Pre-merger origins (1925–1985)
One of Enron's primary predecessors was the Northern Natural Gas Company, which was formed in 1930, in Omaha, Nebraska just a few months after Black Tuesday. The low cost of natural gas and cheap labor supply during the Great Depression helped to fuel the company's early beginnings. The company doubled in size by 1932 and was able to bring the first natural gas to Minnesota. Over the next 50 years, Northern expanded even more as it acquired many energy companies and created new divisions within. It was reorganized in 1979 as the main subsidiary of a holding company, InterNorth, which was a diversified energy and energy-related products company. Although most of the acquisitions conducted were successful, some ended poorly. InterNorth competed with Cooper Industries over a hostile takeover of Crouse-Hinds Company, an electrical products manufacturer. InterNorth was ultimately unsuccessful as Cooper bought out Crouse-Hinds. Cooper and InterNorth feuded over numerous suits during the course of the takeover that were eventually settled after the transaction was completed. The subsidiary Northern Natural Gas operated the largest natural gas pipeline company in North America. By the 1980s, InterNorth became a major force for natural gas production, transmission, and marketing as well as for natural gas liquids, and was an innovator in the plastics industry. In 1983, InterNorth merged with the Belco Petroleum Company, a Fortune 500 oil exploration and development company founded by Arthur Belfer.
Houston Natural Gas
The Houston Natural Gas (HNG) corporation was initially formed from the Houston Oil Co. in 1925 to provide gas to customers in the Houston market through the building of gas pipelines. Under the leadership of CEO Robert Herring from 1967 to 1981, the company became a large dominant force in the energy industry with a large pipeline network as a result from a prosperous period of growth in the early to mid-1970s. This growth was largely a result of the exploitation of the unregulated Texas natural gas market and the commodity surge in the early 1970s. Toward the end of the 1970s, HNG's luck began to run out with rising gas prices forcing clients to switch to oil. In addition, with the passing of the
Natural Gas Policy Act of 1978, the Texas market was more difficult to profit from and as a result, HNG's profits fell. After Herring's death in 1981,
M.D. Matthews briefly took over as CEO in a 3-year stint with initial success, but ultimately, a big dip in earnings led to his exit. In 1984, Kenneth Lay succeeded Matthews and inherited the troubled, but large diversified energy conglomerate.
InterNorth, in its conservative success, became a target of corporate takeovers, the most prominent being corporate raider Irwin Jacobs. InterNorth CEO Sam Segnar, in searching for a company to merge with to fend off takeover attempts as a poison pill, discovered HNG. In May 1985, Internorth acquired HNG for $2.3 billion, 40% higher than the current market price, in order to avoid the corporate takeover attempt. The combined assets of the two companies would create the second largest gas pipeline system at the time in the United States. Internorth’s north-south pipelines that served Iowa and Minnesota complemented HNG’s Florida and California east-west pipelines well.
Post-merger rise (1985–1991)
The company was initially named "HNG/InterNorth Inc.", even though InterNorth was technically the parent. At the outset, Segnar was CEO for a short time, before he was fired by the Board of Directors whereupon Lay was tapped to be the new CEO. Lay moved the headquarters of the new company back to energy capital Houston. The company then set out to find a new name, spent upwards of $100,000 in focus groups and consulting before "Enteron" was suggested. The name was eventually dismissed over its apparent likening to an intestine and shortened to "Enron." (The distinctive logo was one of the final major projects of legendary graphic designer Paul Rand before his death in 1996.) Enron still had some lingering problems left over from its merger, however. The company had to pay Jacobs, who was still a threat, over $350 million and reorganize the company. Lay sold off any parts of the company that he believed didn't belong in the long-term future of Enron. Lay consolidated all the gas pipeline efforts under the Enron Gas Pipeline Operating Company. In addition, the company began to ramp up its electric power and natural gas efforts. In 1988 and 1989, the company began adding power plants and cogeneration units to its portfolio. In 1989, Jeffrey Skilling, then a consultant at McKinsey & Company, came up with the idea to link natural gas to consumers in more ways, effectively turning natural gas into a commodity. Enron adopted the idea and called it the "Gas Bank." The division's success prompted Skilling to join Enron as the head of the Gas Bank in 1991. Another major development inside Enron was the beginning of the company's pivot to overseas that was expanded upon in the 1990s. Starting in 1989, the company received a $56 million loan from the Overseas Private Investment Corporation (OPIC) for a power plant in Argentina.
