The US Federal Reserve, European Central Bank and Bank of England have all cut base lending rates by 0.5 per cent , pushing interest rates to their lowest levels in almost forty years. These actions, which follow months of successive base rate cuts, are aimed at staving off a recession, which seems likelier by the week. While it is convenient to point the finger of blame at the events of 11 September, in reality the economic downturn was brewing well before this date. The events of 11 September merely served to give the economic downturn a new personality and catalyse its impact.
Businesses across almost every industry sector have felt the impact. Some, like the airline industry, have suffered more than most as consumer confidence has been impaired by terrorism fears. Indeed, some will not recover. The Belgian state carrier, Sabena, has filed for bankruptcy. Others, such as engineering group Kvaerner, have had to seek new credit lines from their bankers. But as the economic downturn takes root the banks are less likely to provide loans on standard terms as the risk of payment default increases. Increasingly, the banks are demanding greater collateral against loans that previously would require little, if any. Some banks are demanding repayment at several percentage points above Libor (London Inter-bank offer rate) as indication of the perceived economic risks. And against this scenario the credit agencies are sending out regular credit reviews of debt and downgrading credit ability.
One company more than any other has dominated the energy business media over the past month. But this company has not suffered due to the economic downturn or the events of 11 September. Instead its rapid demise appears to be self-inflicted. The company in question is Enron.
Once the darling of energy, and in particular gas and electricity, markets Enron came dangerously close to financial meltdown. The events stem from a $1.2bn equity write-off revealed by the company on 16 October, which precipitated first an investigation and subsequently, on 30 October, a formal investigation by the US Securities & Exchange Commission. Enron’s debt has been downgraded to the bottom rung of investment grade and credit confidence in the company is at an all-time low. Even the replacement of its chief financial officer, Andrew Fastow, who was at the centre of the SEC investigation, the re-statement of accounts from 1997 and the dismissal of two senior finance officials has failed to quell the company’s decline. At the time of writing Enron’s stock was valued at just a tenth of its value in January.
But Enron’s problems did not start on 16 October, and can be traced back to at least the summer when it parted company with its chief executive officer Jeff Skilling and admitted its broadband business, the value of which the company said last year would exceed that of its energy business within three years, had failed to meet expectations. Broadband offices in London and Singapore were closed last month and incorporated into the Houston office. And even before the broadband business revelations Enron had suffered a similar fate with its water business, Azurix.
From this chronology of events it may be assumed that Enron’s fault lies in its business mantra of innovation and diversification, although the company has not suffered similar woes in its metals business. There are no suggestions that Enron’s equity write-off stems directly from either its water or broadband businesses, but then one of the problems with Enron is its tendency to keep its business procedures relatively opaque and until the SEC investigation is complete the full facts will not become transparent.
Enron’s strength lies in its wholesale energy trading and in its online trading platform, Enron Online. But the success of Enron Online is dependent on the ability of Enron to secure and maintain sufficient credit to maintain its open positions, as Enron is counterpart to all energy transactions on the platform. To date those counterparts trading with Enron have kept faith but the durability of these relationships is coming under increasing strain. Part of this faith is attributed to the respect Enron has in developing the gas and electricity markets in which it is by far the dominant marketer in the US. But this allegiance is also due to Enron being the primary price maker in these markets. It is largely due to Enron that liquidity has developed in the gas and electricity markets. A good example is the UK electricity market where most participants trade off the Enron forward curve.
An obvious concern is that if Enron ceases to function then market liquidity could be impaired. The knock-on effect if Enron ceased to trade could be significant. Although these trading counterparts could use counterparts other than Enron the primary value and importance of Enron is due to its ability to make prices and its willingness to take on risk. While there will be many companies feeling smug about Enron’s demise it is not in the market’s interest for Enron to go under.
It was therefore a relief that Houston-based Dynegy made an offer for Enron of $7.8bn or thereabouts, which has been accepted, and the acquisition should be completed by the third quarter next year. Although the full reasons behind Enron’s demise are not yet known, and will remain so until the SEC investigation is completed, Dynegy appears prepared to take the risk of more skeletons being found in the Enron cupboard and its bid for the company includes an additional $3.5bn to cover Enron debt.
The incentives for Dynegy are significant. Dynegy has its own online trading platform, Dynegydirect, which would correlate well with Enron Online. And a buyout of Enron would elevate Dynegy to the number one gas and electricity marketer in the US, a position it clearly coverts. To cover the cost of acquiring Enron, Dynegy is expected to sell off non-core business including the UK’s Wessex Water and possibly Enron’s metals business.
But there is also a word of caution for Dynegy, which will effectively become the new Enron in every aspect apart from name. It has to learn from the problems that befell Enron otherwise it could risk following suit. Being number one in US gas and electricity is a powerful position, but one that must not be abused. As Enron proved so dramatically, the bigger the company the bigger the potential fall.
