Collapsing Giant

RAY SUAREZ:

Joining us are Vijay Vaitheeswaran, energy and environment correspondent for the Economist magazine; Floyd Norris, senior financial writer for the New York Times; and Michelle Michot Foss, director of the Energy Institute at the University of Houston. The institute is sponsored in part by Enron, Dynegy and other energy companies.

Well, Vijay Vaitheeswaran, let me start with you. This is a company that didn't generate electricity, didn't go crossing the world exploring for oil and natural gas. How did it get to be a huge energy company?

VIJAY VAITHEESWARAN:

Well, in fact, they do own power plants. They do have hard assets, thousands of miles of pipelines. But in broad-brush, what you say is certainly true, that the lion's share of the company's revenues and profits came from trading, from energy contracts. And they became, over the 15 years or so that Ken Lay grew the company from a very obscure gas pipeline concern, to become the biggest energy broker in the world, something like a quarter of the U.S. electricity and natural gas market. And increasingly, they began to see themselves as a Wall Street firm that happened to have some pipelines attached. And I think that was really when they began to get into trouble.

RAY SUAREZ:

Dr. Foss, would this kind of growth have been possible in an era before deregulation and the existence of computer networks?

MICHELLE MICHOT FOSS:

Well, certainly not in the way that Enron did it. They saw a path by restructuring energy markets to build wholesale businesses, October ago… Acting as an intermediary to provide energy to customers after arranging for supplies from producers. It's a very important role to play in restructured competitive markets. I think they very quickly saw their growth path in that business and then started to emphasize that as their core business.

RAY SUAREZ:

So Floyd Norris, help us understand what happened.

FLOYD NORRIS:

Well, a number of things happened. First, they got caught with accounting no one could understand. That had been true for years, but suddenly it began to matter after they took a mysterious write-off to shareholder equity — that's a balance sheet item — and explained it very badly. Then it cascaded. This was at heart a trading firm and it was almost like a bank. Many of its contracts called on it to perform years and years later. And people who had contracts with it got worried whether they'd be able to perform, so they started closing down those contracts and demanding Enron put up more money. And it cascaded. It was almost like a run on a bank before we had deposit insurance. They couldn't withstand the pressure, and nobody was willing to put up enough money to bail them out.

RAY SUAREZ:

So let me see if I understand this. When news started to come out that they had in fact not disclosed large losses, people started to fear that, if they were supposed to sell Enron gas in 2003 or buy electricity from it in 2004, that this might not happen?

FLOYD NORRIS:

Yes. Moreover, they had signed contracts that ostensibly would have protected someone from a rise or a fall in the price, so that they might end up owing somebody a lot of money three years from now if prices fell. Now, they figured they were ahead because somebody would owe them the same amount of money if that happened. But of course that's not the way you would look at it. You'd worry about whether you're going to get your money, and people started to pull out. It was very much like a run on a bank, and the takeover offer from Dynegy fell apart. Dynegy got scared. They worried that perhaps other people understood this company was in trouble, and they'd be in trouble if they bought them, and they ran away.

RAY SUAREZ:

Vijay Vaitheeswaran, how much of the helium in Enron's balloon was some of that market exuberance of the late '90s, analysts crowing about the company, it having a very popular commercial advertising presence on television, that sort of thing?

VIJAY VAITHEESWARAN:

Sure. There's undoubtedly a good amount of it was a willingness by, particularly analysts on Wall Street and at the credit rating agencies, willing to believe the Enron story, the growth story. And not too many hard questions were asked about exactly what the figures meant, the small details and how exactly profits were broken out, for example.

And so I think now quite a lot of hard questions will be asked of the credit rating agencies, of the auditing company that worked for Enron and signed off on those accounts, which have since been restated, as well as the wall street analysts who just a few months ago were saying, "this company is the General Electric of the next century."

RAY SUAREZ:

Well, Dr. Foss, where does this leave other big players in the industry? Are they shaken by bad news from one of their main competitors, strengthened, weakened?

MICHELLE MICHOT FOSS:

Well, I think there are two things going on. First of all, because of the scrutiny of Enron's businesses, everyone who is in a similar business is looking to their own financial statements and their own balance sheets to make sure that things are solid and, also, I think, they are all going to do, hopefully, a better job or the best job of communicating their financial results to investors and to all of their public audiences.

The other thing that's happening, of course, is that Enron's business is now being distributed to its competitors. So a lot of the companies that operate in the same businesses that Enron operates in are taking up the slack. They're starting to work with some of Enron's customers, they're starting to fill the gaps to ensure that all of the energy supplies that we need in the United States are being met.

RAY SUAREZ:

So if you had contracts down the road with Enron, either as a supplier or as a buying customer of energy, you shouldn't be worried tonight?

MICHELLE MICHOT FOSS:

Well, no. You have to do your homework. What you need to be doing now is restructuring all of those transactions and working with companies that can fulfill all of the agreements. So you're in a process, as we speak, of renegotiating a lot of those arrangements to make sure that you're working with a company that you think is going to be around and be able to meet all of the requirements that you have.

