I spoke too soon, a truely astute investigative journalist explains it all.....
How Enron Works
The mule market.
By Joe Bob Briggs, a writer for UPI
January 22, 2002 9:25 a.m.
ere's how Enron works. It's really quite simple. Ismail is a
successful mule trader in Peshawar. Every year Ismail
delivers 30 mules to the Kabul Mule Market and gets $40
per mule.
This year, however, the Khyber Pass is full of warlord
militias, so Ismail is not sure he can drive his mules to market
without losing a mule here and there. Also, the demand for
mules in Kabul seems to be dropping. Maybe he'll only be
able to sell 20 mules, or, God forbid, 15, and then be forced
to feed and water the rest of them on a money-losing trek
back home. In other words, it's a scary market and Ismail is
worried about feeding his family.
What Ismail needs is to limit his risk with an Enron derivatives
package. First he pays $2 per mule for a Khyber Pass
Derivative, so that any mule killed or stolen by warlords will
be reimbursed at the rate of $20 per mule-half the going
market rate, but still better than taking a total loss. Next he
buys Enron Mule Futures. For $28 per contract, he
guarantees delivery of a mule in three months time. He takes
15 of these, figuring that a guaranteed $28 mule sale is better
than showing up in Kabul and discovering that the mule
buyers have been killed by stray bombs.
Meanwhile, at the Enron Mule Trading Desk in Houston,
eagle-eyed yuppies are studying the worldwide mule markets
and starting to have their doubts about those $28 delivery
contracts. Mule use is dropping all over Afghanistan, even as
the mule count is dwindling. Better resell eight of those 15
contracts to a European commodities broker for $24 each,
then make up that $32 loss somewhere else while cutting the
company's exposure in half. But how to hedge the risk on the
other seven?
Aha! A blip on the computer screen. A temporary mule
shortage in southern Iran! With a current mule price of $42 in
Tehran, Enron could offer a Linked Mule Swap Double
Derivative tied to the gap between the price of mules
delivered in Kabul on a given date and the price in Tehran on
the same date. Sure, you would rather have the
quick-and-clean Iran sale, instead of the sale in Kabul that
requires trucking the mules to a foreign market. But even if
you add in $4 per mule for transport through militia-held
territory and averaged the markets together, you can still
clear eight bucks just on the gap alone.
Enron's average price-per-future-mule is now $32.57 when
you include the $4-per-mule loss on the mule futures dumped
in Europe. But based on the amazing $12 Kabul/Tehran
trading gap, they can easily put together a "delivery in either
market" contract that will allow them to ask $36 per mule on
their Mule Online Internet trading system. The first mule
future sells instantly for $36, and the price bobs up to
$36.50. Two mules go for $36.75, and then there's a big
jump for the last three mules to $37.90. Enron has now
off-loaded all its price-based mule futures liability for a profit
of $31.70.
But this doesn't mean they're out of the mule market in
Central Asia. It's still two months until Ismail delivers his 30
mules, and Enron is on the hook for his Khyber Pass
derivative insurance policy.
Things are not looking good in that part of the world, either.
The chances of a mule being picked off as a road-passage
tax are pretty high, and the loss of the whole herd would be a
$600 liability. Quickly, the financial boys go to work, and
part of that liability is resold to a consortium of Singapore
banks, Australian mutual funds, and Saudi Arabian arms
merchant Adnan Kashoggi, thereby reducing Enron's
percentage to 25 percent, or $150 in potential liability against
a $15 premium (remember the $2 per mule paid by Ismail),
and Enron also takes a brokerage fee of $20 from the three
other partners, thereby reducing its real liability to just $120.
But that's still too much of a spread, so Enron continues to
hedge. Fortunately, the company has such a diversified
trading floor that Enron mule-market experts can walk over
to the traders in the warlord-militia derivatives department.
Sure enough, at least four tribes near the Khyber Pass are
increasingly concerned about profit margins. There simply
aren't enough people to rob. Things have gotten so bad, in
fact, that the warlords are hedging against the oncoming
winter by taking futures positions in stolen chickens, stolen
humanitarian aid trucks, and Western hostages. There's not a
mule market yet, because the warlords have successfully
converted many of the recalcitrant villagers into pack animals.
But Enron knows how to MAKE markets.
Quickly the numbers-crunchers go to work, and they soon
determine that the average number of stolen mules per
100-man militia is 1.4 per year. That represents anywhere
from $28 to $56 in lost mule-thievery income if the Khyber
Pass is closed or inhospitable to traders from Pakistan.
Amortizing that amount over 12 months, the warlords have an
exposure of anywhere from $2.33 to $4.67 per month in lost
pillage. Hence Enron announces the new Highway Robbery
Derivative, in which each tribe is guaranteed the value of two
stolen mules in each 12-month period in return for paying a
premium of $4 per month.
Enron's hedge is now complete, and it's a beautiful thing to
behold. The chances of Ismail losing a mule to a raiding party
are approximately one in 30, or 3.33 percent. Since he's
paying $60 for his derivative contract, the expected loss of
3.33 percent of his herd would result in a payment of only
$20 — a more than comfortable spread. Meanwhile, if the
mule is stolen by a warlord holding a Highway Robbery
Derivative, then the payment to the other side would only be
$28 against premiums of $48. If Ismail simply passes through
the Khyber Pass without incident and sells all his mules at the
standard price, Enron pockets $60 from Ismail and $48 each
from four warlords, in addition to the previous profit of
$31.70 from that heady Internet mule-futures trading day and
the $20 in packaging commissions. If each warlord steals his
standard 1.4 mules per year, then Enron still owes six-tenths
of one mule to the warlord, or about $22.20 based on a $37
sale price.
Total expected profit, based on 5.6 stolen mules, one of
which is stolen from Ismail: $143.20. Total profit from all
Ismail-related mule transactions: $194.90. See, it's simple
when you know how it works. Ask Arthur Andersen. |
