Market Volatility

As Dynegy rode roughshod over California ratepayers, it enjoyed the quiet backing of ChevronTexaco. Then Wall Street turned on the nation's energy traders, and now the East Bay leviathan is holding the bag.

History will record two days in March 2001 as perhaps the bleakest point in California’s energy crisis. On March 19, as Governor Gray Davis was negotiating long-term power contracts, dozens of managers working for power producers such as Dynegy, Reliant, and Duke informed shocked state officials that their generators were shutting down, either for unexpected repairs or because they had not recently been paid. As the morning progressed, roughly 7,000 megawatts — enough power to light seven million homes — vanished off the grid. And the afternoon was going to be a scorcher, activating air conditioners all across the Central Valley and Inland Empire.

As director of grid operations for the California Independent System Operator, Jim McIntosh was responsible for hustling up megawatts every single day from his switchboard in the baking heat of Folsom. But on that day, the well finally ran dry. Having no other choice, McIntosh declared a Stage 3 emergency, ordering utilities to begin a wave of rolling blackouts from Mexico to Oregon. And for 530,000 people in Northern and Central California, the traffic lights suddenly winked out, or elevators froze between floors. The next day was even worse, as unscheduled shutdowns claimed 8,237 megawatts — plunging 438,000 Pacific Gas & Electric customers into blackouts. Virtually all of Emeryville lost power, as did portions of Oakland near Highway 13, Berkeley along Sacramento Street, Richmond near Hilltop Mall, and parts of Walnut Creek.

The blackouts finally ended, but the crisis was far from over. If California was going to get through the summer, it would need every drop of available juice. So state officials were livid when three weeks later Dynegy, a Houston-based power and natural gas company, suddenly threatened to withhold yet more electricity. In early April, Dynegy chief operations officer Stephen Bergstrom told San Diego Gas and Electric that he intended to shut down eighteen small power plants unless the System Operator guaranteed Dynegy payment of $224 per megawatt, a 583 percent increase over its market price the year before and five times what the company was then charging elsewhere. This would have taken 267 megawatts off the system, enough to light 267,000 homes.

The utility promptly leaked this bombshell to the press. “Given the energy crisis currently gripping our state, we are appalled that you would even consider such an action,” SDG&E president Debra Reed wrote Dynegy. A spokesperson for Governor Gray Davis called the threat “outrageous and irresponsible,” suggesting that California might seize Dynegy’s generators. Although Dynegy eventually backed down, this may have been that dark season’s most overt example of brinkmanship.

Davis ultimately stabilized the crisis by negotiating a series of long-term contracts with these very power companies — but at a terrible price. State budget analysts believe the contracts will ultimately cost Californians $43 billion. Dynegy, however, had done very well for itself. By the end of 2001, the company reported $648 million in profit — a 326 percent increase over 1999, the year before the crisis began.

Dynegy is one of a small cartel of energy companies that walked away from California’s experiment in electricity deregulation with billions of dollars in public funds. But Dynegy was not the only company to cash in as a direct result of its actions. Dynegy has a partner located right here in the East Bay, whose relationship with Dynegy is so intimate that it may fairly be considered a clandestine beneficiary of the energy crisis. This partner is ChevronTexaco.

Six months ago, the oil giant and its nimble partner seemed poised to dominate the nation’s energy industry. Today, Dynegy is master of nothing but its own gleaming offices. The company is reeling under a mountain of scandals, both real and perceived, and unless ChevronTexaco executives tread very carefully, Dynegy’s liabilities could infect them and their bottom line.

California attorney general Bill Lockyer has filed suit against Dynegy, claiming that it defrauded the state by selling electricity it already had agreed to hold in reserve for emergencies. The Securities and Exchange Commission is investigating a complex natural gas transaction that may have artificially enhanced the company’s cash flow and reduced its taxes. Enron has filed a $10 billion lawsuit against the company as a result of an aborted merger attempt. And two state complaints are still pending before the Federal Energy Regulatory Commission, as are a growing number of shareholder and class-action lawsuits.

