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Enron as a Political Company (Part III: Robert L. Bradley Jr. Interview)

[Part III of an interview of Robert L. Bradley Jr. by Stephen Hicks (website here). Part I (Libertarianism and Energy) and Part II (Expanding Energy Horizons) have been published.]

“Ken Lay lives in Jim Rogers! The master of the regulation game for natural gas transmission brought Lay’s get-out-in-front political strategy from Enron to a company called Public Service Company of Indiana, which became Cinergy, which was bought by Duke Energy. Rogers positioned his coal-laden company as very concerned about climate change and wanting cap-and-trade regulation.”

Kaizen: Enron operated in a highly mixed political and economic environment. In the decades that Enron was operating—the 1980s through the early 2000s—to what extent was the U.S. energy market a free market, and to what extent was it regulated economy?

Bradley: The energy industries—oil, natural gas, and electricity—have all been politicized. And Ken Lay, the big-picture economics Ph.D., had a skill set that was attracted to the mixed economy and thus to energy, particularly to natural gas.

Kaizen: When was Enron created?

Bradley: Lay joined Houston Natural Gas Corporation as CEO in May 1984. The next year, HNG became HNG/InterNorth after a merger with InterNorth, a major Midwest supplier. A year later, in 1986, the company was renamed Enron.

Kaizen: Did it begin as a regulated company?

Bradley: Not really, interestingly. What Lay did in his first six months was to take a company that was selling gas in the largely unregulated Texas market through a vast intrastate pipeline and transform it into a company of interstate gas transmission companies regulated by the Federal Energy Regulatory Commission (FERC) out of Washington, D.C. FERC was the old Federal Power Commission (FPC), where Lay worked while in Washington, D.C.

So in addition to its unregulated core, Enron obtained three major interstate pipelines that are public-utility-regulated. And Lay starts staffing up with some very innovative folks who understood the ins and outs of public utility regulation.

James E. “Jim” Rogers

One was James E. “Jim” Rogers, who had a background with FERC. He was a master at figuring out ways for the regulated pipeline to “beat” its rate case, or how to exceed your authorized regulated rate of return.

Kaizen: So Rogers is a ‘gamer’ of regulation.

Bradley. Yes, but in a good way since in this case regulatory entrepreneurship was to a large extent pro-consumer—doing what your customers want to transport or sell gas in new ways.

Rogers left Enron in 1988 for the electricity industry and is now CEO of Duke Energy, a major electric utility company. He became the leading political entrepreneur of the electricity business. Over the years, he sold his industry on cap-and-trade as a global warming policy strategy—a real blow for the free market and those of us who are against climate alarmism and related policy activism.

Kaizen: So Rogers has continued the political capitalism strategy of the late Ken Lay?

Bradley: Yes–Ken Lay lives in Jim Rogers! The master of the regulation game for natural gas transmission brought Lay’s get-out-in-front political strategy from Enron to a company called Public Service Company of Indiana, which became Cinergy, which was bought by Duke Energy. Rogers positioned his coal-laden company as very concerned about climate change and wanting cap-and-trade regulation.

This might seem to be a paradox—a coal company wanting carbon dioxide regulation—but Rogers’s model, which was the Ken Lay model, was “Let’s see what regulation is coming. Let’s get out in front, get to the table. If you are not at the table eating, you’ll be on the menu.”

Rogers ran the math and figured out that with enough preference under cap-and-trade, he could convert his coal plants to natural gas—or just retire his coal plants, some of which needed to be mothballed anyway—and win in the transition with lots of emission allowances to monetize.

But this is at the expense of consumers: If not his own, then the others who do not fare well in the new world of rationed energy, which is what cap-and-trade is all about.

What Rogers did from the late ’80s to the present has caused a civil war within the electricity industry, which has led to the current cap-and-trade legislation before Congress. Most electric companies including their trade association, the Edison Electric Institute, are for pricing CO2.

But now Rogers is in some trouble because his political promiscuity has not worked out very well. And after raising expectations among Left environmentalists, there are protests in front of his house when he (Duke) proposes to build a new coal plant.

Lay Gets on Top

Kaizen: InterNorth bought HNG, so how did Lay and HNG in Houston come out on top?

