BOOK 3: ENRON ASCENDING: THE FORGOTTEN YEARS, 1984-1996

 

2.1 Regulatory Delay under the Natural Gas Act
2.2 HNG/InterNorth: Joint Ventures, Miscellaneous Assets, and Sales 
2.3 The Nationalization of Belco Peru: A Personal Recollection 
2.4 The Suppressed History of InternNorth 
2.5 Transwestern Pipeline: “Enron’s Laboratory” amid Regulatory Change 
References for Chapter 2 Appendix

2.1 Regulatory Delay under the Natural Gas Act

The entry of Northern Natural Pipeline (NNG) in 1931 had been delayed by the coal interests behind the Midwest’s manufactured gas service. But natural gas was destined to win because it had twice the BTU power (heating content) as did coal gas (Tussing and Tippee, 163). Nevertheless, once NNG was built, “the coal industry continued to do everything in its power to block or at least to delay the progress of its ambitious new competitor” (Szmrecsanyi, InterNorth, 32).

Interfuel politics was given a federal forum with the passage of the Natural Gas Act of 1938. The pipeline witness in the Congressional hearings prior to the passage of the law, a lawyer representing four interstates, called the proposal “sound regulation” that “follows the lines of regulation in many of the states” (quoted in Bradley, “Distortions,” 10). But what he and his industry failed to envision was just how expedient Section 7(c)—the provision requiring certification for new entry or service expansion—would be for coal and fuel oil interests, which did not operate under a similar requirement. Opposition came instead from Cities Alliance, a consortium of 100 Midwestern cities and towns, who warned that Section 7(c) would “creat[e] a towering bureaucracy that feeds upon itself” and “impose unfair and rigid requirements upon an industry which is still young and growing lustily” (quoted in Bradley, Oil, Gas, & Government, 868).

Sure enough, Section 7(c) was the bane of timely expansion. In 1945, Northern Natural Gas Company (Northern) reported:

During recent years, the matter of obtaining Certificates of Public Convenience and Necessity for the construction of new facilities, subject to the jurisdiction of the Federal Power Commission, has been complicated by the appearance in proceedings of opposing coal, railroad and labor interests. The attack centers upon the sale of natural gas for use as boiler fuel (1945 Annual Report, 4).

Sorting through the regulatory morass soon became the job of Willis “Bill” Strauss, who joined Northern in 1948 as a clerk in the engineering department. His job was ordering materials for pipeline expansions, but connecting hundreds of towns clamoring for service required something else. All those new “spaghetti lines” required FPC certification, which required public hearings in Washington. Northern, without a regulatory affairs department, hired a Washington lawyer to represent them. More was needed, however, and in 1955, seven years after he joined the company, Strauss was tapped to run the certificate department, which soon had a half dozen employees (Szmrecsanyi, InterNorth, 230; Strauss interview, 4–6).

Bill Strauss rose quickly at Northern, becoming administrative vice president in 1957, executive vice president in 1959, and, a year later, at age 38, president and COO. His superb people skills would be put to the test in the late 1960s and early 1970s when the best efforts of NNG to find needed gas (for firm service) necessitated rate-increase approvals from FPC. Each request was protested by NNG’s wholesale customers (gas distributors), who had their own (regulatory) problem with passing rate increases on to the final user. At one point Northern had six pending rate cases, meaning that rate increase after rate increase was “pancaked” at the FPC (Strauss interview, 12).

Strauss regularly traveled to Washington to warn regulators about the negative impact of price controls on gas supply. He forthrightly explained the problem to securities analysts in Boston and New York. And he regularly gave speeches throughout Northern’s service territory on the need for price deregulation (Strauss interview, 11). But the “consumerist” FPC would not budge. “The tenor of the times,” Strauss recollected, “was antibusiness” (Strauss interview, 50). The result was physical gas shortages and supplemental gas boondoggles, not unlike that of Transcontinental Gas Pipe Line Company, discussed in Edison to Enron (pp. 5, 323–27, 506–507).

Fast forward to 1986. Noting multi-year certification delays with interstate pipelines, the head economist at the Federal Trade Commission (David Scheffman) stated: “A minor industry of attorneys are kept busy litigating action at FERC.” He added: “Why taxpayers or consumers are thought to benefit from this escapes me” (Gas Daily). Section 7(c) obstructionism by one pipeline to another, or by a rival fuel to natural gas, was alive and well in the Order 436 era.

