(FORTUNE Magazine) – A few years back, Duke Energy CEO Rick Priory left Charlotte, N.C., and headed north to make one of his periodic pitches to Wall Street. As far as Priory was concerned, he had a pretty exciting story to tell, and it went something like this: Duke, which had a long, proud history as a utility in the Carolinas, was about to enter the big time. It was building dozens of efficient, gas-fired plants that would supply electricity to juice-starved markets. It was constructing scores of pipelines and underground storage caverns to take advantage of surging demand for natural gas. And all that shiny new big iron would give Duke's energy traders a leg up in ever volatile commodity markets.

But the suits from the Street seemed--well, they seemed bored. The problem was that Priory had followed an awfully tough act. Literally minutes before he came onstage, the investors and analysts gathered at the midtown Manhattan hotel had been wowed by the top brass of a certain Houston-based energy giant. This company's model was tons sexier and a lot simpler than Duke's--just ditch the power plants and other old-economy relics, and trade your way to glory. Priory stuck to his script, but it was rough going, and the sting of Wall Street's skepticism is fresh even now. "I explained our approach, but the analysts said the story they'd heard before ours was exactly the opposite," he recalls. "They said, 'Ken told us you don't need assets.' I still remember defending myself, saying you have to be able to produce and deliver energy as well as trade it."

As you've no doubt guessed by now, the company with the oh-so-clever strategy was Enron, and "Ken" was Kenneth Lay, Enron's now disgraced former chairman. For Priory, obviously, this is a tale of sweet vindication. Because while nothing is more fashionable in corporate America today than dumping on Enron, conservative Duke has deliberately been the un-Enron for years.

And these days that's really paying off: Revenues rose from $49.3 billion in 2000 to $59.5 billion in 2001, putting Duke at No. 14 on this year's FORTUNE 500. Profits--they seem to be mostly real at Duke, not the product of some accountant's sleight of hand--totaled almost $2 billion. True, the company's giant revenue jump is partly attributable to the way energy traders book sales (see "The Revenue Games People Play"). But it's notable that while Duke and No. 13 American Electric Power posted nearly the same amount in revenues, Duke earned almost twice as much. Better still, while the stock market has drifted downward, shares of Duke have risen 51% since the beginning of 2000, outperforming both the Dow and the S&P 500 as well as market darlings like GE and Exxon Mobil.

That performance is all the more remarkable because last year will almost certainly go down as one of the nastiest patches in recent memory for the energy industry--and not just because of Enron. "On Jan. 2, 2001, all hell broke loose, and it didn't stop," says Priory, referring to last winter's energy crisis in California, when hundreds of thousands of people suffered through rolling blackouts. Priory then ticks off the rest of 2001's troubles: collapsing prices for electricity and natural gas as a result of the slowing economy, the terrorist attacks of Sept. 11, the bankruptcy of Enron, and Wall Street's fear that other energy firms like Duke might get caught in the undertow. "I just can't imagine 2002 being that tough," says Priory.

So far--knock on wood--it hasn't been. On March 14, Duke completed its $8 billion acquisition of Canada's Westcoast Energy, reinforcing its position as one of North America's largest natural-gas players. And over the next few months, as temperatures rise and electricity demand soars, Duke plans to bring 11 new gas-fired power plants online across the country, adding 6,600 megawatts in generating capacity. That's enough juice to power more than six million homes, and it will put Duke among the country's very largest power producers.

All those new physical assets--in terms of both natural gas and electricity--will also help Duke expand its burgeoning trading and power-marketing operation. Unlike Casino Enron, which made huge bets on the overall direction of energy prices, most of Duke's trades revolve around its own assets--selling power in the future from one of its existing plants, buying gas that moves through its pipeline--so with more infrastructure on the ground, there's more room for trading volumes to grow. "In the end, markets ebb and flow," says Priory, sitting in his spacious but spare third-floor office, which overlooks a parking lot next to Duke's downtown Charlotte, N.C., headquarters. "You can only do smoke and mirrors so long. You have to have a background in the energy business."

