Energy traders profit from California's plight

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In Houston, it's known as "the power corner." Separated by just a few city blocks, four major power wholesalers run trading exchanges that have a strong influence on energy prices nationwide.

The trading floors run by Enron, Reliant Energy, Dynegy and Duke Energy represent ground zero in a power crisis threatening the quality of life in much of the western United States this summer.

By seizing on opportunities created by deregulation, the energy traders have turned up the juice in the electricity business in ways similar to how junk-bond traders ignited Wall Street in the 1980s and venture capitalists fueled Silicon Valley in the last decade.

And thanks to an exemption granted in the early 1990s, nobody monitors daily trading to detect unfair or illegal practices.

Utility bills in California have gone up nearly fourfold in the past year, to $27.1 billion. Without fundamental changes in the energy market, this year's bill will rise to $70 billion - more than $2,000 for every person in the state, according to operators of the state's power grid.

The staggering electricity-price increases have pushed the state's largest utility, Pacific Gas & Electric, into bankruptcy and left No. 2 Southern California Edison on the brink of insolvency. The state is spending about $50 million a day to buy power.

The energy wholesalers say they're doing nothing wrong.

They blame the high prices on the rising price of natural gas and the state's botched deregulation plan. By failing to line up reliable power ahead of time and by imposing price caps for consumers, the state put itself into this mess, the companies say.

"There have been accusations of wrongdoing for eight months now and there isn't a shred of evidence to support the allegations," said Gary Ackerman, executive director of the Western Power Trading Forum, a Menlo Park, Calif., trade group. "People are very angry and frustrated about electricity right now, and attorneys are trying to take that anger out on us."

Attorneys general in Washington, Oregon and California are probing whether the wholesalers have violated antitrust laws or engaged in unfair business practices. A California state senate committee may issue subpoenas for records and the testimony of top energy executives, and at least five lawsuits accuse energy companies of market abuses.

"This is the best fraud I have ever seen," said attorney Michael Aguirre of San Diego, who is involved in one of the class-action suits. "The generators are doing everything that you think that they might be doing, only it's worse than you ever imagined."

The lawsuits and investigations allege that generators have conspired to hijack billions of dollars from consumers and taxpayers by withholding electricity from energy-starved California until the last minute, and then supplying it at exorbitant prices.

Using the Internet as a tool

At Enron's Houston headquarters, energy specialists among the company's 1,500 traders swap electricity and natural-gas contracts like stocks and bonds. Mathematicians, meteorologists and economists make complex calculations to identify where to buy the cheapest power and where to deliver it at the greatest profit.

"They are extremely good at what they do," said Severin Borenstein, director of the University of California at Berkeley's Energy Institute.

The Internet has provided the traders with invaluable real-time information on the buying and selling patterns of their rivals.

Two lawsuits allege that traders have parlayed the sensitive information collected online to fix prices artificially high, a violation of antitrust laws.

Aguirre has spent six months assembling reams of data about traders and their activities, but he has yet to develop concrete evidence to prove his price-fixing allegations.

A March 21 report by California's electricity-grid managers concluded that, between last May and November, 98 percent of trading bids were driven up by noncompetitive patterns of behavior.

The California Independent System Operator report stopped short of accusing wholesalers of illegal market manipulation, but it did determine that the wholesalers collected as much as $6.9 billion in "unjust and unreasonable" rates.

Enron says its trading system, particularly the online exchange, has resulted in fairer and more efficient markets. The allegations of market abuse are "just some sour grapes from people who didn't come up with the idea in the first place," said Enron spokesman Eric Thode.

The online exchanges and other industry Web sites provide the energy traders with a window to see the energy availability and bids in markets around the country.

Power-industry critics, however, contend the Web's instant access provides the traders a way to exploit a delicate supply-demand balance.

"The whole trading thing is just a front that lets them game the market," Aguirre said. "They can get away with it because no one (outside the industry) can figure out what they are doing."

Whatever the energy traders are doing, it's not closely monitored by government regulators.

Energy trade gets exemption

In 1993, the trading of energy products received an exemption from oversight by the Commodity Futures Trading Commission (CFTC), a federal agency that oversees commodity and options trading to protect markets from fraud and manipulation. Energy is the only commodity that has received a blanket CFTC exemption.

The exemption was shepherded beginning in 1992 by then-CFTC chairwoman Wendy Gramm, wife of Texas Sen. Phil Gramm. She left the CFTC three months before the exemption received final approval in 1993. That same year, she joined the Enron board of directors, a post that last year earned her $50,000.

Gramm, an economist at the Mercatus Center at George Mason University, said she doesn't recall talking with Enron about the exemption, which she characterized as a routine matter triggered by an antitrust case involving crude oil.

"It really didn't have anything to do with Enron or any specific company," said Gramm. "It had to do with a general market problem."

In granting the exemption, the CFTC accepted the industry's contention that it shouldn't be subjected to the government's usual commodities regulation because its markets are dominated by "large sophisticated commercial entities" capable of protecting themselves - in short, that there would be no little people to hurt.

At the time, then-CFTC commissioner Sheila Bair scoffed at the reasoning, comparing energy traders to boiler-room sales operations that had the potential to violate federal anti-fraud laws.

"Is it really that much of a burden on market participants (for the CFTC) to retain a sliver of authority regarding fraudulent activity?" Bair wrote in a dissenting opinion.

Wholesale electricity prices negotiated by the traders are eventually compiled in quarterly reports and reviewed by the Federal Energy Regulatory Commission. And while FERC by law is supposed to prevent unfair prices, a majority of its commissioners have advocated a hands-off approach to California's energy crisis, insisting that the market can correct itself.

That posture may finally be changing somewhat. On Wednesday in San Jose, FERC Chairman Curt Hebert told lawmakers that his agency hopes to begin "monitoring and mitigating" the wholesale electricity market by May 1. This could allow FERC to pre-emptively influence prices.

Just `good business'

Energy economists who have studied the market see signs of ruthless, but perfectly legal, behavior.

Paul Joskow, an MIT economist, concluded in January that electricity producers deliberately withheld power to drive up prices.

"Every business exercises market power when it can, so I don't know why people are so surprised that (the generators) used their market power," Joskow said. "I didn't see any evidence of collusion in what they did ... It was just good business."

Enron yielded a big payoff last year - an operating profit of $1.6 billion, up 160 percent from $628 million in 1999.

When electricity and natural-gas prices soared to record highs in the fourth quarter, Enron's trading profit more than tripled to $538 million.

"Our success is linked to efficient markets, not higher prices in California, or anywhere else for that matter," Steve Kean, an Enron executive vice president, said in January testimony before the U.S. Senate. "What we are interested in is competitive and well-functioning markets. Our financial success is not built on California's back."