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DukeEmployees.com - Duke Energy Employee Advocate

Deregulation - 2002 - Page Two


"We want to make sure that we don't have a debacle like they
did in California." – N. C. Senator David Hoyle, on deregulation.


Enron Denial

Dow Jones – January 10, 2002

NEW YORK --The Enron Corp. (ENE) executive denial strategy is starting to look and sound uncomfortably like previous headline-grabbing mistakes and failures in which highly placed people denied culpability or knowledge.

Is the important business of post-mortem on America's largest-ever corporate bankruptcy in danger of devolving into another Whitewater? Another Iran-Contra? Another Watergate? Apparently so.

And the alleged culpability of Enron's current and former executives raises an old question yet again: If these people really didn't know what was going on, were they really doing the best job they could?

In a wide-ranging interview Friday with Dow Jones Newswires' Jason Leopold, Enron's former chief executive, Jeff Skilling, said when he left the Houston energy trading outfit in August he "had no concern or any knowledge of problems at the company."

And Enron's chairman and current chief executive, Kenneth Lay, last month described the problems that led the Houston company to sell itself to hometown rival Dynegy Inc. (DYN) - a deal since dissolved - as "very bad investments" like overseas power plants that kept the company from focusing on its core business of trading power and gas. No word about dubious dealings with off-balance-sheet partnerships, including those headed by former Chief Financial Officer Andrew Fastow.

Earlier this month, one of Fastow's lawyers claimed Enron's board authorized all of Fastow's activities. Another attorney representing Fastow cautioned against assuming Fastow had equal knowledge of all the outside partnerships that contributed to Enron's downfall.

Let's recap. The former boss denies knowledge of problems. The chairman seems to deny the elephant in the room - the outside partnerships. And the previous financial chief's counsel apparently is trying to defend his client in part by denying at least some knowledge.

We should not assume that any of this (sic) men are veering from the truth or what they perceive to be the truth, and this column is not taking that position. Investigators, regulators and the courts will get to the bottom of it all in months or maybe even years, hopefully.

We can, however, make two statements of fact about these executives: No one wants to fess up, and everyone wants to deny full or even partial knowledge of the matters that sent Enron into a tailspin.

Political history of the ilk cited higher in the story has taught us not to expect people in high places to come entirely clean when things go wrong. The oft-repeated quote about power corrupting hardly seems worth repeating, despite its status as an aphorism for the ages.

As for denying knowledge, again the great political scandals over the years are instructive.

Denial in whatever form - outright or issue-skirting - remains the favored strategy. Heartfelt or full apologies are rare, even though investors, like citizens, have proven time and again that they can forgive. Imagine what would happen if everyone did his or her job or ran their lives or relationships based on the same strategy.



No Deregulation for Arkansas

Dow Jones – January 10, 2002

(12/28/01) - CHICAGO--Arkansas utility regulators want state lawmakers to either delay the start of electric deregulation for a decade, or to repeal the law calling for deregulation altogether, a state commissioner said Friday.

Arkansas currently plans to launch electric competition in October 2003. But continued uncertainty about wholesale market development, rate benefits for consumers and economic implications shows the state won't be ready by then, said Betty Dickey, commissioner at the Arkansas Public Service Commission.

"At no time in the next ten years would (deregulation) be in the best interest," she said.

In a filing submitted to the state legislature last week, the PSC suggested the state either delay the start of deregulation until 2010 or 2012 or completely repeal the deregulation law. The commission's filing follows similar recommendations made by PSC staff two months ago.

A delay of some length is widely supported in the state, while a repeal of the law has less support, Dickey noted. New Orleans-based Entergy Corp. (ETR), which operates Arkansas' largest electric utility and has more than 650,000 customers in the state, said in November that it supports a delay but not a repeal. The current deregulation plan benefits Entergy by allowing it to recover stranded costs, or the cost overruns associated with some of its nuclear power plants in the region.

Expected Events Didn't Occur

According to Dickey, repealing the deregulation law doesn't necessarily kill restructuring plans in Arkansas altogether. But the current deregulation plan, created in 1999 and modified in 2001, doesn't account for unexpected developments in the marketplace. The law needs to be scrapped or heavily modified if the state legislature still wants deregulation, she said.

