Ken Unplugged

Utilities around the world are being forced to deal with the advent of open competition for electric power is leading the charge to transform power distribution.

November 1 1997 by JP Donlon

If you canvas utility CEOs regarding the one competitor they most fear and admire, the name most likely to pop up is Enron. This Houston-based company-with 1996 revenues over $13 billion-may be one of the largest integrated natural gas and electricity companies in the world, but it’s hardly a household name. Ken Lay, 55, Enron’s short, trim, soft-spoken CEO with an affable Missouri farm boy manner, is an unlikely figure of terror. Leading the charge to open the $210 billion North American electricity market to    competition, Lay is also intent on capturing international energy infrastructure—- business as state-owned and private  monopolies around the world are dismantled and give way to open competition.     

Having already swept the developing world in telecoms and transportation deregulation is descending upon energy as the last monopoly sector to fall. As a result of pending deregulation in the U.S., consumers saw the average price of electricity fall by 0.55 percent according to this year’s National Utility Service International survey (see chart). More than a dozen states have enacted plans or introduced legislation to deregulate at the retail level, and pressure is building for other states to follow.

Given that the country’s retail electricity market is big-larger than the nation’s telecommunication market-Enron is maneuvering past some of the larger utilities selling in wholesale markets by selling directly to other utilities and municipalities. The strategy is to bypass local utilities by selling electricity directly to homeowners, businesses, and industrial users. Traders such as Enron would be able to buy cheap power from some utilities, supplement it with their own power, and sell it in pricier markets. Last year the company paid $3.2 billion for Oregon‘s Portland General, joining a trend of gas and electricity providers becoming hybrid suppliers. The advent of new suppliers of electricity would lead to new services, possibly cleaner energy-and lower rates. Lay estimates competition will reduce consumer electricity bills by 30 to 40 percent-which would be like a national tax cut of around $70 billion.

With the pace of deregulation moving two steps forward and one back it’s not clear whether anyone’s strategy will be a clear winner. At the heart of the deregulatory debate in each state is the recovery of “stranded costs,” investments in expensive and redundant power generation undertaken when costs were routinely passed on to customers via rate regulation. Then there is the question of operational configuration. Some utilities in the end may not control the relationship with their customer. In order to have the freedom to bundle other services, such as telephone and cable TV, some may be regulated to maintain the power wire. Boston Edison is selling off its oil and gas generation plants. Peco and Utilicorp have come together with other utilities to offer a branded product: EnergyOne. “The concept of energy branding,” observes The Futures Group’s Kenneth Sawka, “demands capabilities such as marketing, advertising, and sales-attributes not normally associated with today’s traditional utilities.”

Not content to re-invent itself at home, Enron has been blazing a trail in Europe by entering into power generation deals with Enel, the Italian state-owned electricity company, and gas fired power stations in Poland and the U.K. By 1999, Enron’s ownership of U.K. electricity generation will rise to 7 percent. The company has spent $300 million over the last five years developing proprietary trading and computer systems to help manage risks. Lay figures international markets will deregulate quicker than most think.

The international power game is not for the fainthearted. Five years after announcing its $2.5 billion project in Dabhol, India, Enron is finally building its LNG plant after the Maharashtra government vowed to cancel it. After 24 lawsuits, approvals from three successive governments, and much friction, Enron walked away with a deal $10 billion bigger than the original. Despite the region’s obvious need for power modernization, projects proceed slowly, forcing foreign investors such as Hyundai and Toyota to rethink. Lay, who grew up on a farm in Tyrone, MO, seems untroubled by the risks. Trained as an economist, he earned a degree from the University of Missouri and later worked for Humble Oil. After service with the Navy and the U.S. Interior, he worked for Florida Gas and later became president of Transco Energy. In 1984, he was CEO of Houston Natural Gas and emerged as the CEO of its merger with Omaha-based InterNorth, another struggling pipeline company. An advocate of free markets, Lay says it’s about time gas-fired power took on coal and won economically. So far few are betting against him.


If we are at the dawn of deregulated power, what does this actually mean for business?

For the CEOs who are consumers, it will allow them to have choice of who’s going to provide them their electricity. They can begin to think about buying electricity-and over time natural gas-on a nationwide basis. And, of course, the end result of that will be lower prices.

Most estimates or most studies would indicate that deregulation will initially result in a very significant cost savings of probably 15 to 20 percent on the average across the country and within a five-plus year period, probably as much as 30 to 40 percent.

You’re also going to see a lot of innovation, just as we have in other industries that have deregulated, such as telecommunications. Typically, a regulated monopoly franchised business does not have much incentive to innovate; quite the contrary. But as we deregulate, you’re going to see a lot of new products and services come to the marketplace that really meet the needs of business.

Who are likely to be the biggest winners and losers in this?

Consumers will clearly be the biggest winners-including the smallest residential consumer, the smallest farmer, the most remote consumer-because all consumers will have a choice and have access to competitively priced electricity.

Utilities are going to have to make choices as to what parts of the business they’re going to stay in, and whether they can be competitive in parts of it, because as generation and marketing of electricity becomes a fully open, competitive business, they’ve got to be fully open and competitive to remain in that business.

I imagine to some utilities you must be their worst nightmare.

I’ve been told that. I don’t try to be, but…

Some of them have sunk investment that they don’t think they’re going to recover. What options do they have?

The first thing is to start now and try to reduce operating costs as much as they can, and most of them have started that process. Certainly, many over the last two or three years have postponed investments.

