case

Asia Sase Researah **ntre THI UI\!IVTR$|TY CF }{ONG KONG

HKU7O7

tsffiffiN Pst:n H*rY! l{ai Ss{l6s

PAUL LEJOT FREDERIK PRETORIUS

POLITICS. INSTITUTIONS AND PROJECT FINANCE: THE DABHOL POWER PROJECT

'In l992,Indian authorities entered into an agfeement with Houston-based

Enron Corporation

to build a gas-fired p"*.. pi""i i,t lutt ot in"Maharashtra state, India' This was intended to be

the world,s largest independent power project and the largest single foreign investment in

India. The plant was .o'n*,*"t"i under'pathbreaking tetms because of the liberalization of

"f."irl"i,V supply in India. But when the first stage of the new plant commenced

production'

the price"of eli"t i.lty was perceived to be unaffordable for consumers' Moreover, there were

accusations of corruption in the state government's association with the project, and the

pr":"", became a pawn in the volatile Iniian political environment. Completion of the project

'*u* utro suspended for years, at great costs tt all, and the principal project promoter, Enron,

collapsed in the interim.'could it f,ave been done differently? In all, the. Dabhol Power Project

ofl-ers great insights into the negotiation of complex financial transactions with governments

in unstable institutional environments'

lndia

After gaining independence from the United Kingdom in 1947, India's economy was managed with socialist-oriented <levelopmental policies, and there was

an emphasis on central

planning and intricate regulation of the privale sector. Influenced by Mahatrna Gandhi's

doctrine of swadeshi, or ielf reliance, successive Congress Party governments-all tracing

their roots to Gandhi's independence campaigns-restriited fbreign investment and imposed

high import tariff barriers to protect domestic industries'

By the early 1990s, lndia faced both a severe extemal payments crisis and a debilitating

i"a"rut budiet deficit. At the same time, it was losing a strategic_ally.and economic pattner

with the collapse of the Soviet Union. Faced with apparently hostile neighbours and an

uncertain post-colcl war balance of power, India began to look for new international paftners'

and for the first time consiJered all,owing foreign commercial intere.sts to participate in key

sectors of the domestic economy. Thus in 1991, the Congress PartyJed national government

Grace Loo prepared this cqte under the sup{vision oJ Paul Lejot and Dr Frederik Pretorius /br class d$&s'tton t nls case u

not intended ti show elfective or ineftbctive handling ol decision or business processes'

a200TbvTheAsiaCaseReseqrchCentre'The(]niversityoJHongKong'Nopartofthispublicationmaybereproduce'dor ;*i.rrila'r, )"i't"r. r, ty any means-lectronic, mechqrical, ph"otocopying,

recording, or othe*ise (including the

intemet)-withoui the permission of The University oJ Hong Kong'

Ref.07/335C

1

27

Strayer University-Virginia Beach' "BUS 519 Risk Management", "Fall 2012"

Politics, lnstitutions and Finance: The Dabhol Power Project

under the prime minister' Mr P.V. Narasirrrha Rao, began a program of liberalisation with fwo

major policy changes: ,.ru"hg control of industrial licensing and opening the economy to

foreign investments. '

lndia's Power Sector

ln october 1991, India,s government opened the energy sector for private investors to build

and operate por.. g.n.iution plants without ..rt rJion on foreign ownership' 2 With a

steadily growing poporuiion, mus* o.ban migration and agglomeration, and the beginning of a

phase of above-trend d;th in industrialisation, the power sector was critical to India's

economic development. N",i"*f power demand was growin g at afi annual rate of almost 80%

and was projected to increase to about 140,000 megaiatts lrrrrq uy 2005; but total installed

capacity was only around 80,000MW in the early 1990s''

The power generation system was both_inefhcient and incapable of meeting demand on this

scale. Power plants were fuelled mostly by coal mined in the eastern state of Bihar and

transported to the rest oittre natlon by an ageing and inefficient railway network' a pfocess

involving significant pilferage. The average ml[-tqgOs plant load factor' that is' the plant

capacity used in proarr.iionl*as 57vo, i"1irg rh"J of peak load demand by 20 30Yo.4rn

addition, up to 20oh ";';;; ;";* g.n.rut"J was lost through transmission over poorly

maintained and under-inv".t"a, to*-rrJltage distribution networks. Pilferage of electricity.was

common' with many "on,o.,'... tapping*illegally into the grrd for.their own use or wiring

aroundelectricity..,..,.ou,,oidpuy-"'t.Asmuchaszsy'ofthepowerconnectionsin New Delhi were estimated to be illegal at that time'5

Under the two-tier system of the Indian power sector' responsibility was shared between the

federal centre and the states, all of which maintained u stutt Electricity Board ("sEB")

involved in the generati*,-i."*ttit.ion and distribution of electriciry' While some central

govemmentutilitiesur*'g"n".u."delectricalpower,the-funcl?:,Softransmissionand distribution *... lu.g"ly i.tito ttt" SEBs. In the mid-I990s, about 707o of national

power was

generated and distributedly SE'Bs'u As India stmggled w!1h goyer shortages' the SEBs were

pfone to subsidise the tariffs of agricultural con.uiers while industrial consumers bribed state

ofhcials for lower power bills. *ith lor.". accumulating at up to US$2 billion annually, the

SEBs' ability to invest in new capacity was severely limited'7

Given the importance of the power sector to India's economic development' the government

decided to fast-track.lgfrlpt":*o to induce foreign investment in this sector as part of a

wider program of ..#o*i" iiberalisation. These" projects were_ to be initiated through

individual negotiation rather than public tendering and lisogjgVSa supporl from the-central

govemment, in"frrOlngl..iuin-g"i*nt."rjptrasJt of the Dabhol power plant was the hrst

such project to be launched alnd was widely seen as the flagship initiative marking the

opening of India's domestic energy sector to foreign interests' At the time of its initiation'

1parry, S. (30 December 2001) "Enron's India Disruter"' htto://ww consorliumnews

com'/2001/123001a html (accessed I

FebruarY 2007).

