Enron’s reorganization plan hinges on preserving pipelines, trading group

Faltering Enron Corp. is pinning its hopes for survival on the company’s pipelines and reviving its once-powerful trading operation.

But time is short and the hurdles large to execute on the strategy, analysts say. “There is substantial question about their ability to get back into the saddle,” says Jim Hoecker, former chairman of the Federal Energy Regulatory Commission (FERC) and now a partner with the Washington, DC, law firm of Swidler Bertin Shereff Friedman LLP.

Enron’s trading operations remain largely shut down for new business and the pipelines are heavily encumbered by debt. Competitors aren’t sitting still while Enron’s future is determined in US bankruptcy court.

The Houston company filed for Chapter 11 bankruptcy protection Dec. 1 in New York, temporarily shielding the company from creditors while it attempts to reorganize. Unraveling the largest such filing in US history could take more than a year, bankruptcy lawyers warn, with multiple parties, including federal regulators, claiming standing.

The company also must respond to a growing list of congressional and federal government investigations, and shareholder and employee lawsuits. Meanwhile, Dynegy Inc. and Enron have gone to court over ownership of Enron’s largest pipeline Northern Natural Gas, after Dynegy terminated a proposed merger between the two Houston energy companies.

“They are in a race against time,” says Peter Nance, president of Teknecon Energy Risk Advisers Inc., Austin. “It can’t take too long.”

The plan to revive the trading operation involves setting up a new venture with the EnronOnline electronic trading system and Enron traders, and in which Enron would continue to have an ownership interest. Enron reported it is talks with financial institutions to recapitalize the trading business with a clean balance sheet.

These funds would be separate from the $1.5 billion debtor-in-possession financing Enron obtained from J.P. Morgan Chase & Co. and Citigroup Inc. to fund day-to-day operations and restructure the company. The idea is Enron’s trading expertise could continue make a new company a force in the market and the trading organization could be given new life, if client confidence could be restored. The energy giant, which had $100 billion in revenue last year, accounted for nearly a quarter of all US gas and electric trades at its peak, making a market in both commodities.

Enron Chairman Ken Lay conceded Enron’s precipitous downfall “severely” damaged market confidence in the company, but he said, the company has taken steps to restore confidence of counterparties. Nance estimates Enron has a 3-month window to announce it has an financial agreement in place to revive the trading organization and about 3 months more to go live or be overtaken by such competitors as InterContinental Exchange Inc., Dynegy’s electronic trading system, the New York Mercantile Exchange, and others.

Then the issues will be whether the successor to Enron’s trading operation will be large enough and have enough liquidity to compete successfully, Nance says, and whether it will survive as a market maker, linking buyers and sellers and making money on the spread between the two.

Despite the company’s soiled reputation, Nance believes Enron deserves credit with the way it handled its trading book in the 3 weeks before Dynegy pulled the plug on the proposed merger. Companies renegotiated deals, with Enron effectively doing its own work out rather than handing it over to a third party. In some cases, he says, Enron stepped out of transactions when prices between buyers and sellers were relatively close and allowed the parties to make their own deals.

While it isn’t clear from the outside how much of the book was handled that way, Nance says the effort helped stabilize the market and reduced the number of debtors included in the Chapter 11 filing.

Enron stands accused of “hubris,” but “one thing you don’t hear people saying is they didn’t know what they were doing,” with respect to trading gas and electricity and other commodities, says Hoecker.

Indeed, one of the major uncertainties is who will take the risks on long-term and unusual transactions that Enron was willing to take, Nance says. “Those parties haven’t presented themselves yet,” he says, though it’s possible some will step forward. He suspects the insurance industry will pick up some of the weather derivatives business Enron helped pioneer.

‘Mortal combat’
In making its pipelines the second prong of its survival strategy, Enron would be returning to its oil and gas industry roots.

Enron was created by the 1985 merger between Houston Natural Gas Corp. and InterNorth Corp. Enron’s pipelines, which were excluded from the Chapter 11 filing, contributed $391 million to Enron’s income before income taxes in 2000. The pipeline subsidiaries are Northern Natural Gas Pipeline, Transwestern Pipeline, and Florida Gas Transmission.

Besides the utility Portland General Electric Co., which is being sold, the pipeline group contributed more to earnings than any other Enron segment, excluding the marketing and trading group. But observers say preserving the pipeline assets also will be a challenge.

“Dynegy and Enron are locked in mortal combat” for control of Northern Natural Gas pipeline, says Hoecker. The two companies have gone to court over ownership of Enron’s largest pipeline, after Dynegy terminated the merger.

Enron has asked the court to reject Dynegy’s claim to Northern Natural, which extends from Texas to the Great Lakes region. In a lawsuit filed in Harris County district court, Dynegy asked a judge to enforce a deal awarding the pipeline to Dynegy in exchange for $1.5 billion in cash, under terms of the now-terminated merger agreement with Enron.

Because the pipelines are subject to FERC jurisdiction, that could add a layer of complexity to an already complex case, says Nancy Rapoport, a professor of bankruptcy law at the University of Houston Law Center. That will give the agency standing to raise issues in the various cases, and Rapoport expects FERC to participate.

Hoecker says Enron’s downfall reinforces the need for better regulation of the electricity market, but not, he says, by “reimposing cost-of-service regulation as we have come to love it for 70 years.” He says Enron benefited from an information advantage in a market that is still immature and not transparent.

Reporting needs to be improved, he says, including financial reports to the Securities and Exchange Commission. Agencies also need enforcement authority, particularly with respect to market power abuses, he says.

The stock exchanges and the SEC faced a similar dilemma “decades ago,” Hoecker says, and market oversight notwithstanding, “people regard it as a successful and free market.” He says Enron’s problems, much like California’s electricity shortages earlier this year, stemmed from specific facts and poor market decisions — not systemic problems with electricity deregulation.

He does not expect Enron’s problems to derail competition in the power markets. “The gas markets work very well,” Hoecker says. “Electricity is headed in the same direction.”

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