Natural Gas's Hottest SpotThane Peterson
When Enron Corp.'s shares topped 50 recently, Chairman Kenneth L. Lay gave each of his 7,800 employees a crisp new $50 bill. Lay was celebrating a yearlong burst in the stock--and much more than that, he hopes. Most pipeline shares are soaring as investors bet that President Clinton will promote use of clean, plentiful natural gas. And Enron is leading the pack, based partly on belief in Lay's dream of building the natural gas equivalent of an Exxon, Mobil, or Texaco. Enron already has the largest gas-pipeline system in the U.S. and a big oil-and-gas exploration unit. Now, it is moving aggressively to exploit deregulation at home and privatization of all sorts of energy companies abroad. "Rather than resisting change," says Lay, "we're trying to lead it and prosper from it."
TRYING HARD. In the past three years, Enron's gas-services unit has become a leader in using innovative financial instruments to sell gas to two growing markets: independent producers that supply power to electric utilities, and newly deregulated local gas companies. Enron is also building its own independent power plants in the U.S. and overseas. In 1992, the gas-services and power units accounted for $201 million of the company's $773 million in operating income, up from zip a few years ago. That helped lift Enron's net by 20%, to $306 million, on sales that rose 13.7%, to $6.3 billion--even as average gas prices stagnated. Pipelines, once the dominant business, fell to 42% of operating income.
Lay's sights have risen considerably since 1985, when, as CEO of Houston Natural Gas Corp., he merged it with pipeline company InterNorth Inc. As dereg-ulation opened up the industry, the PhD economist, now 50, showed a knack for strategy and for making influential friends. A supporter of George Bush, Lay has just signed former Secretary of State James A. Baker III and ex-Commerce Secretary Robert A. Mosbacher as consultants to arrange deals in the Mideast and the former Soviet Union. At home, he has entrusted Enron's key units to entrepreneurial lieutenants such as oil veteran Forrest E. Hoglund, 59, recruited from Texas Oil & Gas Corp. to run the exploration unit, and Jeffrey K. Skilling, 39, a former McKinsey & Co. partner who heads gas services.
NEW WAYS TO PLAY. Skilling's fiefdom is Enron's hottest. As deregulation was phased in during the 1980s, federally regulated gas pricing gave way to spot sales on the open market, and by the late 1980s, to more complex contracts. Skilling's group has led the industry in spinning out a variety of longer-term contracts at fixed prices, or at prices tied to the spot market or various indexes. Its operating earnings hit $122.3 million last year--up fourfold in just two years--on revenues that jumped 43%, to $2.8 billion. Lay expects 20% annual compound growth for the group over the next few years.
The unit's success stems partly from production-payment deals it uses to buy reserves from cash-strapped small producers. In one such deal, Enron put up $38.5 million of the $45 million that Denver-based Forest Oil Corp. needed to buy some properties last year. In return, Enron will get about half of the 48 billion cubic feet of gas Forest develops there. Enron had already sold the gas--at higher than spot-market prices--under contracts of varying lengths that are calibrated to the projected life of the reserves. A 30-day contract might earn 1 per thousand cubic feet of gas, Skilling says, vs. 6 or 8 for a five-year contract. Prudential Securities Inc. analyst David N. Fleischer figures that on average, Enron's gas-services unit earns 6 per thousand cubic feet, which he thinks is "higher than even its best competitors."
Enron's approach has gotten a boost from last year's Energy Act. Until it was passed, federal rules required pipeline companies to come to the rescue if local utilities couldn't buy enough spot-market gas. The legislation changed that, however, and now, local gas companies have to line up supplies on their own. C.L. "Chuck" Watson, CEO of Natural Gas Clearinghouse, a big Enron rival, thinks "a huge market will develop" as local distributors seek stable alternatives to spot-buying. Skilling says he now has 57 different types of contracts and services to sell those companies.
Electric-utility deregulation provides a related opportunity. The share of U.S. electricity generated by independent power producers is projected to hit 20% or more by the late 1990s, vs. nothing in 1980. Most independents burn gas, and they often need fixed-price contracts to get financing. Enron has agreed to provide 1.4 trillion cubic feet of gas over 20 years to a 1,000-megawatt project being planned near Oswego, N.Y., by New York City-based Sithe Energies Inc. The contract fixes the price of much of the gas for five years and indexes it after that. Sithe Vice-President James Spencer calls Enron "essential to the deal," since he says none of its rivals could craft the complex terms needed to make it fly. Competitors say the contract was just too risky for them.
HEATING UP. Undaunted, Enron is building power plants. When its $1.6 billion Teesside project on England's northeast coast opens in April, the company expects the 1,725-megawatt unit to fill about 3% of Britain's electricity needs--and generate Enron profits of $30 million or more a year. Enron says it paid for its $150 million, 50%-equity stake from fees for conceiving the project and acting as general contractor. Now, it's trying to do other big deals in India, Turkey, and elsewhere.
The question now is whether Enron can keep the ball rolling. One worry is that profits may shrink as competition heats up in the markets fueling the company's growth. Rivals such as Tenneco, Coastal, Natural Gas Clearinghouse, and the major oil companies are expanding their gas-marketing operations. Many are offering long-term contracts, too.
Enron also must adroitly manage the massive obligations it is building up. Its executives say they have tight financial controls--and swear they never sell fixed-price gas without locking in corresponding reserves. Even rivals say Enron has a safety valve: Its exploration company has about 1.8 trillion cubic feet in reserves to back up gas contracts.
Risky or not, Enron seems to be making the right play. As gas demand rises--and more countries privatize their government-owned energy industries--Lay sees lots of potential. "If we can continue to execute our strategy, we've got tremendous growth opportunities," he says. It might be a good idea, in fact, to gather up more $50 bills.