"It appears to me we would have to go back to the drawing board," she said.

When the Arkansas legislature passed the 1999 deregulation law, they assumed neighboring states would deregulate, the law would attract business, and the Federal Energy Regulatory Commission would rapidly develop transmission organization to run the power grid, Dickey said.

But since then, "none of these things happened," she said. The development of FERC-approved "regional transmission organizations" in the Southeast has been a slow process, creating uncertainty about how the wholesale market will operate in Arkansas. That's a concern, as the development of robust wholesale markets is a key element of restructuring.

California's much-publicized deregulation problems, meanwhile, have also had an impact by clouding the economic benefits of deregulation. According to Dickey, one California company told Arkansas officials it would cancel a move to the state if it enacted deregulation - not the effect Arkansas officials were looking for when they created the plan.

"What we thought would be economically beneficial turned out to be a liability," Dickey said.

Additionally, neighboring states in the region never followed through with deregulation plans as anticipated. Oklahoma recently decided to delay deregulation for several years, and while Texas still plans to open competitive markets Jan. 1, most of the state's transmission system is cut off from the rest of the U.S. grid.

Some of these issues were apparent earlier this year, when the Arkansas legislature delayed the start of competition from January 2002 to October 2003. But it's now clear that delay is too short, the state PSC told the legislature in its report.

Only state lawmakers can repeal the law, and the Arkansas legislature doesn't meet again until 2003. It's possible that, in another required report on the issue before then, the PSC could change its recommendations based on new evidence of successful deregulation in other states or changes in the market place, Dickey said. As it stands right now, though, there is no evidence of completely successful deregulation elsewhere in the U.S., she said.

"To date, no state has implemented an entirely successful retail competition model," the PSC said in its report.



Missing The Enron Point

The Washington Post – by Lanny J. Davis – January 8, 2002

Here's a paradox: Despite predictions of doom from many financial writers, it doesn't matter very much that Enron -- at one time touted as the seventh-largest company in the nation -- failed. What matters is why it failed.

Enron's demise will be little more than a blip on the U.S. economy, with the big losers confined to the same financial speculators who rode the bubble on the way up. But the underlying cause of Enron's fall -- a corporate culture of secrecy and obfuscation -- is not unique to that company. Far from it. Enron's problems are emblematic of myriad public companies in the 1990s, from dot-com start-ups to some of America's biggest corporations, who yielded to the pressure to inflate their stock by whatever means possible.

If that culture isn't replaced by more transparency and accountability, regulated and enforced by the Securities and Exchange Commission (SEC) and U.S. prosecutors, the credibility and integrity of the various stock markets in which millions of Americans are now invested could be seriously undermined. That's why I hope that Sen. Joseph I. Lieberman (D-Conn.) meant it when he said Wednesday -- after his Senate Governmental Affairs Committee announced it would subpoena Enron's top executives and directors -- that the committee's focus will be "to make sure that something like this never happens again."

I know something about the culture of obfuscation. I have spent much of the past three years representing public companies and executives accused of accounting and financial fraud. Sometimes I have been lucky enough to be called in before the bad news hit the fan. But more frequently, I arrived after information had begun to leak out.

In one instance, the new CEO of a Nasdaq-listed company, Lernout & Hauspie Speech Products, retained me and my law firm. He told me he suspected that the books of the language translation software company had been cooked by the company's former CEO. The company, he said, had created the appearance of dramatic growth by establishing outside entities -- investment companies in which money from investors was being used to purchase what turned out to be mostly nonexistent products and services. Liabilities and losses were being hidden in these entities and not included in the company's financial statements.

The new CEO suspected that some members of the board of directors might be complicit. The Wall Street Journal had been writing bits and pieces of the story, but the company, based in Belgium, had either stonewalled or had given out misinformation.

We quickly initiated a two-part strategy based on complete transparency: First, we decided to support an investigation by outside auditors and a new law firm, with a commitment to publish the results and cooperate fully with the SEC; second, we proposed a program of internal reform to clean up the last vestiges of misleading financial reporting. While we knew the company's high-flying stock would take a major beating once we made these disclosures, we believed this strategy offered the only hope for the survival of the company.

