BOOK 3: ENRON ASCENDING: THE FORGOTTEN YEARS, 1984-1996
Chapter 3 Internet Appendix
3.1 Houston Headquarters
3.2 Tenaska: Escape From Enron
3.3 Letter from Ken Lay to T. Boone Pickens
3.4 Fuel Use Act, Incremental Pricing, and Gas Demand
3.5 Rise of Gas Marketing
3.6 ‘Market Conforming’ Intervention: Free Market or Not?
References for Chapter 3 Appendix
3.1 Houston Headquarter
Economists have noted the advantages of proximity for firms within an industry. In his Principles of Economics (1890), Alfred Marshall explained why competitors tend to cluster together.
When an industry has thus chosen a locality for itself, it is likely to stay there long: so great are the advantages which people following the same skilled trade get from near neighbourhood to one another. The mysteries of the trade become no mysteries; but are as it were in the air, and children learn many of them unconsciously….
Employers are apt to resort to any place where they are likely to find a good choice of workers with the special skill which they require; while men seeking employment naturally go to places where there are many employers who need such skill as theirs and where therefore it is likely to find a good market. (Book IV, Chapter X, §3. Available at: https://www.econlib.org/library/Marshall/marP.html?chapter_num=25#book-reader)
Consider the operating advantages for similar firms that are headquartered in the same geographical area. First, it is easier to attract employees who feel they have the insurance of being able to switch firms and not have to relocate their families. Ron Burns, a leading HNG/InterNorth gas marketing and gas pipeline executive, remembers deciding to leave Omaha, Nebraska, for HNG’s home:
I really enjoyed the natural gas business and wanted to stay in the industry. So for me and some others it became: let’s get to Houston as fast as we possibly can, and if for some reason this does not work out, there are plenty of other opportunities there (Burns Interview, 7).
Such proximity also means higher pay scales because of firm-to-firm competition for human capital. Ken Lay was a market leader in employee compensation (including perks), and his draw was higher wages and increased responsibilities to get talent from Winter Park, Florida, and Omaha, Nebraska, to Houston.
Geographical proximity also allows informal interaction between bottom-to-top employees of rival firms, which creates an information flow that would be absent otherwise. Having lunch together or visiting at a social event is more conducive to sharing information than the formality of distant telephone conversations.
It was almost a foregone conclusion that HNG/InterNorth would migrate to Houston from Omaha after the merger in mid-1985. Enron spokeswoman Diane Bazelides (who personally made this move) explained the attraction of Houston:
We feel this is the energy headquarters of the nation. All your competition is here, all the big companies are here, and all the people you generally interact with are here (quoted in Pearson).
Historically speaking, Houston emerged as the energy center of the country after the discovery of the huge Spindletop oil field in nearby Beaumont in 1901. During the energy boom of the 1970s, Houston solidified its hold on this title. As the city advertised in Fortune magazine in 1978:
Twenty-four of the 25 largest U.S. oil companies are either headquartered in the city or have in it major divisions of exploration, production, research, processing or marketing. Houston also contains about 400 other oil companies, over 1000 suppliers and manufacturers of oil-related equipment, and hundreds of marine service companies, geological drilling contractors, seismic companies, and pipeline companies. About 40 percent of the nation’s oil is refined in Houston and the nearby Texas Gulf Coast, and the area manufacturers about 60 percent of the nation’s basic petrochemicals (“Houston,” 28).
During the 1980s retrenchment, energy-firm consolidation often favored Houston at the expense of Midland/Odessa, New Orleans, Oklahoma City/Tulsa, and other oil and gas outposts (Pearson, 1).
3.2 Tenaska: Escape from Enron
In late 1986, Howard Hawks ended his 20-year career at the company that began as Northern Natural Gas and was now Enron. After falling short on an opportunity to purchase from Enron the Central Basin Pipeline Company (the project he put together for InterNorth), Hawks was now on his own looking for projects to buy or develop as a consultant.
