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The Effect of the Bankruptcy of Enron on the Functioning of Energy Markets
Subcommittee on Energy and Air Quality
Mr. Richard C. Green
Thank you, Chairman Barton,
Representative Boucher, and members of the Sub-Committee.
I appreciate the opportunity to testify on behalf of the Electric Power
Supply Association (EPSA) this afternoon.
EPSA is the national trade association representing competitive power
suppliers, including independent power producers, merchant generators and power
marketers. EPSA members provide
reliable, competitively priced electricity from environmentally responsible
facilities in U.S. and global power markets.
EPSA recognizes that competition has brought many benefits to our
customers, and seeks to continue the delivery of benefits to customers as
competitive markets continue to develop. Based in Kansas City, UtiliCorp
United Inc. is an international energy and services company with customers and
operations across the U.S. and in Canada, Europe, New Zealand, and Australia.
Our Aquila, Inc. subsidiary is one of the largest wholesalers of electricity and
natural gas and providers of risk management services in North America, the
United Kingdom and continental Europe. UtiliCorp
also owns traditional investor-owned utilities in mostly non-urban areas of
Missouri, Kansas, Colorado, Nebraska, Iowa, Michigan and Minnesota as well as
utilities in Australia, New Zealand and Canada. At September 30, 2001, UtiliCorp
had combined total assets of $11.9 billion and 12-month revenues of $42.3
billion. UtiliCorp plans to adopt
"Aquila" as its corporate name later in this first quarter to more
accurately reflect our increasing focus on our wholesale energy and risk
management business. My great-grandfather, Lemuel
Green, started the predecessor to our first regulated utility in 1908. What started as a small family business has grown
substantially due to UtiliCorp being in the forefront of change in the
competitive global energy market place.
I have served as the CEO of UtiliCorp from 1985 through 2001, and the
Chairman since 1989. I also
serve on the U.S. Department of Energy's Electricity Advisory Board. The Enron bankruptcy has shaken
the confidence of government, investors, employees and the capital markets.
The tragedy delivered to Enron employees, and shareholders, and the
communities they served is terrible. The Enron bankruptcy has raised
questions about how the wholesale market physically works, the trading of
energy, the security of pensions for employees, and corporate ethics.
It is imperative that we all work together to answer these questions.
Our knowledge of the energy
markets and the facts reported to date indicate that Enron failed due to
questionable non-core business investments and inadequate reporting practices of
financial information to investors, shareholders, and employees that
dramatically reduced investor confidence.
Enron did not fail because it was in the energy marketing business. The underlying business practices of Enron would have created
the same result if their core business had been real estate development,
software products, or sporting goods. Despite the shock of the Enron
bankruptcy, the energy markets did not panic.
The energy market---in terms of delivering power and gas to customers in
a reliable and efficient manner has continued without interruption.
The market was stable and customers were served without interruptions.
Enron was a significant competitor to Aquila's wholesale energy and
risk management business. At
its peak, Enron was responsible for approximately 20% of the trades in the
energy market. Despite the loss of the largest participant, liquidity was
maintained and there were no significant swings in prices or disruptions in the
supply of gas or electricity. In
this regard, the energy industry did not miss a beat. The competitive wholesale market continued to do business as
usual. The energy market, particularly
from the customer's point of view, remained stable---without interruption of
services because of the liquidity and stability provided by the marketplace.
When Enron's situation became apparent, other parties stepped in to
fill the void. The market offered
choice and diversity. Cautiously, companies began to adjust their positions and
move business to alternative companies and electronic trading platforms.
It is a testament to the strength of the energy markets, that in only a
few short weeks, the industry could adjust to the collapse of a significant
player with little effect on the customer. Energy trading volume moved
seamlessly--demonstrating the market diversity---from EnronOnLine, Enron's
proprietary electronic trading platform, to other open many-to-many electronic
trading platforms owned by a group of shareholders such as the Intercontinental
Exchange (ICE), in which my company has a minority ownership interest.
Total volumes on ICE increased by 65% from October to November 2001.
During that time as well, the number of ICE users increased by 30%.
Specifically, ICE saw an increased volume of gas and power trades for
next-day as a result of the need to replace Enron volumes.
Formerly EnronOnLine provided much of this market liquidity.
