A “Green” Company?

Natural gas was the cleanest burning of the three major fossil fuels.³⁶ The self-described “leading integrated natural gas company in North America” naturally sought a valuation premium from this differentiation in an era of political environmentalism. But tensions would emerge when Enron’s green image clashed with Enron’s bottom-line considerations.

“Isn’t it wonderful natural gas is invisible so the rest of nature never will be?” asked Enron’s national advertising campaign in late 1989. In early 1990, Enron unveiled its new vision, “to become the world’s first natural gas major, the most innovative and reliable provider of clean energy worldwide for a better environment.”³⁷ Two years later, Ken Lay presented his Natural Gas Standard in order to cajole electric utilities and their regulators to choose natural gas in place of coal for new capacity.³⁸

Fair enough: Enron tied itself to a fuel that had been artificially held back by government policy and that had both cost and political-environmental advantages, helped by rapidly improving combined-cycle turbine technology to generate electricity. Lay was smartly playing a political angle to promote an advantageous fuel that had been politically victimized by a lesser one.

Green Enron also warred against oil, not only coal. Fuel oil was a competitor to natural gas in Enron pipeline markets from Florida to California. Periodic fuel switching from gas to oil in dual-fuel plants was either occurring or threatening to do so in the mid-to-late 1980s, and after. As a consequence, Ken Lay even came to favor tariffs on imported petroleum to reduce international competition to (domestic) natural gas.³⁹

Yet oil, not natural gas, was the energy choice most desired in many underdeveloped countries for the power plants Enron wanted to build. Typically, natural gas was not indigenous, and liquefied natural gas (LNG) cost more than oil. Accordingly, Enron Development touted its “market-led approach” of “finding solutions to a country’s energy needs rather than selling a specific fuel [natural gas] or pushing a specific project.”

For example, Batangas (105 MW) and half-owned Subic Bay (116 MW) in the Philippines were oil fired, as was an Enron leased-and-operated 28 MW facility at Subic Bay. The 110 MW Puerto Quetzal, a two-barge power plant in Guatemala, half owned by Enron, was oil fired. (These projects were very profitable for Enron, given a government-lending boost.) Oil was also the fuel of choice for the 696 MW Dabhol, India, power plant (Phase I), although it was to be joined by LNG for Phase II once the contracts were in place.

At home, Enron’s natural gas image also had to square with Enron Liquid Fuels, described in Enron’s 1989 annual report as “a fully integrated crude oil entity in North America.” Enron’s midstream oil assets (what was previously called Enron Oil Transportation & Trading) were assembled and taken public (in March 1994) as EOTT Energy Partners. EOTT’s activities in 17 states and Canada encompassed “purchasing, gathering, transporting, processing, trading, storage and resale of crude oil and refined petroleum products and related activities.” EOG, on the other hand, although it had oil reserves and drilled for oil, was close to a pure natural gas play.

Enron was as anticoal as a company could be, having no coal assets; urging utilities to choose natural gas over coal in power generation; and lobbying for public policies disadvantaging coal emissions and usage. But Enron quietly got into the (profitable) coal business.

In October 2001, in what would prove to be his last conference call with security analysts, Ken Lay revealed a previously undisclosed profit center. Enron, he promised, would transition out of its noncore businesses and stay in trading and pipelines—and in coal.

Coal? Who knew that since 1997, Enron had been building this business, first in trading and then in financing coal companies and taking payment in physical coal (volumetric production payments). Enron’s “integrated approach” was explained by one executive: “While we aren’t interested in purchasing a coal company outright, we can use ECT’s capital in a variety of ways to gain access to production which strengthens our physical position.”

To be sure, Enron had already declared itself the world’s first natural gas major and had moved on to a vision of becoming the world’s leading energy company. But Ken Lay’s enterprise was still pushing global warming and green energies. When confronted on the discrepancy by one of his coal executives, Jeff Skilling put the matter to rest with the words: “Mike, we are a green energy company, but the green stands for money.”

Gone were the jokes at Enron headquarters about coal as “flammable dirt.”

The CEO of many masks—procoal at Florida Gas Company and again at Transco—had been against coal upon his arrival at Houston Natural Gas. He continued to be that fuel’s number-one private-sector foe until Enron got into the business, even acquiring coal reserves. But the physical side of Enron’s coal play was not emphasized; logistics were. “Enron provides a single, comprehensive solution to manage all logistics and risk, whether the coal is sourced domestically or abroad,” the last (2000) annual report stated. “In some cases, we have reduced the customer’s cost of coal by as much as 10 percent.”

Enron’s 35-employee coal unit earned $35 million in 1999, a true profit center with $300 million invested in coal reserves to back ECT’s physical trading. “Our position as a ‘green’ company is getting thin,” stated Enron’s head of European affairs, Mark Schroeder. “We will find it increasingly difficult to even maintain the John Browne imitation, having sold solar (to BP), and sometime next year becoming the largest trader of coal in the world.”

Procompetition?

Enron was not an ivory tower, despite its raft of PhD economists (and near PhDs). Ken Lay was a businessman, not an academic or an ideologue. He was a pragmatist first and a visionary second. In the name of profit maximization, Lay was for many things before he was against them, and vice-versa. The iconic institutions of markets and competition were embraced here but not there, even in contradictory public stances. This was the mixed economy in which Enron operated, and a Ken Lay could reach the top.

Early on, Lay was of two minds about the spot-gas revolution and associated transportation versus the old ways of doing business. “About the time people get all the flexibility and transportation they want,” he said in 1985, “they’ll find they don’t want all of that.” Why? Higher prices and profits were needed for his upstream and midstream operations. This from the ex-president of Transco Energy, who had spearheaded the formation of the US Natural Gas Clearinghouse in 1983, not to mention Transco’s special marketing programs in 1982–83.

Low spot prices weighed heavily on Lay. Selling gas “below cost,” he complained, could compromise the service obligation of pipelines to deliver gas and eventually result in a “severe landing” of price spikes later on.

Was Mr. Natural Gas saying that natural gas was anything but abundant and dependable? To electric utilities, Enron’s answer was no … but maybe yes. In order to get electricity generators to forgo coal for their new plants, Enron said gas was a sure thing. They had to; buyers remembered the mid-1970s when gas deliveries were curtailed. And had not the Enron Outlook quantified the robust North American resource base in light of improving technology?⁴⁰

On the other hand, long-term contracts had higher margins than heavily traded, transparent month-to-month spot gas. So, Enron hinted, and a bit more, that gas might not be quite so abundant, reliable, and affordable—and electricity generators should execute long-term, price-premium, fixed contracts for some, even much, of their requirements. And by the way, Enron was the preeminent supplier of that long-term gas.

Ken Lay was a bearish bull. In 1985, he complained that “our industry saying big shortages and big price spirals are just around the corner” was not “a very effective way to sell people on making long term commitments to our fuel.” Yet three years later, Lay warned that gas produced at less than replacement cost was setting up “a real shock and very severe dislocations throughout the industry.”

There was a fence to be straddled. The idea was for utilities to build new gas-fired capacity and to commit to higher-margin long-term supply. Enron would assure them of gas availability just forcefully enough to build, yet it would concern them just enough to sign long-term fixed-priced contracts. In fact, during customer meetings, Enron would present McKinsey’s pessimistic view of natural gas supply, follow with the in-house optimistic view, and then pitch the long-term gas option for locking in the (premium) price.

To encourage long-term contracting, Enron also warned state utility regulators about volatile spot prices and possible supply problems.⁴¹ This was done not only for electric utilities but also for gas utilities supplying residential and commercial customers—for anyone buying gas at wholesale from Enron.

