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Fortnightly Magazine - February 15 2002

The Enron Spin



Dear Sir:

In your Jan. 1, 2002, issue (", p. 4), you printed a humorous example of how Enron might have accounted for a portfolio of cows.

In at least one respect, Enron took things further: Enron "made" markets. If a distributor of electricity wanted to buy power for a future period and a seller wanted to sell, Enron bought and resold the power, placing itself on both sides of the transaction. The New York Stock Exchange provides a market, but it does not own the stock that is bought and sold.

A closer analogy to Enron would be that you own no cows. You learn that your neighbor wants milk from two cows so you buy rights to milk from two cows and contract to sell milk to your neighbor perhaps buying an interest in the cows at the same time, profiting on all parts of the transactions. In theory, Enron could not fail because every transaction was covered by a counter-balancing transaction and because all transactions were protected by Enron's large financial reserves.

The major public policy issue is not the one debated in the press as to whether the Administration did "favors" for Enron. The issue is what governmental and other oversight and checks are needed over the electricity and natural gas markets in which Enron initially made a seeming fortune.

It has become a mantra that unfettered markets will provide "efficient" energy supply. However, it is clear that sometimes dominant companies obtain sufficient market control to cause supply shortages and excessive prices. The participation of dominant firms in multiple areas of energy supply can make market power problems worse.

There is evidence of both physical and institutional barriers to electricity competition, for example. Not only is our transmission system unable to handle all would-be transactions, but dominant sellers of electricity also still maintain substantial transmission ownership and influence. The California experience shows that sellers of power with relatively small market shares may still have the power to unduly influence market prices.

A related problem is the inequality of knowledge between sellers and buyers of electricity. Ultimate consumers of electricity often do not have knowledge of the wholesale price of the electricity that they purchase. Moreover, their monthly electricity bills do not vary with the amount of high priced "on peak" electricity that they purchase except as these costs may be averaged with the costs to serve all other users. Thus, they have limited ability to reduce electricity purchases when prices are high. Under these circumstances, there is at least a question of the extent to which supply and demand will work to reduce demand for excessively priced electricity.

Enron-and not only its demise-raises questions about the limits that we want to place on dominant companies' involvement in supplying multiple aspects of electricity and natural gas and about the nature of appropriate market power controls. For example, excessive electricity and natural gas prices are possible where suppliers offer to sell power at prices that parallel each other (i.e., "conscious parallelism"), even though they do