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2.2 HNG/InterNorth: Joint Ventures, Miscellaneous Assets, and Sales

InterNorth had three joint-venture pipelines that became part of HNG/InterNorth: Northern Border (natural gas), Trailblazer (natural gas), and ETSI (coal slurry, proposed). Each is considered below, before examining two other significant assets inherited in the merger.

1. Northern Border Pipeline Company

Northern Border Pipeline Company (NBP) was formed in March 1978 as a general partnership pursuant to the Texas Uniform Partnership Act (Jensen). The $1.3 billion, 975 MMcf/d, 822-mile system became operational in late 1982 and reached full volumes early the next year, importing Canadian gas from the Montana-Saskatchewan border (Port of Morgan, Montana) to Ventura, Iowa, the take-away point for Northern Natural Gas Company (HNG/InterNorth, 1983 Annual Report, 15, 47). NBPL also interconnected with Natural Gas Pipeline Company of America at Harper, Iowa.

The original owners of NBP and its affiliated companies were:

• Northern Plains Natural Gas Company (InterNorth): 22.75 percent
• Northwest Border Pipeline Company (Northwest Energy Company): 12.25 percent
• Pan Border Gas Company (Panhandle Eastern Corporation): 22.75 percent
• TransCanada Border PipeLine Ltd. (TransCanada PipeLines Limited): 30 percent
• United Mid-Continent Pipeline Company (United Gas Pipe Line Company): 12.25 percent

InterNorth was the driving force behind NBP. InterNorth was part of the study group that devised the project, and InterNorth subsidiary Northern Engineering and Investment Company built the line. InterNorth’s Northern Plains as managing partner operated NBP.

Effective July 1, 1989, Northern Plains, now an Enron subsidiary, purchased United Gas’s 12.25 percent interest for $53 million, increasing Enron’s interest in NBP to 35 percent.

In 1991–92, the system was expanded for the first time since inception by 463 MMcf/d. With additional efficiencies, total capacity was 1,675 MMcf/d, a 42 percent increase from its opening-day capacity a decade before (Northern Border, 1993 Annual Report, 2).

Enron’s bankruptcy filing of December 2, 2001, put the above ownership structure into play. On May 2, 2002, Enron proposed to the creditors’ committee to separate certain core assets from Enron’s bankruptcy estate into a new integrated power and pipeline company. On August 2 of the same year, Enron announced a sales process for certain assets, including Northern Plains. However, on March 19, 2003, Enron’s Board of Directors voted to move forward with the creation of a new pipeline operating entity rather than sell its interests in its North American pipelines, including Northern Plains (Northern Border Partners LP, 2002 Annual Report, 23–24).

On June 25, 2003, Enron organized CrossCountry Energy Corp. to hold, among other assets, Enron’s interest in Northern Plains (Northern Border Partners LP, 2003 Annual Report, 28). On March 31, 2004, Enron transferred its ownership interest in Northern Plains to CrossCountry Energy.

On June 24, 2004, Enron announced that it had reached agreement with a joint venture of Southern Union Company and GE Commercial Finance Energy Financial Services for the sale of CrossCountry Energy. On September 10, 2004, the Bankruptcy Court approved the agreement. On September 16, 2004, Southern Union Company and ONEOK Inc. each announced that ONEOK had entered into an agreement to purchase Northern Plains, an acquisition that closed on November 17, 2004 (Northern Border Partners LP, 2004 Annual Report, 31).

At year-end 2006, NBP consisted of:

• 822 miles of 42-inch diameter mainline with a design capacity of 2,374 MMcf/d from the Canadian border to Ventura, Iowa;
• 147 miles of both 30-inch and 36-inch diameter pipe with a design capacity of 1,484 MMcf/d (total) from Ventura to Harper, Iowa;
• 226 miles of 36-inch diameter pipe and 19 miles of 30-inch diameter pipe designed to transport 844 MMcf/d from Harper to Manhattan, Illinois; and
• 35 miles of 30-inch diameter pipe designed to transport 545 MMcf/d from Manhattan to North Hayden, Indiana.

Compared to InterNorth’s original equity investment of $110 million (InterNorth, 1984 Annual Report, 42), the current book value (gross plant) of NBPL is approximately $2.5 billion.

