Understanding the "Enron Clause"
How the clause in Power Purchase Arrangements came to be, and why the government is challenging it.
Power Purchase Arrangements (PPAs) contain a “change-in-law” clause that allows companies to terminate the agreements in the event that government action makes their projects unprofitable. This standard change-in-law provision was subject to public scrutiny over nearly a year of consulation and was intended to be part of the final language of the PPAs.
The PPA change-in-law provision in dispute, however, was amended at the behest of Enron lobbyists to add the words “or more unprofitable,” just days before the PPA auction took place.
The amendment was never open to public scrutiny. It was temporarily posted online, after the PPA auction had already started.
The following lays out a detailed timeline of the change-in-law provision, including email correspondence which explains how the Enron clause came to be.
PPAs and "change in law"
By July 27, 2000 – five days before the provincial government’s auction of Power Purchase Arrangements (PPAs) -- the government’s PPA process was well underway and a number of key decisions had already been made and announced.
The PPA text was required by law to be written by an Independent Assessment Team (IAT) after receiving proposals from power generators and consulting with potential PPA bidders and other stakeholders, including industrial and other consumers. On July 9, 1999, the IAT filed the text of the PPAs with the Alberta Energy and Utilities Board (AEUB), by way of a letter from Keith Anderson of PriceWaterhouseCoopers on behalf of the IAT (0.2 MB).
The PPAs essentially allowed “PPA Buyers” to purchase at auction the right to buy power from existing power generators or “PPA Owners.” The Buyers would take the Owners’ power and re-sell it to Albertans. The price Buyers paid to Owners for 20 years was essentially to be enough to keep them “whole,” that is, so Owners made as much from their power as they previously did selling it directly to Albertans under the former regulated system. In essence, the Buyers would be paying something analogous to the former “retail” price for the Owners’ power and taking the risk that they could make money re-selling it to Albertans at “retail plus” prices.
Origin of the change in law clause
As part of keeping the Owners “whole”, the IAT recommended in its report – re-drafted and submitted on August 27, 1999 (6.5 MB) -- that an Owner’s cost arising from a “Change in Law” (a government regulation, tax or levy that increased the cost of generating power) be passed through by Owners to Buyers and that a Buyer be required to absorb the Change in Law costs as part of its market operations.
The IAT recommended one sole exception: if a Change in Law cost passed to Buyers by Owners “rendered” the Buyer’s PPA operation “unprofitable,” then the Buyer would be able to terminate the PPA. When a Buyer terminated a PPA, the Balancing Pool (a public body created to manage PPAs) would become responsible to make the Buyer’s payments to the Owner and sell the Owner’s power. Balancing Pool revenues would be returned to Alberta ratepayers, but if the Balancing Pool did not make enough money selling power to cover the Buyer’s payments to the Owner, Alberta ratepayers would have to make up the difference. An example of the Change in Law provision can be seen in section 4.3(j) of the Sundance 3 PPA filed by the ITA filed on July 9, 1999 (0.1 MB).
The IAT explained the basis for the exception to the notion that Buyers should absorb Change in Law costs – if they are “rendered unprofitable” – in a number of places in its August 27, 1999 report (2.0 MB) excerpted below:
- Page 2: “to make the PPA as ‘commercial” or ‘business’ oriented as possible, as if they were contracts entered into freely on the basis of commercial terms with an equivalent risk allocation and level of costs” – i.e. if one of the parties renders you unprofitable, you should be able to exit the arrangement;
- Page 4: because “market risks (e.g. changes in market prices) are best managed by the Buyer who is responsible for selling the output of the plant into the market”;
- Page 16: Some owners “suggested that the Balancing Pool could bear some of the costs on the Buyer’s behalf. The IAT determined that allowing the Buyer relief from any environmental taxes will act contrary to the public good. The IAT also determined that the Buyer should not be shielded from many of the Change in Law provisions”;
- Page 17: “Change in Law (Section 4.3) If the buyer believes that the costs of complying with a Change in Law provision will make the PPA unprofitable, it can terminate the PPA.” [Emphasis added]
- Page 67: “Section 4.3 of the thermal PPA provides for the Owner’s economic position to be unaffected by changes in law which affect the Owner’s costs or revenues associated with the provision of Generation Services. Any change to such costs or revenues is to be passed on to the Buyer. The IAT is of the view that in a cost-based PPA, the Owner is not able to recover any losses arising from such changes, and that the Buyer is better situated to manage such risk (as it stands a good chance of being able to pass on such costs to consumers through its sale of electricity”;
- Page 68: “As well, in the event that a change in law is reasonably expected to make continued performance by the Buyer unprofitable, the Buyer is given the ability to exit the PPA without receiving or paying a termination payment” [Emphasis added]
- Page 70: “Except as specifically provided for in the PPA or regulations [e.g. termination if rendered unprofitable by a change in law] there are no termination rights. The PPA regime is based upon a number of decisions with respect to risk allocation and incentives, and is back-stopped in many cases by the Balancing Pool. To allow for termination in situations other than those specifically provided for would undermine the entire process and potentially expose the Owner, Buyer or Balancing Pool to risks which they were not intended to bear.”
