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The Effect of the Bankruptcy of Enron on the Functioning of Energy Markets
Subcommittee on Energy and Air Quality
Mr. Raymond Plank
Mr.
Chairman and Members: Thank you for the opportunity to speak to the committee today My name is Raymond Plank, and I am the Chairman and CEO of Apache Corporation. In five decades in the oil and gas business, Apache has grown from one of the smallest to one of the larger independent producers. Natural gas is the single most important domestic energy source - an abundant resource that warms millions of homes, fuels much of America's industrial base and plays a large and growing role in the nation's electricity industry. However, while many believe natural gas is the fuel of the future, I believe that future is in doubt because of the flawed structure of the natural gas market in this country. The fact is the nation's energy markets skated by and escaped a disaster in the wake of Enron's collapse. Why? Certainly not because this market serves the nation's needs. No, we avoided a supply crunch because the recession and one of the warmest winters in recent history combined to keep demand in check. If the economy had been more robust, or if weather conditions had been different, the story could have been far different. This is an issue that should be important to the other members of this panel because they have developed business plans, raised billions of dollars from investors and erected power plants based on the availability of reliable supplies of natural gas. The current market, marked by excessive price volatility, has undermined the ability of Apache and other North American producers to meet their requirements. Mr. Chairman, I know you have worked hard to introduce competition into the nation's energy markets. But deregulation has been hijacked by traders, hedge funds and others who profit from volatility and who scorn the hardworking men and women who produce this important resource. If you don't fix the natural gas market, then all your efforts to bring competition to the electricity market will be for naught because natural gas is the fuel of choice for new generating capacity. The uncertainty in the gas market caused by excessive price volatility endangers the infrastructure required to explore for and produce natural gas. Every time the price goes down and Apache and other companies cut back, skilled workers, from roustabouts to engineers to scientists, leave the industry. Drilling rigs are taken out of service and cannibalized for spare parts. Marginal wells are shut in, never to return to production. Right now, the industry is not drilling enough wells to maintain production at current levels. Yes, Mr. Chairman, Enron is gone, but the damage has been done to a vital element to the nation's economic security. In some ways, this is a homeland security issue: There is a sleeper cell out there, a ticking time bomb set to wreak havoc when the economy comes back and demand increases. I'd like to give you some background on how we came to our position. For the last 10 years, our ability to find and produce the natural gas this country needs has been crippled by increasing price volatility. North America is a mature producing province, which means that while there is still a great deal of natural gas to be found, producing it requires better technology, better science, more time and more money. Most of these projects take from 12 months to two years to complete. It is harder and harder to commit capital to these kinds of projects when we can't forecast what the price of our product is going to be tomorrow, much less a year from now. Natural gas prices, like all commodity prices, run in cycles. That's been true as long as I can remember. Recently, however, as hedge funds and traders have come to dominate the market, the cycles have become shorter in duration and more pronounced. In press reports and presentations to analysts, these traders acknowledge that they derive their profits from price volatility. The casino mentality that has taken over the energy markets has a real impact on the consumers as well as producers. Let me give you a real example that we all remember. In December 1999, we were paid less than $2 for a thousand cubic feet of gas. In January 2001, the price climbed to nearly $10, only to fall back below $2 by October. To put that in perspective, think about the impact on the stock market - and the American economy - if the Dow Jones Industrial Average took a trip from 10,000 to 47,000 and back to 10,000 in a year and a half. What would your constituents be telling you if the price of gasoline jumped from $1.20 per gallon to $6 and then back down to $1.20? Last winter's price spike dealt a damaging blow to the industrial economy which in total accounts for 40 percent of U.S. natural gas consumption. Natural gas-intensive industries like steel, plastics and petrochemicals significantly curtailed or shut in production in response to extremely high gas costs. Some of this demand has been permanently displaced. In addition, natural gas volatility played a key role in California's energy problems. The consequences for the economy due to overheated gas prices are painfully clear. But when the price falls back to $2 per thousand cubic feet, the capacity of the industry to supply natural gas is diminished - permanently. One consequence is a brain drain in the industry. The average age of oil and gas workers is 48 years old. As young engineers and scientists seek opportunities elsewhere, the nation will lose its technological edge in this industry. When prices fall, companies like Apache reduce their drilling expenditures and seek more profitable avenues for investment, usually overseas. As a consequence, I can assure you that the next price spike is just around the corner. It may not come until this fall or next winter, but it is inevitable and it could be severe. As much as we know about getting natural gas out of the ground, there are many things about this market that have been hidden from view by powerful insiders who profit from its opacity. We can't find the answers because we don't have subpoena power. It's up to you to break through some of these Chinese walls and get to the bottom of this structurally flawed market. Now, I'd like to discuss some of the most glaring problems with this market and our suggestions on fixing it. Every month, the price we get for our natural gas production is based on indices published in one or more trade publications. The reporters who compile these price indices are hard-working, honest journalists, but their sources - the pipelines, utilities and marketers - are under no obligation to provide complete or even accurate information. Similarly, the American Gas Association's weekly storage report became a major market event because it was a proxy for supply and demand data but it was based on voluntary, self-serving data. In
a market as important as the natural gas market, the government should collect
and disseminate real-time information on natural gas supply and demand from
market participants, with penalties imposed for failing to file accurate
reports. Even some energy marketers acknowledge that the current rules give unfair advantages to integrated energy companies with their regulated pipelines, unregulated marketing affiliates and electric generating units. While allegedly separate, these people go to work in the same office building, share coffee - and benefit from the same corporate incentive systems. The
current rules governing the conduct of regulated and unregulated affiliates are
weak and subject to abuse. To prevent the trading of insider information, these
functions should be geographically separated and their dealings limited to real
transactions with real money changing hands. If companies abuse these rules,
they should be required to divest their unregulated affiliates. Online trading platforms, which operate outside the longstanding framework that regulates commodities exchanges, provide their operators with vast information about the trading positions of other market players which can be used to manipulate the market. These
online platforms are exchanges; they should be subject to similar regulation to
ensure fair treatment of all parties. In the equities market, there is a basic
rule that agents cannot put their trades ahead of their clients' transactions;
similar rules should guide the conduct of the energy markets. The bright light of Wall Street cast on energy marketers in the aftermath of the Enron collapse revealed them to be overleveraged. They rely on mark-to-market accounting of energy contracts that allows them to book the revenues and profits of long-term contracts up front, long before the revenues are collected and the profits realized. Though they appear profitable on the surface, a closer examination reveals that the profits may prove to be illusory. The current system incentivizes traders to book deal after deal, seeking profits from every move in the market and distorting legitimate supply and demand signals. End
mark-to-market accounting and require traders to book their revenues and profits
when they are realized. Impose capital requirements to assure customers that the
traders will be there to deliver the gas and electricity. Some would have you believe that the fact that a company as large as Enron could fail without causing any disruption in the energy markets is a signal that these markets are deep and liquid. I disagree. I think it demonstrates that Enron and others like it add no value. I also believe that failure to reform this market will cause lasting damage to the nation's energy infrastructure and economic health. Mr. Chairman, you have before you the record of the fall of Enron - the self-dealing, the subterfuge and the apparent fraud. I think it's fair to ask whether the same behavior permeated Enron's biggest business - its natural gas and electricity trading operations. Once your committee answers that question, I hope you will conduct a thorough examination of the structure of the energy market and make the changes necessary to ensure that there are not other Enrons out there, waiting to happen. The task before you is clear: To introduce effective oversight and transparency in this market and restore the environment that will encourage producers to make the investments to meet the nation's vital energy needs. Thank
you very much for the opportunity to be here today.
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