BUSINESSWEEK ONLINE : FEBRUARY 12, 2001 ISSUE
COVER STORY ONLINE EXTRA: Q&A with Enron's Skilling "In every business we've been in, we're the good guys" As President Jeffrey K. Skilling prepares to take the reins of Enron Corp. on Feb. 12, he acknowledges that his new role of CEO may require him to be a little "less blunt." Interviews with Skilling at his Houston headquarters make clear doing so will be a challenge for one of the most innovative, provocative players in the energy patch. Thanks to Skilling and his more diplomatic counterpart, current CEO and Chairman Kenneth L. Lay, Enron has quickly transformed itself from a lumbering pipeline into North America's largest buyer and seller of natural gas and electricity, along with a slew of energy-related financial derivatives. And it's quickly conquering Europe and heading for Japan. While California's troubles with electricity deregulation have caught Enron in the spotlight, Skilling hasn't lost faith in free markets and how the company can benefit from them. Here are edited excerpts of his conversations with Dallas Bureau Chief Wendy Zellner: Q: When did you see that your trading model could be applied in a much broader way than just natural gas, where Enron started? A: The real breakthrough for us was electricity. Everyone told us we were crazy, that this just absolutely wouldn't apply, that gas and electricity were different.... I used to remember thinking, well, so what? It's a commodity, for crying out loud. We had the burden of proof, but we were right. We were able to create a market very similar to the market in natural gas. We'd hear talk about what business-to-business people were going to do in these verticals [bandwidth, steel, pulp, and paper]. It was almost naive. We've created markets, and we knew what it took. And it's not as simple as putting a screen up and saying, O.K., everyone, come and buy and sell the stuff. It's logistics, the back office, the scheduling, the risk management, the credit -- all the things that make markets operate. We've done it in gas, we've done it in electricity, we're doing it in bandwidth. Q: But doesn't market knowledge count for something? A: Most of the B-to-B guys weren't bringing the market knowledge. Most of them were from outside the industry [and were forming alliances with industry players]. We'd seen in the gas and the electricity business that the incumbents will fight you to the death. Anyone trying to create an open, transparent market is [their] worst nightmare, right? Q: What's different about taking on the incumbents in these new arenas vs. energy, where you had some assets and market knowledge? A: We'll see.... Maybe we're just crazy enough to think the parallels are pretty clear. I think the challenge is exactly the same. You've got to create liquidity, and you have to create a transaction infrastructure that allows people to [be certain] that if they need the product they can transact for [it] at a price. Once you've got that, then you see these markets explode. At least, that's been our experience in gas and electricity. Q: Why is it so difficult to for others to gain market share in your business? A: If you look at this whole concept of creating markets, the fundamental advantage of a virtually integrated system vs. a physically integrated system is you need less capital to provide the same reliability. How do you do that? It's a financial theory. Nondelivery is a nonsystematic risk. If a pipeline blows up or a compressor goes down or a wire breaks, the bigger your portfolio, the greater your ability to wire around that. So, if for example, I'm just starting in the gas merchant business and I'm selling gas from central Kansas to Kansas City, if the pipeline [between those places] blows up, I'm out of business. For Enron, if that pipeline blows up, I'll back haul out of New York, or I'll bring Canadian gas in and spin it through some storage facilities. If you can diversify your infrastructure, you can reduce nonsystematic risk, which says there's a...very strong tangible network effect.... But you've got to get big, you've got to get that initial market share, or you're toast. That's why we'll continue to see shakeouts in this business. It's impossible to manage risk if you're a little player. Q: Do you see yourself as sort of trustbusters in other industries? A: If you walk around the halls here, people have a mission. The mission is we're on the side of angels. We're taking on the entrenched monopolies. In every business we've been in, we're the good guys. That's why they don't like us. Customers love us, but the incumbents don't like us. We're bringing the benefits of choice and free markets to the world. You have no idea how frustrating it was in the early days of gas. They had built all the rules to protect their monopolies. Q: Has your broadband business developed the way you thought it would? A: When I look at the broadband business, we're way ahead of where we were at this [stage] in electricity. We did over 300 transactions last year, which is great. The first year in electricity, I'd be surprised if we did 50.... There's a huge, huge glut [of high-speed communications