ENRON

Group 2

190102019 Harshil Samani

190102026 Naman Jain
190102031 Pragya Gupta
190101102 Sanjana Aggarwal
190101116 Smriti Shukla
190102060 Sukalp Mittal
 • Enron was an American energy, commodities and
services company based in Houston, Texas
• Energy Trading Model
• Pre-Deregulation- Bundled product of gas and
delivery services at regulated prices (> spot
prices)
• Post deregulation- Decoupled the purchase

Overview
and delivery of gas

Users could Exposure to

save money by short term
separately volatility in gas
purchasing and spot prices
getting it
delivered
 • Enron wanted to help the buyers manage the short-term
volatility in gas spot prices
• Their basic model looked like:

Enron & Gas Producers: Entered

into a long-term contract to
reduce its exposure to the
fluctuating spot prices

Volatility Enron and Buyers: Entered into a

Management long-term contract guaranteeing

stable gas prices until the
contract expires

• 1993- Largest seller of Natural Gas- Gas Trading

accounted to $316 million to its EBIT
• 1999- EnronOnline- web based transaction system
for the buyers
• Late 1990s- moved to asset light strategy to reduce
the debt burden
 • Step into the markets with characteristics like-
• Inefficient markets
• Fragmented and undergoing significant changes (like
deregulation)
• Complex distribution channels

Extending the • Opaque pricing (without proper disclosure)

• Limited flexibility to buyers to manage risks

Trading • New markets like- Electric Power (generation,

transmission and distribution), Broadband Services

Model
(bandwidth trading)
• International Business
• Energy-Asset Construction Business
• Global water business
 • Long Term Fixed Rate Contracts
• Used to buy gas or commodities from suppliers
at fixed costs
• Sell commodities to customers at fixed price
• Swaps or collar
Derivatives • Used to hedge weather risks
• It is based upon warm and cold days in a
Instrument season.
• If warm days exceeds a set level, Enron will pay

s to gas company and if cold days exceed then

Enron will get payment.
• Price Swap Derivative
• Commitment to maintain Raptor value at $1.2
billion
• If value declines, then Enron had to give its
stock to Raptor.
 To reduce Enron's tax payments

To inflate Enron’s income and profits.

Objective of
the To inflate Enron’s stock price and credit

Derivative ratings.

Strategy To hide losses in off balance sheet

subsidiaries.

To fraudulently misinterpret Enron’s

financials in public reports.

Using Derivatives to Hide Losses on
Technology Stocks First
• Enron hid millions of dollars of losses in tech
firms Rhythms Net Connections, Inc.
• Next, Enron entered into a series of
transactions with a SPE –Raptor which was
owned by another Enron special purpose
entity, called LJM1
• Enron had derivative instruments on 54.8
million shares of Enron common stock at an
average price of $67.92 per share, or $3.7
billion in all.
• In these deals, Enron’s obligation is 7% of all
of its outstanding shares. If share price
declined, that obligation increased and
Enron’s shareholders were substantially
diluted.
Derivatives “Outside” Enron
Using Derivatives to Inflate the
Value of Troubled Businesses
• Enron inflated the value of
certain assets it held by selling a
small portion of those assets to
a special purpose entity at an
inflated price.
• Sold “dark fiber” - valued at only
$33 million for $100 million. $30
million in cash plus $70 million
in a note receivable
Using Derivatives to Hide Debts
Incurred by Unprofitable Businesses
• Used derivatives with two SPE (JEDI
and CHEWCO) to hide huge debts
incurred to finance unprofitable new
businesses.
• Enron buys 50 percent of JEDI, and
therefore under accounting rules it
reported JEDI as an unconsolidated
equity affiliate.
 • Prudency Reserves
• Enron derivative trading kept record of Profit
and loss
• Instead of adding full profit they split profit into
actual which was shown in Financial statements
and rest they include in prudency reserves
Derivatives which they use to offset their losses
“Inside” • Mismatching Forward Curves
• A forward curve is a list of forward rates for
Enron arrange of maturities
• Used forward curves to generate profit and loss
statements
• Traders mismatched their forward curves - to
hide losses and were compensated based on
their profits
Outcome of their Derivative strategy and why it
failed
Derivatives to Inflate Asset
Price Swap - Raptors Collar – Rhythms Transaction
Value

Outcome Outcome Outcome

• Hedged investments started falling • Enron paid its SPE $27 million • The Fibre price collapsed
• Credit Capacity Issue • The unwind was not fair to ENRON and it • Enron suffered a loss but deferred the
• More SPEs were created provided windfall to the investors declaration

Why it failed? Why it failed? Why it failed?

• Continuous fall of Enron and technology • Enron was its own counterparty • Artificially revaluing the fibre price three
stock prices • Economically, loss was incurred by Enron times using SPEs
• Delivery of shares diluted Enron's only • Enron had to pay its SPEs as the fibre
earning per share. price collapsed
 • Deploy Mark to Market Accounting in an
efficient manner
• Take majority stake in Special Purpose
What we Entities
• Use Right Forward Rates
would have • Put more focus on core business activities
done • Follow better corporate governance
differently practices
• Avoid conflict of interest in auditing
processes
Thank
You