Conspiracy of Fools (8 page)

After so many months of controversy, the oil-trading-unit scandal appeared all but over.

Lay stretched out his legs as he sat in a soft, upholstered seat on an Enron corporate jet. It was the afternoon of October 9, 1987. He and a few colleagues were somewhere over the Atlantic, flying back from meetings with European investors. Lay was feeling a little sleepy when he noticed one of the pilots coming his way.

“Mr. Lay?” the pilot said. “We just got a message from Mr. Seidl. He’s getting on a plane, and he’s going to meet you in Gander.” Lay nodded. “Okay, thanks.”

This wasn’t good. Lay and the others were already on their way to Houston. What could be so urgent that his president would fly to meet him at a refueling stop in Newfoundland?

More than an hour later, the plane landed at the Gander International Airport. Lay and the other executives traveling with him—Forrest Hoglund from the oil and gas group and Kern, who had recently been named chief financial officer of that division—huddled in a corner of the terminal, waiting for Seidl. His plane arrived in less than an hour, and Seidl hustled off, finding his colleagues at a small table. He grabbed a chair and sat down with them.

“I was just up in New York with Lou Borget,” Seidl said. He had gone there for a social lunch at the Pierre Hotel, hoping to repair the relations strained by the investigations months before. But over the meal Borget had dropped a bombshell. His group’s bets on the direction of oil prices had been going badly. The group had been trading on expectations that prices would fall, but then they rose. When Borget doubled his bet, hoping to make up the loss, they rose again. To hide the problem, Seidl said, Valhalla kept two sets of books, never revealing their position to Houston.

“Now the trading desk has got some very, very large exposed positions that we didn’t know about,” Seidl said.

“How much are we talking about?” Lay asked.

Seidl took a breath. “Hundreds of millions, maybe more than a billion if the market goes the wrong way.”

Lay was speechless.
A billion dollars in potential trading losses?
With Enron still struggling under all the debt it had assumed in the merger, this could bring the company down. Immediately, the pilots were told that Lay’s flight plans were changing; he was heading to Valhalla.

Before getting on the plane, he contacted Mike Muckleroy, an experienced Enron oil trader in Houston who for months had been warning—just as the Andersen report had cautioned might be the case—that Borget had to be busting through his trading limits. But Lay hadn’t listened, chalking Muckleroy’s complaints up to jealousy. Now he needed Muckleroy to help save the company by cleaning up Borget’s mess.

By Saturday morning, Lay had arrived in Valhalla and summoned Borget to a nearby hotel conference room. Borget sauntered in, all smooth and self-confident.

“Okay, Ken,” he said. “I know we’ve got a problem here, but it’s manageable, and we’re going to solve it.”

“How did the problem happen, Lou?”

“Ken, I just saw it as a great opportunity for the company, a real chance to hit a super home run. I figured everybody in Houston would be nervous about it, but I didn’t think we could afford to pass up the opportunity.”

Borget pressed his charm offensive, but this time Lay wasn’t buying. Instead, he pumped Borget for information to help Enron minimize the disaster. Finally, when he figured he had heard everything Borget had to offer, Lay lowered the boom.

“Lou, you know you violated a lot of company policies in all of this,” he said. “And you’ve really exposed us to possibly horrendous downsides here.”

“Well, again, Ken, I’m very confident we can work all of this out without any harm to the company.”

Lay ignored him. “Lou, I have no choice but to terminate you.”

Borget sat back, speechless.
“What?”
he sputtered. “You can’t work your way out of this problem without me!”

“Yeah, Lou, we can.”

Borget pushed him to change his mind, but Lay was unbending. Finally Lay’s message sank in. Borget stood and made his way to the door, then stopped and turned.

“Well, if you decide you need my help, I’ll be at home. You can call me.”

With that, Borget strode away, leaving Enron forever.

———

The second scandal in the oil-trading division transformed Enron, destroying old internal alliances and reshaping the corporate leadership structure.

For three weeks, Mike Muckleroy led a group of traders in gradually shrinking the size of Enron’s oil-market position. They were in constant fear that competitors would realize the gravity of Enron’s situation and bid up the price of oil; after all, the company had to pay pretty much any price to save itself. But they pulled it off. By late October, Enron’s after-tax losses had shrunk to a manageable eighty-five million dollars.