Bradley: It was a reverse merger where the Chairman and CEO of the bigger InterNorth was an older man eyeing retirement. He saw the young Ken Lay as the future of the industry, and Lay worked a deal with InterNorth whereby HNG stockholders made out very well. That positioned Lay to become CEO of the combined company in short order.

Kaizen: But Lay was probably different from the old-school head of InterNorth.

Bradley. He was. He had already transformed the old Houston Natural Gas into something political. It started with federally regulated interstate gas transmission and continued with a number of profit centers that had lots to do with government intervention.

The Enron model was new for the energy industry. Really, Enron was the first energy company whose comparative advantage was playing the government side in the mixed economy, the political side of political capitalism.

Kaizen: The concept of “political capitalism” involves a distinction between market entrepreneurs and political entrepreneurs. What in general terms is the distinction between market and political entrepreneurship?

Bradley: Market entrepreneurship occurs where government is neutral, passive, and consumers drive outcomes. There’s no special government favors with the tax system, with regulations, or with financial grants. All firms are treated alike—no government picking winners or losers, other than government procurement (which can be neutrally outsourced).

So here you have Ken Lay—who is not an engineer like most successful energy company heads. He is a Ph.D. economist. He’s interested in the big picture. And Lay’s background, before entering the private sector for good in 1974, was heavy with Washington experience. Lay was a natural gas regulator with the predecessor agency to the FERC, the Federal Power Commission. Then Lay joined the Department of the Interior to regulate oil after Nixon imposed wage and price controls that caused oil shortages and led to a lot of allocation controls.

With his interest in the big picture and his Washington regulatory experience, Lay joined Florida Gas Transmission, whose major asset was an interstate, federally regulated pipeline. Then Lay goes to Transco Energy Company, whose major asset is a federally-regulated interstate pipeline. And then he’s hired away for Houston Natural Gas, which is largely unregulated, but within a year Lay has his company primarily in the regulated interstate gas transmission business. That was the beginning of his political business model.

A Political Company

Kaizen: If there is neutral government in a free market economy, as you mentioned, the way one makes money is by developing new products, increasing quantity, increasing quality, increasing customer service, and so on.

But in the political model—to the extent that the government is regulating the business sector—one’s route to success is through political ins and outs. In the political entrepreneurship model, you use your economic power to get a seat at the table, so to speak, to influence legislation, to get targeted subsidies, to put obstacles in the way of competitors.

So your thesis is that Ken Lay’s conscious strategy was for Enron to be a political company, one where business success would come through playing the political system well.

Bradley: Right, this is a new and fairly unique area of emphasis. But you still have the engineering, the accounting, all the traditional business functions that you need to do well. This extra layer of government involvement is Ken Lay’s comparative advantage.

Kaizen: And so-called “crony capitalism” then becomes essential, knowing the politicians, knowing the regulators, and having good relationships with them so as to be in a better position to get favorable regulations and largesse.

Bradley: Correct.

Kaizen: You were saying that at the beginning of the 1980s the energy field as a whole was much less regulated. Or was it still significantly regulated but what Ken Lay was doing was speeding up the process?

Bradley: A lot of the 1970s oil price and allocation regulation is gone by the early 1980s. But Lay was not interested in oil—no comparative advantage there with a free market back in control. But there is a lot of regulatory change with re-regulation of natural gas and electricity on the federal or wholesale (interstate) level. And on the state level too.

Within the state of Texas, there was very little energy regulation with natural gas at wholesale. And the old Houston Natural Gas was an intrastate gas company that was largely unregulated. So to answer your question, the energy industry was extremely regulated, except in some energy states where the main activity was intrastate.

Kaizen: So federal regulation is evolving and there’s variability among the states. I know that Enron was significantly involved in California toward the end, and California’s regulations were a significant part of the Enron story. It becomes a very complex political landscape.

Bradley: California transformed its regulation of electric utilities. It was part of a national movement spurred by Enron to get states to implement open-access, so that marketers (read Enron as first mover) could buy and sell power in the state rather than just interstate (wholesale). California’s new rules were a mess, and Enron’s traders infamously exploited them. The full story is in the books and covered in the movie, Smartest Guys in the Room. But this was not about deregulation and the free market by any means.

Kaizen: And this is part of a broader effort of Enron, the common denominator being regulatory change and government largesse.

Bradley: Enron gets involved in new areas that are very government driven, part of Enron’s self-described ‘revolutionary’ way of doing things.

