Enron

Shares of Enron Corp. (NYSE: ENE - Quotes, News, Boards) were smacked around
again yesterday, following close on the heels of seven-session decline that
sent the stock down more than 13 points, or 16%, from its recent high of
$84.63 (December 28), all amid uncertainty and considerable volatility.
The pullback doesn't appear to be company-specific exactly, although the
rumblings in a certain geographic region, namely California, are triggering
aftershocks
throughout the U.S. energy community.

As we outlined in a report on January 4, the energy situation in California
has rapidly reached crisis proportions. Strict environmental legislation and
the uncertain
profit potential post-deregulation has kept utilities from installing
sufficient generating capacity in the state over the last 10 years.

The state's two major utilities, PG&E Corp. (NYSE: PCG - Quotes, News,
Boards) and Edison International (NYSE: EIX - Quotes, News, Boards) , are
facing the
prospect of eventual insolvency due to the spiraling costs of electricity
purchased on the open market. However, the rates the utilities can charge
their customers
for power represent a fraction of the costs that prevailed during the
gradual rollout of full-scale deregulation.

The risks to Enron are two-fold.

For one, the crisis in California may result in a default of payments to the
state's major wholesale energy providers, including Enron. Although the
company does
operate in California, the bottom-line impact would likely be shielded to a
considerable degree because of Enron's size, strength, and diversified global
revenue
streams. In addition, Enron would likely be high on the list of default
payees given its importance to future wholesale energy supplies in the
region.

More significantly, investors are concerned that California legislators may
pull the plug on deregulation entirely, or at least until the current crisis
abates. Some also
fear this mess might derail utility deregulation in other states as
regulators and politicians alike become fearful of adverse and unintended
economic consequences.

Neither scenario is probable. For one thing, the airline industry was
deregulated in fits and starts, with plenty of mistakes and recrimination
along the way. And a
strong argument can be made that the shortage of electric power would have
pressured rates sharply higher even in a fully regulated environment.

The California Public Utility Commission will attempt to decide the best
course of action this week. It appears inevitable that, regardless of PG&E
and Edison's
ultimate fate, the state's energy consumers will likely absorb much of the
burden through an increase in the prevailing rate cap.

Enron has also fallen victim to the rotation out of strong defensive stocks
on the heels of the Federal Reserve's unexpected interest-rate cuts last
week. The initial
euphoria has waned, however, upon the realization that the sharp rate cuts
will serve to offset what appears to be a rapid rate of erosion in domestic
economic
growth, rather than generating a rebound in economic activity. As a result,
we expect investors once again to seek the shelter of well-capitalized
defensive plays
like Enron.

We would emphasize that several factors that weigh in Enron's favor have been
overlooked amid the California crisis. The November-December period was
18% colder than normal and the second-coldest start to the winter months in
the past 50 years. Coupled with an uncertain supply situation, particularly
in natural
gas, Enron stands to profit handsomely from energy volatility and pricing, an
environment that is likely to exist for at least the next 12 months.

In addition, Enron's diversification into still more new avenues of growth
help to insulate the company from additional challenges of this sort in the
future. The
markets for EnronOnline, a real-time commodities exchange vehicle, and
Enron's broadband services unit are expected to at least triple over the next
year.
An eventual inflection point in the groups' profitability would serve to send
profits measurably higher in the long term.

Despite the recent turmoil, Enron's consensus earnings estimate for 2001,
according to First Call, has come down a mere penny, to $1.65 a share.
Although the
stock's rich price/earnings multiple of 43 times may aggravate its near-term
volatility, the absence of a complete collapse of the stock indicates the
market
approves of Enron's maneuvers so far and is confident in its prospects going
forward