In the months that followed, the Valhalla unit was shut down. Within a few years, Borget and Mastroeni were charged with fraud and tax crimes; Borget was also charged with aiding Enron in filing false income-tax returns through the profit shifting. Both men pleaded guilty; Borget was sentenced to a year in prison, and Mastroeni received a suspended sentence and probation.

Lay and Seidl knew someone had to pay the price for the debacle, and it certainly was not going to be Lay. While Seidl continued at Enron for a couple of years, his responsibilities gravitated to Rich Kinder, now working as chief of staff, sort of a roving Mr. Fixit. While Seidl was viewed internally as indecisive, Kinder was a barn-burning man of action who inspired fear in Enron’s executive ranks—just the sort of manager the company needed.

Lay acknowledged soon after the announcement of the trading losses that Enron would have to change its ways. In late October 1987, he called an all-employee meeting in Houston. He held himself up as a victim of Borget and Mastroeni, as someone who had no reason to suspect the problems in Valhalla. But, he said, he walked away from the scandal having learned an important lesson.

“We became involved in a business with risks that we did not appreciate well enough,” Lay told the assembled crowd. “And I promise you, we will never again risk Enron’s credibility in business ventures without first making sure we thoroughly understand the risks.”

It was a commitment he would fail to keep.

THE ELEVATOR DOORS OPENED
, and Jeff Skilling stepped into the broad hallway on the forty-ninth floor of the Enron building. He walked past a few inexpensive, nondescript paintings and turned left toward a solid-oak door. Fishing out his wallet, he rubbed it against a sensor in the wall and waited for the magnetic card inside to be read. The electronic lock clicked almost instantly.

Behind the door was a drab corridor with row upon row of empty offices and cubicles—space Enron had paid for but had little hope of filling anytime soon. Striding down the stark hallway, Skilling did not cut an impressive figure. At thirty-five, he was of medium height with a receding hairline and a few unnecessary pounds, the image of just another anonymous consultant working in the dreary surroundings of another besieged American corporation.

It was December 1988. For weeks Skilling and his team from McKinsey had been working here, struggling with Enron’s growing and maddeningly complex challenges. Deregulation had upended the game board for gas pipelines, but Enron had yet to devise a strategy to flourish in the new world. McKinsey was supposed to fix that, but after weeks of work Skilling’s team was no closer to an answer.

Skilling reached a large, open area lined with empty offices. His was the first on the right; a large conference table filled the room, piled high with stacks of paper—reports, memos, and other remnants of dozens of rejected strategies. He sat, reaching for a pad of quadrille paper. Something was tugging at the back of his mind—an idea, a thought, something Skilling had ruminated about for years. Maybe if he wrote it down, it would become clearer.

Pulling a pen out of his shirt pocket, Skilling sketched an axis, then drew a declining curve. He divided the curve into sections—at five years, ten years, twenty. He tore off the sheet and scribbled calculations on the next page. After about thirty minutes, he set down his pen and studied what he had written.

This is fucking brilliant
.

Could it be this simple? Here, on a couple of pages, was the answer to
Enron’s problems—hell, to the
industry’s
problems. Over the years, Skilling had often been electrified by his own ideas, but this one,
this
one was a gold mine. It was so elegant. It had to work.

Tearing the second sheet off the pad, Skilling scrambled out of the office in search of Rich Kinder, who was just moving up to the job of Enron’s vice chairman. As a consultant, Skilling couldn’t just take an idea and run with it; somebody at Enron needed to give the green light. He figured Kinder not only would understand his brainstorm but would have the guts to get it done.

On the other side of the building, Skilling rode a small executive elevator to fifty, then walked past the boardroom into Kinder’s office.

“Rich …”

“Jeff. What’s up?”

Skilling laid his quadrille paper on a small conference table. “Look at this.”

Kinder strode over to the table and skimmed the page. A bunch of numbers. He shrugged. So?

“Let’s say we go out and buy gas reserves,” Skilling said. “Give me a number, Rich. How much is it going to cost to buy gas reserves?”

