The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron

by Bethany McLean

  Skilling threw his crack troops into the power game, but the early years were tough. With Lou Pai leading the charge, Enron had begun trading in June 1994, even before the federal open-access rules had passed. The originators, led by Ken Rice, began trying to make long-term power deals with the utilities, both to buy and sell electricity and to arrange for access to their transmission lines. But the industry simply wasn’t interested in letting Enron into the club; many utilities wouldn’t even talk to Rice’s deal makers. Skilling then dreamed up the idea of forming a consortium with a dozen far-flung utility companies. As he envisioned it, the utilities would build and manage the power plants; Enron would market the electricity they generated, do the trading, and use its lobbying resources to widen deregulation. He even had a vaguely ominous name for it: NAPCON, for North American Power Consortium.

  But Skilling’s grand scheme went nowhere. Utility executives weren’t about to hand over the keys to their kingdom to Enron. Skilling’s notion was naive and presumptuous. “You’ll never get 12 utility executives to agree on anything,” one of his deputies tried to tell him. “Why not?” responded Skilling. “This makes perfect sense!” So Skilling sent some of his people to shop the idea around. “We talked to a dozen utility executives, and they all kicked us out of their offices,” recalls one of his former aides. “Jeff didn’t have the practical experience to realize there are some things you can’t do.” Skilling finally came to appreciate the state of affairs. “They hated us,” he later admitted. “The electricity guys were scared to death of Enron. It was very hard to break into the electricity market.”

  So Skilling went in another direction: he decided to buy his way into the club by having Enron purchase a utility. He wanted one in the West, with access to the California market, in part because that market was so big and in part because it was one of the few states up to that point to pass any form of retail deregulation allowing direct access to consumers of electricity. He had other criteria as well: he wanted a utility with no nuclear power plants (a political nightmare), one that wasn’t too big (so Enron could swallow the acquisition), and one that had a short position in power (Enron was expecting prices to fall).

  Once again, he met with stiff resistance. Cliff Baxter, his chief deal maker, approached dozens of utilities, none of which wanted anything to do with En-

  ron. Finally, though, he found one: a midsize utility in Oregon, called Portland General.

  To get the utility to agree to a buyout, Enron offered a price—$2.1 billion plus the assumption of another $1.1 billion in debt, which represented a 46 percent premium to its market price. (Because of the high price, Enron stock dropped nearly 5 percent on the news.) That was yet another difference between Skilling and Kinder: once Skilling got his eye on the prize, price was no object. He believed that the business he would build with the asset would make so much money that it didn’t matter if he overspent in the beginning.

  In fact, the real price of Portland General was even higher. In the wake of the June 1996 announcement, Enron was so high-handed with the Oregon Pub-

  lic Utility Commission, whose approval was required, that one commissioner publicly upbraided the company’s management, with Lay in attendance, for treating the state officials like rubes. “We don’t ride around in turnip trucks here,” the commissioner declared. Responding to the company’s refusal to provide documents or make concessions, the panel’s staff actually recommended rejecting the acquisition until Cliff Baxter presented an offer to give Oregonians a $141 million rate cut. The deal didn’t close until July 1997.

  The purchase gave Skilling what he wanted: entrée to California’s power grid and a copy of the utility industry’s secret playbook. It also gave him a big supply of electricity to trade. In both the United States and overseas, Enron’s originators were now pitching electric power and natural gas—often to the same big customers. By 1998, it was the biggest power merchant in North America.

  No longer satisfied with being “the world’s first gas major,” Enron had adopted a new, more aggressive corporate goal: to become “The World’s Leading Energy Company.” Skilling even had vanity license plates made for his car with the initials WLEC.

  • • •

  Then there were the divisions that Skilling felt no longer deserved a prominent place in Enron’s portfolio. These were largely the parts of the company that Enron had been built on—the old-fashioned parts of the old HNG and InterNorth, such as the pipelines. Skilling, in fact, considered selling the pipeline division itself, though he eventually backed away from that idea.

  In other cases, when he saw an opportunity to shed an old business, he took it—even when that business was profitable and brought cash in the door. Consider the case of Enron Oil and Gas, or EOG, as everyone at Enron called it. Though it was a separate company with its own publicly traded stock, EOG was, in effect, Enron’s in-house oil and gas production unit. (Enron held a majority stake in it.) EOG made its money by drilling wells in search of hydrocarbons, as wildcatters had been doing in Texas since the turn of the century. You could not find a better-run part of Enron; under CEO Forrest Hoglund, who’d had the job since 1987, EOG’s production had tripled and costs had been cut to the bone. It had long provided Enron with both cash flow and profits. But Hoglund was fiercely independent and no fan of Jeff Skilling.

  Over the years, EOG had played two important roles for Enron. First, it had provided a backup source of natural gas for Enron’s customers. Second, thanks to a series of well-timed public offerings, it had been instrumental more than once in allowing Enron to hit its earnings targets. Along the way, Enron Oil and Gas had also made its shareholders very happy. In 1994, with the stock soaring, Hoglund himself had cashed in $19 million worth of options, a development Lay touted as evidence of Enron’s entrepreneurial environment. (“If Forrest creates enormous value for the shareholders and receives enormous compensation for it, then Godspeed to him. I’m not afraid to hire someone who’s smarter, more creative, prettier, more handsome, or more highly paid.”)

