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July - Duke Energy Employee Advocate

Deregulation - Page 26 - 2002

Enron Whistleblower Resigns

Reuters – November 16, 2002

HOUSTON (Reuters) - The Enron Corp. executive who warned of questionable accounting months before its stunning collapse is leaving the company on Friday to advise corporations on ethical issues.

Enron Vice President Sherron Watkins, who wrote she was afraid Enron's accounting misdeeds could "implode" the company, testified before Congress earlier this year on the scandals that eventually devastated the energy-trading and accounting industries.

"She is in fact leaving today and she plans to go into consulting work in the area of corporate governance," her lawyer, Philip Hilder, told Reuters.

"It was a voluntary decision and we wish her all the best," Enron spokesman Mark Palmer said.

Watkins, 43, could not be reached to comment on her plans, but the March 2003 publication of her book titled "Power Failure: The Inside Story of How Enron's Culture of Arrogance and Greed Led to the Biggest Bankruptcy in American History," written with Mimi Swartz, is already being advertised.

"That will be her statement," lawyer Hilder said with a laugh. "I think that will act as any statement as to her time with Enron."

Watkins, a former accountant, wrote to Enron Chairman Kenneth Lay in August 2001: "I am incredibly nervous that we will implode in a wave of accounting scandals."

The scandals that did indeed collapse the company also toppled the accounting firm Andersen, reduced the energy-trading business to rubble, especially in regard to the California electricity crisis, and raised questions about Lay's relationships with government officials and regulators including President Bush.

Watkins worked at an Enron unit run by former Chief Financial Officer Andrew Fastow, who pleaded not guilty last week to charges he defrauded Enron and its shareholders by creating outside partnerships, profiting him millions of dollars. Fastow, 40, was indicted on 78 counts, including fraud, money laundering and obstruction of justice.

Watkins, a certified public accountant who had not been an active accountant since before her nine-year stint with Enron, has already made several speeches on business ethics, her lawyer said.

"I would anticipate she will now have more time to take on additional speaking engagements," said Hilder, who described his role as "generally shepherding her through the legal system. There were numerous government investigations, congressional hearings and the like."

She worked as an accountant at Arthur Andersen, Enron's former auditor, before joining Enron in 1993.

The Texas Deregulation Runaround

The Dallas Morning News – by Sudeep Reddy - November 15, 2002

(11/13/02) - Kathy Jackson tried to sign up with a competitive electric company when she moved into her Flower Mound apartment in May.

Six months later, she's still trying.

The technical glitches that plagued the state's deregulated electricity market earlier this year are still testing the patience of consumers like Ms. Jackson, who has spent 20 hours on the phone with electric companies since May as she tried to resolve her problems.

"I just want cheaper rates," she said. "They're going back and forth with all these rules and regulations. They've got me stuck in the middle."

The technical difficulties, including switching and billing mistakes, have frustrated and angered some consumers who turned to the competitive electricity market seeking lower rates and better customer service.

"We're 10 months into the market, and people still aren't getting the right answers when they call these customer service lines," said Carol Biedrzycki, executive director of Texas Ratepayers' Organization to Save Energy, a consumer group. "Maybe it's a learning curve, but it's a long learning curve."

About 82,000 Texas customers are missing at least one electric bill since the deregulated market opened in January, according to the latest Public Utility Commission figures. That's about 1.5 percent of all customers on the state's electricity grid.

The billing errors have decreased since May, when more than 250,000 customers were missing bills. But consumer complaints have skyrocketed. The PUC received 8,547 complaints against electric companies in its fiscal year that ended in August, compared with 2,062 a year earlier.

Even though the number of errors has decreased, it's still not low enough, said Randy Chapman, executive director of the Texas Legal Services Center. "Until they get all these problems fixed, the last thing I would recommend is a voluntary switch," he said. Texas' deregulated electricity market involves a multi-leg process of sending customer information among several players -- including a retail electric company, the state's electricity grid operator and the transmission and distribution company. Data can get lost anywhere in the system.

"It's by definition more complicated, and there's really no way around that," said Jim Burke, senior vice president of consumer operations for Houston-based Reliant Energy, which markets as a competitive provider in North Texas. "If you're going to open the market up to competition, you have to segregate the duties."

Early in the year, some customers who moved into houses or apartments could not get their electricity turned on. After those issues were resolved, Mr. Burke said, customers haven't had as much difficulty with getting power as they have with receiving bills.

The problems "are the exception rather than the rule," said Tom Noel, chief executive of the Electric Reliability Council of Texas, which operates the state's electricity grid.

ERCOT's systems -- which serve as a clearinghouse for customer data -- have been the source of fewer problems for customers than they had been earlier, but "that doesn't give me any satisfaction," he said. "The reality is somebody's expectations were not met."

Companies can bill consumers for up to six months of service, and all the Texas companies have said that consumers will get extra time to pay their delayed bills.

