The ENRON Power Purchase Agreement

The ENRON Papers consisting of the Power Purchase Agreement, the guarantees and counter guarantees provided by the Maharashtra and the Central Governments respectively are now in the public domain. This has helped to lift the veil on a deal that should never have been kept secret. If Maharashtra Government is entering into a commercial arrangement to buy electricity on behalf of the people of the State, the people have a right to know on what costs such purchases are being made. The publication of the ENRON papers now makes clear why the Government wanted so desperately to hide this deal. A cursory examination of the papers shows that the major arguments against the ENRON deal are all substantiated by the documents now made public.   Let us take what has been the most hotly debated issue — the costs of the project. The ENRON papers show that the cost of main plant equipment  is Rs.610 crore while the project costs are five times this amount. The cost of Rs.610 crore for main plant equipment is comparable to indigenous power equipment costs — the significant difference being that in Indian Plants, main equipment costs are roughly 60% of the total project costs. Even if we take into account additional financial costs in going the private sector route, other costs should have been at most equal to the main plant equipment costs. The total cost of the project based on Rs.610 crore for main equipment should not have exceeded Rs.1200-1300 crores — this is what the critics have held all along.

Why do the ENRON costs go up from Rs.610 crore to a mammoth Rs. 3000 crore? The major chunk of the increase is in the contract ENRON has reached with GE and  Bechtel for the turn key construction of the power station. The total contract value for the construction of the project is Rs. 1872 crore, three times the value of the main plant equipment! A classic case of what the World Bank calls a “sweet heart deal”. Expressing its concern with the Government’s policy of a fixed 16% rate on capital, The World Development Report, 1994 had given the example of the Indian Railway System built under the British where massive cost padding had occurred due to such incentives. GE and Bechtel are co-promoters of the Dhabol Power Project. This explains the “sweetheart” deal with GE and Bechtel for the turn key construction contract. It is also advantageous for ENRON to have higher project costs as the fixed guaranteed return on capital would translate to even higher profits. Only the consumers would lose as they would have to pay for all this cost padding with higher power tariffs.

The rest of the costs — from Rs. 1872 to Rs. 3000 crore, is the cost of ENRON financing the project. A number of dubious items of cost have already been highlighted in the press earlier, the most infamous being the developer’s fees by which ENRON was to take out Rs. 86 crore in the beginning of the project — the developer’s fees included costs incurred by ENRON towards projects that never took off the ground. In other words if ENRON develops a basket of projects, the costs of these come not out of the profits of the successful projects but out of the costs of the successful ones. ENRON also wanted the interest charges of its loan equity  to be included as a part of the project costs. IDBI finally managed to slash some of these costs though they seemed to have slipped the notice of the Maharashtra and Central Governments.

The issue here is not only the undoubtedly high pre-operative costs, development costs and various fees levied by ENRON on the project. The issue is also how ENRON is leveraging its equity while putting in a measly amount — it is bringing in only 1.5% of the total project cost as equity while it will own 80% of the total equity.  The documents show that ENRON will bring in Rs. 30 crore in cash while the rest will be brought in through loans. This loan equity will be substituted by real equity during the construction phase. Even a cursory examination of the financing costs and fees paid to ENRON during construction makes clear that the rest 28.5% equity will be generated from the recycled project funds itself. This also explains the high pre-operative costs and the various fees it is claiming from the project. And if this is not enough, they are also allowed to sell off 30% of their equity before the project is commissioned. As the rate of return starting in 1997 is 15% and goes upto 57.83 % by 2016 (an average rate of return of over 40%) and is also guaranteed against foreign exchange fluctuations by a sovereign government, there is every likelihood of a high premium — another windfall for ENRON. Thus ENRON will make a killing before even one MW electricity has been generated.

The return on equity for the project is shown to be 15% in the first year rising to an astounding 57.83% by 2016 — an average of more than 40%. The Government policy has fixed a return on equity of 16%. As the capital recovery charge is fixed for the entire duration of the Power Purchase Agreement, the 16% rate of return should be computed as an average rate of return for the entire period and not a rate of return of 16% for the first year alone. The Government should explain why such a violation of policy has been accepted for this project. Or is it the Government’s contention that the rate of return on equity is only to be computed for the first year of project commissioning?