  But with trading now the dominant motif at Enron, the company no longer felt it was necessary to have a homegrown supply of natural gas. As an EOG executive summed it up: “They didn’t feel they needed the gas wells and the people. If they wanted to go long gas, they could just do it on the trading floor.” As for the profits Enron had reaped from those stock sales, well, Skilling felt pretty sure he wouldn’t be needing those anymore either, not after he finished remaking the company. What he especially disliked about EOG was that its profits were erratic and volatile, which made it that much more difficult to show Wall Street the kind of smoothly rising earnings that would move the stock.

  In late 1998, Enron was approached by Occidental Petroleum, which wanted to buy Enron’s majority stake in EOG. It was a shrewd move by Occidental; because of a deep slump in gas prices, EOG’s shares had sunk to $14, the lowest they’d been in years. The oil company saw a chance to grab a great asset at a below-market price. Which it very nearly did. Skilling (and Baxter, who, as always, conducted the negotiations) very quickly cut a deal with Occidental. Under the terms, EOG would be dismembered: Occidental would get its North American assets, Enron would get its international properties. Occidental would pay with a combination of stock and cash. Enron, however, would get all the cash, and EOG shareholders would get the stock. When you added it up, the sale price amounted to a small premium over the market price but nowhere near the $25 a share the company had been worth early the previous year.

  Hoglund was livid when he learned about the deal. The price was much too low, he said. And the EOG shareholders were being cheated by having to take Occidental stock when Enron itself was getting cash. Hoglund quickly hired Goldman Sachs as an outside adviser, demanded a review by EOG’s independent directors—who voted down the deal—and threatened a public fight. It took him five months, but Hoglund killed the deal. (As a result of this conflict, Enron for years largely excluded Goldman from consideration for its lucrati
ve investment-banking business.)

  Now it was Skilling’s turn to be furious. More determined than ever to unload EOG, Skilling sent Baxter to negotiate with Hoglund directly. After weeks of bitter talks, Hoglund won EOG’s independence. Enron would sell the bulk of its stake in EOG, mostly back to the company. In return, Enron would get $600 million in cash and EOG’s holdings in China and India. At the time of the deal, EOG stock was valued at about $22 a share. When the brutal negotiations were finally over, Baxter, who was largely outmaneuvered by Hoglund, sent his crusty adversary a huge bouquet of flowers, accompanied by a conciliatory note: “Forrest: We finally got the right deal done.” Hoglund sent Baxter a droll response: “Dear Cliff: There’s no question we finally got the right deal done. But what you need to understand is that I’m from the Midwest, and I think this means we’re engaged.”

  After the EOG spinoff was complete, Hoglund retired, turning the company over to his second in command. Sure enough, by the end of 2000, EOG’s stock had risen to $54 a share, more than twice the value at which Enron had sold it. In his eagerness to unload Enron’s EOG stake, Skilling had left more than $1 billion on the table.

  • • •

  Don’t think for a minute that Skilling had forgotten about Rebecca Mark—or that she had forgotten about him. Mark was furious about Skilling’s promotion. It meant that Ken Lay had lied to her: he had said that he wasn’t going to replace Kinder anytime soon.

  With Skilling in charge, Mark’s charmed career at Enron was not likely to be charmed much longer. Skilling had long been her chief in-house critic, disdainful and suspicious of her deals and her operation. But as long as they’d been equals, she’d been able to fend him off. Now that Skilling was her boss, she darkly suspected that her days at Enron were numbered. In this, she was completely right. Over the next two years, the two became locked in the business equivalent of guerilla warfare. It was a war Rebecca Mark never really had a chance to win.

  In later years, the media explained the divide between Skilling and Mark as a fundamental difference of business philosophy: Skilling believed Enron’s future lay in what came to be known as his asset-light strategy, driven by brainpower not physical infrastructure. As Mark herself liked to put it: “Oh, Jeff just hates assets.” And of course Mark’s division was nothing but hard assets.

  But that was never quite right. Physical assets were always the foundation for Skilling’s own business success. Enron’s pipeline system revealed the secrets for making a fortune trading natural gas; the Portland General acquisition provided entrée into the new world of electricity trading. Later Skilling bought paper mills so Enron could start trading pulp and paper, and a billion-dollar fiber network launched broadband trading. Skilling thought he had it down to a formula: En-

  ron would buy the infrastructure needed to crack the code, build a new trading business—and then unload the assets when everybody else started to pile in. During his tenure at the top of Enron, the company spent billions on physical assets.

  His problem with Mark’s overseas plants and pipelines was that he simply didn’t believe her deals made sense. There was no particular strategy driving her empire-building; she would strike deals in any country that would have her and for just about any kind of power or energy project. “When they found a deal, they did a deal,” recalls a former Enron executive. “It was buckshot all over the globe.” Mark used to speak nobly about helping the world’s underdeveloped nations. But, as this same executive pointed out, “bringing technology and light to people in darkened states is not a business.” Skilling believed that Mark’s projects could be justified only if their returns were extraordinarily high, because the risks she was taking in volatile emerging markets were enormous. And in his opinion, the returns just weren’t there.