capacity]. This is exactly our environment. This is natural gas in 1988. Look at the telecom business. What's the price of throughput? It's collapsing. It's like gas prices did. They're all absolutely leveraged to the hilt, and they need money. [He figures that gives Enron an opening to create forward contracts that will allow such players to get financing, as it did in the gas business.] Q: But in steel and pulp and paper, those players have been around a long time and gone through more commodity cycles than the telecom guys. Why has it taken so long for industries like that to get on board your market-making model? A: The old way they reduced the risk is they'd vertically integrate. If you were Exxon in the old days, you integrated across the whole chain.... If you were afraid crude-oil prices would go down, you'd own the refinery, too, because you liked it if crude prices went down.... That made a lot of sense...because it was very expensive to make sure you could get reliable supplies of crude oil to go into a refinery if you didn't own the crude oil. Well, now you go on your computer and get it instantaneously.... If you have somebody who comes along and says hey, look, I'm going to virtually vertically integrate because it's a whole lot cheaper, you're not going to be cost-competitive. Q: Do you have a different strategy when it comes to assets than some of your competitors who are buying up power plants? A: Right now, it's not a bad thing to have, but two years or three years from now.... Electricity is a totally undifferentiated product. It's going to be worse than the commodity chemical business. The last thing you want, in my view, is a gigantic navy of power plants. Q: But someone has to own the plants. In your view, who would want them? A: Financial institutions, insurance companies, and pension funds. They have the lowest cost of capital. What we should be doing as an industry is packaging them in a way where we take away the risks that they don't like. They don't like to operate things. They don't like to take the risk on commodity prices. We ought to do that stuff and then sell them the underlying asset with kind of an annuity return. Q: Is there any kind of commodity that doesn't fit what Enron does? A: Things that are really unique, one of a kind, knickknacks. And any truly financial commodities don't do much for us. I don't want to compete with Goldman Sachs because I'm not good at what they're good at. They're not good at what I'm good at. I want to focus on things where there tends to be a dedicated, unique delivery and logistics system attached to the commodity and a quasi-commodity. If it doesn't have either of those, I'm not real interested. Q: How much growth [potential] is in the energy side of the business? A: If you look at the wholesale side, between the U.S., Europe, and Japan, probably only about 20% of the market has converted from regulated to nonregulated. If we just hang on to our market share, we'll grow by a factor of five over the next couple of years.... Our investors should be watching carefully how we do in pulp and paper and metals. If we're successful there, that's ironclad proof the model translates beyond pure network businesses, like gas and electricity and bandwidth. Then there's really no stopping. Q: Do you fear you're spreading yourselves too thin, given how much growth is left in the core business? A: I really don't. I think it's just the opposite. [Enron is out of exploration and development and international development of assets in 27 countries.] Two years from now, we'll be making markets in a number of different commodities, but we'll be making markets -- and that's it.... In a lot of ways we're concentrating, getting more focused as time goes on. Q: What did you learn from the Azurix flop? [Water company Azurix is an Enron spin-off that it recently bought back, after the company failed to meet earnings expectations and the share price plummeted.] A: It reinforced the realization that it's very hard to earn a compensatory rate of return on a traditional asset investment.... In today's world, you have to bring intellectual content to the product, or you will not earn a fair rate of return. Q: How do you see outgoing CEO Ken Lay's role changing? [Lay remains as chairman.] A: Ken has always been in a lot of ways the face of Enron to the outside world, and that's great because Ken is a tremendous representative of the company with the government, the regulators, the customers. I hope Ken will keep doing that. To be honest, I don't think there's going to be a whole lot of change in the way we work together. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Enron's Power Play COVER IMAGE: Power Broker CHART: Enron Taps Volatile Energy Markets...To Dominate Power Sales... TABLE: The Enron Way TABLE: Is There Anything They Can't Trade? Enron's Big Wheel Has a Heavy Tread Derring-Do in the Corner Office RESUME: Jeffrey K. Skilling Commentary: Enron Hasn't Made Many Friends in the Third World (int'l edition) ONLINE EXTRA: Q&A with Enron's Skilling INTERACT E-Mail to Business Week Online

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