For example, Enron became very involved in building pipelines and power plants in poor areas of the world. The infrastructure is badly needed, but the governments were bad, explaining why the country was so poor. This required that the U.S. government get involved to secure financing. Enter the Export/Import Bank and the Overseas Private Investment Corporation. So Enron has major projects based on taxpayer guarantees.

Enron was also doing some things that didn’t require government intervention. For example, in the U.K., where Margaret Thatcher opened up the market, allowing natural gas to compete with subsidized coal. Enron built the world’s largest gas-fired power plant in England, the Teesside project, in response to Thatcher’s privatization and deregulation. So there’s an instance that that got lots of media coverage where Lay and Enron wore the white hat.

But for the most part Enron’s profit centers had something to do with government intervention, whether it was with interstate gas pipelines, international asset development, energy trading with natural gas and later electricity under mandatory open-access, or wind and solar energy development.

Enron’s air emissions trading was another example, although such trading was not related to mandatory open access but to air pollution laws. Enron was the market leader with nitrogen oxides (NOX) and sulfur dioxide (SOX) and was gearing up to do the same with carbon dioxide (CO2), the major global warming gas.

Kaizen: Explain mandatory open access.

Bradley: It refers to a type of regulatory mandate, under public utility regulation. One sees it with long distance telephony, where interstate transmission has to be offered on a nondiscriminatory, rate-regulated basis to marketers of the commodity.

With transmission access from point A to point B, there could be buying and selling of the commodity, the gas or the electrons, by independent third parties that might or might not own the assets. And Enron did a lot of innovative things to be the leader in gas and in electricity marketing, two huge new businesses.

Enron is making a market, but this competitive space was in a contrived market, given mandatory open access. In a free market, the owners of the pipelines or wires could chose not to allow access to an outside party and do the marketing themselves. Or there could be integrated ownership involving the customers where a third-party marketer such as Enron was precluded.

Kaizen: So Enron emerges with some market-oriented segments and some political ones.

Can we put some approximate numbers to it? To what extent was Enron’s financial success in the early days a result of money coming in from government activities versus non-governmental activities?

Bradley: You could separate out those numbers. The trading business, first with natural gas and then with electricity, was really the major money-maker for the company, and this whole trading operation was built upon mandatory open access, as I just mentioned. So that would be on the government side of the ledger, although under government rules the transactions are voluntary by buyers and sellers. The wind and solar businesses are government dependent, as are investments such as the Dabhol powerplant in India, which was built on the strength of a federal loan guarantee.

The other thing that’s happening is that Enron’s public relations and government affairs departments are exploding. This is an incremental cost of Enron’s political capitalism model. And this gets to the “tar-baby effect” of more and more complex government intervention, with problems developing and the lobbyists having to work overtime to make things “fair” to the company. Enron is in the middle of this.

Kaizen: Rent-seeking and lobbying government can involve lots of sub-strategies, from just having a seat at the table to lobbying hard to push a certain interpretation or a change of regulations, to having inside knowledge or foreknowledge about what is likely to come along. All those things can still be within the purview of political entrepreneurship system—they are fair game so to speak.

Was Enron involved in anything beyond the standard ethical or legal limits here? Is there undue influence on regulators or politicians or outright bribery?

Bradley: The general answer to the best of my knowledge is No. Enron was certainly a master at stretching the interpretation of the law. But Enron’s smartest people, and the high-priced legal and accounting talent behind the company, were all about doing things legally, while helping the company.

I remember very distinctly Ken Lay’s concern about violating the Foreign Corrupt Practices Act. A violation might have occurred if an Enron official took a bribe from a foreign government, in country where bribes were okay. Remember: we were dealing with governments that were unstable or shady. I remember at a management conference he warned that if anybody violated this they were gone; there would be zero tolerance.

So Ken Lay was trying to be careful. He did not want to break the law, and his image as being someone who was shady or would break the law was completely counter to the image he wanted to have and to what he internally believed.

Fall of a Company

Kaizen: What about things worsened and then got desperate?

Bradley: As time went on, and he and the company got into trouble, things no doubt changed. There was tremendous pressure on Enron to find new things and to make new profits, and Ken Lay was very aggressive about Enron becoming “the world’s leading energy company,” which he said we achieved, and then becoming the world’s leading company period, which was our final vision as we peaked, before heading to the bottom.