Make no mistake: Ken Lay knew where Enron’s bread was buttered. He saw, early on, how money could be made as a marketer, not just as a transporter, of natural gas. And that long-term contracts were far more profitable than transacting on the spot market.

Asset collectivism represented a far more fundamental contradiction for the allegedly free-market Ken Lay. Early on, however, he saw that more money could be made if Enron was an independent marketer of natural gas as well as a transporter. Separating sales and transportation would create two profit centers where before there had been only bundled pipeline sales (no margin) and transport. The same principle—separating sales and transportation—could also be applied to the much larger electricity industry.

Separating sales and transportation required Enron to accept FERC’s program of mandatory open access (MOA), whereby interstate natural gas pipelines (and, later, electric utilities) agreed to let all comers use their transportation capability at nondiscriminatory prices and other terms of service. At first, this would apply at the wholesale level (pipelines, transmission wires) but later was also to apply at the retail level.

Using other companies’ assets via “infrastructure socialism” allowed Enron to create a unit devoted solely to marketing natural gas and electricity, a very good thing for an asset-light company trying to grow quickly and have a high credit rating at the same time. MOA was procompetition, exhorted Enron, and competition was good, even when it took place on a regulation-communalized playing field.

To Lay, MOA was a means to an end: making money. He was not concerned about real deregulation: namely, repealing decades-old public-utility protection to remove franchise protection and to remove rate caps. That was not in political play.

Enron championed MOA, first at the federal (interstate wholesale) level, which allowed Enron to form EGS/EGM/ECT as a new innovative profit center. MOA was now advocated by Enron for retail (the distribution level) as Enron’s next big thing, as discussed in both chapter 15 and the Epilogue.

Expediency in place of principles created unusual situations for Ken Lay. One tension emerged when potential state-level MOA threatened the profitability of supply sales from two intrastate pipelines. In Texas, a long-term sales contract to Entex by Houston Pipe Line was at risk. What if the Texas Railroad Commission did what FERC had done: issue an open-access order abrogating the very profitable contract in favor of (lower-margin) spot gas?

“There is a need to coordinate our policies, statements, and positions with one another to avoid diverse positioning at Enron,” an ECT Legal memorandum stated in 1997. The issue also was alive next door concerning gas sales off of Enron’s Louisiana Resources pipeline.

It was all-hands-on-deck to “assist in resolving contrasting interests in order to formulate ECT positions to support the needs of ECT Retail with the least damaging consequences to our intrastate pipelines and wholesale business units.” As it turned out, a crisis was dodged (in-state MOA was avoided), and Enron’s two-faced policy did not become public at a most inopportune time.

In South America, the same tension emerged. Enron preferred a closed, integrated, bundled approach upon building or buying natural gas infrastructure. Producers would sell gas to Enron, which would then transport and burn the gas in its power plants, capturing profits across stages where little outside competition existed. Open-access pipelining, on the contrary, increasing competition and adding price transparency, would lower returns.

“Can you e-mail folks to set up a meeting … to discuss infrastructure integration?” an internal memorandum read. “We really need to resolve the two [positions] to give Ken [Lay] some guidance, and right now I’m pretty lost,” wrote Enron’s director of public policy analysis (the present author).

Other competition-here-but-not-there examples can be cited. By assigning Enron’s travel business to his sister’s travel agency, an allegedly procompetition CEO was anything but. By accusing major oil companies of predatory pricing with wellhead gas sales in the early 1990s, Ken Lay was really complaining about too much competition (led by his own affiliate, EOG), not too little.

Lay and Enron actively lobbied for the passage of the North American Free Trade Agreement (NAFTA), which on the first day of 1994 prohibited tariffs and other restrictions on oil or natural gas imported from, or exported to, Canada or Mexico. Yet foreign oil was too cheap (competitive) for Lay, who sought a tariff in 1993 to lessen oil’s competition to natural gas.⁴² Lay also lobbied for a Btu tax to favor natural gas relative to oil and coal—until Clinton’s draft proposal had the unintended consequence of gumming up ECT’s long-term gas deals then in negotiation.

Natural gas was the natural winner over coal and oil in power generation, Enron claimed from at least 1987 on. EPA’s political regulation favored gas because of its emission profile, and 1970s-era regulation favoring coal was repealed, or nearly so. Still, Ken Lay wanted any advantage he could get against his two rival fuels. A tax differential against oil and coal to benefit natural gas was an example of less competition and anticonsumerism for the sake of Enron’s bottom line, given that existing fuel-specific environmental regulation was in place by the early 1990s to equalize the playing field.

Political Capitalism

Chapters 7 and 13 focus exclusively on political opportunity and rent-seeking at Enron, supplementing the chapter-by-chapter discussion of government in particular business situations. This macro/micro treatment underscores the unique dependency of Enron on the political process, quite outside a simple private-property free market.

Political Lay and political Enron were virtually inseparable. The politician-CEO was front and center in all things governmental. Business historians will be hard pressed to find another business leader with more Washington opportunity, drive, and results. Part of this was the nature of the energy business, long regulated at the state and federal levels, as summarized in the Epilogue of Book 2 (Edison to Enron). Part of it was Ken Lay’s gravitating to regulated businesses and championing new interventionist policies.⁴⁶ “Ken Lay plays offense, not defense,” as one company lobbyist remembered.

Virtually all Enron profit centers benefitted from and/or sought major government intervention: mandated access to interstate (wholesale) transmission for gas marketing; special incentives for independent (nonutility) electric generation; mandated access to interstate (wholesale) transmission for power marketing; special tax treatment of resource extraction (tight-sands gas); regulation of criteria pollutants (and, perhaps in the future, carbon dioxide)⁴⁷; special tax treatment of solar power and wind power production (and, later, state quotas for qualifying renewable output); and loan assistance for foreign projects. These laws and administrative regulations, some originating in the 1930s, were in play in Enron’s era, some with crucial Enron drafting and lobbying.

Still, laws could hurt rather than help Enron. The Public Utility Holding Company Act of 1935 was a burden for a nonutility, such as Enron, that built power plants and traded electricity in various states. Exemptions would be required until this law was formally amended in 1992.

Another thorn in Enron’s side was environmental regulation, which encumbered pipeline operation and delayed pipeline expansions, although Enron (Transwestern and Florida Gas, in particular) innovatively minimized this inefficiency. With rate base treatment of environmental capital costs, Enron (and competing projects) could live with this hassle factor.

Enron’s interstates were more disadvantaged than helped by FERC public-utility regulation of rates and service. A capacity surplus in interstate (wholesale) markets beginning in the early-to-mid 1980s, creating pipe-on-pipe competition, made traditional cost-plus ratemaking unnecessary and counterproductive to the goal of market-responsive pricing. Maximum regulated rates might be above market, requiring a discount lest the rate become zero from lost business.

Such laws could hurt Enron’s competitors to lessen the pain, at least relatively. What Ken Lay sought was government intervention that helped Enron despite its negative effects on competitors, not to mention rate payers or taxpayers. In so doing, Enron became addicted to special government opportunity—whether a favorable regulation, tax advantage, or check written on the US Treasury.

But Enron’s core competency certainly did not begin with Ken Lay. Rent-seeking alarmed Adam Smith in the 18th century, and leading US political economists explained its nefarious presence in the 19th century.⁴⁸ Natural Gas Week editor John Jennrich described it succinctly during Enron’s day: “This is, after all, not a philosophical discussion,” he noted about various industry positions taken about a regulatory matter. “This is about M-O-N-E-Y.” Such pragmatism was old hat in the US energy business, where the long tradition of business morality and bourgeois virtue, from Adam Smith and Samuel Smiles onward, was often ignored.