Dynegy spokesperson Steve Stengel refused to comment on either Lockyer’s lawsuit or the FERC complaints. “We’ve played by the rules and have responded to all the inquiries, and done all we can to keep our plants open in California to meet the needs of all Californians,” he says. Stengel referred our questions about the SEC inquiry to the company’s latest quarterly report, in which Dynegy said it has agreed to restate the transaction as financing activity and not at operational revenue.

Still, Dynegy’s stock value has evaporated as fallout from its own problems, as well as the climate of fear plaguing the energy sector, has frightened investors away from the industry. And on May 28, as the lawsuits and investigations mounted, Dynegy chairman and CEO Charles Watson resigned, sweeping away the visionary who had transformed a modest natural-gas outfit into one of the leading lights of energy trading, forging an alliance with ChevronTexaco in the process.

Stepping forward to replace Watson was none other than Glenn Tilton, one of ChevronTexaco’s three representatives on the Dynegy board of directors, who agreed to serve as Dynegy’s interim chairman for the indefinite future. Analysts predict this move signals the end of an era in which the oil giant played the role of passive investor at Dynegy. From now on, they believe, ChevronTexaco will have a firm hand on Dynegy’s reins. But even this extraordinary step has done little to ease the fears of investors, who seem convinced that the nation’s emerging energy sector, once the wunderkind of American capitalism, is trapped in a quagmire from which there may be no escape.

ChevronTexaco has spent thirteen years getting into this mess. Eager to expand beyond the static oil sector, the venerable corporation invested in and built a relationship with Dynegy until the two firms were virtually joined at the hip. But no one could anticipate just how flammable California’s newly deregulated energy markets truly were. Beginning in 1999, Dynegy went on a wild ride through the state’s energy markets, reaping a fortune before seeming to devour itself in the last few months. And ChevronTexaco could only hold on and hope it landed softly. Now the East Bay’s largest corporation must find a way to salvage Dynegy’s ailing fortunes — or face the prospect of watching helplessly as a firm that it looked to for its own future collapses altogether.

For eighteen years, Chevron has run its North America products division out of Chevron Park, a sprawling, manicured campus in San Ramon. While Chevron’s senior executive officers remained in San Francisco’s Financial District, roughly 3,500 employees in San Ramon oversaw the refining, distribution, and marketing of every drop of oil Chevron develops in the United States. But as the company finalized its historic 2001 merger with Texaco, executives decided to leave the West Bay and move into the newly renamed ChevronTexaco Park. Spokeswoman Bonnie Chaikind says the company’s senior executives should be ensconced in their new San Ramon headquarters by the end of the year. Then the East Bay will be home to what Fortune magazine calls the eighth largest company in the nation.

For most of its history, ChevronTexaco was known by a different name. In 1906, oil magnate John D. Rockefeller merged San Francisco’s Pacific Coast Oil Company with a host of Los Angeles drilling and exploration operations, and the enterprise later known as Standard Oil of California took its humble place as a small arm of Rockefeller’s vast petroleum empire. By the turn of the twentieth century, Standard Oil controlled ninety percent of American oil production, and as the country grew more dependent on fossil fuels, Rockefeller seemed destined to wield an unbreakable monopoly and dominate the nation’s economic future. Instead, Standard Oil became the great test case of the country’s tentative antitrust impulses. In 1911, after a five-year legal battle, the government broke Standard Oil into eleven different gasoline empires, including the companies that would go on to become Exxon, Mobil, Amoco, Arco, and Conoco.

Compared to some of these behemoths, Standard Oil of California seemed a mere footnote in the history of the oil industry. But that all changed in 1933, when King Ibn Saud granted the company a concession to explore the oil fields of Saudi Arabia. The deal made Standard Oil a giant among oil producers, and the Saudi reserves proved so vast that the company was forced to form Caltex, a marketing partnership with its Houston-based rival Texaco. As the West Coast’s population boomed in the postwar years, so did Standard Oil, which branched out to the southern United States and explored reserves in Nigeria, Southeast Asia, and the North Sea. During the leveraged buyout craze of the ’80s, Standard Oil changed its name to Chevron and came to the rescue of Gulf Oil, which faced a 1984 hostile takeover by maverick oil magnate T. Boone Pickens Jr.

