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The Effect of the Bankruptcy of Enron on the Functioning of Energy Markets
Subcommittee on Energy and Air Quality
The Honorable Thomas L. Welch
Summary of Remarks
Good morning, Mr. Chairman,
members of the Subcommittee. Thank you for this opportunity to report to the Subcommittee on the effects of the Enron Corporation's recent decline on the electricity market in Maine and New England. I am Thomas L. Welch, Chairman of the Maine Public Utilities Commission (MPUC). To aid the Subcommittee's
work on restructuring the electricity industry, I have brought copies of the
Maine Commission's very recent Report on Restructuring in our state.
This document can also be found on the MPUC website at: www.state.me.us/mpuc/2002legislation/2002legreports.htm. No state has a greater interest
in the success of the wholesale electricity markets than Maine.
In the two years since we opened our retail markets to competition,
Maine's consumers have been directly and often immediately affected by changes
in the wholesale prices in New England. As
much as any jurisdiction, Maine cut the regulatory tie between electricity
supply and delivery by requiring its utilities to completely divest themselves
of generation. We did so because we
believe that competition in electricity markets is likely to be fairest and most
robust when the transmission and distribution utility, the T&D utility, has
no reason to favor any one competitor over any other.
Apparently energy companies agree; currently 14 of them have competed and
won customers in Maine, including Enron, which-by our best estimates-serves
fully one quarter (an estimated 450 megawatts) of Maine's load-or at least
it did so prior to its recent troubles. Maine's interest in the success of the wholesale electricity markets is further rooted in our decision to forego artificial price-controlling devices such as price caps or long term fixed supply contracts that insulate consumers from the prices revealed in the wholesale markets; even Maine's Standard Offer (default or provider of last resort) supply is provided at prices that are set by competitive bid. The effect of Maine's approach to restructuring has been dramatic:
Maine's aggressive
adoption of the competitive model, however, comes at a price.
The prices paid by Maine's consumers are--perhaps as much as any in the
country--sensitive to the vagaries of the wholesale market.
Accordingly, we have worked hard to ensure that the wholesale market
reflects the economics of supply and demand, and does not provide either
inadequate incentives for efficient investment or opportunities for gaming and
the exercise of market power. We
have tried to avoid or minimize the impact of any events which will impair
competition or unfairly injure consumers-residential or business. And, thus far, I am relieved to
report, both Maine and New England have apparently avoided significant injury
from Enron's recent financial collapse. Most
feared were threats to the reliability of supply and to the prices paid by
Enron's customers. Supply
continued without discernible disruption. And,
because of very careful management, particularly by the ISO-New England and
participants in the New England Power Pool (NEPOOL), there was little
instability in the markets and apparently no major financial losses. Enron's
collapse did not cause a reliability problem because Enron does not own the
generators. The generation
owners' interest remained unchanged: run their generators and sell the output.
Customers continued to want that output. Loads did not change. Generators
did not go anywhere. So reliability
was unaffected. And
in this environment the stressed and ultimately bankrupt Enron continued-and
continues-to meet its contractual supply obligations, most-if not all-of
which were profitable in today's energy market.
Those contracts required customers to pay a higher price than the current
market price. Nevertheless,
companies who owned the generators, fearing that Enron might not pay for its
power purchases, opted out of contracts when possible and instead sold into the
spot market. NEPOOL's
old financial assurance policies allowed the organization to rescind membership
in the Pool, but did not allow NEPOOL to cut off a company from trading in the
energy markets in response to a situation like that posed by Enron.
NEPOOL and ISO-New England's new policy will automatically restrict a
company's trading in the pool if its credit rating falls below a certain
level. The
sudden Enron disintegration impaired its ability to arrange bilateral contracts
with generators. In response, Enron
bought more and more from the Pool each day.
When Enron declared bankruptcy, it was carrying a large, negative
financial balance with the Pool (pre-bankruptcy-petition debt).
There are two possible remedies for this pre-petition debt. The bonds that Enron was required to post to establish credit
with the pool may cover the debt; and if not, NEPOOL has filed a claim in the
bankruptcy proceeding. Enron
fought to avoid giving up its trading activities.
In lieu of the 30-day settlement process accorded healthy energy trading
companies, Enron negotiated a new 3-day-rolling-average payment arrangement with
the Pool (administered by the ISO). Enron
now maintains a 3-day cash balancing account with the ISO.