'eo*urar, s. uni Shuklu, M. (october 1995) "The Mugging ofEnron"' Euromoney'

,, Hill, c.w.L. (2005).,Eroon Intemational in India", additional case fof Internqtionql Business: competition in the Global

Marketptace,stH eo t on, rrttp.lriisi"ri;-m;-;w hill ";ntsitesloorztz:qszlst"oe"trrvg@dtlia!d-94!9$I!q1i *t"ft.fr"t, "n.

1+ augtrt telj{igitts Go out for India's Foreign Investors"' Financial Times'

5 choukroun, S. (2002)

.,Emon in Maharashtra: Power Sector Development and National Identity in India"' MA Thesis'

UniversitY olPennsYlvania, P 15 6 Hiu, c.w.L. (2005) op. cit 7 Hitl, c.w.L. (2005) op. cit. * put"r.on, C. (Mrch 2006) "Investor-to-State Dispute Sefilement in Infrastucture

Projects"' OECD Working Papers on

Intemational Invest-"nt tio* ogcl, Directoraie lor Financial and Enterprise Affairs, No200612'

ft tf ,/l**..otr"" oecd orgll0 lTST /416335763425 (accessed 1 Jmuary 2007)'

2

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Strayer University-Virginia Beach, "BUS 519: Risk Management"' "Fall 2012"

O7l335C Politics' lnstitutions and Project Finance: The Dabhol Power Project

Dabhol was the world,s largest independent power project and the largest foreign-sourced

investment Project in India'

Enron

Enron Corporation (..Enron,') began in Texas in 1985 as a pipeline distribution company

delivering gas to power utilitiei and other commercial businesses' With the landmark

deresulation of the us electrical power markets, Enron expanded its activities to include ffit#il:i".ot"i*';."t"cting sulstantial margins from differences.in inter-state wholesale ;ffi;",j.;il;:id'i;r began to devise complex supplv contracts that sought to

protect its

customers from certain risks, such as changes in interest rates of an inability to pay' but

entered into a far higher number of such contracts than its supply conhacts would ever need

for risk management p".p;;;;. Th" .o*puny became authodsed by the tlS Federal Securities

and Exchange commission to adopt accounting practices customarily associated with

securities or commodity i*a.rr, and portions of its balance sheet assets and other receivables

were marked-to-.u.t"t ."guJi"tt oittt.it liquidity or likelihood of being realised' The result

was eamings generation that could best be termed mythical'

This aggressive corporate approach became. further manifested in the falsification of revenue

and income to supporl it " g-,rp'* share price. This grew increasingly complex, in particular

involving a series of transictions to conieal overalifunded liabilities and to present a less

highly leveraged appeafance to shareholders and hnancial analysts' Doubts about Enron's

reporting and true performance furned from wall Street rumour to widespread concern in

2001, and towards the end of that year Enron admitted to having overstated group eamings

over four prior years UruSSsaO *ittion and of concealing liabilities of around US$3 billion'

Theensuinglossofconfidenceandcollapsewasprecipitate.in|w;m!er2001,Eruon'sdebt was downgraded to ju;k;ond ,au**tt a-.d the .t,''putty filed for bankruptcy

within weeks'

Enron employed some 21,000 employees worldwide at that time'

In the early 1990s, Enron began to expand downstream activities, for example in developing

po*.. g"*.ution projects to- serue-ai buyers of nafural gas.'' It also sought to move into

newly privatir"d non-Ui *arkets.l3 A sulsidiary, Enron Intemational, was set up in 1990

with the mandate of running power generation projects in developing markets' Rebecca Mark'

a p.otege of Enron chainian Kenneth Lay, wai appointed its chief executive. Mark was

considered ambitious and influential, and became one of Enron's more high-profile !g"::talj.

Mark's vision was fbr Enron to become the largest distributor of liquefied natural gas ("LNG")

inlndia,requiringcapitalinvestmentofuptoUS$20billionby2010.Inthisvision,Enron wouldsetuptwoLNGterminalsandre-gasifrcationunits,thefirstbeingatDabholin Maharashtra. LNG would be imported to meet projected national

needs through a terminal

facility that Bnron was building in Qatar, u gas-rich ilulf state. The two Indian LNG terminals

would also help h,nron to meeithe iSX urrnrul return that it had promised to investors in the

Qatar facility.l5

e Washington Post (2004) "Understanding En'on", http://ww washington (accessed

8 January 2007). l0

Online NewsHour (June 2002) "Enron: After the Collapse"'

ittp:-//www.pbs.ore/newshour/bb,/business/emon/whatiseroon html (accessed 5 Januuy 2007)'

lr Washington Post (2004) oP. cit.

