by Robert Bryce
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|Table of contents
|The Job Fair
|John Henry Kirby and the Roots of Enron
|Buy or Be Bought
|The Lays Move to River Oaks
|The Valhalla Fiasco
|"The Smartest Son of a Bitch I've Ever Met"
|Banking on the Gas Bank
|Enron Goes International: Teesside
|The Big Shot Buying Binge
|The Dabhol Debacle
|OPIC: Sweet Subsidies
|A Kinder, Gentler Enron
|The Reign of Skilling
|"A Pit of Vipers"
|Cash Flow Problems, Part I
|Chewco: The 3-Percent Solution
|The Family Lay
|Buying Off the Board
|The Deal Diva
|Hyping the Bandwidth Bubble
|Andy Fastow Arrives...in River Oaks
|Strippers and Stock Options
|Casino Enron: Cash Flow Problems, Part 2
|The Big Five Versus the SEC
|Ken Rice: Missing in Action
|Analysts Who Think
|Skilling Says a Bad Word
|George W. to the Rescue, Part 1
|Sleepless in Houston: Cash Flow Problems, Part 3
|Sherron Watkins Saves Her Own Ass
|George W. to the Rescue, Part 2
|You Gotta Have Art
|Revenge of the Raptors
|"An Outstanding Job as CFO"
|Fastow Goes Bye-Bye
|Greenspan Gets the Enron Prize
|One Restatement Too Many
|Epilogue: "Salvation Armani"
J R Ewing never talked about pipelines. Jett Rink was interested in drilling for oil, not shipping it through a maze of unseen steel tubes. Real men - particularly fictional ones like Ewing and Rink - find oil and gas. Lesser mortals navigate the maze of engineering, metallurgical and legal wrangles that are needed to get those hydrocarbons delivered to the nearest refinery or storage terminal. Face it, there's no sex in laying pipe.
Yet pipelines are the conduit for the American Dream. Every year, pipelines carry some 550 billion gallons of crude and petroleum products to refineries, airports, rail yards and other locations. Trillions of cubic feet of natural gas are moved through some 2 million miles of interstate, intrastate and local pipelines. Pipelines are the largely invisible, sometimes dangerous, infrastructure that allows America to consume more energy than any country on earth. By the early 1990s, when Jeff Skilling, a former McKinsey consultant, began his rise to power within Enron, the company and its leaders were, says one veteran gas man, "the kings of the American pipeline business". Enron owned the greatest collection of tubular steel infrastructure ever assembled in one company. It was transporting or selling 17.5% of all the gas consumed in the United States.
Those pipelines were profitable but they were, and still are, heavily regulated by federal authorities. With all of the federal regulations on pricing, the pipeline business is more akin to the utility business than the energy business. Pipelines carry a product from one spot to another, and the owner of the pipe gets paid a fee for the service. It's a straightforward, profitable business. As one former Houston Natural Gas executive said of pipelines: "All they do is make money. It's boring, but it's dependable."
Perhaps that's why Skilling hated them so much. Skilling's brain was too big for pipelines. He was always thinking big thoughts. And big thoughts have no place in the pipeline business. Pipeline companies demand solid managerial skills from people who show up every day and stick to their business. Skilling was not a manager, he was a deal-maker. Exotic financing schemes and the deals that came with them excited Skilling. Collecting nickels, dimes and quarters from what was essentially a new-fangled toll road that no one could even see, did not. The only thing that mattered to Skilling about Enron's pipelines was that they kept providing him with cash that he could use elsewhere.
For Skilling, elsewhere meant only one place: the trading business. Skilling may have disliked pipelines, but he was an absolute genius at figuring out how to trade the precious commodity that moved inside them.
As soon as Skilling moved on to the 50th floor, he began a hiring binge that didn't stop until the company went bankrupt. But give him credit: he attracted the best and the brightest. Harvard, West Point, Rice, University of Chicago - every prestigious school in the country began feeding their best MBAs, engineers and maths wonks to Enron. At the same time, Skilling began raiding Wall Street, stealing traders, investment bankers, information technology whizz kids, programmers and every other skill-set that Enron needed.