The government of the day said that its policy would allow competition, opportunities for investor profits and a shift of market and other risks away from consumers to companies.
The IAT's recommended change in law clause followed this logic: PPA's would be "commercial." Buyers seeking the right to compete with other buyers in the market would all share the same risks. And specifially, the IAT said buyers should absorb market price, risks and all change in law risks except if change in law costs became so large they rendered a PPA unprofitable when it would otherwise be profitable.
Could the IATs PPAs be changed?
Also by law, the AEUB was required to give notice to the public when the AEUB received the IAT’s PPAs and Report. It did so three days after receiving the PPAs, by Notice of Filing to stakeholders, consumer representatives and the public (0.7 MB) on July 12, 1999.
The AEUB Notice is also important as it sets out for the public the AEUB’s legal duties in regard to the PPAs filed by the IAT as set out in section 45.91(1)(a) of the 1998 Electrical Utilities Act. By that law, the AEUB “shall approve” the PPAs as filed by the IAT, unless the Board is satisfied, in regard to the PPAs or part of them, that:
- the IAT did not carry out its duties in accordance with the Electrical Utilities Act (“EUA”) and the regulations; or
- the PPAs or other determinations of the IAT are:
- obviously unreasonable;
- not supported adequately by economic analysis; or
- are not in the public interest.
When the AEUB was soliciting stakeholders’ and the public’s ideas to “vary” the PPAs, it had to assess those variance ideas in light of whether the above four legal conditions for variance were met.
In October 1999, the AEUB held public hearings on the PPAs which were attended by dozens of municipalities, industrial consumers and consumer advocates. Though there were some variances requested, no participant proposed or discussed varying the IAT’s July 9, 1999 section stipulating that a Buyer could terminate a PPA for reason of a Change in Law, but only if rendered unprofitable by government action.
On May 8, 2000, the AEUB made and published its Order U2000-190 (0.1 MB). Regarding whether the four legal conditions for varying the PPAs were met, the AEUB said of its proceedings:
- “...the Board found that it had not been satisfied by those parties making the variance requests that the IAT had not carried out its duties in accordance with the EUA, or that the PPAs and relevant determinations of the IAT were obviously unreasonable, were not supported adequately by economic analysis, or were not in the public interest. The Board therefore made no variations to the PPAs or the IAT’s other determinations”;
- “On April 24, 2000, the IAT filed the revised PPAs incorporating the revisions necessitated by Decision U99099 and any PPA amendments proposed before or after the IAT’s August 27, 1999 filing including those presented at the hearing” (Decision U99099 was AEUB direction that the IAT fix opening balance, algebraic and other errata as amendments, separate from “variances” proposed by others - which the AEUB rejected);
- “Therefore, the Board pursuant to section 45.91(1)(a) of the Electrical Utilities Act, S.A. 1995, C. hereby orders that: 1. The Power Purchase Arrangements and other determinations made by the Independent Assessment Team are approved”
The order was signed by AEUB chair Neil McCrank.
The PPAs approved in the AEUB order signed by its chair have the same July 9, 1999 Change in Law clause 4.3(j), requiring that Buyers wanting to terminate a PPA on the basis of a Change in Law would have to prove that the change “rendered unprofitable” the operation of its PPA.