Several electricity providers have told the PUC that they waived charges for customers who did not receive bills early in the year. And some customers may be lost in the system -- not receiving bills at all for their electric service.

Bedford resident B.L. Stroud switched from TXU Energy to Reliant in January. By June he decided to switch back because he had received only one bill from Reliant -- with two months of charges and a "past due" notice, even though it was the first bill he had seen.

Mr. Stroud said he would be reluctant to try switching again.

"It's true that I might have saved and might save money with a competitor," he said. "But it's not worth the money, and I'm not going to take a chance on it."

Reliant said Mr. Stroud's frustrations were a combination of a billing delay and the standard switching procedures, which did not convert him to Reliant's systems until March 1.

Ms. Jackson's ordeal started in May, when she moved into her Flower Mound apartment and signed up with First Choice Power. "It has been a nightmare since May 14," she said. By the end of last month, she had received four notices from ERCOT that her electricity provider would be switched -- even though she made only that first request in May.

Somehow her service kept getting kicked back to TXU, which serviced her apartment before she moved in. At one point, a TXU representative told her that her power would be shut off if she did not pay -- even though she had not received a bill and never chose TXU.

Despite having to make regular calls to the electric companies, Ms. Jackson said she'll keep trying to switch instead of giving up.

"It's just kind of the battle," she said. "But I don't know if I would do this again if I moved."

TXU spokesman Chris Schein said that for every consumer who has been soured by the deregulation experience, hundreds more have saved money without any problems.

And deregulation has forced the company to work harder to keep its customers, he said.

"We're paying both for our actions and our behaviors," Mr. Schein said. "If we are not able to provide a level of service to a customer and he gets mad and goes someplace else, that's lost revenue to us. Now we've got to work twice as hard to win him or her back as the customer."

Mr. Noel, ERCOT's chief executive, called the system "a work in progress." But, he said, it's "unrealistic to expect that we'll ever get to the point where things are flawless."

"They were not flawless under a regulated environment; I doubt that they'll ever be flawless in a restructured environment," he said.

Deregulation Plagues Ontario

New York Times – by Bernard Simon - November 15, 2002

(11/13/02) - Across much of North America this fall, electricity bills are being held in check by a slack economy and intense competition among producers. But not in Ontario, where politicians are scrambling to quell a public outcry over soaring power prices.

Six months after deregulating its power market in hopes of promoting competition and encouraging investment in new capacity, the government of Ontario, Canada's most populous and industrialized province, backtracked late Monday and said it would freeze retail electricity rates for the next four years.

Households and small businesses will be given rebates averaging about 75 Canadian dollars ($47.79) to compensate for the surge in electricity bills since the start of deregulation in May, the government said. It also froze the fees local distribution companies charge customers for delivering power from producers to them, reversing an earlier decision to allow them to rise gradually.

''We have to smooth out the bumps along the road to a competitive market,'' John Baird, the province's energy minister, explained.

Critics said they saw in the decision the seeds of a crisis like California's in 2001. A price freeze, they said, would significantly increase the risk of blackouts in coming months, and threaten the financial stability of some utilities.

''The retreat is so dramatic,'' said Tom Adams, executive director of Energy Probe, a Toronto research and consulting firm. ''It would be positively hazardous for anyone to lay down their cash here in any form of long-term investment.''

With the ruling Progressive Conservative party trailing in public opinion polls, Mr. Adams said, the government's action looked like a political ploy. An election is expected to be called here within 18 months.

Electric bills have become a major issue for many businesses, from hotel operators to mushroom growers. The situation is ''a mess,'' said Gregory Gray, operations manager at Money's Mushrooms near Campbellville, west of Toronto.

Mr. Gray's company produces 22 million pounds of mushrooms a year, using large amounts of electricity for climate control in its greenhouses. He said the power bill in August was 40 percent higher than the year before, and the September bill will probably be more than double.

High demand in an unusually warm summer was partly to blame for big power bills, analysts said. But the volatile prices and the deepening financial problems experienced by many North American utilities since the collapse of Enron have also exposed flaws in the government's blueprint for the power sector.

''It is important to recognize that the world in which we operate is much different than the world in which the Ontario market was created,'' said Duane Cramer, vice president of Sithe Energies, a New York-based power producer, at a conference here last month. Sithe is a unit of Vivendi Universal.

Sithe recently shelved plans to build two power stations on the outskirts of Toronto. ''We've spent much of the past year spinning our wheels, and we've run out of rationales to continue spending money,'' Mr. Cramer said.

According to Rocco Sebastiano, a lawyer at Osler Hoskin & Harcourt who specializes in energy matters, ''there isn't the appetite in the marketplace to make significant investments in energy these days.''

Despite deregulation, Ontario's power market is still dominated by two government-owned companies. One, Ontario Power Generation, was created to take over the power plants owned by the old provincial monopoly, Ontario Hydro, when the monopoly was broken up in 1999; the other, Hydro One, was created at the same time to take over Ontario Hydro's transmission network.