His best opportunity was cogeneration, an area he knew well from his Texas City work. At Hawks’s side was Tom Hendricks, who as manager and business development officer had been his number two at Northern Natural Resources. In early 1987, the two began as consultants working in a leased basement in Omaha. Never could they have imagined that 20 years later this beginning would result in a company with $2.8 billion in assets and an equity value of $1 billion (Tenaska, 2006 Annual Report, 2–4).
The first opportunity for Hawks, Hendricks, and several other InterNorth ex’s was to revamp a non-financeable cogeneration project in Big Spring, Texas. At stake was an all-or-nothing fee of $1 million if the project could be saved. The project had some important elements in place, such as ready buyers of the steam (Fina Oil and Chemical, now Alon) and power (Texas Utilities Electric Company, now TXU). Their reconfiguration, achieved in two months, resulted in the construction and profitable operation of Falcon Seaboard, a 200 MW plant that was more than double its originally planned size.
With this fee income in hand, it was time to form a company. The name Tenaska was chosen (Tenaska, 1987–2007, 1, 4), using letters from Texas, New Mexico, and Nebraska, as well as playing off of the words “tenacity” and “ten” (meaning “perfect”).
The moniker worked. “We never encountered a name conflict,” recalled Hawks, “and we didn’t end up paying a fortune to some Madison Avenue public relations firm to come up with a ‘New Name’ like big energy companies in the 1980s” (Tenaska, 1987–2007, 4). One of those companies was Enron (née Enteron).
The next opportunity proved to be a company builder: a 223 MW cogeneration plant in Paris, Texas, where TXU would buy the power and Campbell Soup Company the steam. Assembling a team of experts was easy: “All I did was use the old InterNorth phone book,” remembered Hawks (Tenaska History, 3). But financing challenges almost sank the project—and the young company. An eleventh-hour breakthrough saved the day, and now with a track record, new projects came forth.
Hawks thought he would end up with a company of 25 to 50 people. Instead the number would grow to the hundreds as Tenaska’s core came to include natural gas marketing (1991), power marketing (1996), power-plant management (1999), power-plant funding (2003), and, most recently, biofuels (2006) (Tenaska, 2006 Annual Report, 1).
Tenaska’s full stride reflected one advantage that neither the old InterNorth nor the new Enron enjoyed: being a private company that could focus on creating long-term value rather than meeting short-term expectations set from the outside. “Tenaska is and will remain a privately-held company,” Hawks explained in 2007. “This allows us to focus on doing the right thing for the long-term benefit of our customers and employees, rather than being subject to pressures of book income, quarter-to-quarter earnings and the whims of public equity markets” (Tenaska, 2006 Annual Report, 2).
Hawks also attributed Tenaska’s success at the 20-year mark to its “reputation for fairness, integrity and dependability” and its “conservative, risk-minimization approach to its business” (Tenaska, 2006 Annual Report, 2).
Tenaska turned out to be an anti-Enron in both approach and result. And looking back, Tenaska can be seen as one of the opportunities foregone by InterNorth when Sam Segnar’s company decided to acquire Houston Natural Gas. If InterNorth had not “panicked” (as Hawks put it) in the face of the overtures of corporate raider Irwin Jacobs, Northern Resources would have had the capital to add to its first two (stellar) projects, Central Basin Pipeline and Northern Cogeneration One, to become—for its parent—a minor “Tenaska.”
3.3 Letter from Ken Lay to T. Boone Pickensn
A three-page personal letter written by Ken Lay to Boone Pickens during the week of the Jacobs/Leucadia buyout shows several sides of Ken Lay, as well as offers a snapshot of where Enron was in October 1986.
At the broadest level, the letter revealed Lay’s sensitivity to criticism and his drive to justify his actions to important people. The communication also showed the utmost tact, opening with “I was surprised and disappointed at ….” and ending with “I would hope that you might rethink at least some of your position based on the above information” (Lay, Letter, 1, 3).
This tone was different from, say, “I am in profound disagreement with” and “you should reconsider some if not all of your position.” Lay was a “politician” in the corporate world who thought from the outside in, not inside out. But perhaps Lay knew that his position was far from unassailable.