The regulatory framework has been one that has encouraged the wrong kind of decisions. As long as you have a monopoly franchise and you have pretty much a guarantee from the regulators that you can recover your costs plus get a return on your investment, you build in the wrong incentives. That’s exactly what we’ve done here. We’ve built in incentives that actually provided very little incentive to hold down operating costs and provided a lot of incentive to put in very expensive investments, particularly power generation. Because the more expensive the power plant, the more money that was made as far as the return on equity, which was pretty much guaranteed in the old regime.

Increasingly, pressure has been on the state regulatory commissions as well as people in Washington, that this last big remaining monopoly franchise must be opened up for competition. So, many states have already taken action.


If it’s true that to some degree, the utilities industry is a prisoner of its regulated past, then you too were in that prison. How did you personally change to anticipate this new world of deregulated power?

It probably goes back to a couple of things. One is my academic training in economics. There you spend an awful lot of time figuring out how markets work and why they work and how they might work better and differently. So I started off with a pretty good underpinning. And secondly, I’m a strong believer that the market’s still the best way to allocate resources and set prices in any society, and I think that’s now been pretty well demonstrated around the world.

So, even when I was on the staff of the Federal Energy Regulatory Commission, which obviously regulated the natural gas business in the early ’70s, I was more interested in trying to figure out how we could let markets versus regulators make more of the decisions.

In this post-deregulated world, when everybody’s playing by the same rules, where is your advantage?

First is a culture of competition. We were certainly one of the leaders in bringing the natural gas industry through a deregulated phase, and as part of that, we have put in place a lot of people, investments in technology, and a culture where, in fact, we are very aggressive marketers. Before the year’s out, we’ll probably be the largest marketer of electricity in the country, period. With our Portland General acquisition, with continued strong growth in our wholesale volumes, we’ll be the largest wholesale marketer.

That gives us some scale advantages, and some technology advantages. We’ve invested hundreds of millions of dollars in computer systems and control systems as well as in training our people. We’ve also been the leader in the natural gas markets on providing longer term contracts, and on providing different types of options for both buying and selling gas.

How much market share do you reckon you’ll have when the smoke clears ?

We will be very disappointed if we don’t have at least 10 or 15 percent. Right now, we have 16 to 18 percent of the national market in natural gas, and more than 25 percent of the wholesale electricity market as it’s opening up.

What do you see in terms of deregulation of energy markets outside the U.S.? Where are your big opportunities?

I think Europe‘s the next big opportunity. And it’s probably about five years or so behind the United States. The U.K. market is already pretty well liberalized-at the wholesale level. And all of the retail natural gas and electricity markets in the U.K. will open up in 1998, across the whole country. That’s about a $14 billion market.

We are now the third largest wholesale marketer of natural gas in the U.K. behind British Gas and British Petroleum. We’re the largest independent marketer of wholesale electricity in that market. We have a small retail company in the U.K. beginning to market gas and electricity to the retail market.

How does what you learned from the episode in India inform your future strategy related to similar types of international projects?

As I look back at it-and I was right in the middle of a lot of it-I’m not sure we could have done things much differently than we did.

But I think the first thing it points out is, no matter how thorough you are and how careful you are putting these projects together in developing countries, there can always be surprises. In this case, it was a change in political leadership, and of course, you particularly don’t expect that in a democracy, but it can happen.

It points out the importance of the legal instruments. I mean, making sure that you really have strong contracts, but also, strong legal recourse. In this case, we had very strong arbitration rights. And the language was such that, in the end, we might have ended up with more money by not building the plant than building it.

But, it turned out okay, and now the project’s about 70 percent completed, and the first phase will be generating electricity by late next year. And now that we’ve gone through it, we have a very strong, positive reputation within India, because people believe that we did stand up to politicians for our rights, while, at the same time, we were reasonable about trying to meet their needs, too. So, now we have all kinds of opportunities being brought to us in India because people feel like we are a company that can get things done in India. And, India is a difficult country to get things done in.


What is the outstanding challenge that lays ahead for you at Enron?

On the market side, the biggest challenge will be to successfully execute this strategy to capture a significant portion of the retail electricity and natural gas market in the U.S. and in Western Europe. We’re obviously spending a lot of money and resources on trying to do that or getting ready to do that right now. But we still have to execute. And that will all start in earnest early next year, but will extend over the next few years.

And, if we can do that, then, of course, we will move Enron again to a whole different level. Over the next five years, there’s no reason that that retail electricity and natural gas business alone couldn’t double or more than double the current size of the company, both in terms of revenue and net income. So, it’s got enormous potential; but it’s not on automatic. It’s going to take a lot of execution.

Next to that, the biggest single challenge is going to be to continue to attract very, very bright talent, very creative talent, and create an environment where we can retain most of them and keep them generating the kind of ideas and the type of innovation we’ve had here the last several years.

Apart from those business issues, is there a personal challenge you face?

Given the amount of growth we’ve experienced and expansion into so many international markets, it’s so time consuming that it’s challenging to figure out how to keep carving off a little time to do other things, such as being with my wife and family.

I enjoy golf; I just don’t get out to do it as often as I’d like. I love snow skiing, which I do a lot of during the winter. I have a house in Aspen. I jog and work out quite a bit, just about every morning, to stay semi-physically fit, particularly with all the travel.

Was there any person or event significant in your life, in forming you as a person?

My parents. I had two very loving parents and very supportive parents. We didn’t have much from the standpoint of material things, but we had a very loving family, and-this is probably true of everybody-that probably did more to form my foundation and my life and my values than anything else.