But even as Chevron was growing, it fell behind its rivals in diversifying its business. Like its peers, it was reeling from the oil shocks of the ’70s, especially when the Saudi government took control of oil production in 1980. Global oil reserves were being depleted, and new reserves lay far out of reach beneath the ocean. Consumers engaged in a brief spell of energy conservation in the early ’80s, and old, dirty refineries faced new mandates to clean up their operations, which led to the closure of some 170 refineries between 1985 and 2001, as refiners shut down the plants rather than modernize them.

In fact, analysts and oil concerns gradually have come to agree that the future of energy lies not in oil, but in natural gas. Natural gas lies in virgin underground reserves across the country, a resource considered inexhaustible well past our lifetimes. “If you look at a curve of maturity, oil is a lot more mature,” says Peggy Williams, exploration editor for the industry newsletter Oil and Gas Investor. “It’s been explored very heavily for decades, and there just aren’t these tremendously large fields anymore. Gas, though — you can still find quite a bit of it. … Natural gas is the future.” And unlike gasoline, natural gas is integral to the production of electricity. Although coal is still the primary US fuel for power generation, almost every new plant now under consideration will be gas-fired, because natural gas burns 33 times more cleanly than coal.

The potential revenue of this market is dizzying, and ChevronTexaco has moved aggressively to get into the game. By the mid-’90s, Chevron was producing vast amounts of natural gas and sought to get into the business of shipping and selling it downstream — where the real money is made. “The cardinal rule of commodities markets is: ‘Those who control the flow of supply make all the money,'” says John Olson, an analyst specializing in natural gas for the investment bank Sanders Morris Harris.

But Olson and other analysts say the oil giant was too lumbering to make its own way in the volatile natural gas market, where prices could shoot up or down every day. Chevron was a vast, powerful giant, and like any company of its size, it was often ponderous and slow — oppressed by layers of bureaucracy and hamstrung by international politics. “ChevronTexaco’s core business was drilling for gas and oil and marketing it,” says Mark Easterbrook, an energy expert for the investment analysts Dain Rauscher Wessels. In gas transportation, the company needed a young and hungry partner capable of profitably running such a business. “Rather than throwing a lot of money at it, they could invest it in a company that already had a natural expertise.”

That’s where Dynegy came in. Chevron found the partner it was looking for in 1989, when Dynegy went by the name of US Natural Gas Clearinghouse and was little more than a marketing company jointly owned by six natural gas pipeline companies. Dynegy’s lean, aggressive culture offered a flexibility that Chevron never could have acquired on its own — a valuable trait in the deregulated natural gas markets, where prices fluctuate overnight. “Power and gas trading is highly volatile, weather-sensitive, and highly competitive, and that’s where Dynegy can run rings around a big company like ChevronTexaco,” Olson says. “ChevronTexaco’s smart enough to know that the cultures are different. They knew you had a different animal working at Dynegy.”

Charles Watson epitomized that animal. Watson first showed up at Dynegy’s door in 1985, and during the next fifteen years, he transformed it into a giant of American enterprise. Like Enron’s Kenneth Lay, Watson’s genius lay in his ability to anticipate the profit potential in recently deregulated industries. But where Lay focused eighty percent of Enron’s business on energy trading — living in the margins between wholesale and retail and flipping every commodity he could think of — Watson adopted a more cautious strategy, diversifying his company’s businesses to include natural gas transportation and electricity generation. This gave Dynegy reliable revenue and left it less vulnerable to the whims of energy arbitrage that ultimately cut the legs out from under Enron.

In 1996, the two companies signed an exclusive contract for Dynegy to sell all of Chevron’s natural gas in North America, with the exception of Alaska. It was the first exclusive natural gas marketing arrangement since gas was deregulated in the 1980s, and with Chevron producing two million cubic feet of gas every day, the scale was staggering. Watson touted the pact’s potential to make Dynegy “the largest electric power marketer in North America.”