Illuminating what would transpire in 2001 when Ken Lay exhorted his employees to hold their stock and buy more, the letter shows Lay’s strong, even messianic, belief in employee stock ownership as a way to align the interests of workers and stockholders, institutionalize good decision-making, and create a strong company. “I personally believe this will provide tremendous motivation for all employees to be as cost conscious and productive as possible to benefit all the shareholders, including themselves,” Lay wrote (Lay, Letter, 1).
Lay’s letter to kingmaker Pickens also criticized takeovers as such, arguing that senior management wins and rank-and-file employees lose:
It is my studied opinion that the people who really get hurt in a takeover are the middle level and lower level managers and professionals who are surplused and who have not accumulated significant personal financial resources and who do not have many, if any, professional alternatives. This is particularly true at the present time for geologists, petroleum engineers, and other E & P related professionals where unemployment rates, as you know, are the highest since the depression of 1930’s (Lay, Letter, 2).
This egalitarian argument gave short shrift to an Economics 101 argument that takeovers are part of the market adjustment process to shift resources out of uneconomic areas into more productive ones. Transition costs aside (and severance pay and social welfare programs are important here), economists would argue that a takeover market accelerates reform to realign resources to consumer demand. Seen another way, to retain resources just to retain them is uneconomic.
Despite the traumatic end for thousands of Enron employees in 2001, Lay did have a genuine concern for employees and their welfare, at least by all outward appearances. He was very interested in the little fellow given his own history of growing up on a farm in rural Missouri, as well as his interest in employees who were many rungs below him. Middle-management compensation and perquisites were very competitive, even industry-leading, at Enron. This is why Ken Lay had such strong employee loyalty up until the last months before bankruptcy.
Very few employees knew their loyalty was blind given that Ken Lay was a dreamer who too often took big risks rather than make hard, tough-love decisions. In fact, he would become philosophically unhinged as time went on at Enron, particularly after 1996 when disciplinarian Richard Kinder left the company.
3.4 The Fuel Use Act, Incremental Pricing, and Gas Demand
Federal energy intervention is a forest of trees with many branches. New branches have sprouted as new intervention was enacted to address the problems created by prior government. This interventionist dynamic, described in Edison to Enron (496–97; 500–511), was alive and well with natural gas in the 1970s.
Long-standing wellhead price controls on natural gas bought and sold in interstate commerce (including deliveries by Florida Gas Transmission, Northern Natural Gas, and Transwestern Pipeline) predictably created shortages during peak-demand periods. After the severe winter 1976/77 shortage (“curtailments”), fixity-depletion thinking reached its peak with U.S. energy-czar James Schlesinger warning about “a classic Malthusian case of exponential growth against a finite source” (quoted in Bradley, Edison to Enron, 491). With declining supply from price controls intended to “protect” consumers, government conservation (conservationism) became the interventionist impulse (Bradley, Capitalism at Work, 241–42; Bradley, Edison to Enron, 226–27).
The legislative result was the five-part National Energy Act of 1978, championed by President Carter and enacted after vigorous debate by Congress. Two notable interventions impacted natural gas demand. One was intended to husband scarce (“depleting”) gas supply for high priority uses; the other was intended to protect captive gas consumers from rising prices. Each backfired when gas markets shifted from shortage to the “gas bubble” and were weakened in the 1980s and formally repealed in the 1990s.
- Fuel Use Act
The Powerplant and Industrial Fuel Use Act of 1978 (Public Law 95‑620, 92 Stat. 3289) sought to replace (“conserve”) natural gas and fuel oil and promote “energy independence” with coal in powerplants and major fuel‑burning installations (Lublin and Pickholz, 487–88). The FUA, commented FERC the next year, “reflects the national energy policy to encourage the consumption of coal, which is our most abundant energy resource, in those facilities where coal can be utilized” (FERC, Docket No. RM79-45, September 28, 1979).
Existing plants were restricted to their current usage of oil and gas until 1990 when an outright oil and gas ban was to take effect. New plants could not use oil or gas without a special exception authorized by the U.S. Department of Energy (DOE), which in effect restricted them to coal burning pending the development of alternative fuels, cost and environmental considerations aside.
