BOOK 3: ENRON ASCENDING: THE FORGOTTEN YEARS, 1984-1996
Chapter 6 Internet Appendix
6.1 Natural Gas Visions at Enron
6.2 Mandatory Open Access Orders: 1985-92
6.3 Other Federal Natural Gas Regulation
6.4 Incentive Regulation and Enron: 1989-92
6.5 Mandatory Open Access Reconsidered
6.6 TGS Argentina’s Privatization
6.7 International Starts, Not Finishes
6.8 The Tight-Sands Gas Tax Credit of 1990
6.9 Reformulated Gasoline and the Clean Air Act of 1990
References for Chapter 6 Appendix
6.1 Natural Gas Visions at Enron
In a (pay-for-privilege) address to the Newcomen Society of the United States in 1990, Ken Lay reviewed the history of the two major predecessor companies to Enron, Houston Natural Gas and InterNorth. “The Enron Story” also described the company’s progressing natural gas focus and vision.
The original post-merger vision—or “mission” to use Lay’s term—was to become the most innovative, integrated natural gas company in North America.” Lay explained:
After recognizing early on that the natural gas pipeline business was the backbone of the corporation, we concentrated on growing our existing businesses—our exploration and production, gas liquid fuels, and cogeneration operations—which best complemented and are complemented by our pipeline activities.
With this mission in mind, we continued to dispose of unrelated assets, at what we believe were premium prices, to form joint ventures and to consolidate our core [gas] businesses (Lay, The Enron Story, p. 17).
Now, with its natural gas pipelines leading the U.S. with a 17-to-18 percent market share, the industry’s premier national gas marketing division, and a major forthcoming international gas project (Teesside cogeneration plant), Enron adopted “a new vision that will guide us through the coming decade” (22).
Referring to the oil majors—at least to “twenty to thirty years ago … when they were at their peak”— Enron was now in pursuit of becoming “The First Natural Gas Major, the Most Innovative and Reliable Provider of Clean Energy Worldwide for a Better Environment” (p. 23).
“We want to be fully integrated, to add value throughout the whole natural gas chain, from finding and producing natural gas at the wellhead to extracting, transporting, and marketing natural gas, gas liquids, crude oil, and finally, to using natural gas for efficient generation of electricity,” Lay posited. And there was more:
We also want to continue our expansion into the international marketplace with the intent of establishing worldwide markets for all our integrated operations. Finally, through our involvement with natural gas, an efficient, clean-burning fuel, we want to be part of the solution in dealing with one of the most critical problems facing all of us worldwide: the environment (23).
The last point played to the favorable politics of natural gas relative to oil and to coal on both environmental and energy-security grounds—a turnaround from the 1970s when abundant coal got the upper hand because lawmakers believed oil and gas to be rapidly depleting.
Enron as the first natural gas major would be “the supplier of choice worldwide” by being “the most reliable and safest provider of clean fuels, the best executor/implementer in the business, [and] … the most innovative supplier and quality leader in the natural gas industry,” Lay concluded (23).
The effectuation of this vision in the next years would establish Ken Lay as Mr. Natural Gas. At least for his shining years, dating roughly from 1983 through 2000, Lay could form a trifecta with Mr. Petroleum John D. Rockefeller and Mr. Electricity Samuel Insull in the history of the U.S. energy industry.
6.2 Mandatory Open-Access Orders: 1985–92
In June 1984, FERC Order No. 380 (49 Fed. Reg. 22778 [June 1, 1984]) invalidated the variable cost portion of the minimum-take (“minimum bill”) contracts between interstate pipelines and their local distribution companies (LDCs). But this left in place a parallel market relationship between the involved pipelines and their wellhead contracts with producers.
With pipeline-specific rulings upheld, utilities began to substitute spot gas and Section 311 transportation for higher-priced pipeline sales.[1] Pipelines, eager to regain markets and minimize take-or-pay exposure, responded by releasing their system supply into special segregated supply pools to bid into the 30-day spot market. The invalidation of minimum-bill orders greatly accelerated the movement of spot gas. By early 1988 the market share of spot gas sales and congruent transportation had overtaken traditional pipeline commodity sales (INGAA, “Carriage Through the First Quarter of 1988,” August 1988). By the end of the decade, over two-thirds of all sales would be transported nonjurisdictional sales (INGAA, “Carriage Through 1989,” April 1990).
In May 1985, a D.C. Circuit Court decision invalidated the special marketing programs (SMPs) that had proliferated since 1983. The court found that the benefits of spot gas were targeted to alternate-fuel customers and thus discriminated against captive gas users (such as households), in violation of the Natural Gas Act (Maryland People’s Council v. FERC I, 761 F.2d 768 (D.C. Cir. 1985); Maryland People’s Council v. FERC II, 765 F.2d 450 [D.C. Cir. 1985]). Three weeks later, on May 30, the FERC issued a proposed rulemaking to put pipelines permanently in the transportation business.[2] Issued on October 9, 1985, as a final order, Order No. 436 set forth a blanket (one-time certificate) open-access, nondiscriminatory transportation program for spot gas in contradistinction to case-specific Section 7(c) and Section 311 alternatives.[3]
The interstate industry had dodged mandatory common-carrier regulation in 1935. Fifty years later regulators determined that the escape from record-high prices amid a growing gas surplus was to demote the pipelines’ merchant role to let producers and marketing companies directly transact with LDCs and large industrial and electric-utility customers able to bypass their LDCs.
