The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron

by Bethany McLean

  The Dahbol saga began in early 1992, not long after Mark became head of Enron Development. An Indian delegation, led by the country’s power secretary, came to the United States touting the government’s program of economic reforms, and seeking investors to help India address its chronic energy shortages. Many American energy companies, wary of the problems that came with doing business in India, held only cursory meetings with the delegation. Not Enron. Mark spent an entire day with the Indian delegates. Eventually she told them that Enron would be the country’s first investor, but only if India were willing to meet three conditions. It would have to work with Enron on an expedited basis, it would have to commit to using natural gas, and it would have to back up any deal with ironclad government guarantees.

  On June 30, Enron signed a letter of intent with the electricity board in Maharashtra, India’s wealthiest and most heavily industrialized state, which was desperately in need of power. That summer, on one of her now-frequent trips to India, Mark spent three days with Maharashtra officials driving down the coast in search of the perfect site for the plant. The spot they chose was so remote that the project would have to develop its own roads, hospital, housing, and port. Enron was awarded the right to develop the site without competing bids.

  Eighteen months later, in December 1993, Mark inked a 20-year power-

  purchase contract with the Maharashtra State Energy Board (MSEB). The terms called for Enron to build an enormous, 2,015 megawatt plant—bigger than Teesside. The construction would be done in two phases at an estimated cost of $2.8 billion. The two sides agreed that power prices in the region would rise once the plant was up and running, in part because, for environmental and reliability reasons, the fuel would be imported liquefied natural gas, an expensive fuel. The bill for the power would be calculated in dollars, so that the MSEB, not Enron, bore the currency risk. Finally, the MSEB promised to buy 90 percent of the power Dabhol produced for the entire 20-year period. Its ability to pay was guaranteed by both the state and the central government.

  It is astounding, in retrospect, that no one on the Enron side could envision the kind of resentment and backlash such a one-sided agreement would engender. To many Indians, the deal came to represent nothing less than a huge giveaway to a rapacious multinational corporation. But even putting that aside, the deal was a huge gamble for Enron. If the MSEB was ever going to be able to pay for the power on its own, the Indian government would have to push through serious economic reforms, reforms that would put state electricity boards such as the MSEB on a firm financial footing. But such reforms were politically contentious because they would mean increasing the price of power for some consumers. On top of the normal economic risk was a frightening amount of political risk.

  Still, at first, Mark seemed brilliantly ahead of the pack, just as Wing had been with Teesside. After Enron signed its letter of intent, other companies worried that they might be missing out. During 1992 and 1993, almost 200 memorandums of understanding were signed to build plants in India. (Very few were ever built.) And Mark began unloading some of Enron’s exposure, insisting, for instance, that GE (which was selling turbines to Dabhol) and Bechtel (which was constructing the plant) each put up 10 percent of the equity. They agreed.

  Then the problems started mounting. The first big hurdle was financing. For years, the World Bank had held a near monopoly on financing infrastructure investments in India. But the bank objected to the project, warning that Dabhol was “too large” and “not economically viable” and would “place a heavy financial burden on Maharashtra.”

  Mark and her team fumed that the World Bank, which was the biggest lender to Maharashtra, didn’t want its position usurped by private developers. It took Mark almost two years, but in February 1995, after two government reviews, nine court cases, and reviews by over a hundred outside lawyers, advisers and bankers, Mark finally got her financing. Dabhol received a total of $643 million for Phase 1 of the project from sources as varied as OPIC, a syndicate of Indian banks, and Bank of America.

  Just weeks after Bechtel bulldozers began flattening the red rock hillside in Dabhol, there was an ominous development. In Indian state elections that took place in March 1995, the ruling Congress Party in Maharashtra lost to a Hindu nationalist coalition that had campaigned on an anti–foreign investment platform and a promise to “push Enron into the Arabian Sea.”