't erri*n,-r. (18 January 2obtl "Enron's Eight-Year Power Stru881e in India"' lsla Times online'

trtto;//ww.atimes.com/reports/CAt3AiOt html (accessed 29 December 2006)'

tt nfioJ-. O t r"u.*u,y z00z) "enron Chief Scomed Asset Division" ' Finqnciql Times'

-Utpyi.;";r"r..r,.".;* (accessed 28 January 2007)

'o;-d";;Fl% N*-ber 2001) "Free and clear of Enron's Woes"' Business week'

liJ.:lii""ww.u)siness*eet.com/masazine/conte.vot +slc:zsgot+.h!!1(accessed26January2007). 1s Hilt, c.w.L. (2005) op. cit

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29

Strayer University-Virginia Beach, "BUS 5l g: Risk Management""'Fall 2012"

Politics. lnstitutions and The Dabhol Power Project

Thus Enron opened discussions in 1992 with the lndian authorities over the Dabhol power

pr"*, a t. built, owned u"J op".ut"a uy Dabhol Power Company C'DPC')' an Indian private company unusually o*n"d .nii..ly by ioreign interests. Enron owned

80o/' of the company'

with General Electric C;.p;;i; 1:'cn'1"-a Bechtel Enterprises Inc' ("Bechtel") each

holding 10olo interests. Cg *oJO supply gas turbines for Dabhol and Bechtel would serve as

the turnkey engineering procurement and construction contractor'tu The three shareholders

controlled DPC through u'r".i", of companies registered in Mauritius, which had favourable

double taxation agreements with India that might"help the owners lessen withholding taxes in

the event of the project p;;d";i;g surpluses foi distritution'" A turther Enron subsidiary was

made tumkey contractor for the r:e-gasification plant'r8

The Dabhol Proiect

Development

The Dabhol plant was controversial from inception. Following the decision to open the power

sector to foreign direct investment, Indian ofhcials visited the uS in May 1992 to seek

investment and te"n rotogi"ui."*.t ".. for the sector. The delegation met Enron officials'

including Rebecca Mark,"and indicated their interest in commissioning a private power plant'

Immediately upon the'a.1"gutlon't return' the secretary of power informed the state-

controlled power suppliei-fr4-unu.urttt a State Electricity Board (';trlseB"), that Enron would

visit the state in:rrn. to';r..f".i fot"otiuf sites along the state's coastal areas for a proposed

power project.

Maharashtra is one of India's most prosperous and developed states and the state capital

Mumbai (formerly g"-t"yl is the iountry's main financial and commercial hub. when

Enron and GE executive, urti.o"a in India, they first met central govemment officials in Delhi

and then travelled to ftl"LUui to inspect ,i", una meet state representatives' Soon afterwards' on 20 June 1992, Enron and the Maharashtra state

governmint signed a memorandum of

understanding(..MoU,,)todevelopa2,000MWtNG-firedpowerplantatDabhol,l80km south of Mumbal. Rg."e-Lrri in principle over the us$3.1 billion

project was made unusually

o;r;1}.r;*;i h". ".-"t "r nor state government engaged independent technical assistance

or

conducted a financial appraisal of tie project ana tn" main contract was concluded without

competirive bidding of any kind''"

16 Nuik, N. (2003) "Dabhol Power company", case study' London Business School'

(accessed 28 December 2006)'

ItAllison, T. (18 Jmuary 2001). op cir' 18 Nuik, N. (2003) op. cit. D cuuu.i, R. (2002)

,.Dabhol: Emon Timeline,,, http://ww.albionmonitor.com./0202a./enrontimeline'html (accessed 28

p"l"-U"t )oooll gdwar<1s, B. and Shukla, M' (october 1995) op cit' 20 Allison, T. (18 January 2001) op cit'

4

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Strayer University-Virginia Beach, "BUS 51 9 : Risk Management""'F all 2O1 2"

O7l335C Politics' lnstitutions and Project Finance: The Dabhol Power Project

A state govemment committee reviewed the project in 1995 and commented that:2l

In a matter oJ'less than three days' an MoLI was signed between Enron and

MSEB in a matter involving a proiect of the value of oy1 10'000 crore

[US$2'5 billion] rupees at i'" ti*"' with entirely imported fuel and largely

imported equipmeit, in which, atlmittedly' no one in, the .gouernment had

expertise or experience' Infact' the Jile [on the Dabhol project] did not even

showwhatEnronwas..whatitshistoryis,businessoraccomplis'hment,[,..J Itlookedmorelikeanadhocdecisionratherthanaconsidereddecisionona durable orrori'"-"'t with a party after obtaining adequate and reliable information. ieither the balaice iheet and annual accounts of

Enron, nor

any information about its activities, area ofoperation' its associates' etc' was

oitaiiert ny the government then, or even later' 22

Project Structure

Two months after signing the MoU, Enron submitted detailed implementation proposals to

India,s Foreign tnv"strneit promotio' Board,2r and on its recommendation, split the project

into two separate phases. MSEB had earlier suggested that the project be divided in such a

way but Enron had disagreed oq the gro,rnir" that it would adversely affect Dabhol's

economies of scale i" p;#;;il"i; vsgil't motivation is unclear,'s but splitting the project

-t" ;" phases might have made it easier for the board as Dabhol's sole power buyer to cope

with the financial consequences of the project, which in every sense was transforming for the

state in terms of capacity, output and costs'

Phaseloftheprojectinvolvedtheconstructionofa6g5Mwgas-f,lfedpowerstationthat would run on imported distillate oil, and was scheduled to commence

production in

December 1997. phase II would expand the capacity of the plant to..2,0l5MW and involved

the construction of a 1,320MW gas-fired plant, a 1s-gasification facility., and an LNG carrier

as well as co'esponOirrg p"rt?cilities inciuding-a fuel jetty, navigation channel, and

il"t*"r...rtft " *".onJ"piur. *u, scheduled foicommissioning at the end of 2001, and

.,pon an" completion or pnur" Il, the entire plant would switch to using LNG for fuel'

with the completion of Phase II, Dabhol would run on Qatar-sourced LNG, where Enron had

extensive interests, including the US$4 billion development of u 19- g?: held2T,and other

pipeline construction. OabhJl's total cost would exceed US$2.8 billion.28 The scheme was

designed as a gas-fired baseload station that generates electricify- constantly' compared to

f.uftoua statio-ns that generate power only during peak hours. Under a 21-yeat contract'

MSEB would buy u #rrimom amount oi electricity at a plant load factor of 90%. The

nroiect,s debt-to-equity ratio was intended not to exieed 70'-30. The capital cost of Phase I

"*"i USSS20 -illion,2dand that of phase Il would be about US$1.9 billion.