The ability to move to other trading platforms did not destabilize the
energy market. In fact,
"choice" promoted stability. As a result of the Enron
collapse, questions have been raised about the use of derivatives and accounting
disclosures of derivatives. I urge
members to distinguish between derivatives themselves and these accounting
disclosures. Derivatives, as
financial instruments, first evolved in the 1850s after the railroads and
telegraph communications developed on a widespread basis. With available transportation to move agricultural products a
long distance and the advent of telegraph communication, farmers could sell
their crops while they were in transit or before the crops were harvested.
The derivative tool, when used as a hedging instrument, removed exposure
to fluctuating prices from the farmer's income.
As noted by the acclaimed historian, Alfred Chandler, "the
standardizing and systemizing of marketing procedures carried out by the
exchanges transformed methods of financing and reduced the costs of movement of
American crops." The use of derivatives evolved well beyond agriculture
to numerous industries such as metals, banking---for exchange rate fluctuations,
and energy. The use of derivatives helped
to stabilize the markets after Enron's collapse.
Derivatives are financial tools, reflecting the underlying value of the
commodity, that allocate risk and promote liquidity.
I would agree with Energy Secretary Abraham's remarks, recently
appearing in The Washington Post, that the pioneering work in energy
trading, particularly derivatives, played a central role in providing market
liquidity and risk allocation during the Enron collapse.
I would also agree with the
National Association of Regulatory Utility Commissioners' (NARUC's) recent
comments on derivatives. NARUC
adopted a resolution, passed by their Board of Directors in July 2001 that
"recognizes the important use of financial and physical mechanisms to reduce
electricity and natural gas market volatility".
The NARUC resolution states that that these financial instruments are a
"component of a comprehensive energy procurement program."
Furthermore, NARUC states "that
the Board of Directors of NARUC, urges each State Commission to explore and
examine the potential benefits to consumers and distribution utilities of using
financial and physical mechanisms to hedge against market volatility in
wholesale electric and gas markets." Derivatives are important
to consumers and to regulated utilities in providing price stability. Furthermore, derivatives can be customized specifically to
the purchaser's unique circumstances and needs.
I would point out the following examples of customized derivative
products that Aquila provides to help our customers, such as regulated utilities
or businesses, control their risks and lower the costs to their customers. Example
#1 Example from Summer 2001): Sacramento,
California's municipal utility (SMUD), pays close attention to weather
forecasts. During droughts, because there is no water to go through the
dam, Sacramento gets less of its electricity from hydroelectric dams and must
pay higher prices for power on the short term, open market.
To ease the pain of buying high-cost power during droughts, the municipal
utility entered into a five-year derivative contract with Aquila.
The Sacramento utility receives replacement power or cash to purchase
replacement power from Aquila when measured rainfall is below a certain level.
In this way, SMUD cushions the risk of a budget hit due to
lower-than-expected rainfall. This allows the Sacramento utility to protect its
customers from rate increases to cover the costs of purchasing last minute power
at high prices on the open market when such hydroelectric generators cannot
operate. Example #2 -
Production of aluminum is a very energy-intensive business. One aluminum
producer traditionally obtained its electricity from the hydroelectric
facilities it owned at a nearby river. As
a result, it used to schedule aluminum production based on projection of that
river's spring flows. In essence, their ability to produce efficiently hinged
on sufficient snowmelt and rainfall to fill the hydro dams. Today, Aquila supplies
that smelter with all of its energy, so production can be based on raw material
market conditions---not weather and rainfall.
In exchange for the purchased derivative, customized specifically for
this plant in this location, we maximize the use of energy from company's dams
on the river. Of course, if
the manufacturing company requires more electricity than those dams can supply,
we obtain it from regional markets and other power plants at a predetermined
price. This derivative "cushions the risk" for the manufacturer and its
production schedule. It allows the
manufacturer to be more competitive in the global market. Example #3 - Aquila
has customized a derivative product called Guaranteed Bill for the customers of
a Midwestern regulated utility. Guaranteed
Bill is marketed to its residential customers by the local utility. The service
offers customers a fixed monthly bill for natural gas.
It is designed to put the retail customer in control and allows the
individual to fix his/her energy costs. Historically,
a customer trying to control costs was limited to a level payment plan which
offers no insulation from weather or commodity price fluctuations, only the
averaging of monthly payments over the course of the agreement. With Guaranteed
Bill there is no end-of-agreement "settle up" payment due at the termination
of the agreement. Aquila provides the utility with a weather hedge and a fixed
commodity price allowing the utility to provide its customers true price
certainty. A
further illustration of the increasing recognition of the importance of
derivatives is Aquila's teaming with The World Bank and the International
Finance Corporation (IFC) to launch a global weather risk facility that will
sell weather derivatives to companies in emerging markets.