  Not that he had any way of knowing for sure. That was another of his beefs: her international deals routinely sidestepped internal corporate review. Skilling complained it was impossible to get good numbers from Mark. Even as her peer, back when he’d been running ECT, Skilling had argued that his own risk-control group should be charged with reviewing her deals. Intent on maintaining her autonomy, and suspicious of Skilling’s motives, Mark had beaten back the effort. But Skilling had managed to make other incursions. In 1993, he took over responsibility for all North American power plants, which had been part of Wing’s old empire. Soon he was given responsibility for England as well.

  Then there was the matter of compensation. Nothing bugged the executives at ECT more than knowing that Mark and her developers were paid huge bonuses without regard for how their deals turned out. Mark, for example, received bonuses of $1 million to $2 million, even for some small Enron International projects. As the ECT side saw it, this provided a mindless incentive for the developers to keep building—and gin up a rosy projection to justify it.

  Valid as the criticism was, it contained a large element of hypocrisy. After all, ECT’s traders and originators were also richly rewarded up front based largely on their own long-term profit projections, which could be every bit as rosy. And unlike the traders, the international developers often put in years of work on a project before getting a bonus at all. One former Enron executive says: “It was basically prima donnas accusing other prima donnas of being a bigger prima donna.”

  Still, bringing Mark to heel was not going to be easy; her projects had enormous momentum. Nonetheless, Skilling began the process of slowly clipping her wings. His first big move after becoming president was to pitch Lay on the idea of giving him responsibility for all of Enron’s operations in western Europe. His reasoning was that Enron’s plants could be used as a platform for building a regional trading and marketing business, in essence, a foundation for a global ECT. Besides, the plant developers needed ECT’s trading and risk-management expertise. Hadn’t the J-Block disaster proven as much?

  Mark objected bitterly and lobbied Lay to let her keep that part of her empire. The fight came to a head at an Enron off-site meeting in San Antonio, where Lay convened a meeting with the principals. Mark made the case that her people knew Europe and Enron’s projects there best; she viewed Skilling’s proposal as a brazen power grab. “As soon as we build something,” she said, “you want to take it away!” When it became clear that Lay was siding with Skilling, Mark and her deputy, a former military man named Joe Sutton, got up and stormed out of the meeting.

  Mark later described the resulting encounter with Lay to friends. “I’ve never had anyone walk out on me in my whole business career,” he told her.

  “Ken,” Mark responded, “all you want is what Jeff wants.”

  To the outside world, Rebecca Mark was still riding high. Fortune put her on its list of the 50 most powerful women in American business. Media profiles gushed that she had a shot at eventually replacing Lay as CEO.

  But Mark knew the battle was lost. She was desperate for a way out of the company and away from Skilling. She was contemplating quitting when another idea landed in her lap: selling Enron International to Shell. Skilling agreed to consider it, as long as Cliff Baxter served as lead negotiator. Discussions went on for months. Lay, in the summer of 1997, sat down for lunch with a top Shell executive. A price tag was even batted around: as much as $3 billion for a 50 percent stake. But there was never a formal offer on the table. A Shell negotiator says the company was worried about the cultural fit, among other things. Mark blamed Baxter and Skilling for mismanaging the negotiations.

  During that same period, something truly curious happened. During the summer of 1997, Mark invited Skilling to spend a week with her touring development prospects in South America, and he accepted. She had employed this tactic before, with board members. She’d taken them overseas, wined them and dined them with high-ranking officials, given them tours of the projects, and explained the good they might do someday. It worked like magic.

  Amazingly, her tour had the same effect on Skilling. He came back eager to pour money into the continent’s southern cone. Of course, he used th
e classic Skilling rationale: if Enron could build a critical mass of infrastructure in South America, it could leverage those assets into a big new trading business. “South America—awesome story,” he gushed at an Enron employee meeting in May 1999. “. . . South America may be our strongest network in the world. . . .” Skilling was so jazzed about his visit he even bought a beach house in Brazil with an executive from Enron’s South American operations. The transformation was so dramatic that rumors started flying that the ever-beguiling Mark had—literally and figuratively—seduced him. (Both have denied any personal involvement.)

  Nevertheless, Skilling continued to make Mark’s life miserable, gradually stripping Enron International of its independence. By May 1998, she’d finally had enough. Mark handed her post as CEO of Enron International to Joe Sutton while remaining EI’s chairman. She also became an Enron vice chairman, a title known internally as “the ejector seat” because it was viewed as the first step out the door.

  And yet when you look back on the two years the two battled for control of Enron International, one striking fact stands out above all else: in all that time, Rebecca Mark kept striking deals and building power plants. And Skilling, for all his talk about how poor her assets were and how unreliable her numbers, never shut off the flow of Enron’s cash—and never shut down her deals.