The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (51 page)

Statewide blackouts were narrowly averted at the last minute when U.S. Energy Secretary Bill Richardson imposed a state of emergency, requiring marketers to sell to California.

Incredibly, around the same time, Ken Lay telephoned Richardson and asked him to use his emergency powers to deregulate the nation’s electricity transmission grid. “We don’t think we can do that,” Richardson replied. “We don’t think it is appropriate.” A former Richardson aide said, “I was floored by the request. I couldn’t believe they were asking this.” Even one of Enron’s lobbyists later called it “a dumb idea.”

During the first week in December, power had become incredibly scarce. Nearly a quarter of the state’s entire system was off line, and the ISO was unable to buy in-state power that fell under the price cap because prices as high as $5,000 a megawatt in neighboring states were sucking supply out. The situation was so desperate that the CEO of the ISO finally asked the FERC to, in essence, abolish the price caps. The FERC complied on December 15. By the following week, prices had risen to as high as $1,500 per megawatt.

Inside Enron, meanwhile, the lawyers had held another two days of meetings in Portland on December 11 and 12. It was at these meetings—several months after first learning of the West Coast traders’ strategies—that they finally told the traders to stop. The lawyers still hadn’t decided if Belden’s actions were illegal or not, but by that point, several lawsuits seeking class-action status had been filed in San Diego against Enron and other power companies. “We were stopping because the heat was too hot,” says Sanders.

By then, though, Belden had other things on his mind: he and his wife were waiting for their first baby (a boy) to arrive. On December 21, a friend e-mailed him: “Hey you must be going crazy with the California energy crisis! Is SoCal and PCG going out of business or what???????” Belden wrote back: “any day now . . . the official due date is christmas. i’m ready. sue is ready. bring it on. work is crazy! pcg and eix are running out of cash. it’s not a pretty situation. those safe utility bonds aren’t quite so safe anymore . . .”

Did the effective elimination of price caps end the California crisis? Not a chance. Though Enron had long argued that the caps were an impediment to the free flow of electricity in California, when they were finally lifted, the crisis seemed only to worsen. By mid-January, the credit rating of the utilities was sliding toward junk from fears that they would default on their debt. On January 17, rolling, hour-long blackouts swept through Northern California. For an hour at a time, modern life ground to a halt: elevators packed with passengers stopped between floors. Traffic accidents occurred because traffic lights suddenly shut down. Computers and ATMs went blank.

Governor Davis, who refused to allow the utilities to raise the rates they charged consumers, signed an emergency order permitting the state to buy power on behalf of its citizens. To keep the power California so desperately needed from flowing to other states offering higher prices, Davis and others began to call for regional price caps, a move that Enron vehemently opposed.

Meanwhile, the legacy of the entire mess was starting to be felt. In a
San Francisco Chronicle
survey, 92 percent of Californians described the deregulated energy market as a problem. In January 2001, according to a later Moody’s presentation, Belden’s West Coast power desk had its most profitable month ever: $254 million in gross profits.

It was around this same time that Belden’s actions were publicly acknowledged by his superiors at Enron. No, he wasn’t reprimanded—he was
promoted,
to managing director. Later, he was put on the powerful vice president’s PRC committee, meaning that he evaluated the performance of the company’s vice presidents, helped set bonuses, and recommended promotions. (Ben Glisan and Michael Kopper were also on the committee.) “i looked at that list and thought—wow, i’m hanging with the muckety mucks now . . . the down side is that i have to go to houston and hang out in meetings,” Belden e-mailed a colleague. In 2001 alone, Belden was paid over $5 million in cash bonuses, ranking him among Enron’s top earners.

 • • • 

The crisis didn’t end until the summer of 2001. In April, Pacific Gas & Electric filed for bankruptcy. Two months later, the FERC finally decided to reverse course and instituted price caps across the Western market. Enron had lob-
bied furiously to prevent the caps from being approved, arguing, as ever, that they’d only make matters worse. (Of course, regionwide price caps would also eliminate such strategies as megawatt laundering.) But by then, the FERC was under too much political pressure from the other direction; it finally sided with California.