Chevron benefited too. By the time that it let Dynegy market virtually all of its North American natural gas, natural gas liquids, and electricity, as well as supplying energy and feedstocks to Chevron’s refineries, chemical plants, and other North American facilities, ChevronTexaco had acquired 26.5 percent of Dynegy, with an option to expand its holdings to 36 percent. It also acquired three seats on the company’s fifteen-seat board of directors. “Dynegy was one of the best investments ChevronTexaco ever made,” Olson says. “For five years, the stock was rising at 112 percent a year, at a time when the biggest bull market in history rose at 28 percent.”

The deal was a windfall for both sides, but Watson’s ambitions were just beginning. Taking his company public in 1997, he used the capital to push further into electricity, buying power plants in states undergoing energy deregulation. In 1999, Dynegy bought a fifty percent stake in 37 power plants throughout Southern California, plants with a capacity of 2,678 megawatts, or roughly 5.6 percent of the state’s generating capacity. There seemed no end to the company’s growth. Despite Dynegy’s remarkable success, Watson reportedly chafed at the gushing publicity enjoyed by his flashier rival over at Enron. So it seemed perfectly delicious last October when, as Enron’s cash flow began drying up and rumors spread about its viability, Enron CEO Ken Lay personally called Watson and pleaded with him to buy the undisputed giant of energy trading before it was too late.

Although Enron faced rumors about overstated revenue and accounting trickery, Watson believed the company was undervalued and Dynegy offered $9 billion to absorb its operations. But Dynegy, the thirtieth largest US corporation, didn’t have enough money to buy Enron, the fifth largest. So one month after Chevron and Texaco completed their own merger, ChevronTexaco floated Dynegy $1.5 billion to keep Enron afloat and promised to buy another $1 billion in Dynegy stock when the deal concluded. ChevronTexaco chairman and chief executive officer David O’Reilly said, “Our equity interest in Dynegy is highly complementary to our larger portfolio of assets and activities, and reflects our strategy to participate in the growing energy convergence marketplace, including wholesale and retail marketing, and trading of energy products and services.”

The deal collapsed rather spectacularly twenty days later, soon after Watson discovered that Enron had far less cash than he thought. The story of Enron’s slide into bankruptcy is now familiar to almost everyone, and by the time the merger had collapsed, the company was worth a mere $270 million. Watson had barely avoided a fatal mistake.

Or had he? When ChevronTexaco infused $1.5 billion into Enron, the company’s executives had offered as collateral the Northern Natural Gas pipeline, which was valued at between $2 billion and $2.7 billion. Roughly seven times as long as the Mississippi River, and capable of feeding 4.3 billions of cubic feet of natural gas per day to countless power plants, the massive system runs north from Texas into such states as Oklahoma, Kansas, Nebraska, Iowa, and Illinois. Although Enron still has the legal right to buy the pipeline back by June 30, no one seriously expects the company to do so, and Dynegy will then own Enron’s crown jewel.

The pipeline is hardly a cash cow. Dynegy was forced to assume liability for $950 million in Enron debt as part of the package, and many analysts say the pipeline’s average annual earnings of $116 million are low, considering what Dynegy paid for it. But the upside could be huge. Most midwestern states have not yet begun to deregulate their electricity markets, and if they do, the pipeline will be an invaluable asset to Dynegy, which has a history of reaping a fortune from such markets. Olson expects the demand for electricity in these states to grow at five percent a year, and Dynegy and ChevronTexaco had put themselves in the perfect position to cash in on that growth. Watson went so far as to predict that Dynegy stood to expand its business by twenty percent in 2002.

But the ultimate beneficiary may not be Dynegy but its partner, according to Cameron Payne, a Houston-based financial analyst who specializes in oil and natural gas. The pipeline not only offered Chevron a remarkable opportunity to vertically integrate its operation, but also to obtain a unique glimpse into the business of its competitors. “Owning the pipeline gives the owner market intelligence not available elsewhere,” Payne says. “Also, it puts the owner in the position of control to some extent as to who can put gas through the pipeline.”

Olson agrees. “The best business model you could have had is converting yourself into an energy conglomerate,” he says. “ChevronTexaco’s got the natural gas, and Dynegy’s got the marketing and trading, the pipeline capacity, and the power plants, so you have a de facto integration going on.”