FERC Order No. 436 set forth a first-come/first-serve queue to determine the priority for a pipeline’s interruptible capacity. The contract carriage plan opened the field for producers and marketers to secure carriage and directly contract spot gas to end users, although firm transportation customers (generally the LDCs) could “bump” interruptible users and pipelines could (and would) protect themselves by securing high log (queue) positions for their released-gas sales. The same order also allowed firm transportation to substitute for firm sales.
“Going open” under Order No. 436 was resisted by pipelines whose take-or-pay liabilities would worsen if their sales were replaced by off-system spot gas transportation. The FERC rejected direct-billing take-or-pay costs through the PGA in 1986–87, and the courts were upholding producer contracts as legally enforceable.
Recognizing the unresolved problem of the large and growing take-or-pay problem, a federal court remanded Order No. 436 to address this issue. The same court, however, blessed mandatory carriage as within the Commission’s authority under the Natural Gas Act.
The Commission’s response was Order No. 500 of August 7, 1987, a remake of Order No. 436 with a new section addressing take-or-pay. (52 Fed. Reg. 30,334 [August 7, 1987]). A transition cost recovery (TCR) methodology was introduced to allow pipelines to recover up to 75 percent of prudently incurred take-or-pay costs.
To reduce prospective liabilities, a broad take-or-pay crediting mechanism was specified for open-access pipelines transporting gas for producers. To the same end, a gas inventory charge (GIC) program was outlined for pipelines to re-establish throughput commitments with LDCs in the post-minimum bill era. The GIC was akin to the voided minimum bill contracts. End users failing to take their nominated quantity were subject to a (GIC) fee that acted as a demand-charge for producers who “stood ready” to supply gas.
With a resolution of take-or-pay liabilities now possible within a transition to open-access transportation, and heavy-handed incentives by the FERC in rate proceedings to steer pipelines toward open access, every major interstate pipeline would become a contract carrier. With the DC Circuit Court of Appeals upholding the major aspects of the Order 500 series in August 1990, the legal basis of the contract carriage era was secure (American Gas Association v. Federal Energy Regulatory Commission, No. 87-1588 (D.C.Cir. 1990).
6.3 Other Federal Natural Gas Regulation
The contract carriage era under the Natural Gas Act, unbundling sales from transportation, has allowed the sales function (where numerous competitors exist) to be deregulated. With falling prices paving the political way, several administrative orders by the FERC accelerated wellhead and sale-for-resale deregulation.
Effective January 1, 1993, the Natural Gas Wellhead Decontrol Act completely deregulated natural gas production for the first time in over fifty years.[4] Downstream sale-for-resale deregulation by marketing companies was deemed nonjurisdictional by FERC as well.
FERC briefly considered a methodology to deregulate interstate transmission rates on a case-by-case basis. In 1992, the FERC formed a task force to determine whether a market was “workably competitive” to this end. Led by Commissioner Branko Terzic, the Pipeline Competition Task Force recommended market-based rates for released (firm) capacity and hub-to-hub corridor markets the next year—but not mainline transportation.[5] (FERC implemented the first part of the recommendation.)
Short of rate deregulation in “workably competitive” markets, FERC promoted incentive ratemaking as an alternative to cost-of-service ratemaking. Stated FERC in a March 1992 policy statement: “The Commission is not required to follow any specific type of ratemaking formula and is not limited to designing rates for the utilities it regulated based on traditional cost-of-service ratemaking” (“Notice of Proposed Policy Statement on Incentive Regulation,” Docket No. PL92-1-000 (March 13, 1992), p. 4.)
A third area of enduring regulation, in addition to rates and transportation access, has been new-project certification. This long-standing requirement was not relaxed in the open-access era but actually worsened. While the Commission briefly pursued and implemented expedited certification for new pipeline projects, Order No. 555 (the Construction Rule) required 10-year firm contracts for 100 percent of capacity and a 90 percent throughput factor for rolled-in (versus incremental) rate treatment. If these conditions were not met, then the sponsors were “at risk” for cost underrecovery. Demand charges could also be reduced for all firm capacity holders to the lowest negotiated rate. Another particularly onerous provision was that up-front environmental compliance had to be secured before construction could begin.
The open-access era entered into its mature phase with FERC Order No. 636, the Restructuring Rule. This order, which completes the transition to open access begun by Orders 436/500, requires interstate pipelines to unbundle transportation from sales and offer identical services to shippers as for its own jurisdictional supply. The rule also mandates straight fixed variable rate design, placing all fixed costs, taxes, and the rate of return in the demand charge to leave variable costs (mainly fuel) in the commodity charge. Another provision, some 51 months after originally proposed, allowed capacity release by the holders of firm pipeline capacity and the interstate pipelines themselves (Order No. 636, FERC Stats Regs. [CCH] #30,939 [April 8, 1992]).