Mixed-Economy Competition

Legislation and administrative regulation enabled politically attuned, politically correct Enron to make hundreds of millions of dollars between 1984 and 1996. Regulation of a different kind (accounting, finance) enabled Enron to self-interpret its results in order to appear to be more profitable and sustainable than it really was. But in some cases, Enron found itself engaged in political lobbying that promoted competition and wealth creation.

Ken Lay’s opening move to acquire two interstate pipelines brought federal regulation to HNG’s core. This was about market-side profit-seeking under regulatory constraints, not rent-seeking. Interstate gas transmission was a consumer-driven business that its energy rivals—manufactured (coal) gas and fuel oil—routinely obstructed through the political process. In fact, the entry of Northern Natural Gas Pipeline in 1931 was delayed, and entry of Florida Gas Transmission in 1959 nearly derailed, by interfuel rent-seeking by coal and oil interests.

In a competitive market with FERC leaning toward competition, Enron’s regulatory initiatives were procompetition—liberalizing service so that consumers increasingly had choices between gas providers and between fuels.⁴⁹ The exception to this was Ken Lay’s push for oil tariffs to protect gas pipeline volumes against foreign oil.

Inherited Intervention Opportunities

The Natural Gas Policy Act (NGPA), part of the five-law National Energy Policy Act of 1978 (NEPA), was foundational to what would be Enron’s core business. Two lawyers described the phaseout of price controls, as well as the act’s other provisions, as “the most complicated and ambiguous statute ever enacted.” Total deregulation (to create a true free market) it was not; nevertheless, deregulatory momentum was secured that would lead to more freedom of action and competition.

Section 311 of the NGPA began the process of unbundling the gas commodity from interstate transportation. Spot-gas carriage programs, approved on a case-by-case basis, were supplanted and universalized by FERC’s generic open-access orders, which created a new industry: interstate natural gas marketing.

NGPA accelerated the process of federal wellhead price liberalization that ended gas shortages—and created an institutional framework for open-ended resource abundance. Supply problems overcome, Ken Lay implemented a natural gas–focused business model that was sustainable and profitable.⁵⁰

PURPA Opportunity. Another part of NEPA, the Public Utility Regulatory Policies Act of 1978 (PURPA), was a precursor for Enron’s new business of power plants. The law was intended to aid renewable energies when natural gas was considered to be a fading resource to generate electricity. Still, efficient new gas technologies qualified for the law’s preferences.

Lo and behold, natural gas became plentiful, and natural gas combined-cycle technology rapidly improved in the 1980s, generating increasing amounts of electricity per unit of gas. PURPA predated Enron, but Ken Lay, having seen good results with independent power generation at Transco, his former stop, was an early mover at HNG.

PURPA opened a new market for independent gas-fired cogeneration plants by requiring utilities to buy power at a lucrative, regulatory-assigned “avoided cost” as if the utility had built the capacity itself.⁵¹ Enron Cogeneration Company—a much-needed new profit center and, in fact, Enron’s highest rate-of-return business—built or acquired six plants between 1985 and 1988 that contributed tens of millions of dollars to the bottom line. Lay wanted this business right off the bat and found his leader in John Wing, formerly at GE.

Multiple Enron divisions benefitted from Wing’s PURPA-enabled deals. The sizeable gap between (low) gas costs and (high) avoided-cost power prices allowed the Texas City project not only to lock in high margins but also to buy 75 MMcf/d from Enron Oil & Gas “at prices substantially above spot market levels.”

Texas City’s avoided cost was based on the estimated cost of a new coal plant outfitted with expensive pollution-control equipment (scrubbers) pursuant to the Clean Air Act of 1990. The difference between Wing’s $300 per kilowatt high-efficiency cogen plant and the regulatory-approved $1,100 per kilowatt of installed coal capacity allowed (regulatory) windfall profits for EOG and transporter HPL.⁵²

This power-sales contract was so high that natural gas could be profitably purchased from EOG at $3.25/MMBtu (with a 6 percent escalation factor) at a time when spot gas was averaging less than $2.00/MMBtu. Credit Enron for fully capitalizing on regulatory opportunity, one of many instances that defined a politically alert company operating in a politically shaped industry.

Under a more reasonable interpretation of avoided cost, the power contract would have been based on the utility’s constructing its own gas-fired cogen plant (what Enron’s John Wing was doing). The gas-purchase price would then have had to be closer to spot. But Texas Utilities as a franchised monopolist was indifferent so long as it could sell the (PURPA) purchased power.

Captive electric ratepayers, in other words, lost what Enron gained in the 1984–89 heyday of PURPA. An energy-crisis law had quite different results in an energy-surplus era, an unintended consequence of government intervention from changed markets.

Export Aid. Enron’s infrastructure projects in the least-developed areas of the world were enabled by long-standing laws that created the Export-Import Bank (Ex-Im) in 1934 and the Overseas Private Investment Corporation (OPIC) in 1971. Rebecca Mark’s mandate was to “plant the flag for Enron in as many developing nations as she could.”

Why go to the poorest, riskiest markets? Because other energy companies were ensconced in the better markets, and Enron wanted the higher profits that came from greater risk. Government financing and/or government risk insurance, combined with Enron’s favorable reputation post-Teesside, were enough to attract other private financing to get projects done.

Ex-Im was reauthorized three times in Enron’s solvent life: 1986, 1992, and 1997. When OPIC’s reauthorization was blocked by a House vote in 1996, Enron’s lobbying went into high gear. “As we move toward projects in Croatia, Mozambique, Bolivia, Poland, and a number of other emerging democracies,” Ken Lay wrote in the Journal of Commerce, “OPIC will again be a key agency enabling Enron to contribute to private investments to these struggling countries.”

Ex-Im and OPIC were joined by other taxpayer involvement with Enron’s overseas ventures. According to one study, “at least 21 agencies, representing the U.S. government, multilateral development banks, and other national governments,” approved $7.2 billion for 38 Enron-related projects in 29 countries.

No other company before or after could point to the breadth of such assistance. The irony was evident. “There were times when Lay’s lobbying seemed at odds with his oft-stated belief in free-market solutions,” noted Bethany McLean and Peter Elkind. “A classic example was Enron’s dependence on such government agencies as [OPIC and Ex-Im].”

Shaped Intervention

Enron shaped, but did not originate, important legislation and administrative regulation between 1984 and 1996. Two major areas were (1) MOA for interstate natural gas transmission and (2) emissions regulation under the Clean Air Act as amended in 1990.

FERC Open Access: Wholesale Gas. FERC’s aforementioned implementation of mandatory open access began with a May 1985 Notice of Proposed Rulemaking that became administrative law later that year.

Regulation of Natural Gas Pipelines after Partial Wellhead Decontrol (FERC Order No. 436) birthed a national interstate gas commodity market. The new regime for pipelines was supported, even championed, by HNG/InterNorth and personally lobbied for by Ken Lay.⁵³ The rules for MOA were finalized in the Pipeline Service Obligations and Revisions to Regulations Governing Self-Implementing Transportation Under Part 284 of the Commission’s Regulations. FERC Order No. 636 of 1992 was Enron-stamped: “Many of the proposals advocated by HNG/InterNorth in our written comments are incorporated into the Final Rule,” an internal Enron memorandum stated.