But there may be a darker side to this deal. Critics and consumer advocates warn that whenever Dynegy and ChevronTexaco have assumed commanding roles in energy markets, they have used their market share to force prices as high as possible and extract hundreds of millions of dollars in excessive profits. “ChevronTexaco can connect the dots between its nearly three billion cubic feet of daily domestic natural gas production and Dynegy’s [18,910] megawatts of electricity generation, since two-thirds of its electricity is fired by natural gas,” warned Tyson Slocum, research director for the energy arm of Ralph Nader’s advocacy group Public Citizen. “This synergy of collusion will create America’s largest vertically integrated energy company, enabling Dynegy to charge its customers higher prices for natural gas and electricity, and force its power generation competitors to pay monopolistic prices for natural gas.”

In fact, it was in the natural gas market that state utility regulators claim Dynegy first honed its skills. Three years ago, lawyers with the California Public Utilities Commission accused Dynegy of conspiring to withhold capacity on the state’s largest natural gas pipeline, clamping a stranglehold on the gas supply and driving up the price. This allegedly set in motion a chain of events that cost the state $3.7 billion.

To understand this charge one must know something about the recent history of natural gas. When the federal government deregulated the industry in the ’80s, restrictions were lifted on gas prices at the wellhead, and competition among rivals bid down the price. But because of the small number of pipelines around the country, the transportation of gas remained a monopoly, and the feds capped the price at which pipeline owners could sell the right to transport gas through them. Unfortunately, they left a loophole. Whoever bought the right was free to turn around and resell it at whatever the market would bear.

The El Paso natural gas pipeline is by far California’s largest, accounting for almost half of the state’s natural gas supply and shipping 3.2 billion cubic feet of gas a day from Texas into Southern California. In 1998, the El Paso company sold one-third of its pipeline capacity to Dynegy. Back then, the resale value was next to nothing, and everyone thought Dynegy had just been played for a sucker. But instead of reselling the capacity at a loss, the company jacked up the price so high that no one ever bought it. Rival gas marketers were shocked at this development, which was perhaps the first indication that electricity deregulation wouldn’t go ahead as planned.

When California Public Utilities Commission lawyer Harvey Morris saw what Dynegy was doing, he filed a complaint with the Federal Energy Regulatory Commission and accused the firm of anticompetitive behavior in violation of federal regulations. Although almost no one bought space in Dynegy’s share of the El Paso pipeline, Morris says Dynegy profited anyway. That was because Dynegy happened to control a large amount of capacity in a different pipeline — capacity it had acquired from ChevronTexaco two years earlier.

When Dynegy hoarded capacity on El Paso, the market price of natural gas went up all over the state, and Dynegy cashed in on its other holdings, Morris claimed. “Dynegy realized that if you controlled the bottleneck, then you can manipulate prices,” Morris says. “We protested that they were hoarding capacity to drive up the border price, and they also had capacity on other pipelines. So that by driving up the price on El Paso, they made money on the others. Dynegy also owned equity interest in a number of [power plants], whose prices were tied to the cost of natural gas. So the rising price of natural gas was reflected in the price of their electricity.”

Dynegy’s Stengel would not elaborate on this transaction, except to repeat his assertion that his company always played by the rules in California. “Dynegy did not restrict gas supplies,” Stengel says. In fact, he added, federal regulators approved the contract with El Paso and denied the state’s request for a rehearing.

Federal regulators ruled that even if Morris’ allegations are true, Dynegy’s acts couldn’t be considered an egregious abuse of market power because gas supplies were so high that year. Indeed, Dynegy only succeeded in driving up the price by roughly twelve cents per million British Thermal Units (BTUs), which cost the average California ratepayer $7.56 a year, according to PG&E spokesman Jason Alterman.

But all hell broke loose a few months after Dynegy let its pipeline capacity revert back to El Paso, Morris says. The pipeline owner then leased the capacity to its own marketing affiliate and used Dynegy’s strategy to raise the price of natural gas in December 2000 — when supplies were tight and the state was in the grip of the power crisis. Gas prices that month spiked from $2 per BTU to an astonishing $58 per BTU, throwing an already overheated power grid into chaos.