  Suddenly, questions that had been bubbling in the background erupted. How could a project the size of Dabhol have been approved without bribes? Just where did the $20 million that Enron said it spent on “educating” the Indians about capitalism really go? Why had the Enron contract been negotiated in secrecy, without a competitive bidding process? How was MSEB ever going to be able to afford to buy all that power? “India’s status will be enhanced, not lowered, if it tells the world that it is no pushover, no banana republic ready to accept an atrocious deal,” opined the Times of India. The new ruling party immediately began a review of Dabhol.

  The situation soon got uglier. In May, hundreds of protesting villagers swarmed over the site, and a riot broke out. Human Rights Watch and Amnesty International eventually charged security forces guarding Dabhol for Enron with human-rights abuses; Human Rights Watch blamed Enron for being “complicit.” Meanwhile, various Clinton administration officials, including Treasury Secretary Robert Rubin, weighed in on behalf of Enron; in June, the Department of Energy issued a statement saying that canceling Dabhol could have an adverse effect on India’s ability to attract foreign investment.

  On August 3, the Maharashtra state government ordered the project halted because of “lack of transparency, alleged padded costs, and environmental hazards.” Construction ground to a halt; by then, some $300 million had been spent on the project. “What we are experiencing here is every investor’s worst nightmare,” Mark told the newspapers. “I’m in grief.”

  Over the next year, an Enron senior management group, spearheaded by Kinder, convened every day at 8 A.M. to review the company’s options. Meanwhile, Enron fended off two dozen lawsuits from various Indian entities trying to undo the Dabhol contracts. Enron’s stock, which had been on a tear, stalled, as the deadlock at Dabhol cast broader doubt on Enron’s international strategy.

  What followed can be described as either a triumph of Mark’s negotiating prowess or as a disastrous doubling of an already risky bet. While the lawyers in Houston dug through the contracts, Mark got on a plane to India and spent the next six weeks there. She later described it to one friend as refusing to “listen to negativity.” She and her team talked to over a thousand people, offering to renegotiate the price of the power, the capital costs of the plant, even offering to switch to a cheaper fuel. After nearly two months, the Indian team agreed to reopen negotiations.

  Mark had breathing room, but only if the entire project, not just the first phase, were renegotiated. Over the previous four years, costs for much of the major equipment had plunged, allowing Enron to slash its costs on the second phase, whose equipment had not yet been purchased and which India had not yet approved. That meant Enron could offer a major overall rate reduction while preserving the economics of the deal, but only if both parties doubled their bet.

  On February 23, 1996, Maharashtra and Enron announced a new agreement. Enron cut the price of the power by over 20 percent, cut total capital costs from $2.8 billion to $2.5 billion, and increased Dabhol’s size from 2,015 megawatts to 2,184 megawatts. And both parties formally committed to developing the second phase. On December 10, 1996, Enron announced that the financing for Phase 1 had again been secured, and that construction had resumed.

  The MSEB also won the right to be able to purchase a stake in the venture; it eventually owned 15 percent of Dabhol. If the foreigners were going to make so much, India wanted a piece of the action. But the MSEB’s obligations still remained mammoth. Under the revised terms, it was required to purchase more power than before, by some estimates as much as $30 billion worth over the life of the contr
act. It was a preposterous sum. Critics in India, meanwhile, continued to hammer away, complaining that Enron’s estimated return, which by some calculations could be as much as 30 percent, was shockingly high. Accusations of bribery and corruption, though never proven in court, never went away. Mark’s team hung in through it all. The first phase began producing power in May 1999, almost two years behind schedule, and construction started on phase 2. Costs would ultimately climb to $3 billion.

  Then everything came to a stop. The MSEB refused to pay for all the power, and it became clear that getting the government to honor the guaranteees would not be an easy task. Although Maharashtra still suffers from blackouts, it says it does not need and cannot afford Dabhol’s power. (The New York Times calculated that the cost would exceed Maharashtra’s entire budget for primary and secondary school education.) And India’s power sector still loses roughly $5 billion a year. Today, Dabhol, in which Enron invested some $900 million, sits silent, a gigantic, wasted marvel of modern technology.