The fleet of newly hired hotshots were never short of confidence or the belief that they were working at the best, smartest, fastest-moving company in the world. One longtime Enron employee (who held a PhD from the University of Maryland) said: "There's no question that Enron people arrogantly thought they were smarter than everybody else. There's no excuse for that. But they were smarter than everybody else."
By mid-2000, Skilling had achieved his goal: almost all vestiges of the old Enron, the stodgy, slow-growing pipeline-based entity that transported gas and generated a bit of electricity, were gone. In its place, Enron had become a trading company. And with that change came a rock-'em, sock-'em, fast-paced trading culture in which deals and "deal flow" became the driving forces behind everything Enron did.
Traders ran the place. All of the company's top executives - particularly those close to Skilling - were either traders or had helped run trading operations. And all of them believed in Skilling's vision of Enron as a trading company. Chief financial officer Andy Fastow (who was last week charged with 78 counts of fraud and money-laundering) had learned the trading business while in Skilling's group in the early 90s. Greg Whalley, the president of Enron Wholesale Services, the entity that ran the company's trading operations, had worked in Europe as one of Enron's chief power marketers. Mark Frevert, the chairman and CEO of Enron Europe, had overseen the company's European trading operations. Other top execs, such as Lou Pai, had been involved in trading for years.
Pai, who owned a 14,000ft mountain in Colorado, had two passions in life: money and watching young women take their clothes off - but not necessarily in that order. At Enron, he was able to gorge on both. Stories of Pai's fascination with strippers were legion. One executive recalled getting an expense report from Pai in 1990, shortly after Pai began working for him. "It was $757 [£484] for one lunch. He and two or three co-workers had gone to Rick's [a Houston strip club]. I said, 'I'm not approving this. You are going to have to take care of this yourself.' You just don't do that in business."
But Pai's attitude to women and sex was far from exceptional at Enron. Several women who worked at Enron said that Skilling and the young traders who dominated the company viewed women as a commodity that could be bought and sold just like gas, electricity, or any of the other products Enron was trading. And since Houston's strip clubs are among the best in the country, it was only natural that Enron's boy geniuses visited them regularly.
Sex and extramarital affairs are not, by themselves, a problem for companies. But at Enron, the sexual misconduct happened at such high levels that it became a part of the company's culture. The sex, said one executive, "set the tone for the rest of the company. And you couldn't get away from it. It was like a humidifier. It was in the air."
Enron's massive new edifice to itself, a 40-storey, 1.2 million sq ft building was going to be a monument to trading. The building, designed by acclaimed architect Cesar Pelli, would have four trading floors - each big enough for 500 "transaction desks" - with state-of-the-art communications systems. Chairman Ken Lay and Skilling would move their offices from the 50th floor of the old building down to the seventh floor of the new one. Instead of overlooking all of Houston, their new offices would be on a balcony overlooking the new trading floors. And they wouldn't have to take elevators to get to the traders: two snazzy, curved stairways were going to connect their floor with the trading area.
The new tower had been under construction for nearly a year and was costing Enron a fortune. Pelli's design, which would mimic the glass-sheathed oval tower Enron already occupied, was going to give Enron the most expensive building in downtown Houston. The final bill would be about $300m.
Enron was wasting even more money in Europe. The company's European trading operations were located in an impressive new building named Enron House, located at 40 Grosvenor Place, in the heart of London, on land owned by the Duke of Westminster. Although the building cost $74m to construct, Enron spent another $30m in bringing it up to the company's lofty standards. When it moved into Enron House in November 1999, the top executives, including Frevert, could sit in their top-floor offices and look down on rear gardens of Buckingham Palace. The rent for the new digs? A bargain at a mere £8m a year.