This initiative of the World Bank and the IFC has grown out of the
multilateral agencies' plans to broker weather derivatives to boost
agricultural yields in North Africa. It is imperative that the value
and utility of derivatives themselves not be confused with questionable
accounting practices and questionable financial reporting.
It is imperative that companies reports provide accurate and transparent
information concerning their actions and financial health of companies.
I understand the concerns of
Congress and the other regulatory agencies such as the Securities and Exchange
Commission (SEC), the Federal Energy Regulatory Commission (FERC), and the
Commodity Futures Trade Commission (CFTC) in considering and examining the
energy industry issues and accounting and pension issues affecting all
industries catapulted into the spotlight by the Enron collapse.
The Enron actions have understandably raised questions about the
necessary protections required for shareholders and employees. Congress
should look at several issues that will help restore their confidence in the
energy industry as well as other industries in order to ensure that employees
and investors are protected.
(1) The inability of Enron
employees to diversify their retirement portfolios as the stock price of Enron
declined having high concentration of Enron stock ownership within their
portfolios must be examined and corrected.
Legislation that addresses these employee concerns and allows employees
at any time to diversify is needed. (2)
The standards for disclosure of special purpose entities (SPEs) and
off-balance sheet financing need examination and correction. I believe that the SEC has the proper authority to make these
changes that will provide for appropriate disclosure of such entities.
Investors should have confidence that such entities are adequately being
disclosed. (3)
The standards required for the oversight of external auditing needs
examination and resolution. Currently,
the accounting industry would be characterized as self-policing. The SEC has the authority to require the independent
oversight of audit procedures and standards.
Investors should have confidence that there is an independent oversight
function. Such an independent
oversight body could also review audit failures and should have subpoena power. Aquila
has made and will make every effort for full and open disclosures within the
energy industry. Just recently, Aquila executives conducted a seminar for Wall
Street and investment analysts about accounting methods.
I believe that it is crucial that we educate these groups and others
about the accounting methods and practices applicable to our industry.
Our disclosure practices and communication of our financial information
are not like Enron, and we find ourselves in the position of having to explain
that very clearly. Lack of confidence by the
capital markets in the energy industry has been raised as a result of the Enron
collapse. Rating agencies have
raised the credit standard for generators and traders.
There have been steep declines in stock values.
There is a new appetite for a stronger capital ratio reflecting greater
equity value and less debt. This shift in the capital
structure will force many energy companies to reduce debt and to scale back
investments in new gas processing, development of storage facilities and
pipelines, and generation plants. The
result could be a shortage of generation in the long-term. Since 1990, the competitive
power supply industry has accounted for more that half of all the power
generation capacity brought online in this country, and we expect this
percentage to increase as competitive wholesale markets continue.
The loss of confidence by the capital markets in the wake of Enron's
demise will likely result in a reluctance to invest in the critical
infrastructure for our energy supply and delivery. Congress can help to encourage confidence and to encourage
the capital markets to invest in much-needed energy infrastructure by passing
legislation to continue to make markets more efficient. Briefly, I would commend the
Bush Administration, Chairman Bingaman, Chairman Tauzin, Congressman Barton, and
the Federal Energy Regulatory Commission (FERC), as well as many others, for
their various proposals for new legislation that encourage a further efficient
marketplace in which consumers will benefit. The energy areas in which I
would submit that you take action include:
existing federal legislative reform, the standardized interconnection to
the power grid, and the formation of regional transmission organizations. Federal Legislative
Reform: While PURPA in 1978 opened
a new path for independent power companies to create wholesale generating
capacity outside traditional utility regulation, the independent power
generation industry is now mature and robust.
Moreover, subsequent law enacted by Congress in 1992 effectively
deregulated the creation of wholesale generating capacity.
If PURPA is repealed
prospectively as part of a comprehensive federal electricity bill, there must be
explicit recognition and preservation of existing PURPA contracts as negotiated
in good faith. I also endorse efforts to guarantee the recovery of PURPA
contract costs as appropriate federal policy.
