Enron's End

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 2, 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 $3-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?

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