With improving supply conditions, the Fuel Use Act was amended in 1981 (Omnibus Budget Reconciliation Act, Public Law 97‑35, 95 Stat. 357 at 614) to allow existing plants to increase natural gas consumption. The 1990 ban for new facilities was also removed (Bradley: Oil, Gas, & Government, 940). Meanwhile, DOE routinely granted exemptions beginning in 1979, which reached 18 in 1982 and increased to more than 100 annually by the mid-1980s (Cano).
While the National Coal Association (NCA) protested exemptions with expert testimony, the natural gas industry fought for waivers and for outright repeal. The “Holy War” between coal and gas in 1986–87 prominently included debate over waiver request by Virginia Power to use natural gas for a new 400 MW baseload plant. The NCA skirmished against the National Gas Supply Association.
The American Gas Association, which originally favored the law to ensure ample gas to the residential (utility) market, now favored repeal given the gas surplus and the desire for lower rates from increased gas-pipeline throughput and thus lower FERC-authorized transportation rates (Valdez). Virginia Power received its exemption after reaching an understanding with NCA that its plant would be built capable of burning coal as well as gas (“National Coal Association”).
Ken Lay and Enron became the face of natural gas against the Fuel Use Act. In March 1987 testimony before the Senate Subcommittee on Energy and Natural Resources, Lay advocated repeal as a “win-win proposition” for all consumers, while challenging the coal industry to compete “head-to-head” with gas-fired plants to produce lower-cost electricity (Blauvelt).
Lay’s marketplace argument was that free competition would result in more gas usage and thus lower interstate-pipeline rates as fixed costs were spread over more volume under cost-based regulation. Higher gas demand benefitted many Enron profit centers; the concern by independent cogenerators that repeal would allow more utilities to build their own plants (McCormack) was not enough for pragmatic Enron.
The Fuel Use Act—nicknamed the Less-Than Full Use Act by one wag (quoted in Jennrich, “FUA Repeal”)—was significantly weakened in 1987 (Public Law 100-42, 101 Stat. 319) and repealed in 1992 (Public Law 102–486, 106 Stat. 3128).
Few laws were passed in more artificial circumstances. And few had more unintended consequences: higher costs for consumers, as well as greater emissions of criteria air pollutants from incremental coal burning (Bradley, Oil, Gas, & Government, 1267).
- Incremental Pricing
Title I of the Natural Gas Policy Act of 1978 increased maximum interstate (federally regulated) gas prices in most of its 20-plus categories to conform to market realities and thus to end shortages. Title II of the NGPA, called incremental pricing, was intended to shield the most vulnerable gas users from such higher prices.
The means for the alleged protection was a rate design by which interstate pipeline costs, and thus rates, were skewed toward industrial and power plants to leave less cost for captive (utility franchised) residential and commercial users. One constraint was that higher gas costs could not exceed the cost of an alternative fuel (No. 2 fuel oil) to prevent interfuel substitution. Exempted from incremental pricing were industrial users under 300 Mcf per day, agricultural users, schools, hospitals and other public institutions.
Contrary to intention, fuel-switchable gas users responded to their disproportionate cost allocation by fuel switching (to oil, given the price collapse in 1986) or even shutting down given relatively high domestic energy costs (Bradley, Oil, Gas, & Government, 893). Coal plants were substituted for gas plants to generate power. Lost gas demand decreased throughput on interstate pipelines to hurt captive users, the very customer class that the law was intended to help.
In the words of one FERC official: “The intended price-shielding effect of incremental pricing is eroded and [the] burden of the system’s fixed costs on high-priority customers is increased if price-sensitive industrial loads are lost due to a long-term decline in alternative fuel prices” (“FERC Staff Director,” 43). Still, such FERC exemptions could take a year and cost as much as $100,000, so some firms would give up rather than file a request (“AGA Disputes”).
Politics begets politics. Groups such as the Process Gas Consumers Group, the American Iron and Steel Institute, the Chemical Manufacturers Association, and the Association of Businesses Advocating Tariff Equity lobbied against the artificial rate design by the mid-1980s (“Time is Ripe”).