'' Ibid. " n"pon of,n" ft'laharashtra State Cabinet

Sub-Committee to Review the Dabhol Project' 1995'

23 Allison, T. (I tl January 2001) op cit to H"*""'nigiro watchi1999)

,,The Enron Corporation: Corporate complicity in Human Rights violation"'

htioJl;.i.tt*.orglr"nort.llqqql"ntonl"nton-u'htt (accessed 10 December 2006)

tt Ibid. 26

Project Finance (January 2000) "Dabhol: The Big One"' 27 erurcfrti, I\4.w. i+ augurt 1995) "Emon Project is Scrapped

by India State"' LTqll Street Joumal'

28 Human Rights Watch (1999) op cit'

,r s"r,, c., dixit, S. and Wagle, S. (September I 995) "The Emon.Controversy: Techno-Economic Analysis and Policy

Implications", Prayu$ Prt", tndi. i'ttp'//*** r"oyum (accessed 28

December 2006).

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Politics, lnstitutions and Project Finance: The Dabhol Power Project

07/335C

Objections

Both Enron and the central govemment sought financing from the World Bank for Dabhol'3o

This was a strategic a."irion] fo, not only Aia ttre World Bank offer loans on favourable terms

for many such power p.":..i, L"tro ,uir" funds in this way would represent endorsement of

the project so as to muke comm"rcial funding easier to obtain. However, the world Bank's

analysis showed that thi ;;;j;.t would pro"duce too much power at too high a cost for

Maharashtra. N.* ,rn*uoi"d capacity would compel MSEB to replace cheaper coal-fired

power output with a source thai was as much u, firr" times more costly,rr for MSEB was

contracted to buy a minimum amount from Dabhol even if the plant's output was unwanted'"

As transmission network capacity between India's five regional grids was limited'33 and most

state electricity boards *.ii in poor hnancial condition, selling power to other states was

scarcely viable.

The World Bank also noted that the Dabhol plant was planned as a baseload power station

when Maharart t u fu."J.t."i"tlty shortage only during pt?! hgYtt'. and the use of LNG as

fuel was dubious given the cost of domestic .oul *u, considerably lower' It concluded that

the project did not meet a least-cost test, lacked an overall justification and the Maharashtra-

EnronMoUwasundulyfavourabletoEnron.InAprillgg3,theWorldBankfurneddownthe Maharashtra govemment,s loan application on the grounds

that the project was "not

economically viable".

India,s federal authority supervising the power sector, the central Electricity Authority

i;:cBe'f, studied the proj"ci indepeidently and also found that "the entire MoU was one-

sided" in favour of Enrorr.'ftt" CEA specifrtally noted that:34

rSpecificdetailsaboutprojectcostsaSrequiredunderlndianlawwereabsent. . ttre price of electricity generated by Dabhol was high' r The MoU failed to'siecif,' when the Z}-year contract-would begin' and lacked

a

specification as to when electricity supply or payment would commence'

o The structure of payments did not .onro.- to earlier guidelines issued by the central government in 1992.

I No provision was made for auditing the project to ensure that the price of electricity was

commensurate with its cost' rMSEBguaranteedaminimumfuelpurchasebutthefuelsupplierwasnotboundto

provide a minimum quantitY of fuel'

r MSEB had not verified whether the price of fuel was economical'

Deal Closed

cEA withheld clearance for the project on the grounds that the tariff was overly high'

Nonetheless, the Maharashtra government urged the central government to give clearance to

the project and the central government succumbed' despite CEA

"l"ututt"e for such projects

being mandated Uy taw.35 Ii December 1993, Maharcshtra signed a 21-year power purchase

agreement with Dpc, prrttirrg tn" ^final seal on the project.s6 To allow Dabhol to proceed,

Enron needed to secure'some"l50 federal and state upp.o.\,ult, resolve many legal issues' and

t0 Hu-un Rights watch (1999) op. cit 31

Choukroun, S. (2002) oP. cit. 32 Allison, T. (18 January 2001) op cit' 33 Ibid. to Ibid. tt ouio, s. (2002) "The Emon Saga", ICFAI Center for Management

Resemch

16 Nuik, N. (2003) op. cit.; Allison, T (1 8 January 2001 ) op cit

6

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Politics, lnstitutions and Project Finance: The Dabhol Power Project

07/335C

deal in principle with complicated federal and state taxes.37 Enron, with its aggressive

lobbying eflbrts, overcame the notoriously conservative Indian bureaucracy with exceptional

speed.

Power Purchase Agreement

The power purchase agreement between MSEB and Enron was a take-Or-pay contract under

which MSEB committed to purchase an agreed amount of power capacify without heed to the

amount of energy it used. MSEB would buy power from Dabhol for 20 years, regardless

^of demand or whether cheaper sources of fuel were available. While the

tariff for electricity for

most state power projects increased or decreased marginally over time,.the tariff for Dabhol

was structured such that it was expected to increase ste"adily tver the project's life'38

Each unit of electricity purchased by MSEB comprised a capacily,charge and an energy

.rrurg" The capacity "hu.g. "o.o"r.dthe

recolery of capital invested in the project and was

calcJlated predominantly ii US dollars, with MSbB bearing all currency risks' The capacity

"rrurg. *o"ra be applied in full whenever a plant load factor of 90Y' was achieved' The

energychargewasavariablecomponentofthetariffbaseduponthevolumeoffuel consumed, variable operations and maintenance charges, take-or-pay

charges for fuel supp!i99,

andspecialoperationsfees.ThefinalpriceofDabholpowerdependedlargelyontheUS dollar rupee exchange rate, oil price levels and the plant's actual load factor.