So Lay’s very aggressive vision increasingly came into conflict with the reality of what Enron could do. The lack of midcourse corrections, which would have put these ambitious visions on ice, was just not something he could stomach.

Kaizen: And how about with your presentations. Did you have to resort to fudging?

Bradley: Ken Lay never asked me to use a bad number in a presentation to my knowledge. And I never knew about a bad number that I got from accounting and the different divisions. If I had known about it, I would have remembered it and, in the spirit of things, asked questions.

I am sure that I would have gone to Ken Lay about it, given that I, like many others (including Sherron Watkins, the famous whistleblower at the company), believed that Lay was honest. Some of this faith was naïve, in retrospect, as she found out, and I would later find out researching Enron from the outside well after my layoff in December 2001.

Interventionist Theory–and Rent-Seeking

Kaizen: Your case studies of government intervention have put you on the front lines of the theory of political capitalism. Is this what your Enron-inspired book Capitalism at Work is about?

Bradley: Yes. It actually began with Oil, Gas, and Government. I got to the end of that treatise, which summarized oil and gas intervention at all government levels from the nineteenth century until the 1980s, and I had to make sense of it all. What commonalities are there between the thousands of interventionist acts and hundreds of regulatory episodes? How do they fit with one another?

So I ended up creating a typology of intervention with categories and terms that I revised and published in an essay of a book dedicated to an old friend of mine who tragically died of cancer at age 51, Don Lavoie. That book is Humane Economics: Essays in Honor of Don Lavoie, edited by Jack High (Edward Elgar: 2006). My essay is “A Typology of Interventionist Dynamics.”

Oil, Gas, and Government also identified the different regulatory personalities in one of the concluding chapters, an early excursion by me into public choice theory.

Kaizen: What is a classification or distinction of your typology that might apply to Enron?

Bradley: A particularly useful one is that the political companies can practice either defensive or offensive rent-seeking.

An example of offensive intervention is where you’re really picking a fight and trying to create a whole new government opportunity in a new line of business. Trying to get open-access for electricity is one example: Enron hires a small army of lobbyists to get rule changes state-by-state. Enron did not have an electricity trading profit center, but it wanted to create one for new competitive space and profit-making.

Another example is building a power plant in a new country where government loan guarantees are needed. That is a whole new project and profit center—that’s going out of your way to violate free-market capitalism.

Defensive intervention is where you’re in an existing market, changes occur, and you’re in a bind and need government help.

An example would be clamoring for oil tariffs to raise the price of imported oil to help natural gas fend off residual fuel oil in dual-fuel power plants. That is exactly what Enron wanted, in 1986 and forward, to help gas compete against oil in Florida, for example, to aid Florida Gas Transmission, one of our interstate pipelines.

Kaizen: Is defensive rent-seeking any better?

Bradley: It is more common and more understandable. Imagine if you or I had a business that was threatened by imports of some kind. We have our equity and salaries in our business. We know the workers and even some of their families. The amoral decision would be to get legislative help—‘temporary’ of course.

The right answer would be to not be in that type of business, or to sell or liquidate it ahead of its crisis. Don’t put yourself in a position to be a government welfare case.

Kaizen: So there are examples of both with Enron.

Bradley: There are both, but what is pretty amazing in retrospect is how much offensive intervention there was. The scope and variety of rent-seeking in this regard was unprecedented to my knowledge. Again, this gets right to Ken Lay’s skill set as the big-picture Ph.D. economist.

3 comments

1 Bill Batt { 01.22.11 at 4:55 pm }

How in the world did that happen? Amazing!
Even acknowledging third party sources in places, the truth, or mostly true, comes out. Ken Lay made money by economic strategy and accounting tactics using the government against the government in a win-win ploy. WOW.

2 Jon Boone { 01.23.11 at 10:45 pm }

Political promiscuity indeed. An extraordinary account now descriptive of much energy policy. Although offensive and defensive intervention has been going on since before 1776, its scale is now ubiquitous, pervading every nook and cranny of government. Getting out in front of the “game” by rigging it in back rooms has become de regueur.

3 Rod Adams { 01.26.11 at 3:47 am }

Robert – thank you for sharing this information. I found it fascinating and potentially useful to know a little more about how political capitalism works.

I still have trouble figuring out how Lay thought of Enron as an energy company since they did not actually produce anything. All they seemed to do was to trade.

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