Back to The Bush Presidency indexIn the sea of peril that was about to engulf Enron, the co-opting of Arthur Andersen was a very small ripple. That was especially true when compared to the energy crisis in California, which was deepening simultaneously.
In the mid-nineties, California was the first state to deregulate electricity. It happened as companies were leaving the state in droves, creating a devastating recession. Along with the exorbitant state taxes, businesses complained about the high costs of energy. Deregulation was supposed to break the back of the old-fashioned, entrenched greedy utilities and, by 1998, give rate payers a 10 percent reduction in their bills. There didn't seem to be any downside.
But the solution turned out to be worse than the problem. California deregulated the wholesale side of its energy market, while keeping price caps on the retail side. Simultaneously, the state barred its utilities from Signing long-term fixed-price (i.e., cheaper) deals for power, forcing them into an increasingly volatile spot market. The stage was set for disaster. Soon the utilities were paying a fortune to power producers but couldn't pass their costs on to their customers.
Enron joined the deregulation fight early and poured millions into on-the-side-of-angels public relations campaigns, styling themselves as the good guys against the antediluvian utility owners. Skilling promised the state's regulators in June of 1994: "Under deregulation, California would save about $8.9 billion per year. . . . If you had S8.9 billion . . . yon could triple the number of police officers in Los Angeles, San Francisco, Oakland and San Diego . . . you could double the state of California's construction for hospitals . . . you could double the number of teachers in Los Angeles, San Francisco, Oakland and San Diego . . . and you'd have enough pin money left over to cover the CPUC's budget." Enron promised to deliver power more efficiently, and to build better plants that ran on cleaner, cheaper fuels.
There were just a few signs that Enron might not have been playing straight with the market. One occurred in May 1999—a difficult year in Enron's earnings department—the so-called Silver Peak Incident.
Timothy Belden was another Enron star. When he graduated from college in 1990, he joined the Lawrence Berkeley National Laboratory, a research institution supported by the Department of Energy. He was a wonk who wrote policy reports on topics like "Theory and Practice of Decoupling." From Berkeley he moved to Portland General, where he continued to ponder the state of the electricity market: "It is doubtful that state PUCs will have time and expertise to reconstruct and dissect hedging decisions made by distribution utilities," he noted presciently in one report. He also stated that PUCs should act to "guard against speculation on the part of distribution utilities, even though it can be difficult to establish simple rules that can prevent speculative transactions."
But then, in 1999, Belden went to work on Enron's trading desk, where he came to run the western electricity-trading operations. Whatever contemplative life he may have envisioned for himself fell away under the pressures and rewards of his new employer. Before long, the committed environmentalist became a company man, swaggering across the trading floor, making millions for himself and the company.
Hence the events of May 24, 1999: Belden tried to send an enormous amount of power over some aged transmission lines—2,900 megawatts of power over a 15-megawatt path. Such a plan was destined to cause congestion on the line. California had an automated response to overloaded lines. Immediate electronic requests went to all the state's suppliers—Do you have Power coming across this line? Can you remove it? We will pay you to take it away! But on this day, there also happened to be a human watching the wires for California's Independent System Operator, who couldn't imagine why someone would send so much power over such a small line. "That's what you wanted to do?" the dubious operator from the ISO asked when she called to check to be sure that the transaction had not been requested in error.
When Belden replied in the affirmative—"Yeah. That's what we did."—she became even more incredulous. "Can I ask why?"
"Um," Belden replied, "there's a—there—we just, um—we did it because we wanted to do it. And I don't—I don't mean to be coy."
The operator suggested it was a pretty "interesting schedule." Belden agreed. "It—it's how we—it makes the eyes pop, doesn't it?"
The operator conceded that it did, and for that reason she would have to report the transaction to the power grid regulators because it was, in her words, "kind of pointless."
"Right," Mr. Belden answered.
From Enron's perspective, the trade wasn't pointless. Belden's move caused congestion that, in turn, drove the price of electricity up 70 percent that afternoon. The compliance unit of the state's power exchange investigated the trade and a year later fined Belden $25,000, but that was a small price to pay—Enron cleared S10 million that day, while California's electricity customers overpaid by around $55 million.
California's human-free automated system was completely dependent on the honesty of the power suppliers. But they weren't honest. Abusers like Belden found novel ways to game the system, converting it into a slot machine perpetually set on "jackpot." Belden was only too happy to pay meaningless fines when and if he was apprehended by plodding state regulators. And he was not alone. By June of 2000, the people of California, who had expected lower rates and better service from deregulation, found they had neither. Wholesale electricity rates in the state jumped 300 percent, an amount that made Texas energy trading companies who supplied the power—Reliant, El Paso, Dynegy, as well as Enron—delirious.
Whatever Enron and its competitors promised about deregulation—lower prices, freedom of choice, et cetera—they found out that they needed volatility, not stability, to make money. In a stable market, no one worried about their power supply, because the lights always came on and the air conditioner always worked. But if the supply was questionable, customers got anxious, and if the supply dwindled, they became willing to pay any price to keep their homes and businesses running smoothly. As Belden would write in an e-mail to Houston in the spring of 2000, as power prices soared, "We long. Prices keep going up. So far so good."