Duke has come a long way since founder James "Buck" Duke began selling power from his plant on the Catawba River to nearby textile mills nearly a century ago, but its risk-averse culture is shaped by its history as a utility in the Carolinas. Duke Power, the company's regulated utility division, supplies electricity to more than two million homes and businesses in North and South Carolina, and while this unit isn't a growth dynamo--the local public-service commission has essentially kept rates flat for the past 16 years--it is a cash cow. Duke Power generated $1.6 billion in earnings before interest and taxes (EBIT) last year, and economic growth in the Carolinas should help its profits continue to grow by 3% to 4% annually. What's more, the unit's steady stream of earnings balances out the risk in more volatile business areas like unregulated power generation and energy trading.

The company's small-town Tar Heel roots still reach way down. Like many of his predecessors, Bill Grigg, a courtly native North Carolinian who served as CEO from 1994 to 1997, hails from a rural town and attended Duke University, which was endowed by Buck Duke with the millions he made in electricity and tobacco. "I'm deep Duke," says Grigg, who came aboard as a lawyer at age 31 and worked his way up to the top job. Fifty-five-year-old Priory, Grigg's handpicked successor, isn't quite as deep Duke. He grew up in New Jersey and studied engineering in West Virginia and at Princeton, but he's practically a lifer, having joined the company at age 30 as a structural engineer. Rich Osborne, who serves as chief risk officer and is one of Priory's top lieutenants, was raised west of Charlotte in the textile town of Gastonia and joined Duke straight out of college in 1975. "Our values are rooted in that North Carolina history," says Priory. "The utility business gave us a deep understanding of the energy business and a real knowledge of operating assets. We're grounded, so we didn't fall victim to short-term fads or accounting tricks."

The newspapers often make it seem as if Enron's funky accounting, shady partnerships, and off-balance-sheet financing were all cooked up by former CFO Andy Fastow himself. The reality is that most of the financing tricks and complex partnerships used and abused by Enron were marketed to many companies by some of Wall Street's biggest investment firms. Duke listened to them all. It just said no.

Facing down the legions of product-pitching bankers and analysts was the job of David Hauser, who joined Duke Power in 1973 at age 21 and now serves as senior vice president and treasurer. Although Hauser is typically Duke in his refusal to identify which firms came down to Charlotte--he'll only say that nearly every big investment and commercial bank was represented--he does offer a detailed description of the stratagems that were all the rage just a year or two ago. One was the shared trust, a credit vehicle in which stock, along with a real asset like a power plant or a pipeline, is offered as collateral for a loan. The advantage of a shared trust is that a company can borrow more than it could in a traditional secured transaction while keeping that extra debt off the balance sheet. The danger in this kind of deal, says Hauser, is that if the borrower's stock drops, a company could end up being forced to issue more and more shares in order to keep the level of collateral up. "It can be very dilutive," he says.

Indeed, financial vehicles dependent on infusions of fresh equity were a key factor in Enron's death spiral. "They told us we were being too conservative, that any problems would be unlikely, but these proposals didn't get beyond me," says Hauser. "We make our decisions based on the economics, not on the accounting implications."

While Hauser was keeping the bankers at bay, Wall Street analysts were advising energy companies to borrow and build as much as they could to take advantage of high power prices. In fact, Duke's A credit rating and strong balance sheet was seen as a liability in some quarters. So was the company's reluctance to spin off its trading operations and go the "asset light" route, even though that undoubtedly would have resulted in a hot IPO and quick stock market gain. Other Wall Streeters advised Duke to do an IPO of its unregulated power generation unit, back when electricity supplies were tight and power merchants were considered hot on Wall Street. "Investment bankers are a voracious lot," says Bruce Williamson, head of Duke Energy Global Markets. "They called everyone from Rick Priory on down to push an unregulated spinoff." But the company didn't budge. "We weren't convinced that an IPO was the way to go," says CFO Robert Brace. "It certainly would have created investment banking fees. But it would not have created long-term value."