And if the Pelli-designed building was going to make a statement, it had to be decorated. It needed art. Expensive, trendy art. And Andy Fastow and his wife Lea - modern-day de Medicis - were just the ones to make sure Enron made the right decisions. Beginning in the summer of 2000 and continuing right through until the autumn of 2001, as Enron began to spiral downward, the Fastows were the driving force behind an amazing art-buying binge. They spent $575,000 on a soft sculpture by Claes Oldenburg. They paid $690,000 for a wooden sculpture by Martin Puryear, a record amount for his work sold at auction. The committee also bought works by the sculptor Donald Judd, the painter-printmaker Vic Muniz, the video artist Nam June Paik, the photographer Julie Moos and the painter Bridget Riley. By August and September 2001, the company had spent about $4m on 20 different pieces.
Extravagantly appointed offices were far from the company's only indulgence. In 1997, Skilling's gas and power trading group, Enron Capital and Trade, spent about $2m on flowers, according to an auditor who worked for the division. "Oh yeah, we had secretaries sending their bosses flowers, bosses sending their secretaries flowers. For a while, we were the biggest customer for about five florists all over Houston," said the auditor. "We found out some secretaries were sending flowers to their friends so that the secretaries could get the pretty vases the flowers came in."
Flowers, first-class airfares, first-class hotels, limousines, new computers, new Palm Pilots, new desks - Enron employees began to expect the best of everything, all the time.
But cost-control was never a consideration for Skilling and Lay. After all, EnronOnline, the company's new website, was the toast of cyberspace. In the few months since it had been launched in November 1999, it had quickly become the biggest e-commerce site the internet had ever seen. The trading site had been the brainchild of a trader, of course, named Louise Kitchen, a brash young Brit who had been Enron's head natural gas trader in Europe. Cocky and impatient, Kitchen was emblematic of Skilling's new version of Enron. At just 31 years old, she was young, rich (in 2001, her total pay from Enron was $3.47m), and she believed that there was no end to what she - and Enron - might do.
While she and her team were developing the site, Kitchen said: "I didn't need a pat on the back from Ken Lay or Jeff Skilling. It was obvious that we should have been doing this ages ago."
Kitchen's attitude was typical among the traders. They were the uber-Enroners, the ultimate masters of the universe. Kitchen, along with another thirtysomething trader, a Canadian named John Lavorato, was rapidly consolidating her power within Enron. And within a few months of EnronOnline's debut, the pair were heading all of Enron's North American trading operations. There were hundreds of traders, lined up with banks of computer screens, keyboards, telephones - and adrenaline. In the first five months of 2000 alone, the website did 110,000 transactions with a total value exceeding $45bn. Deals could be done in seconds, rather than minutes or hours.
Electricity, natural gas, coal, oil, refined products, bandwidth, paper, plastics, petrochemicals, and even clean-air credits were for sale on Enron's website. Within a few weeks of its launch in November 1999, EnronOnline was the biggest e-commerce entity in the world. In all, the company was selling over 800 different products.
EnronOnline was the logical outgrowth of Enron's gas trading business. What had been done by phone and fax was now being done on the web. The company's trading business surged, in large part, because of tremendous increases in gas consumption in the United States. Between 1983 and 2000, demand for natural gas in America rose by nearly 30%, to 22.5 trillion cubic ft per year.
Enron transferred what it learned in gas to the electricity business. Once confined to trading among utilities, Enron elbowed its way into electricity trading in the mid-1990s. It was selling gas and power, but all the while it was collecting still more information that provided a constant feedback loop. Enron owned pipelines and power plants, and with EnronOnline, it could instantly tell in which direction the market was going. It could also tell who was buying, who was selling, and where it should be placing its own bets in the marketplace.
In a very short time, Enron had remade itself from pipeline company to the largest energy marketer in the country. But Skilling wasn't satisfied. He wanted more. So in May 2000, Enron announced that it would buy the London-based MG plc, one of the biggest metals traders in the world, for $446m. Lay said that the deal would allow Enron to claim a major role in the $120bn-per-year metals market. "Our business model, which we have proven in the natural gas and electricity markets, will give us a tremendous advantage in an industry that is undergoing fundamental change."
There it was again: Enron knew how to trade gas; it knew how to trade electricity; now it would apply those lessons to the metals business.