Enron’s interstates were entirely open access by 1993. No longer did Transwestern, Florida Gas, Northern Natural, or Northern Border buy or sell gas; they only transported gas owned by others (including arm’s-length Enron affiliates). From Enron’s viewpoint, the transition had gone well. “Order No. 636 will have a positive impact on Enron and the natural gas industry as a whole,” read the company’s 1993 Form 10-K. Echoed the annual report: “Full implementation of the Federal Energy Regulatory Commission’s (FERC) Order 636 and the successful settlement of all significant regulatory issues on our interstate pipelines during 1993 should provide a constant and reliable stream of cash flow over the next several years from our largest single earnings contributor” (meaning the now-unbundled pipelines).

MOA to all 28 major interstate pipelines, not only to Enron’s several, allowed Enron Gas Marketing (1986–90), Enron Gas Services (1990–94), and Enron Capital & Trade Resources thereafter to profitably buy and sell natural gas nationwide. “We’re going through a ‘once in a hundred years’ transition in this industry,” Jeff Skilling told employees in 1994. He was speaking about natural gas, but the same “infrastructure socialism” with electricity was ahead, first at wholesale and then, if Enron’s massive lobbying bet succeeded, at retail.

Clean Air Act Emissions Control. What became the Clean Air Act of 1990 (aka the acid-rain bill) was of vital importance to the gas industry, partly because Enron made it so. Ken Lay testified on behalf of both the Interstate Natural Gas Association of America and the American Gas Association (the industry’s midstream and downstream trade groups, respectively) before the Subcommittee on Energy and Power (House Committee on Energy and Commerce) in September 1989.

Emphasizing how natural gas had “virtually no sulfur dioxide emissions and one-third the nitrogen oxide emissions of coal,” Lay argued for a “freedom of choice” approach to allow electric utilities to reduce emissions via SO₂ and NO_X trading. “Legislation should not mandate the installation of scrubbers by utilities,” Lay implored. Nor should so-called clean-coal technologies be subsidized beyond the feasibility stage for commercialization.

Emission-reduction requirements should be allocated systemwide, regionally, or statewide, not quantified by individual plant. Lay and the gas industry also supported emissions trading and a tax on other fossil fuels (not natural gas) “to help fund the [emission reduction] program.”

Enron stood to benefit in existing and potential ways. Higher gas demand benefitted Enron’s exploration and production, transmission, and marketing businesses. Prospectively, emissions trading in SO₂ and NO_X could be done by a well-positioned gas company, such as Enron. And methane-intensive oxygenates could be important on the transportation side, a frontier for natural gas. Within several years, in fact, Enron would become a major player in both emissions trading and reformulated gasoline.

The Clean Air Act of 1990 moved the marker for Ken Lay. Before, his lobbying had been about getting back to even with coal, legislatively and administratively. Now, it was about getting ahead. In speeches and in print, Lay cajoled electric utilities to go “beyond Clean Act compliance” with “natural gas co-firing, gas conversion, or new gas-fired capacity [that] would hedge the risk facing ratepayers resulting from potential CO₂ emissions limits or taxes in the future.” Carbon dioxide regulation? That was another gas-for-coal and gas-for-oil play that Lay and the Enron-pushed natural gas industry sought.

Championed Intervention

Enron was also instrumental in enacting major legislative provisions. One home run was a clause in the Energy Policy Act of 1992 requiring electric utilities to provide transmission services to outside parties for sale-for-resale transactions. As told in chapter 11, this provision birthed wholesale power marketing, of which Enron became the market leader, and set the stage for retail MOA, the subject of chapter 15.

Another Enron-driven provision was in the Omnibus Budget Reconciliation Act of 1990, which provided a tax credit of $0.52/Mcf for natural gas sales from qualifying tight-sands gas wells drilled in 1991–92. The pretax benefit of $0.80/Mcf for Enron Oil & Gas equated to a 50 percent increase in the then price of wellhead gas.

Although already producing such gas, EOG “did a 180-degree shift” to became the nation’s leading tight-sands company. Enron’s 1991 annual report stated the good news: “The supportive role Enron Oil & Gas played in the passage of tight sands legislation … could be worth more than $100 million to Enron on a net present value basis.” The cumulative effect, in fact, would be double this.

Far from coincidental, Enron and EOG “diligently” worked to give an expired credit new life. “We spent a lot of time working that issue and actually got an extension of the Section 29 credits, which had, frankly, expired,” remembered Joe Hillings, head of Enron’s Washington office. “Enron essentially was the biggest winner in that legislation.”

EOG tried and failed to extend the start date for qualifying wells past 1992, but drilled wells had a 10-year credit window, which resulted in a nine-figure tax savings as wells drilled in 1991–92 gave their bounty.

Enron’s Washington office often responded to company emergencies with legislative fixes. One was the aforementioned pushback against funding cuts for OPIC and Ex-Im. That was defense. On offense, one emergency concerned two Enron pipeline expansions that faced a shortage of pipe and construction delays from a tariff on imported steel. So, in 1989, “Enron succeeded in inserting language into the law that created a short-supply relief mechanism.” In this instance, Enron’s benefits were shared by consumers.

Joe Hillings, Cynthia Sandherr, and the rest of Enron’s staff in the nation’s capital were always busy with the day-to-day minutiae of national and international Enron. Setting up visits between Enron developers and foreign dignitaries or trading favors with the US Department of Energy or the US Department of Commerce were the daily fare of a fast-track company in a political world.

Desired Intervention

There was legislation and administrative regulation that eager Enron could not land. One area concerned an oil-import tariff promoted by Ken Lay to reduce oil-to-gas competition. A more ongoing effort was to regulate carbon dioxide by pricing CO₂ emissions either by cap-and-trade or by an emissions levy. Ken Lay preferred emissions trading (in which Enron could be a market maker), but he was amenable to a carbon tax.

A third effort, the biggest of the three, was the lobbying effort to get MOA for retail electricity (and natural gas) either from individual states or via federal legislation that would pre-empt the states. That broad, costly effort would be slow, mixed, and ultimately unsuccessful in Enron’s life.

Oil Tariff. Oil was a thorn in the side of the natural gas industry beginning in the mid-to-late 1980s. Fuel switching in dual-fuel power plants was an issue in markets served by Florida Gas Transmission and by Transwestern Pipeline. Cheap gasoline was a barrier to commercializing natural gas vehicles as well.

In the 1980s, Lay flirted with endorsing an oil-import fee, a policy he had championed with Jack Bowen back at Transco. Lay stopped just short of protectionism in the wake of the 1986 oil price collapse. But in mid-1991, after the Gulf War, he endorsed an oil tariff in a speech before the Aspen Institute Energy Policy Forum, a sort of trial balloon.⁵⁴

Lay went all in with a four-page Enron press release in early 1993: “Enron Corp. Chairman Kenneth Lay Cites Means by Which to Rebuild U.S. Energy Infrastructure, Create New Jobs and U.S. Investment.” In the Petroleum Economist, Lay proposed a $5 per barrel, $75 billion tariff to drive greater domestic oil and gas production, as well as to underwrite crude-oil purchases for the Strategic Petroleum Reserve. Little thought was given to the politics and mechanics of the policy, such as an inability to tax oil from Canada on one side and Mexico on the other, following the passage of NAFTA (which he strongly supported).

CO₂ Limits. “I think we need to do something,” Ken Lay told a conference of academics and industry leaders in 1996. “Perhaps the first thing will be some kind of an emissions trading system where we will put some limitation on CO₂ emissions…. I do not think we will see a big carbon tax for some time.” In fact, pricing CO₂ had been a goal of Enron’s CEO since the global-warming issue emerged in 1988. It became part of the Enron-led “corporate green movement” that split the fossil fuel industry into two parts, if not into three.