RAY SUAREZ:

Floyd Norris, what about the wider consumer base? I mean if you're just one of those people who's about to put a plug into a wall, how does this affect you?

FLOYD NORRIS:

Oh, it probably will have minimal effect on consumers. There are people who had direct deals with an Enron subsidiary. They probably won't be affected very much. The larger significance of this, I think, for a lot of people will be that the energy markets are likely to change. Led by Ken Lay, they vigorously resisted regulation; they vigorously resisted disclosure. They're probably going to get some of each now and it's probably going to be a good thing.

RAY SUAREZ:

So Vijay, weigh in on that. Do you agree with Floyd Norris that this is something that's going to give states a second look at deregulation and give the industry itself a sort of warning shot?

VIJAY VAITHEESWARAN:

Sure. What I would say is certainly Floyd is right in pointing out that the nature of regulation will change, especially in terms of financial disclosures. Now, what brought Enron down was the financial shenanigans of its top officers, not its very successful trading business. The very dubious practices, not necessarily illegal, and we've already gotten a hint of what may come from one of the commissioners at the FERC, the Federal Energy Regulatory Commission, Nora Brownell, who just said in the wake of this chaos that, "When you don't have a ten commandments, it's very hard to have a sinner."

And I think that points the way towards something like a ten commandments, proper supervision. And if I may make a point that drawing on experience of competitive markets in Britain and Australia and other parts of the world that have forged ahead with deregulation before the US did, there's often a confusion here and in California especially, competitive markets are not the same as saying no regulation. Deregulation requires a much more vigilant but carefully circumscribed role for the regulator, and I think that was the missing link here in the wholesale markets in the US

RAY SUAREZ:

Well, you brought up California. Those of us who were following the California story earlier kept hearing the name Enron popping up, and it made it sound like billions of dollars were flowing into Houston from California ratepayers. What happened? Weren't they making that money?

VIJAY VAITHEESWARAN:

A lot of that is actually political hay made by Governor Gray Davis in trying to respond to what was a very difficult situation he inherited. What California did was not deregulation by any stretch of the imagination. It was an approach to market reform that had all sorts of political bells and whistles that kept regulators hand in, in parts and didn't allow companies to compete in others. It's really a muddled approach that should be a warning to everyone in the world: Don't ever do this. Look to other places in the world, again, you can look to Pennsylvania, you can look to Texas, you can look to Britain, that have done this successfully.

I don't think anybody will hold California up as a model of deregulation. But it is true that, for part of that time, the companies, not only Enron– in fact, Enron was not the biggest beneficiary of California. A lot of its rivals in Houston, other power generators, the Los Angeles Power Authority, in fact the state-run — municipally run power authority made huge amounts of profits that nobody wants to talk about it because it's a government-run entity in California. So the picture as a little bit more complicated and Enron is not a clear villain in the California situation, nor is deregulation.

RAY SUAREZ:

Dr. Foss, let's talk for a minute about where this leaves Houston. Enron was a big company in the city's profile, a big contributor to its skyline, the naming rights on the baseball field. What happens now?

MICHELLE MICHOT FOSS:

I want to say quickly, by the way, that I agree with Vijay's analysis on this with regard to California and also to point out that Enron is only one of a number of energy producers that operate not only in Houston but in other places. Sure, they were a big corporate citizen here, important to the community in both business presence, as well as a civic presence, major donor in town for a lot of important things, a major donor to higher education, not just us, but universities in Texas, universities across the United States.

They were trying to, I think, elevate Houston to its world-class status, to improve quality of life, to make it an attractive place for the kind of talent that they wanted to bring into their company. So this is a very poignant situation for us, to know perfectly well why all of this is happening and, for some of us to have been concerned all along and perhaps to have expected it, but to have to deal with the consequences of this very important corporate citizen having to go through this process is a tough thing around town right now.

RAY SUAREZ:

And what about the 21,000 jobs? Is Houston growing in a way that lot of those people might have a shot at picking up with another company doing similar things?

MICHELLE MICHOT FOSS:

Well, in all honesty, it's tough right now. Of course we're feeling the slow pace of economic activity elsewhere in the United States. It also happens we have a lot of other things going on in Houston right now. We have a major airline company that is trying to deal with the fallout from everything in September. We have Compaq and HP struggling with their own merger. We have a soft environment right now for energy prices. A lot of uncertainty about what oil prices will be next year, natural gas prices and so on.

It happens that most of the energy companies in town are fully staffed, especially in their wholesale trading and marketing businesses, which is where a lot of the flow of personnel from Enron will come from. Enron has been shedding employees for a while. Anybody who could look to other opportunities has been doing so. It's going to be tough to absorb people who want to stay in the Houston area. But this is a pretty resilient town. We've come off some pretty bad times and have had some really excellent times lately. So I would suspect that, among those Enron employees, we have probably some folks who are going to build brand new energy businesses.

RAY SUAREZ:

Dr. Foss, guests, thanks a lot.