However, we ran into a glitch. The company's board of directors opposed full disclosure. The new CEO defied the board and directed me to give the report to the Wall Street Journal and to other newspapers and to post it on the company's Web site. We both agreed he had no alternative if he were to avoid becoming part of the coverup. One immediate result of our strategy: The new CEO was summarily fired by the board -- as were my law firm and I. Another result: A short time later, the company filed for bankruptcy and was liquidated. The former CEO and some board members were charged with fraud and stock manipulation. All have denied these allegations. The investigation is continuing.

So you can see why I took such an interest in the rise and fall of Enron. As Yogi Berra would say, "It's déjà vu all over again." Enron, too, developed outside entities that supposedly generated revenues for the company, while keeping the expenses and contingent liabilities associated with those transactions off the books. And Enron's business, like Lernout & Hauspie's, didn't focus on selling real products to consumers with real profit margins. Rather, Enron was essentially a broker: It bought, resold and invested in commodities futures contracts, gambling on future prices and market conditions. One example of this business model is a brokerage company such as Goldman Sachs. But perhaps a more apt analogy is Las Vegas.

It really didn't matter what commodities Enron was betting on. Although it was known as an energy company, trading in natural gas and electricity contracts, it also speculated in water contracts, advertising and time contracts, complex derivatives, broadband capacity futures and weather derivatives (whatever that means). Its former chief executive, Jeffrey K. Skilling, actually once boasted about the company's absence of hard assets. He proudly described its approach as "asset lite," adding: "In the old days, people worked for assets. We've turned it around -- what we've said is, the assets work for people."

This characterization is the key to understanding both the breathtaking speed of Enron's collapse and the reason its failure will not have much impact on the nation's economy. Enron's geometric growth from a sleepy natural gas pipeline company in the '80s to a global giant -- with 21,000 employees, 3,500 subdivisions around the world and, by the summer of 2000, a total "market capitalization" value of more than $80 billion -- was based on perception rather than reality. As long as everyone saw the stock price going higher and higher, people were willing to bet their money (through loans, equity investments and credit on trades) on Enron. J.P. Morgan Chase & Co., for example, lent Enron $500 million without security and another $400 million purportedly secured by something.

But if you live by the perception and the illusion of growth, then you die by it once reality sets in. Being "asset lite" meant that once Enron's numbers and disclosures became suspect, there was no foundation of hard assets -- real products with real value -- to fall back on. Not surprisingly, once the first card of credibility was lost, the rest of the house collapsed quickly. On Oct. 17, Enron was forced to announce that it had hidden $1 billion of losses resulting from the outside entities; the next day it reduced its assets by $1.2 billion. Just six weeks later, on Dec. 2, after weeks of putting out deceptive information, Enron filed for bankruptcy. Its stock price had fallen from $90 a share in the previous year to just 87 cents.

The fallout? Thousands of Enron employees who lost their jobs and much of the value of their 401(k)pension plans, which included now-worthless Enron stock, will feel a deep impact. Because of decisions made by senior management, these employees were not allowed to sell the stock as it was dropping in value, though those same managers had sold nearly $1 billion worth of shares throughout the year. Others likely to suffer from the company's failure are the banks, investors and trading partners who willingly advanced Enron their money as the stock soared.

But it's hard to feel much sympathy there. Consumers won't really notice the difference. The electricity, natural gas and water supplies that were the subject of Enron futures contracts will still be delivered to their homes one way or the other. Speculators in Enron's "weather derivatives" may have lost some money, but that's not likely to have much effect on whether it rains or shines each day.

So if Enron's fall doesn't really matter in macroeconomic terms, why should we care? Because the corporate culture that bred that failure has undermined trust in the integrity of the public markets. The goal of "meeting the numbers" projected by analysts for each quarter has too often become the overriding goal -- to be achieved in the accounting department if it cannot be achieved in the marketplace. As Michael R. Young has written in "Accounting Irregularities and Financial Fraud," his seminal book, "What moves financial markets is the published expectations of Wall Street analysts." They "are perceived to establish, within a very narrow margin, the parameters for the upcoming actual financial results. Analyst expectations have become, in effect, a company's reported earnings."

