Dabhol Power Project
Stakeholders: Identify all the major stakeholders in the DABHOL power project. What are the intended benefits and costs of this project for the stake holders? Analyze the roles, responsibilities and reward structure of the stake holders. Based on the case study do you foresee a need to change the reward structure? Enron, Bechtel Enterprises, and General Electric—through offshore subsidiaries—formed Dabhol Power Company to build the first phase of a major power plant in Maharastra state in India.
Later, part of the equity was sold to the Maharastra State Electricity Board. Enron is also a stakeholder as fuel supplier and as the operator of the plant. Bechtel’s construction arm has engineering, procurement, and construction stakes; General Electric is a major equipment supplier; and the Maharastra State Electricity Board is the electricity purchaser. There are also other major sponsors of IPPs, such as AES Corporation, whose sole business is developing, owning, and operating electric power facilities.
Moreover, the Asian Develop- In India’s Dabhol project, for example, the owners are Enron, Bechtel, and GE Capital. Shareholding Pattern [pic] Investment by Stake Holders | | | |Foreign lenders (ABN AMRO, Standard Chartered, BNP Paribas, Calyon, CSFB, etc. |USD 325 million | |Domestic lenders (the largest being IDBI, ICICI, SBI, Canara Bank and IFCI) |Rs. 62 billion | |Export Credit Agencies (JBIC, US EXIM, Belgium OND) |USD 480 million | |Overseas Private Investment Company (OPIC), USA |USD 250 million | Counter guarantee by Govt. of INDIA Ownership stake Stake Holder |% stake | |Enron (indirectly through a series of shell companies) |65% | |GE (indirectly through a series of shell companies) |10% | |Bechtel (indirectly through a series of shell companies) |10% | |Maharashtra State Electricity Board (MSEB) |15% | Responsibilities & Rewards Enron ? Phase 1 • Construction of a 695MW gas-fired power station to generate electricity constantly at Dabhol, Guhagar taluka, Ratnagiri district, Maharashtra scheduled to commence production in December 1997. • Capital cost- $920 million. ? Phase 2 • Expand the capacity of the plant to 2015MW and involved in the construction of a 1320MW gas-fired plant, re-gasification facility, and an LG carrier as well as corresponding port facilities including a fuel jetty, navigation channel, and breakwater.
It was scheduled for commissioning at the end of 2001. • Switch the entire plant to LNG for fuel upon the completion of Phase II. • Capital Cost – $1. 9 billion ? Renegotiated deal • Enron cut the price of the power by over 20 percent, cut total capital costs to $2. 5 billion and increased output to 2184MW. • Enron suggested switching from distillate fuel to naphtha or LNG from domestic suppliers. • Devolving of the re-gasification plant into a separate venture. • Enron offered MSEB a 30% share in DPC. This would reduce the project’s annual cash outflow by US$ 150-170 million. ? Annual return promised to investors in the Qatar facility was 15%. Power purchase agreement assured DPC of an internal rate of return of 16% which as per industry observers was calculated as DPC’s real post-tax interest rate of return to be between 26% and 32%. MSEB ? Take-or-pay contract – MSEB to buy a minimum amount of electricity at a plant load factor of 90% as per 20yr contract irrespective of amount of energy used. ? MSEB to bear any increase in fuel price. ? MSEB to pay DPC $ 220 million per year. ? MSEB was required to build transmission lines from the power station to its power grid. ? MSEB to receive 30% profits of DPC annually. State Government ? Guarantee from the state government in the form of Letter of credit for credit support also waived sovereign immunity. Main recipient of electricity due to the paucity of energy in the state. ? Provide land for construction of the power station, power, communications, water, and approach roads during construction. Central Government ? Central government provided counter-indemnities. ? Escrow account over some of MSEB payments. Oman Gas Company ? Entered into a contract with the DPC to supply gas. Business Plan viability and Execution: Identify and discuss the original business plan of this project. Given the data of this case, was the DABHOL power project a feasible and worthwhile business proposition? In view of the business plan, critically comment on the project execution strategy.