The mandatory contract carriage era is a cumulative intervention from previous industry regulation, particularly wellhead price controls that led to interstate gas shortages and then surpluses. It is also handmaiden to Order No. 380 that greatly enlarged the spot market by removing the utility’s obligation to buy the pipeline’s merchant gas. But Order No.’s 436/500/636 have not been ends in themselves. To make open access work, another cumulative intervention was necessary. The marketing affiliate rule, FERC Order No. 497, effective July 14, 1988, set strict conduct standards for pipelines doing business with affiliated gas marketing companies to “prevent preferential treatment of an affiliated marketer by an interstate pipeline in the provision of transportation services.”[6]
To give “nondiscriminatory access” to nonaffiliated marketers, pipelines were required to segregate their transportation and spot-gas activities. Summarized David Teece: “Open access has been a response to previous regulatory errors, but it is not part of the natural evolution of the industry” (David Teece, “Structure and Organization of the Natural Gas Industry: Differences between the United States and the Federal Republic of Germany and Implications for the Carrier Status of Pipelines,” The Energy Journal [July 1990]: 24).
Within the spate of FERC activities, two cumulative processes—one regulatory and one deregulatory—have been at work. But one thing is clear: public-utility regulation of interstate transportation is alive and well under the current interpretation of the “just and reasonable” and “public convenience and necessity” clauses of the Natural Gas Act by the FERC and judiciary.
6.4 Incentive Regulation and Enron: 1989–92
FERC chair FERC chair Martha Hesse in the late 1980s endorsed incentive regulation on a case-by-case basis (rather than generic rulemaking) “to reduce pipeline costs, to reduce administrative burdens, and to improve pipeline priced services.” She challenged her colleagues to rethink FERC’s view of market power, cost determination, and rates of return. (Hesse, “Incentive-Based Regulation,” pp. 1–2.
Another commissioner, Branko Terzic, sought to escape from cost-based ratemaking to incite high-risk, high-return pipeline entrepreneurship.
I’m ready to go with the markets. Markets are superior to regulation when it comes to introducing economic efficiency. Where there is competition, we can allow it to work (Inside FERC, November 12, 1990).
But the caveat “competition” meant one thing to regulators and another in the real world. Hesse, however, had stated that “fully competitive markets” were not required given rivalry from other pipelines and fuels (Macey, October 18, 1989).
Enron, and Ken Lay in particular, as discussed in chapter 6, were interested in extra profit for superior performance. But there was a dichotomy between FERC’s view of competition and efficiency and Enron’s in-the-trenches view of those things. An internal Enron memorandum explained why. Critically evaluating a working paper on the subject by FERC’s Office of Economic Policy, the present author wrote:
What is underemphasized or missing in the working paper is consideration of real-world competition as the industry understands it. In other words, rate discounting, surplus capacity, new entry and bypass, alternate fuel competition, and other factors make markets very competitive whatever the market shares of its individual participants. For example, the California gas market is not workably competitive under the HHI index because one supplier (El Paso) has a market share over 50% (or HHI of over 2,500). Yet this market is extremely competitive because a 20% capacity surplus has forced discounting by pipelines to attract incremental business.
Second, the static approach of formal modeling to measure competition ignores the fundamental point that competition is a process and not a state. In other words, to the extent that an imperfect market allows transporters to earn monopoly rents or offer inferior service, incentives are created for existing suppliers or new suppliers to rectify the situation. Point-in-time analysis misses the fact that markets are often self-correcting as entrepreneurs continually try to improve upon the status quo.
Third, the paper never considers the imperfections of regulation itself. It is assumed that regulation is a costless alternative to correct imperfect pipeline markets. If the working paper assessed a realistic estimate of the cost of FERC regulation, then a range of alleged pipeline-market imperfections could be accepted as optimal. Policy reform could also focus on removing anti-competitive regulations to allow pipeline markets to be workably competitive.
The working paper reflects one school of thought on the competition issue–the so-called “structure-conduct-performance” school. In the last decade, however, a new orthodoxy has emerged. The so-called “New School” or “Chicago School” of industrial organization tends toward a process view of competition and emphasizes institutional factors such as asset specificity and transactions costs to explain i) how industrial concentration has emerged and ii) the high cost of imposing atomistic competition. As Paul MacAvoy recently told the INGAA board on this issue, the Chicago school is now the dominant one in the profession (Bradley memo, December 15, 1992).
Hesse’s argument for incentive rates touched upon the above distinction by channeling Joseph Schumpeter (1883–1950), whose view of competition was influential on the above Chicago School (and the Austrian school, aka market-process economics). As Hesse put it in a 1988 speech:
In open markets, it is the entrepreneur, the innovator, the risk-taker, who provides for progress and growth.
By an “entrepreneur,” I have in mind a person who finds new ways of doing old things, who finds new products or makes new markets and who has what it takes to overcome the resistance to new ways of doing things.
