Case Study

Topics: Enron, Financial statements, Enron scandal Pages: 7 (2156 words) Published: June 5, 2013
Enron Corporation began as a small natural gas distributor and, over the course of 15 years, grew to become the seventh largest company in the United States. Soon after the federal deregulation of natural gas pipelines in 1985, Enron was born by the merging of Houston Natural Gas and InterNorth, a Nebraska pipeline company. Initially, Enron was merely involved in the distribution of gas, but it later became a market maker in facilitating the buying and selling of futures of natural gas, electricity, broadband, and other products. However, Enron’s continuous growth eventually came to an end as a complicated financial statement, fraud, and multiple scandals sent Enron through a downward spiral to bankruptcy.

During the 1980s, several major national energy corporations began lobbying Washington to deregulate the energy business. Their claim was that the extra competition resulting from a deregulated market would benefit both businesses and consumers. Consequently, the national government began to lift controls on who was allowed to produce energy and how it was marketed and sold. However, as competition in the energy market increased, gas and energy prices began to fluctuate greatly. Over time, Enron incurred massive debts and no longer had exclusive rights to its pipelines. It needed some new and innovative business strategies.

Kenneth Lay, chairman and CEO, hired the consulting firm McKinsey & Company to assist in developing a new plan to help Enron get back on its feet. Jeffrey Skilling, a young McKinsey consultant who had a background in banking and asset and liability management, was assigned to work with Enron. He recommended that Enron create a gas bank to buy and sell gas. Skilling, who later became chief executive at Enron, recognized that Enron could capitalize on the fluctuating gas prices by acting as an intermediary and creating a futures market for buyers and sellers of gas; it would buy and sell gas to be used tomorrow at a stable price today.

Although brilliantly successful in theory, Skilling’s gas bank idea faced a major problem. The natural gas producers who agreed to supply Enron’s gas bank desperately needed cash and required cash as payment for their products. Enron also had insufficient cash levels. Therefore, management decided to team up with banks and other financial institutions, establishing partnerships that would provide the cash needed to complete the transactions with Enron’s suppliers. Under the direction of Andrew Fastow, a newly hired financial genius, Enron also created several special-purpose entities (SPEs), which served as the vehicles through which money was funneled from the banks to the gas suppliers, thus keeping these transactions off Enron’s books. As Enron’s business became more and more complicated, its vulnerability to fraud and eventual disaster also grew. Initially, the newly formed partnerships and SPEs worked to Enron’s advantage. Yet in the end, it was the creation of these SPEs that culminated in Enron’s death.

Within just a few years of instituting its gas bank and the complicated financing system, Enron grew rapidly, controlling a large part of the U.S. energy market. At one point, it controlled as much as a quarter of all of the nation’s gas business. It also began expanding to create markets for other types of products, including electricity, crude oil, coal, plastics, weather derivatives, and broadband. In addition, Enron continued to expand its trading business and, with the introduction of Enron Online in the late 1990s, it became one of the largest trading companies on Wall Street, at one time generating 90% of its income through trades. Enron soon had more contracts than any of its competitors and, with market dominance, could predict future prices with great accuracy, thereby guaranteeing superior profits.

To continue enhanced growth and dominance, Enron began hiring the best and brightest traders. However, Enron was just as quick in firing its...
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