Dabhol Power Company was a unlimited liability special purpose company (SPC) incorporated to execute the project. The power project at Dabhol was one of the eight fast track power projects identified by GOI post the liberalization of the Indian economy. An MOU was signed between Enron and Maharashtra Govt in June 1992 which marked the beginning of the project. Salient Features of the project were as follows – | |Phase 1 |Phase 2 | |Capacity |740 MW |2015MW | |Cost |USD 920 M |USD 1. B | |Fuel |Naphtha |LNG (Sourced from Qatar) | |Planned Completion |Dec-97 |End of 2001 | Right from the inception the project was criticized by masses and viewed to be highly in favour of Enron (Majority stake holder in DPC). Even the World Bank turned down Maharashtra govt’s loan application terming the project as “not economically viable”. Some of the critical objections were as follows – 1. The govt hurried in closing and the deal, and no other vendors were considered. 2. No EIA was carried out. 3. The project would produce too much power as compared to the state demands.
And given the poor transmission system between the regional grids this would imply much higher costs for the govt. 4. The MOU required the state to pay DPC at 90% load factor irrespective of the demand; this was highly in favour of DPC and virtually assured the company of zero business risk. 5. As per the MOU, the govt had agreed to pay DPC as per base load independent of the actual demand. This was heavily criticized as the state faced shortage of power only during peak hours. 6. The structure of payments did not confirm to earlier guidelines issued by the central govt. 7. Naphtha wasn’t a cheaper source of power as compared to the orthodox sources like fuel. 8. Sufficient audit measures were not assured, to regulate the cost of power. 1.
MSEB had guaranteed a minimum fuel purchase from the supplier (Enron had heavy investment in the company) but the supplier wasn’t bound to provide a minimum quantity of fuel; In addition to it, MSEB had agreed to bear any further increase in the fuel price! 2. All currency risk was taken by MSEB and not by DPC. All these guaranteed an extraordinary IRR of 26 to 32% (post tax) to DPC. Project Financing: Identify the possible sources of financing for a major infrastructure power project of this nature? Critically examine the financing options used by the DABHOL power project. What was the impact of the financing decision for the overall risk and success of this project? Explain, with rationale, what should have been done differently to finance this project?
The possible sources of financing for a major infrastructure project of this nature are: Combination of debt and equity: Debt could be raised through a syndicate loan or loans from commercial banks and financial institutions. Equity could be pooled in by the promoters/sponsors 1. Securitization of the receivables i. e. in this case, the proceeds from running the power plant 2. Subordinated debt or mezzanine debt (multi-tranched) 3. External commercial borrowings 4. Equity financing using QIBs, strategic investors, or private placements 5. Bridge financing for short term requirements Dabhol Power Project used the following financing structure for the 2 phases: Phase I |$ mn | |Phase II |$ mn | |Equity |276 | |Equity |414 | |Debt | | |Debt | | |Syndicate Loan (BankAm-ABN Amro Led) |150 | |Syndicate Loan – IDBI Led |333 | |US Exim |298 | |Syndicate Loan – Domestic & Offshore lenders |497 | |OPIC |100 | |OPIC |60 | |IDBI |98 | |Jexim |258 | |Debt/Equity Ratio |2. 4 | |Commercial Banks |175 | | | | |US Exim |90. 8 | | | | |Debt/Equity Ratio |1. 75 | As is evident, Dabhol Power Company raised a large amount of debt to finance the project and a large portion of it was also from the export credit corporations. Phase I had a D/E ratio of 2. 34, while Phase II had a D/E ratio of 1. 75. DPC depended solely on MSEB as a consumer.
If MSEB were to default on its payment, it would struggle to pay back its debt obligations. On the other hand, given the excruciating clauses in the PPA, it was very likely that MSEB would not be able to purchase power from the Dabhol Power Plant and sell it profitably. It would have to incur a loss and have the state & if required central governments provide cover. The alternative that Dabhol Power Company could have taken in terms of financing the project was to raise more equity from the sponsors or through the market (though this might have been relatively difficult given the long incubation period typical of these projects). They could also have opted for the securitization route.