The original 975 MMcf/d system from Port of Morgan to Ventura was expanded and extended in 1991 to 1,125 MMcf/d, in November 1992 to 1,675 MMcf/d, and in December 1998 to 2,374 MMcf/d). The Harper-to-Manhattan extension (545 MMcf/d) was completed in October 2001, and a 130 MMcf/d extension from Harper to the Chicago market became operational in April 2006. NBP added more Midwest drop-off points in the 1990s, interconnecting with Northern Natural at Ventura, Iowa, as well as multiple smaller interconnects in South Dakota, Minnesota, and Iowa.

In April 2006, ONEOK and Northern Border Partners completed a series of transactions, which resulted in ONEOK’s owning 100 percent of the general partner interest and 45.7 percent of Northern Border Partners. The Partnership also sold a 20 percent interest in Northern Border Pipeline Company to TCPL LP, which resulted in giving the Partnership and TCPL each 50 percent of Northern Border Pipeline, while an affiliate of TransCanada became the operator of the Northern Border Pipeline in April 2007.

On May 17, 2006, Northern Border Partners LP (NYSE: NBP) was renamed ONEOK Partners LP, with public trading of ONEOK Partners (NYSE: OKS) common units on the New York Stock Exchange beginning on May 22, 2006.

From inception, NBP was certificated as a cost-of-service pipeline, which allowed automatic billing to customers of all costs pursuant to long-term contracts. This unique rate design reflected international precedent and politics, not FERC policy, which worked the other way: putting risk on the operator to earn some revenue only with physical deliveries.

Northern Border’s Canadian supply has been a major supply source for Northern Natural Gas Pipeline Company, making an integrated North American gas market via free trade with Canada an important company position.

2. Trailblazer Pipeline

In October 1983, Trailblazer Pipeline (TP), 20 percent owned by InterNorth, began delivering natural gas to southeastern Nebraska interconnects of Northern Natural Gas Company and Natural Gas Pipeline of America from the Overthrust Belt of northeast Colorado and southwest Wyoming. The $550 million, 800-mile, west-to-east system, had an original capacity of 300 MMcf/d (InterNorth, 1982 Annual Report, 18).

Housed within Northern Natural Resource Company, InterNorth had an ownership interest in two of the three legs of the system: an 18 percent interest in the 88-mile western leg and a one-third interest in the 436-mile eastern leg (InterNorth, 1982 Annual Report, 46). HNG/InterNorth had a $30 million equity interest as of year-end 1985 (HNG/InterNorth, 1985 Annual Report, 46).

In 2002, a 324 MMcf/d expansion brought TP’s total capacity to 846 MMcf/d. The 454-mile system (gathering lines has been sold off) had an approximate capacity of 900 MMcf/d. In this year, Kinder Morgan Energy Partners purchased Enron’s interest in TP, with operations placed within its wholly owned subsidiary, Natural Gas Pipeline Company of America (NGPL). In 2012, Kinder Morgan sold TP to Tallgrass Energy Partners.

With its purchase of El Paso Corporation in 2012, Kinder Morgan was required by the Federal Trade Commission to sell TP and other pipeline assets. The buyer was

Tallgrass Energy Partners LP, owned by the management team of Tallgrass, Kelso & Company, and a limited group of investors led by The Energy & Minerals Group, including Magnetar Capital.

3. ETSI Coal Slurry Pipeline

Effective January 1, 1983, InterNorth’s Northern Coal Pipeline Company purchased a 29.5 percent interest in Energy Transportation Systems Inc. (ETSI), a proposed 1,400-mile coal slurry pipeline designed to carry 20 million tons annually from Wyoming’s Powder River Basin to power generators in the south-central United States. Sam Segnar’s ambitions produced more misses than hits with his purchases prior to acquiring HNG, but this on-the-cheap investment would turn into a financial gusher despite the project never being built.

Organized in 1973, ETSI was a joint venture between Atlantic Richfield, Bechtel, Kansas-Nebraska Natural Gas, Lehman Brothers, Kuhn-Loeb, and Texas Eastern. Completion of the $3 billion project was anticipated by 1986 (Coffey and Partridge). Since the project’s inception, the partners had spent approximately $125 million. InterNorth’s Northern Coal paid $5 million (InterNorth, 1983 Annual Report, 15), an 85 percent discount to a cost basis of approximately $37 million (“very attractive terms,” said Sam Segnar in the 1982 Annual Report [3]). But the project was stymied for want of rights-of-way, suggesting that InterNorth was willing to take a long shot.

