Can Energy Markets be Trusted? The Effect of the Rise and Fall of Enron on Energy Markets

Abstract

Enron's rise was synonymous with energy trading in the new gas and electric markets that developed with energy deregulation in the United States and abroad. Its collapse spawned a new word 'Enronitis': a lack of trust in corporate enterprise and markets. This article asks whether energy markets can be trusted. It surveys government reports, agency dockets, economic analyses, academic journals, press accounts, and industry and trade association publications and websites, critically assessing the biases and ideologies of the many varied sources that have investigated, analyzed or commented on post-Enron events in the deregulated gas and electricity markets. Each part of the article begins with quotations that capture the opinions of key participants or policymakers in the deregulated markets so that readers without a specialized background in energy can nonetheless understand the contours of the battle between regulation, market power and competition in the newly created power markets - and the ability of regulators to protect the public interest in these markets. Myths, nurtured by ideological biases, already abound in many of the analyses of energy markets. After laying an introductory framework, Part II of the article looks at Enron's role in creating energy markets and the success and failure of the business models it developed, from the early Gas Bank to commodities trading on Enron Online and the provision of risk management services. Enron's growth tracked the opening of gas and electric markets to competition through unbundled services, open access transportation, and light-handed regulation. Part III links Enron's trading practices to developments in the California energy crisis through a chronological account of the four major problems that were discovered, often slowly and haltingly, by regulators, consultants, economists and lawyers in the California energy markets, and which eventually implicated many more companies than Enron alone: (1) gaming a flawed deregulatory plan; (2) withholding generating capacity (3) affiliate abuse in the gas pipeline sector; and (4) pervasive manipulation of gas and electric prices by market participants to favor their trading desks. Part IV asks: Where was FERC during the long year of chaos in California? Imbued with the ideology of light-handed regulation, the then-FERC Commissioners neither understood the markets nor had adequate data or monitoring in place to police the market for abuses. California was left to attempt to solve its own problems in a regional power market that only a national regulator like FERC could control. Part V documents the reforms, many of them still proposed rather than enacted, by Congress, at FERC, and by industry's adoption of self-regulating codes of conduct. Many major issues remain unresolved, including accurate ways to determine market power in electricity generation; preventing affiliate abuse; and establishing trustworthy indices of gas and electric prices. Parts VI and VII describe the fallout from the Enron scandals and future prospects for retail electricity markets. Energy trading is virtually dead as a stand-alone enterprise; retail electricity restructuring has halted at the state level; a debt crisis enshrouds the deregulated sector of the energy industry; and FERC has been thwarted in its push for more open national markets in electricity. No vibrant retail market in electric power yet exists in the United States, and there is little evidence to date that the residential consumer will benefit significantly from electricity restructuring. The article concludes that energy markets may be 'made to work' but only by imposing on them a degree of market intervention and monitoring that defies the label of 'deregulation' Deregulation is more corruptible and has a far greater risk of creating dysfunctional markets that are both unfair and inefficient than the regulation it replaced. The article concludes with a coda, reflecting on the lessons that might be learned from the shameful conduct embraced by so many participants in the new energy markets. Greed, ideology, and the complexity of the energy and financial derivatives markets explain much of the doleful history that has caused a lack of trust in energy markets.