In response, flexible rate designs based on market‑clearing considerations began to be introduced by FERC and the involved companies in 1983–84. Phase II of incremental pricing, intended to extend requirements from large industrial facilities to all industrial customers, was postponed and finally revoked by the FERC in March 1984 (Bradley: 1996, 893). Title II of the NGPA was effectively repealed in 1987 (Public Law 100-42, 101 Stat. 319) and formally repealed in 1992 (Public Law 102–486, 106 Stat. 3128).
3.5 Rise of Gas Marketing
The Open Access Rule, FERC Order No. 436, became effective November 1, 1986. Self-described as a voluntary program for interstate pipelines to convert from traditional bundled sales/transportation to transportation, with the gas commodity function handled by others (independent marketers), industry conditions and regulatory incentives dictated the election of “going open.”
The marketing segment had been growing for some years before Order No. 436. In 1985, approximately one-third of the nation’s natural gas was sold short-term. About a third of such “spot” sales was arranged by gas marketers, described as “a relatively new breed of gunslinger, one who relies on a fast mind, fast calculator and fast telephone … plus a BIG Rolodex of gas industry contacts” (Jennrich, “How Many Marketers,” 1986).
The discovery of network opportunities by the new logistics specialists brought forth economies never before seen. One example was concocted by a Washington attorney who “took a package of gas from Indiana to Louisiana” without breaching FERC’s interstate jurisdiction because “the gas didn’t move.” The “backhaul” arrangement was just the beginning of “bypass by exchange” and “black-box transportation,” as Connie Barlow of ARTA’s Natural Gas Insights termed it (“Getting Gas Moved”).
The April 1987 edition of Petroleum Independent, a monthly publication of the Independent Petroleum Association of America (IPAA), reflected the new world of gas sales between the wellhead and downstream markets. There were explanatory articles such as “Natural Gas Marketing” and “How to Select a Gas Marketer.” Marketing firms such as Natural Gas Clearinghouse (NGC) and Mock Resources advertised in the issue. The 16-page special section on marketing also included a directory for 25 interstate pipelines of Order No. 436 status, marketing affiliates, and transportation and exchange specialists.
The maturation of the NGC in 1987 from a broker to a marketer on Order No. 436 pipelines under new CEO Chuck Watson, formerly of Conoco, was a big story of the period. Gas Daily’s George Spencer noted how 15 employees a year ago at Clearinghouse were now “over 40 with a T&E department and accountants to keep track of all the gas and a cadre of marketers with geographic assignments … moving over 900 million [cubic feet per day] this summer” (“The Gas Clearinghouse”).
The gas marketing segment would only grow, from 51 companies in 1986 to 200 in 1987, 313 in 1988, and 338 in 1989 (Jennrich, “Directory Update”).
3.6 “Market Conforming” Intervention: Free Market or Not?
The Clean Air Act Amendments of 1990 introduced, relatively speaking, let-the-market-decide pollution control regulation in place of the Clean Air Act Amendments of 1977’s emphasis on plant-by-plant (facility-by-facility) emission limits for sulfur dioxide (SO2). (Nitrogen oxides trading would join in later that decade.)
The latter command-and-control approach mandated best available control technology (BACT); the new approach set an overall emission reduction cap and allowed emitters to trade among themselves for the right to pollute. Thus, firms with relatively low reduction costs reduced emissions and sold credits to firms with higher marginal emission abatement costs to approximate an overall pollution reduction goal.
In congressional testimony, Ken Lay supported emissions trading for SO2 and NOX as a “freedom of choice” approach (see Introduction, pp. 43–44, 322–23). A plant could install BACT (as before) or buy emissions credits instead. Perhaps one company could reduce emissions at one location enough to increase emissions elsewhere and still meet the cap. (Lay, Clean Air Act Reauthorization)
As a regulatory tool to reduce overall emissions of a well-determined (sound-science-determined) bad (a criterion pollutant), economists have supported such trading over command-and-control regulation. For the private-sector overall, costs are lowered to promote emission reductions or just gain the support to have the program in the first place. (The Environmental Defense Fund championed the program for this reason.) But the downside is that such efficiency might be enough to regulate an emission that should not be regulated, the most prominent example being carbon dioxide (CO2).
