Picking Up The Pieces At Dabhol As Enron Implodes

Enron effectively imploded on Wednesday, November 28, with Dynegy refusing to go ahead with its proposed merger deal. Enron’s shares are now trading for only a few cents and Enron is now heading towards an inevitable bankruptcy, if not liquidation. This has brought to an ignominious end a high profile, new-economy company, which many believed had ushered in a de-regulated energy gold rush. The impact of Enron’s collapse is going to be felt far and wide; India for instance, now has to pick up the pieces of its Dabhol project. The Indian Financial Institutions (FIs) have an exposure of nearly 2 billion dollars in the Dabhol project, including loans and guarantees to the foreign lenders.

Enron had transformed itself in a scant 15 years from a sleepy natural gas and pipeline company to a powerful energy multi-national, with friends in very high places. Kenneth Lay was not only one of the most influential backers of George Bush, the current president of the US, but also a close personal friend. In the earlier Bush administration, Enron played an important role, particularly in de-regulating the gas and electricity sectors. In California’s summer meltdown last year, Enron was identified as one of the Texas energy companies involved in price gouging. California also blamed Enron for influencing the Federal Electricity Regulatory Commission with its free-market philosophy, and not allowing price caps when the price of electricity in California had shot up to10 times over its cost.

It is ironic that Enron should now fall prey to the same “sacrosanct” market forces that it espoused. In a scant six weeks, Enron’s market capitalisation dissolved from 62 billion dollars to zip, making it one of the most spectacular bankruptcies in US history. How did Enron fall from the dizzying heights of a Fortune 10 company last December to nothing in just one year? How did a nondescript Texas company, owning a few pipelines, become an economic powerhouse, influencing the policies of the US, the world’s most powerful democracy and India, the world’s most populous democracy?

To unravel this mystery, we must look at the kind of business Enron built up. Enron, though in energy business, was quite different from the usual energy companies that have large physical assets. Under Kenneth Lay, it built itself up as an energy trader, with a world wide, computerised energy trading system, EnronOnline. In this system, the bulk energy suppliers sold energy, while bulk consumers bought electricity. These were effectively contracts with Enron for the future delivery of energy. This could be either short term or long term, “buys” or “sells”. In other words, Enron was buying energy at certain prices for the future, while selling the same at higher prices, pocketing the difference. In order to protect itself from adverse movement of prices, it had also created certain derivatives and hedges; if the prices fell lower than what Enron had anticipated, it had bought some insurance.

Playing the future markets is a risky venture – as a number of mutual funds and banks have discovered. The Barings Bank went belly up a few years back when its Singapore trader Nick Leeson blew away a fortune betting the wrong way on the Nikkei. Enron seemed to have mastered the energy future markets quite successfully, seemingly making hefty profits year after year. Its share price climbed steadily, rising to a high of more than 90 dollars last August. Jeff Skilling, who became Enron’s CEO last December, and Kenneth Lay, the earlier CEO, both made over 200 million dollars in stock options.

The first hint of trouble was when Skilling left abruptly after six months and Kenneth Lay took back the reins of the company. Enron’s stock price fell continuously, drifting down to about 37 dollars in October. Its share prices went into a tailspin in mid October, when Enron announced equity write-off of 1.2 billion dollars due to undeclared, off the balance sheet loans and losses.

Enron’s admission of unexplained losses caused an immediate uproar, with the Securities and Exchange Commission (SEC) issuing show cause notices to Enron and Wall Street demanding an explanation. The picture that emerged was clearly murky. Enron admitted to cooking its financial statements for the last five years to show spurious profits. In order to cover its losses, its officers set up shell companies that took loans guaranteed by Enron and ploughed this money into Enron claiming cash profits. The loans did not appear on the balance sheet, as Enron was, technically, only the guarantor of the loans. As Enron’s future trade ate up more and more money, Enron borrowed more and more while dressing up its balance sheet for its investors.

Tragically, while Lay and Skilling cashed in on Enron’s stock price rise, Enron’s employees saw their pension funds evaporate by an estimated 1 billion dollars as it is held largely in Enron stocks, now worthless. Currently, not only is SEC investigating Enron, but also dozens of cases have been launched against its officers, including its employees. Its auditors, Arthur Andersen are also being sued for certifying as correct such “fancy” accounting practices. The auditors are also under investigations for helping Enron set up, for hefty fees, some of the shell companies that Enron used to manipulate their balance sheets.

One of the reasons for Enron’s rise was its ability to influence policy. Its future energy trade depended on knowing which way the market was going, and if not, to nudge it in the right direction. Influence peddling was far more important to this new age company than the more traditional energy companies. The influence peddling in the Dabhol project and the long list of Enron’s friends in India are very much a part of Enron’s business “ethics”. The numerous policy changes that India introduced, including the now acknowledged disastrous fuel change to naphtha for power production, are some of the Enron’s interventions in India.

It has been documented that Enron dictated each government notification that was issued on Independent Power Producers. The shenanigans in high places are the common feature of Enron’s operations both in the US and in India. Readers may remember that one of Ambassador Blackwill’s earliest statements on Indo-US relations was that there are five letters that stand between India and the US – ENRON. Subsequently, sources in the government indicate that the Indian government had agreed to take over Enron’s equity at the price of more than a billion dollars, an agreement that was to be announced during Vajpayee’s recent visit. Enron’s collapse has saved the Indian people from this disastrous deal.

At one stage, it seemed that Enron’s core business would survive. Dynegy, a much smaller rival, was willing to take over Enron for about 9 billion dollars and even made a cash infusion in Enron of 1.5 billion dollars. However, a closer look at its accounts and Enron’s future exposure caused Dynegy to back off from the deal. The financial rating agencies downgraded its bonds to junk status, effectively pulling the plug on the company. They will not lose their money, having received, Enron’s Northern Natural Gas valuable 16,500-mile pipeline, as a loan security. Enron is suing Dynegy for withdrawing from the deal and contesting Dynegy’s claims on the pipeline, but more as a public relations exercise than a serious legal claim.

While Enron’s fall will add to the fall of the new economy and the dot.com bust, Indian financial institutions will now have to address their problem of lending Enron huge amounts of money without evaluating the viability of the Dabhol project. Not only did IDBI, IFCI and others lend Dabhol 1.2 billion dollars; they have also given guarantees to US Exim and other lenders. Out of the 2.1 billion dollars of loans to Dabhol Power Company, it appears that 1.9 billion dollars is the exposure of the Indian FIs. With Enron headed towards bankruptcy, its shares cannot be acquired without going through the tortuous process of US courts. The first phase of Dabhol plant is now shut down, and its half-built second phase is in stasis. Both will soon turn to junk unless we take immediate measures. Indian lenders will then face bankruptcy themselves.

But despite this grim scenario, there is no indication that the Indian government – more specifically the finance ministry – even understands the enormity of what is happening.

If it did, the finance ministry would have realised by now that it must bite the bullet and take recourse to the only option available: take over Enron by an act of parliament; pay the existing shareholders including Enron, GE, Bechtel and MSEB a fair compensation, a compensation to be decided after examining the actual equity brought in by each of the parties. After Enron’s fancy book-keeping has been exposed in the US, we need to check what Enron really brought in – not what it claims. Only this step will save Maharashtra and the FIs. To a government that believes the mantra of the market, such a step must be particularly galling. Can the government go beyond its ideological straitjacket and try to save the country’s 1.9 billion dollars? Or are we going to be treated to the familiar spectacle of Yashwant Sinha fiddling while his financial institutions go up in flames once again?