Walk out on to one of the trading floors in Houston's "Energy Alley" and you
might think you're back in the Wall Street described in the early to mid-1980s
in the book Liar's Poker or the movie Wall Street. Rows of
casually dressed young traders stare at flat-screen monitors and talk quickly
into headsets -- buying and selling energy and other commodities at the push of a button.
Johnson was a field producer for "Blackout."
But on the giant trading floors of these companies -- some the size of a typical airplane hangar -- they're not trading shares of Amazon.com, AT&T, or other equities. They are trading some physical commodities -- everything from natural gas to coal to crude oil. What is different at some of the Big Energy companies is that they're also trading financial instruments called
derivatives, like the amount of pollution a factory is allowed to generate,
space on the internet or bets on how hot it will be this summer in the United
Many of the companies started out as traditional natural gas suppliers or
electric utilities. Since the deregulation of the industry they have
been allowed to trade in complex financial products, combining established old
business practices with modern Wall Street-type trading operations. However,
this new type of energy trading is completely unregulated, and the rising Big
Energy companies of Houston are making a lot of money. In 2000, Dynegy saw
revenues rise by 90 percent from 1999; Reliant's rose by 92 percent and El Paso's revenues rose by 107 percent. All three of these companies are within 100 yards of each other in Houston's Energy Alley. Nearby, with one skyscraping glass tower in place and another one in the midst of construction, is Enron, the biggest of them all.
The sharp increase in profits for the energy companies comes from a shift in
emphasis from trading only physical commodities like natural gas, to risk management
efforts that attempt to decrease the risk of trading a
commodity. They do this by both buying and selling positions in the commodity
and spreading the risk out over a period of months or years. For example, if
California's electricity buyers had negotiated long-term contracts that
contained a fixed price for electricity a year ago, instead of entering the
volatile "spot market," which is basically institutionalized day trading, it
would not be facing as much of a financial crunch today.
It's difficult to determine exactly how much of a company's profits are derived
from this type of trading because it is proprietary information. But Enron,
which as recently as the early 1990s was primarily in the gas pipeline
business, earned more than 90 percent of its revenues from its wholesale services division in 2000, the division that includes its energy trading operation. And that's where all those traders stretching from one side of the building to the other come in. Many are both buying and selling positions, known as making a market, in power and other commodities. But they don't take actual physical possession of the commodities, instead sometimes "flipping" the product to another customer and making a fraction of a cent on the transaction in profit.
A lot of speculative money flows through Enron's trading floor in a day.
"Probably close to $3 billion -- $2.5 billion to $3 billion a day in purchases and sales of natural gas. That would be a notional factor," according to Enron CEO Jeff Skilling. "Notional factor" means that the 2 to 3 billion is not the amount coming into the coffers of Enron, just the amount traded. Skilling says Enron basically created the market for trading in electricity, a commodity he sees no differently than wheat, steel, or even water. That is a core belief of those working on Enron's and the other Big Energy companies' trading floors: You can make a market and trade in almost everything.
In the future, traders may not need to wear telephone headsets, as they move
headlong onto the internet and online business-to-business operations. Enron
created EnronOnline, which they describe as "the world's largest ecommerce web site for global commodity transactions." Enron's new worldwide ecommerce arm traded over $330 billion in commodities last year, mostly in electricity and natural gas. And in 2000, Dynegy created DynegyDirect, designed to "enable Dynegy to execute its long-term strategy to become a leader in the converging energy and communications economy." These online business-to-business operations allow a greater reach for trading in a variety of commodities, from risk management on the weather to emissions allowances, around the world, at any time of the day or night.
But does the trading in virtually any type of commodity, much of it
unregulated, help consumers, or does it just increase the profit margins of the
large market makers engaged in the trading? Skilling, Enron's CEO, has no doubt
about the effectiveness of the marketplace. "We're working to create open,
competitive, fair markets. And in open, competitive fair markets, prices are
lower and customers get better service. We are the good guys -- we are on the
side of angels."
Ratepayers in California may not see Enron and other energy companies as
angelic, but as economist Frank Wolak points out, "You can't blame the Enrons. That's what they do. They try to make as much money from the money that
they get invested."
With the ongoing electricity crisis in California, these new markets are attracting a lot of attention. Many consumers, who did not know or care
that the price they pay for energy is in some way impacted by a trading floor
in Houston, are starting to pay attention to activity that up until this point
has been relatively free of scrutiny. As the veil is lifted on some of the
unregulated trading activities, and more questions raised about their conduct
in these obscure markets, the new new businesses may find more roadblocks on
their way to large profit margins -- if the regulators can figure out how they're making the money.
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