Credit Risk Analysis

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Case Study on

Dabhol Power Project

Submitted to:Submitted to:Submitted to:Submitted to: Submitted by:Submitted by:Submitted by:Submitted by:

Prof. Vivek Saxena Ashish Shah (218)

Course In-charge Gopal Sharma(231)

Credit Risk Management

NIIT University, NeemranaNIIT University, NeemranaNIIT University, NeemranaNIIT University, Neemrana

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Brief Timeline of Enron’s Dabhol Power Project:

1991-1992

India opens its power sector to private foreign investors.

Feb. 1992

Enron begins investigating opportunities in the Indian power sector.

May 1992

Enron executives pitch their ideas to the Indian power secretary, who is in the

United States to encourage foreign participation in the Indian power sector.

June 1992

Enron and General Electric sign a memorandum of understanding with the

Maharashtra State Electricity Board (MSEB) to build the Dabhol project. The operating entity is the Dabhol Power Company, a joint venture. Enron is the

majority owner, while General Electric and Bechtel each own 10% shares.

June 1992-

The parties negotiate the terms of the deal. Enron obtains the necessary

Dec. 1993

approvals for the project from the Indian government.

Dec. 1993

The Dabhol Power Company and MSEB sign the power purchase agreement.

1994-early

Indian political parties opposing the ruling Congress party campaign on an anti-

1995 Enron platform. Enron seeks and obtains $635 million in financing, insurance, and loan guarantees from Bank of America, ABN Amro, a group of Indian banks, the U.S. Export-Import Bank, and the Overseas Private Investment

Corporation (OPIC).

Jan. 1995

Commerce Secretary Brown visits India, accompanied by Ken Lay, and oversees signing of loan agreements by the Dabhol Power Company with the U.S. Export Import bank and OPIC

Spring The opposition alliance wins the election in Maharashtra in March, and in May 1995 the new government appoints a committee of state ministers (the Munde

Committee) to review the Dabhol project.

Aug. 1995 The Munde Committee issues a sharply critical report that recommends

scrapping the Dabhol project. The state government acts on this advice.

Aug.-Dec. Enron enters arbitration and seeks $300 million in compensation. The state 1995 government files suit in September to void the agreement, alleging fraud and

misrepresentation. U.S. officials, including Energy Secretary Hazel O’Leary,

warn India that its action will discourage foreign investment.

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Nov. 1995 Rebecca Mark, Chairman of Enron International, meets with Bal Thackeray, the top power in one of the ruling parties. Afterwards, negotiations resume between

Enron and the state.

Jan. 1996 The state announces it will accept a revised agreement.

Feb. 1996 The state and the Dabhol Power Company finalize the terms of the revised

agreement.

1996-1997 Legal challenges to the project by Indian groups continue, but are eventually

dismissed.

1997 Enron obtains approval from the Indian government to expand the Dabhol liquified natural gas terminal to allow it to process 5 million metric tons

annually.

May 1999 Dabhol Phase I (740 megawatts) begins generating power.

Jan. 2001 The state of Maharashtra stops paying for Dabhol as of its $22 million December 2000 bill. The state subsequently seeks to cancel the power purchase

agreement.

April 2001 Enron begins arbitration proceedings.

April 2001 Secretary of State Colin Powell raises Enron’s problems regarding Dabhol in a

discussion with India’s foreign minister.

May-June The Dabhol Power Company ceases operation of the Phase I portion of the plant 2001 and halts construction on the 90% completed Phase II portion (1,444

megawatts).

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1) Risk Analysis & Mitigation Arrangements:

Risk Mitigation

Strategy Borne By

Ability to

Bear Magnitude

1. Economic/

Demand

Through

Contract - PPA MSEB Questionable High

2. Currency Through

Contract

MSEB/GoM/

GoI Questionable Medium

3. Financial Leverage Good

Credit Rating DPC Good Low

4. Technical Partner with

GE & Bechtel DPC Good Low

5. Political Govt

Guarantees

OPIC/GoM/

GoI Good Low

6. Social - DPC/MSEB/

GoM Questionable Medium/High

7. Environment GoI/

Pollution Board DPC Questionable Medium

Contractual Operational risk management/mitigation arrangements that underpinned the

original Dabhol Power Project include the following:

• The MOU was signed between Enron and MSEB in less than 3 days in a matter

involving a project of the value of over USD 2.5 Billion and also neither central nor

state government engaged independent technical assistance or competitive of any

kind.