Clearly, the onus is on those who take a different view - that the PPAs were not finalized by this AEUB order and were lawfully amended later to prove that claim.
Enron Clause: “more unprofitable”
On Thursday, July 27, 2000 – nine months after the PPA public hearings, almost 12 weeks after the PPAs were approved by AEUB order and five days before the August 2, 2000 start of the PPA auction – Enron’s government affairs director Robert Hemstock wrote to Alberta Department of Resource Development (ADRD) electricity executive director Larry Charach. The letter covered two Enron concerns (0.2 MB).
Enron said it wanted the AEUB to amend the Board’s May 8, 2000 Order 2000-190 to incorporate the PPA variances Enron is seeking. These variances include changing the July 9, 1999 Change in Law clause approved by Order 2000-190 to add the words “or more unprofitable”. On page 3 of the ADRD’s July 28, 2000 document “PPA Auction: Concerns for Bidders” (0.8 MB) there is reference to Enron’s requests under items n), o) and p).
Enron wanted an amendment that would allow a PPA Buyer to transfer its PPA obligations to the public Balancing Pool and, therefore, ratepayers – even if a PPA was already unprofitable and not rendered unprofitable by government action. Euphemistically referred to here by Mr. Hemstock as “Errata/Clarification,” Enron wanted its “or more unprofitable” amendment to be made a subject of an amended or new AEUB order because, as Hemstock quite presciently noted:
“The Board’s characterization of these changes as typographical errors and minor clarifications appears to indicate a lack of appreciation of the fact that the implications of some of these changes in the entitlements and obligations of the parties to the PPAs [are] in the order of hundreds of millions of dollars.”
Mr. Hemstock seemed to understand that what was at stake was much more than math errors or other errata. He was concerned Enron's clause might not be sustained as law, and, as the government argues in it's Originating Application, he was very likely correct. The problem for Enron and the PPA Buyers is that, while the AEUB tried to implement Enron's request, it did not have legal authority to either amend the PPAs in the way it did or make them into a regulation.
Mr. Hemstock urged Mr. Charach to have the AEUB amend its Order 2000-190 or make a new order and for the cabinet to file the new Enron amendments to the PPAs with the Registrar according to the Regulations Act – before the auction was to begin on August 2, 2000.
Later on Thursday, July 27, 2000 the ADRD’s Mr. Charach wrote an email to the AEUB’s executive director Bob Heggie (0.02 MB), the senior staff person to AEUB chair Neil McCrank. Mr. Charach also copied ADRD’s legal counsel Joseph Segatto asking both men to get in touch with Mr. Hemstock about Enron’s concerns and advice.
Mr. Charach implied that Mr. Heggie and/or the AEUB believed that substantial amendments, such as the Change in Law variance sought by Enron, could not be made without the AEUB returning to the hearings originally convened with municipalities and others after which the PPAs were approved. Mr. Charach asked Mr. Heggie to contact Mr. Hemstock about the necessity of public hearings to see if he can be persuaded that they are necessary, as appeared to be the AEUB's position. Mr. Charach said in his e-mail to Mr. Heggie that Mr. Hemstock
“fails [sic – “feels”] that the EUB could formally approve the Errata/Clarifications without a hearing. I realize you believe otherwise. Perhaps a discussion could close the gap.” [Emphasis added].
Further, Mr. Charach wrote to Mr. Segatto, apparently regarding Enron’s request that the PPAs be incorporated into a regulation – something the government had not contemplated and that never arose before Enron’s request:
“Also feel free to call Rob re: the regulation filing issue.”
Mr. Charach signed off with the following note to both men, evidently regarding Enron’s desire for an amended or new AEUB order and a government regulation:
“By the way, Rob felt an agreement by the owners and the PPA buyers would not be sufficient since the PPAs are a legislated instrument and also affect consumers. Again, if you don’t agree feel free to discuss this with him and maybe sway him.” [Emphasis added].
Essentially, the government’s senior electricity policy official tells the senior staff person of an independent regulatory board and the lawyer for the department to see if they can prevail upon Mr. Hemstock in respect of Enron’s positions.
It is clear from the events of the next 24 hours that it was Enron, and not the public officials or their concerns, that prevailed.