However, such cost recovery must be explicitly related to the honoring of
existing contracts. Moreover, the
existing QF ownership restrictions in PURPA have outlived their usefulness.
They are an artificial and outdated restriction on the transfer of
ownership of QF facilities. These
restrictions lead utilities that want to acquire QFs to resort to the use of
complex, temporary, corporate shells or trusts to dilute the utility ownership
below 50%. The artifices are expensive, cumbersome, and serve no
apparent useful public policy. Standardized Interconnection:
The power transmission grid has been compared to the national highway
system in terms of its importance to our economic infrastructure.
The highway system, along with protections to promote interstate
commerce, has allowed a flow of benefits between regions.
The national power grid requires standardization to promote the flow of
power between regions as the national highway systems supports the flow of goods
and services. I endorse a clarification and
standardization of interconnection rules for new sources of power generation.
I cannot overemphasize how important this issue is for investment and
construction of new generation. For companies interested in expanding electric generation
capacity---critical to affordable power rates throughout the country, the
physical interconnection of the generation plant to the power grid has become
too often the "choke point" for project development. Ad
hoc interconnection standards
create uncertainty, extensive delays and unexpected or unfair costs for
developers. Legislation needs to affirm the right of new generation to
interconnect on a non-discriminatory basis to transmission facilities, provide a
clear avenue for the federal review of interconnection policies, and establish a
timely remedy, if necessary, for any abuse.
Access to the transmission grid should be uniform just as entrance and
exit ramps are uniform throughout the interstate highway system. RTOs:
Congress should affirm FERC's authority to order utilities and other
entities that own transmission assets to join a FERC approved Regional
Transmission Organizations (RTOs) in order to realize a truly open and
competitive transmission grid. I am
supportive of FERC's directive to organize large, regional RTOs to reflect the
way power flows. Independence in
operation and market monitoring are crucial for the achievement of the open
access initiated by Order 888. The nation's transmission
system is in need of upgrades and new investment to take economic advantage of
available and most advantageously priced generation supply.
I support market-like incentives to encourage new transmission builds in
place of cost-based ROE. Pricing
for transmission should preclude "pancaking" (multiple charges as power
flows from one transmission system to the next) which can increase costs to
customers due to excessive transmission charges for the delivery of power
supply. Each user of the
transmission grid must be required to take service under a single open access
transmission tariff. The
information system that guides the reservation and pricing and rules of
transmission access should be standardized to increase transparency, reduce
costs, and level the playing field. Congress should reaffirm
FERC's authority to set and enforce a clear deadline for all utilities and
other transmission owning entities to join Regional Transmission Organizations (RTOs).
The continued support of
Congress and FERC is necessary to re-establish confidence, to foster the
creation of new technologies, to attract the necessary capital for
infrastructure and to ensure a robust marketplace for the future. This will
result in the reliable, affordable supply of energy.
While all companies are
naturally concerned about creating shareholder value, companies must demonstrate
equal concern and diligence for monitoring the human capital within their
organizations. A foundation
principle of our company is that the best companies are those where its people
are rooted in a common understanding of expectations, and share in the ownership
of the company. Furthermore, when
business values and codes of conduct are integrated into performance management
and business processes, they serve as a system of checks and balances as these
values are upheld in practice. We
all must make every effort to provide transparent information that facilitates
the understanding of our financial actions and their results----which earns and
maintains investor confidence. Four important
stakeholders that are vital to the company's long-term success ultimately
evaluate a company's success: employees,
customers, communities and shareholders. Employees
vote their confidence in the company by taking advantage of ownership
opportunities, referring friends for employment, and advancing their career
within the company. Customers show
confidence in our ability to provide superior energy solutions by selecting us
over others in the marketplace. Communities
cast their votes of confidence by providing us with operational franchises,
purchasing our services, and partnering with us on vital economic development
initiatives. The value of corporate
citizenship must first be demonstrated in the very communities in which we live
and work. Finally, shareholders
demonstrate confidence by investing in our company. The
UtiliCorp/Aquila culture identifies values that are the foundation for success.
We have also recognized that by effectively executing compliance with
these values, the company is creating discipline and durability to deliver
performance to our stakeholder groups. The Enron collapse is
tragic for employees, their communities, and their shareholders.
. Enron failed, not the
energy market. We must all work
together to re-establish and restore confidence so that customers will continue
to benefit. Thank you for the invitation to appear before your Committee. I will be happy to answer any questions you may have.
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