With millions of Americans now invested in the stock market, this is no longer a concern limited to financial elites. We cannot afford to preserve a system in which perception is more important than reality.

The solutions are as obvious as they are unlikely to be met. The rule of thumb must be transparency, in word as well as deed. On a technical level, accounting rules and disclosure requirements have to be tightened up. Off-balance-sheet entities that create even the slightest contingent liabilities should be incorporated into the company's publicly filed financial information. We must also move to a system of real-time financial disclosures, with online access to the latest financial information. This is what SEC policymakers and congressional investigators should concentrate on.

In addition, white-collar criminals who cook the books should be prosecuted, sent to jail and required to disgorge profits from all stock sales made during the period of fraud, rather than receiving what is too often a slap on the wrist and a reminder to the corporate world that crime can pay.

Finally, corporate managers must practice the basic rules of crisis management -- which may mean defying the advice of many of their lawyers -- when they learn about bad news that could hurt the company's stock price. The truth will come out anyway, and dribs and drabs will only make its impact worse. So you might as well put it out yourself -- and then do something to fix the problem.

Of course, this advice to tell all the truth has been rejected, time and again, and not only by business executives. It has been ignored by politicians as well. The effect on the public's trust -- whether shareholders' or voters' -- has been the same.



Deregulation Folly

San Francisco Chronicle – by Carolyn Said - January 6, 2002

It was supposed to save money.

Now that California has burned billions of dollars to keep the lights on over the past 18 months, it seems absurd. The entire impetus for the state's grand experiment with electricity deregulation was to cut costs -- for everyone from manufacturers to consumers to utilities to power generators.

Instead, California could be paying the tab for years. The state must come up with billions to cover its new role as electricity purchaser. And even though energy prices now have fallen, consumers and businesses still pay the higher rates imposed during the dark days of last spring.

It's a far cry from the rosy scenario of savings for everyone envisioned when deregulation got its start. As predictable as characters in a commedia dell'arte, representatives of assorted interest groups trooped to Sacramento in the mid-1990s, enacting set pieces about their agendas -- all with the common interest of structuring deregulation to their benefit.

-- Manufacturers, who had just weathered a devastating recession in the early '90s, wanted flexibility to negotiate better power rates from providers other than the state's investor-owned utilities.

"Before deregulation, California had 50 percent higher (electricity) rates than its neighboring states," said Gino DiCaro, spokesman for the California Manufacturers and Technology Association. "That's why large industrial users pushed for it so hard."

-- Utilities -- San Diego Gas and Electric, Pacific Gas and Electric and Southern California Edison -- wanted a way to recoup the billions of dollars in "stranded costs" they had sunk into nuclear power plants and contracts for alternative energy.

-- Consumer advocates wanted to shield electricity users from future hikes.

-- Power generators wanted every home, office and factory to be able to buy electricity directly from a supplier -- i.e., themselves.

-- Power regulators and lawmakers wanted to loosen the utilities' monopoly on both power production and supply.

CRAFTING LEGISLATION

The Legislature was eager to accommodate everyone.

Once the Public Utilities Commission voted in 1995 to institute deregulation, the task of crafting a plan was entrusted to state Sen. Steve Peace (D-El Cajon).

Peace, such a policy wonk that he makes Al Gore look like Dan Quayle, plunged enthusiastically into the minutiae; his marathon late-night sessions to thrash out arcane details became known as the "Steve Peace Death March."

The complex bill passed with no dissenting votes, although later lawmakers admitted that many hadn't understood it. Gov. Pete Wilson signed it on Sept. 23, 1996.

The plan had something for everyone.

Manufacturers -- the steel makers, mining concerns and cement makers that spend a quarter of their overhead on electricity costs -- could line up their own sources of energy. Utilities were instructed to sell off their power plants so they would get payback for their initial investments, and also would no longer have a monopoly over both power production and supply. Consumers got a 10 percent rate cut and a promise of no rate hikes until 2002 or until utilities paid off their capital investments in power plants, whichever came first. The rate freeze also mollified the utilities, who wanted to make sure that rates would not go down.