• Nobody bothered to know the details about Enron i.e. what its history is, business or

accomplishments. Neither the balance sheet and annual accounts of Enron, nor any

information about its activities, area of operation, its associates etc, was obtained by

the government.

• Dabhol plant was planned as a base load power station when Maharashtra faced

electricity shortage only during peak hours. So the project will produce a surplus

power at much higher cost and also Maharashtra Government has to buy that Power

at much higher agreed cost.

• Also despite of Project rejection by CEA, the central government has approved the

project despite of the fact that CEA approval is mandated by law in such scenario.

• Audit provision in not mentioned in the MoU and also it did not specify when the 20

years contract would begin.

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2) How Enron may have demonstrated “Credible Commitment” to the Dabhol Power

Project?

Enron has to deal with the various land and legal issues and also they have to struggle for

getting loan from World Bank for their project because of the nature of the project (DPC is

base load project whereas Maharashtra required power only for peak hours and also the

power supply cost to government is costly and they sense that the Maharashtra-Enron MoU

was unduly favorable to Enron)

Enron demonstrated “credible commitment” to the Dabhol Power Project in the following

ways:

• The Dabhol Power Company (DPC) formed to operate the plant was 80% owned by

Enron along with GE (10%) and Bechtel (10%).The total equity investment done by

the 3 foreign companies was USD 276 million.

• Enron agreed to invest a sum of over USD 3.1 billion in India in a matter of 3 days.

• Two months after signing the MoU, Enron submitted detailed implementation

proposals to India’s Foreign Investment Promotion Board, and on its

recommendation, split the project into two separate phases.

• With completion of Phase II of Dabhol project, it would run on Qatar sourced LNG,

where Enron had extensive interest.

• To proceed with the Dabhol project, Enron needed to secure more than 150 federal

and state level clearances. They had to deal with various land and legal issues.

Additionally various central and state taxation had to be dealt with to start off with

the project. Enron with its aggressive efforts overcame the notoriously famous and

slow Indian bureaucracy with great speed.

• Enron persevered to educate the Indian public about the benefits of the project by

running full page advertisements in leading newspapers dailies.

• After the project was cancelled, Enron proposed a tariff revision to take account of

Dabhol’s infrastructure and tax requirements and to match the most favourable

offer delivered under similar private power projects. Enron offered MSEB 30% stake

in DPC and also suggested switching from distilled fuel to naptha or LNG from

domestic suppliers.

• Enron made negotiations with the government on accepting a new turbine design

which would reduce the capital cost by USD 300 million, re-gasification project

devolved into a separate venture.

• Enron agreed on lowering the unit rate of power from USD 0.055 to USD 0.043 due

to which the expected ROE for Enron reduced from around 30% to 20%.

Even after so much of delays and all the political disturbances and local unrests around

the project, Enron remained committed to the project.

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3) Approaches to manage risks in an unstable political and Institutional Environment:

Enron could have clearly specified the terms and condition to MSEB and also it should be

thoroughly scrutinized by officials of MSEB which was not done. Also Capital Cost of the

project was artificially inflated as per Mundane Committee report. Also instead of foreign

currency denomination of tariff payments, they could have allowed to be paid in local

currency i.e. Indian Rupees so rate will be considerably lower for the consumers and also

foreign exchange risk will be minimized in this way.

Also it could have taken local parties and people so that in future in case of change of

government they don’t have to face a problem of newly electing party cancelling the

contract made by loosing party. Because they had failed to gather local public and Media

support, they had to suffer a lot in terms of project delays and revision in the terms and

conditions of the project.

Even Enron hasn’t clarified many things to MSEB and they have structured the deal in their

favors which was later identified by CEA and World Bank. They could have made deal more

transparent and beneficial for the parties.

In order to manage such risks the project should be independently audited by experts

involving technical and financial feasibility so that any future event related to political

instability doesn’t hamper the project. Whenever a project of such large magnitude is

undertaken the local public should be well educated and kept in loop and also be involved in

opportunities created by such projects. This would benefit the project in case of change of

governments at state or central levels.

Another important fact to be considered is that the shareholding pattern should have a

sizeable representation from the local nationalized company. This would ensure that the

interest of both the parties is maintained in project completion.

Apart from these the following points should also be taken into account while engaging in

large projects for national benefit: They should have ensured payment guarantees and

should make transparent bidding process.