Lay led the charge, even when he was outnumbered in the gas industry and perceived as ceding to the Democrats and anti-industrial Left. “Maybe we ought to be very careful about leading the fight to kill the carbon tax,” he diplomatically suggested to Natural Gas Week in 1990. Two years later, Lay endorsed Clinton’s Btu tax so long as it had a “heavier tax on dirtier fuels.”

Pricing CO₂ was an intervention that promised profit opportunities in divisions across the company. Four were gas production, transmission, and marketing, as well as gas-fired power plant construction. Enron’s entry into solar (1995) and wind power (1997) were two more. Outsourcing for electric utilities via Enron Environmental Services brought the count to seven.

Emissions trading rounded out the list. Enron entered this last-named market in early 1993 with the acquisition of the air-emission consultancy AER*X, which traded SO₂ allowances in Los Angeles pursuant to regional regulation. The founder and president of AER*X, John Palmisano, would join Enron and get busy as Enron’s chief climate lobbyist to pursue CO₂ trading.⁵⁵ Before it was all over, as an ex-Greenpeace official observed, Enron would be “the company most responsible for sparking off the greenhouse civil war in the hydrocarbon business.”

MOA: Retail Electricity. The most coveted government intervention, the linchpin of Enron 2000 (the promise to double the size and profitability of Enron in five years), was state-level retail access for natural gas and electricity. Utilities would not voluntarily grant marketers such as Enron access to their customers, whether it was off the last increment of pipe for gas or of wire for electricity. State regulatory authorities would have to compel MOA.

MOA was achieved for wholesale gas via FERC regulations between 1985 and 1992. The same was achieved with wholesale electricity via the Energy Policy Act of 1992, implemented by FERC in the next years. This left retail, which was a state-by-state battleground, short of a federal law to preempt state authority and get it all done in one step. Enron pursued both with vigor, an effort that began in 1995 and reached its apogee with the California electricity crisis in 2000, a subject of the final book in this tetralogy.

Surging ENE

In its first decade, Enron was relatively successful in a period of industry turmoil, giving the appearance of superior vision and execution by Ken Lay, his top management, and a motivated, talented workforce. A company valued at less than $2 billion in the mid-1980s doubled its market capitalization to $3.5 billion in 1991, doubled it again by 1994, and reached a market value of $11 billion by 1996. A stock valued at $5 per share (split-adjusted) in 1986–88 doubled by 1992 and doubled again by 1996, soundly outperforming the competition and overall market.

To be sure, net income was modest compared to the premerger days of Houston Natural Gas and InterNorth. But ENE was premium priced because of Ken Lay’s narrative about an integrated natural gas play in a new energy era, one propelled by a fourth industry segment, interstate marketing. “The natural gas industry lives, and it looks a lot like Enron,” one Wall Street analyst opined in 1992. “Those companies that live beyond the commodity price alone will do well.”

ENE’s price/earnings (P/E) ratio tells the story of increasing confidence. The company’s aggregate stock value divided by annual income increased from 14 in 1988–1991 to 20 in 1992–96. If earnings were driving valuation, this meant that investors gave every dollar of income more market worth in the mid-1990s than before, much of the optimism being tied to the surge in reported income from gas marketing.

Was the premium justified? Analyst John Olson, unlike almost all his colleagues, was wary. Oil-trading companies’ lower ratio reflected its high risk, and gas-side comparables were scant. Peer companies, mostly with pipeline assets, traded at a half to two-thirds of Enron’s P/E ratio. The 20 P/E ratio at which InterNorth valued HNG before the merger proved to be too high also, creating a goodwill account in excess of $1 billion for the new company.

Olson, in fact, had resisted the Enron narrative since 1990, causing Lay to complain to Olson’s superiors at the investment firms that did business with Enron. “Ken Lay tried to get me fired three different times,” the maverick remembered.

Vindicated in the end, Olson described a company obsessed with money and power. He characterized Enron’s “game plan” to “get rich quick” as follows: “buy influence, issue big stock options, play Wall Street, goose the stock.” Analysts, auditors, lawyers, and investment banks were paid well to perch ENE as a momentum stock, Olson noted. Enron’s board of directors, explicitly supporting and otherwise apprised of Lay’s strategy, was culpable, in Olson’s telling. So was president and COO Rich Kinder until his departure.

Enron was buying political influence across the political spectrum, issuing outsized stock options for the smartest executives in the room, strong-arming the Street to share the narrative, and paying top legal and accounting talent to game the rules. The largesse of Ken Lay and Enron would increasingly compromise external constituencies—not to mention the company’s own executives, employees, and board—to bring capitalism (but really contra-capitalism) into disrepute.

Profitable Core

Double-digit earnings growth per share for nine straight years (1988–96), a rarity in energy and practically everywhere else, was done by financial engineering (gaming). Still, Enron had five solidly profitable divisions. They were, in order of importance:

• The “cash cow” interstate gas pipelines, Enron’s major asset base and the largest overall net cash contributor in the period under review;
• Enron Oil & Gas, which became Enron’s top performer with annual cash-flow growth averaging 19 percent between 1989 and 1996—and with a debt ratio between 20 and 30 percent;
• Gas marketing, which became a notable profit center by 1989 and, with discretionary accounting help, became Enron’s largest profit contributor by 1993;⁵⁶
• Power generation (cogeneration), which became a major profit maker between 1986 and 1993 with US projects and Teesside UK;
• Gas liquids, a dependable contributor that offered contracyclical benefits when natural gas prices were low.

International, ensconced in developing countries, was profitable too. But its biggest project, Dabhol, cast a cloud on the whole unit’s performance.

EOG was the truest growth story in Enron’s stable, even accounting for its significant government-related favor. Unlike its parent, EOG was a low-cost, no-frills operator. Hoglund’s rejection of artificial earnings acceleration (“We’re not playing the easy type of game”) ensured stability. Enron would monetize EOG thrice to keep the parent’s earnings story hot before completely selling the company to public investors in 1999.

The interstate pipelines did well, increasing annual earnings by around 5 percent, more when expansion projects came on line. Cost reductions via automation and fully subscribed expansions overcame FERC’s regulated rate of return embedded in maximum rates. In the competitive liquids business, finally, annual earnings growth in the mid–single digits was good—and achieved.

Cogeneration and gas marketing were high-return businesses in a market shaped by PURPA regulation and infrastructure socialism, respectively. But competition was at work in the regulated space, normalizing returns over time. Regulators, too, pulled back their generous interpretation of avoided cost. In John Wing’s case, the lucrative US market dried up by 1990, necessitating the move abroad (to a market newly created by privatization). For Jeff Skilling, profit spreads narrowed by the early-to-mid 1990s, bad news since earnings had already been recorded for the out years of the previously done long-term deals.

Management talent drove the profitable core. Ken Lay’s philosophy to “try to get a game breaker in every key position” paid dividends and might well have been the difference between survival and failure in the dicey early years at Enron. Remuneration and payouts for superior performance, even in excess of that offered by other firms, were his means. Multiyear contracts for John Wing, Forrest Hoglund, and others were quite different from the philosophy back at Lay’s Transco, where Jack Bowen believed that top executives were paid by the day. (Hoglund did receive a five-year contract to leave Exxon and join USX back in 1977.)

Lay’s incentive approach, comparing stock values against a peer group and general market, proved to be imperfect, as short-term results could and would be overemphasized and overrewarded and as the competition rose to Enron’s pay scale. Still, Lay’s divisional heads, a few inherited but mostly new, were superior in Enron’s first decade.