As the economist [Joseph] Schumpeter put it—and this is something I can empathize with—undertaking new things is difficult not only “because they lie outside the routine tasks which everybody understands,” but also because the environment resists in ways that vary “from simple refusal either to finance or to buy a new thing, to physical attack on the man that tries to produce it.”
By definition, as Schumpeter described it, an entrepreneur or innovator is, for a time, a monopolist. If successful, greater than normal profits are enjoyed. But success invites imitators and competition. So the typical life cycle of successful innovation is high, early profit, but it gradually erodes over time (Hesse).
To escape these problems, end-users, even captive ones that the PUC is “protecting,” could organize to bargain directly with the LDC in order to obtain the desired rates and services and bypass the litigious process of cost-of-service regulation. For example, private consumer advocates might interest a large block of captive residential and commercial ratepayers in a lower price and/or new service terms that are more advantageous than the status quo. The advantage might be the removal of some social programs (“we don’t want demand-side management, thank you”) or a long-term commitment to the LDC that can dispense with costly regulatory oversight. Thus, an element of competition is injected into monopolistic regulation that, potentially, could result in “the privatization of public utility regulation” (ibid., p. 2).
The evolution of a competitive, market-driven contracting process could have become a harbinger of a free-market era in which mandates for (MOA) are removed. Consumers are assumed to the want the best price and service terms, not MOA per se. If contracts could be met best by rebundling and formal integration, this should be allowed to happen. For example, if Marketer A wins a 5-year contract to provide gas at a certain price over a large enough segment of the market (or can subcontract with other contract providers for a substantial segment of the market), then this firm could decide to purchase the assets between the wellhead and burner tip to improve the spread between costs and selling prices. This would replace open access either in a de facto or de jure sense, but end-users presumably are more interested in the terms of their contract than industry structure or the age-old call for “the right to do an independent business” (Tarbell).
The growing consolidation of firms within the four major industry segments—production, marketing, transmission, and distribution—will facilitate the transformation from OAC to free-market private contracting. As the number of competitors contracts, the “little guy” politics behind OAC will diminish too. Back-door integration will grow as quasi-natural gas majors emerge that perform two or more major industry functions. Formal integration and bundling will easily follow, and the most efficient integrated firms can be expected to lobby to remove burdensome OAC requirements. Of course, none of this will occur if a non-integrated, unbundled industry structure is equally efficient as an integrated, bundled one. But judging from the experience before regulation, in other countries today with less regulation, and with the oil industry, one industrial organization economist thinks that a market discovery process will result in an industry that is at least partially integrated and bundled. (David Teece, “Structure and Organization of the Natural Gas Industry: Differences between the United States and the Federal Republic of Germany and Implications for the Carrier Status of Pipelines,” pp. 1-35).
6.5 Mandatory Open Access (MOA) Reconsidered
The new era of mandatory contract carriage brought on by FERC Orders No.’s 436/500/636 was been hailed as what the Natural Gas Act should have originally done in the 1930s (Richard Pierce, “Reconstituting the Natural Gas Industry from Wellhead to Burnertip,” The Energy Journal [Vol. 1, 1988]: 24). By eliminating the monopolistic constraint of 28 major interstate pipelines servicing 1,400 LDCs and thousands more producers, price competition could assert itself from the wellhead to the burner tip (Putnam, Hayes, & Bartlett, Inc., Mandatory Contract Carriage: An Essential Condition for Natural Gas Wellhead Competition and Least Consumer Cost, September 1984, p. 3. Also see Harry Broadman, “Deregulating Entry and Access to Pipelines,” in Joseph Kalt and Frank Schuller, eds., Drawing the Line on Natural Gas Regulation (New York: Quorum Books, 1987), pp. 127-146).
Yet this new phase of regulation had created many distortions. First, the efficiencies of integration and bundling were sacrificed on the altar of more-rivals-the-better. The “three-headed monster” of production, transmission, and distribution became a “four-headed monster” of production, transmission, marketing, and distribution.
Second, the first-come/first-serve queue for interruptible transportation could ration transportation space according to economic need. Many shippers without high queue positions suffered transportation shortages that they could not contractually address. (One escape was for would-be shippers to bid up a discounted rate, although matching at the maximum rate returns priority to the queue.)
Mandatory carriage was thus a very imperfect substitute for contractually reallocated transportation priority where firm-service holders could sell their unwanted capacity to interruptible users willing to trade up. Capacity brokering in FERC Order No. 636 was belated recognition of the advantages of a market-oriented approach to transportation priority in place of Order No. 436.
Third, costly regulation to make open-access transportation “nondiscriminatory” was resorted to. Marketing affiliate rules broke up interstate pipeline departments and forced job replication or reduced services as an alternative to replication. The legal effort and documentation required to make sure the regulated pipeline-side of the company does not share “privileged” information with the nonregulated side of the company—often between persons formerly working side-by-side—has increased the cost of doing business for interstate carriers trying to reduce costs to stay competitive with other gas suppliers and alternate fuels without this burden. Furthermore, the influx of independent marketers, many of them being of the mom-and-pop variety, has further politicized FERC regulation to slow down the approval process (GAO, “Natural Gas: Factors Affecting Approval Time for Construction of Natural Gas Pipelines, p. 2).