- New regulations gradually create a market-pricing system for natural gas. Federal Energy Regulatory Commission (FERC) Order 436 (1985) provides blanket approval for pipelines that choose to become common carriers transporting gas intrastate. FERC Order 451 (1986) deregulates the wellhead, and FERC Order 490 (April 1988) authorizes producers, pipelines, and others to terminate gas sales or purchases without seeking prior FERC approval. As a result of these orders, more than 75% of gas sales are conducted through the spot market, and unprecedented market volatility exists.
- Houston Natural Gas, run by Kenneth Lay merges with
Internorth, a natural gas company in Omaha, Nebraska, to form an interstate and intrastate natural gas pipeline with approximately 37,000 miles of pipeline.
- Lay is appointed Chairman and Chief Executive of the combined company. The company chooses the name "Enron" after rejecting "Enteron"
- Company moves headquarters to Houston, where Ken Lay lives. Enron is both a natural oil and gas company.
- Enron's vision: To become the premier natural-gas pipeline in America
- Enron Oil, Enron's flourishing petroleum marketing operation, reports loss of $85 million in 8-K filings. True loss of $142 – $190 million is concealed until 1993. Two top Enron Oil executives in Valhalla plead guilty to defraud and to filing false tax returns. One serves time in prison.
- The Company's major strategy shift - to pursue unregulated markets in addition to its regulated pipeline business- is decided in a gathering that became known as the Come to Jesus meeting.
- Enron enters UK energy market and becomes the first U.S. company to construct a power plant in Great Britain after electric industry there is privatized. The power plant is located in Teesside, UK.
- Enron launches Gas Bank, that will be run by CEO Jeff Skilling in 1990, which allows gas producers and wholesale buyers to purchase firm gas supplies and hedge the price risk at the same time.
- Enron begins offering financing to oil and gas producers.
- Transwestern Pipeline Company, owned by Enron, is the first merchant pipeline in the United States to stop selling gas and become a transportation only pipeline.
- Enron adopts mark-to-market accounting practices, reporting income and value of assets at their replacement cost
- Rebecca Mark becomes Chairman and CEO of Enron Development Corp., a unit formed to pursue international markets
- Andy Fastow forms the first of many off-balance-sheet partnerships for legitimate purposes. Later, off-balance-sheet partnerships and transactions will become a way for money losing ventures to be concealed and income reporting to be accelerated.
- Enron acquires Transportadora de Gas del Sur
Over the course of the 1990s, Enron made a few changes to its business plan that greatly improved the perceived profitability of the company. First, Enron invested heavily in overseas assets, specifically energy. Another major shift was the gradual transition of focus from a producer of energy to a company that acted more like an investment firm and sometimes a hedge fund, making profits off the margins of the products it traded. These products were traded through the Gas Bank concept, now called the Enron Finance Corp. headed by Skilling.
Operations as a trading firm
With the success of the Gas Bank trading natural gas, Skilling looked to expand the horizons of his division, Enron Capital & Trade. Skilling hired Andrew Fastow in 1990 to help with this.
Entrance into the retail energy market
Starting in 1994 under the Energy Policy Act of 1992, Congress allowed states to deregulate their electricity utilities, allowing them to be opened for competition. California was one such state to do so. Enron, seeing an opportunity with rising prices, was eager to jump into the market. In 1997, Enron acquired Portland General Electric (PGE). Although an Oregon utility, it had potential to begin serving the massive California market since PGE was a regulated utility. The new Enron division, Enron Energy, ramped up its efforts by offering discounts to potential customers in California for switching their electric supplier to Enron from their previous supplier, starting in 1998. Enron Energy also began to sell natural gas to customers in Ohio and wind power in Iowa. However, in 1999, the company ended its retail endeavor, only offering wholesale energy as it was revealed it was spending upwards of $100 million a year.