At the end of each day, the ISO withdraws enough money to cover the
transactions that occurred three days previously. Enron has agreed to wire-transfer to the ISO--by the end of
the next day-enough money to replenish the account. In December this arrangement and term sheet were submitted to
the FERC for emergency approval. The
FERC promptly approved it. There
was further concern in the New England market that, because parties with
bilateral contracts to supply Enron could terminate those contracts because of
the bankruptcy but Enron could keep buying what it needed in the spot market,
Enron's resort to the spot market could produce over-reliance on it (similar
to what happened in California), sharply increasing spot-market prices. While that did not happen in this instance, it remains at
least a theoretical possibility in the event of the financial collapse of
another big player. Outcomes like the one Maine and
New England just experienced frequently leads to the oft-used phrase "we
dodged the bullet." True, the
bullet did not hit us. But it was
not because we were smart enough or nimble enough to escape its blow. We were simply and profoundly lucky. We are, and have been for many
months, in a falling energy-price market, one in which suppliers with a fixed
price can profit from declining prices. Had
the same set of events occurred against a backdrop of rising energy prices,
suppliers would have had an extraordinary incentive to escape their obligations.
(Maine has had direct experience with such circumstances.) Had Enron's implosion
occurred in a rising market, Maine's ratepayers could have taken a "hit"
in excess of $50 million, perhaps $100 million.
And, remember, Maine is a state of fewer than 1.3 million people.
If Enron has captured as much of the market across New England as it has
in Maine and if we were in a rising-energy-price market, the comparable
"hit" for ratepayers across New England could have approached $1 billion. For ratepayers, there is a certain "heads you win, tails I lose" aspect to the energy market. If a customer signs a contract with an energy supplier and market prices fall, the customer is stuck with paying the now higher-than-market price for its energy. This remains true even if the supplier-as has Enron-goes bankrupt; the contract is a valuable asset of the bankrupt, one which the Bankruptcy Court will seek to use on behalf of other creditors. But if a customer has a
contract with an energy supplier, market prices rise, and the supplier (for
whatever reason) goes bankrupt and defaults on the contract, the customer must
buy new supply in the high-priced energy market and take its place in line with
all the other creditors with little hope that the protections the customer
negotiated in its supply contract will provide sufficient relief. Maine tries to minimize such
risk to the state's Standard Offer electricity customers by requiring licensed
suppliers to provide evidence of their financial soundness, either by posting a
substantial bond or (in the case of companies whose guaranteeing parent has a
minimum credit rating of BBB+ or equivalent) by providing us a corporate
guarantee that the supplier will meet its obligations. But
even if we had required and Enron had provided a bond to protect Maine's
Standard Offer customers, we would have had little meaningful protection-at
least sooner than the conclusion of very protracted litigation.
Reportedly Enron had purchased surety bonds to guarantee billions of
dollars of natural gas and crude oil to two offshore companies. Enron declared
bankruptcy in November, ostensibly leaving its guarantors with the bill. Enron's
failure (perhaps amplified by large claims associated with Kmart's failure)
supposedly represents one of the largest payouts ever for the surety industry,
about $2 billion, according to experts. Reportedly,
it is comparable to the effect of the September 11th terrorist
attacks on the property and casualty insurance industry, and the magnitude of
these losses may force some bonding companies out of the surety-bond business. As a result, bond companies
likely will raise prices, require collateral, tighten underwriting standards,
and cancel some policies. Thus, it
could be more difficult for some companies to obtain bonds, thereby reducing the
number of competitive providers and making competition less vigorous.
Energy market prices may reflect these additional cost burdens. In conclusion, well-structured,
well functioning energy markets can bring substantial benefits to consumers and
opportunity to ethical, well run businesses, and strengthen the U. S. economy.
Benefits will be realized regardless of whether a state or states open
their markets to retail competition. The keys to a well structured,
well functioning market are rules that allow all players to compete fairly,
based on the underlying economics of what they bring to the competition, and on
the integrity of the players. Absent
the latter, competitive energy providers will not enjoy the confidence of
investors (hence their financial support) or other players in the market (making
it harder for them to bring valuable products to the market). Energy providers, consumers,
and investors very much need reforms that will restore confidence in markets. By themselves, states cannot protect against a incompetence
or purposeful cheating by a major national company. Apart from the costs and limited effectiveness of the
protections mentioned earlier (e.g., surety bonds, corporate guarantee),
unscrupulous players can avoid state-designed and -enforced protections by doing
business only in states with the least restrictive protections.
The specific reforms of this nature must be national in scope and
carefully designed to balance the price of that protection-both financial and
regulatory-against the value of the additional assurances received.
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