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Friday, November 30, 2007

Local Power Blog: How the Story of Enron Reflects on the Failures and Promises of Repowering Cities

We read "The Smartest Guys in the Room" out at Burning Man this year, and what follows is a lengthy reflection on the regulatory structures that doomed the initial round of energy deregulation and the promise of Local Power's new approach to electricity markets.

Enron sold power to big business and spot markets; Local Power repowers your home, your community and your city, whether you are large or small, resident or business, private party or public agency.

We serve the community, and define success on a multi-decade basis. Enron power and gas marketing were discount-based – promising cheaper power. Local Power is price neutral. We don’t want to be cheaper. We give you a vastly superior energy system for the same price - not just dramatically greener, locally built, and owned by local residents, businesses and governments – we offer long-term savings from less power consumption, less fuel charge exposure to global fossil fuel markets, and lower cost of service. We are simply better, and offering something that no one has ever offered American residents, business owners and governments.

Our product sells itself to consumers based on a new criterion: not cheaper power, but greener, more secure, less volatile power:predictability, better planning, and blackout protection. In other words: Repowering.

To the extent that Enron participated in longer-term contracts, their business development relied on cherry picking single customers (except when it unsuccessfully tried to buy Philadelphia customers in an effort to simulate Local Power conditions). Local Power serves whole communities through the Community Choice Aggregation opt-out mechanism. Enron abandoned the retail market just a few months after the market legally opened in California in 1998. Ken Lay was quoted announcing the failure of the market – saying it cost too much to “acquire” a customer to be worth the marketing effort.

Lay announced Enron would concentrate on spot market trading and large institutional customers only. Even among large corporate entities, only a few ever found suppliers. This was the unofficial beginning of the failure of “the California Model,” as its local supporters called it. Local Power is premised on substantial macroeconomic improvements on Enron - it is the solution not just to Climate Change, but to the Energy Crisis itself.

Local Power was developed at the same time that Enron was created, in the early 1990's, with the advent of the national electric industry restructuring debate. As the Enron model declined, Local Power has risen from the deregulatory ashes as the best answer to the failure of deregulation in California and other states, where utilities routinely abuse market power to block competitors, and the wide use of surcharges to bail out utilities. In particular, Local Power has been designed over ten years specifically to improve upon perceived weaknesses of deregulation as was invented in Great Britain and exported to California in the mid-1990s – specifically the weakness of electricity competition given the extreme capital cost to revenue ratio and the (hitherto) generic nature of commodity electricity. Local Power is designed to address these very flaws of Prime Minister Margaret Thatcher’s program.

Enron was based on gas commodity and gas-fired generation. Local Power is based on reducing gas price exposure and transmission dependency through a strategic investment in new local renewable power generation and demand-side technologies. Enron was behind the scenes in trading rooms or deal making.

Local Power is an operations enterprise emphasizing direct participation by any resident or business that chooses to own their own solar, wind or energy conservation financed by taxable bonds, or local government agencies using tax exempt bonds.Local Power deliberately integrates “high-cost” solar photovoltaics, demand response, and other distributed renewable technologies into its standard portfolios. Our contracts pencil from day one. As load reductions come on line in the system, our commodity coststructure improves as exposure to gas-fired generation fuel cost volatility declines. Enron’s (or the typical utility's) throughput-based profits, the global industry standard, is changed by Local Power – we focus on the avoided cost profit center of “phasing down”future wholesale power purchasing, particularly peak load scheduling.

Local Power bets against fossil fuels and for solar power, making our commitments less vulnerable to increasingly volatile and uneconomic fossil fuel-fired power generation. Because we focus on distributed technologies specifically, theresulting throughputs are also less vulnerable to transmission congestion-related costs.

Enron relied on its gas infrastructure to provide it with solvency and market power in its trading operations, but Skilling sought to unload it – one of the great ironies of Enron to the last breath. Enron and philosophy was deliberately Asset Lite: Enron billed itself a "logistics company," modeling its operations on Wall Streettraders and risk managers. This was the rage: when Azurix went south, Wall Street used it as proof that Skilling’s “lite” approach was superior to the large investments being made by Enron's water operations.Where Enron did make investments, it invested in traditional throughput-based utility deals. In the French water municipal privatization, a depreciated old water utility could not perform on the speed of return that investors expected. Returns were too slow for “equity investment lions.” Enron seemed divided from an over- “lite” business philosophy doing yin and yang battle with an over-heavy utility purchasing operation. Their economics were inelastic in either direction, indeed fundamentalist.