“I don’t know, one dollar per mcf.”

A dollar for every thousand cubic feet of gas. Just as Skilling had figured. “Okay,” Skilling said. “So if we bought reserves at a dollar, we could take them and carve them up, send them to different term markets.”

Kinder didn’t know where this was going.

“Different contract terms,” Skilling continued. “Twenty years, ten years, five years, it doesn’t matter. And then we lock in their price with the contract.”

Skilling scribbled his graph again. Kinder recognized it as a standard gas-production curve. Gas wells are a lot like a shaken-up bottle of soda; when they are first tapped, built-up pressure pushes out fuel, but over time that force—and the volume of gas coming out—drop. That was reflected in the curve Skilling sketched, showing declining production over many years. But, he said, if Enron owned reserves with a production curve of two decades, it could calculate a fixed price for gas sales over periods of years. The longer the term of the contract—the further out on the production curve—the more expensive the price. The market movement for gas prices wouldn’t matter, since Enron would already have locked in its costs at one dollar.

Kinder understood the implications immediately. With deregulation, the old world of fixed gas rates was gone, and prices were now dictated by the open market—meaning a cold snap, a shortage, anything could drive them up rapidly. Suddenly industrial customers couldn’t anticipate fuel costs, pipelines couldn’t be sure they could guarantee delivery on a long-term
contract, and producers were only as good as their last well. The uncertainty was already driving industry toward dirtier fuels—coal, oil—with more reliable pricing. This Skilling idea might change all that. Enron could transform cleaner natural gas into a dependable choice, buying it at fixed, rock-bottom prices, selling it for more, and pocketing the difference.

It would be like a bank, Skilling said, but instead of taking in and sending out money, Enron would traffic in gas. Producers would be depositors, gas customers would be borrowers, and Enron would be rich. To attract the business, he said, Enron would need a marketing division, but from there everything should come together.

“Rich,” Skilling said. “What if I told you that I can construct a twenty-year contract, right now, at $2.20.”

Kinder stood back. “You’re fucking kidding me.”

“No, I’m not fucking kidding you.”

It was one of those rare eureka moments. Industrial customers were having enough trouble obtaining twenty-year contracts, and finding one at less than four dollars per thousand cubic feet was thought to be impossible. A guaranteed fixed price from Enron of just over two dollars would bring every customer to the company’s doorstep.

“If that’s true,” Kinder said, “then we will own the power-generation market in North America.”

Skilling beamed. “Yep,” he said, nodding.

Word of some gangbuster new McKinsey idea crackled through Enron, and soon everyone wanted to hear the details. Within days, a group of about twenty Enron executives gathered in conference room 49C1 for their own briefing from Skilling. Most were ready to give up much of their afternoon; typically, McKinsey reports ran on for as long as a hundred pages and took hours to review.

Once everyone was seated, Skilling stepped forward and placed a single transparency on an overhead projector. It was a more professional version of his original scribbles.

“The concept is pretty simple,” Skilling began, launching into his analysis. After about twenty minutes, he stepped away from the projector.

The room was silent.

“That’s it?” Kinder asked. He had been expecting a beefed-up presentation this time.

“Yeah, that’s it.”

Kinder nodded. “Okay, let’s go around and see what everybody thinks.” To one side, Jim Rogers Jr., head of the interstate pipeline operation, waved a hand. Kinder nodded his way.

“Yeah,” Rogers said. “I’ve got to say, that’s the dumbest idea I’ve ever heard in my life.”

Skilling’s face fell.

“Who’s going to do this?” Rogers continued. “Why is somebody going to sell at those prices? Why will customers come to us? That’s not our business.”

Rogers’s scorn unleashed a torrent of doubts and criticism from other executives in the room. Skilling had failed to take a proper account of the take-or-pay contracts, they said; worse, it forced Enron to be responsible for maintaining a market for gas, making its pipelines almost beside the point. It just wouldn’t work.

The meeting ended, and Skilling, downcast, followed Kinder to the elevator for the fiftieth floor. Kinder pulled out an unlit cigar, chewing it as the doors opened. He pushed the button for fifty.