The complex California connection

At a meeting of the IEEE's Power Engineering Society in Vancouver, B.C., Canada, in July 2001, attendees reacted with considerable skepticism to arguments made by California regulators and economists that generators had withheld power during the 2000-01 Western energy crisis to drive prices higher.

All such good-willed disbelief was swept away by a smoking gun internal memo that emerged early in the Enron investigations. It outlined a series of manipulative trading transactions with names like "Get Shorty," "Ricochet," and "Death Star," and detailed ways Enron's traders had manipulated the California market to get top dollar for power the company was selling into the state.

It would be tempting to conclude that electricity trading in general or Enron in particular was single-handedly responsible for the California debacle. But, in fact, unexpectedly rapid growth in demand, an unusual shortage of generation (driven in part by a bad year for hydro in the Pacific Northwest), and some legitimate disconnection of generators for maintenance purposes also played important roles. Most important of all, California's poorly conceived restructuring plan was a setup for market manipulation and magnified the imbalance when manipulation occurred. An ill-advised ban on long-term power purchases put utilities at the mercy of the spot market, and when prices on that market skyrocketed, the ceiling set by the state on retail prices left them unable to recover costs.

Arguably, then, "Enron's actions [only] make it [more] difficult to sort out how much of California's problems were real and how much were due to illegal market manipulation," says John Rowe, chairman of Chicago-based Exelon Corp. Energy economist Jonathan Falk, vice president at NERA, the highly regarded consultancy with offices in New York City and London, went so far as to argue that "the majority of Enron's strategies" actually corrected design flaws in the California market, sometimes to good local effect.

However that may be, the general effect of trading misconduct was clearly devastating. What was behind that misconduct, aside from obvious personal greed? Why did chief executives, boards, and auditors turn a blind eye?

David Penn, executive vice president at the American Public Power Association (Washington, D.C.), pinpoints the insatiable need to demonstrate rapid growth in a business that in fact was not growing all that quickly. Penn may somewhat overstate his case. As U.S. energy demand grew at a faster pace than expected in the 1990s while generating capacity largely stagnated, reserve margins, traditionally on the order of 18 percent, shrank everywhere [see "Restructuring the Thin-Stretched Grid," IEEE Spectrum, June 2000, pp. 43-49]. As a result, electricity trading grew much faster than the sector as a whole, because increasingly power had to be transferred over long distances to avert shortages.

But even so, trading apparently did not grow fast enough to satisfy traders like Enron that their performance, on its own merits, would be impressive enough to satisfy investors, creditors, or even their own customers. The whole business depended on faith that if a broker promised to deliver a certain amount of electricity at a certain date, the broker would actually be in a position financially to deliver.

Confidence, says Massachusetts Institute of Technology energy economist Richard Tabors, is the resource that energy trading depends on. And now "there is a tremendous lack of confidence on the part of financial markets."