact that federal prosecutors went all-out to indict Lay and his associates for crimes that apparently have little or no legal definition or the fact that so many people are happy to see Lay et al. facing "justice" for what they've done. It's as if someone has to pay for the collapse of the go-go 1990s, and since Bill Clinton can't, and all the dot-com bazillionaires have disappeared into the muck from which they emerged, it might as well be Martha Stewart and Ken Lay, the last two sad faces of a strange era in which companies thought they could make a whole lot of money without actually making any money at all.
The pillory, a bucket of hot tar and a pillow of goose down for them. And then a rail, to run them out of town on. Such is "justice," I suppose.
I had a run-in with the clever young men of Enron, in the middle of 2001, as that company and my own were both dying. Everyone knew Bridge Information Systems was doomed, even in April. A few smart people had inklings something was beginning to stink at Enron, but suspicion would not be widespread in the energy industry press until late summer.
It was hard to know what was going on, since most corporations I covered during quarterly earnings — a collection of natural gas distributors, merchant power generators and publicly traded utilities — wouldn't let journalists ask any hard questions. Usually, the earnings conference calls were open only to a select group of "financial analysts," one of whom would usually start his question with "Great quarter Biff! Are we up for golf next weekend?" Rarely would anyone ask penetrating questions about the actual balance sheet or what stuff on that actual balance sheet meant.
All that mattered, especially for the merchant energy firms, was manipulating the government-mandated quarterly reporting process to boost the stock price.
I was covering California power markets during the horrid winter and spring when the Golden State was struck by rolling blackouts, Pacific Gas & Electric went belly up (okay, not really, they only filed the belly-up papers in court) because they were unable to raise their rates thanks to some extremely stupid business decisions made by PG&E and Southern California Edison when California "liberalized" its power markets, and wholesale power prices neared $500 per megawatt. We had developed a daily story that required me to visit some websites for information (power flows on the big direct current intertie between the Grand Coulee Dam and Northern California, the snow pack in Northern California, water levels in Washington reservoirs, and the California Independent System Operator's projected loads for the day) and then call up a bunch of West Coast spot power traders and ask for prices or bid/ask spreads if no power was trading. That was rare, since power was usually always trading. California needed it.
There were a number of traders I learned to rely upon as sources, traders with smaller merchant power firms or public utilities — Avista Energy, the Sacramento Municipal Utility District, Sempra, Dynegy, there were a couple of others I'm not remembering. But Enron was the player, the big trader of spot and next-day electricity on the West Coast, and the traders at Enron would rarely talk to me, and almost never until after trading was over, which by then was too late for my deadline.
If you remember the film Fast Times at Ridgemont High, I can tell you what Jeff Spicoli did when he grew up: he became a wholesale electricity trader for either Enron or Dynegy, replacing his marijuana-induced mellowness with a take-no-prisoners view of getting the top dollar for the electrons his company had for sale. Nothing wrong with that, that's how traders make a living and that's how people get hog bellies, coffee, sugar, gold, oil and platinum and a whole host of other things.
"Dude, I wish I was back in San Diego, cuz I'd be surfing right now," a Phoenix-based Dynegy trader once told me after a particularly rewarding day.
One morning, I had gotten on the phone, dialed up Avista Energy, and got a very puzzled trader on the phone. "Off-peak power at Palo Verde [the California-Arizona border, when the three units of the Palo Verde nuclear power plant feed into the California power grid] is quite a bit more expensive than daytime power," she said to me. "If you find anything out, please let me know."
In addition to being a reporter, I was also something of an information broker, not only asking traders what prices they'd seen, but sometimes giving them the other prices I'd found. Sometimes, the trader did that just to see if I knew what I was doing. But sometimes that became a favor I could trade for later. Like a price quote during a very busy morning. Or the rumor of the day.
So, after trolling around and finding other allegedly perplexed traders seeing the same thing on their trading screens (Enron's online service, I suspected), I called the aspiring wave riders of Dynegy in Phoenix. "Somebody at Enron has heard a rumor about Palo Verde," the trader responded. "Don't know what it is."
I stared long and hard at the phone. I'd never made any headway talking to Enron traders, and I didn't expect to do so that day. But I owed my editor and the readers of my power report something, even if it was "Enron traders refused to comment." (The folks at Palo Verde, operated by the Arizona Public Service Co., never talked about "market sensitive" plant operations, and calling them for information on an unspecified rumor had proven pointless.)
So I picked up the phone and dialed Enron's trading floor. What I expected was defiance and "go away." Instead, what I got was embarrassed silence. "Um, yeah, the number three unit is being taken off-line overnight, an unscheduled outage. We figured we could take advantage of the loss of base load to Southern California," the trader told me.
It was the first — and last — time anyone at Enron ever gave me any useful information.
But what stunned me so about the whole encounter was not just that the Enron trader talked to me, but that he sounded so sheepish, so guilty, so caught. As far as I know, there was nothing wrong, nothing illegal, about having that bit of advance knowledge and then using it to raise the ask price of off-peak power. Even the most anxious power buyer or power scheduler, who would have access to better sources of information than I did and who would probably have more favors to call in and dole out than I did, could probably have figured it out eventually. Palo Verde was the only West Coast trading point that day where off-peak prices were higher than peak prices; someone would have eventually concluded something was up with one of those reactors or the substations which connect them to the grid.