Morris says El Paso’s practice cost the state $3.7 billion in added gas and electricity costs. He filed another complaint. Last October, Administrative Law Judge Curtis Wagner of the Federal Energy Regulatory Commission ruled that El Paso engaged in illegal collusion with its own affiliate, but that the state had failed to prove that the company deliberately withheld capacity. California’s appeal is still pending.

Although El Paso allegedly played the game better, Morris claims that Dynegy invented the game. “The difference between the Dynegy days and the El Paso days was that there was too much excess capacity for Dynegy to be effective in driving up the price,” he says. “But the model of hoarding an incredible amount of capacity was created by Dynegy.”

But natural gas is a mere footnote in the story of Dynegy and ChevronTexaco. When historians chronicle the rise and spectacular fall of Dynegy, they will inevitably turn to the role its Southern California power plants played in the crisis. It was here Watson made a fortune for Dynegy and ChevronTexaco, and here that a subsequent web of lawsuits and state and federal investigations dragged him back down to earth.

For the better part of the last century, California’s electricity was firmly in the hands of a small number of regulated monopolies. The state granted utilities such as PG&E exclusive franchises to generate, transmit, and distribute power within a given region, and the Public Utilities Commission set rates that balanced modest profits for the utilities with cheap, reliable service for ratepayers.

The arrangement worked, but it was never pretty. Hidden costs and inefficiencies were built into the regime, and economists began to regard such plodding, statist solutions as leftovers from a bygone era. The energy crises of the ’70s marked the beginning of the end of regulated power monopolies in California. The Carter administration sought to ease the nation’s reliance on fossil fuels by allowing factories that produced heat as a by-product to generate their own electricity and sign long-term contracts with the big utilities. As competition entered the power markets for the first time in seventy years, the logic that electricity was a natural monopoly began to erode. It was the beginning of a twenty-year trend toward deregulation. From trucking to airlines to telecommunication, vast monopolies were broken into lean, hungry firms, and competition produced lower prices and remarkable consumer savings.

In 1996, California became one of the first states to break up its power monopolies. The logic seemed perfectly sound: Decentralize the generation of electricity among competing private companies, and these firms would bid the wholesale price of power down to bargain basement levels. Meanwhile, the transmission and distribution of energy would remain in the hands of the big utilities, which would buy power on the market and resell it at a reasonable profit to everyday customers.

California’s utilities sold off nearly all of their gas-fired power plants, capacity that produced thirty to forty percent of the state’s power. Five companies each ended up with six to eight percent of the state’s capacity. One was Dynegy, which bought 37 power plants in Long Beach and the San Diego area in partnership with NRG Energy Inc.

No one knew at the time that California had just created a terrible monster. If the state had allowed utilities such as PG&E to enter into long-term contracts with the power wholesalers, the utilities might have been able to play one company off another and drive the price down. Instead, the state created two electricity auctions, which gave Dynegy and its peers the opportunity to form an ironclad energy cartel.

Most experts now say both of these systems were inadvertently rigged, allowing each of the major power companies to force the state into blackouts simply by throwing a switch. “The big money was with the companies that owned generation and figured out how to withhold it, or bid high and drive up the market price,” says Severin Borenstein, a UC Berkeley business professor who directs the UC Energy Institute and is one of the foremost experts on the state’s energy crisis. “In so doing, they transferred billions of dollars in wealth out of the state.”