When the project was terminated in August 1984, the four partners (InterNorth, Bechtel Group, Inc., KN Energy Inc., and Texas Eastern Corporation) sued a group of coal-carrying railroads for $2.8 billion, claiming a conspiracy to deny rights-of-way and other obstruction in violation of antitrust law (InterNorth, 1984 Annual Report, 41). Some individual settlements followed, and the remaining litigants went to court.

Enron and the other plaintiffs settled with five of the six railroads, receiving $29 million. Santa Fe Southern Pacific Corporation went to court, and in March 1989, the jury found the defendant guilty. Their $345 million award was trebled to $1.035 billion under the law, of which Enron’s share was $147.5 million (Enron, 1989 Annual Report, 52). Santa Fe settled for $350 million, which resulted in $67 million for Enron in 1990, its final payout. This brought Enron’s total receipts from ETSI-related litigation to just under $100 million, as follows:

• $5 million in 1987;
• $15 million in 1988;
• $12 million in 1989;
• $67 million in 1990 (Enron, 1990 Annual Report, 54).

This windfall—all from InterNorth’s $5 million investment in 1983—would help sustain Enron through hard times and assist in its recovery. Seen another way, it was the positive surprise from the InterNorth merger that made up for the negative surprise of the earlier Peruvian nationalization.

Another big winner from the suit was Vinson & Elkins, the Houston-based law firm that took the case for a one-third contingency fee by representing one of the plaintiffs, Texas Eastern. Vinson & Elkins’s $200 million payday was used to retire the firm’s debt and make special distributions to everyone at the firm. It was well-timed: “ETSI had helped V&E survive the Texas-sized economic downturn in Houston,” an article in the American Lawyer stated (quoted in Hyman, 508).

4. Mobil Stock

Another InterNorth-side revenue source for Enron was Mobil Corporation common stock, which was obtained in 1964 when predecessor Northern Natural Gas Company sold Northern Natural Gas Producing Company for 946,500 shares of Socony Mobil Oil Company stock (NNGC, 1964 Annual Report, 3).

The stock sales resulted in the pre-tax gains for Enron of:

• $97 million in 1988
• $73 million in 1989
• $28 million in 1991
• $52 million in 1992 (Enron, 1990 Annual Report, 51; Enron, 1991 Annual Report, 34; Enron, 1992 Annual Report, 35);

5. HNG/InterNorth International

InterNorth CEO Sam Segnar, with international ambitions, formed InterNorth International to house new investments in Europe, Asia, and South America. Its three subsidiaries were:

• Northern Liquid Fuels International, a transporter and seller of liquefied petroleum gases (LPG), as well as a marketer of petrochemicals worldwide;
• Protane Corporation, a manufacturer and marketer of industrial gases and appliances in the Caribbean and Venezuela, as well as a seller of propane;
• Consolidated Companies of Canada, a transporter and marketer of natural gas in Canada.

These investments were small and nondescript, but a gas explosion in November 1996 in San Juan, Puerto Rico, linked to San Juan Gas Company, a wholly-owned Enron subsidiary, resulted in protracted litigation that was not resolved before Enron declared bankruptcy in December 2001 (Enron, 1997 Annual Report, 68; 2000 Annual Report, 47).

6. Post-merger Sales

The Federal Trade Commission, pursuant to the Hart-Scott-Rodino amendments to the Clayton Antitrust Act, required HNG/InterNorth to divest several Texas intrastate pipelines as a condition to approving the 1985 merger. In addition to an ownership reduction in Oasis Pipe Line Company, three sales were made of HNG/InterNorth’s interests in Red River Pipeline; Valero Energy’s West Texas Pipeline. Additionally, Llano Inc., a gas pipeline system in southeastern New Mexico, was sold to Hadson Petroleum Corp. for approximately $45 million (“Hadson”).

To pay down the debt associated with the acquisition, HNG/InterNorth also sold miscellaneous assets such as the Granby Ranch in Colorado and Bear Paw Pipeline in Northern Montana (for $17.5 million to Tricentral).