A combination of government action and inertia eventually did my daily power story in. First, it's hard to continue working for a dying company, even if you plan to stick it out to the last day. Second, George W. Bush's Federal Energy Regulatory Commission capped the price of West Coast wholesale power at something between $96 and $97 a megawatt, and that ended that. No point trying to discover prices when the legal cap became the only logical price.
The principle behind what Enron was trying to do — turn everything into a traded commodity — was not a bad one. In fact, it is a rather nifty idea, and one whose time will come again (and again, and again, and again). But the founders and traders of Enron made two important mistakes. First, they tried to prove the notion in thinly traded and very closed commodity markets, which was just plain stupid. And second, they thought the rules — and by this, I do not mean the law — did not apply to them. Enron became another dot-com, a business trying to prove you can make money solely by buying and selling stock, by hyping ideas, rather than actually selling products to paying customers.
Truthfully, no one in their right mind with speculative venture capital invests in traded electricity. So far as I know, no major investment funds are trying to make power trading work. There is almost no mechanism for paper settlement of contracts — if you trade at the South Path 15 (the connection between the PG&E and Southern California Edison), you'd better be prepared to take "delivery" of whatever electricity you buy. The PJM (Pennsylvania/New Jersey/Maryland) electricity contract is only slowly evolving as a proper electricity future. It does not help that across North America, government-regulated utilities built power grids that made it difficult rather than easy to move power from one state or region to another, meaning that the logical trading hubs are also choke points.
Without speculators — the speculators and investment funds who make the oil, wheat, platinum, sugar, coffee, natural gas, and frozen concentrated orange juice (to name a few) markets work — then you do not and cannot have a proper market. The pari-mutuel betting (think: horse racing) that typifies the derivatives markets may not be real hedging or risk management, but without at least a few people willing to place bets against each other and settle their wagers at the end of the day (and who wouldn't know what to do with a barrel of oil, a bushel of wheat, or a short ton of frozen concentrated orange juice), all you have is a really fancy spot market on expensive real estate tailored for a few dozen power schedulers and ISO managers.
Looking back, it amazes me that anyone at Enron thought they could make a go of this. It is more amazing that anyone else took them seriously. (And they talked about trading telephone bandwidth, a good that simply isn't scarce enough to trade; and municipal water, systems that are even more closed, isolated and regulated than electric grids.)
And this gets to the second point. Every now and again, human beings go crazy and decide certain physical and natural laws no longer apply. The 1990s was just such a time. Common sense abandoned much of the business world, and companies floated along solely on the value of their stocks — values not based on anything resembling sales or income. Enron and Dynegy's traders thought they could buy and sell the world. They flew high. There was no down to fall to.
But there is a price for thinking that neither gravity nor profits and losses apply anymore, and Enron paid that price — the company went bankrupt after swirling the drain for some months while accountants and senior executives conjured up new gimmicks to make the company appear profitable (and thus boost the value of the stock) when it wasn't. Bankruptcy is the best price to be paid for such a thing; it is the best remedy for those who think their business models are too clever by half. It's final. It's the closest thing we have to a truly objective assessment of a business. Because no matter how nifty your business model is, or how handsome your CEO looks when talking on CNBC's Squawkbox, if the checks cannot clear, then you're done.
No investor wants to be made the fool. No investor wants the value of his or her investments to ever go down. And no one wants to get stuck holding worthless stock that had only, months before, been a ticket to a life of wealth and ease. One of the things the complex welfare state we live in claims to guarantee is that no one will ever be poorer at the end of a day than they were at the beginning. Much of the state's regulatory apparatus is designed to show that state managers are doing their darnedest to prop up the value of shares, of bonds, of real property, or prevent what the state simply cannot — the kind of foolishness and idiocy that allows people to think they can make a zillion dollars without actually having to do anything.
It's hard enough protecting honest folks from grifters and pickpockets, much less the gullible, the foolish and the greedy from hucksters and showmen whose only real crime is the fact that they have successfully deluded themselves.
Hope is a wonderful thing. It makes human beings wake, work, love and persist when there appears to be no real reason to do so. But it also deludes and blinds, and leads people to think something can be had for nothing, that cargo is coming, that government can cure all ills, that share prices or house prices or commodity prices can never or will never fall. Puncture that false hope, leaving men and women with nothing but the shards and shreds of their delusions, and you risk provoking the mob. Near as I can tell, it is the way of things.
So the mob grabs its torches and its pitchforks. It wants vengeance. It wants the sport and satisfaction of seeing the culprits suffer, and it isn't enough to sue them into oblivion. The mob wants blood — blood only the federal government, as the instrument of the people's wrath, can properly shed.
Whether that beats the noose dangling from a lonely cottonwood that both Ken Lay and Jeffrey Skilling might have faced in another era is something they'll have to decide on their own. They will soon have plenty of free time to ponder this.
It's time you and I are going to pay for, too, whether we like it or not. At least we had a choice when it came to buying Enron's shares.
May 27, 2006
Charles H. Featherstone [send him mail] is a Washington, D.C.-based journalist specializing in energy, the Middle East, and Islam. He lives with his wife Jennifer in Alexandria, Virginia.
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