Duke also chose not to trade bandwidth, the telecommunications commodity that turned into a huge money pit for Ken Lay & Co. In fact, the way Duke handled bandwidth vs. how Enron did illustrates just how different the two companies are. While Enron was hiring hundreds of employees and spending millions on bandwidth, Duke's Energy Services president, Harvey Padewer, assigned five veterans to check out this niche. "Enron showed up and made a pitch [for us] to trade bandwidth with them," recalls Padewer--a move that only increased Duke's wariness. "Why would Enron be trying to convince us? If counterparties have a good business, they generally don't have to come to you and say 'trade with us.'" After spending six months and $3 million, the five-man group concluded bandwidth was a loser, and Duke dropped the idea. Enron, meanwhile, ended up employing more than 1,500 people in its broadband unit, racking up hundreds of millions in losses. "Whatever Enron did, they did it big--metals, water, projects in Europe and India," says Padewer, reeling off a list of other Enron money losers. "That's fundamentally different from the Duke approach. You go in small and try to understand a new market. You get your feet wet. You don't bet the company on it."

These days Duke is saying no to something else--hiring legions of ex-Enron traders. Although the company has made selective hires, executives decided not to import whole teams of Enron people despite the fact that Duke's trading operations are also in Houston. "We'd rather hire individuals, because when you hire a team you get the culture as well as the team," says Ruth Shaw, Duke's chief administrative officer. "It's a message about how important we think it is to preserve our culture."

Rising more than 500 feet into the misty air along the Pacific Coast Highway near Carmel, Calif., the giant smokestacks of the Moss Landing Power Plant are a monument to the Golden State's ravenous need for power. Known as "Mighty Moss" to the men and women who watch over its maze of giant steam pipes, 2,000-degree furnaces, and mammoth turbines, this is about to become the largest fossil-fuel plant in the state. Built in the 1960s, Moss Landing has a capacity of just over 1,500 megawatts--enough power for 1.5 million homes--and was acquired in 1998 from Pacific Gas & Electric. Since then Duke has spent about $250 million on the aging plant, reducing its emissions of smog-causing nitrous oxide with new four-story scrubbers, and upping its peak output.

This coming summer, though, "Mighty Moss is about to get mightier, almost enough to make your knees buckle," says manager Gene McCrillis. A couple of hundred yards from the old smokestacks and boilers, Duke is spending more than $500 million on a brand-new facility that uses the latest in natural gas-fired generating technology. Known as a combined cycle plant, it will use a jet engine-inspired system to churn out another 1,000 megawatts in power production. Although power prices in California have dropped since construction began 18 months ago, the new plant has a big advantage: It uses nearly 30% less natural gas than most conventional plants in the state to produce each megawatt of power. So even if electricity prices remain low, the new facility should be a moneymaker. And when both plants are online later this year, Duke will be California's largest non-utility power producer.

But Duke isn't just throwing money into new plants and hoping electricity prices stay high. Because electricity can't be stored and the nation's transmission grid is full of bottlenecks, power prices can vary widely across regions. So Duke puts enormous effort into finding locations that afford the maximum amount of flexibility. For example, its 1,200-megawatt Moapa plant under construction in Nevada can send power to California if prices are high there or, if not, ship the power to fast-growing Las Vegas.

And because all these plants are gas-fired, Duke's trading and gas-pipeline operations can take advantage of shifting prices for electricity and natural gas. Here's how it works: Let's say electricity prices are down in the West because of weak demand, but it's cold in the East and Midwest so natural gas prices are up. Duke can simply turn off the generators at places like Moapa and Moss Landing, sell the natural gas for home heating, and capture a much fatter profit margin. That's the winter scenario; if it's a hot summer and natural gas prices are weak but power is expensive, Duke can simply buy cheap gas and turn it into more richly priced electricity, making money on the other side of the same trade. The best part? Duke can ship all that gas through its huge pipeline system, slicing off additional profits as volumes rise.