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2.3 The Nationalization of Belco Peru: A Personal Recollection

Ross Workman was hard at work on the proposed Mojave Pipeline project for HNG/InterNorth when Ken Lay called him with an emergency. The new government of Peru had nationalized Belco Petroleum Corporation of Peru (BPCP), and Lay needed a good lawyer who understood business. Tens of millions of dollars were at stake, as well as the company’s international image.

Workman summarized the saga as follows:

The American Popular Revolutionary Alliance (APRA) had been around Peruvian politics for a long time, but it had never won an election until its presidential candidate, the manic-depressive Alan Garcia, won in 1985. Garcia was a young man anxious to make a name for himself, so he cancelled the production sharing contracts of BPCP and Occidental Petroleum Corporation (Oxy), forcing renegotiations. The government of Peru (GOP) negotiated a deal with Oxy and then seized Belco’s Talara property and Lima office at gunpoint.

Lay, Mick Seidl, and a New York lawyer flew down shortly after Christmas and had no luck. A staff of Belco people set up an office in Lima to commence meetings with the GOP.

Meanwhile, AIG, after receiving notice of the expropriation, found some alleged defects in the political risk insurance policy application and rescinded the policy. It looked like it could be a long hard slog, so I was assigned to manage the negotiations with the GOP and coordinate the litigation against AIG with the New York lawyers.

The GOP’s position was that they recognized they owed just compensation, but they had no money to pay it. They offered to pay in local currency which was experiencing hyper-inflation in the 5,000 percent per year range. Meanwhile the Shining Path terrorists were setting off bombs in Lima and killing cops and soldiers in the hinterlands. Routine criminal gangs were kidnapping for ransom weekly in Lima.

I went to Lima about every other month for a week at a time and had meetings with our local lawyers, GOP representatives, and a variety of third parties who purported to be able to help us solve the problem. One third party contact took me to Paris to meet the GOP Minister of Energy and then to Madrid where my host presented assorted schemes for Enron to get compensated by starting new business in Peru. We had an insurance policy obligation to pursue any possible method of recovery, so we had to do that to keep alive our claim, which then was being considered before a three-member arbitration committee in New York. HNG/InterNorth, and later Enron, did not pursue other Peruvian investments that the government could help pay for in local currency as part of its repayment.

Trips to Lima alternated with trips to New York hearings which went on for something like 50 days. Seidl was frequently involved, but nobody else from Houston was; Belco’s New York office was running the show because they had all the facts and history. Houston and even Omaha were certainly not expert about their business.

After we won the $163 million arbitration award, AIG switched from being our adversary to being our partner. They started going to Lima with me, which added another layer of lawyers (in New York and Lima) and contacts to the mix.

The Garcia government’s position never changed. Alberto Fujimori was elected in 1990 and had no stake in the expropriation. But by then, the Talara property was firmly embedded in the national oil company, Petroleos del Peru, so there was no way for them to give it back.

Eventually some kind of a deal was arranged with the GOP, but I don’t recall the amount of money involved. Having paid Enron what the arbitrators found to have been Enron’s loss on Belco, AIG got the lion’s share of whatever Peru was able to put on the table to make it all go away. Their main incentive was to get back in the good graces of the U.S. government and the World Bank.

In broad strokes, that’s what happened. The details were myriad and fascinating for me. I have never encountered as interesting a legal, political or business problem. It was fun, as long as you didn’t get blown up or kidnapped (email communication to the author, April 3, 2007).

Workman also remembers that Garcia’s government was more eager to work with Occidental Petroleum Corp., which was bigger and more politically connected with the U.S. government (email communication to author, December 2, 2006). A contract renegotiation required Oxy to explore in new inland areas, an arrangement that would bring hydrocarbons but also native unrest. This arrangement survived until 2006 when Oxy announced it was leaving Peru entirely to concentrate on its North American and Middle Eastern properties (Semuels).

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2.4 The Suppressed History of InterNorth

The cover of the completed 305-page double-spaced manuscript, Internorth: The First Fifty Years, was subtitled: “The Officially-Commissioned, Unpublished History of the Omaha-Based Energy Company Covering the Years 1930 to 1980.” The book that was not to be was kept in a safety deposit box in Omaha for almost two decades before being unearthed in 2000 as part of the Enron Oral History Project. (This project was co-directed by the present writer, then an employee of Enron, and Joseph Pratt, Cullen Professor of Business and History at the University of Houston.)

