Introduction

Enron’s breakout in the early 1990s centered on natural gas commoditization. Enron Gas Marketing (EGM), renamed Enron Gas Services (EGS) in 1991, was the locus for turning the power-generation market from coal to gas as part of Enron’s quest to become the world’s first natural gas major. This bold vision, which had deep public policy implications (via environmentalism), began with gas demand but quickly went to supply in order to allow end users to get their preferred product.

The EGM/EGS heyday marked a high point for the natural gas industry. Other marketers, the most prominent being the U.S. Natural Gas Clearinghouse (later NGC, then Dynegy), also sprang up in response to the business opportunity created from mandatory open-access (MOA) rules promulgated by the Federal Energy Regulatory Commission (FERC).

By the late 1980s, EGM was supplementing its short-term (spot) sales with multimonth and multiyear contracts. (The large capital requirements of the industry—estimated by Enron to be $25 per Mcf per year from exploration and production to marketing and transmission to power generation—required price certainty under long-term contracts.) In the early 1990s, EGS created a macromarket in gas products. The old days, when one company’s gas would literally flow point to point, gave way to network economies and financial (derivatives) trading.

Between 1990 and 1993, Enron’s burgeoning natural gas merchant function would expend $60 million on proprietary systems “that permitted the organization to function as the trading desk of an investment bank.” The buying and selling of gas and related transportation services across North America—varying in time (multimonth, multiyear, hybrids), quality (firm, interruptible, hybrids), and price (variable, fixed, hybrids)—represented a major advance in methane merchandizing. It was also the most enduring contribution of Enron in its brief life.

The Enron of fame and infamy arguably began with the 1990 hiring of Jeff Skilling, formerly of the consultancy McKinsey & Company, and with his assignment to energize the newly created Enron Finance Corporation. The challenge was to create a long-term gas-supply market to meet the demand for long-term contracts that had been proved by Gas Bank (discussed in chapter 5). This foundation, coupled with the successful launch of gas-futures trading (via NYMEX), would lead to financial products (derivatives based on physical products) for hedging and other purposes.

With John Esslinger remaining in place atop EGM’s physical trading, a new team would emerge in the Skilling era: Gene Humphrey (long-term gas supply), Mark Frevert (long-term gas sales), Joe Pokalsky and Kevin Hannon (derivatives), and Andy Fastow (structured finance, also known as securitization). Lou Pai would take over for Pokalsky and hire a quantitative specialist, Vince Kaminski, to model EGS’s book of business in order to better price products and gauge overall risk for the corporation.

With a new accounting methodology that immediately booked estimated future earnings from long-term contracts, EGS became Enron’s second-largest income generator in 1992. Mark-to-market accounting became central to Enron’s 15 percent annual-earnings growth story, which propelled ENE as a momentum stock. But this future-now philosophy would have negative consequences as the decade progressed.

Enron Finance was just the beginning of three years of innovation, restructuring, and expansion at EGM/EGS. Three new divisions were formed in 1991: Reserve Acquisition, Enron Power Services, and Enron Risk Management Services. The next year, three more were added: Enron Producer Services, Enron Gas Transportation and Trading, and an EGS–Canada unit to reach North American scope.

In 1992, EGS’s domain grew when the methanol and MTBE facilities, as well as the commercial side of Houston Pipe Line, were assigned to Skilling. In that same year, EGS bought retail-natural-gas-marketer Access Energy, followed in 1993 by emissions trader AER*X and intrastate pipeline and storage company Louisiana Resources.

Some innovative offerings by Enron would not survive the creative destruction of the marketplace. A group of geographical gas-pricing points (hubs) did not take as an alternative to the central NYMEX point of Henry Hub, Louisiana. EnGas and GasTrust were other offerings that fell short (see chapter 9, p. 387). A game effort to commercialize natural gas vehicles (Enfuels) was discontinued.

EGS became a very large company within a company in the period under review. In becoming the largest buyer and seller of natural gas in the United States, EGS did not record any write-offs, much less scandal. On the contrary, the unit’s reputational value in the outside market was very high, important for both counterparty confidence and credit ratings.

At year-end 1993, EGS’s thousand employees provided one-fifth of Enron’s income, three-fourths of its revenue, and nearly one-half of its assets. Better yet, EGS was asset-light, using other companies’ transmission systems as easily as it used Enron’s own interstates. The secret of EGS, and thus Enron, was its entrepreneurial alertness to a once-in-a-generation regulatory opportunity.