Hydro One was supposed to be floated in an initial public offering, but unions and advocacy groups heatedly opposed the sale, and Ernie Eves, the provincial premier, called it off shortly after taking office. Instead, the government is trying to find a buyer for a stake of up to 49 percent in Hydro One.

To increase competition, the government ordered Ontario Power Generation to give up control over at least 4,000 megawatts of generating capacity over the next three years, about one-sixth of its total capacity. By 2012, Ontario Power is meant to control no more than 35 percent of the province's electricity supply; it now has more than 75 percent.

But the government recently forced Ontario Power to cancel a proposed sale of two coal-fired power plants because the buyers would not promise to convert them to run on natural gas or another energy source cleaner than coal.

The power picture has not been helped by delays in getting a nuclear plant at Pickering, east of Toronto, running again. The plant, which can produce 2,060 megawatts of power in all, has been closed since 1997 because of safety concerns.

The first of the four generating units was to be restarted before deregulation began, but Ontario Power now says it will not come online until the spring. In the meantime, Ontario has had to buy power from neighboring provinces and from the United States at greater cost.

Refurbishing the Pickering plant has also eroded Ontario Power's profits, with much of the rising cost, now estimated at about 2.3 billion Canadian dollars ($1.47 billion), charged off as operating expenses.

As a result, the company made no contribution last year toward paying down the 20.1 billion Canadian dollars in ''stranded debt'' that the province assumed from Ontario Hydro to make its two successor companies more attractive to outside investors. According to Mr. Sebastiano, Ontario Power ''hasn't moved to market-driven forces -- they're still in a monopoly position.''

At the time of deregulation, the government said rising prices would curtail demand and be self-correcting. Mr. Baird said today that he now expected demand to be held in check by conservation. To set an example, the government said it would use only half the usual number of Christmas lights to decorate the giant tree at the provincial legislature.

Faking Ethics After Enron

The Charlotte Observer – by Joan Ryan – November 14, 2002

Companies are learning how to substitute one sham for another

(11/13/02) - SAN FRANCISCO - I haven't seen the tape myself, but it gets my nomination for official symbol of the post-Enron era. Here's a description from the Associated Press:

"At defense contractor Raytheon Co., a training film features Patti Ellis, vice president for business, ethics and compliance, sharing a theater balcony with movie critic Roger Ebert. The two flash thumbs-up or thumbs-down concerning certain practices, such as skimping on required tests to get a product out more quickly or making sure the company doesn't inflate the cost of labor."

All together now, boys and girls: Cheating bad. Honesty good. Maybe the company chose Roger Ebert because Bert and Ernie were unavailable.

The Raytheon film is part of a new trend of remedial ethics in the adult world. It's not just corporations teaching right from wrong to those they think somehow missed it. Colleges are beefing up honor codes, requiring "student integrity contracts" and launching "academic-integrity education campaigns."

A recent informal survey of 1,139 students at 27 American universities suggests there is a need. Nearly 60 percent of the students admitted to cheating on a high school or college test. So colleges have a legitimate concern and their attempts to raise standards seem genuine.

The business world is quite another story, however.

The ethics crisis has been playing out in the executive suites, as one top boss after another slips into the back seat of a cop's sedan, charged with corruption, cheating, lying, fraud or insider trading. Thus, facing the problem of corruption in the executive suite head on, corporate America is requiring employees to take ethics classes.

Corporations are contracting by the dozens with hot new companies such as Integrity Interactive Corp. and LRN, The Legal Knowledge Co., which provide Web-based ethics classes to employees. They are hiring ethics officers, who now have their own association. (The group recently reported an upsurge of 100 new members, bringing their total to about 850.)

These officers produce and distribute thick manuals that often read like tax codes, complete with loopholes and fine print. Enron's ethics manual was 51 pages.

"Why do they need 51 pages? The Ten Commandments is 75 words," says Pete Thigpen, a former Levi Strauss & Co. vice president who teaches an ethics course at the Haas School of Business at the University of California-Berkeley.

As businesses suffer from corrupt executives, as distrust and cynicism grow among stockholders and customers, the corporate solution is to teach employees the Golden Rule, as if they didn't quite grasp it in kindergarten. If you're moved by this rush to instill ethics in corporate America, don't be. This isn't about being ethical. It's about evading punishment. Under federal guidelines, companies that have ethics programs are eligible for reduced fines if convicted of wrongdoing.

If companies truly cared about instilling ethics throughout the workforce, they would look at their leaders. When leaders behave ethically, when they are ruthless with those who compromise the company's reputation, the standard for employees is clear.

But the post-Enron era is much like pre-Enron. Companies were cooking the books, faking transactions, lying to shareholders. The problem was about perpetuating a sham. Now so, too, is the solution.