The critical reason for this disaster is that power isn’t a normal commodity. First of all, it can’t be stored. Every watt of energy that Californians demand must be instantly available with the flick of a switch. Secondly, electricity is integral to modern life in a way that almost no other commodity or service is. If the price of ice cream were to suddenly double, consumers could simply diet. But if power providers double their prices and order customers to pay or do without, most customers will do whatever they say, because they can’t imagine life without electricity and have no alternative power source. This is exactly what happened in California. For the first sixteen months of deregulation, power prices fluctuated wildly from day to day, hovering around $50 per megawatt — about $14 higher than expected. The California Energy Commission and other agencies warned of ominous trends, but few people paid much heed. But that all changed in the summer of 2000, when San Diego Gas & Electric was allowed to lift a temporary cap on retail rates right at the moment when wholesale prices skyrocketed. San Diego power bills doubled overnight, prompting a ratepayer revolt and startling politicians. The legislature immediately reimposed retail price caps, but this did nothing to address the real problem. As long as wholesale prices continued to rise, utilities such as PG&E and SDG&E would be bankrupt in six months. “Many people were surprised by the market disruption, but in retrospect the surprise should have been that the market, as it was designed, took two years to self-destruct,” Borenstein wrote in a white paper for the UC Energy Institute.

October 2000 marked the beginning of a new phase in the crisis, in which power generators allegedly began withholding electricity to drive up the price. According to a study by the Foundation for Taxpayer and Consumer Rights, there were 2,650 plant-closure incidents in the period between April 1999 and September 2000. In October, there were 7,633 such incidents, and the numbers got worse as the crisis proceeded. On January 17, one day after Southern California Edison defaulted on its wholesale electricity bills, the first two days of blackouts hit the state. According to state records, Dynegy shut down enough power to light 454,000 homes the first day and 253,000 homes the following morning, all as a result of “unplanned outages.” Over the course of two days, the state had to pull the plug on more than one million Northern California customers before Gray Davis pushed through emergency legislation to buy power for the utilities.

The Independent System Operator later published a study of the bidding strategies employed by power companies during the early days of the crisis. From May to November 2000, the study concluded, five large power companies deliberately leveraged their market power to extract excessive profits from the utilities, either by asking an outrageously high price for their power or by shutting down generators to overheat the market. In fact, of the 25,000 hours of bidding examined by the authors, less than two percent were not tainted by market manipulation, and the result was an estimated $500 million in extra profits drained from the state. The study declined to name the companies in their study, but agency officials later acknowledged that one of them was Dynegy. The agency has filed a federal complaint charging that Dynegy abused its market power so badly that federal energy regulators should revoke the company’s right to sell power at a price of its own choosing — and order Dynegy to refund, with interest, all excessive profits for the year that started May 1, 2000. Altogether the agency is seeking $8.9 billion from power companies.

Dynegy’s Stengel tells another story. He says rising demand for electricity took its toll on the company’s aging power plants, and that Dynegy had no choice but to shut them down for unexpected repairs. “I don’t know what the individual causes were for every power plant, but those plants were forty and fifty years old, and if you look at how much they ran, you’ll find they ran at unprecedented levels to meet the needs of California,” he says. As proof, he cites a report by the South Coast Air Quality District, which indicated that power-plant emissions for the period of the crisis increased dramatically. Stengel says this shows that power plants were running faster and hotter, and were more prone to break under the stress. District spokesperson Sam Atwood says that Stengel is only partly right. “The total emissions were higher, but the relationship between emissions and energy production is not one to one,” he says. “It depends on the amount of air pollution controls on the facility.”

But an army of legislators, state officials, and consumer advocates hold Dynegy and the rest of the state’s power generators directly responsible for the crisis — and are calling for retribution. Governor Davis is trying to renegotiate the long-term contracts, and state and federal investigations are still ongoing. California’s experiment in electricity restructuring proved so disastrous that it has shaken the nation’s very faith in deregulation, and state officials around the country are scrambling to reassure nervous consumers of its virtues. Dynegy and other power companies may have made a killing in California, but they may well have mortgaged their future in the process.

For those brief but terrifying months of the electricity crisis, millions of Californians watched as their lights flickered and their state’s treasury bled money into the coffers of Dynegy and its counterparts in Texas. Now, everything has changed. As Dynegy struggles with countless lawsuits and investigations, and scandals erupt from every corner of the sector, investors have fled the company, driving its stock price down as much as 88 percent of its value last year. The Moody’s credit-rating agency recently announced that the energy-trading sector does not justify further investment without fundamental restructuring. As the Financial Times reports that Dynegy is trying a sell a fifty percent stake in the Northern Natural Gas pipeline, the small, hungry firm that once seemed to represent ChevronTexaco’s future now hangs like a millstone from the oil giant’s neck.