The opportunity cost of MOA was unregulated interstate transmission not unlike that practiced in the intrastate gas market. Deregulation might be thought of as privatized regulation via voluntary business contracts. Such regulatory bypass could replace bureaucrats with lawyers and allow FERC and the involved companies to cut back staff significantly.
A template for generic private contracting to bypass regulation was provided by the Transwestern Pipeline settlement of 1995, which effectively rate-deregulated the interstate for ten years (Bradley, Enron Ascending, pp. 434–36). Transwestern and its customers reached a global settlement of issues; any interstate could also be required by FERC to hammer out an agreement in a long-term contract to replace FERC regulation. Private arbitration and the courts would be the forum to settle disputes under the contract; not Washington DC regulators.
Come the end of the long-term contract, the parties would be on their own to set rates and establish other terms of service, including access. Should “open access” continue and under what terms? The self-interest of the asset owners to maximize revenue and the self-interest of shippers to minimize costs would intersect to amend and extend or replace the existing contract with a new one. Organization by shippers would create a monopsony to deal with the single pipeline owner. And in so doing, the regulatory costs of FERC for pipelines (a user fee as it now stands) would be replaced by the (far less) cost of private contracting.
6.6 TGS Argentina’s Privatization
The winning bid of (consortium-led) Enron Pipeline Company-Argentina to buy 70 percent of the stock of that nation’s Southern Gas Pipeline System was a subject of the muckraking press. After all, Argentina had long been shady territory for private interests in a government-dominated economy.
A 1992 article in the New York Times, “The Big Push Toward Privatization in Argentina,” published prior to Enron’s pipeline purchase, explained how Argentine business had for decades been a “secret society” where politically connected families ran government-enabled monopolies or oligopolies, dealing with inflation and military coups along the way. “Intense lobbying, close ties with the military and political groups and, of course, payoffs at almost every level reaped lucrative contracts to build power plants, roads, bridges and dams.”
Privatization meant turning a new leaf, prompted by poor service and poor returns hurting the citizenry coming and going. “But the old ways are changing,” explained the Times’s Nathaniel Nash,
as the Government of President Carlos Saul Menem sells off by the middle of next year a host of state-run businesses that were losing $5 billion a year. And four of Argentina’s major industrial concerns—Perez Companc, Techint, Comercial del Plata and Astra—have not missed the opportunity to buy and are expected to end up with the concentration of power.
Their efforts are already improving services and capital investment flows—and should bring almost $20 billion in cash and debt reduction.
“All the big groups now realize there is no more money to be made from the state,” said Miguel Angel Broda, an independent economist. “They now realize the best business is buying the goods of the state. They are finding that with only modest changes, good management and investment, these can be very profitable enterprises.”
Nash surveyed the potential investment interest:
While most United States investors, wary of Argentina’s penchant for strident nationalism and anti-Americanism, are staying on the sidelines, the Argentine groups have brought in Italian, Spanish, Chilean and French partners to help run the newly privatized concerns. [US Enron would announce to join this group two months later.] Foreign investors here say the business climate in Argentina is among the most favorable in the third world. Perhaps more than any other Latin American country, Argentina has deregulated its economy, opened its capital markets, lowered barriers to trade, and cut red tape.
Nash’s (privatization-as-a-necessary-evil) bias shows through with his next paragraph:
But the broader question is whether privatization is the answer to modernizing third-world economies. Most here agree there is little alternative even though the short-run effects include thousands of people forced to find new work and higher prices for consumer goods. “There just is no alternative for this process,” said Steven Darch, former head of Morgan Guaranty’s office in Buenos Aires. “If this country wants to be part of the competitive international markets, it has to sell off these enterprises. How can you have a phone system that doesn’t work and expect to attract foreign investment?”
The challenge of privatization for the new owners was then discussed.
But buying government assets is not always easy. As they enter new businesses and confront competition for the first time in years, many of the groups are undergoing major upheavals at the executive level. Previously, family members of differing skills ran a cornucopia of businesses, creating top-heavy, inefficient management.
“Companies in Argentina have been very family-oriented, but there is now a shift toward bringing in more professional management and putting shareholders in a more passive role,” said Martin Redrado, chairman of the National Securities Commission.
Many companies are still secretive, reluctant to open their operations to the public or be interviewed even though their stock is publicly traded. Much of this stems from the military and authoritarian governments of the 1970’s, when businessmen with ties to the Government were frequently kidnapped for ransom and killed by leftist groups.
Even with privatization, the heavy hand of government lurked. Nash continued:
Privatization will not necessarily end corruption. Most of the companies are still dependent on the Government setting rate schedules, which opens the door to influence buying and represents a challenge to put the consumer before the business executive….
Nash next discussed the very group that would join Enron’s consortia with a 25 percent interest in TGS.
PEREZ COMPANC [part of the Enron-led consortium for TGS] is the largest industrial group in Argentina, as well as its largest private oil company. Founded in 1946 by the Perez Companc family, it has been the most aggressive in the privatization program, buying exploration and drilling rights to some of the country’s largest oil fields, toll roads and a 15 percent holding in Telecom, one of the two private companies created in the sell-off of the Argentine telephone company.