Landing Forrest Hoglund in 1987 to awaken and grow Enron Oil & Gas was pure gold. Hiring Jeff Skilling, first as a consultant and then as an executive, accelerated product development in wholesale gas marketing. Interstate-pipeline head Jim Rogers was a Lay-alike who had fun shaking up FERC just as FERC was shaking up Enron and the whole industry.

John Wing in cogeneration was a value creator in PURPA-regulated space, albeit a very trying one. Only Ken Lay could keep Wing in the stable as long as was possible, a good thing judged by the projects that got done on time and within budget—and very profitably so.

Mike Muckleroy gave Enron good value, beginning with his first job as director of special projects, selling stray assets after the merger of InterNorth and HNG. Muckleroy successfully merged two liquids units into one and became Enron’s savior in the Valhalla crisis. Muckleroy was also a voice of conscience at Enron, questioning mark-to-market accounting as well as International’s overreach into unstable, anticapitalistic countries.

Two risk-mitigation strategies were instrumental in Enron’s superior performance during an industry recession. One allowed the interstate pipelines to remain cash cows; the other helped EOG prosper in a period of low wellhead prices. Both reflected instances of entrepreneurial insight and prudence that gave Enron and Ken Lay a (more-than-deserved) aura of superiority in the industry and to Wall Street.

Lay’s charge to the interstate pipelines to expeditiously settle take-or-pay claims proved sound. Producers needed cash, and Enron, unlike other interstates, did not bank on higher wellhead prices to remove its liability.⁵⁷ Wall Street liked resolution in place of uncertainty, boosting ENE as Enron’s take-or-pay liabilities fell from $1.2 billion in 1987 to “not material” by 1992.⁵⁸ This played a role in making the return to Enron’s shareholders double that of its peer group between 1987 and 1992.⁵⁹

Risk-minimization strategies helped EOG in low-price periods. “We try to hedge the prices of most of our natural gas, our more modest oil production, and the interest rates we pay,” noted Ken Lay in 1995.⁶⁰ Another corporate synergy was long-term gas sales sourced from EOG, which produced incremental gains of $131 million for Hoglund in 1990–91 alone.

But what about Enron’s naked risk taking elsewhere? Teesside II’s open-ended supply contract, for example, ignored the history of take-or-pay problems in the United States for interstate pipelines, including those of Enron. Rushing to anticapitalistic countries, and especially India, was high risk, even with government loan aid. As it was, Enron’s advertised prudence masked its imprudent strategies elsewhere, part of the false confidence Enron engendered for most of its solvent life.

Other contributions and positives of Enron’s rise to prominence should be mentioned. Financing techniques, such as credit-sensitive notes, inaugurated by Enron in 1989, were recognized as innovative in the business world. Derivatives trading with natural gas and electricity was pioneered by Enron. Securitization vehicles, although abused over time, had sound applications, such as Enron Finance Corporation’s volumetric production payments in the early 1990s.

The Enron experience was certainly positive for the large majority of employees in the period under review. By the late 1980s, Ken Lay was a nationally known corporate leader and a major figure in energy. In hometown Houston, Enron was considered one of the best companies to work for. Enron was new school, while Exxon (soon to be Exxon Mobil) remained the old-school standard of excellence. Employees were well compensated and then some with two-for-one ENE stock splits in 1991 and again in 1993. A boom was happening inside Enron, not only outside it.

Overall, Enron did find a unique niche in the cyclical energy business to outdistance and even separate from its peers. But the first-mover advantage was also becoming contra-capitalist, violating best-business practices, the morality of the market, and the political constraints of the free market itself.

Competitive Pipelining

Enron’s 1986 annual report justifiably stated that the company’s interstates “led the industry in the creation of innovative ways to serve widely different markets.” A year later, the company reported: “Enron supports the move toward deregulation as evidenced by the fact that three of its affiliated interstate pipelines officially opened their systems to nondiscriminatory transportation during the year.”

Deregulation in this sense was not FERC deregulation of rate and terms of service for interstate transmission. It referred to competition within the framework of mandated open access, whereby (unregulated) spot gas sent a price signal from the wellhead all the way to the city gate (the gas utility) or the end user (electric generator). California, served by Enron’s Transwestern, achieved real-time scarcity pricing when a cold spell in early 1987 increased prices overnight by 15 percent. “We didn’t require one regulator from Washington or any other state to allocate anything,” one participant marveled.

Enron’s intrastate system (Houston Pipe Line, later joined by Louisiana Resources Company); interstate systems (Transwestern Pipeline, Florida Gas Transmission, Northern Natural Pipeline); and four joint-venture lines (Northern Border, Trailblazer Pipeline, Texoma Pipeline, Oasis Pipeline) increased their market share in trying times. In 1985, Enron’s 37,000-mile network delivered 13 percent of the US total. Five years later, the 38,000-mile network had an 18 percent national share, where it would remain in the next years.

The interstates for many years led Enron in revenue and earnings, the work of such leaders as James E. (Jim) Rogers (1985–88), Clark C. Smith (1985–88), Oliver (Rick) Richard (1987–91), and Stan Horton (1985–2002). Each devised new means to loosen the regulatory shackles and allow entrepreneurship to generate good profits.⁶¹

Enron’s interstates busied FERC with innovative proposals to liberalize their rates and terms of service. Early on, Enron forced FERC to confront the long-standing public service obligation of interstates (including Enron’s) to obtain and deliver supply now that federal policy voided pipeline sales in the open-access era. “Like a velvet hammer, executives of the 37,000-mile pipeline are prepared to break new legal ground in forcing FERC to decide this issue,” Natural Gas Week reported in 1987.

Transwestern, a relatively simple rifle-shot pipeline to California, received a whole new management team when it was acquired in early 1985. It became Enron’s “laboratory” in pushing market and regulatory change. Transwestern, as well as the company’s other jurisdictional pipelines, blended market and regulatory activism by several means:

• Supporting and refining FERC’s open-access transportation policy, while suggesting how pipeline gas could be competitive with spot gas to avoid wellhead take-or-pay liabilities.⁶² “We were, consequently, leaders in the natural gas restructuring process,” remembered Stan Horton. “We tried to be first in everything that we did.”
• Pricing transportation services at market rather than cost-based regulatory maximums. Beginning in 1985, Enron’s rate proposals contained such adjectives as negotiated, flexible, seasonal, incentive, fair-value, and market-based—all intended to better reflect shifting demand and changing cost.⁶³ Between legalized flexibility and market competition, the Natural Gas Act of 1938 was becoming anachronistic. “Despite the fact that interstate pipelines still are regulated and the FERC will set minimum and maximum rates for each of our unbundled services,” Horton remarked in 1993, “we’re finding that competition is determining what we can actually charge.”
• Entering new markets to increase competition and pushing FERC to expedite certification for much-needed new natural gas capacity. Regarding the former, Enron-led Mojave Pipeline, first proposed in 1985, challenged a long-standing California monopoly divided between the state’s two major gas utilities. Regarding the latter, Transwestern pushed FERC and set “a modern-day record” of 18 months from application to completion (September 1990–February 1992) to end natural gas shortages in the Golden State.⁶⁴

A highlight of Enron’s FERC-leading initiatives was a pioneering rate-case settlement by Transwestern (effective November 1996) that effectively deregulated the pipeline for a decade. The negotiated agreement with some 25 customers, prompted by an immediate revenue shortfall for Transwestern from a large expiring contract, shared risks and rewards, and left the pipeline with contractual responsibilities instead of regulatory ones, as had been the case. Rates were indexed to inflation, leaving Transwestern with the opportunity to take improved efficiencies to the bottom line for a decade (rather than every three years in the traditional rate case). With this and other entrepreneurial decisions, a nominally FERC-regulated pipeline put itself in position to be “a growth story for Enron.”⁶⁵

Transwestern’s settlement “shows that tough situations can be handled through the self-regulation of long-term contracts,” offering the upside of “eliminated regulatory costs, increasing business certainty, and increasing entrepreneurial opportunity,” an internal Enron memorandum by this author noted.

