A New Frame on Enron's Founding Idea

Now that Skilling, Fastow and Lay have been shown by a bunch of greedy bankers to be complete amateurs when it comes to the mass destruction of wealth, it is probably worth changing the frame and reminding ourselves of the sheer brilliance behind the (entirely legal, decent and honest) idea that got Enron started.

Enron started life as a gas pipeline company. It bought gas from people taking it out of the ground and transported it to customers (power stations and others) somewhere else. Now the price of natural gas is volatile, but the difference in the price of buying and selling at the two ends of the pipe is pretty constant. The prices move up and down in lock step. If the cost of transporting the gas is less than the difference in price—it is, and it doesn’t fluctuate much—this is a nice business.

So far, so ordinary. Lots of businesses, from stock market traders to grocers buy goods that fluctuate in price day-to-day. They sell them before the price changes much and they make money on the margin (the difference in price). It’s called exploiting a natural hedge.

Enron went one step further. Recognising that its suppliers were concerned about the uncertainty in future gas prices, it offered to buy gas at a guaranteed fixed price. This eliminated the risk for the gas producers and they were happy to receive a little less that the expected future price. Enron’s customers were also concerned about uncertainty in gas prices, and they were happy to accept a price a little higher than the expected price to have that uncertainty taken away. So now Enron’s suppliers are happy and their customers are happy. And Enron’s bean counters are very happy to be buying at a fixed price and selling at a higher fixed price, and pocketing the value given up by their suppliers and customers for taking on their risk. Enron was paid to take over risk by both suppliers and customers, but faced none itself. Absolutely brilliant!

Could your business exploit risk in this way? Taking over someone else’s risk has value. Can you organise it so that it doesn’t have a corresponding cost?