Enron’s Ken Lay On Energy and Boards
from
Summer 2001
by Ann Reilly Dowd
When
Vice President Dick Cheney sought input in formulating a national
energy policy, one of the people he listened to most intently was
Kenneth Lay, chairman of Enron and a longtime George W. Bush supporter.
In 15 years Lay, 57, has turned a traditional pipeline company into an
aggressive trader of gas and electricity and a provider of broadband
services. Until the deal bogged down, it looked last year as though
video rental giant Blockbuster would use the Houston outfit’s network
systems to deliver online movies. Lay’s ambitions for Enron don’t stop
there. He wants federal regulations removed so the company can build
power plants and power lines, which would put it in direct competition
with utilities. In a conversation with Corporate Board Member’s Ann
Reilly Dowd, Lay discussed the energy crunch gripping the United States
and what government and boardrooms need to do about it. He also
describes how he assembled a board that enabled him to push Enron so
far into the future. Excerpts:
On how real the energy crisis is: We have a genuine energy crisis in California, which will see severe shortages or disruptions over the summer, and a serious energy problem in most other places. Outside of California, the supply/demand balance is very tight, and maybe the infrastructure is being pushed a little hard. But the energy situation certainly needs attention. In many ways, this country has underinvested in energy supply and infrastructure for at least 15 or 20 years. We need to start correcting for that.
On deregulation: What led to California’s energy crisis was not deregulation but a very flawed command-and-control regulatory system where most consumers don’t have any choice. Deregulation is not where you have a fixed price on the retail side of the market and a floating competitive price on the wholesale side. It’s also not where everybody has to buy most of their supply on the wholesale spot market. That was very, very dangerous from day one. We need to give consumers the benefits of real deregulation.
The solution for California’s problem has to be in California. Nationally, we need to get the rules right as quickly as possible. Part of the problem is that there has been uncertainty in some states and regions as to what the rules are. Uncertainty tends to lead to inaction. So we need to go ahead and finish up the deregulation process. Mainly, we need to remove barriers for rebuilding the infrastructure, getting the right-of-way for new transmission lines, and building power plants.
We need to distinguish between deregulating the retail and the wholesale electricity market. On the wholesale side, the federal government, mainly the Federal Electricity Regulatory Commission, has a great deal of authority. One of our recommendations has been that we need to get larger transmission grids—regional, not just state grids. We need those to operate independently of the distribution and power generation functions. And we need those larger regional grids to be truly open access and nondiscriminatory. We and many other people are convinced that would increase the carrying capacity of the system and help us in the interim as we expand and build out the system.
On price caps: I don’t hear anyone arguing that price caps would either reduce demand or increase supply. And many people would argue just the opposite, that they would increase demand and reduce supply.
Here’s one example. Enron was getting ready to build a peaking power plant in California last October. We already had the site approved, and the turbines. Then the state imposed price caps, and we had to cancel the project because we couldn’t justify making the investment with the price caps. At least one other company, CalPine, did the same thing. That means that this summer there will be about 1,000 megawatts less power available for the California market than there would have been otherwise. That’s about 20% of the estimated peak shortage that would have been available if there had not been price caps.
Second, price caps tend to allow political leaders to delay making the tough decisions necessary to solve the problem. Price caps may camouflage the problem temporarily, but they don’t solve it. And to the extent that the right decisions and action are not taken, the problem just gets worse.
On the public backlash against energy companies and their boards: Every time we’ve had an energy problem, we get this same reaction. There is always a discussion of conspiracy or collusion or anticompetitive behavior or excess profits or whatever. Each time there are investigations.
In California, it seems the political leaders are trying to blame everybody but themselves. They need to face up to the fact that the rules are wrong and led to a drastically dangerous situation. Now we’ve got to solve it.
