No one really understood Enron’s business

What worries me is, it could happen here.

The Enron collapse reminded me of a child's story: Enron actually wore no clothes but regulators, analysts, bankers and journalists oohed and ahhed about how great Enron looked in the new energy environment. The truth is, no one really understood Enron's business plan but everyone was just too embarrassed to admit it.

It was only when California started suffering debilitating power shortages and its large power distributors started filing for bankruptcy that anyone started musing that something was amiss. But, going back to our child's story, Enron, continued to play the role of the crafty tailor of new clothes. Enron executives arrogantly told doubters they were just too stupid to understand how the new energy economy worked.

Insulting critics seemed an effective way for Enron to keep on going its merry way. But the yarn was just too good to last. As greed overwhelmed the top executives of Enron, the financial fundamentals of their schemes grew shakier and shakier.

Last weekend, Enron collapsed but not before its top conspirators got to their safe havens with their personal loot intact. Enron’s collapse followed revelations of questionable partnerships that kept billions of dollars in debt off its books. Enron had to admit that it overstated profits for four years.

Enron had its origins in the gas pipeline business. But that wasn't sexy enough. Its ambition and boundless appetite for risk found Enron creating markets where none existed. It didn't own as many power plants nor did it control as much reserves of natural gas as its competitors, but Enron had a larger impact on the energy market.

Enron's business was in trading energy supplies. Enron bought excess electricity from one area and sold it in another. It handled futures contracts, guaranteeing the supply of electricity or natural gas to customers at a particular time and for a particular price. Enron also cashed in on the dot.com mania with Enrononline, a web-based trading service.

Enron’s aggressive tactics in filling the free-market vacuum left by energy deregulation made it a star in Wall Street. Analysts heaped praise on the company for its "innovative" approach in bringing high-tech and complex finance to energy trading.

Enron expanded beyond energy into telecommunications, selling Internet bandwidths. It was an investment company, a paper and lumber producer and an insurer. It had revenues in excess of $100 billion last year, making it America’s seventh-largest company.

Enron's fall, according to the Christian Science Monitor, is "a warning that governments should be more careful in how they deregulate public utilities such as electricity." Enron's fall has Washington debating the way it oversees the $200 billion power industry. American energy officials are quick to point out that Enron's failure does not mean the concept of energy deregulation is faulty. But they admit that they'd be crazy not to study the lessons learned from the Enron experience.

An article at the Los Angeles Times wondered if we really need energy traders like Enron. "For Enron, a market was a tool for profitability, not productivity. Rather than add efficiency to the energy delivery system, Enron simply added layers of expense."

After Enron, middlemen are now everywhere in the energy system. A kilowatt hour of electricity can be bought and sold 10 times between the time it is produced and the time it is consumed. Enron used deregulation to make money out of nothing, simply by adding cost to the product en route.

London's The Guardian sums up the reasons why energy deregulation will be reassessed in the light of Enron. "Enron’s collapse raises questions about the wisdom of letting market forces – in reality a handful of energy companies – manage prices. At the very least, regulators will have to watch more closely the energy markets and insist on more transparent financial practices among energy trading companies."

Back here at home, the implementing rules and regulations for the Power Sector Reform Law are still being finalized. It makes sense to revisit the draft before it is promulgated, to check if the dangers of an Enron-like situation are present. The concept of a deregulated energy market is new and when tested in the US, resulted first with the California blackouts and now, with the Enron fiasco.

The lesson of Enron is, we shouldn't be too embarrassed "to expose our ignorance" and "ask stupid questions" about these newfangled concepts with a large potential for damage.

Accounting standards

In the wake of the Enron debacle, accountants are being asked to account. America's top five largest accounting firms responded with a press statement promising to abide by higher standards in the future. One of them, Arthur Andersen had been issued a subpoena by the US Securities and Exchange Commission related to its auditing of Enron’s accounts.

According to the Associated Press the accounting executives said they would jointly submit to the Securities and Exchange Commission their recommendations by the end of the year that would encourage their clients to provide better information about trading activities and risks, including those related to energy markets. "Too often, financial statement disclosures are plentiful but may lack meaning," the executives said.

"Many different streams of information – not just earnings – are needed for informed decision-making, and backward-looking financial statements delivered on a periodic basis no longer are sufficient to communicate real value and risk." The goal is for this added information to appear as part of companies’ 2001 annual reports, the executives said.

Again back here, our own SEC cannot be too careful. Similar restrictions and caution are needed to protect investors from corporations whose financial reporting are less than transparent.

Good news, bad news

This wicked one is from reader Orly Morabe.

"I’ve got some bad news and I’ve got some good news," says the doctor.

"What’s the good news?" asked the patient.

"You can expect your p*nis to grow several inches in both length and diameter over the next few months."

"Wow," says the patient. "What’s the bad news?"

"It’s malignant," answered the doctor.

(Boo Chanco's e-mail address is [email protected])