A series of sham electricity option trades Merrill Lynch entered with Enron in late 1999 that allowed the latter to book a fictitious USD60 million profit have come home to roost, reportedly resulting in the termination two weeks ago of Dan Gordon, Allegheny Energy's president of energy trading, according to an official familiar with the situation at Allegheny. The deal, which was first reported by The New York Times last month, apparently infuriated Allegheny's management because it raised awkward questions over the valuation of two acquisitions: the three Midwest peakers Allegheny bought from Enron in November 2000 and Merrill's energy trading team it purchased in January last year. Gordon, who was terminated as president of Allegheny's energy trading group on Sept. 5, was previously head of Merrill's energy trading team and took the Enron trade to senior Merrill management to get it signed off.
Mike Morrell, president of Allegheny Energy Supply Co., did not return calls. Debbie Beck, an Allegheny spokeswoman in Hagerstown, Md., said Gordon was terminated for violating internal corporate policies, declining further comment. Gordon did not respond to repeated messages left with officials at Daticon, a computer company in Gales Ferry, Conn., of which he is chairman. At the time of his termination Gordon told The Day, in New London, Conn., "I deeply regret and strongly disagree with the various statements that have been made about me." In a statement e-mailed to DW, Bill Halldin, a spokesman at Merrill in Sacramento, Calif., said "The trades with Enron were legitimate transactions involving real risk." He declined further comment. Calls to an Enron spokesman were not returned.
In the virtual power transactions conducted in late 1999, DW has learnt that Merrill agreed to buy and sell a series of physical and financially settled options based on the output of Enron's Gleason, Lincoln and Wheatland peakers in the Midwest. Although the deals contained some basis risk, they were effectively market neutral, according to a trader. Under the terms of the transaction, Enron agreed to pay Merrill USD430,683 per month for four years, which gave the deal a net present value of USD17 million for Merrill. Enron booked USD60 million in profit from the deal, which helped the Houston company meet its year-end targets and triggered the payments of bonuses to its staff. The deal was signed off for Enron by Cliff Baxter, vice chairman, who committed suicide in January as the Enron scandal unfurled. The deal is believed to have been unwound in the first quarter of 2000, and resulted, according to The New York Times, in a net profit of USD8 million for Merrill.
The profits Merrill booked from this transaction would have only added to the perceived value of its energy trading group, which Allegheny subsequently purchased for USD490 million in January 2001, said market officials.
In addition, it is highly likely that Allegheny would have used the Enron/Merrill deal as a reference point to value the three Midwest peakers, which it bought from Enron in November 2000 for approximately USD1.1 billion, according to a former senior risk manager. Since the secondary market for generation assets is not liquid, it would be standard practice to look at capacity deals--such as the Enron/Merrill transaction--to arrive at a valuation for a generation asset, he noted.
Allegheny announced in July that Gordon would step down as head of trading but would stay on as an advisor until 2003, reflecting the general downturn across the U.S. energy markets. In an abrupt about turn it announced Sept. 5 that Gordon had been terminated. Allegheny "threw caution to the wind in seeking a way to get rid of Gordon,"--who had been held in high regard at the company prior to the Enron/Merrill trades becoming public, according to the official familiar with the situation at Allegheny. "They had the veil pulled from their eyes," he added.