The power purchase agreement assured DPc of an internal rate of return of l6oh' which was

less than many analysts deemed adequate to attract foreign capital,taking into account foreign

investors' peiception of the risks involved in investing in India' Nonetheless' industry obser-vers calculated DPC's real post-tax internal rate of return to be between

26%o and32%"

which amounted to annual .*".r, puy-.nts of between US$15.9-20.4 million from MSEB'3e

Phase I Financing

Financing for phase I of the project was arranged by,March.l?95.it The three foreign rp""r"*-r"g"ther contributed an equity investment of US$276 million' Debt financing

came

in four main parts: "'

. US$150 million through a syndication of 12 banks, arranged by Bank of America and ABN Amro Bank NV

o About US$298 million in commercial export credit loans guaranteed by the US Expofi- Import Bank usstoo million loan from the overseas Private lnvestment corporation

("oPIC"), a uS

agency that provided political risk insurance

ulssg million in long-term loans through Industrial Development Rank of India ("IDBf'), a state-sector lender.

credit support came in the form of a letter of credit, a guarantee from the state government'

counter-indemnities fiom the central government and an escrow account over some of

fnliBg'r payments. Dabhol was the firJ of the eight fast-tracked energy projects for which

central gwernment offered guarantees in order to altract private sector involvement'

t7 Flill, c.w.L. (2005) op. cit. 38

Sant, G., Dixit, S. and Wagle, S. (September 1995) op cit' 3e Ibid. 40

Euroweek (3 March 1995) "Financing in Place for $920m Indian Project"' al I.temationul Financing Review (lg March 1g95).,Power Project Propelled: Tum Up

md Go"

,7

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Strayer University-Virginia Beach, "BUS 5l g: Risk Management""'FaI\2012"

Politics. lnstitutions and The Dabhol Power Project

Agreement Revised

In March 1995, prior to the commencement of construction of Phase I'42 a new coalition of

the nationalist Bharatiya Janata Parff C.BJP,) and the Hindu nationalist Shiv Sena replaced

the Congress state government that trad been responsible for entering into the Dabhol contract'

Both the BJp and the Shiv Sena campaigned for election on an anti-Dabhol platform, fannilg

the widespreuo perception that dealiigs with foreigners were likely to be to India's

disadvantage.al

Antagonism towards llabhol was accentuated by a statemenl-befott..l us congtessional

hearing by a senior .;;;;y ofhcial that Enron had spenr us$20 million in education in

India to show the benefits of private power proJects,a a sum which many in India interpreted

to mean bribe money. the new Maharashtra coalition goveffrment quickly formed a

committee to review ,rr" p.":".i led by Gopinath Munde, deputy chief minister and state

president of the BJp, *tt" a*t"i the campaign had visited Dabhol and pledged to "throw

Enron into the Arabian il'." i# Munde iommittee studied the project and concluded:

r There was no reason not to include competition in bidding for the project' It was an act of

i-p.op.iety for the central government to negotiate solely with Enron'

. Th; capitai costs of the Dabhol project were artificially inflated' r The foreign .or."n.y d"no-ioutlon of tariff payments would lead to uniustihably

high

rates for consumers. oThehighcostofpowergeneratedbyDabholwouldadverselyaffecttheeconomic

develofment of, Maharashtra'46

The report was never published although sections were leaked to the Indian press' In response'

Enron,s Mark indicated that the company had taken into account that duties on imported

equipment would be ,"t:".i to tt" *'t i* of the lndian customs, implying that Enron had

iniela nragea the costs.aT

ThestategovemmentdeclaredtheDabholprojectcancelledinAugustlgg5atthe recommendation of the Munde Committee. State chief

minister Manohar Joshi called a halt to

construction work of pfrur. f until the Dabhoi contract could be rescinded'48 "This deal is

against the interests oi tututtu.u*ttt a", Joshi said before the state legislature' and "accepting

this deal would indicate an absolute lack of self respect and would amount to betraying the

ilrr;fu;;;oi.Im *".rrt.less, Joshi also hinted ihat the state govemment would be open

to renegotiaiion if E.ttott took the appropriate initiative'

The state govemment,s decision to declare the Dabhol project cancelled prompted Enron to

issue an arbitration notice and demand compensation for US$300 million that DPC had by

theninjectedintotheproject.Thecompanyranadvertisements^inprominentlndian newspapers publicising ttre ie"efits of the project'50 By September

1995' polls showed that

g0% of the state and oEy" of trr. nation wanted itre project to resume. In the hope of saving its

investment,Marksugge..,.du,.,'"gotiationtoJoshi,p'oposingatariffrevisiontotake

ffiubmitsRenegotiationProposalsforPoweIProject,,,,,,genceFrancePresse. 43

Dutta, s. (2002) op. cit a

Human Rights Watch (1999) oP cit a,

Dutta, S. (2002) ,.The EnroJ Sigj: nu.n"r, Cuse by ICFAI Centre for Management Research,

Hyperdad' India'

4o Drttu, s. (2002) op. cit. a7

Capital Market (13 October 2003) "DPC: WhoseBaby ls-it Anyway?" htto://w capitalmarket com'/CMEdi/SFArtDis'asp?

irsNo:osos.SpesNo=t z (accessed 20 December 2006) as

Feman<les, N. (3 August 1 995) "state Halts India's Largest Fofeign Investment, Enron's $2 8 Billion" '

Associqted Press'

ae Brauchli, M.W. (4 August 1995) op cit' to

Hi1l. c.w.L. (2005) op. cit.

