Enron's End

No one pushed harder for deregulation, and no one had more to conceal, than this pillar of the new economy.

by William Bradley

The American Prospect magazine, January 2002


The spectacular fall of the house of Enron would have been a huge news story were it not for the terror war. Just a few months ago, Enron Corp. ranked number seven on the Fortune 500. But in little more than 15 months, it managed to lose over 99 percent of its equity. As the nation's biggest electricity marketer in the late 1990s, the company led the way for the energy industry-taking advantage of deregulated markets, boldly forging ahead into new ventures around the globe, and impressing uncounted business commentators with its "innovation" and "brand-new thinking." Enron's vaunted CEO, Kenneth L. Lay, emerged as one of the principal backers of, and advisers to, George W. Bush.

"Enron was the next big thing," says V. John White, executive director of the Center for Energy Efficiency and Renewable Technologies. "Like the dot-coms, it lived and died on that." But unlike dot-com companies that rose up and flamed out with little fanfare, Enron cut an enormous swath through the real economy. At its peak, this was a $70-billion company that helped to bring gas and electricity to people around the world. After it filed for bankruptcy on December ~, more than 4,000 employees in Houston were out of a job. At least $30 billion in company debt now must be dealt with, according to bankruptcy filings.

This is a stunning reversal for an energy company that began in 1985 with the merger of two pipeline concerns. Those were the days when deregulation in the financial industries was beginning to lead to dizzying failures-such as the collapse of junk-bond impresario Michael Milken's investment banking firm, Drexel Burnham Lambert. But the gradual deregulation of the natural-gas industry was just under way. Under Lay's leadership, Enron became a leading natural-gas company. It pushed aggressively for deregulation-first of natural gas and then, in the 1990s, of the electricity industry.

By 1997, Lay and his new partner, Jeffrey K. Skilling, who had been a management consultant at McKinsey and Company, decided to transform Enron into a new kind of powerhouse-one that would take full advantage of the freewheeling opportunities in energy. Skilling decided that the heart of the business would not be in assets-power plants and pipelines-but in trading long-term energy contracts. In other words, the game was to match up sellers that had excess power with buyers that needed power. This was a radical innovation in the energy industry.

As Skilling and Lay got more creative, Enron's involvement in relatively straightforward long-term contracts evolved into new arrangements involving complex and exotic financial deals. Lay claimed throughout that it was all a matter of creating efficient markets. "Technology is changing," he noted repeatedly, "and there's a lot more value in flexibility and optionality. Just about in every industry, you can make them a lot more efficient when you have more optionality."

What exactly this gauzy talk about "optionality" meant wasn't all that clear to many listeners or, as it turned out, to Lay himself. But like Milken in the 1980s, Lay seemed to be a man very much of the moment, in possession of special knowledge not available to mortals.

One of Skilling's beliefs was that Enron could win big by branching out into the commodities business. In the hope that the company could create an international, privatized water market, just as it helped spur a global movement to privatize energy, Enron's leaders in 1998 set up a subsidiary called Azurix. It started off with a major water concession in England but soon ran afoul of British regulators who cut the firm's rates-a sign that without deregulated markets, Enron's style was significantly cramped. Azurix's expansion into Brazil also worked out badly due to local politics. Enron hid the mounting debts in an off-the-balance-sheet partnership. That turned out to be a technique that was all too common and that led to the kind of debt load that became unsustainable when investors lost confidence in Enron's numbers.

Enron also jumped feet first into the broadband business with massive investments-and losses-in fiber optics (just like another reeling high-concept concern: Global Crossing, run by former Milken associate Gary Winnick). Enron spent $1.2 billion to build a fiber-optic network, but the ballyhooed broadband business, which attracted huge amounts of capital as the latest "next big thing," failed to take off. Too many investors were chasing too few interested consumers, creating too much capacity. Beyond broadband, Lay and Skilling had their eyes on the broadcast spectrum-the airwaves over which entertainment and other communications are transmitted-a publicly regulated and sometimes publicly owned commodity. But some of that spectrum goes unused for stretches of time. A spot market is likely to emerge for the unused spectrum, just as it did for satellite time access. A company that wants to play in this new market can't afford to be on the bad side of Democrats in a divided federal government. But Enron's broadcast bazaar was not to be, for the company was already running afoul of federal regulators. As news of an investigation by the Securities and Exchange Commission got out, Enron's stock began to drop.