In late July, Perez Companc teamed up with two Chilean companies in a consortium that won the bidding for half of the Government’s power company, Segba, considered a future gold mine. The price was $500 million….
“Technint and Perez Companc have total access to Cavallo and Menem,” said a prominent economist, referring to Argentina’s president and its Economy Minister Domingo F. Cavallo….
“We have come to the point in Argentina where every company has to reduce costs, be efficient in order to be able to compete.” Mr. Gruneisen said. “This is a change we cannot go back on.”
Enron’s winning bid for Argentina’s southern gas system was subject to speculation and muckraking. The Mother Jones story, “Don’t Cry for Bush, Argentina” (March/April 2000) describes the involvement of George W. Bush in Argentinean politics.
“The little-known tale begins with George W. making a phone call to secure a $300-million deal for a U.S. pipeline company—a deal that provoked a political firestorm in Argentina, drawing scrutiny from legislators and a special prosecutor.” Authors Lou Dubose and Carmen Coiro went into this history.
Bush first made his presence felt in Argentina in 1988, shortly after his father was elected president. At the time, the junior Bush’s political career was just beginning—and the political career of Raúl Alfonsín, who was approaching the end of his term as president of Argentina, was ending.
Alfonsín had returned his country to civilian rule, prosecuted those responsible for human rights abuses during Argentina’s rule by a military junta, and struggled to manage an economy that seemed to defy management. Determined to complete one major private-sector industrial program, he pushed for the development of a “gasoducto” that would connect Argentine gas fields with domestic and foreign markets. And he appointed his minister of public works, Rodolfo Terragno, to oversee the pipeline project….
In 1988, Terragno was considering two proposals for the $300-million pipeline, one from an Italian firm called Ente Nazionale Idrocarburi and the other from Pérez Companc, an Argentine company working in partnership with Dow Chemical. After a year of consideration, the minister was close to making a decision when Enron, the largest pipeline company in the United States, suddenly entered the bidding….
Terragno was concerned that a newly formed corporation with no resources was attempting to land a contract that companies with proven track records had been working on for a year. “I had a lot of reservations about Enron because the company wasn’t well established in Argentina,” Terragno told Mother Jones, providing details of the episode for the first time.
The minister recalls that Enron sent him “a one-page outline” proposing a price Terragno now describes as “laughable.” Enron wanted to pay “something like 20 percent of the international market price,” he says. “It all seemed so inadequate. Enron asked the country of Argentina to practically give them the gas.”
Terragno was unenthusiastic about the pipeline bid, but Enron initiated a full-scale campaign to pressure him. Pro-business newspapers attacked the minister for blocking the proposal, and Terragno recalls that Ted Gildred, the U.S. ambassador to Argentina, “called me and visited me constantly” to push the deal.
Terragno wasn’t concerned about the ambassador’s lobbying—that was politics as usual. “It was good that he was representing the interest of his country’s businesses,” he says. But Terragno found that some of the politics surrounding Enron’s campaign were anything but usual.
A few weeks after the U.S. presidential election in 1988, Terragno received a phone call from a failed Texas oilman named George W. Bush, who happened to be the son of the president-elect. “He told me he had recently returned from a campaign tour with his father,” the Argentine minister recalls. The purpose of the call was clear: to push Terragno to accept the bid from Enron.
“He was taking a moment to call me because he knew that I was dealing with this,” says Terragno, adding that Bush told him that he “viewed with some concern the slow pace of the Enron project.” According to Terragno, the president-elect’s son noted that a deal with Enron “would be very favorable for Argentina and its relations with the United States.”
When a brief report on the attempt to influence the Argentine deal appeared in The Nation and the Texas Observer years later, the Bush team reacted angrily. His staff produced a copy of his day planner to show that Bush never placed the phone call, and a top-level adviser personally called reporters to dismiss the story as a fantasy by “some guy in Argentina.” Bush’s staff continues to deny his involvement, and no other media outlet ever reported on the episode, despite the high-ranking source….
Enron, for its part, couldn’t have appointed an Argentine president more favorable to its interests. A right-wing follower of Juan Peron, [Carlos] Menem was eager to open his country to American enterprise….
Several days after the president’s trip in 1990, Bush’s ambassador to Argentina, Terence Todman, wrote a stern letter to Menem’s minister of the economy to follow up on issues that Bush had “intended to address, but failed to do so for lack of time.” Todman went on to imply that eight U.S. companies would walk away from their investment plans unless Argentina stopped favoring domestic corporations. The first company on the list was Enron, which the ambassador described as being “poised to invest $250 million”—as soon as the Argentine government met its demands for tax breaks. Todman closed his letter by warning that the Enron decision was “extremely urgent,” as the gas company would make a final decision on its investment in less than a month….
Todman prevailed: Menem agreed to the company’s terms, signing a presidential decree that included Enron in a national program freeing it from tariffs and valued-added taxes.