Probes Proceeding on Several Fronts

Houston Chronicle – by Harvey Rice – November 14, 2002

(11/11/02) - SACRAMENTO, Calif. -- Bulging boxes holding thousands of Enron documents line the walls four high in the offices of the Energy Task Force on the 18th floor of a downtown building leased to the California Attorney General's Office.

Some of the task force's 85 attorneys are sifting through more than 400 boxes of documents and 400 computer disks, the equivalent of about 2,500 more boxes of paper documents.

The task force takes up half the 18th floor and has similar-size branch offices in Oakland and San Francisco. With a budget of $9.7 million, it shows the importance that California attaches to finding out what caused the 2000-01 power crisis.

"It's a huge deal for us," said Senior Assistant Attorney General Tom Greene, who heads the task force.

The attorney general's investigation is only one of several under way by state and federal agencies. The investigations are beset with political maneuvering, squabbling between state and federal agencies and criticism from the power industry.

Enron looms large in the investigations, although other energy companies are targeted as well.

It was a top Enron trader, Tim Belden, who pleaded guilty last month to criminal manipulation of markets, a development that grew out of Enron's release of two memos outlining manipulation devices that reinvigorated the investigations in May.

"Enron was the most influential formal market participant on the playing field," said Eric Saltmarsh, acting executive director of the California Electricity Oversight Board.

Although Enron's direct share of power sold to California was small, when the power sold by Enron to a third party and resold to California is taken into account, the company may have controlled 30 percent of the trading market, according to Greene and Saltmarsh. Industry analysts and other government agencies say that figure is vastly inflated and relates only to trades, not actual supplies.

The investigation is proceeding on several fronts:

  • The effort by the office of state Attorney General Bill Lockyer is probably the largest. The Energy Task Force has filed at least 70 legal actions before the Federal Energy Regulatory Commission and state and federal courts in an attempt to recover billions of dollars it alleges was bilked from California ratepayers by energy companies.

    The largest action asks the FERC to refund $8.9 billion to California ratepayers.

    Lockyer made it clear long before evidence turned up implicating Enron that he wanted to prosecute Ken Lay, then the company chairman.

    "I would love to personally escort Lay to an 8-by-10 cell that he could share with a tattooed dude who says, `Hi, my name is Spike, honey,' " Lockyer told the Wall Street Journal.

    So far, Lockyer's office has brought no criminal prosecutions.

  • The only criminal prosecution stemming from the energy crisis has come from the newest investigation. The office of Kevin Ryan, U.S. attorney for the Northern District of California, began its grand jury investigation after the Enron memos were made public in May.

    His prosecutors obtained a guilty plea Oct. 17 from Belden on a charge of conspiracy to commit wire fraud. Belden, who headed Enron's West Power Trading Division in Portland, Ore., is cooperating and is expected to lead them to others.

    Last Friday, Ryan's office also served subpoenas on Duke Energy Corp., AES Corp. and Williams Cos. The FERC is also investigating the Charlotte, N.C.-based Duke and the Tulsa, Okla.-based Williams.

  • The California Senate Select Committee, under the flamboyant Sen. Joe Dunn, a Democrat from Orange County, has kept the investigation in the spotlight.

    He has accused the Independent System Operator, created by California's 1996 electricity-deregulation law to manage the power grid, of manipulating the market and has called for the resignation of its director.

    His committee persuaded the Senate to hold Enron in contempt for failing to produce some documents and forced Ross Perot to testify about allegations that Perot Systems Corp., the computer-services company he founded, tried to teach energy companies how to manipulate the deregulated market.

    "The committee made it impossible politically for market manipulation to be ignored," said Larry Drivon, chief counsel for the committee. "I think more revelations are coming than most people realize there are."

  • The California Public Utilities Commission was one of the first state agencies to suggest that the market was being manipulated. But early on, it turned the investigation over to the attorney general's office, PUC President Loretta Lynch said.

    The PUC investigation had focused on power generators and in September issued a report alleging that Dynegy, Reliant, Duke Energy, Mirant, AES and Williams kept power plants idle or off the market during the height of the energy crisis.

    The Independent Systems Operator issued a report this month questioning the PUC allegations, but Lynch said she stands by the report and that the commission will issue a rebuttal within weeks.

  • The FERC is investigating a finding by an administrative law judge that Houston-based El Paso Corp. withheld capacity on a major interstate natural gas pipeline, driving up the cost of operating gas-fired generating plants during the electricity shortage. The company vigorously disputes the finding.

    The commission has scheduled a hearing on the matter Dec. 2.

    FERC officials also have been studying Enron Corp.'s former online trading system, Enron Online, to determine if it was employed to manipulate the system, said Donald Gelinas, the commission's associate director for the Office of Markets, Tariffs and Rates.

    FERC officials are scheduled to testify Tuesday before the Senate Governmental Affairs Committee to discuss the agency's oversight of Enron.

  • The Oregon and Washington state attorneys general are cooperating with Lockyer's investigation as they pursue their own probes. The power crisis in California spilled into other Western states, causing a 40 percent increase on some days in Oregon rates, said Kevin Neely, spokesman for the Oregon attorney general's office.

