A Final Word with Chuck Watson

Shortly before his ouster, Dynegy's CEO explained why the market is bigger than anyone...even bigger than the State of California

On May 28, Chuck Watson, chairman and chief executive of Houston-based energy-trading giant Dynegy, resigned after the company's board of independent directors requested he leave. The Friday before, in his last interview with the media, Watson sat down with BusinessWeek's Christopher Palmeri in an attempt to clear the air about the various controversies surrounding the company he founded in 1985.

Watson spoke about the Enron memos on power-market manipulation, the Securities & Exchange Commission's investigation into Dynegy, and the future of the U.S. power business. Edited excerpts of their conversation follow:

Q: What was you reaction when you first read the Enron memos?


I was taken aback. I really was surprised. There was clearly some scheming going on, and I think that's unfortunate. That's not characteristic of the rest of this industry. We looked at all our trades and all our transactions, over 100,000 of them. We don't see an industry that's wrought with people doing things that don't look legal or ethical.

Q: But the memos did mention that other companies were doing it?


In talking to our team, this is not something that was prevalent. Everybody isn't sitting around talking about how to game the system. That doesn't happen. I'm not suggesting this is all about nothing. These are serious accusations. They ought to be investigated. But to make the assumption that everybody else did it -- that's unfair. With the elections coming up, it's going to be big news. It will probably stay on the front page until November.

Q: Some of the trading schemes seem more like common sense than anything criminal, such as megawatt laundering. If there's a price cap in California, it makes sense to sell the power out of state and sell it back at a higher price.


Megawatt laundering isn't a practice that our people engage in. Even if it's following the letter of the law, doing so certainly isn't in the spirit of the law, and Dynegy did not do that. From a fundamental standpoint, you're right, that's what interstate power is. The whole concept of what we do is move power in and out of state. But Dynegy sold 10 times more power in California than we ever exported to other markets.

Q: Your price per megawatt in California was $28 this most recent quarter. A year ago, it was $224. Such a drop in price is remarkable. What precipitated that, if not some kind of manipulation?


It wasn't just California -- prices in the whole Western market, the whole U.S. market, started moving down. The main reason is that [earlier, California] Governor [Gray] Davis increased rates, and demand was mitigated, [pushing prices back down. And] the weather changed. Clearly the long-term contracts helped push prices back down. We were getting twice the price in the open market than what we signed our long-term contract for. I don't think this was much more than supply and demand and a regulatory structure that didn't work. There's no one company, no one thing that impacts this market. It's bigger than anyone. It's even bigger than the State of California.

Q: The SEC is presently investigating Dynegy's "round-trip" transaction with CMS Energy. The two of you traded power in a manner that may have inflated revenue but didn't amount to an actual sale. There are also issues regarding how you accounted for a natural-gas contract called Project Alpha. Can you explain what went on in these transactions?


There was an error. When this transaction was done, it shouldn't have been done. It didn't impact the market. My team caught the transaction and accounted for it in the fourth quarter. At the end of the day, what other people have done I can't speak for. This was not something we did to inflate our volumes.

The Alpha transaction was a gas-supply transaction that had some tax incentives, and the cash that we received was the issue with the SEC. The only issue they had was if the cash we received was operational or financial. Nobody has implied that it's illegal. The SEC said it's more financial, [so] we put it in the financial column. That was not like anything you saw in the partnerships with Enron.

Q: Where does Dynegy stand financially at this point?


Dynegy already has done the financing that's required to maintain adequate liquidity to run the business. We've had that liquidity for the last three or four weeks now. We've been operating under the parameters as if both ratings agencies have downgraded us -- even though they haven't. We've actually been running the business for the last month in a worst-case scenario. We've got $10 billion in hard assets that we own 100% of. We have what we need to adequately run the business. And we've got very solid plans in place to improve our balance sheet.

Q: What does the future hold for electricity deregulation? Could we be short of power again?


What's unfortunate here is that the companies that seem to be under attack are the ones that have over the past five or six years built all the power plants. To me, there's a very strong need and role for the energy merchant. The energy merchant is the link between supply and the customers. Right now, because of the way the futures market is, we can actually buy power in the future cheaper than we can build it. So there's no incentive for us to build plants.

Unfortunately, demand continues to grow, and supply and our infrastructure continue to lag behind. Sooner or later, we all know what that means. At the end of the day, that's a recipe for disaster. Somehow, we have to fix the energy balance in this county. We need a national energy policy. We need to focus on natural gas and power as the sources of energy, and that's not happening right now. That has been really damaged by the fall of Enron and the scrutiny that's been applied to generators. We had planned over the next several years two and three new plants per year. [Given the skittishness in the market for energy projects], we're probably looking at one in the next couple of years now.

Edited by Patricia O'Connell

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