Contrary to the Mother Jones article, the Enron-led consortium won in a formal, transparent bid process. Enron’s operational improvements, summarized in chapter 6 (pp. 273–76), were summarized in a TGS document written several years after the purchase:
Enron’s value-add was apparent for the very beginning through its roles as CIESA’s consortium leader and qualified technical operator, due-diligence and valuation leader, take-over architect and by filling key positions ….
This methodology, novel then for a formerly owned State enterprise yet now institutionalized, quickly became part of TGS’s DNA and fundamental to the Company’s recognized success since its formation.
6.7 International Starts, Not Finishes
For Enron, any international progress was an opportunity for publicity. Whereas the established energy majors would await concrete developments before announcing a project, Enron was ready to announce negotiations and early approvals.
In May 1992, Enron announced the following prior to conducting feasibility studies on both the plant and fuel supplies:
Enron Europe Limited, the Wing-Merrill Group and Turkey’s GAMA group (GAMA) have signed a Protocol of Intent to conduct feasibility studies to build, own and operate a 1,700-megawatt natural gas-fired, combined-cycle cogeneration plant, fully in compliance with the latest international environmental requirements, in Turkey’s Aegean region. The proposed plant would provide electricity to the Turkish Electric Authority and would sell steam and electricity to local industries.
“The successful completion of the project would meet many of the government’s established public policy objectives, including development of economical energy sources, investment of foreign capital for the country’s infrastructure and access to leading-edge technology,” said S. Yucel Ozden, a GAMA representative. “The plant also would be a model for further efforts to privatize state-owned industries,” he added.
“The plant would provide Turkey with a reliable, long-term, cost efficient source of electricity,” said Kenneth L. Lay, chairman and CEO of Enron Corp. “In addition to improving efficiencies, the power generating plant would improve air quality because it would be fueled by clean-burning natural gas,” he added.
This project, like so many others described in chapter 12, pp. 490–92, did not reach the construction stage.
As a momentum stock, Enron sought to stay in the news with as many different projects in different places as possible. Hometown Houston offered multiple news outlets, from the Houston Chronicle to the Houston Post (until 1995) to the Houston Business Journal, and Enron and Ken Lay always made for good story.
6.8 The Tight-Sands Gas Tax Credit of 1990
Enron and EOG activity lobbied to restore an expired tax credit for natural gas drilled from new wells in tight formations, defined by a permeability standard below 0.1 millidarcy. Section 11501 of the Omnibus Budget Revenue Reconciliation Act of 1990 amended Section 29 of the Internal Revenue Service Code to extend, by two years, such wells drilled before January 1, 1993, with the tax credit applicable for gas sold by year-end 2002 (sunset date).
The tax credit had expired for wells drilled or recompleted after May 12, 1990, or for gas that had been deregulated under the Natural Gas Wellhead Decontrol Act of 1989. Now, wells qualified if they had been drilled after December 31, 1990, as did production which, as of April 20, 1977, was committed or dedicated to interstate commerce.
But there was still a needed interpretation to win the provision. When announcing the “significant event” (2) in its 1990 annual report, Enron noted in its 1990 10-K SEC filing:
The company believes that a portion (and in some cases a substantial portion) of EOG’s natural gas production form new wells … [in] its most significant areas … can qualify. However, because of the lack of Internal Revenue Service regulation or definitive interpretations of the technical request for obtaining the credit, there can be no assurances that EOG will qualify for the credit with respect to such production” (15)
A favorable IRS interpretation would be forthcoming. As far as the tax carve-out’s public purpose, at least from the company side, Enron’s Diane Bazelides stated in 1992: “We feel that the use of that credit has been very beneficial in keeping gas rigs operational and in stimulating technological innovations in drilling” (quoted in “Berg,” 6).
6.9 Reformulated Gasoline and the Clean Air Act of 1990
Methyl tertiary butyl ether (MTBE), a manufactured volatile organic compound (VOC), was the gasoline additive of choice to enhance octane and/or to increase oxygen content to reduce emissions of carbon monoxide and other pollutants.
MTBE, primarily produced from natural-gas-derived methanol, enjoyed low production cost and had good blending characteristics at 10–15 percent to straight gasoline. As such, it became the additive of choice for reformulated gasoline in the early 1990s.
MTBE, a colorless liquid, is odorous and highly persistent in the environment. It moves through soil and finds a home in water, despoiling both its smell and taste. Water contamination and reported health problems plagued the EPA-instructed introduction of reformulated gasoline. Opt-outs began, and states began to ban MTBE in 2000. By the end of the decade, more than half of the states had banned its use (EPA, 2008, 13-59).
In the 1990s, MTBE usage increased due to two programs established by the 1990 Amendments to the Clean Air Act (CAA) that required oxygenated gasoline. In 1992, EPA implemented the Wintertime Oxygenated Fuel (wintertime oxyfuel) program for metropolitan areas with elevated levels of carbon monoxide (about 4 percent of the nation’s gasoline is oxyfuel). The oxyfuel program requires gasoline to have an oxygen content of 2.7 percent by weight (USEPA, 1998b). Although ethanol is the most common oxygenate used to meet this requirement (7.3 percent by volume), MTBE is also sometimes used at concentrations of up to 15 percent by volume (USEPA, 1998b; 65 FR 16097).