8

34

Strayer University-Virginia Beach, "BUS 519: Risk Management"' "Fall 2O12"

account of Dabhol's special infrastructure and tax requirements and to match the most

favourable offer delivered under similar private power projects recently approved in

il;;;h;r"itB*o' also suggested switching from distillate tuel to naphtha or LNG from ao-"rti. suppliers, and offeie? MSEB a 30oh share in DPC. The state govemment

began

negotiations with Enron and in February 1996 the two parties agreed to revise the Dabhol

agreement.t' Under the new terms:s3

. A new turbine design with a fall in price of generation equipment-would reduce capital costs by us$300 -iilion, while increasing total capacity

from 2,015MW to 2,184MW.

o The re-gasification plant would be devolved into a separate venture' rPhasetortneprojectwouldusedomesticnaphthainsteadofdistillateoil' o Separation of the re-gasification plant and the fuel switch would reduce costs by US$450

million and lower thJ unit rate of power by cutting the fixed cost component of the tariff'

This would lessen Dabhol's average unit rate of powerta from uS$0.055 for Phase I to

US$0.043 for the entire project, *.'uking Dabhol the cheapest large-scale power project

under negotiation or implementation in India'

o MSEB was given the option to acquire a 30Yo shate of DPc, which would reduce the project's anniral cash orriflo* by US-$150-170 million'55

r The sponsors could sell re-gasified LNG to customers other than MSEB.56 o phase I and ll would bJ implemented simultaneously to cover four months' lost

construction time.57

The revised agreement was given a counter-guarantee by the central government and a new

nower Durchase agreement was signed in August 1996' Construction work on Phase I

;;;J ;; t;r. ind.rt Under the revised agreement, DPC's annual retum on the entire

project was expected to be around 20o6.5e

The state government's attempt to cancel the Dabhol project posed a serious setback to the

central government's elfort to attract foreign investment, .rp..iutty in India' energy sector'60

Dabhol was intended as a trailblazer to lure foreign investment, butlhe state's behaviour was

-hi[ing to certain foreign investors, heighteningiheir perception of India as being

relatively

.i.t' fi. cross-border iivestment. To many observers, the state government's decision was a nolitical oloy by the BJP to discredit the congress parly central govemm€nt

prior to a national

ffiii;;;;: ; -iss].;'Critics

suggested ihat ih. n.* asreemenl^lailed to address the underlying cost issues olthe projeci*and *orsened MSEB's position"6'mainly

by removing

the optional naftre olPhase Il olthe project'"'

Phase ll Financing

More than 40 lenders became financially committed to aspects of the project, but it took orrer

12 months before a bank syndicate could be formed to fund the foreign currency debt

07/335C Politics, lnstitutions and Project Finance: The Dabhol Power Proiect

slNuinan, M. (19 September 1995) op. cit. 52 uJHour" oin"presentatives (22 February 2002) "Fact sheei: Background on Enron's

Dabhol Power Project"'

,, i.oiu grrin"* Intelligence (2g November 1995) "Dabhol is Hea<ling for a Happy conclusion". 54

Averaged unit rate ofpower refers to the unit rate olpower over the lifetime olthe project'

tt f"Lp"n, A. (2002) "Enron ancl the Dabhol Power Company", Case Study, Thmderbird School of Global Management'

so Nuik, N. (2003) op. cit. s7

India Business Intelligence (29 November 1995) op cit' t8 Nuik, N. (2003) op. cit. 5e India Business Intelligence (29 November 1995) op cit uo Ni.holron, M. (4 Augusl lq95) op. cit' 6r

Femandes, N. (3 August I 995) "S1at€ Halts India's Largest Foreign Investment, Enron's $2 8 Billion Project"' I ssociated

Prass:Nadkarni,S(5Augustl995)"EnronMovesendsOutWrongSignal"'SoalrChinaMorningPost' 62 India Business Intelligence (29 November 1995) op cit' 63

Human Rights Watoh (1999) op. cit.

9

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Strayer University-Virginia Beach, "BUS 5l g : Risk Management""' F all 2O1 2"

lnstitutions and Project Finance: The Dabhol Power

requirementsofPhasell.FinancingforPhasellwascompletedinMay.|999,withtheloan described in the specialist financial press as among the most

successful international project

financings. The projectJ capital c;st of phase Ii, including re-gasification facilities' was

us$l.9 billion, with US$l.41+ tittion in loans and uS$452 million in equity investment from

the original foreign sponsors.4 Foreign debt was US$1.082 billion, representing the most

sizeable foreign uo.ro*ing sanctioni by India.6s The debt package was obtained from a

number of sources:66

. A local curency loan equivalent to US$333 million was provided by Tndian banks with IDBI acting as arranger.

r Groups of domestic and offshore lenders provided a syndicated loan of US$497 million' . OPIC provided US$60 million in project finance loans' o US$433 million as an export...dit ioun, of which US$258 million was provided by the

Export-Importeuntorlapuo(Jexim)andguaranteedbylndianfinancialinstitutionsand commercial banks. The ,"-uinirrg US$175 million was provided by

commercial banks

withaguaranteefromJapan,sl,tinistryoflnternationalTradeandlndustry. . A second us$gO.g million export credit loan was provided by commercial banks with

Belgium,s office Nationale du Ducroire providing a 95o/o guarantee, and the other 5o/o

guaianteed by long-term Indian policy banks'

Theproceedsweretobeappliedtowardstheconstructionofanadditionall,320MWof generation capacity, an LNG re-gasification facility and port -fltJtlb:

Enron had by now

secured 2l_year conffacts to buy innually 1.6 million tonnes of LNG from oman LNG LLc

and 460,000 tonnes fiom Abo lt uUl Liquefaction Gas Co. Ltd.67 Unlike Phase I, financiers of

phase II received rro .o.rnt.. indemnities but did receive support from the central government

through the MSEB backed by the Maharastra state government.68

Godbole Committee

During the 1999 Maharashtra elections, the Congress Party, now_ projecting Dabhol as a

symbol of its opponent*, .urnpuig".d against the project and defeated the ruling coalition' The

new administrution ,.iop u Jo#-itt"."to review Phase II of the project. Many saw the move

as a ploy by the incomirf,aa-irrl*t ution to undermine the BJp, which at the time was leading

the federal govemment. ihe co*mittee, led by Madhav Godbole, released its findings on l2

Aprll 2002after studying the project for two months and recommended a renegotiation of the

power purchur. ug."oi.nt (l.ppa') with a reduction and re-denomination of the tariff.