Local Power innovates here where Enrons and utilities are weakest,investing in infrastructure that is fuel-free rather than heavy – distributed generation and demand response infrastructure rather than pipes and wires. Silicon and software rather than steel.

The UK's Wessex water was a cost-based Enron franchise “concession” subject to regulation: unanticipated rate decreases by regulators single-handedly eliminated profits and revenues that Azurix had taken for granted in its Mark to Market accounting, and related stock value assumptions. By comparison, Local Power is a physically and symbolically present in its regional markets. Local Power has hardhats and trucks with logos, employing local electricians and installers, targeting rollout opportunities specifically (not get-in-get-out) and focuses itsinnovation on repowering the city. We emphasize visible, dramatic new infrastructure and technology from out in the street to inside your house and up on your roof.

This is reflected in the skills of Local Power's core group. Our company combines expertise in energy law, regulation, economics, design-build-operate-maintain contracts, performance incentives, portfolio design and deal structure, but also industrial multi-site acquisition and permitting, data rocessing, candidate selection, commodity monetization, network design, mapping, logistics, and permitting & zoning. We have developed proprietary software for managing the many complex and parallel processes involved in Local Power and are developing options for its commercialization. We regard this new system as a thing: a new kind of power plant.Enron relied heavily on commercial credit for trading, gas supply contracts and assets.

Local Power is based on a long-term partnership with a local government, enjoying access to low-cost, tax-exempt municipal bonds (H Bonds) and direct investment to finance facilities. Indeed, loss of credit rating was the coupde gras that took Enron down, forcing it to sell or lend against anything Enron owned just to make payroll: Enron wholesale was hitting all its targets during the collapse. As Enron became unable to roll commercial credit, it could no longer provide basic security on even short-term trades. Its trading business was “the core of its business survival” at the time of collapse; yet it also “consumed billions in cash": its structure rested on its credit rating, which under the Special Purpose Entity (SPE) deals depended on its stock price: no credit, no trading - and no earnings. Once the pretense of Fastow’s pre-liquidation of assets and contracts into collateral had securitized a deal and created an illusion of cash flow (two birds with one stone) by postponing the day of reckoning. By doing so made it made the collapse all the more severe when it finally occurred: credit rating drops, instant $3.9B in debt triggered. Collapse into insolvency. The day Enron showed negative cash flow, Skilling resigned.

The series of major Enron projects shows a progression of attempts to securitize power transactions in various ways:
• Enron Oil Scandal 1987’
• J Block 1997
• Brooklyn Union
• Long Island
• Teeside
• Sithe
• Azurix Wessex water
• Buenos Aires
• Medera County
• Elektro-Electricidade
• China, Dominican Republic, Brazil, Poland, India - Dabhol

In each deal, Enron had to somehow provide security for a supply chain deal between large entities: putting up its own money to pre-purchase huge quantities of gas in advance, then providing none, then giving up on structured rates and accepting market based prices. It never found a glove that really fit.

Enron’s “earthward spiral” was caused by this inherent weakness of its businessmodel, not the failure of all of its enterprises and projects. Local Power does not rule out commercial paper to finance locally-owned renewable energy and demand response systems, but unlike Enron its success does not depend on commercialcredit to do business, and not only is not a “trading only” business, but does not treat trading as the primary profit center. We are less vulnerable in terms of credit to build things or underwrite trades to provide a shockingly superior service – a major structural advantage over older power structures.

As an unregulated or quasi-regulated non-monopoly Enron was attempting to compete with the Big Energy companies as a market entrant (however leveraged), and also competed with Wall Street – with disastrous consequences. Lacking the regulatory guarantees and quasi-governmental sanctions andassociated privileges of investor-owned utilities, Mark-to-Market (M2M) accounting to show earnings to get credit and raise stock price, ginning up or imitating electric utility finance without having the resources to achieve it legitimately.