From the Friday, July 28, 2000 ministry report on the state of Enron's requests - “PPA Auctions: Concerns for Bidders” - referred to earlier, it appears that one day after Mr. Hemstock’s email and Mr. Charach’s urging of Mr. Heggie and Mr. Segatto to call the Enron lobbyist that there is a) a response ready on adding “or more unprofitable” and b) a decision is expected on EUB approval of errata and c) that ADRD has already agreed to a regulation, but it will not be ready before the start of the auction.
The day after Mr. Charach's email to his colleagues, there is no mention of the AEUB concern that Mr. Charach attributed to Mr. Heggie that the importance of some “Errata/Clarifications” (“hundreds of millions of dollars” according to Mr. Hemstock) would require the AEUB to reconvene the public hearing. The government’s Originating Application (0.8 MB) challenges both whether the AEUB had authority to amend the Change in Law provision for Enron, given the desired variance does not appear to meet any of the four legal conditions for any PPA variation and was purported to be done after public hearings on variations had already concluded and the AEUB approved the resulting PPAs in its Order 2000-190.
Also on Friday, July 28, 2000 – 24 hours after Mr. Charach urged officials to try to sway Mr. Hemstock, the Enron director boasts to Enron colleagues in an email here about his lobbying success (0.1 MB) outlined in the PPA Auctions: Concerns for Bidders and ascribing much of it to his relationship with government officials:
“Subject: ADRD Response - Enforceability Risk and PPA Errata/Clarification
I spoke to Larry Charach and he advised:
1) He has authority from the Deputy Minister [Kenneth Smith] to request and recommend the Registrar to answer questions respecting why this is necessary and what [sic] it needs to be done on an expedited basis. Apparently, even expedited it will take a week for the registration process such that the ADRD intends to send a notice to all bidders on Monday that it has received approval for the PPAs to be registered as a regulation and that such registration will not likely be effective after the PPA auction has commenced.
2) He has spoken with the Executive Director of the AEUB, Bob Heggie, who has indicated that he intends to recommend to the Chairman of the AEUB on Monday morning that the AEUB issue an AEUB Order accepting the 26 errata/clarifications identified by PWC on June 2000 and the subsequent errata/clarifications that have been identified since. Apparently PWC will have this letter done on Monday and I expect it will include the FRDT and PRDT issue.
I believe all of the following outstanding errata/clarifications have now been addressed to Enron’s satisfaction:
(a) NPV in RBPA
(b) parasitic load
(c) change in law - more profitable [sic-"unprofitable"]
(d) clarification of FCR
(e) FRDT and PRDT (Article C7).
Mr. Hemstock forwarded this email to another colleague in Enron’s Toronto office adding the following to the body of the email:
“…I am quite proud of having accomplished the results we achieved in relation to identifying the regulatory risks and advocating for changes that would mitigate or eliminate many of the risks in the PPAs over the last few months. In particular, I thought to write this note to you because I am proud of the comment I received from Larry Charach this evening during our final conversation in relation to the issues described below. Larry said to me that his decision to take steps to address Enron’s concerns at this late date was based in large part on our relationship and the trust that he has development in me as a result of having worked with me for some time.” [Emphasis added]
On Monday July 31, 2000, Enron VP Richard Shapiro praises Hemstock in an email for his work (0.3 MB) under the subject line “Alberta PPA”:
“Your work on the Alberta PPA has not gone unnoticed and really is a model for the rest of the group as to how to approach the review and analysis of a significant transaction w/ huge reg. risk- the thoroughness and quality of your work were top notch as was the teamwork you exhibited throughout the process..... not to mention the external leadership you provided on the issue w/ folks like Larry Charach. Thanks very much!”
Enron Chief of Staff Steven Kean adds more praise:
“ditto -- nice work Rob. Your insights on project stanley are also much appreciated”
On Tuesday, August 1, 2000 – the day before the PPA auction begins - AEUB Chair Mr. McCrank writes a letter to ADRD Minister Cardinal (0.5 MB). The chair informs the minister, among other things, that by the letter he “hereby amends Board Order U2000-190” and that the PPAs (which have never, to this day, been amended in their text) should be read as including the “or more unprofitable” language. The government’s Originating Application challenges the AEUB’s authority to amend the PPAs, including that the AEUB could not show that any of the four legal conditions for variance were met and that the AEUB cannot amend its orders by letter.