  But that became clear only much later. For Rebecca Mark, the near-term effects of Dahbol were entirely different. For one thing, it made her rich. One executive remembers a conference call between Mark and Ken Lay to discuss Mark’s bonus for Dabhol. The cash-flow estimates she had prepared assumed, naturally, that everything would go smoothly, but Lay offered no objections to her spreadsheet. The project team split $20 million, of which she received a huge chunk. Soon she was zipping around Houston in a ruby-red Jaguar XK8 convertible. She had a Land Rover for the kids, a lake house, a ten-acre retreat in Taos, and an apartment on Manhattan’s Upper East Side.

  The near-miraculous resurrection of Dabhol made Rebecca Mark into even more of a rock star. The press was fawning: “From near disaster, Mark and Enron have wrested a victory,” wrote Forbes. Pulitzer Prize–winning energy historian Dan Yergin told Fortune: “Rebecca is tops in her business.” Jeffrey Garten, the dean of the Yale School of Management, said to Institutional Investor: “Enron has gained tremendous respect for their manner abroad. . . . What develop-

  ing countries want, especially in sophisticated energy industries, is first-rate American companies with the best of American management and technology. That’s what Rebecca gives them.” Garten added that Mark and Lay were “clearly willing to take major risks before they know what the endgame is in a business with huge capital requirements, and they are willing to stick it out through the ups and downs.” Both inside and outside the company, there was speculation that Mark would be Enron’s next CEO. Enron International accounted for more than 15 percent of the company’s earnings in 1996, and Enron was soon predicting that its earnings from International would grow at 20 percent a year for the forseeable future.

  At least one person other than Skilling was not convinced: Rich Kinder. Ever the hard-core numbers guy, Kinder was skeptical of everything, but he was especially skeptical of Mark’s business. There was no way he could evaluate its performance, because so much of the profits were on the come. But globalization had caught on, the board belonged to Ken Lay, and Mark was his star. To other Enron executives, it appeared as if Kinder was afraid to take her on, because he realized this was one battle that he would lose.

  Events were brewing under the surface, however, that would change everything—and inside Enron, decisions were being made that would set the company on a very different course.

  CHAPTER 7

  The 15 Percent Solution

  By the mid-1990s, it all seemed to be clicking, at least on the surface. Enron now had a story Wall Street loved, the story of a company transforming itself into something new and shiny and different, a company that relied as much on trading screens as on pipelines and that landed breathtaking deals in far-flung places. With every passing year, it seemed, Enron was posting record profits, from $387 million in 1993 to $453 million in 1994 to $520 million in 1995. The community of Wall Street analysts and institutional investors that followed the energy industry was enthralled with the company and rewarded Enron the only way it knew how: by buying the stock. From mid-1990 to late 1995, Enron’s stock price tripled.

  And who was responsible for this remarkable transformation? Why, it had to be Ken Lay, didn’t it? Certainly, that’s what most people outside the company assumed. He had long since begun the process of raising his profile, in Houston, on Wall Street, and especially in Washington, D.C.; in the process, he crafted an image as a thoughtful and visionary businessman, a caring community leader, and the philosopher-king of energy deregulation. It didn’t hurt that the philosophy Lay had long espoused had largely become accepted wisdom, not just by Republicans but by Democrats as well. “Ken is a profound thinker, a great long-term strategist who has been on the forefront of the natural gas industry for many years,” said a PaineWebber analyst named Ron Barone in 1996. “He knew where this industry was going ten years before it happened.” Such accolades were typical by the mid-1990s.

  But inside the company, especially among the top executives, it was a different story. Lay was a pushover when it came to negotiating pay and bonuses and could always be held up for more money. Even though Skilling’s business was transforming the company, Lay’s understanding of how ECT worked was fuzzy at best. He usually seemed at one remove from the nitty-gritty of the business itself. In his early years as CEO, Lay had been a workaholic who usually traveled with a bulging briefcase. Now, increasingly, he appeared more invested in his outside endeavors, from the Houston charities he was involved in to the campaigns he raised money for to the Washington think tanks whose boards he sat on, than in Enron. “If you wanted to get Lay to attend a meeting,” recalls a former executive, “you needed to invite someone important.”

