This time last year, energy executives pulled out their calculators and began tallying up their exposure to Enron's sudden plunge into bankruptcy. In short order, Enron's trading partners delivered specific predictions. El Paso ( EP) gauged its damage at $50 million. Dynegy ( DYN), which had just scrapped plans for an Enron buyout, set its exposure at $75 million. Williams ( WMB) and Duke ( DUK) conceded that they could lose as much as $100 million each. Given the lavish multibillion-dollar valuations the companies carried in a marketplace still agog with visions of vast trading profits, the price tag didn't seem too steep. Indeed, many of Enron's rivals expected to recoup their losses and then some by gobbling up market share in a business that sprouted out of the 1990s belief that private enterprise could solve virtually any problem. With newly created energy trading operations simultaneously relieving pressure on the nation's decaying electricity grid and churning out massive profits, analysts saw in Enron's demise a win-win situation for investors. "We feel that all energy merchants -- including Dynegy, Williams, Duke and El Paso -- will ultimately benefit from Enron's collapse," Prudential analyst Carol Coale said just ahead of Enron's bankruptcy. But a year later, it's apparent that Enron was merely the first casualty in the now deeply distressed energy-trading business. Of the four competitors mentioned by Coale, only Duke still operates a major trading business, and it's a money-losing venture. The others, now saddled with mounds of junk-rated debt and cash flows that have slowed to a trickle, are struggling for the means to fund more routine -- and affordable -- operations like energy production and transportation. All the energy-trading companies have seen their stocks decline sharply.
Meanwhile, huge trading divisions lay near ruin, sullied by questionable business and accounting practices that have triggered myriad governmental investigations. Dynegy, for one, has already paid a $3 million fine to end a high-profile probe by the Securities and Exchange Commission. All the same, Duke remains stubbornly committed to the fallen trading business. "We're very proud of our trading and marketing operation," CFO Robert Brace told investors, even after the division's dismal third quarter. "We're not looking at pulling back." Duke spokesman Randy Wheeless has since reinforced that commitment. "We have one division that's not doing that well," Wheeless said of the trading unit. "But with any kind of modest upturn, it will return to its very healthy ways." Still, some merchant energy critics insist that the excesses underlying the industry that Enron built will continue to plague investors for years to come.
High StakesThese days, energy companies are lucky to collect a sliver of profit from the electricity they sell. Once-mighty power producers like Calpine ( CPN) and Mirant ( MIR) spend nearly as much fueling their power plants as they earn for the electricity those plants spit out. They describe this decline in "spark spreads," and the resulting erosion of profits, as unthinkable a year ago. But the thinking back then was still influenced by the heady rise of Enron. Although most industry players acknowledged even then that huge profit margins -- like those realized during the California energy crisis -- were unsustainable, they assumed that sinking margins had already hit "reasonable" levels. But their own bank accounts, fattened by the recent volatility, should have told them just how violently energy prices can swing. At its cheapest, during a brief period on the day California launched deregulation, wholesale electricity was actually free. But roughly 100 days later, Dynegy set a new tone for the business. Exploiting a loophole in California's deregulation system, Dynegy offered to sell standby power to the state for a whopping $9,999 a megawatt hour (compared to pre-deregulation rates of $10 a mwh) -- an offer that, by law, California was forced to accept. Official records show that this strategy allowed Dynegy, together with two other energy companies, to reap $8 million in profits for simply keeping their power plants on call for five short hours. The high-stakes California power business -- likened by some at Enron to a giant video game -- had only just begun. Crafty energy traders honed their skills to near perfection by the time the "perfect storm" of extreme weather and power imbalances hit California in 2000. The average merchant energy stock would double that year. Dynegy tripled, ranking among the top performers on the New York Stock Exchange. Enron, noted as much for its political clout as its aggressive business strategy, ended the year within dollars of its all-time $90 high. The stock, celebrated by most analysts as a phenomenal investment, was less than a year away from being worthless.
Hijacking DeregulationDuring Enron's heyday, critics of the company could barely find an audience. Apache ( APA), a onetime owner of Dynegy's predecessor, screamed aplenty about shenanigans in the industry. But the company has only recently gained a platform before Congress and other powers that were once under Enron's financial thumb. All along, Apache has blamed a handful of companies -- most notably Enron and Dynegy -- for poisoning a deregulation movement that could have been good for the country. Ken Malloy, CEO of the Center for the Advancement of Energy Markets, said the turmoil could cripple the nation's power system for years. He's seen progress on deregulation come to a virtual standstill since Enron's demise. "We had a few companies that spent a lot of money in Washington to get legislation passed that allowed them to operate totally in secret with no regulation whatsoever," said Obie O'Brien, director of governmental and regulatory affairs at Apache. "They literally hijacked and corrupted the deregulation process, and they didn't even provide much of a service -- except to line their own companies' pockets." If anything, power consumers suffered more from Enron's participation in, not exit from, the energy trading business. The last blackout occurred when Enron was at the top of its game. Since then, governmental investigations have uncovered mounting evidence that not just Enron, but also surviving companies like El Paso and Williams, may have schemed to drive California power prices to outlandish highs. This week, on the one-year anniversary of Enron's bankruptcy, El Paso must fight to prove its innocence in a pivotal hearing before the Federal Energy Regulatory Commission. The company, which once pinned its future on energy trading, recently joined the parade of battered players fleeing the business in a panic to survive.
No company -- except Enron -- has managed to sell its trading division. UBS Warburg, which got Enron's prized trading arm for nothing, hardly flourished because of that "sweetheart" deal. UBS announced last month that it will pack up its business in Houston, where the taint of Enron still lingers, and focus on a much smaller trading operation in Connecticut. Elsewhere, energy companies are taking billions of dollars in charges to shut down trading operations that nobody wants to buy. But the weaker players may have stayed in the game too long. Some companies, like Dynegy and Williams, have already skidded close to bankruptcy and still remain at risk. Others, including debt-laden AES ( AES) and Reliant Resources ( RRI), are viewed by some as even more vulnerable. Experts believe casualties are inevitable. They're just waiting to see which company will be the first to follow Enron into bankruptcy. They see the shakeout as a necessary step toward successful deregulation and a legitimate trading industry. "We absolutely need a place for buyers and sellers to come together," Malloy insisted. But Malloy acknowledged that much of the past energy trading, like that conducted by Enron, was unnecessary. And O'Brien called Enron's business strategy, once touted as the "new American business paradigm," an outright fraud. "It turned out to be the oldest way of making money -- stealing it -- even if it was wrapped up in a new package," O'Brien said. "They got greedy, and they got caught. Otherwise, they'd still be doing it today."