All the while, Lay's influence was being felt in the political world-chiefly, through the Bush administration's moves to save electricity deregulation. Lay was instrumental in getting right-wing ideologue Curtis Hebert replaced as head of the Federal Energy Regulatory Commission (FERC) with a Texas friend of his and of President Bush: Pat Wood, former chairman of the Texas Public Utility Commission. Hebert-who refused to scrutinize even the most egregious price gouging- had become a lightning rod for California Governor Gray Davis and other critics of California's misfired experiment in deregulation. Wood proved to be just the ticket. His moderate posture helped to reassure states that were losing confidence in deregulation.

Last May, Lay convened a meeting of mostly conservative Los Angeles notables in a bid to preserve deregulation in California and quash a nascent public-power movement. Among those in attendance were Arnold Schwarzenegger, former L.A. Mayor Richard Riordan (now the Republican front-runner for governor), and, yes, Riordan's old business buddy, Mike Milken. Lay made the case for deregulation and predicted that prices for electricity would begin to fall from their skyrocketing levels.

And, as it happens, prices started to go down about that time. The FERC was still balking at reining in runaway gouging. Big rate hikes had not yet gone into effect, and California's new conservation programs were mostly in the planning stage. Plainly, Enron and others in the energy business had an interest in cooling the price gouging: first, to save deregulation, and second, to expand into new business areas.

Deregulation, in fact, is proceeding not just in the United States but around the globe. U.S. investment in foreign utilities-which, following the lead of Thatcherite Britain, have been privatized not only across Europe but through virtually all of Latin America and much of Asia and Africa-quadrupled in the last half of the 1990s.

As U.S. power companies globalize, they confront a dizzying array of options with varying degrees of risk and reward. Although Enron and the other new-wave energy firms act with a great deal of bravado, when you strip away the facade of big money, fast computers, and snazzy Italian suits, this is all very new to them. After all, the energy business has historically been essentially a resource-extraction business: Drill holes in the ground, find oil and gas (or not), line up buyers, sell, repeat. Since energy is something that people actually need, jacking up prices leads to a negative reaction, especially in countries in which free markets are not venerated. Enron's pattern was to think short-term and to go for the money while it could.

Enron's failing operations in Dabhol, India, are an example of how things can go sour. Enron made a s3-billion power plant investment in India-that country's largest foreign investment and the world's biggest natural-gas-fired project. But it was all thrown into disarray when the Maharashtra state government canceled the power-purchase agreement in May, complaining that Enron was overcharging. While a panel of international arbitrators tried to work things out, with Indian politicians demanding contract renegotiation, Lay created an international incident with comments in August to The Financial Times in which he appeared to threaten to use his influence with the White House to bring U.S. sanctions against India. | The newspaper quoted Lay as saying that U.S. law "could prevent the U.S. government from providing any aid or assistance or other things to India." In a subsequent letter to Indian Prime Minister Atal Behari Vajpayee, Lay denied asking any American official to impose sanctions against the nation's most important ally in Southwest Asia.

But by August, Lay and Enron had bigger problems. Skilling stunned Wall Street analysts by abruptly quitting the company, and Enron stock-once trading at $90 a share-was dropping fast, eventually bottoming out at 26 cents.

Financial analysts say that the end of Enron is going to make it harder in the short-term for the entire energy industry to raise capital. The days of easy access to funding and low interest rates are over for the industry, at least for now. Energy developers will have to prove the profitability of every project, in contrast to the days when Enron's breezy bafflegab satisfied the auditors and regulators who were supposedly minding the store.

Meanwhile, the political questions are just beginning. Enron's 'success" supposedly proved that the free market leads to efficiency and prosperity. What, then, does its failure tell us?


WILLIAM BRADLEY, a California-based writer on politics and energy, has served as a senior adviser in Democratic presidential and gubernatorial campaigns.

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