Without the “oxygen” or “lifeblood” of credit, the demand for Enron collateral to cover a trade was a “run on the bank,” exposing the financialsmallness of Enron without the traditional monopoly advantages put in place after the Great Crash of 1929 to prevent recurrence of such crises.

After the backup credit vaporized, Lay had to ask Alan Greenspan to ask the banks (which Skilling thought he was himself) to loan Enron a $ Billion or two. During the collapse, Enron burned a $ Billion in six days and $2 Billion in less than a month. Once the true state of Enron’s financial security was known, the Bankers (who were in some ways Enron’s competitors, in other way’s Enron’s analysts, and yet also its lenders) came back on their terms: demanding, naturally Enron’s last major asset: the Transwestern and Northern Pipeline System as collateral for commercial paper credit.

Skilling said “Either lend money or make an equity investment”; but this ignored the fact that for normal trading of commodities from capital-intensive, generic energy infrastructure debt does not distinguish between lending and owning: investor owned utility monopolies put debts and assets on the same balance sheet – in California, state regulators have become alchemists of non-bypassable surcharge-financed investment mechanisms, from funding bailouts to subsidizing energy efficiency programs.

Once Enron opened its books to its banks for the final emergency loan, and the banks started treating Enron as the non-utility it truly was in the financial security sense of the term, the bankers instantly commenced to regard it as prey - a waiting possession. That is because Enron’s concavity diluted its very existence: even Dynegy claimed ownership of Enron’s pipeline asset after its last-minute merger deal fell through. The Special Purpose Entities of Enron’s were invented to simulate a debt and revenue package not unlike a traditional municipal revenue bond. But Enron lacked the traditional partners. The utilities and cable companies, just like Wall Street, used every advantage to blocking any new market entrant into their quasi-monopolies.

Enron was big, but still small in this sense. Lacking any real equitypartner, Enron put up 3% equity for the CALPERS Special Purpose Entity as if to be “third party” to its own creation. Under Local Power, we don’t just have a third party: we have municipal revenue bonds and recurring revenues in a mechanism we have crafted to deliver a revolutionary scaled green power conversion of entire cities at prices that are the same (and lower in the long term) than utility power: a painless, rapid transition to a Clean Tech (and eventually the solar hydrogen) era.

For Enron, in the end, it became clear to the courts and Wall Street that the security on its debt was a fiction – what Fastow called “optimization”(again, resembling the utility finance paradigm): it is noteworthy that JP Morgan Chase and Citigroup confessed to have helped commit fraud against Enron investors through misrepresentation about the value of its stock; or Ben Glisan’s ultimate legal confession: “this transaction was accounted for in a manner inconsistent with its economic substance .” The Enron Board cried victim along with the banks, the analysts, and the accountants: but they could not escape the PRUDENCE principle: they had after all approved $38B in debt to Enron with no cash flow to show for it. Where capital costs are a factor, commercial credit cannot get the job done. There were limits to the New Economy after all. With Enron, success became failure when share value lost its stability (TSGITR p.232).

Its all about substance: Local Power provides precisely the substance that Enron lacked. Enron was a sink-hole of value. In the starkest contract, Local Power’s financing is as real as it gets. Local Power uses the balance sheet of municipal bond financing, regional recurring revenues and structured long-term repower services that dramatically green your community grid at competitive prices. In this sense Local Power does what Enron tried to fake: utility-grade deal structures with scalable security. With it we can facilitate the rapid growth that is necessary for a market entrant to build a revolutionary, visible new local power infrastructure globally within just a few decades. On Climate solutions, Local Power gets you there, and faster. Whereas Enron sought to own “50 percent of every transaction” globally, in spot markets via EOL and Enron Trading or wholesale contracts, Local Power seeks to enable 50 percent of one regional aggregated retail transaction – to provide commodity electricity and related services to a single whole community in return for our innovative repowering and enrichment of the community.

Local Power is based on longterm contracts with opt-out recurring revenues to reduce risk and provide legitimate security (thus lower interest rates and power cost) on its municipal financing. Enron was based largely on spot market trading with incremental earnings. Enron was spread out and virtual: Local Power is physically present in your neighborhood for decades in rollouts, operations and maintenance. Enron hid. We want you to see us.

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