Enron E-Commerce Success Exemplary, Unsettling
An extraordinary year for electricity and natural gas pricing nationwide and the rise of trading on the Internet have combined to give Enron Corp. a dramatic surge in revenue while helping it create a new business model for energy and other industries.
Enron revenue shot up to $100.8 billion in 2000 from $40.1 billion in 1999. Almost all the increase in revenue came from buying and selling contracts in natural gas and electricity.
Enron Online, launched last year, executed more than half a million transactions in commodities totaling $336 billion in value, which quickly made Enron the world’s largest e-commerce company.
Global moves toward deregulated energy markets and increased price volatility in all sectors of industry, brought on by the rise of bidding on the Internet, have driven Enron’s growth. Its revenue has multiplied sevenfold and its profit has more than doubled in five years.
Enron’s emphasis on trading to hedge its risk is being emulated by companies in many industries that now use futures markets and other hedging mechanisms as an integral part of their operations.
Still, Enron’s visions and ambitions have been frustrated in California. And California’s solutions to its energy crisis, if they involve new forms of regulation and influence other state governments, could cast a shadow on Enron’s prospects, utility executives say.
But there is no doubt that Enron is a thought-provoking company at a critical juncture in world business history.
Developing over the last 15 years from a collector and transporter of natural gas, Enron has become the antithesis of vertical integration--the term used to describe electric companies that generate, transmit and distribute power to customers, for example, or oil companies that own oil wells, refineries and gas stations.
Enron’s way, by contrast, is to create a “virtual integration” through access to millions of suppliers and purchasers of commodities and services. From such access, which the Internet multiplies tremendously, Enron becomes the central marketplace for contracts in power or gas or other goods and services.
It doesn’t simply trade commodities, but puts up its own capital to buy and sell them. This gives it tremendous knowledge of markets and future supply levels.
Enron sold its natural gas production operations in 1999. Its business is centered on five trading floors in Houston, four in London and others spread from New Orleans and Cincinnati to Amsterdam; Frankfurt, Germany; Tokyo; Sydney, Australia; and Sao Paulo, Brazil.
After a decade-long hibernation, “Enron’s strength is in the knowledge its market-making gives it,” says a utility executive whose firm competes with Enron. With such knowledge, Enron constructs price models for future markets.
“The good news is that natural gas and electricity’s forward curves show prices coming down fairly sharply in the next three, four, five years. So you can lock in [future] prices that are lower, much lower,” says Kenneth Lay, Enron’s chairman and chief executive, who has a doctorate in economics.
An example of how Enron does business is the contract it wrote with United Illuminating, a Connecticut utility that needed to supply power to customers for four years after that state’s deregulation went into effect last year.
Enron contracted to supply the electricity at a fixed price until 2003 at a 10% discount to prices United Illuminating had charged customers in previous years.
Then Enron put together the electricity to meet the contract from a variety of sources--buying spare power from an industrial company in Pennsylvania, mixing contracts of varying durations and prices.
The profit margins in such business are not large. Enron’s profit growth, while impressive, was not as fast as its revenue growth last year. And like all experimenters, Enron doesn’t win them all.
Enron’s $1.26-billion net income last year was reduced by a $326-million write-down on Azurix Inc., a troubled venture in water trading that operates in the San Joaquin Valley.
Enron is developing a business in trading broadband services--buying and selling time on fiber-optic cables and such. But that venture will be losing money for a couple of years yet, analysts say.
But Wall Street likes the prospects for growth and gives Enron a premium stock price. “We see an acceleration in Enron’s growth as many industries, manufacturers and building managers are seeking ways to lower energy bills,” says analyst Donato Eassey of Merrill Lynch. Enron’s stock shot up 15% last week after its revenue and earnings report, and closed Friday at $82 on the New York Stock Exchange.
Aspects of Enron’s business are age-old. Farmers and grain processors have always used commodity futures markets to protect themselves against swings in crop prices; banks have hedged against currency risks.
And Enron’s trading doesn’t eliminate the need for generating plants, says Edward Muller, former head of Edison Mission Energy. “Just as farmers, who depend on futures markets for pricing, still need to grow the corn, so we still need generating plants and transmission lines and companies to build them,” Muller says.
Enron’s role is to offer a financial service, Muller adds. “Enron may help such plants obtain financing by contracting for their output.”
But there is also a new and challenging aspect to Enron’s business model. It is the concept of “optionality,” which was pioneered by Jeffrey Skilling, 47, Enron’s president who will become its chief executive Feb. 12. (Lay, 58, will remain chairman.)
Optionality means that a business uses access to many customers and suppliers to minimize risk and maximize value in any transaction. An electric company, for example, might not use a power plant to generate maximum electricity, if selling the plant’s natural gas fuel could bring a higher price at that moment.
Optionality emphasizes flexibility, but can be unsettling, as California learned in the last year, when electricity generators appeared to be withholding production and selling power out of state.
Significantly, California has not been successful territory for Enron. Markets in water didn’t develop as Azurix envisioned; Enron’s plans for selling electricity to retail customers were deferred years ago because the state’s deregulation formulas didn’t allow room for retail competition.
And California might put a crimp in Enron’s future progress, some analysts suggest. The California electricity crisis has already scared other states about deregulation’s perils.
If the state’s solutions to its problems involve restrictions on power trading, it could set an example that would slow development of new electricity markets that Enron is counting on.
The company didn’t bid in California’s power auctions last week because the state imposed terms that excluded Enron. Still, sources say Enron may be involved in the long-term contracts California is about to negotiate for future power.
Enron is a complex company, admired by many, criticized by some. Most businesspeople bring up Lay’s longtime connections to the Bush family--he was formally an energy advisor to the first Bush administration, informally an advisor to the new one. “You hear his thoughts coming out of Dubya’s mouth when he speaks about energy,” says one utility executive.
But more significant than Lay’s contacts is the new business landscape brought about by global competition and the rise of the Internet. In that environment, companies everywhere are likely to become students of the Enron model.
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James Flanigan can be reached by e-mail at jim.flanigan@latimes.com.
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Trading Surge
Rising natural gas prices and electricity deregulation have boosted Enron’s business. Figures are for the volume of natural gas and electricity contracts that Enron bought and sold.
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Enron by the Numbers
Enron’s revenue comes chiefly from its wholesale service of making markets in long-term contracts for electricity, natural gas and other commodities.
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Income before 2000 revenue interest and taxes Enron divisions (billions) (billions) Wholesale energy and commodity contracts $94.90 $2.26 Retail gas and electricity services 4.60 0.10 Portland General Electric 2.26 0.34 Natural gas pipelines 0.70 0.39 Broadband services 0.41 -0.06 Corporate charges and interdivision transactions -2.00 -0.29 Totals $100.87 billion $2.74 billion
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Source: Company reports
