Enron Mail

Subject:Agenda Items Number Two and Five for Wednesday 5:00 Meeting
Date:Tue, 22 May 2001 13:35:10 -0700 (PDT)

Dear Ken:

We have very serious offers out to two young - but very highly
regarded - economists doing work in areas of interest to Enron.
(Please see enclosed.)

Hendricks is being recruited for one of the Lay family chairs.

Rust, now at Yale, is being recruited for our new university-wide
Center in Computational Economics and Finance. His work is likely to
be of considerable interest to Enron.


<X-Sender: hartley@pop.ruf.rice.edu
<Date: Tue, 22 May 2001 11:50:04 -0500
<To: mgillis@rice.edu
<From: Peter Hartley <hartley@rice.edu<
<Subject: Hendricks and Rust - research of interest to Enron
<You requested some notes on the potential interest of Enron in the
<research of Ken Hendricks (the proposed occupant of the Lay family
<chair in industrial organization) and John Rust (the proposed
<appointee from Yale to the Center in Computational Finance and
<Economics). The research programs of Hendricks and Rust look
<extremely exciting and bode well for a very productive relationship
<between Enron and the economics department at Rice were we to succeed
<in recruiting both of these outstanding economists at the peak of
<their careers.
<1. Ken Hendricks: (Visiting U.T. Austin - professor at U.B.C.)
<Ken is regarding as one of the leading experts (along with his
<co-author) on testing the implications of auction theory for
<real-world auctions. In particular, Ken and his co-author (Rob Porter
<from Northwestern) pioneered the study of auctions of Outer
<Continental Shelf (OCS) oil and gas leases. The work on auction
<theory is one of the most spectacular successes of strategic modeling
<in economic analysis. It has influenced the design of emerging
<markets for gas and electricity, pollution permits and the FCC
<auctions of parts of the electromagnetic spectrum for communications
<services. The empirical verification of many of the detailed
<predictions of auction theory by Hendricks and a handful of other
<scholars has been critical to the influence of that theory on the
<design of new resource allocation mechanisms. Ken is keen to extend
<his empirical work on auctions to other more recent examples.
<Ken's interest in the oil and gas industry extends beyond the auction
<of leases. He has also worked on oil exploration and production,
<strategic issues in the gasoline market and oil and gas pipelines.
<Ken Hendricks has also produced ground-breaking research on the
<economic analysis of networks. The initial application of this work
<has been to the airline industry. Ken is keen, however, to apply the
<insights gained from this analysis to other network industries. In
<particular, he is keen to study the electricity and natural gas
<industries not only from the network perspective but also from the
<perspective of auction theory.
<2. John Rust: (Yale - young full professor)
<In a recent theoretical paper, written with a colleague from Yale,
<John Rust studies the conditions under which a "market maker" can
<enter a commodity market and gather a substantial market share and
<substantial profits, while at the same time making the market more
<efficient by driving out the least efficient middle men and reducing
<the average bid/ask spreads charged by the surviving middle men in the
<market. This research is of relevance to "emerging markets" in so far
<as falling transaction and information costs have played a critical role
<in allowing such markets to develop.
<As part of this research program, John has developed a relationship
<with a large New England steel service center, which is essentially a
<"middle man" in the regional steel market. The firm buys large
<quantities of steel domestically and internationally, storing these
<as inventories in its warehouses, and subsequently selling the steel
<to retail customers in the New England area at a markup. There is no
<formal market for steel, such as exists for gold or platinum on the
<London Metal Exchange or for commodities such as wheat on the Chicago
<Mercantile Exchange. John believes that his work on the steel market
<is likely to be of substantial interest to Enron.
<John and his co-author argue that the first market makers entering
<the steel market, esteel.com and metalsite.com do not have the
<correct business model (they fail to post publicly observable prices
<and are more akin to computerized chat rooms where private
<negotiations occur) and thus are unlikely to be successful in
<transforming the market for steel. However the site gofish.com does
<have a good business model and is rapidly transforming the market for
<commercial purchases of fish in the U.S.
<How does this relate to Enron? Enron Industrial Markets (EIM) is
<serving the role of market maker in a number of different commodities
<such as natural gas and electricity. Coincidentally EIM just made a
<presentation of its plans to enter as a market maker in the steel
<market, and the executives at the steel company that John and his
<co-author work with in Connecticut shared with John an impressive
<binder from a recent presentation by EIM. After
<discussing this presentation with the general manager and studying
<the presentation binder, John feels that Enron's business plan is
<much more likely to succeed than either esteel.com or metalsite.com.
<His analysis of the steel market suggests that there are considerable
<informational imperfections, and that there is ample room for
<successful, profitable entry by a leading company such as Enron that
<has an intelligent and aggressive business plan. John believes that
<Enron is in a strong position to succeed in the steel market using
<its experience in other markets, their successful enrononline.com
<trading site, and their huge financial resources that would enable
<them to conduct the marketing operations to get their market off the
<The other area where John feel's that his research could connect to,
<and be useful for, Enron in steel and other commodities markets is
<his work on using dynamic programming methods to solve for and
<compute optimal speculative trading strategies. John is perhaps the
<world expert in calculating optimal policies with regard to managing
<inventory levels. These include the optimal timing of purchase
<decisions, the optimal quantities to purchase when purchases are
<optimal, and the optimal markups of retail prices over wholesale
<prices. John and his co-author have developed computer programs that
<can rapidly compute the optimal policies (in less than 2 minutes on
<an ordinary PC) for the steel distributor he has been working with in
<New England. They plan to deliver a computerized version of their
<trading strategy on a laptop computer to the executives at the steel
<company. John and his co-author hope to compare how the trading
<profits generated by the computer program compare to the trading
<profits that would be earned if the firm continued with its current
<business practices.
<John's work may be of interest to Enron since it can be extended to
<predictions of the optimal inventory holdings and bid/ask spread that
<should be quoted by a market maker like Enron. John and his co-author
<are currently working on extending their model to predict how traders
<in the steel market would value various options and futures contracts
<for hedging risks, leading to predictions for the pricing of these
<derivative financial instruments.
<John would be very keen to attain a close working relationship with
<Enron. He believes such a relationship could have a huge effect on
<the course of his research, spawning a number of additional new
<research projects that would benefit students and faculty at Rice as
<well as having substantial potential benefit for Enron.
<Peter Hartley

Malcolm Gillis
Post Office Box 1892
Houston, Texas 77251-1892

6100 Main Street
Houston, Texas 77005

Internet: mgillis@rice.edu
Telephone: (713) 348-4041
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