This time, the tactic appeared to work. By the end of June, prices were down to $43 per megawatt hour at one key hub, well below the cap of $92, according to McCullough. The last emergency took place on July 3, after which everyone began toting up the damage. During the crisis, California paid some $40 bil-
lion for electricity, more than quadruple the cost during a similar period a year earlier.

And yet, it’s impossible to say with certainty that the caps themselves were what did the trick, just as it’s impossible to say for sure what caused the crisis in the first place. Even now, opinion is widely divided on the question, and hard answers are nearly impossible to come by. Was the culprit California’s flawed deregulation plan? Or was it the power companies, which learned to manipulate the market and took greedy advantage of the loopholes they found?

Throughout the crisis, this debate had raged on, with most Californians convinced that their state’s power infrastructure had been abused by the companies that sold the state its electricity. “Why are prices on a Sunday in 1999 seven times lower than prices on a Sunday in 2000?” asked an executive at Southern California Edison, summing up the prevailing view for the
Los Angeles Times
. “Same load [demand], no plants are out or anything like that. What would do that? . . . As demand started going up, the marketers figured out a way that they could exercise market power.”

Later, others argued that the energy companies were indeed exercising market power. After Enron collapsed, the FERC, while still blaming a “significant supply shortfall and a fatally flawed market design,” also agreed with many of California’s allegations, arguing that there was “clear evidence of market manipulation” on the part of many of the big energy traders, including Enron. The FERC also said that Belden’s strategies were “forms of gaming based on price manipulation and the falsification of information.” The FERC would also—long after it mattered—strip Enron of its ability to compete in gas and electricity markets. But even that didn’t end the debate. It seems that no one agrees what the rules should be when it comes to a commodity that is essential to modern life.

But the academic debate was lost on Californians, who were enraged at the way the nation’s energy executives and their political supporters had dismissed their pain so cavalierly. It was as if their complaints were the baseless grumblings of rubes who were incapable of fully appreciating the glory of the free market.

“The deregulation that wasn’t,” sniffed McKinsey, Enron’s favorite consulting firm. “As they suffer the consequences of their own feckless policies, political leaders in California blame power companies, deregulation, and everyone but themselves,” Texas Senator Phil Gramm (whose wife, of course, sat on Enron’s board) told the
Los Angeles Times
. “Price caps are not a help,” said Vice President Dick Cheney. “They take us in exactly the wrong direction.” “California has done nothing to curb demand and nothing to help supply,” said Dynegy CEO Chuck Watson. “Even an old econ major from Oklahoma State like me realizes that’s a collision course.”

No one was smugger or more dismissive than Enron executives themselves, and no one was more insistent that they had done absolutely nothing wrong. Skilling “clearly thinks Californians should be thanking Enron, not castigating it, for its role in trying to push open the state’s power markets,” wrote
BusinessWeek
in February 2001. “We’re on the side of angels,” Skilling said.

In an interview he gave to the online financial site the Motley Fool, Skilling said of California’s degulation effort: “It is something I think that a central planner from the old Soviet Union would understand exactly.” “You probably couldn’t have designed a worse system,” he told Reuters. And as late as June of 2001, he was still taking potshots at the state. At a conference in Las Vegas, Skilling offered up an astoundingly insensitive joke: “You know what the difference is between the state of California and the
Titanic
?” he asked, with a grin. “At least the lights were on when the
Titanic
went down.” Later, in that same appearance, he added, “Please do not use the terms California and deregulation in the same sentence.”

Ken Lay was every bit as dismissive. At one employee meeting, he said that California had “set up a system that was doomed to failure at the beginning . . . they’re going to have a really, really tough summer, much tougher than they’re talking about. . . . I mean it could be almost catastrophic from the standpoint of electricity shortages and blackouts . . . now we’ll try to work with them and help them where we can, but indeed, we think they ought to be trying to make the system work effectively with competition and with markets.”

