Enron Plays The Pipes

By Frank Gibney Jr./Houston

It's Saturday night, and the only thing between you and a movie from Blockbuster Video is the unpaid late fee for last week's rental. If that sounds familiar, then you'll appreciate this: next year Blockbuster plans to offer up to 500 movie titles online in more than a dozen major cities around the U.S. That's right, video on demand (not the frustrating no-rewind, no-pause pay-per-view offerings of today) for anyone with a DSL line at home.

What's remarkable is that Blockbuster's partner happens to be an energy company called Enron. At a time when so many old-economy companies seem helpless against the dizzying pace and technology of the digital age, Enron is demonstrating why FORTUNE magazine keeps voting it the most innovative large company in America. For years the Houston-based firm simply produced, transported and marketed natural gas. Then, as energy deregulation threatened profit margins in the gas business, Enron discovered it could make billions by trading and brokering packages of energy the way Midwesterners do pork bellies. Now Enron is moving into the telecommunications business, with a national fiber-optic cable network and a floor bulging with Sun supercomputers.

In fact, Enron may be the most interesting old-economy company around. Since moving its trading operations from the phone to the Web eight months ago, the company has doubled revenues to more than $30 billion. Most of that is made through trading everything from energy and paper to weather risk derivatives and now bandwidth--more than 800 offerings in all. Think of eBay, but instead of auctioning $5 used Baby Gap pajamas, the company trades $600,000 blocks of natural gas--and pockets commensurately huge commissions. Boasts Enron president Jeffrey Skilling: "In terms of dollars transacted, we're the world's largest online site by a factor of 10."

So far this year, that has meant $120 billion in transactions. And when you're running the network, all sorts of profitable opportunities arise. Last week, when word spread that natural-gas prices would spike this winter, Enron's in-house traders saw their gains surge as customers raced to lock in future supplies at today's prices. And Enron's stock price? It hit $90 last week, tripling its value of a year ago. Kind of like an Internet play, only better.

The market loves Enron because Skilling and CEO Kenneth Lay seem to have come up with a business model that works for just about anything. They provide a service to their customers by packaging a supply of name your commodity and then using the efficiency of their vast network to beat most prices. They arrived at this model back in the mid-1980s almost out of desperation, when crude-oil prices had collapsed, natural-gas deregulation had thrown that market into chaos, and the Peruvian government had just nationalized Enron's offshore properties. Figuring they might as well leverage deregulation instead of succumbing to it--call it business judo--Skilling, a McKinsey & Co. consultant at the time, came up with a plan called the Gas Bank, to buy up reserves of natural gas, then package them for sale, with various prices and conditions for different customers. When electricity markets deregulated a few years ago, the company did the same. It's the oldest concept in business: buy low, sell high.

Enron also leverages its assets and expertise to provide services to big customers. Since 1997, companies like Owens Corning and Chase Manhattan Bank have signed long-term, multibillion-dollar contracts with Enron subsidiary Enron Energy Services (EES) that lock in their energy costs for up to 10 years and provide Enron with a steady revenue stream. What's more, Enron is beginning to actively manage its clients' heating and cooling plants, installing new equipment when necessary and monitoring it all over the Internet.

Skilling's latest gambit is to apply the same principles he learned in the power and energy sectors to making Enron a leader in the booming telecommunications business. The plan isn't to go head to head with established fiber-optic carriers such as AT&T, Qwest and Williams Communications. Instead, Enron wants to use new switching technology and its expertise in trading pipeline access to transform a modest telecom network into a powerful arbiter of bandwidth. Enron's bet is simple: supply and demand will increase exponentially, turning bandwidth into a tradable commodity, just like gas and electricity. Along the way, why not partner with companies such as Blockbuster and use this new technology to offer content--like movies--and blow it through existing, underutilized pipe? "They are jump-starting an application [telecom content] with a potential market of $200 billion a year," says Tom Nolle, president of the telecom consulting firm CIMI.

Other new-economy players are also beginning to see the power merchant as a prize partner. IBM and AOL have joined with Enron to form the New Power Co. (TNPC), an independent start-up that will offer pricing schemes and a choice of power and gas service for residential and small-business customers. Enron provides the electricity; AOL enables customers to buy it via the Web; and IBM takes care of the billing. "It's ludicrous that we're in the 21st century, and you still have people jumping over fences to read meters," says Skilling, pointing out that the technology exists to offer real-time pricing for gas and electricity. In deregulated markets, TNPC will allow consumers to switch power companies as easily as they do phone companies.

Despite all Wall Street's enthusiasm for Enron's bold plans, there are still plenty of skeptics. Critics point out that there is barely a market today for the company's bandwidth trading exchange. They also stress that pushing digital signals through pipe is a world away from routing natural gas. Although there is plenty of cable across the country, carriers are not set up to mix and match access to it. "It's a very, very difficult concept," says Nolles. Even the Blockbuster venture is risky: technology aside, there is also the highly political question of digital rights. How do you satisfy Hollywood that its content is secure?

But Skilling and his lieutenants are quick to counter that everyone thought they were crazy to try to make markets in gas and electricity. And Enron, after all, is a company that thrives on entrepreneurial defiance of convention. Many of its new ventures were started because managers simply set new ideas in motion without waiting for approval from the top. Even the online operation was cobbled together in a mere seven months. Skilling and Lay found out about EnronOnline only two weeks before it went live.

Is taking risks really a part of a gas-pipeline company's culture? Just ask John Arnold, the 26-year-old chief of natural-gas derivatives, who after nine hours and $1 billion in trades last Wednesday had this to say: "You can't turn away for a minute or you get picked off." That has happened to too many traditional companies because they were unable to find a niche in the new economy. Enron, however, has traded its way into a starring role, and now it hopes it is ready for the movies.