"Watt a Scandal": Enron’s Power Surge that ended in Blackout

Once hailed as a Wall Street Darling, the story of the rise and collapse of the Enron Corporation has become one of the most eloquent examples of corporate deception being unclothed.

The Enron Corporation was a result of the merger between two companies----- Kenneth Lay's Houston Natural Gas and InterNorth Inc., based in Texas and Omaha respectively. The story started with the appointment of Kenneth Lay (then, CEO of Houston Natural Gas) as the CEO of Enron Corporation, who later appointed Jeff Skilling (then, a senior partner at McKinsey------ consulting advisor for Enron).

Later, in 1992, Jeff Skilling put a proposal before the Securities & Exchange Commission to approve his technique of adopting a method of "Mark-to-Market Accounting" for Enron, which eventually got approved.

Jeff Skilling

Mark-To-Market is a distinct method of accounting which allows corporate structures to record present value of future profits from long-term contracts as current income, which may or may not materialize later at the maturity of the contract.

Skilling, aware of all the perks the technique had to offer, enforced an aggressive application, which not only hyper-inflated the revenue and income of the corporation but also led to a steep rise in the market valuation. Throughout the 1990s, the stock price of Enron rose enormously------ $10 in 1990 to $85 in 2000 (values presented are estimates and may not represent actual data). Since, most of the rise in the earnings was due to the recording of future profits, they didn't reflect the actual cash inflows.

Irrespective of this, the stock was a no brainer to invest in, since the company showed tremendous revenue growth (YoY) and an excellently healthy Debt-Equity ratio.

Rise in Earnings Per Share and Stock Price (1991-2001)

The Joint Venture of Enron-MSEB (DPC) 1992

The Year 1992 saw the signing of a Power Purchase Agreement between the Enron Corp. and the Maharashtra State Electricity Board (MSEB). The deal promised Enron a larger holding and also led to the formation of Dabhol Power Company (DBC).

The Power Plant finally got a green light in the year 1999.

Initially, naphtha------ an expensive petroleum product (r. prices tied to the prices of oil) was used as the fuel for the power plant.

The PPA, outlined the deal as "Dollar-Denominated" and one with "Fixed Capacity Charges". This ensured that even if the prices of Naphtha (later replaced by LNG------ liquified natural gas) rose, instead of bearing losses, the company would rather reap profits owing to an inflated price of electricity (due to currency exchange risks). Further, the MSEB was forced to provide compensation for the full capacity of the plant, regardless of whether it utilized the full capacity or not. Therefore, the original terms of the deal were extremely limiting and stringent. The high costs eventually made the project unsustainable for MSEB and, thus, it started to default on its payments.

The issue was eventually taken to the London Court of International Arbitration (LCIA), but remained unresolved, since the Enron Corporation filed for bankruptcy a year later in 2001.

Later, the Dabhol Power Company was revived by a conglomeration of numerous PSU, National Thermal Power Corporation (NTPC), Gas Authority of India Limited (GAIL) etc. The project was renamed as the Ratnagiri Gas and Power Plant Limited (RGPPL), but couldn't change its fortune, for the company still struggles to operate profitably and its fate remains uncertain.

At the start of the new millennium, Enron Corp. was already in "the jaws of death". The billables did not reflect the actual cash inflows. This overall lead to the unravelling of the company since in most cases the assumed profits failed to materialize.

The Enron Corporation Ltd.

This issue got exacerbated when Enron entered into a deal with Block Buster Video------ a Video on Demand platform.

Enron coupled the use of fraudulent accounting practices with special purpose entities (SPEs), to hide debts and inflate their profits, making the venture appear more successful than it actually was.

As expected, the deal eventually failed, and Blockbuster pulled out of the venture. However, this time, the failed deal exposed the corporation's deceptive activities.

The stock prices crashed, leading to the loss of billions of dollars in market value and the investor confidence eroded significantly.

The Enron Corporation finally filed for bankruptcy in Dec 2001, followed by the dissolution of Arthur-Andersen------- the accounting firm for Enron (later acquired by Deloitte-Touche).

Overall, this classic example reflects the greed-driven, flawed practices adopted by Enron Corporation, which ultimately unraveled as one of the biggest corporate scandals in history.