As fiber optic technology progressed in the 1990s, multiple companies, including Enron, attempted to make money by "keeping the continuing network costs low," which was done by owning their own network. In 1997, FTV Communications LLC, a limited liability company formed by Enron subsidiary FirstPoint Communications, Inc., Williams Communications Group, Inc. and Touch America. FTV constructed a 1,380 mile fiber optic network between Portland and Las Vegas. In 1998, Enron constructed a building in a rundown area of Las Vegas near E Sahara, building right over the "backbone" of fiber optic cables providing service to technology companies nationwide. The location had the ability to send "the entire Library of Congress anywhere in the world within minutes" and could stream "video to the whole state of California." The location was also more protected from natural disasters than areas such as Los Angeles or the East Coast. According to Wall Street Daily, "Enron had a secret," it "wanted to trade bandwidth like it traded oil, gas, electricity, etc. It launched a secret plan to build an enormous amount of fiber optic transmission capacity in Las Vegas ... it was all part of Enron’s plan to essentially own the internet." Enron sought to have all US internet service providers rely on their Nevada facility to supply bandwidth, which Enron would sell in a fashion similar to other commodities.
In January 2000, Kenneth Lay and Jeffrey Skilling announced to analysts that they were going to open trading for their own "high-speed fiber-optic networks that form the backbone for Internet traffic". Investors quickly bought Enron stock following the announcement "as they did with most things Internet-related at the time", with stock prices rising from $40 per share in January 2000 to $70 per share in March, peaking at $90 in the summer of 2000. Enron executives obtained windfall gains from the rising stock prices, with a total of $924 million of stocks sold by high-level Enron employees between 2000 and 2001. Head of Enron Broadband Services, Kenneth Rice, sold 1 million shares himself, earning about $70 million in returns. As prices of existing fiber optic cables plummeted due to the vast oversupply of the system, with only 5% of the 40 million miles being active wires, Enron purchased the inactive "dark fibers", expecting to buy them at low cost and then make a profit as the need for more usage by internet providers increased, with Enron expecting to lease its acquired dark fibers in 20 year contracts to providers. However, Enron's accounting would use estimates to determine how much their dark fiber would be worth when "lit" and apply those estimates to their current income, adding exaggerated revenue to their accounts since transactions were not yet made and it was not known if the cables would ever be active. Enron's trading with other energy companies within the broadband market was its attempt to lure large telecommunications companies, such as Verizon Communications, into its broadband scheme to create its own new market.
By the second quarter of 2001, Enron Broadband Services was reporting losses. On March 12, 2001, a proposed 20-year deal between Enron and Blockbuster Inc. to stream movies on demand over Enron's connections was cancelled, with Enron shares dropping from $80 per share in mid-February 2001 to below $60 the week after the deal was killed. The branch of the company that Jeffrey Skilling "said would eventually add $40 billion to Enron's stock value" added only about $408 million in revenue for Enron in 2001, with the company's broadband arm closed shortly after its meager second-quarter earnings report in July 2001.
Following the bankruptcy of Enron, telecommunications holdings were sold for "pennies on the dollar." In 2002, Rob Roy of Switch Communications purchased Enron's Nevada facility in an auction attended only by Roy. Enron's "fiber plans were so secretive that few people even knew about the auction." The facility was sold for only $930,000. Following the sale, Switch expanded to control "the biggest data center in the world."
Enron, seeing stability after the merger, began to look overseas for new possible energy opportunities in 1991. Enron's first such opportunity was a natural gas power plant utilizing cogeneration that the company built in Teesside, UK. The power plant was so large it could produce up to 3% of the United Kingdom's electricity demand with a capacity of over 1,875 megawatts. Seeing the success in England, the company developed and diversified its assets worldwide under the name of Enron International (EI), headed by former HNG executive Rebecca Mark. By 1994, EI's portfolio included assets in The Philippines, Australia, Guatemala, Germany, France, India, Argentina, the Caribbean, China, England, Colombia, Turkey, Bolivia, Brazil, Indonesia, Norway, Poland, and Japan. The division was becoming a large share of earnings for Enron, contributing 25% of earnings in 1996. Mark and EI believed the water industry was the next market to be deregulated by authorities and seeing the potential, searched for ways to enter the market, similar to PGE.