  The person who usually ran those meetings was Lay’s tough number two, Rich Kinder. It could have been the perfect arrangement, with Lay as Enron’s Mr. Outside and Kinder as Mr. Inside. But such arrangements work only if each man respects and values what the other brings to the table. And they only work so long as the number two is content to remain behind the scenes while the CEO is taking all the bows. By the mid-1990s, that was no longer true of Ken Lay and Rich Kinder.

  • • •

  When did Ken Lay even have the time to run Enron? Turning himself into a public figure was pretty much a full-time job. Like many prominent CEOs, he sat on other corporate boards, joining Compaq’s board of directors in 1987 and adding Eli Lilly’s in 1993. He and his wife, Linda, were fixtures on the charity dinner circuit. They were among the premier hosts in Houston, throwing cocktail parties for important people passing through the city. The Lays and their personal charitable organization, the Linda and Ken Lay Family Foundation, gave millions to local causes. They also gave generously to out-of-town organizations, such as the Baptist Church in Columbia, Missouri, the Character Education Partnership in Washington, D.C., and Aspen’s Biochemical Research Foundation. He served as chairman of the Greater Houston Partnership and raised money for the Houston United Way.

  For local politicians, getting an audience with (and a donation from) Ken Lay was practically a rite of passage. Indeed, anyone involved in Houston’s civic life simply had to get to know Ken Lay: he was the man who could make things happen. In 1996, when Lay read that the city’s National League baseball team, the Houston Astros, might move unless it got a new stadium, he raced into action, working tirelessly to get a referendum passed authorizing construction of the stadium. In 1999, Enron agreed to pay $100 million over 30 years to have the stadium named Enron Field; Enron also got a 30-year contract, which it valued at some $200 million, to manage the stadium’s energy needs. On the first day of the 2000 season, Lay was invited to throw out the first ball, while both generations of George Bushes and their wives cheered him on from their seats behind home plate.

  Though he’d lived in Houston since the early 1980s, Lay had never lost his taste for Washington, D.C. Now, as a wealthy and prominent CEO, he could indulge it. He traveled to Washington frequently—often without informing Enron’s Washington public
-affairs office—arriving on a company plane and staying at a swanky hotel. He would be chauffered around town. His assistant, a commanding woman named Nancy McNeil—“the little general,” some people at Enron called her—was considered a key go-between for politicians, all of whom knew her, and Lay. Lay, though, didn’t often spend time with run-of-the-mill politicians. He preferred high-ranking executive branch officials.

  He had become close friends with Charls Walker, the brother of his old mentor Pinkney Walker. Charls Walker was one of the most well-connected lobbyists in the capital. He joined Enron’s board in 1985, and his firm was retained to lobby for the company. Realizing that Lay was an unusual asset—a CEO who had once been a government policy maker and understood the byways of the capital—Walker recruited him that same year to cochair something called the Coalition for Jobs, Growth, and Competitiveness, which lobbied against any increase in taxes for corporations. In the mid-1980s (and again in the year 2000), Lay served on the board of Resources for the Future, a respected environmental-policy development organization. And in 1995, Lay was elected to the board of the American Enterprise Institute, a right-leaning think tank that is a meeting place for Washington’s conservative elite. Future vice president Dick Cheney was also a trustee; his wife, Lynne, is still a staff scholar there.

  Of course, it wasn’t just Lay’s personality that won him friends in Washington; he also had Enron’s money to spread around. Between 1989 and 2001 Enron and its executives contributed nearly $6 million to political parties and candidates, two-thirds to Republicans, according to opensecrets.org., a site that tracks political contributions. Over that same period, Ken and Linda Lay individually contributed over $880,000, of which 90 percent went to Republicans. Enron was a major supporter of Tom DeLay, the House Republican leader from Texas, and of Senator Phil Gramm, another Texan. And Enron was one of George W. Bush’s biggest supporters.