In 1995 EPA established the Federal Reformulated Gasoline (RFG) program, which required gasoline used in the nation’s most polluted metropolitan areas to contain 2 percent oxygen by weight. In 1998, this requirement applied to about 30 percent of the nation’s gasoline, for which 11 percent MTBE or 5.4 percent ethanol (by volume) would meet the standard (USEPA, 1998b). At the time, MTBE was the primary oxygenate in over 87 percent of RFG, while ethanol in approximately 12 percent (65 FR 16097).
The “non-attainment areas” required to participate in the program are metropolitan areas where ozone levels are too high. Other areas of the country voluntarily “opt in” to the RFG program to improve air quality. The total number of areas participating in the RFG program depended on year-to-year “opt-ins” (USEPA, 2000). A list of participating and formerly participating areas was available on the Internet (USEPA, 2005).
There would be considerable variation in the extent to which participating areas relied on MTBE. Some areas were in states or localities that implemented MTBE bans, requiring other oxygenates. In Chicago, for example, MTBE was banned in 2000, followed four years later by a Statewide ban for Illinois (Lidderdale, 2003).
References for Chapter 6 Appendix
Berg, Thomas. “Section 29 Extension Bill Gets Mixed Industry Reviews. Natural Gas Week, August 24, 1992.
Berger, Kevin. “The Superfund.” San Francisco Magazine, June 29, 2006.
Bradley, Robert, Jr. Capitalism at Work: Business, Government, and Energy. Salem, MA: M & M Scrivener Press, 2009.
Bradley, Robert, Jr. Climate Alarmism Reconsidered. London: Institute for Economic Affairs, 2003.
Bradley, Robert, Jr. “Evaluation of FERC Discussion Paper Assessing Competition in Natural Gas Transportation.” Enron memorandum, December 15, 1992.
Bryson, Reid. Preface to Lowell Ponte, The Cooling. Englewood Cliffs, NJ: Prentice-Hall, 1976. pp. xi–xii.
Enron Corp. Annual reports, various years.
Enron Corp. Form 10-K Annual Report to the Securities and Exchange Commission, various years.
Fleming, James. Historical Perspectives on Climate Change. Oxford: Oxford University Press, 1998.
Hesse, Martha. “Incentive-Based Regulation Targets Increased Efficiency by Gas Pipelines.” Oil Daily, October 5, 1988.
Kinder, Richard. “Argentina Pipeline Project.” Memo to All Employees from the Office of the Chairman, December 3, 1992 (copy in the author’s possession).
Lay, Ken. The Enron Story. New York: The Newcomen Society for the United States, 1990 (pamphlet).
Macey, Daniel. “Hesse Endorses Case-by-Case Incentive Regulation.” Gas Daily, September 18, 1989.
McConnell, Beth. “Congress Responds to Greenhouse Gases.” Natural Gas Week, August 15, 1988, 2.
Nash, Nathaniel. “The Big Push Toward Privatization in Argentina.” New York Times, September 6, 1992.
Tarbell, Ida. The History of the Standard Oil Company, 2 vols. (New York: McClure, Phillips, and Company, 1904), vol. 2, p. 255.
U.S. Environmental Protection Agency. Regulatory Determinations Support Documents for Selected Contaminants from the Second Drinking Water Contaminant Candidate List, June 2008.
“Wirth Says Gas Plays Role in Cooling Greenhouse Effect.” Natural Gas Week, June 20, 1988, 7.
Interviews
Bennett, Gerald. Interview with Robert Bradley Jr., Houston, Texas, May 13, 2006.
[1] Section 311 of the Natural Gas Policy Act allowed interstate pipelines to act as a pure transporter in interstate commerce if the shipped gas was “on behalf of” an intrastate pipeline or LDC.
[2] 50 Fed. Reg. 24,130 (June 7, 1985). For a summary of the dramatic proposal, see Stephen Williams, The Natural Gas Revolution of 1985 (Washington: American Enterprise Institute, 1985).
[3] 50 Fed. Reg. 42408 (October 18, 1985). Existing 311 arrangements were grandfathered under Order 436 until October 9, 1987 or sooner if they expired under their own terms.
[4] Public Law 101-60, 103 Stat. 157 (1989). The Commission also ruled that gas production by pipelines for system supply was deregulated retroactive to July 27, 1989. Order 523, 55 Fed. Reg. 17,425 (April 25, 1990).
[5] FERC News Release, “Commissioner Terzic Announces Start of Pipeline Competition Task Force,” (July 8, 1992). Bradley, Robert L., 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, p. 18.
[6] 53 Fed. Reg. 22,139 at 141 (June 14, 1988); Order No. 497-A, 54 Fed. Reg. 52,781 (December 22, 1989). The FERC in October 1989 interpreted the affiliate rule to apply to supply affiliates as well as marketing affiliates. 49 FERC 61,083 (October 6, 1989).