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From: Dave Stevenson [mailto:dstevenson@houston.netversant.com]
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Subject: FW: Joe Bob Briggs Explains How Enron Works


Scott,

Classic!

Dave

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Subject: Joe Bob Briggs Explains How Enron Works



----- Forwarded by Will Bowen/BMB on 01/22/02 05:35 PM -----


                    Art Smith

                    <ASmith@herold       To:

                    .com>                cc:     'Jeff Hewitt'
<jhewitt@burl.com>,
                                          Wbowen@bmb-inc.com,
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                    01/22/02 12:26        <rhollo@aries-operating.com>,
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                    PM
<averyt.knapp@lawrencemarshall.com>,
                                          Will.LEVEN@US.CIBC.COM,

                                          scott_nyquist@mckinsey.com,
jdpellegrin@aep.com,
                                          DAPustka@aol.com, "'Richard
Smalling, MD, PhD'"
                                          <Richard.W.Smalling@uth.tmc.edu>,
Art Smith
                                          <ASmith@herold.com>, "'St.Paul,
Chris'"
                                          <chris.stpaul@csfb.com>, "'Wood,
Tom'"
                                          <TWood@rwbaird.com>

                                         Subject:     Joe Bob Briggs
Explains How Enron
                                          Works








How Enron Works
The mule market.
By Joe Bob Briggs, a writer for UPI
January 22, 2002 9:25 a.m.

Here'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.

Copyright 2002 by United Press International.