When Royal Dutch/ Shell saw how much money Enron appeared to be making out of power trading in the late 1990s it called in McKinsey, the consultants, to draw up a strategy to emulate Enron's success. That strategy resulted in a rapid expansion into power trading which is now drawing criticism from analysts and former executives.
To spearhead the expansion, the Anglo-Dutch oil giant promoted a former top Enron trading executive, Debbie Wernet, to president of Shell Trading in Houston. Ms Wernet's plan was to "trade around" Shell's assets, using its gas to produce and trade power. Ms Wernet promoted the strategy to Walter van der Vijver, Shell's head of exploration and production, as a way of giving Shell alternative outlets for its gas supplies.
But the plan was dealt a blow by a Shell decision that stripped the trading arm of any real power assets. In 1999, Shell put its Coral Energy unit's power assets into InterGen, a joint venture with Bechtel, the engineering group.
As a result, Shell Trading proposed stepping up its investment in tolling deals with power station developers. These agreements involve annual payments to the developers, now totalling $7.4bn over the next 20 years. In return, Shell received options to sell power from the plants, generated using its gas.
George Namur, a former Shell Trading executive, says the group's head office was initially concerned about the proposed deals and asked Houston for a detailed report explaining and justifying them in terms of the group's return on investment rules.
Mr Namur says the Houston operation was determined to go ahead with the deals to justify its existence. Mr Namur claims he was asked to come up with very optimistic power price forecasts and other questionable valuations, so that the deals would appear to produce returns on investment in excess of the 15 per cent rate required by Shell's head office. "Shell is plunking billions of dollars on options based on fantasy returns," says Mr Namur. He says if power prices continue to fall, the deals could be worthless, and Shell cannot hedge the risk. While the deals give Shell control of the assets, ownership reverts to the developers at the end of the agreement.
Only one other US energy company, Williams, is thought to do such long-term tolling deals, though many companies are involved in short-term deals to bet on seasonal price fluctuations.
Mr Namur, who worked in a senior position in Shell Trading for three years, says he left in August 2001 because of pressure from management to give what he judged were over-optimistic valuations of the deals to Shell's head office.
Before joining Shell's power group, Mr Namur worked on embedding options into Shell's gas deals. In an interview, Ms Wernet defended Shell's decision to increase its power efforts three years ago, saying it was based on customer demand.
Mr Namur, who has a PhD in engineering and an MBA in analytic finance and business economics, claims the deals also raise accounting issues. Shell's accounts show it is committed to $7.4bn of capacity payments in relation to the tolling deals, which appear as liabilities on its balance sheet. But the accounts do not state the asset value put on the deals.
Mr Namur claims the value of the agreements should have been written down by billions of dollars, partly because of the fall in power prices. In its 2001 accounts, Shell merely states that the value and effect of the agreements on net income in 2001 and 2000 was "not significant".
Shell said it took "a very conservative approach" in recognising income from tolling agreements. The contracts were valued in accordance with the generally accepted accounting principles in the US, it said.
"We maintain this conservative [accounting] approach after the facility begins production," Shell added. According to Shell's accounts, obligations under the agreements as at December 31, 2001 were $104m in 2002, $191m in 2003, $332m in 2004, $362m in 2005, $353m in 2006 and $6bn in 2007 and thereafter.
Williams said the tolling deals helped it to manage the risk associated with owning a power plant. "We are not plant operators. We are not good at it. For us, it is the amount of risk we want to manage as energy marketers and traders."
Asked if tolling agreements were profitable for Shell, Ms Wernet said: "You don't look at it and say 'will it make money'." Each plant was part of a bigger portfolio, she said, and tolling was an important part of Shell's strategy. "There's a place for asset ownership, and a place for tolling in an overall asset portfolio. There are clear instances where we don't want to be the owner of the asset," she said.