On Wednesday, August 2, 2000, the PPA auction began.
Also on Wednesday, August 2, 2000, Enron’s request that the PPAs be filed as a regulation is fulfilled. The Registrar purports to receive a Power Purchase Arrangements Determination Regulation, AR 175/2000 which is simply a collection of Order U2000-190 (with the May 8, 2000 PPAs), two IAT letters of June 26, 2000 and July 31, 2000 (0.5 MB) and the August 1, 2000 Mr. McCrank letter. The government’s Originating Application says that the AEUB did not even have the legal power to promulgate a “Regulation” as that is defined in the Regulations Act.
Did the experts mean "or more unprofitable" all along or only after Enron's intervention?
The July 31, 2000 letter from the IAT’s Mr. Anderson IAT to Mr. Charach says it was always the IAT’s intention that section 4.3(j) should be read to include both the cases a) when a PPA is rendered unprofitable by government action (as Mr. Anderson wrote and filed clause 4.3(j) on July 9, 1999 and the AEUB approved on May 8, 2000) and b) as Enron requested, when a PPA buyer is already unprofitable by its own business decision or market conditions and government action adds any cost at all to make it “more unprofitable”. This IAT claim does not seem credible, given that:
a) in its August 27, 1999 report, rendered as part of its statutory duty and following much consultation, the IAT says, as outlined above in a number of different ways: the Buyers should bears market risks and the Buyers should bear Change in Law costs risk – with one sole exception: when government action renders a PPA unprofitable – there is nowhere mention of termination due to cost added to an already unprofitable PPA; and
b) if the IAT really meant that termination could happen when a government action “renders a PPA unprofitable or more unprofitable”, it would have been more clear, straightforward and grammatical to say in July 1999 that a Buyer can terminate a PPA whenever a Change in Law costs it anything at all – but the IAT Report said something entirely different.
On Thursday, August, 3, 2000 – the day after the PPA auction began - the August 1, 2000 Mr. McCrank letter is posted on a government website, but is removed from it five weeks later.
On Wednesday, September 20, 2000, while the purported Power Purchase Arrangements Determination Regulation, AR 175/2000 has gone no further than the Registrar’s office, the cabinet issues the Dispensing with Publication Regulation, AR 201/2000. This action exempts AR 175/2000 from being published in the Alberta Gazette – the "official newspaper" of the Government of Alberta published twice a month by Alberta Queen's Printer and including new and amending Regulations, assorted government notices and private sector public notices that are required by Statute to be published.
As a result of the exemption, the PPA “regulation” was not made available to the media or the public in the normal course. Even today, AR 175/2000 is not mentioned in the Alberta Gazette or listed in the Queen’s Printer paid on-line subscription list of regulations.
Enron’s government affairs director Mr. Hemstock was justifiably proud of his achievement of altering the government’s course of action in the six days prior to the PPA auction. The then officials did not manage to “sway” Mr. Hemstock and the government decided on or about July 27 or 28, 2000 to “close the gap” in favour of Enron.
By way of chair McCrank’s August 1, 2000 letter, the AEUB purported to amend the Change in Law clause, raised by Enron:
a. despite having publicly approved the original Change in Law clause by Order 2000-190 and without any new or amended public AEUB order;
b. without explaining how the variation fit AEUB’s statutory restriction of only varying a PPA if the IAT did not carry out its duties in accordance with law or the filed PPA Change in Law clause was obviously unreasonable, not supported adequately by economic analysis or not in the public interest; and
c. despite no request for varying the Change in Law clause having been raised at the public hearings and the AEUB’s apparent view - as late as July 27, 2000 - that the AEUB could not formally approve the “Errata/Clarifications” without a hearing.
Enron prevailed upon the AEUB to engage in a legally-tenuous exercise of purporting to make a “regulation” out of a collection of documents, a “regulation” that the provincial cabinet of the day later exempted from publication.
Unless the Enron clause purporting to add “or more unprofitable” is successfully challenged in court, after collectively making about $10 billion in profit since the auction, the Buyer’s “termination” of their PPAs obliges the Balancing Pool and, therefore, ratepayers, to absorb up to $2 billion in losses.