    Cheryl Reid, spokeswoman for the Washington attorney general's office, said the price per megawatt in that state spiked from $30 to $3,000 at one point during the crisis.

  • The Oregon Public Utilities Commission is trying to determine whether Enron subsidiary Portland General Electric and other power suppliers owe refunds to consumers because of market manipulation. PUC spokesman Bob Valdez said the commission wants to know whether a regulatory firewall between Portland and Enron was breached, whether FERC codes of conduct were violated or PUC orders disregarded.

The investigations are complicated by a strain between the FERC and the California agencies, who have accused the federal agency of being slow to act.

"We have to give everybody due process," FERC spokesman Bryan Lee said in response.

Spokesmen for the energy industry praise the FERC, but call the state investigations useless and a damper on the state's business climate.

"I would say 99 percent of it right now is driven by politicians," said Jan Smutny-Jones, executive director of the Independent Energy Producers.

Gary Ackerman, executive director of the Western Power Trading Forum, said, "Politicians are getting a lot of heat to do something, and throwing lawsuits around is one way to get a lot of press."

But Frank Wolak, a Stanford economist and member of the FERC Market Surveillance Committee, said the state was forced to take action because the FERC failed to do it.

"I'm certainly sympathetic to Jones' and Ackerman's perspective, but what do you expect?" Wolak said about the state investigations. "What are they going to do, just say we will ignore this sequence of events?"

David Ivanovich, of the Chronicle's Washington Bureau, contributed to this report.

FERC Was Asleep at the Wheel

Reuters – November 13, 2002

Senate panel: missed Enron clues

WASHINGTON - The Federal Energy Regulatory Commission ignored or missed early clues that Enron Corp. might be manipulating wholesale electricity prices in California and Western markets, Senate investigators said in a report issued on Tuesday.

The Democrat-controlled Senate Governmental Affairs Committee concluded that as a result of these omissions, FERC failed to protect American consumers from alleged market abuses by Enron during the California power crisis of 2000-01.

The report was released at a panel hearing, where FERC Chairman Pat Wood and commissioners Nora Brownell, Linda Breathitt and William Massey were scheduled to testify. Wood, a Texas Republican with close ties to the Bush administration, was appointed more than a year ago.

In February 2002, FERC launched a formal probe into Enron's trading activities during the California electricity crisis. The nation's most populous state was rocked by black-outs, billions of dollars in higher wholesale power prices and the bankruptcy of one of the state's major utilities, Pacific Gas & Electric, a unit of PG&E Corp. .

But FERC "has yet to prove that it is up to the challenge of proactively overseeing changing markets," the report said.

"On a number of occasions, FERC was provided with sufficient information to raise suspicions of improper activities -- or had itself identified potential problems -- in areas where it had regulatory responsibilities over Enron, but failed to understand the significance of the information of its implications," the Senate panel's report said.

Sen. Joseph Lieberman, a Connecticut Democrat who heads the committee, said the investigation found "an embarrassing and unacceptable failure of the federal government to protect millions of consumers, stockholders and workers."

"Again and again, FERC failed to ask critical questions about Enron's business practices," Lieberman said.

Tennessee Sen. Fred Thompson, the panel's ranking Republican member, defended the agency and said many of the problems occurred before President Bush took office.

"Obviously, there are some shortcomings there that need to be addressed," Thompson said. "Some very good things have happened under the FERC watch of this administration."


The report criticized several specific Enron activities.

In one instance, FERC had information five years ago that should have raised doubts about the validity of transactions involving wind farms owned by Enron, the report said.

Federal law requires U.S. electric utilities to buy renewable wholesale electricity at premium prices from independent power producers such as wind farms. Soon after Enron acquired the utility, Portland General, in February 1997, Enron's three wind farms told FERC that Enron would dispose of its ownership interest in them.

However, lawsuits recently filed against former Enron chief financial officer Andrew Fastow in Houston contend he tried to hide the company's stake in the three wind farms.

Last month, FERC said it would investigate the wind farms' ownership.

In another instance, investigators said FERC ignored how Enron's successful Enron OnLine trading platform dominated California power trading.

FERC staff prepared an analysis of Enron OnLine in August 2001 that found the trading platform gave a competitive advantage to Enron's own traders by reducing their transaction costs and allowing them to see details about individual trades while competitors could see only bid and asked prices.

Wood told the Senate panel that FERC will end its investigation into the California power crisis by February, and submit its findings to Congress

"I can assure you that our institutional commitment to remedy and prevent market abuses is now and will continue to be an ongoing one," Wood said. "We intend to work with other federal agencies to ensure that we regulate energy industries in a coordinated and effective manner so that customers and investors are fully protected"


The Senate report said FERC was slow to investigate the cash management practices of Enron, which regularly borrowed cash from its subsidiaries at the end of each day.