References for Chapter 3
“AGA Disputes IPAA VP Anderson on Fuel Use Act Repeal.” Gas Daily, May 12, 1986, 2–3.
Blauvelt, Randal. “Enron Chairman to Senate Panel: Fuel Use Act Repeal Best for Consumers.” Enron Corp News Release, March 12, 1987.
Bradley, Robert, Jr. Capitalism at Work: Business, Government, and Energy.
Salem, MA: M & M Scrivener, 2009.
Bradley, Robert, Jr. Edison to Enron: Energy Markets and Political Strategies.
Hoboken, NJ: Wiley & Sons; Salem, MA: Scrivener Publishing, 2011.
Bradley, Robert, Jr. Oil, Gas, and Government: the U.S. Experience. Lanham, MD: Roman & Littlefield, 1996.
Cano, Craig. “Incremental Pricing, FUA Waivers Available, But Rules Seen as Outdated,” Inside F.E.R.C., August 25, 1986.
Enron Corp. Annual reports, various years.
“FERC Staff Director Shifts Policy, Grants Exemptions from Incremental Pricing to Eight Companies,” Foster Report, May 1, 1986, 42–43.
“The Gas Clearinghouse? Our Favorite Phoenix.” Gas Daily, September 18, 1987, p. 1.
“Getting Gas Moved without Actually Moving It,” Gas Buyers Guide, June 16, 1986.
“Houston: A City Coming of Age.” Fortune, January 30, 1978, 24, 27–28, 30, 36, 40, 43, 45.
Houston Natural Gas Corporation (HNG). 1981 Annual Report.
Independent Petroleum Association of America, Petroleum Independent, April 1987.
Jennrich, John. “Directory Update Shows Maturing Marketers,” Natural Gas Week, October 9, 1989, 2.
Jennrich, John. “FUA Repeal: Between Rock & Hard Place,” Natural Gas Week, March 16, 1987, 2.
Jennrich, John. “How Many Marketers on Head of a Pin,” Natural Gas Week, May 5, 1986, 2.
Lay, Ken. Clean Air Act Reauthorization. Hearing before the Subcommittee on Energy and Power, Committee on Energy and Commerce, House of Representatives, 100th Cong., 1st sess., 1989, 471–490, 516–517. (Cited as Lay, Clean Air Act).
Lay, Ken. Letter to Mr. T. Boone Pickens, Jr., October 24, 1986 (copy in files).
Lublin, Edward, and Marvin Pickholz. “Introduction to the Powerplant and Industrial Fuel Use Act of 1978: Securing Exemptions for Utilities and Major Industrial Users,” The American University Law Review (vol. 29: 1980], 485–513.
McCormack, Richard. “Fuel Use Act Repeal Worries Cogenerators.” The Energy Daily, March 13, 1987, 2.
“National Coal Association Withdraws Opposition to Fuel Use Act Exemptions Sought by Virginia Power for Gas-Fired Combined-Cycle Electric Generating Units, but Protests Similar Request for FUA Exemption by Ocean State Power.” Foster Report, March 26, 1987, 3–4.
Pearson, Anne. “Oil Firms Moving Hubs to Houston.” Houston Chronicle, July 31, 1988, Sec. 8, pp. 1, 4.
Tenaska. 2006 Annual Report.
Tenaska. 1987–2007: Celebrating Twenty Years of Growth (company brochure, 2007). (Cited as Tenaska History)
“Time is Ripe for Elimination of Incremental Pricing, Say Industrials,” Inside F.E.R.C., June 9, 1986.
Valdez, William. “Coal, Gas Holy War Spreads: Wednesday ERA Hearing Crucial,” February 16, 1987.
Interviews
Burns, Ron. Telephone interview with Robert Bradley Jr. December 6, 2006.