Steve Peace, for one, believed that only a tiny fraction of electricity would be bought in emergency markets by the Independent System Operator. As it turned out, the higher prices on the emergency ISO market turned out to be too strong of a lure for the new traders at Enron and Koch to ignore.
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When Melissa Beckett started her day on Koch’s trading floors, she bought and sold electricity contracts in the same way other Koch traders bought and sold crude oil futures. But this time, her customers were the large utilities in California that had been stripped of their power plants and forced to buy megawatts on the open market. Beckett and her team of megawatt traders were one of the most important players in California’s new market.
Her trading desk wasn’t glamorous. It looked like the desk of a telemarketer. The traders sat shoulder to shoulder in their stations, speaking into black microphones, checking their computer monitors, occasionally glancing up at the large television screen suspended from the ceiling that gave them minute-to-minute headlines. Their desks were covered in drifts of papers and file folders, littered with empty coffee cups and boxes of Kleenex tissue perched on top of files.
Through the course of an average morning, Beckett called traders, brokers, and customers west of the Rocky Mountains. She greeted them by name—“What’s going on, Billy?”—and began to haggle with them over the cost of a megawatt-hour. She sounded casual, but Beckett was trading based on information, analytics, and the projections produced by Koch’s elaborate West Power Clearing Model.
California’s new electricity markets were ambling along peacefully during their first years of operation. Prices were relatively low, as legislators like Steve Peace had expected them to be, and the market was relatively stable. Most of the power was bought and sold in the day-ahead Power Exchange and very little power was traded in the emergency hourly markets, where prices were much higher.
But then, during the first days of January in 2000, the West Power Clearing Model began to produce some very strange numbers. It seemed that there was a supply crunch looming in California. The state had not built a new power plant in about a decade, and demand had been rising steadily. Water reservoirs were getting low, thanks to a dry year with little rainfall. A hot summer seemed to be on the way. Demand was high and supplies were tight, which meant that prices would soon be rising. This was essentially the same analysis that Brenden O’Neill was seeing on the natural gas desk. There would be a spike in both gas and electricity prices, which were closely connected.
There was a small problem, however. California’s day-ahead market on the Power Exchange had a price cap on it. This created a potential distortion in the market: the real price of power might float higher than the capped price, which would force producers to trade at a loss. There seemed to be some gaming going on in this market in response to the price caps—it looked like some utility companies were intentionally underscheduling their loads in the day-ahead market to try and evade the price caps. The traders believed that California’s new system was imperfectly deregulated because of the price caps, and they also seemed to believe that the state’s political leaders were too dumb to recognize the fact or change it. The traders weren’t sympathetic to the idea that they should abide by the price caps if the market dictated otherwise.
The thinking of Enron traders was captured in recorded phone calls, later obtained by investigators, which included gems such as: “Grandma Millie, man . . . now she wants her fucking money back for all the power you’ve charged . . . jammed right up her ass for fucking two hundred fifty dollars a megawatt-hour.”
It would be up to the traders, then, to figure out how to make the markets work in spite of California’s jerry-rigged system. In the spring of 2000, these traders were looking to do one thing—they were looking to “gain length,” as Beckett put it. They were looking to own megawatts and sell them at a price higher than the state-imposed price caps on the California Power Exchange. The only way to get a higher price for the megawatt-hours was to sell them in the small emergency market on the day that power was needed: the ISO market. But Koch was prohibited from doing this—only companies that owned a power plant and could promise to deliver the power on a given hour could sell into the ISO market. Koch needed to find a way to break into the hourly markets, regardless of what the rules said. Or, as Darrell Antrich would later put it when questioned by federal investigators: “We thus concluded that we were more likely to be profitable on our positions if we had the flexibility to carry our long positions into the real-time power market.”
Antrich discovered a pathway into the pricier ISO market almost by accident. He was meeting with a salesman for a power plant company named Tom Nesmith, who pitched Antrich a novel idea. It was called “parking.” It would deliver Koch the profits it desired in California. Federal regulators later determined that the trading technique violated the law.
* * *
Antrich wasn’t looking for a new trading technique when he first met with Tom Nesmith. He just wanted information. There was one critical piece missing in Koch Energy Trading’s intelligence network. Koch Industries didn’t own any power plants, so it didn’t have access to the kind of inside information that made its energy trading desks so successful. Antrich was on a quest for such information, and he tried to get it by forming information-sharing systems with utility companies that owned the plants.
Antrich approached one such utility outside California: Public Service Company of New Mexico, or PNM, as most people called it. The company owned a power plant in Arizona that sold electricity into California. This meant that PNM could sell into the coveted ISO market. Antrich wanted PNM to sign a deal that would give Koch’s traders access to PNM’s inside information, such as information on plant outages, its own weather forecasts, and other data that could give Koch a head start on responding to changes in the market. In return, PNM would get access to Koch’s trading analysis, its secret in-house weather projections, and its forecasts on natural gas markets, among other things.
Antrich and his team drew up a consulting agreement for PNM that spelled out the information-sharing agreement, and he pitched it to Tom Nesmith. The salesman was interested in this arrangement. But he wanted to pitch Koch on a special opportunity: the parking trading strategy that Koch could execute in partnership with PNM. The strategy was apparently dreamed up by traders at Enron, and it was later judged to be illegal.
Enron traders seem to have invented the parking scheme sometime in the late 1990s. To execute a parking trade, a trader at Koch or Enron sold electricity from a power plant in California to a customer outside the state, like PNM in Arizona. This sale was made in the day-ahead market, where prices were capped. But the sale was bogus. The next day, when power was supposed to be delivered from California to PNM, the utility would suddenly sell the exact same amount of power from Arizona into California, and into the much pricier ISO hourly market. The two sales would be orchestrated to cancel each other out: 100 megawatts out of the state to PNM, and 100 megawatts into the state from PNM.
Here’s why the scheme was fraudulent: the electricity never made the round-trip journey that the paper trail would indicate. Instead, the power was generated at the original point inside California, and then sold to a customer in California the next day without ever leaving the state. It was only a paper game between PNM and Koch that made it look as if Koch had moved electricity from California to Arizona, and then back into California again. In reality, the power had just gone from point A to point B inside California. The reason this is so important is that, under the arcane rules of California’s system, the power from Arizona was allowed into the pricey ISO market, while the power from California was not.