As Enron struggled to avoid bankruptcy late last year, it borrowed a total of $1 billion in unsecured loans from two FERC-regulated interstate pipeline subsidiaries. After filing for bankruptcy protection, the two pipelines were left to pay off the entire amount to the banks -- raising the potential for the pipelines to seek rate increases from shippers.

Last August, FERC said it was investigating the loans.

Enron also exploited regulatory void created by overlapping jurisdictions among FERC, Securities and Exchange Commission and Commodity Futures Trading Commission, the report said.

FERC regulates interstate electricity markets. The SEC oversees the accounting practices of companies that trade electricity and the CFTC has jurisdiction over energy contracts traded on U.S. futures exchanges.

The Next Hammer To Drop?

EnergyPulse – by John Sodergreen – November 13, 2002

Editor-in-Chief, The Desk newsletter, Scudder Publishing Group, LLC

(11/8/02) - You Know Us. We Don’t Pull Punches or play “gotcha.” We try to tell it to you straight. So when we see something potentially bad coming down the pike, we won’t hesitate to make a call. Forewarned is forearmed. A few weeks ago we highlighted the story about Dynegy’s admitting that it had supplied bogus numbers to published indexes. We described a resulting scenario as potentially “the nastiest daisy chain event we’ve seen since the summer of ’98.” Next, AEP admitted a similar case of fraud – five traders were immediately sacked. In the background, the CFTC and FERC are plowing through a bazillion documents from a dozen or more companies looking for evidence of market manipulation. They have found much evidence, and we reckon they will continue to do so. Other companies have admitted to supplying false prices to published indexes. The plot thickens. Remember, forewarned is forearmed. The point of this story is less of a finger-wagging, but more of a heads-up that perhaps our previous stories on the price index manipulation subject are not so far out in left field as was suggested to us several weeks ago. It’s our impression that not only are companies considering the issue, but arguments are already being formed to move this possibly systemic case of fraud to the next level.

In the middle, we have a news company that by and large has a monopoly on gas and power indices, Platts. For years, traders have complained about the veracity of these and other indexes. Setting index prices is not an exact science afterall. Much is tied to the integrity of the market reporter’s conversation with traders. And in this market, as in any commodity market, traders are often prone to “talk their book.” According to the several dozen traders, desk chiefs, attorneys and policy makers we spoke to, the attempted or actual manipulation of indexes, by way of offering bogus prices to index publishers, is commonplace in the power, gas and oil sectors. One trader suggested that the propane market is the worst. But to a man (or woman), each of the market participants we spoke to, while admitting they were aware of such price index manipulation, was also quick to say that such risk is generally known and accepted by all concerned. “That risk is the price you pay for playing in this market,” was the common line. FERC, in its recently released staff report (PA02-2) on market manipulation in the West (2000-2001), found that a review of the responses from the index publishers, revealed that there were several major problems. The staff report stressed the heavy reliance of the natural gas and electric industries on using published index prices as the forward prices for contract settlements. Also, commodity prices in many energy purchase/ sales contracts are indexed to published prices. “In theory, this would give the sources the reporting firms rely on a significant economic incentive to attempt to manipulate reported prices,” the staff reasoned. Another glaring problem staff found was the lack of formal verification or corroboration of the published data, leaving the door open for entities to deliberately give inaccurate information in order to manipulate prices or volumes for both electricity and natural gas.

Our position is that, if the indexes were knowingly, fraudulently manipulated by a company, then it would be reasonable to argue that any deals marked to a certain index, at a certain time, either at or after the bogus numbers were given, could reasonably be challenged by the buyer.

Sure, that might sound weak, but think of it again for a moment. Any deal that may have been marked to an index during a certain period – and knowing what we know now, the broad evidence that manipulation did occur by the sector’s biggest market makers – why wouldn’t a buyer, one that is perhaps locked in such a bad deal, cry foul?

“This little hiccup will be a volcanic eruption before too long. Remember, birds gotta fly, fish gotta swim and lawyers gotta litigate. Forecast: choppy seas ahead, possible typhoons. Look back at advance payment litigation for previews...” Our attorney friend who offered the preceding view was referring to the general train wreck of many years ago, left after producers entered into long-term contracts with pipelines and others for gas sales at above market prices. All hell broke loose for many years on the litigation front, using any and all attacks to break the contracts. The same could be said, our attorney friend suggests, in the case of out-of-market priced QFs. Qfs and take or pay. The industry has a vivid history indeed of shredding contracts after the fact. So why, we argue, should this situation be any different?

The note we sent to about a dozen experts in the area, many with 20-plus years experience in this sector, went something like this: As a buyer (C&I, Muni, utility or otherwise), I think, wow. The guys I bought energy from lied about prices. It may not be a certainty, but maybe my deal with the supplier could have been impacted. So maybe I can get out of this deal, or maybe I can get a refund...or a better deal. So, I call the supplier and say I want to rework the deal. The supplier says “pound sand.” The buyer threatens to stop payment (and at the same time lines up an alternative supplier). The supplier sues. The buyer countersues. While it’s in court, the supplier is not paid. Now, multiply this scenario by 1,000. Or 50,000. You get the idea. Is this a reasonable if not likely scenario, we asked?