FLAWED FROM THE GET-GO

The fundamental flaws stemmed from the fact that deregulation tried to have the best of both worlds: rate controls that applied only to wholesale prices, not retail prices; power plant ownership that rested in the hands of out-of- state generators, not local utilities; a dependence on the volatile spot market for purchases; and no flexibility for those buying electricity to just say no when the wholesale price got too high. The breakdown on specific defects in the plan:

-- Rate freeze. Even though the consumer rate freeze was what made deregulation palatable to consumers -- and thus legislators, who wanted credit for saving people money -- it didn't encourage conservation among consumers or competition among electricity suppliers.

-- No cap on wholesale rates. The rate freeze affected only half the equation -- the amount consumers paid for electricity. There was no concurrent cap on what the utilities paid for electricity. That meant things could -- and did -- get drastically out of control. In fact, to encourage power generation, deregulation guaranteed the highest price for wholesale electricity. The last bidders in the market, who paid the most, set the price for everyone.

-- No long-term contracts. The plan forced most electricity purchasing to occur a day ahead or on the volatile spot market. The result was no ability to lock in cheap rates with longer-term contracts.

-- No flexibility to say no. The ISO managers were bred in the bone to keep the lights on at all cost. That meant that when supplies were tight, they would pay any price to ensure a consistent flow of juice. Power companies figured this out: Charging what the market could bear meant the sky was the limit.

-- No true competition. Competition among electricity generators was supposed to be one of the hallmarks of the new market. Theoretically, consumers would shop for the best electricity plan just as they do for the best long-distance phone plan, and the electricity companies would vie to offer the best rates. But because of the rate freeze, consumers didn't have any reason to switch suppliers. By early 2000, only 1 percent of consumers had switched.

-- Tight supply. A new power plant costs a staggering half a billion dollars for a 500-megawatt facility (large enough to light 500,000 homes). During the years the state thrashed out deregulation, companies were reluctant to invest in building plants in California, because they didn't know if the new market structure would let them recoup their investments.

Consequently, throughout the 1990s, the state built only a handful of small plants totaling 1,075 megawatts. But by the mid-90s, California was back to being a gold-rush state, with the population on the upswing and the tech economy booming. Generating capacity fell behind demand.

CLUES SOMETHING WAS WRONG

One of the first steps in implementing deregulation was for the utilities to sell off their power plants. That would open the market to a bevy of competitors, who would then vie to offer the lowest prices -- or so the theory went.

Out-of-state power companies, not ordinarily known for their spendthrift ways, bid big bucks to take over decades-old power plants -- a motley collection of black-smoke belching, decades-old electron factories. Six power firms spent $3.5 billion, many times the book value of the 17,000 megawatts of facilities. In retrospect, experts said, those big-bucks purchases showed that the companies must have realized that deregulation was going to be a happy hunting ground for them.

"Most industry observers thought those older-generation assets would go for bargain-basement prices," said state Sen. Joe Dunn (D-Santa Ana), who heads the Senate Select Committee to Investigate Price Manipulation in the Wholesale Energy Market. When instead they sold for huge prices, it should have raised some suspicions: "What did they know that the rest of us didn't?"

The Bay Area got a taste of blackouts during a bout of hot weather in June 2000. The sudden spike in demand not only shorted out the grid, it brought about an epiphany for power generators, according to Michael Shames, head of Utility Consumers Action Network in San Diego.

"The generators figured out how to game the market when San Francisco had that blackout from the freak heat wave," he said. "When the prices went as high as they did, they realized, 'You know what? If there's a shortage, there's no limit on what we can ask.' "

Ongoing hot weather down south kicked off another ominous chain of events. In San Diego, which essentially was the canary in the coal mine, the little clause that said the rate freeze could end once utilities paid off their debts turned out to have teeth.

The windfall from selling off its power plants gave SDG&E enough money to pay off its $2 billion in stranded costs. That meant the rate freeze was no longer in effect; instead, customers' prices would be determined by the market.

And the market went haywire.