According to the Godbole rePort:

DPChasemphasizedthesanctityoJ'thecontractsenteredintowithit. However,itiswellknownthatmanycommercialcontractsareroutinely renegotiated with major changes' In a sense' economic reality dominates

techiical tegality in tie commercial world'6e

With 90% of the construction cost of phase lI already committed, Dabhol's sponsors strongly

opposed the recommendations of the committee but negotiations between the state and Enron

broke down for lack of an agreement'

6a Allinson, T. (lg January 2001) op. cit; Anonymous (15 May 1999) "India-Dabhol Powers Down" International Financing

Review. u5 Alli.o., T. (18 January 2001) op cit 66

Intemational Financing Review (15 May 1999) "India-Dabhol Powers Down"; Project Finmce (Jmuary 2000) op' cit

"7 Proj..t Finance (Januar) 2000t op cit u8

Ibid. 6e

Report ofthe Energy Review Committee (10 April 200t) "Report olthe Energy Review Committee"' Govemment of

Maharashtra, Intlia (accessed 4 Jmuary 2007)

10

36

Strayer University-Virginia Beach, "BUS 519: Risk Management"' "Fall 2012"

Cash Crises

phase I of the Dabhol plant began operations in May 799970 and within one month MSEB

raised concerns about its ability to pay a US$20 million monthly bill-7l Although MSEB had a

."f"i*AV strong financiat position among lndia's state electricity boards, it faced common

i"rgrt""Ai"g fiiancial probl.-r, in part due to receiving payment for only a portion of the

"i""?i.ity tiat it ,.rppriJ.i vtrrch'or its supplied power was lost through transmission

inefficiency and pilf-erage, while MSEB also iubsidised tariffs to the state's most sensitive

electorate, especially in- the agricultural sector.T' Phare I of Dabhol consumed naphtha' a comparatively expensive fuel Jil derivative, and crude oil prices had risen

sharply in 2000'

This was aggravated Uy u futmg rupee, given that MSEB was bound to a US dollar-

;il;;il;?.i...twril. MSEilwas u"vtlg only 33-60%o of Dabhol's output, its take-or- nav commitment of a 90o/o capacity take-upttconverted its low usage into a

higher avetage

il#;;;;;.;;fi i..tra oizoob, MSE6 was paying almost five times more at US$0'161

for each kilowatt-hour of electricity compared *ittt USSO.O:4 in most other states'77 Faced

with financial difhculties, MSEB ,ota nutt its 30o/o stake in DPc which it had acquired after

the 1996 renegotiations, increasing Enron's shareholding in DPC to 65%o'

with its single customer unable to pay for power, DPC invoked the central government

counter-indemnity in February 2001 to fecover us$17 million owed by MSEB since

November 2000. The state government eventually paid the amor11t.78 In the same month,

MSEB accused lpC of -i.:"presenting Dabhol's technical capability and made a claim for

compensation of around us$86 million. This was disputed by DPC as an attempt by MSEB

toevadecontractualpayments.AlthoughpowergeneratedfromDabholwouldbecome cheaper when Phase tt went into operation at year-end since natural gas was substantially ch"ap". than naphtha, MSEB's overall costs would increase as it was bound

to buy LNG

under a 2}-year iupply contract.Te

DpC had few options if MSEB was unable or unwilling to pay or stopped taking power from

Dabhol. Although elechicity was in shortage throughout India, cross-state sales were hampered ty po-or infrastructure. Independenl power projects wishing to sell outside their home state needed approval from the state of domicile as well as approval

of the tariff by the

consuming state's regulatory authority.tu Since 1999, Enron had tried without success to

persuade ihe federal-and Maharashtra governments to relax these rules so as to enable

iJ.f"na.nt power projects to sell po*"t io more than one state'8r

Foreign creditor banks were now also concerned about MSEB'S payment problems, notleast

since the central government's counter-indemnity applied only partially to Phase II and funds

for its construction had ceased to be made available in March 2001 when construction was

;;;;dffi;irrr"a.-'Indian creditors, on the other hand, reduced interest rates on DPC's

07l335C Politics, lnstitutions and Project Finance: The Dabhol Power Projecl

70 The Economist (31 January 2001) "Generation Gaps"' 7r

Choukroun, S. (16 April 2002) op. cit 72 Put"rrnn, C. (March 2006) oP cit. tt Th. E"ono*i.t 126 February 1994) "Infrastructure in Asia: The Trillion-Dollar

Dream"

to Inkp"n, A. (2002) oP. cit. 7t Ibid. tu p"r,u, l. (7 December 2000) "Indian State Looks Again at Enron Project: Calling Power

Princes High' Official Wmts New

Talks", Wall Streel Journal. 7t Ibid. 7s New York Times (30 May 2005) "GE to Help Restart Power Plant

in India" 7e

Tbe Economist (3 I January 2001 ) op. cit' * ;;d t. (spring zooz) *luut ot, a case study ofRestructuring lnfrastructure Projecrs", Journal

of structural and Proiect

Finance. *'Ibid. 8t Ibi,r.

