Enron Gas

Services
 Que.1 What was Enrons Contractual
Innovation?
Enron allowed for innovation in following contracts:
Long-term contracts and fixed gas price:
Natural Gas producers had to make large capital investments
to create new supplies
Most banks were unwilling to provide funds to producers
because of wide range price fluctuations
So, EGS started financing gas producers thereby signing long-
term contracts with them to secure future supply of the gas
Contracts resembled in terms of debt and equity, at the equity
end EGS would buy all of the land and mineral reserve
Que.1 What was Enrons Contractual
Innovation? (contd.)
EGS developed an innovative equity contract that would
provide long term gas to with minimal risk of price, quantity,
production cost and credit fluctuation
The contract termed Volumetric Production Payment (VPP)
structure, wherein owner is entitled to designated share of gas
production for a limited period of time
In VPP, EGS would pay for the gas in advance for
predetermined volume of produced gas over certain period
of time, free of cost of production in return
EGS constructed cactus fund with a pool of VPP contracts that
would produce gas supplies which could be sold at spot
prices
ERMS would enter into a natural gas swap in which it would
exchange floating rate gas prices for fixed prices for the
amount of production committed from the vpp.
Que.1 What was Enrons Contractual
Innovation? (contd.)
Enron could engineer any type of financial contract its
users demanded, it often bundled physical and
financial contracts together for ease of marketing
Enron developed a product line called Enfolio
Enfolios products could be customized on various
aspects like quantity of gas delivered, period of time
covered by contract, index against which prices could
be set, level at which prices could be reduced etc.
EGS also offered highly customized long term contracts
to electric utilities and independent power producers
Que. 2 Knowing that Enron eventually failed, can
you speculate what may be the reason for its
failure? Was Enron fated to fail, or was it a poor
implementation of an otherwise excellent idea?
Enron used mark to market accounting in which it
recognized as current income a portion of the net
present value of hedged transaction at the time of
contracts were initiated
Commitments to be made were categorized as current
assets and liabilities
Since initially all of the derivatives markets have more
profits but it would decrease eventually.
You need to generate number of costumers according
to decreasing profit to remain sustainable in the market,
which did not happen in the Enrons case
Thank You