Enron GasServices Que.1 What was Enron’s 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 Enron’s 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 Enron’s 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 Enfolio’s 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 Enron’s case Thank You