Surely, Enron would succeed. The company owned pipelines and power plants, valuable assets that gave it visibility in the gas and electricity markets in North America, South America, Europe and Asia. It had a big trading operation in Europe. EnronOnline was becoming the de facto standard for traders all over the world. Commodity traders on Wall Street relied on EnronOnline for pricing on dozens of different products and invariably had one of their computer screens tuned to the website. And Enron had one of the most sophisticated trading platforms ever developed. The company's traders could assess the risk on any deal almost instantaneously. Any deal they made was instantly processed and accounted for in the company's massive data centre. Almost any position Enron took in the commodities market was quickly hedged with a countervailing position. Furthermore, it had a battalion of traders who were among the sharpest in the business. They made more money, had bigger egos, and drove faster cars than just about anybody.
Skilling became convinced that Enron simply couldn't lose. In the lingo of his predecessor, Rich Kinder, Skilling began "smoking his own dope". Skilling had made Enron into the trading company that everyone was talking about. Enron had become the 900lb gorilla in the marketplace. It didn't just own the casino. On any given deal, Enron could be the house, the dealer, the oddsmaker and the guy across the table you're trying to beat in diesel-fuel futures, gas futures, or the California electricity market. With all of those advantages, Enron's trading business must have been a cash machine. Right?
Like every business Skilling created while he was piloting Enron, the trading business was a loser. Sure, trading was glamorous and sexy, but it generated virtually no cash for Enron. And that was a problem. Instead, Enron's trading operation had an insatiable appetite for cash. Unlike other online energy marketplaces such as Altra or the consumer-goods auction site, eBay - which matches buyers and sellers for a fee - EnronOnline was the principal in every transaction. That's a very expensive place to be.
If a seller agreed on Enron's posted price for, say, natural gas to be delivered on a certain date, that seller could sell it immediately to Enron. The company would then take title to the gas and try to sell it to another party. That may not sound like a big deal, but by mid-2000, Enron was doing several billion dollars' worth of trades every day. And because it was in the middle of every transaction, Enron would have to hold some of those commodities for days or even weeks before it could get the price that it wanted on its trades. That meant Enron had to have billions of dollars in cash at the ready. The sort of ready cash needed to clear and fund each sale and purchase - often called a company's "float" - can be enormously expensive. And the bigger the float, the bigger the expense.
Every day that Enron held on to a big position in a commodity, it had to pay interest on the money it borrowed to take that position. For instance, one of Enron's gas traders might be betting that gas prices would rise and therefore go "long" on gas contracts in the amount of 500 million cubic feet of gas. At $3 per 1,000 cubic feet, the gas could be worth $1.5m. That might not sound like much. But Enron had hundreds of traders, some going long, others going short in gas and dozens of other commodities. Supporting all of those positions required huge amounts of capital. And as the number of transactions handled by Enron-Online grew, so did its appetite for capital. The new operation had to have enough cash to keep a liquid market in 800 different products, each of which was seeing a big surge in volume.
In the first six months of 2000, Enron borrowed more than $3.4bn to finance its operations. The company's cash flow from operations was a negative $547m. Enron was losing money - real money, cash money - hand over fist by just being in business. Interest expenses were surging.
By the end of June 2000, Enron was paying about $2m per day in interest to banks and other lenders. The $376m in interest charges for the first half of 2000 was more than it paid in all of 1996. Despite EnronOnline's voracious appetite for capital, Skilling was able to convince a nearly constant parade of reporters that Enron's trading business was the golden goose. Other companies were going to explode as Enron figured out how to buy and sell every part of an individual company's traditional business. Enron was going to intermediate everything, commoditise everything. Just as the Ford Motor Company didn't have to own the steel mill to build cars, Enron was going to speed the breakup of every business in the world into its individual parts.
"We believe that markets are the best way to order or organise an industrial enterprise," Skilling told the Financial Times in June 2000. "You are going to see the deintegration of the business systems we have all grown up with."
If Enron was going to help that "deintegration", its trading business was going to keep growing. And that meant Enron would need more capital, lots more capital. But there was a problem: Enron could not raise capital by adding more debt. More debt on its balance sheet might lower the company's credit rating, which would further increase the company's already high interest costs. Skilling needed more cash but no more debt. Some smart "financial engineering" was required.
© Robert Bryce
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