This was, the interest expenditure on debt would have been manageable. Also, based on the revised terms, MSEB received a 30% stake in the company. The equity stake was a double-edged sword. While on the one hand, it gave MSEB an opportunity to partake in the profits; on the other hand, it also made it difficult for MSEB to negotiate, since it was the sole customer too – implying a conflict of interest. Lessons Learnt and exit strategy: What are the crucial lessons of the DABHOL power project for other strategic initiatives in India? How do you address the risk inherent in such enormous global projects? How do you immunize against such risks?
What other strategic, financial and regulatory initiatives would you recommend for such projects to succeed? Lessons The Enron Dabhol project has offered many lessons for any future strategic initiatives in India and it is imperative that the mistakes made in the DPC agreement must not be repeated. In order to avoid such situations from arising in the future, it is crucial to learn lessons from the shortcomings of the agreement. This will protect future stakeholders and provide benchmarks to examine other future agreements. 1. A surplus of power is as harmful as a shortage of power. Under certain circumstances, it may be cheaper to have no power than buy exorbitant unaffordable power.
It is crucial to study the tariff implications of any supply-demand matching exercise. 2. Competitive bidding procedures rather than MoUs and counter-guarantees are the most effective method of getting the best terms from investors. The PPAs may come in the way of merit order dispatch, which is the most cost-effective way of supplying electricity to meet demand. 3. The broader developmental implications of expansion must be kept in mind. The given sector must pursue the goal of universal access to affordable utility. A stress on self -reliance as a central developmental objective to avoid control being taken over by foreign forces can be essential at times. 4.
To protect against exchange rate volatility, the forex indexation of a given project costs must be avoided as far as possible. For instance, to protect against the impacts of international oil price rises, fuel policy must be based, ceteris paribus, on indigenous resources. 5. There must be not only competitive bidding in the process, but also transparency, accountability and participation. The right to information is crucial tool in the hands of people which they must exercise with the assistance of public-interest organizations. The DPC episode demonstrates that despite the presence of certain safeguards, the lack of transparency in the agreement inevitably resulted in its failure.
It also clearly reveals the extent of Government and investor indifference to consumer interests. Risks There is a high risk inherent in such enormous global projects. It could vary from political and economic risk to country and lending risks. Some of the risks involved would be: 1. Industry cycle and the prospects of growth of the industry over a longer period 2. Competitive positioning that would determine the market share, substitutes, variable costs of production etc 3. Regulation that would impact quickness and smoothness of decisions and actions and transparency in the process 4. Tariff structure and Government support 5. Repayment risk 6. Currency risk
To generalize, it can be said that the large-scale projects require massive capital investment with long completion times, and they carry political, economic, legal, regulatory and financial risk. A key issue becomes how to attract private investors willing to participate in projects given their complex and risky nature. Cases of corruption and political and economic risk in the developing country make investors hesitate. To mitigate these risks and fears, the Government must ensure that a clear investment policy, structured process flow, transparent mechanism is established which makes the investment environment conducive. Tools of project financing must be appropriately employed.
In addition, keeping in mind the learning from the past can go a long way on making the project successful. Recommendations The following recommendations will help future agreements to avoid the difficulties that have arisen in the Dabhol case: 1. Any potential problem in agreements should be thought about, planned for, and dealt with in the first set of negotiations, rather than rectified time and again later. 2. Transparency is the key to the successful implementation of any agreement. 3. Negotiating with investors is a task that needs an expert panel that can professionally handle a given situation and can ensure stakeholder representation 4. Investors have a legitimate right to maximize their gains. 5.
Government must recognize that the best incentive to investors is credible policy and a transparent investment environment, not the unsustainable artificial incentives. 6. While protecting the interests of the electorate should be the government’s top priority, the consumers must not take it for granted that the Government will protect their interests. 7. Consumers need to become more organized and vocal and push for a greater role in policy decisions. 8. Investors must understand that unrealistic commercial agreements result in enhanced risks and are likely to fail. 9. Investors must understand and accept the commercial risks of the investments accompanied by high rates of return. ———————– Dabhol Power Project