Enron’s pipelines developed new information technology and protocols to compete in the new open-access world. As the largest and most flexible operator, Enron found itself acting as a bank whereby its rivals could borrow (short) gas during tight supply periods for repayment later (profit was not allowed for gas buying and selling by regulated interstates). This led Ken Lay to confront other pipeline CEOs at a 1990 board meeting of the pipeline trade group, Interstate Natural Gas Association of America (INGAA). “Ken Lay’s quite forceful language behind closed doors was arguably the beginning of the protocols operational flow orders and operational balance agreements that became the industry norm by 1992,” remembered one participant.⁶⁶

Enron’s investment in information technology under MOA transformed a balkanized latticework of pipe into a “single networked system.” It began with electronic bulletin boards in 1994 and culminated several years later with the FERC-directed Gas Industry Standards Board (GISB), which codified more than 100 best-practice standards for nominations, allocations, title transfers, and invoicing. All told, Enron led the industry in best practices by which independent marketers (non-ECT, ECT) competed fairly and cleanly.

Enron had a Teesside-worthy success with the acquisition, revitalization, and growth of the southern side of Argentina’s natural gas–transmission system. In 1992, an Enron-led consortium purchased the 1.3 Bcf/d, 3,800-mile Transportadora de Gas del Sur (TGS) for $550 million. Importing its North American expertise, Enron turned an aging, 85-percent-utilized system into a fully utilized modern pipeline and expanded the line by 25 percent the next year. Performance incentives were met to earn extra profit—what FERC could never finalize as incentive ratemaking at home.

Led by such notables as Mike Tucker and George Wasaff, this best-of-Enron venture contributed to what became recognized, at least for its too-brief time, as the third Latin American miracle.⁶⁷ True, politics was heavily involved with the government as seller and close regulator, and Enron received political-risk insurance from OPIC. But as a case study in the private-sector reform of a hitherto ailing, underachieving government asset, TGS in the 1993–99 era was very successful.

Commoditizing Natural Gas

From the beginning, Enron was the leading gas marketer in the United States. It was in the DNA of both Houston Natural Gas Corporation and InterNorth Inc., the precursors of Enron. Houston Pipe Line was an experienced gas seller in the very competitive, virtually unregulated Texas market; Northern Natural Gas Pipeline’s salesmanship culture was necessitated by its “spaghetti lines” serving small Midwest locals.

Interstate gas marketing became a fourth industry segment (joining the traditional production, transmission, and distribution segments) under the mandatory federal rules of infrastructure socialism. At Enron, it began with the Transportation & Exchange division of Northern Natural, which grew into a nonregulated affiliate, Northern Gas Marketing. NGM became the guts of HNG/InterNorth Gas Marketing, renamed Enron Gas Marketing (EGM) in 1986, headed by a new hire from Transco, John Esslinger.⁶⁸ EGM became EGS in 1991 and ECT in 1994.

EGM became a notable profit center by 1989, supplementing its short-term sales with high-margin long-term contracts. Gas Bank, described in chapter 5, was the beginning of a portfolio approach offering to gas utilities, electric utilities, municipalities, or independent power generators a variety of products differing in price (variable, fixed, or both); term (multimonth, multiyear, or both); and service (firm, interruptible, or both). What had been chocolate and vanilla (firm or interruptible for the long term) was now 31 flavors.

The second takeoff began in 1990 when Jeff Skilling’s Enron Finance Corporation developed new ways to lock up gas supply to satisfy a waiting long-term sales market.⁶⁹ The same year inaugurated natural gas futures trading, which gave the gas market a national pricing point from which basis differentials across the country could be tied.

With firm gas supply in hand (no easy task, as described in chapters 8 and 9), EGS ramped up gas marketing to electric generators: first the independents and then the utilities. Business strategist and historian Malcolm Salter recognized a “complete virtuous circle” of buying, selling, and, often, transporting the same gas. Ken Lay’s Natural Gas Standard, stressing the economic and environmental benefits of methane relative to coal and oil, was brought to fruition by Jeff Skilling in what was, arguably, Enron’s greatest contribution to the gas industry—and business generally.

Enlarging the market from physical to financial products, as well as standardizing complex contracts, thus reducing negotiations from months to weeks, was part of the EGM/EGS/ECT contribution. Calls, puts, options, forwards, hedges, swaps, hybrids, and other “exotic options” were pioneered by Enron for gas and adopted by the industry in the early-to-mid 1990s. Small wonder that Enron was tops of several hundred gas-marketing companies in terms of volume and overall reputation from the late 1980s forward.

Enron made natural gas the “fuel of choice” for electrical generation—intellectually, operationally, and in public policy. Enron’s chairman explained time and again (as did virtually all energy economists) that federal price controls on natural gas had resulted in physical shortages and, ironically, artificially high prices in the end. Deregulated prices would coordinate supply and demand, Dr. Lay knew, as well as improve confidence in natural gas for long-lived projects, and none more than for power generation.

Led by economist Bruce Stram, Enron challenged the pessimistic “hard landing” studies of private consultants predicting that then low gas prices would result in declining natural gas production, higher prices, even physical shortages. The first Enron Outlook for Natural Gas (1989) forecast year-2000 demand of 18.5 trillion cubic feet at a time when Groppe, Long & Littell (1987) and McKinsey (1988) predicted a much smaller market. (The actual figure of 19.2 Tcf made Enron a tad low but quite accurate.) Enron’s 1991 Outlook for Natural Gas increased its estimate to 22 Tcf for 2005, which proved exactly on the mark.⁷⁰

Enron’s bottom-up forecast correctly captured the growth in gas demand for power generation and strong supply from drilling improvements despite prices that were lower than predicted. EOG proved Enron right regarding the latter, and EOG Resources would continue to lead the upstream gas market (and, post-Enron, eventually become the nation’s leading onshore lower-48 oil producer).

As detailed in chapter 7, Ken Lay and Enron worked tirelessly to level the playing field for natural gas. This meant repealing the Fuel Use Act of 1978 and the incremental-pricing provision of the Natural Gas Policy Act of 1978, both of which artificially advantaged coal in the all-important electric-generation market. Getting utilities and their regulators to think as if they were subject to market forces (rather than maximizing the regulatory rate base) before building a new coal plant (rather than a gas plant) yielded a more efficient outcome, though still a government-influenced one.

Enron did more than commoditize natural gas to challenge, and beat, coal in head-to-head competition at home. Teesside’s “privatization showcase” sparked England’s “dash for gas” in place of government-protected coal-fired generation. British Gas (later BG), which hitherto called the shots in the region, had geographical competition for the first time—from US-based Enron, no less. In the UK and other European markets, ECT commoditized natural gas in the mid-to-late 1990s within what had been a monopolistic, balkanized market.

Bourgeois Vice

This category of contra-capitalism is the most internal and personal: violations of the “capitalist spirit” that comprise “the bourgeois virtues.” One interpreter of Adam Smith listed those virtues as “prudence, restraint, industry, frugality, sobriety, honesty, civility, and reliability.”

A century after Smith, Samuel Smiles exalted respect, reverence, honesty, thrift, politeness, courtesy, generosity, forethought, and economy, and, most of all, a focus on the longer term via perseverance. The antibourgeois vices, according to Smiles, included avarice, greed, miserliness, fraud, injustice, thoughtlessness, extravagance, selfishness, and improvidence.