The manuscript reads well. It covers a lot of interesting history—from the 1920s when coal and oil interests hampered the entry of natural gas in the Midwest through the remaking of Northern Natural Gas Company in the 1970s. The book imparts the highs and lows of the company and the personalities involved. And it is here that the book must have become too hot for the community-minded InterNorth to handle. Instead, the company released a 25-page booklet, Northern: The First Fifty Years, which opened with a note from Bill Strauss and closed with a message from Sam Segnar.

InterNorth: The First Fifty Years was no coffee table or puff book. Stephen Szmrecsanyi, a Ph.D. historian and university professor, was no stooge. He gained full editorial control (which real historians do) and wrote the history as he found it. What he found were different company leaders—strong, weak, colorful, and even controversial. For example, Northern Natural’s second president (1933–35), the “brutally aggressive” (33) Louis E. Fisher, is described by this incident:

“What’s your job?” asked Fisher during one of his trips out to the field offices.

“Well, I’m an office engineer,” replied the Northern Natural employee.

“What in blazes do we need an office engineer for? You’re fired!” (38)

Fisher would remind his lieutenants: “I am perfectly frank in inviting you to see that no deadwood is being carried” (ibid).

Louis Fisher’s actions can be taken as an example of uncivil capitalism. But Northern Natural was built in the depths of the Great Depression, when having a job was a luxury, and eager replacement labor waited in the wings. Northern Natural’s low-cost gas was displacing higher-cost alternatives, with benefits to the consumer. Working life, which was just about every day all day, “was certainly no paradise,” Szmrecsanyi stated, and “most of the men were grateful for the chance to be working” (77).

Fisher was also described as a heavy drinker and inveterate swearer. But then there was Hiram Carson, a Northern Natural executive during and after Fisher’s presidency, who was quite the opposite. Carson would blurt out in moments of exasperation, “Oh dear,” and was remembered by one colleague as “probably the finest gentleman who ever worked at the company” (quoted in Szmrecsanyi, 44). Carson and Fisher, bitter rivals given their contrasting approaches to business and life, might have been the oil and vinegar that made the salad work at Northern during some very difficult economic times.

Szmrecsanyi’s other contrasts present history as it was and not how it “should” have been. Frank Brooks (1935–39), Northern Natural’s third president, was described as inadequate for the top job. Obsessed with frugality, Brooks let the pipeline system fall into disrepair. Burt Bay (1939–50), Brooks’s successor, also received a failing grade from Szmrecsanyi. “Burt Bay’s unimaginative and chronically conservative leadership mirrored and, in some cases, even prolonged the government induced paralysis which made his eleven years in office the least productive period in Northern’s fifty-year history” (98).

Then the company got better executives, at least in Szmrecsanyi’s estimation. John Merriam (1950–60) was described as “scholarly and reserved” by some and “cold” and “somewhat aloof” by others (135, 137). But Szmrecsanyi documents Merriam’s accomplishments in six areas: pipeline expansions to new markets, diversification, managerial innovation, codifying job rankings and introducing new employee benefits, maximizing company profits, and expanding civic activities (138).

Merriam’s tenure was the victim of heavy-handed federal regulation by the Federal Power Commission and warring distribution companies who wanted Northern Natural’s gas at cheap, regulated rates, damn the consequences. But Merriam was immersed in the company’s details and made good, tough decisions.

Bill Strauss (1960–76) graded out the best (229–33). Strauss had intellectual firepower. His superb people skills—backed by an honest, authentic self—allowed him to be a bona-fide Mr. Inside and Mr. Outside at Northern/InterNorth. Employees revered him, and federal and state regulators and Northern Natural’s customers respected him. Under his leadership, Northern Natural Gas Company was able to turn over a new, better leaf with its adversaries.

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2.5 Transwestern Pipeline: “Enron’s Laboratory” Amid Regulatory Change

When natural-gas surpluses emerged in the late 1970s and early 1980s, end-users substituted (cheaper) spot gas for traditional pipeline (“system”) supply. Industrial customers and power plants with the ability to substitute fuel oil for gas were able to gain price concessions—and leave the pipeline to deal with its contractual take-or-pay liabilities with producers.

As good as this was for price-sensitive, fuel-switchable customers, residential and commercial customers were on the outside looking in. Served by the monopoly gas utility (or municipality), and not able to switch fuels, these small users were stuck with the pipeline’s (more expensive) contracted supply.

