This is part of IEEE Spectrum's special report: What's Wrong—What's Next: 2003 Technology Forecast & Review.
On 3 October 2001, Enron Corp.'s chief executive officer Ken Lay was in his element, chairing a day-and-a-half, invitation-only conference on national energy policy at a swanky hotel just outside Washington, D.C. It was wall-to-wall policy types, just the sort of gathering in which the Ph.D. economist reveled.
The giant Houston-based company once again was doing well in the stock market. It had recovered from a bad dive it took after the mysterious resignation of Jeff Skilling as CEO, which had forced founder Lay to resume the day-to-day management of the company, the most admired in the United States for several years running, according to Fortune magazine surveys. The future looked bright for Enron and its rivals in the intensely competitive business of selling electricity, natural gas, and financial products based on energy prices.
In the previous decade, energy trading had emerged as the fulcrum of efforts to restructure electricity markets not only in the United States--something of a Johnny-come-lately to the game--but also in the United Kingdom, Norway, New Zealand, and Chile. The general idea was that transmission systems would be made open-access, rather like the restructured long-distance telephone system in the United States, and any generator of electricity would be entitled to sell into the system.
Distributors of electricity, the classic utilities, would be stripped of generation and transmission assets and would purchase electricity wholesale on the open market. Brokers, relying on the most advanced Web-based communications, would play a key role as intermediaries, getting electricity from places it was in surplus to the places it was needed most. Among such brokers, Enron was seen as the world leader--highly skilled, absolutely sure of itself to the point of arrogance, and immensely profitable.
Yet in hindsight, it's apparent that Lay's top-of-the-world posture at the D.C. policy conference in October 2001 was truly his last moment in the sun. Two months later Enron was in bankruptcy, and four months later Lay would decline to testify to Congress on the advice of his attorney. There followed a drumbeat of funereal news from the energy trading business: self-dealing with specially created entities to hide losses from balance sheets and create dubious profits, bogus round-trip trades executed only to inflate apparent revenue, deals made to create transmission congestion that then would be relieved by follow-on sales of electricity at inflated prices, and withholding of generating capacity and natural gas supplies to also inflate prices [see Timeline, facing page].
By last fall, a year after Lay's D.C. conference, the electricity business looked like the Gettysburg battlefield, the day after. Among the dead or mortally wounded: the public-private California Power Exchange, the Arthur Andersen accounting firm, Enron itself, and the energy trading unit of its fellow trading pioneer in Houston, Dynegy. The walking wounded included generating companies such as AES and Calpine, and utilities that got burned in electricity trading like CMS Energy, Reliant Energy, and Allegheny Energy, not to mention two of California's three huge electricity distributors: investor-owned Pacific Gas and Electric Co. (PG and E) and Southern California Edison.
Under California's seriously defective restructuring plan, the state's three utilities had found themselves in an unhealthy position--having to buy electricity wholesale at inflated so-called free-market prices while having to sell retail at much lower regulated prices. The result was almost instantaneous bankruptcy for PG and E and near-bankruptcy for Southern California Edison.
Enron is now a dirty word, embodying the corporate malfeasance that allowed executives to walk off with millions, while investors and employees saw their life savings go down the tubes. What happened? And what needs to be done to make electricity trading the transparent and honest business it must be if energy is to be produced and distributed to best economic effect?