By the fall of 2000, California's major electricity generators had a big problem: They were facing power shortages but realized that they could not afford to buy power from the companies selling it on the spot market, as deregulation required them to do. The utilities began pushing for rate increases they could pass on to their customers. When the legislature refused, the power companies had no choice but to institute cutbacks.
Consumers were furious when denied power. The state then petitioned the Federal Energy Regulatory Commission to install price caps on the suppliers so it could afford to buy what little power was available. When the FERC did so, out-of-state suppliers immediately vacated the scene.
By December 2000, the situation was perilous: That month, the state experienced its first Stage Three "rolling blackout"—meaning that the state was close to exhausting its electricity reserves. Literally, California's lights were going out, and with it the health and well being of the state's economy. The California official charged with keeping power flowing throughout the state panicked and then asked the FERC to lift price caps so that power sellers would return to the state. They did—charging even higher prices than before.
Meanwhile, in Houston, an Enron attorney named Stephen Hall started to worry. He was asked in October to research the company's electricity-trading practices because of an investigation conducted by the California Public Utility Commission. The more he researched, the more concerned he became. With a team of attorneys, he wrote an eight-page memo that detailed the tactics Enron's traders were using to take advantage of the state's energy crisis. With names like "Fat Boy," "Death Star" and "Get Shorty," Hall revealed how Enron created false congestion on power lines, transferred energy in and out of state to avoid price caps, and charged for services the company never actually provided.
Hall later met personally with various Enron executives, including Mark Haedicke, the general counsel for Enron's Wholesale Trading Group, and Richard Sanders, a vice president and assistant general counsel, and warned them that the practices could violate ISO tariffs and, more important, criminal laws. Sanders would later claim that after he got the memo in December he demanded that the practices be stopped. (He would brief Skilling on the subject in June 2001.) Internally, executives argued about repaying the California ISO for money made on improper trades, but decided against it. "If we send money back," traders told Sanders, "they'll know what we're doing." Whatever did or did not happen next, the subject became the hottest of hot potatoes. Haedicke's name subsequently disappeared from the distribution lists of Hall's anxious memos.
The situation in California did not improve, however, with the end of California state price caps and Enron's promises to behave. In fact, things got worse.
By mid-January 2001, California Edison defaulted on $596 million worth of payments to power companies and bondholders, and the rolling blackouts spread to northern California—that is, Silicon Valley and its environs. Governor Gray Davis drafted emergency legislation allowing the state to buy power, a situation that only made things better for the Texas companies—now they could negotiate long-term contracts at inflated rates with hapless state employees. Residential rate hikes were imposed in January and March, increasing rates by 40 percent. In April, Pacific Gas and Electric filed for Chapter 11 bankruptcy protection. It was at this time that Texas Senator Phil Gramm chose to weigh in, in an interview with the Los Angeles Times: "As [Californians] suffer the consequences of their own feckless policies, political leaders in California blame the power companies, deregulation and everyone but themselves, and the inevitable call is now being heard for a federal bailout. I intend to do everything in my power to require those who valued environmental extremism and interstate protectionism more than common sense and market freedom to solve their electricity crisis without short circuiting taxpayers in other states."
That statement sounded good if you lived in Texas: Those flakey, self-absorbed Californians plunged themselves into the energy shortage because they wouldn't despoil their paradise with enough plants to power their laptops, air conditioners, and juice bars. California, they charged, built no new plants in a decade, so what did they expect?
Enron rolled out a cadre of academics to back them up, people like economist Paul Joskow, the director of MIT's Center for Energy and Environmental Policy Research, whose funding came from Enron and Reliant, among others. In a New York Times Op-Ed piece, Joskow chided California for failing to build enough power plants for its population: "The lesson to be learned from California's [electricity crisis] . . . is not, as some have suggested, that deregulation is a bad idea."
The new U.S. president turned his back on California too. In early 2001, Bush adamantly refused to reinstate price caps in a state that, coincidentally or not, had supported his opponent.
Investigators from various governmental bodies began working on the crisis in the late winter and early spring, and made some interesting discoveries: They found that Californians, already ranked as the second-most-efficient energy consumers in the nation, actually used less energy in July of 2000 than the same month of the previous year. Then, too, California's energy usage during the current energy crisis never approached the all-time peak that had occurred in July 1999. Even more interesting, the actual demand for electricity never exceeded the generation capacity of the state's plants. Demand in January 2001—the month Senator Gramm chastised the state—was nearly 10 percent lower than in previous years, when there had been no blackouts. Power usage on blackout days was also lower than in previous years.
And contrary to popular opinion outside California, 170 new generation and cogeneration facilities had been built in the state in the 1990s, plenty to meet the energy needs of the populace.
It began to dawn on some California public officials that maybe some plants being shut down for maintenance—as their owners claimed—didn't really need it. Maybe drought conditions—also blamed by power generators for the crisis—weren't to blame either.
Maybe there was another explanation entirely for California's problems.
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