Charles Koch has recently codified the important virtues driving business success. In order to “optimize resources,” it is necessary to “adjust value for risk,” proceed by “experimental discovery” (trial-and-error), “challenge hypotheses,” and “admit mistakes” and “take responsibility.” But Koch goes deeper by also emphasizing how each employee must have “respect” and “empathy” for others; act with “integrity”; have “passion” and “pride” in work—yet maintain “humility” in the face of limitations and ignorance.

Enron stressed values in its corporate culture to go along with its aggressive visions (which circa 1996 was to become the world’s leading energy company). In its final and highest form, “Our Values” were respect, integrity, communication, and excellence (RICE, for short).

Three of the four values—respect, communication, and excellence—were internal, telling employees, in effect, to get along, work well, and get results. But Enron’s other value—integrity—was both internal and external: “We will work with customers and prospects openly, honestly and sincerely.” Then the second part: “When we say we will do something, we will do it; when we say we cannot or will not do something, then we won’t do it.”

But was the “something” being done ethically?

Contra-capitalism was not halted by any of Enron’s values except integrity. Moreover, missing from RICE (as interpreted by Ken Lay and Enron) were the capitalistic virtues of humility, honesty, transparency, and respect for consumer-driven, taxpayer-neutral markets.

Enron’s enunciated values were, at best, a safe harbor, a check-the-box exercise, a mask, rather than a firm check against employee and company misbehavior. Values were not fixed but adopted pragmatically. The ends (avoiding failure, declaring success) justified the means; the means were not held to be inviolate regardless of ends.⁷¹

Philosophic Fraud

Even when it does not violate the law, philosophic fraud violates the market’s spirit and frustrates its efficient working. The ability of dispersed knowledge to morph into a rational, undesigned whole is hampered; mutually beneficial exchange thwarted; and reputational trust (a hallmark of commerce) diminished.

Market signaling via prices and profits can be compromised to the point that the guilty firm misleads itself. (Enron’s clever finance and accounting executives certainly fooled the rank-and-file.) Worse, the dishonest company must continue its dishonesty in order to cover up its past. Two disciples of Ayn Rand described the mental process of the dishonest CEO: “He is shifting his primary focus away from the facts relevant to the conduct of his business and toward the deception of others.”

This is the context in which historians of Enron must characterize Rich Kinder’s insistence on making the numbers, Jeff Skilling’s mark-to-model accounting, Rebecca Mark’s snowball, and Andy Fastow’s special-purpose vehicles. In Enron’s next and final phase, such philosophic fraud would spread and grow, leading to corporate collapse.

“Contracts, or promises obtained by fraud, violence, or under fear, entitle the injured party to full restitution,” wrote natural-rights philosopher Hugo Grotius in 1631. “For perfect freedom from fraud or compulsion in all our dealings is a right which we derive from natural law and liberty.” In short, Enron’s illegalities cannot be pinned to free enterprise or its rules, traditions, or ethics.

As detailed in Book 1, opportunistic deceit has long been denounced by classical liberals, from Adam Smith to Samuel Smiles to Ayn Rand to Charles Koch. In Enron’s case, a variety of contra-capitalism, philosophic fraud, was employed to reach Ken Lay’s heady goals.⁷² Most infamously, Enron gamed the US accounting code in order to portray the company as more profitable than it really was.⁷³

When seeking permission to use mark-to-market accounting (not an inherently fallacious method), Enron assured the Securities & Exchange Commission that its calculations of revenue and profits would be based on “known spreads and balanced positions” rather than be “significantly dependent on subjective elements.” In fact, as explained in chapter 8, upon receiving SEC permission in January 1992, Enron Gas Services retroactively applied the methodology to 1991 earnings, telling the SEC that the action was “not material.”

Yet the switchover gained $25 million, or 10 percent of the unit’s total earnings, allowing Lay, along with COO Rich Kinder, to gush about the unit’s “exceptional” performance in the 1991 annual report. For Enron as a whole, that increment helped turn single-digit earnings growth into a 20 percent growth story, boosting ENE’s year-end price.

Books and articles have portrayed Enron’s financial practices as fraudulent and illegal. (Enron also pioneered financial practices that notably benefitted energy producers and energy consumers in the early 1990s.) But less than criminal were Enron’s “exquisitely fine judgement calls” exploiting “the shadowy space of legal ambiguity,” as Harvard Business School’s Malcolm Salter noted.

“Many of Enron’s complex transactions, questionable accounting choices, vague disclosures, and corporate reorganizations” occurred in “the penumbra between the clear light of wrongdoing and the clear light of rightdoing,” Salter found. “While an alarming portion of Enron’s financial maneuvers had an aroma of deception, lacked respect for the spirit of the law, and thus reflected ethical delinquency, much of this behavior was not clearly unlawful.”

Enron’s problem was not complex financial deals per se—or the government’s tight regulatory controls (which in fact lulled watchdogs into complacency). It was that Enron’s “culture of gamesmanship” (aka philosophic fraud), violated classical-liberal entrepreneurship. Enron was contra-capitalistic, not only ethically challenged.

Political Capitalism (Rent-Seeking)

A sociopolitical category of political capitalism joins the moral (bourgeois vice) and the epistemological (philosophic fraud). As developed by the late socialist historian Gabriel Kolko, political capitalism refers to the acquisition of political means to achieve economic success. Although Kolko believed it was an inevitable aspect of capitalism, its practice has been denounced by capitalist thinkers as unfair and (socially) uneconomic, from at least the time of Adam Smith.

This book refers to businesses’ pursuit of special government advantage as rent-seeking. Sociologically, the prevalent practice of firm or trade association rent-seeking is called political capitalism.⁷⁴ When the advantages are granted to a donor or a friend, political capitalism becomes crony capitalism.

Typologically, the most flagrant forms of contra-capitalism—rent-seeking achieved by political capitalism, even crony capitalism—have been denounced over the centuries by classical liberals. “I expect all the bad consequences from the chambers of Commerce and manufacturers establishing in different parts of this country, which your Grace seems to foresee,” Adam Smith wrote in 1785. “The regulations of Commerce are commonly dictated by those who are most interested to deceive and impose upon the Public.”

Some 150 years later, Ayn Rand wrote: “I glorify the real kind of productive, free-enterprise businessman in a way he has never been glorified before,” but “make mincemeat out of the kind of businessman who calls himself a ‘middle-of-the-roader’ and talks about a ‘mixed economy’—the kind that runs to government for assistance, subsidies, legislation and regulation.”

In our day, classical-liberal entrepreneur Charles Koch has denounced “corporate welfare” as bad business. “The role of business is to respect and satisfy what customers value (even if it’s other forms of merchandizing) rather than lobbying the government to mandate what can or cannot be offered,” he explains. “Such activities are the ultimate form of disrespect for customers.”

Enter Enron, whose profit centers time and again benefitted from special government favor, some inherited and much expressly sought in state capitals and in Washington, DC. More than just a strategy, rent-seeking became a core competency at this corporation—and, in the frantic end, a life-preserver out of reach.

Mandatory open access for energy trading; loan assistance for international projects; tax credits for domestic tight-sands production; solar and wind production tax preferences. No less than seven Enron profit centers were tied to Ken Lay’s cause célèbre: (government) priced carbon dioxide emissions. Little wonder that Enron had an unmatched donor profile at the local, state, and federal levels—crony capitalism in action.

True, political interference with markets has long marked the American economy. True, identifiable business interests have self-interestedly shaped much of that intervention. But in size and scope, Enron benefitted from government subsidies and regulations as no other leading US company ever had.