ll

37

StrayerUniversity-VirginiaBeach,"BUS5.19:RiskManagement""'Fall2012"

Finance: Ihe Dabhol Power Project

local currency loans to help avoid statutory provisioning for their loans'*t In April' DPC

commenced arbitration proceedings in London uod r.*.d""otice of politicalforce maieure'84

Wlrh puy-.nts outstanding from"four months earlier, DPC threatened to cease supply even

though MSEB had paid a later invoice'

Neither state nor central government would meet MSEB's payments on the grounds that the

;il''}g;; A^irp"i-.;-olc tried to recover paymel-t through the project escrow account but MSEB sought injunctions to block the attempt.*6 In May 2001, DPC stopped

Phase I

;;;j7;L"giil6r"-",ional arbitration and issued a preliminary termination notice to

MSEB, a prescribed step towards ending the supply contract that also'triggered a six-month

cooling-off period. VfdBg disputed G p.o."it - and asked the Maharashtra Electricity

Regulatory Commission ("VnfiC'1 to adjudicate the disputed resolution process' claiming

that MERC held qrmsi-judicial powers to adjudicate all state power disputes' ln May 2001,

MSEB rescinded the ppA, claiming that Dpi had misrepresented the power plant's ramp up

capability," and declaredihe ppA riull and void.Ee Construction of Phase II was halted in June'

Claims and Settlements

In September 2001, Enron's chairman Kenneth Lay announced that the.corporation planned

to divest assets of US$+-l Uiifio*'and in the same month offered to sell Enron's 65% DPC

stake to the Indian government for US$2.3 billion, with US$l'l billion covering Enron's

investment and US$1.1 Uittion to acquire the claims of offshore lenders' The two parties

disagreed with the terms and no settletnent was reached. Enron then invoked clauses in the

Dabhol contract to claim us$5 billion from the central and state govemments on the grounds

that MSEB had violateJth" ppA.nt py the end of October 2001, DPC was preparing to issue

a final termination notice to MSEB'e2

At home, however, Enron's fraudulent financial and accounting strategies were being exposed'

anditsoughtbankruptcyprotectioninDecember200l.DPCcreditorsinlndiaaskedthe Mumbai courts to ptu.. buUnol in receivership to prevent it from being

absorbed in Enron's

bankruptcy proceedings. Dabhol then lay idl; foi several yeafs as sponsors, domestic and

i";.ig" financial .r.ditorr, and national and state governments spun a web of settlement' damages and counter claims. In March 2004, Indian receivers took

control of the Dabhol

;i;;i?ili;r"tgn .L--".cial lenders terminated the PPA one month later' At the same time'

Bechtel and GE acquired Enron's 65Vo stake in DPC for uS$23 million through an American

bankruptcycourtandinitiatedarbitrationstomakegoodtheirlosses.

EPilogue

ln2004,lndia's United Progressive Alliance took over the central government and set out to

clear the foreign detts thaiarose from Dabhol and restart operations at the plant. By July

83 Puterson, C. (March 2006) oP cit 8a

The Economist 121 April 2001) "Emon, and On, and On"' 8s

Paterson, C. (March 2006) op. cit' 86 ittid. 87

US House ofRepresentatives (22 February 2002) op- cit' s8 A measure ofthe time taken for the plant to go from a cold start to

full output' *n

Nuik, N. (2003) op. cit n0 tvt"L"-, g. (24 December 2O0 l ) "why Etron Went Bust"' Fortu ne 1 44' p 13' e,Mcleun,B.(5March2001)"IsEmonOverpriced?"Fortune143,p 5;Weil,J (20September2000)"EnergyTradersCite

Gains, But Some Math Is Missing", Wall Street Joumql' et Nuik, N. (2003) op. cit. e3 BBC 12 April 2002)..Indian Receivers Take control

ofDabhof'http://news.bbc.co (accessed 7

Jmuary,2007).

t2

38

Strayer University-Virginia Beach, "BUS 5lg: Risk Management""'Fa|1 2012"

Politics, lnstitutions and Pro.iect Finance: The Dabhol Powel

2005, the government had concluded the arbitration and legal cases arising from Dabhol after

settling with Bechtel, which received US$160 million in settlement' ea and GE' which

accepted US$145 *1rion.;; soth sought to minimise their losses, and unlike DPC's financial

creditors, were able to use the levelage in bargaining that technical resources had been

provided, without wtrictr restarting the pJwer ptaniwouti Ue difficult to achieve'e6

Amounts overdue to 19 overseas lenders were settled for US$230 million ata20Yo discounteT

while oPIC received a settlement of uS$228 million from India's Gas and Power Investment

corrp"ryr_i-ited fundeJby domestic^lenders including IDBI, ICICI Bank, IFCI and canara

Bank, and the sale of Oo-..ti. bonds.es The settlemeniwith foreign debtors enabled Dabhol

to be revived, and the plant was restarted in April 2006'

e4 Paterson, C. (March 2006) oP. cit

nt Ibid.

e6 The Economist (1 Mav 2004) "Can Dabhol Be Firetl-Up Again? Energy

in India"

e? Sridhu., V. (30 July to I 2 August 2005) "RevivingDabhol"' Frontline'

'* Kupoor, S. iSeptember 2005) "Power Play in Dabhol Power Plant Revival"' Hmdnews'

hnp://www.hr<lnewsmedia.com/pp{a!12QQ51091!Qa(accessed3January2007).

l3

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Strayer University-Virginia Beach, "BUS 5 l g Risk Management""'F all 2012"

40

Strayer University-Virginia Beach' "BUS 519 Risk Management", "Fall 20.12"