In 1998, Enron International acquired Wessex Water for $2.88 billion. Wessex Water became the core asset of a new company, Azurix, which expanded to other water companies. After Azurix's promising IPO in June 1999, Enron "sucked out over $1 billion in cash while loading it up with debt," according to Bethany McLean and Peter Elkind, authors of The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron.:250 Additionally, British water regulators required Wessex to cut its rates by 12% starting in April 2000, and an upgrade was required of the utility's aging infrastructure, estimated at costing over a billion dollars.:255 By the end of 2000 Azurix had an operating profit of less than $100 million and was $2 billion in debt.:257 In August 2000, after Azurix stock took a plunge following its earnings report,:257 Mark resigned from Azurix and Enron. Azurix assets, including Wessex, were eventually sold by Enron.
Misleading financial accounts
In 1990, Enron's Chief Operating Officer Jeffrey Skilling hired Andrew Fastow, who was well acquainted with the burgeoning deregulated energy market that Skilling wanted to exploit. In 1993, Fastow began establishing numerous limited liability special-purpose entities (a common business practice in the energy industry); however, it also allowed Enron to transfer liability so that it would not appear in its accounts, allowing it to maintain a robust and generally increasing stock price and thus keeping its critical investment grade credit ratings.
Enron was originally involved in transmitting and distributing electricity and natural gas throughout the United States. The company developed, built, and operated power plants and pipelines while dealing with rules of law and other infrastructures worldwide. Enron owned a large network of natural gas pipelines, which stretched coast to coast and border to border including Northern Natural Gas, Florida Gas Transmission, Transwestern Pipeline company and a partnership in Northern Border Pipeline from Canada. The states of California, New Hampshire, and Rhode Island had already passed power deregulation laws by July 1996, the time of Enron's proposal to acquire Portland General Electric corporation. During 1998, Enron began operations in the water sector, creating the Azurix Corporation, which it part-floated on the New York Stock Exchange during June 1999. Azurix failed to become successful in the water utility market, and one of its major concessions, in Buenos Aires, was a large-scale money-loser.
Enron grew wealthy due largely to marketing, promoting power, and its high stock price. Enron was named "America's Most Innovative Company" by the magazine Fortune for six consecutive years, from 1996 to 2001. It was on the Fortune's "100 Best Companies to Work for in America" list during 2000, and had offices that were stunning in their opulence. Enron was hailed by many, including labor and the workforce, as an overall great company, praised for its large long-term pensions, benefits for its workers and extremely effective management until the exposure of its corporate fraud. The first analyst to question the company's success story was Daniel Scotto, an energy market expert at BNP Paribas, who issued a note in August 2001 entitled Enron: All stressed up and no place to go, which encouraged investors to sell Enron stocks, although he only changed his recommendation on the stock from "buy" to "neutral."
As was later discovered, many of Enron's recorded assets and profits were inflated or even wholly fraudulent and nonexistent. One example of fraudulent records was during 1999 when Enron promised to repay Merrill Lynch's investment with interest in order to show a profit on its books. Debts and losses were put into entities formed "offshore" that were not included in the company's financial statements, and other sophisticated and arcane financial transactions between Enron and related companies were used to eliminate unprofitable entities from the company's books.
The company's most valuable asset and the largest source of honest income, the 1930s-era Northern Natural Gas company, was eventually purchased by a group of Omaha investors, who relocated its headquarters back to Omaha; it is now a unit of Warren Buffett's Berkshire Hathaway Energy. NNG was established as collateral for a $2.5 billion capital infusion by Dynegy Corporation when Dynegy was planning to buy Enron. When Dynegy examined Enron's financial records carefully, they repudiated the deal and dismissed their CEO, Chuck Watson. The new chairman and CEO, the late Daniel Dienstbier, had been president of NNG and an Enron executive at one time and was forced out of Enron by Ken Lay. Dienstbier was an acquaintance of Warren Buffett. NNG continues to be profitable now.