When local distribution companies (LDCs) asked Northern Gas Marketing (NGM) for the same deals as large end-users, they were referred back to the pipeline (Burns interview, 19–20). The pipeline served them with system supply, knowing that they were captive and would use about the same amount of gas whatever the price. The same was true with other pipelines with a marketing affiliate (Tussing and Tippee, 202–4).

This dichotomy led to a lawsuit by the LDCs on the grounds of discrimination, which in turn led the Federal Energy Regulatory Commission (FERC) to issue Order No. 380 in May 1984. That order voided the minimum-bill portion of pipeline contracts with utilities. This was a blow to business-as-usual on interstate pipelines, including Northern Natural Pipeline, but it was a boom to NGM and other marketers around the country that gained both markets and released gas from pipelines for spot market activity.

Enter Transwestern Pipeline Company, purchased in late 1984 by Houston Natural Gas Corporation from Texas Eastern Corporation. Transwestern delivered gas from Texas and Mexico to southern California, the territory served by Southern California Gas Company (SoCalGas). In the wake of Order No. 380, SoCalGas presided over the largest market for spot gas in the country.

Transwestern became Enron’s laboratory of innovation to maximize profits under radically changed market and regulatory conditions (Wasaff interview, 28). Transwestern’s initiatives on the state level before the California Public Utilities Commission (CPUC) and on the federal level before FERC are unique stories in the annals of interstate gas transmission industry.

Transwestern’s high degree of innovation reflected not only a new, handpicked management team, described in chapter 2. It also reflected the fact that Transwestern was a smaller and less complex gas transmission system than that of El Paso Natural Gas, which allowed the former more flexibility for change. El Paso was also slower to embrace the new environment; leading to Clark Smith and then George Wasaff leaving the marketing arm of El Paso for Transwestern in August 1985 and February 1986, respectively (Smith interview, 2–3; Wasaff interview, 4–11). Still, El Paso would change their old ways of doing business (Vietor, 140–44; 153–57), one reason being that regulation itself and first-mover Transwestern were forcing their hand.

At the time of FERC Order 380, as mentioned in chapter 2, Transwestern had a provision that required Pacific Lighting, the monopoly utility serving much of Southern California, and the parent of SoCalGas, to pay for 91 percent of the contract volume whether or not the gas was taken. This “minimum bill” contract guaranteed an income stream to cover Transwestern’s fixed costs (collected in monthly demand charges, which FERC’s order did not disturb). It also provided an income stream to cover Transwestern’s gas costs and other variable expenses. This was as close to a guaranteed profit as a company could have, and Texas Eastern did not need to devote entrepreneurial talent to manage Transwestern, its smallest line.

FERC’s invalidation of minimum-bill contracts in May 1984 was a pragmatic step to allow gas distributors to access lower-priced “spot” gas rather than be captive to a pipeline’s system supply. Spot gas needed transportation capacity to reach an interstate destination, but the two went together in the sense that if a pipeline lost a customer, that same pipeline had an incentive to come back with spot gas (from the same system-connected producer) in a transportation arrangement. Thus, in November 1984, just prior to its sale by Texas Eastern Transmission Corporation, Transwestern activated the force majeure clause in its producer contracts, unilaterally reducing its takes, which put producers in a situation of releasing their contract supply to spot gas/transportation in order to regain the market.

The CPUC took over where FERC’s jurisdiction stopped, adopting a gas sequencing policy for distribution companies in the state. SoCalGas, Transwestern’s predominant customer, was instructed to choose the cheapest gas from either Transwestern or El Paso. That December 1985 policy was followed by a customer agreement whereby FERC accepted a 60 percent minimum bill, pending judicial review. Transwestern (and El Paso) also set forth a nondiscriminatory transportation tariff (pursuant to Section 311 of the Natural Gas Policy Act) to move greater volumes than 60 percent of their contract amounts.

In July 1985, Transwestern and El Paso entered the spot gas/transportation world in a big way, bidding against each other in SoCalGas’s program. Transwestern reached capacity on the strength of winning bids of gas on its system, some of which was released Transwestern gas bid by affiliate Pacific Atlantic Marketing, Inc., or PAMI, as well as gas bid by other HNG/Interstate spot-gas affiliates. PAMI would continue to attract gas from producers in return for take-or-pay relief for bidding to SoCalGas.

