New York Times - 9 May 02

Prof. Robert B. Laughlin
Department of Physics
Stanford University, Stanford, CA 94305
(Copied 7 May 09)

California May Have Had Big Role in Enron's Fall

Published: Thursday, May 9, 2002

One of the deepest mysteries in the collapse of Enron has been the role that the power crisis in California played in the company's rise and fall.

This spring, as authorities focused their attention on the off-balance-sheet partnerships that Enron used to inflate its profits, it seemed that the question might be forever buried under more pressing inquiries.

Now, though, newly released documents about Enron's practices during the crisis in 2000 and 2001 are causing regulators and prosecutors to re-examine the connection. Some outside experts say they may find that California played a crucial role in the company's demise.

Fallout from the documents -- memorandums that appear to offer the first proof that Enron deliberately manipulated California's energy market -- widened yesterday. Federal regulators demanded that other power trading companies acknowledge whether they used strategies similar to those mentioned in the documents, while the secretary of the Army, Thomas E. White, who has already been criticized for his role as a former Enron executive, faced a new call to resign from Public Citizen, a liberal public interest group.

Enron first came to public attention in late 2000 not for its accounting methods but as the leader of a group of companies, many based in Texas, that were profiting hugely as electricity prices soared in California. Enron and its peers vigorously denied wrongdoing, saying that the price increases were nothing more than the inevitable result of the state's shortage of power.

In June 2001, after the Bush administration imposed interstate power price caps that California had sought months before, the crisis suddenly eased, and prices in the state plunged.

Five months later, Enron filed for bankruptcy protection.

So far, the nexus between those two events, if there is one, has not yet been found. But there are some hints of a connection, including the billions of dollars in cash that flowed in and out of Enron as the crisis waxed and waned, as well as the company's well-publicized belief that power prices in California would remain high for several years.

When prices dropped last summer, Enron's profits from California turned to losses, said John Rozsa, an expert on deregulation who is an aide to State Senator Steve Peace of San Diego, a Democrat.

Though the company had many other problems, those losses were "the straw that broke the camel's back," Mr. Rozsa said. "They made a bet in 2000, which they won. They made a bet in 2001, which they lost."

It is too early to know whether that theory will ultimately prove correct. But the Enron memorandums released on Monday all but ensure that prosecutors and regulators will look hard to find out whether it is accurate.

The documents, made public by the Federal Energy Regulatory Commission, appear to show that power traders at Enron deliberately manipulated California's electricity markets even as the state was scrambling to avert blackouts. According to the memos, the strategies, which had colorful names like Fat Boy and Ricochet, were designed to exploit flaws in California's system for pricing power -- and to circumvent its price caps.

The disclosures have led to new anger in California, where consumers and politicians are still bitter about the blackouts and price spikes the state faced during the winter of 2001.

The crisis forced Pacific Gas and Electric, one of the state's two big utilities, to seek bankruptcy protection and caused the state to sign long-term contracts at high prices in a last-ditch attempt to guarantee a stable supply of power.

On Tuesday, Gov. Gray Davis and the state's senators, Dianne Feinstein and Barbara Boxer, asked Attorney General John Ashcroft to open a criminal inquiry into Enron's trading practices. Enron is already under federal criminal investigation for its accounting practices.

Meanwhile, the release has led to new pressure on FERC to find out what was really happening in California in 2000 and last year. Yesterday, the commission told other energy trading companies that they had until May 22 to admit or deny using trading strategies like those outlined in the Enron documents.

About 150 power marketers, independent electricity generators and energy traders must turn over e-mail messages, instant messages, phone logs, internal memos and other internal documents, the commission said. The request covers all sellers of wholesale power into California in 2000 and 2001, the period of the state's energy crisis, including Dynegy, Duke Energy and Mirant.

"The shift in FERC's attitude is significant," said Robert McCullough, an industry consultant in Portland, Ore. Previously, the agency has been reluctant to examine California's market carefully, he said.

Mr. McCullough said he thought that the rapid unwinding of the California crisis had contributed to Enron's collapse. "They clearly had prepared themselves, we know this out of the risk management statements, for a long crisis," he said. If Enron had lined up, and paid for, supplies of high-priced power in the expectation that the crisis would continue through the summer of 2001, the sudden plunge in power prices would have been financially devastating, he said.

Another hint of the effect that declining prices had on Enron came from the company's financial statements for the second quarter of 2001, which revealed that Enron paid $2.3 billion to its trading partners during the first half of the year. In an interview in August, Rick Causey, Enron's chief accounting officer, said the payments did not represent profits or losses for Enron but were instead the return of "margin deposits" its partners had made to guarantee trades in California and elsewhere.

"Price levels have decreased, and we have had to pay back the margin that we were paid," Mr. Causey said at the time.

But Mr. McCullough said that Enron might have deliberately understated profits from its California trading in 2000 by misclassifying trading profits as margin deposits from customers. If that were the case, the return of the deposits would actually have represented a loss, he said.

Even if Mr. Causey's explanation was accurate, and the cash outflow was nothing more than the return of deposits, it came at a very bad time for Enron, Mr. McCullough said.

"They collected $5 billion in customer deposits at the time of the crisis, and those monies were flowing out," he said. Enron might have used the deposits to cover its losses in other business ventures, expecting that prices in California would stay high and it could hold them indefinitely.

"Their cash position was worsening day by day in 2001," he said. Referring to Jeffrey K. Skilling, who cited unspecified personal problems when he resigned as Enron's chief executive in August, then later said the company's declining stock had played a role in his departure, Mr. McCullough said, "It's quite possible the reason Skilling took early retirement was that he knew they were going to run out of cash."