“I think your scenario is a possible...people will make assertions to avoid a bad trade....but one real issue is reliance. The deals were not really [or necessarily] done in reliance that the [index] number was accurate,” one legal source said. “Reasonable? Of course it’s reasonable. As in most cases such as this, the customer will need to take a close look at the contract. The fact the index turns out to bogus could very well constitute a force majeure,” another DC energy attorney tells us. While expert attorneys have registered a consensus that this whole situation may turn into a very bad thing – particularly as the admissions of giving false prices continue to come in (this morning Williams weighed in), desk chiefs around the sector aren’t so sure.

One Houston-based exec, one that’s admittedly “seen it all” over the years in power and gas, suggests that, “While this may be Texas, the attitude of ‘shoot now, and then ask questions’ is a bit archaic. And that’s what the customer would be doing in your scenario. Additionally, I suspect traders in all industries have been known to ‘talk their book’ when responding to price survey inquiries from reporters. The whole thing reminds me of that classic scene from Casablanca where the French police chief announced, ‘I am shocked, shocked to find that gambling is going on in here!’ ”

Well, maybe. Nobody denies that prices aren’t massaged a touch when market price reporters come calling. But times have changed. An occasional wash trade here and there, particularly in new markets, never before this year got regulators’ dander up either. It does now. Power companies are now expected to be unreasonably squeaky-clean, up and down the corporate food chain, regardless that the banks, regulators and credit analysts are hardly unsullied themselves. And even if it happens that only a half-dozen major companies come forth or are found to have provided false numbers, in this era of guilt by association, the sector will suffer in toto.

As for what exactly a customer would hope to accomplish by pulling the “perceived fraud” card, our desk chief had this to say: “What would you renegotiate? If your deal was a fixed price deal, any ‘influence’ over the index is irrelevant. If your deal was a floating price deal 1) any ‘influence’ was in the past and you can’t assume it will occur in the future, and 2) for past periods, how do know a) your index was the one that was ‘influenced,’ and b) that it was ‘influenced’ against you. After all traders don’t have a natural long or short does such ‘influence’ impact the calculation of the index? For example, in times past I recall the index publications’ calculation methodologies having mechanisms for throwing out suspect prices. And if the publication didn’t throw out that suspected price, does that mean it was really in the day’s range and didn’t impact the index calculation? Now there’s a thought, too. What if in so doing, the publication’s discarded legitimate prices or what if this mechanism encouraged ‘aggressive survey responses’ by traders to make sure their legitimate prices were not discarded by the publications? After all, if you picked off someone in the market, wouldn’t you probably want that reflected in the index?”

In response to all the recent attention, publishers like Platts suggest that perhaps it may be time for a change. At a recent PMA event, Brian Jordan, a long-time McGraw Hill/Platts energy reporter/editor/exec, said that recent revelations have prompted Platts to “ratchet up the quality of the data,” especially on its daily gas and power surveys. In a Restructuring Today story this week. Jordan suggested that Platts first proposed in July that traders report systematically “not from a trading desk but from a back office.” Platts, said Jordan, is about to issue a formal notice telling the industry it wants formal reporting from back offices or some other central point. “And we will ask all the market participants to sign a certification that says the data is accurate,” Jordan disclosed. Platts’ goal? By year’s end, Platts hopes to be phasing out lower quality data and begin using only quality, verifiable data from companies reporting centrally from a back office and certifying their information as complete and accurate. Here again, the Platts change suggests that not only was the past data of lesser quality, but possibly inaccurate. And certainly, it wasn’t verifiable to any true degree. We read this as possibly more fuel for the fire. According to the Restructuring Today coverage of Jordan’s talk, he senses the industry realizes accurate data is in everyone’s best interest, citing “agreement that if people wanted to trade more on these indexes and ... increase the amount of risk they were putting on the accuracy of the index, they would like to see them more bullet-proof. It’s too bad it took this to get us there, but it’s very heartening ... after several years of beating the industry over the head to finally reach the point where we can get data that is very high quality and verifiable. That is the one good thing that will come from this,” Jordan declared. FERC asked Platts recently to share with the commission data from reporting companies. “We told them we’re journalists and we’re protected by the First Amendment and we’re not going to turn over information from our sources,” Jordan responded. We’ll see.