In a March 27, 2001, interview with the PBS show
Frontline
, Lay cited the lack of new power plants as the primary cause of California’s crisis and brushed off any suggestion that Enron might have done something wrong. “If we think there’s market power, if we think there’s manipulation by anybody in the industry, either inside the state or outside the state, then that ought to be attacked, and attacked aggressively,” he said. The interviewer asked, “So you didn’t see any market power being exercised this past winter in California?” Said Lay: “We did not . . . every time there’s a shortage or a little bit of a price spike, it’s always collusion or conspiracy. It always makes people feel better that way.”

In speech after speech, Lay told Californians that they had only themselves to blame for having done such a dismal job of deregulating. And in private he could be even more withering. David Freeman, who during the crisis ran the Los Angeles Department of Water and Power, told the
Los Angeles Times
about a conversation with Lay in the latter part of 2000. Lay was trying to persuade Freeman that price caps weren’t necessary; Freeman argued with him that they were. “Well, Dave, in the final analysis it doesn’t matter what you crazy people in California do,” said Lay. “ I’ve got smart guys out there who can always figure out how to make money.”

Long before there was an Enron scandal, there was at least one public figure who wanted to prosecute Ken Lay and the company. That was California Attorney General Bill Lockyer. In a May 2001 interview with the
Wall Street Journal,
he summed up all the fury Californians felt: “I would love to personally escort Lay to an 8 by 10 cell that he could share with a tattoed dude who says, ‘Hi, my name is Spike, honey.’ ”

 • • • 

Even though the crisis was over, the investigations were just beginning. The immediate threat lay in California, where a state senate committee was pushing hard on its own investigation. It had subpoenaed documents from Enron, but the company stonewalled; in fact, Enron sued, arguing that the committee had no authority to investigate Enron. Enron relented in late July only when it faced the possibility of contempt charges and financial sanctions. Of course, the real reason Enron was stonewalling was that its lawyers knew full well what the documents would reveal, and they wanted to delay the discovery of Deathstar and Get Shorty as long as they could—forever, if possible.

There was another issue the company didn’t want to disclose. When the traders closed the books on 2000, Belden’s West Coast power division had booked $460 million in profits. Most of that resulted from the large long position that Belden’s team had taken. There was nothing illegal about that, but how profitable would the position have been if the market hadn’t been manipulated, both by Enron and others? And how would it look if that profit was revealed? The West Coast gas traders—who also benefited from the crisis in California—made even more than Belden’s group: $870 million. Overall, Enron’s North American trading desk had made a staggering $2.2 billion for the year, according to the Moody’s presentation.

Of course Enron wasn’t just trying to hide this fact from the prying eyes of some investigators. It didn’t want
anyone
to know how much it had made from trading—even its own investors. After all, it was simply not possible to make that kind of money acting as a logistics company. It could be made only by speculating. To reveal that number would be to reveal the truth.

And it found a method to avoid doing so. Enron also knew it had potential legal issues in California. As early as that fall, Belden noted that he had begun working with Houston trading executive John Lavorato to ensure that his books were “reasonably reserved for political exposure.” So Enron took a huge amount of trading profit—upward of $1 billion, says one former executive—and booked it as a reserve against the potential liability it faced in California. This was not disclosed anywhere in Enron’s books, although the company did repeatedly tell investors that it was “fully reserved” for any problems in California. Such is the murkiness of Enron that it’s not clear if even the profits the company showed Moody’s reflected reserves that had been put aside.

By spring 2001, even before the California crisis had ended, Enron’s fundamentals group was forecasting lower energy prices and less volatility, partly because of the weakening economy and successful conservation. This view was extremely contrarian: other power trading companies were racing to build new power plants in California, but now the Enron team was arguing all that new power wouldn’t be needed. Whalley didn’t buy it at first, but after a trip to Portland, he came back convinced.