Power generators "started holding back from the day-ahead market and pushing transactions closer and closer to real time," said Arthur O'Donnell, editor and associate publisher of California Energy Markets, a newsletter in San Francisco. "That turned out to be a recipe for disaster. Essentially, (generators) could double or triple what they might get by holding back."

Rates soared by a factor of up to 20 times for the 3 million SDG&E customers. The Legislature had to step in in late August to impose price caps.

PG&E and Edison were experiencing similar difficulties with ballooning power rates. As they were still barred from passing their escalating costs to customers, they began to accumulate billions of dollars in debts.

MOTHER NATURE STEPS IN

Meanwhile, weather conditions were building to create a "perfect storm" scenario that would come into play for the entire state later in the year:

-- For several years, winters had been mild, so consumers used less heat, so natural gas providers slowed exploration, while utilities allowed stockpiles to be depleted.

-- The Pacific Northwest was in the third year of a drought in 2000; that meant the source for a significant portion of California's electricity would have an empty cupboard when crunch time hit.

-- The summer of 2000 was unusually hot, triggering increased use of electricity.

-- The winter of 2000-01 was unusually cold and everyone cranked up the heat. Natural gas was in short supply, so its price soared overnight. Most power plants in California also use natural gas to produce electricity, so suddenly their basic input was astronomically expensive -- which meant so was their output.

HITTING THE FAN

By last winter, human myopia and greed, coupled with nature's relentlessness, had set the stage for an electricity fiasco.

And that's exactly what we got.

In January, the first rolling blackouts directly attributable to deregulation, not the weather, hit California. Their timing was mysterious, coming during the winter when electricity demand is low because no one's using power-guzzling air conditioners. The proximate cause was that a number of power plants were unexpectedly off-line, a situation that caused power prices to shoot up.

Power generators "would reduce power and see what happens to the price, just like Homer Simpson in the Barcalounger saying, 'The chair goes up; the chair goes down,' " O'Donnell said.

Still, he added, "There was nothing illegal or even especially bad about such activities -- merely profit maximization behavior by sellers taking advantage of flaws in the system to make money."

This pattern repeated itself for months. It led to speculation that generators were "gaming" the market, purposefully taking plants out of service to drive up prices. But substantiating those charges would require a smoking gun -- some tangible proof that electricity firms explicitly colluded to set prices -- something that has eluded investigators.

"If you go to a plant, and they tell you it's down, they'll say they have good reasons," said Severin Borenstein, director of the University of California Energy Institute. "What are you going to say, 'We don't think that cog needs to be replaced'?"

As the situation continued to spiral out of control, the state had to step in to take over the purchase of electricity from the foundering utilities, and slapped Californians with a rate hike to help pay the piper. Edison and PG&E essentially ran out of money -- although their parent companies continued to exhibit healthy balance books. PG&E filed for bankruptcy reorganization in April, with Edison cutting a separate, $3.3 billion rescue deal with California.

LONG-TERM CONTRACTS

Grasping for a lasting solution, Gov. Gray Davis negotiated long-term power contracts so blackouts would no longer loom as a threat, paying $43 billion for power over the next 20 years.

But his timing was equivalent to buying, say, Amazon.com stock just before the dot-com swoon on the Nasdaq. "He basically bought this huge insurance policy through long-term contracts (but) paid way too much," said Peter Navarro, an economics professor at the University of California at Irvine Business School.

By signing the contracts at the height of the market, Davis locked the state into billions of dollars more than it should have to pay, observers said.

Davis retorted that the contracts were what brought down power prices. Now, Davis is scrambling to renegotiate those deals.

Philip Verleger, a Newport Beach economist, sees the genesis for the whole debacle in the blueprints for deregulation so tortuously drafted over half a decade ago.

"It's like the old joke about an economist: someone who knows 250 ways to make love and has never had a date," he said. "Everybody who was involved with the designing of this electricity system knew lots of ways to set up a market for electricity, but they had never traded.

"There's a wonderful saying by Ben Franklin: There's no uglier sight in life than a beautiful theory mugged by an angry gang of facts. California got squeezed about a million times, and its electricity market didn't figure it out."


Deregulation - 2002 - Page One