Energy Trading Goes On, But Buyers Are Smarter

By Steven Mufson
Washington Post Staff Writer
Saturday, May 27, 2006

When Enron collapsed in 2001, the idea of trading electricity seemed headed for the scrap heap of failed financial innovations.

Enron's victims were everywhere: Residential ratepayers in California were forced to accept crushing prices, some industrial customers in the Pacific Northwest were stranded for a while without any electricity at all, and Enron itself went bankrupt. Just the previous year, it had been hailed in a major business publication for its "flexible culture and track record for innovation" and for having "revolutionized the marketing of natural gas and electricity after deregulation."

But a surprising thing has happened since Enron's demise: The revolution didn't end. Deregulation didn't go away and new marketing and trading techniques are becoming the norm in the once-staid and highly regulated business of electric power.

"The business of energy trading went through a real collapse right after Enron because there was a real loss of confidence in the legitimacy of the companies doing the trading," said Severin Borenstein, a professor at the University of California at Berkeley and director of the university's Energy Institute. "That has gradually reversed over the years. There is a legitimate need for companies to make markets in electricity and to trade power and natural gas. We've seen a resurgence of those markets."

There are differences, of course. Regulators and big industrial customers are slowly getting savvier, and the companies trading electricity are more cautious and financially stable than Enron was. Today the big players are companies like the investment bank Morgan Stanley & Co., energy producer BP PLC, the utility and power generation holding company Constellation Energy Group Inc., and Sempra Energy, which owns two California utilities and which has built up the energy trading operations it bought from insurance giant American International Group Inc. several years ago.

"We are nothing like Enron," Constellation chief executive Mayo A. Shattuck III said in an interview published two years ago. "We have no special-purpose entities, no directional trading, we are not asset-light. We love hard assets."

Borenstein said: "People are more careful. There is not a Wild West economic environment where there are no rules and everybody thinks he can make money, which was the view back in the days of Enron."

Electricity had not been treated like oil, gasoline, pork bellies, sugar or soybeans. It wasn't traded on commodities markets. After securities legislation regarding utilities was adopted in 1935, utilities had their own power generation plants, and state public service commissions determined the profits the utilities could make on their investments, transmission services and fuel sales. Utilities were local, vertically integrated companies, doing everything: buying the fuel, running the generating plant, caring for the transmission lines and billing homeowners and businesses. It wasn't sexy, but it was steady and secure.

In the 1990s, however, many states deregulated their local utilities, freeing them to sell generating plants and seek new market-oriented deals for power. The idea was that companies would become more efficient and that consumers would benefit. A market was created.

The theory didn't match reality, though. Electricity produced in one place couldn't necessarily be delivered someplace else because of grid limitations. Moreover, "You can't store electricity. That's a problem," said Peter C. Fusaro, author of "What Went Wrong at Enron" and chairman of the New York-based consulting firm Global Change Associates Inc. "In all the other commodity markets you have storage. As a result, electricity is a real-time commodity. That means a lot more price volatility."

California regulators, who didn't trust the state's utilities to make the best longer-term deals possible, pressed those companies to buy electricity at spot-market rates. When a crunch came in 2000, half the state's power was priced on the suddenly exorbitant spot market. But with prices capped, utilities couldn't afford to buy enough supplies. "It's just not how you run a market," Fusaro said.

Enron was a big beneficiary because it was dominant, controlling 20 to 30 percent of the nation's electricity market, by some estimates. No single company dominates the market like that today.

The trials and tribulations of Ash Grove Cement Co.'s Montana plant illustrate how deregulation initially went wrong, how Enron briefly took advantage of it, and what has happened since Enron's collapse.

In 2000, the plant was scrambling for reliable electricity. Thanks to deregulation, Montana Power Co., the local electricity utility, had been allowed to sell all its generating plants and transmission lines and invest the proceeds in a fiber-optic network; soon it would go bankrupt. The company that had bought the generating plants, most of them hydropower plants in the area, was under no obligation to sell the power to Montana; it could sell the electricity anywhere on the grid for the highest price it could get.

Meanwhile, customers like Ash Grove were desperate. A cement plant, which consumes vast amounts of energy, cannot be turned on and off like a light bulb. It needs to run all day and night. So the cement maker leased costly oil and diesel generators and put them on rail cars near the plant.

Then along came Enron, a former oil and gas pipeline company that said it was making 80 percent of its profit from trading electricity, oil, natural gas and even broadband capacity. Investors loved it. It seemed like a good, reputable alternative.

Enron offered to sell Ash Grove power at a price four times what the cement maker had paid the old Montana utility. At least the power was available, the cement maker thought. Then an Enron executive called to offer a 5 1/2 -year contract, with the first six months at twice the old rate and then five years at close to what Ash Grove had paid in the past. The Enron executive gave Ash Grove just one day to take it or leave it. The company took it. Six months later, Enron collapsed and couldn't deliver.

That wasn't the end of the story. Since Enron vanished, Ash Grove has become part of the new system of buying and selling electricity. Now it buys on medium-term contracts and thinks about whether its suppliers have generating plants and the ability to deliver. Ash Grove now buys power from Pennsylvania Power & Light Co., which bought the old Montana generating plants. The cement maker has a one-year contract, which expires in December, when it will shop around for prices it hopes will be lower. Neither Ash Grove nor PP&L is obligated to do business with the other again.

"Things have basically returned to lower levels," said Jack Ross, Ash Grove senior vice president and general counsel. "You don't have the type of business entity that basically gamed the system. You are able to get power from a number of sources. Though the prices are not particularly attractive, they're reasonable enough to turn a profit on.

"Probably like many buyers, we're unwilling to go into something long-term for fear that we're going to end up on the short end of the stick. We've been burned."

The main hangover from the crisis of 2001 is that Ash Grove and Enron are still fighting over the contract; Enron claims that Ash Grove owes it $5 million. The Enron trader who signed the contract, Timothy Belden, pleaded guilty to wire fraud for participating in schemes to game California's power markets during the state's energy crisis in 2000 and 2001.

Across the United States, more and more businesses are buying electricity at negotiated rates rather than simply accepting the regulated rates of the past. Many residential customers have had prices dictated by auctions held by local utilities, even if related subsidiaries end up with winning bids. Recently those auction prices have been high, prompting calls for re-regulation of utilities. But that seems unlikely.

"For 20 years there's been a movement toward markets. That horse has left the barn," said Martin Cohen, director of consumer affairs for Illinois Gov. Rod Blagojevich (D). "So much of power generation is held by non-utility companies, there's no turning back to a regulated utility model."

Instead, regulators, many of which approved auctions for three-year electricity contracts (as in Maryland), are using a series of auctions in successive years to spread out payments and smooth out energy-price fluctuations.

What went wrong with Enron? Fusaro said it was mostly about Enron. "They were a company swimming in debt. It had nothing to do with energy trading. They had good risk analysts. But they made a lot of bad investment decisions and tried to hide their losses."