ENRONTHE RISE AND FALL

LOREN FOX

JOHN WILEY & SONS, INC.

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ENRONTHE RISE AND FALL

LOREN FOX

JOHN WILEY & SONS, INC.

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Copyright 2003 by Loren Fox. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.

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CONTENTS

Preface vTime Line vii

1 Pipeline to Profit 12 Where the Money Is 223 Major Ambition 434 Electrifying Opportunity 595 Culture of Creativity? 776 The Energy Buffet 987 Taking the Plunge 1228 Enron Gets Wired 1439 Power and Glory 170

10 California Dreamin 19611 Power Overload 22112 Downward Spiral 24713 Racing the Clock 26714 Endgame 286Epilogue 307

Authors Note 314

Notes 315

Index 357

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PREFACE

When Enron conducted a name-recognition survey in 1996, it foundthat ordinary people were guessing that Enron was a politician or ascience-fiction weapon. Its now 2002, and Enron needs no introduc-tion. Like Watergate, it has entered the collective vocabulary as a one-word symbol of an entire regime. Enron now represents greed andhubris, deceitful accounting and Wall Street favors, and, in short, every-thing thats wrong with corporate America.

As familiar as the word has become, the actual story of Enrons declinefrom business superstar to embarrassing bankruptcy is still not well un-derstood. How did a $100 billion company collapse in a matter ofweeks? What were the partnerships that shocked Wall Street and dam-aged some of its venerable reputations? Who were the people behind thiscomplex enterprise? This book is one journalists attempt to explain whathappened from beginning to end.

Other accounts of the Enron scandal have concentrated on the com-panys decline, but the story really begins with the creation of the com-pany in 1985. The fall of Enron would not be possible were it not for thepreceding rise, and the companys misstepsboth intentional and unin-tentionalwere not possible had it not enjoyed successes early on. Thosesuccesses were what drew me to the story originally, and then my interestrose as this flourishing company began to encounter great difficulties.When I proposed a book about Enron in the fall of 2001, I knew itwould make a fascinating topic. The drama then intensified at an amaz-ing pace. In quick succession, Enrons weakened stock went into freefall,it struck a deal to be acquired, that deal then fell through, and Enronfiled for bankruptcy. The story leapt from the business pages to the frontpages, and then to everyday conversation.

My research uncovered details of the intense corporate culture and therecklessness with which the company pursued strategies. I found an orga-nization that, in the spirit of the last decade, over-reached; ChairmanKenneth Lay, Jeffrey Skilling, and company believed they could trans-form a pipeline operator into a virtual corporation that traded a dizzying

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array of commodities. To support the financial underpinnings of thatmission, Enron eventually cooked its books. While telling that story, mybook highlights the system that allowed such rule breaking. Nearlyeveryone shares some blame, from Republicans to Democrats, from ac-countants to lawyers, and from Wall Street to Main Street.

This striving corporation sat at the epicenter of the most significanttrends in finance, energy, and online commerce. As a result, the storycontinues even as I write this. The dimensions of business have beenchanged forever. Politicians are debating the regulations of energy trad-ing. Enrons bankruptcy continues to frustrate the creditors fighting overthe scraps. Meanwhile, one ex-employee has pleaded guilty to twofelonies arising from his actions at Enron, and the public awaits criminalcharges against other former Enron officials. We havent heard the last ofEnron, as either icon or business saga. With that in mind, the followingpages explain the story behind the symbol.

Loren FoxAugust 2002

vi PR E FAC E

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TIME LINE

July 1985: Houston Natural Gas, run by Kenneth L. Lay, merges withInterNorth, a natural gas company based in Omaha, Nebraska, to forman interstate and intrastate natural gas pipeline company with approxi-mately 37,000 miles of pipe.

November 1985: Ken Lay is appointed chairman and chief executive ofthe combined company. Later, the company chooses the name Enronafter rejecting Enteron.

October 1987: Enron discovers that oil traders in New York have overex-tended the companys accounts, costing the company $142 million.

1988: The companys major strategy shiftto pursue unregulated mar-kets in addition to its regulated pipeline businessis decided in a gather-ing that became known as the Come to Jesus meeting.

1989: Enron launches Gas Bank, which allows gas producers and whole-sale buyers to purchase firm gas supplies and hedge the price risk at thesame time.

October 1989: Enrons Transwestern Pipeline is the first merchantpipeline in the United States to stop selling gas and become a transporta-tion-only pipeline. Also, Enron sells 16 percent of Enron Oil & Gas tothe public.

June 1990: Jeff Skilling joins Enron after leading McKinsey & Co.s en-ergy consulting business. He will lead the nascent trading and financeoperation.

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April 1993: Enrons Teesside power plant in England begins operation,one of the first big successes for the companys international strategy.

December 1993: Enron and Maharashtra reach agreement to build themassive Dabhol power plant. The $2 billion Indian project would be acontinual headache for the company.

June 1994: Enron conducts its first electricity trade.

November 1996: Chief Operating Officer Richard Kinder announcesthat hell leave the company. In December, Skilling becomes Enronspresident and chief operating officer, beating out rival executive RebeccaMark.

June 1997: Looking to expand in electricity, Enron closes its acquisitionof electric utility Portland General Corp. in a $2.1 billion stock swap.

August 1997: Enron trades its first weather derivative. Enron goes on totrade coal, pulp, paper, plastics, metals, and bandwidth.

November 1997: Enron forms Chewco Investments, managed by En-ron employee Michael Kopper, to buy out CalPERS stake in a jointventure. This is the first independent partnership run by an Enronemployee.

March 1998: Enron promotes Andrew Fastow to chief financial officer.

April 1998: In a dramatic change in strategy, Enron pulls out of Califor-nias residential electricity sector, citing problems with the states deregu-lated market.

July 1998: Enron agrees to buy Wessex Water, a British water utility, for$2.2 billion. Wessex becomes the core of Enrons new water unit, Azurix,run by Rebecca Mark.

viii TI M E LI N E

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March 1999: Enrons giant Dabhol plant in India opens.

April 1999: Enron agrees to pay $100 million over 30 years for thenaming rights to Houstons new ballpark, Enron Field. Also, Enronbegins commercial operation of its nationwide fiber network for high-bandwidth uses.

June 1999: Azurix goes public with a $700 million initial public offering.Also, Enron creates the first LJM partnership in order to hedge its invest-ment in an Internet company. Fastow gets a waiver of the code of con-duct to manage LJM.

August 1999: Enron w