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Financial Engineering Case Study Solution

Enron

Enron created many sort of products based around natural gas and called it EnFolio Gas Bank. The production and supply became highly customized as various customers demanded various prices, while investors looked for a stabilized return on income. The gas industry proved to be highly volatile with four times greater the risk of oil sector. To bridge the gap between buyers and sellers, Enron worked out several solutions based on the prevailing market conditions like:

Fixed Volume at Fixed Prices

Gas is a natural resource which has to be used as a sustainable energy in future, so control over such natural resource is essential. In order to address the need of natural gas as a fuel source for significant amount various governments and authorities have set out to control the prices according to the market forces. The main reason for this can be said to be controlling the market forces.

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In order to prevent the natural resources from becoming a part of private competition, the various authorities controlled prices to deter emergence of private companies in this field. However, despite the control over prices, private companies did show interest in venturing into this field. This was because of profitable returns in long run from riskier investments in the field and highly volatile nature of the industry itself.

Oil was considered to be highly profitable development in hands of private investors but it would result in high discrepancies occurring throughout the world with control over resource fields and rise of monopolistic pricing depriving the usage of resources for production. This led to monitoring of natural resources at fixed prices, so that everyone can benefit. Enron provides gas at fixed price to Sithe Energies Group operating in New York. This partnership focuses on generating huge amounts of mega-watts from gas-fired turbine. This would make the plant to be the biggest co-generator plant in the U.S.

Volume to Natural Gas Price Index

Enron is able to differentiate its product supply through the service it provides in relation to that product, instead of altering the nature of the product itself. This is an effective strategy to increase its investor and consumer base. However, the drawback it faces is in the form of government rules and regulations. Being a multinational company, Enron operates in many countries, which means that it is subjected to various forms of regulations and pricing policies.

Enron’s main focus is to bridge the pricing gap by usage of derivatives to gain advantage over competitors and to react according to the trends. The derivatives will help the manager in outlining the areas where there ishigh risk and to create personalized derivatives which deal with those risks. Where Standard and Poor (S&P) index states the gas field to be riskier than oil sector, the main reason behind was highlighted to be highly fluctuating prices. The main agenda which is to find a spot price that is the price which is acceptable in highly volatile pricing environment, can help Enron in gaining more markets by offering a single price while hedging the risk of the price fluctuations themselves. The main purchasers under this scheme are the countries where Enron is expanding to, including to Middle-Eastern and African countries.

Capped at Determined Level

In their bid to gain a spot price while absorbing the risk of fluctuating prices is highly technical and risky for any sort of company. Given the volatile nature of the industry in which Enron is operating, the main focus should be on using the derivatives on personalized situations to mitigate the business risk up to a significant level. This means that a capped level is more or less functioning like spot price. The capped value is determined by the government regulatory bodies to ensure that a negative impact of trade is minimized. The spot value on the other hand focuses on one price which is feasible to all related parties involved in the transaction, including customers, investors and suppliers. Under this Enron is trying to attract more investors, so the supplies being made at determined level are to firms like Phibro, AIG, Chase and Citibank.......................

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