“For power, index manipulation is less of a big deal because, with the exception of the ‘pools’ (PJM, NY, and New England), very few transactions are settled vs. power indices. Furthermore, the pools have a tendency to ‘massage’ (i.e. overwrite) market price anomalies for gas. I concur that index manipulation is a huge deal and we haven’t heard the end of the firings and investigations,” says a Southern-based desk chief. “Many LSEs, like coops, muni’s, and IPPS, have power contracts based on gas supply indices. I don’t even think the C&I sector is aware of the potential money that has been lost...Imagine if you’re a Gulf Coast fertilizer plant that has a 40,000/d (equivalent to 1,460 contracts/yr) with Dynegy, on GD ANR, LA, and you learn that Dynegy has been reporting false gas numbers in an attempt to manipulate the indices? Can you say lawsuit?” Another attorney suggests that this indeed might be a very convenient gimme for buyers wanting to back out of deals. “It’s the same with any long-term agreement in any industry where after a while it looks like one side guessed wrong. We may as well look at five-year deals to place ads on AOL. But so much for the motive. The implications are different in power. We build power plants based on these deals. That’s the reason that recent FERC intervention is so toxic in the CA market manipulation investigation and findings. It’s not the attempt to break contracts – that’s what we lawyers are there to protect against – it’s when FERC makes noises about voiding them for being ‘unreasonable’ that you create the potential for power shortages...because you can no longer count on long-term contracts to support financing. “There’s also good chance that any of these ‘suspect’ contracts would be interpreted according to the Uniform Commercial Code, so long as it is gas, liquids, etc, but not power. The UCC expressly requires parties to execute the contract in good faith. Tough to find a judge that would consider false info to Platts as an exercise of good faith. The other avenue is to sue the energy company for negligence. This is now a tort action. Negligence would require for instance, the C&I customer to prove: 1) that the energy company had a duty to the C&I; 2) that the energy company breached this duty; 3) that the breach was the cause of damages and finally; 4) that damages did in fact happen. So where does the energy company owe the C&I a duty? There is a duty to execute contracts in good faith. Breach of this duty via fraud. Fraud caused damages? Now that may be a tough one. Causation always is. Most likely it would be held to a reasonable person standard. That it is ‘reasonably foreseeable’ that lying to Platts would cause the contractee damages. Finally, did damages actually occur? I should note that the presence of fraud in a case like this could always raise the possibility of punitive damages. This can be a whopper.”


Our source lays out the basics pretty effectively, we think, but his postscript comment may be the final nail: Street law. “If you are an energy company defendant, are you actually going to sit before a jury and say... ‘Well, yes, we admit to fraud but it did not actually cause the plaintiff damages?’ In the end, the smell test is the strongest argument. The energy companies’ hands are dirty – or at least according to the popular sentiment they are – and generally their case has a lot of smell to it. So, the energy company can quietly let it go and take a loss. Give the customer least an opportunity to renegotiate from a more informed standpoint. Or, as I suggested earlier, take it up in protracted litigation. Because of the fraud and collusion and all the other things that trial lawyers relish, they run the risk of a class action and even more bad publicity.” A comment we received this week from a former Wall Street desk chief desk, who now spends much of his time on the process side of energy trading, offered what we think is the strongest argument so far as to how this particular slice of sector history might play out, and why. “The customers may attempt to get out of deals. A dealer, or perhaps even the court system, might let them out of a deal. That doesn’t mean there’s really any basis for getting out of the deal,” our source says. “Here’s why. Let’s stipulate that energy traders did inflate the index settings for Platts or some other price-reporting service. So what? In a fixed physical deal, where the consumer pays a fixed USD/MMBTU amount agreed up front, and receives physical MMBTUs, the fixed price agreed by the customer and the dealer has nothing to do with the historical price fixes. It’s a separate quantity, established by supply/demand equilibration of the market for energy with future delivery. “Now, let’s say a customer transacted a fixed financial swap. In such a deal, the customer pays a fixed-price agreed up front, and receives a floating price that’s a function of the Platts settlements, for net cash settlement. Once again, the fixed price agreed up front has nothing to do with the Platts fixes. However, as the monthly coupons of the deal begin settling off, the net cashsettlement quantity will depend on the indexes, which, as we now know – surprise! Shock! – were being manipulated. I think everybody knows that Platts indices were manipulated. Anyway, in this case, the customer will have an argument for going back and adjusting cash settlements that occurred in the past. The weird thing here, however, is that the customer will want to dispute the historical cash settlements only in cases where he could claim that the dealer had manipulated the Platts indices to be lower than they should have been.” “Most customers, however, will be transacting a fixed financial swap in conjunction with a floating physical deal. Because the floating payments wash out, the customer still pays the fixed price, receiving physical MMBTUs, and isn’t affected by any manipulation of the index. “The last case is the one where the customer transacts a floating-price physical: The customer pays the Platts index price, and receives physical MMBTUs. In this case, the customer may argue that he overpaid in the past because the dealers manipulated the indices. He may want a refund on those payments. I wouldn’t be surprised if all kinds of customers make all kinds of arguments. It’s also possible that the whole thing blows over – mostly because anybody who’s anybody has always known that the indices are manipulated; that’s part of the risk you take on when you do these deals.”

Deregulation - Page 25 - 2002