Capturing the differences in gas and electricity prices--known in the business as the "spark spread"--is only one element in the strategy of Duke's North American Wholesale Energy (NAWE) unit in Houston, which includes both trading and unregulated power production. Thanks to high electricity prices in early 2001, fat spark spreads, and huge trading opportunities from all the volatility, NAWE was Duke Energy's main growth engine last year. EBIT more than tripled, to $1.35 billion, while revenues rose from $33.8 billion to $43.1 billion. Lower energy prices and reduced volatility make it unlikely that NAWE can match that kind of gain in 2002, but the company predicts--and Wall Street expects--annual EBIT growth of 30% to 40% from NAWE in the next few years.

Now that Enron is history, Duke's Houston trading floor is the largest in the city, and the company is keenly aware of how controversial energy trading is in the post-Enron era. But here again, Duke's approach is quite different, because about 80% of its trades involve its physical assets rather than making speculative plays on overall energy prices, as Enron did. Of course, even in the best of circumstances, trading carries risks. Analysts like Morgan Stanley's Kit Konolige estimate that about 10% of Duke's overall EBIT last year came from trading. And while Duke's traders may be smart, that kind of success can hardly be guaranteed year after year. "Compared with most of the businesses Duke engages in, trading is a higher-risk, higher-reward segment," says Konolige. "If they have a disappointing year in trading, other parts of the business would have to make up for that."

In addition, a sizable chunk of Duke Energy's EBIT--about 13%, Konolige estimates--came in the form of "mark to market" gains, income that's recorded now but won't actually come in for months or years, when forward contracts are settled. So if power prices go against Duke and the company isn't adequately hedged, those mark-to-market gains might turn into losses at some point. "Mark-to-market accounting has become controversial," Konolige says, "but it's normal industry practice. In fact, it's required for many transactions." That's certainly true. But such bookkeeping does make earnings somewhat less dependable.

Managing those potential dangers is the job of Rich Osborne, Duke's bow-tied chief risk officer. Although many other companies have chief risk officers these days--believe it or not, even Enron had one--Osborne's unit actually has teeth. For starters, he was Duke's CFO until CEO Priory created his current job in 2000, and Osborne still reports directly to Priory. Even more impressive, Osborne's team is bigger than CFO Robert Brace's, with about 250 people on the staff, including accountants located directly in the middle of the Houston trading floor. Besides preventing a rogue trader from blowing up the company, Osborne's job entails smoothing out the risks inherent in any volatile commodity-oriented business. That means making sure the company is hedged against swings in power prices while also seeing to it that Duke's trading partners are creditworthy.

Judging by 2001's numbers, Osborne has had a pretty good run. A few months before Enron's collapse, Duke's exposure to Enron ran into the hundreds of millions, Priory and Osborne say. By the time Enron filed for bankruptcy, Duke's hit totaled just $43 million. "We didn't know it was going to go bankrupt, but by the fall it was clear from the falling stock price that Enron was in trouble," says Osborne. "So we traded away from them, selling Enron deals to other parties or paying a penny or two more on contracts so we weren't trading with Enron." Osborne was also savvy enough to protect Duke from plunging electricity prices by hedging much of its non-utility power production back when prices were high. About 91% of the unregulated power Duke will sell this year has already been hedged, so gains are locked in. And more than half the power Duke will sell in 2003 and 2004 is similarly hedged, protecting future profits from the weak spark spreads that now prevail in many key markets.

Those hedges sure look smart now, but when Duke made them in 2000 and 2001, the company had to pass up some short-term profits. That kind of thinking is fundamental to the company, says Priory. "I went through a lot of pressure two years ago," he says. "Everybody in the industry thought prices would go up and up, and the top would continue forever. But we've been in this business for a long time, and we know there are going to be cycles."

Today, power prices are weak amid fears of an electricity glut. Shares of many energy companies are in single digits, and Duke's rivals are putting assets up for sale. Although he's an engineer by training, Priory is enough of a trader to think that all the doom and gloom out there means that things are about to turn around. "We sold plants at the top when prices were at their peak," says Priory. "Now that everybody's selling, we're anxious to buy assets. It takes a hell of a lot of discipline, but sometimes you have to go against the market." Buying assets? Showing some discipline? You just don't get any more un-Enron than that, do you?

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