As Glenn Tilton, ChevronTexaco’s new man at Dynegy’s helm, surveys what’s left of this once-mighty company, he must surely marvel at the wreckage. ChevronTexaco representatives declined several requests for comment on Dynegy’s operations. The company line maintains that there is an impermeable firewall between the two firms, and that Tilton is simply in office in an interim capacity.

And Stengel of Dynegy will only say that his company is rebuilding. “Our company and the industry are going through some changes,” he says. “We have said that our priority was to work with the rating agencies and explain how we make money. And we’ll improve our liquidity position. We are an asset-backed company, a provider of commodities, and that is something that is needed in the marketplace.”

On Monday, Dynegy announced a series of cost-cutting measures designed to shore up the company’s liquidity, including selling a stake in the Northern Natural Gas pipeline, closing its online energy trading arm, restructuring much of its debt, and making its financial data more understandable by average investors. The company has ditched the scandal-ridden accounting firm Arthur Andersen and retained Price Waterhouse, which is re-auditing all of Dynegy’s finances for the year 2001.

John Cusick, a research analyst with the securities firm Fahnestock and Co., says that Wall Street isn’t exactly buying either line. On June 19, ChevronTexaco hosted a meeting for analysts in New York, in which executive vice president Darry Calahan claimed that Dynegy’s core businesses are solid and assured investors that the power sector will see promising growth soon. “We expect to get at least a twelve percent rate of return on capital employed,” Calahan said, “and we think that it probably will grow somewhat, but not hugely.”

When analysts pressed for comment about Dynegy’s performance, ChevronTexaco’s chief financial officer John Watson, who also sits on the Dynegy board of directors, stepped forward and promised that Dynegy will clean up its accounting practices and raise the money it needs to pay its debts — even as he kept alive the notion that the two companies are completely separate. “In the wake of the Enron scandal … boards are taking a very active role and taking their responsibilities quite seriously,” Watson said. “But it should be no surprise that Darry and I and Glenn are active members of the board. But we are just three board members; we own 26 percent in Dynegy, we don’t run the company.”

But Cusick claims that analysts walked away feeling lukewarm at best. “They say they’re just an investor, and they weren’t answering any operations questions about Dynegy,” Cusick says. “But it’s hard to reconcile when the ChevronTexaco vice chair is running Dynegy. I think that was met with a little skepticism.”

In fact, Cusick says analysts are beginning to question whether ChevronTexaco should ever have hitched its wagon to Dynegy’s star. As every day brings a new bombshell about what happened to California’s energy market, ChevronTexaco’s impassive demeanor offers less comfort. “They presented a lot of ideas where they thought there would be growth, but I don’t think we came away with anything; we weren’t overwhelmed,” he says. “They focused a lot on the cost savings on the merger with Texaco, but I think we were looking for something other than that. People have questioned whether Dynegy’s problems will hurt the stock. Somewhere along the line, there’s gonna be lawsuits, and someone may try to go for the partner with the deep pockets. I think people would be much happier with ChevronTexaco if they weren’t involved with Dynegy. It’s proven not to be a great decision on their part.”

For better or worse, ChevronTexaco will play the Dynegy hand to the end. Over the decades, the company has exemplified the Big Blue school of corporate stability: slow and ponderous, but reliably hitting its modest quarterly numbers. But faced with the inevitable end of oil production, this stable giant knew it had to find the future of the world’s energy, and rolled the dice on natural gas and a young, brash firm that seemed to promise the world. Now ChevronTexaco has learned the same lesson we all have: the deregulated energy market is a beast that can be temporarily cowed, but never tamed. If the old system of bloated, inefficient monopolies must be discarded, we must also accept that our new, streamlined system is ruthless and adversarial, where the slightest miscalculation can cost the public billions of dollars. Last year, the energy markets bled California white, and this year those same markets ended the careers of Charles Watson and Ken Lay. Now it’s ChevronTexaco’s turn to see if it can avoid that fate.

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