ENRON TAPES – California energy markets: deliberately designed "… to provide wealth for Enron and others of its ilk."

I don’t want to flood Dave’s blog, but I have to say this:

Even more astonishing to me than the sheer calumny of Enron’s trading staff, was the sheer absurdity of the way the California energy market was structured… I’m not an expert here, by any means, but it is my understanding that California choose to adopt a “bi-lateral” trading system – one in which sellers and producers contracted directly with each other to buy and sell power, and no public “market clearing price” existed in most cases… a structure that Dr. Carl Pechman contends, in his testimony of February 27th, 2004 (page 59 and onward) was deliberately fostered by Enron, with the goal of ultimately being able to profit from it due to what they believed were superior methods of garnering information about the true market price of energy (many of them based on “inside information” gained from various deals they had put together to manage other companies energy trading and sales). This is opposed to a “stock market” like model (POOLCO is the term, see pages 62-65 of Dr. Pechman’s testimony), in which there are publicly disclosed bids and offers, which all eventually resolve to a single market price.

Here’s a direct quote from Dr. Pechman’s testimony:

“…many of the traders were benefiting from a market that they themselves had helped design. The market had been designed to be very inefficient to allow gaming, and to provide wealth for Enron and others of its ilk.”

The following paragraphs of his testimony describe, in detail, exactly what Enron did to ensure that inefficient markets were created – ones with plenty of opportunities to “steal” … oops, let me rephrase that, “arbitrage” millions of dollars a day, and the reasons why the inefficiencies in question were artificial in nature. If you care about understanding what happened to California, as I said in a previous posting, you’ve GOT to read Dr. Pechman’s testimony (warning: 15 megabyte PDF). It is only 98 pages, and worth every minute spent downloading and reading it.

What this translated into, in practice, was an utterly insane system in which you had traders sitting around randomly calling each other to say, “Hey, you got any energy? No? Have you heard that anyone else is selling?” “Yeah, I hear that Bob over in Podunk’s been selling for the past few hours.” Then the energy trader calls Bob at Podunk Energy, Inc. and Bob says, “Nope, sold it all a few minutes ago… but I hear that Mary over at Pipsqueak’s got some. Don’t think it’ll come cheap though.” Then the energy trader calls Mary at Pipsqueak, and they cut a deal – often at a price that varied significantly from the one the trader cut just a few minutes before with someone else. Sometimes, Enron’s traders would arrange to buy energy from one company, and then, before closing the deal, put them on hold, call up another company, and sell it at a premium, before going back and closing the first deal. Pretty cool if you’re running a swap meet, not very cool if you’re a ratepayer at either end of that deal.

Meanwhile, Joe Blow a couple of desks over is spending half his day trying to track down a 2 megawatt discrepancy in a power schedule. And Anna Podana is trying to figure out why her notes say Enron sold 25 megawatts to Bigassenergyco, but Bigassenergyco says they bought 30. When she calls them up, the trader over there says, “Oh yeah, sorry about that, I guess I wrote it down wrong.” Doh!

I’m serious. This is the kind of craziness I listened to every day. It is a bleedin’ miracle that the system worked as well as it did! The system was completely dependent on very labor intensive and error-prone manual accounting / papershuffling (whole categories of people existing to do nothing more than call each other up all day and arrange accounting “swaps” that canceled out debts the companies owed each other – at least this was my understanding of what they were doing) and subject to simple human error at every step of the way (something that appears to have happened regularly). As someone who built a multi-million dollar business on automating stupid, repetitive, human-error prone processes, what I heard just blew my mind. The politicians who allowed this system to be created oughta be tarred and feathered and run out of town on a rail, and the Enron executives who promoted it ought to be sentenced to breaking rocks on a chain gang for the next fifty years! Even then, that hardly makes up for seeing my energy bill go from $120/mo. to $600/mo. and counting before I was finally forced to sell my house (for that and other reasons).

Thomas Leavitt