Spot gas on both Transwestern and El Paso went to 60 percent from 40 percent of contract effective November 1, 1985. Intense competition required innovative bidding, such as lowering the weekend rate when demand was less, a move that won gas business for Transwestern at the expense of El Paso (Transwestern, 16).

In January 1986, Transwestern announced its intention to open its system to transportation under the rules of FERC Order 436, issued October 1985. El Paso immediately followed suit. Transwestern would become the first open-access interstate pipeline that summer (Transwestern, 16, 18).

CPUC rules did not originally allow end-users behind SoCalGas to buy their own spot gas and arrange for transportation. This changed in March 1986, when SoCalGas, Pacific Gas & Electric (in northern California), and San Diego Gas & Electric (a utility behind SoCalGas) were ordered to file intrastate transportation rates. This meant that the customers of SoCalGas, not just the utility itself, could take bids for spot gas to meet their requirements (Transwestern, 17).

When competition intensified in 1986 because of falling oil prices, Transwestern received approval from the FERC to change its rates on a one-day notice rather than either twice a year under traditional filings, or once every 30 days under out-of-cycle filings (Transwestern, 17). Such flexibility priced natural gas to market conditions, whether to beat fuel oil from Indonesia or spot gas delivered by rival El Paso.

The above proactive strategies included some innovative proposals by Transwestern that were turned down by the FERC. Jim Rogers, formerly of FERC, and now a seasoned and respected negotiator with FERC as head of Enron Interstate, did not get everything he wanted. But a variety of innovative “win-win” initiatives were launched that benefited virtually all parties in the natural gas industry, including consumers. FERC “loved dealing with Transwestern,” Terry Thorn remembered. “They would [say] … what’s Transwestern going to walk into the room with today?” (Thorn interview, 37).

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References for Chapter 2 Appendix

Bradley, Robert, Jr. “The Distortions and Dynamics of Gas Regulation.” In New Horizons in Natural Gas Deregulation, edited by Jerry Ellig and Joseph Kalt, 1–29. Westport, CT: Praeger, 1996.

Bradley, Robert, Jr. Oil, Gas & Government: The U.S. Experience. Lanham, MD: Rowman & Littlefield, 1996.

Coffey, George, and Partridge, Virginia. “Coal Slurry Pipelines: The ETSI Project,.3.” Right of Way, August 1982, 11–16.

Enron Corp. Annual reports, various years.

“Hadson to Buy Llano,” Natural Gas Week, February 10, 1986, 6.

HNG/InterNorth. Annual reports, various years.

Hyman, Harold. Craftsmanship & Character: A History of the Vinson & Elkins Law Firm of Houston, 1917–1997. Athens: University of Georgia Press, 1998.

InterNorth. Annual Reports, various years.

Jensen, Beth. E-mail communication to author, November 15, 2006 (copy in author’s possession).

Northern Border Partners LP. Annual reports, various years.

Northern Natural Gas Company. Annual reports, various years.

Northern Natural Gas Company. Northern: The First Fifty Years. Company brochure, 1980.

Semuels, Alana. “Occidental Washes Its Hands of Peru,” Houston Chronicle, December 8, 2006, D6.

Szmrecsanyi, Stephen. “InterNorth: The First Fifty Years.” Unpublished manuscript, completed in 1981.

Transwestern Pipeline Company. 30 Year History. Typescript. Internal company document, Summer 1990.

Tussing, Arlon, and Tippee, Bob. The Natural Gas Industry: Evolution, Structure, and Economics. Tulsa, OK: PennWell, 1995.

Vietor, Richard. “El Paso Natural Gas.” In Contrived Competition: Regulation and Deregulation in America, by Vietor, 91–166. Cambridge, MA: Harvard University Press, 1994.

Interviews

Burns, Ron. Telephone interview with Robert Bradley Jr. December 6, 2006.

Smith, Clark. Interview with Robert Bradley Jr. Houston, TX, May 3, 2006.

Strauss, Bill. Interview with Robert Bradley Jr. and Joseph Pratt. Omaha, NE, August 17, 2000.

Thorn, Terence. Interview by Robert Bradley Jr., Houston, TX, June 6, 2001.

Wasaff, George. Interview with Robert Bradley Jr. Houston, TX, March 7, 2001.