First of all, we’ve got to get the prices right, so consumers realize we’ve got to use a lot less and suppliers realize we’ve got to produce a lot more. We’ve got to streamline the process to site and build power plants. We’ve got to do some very significant things from the point of view of reducing demand. And we need to open the market for competition. Then this problem will get solved very quickly—a lot more quickly than trying to put on artificial price caps. Everywhere we’ve tried price caps they have led to enormous economic inefficiency and distortions.
The way we handle the criticism—and Enron’s board knows this—is by being very open and proactive, trying to work through solutions rather than pointing fingers and conjuring up conspiracies. I and others on the Enron team have been to California to meet with editorial boards and business and political leaders. We try to educate various groups on what caused the problem and what needs to be done to solve it.
On the need for all companies to have an energy policy: Even before this recent increase, it’s been our experience that many companies have exposed themselves to a lot more price risk in their energy use than they realize. It’s an area that quite often is not as actively managed as, for example, the balance sheet. There is a lot of attention on interest rates and the portfolio approach with some short-term, some medium-term, and some long-term debt. We usually don’t see anywhere near the same sophistication applied to energy, even though in many cases, companies have a lot more risk exposure in their energy purchases or procurement than they do in their debt portfolio.
On what boards should push for: I think the kind of questions board members should be asking are: What is our policy on hedging fuel prices? Did we lock in any of our energy prices? If not, why not? What are we doing about the future? Have we looked at all of our conversion and control equipment and all of our policies and procedures? Are they truly “best in class?” Are we getting advice from companies that are truly world-class in this area?
On energy as a corporate asset: Enron has a major business outsourcing energy for large industrial and commercial companies. We go in and evaluate the energy activity, the equipment, the control systems, and the procurement policies. Even before the recent run-up in prices, we had yet to find a well-run business where we couldn’t reduce energy usage and costs by 5% to 15%.
Most companies, even fairly energy-intensive companies, are not necessarily world-class at managing their energy activities. It’s not a core competency. It’s not where the best and the brightest want to spend much time. It’s also not a place where many companies want to spend much capital. For all those reasons, quite often the energy convergence and control equipment may not be the latest and most efficient, and companies may not be using best practices.
We have looked at small companies, which may not be one-tenth or even one-twentieth the size of Enron, that are exposing themselves to more energy-related risk than Enron does worldwide. Usually they don’t know that until they get a price spike. Then all of a sudden, it becomes a big factor in why they aren’t meeting their earnings and cash-flow targets. In many companies, energy is 10% to 20% of operating costs. If suddenly that rate goes up 50% or 75% and a company is operating on thin margins, the profits begin disappearing,
On how to build a world-class board: At Enron, I went outside and brought in a few key directors with a lot of creative ideas to stimulate the board’s thinking. As we had turnover, I kept bringing in new people and, increasingly, people from other countries, who brought specific talents that we thought would be helpful. I also brought in a number of new executives from different fields and backgrounds to help us jumpstart our effort to build a significant business in the deregulating natural gas markets.
It’s the old chicken and egg proposition. The top board members want to be with the top companies. So as you’re rebuilding the board, you’ve also got to rebuild the company. You have to make sure you are bringing in the management talent you need and developing and executing the strategy to move the company in different directions. It all feeds on itself. As the talent base improves and the company’s success is recognized, it’s easier to bring in directors. The better directors you have, the more success you’re going to have in business.
On transforming companies: Our biggest turning point was in the late 1980s, when we decided to let our new deregulated business compete head-on with our well-established and regulated pipeline business and, in the process, maybe antagonize some of their customers and suppliers. Clearly we had divisions in the company where some of the executive team thought that was smart, and some thought it was dumb. We all understood it was fairly risky. The main battles were internal within the management team. The board was supportive of taking that risk.
Today our regulated pipelines are still a good business, but certainly that would never give us the kind of growth and opportunity we could obtain if we became truly “best in class” in operating in the deregulating energy markets.
On the biggest lesson learned: The most important thing is quality of talent. That’s true both on the management team and on the board. You have to have good talent to attract more talent.
