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 ofthe 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 flamedout with little fanfare, Enron cut an enormous swath through the real economy. Atits peak, this was a $70-billion company that helped to bring gas and electricityto people around the world. After it filed for bankruptcy on December 2, morethan 4,000 employees in Houston were out of a job. At least $30 billion incompany debt now must be dealt with, according to bankruptcy filings.
This is a stunning reversal for an energy company that began in 1985 with themerger of two pipeline concerns. Those were the days when deregulation in thefinancial industries was beginning to lead to dizzying failures--such as thecollapse of junk-bond impresario Michael Milken's investment banking firm, DrexelBurnham Lambert. But the gradual deregulation of the natural-gas industry wasjust under way. Under Lay's leadership, Enron became a leading natural-gascompany. 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 amanagement consultant at McKinsey and Company, decided to transform Enron into anew kind of powerhouse--one that would take full advantage of the freewheelingopportunities in energy. Skilling decided that the heart of the business wouldnot be in assets--power plants and pipelines--but in trading long-term energycontracts. In other words, the game was to match up sellers that had excess powerwith buyers that needed power. This was a radical innovation in the energyindustry.
As Skilling and Lay got more creative, Enron's involvement in relativelystraightforward long-term contracts evolved into new arrangements involvingcomplex and exotic financial deals. Lay claimed throughout that it was all amatter of creating efficient markets. "Technology is changing," he notedrepeatedly, "and there's a lot more value in flexibility and optionality. Justabout in every industry, you can make them a lot more efficient when you havemore optionality."
What exactly this gauzy talk about "optionality" meant wasn't all that clearto many listeners or, as it turned out, to Lay himself. But like Milken in the1980s, Lay seemed to be a man very much of the moment, in possession of specialknowledge not available to mortals.
One of Skilling's beliefs was that Enron could win big bybranching out into the commodities business. In the hope that the company couldcreate an international, privatized water market, just as it helped spur a globalmovement to privatize energy, Enron's leaders in 1998 set up a subsidiary calledAzurix. It started off with a major water concession in England but soon ranafoul of British regulators who cut the firm's rates--a sign that withoutderegulated markets, Enron's style was significantly cramped. Azurix's expansioninto Brazil also worked out badly due to local politics. Enron hid the mountingdebts in an off-the-balance-sheet partnership. That turned out to be a techniquethat was all too common and that led to the kind of debt load that becameunsustainable when investors lost confidence in Enron's numbers.
Enron also jumped feet first into the broadband business with massiveinvestments--and losses--in fiber optics (just like another reeling high-conceptconcern: Global Crossing, run by former Milken associate Gary Winnick). Enronspent $1.2 billion to build a fiber-optic network, but the ballyhooed broadbandbusiness, 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 onthe broadcast spectrum--the airwaves over which entertainment and othercommunications are transmitted--a publicly regulated and sometimes publicly ownedcommodity. But some of that spectrum goes unused for stretches of time. A spotmarket is likely to emerge for the unused spectrum, just as it did for satellitetime access. A company that wants to play in this new market can't afford to beon the bad side of Democrats in a divided federal government. But Enron'sbroadcast bazaar was not to be, for the company was already running afoul offederal regulators. As news of an investigation by the Securities and ExchangeCommission 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 ofthe Federal Energy Regulatory Commission (FERC) with a Texas friend of his and ofPresident Bush: Pat Wood, former chairman of the Texas Public Utility Commission.Hebert--who refused to scrutinize even the most egregious price gouging--hadbecome a lightning rod for California Governor Gray Davis and other critics ofCalifornia's misfired experiment in deregulation. Wood proved to be just theticket. His moderate posture helped to reassure states that were losingconfidence in deregulation.
Last May, Lay convened a meeting of mostly conservative Los Angeles notablesin a bid to preserve deregulation in California and quash a nascent public-powermovement. Among those in attendance were Arnold Schwarzenegger, former L.A. MayorRichard Riordan (now the Republican front-runner for governor), and, yes,Riordan's old business buddy, Mike Milken. Lay made the case for deregulation andpredicted that prices for electricity would begin to fall from their skyrocketinglevels.
And, as it happens, prices started to go down about that time. The FERC wasstill balking at reining in runaway gouging. Big rate hikes had not yet gone intoeffect, and California's new conservation programs were mostly in the planningstage. Plainly, Enron and others in the energy business had an interest incooling the price gouging: first, to save deregulation, and second, to expandinto new business areas.
Deregulation, in fact, is proceeding not just in the United States but aroundthe globe. U.S. investment in foreign utilities--which, following the lead ofThatcherite Britain, have been privatized not only across Europe but throughvirtually all of Latin America and much of Asia and Africa--quadrupled in thelast half of the 1990s.
As U.S. power companies globalize, they confront a dizzying array of optionswith varying degrees of risk and reward. Although Enron and the other new-waveenergy firms act with a great deal of bravado, when you strip away the facade ofbig money, fast computers, and snazzy Italian suits, this is all very new tothem. After all, the energy business has historically been essentially aresource-extraction business: Drill holes in the ground, find oil and gas (ornot), line up buyers, sell, repeat. Since energy is something that peopleactually need, jacking up prices leads to a negative reaction, especially incountries in which free markets are not venerated. Enron's pattern was to thinkshort-term and to go for the money while it could.
Enron's failing operations in Dabhol, India, are an example of how things cango sour. Enron made a $3-billion power plant investment in India--that country'slargest foreign investment and the world's biggest natural-gas-fired project. Butit was all thrown into disarray when the Maharashtra state government canceledthe power-purchase agreement in May, complaining that Enron was overcharging.While a panel of international arbitrators tried to work things out, with Indianpoliticians demanding contract renegotiation, Lay created an internationalincident 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 Streetanalysts by abruptly quitting the company, and Enron stock--once trading at $90 ashare--was dropping fast, eventually bottoming out at 26 cents.
Financial analysts say that the end of Enron is going to make it harder in theshort-term for the entire energy industry to raise capital. The days of easyaccess to funding and low interest rates are over for the industry, at least fornow. Energy developers will have to prove the profitability of every project, incontrast to the days when Enron's breezy bafflegab satisfied the auditors andregulators 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?
