New York Times - 8 May 02

Prof. Robert B. Laughlin
Department of Physics
Stanford University, Stanford, CA 94305
(Copied 15 May 09)

How Enron Got California To Buy Power It Didn't Need

Published: Wednesday, May 8, 2002

Fat Boy. Death Star. Get Shorty. These were the cocky nicknames that Enron traders gave the complex trading strategies they employed in 2000 and 2001 to maximize gains in California's wholesale electricity market.

Enron is no longer in the trading business, and today its interim chairman, Norman P. Blake Jr., condemned the company's old tactics as "seemingly gaming the system" and "very offensive," in testimony before a Senate panel.

But documents released this week by federal regulators and interviews with California officials indicate that when Enron was flying high, its trading tactics exploited weaknesses in the state's energy markets to the hilt.

One set of strategies -- which traders called Death Star and Load Shift -- involved creating the appearance of congestion on California's power grid and then arranging for the state to pay Enron to relieve the congestion.

This could be done in a variety of ways, Enron lawyers explained in internal memos. One method called for traders to schedule power deliveries over lines already known to be heavily congested. Meanwhile, they would keep loads light in another part of the state.

This tactic, the lawyers explained, would often result in the state power-grid operator increasing the amount it was willing to pay to electricity traders who were willing to alter their deliveries to reduce congestion in the busier region. And that is just what Enron did, collecting money for "reverting back to its true load."

Describing a related maneuver, the lawyers wrote, "Enron gets paid for moving energy to relieve congestion without actually moving any energy or relieving any congestion."

The lawyers added that such congestion deals could be quite profitable. "Because the congestion charges have been as high as $750 per megawatt-hour, it can often be profitable to sell power at a loss simply to be able to collect the congestion payment," they wrote. By comparison, when markets are functioning normally, electricity often costs no more than $30 to $40 a megawatt-hour.

The lawyers acknowledged that the money collected by Enron came at the expense of utilities and consumers in California.

"By knowingly increasing the congestion costs, Enron is effectively increasing the costs to all market participants," they said, noting that one related tactic generated $30 million in profit in 2000.

A second set of strategies involved buying power in the state at capped prices and then selling it for much more elsewhere.

With power costs soaring as the energy crisis developed late in 2000, California imposed price caps that for much of the time set the maximum price for power sold within the state at $250 a megawatt-hour.

But the price limit could easily be defeated by a crafty trader, because it did not apply in surrounding states, where power could be bought and sold at prices up to five times the price cap.

Federal regulators fixed this problem in June 2001, when they imposed broad price restraints throughout the Western United States. But for a time, as federal regulators refused to take action, Enron traders reaped huge profits, the memos from the Enron lawyers indicate.

One approach was to simply take power bought in the state and resell it in a nearby state. The documents describe this as traders taking "advantage of arbitrage opportunities."

On Dec. 5, 2000, one Enron memo noted, "Traders could buy power at $250 and sell it for $1,200." Doing so, it said, "appears not to present any problems, other than a public relations risk arising from the fact that such exports may have contributed to California's declaration of a Stage 2 Emergency yesterday."

In a Stage 2 alert, which is declared when grid managers see that power reserves are declining below 5 percent of the system's capacity, California officials ask that power consumers voluntarily curtail their use of energy.

Enron also engaged in what energy traders call "megawatt laundering," a tactic labeled Ricochet in the Enron documents.

While the price caps prevented power from being sold in California for more than $250, power brought in from out of state could be sold for a higher price if the seller could justify the costs -- by explaining, for example, that it had been acquired at a very high price.

As described in the lawyers' memos, Enron bought electricity in California and scheduled it "for export." The electricity, they wrote, "is sent out of California to another party, which charges a small fee per megawatt, and then Enron buys it back to sell the energy" to the state's grid operator.

The third maneuver -- the one called Get Shorty -- involved a strategy much like short selling shares of stock. Betting that the price of a company's stock will fall, short sellers borrow shares they do not own and then sell them in the open market. If all goes well, they buy the shares back later at the lower price and pocket the difference.

Enron was essentially doing the same thing in the California market, according to the internal documents and state officials. Its traders shorted so-called ancillary services -- the term that is used to describe commitments by energy companies to maintain idle power-generation capacity for a set time, to be called on as needed.

"The profit is made by shorting the ancillary services, i.e., sell high and buy back at a lower price," the Enron lawyers wrote.

But there were risks to this strategy, the lawyers wrote, as illustrated on one occasion when a trader failed to cover a short position and the state's grid operator called on Enron to fulfill its standby commitment to provide power.

The Enron lawyers also noted that the state grid operator's rules required that sellers identify the specific source of the power that would be provided, if the ancillary services were called on.

"As a consequence," the lawyers wrote, "in order to short the ancillary services it is necessary to submit false information that purports to identify the source of the ancillary services."

In the documents, the Enron lawyers said that many of the same tactics were used by other energy companies doing business in California. Both state officials and federal energy regulators said today that they would question other companies about whether that was true.

Whether any or all of the tactics are legal will be the focus of considerable debate. But today, the Washington trade group that represents the nation's independent power traders, the Electric Power Supply Association, distanced itself from the activities that were described in the Enron documents.

"Practices designed to manipulate customer prices, create unfair advantages for specific market participants or threaten the reliability of the electricity grid cannot be condoned," the group said.