Calif. Was Waterloo but Industry Thrives
California was the beginning of the end for Enron Corp. One of the company’s first real failures in the marketplace occurred in California as electricity deregulation began in 1998.
The big energy trading firm came barreling into California prepared to sell electricity to retail customers at lower prices than local companies could.
Enron invested at least $250 million preparing to expand in California, including ads on the Super Bowl telecast in ’98.
And Enron gave the University of California and California State University systems a good deal with long-term contracts for electricity at 5% below market prices.
Enron came to the state a resounding success, having seized opportunity in the 1980s and early ‘90s to make itself the largest dealer in contracts for electricity and natural gas, profiting from the margins between its buying and selling prices.
The company pioneered markets in those basic commodities, providing a necessary innovation in the evolution of the electric power industry. And even as Enron sinks under billions of dollars in previously undisclosed debts, its legacy will be a vibrant energy trading industry that will prosper with greater regulation and stability.
But back in 1998, Enron’s ambitions for a huge retail market were foiled by the intricate method California legislators and utilities devised for deregulation and by its own bungling.
It’s important to note the bungling. As Enron has descended toward bankruptcy, its executives and traders have been depicted as whip-smart dynamos of capitalism.
But they weren’t so smart. In California, their strutting arrogance irritated legislators whom a wiser company would have wooed. Also, Enron didn’t have the low-cost energy supplies needed to compete with home-grown independent suppliers. “We beat them to customers, supplied Ralphs and other retail chains because we had access to cheaper power,” says Michael Peavey, who headed New Energy Ventures, an independent marketer, at the time.
Enron’s bright idea back then was to acquire Oregon’s Portland General Electric, with the intention of sending power into California. But Oregon regulators ruled against that idea and Enron was stuck with an investment it couldn’t use as intended and still had a problem of supplying power competitively to California.
The company retreated from active presence in the California market, its president, Jeffrey Skilling, loudly denouncing the state’s utilities and legislature.
Nonetheless, Enron’s business grew after that--indeed, to almost $200 billion in revenue so far in 2001--with its Internet trading operation EnronOnLine accounting for 25% of all the contracts in natural gas and electricity.
But without California’s market, Enron was driven to wilder ventures to maintain its momentum and high stock price. It invested unwisely in a network to trade broadband Internet access. That network lasted scarcely a year before being disbanded in 2001. Result: “Not much to show for a $900-million investment,” says an investment banker who has dealings with Enron. It attempted to trade water rights in California, through its subsidiary Azurix Inc., defying the fact that water rights are sensitive matters, fraught with history and politics. Azurix failed and was dissolved this year at a loss of $326 million.
Yet Enron’s energy innovations live on in other trading firms, electric utility companies, major banks and investment firms.
Major participants trade contracts worth more than $6 billion a day. The main firms are subsidiaries of electric utilities.
“We’ve been in energy trading for 15 years. We can take on the business that Enron leaves behind,” says Kevin Fox, general manager of commodities and trading for Aquila Energy, a subsidiary of Utilicorp United of Kansas City.
Unlike Enron, these trading companies generally have strong balance sheets and steady earnings from basic electric power. They will carry on trading, which became an essential activity as electricity evolved into a competitive business.
With natural gas and electricity being bought and sold at varying prices, a need arose for electric companies to gain predictability of costs. And so the electric industry began to contract for forward delivery at fixed prices, using techniques originated in the 1850s in Chicago’s corn and wheat exchanges.
So what lies ahead? “We will see more regulation,” says Stephen Baum, chief executive of Sempra Energy, the holding company that owns San Diego Gas & Electric and Southern California Gas and is a big energy trader.
A focus of regulation will be greater transparency of prices and contracts, a feature of public exchanges but not of transactions handled by dealers. Many experts foresee a centralized exchange for electricity, akin to the Chicago Board of Trade or the New York Stock Exchange. The industry may self-regulate or be overseen by the Commodity Futures Trading Commission or the Securities and Exchange Commission.
The business is poised to prosper, say analysts Steven Fleishman of Merrill Lynch and Christopher Ellinghaus of Williams Capital, as summer energy shortages loom again in many parts of the country.
But as Enron passes, it leaves lessons for all business. One is to establish a reputation for reliability and integrity. As Enron encountered difficulty turning a profit from the long-term deals it had given the California university systems, it tried to repudiate the contracts. The universities sued and Enron was forced to live up to its contracts, earning a reputation as slick and unreliable.
A final lesson is that innovation is exciting but building takes time and effort. Enron could have brought its trading operation along with appropriate financing and grown more slowly, but more surely. It might not have attained the sky-high stock price and aura of dash that it enjoyed for a brief period. But its shareholders and employees, not to mention bankers, suppliers and customers would have been better off.
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James Flanigan can be reached at jim.flanigan@latimes.com