The other important fact that has been now revealed is the Government hype about a super efficient ENRON and its commitment for a 90% PLF. Various critics had pointed out that a 90% off-take is highly advantageous to ENRON as the load factor in Maharashtra is only about 61%. It now appears that while MSEB is guaranteeing 90% off-take, ENRON’s commitments are far less stringent. The 90% guarantee is computed on the 625 MW base load portion of the plant. As ENRON is also installing an additional peaking capacity of 70 MW, any shortfall on the base load plant can be easily made good by running the additional gas turbine kept for peaking purposes. The operating cost for the peaking cycle will be a little higher than the operating cost of the base load plant but still well below the Rs. 2.40 per unit that MSEB has to pay. As there is also a built in cushion of 5% margin on plant capacity, the guaranteed 90% PLF on ENRON’s part, translates into an actual commitment of only 79% PLF — a figure that is on par with the availability of Indian coal based plants. And it is well known that coal based plants have much lower availability than gas based plants. t may also be noted that the additional margin available (7%) in the plant beyond what has been considered for commercial purposes, makes it possible for ENRON to claim bonus even beyond 100% plant availability.

The one sided guarantees being extended to ENRON are another source of worry in the contract. While there are clear obligations on MSEB and Maharashtra Government with attendant penalties, there are no corresponding obligations for ENRON. ENRON, GE and Bechtel are all operating through unlimited liability shell companies located in Mauritius. The term unlimited liability only means that in case ENRON defaults, the only recourse the Government and the lenders will have will be from the assets of the power plant. While the foreign lenders’ have been given guarantees by the Government, Indian lenders such as IDBI have no such guarantees. IDBI has also extended guarantees to EXIM Bank of US for the credit that EXIM Bank is extending to ENRON. All the financial and attendant risks are being taken by MSEB, Maharashtra Government and the Indian financial institutions while the ownership vests with ENRON. This despite ENRON bringing in virtually peanuts for the project — a ridiculous Rs. 30 crore.

The recent Budget has exempted the foreign investor owned projects from customs duty. Apart from penalising further the Indian capital goods sector, it is not clear whether this benefit would be passed on to MSEB in terms of reduced power tariff. The documents are rather ambiguous on this count as they show that not all the duty and tax exemptions will be passed on to MSEB. If the PPA terms do not lead to a passing on of this amount through reduced tariffs, the Parliament should not accept this proposal of the budget as it will lead to a further gain of possibly Rs. 200 crore to ENRON. And MSEB will have to pay an average return of more than 40% on the equity portion of this Rs. 200 crore also.

The contours of the ENRON’s Dhabol project are becoming clearer. The Government of Maharashtra and the Union Government are to underwrite all the risks of the project, provide an average return over 40%, guarantee a 90% off-take by shutting down their much cheaper generation and provide various other facilities under threat of penalties. ENRON will bring in Rs. 30 crore, own the plant and have very little liabilities. If they renege, the assets or the lack of it that may be available at that time is all they are accountable for. For this dubious privilege, MSEB will have to shell out about Rs. 1200  crore in the first year of its operation, this cost rising every year by 4% on capital servicing account, inflation, foreign exchange rate variation and increased fuel costs.

The Dhabol project is going to be an albatross round the neck of the people of Maharashtra. There is no away that such a contract can be operated without bankrupting the state. The amount that MSEB will have to pay ENRON in the first year of its operations is about Rs. 1200 crore. If we take the average price that MSEB realises from the customer and deduct the transmission losses, distribution costs and wheeling charges, MSEB will suffer a loss of about of Rs. 600 crore in the first year of operations alone. And as the tariff is back loaded, the losses will continue to mount over time unless the consumer’s tariffs are raised dramatically. There are some indications that MSEB is already working towards this and sharp increase in tariffs are in the offing even after the steep rise that has already been effected last year. Clearly, if the second phase of ENRON also goes through, the people of Maharashtra will pay a very heavy price indeed for their power.

We do not believe that this deal struck behind the back of the people in Maharashtra can be salvaged without a heavy drain on the resources of Maharashtra and the nation. The only solution lies in terminating this deal and taking over the existing assets of Dhabol Power Corporation. Whatever termination charges are involved, they would be much smaller than the losses that MSEB will incur even in the first year of its operations. The second phase should be scrapped immediately. With the take over of Dhabol Power Corporation, the project can be restructured to be a peaking duty station rather than a base load one. If imported diesel is to be the feed stock, it is preferable to use it for peaking duty rather than for base load purposes.

Table 1 Break up of Capital Costs (Rs. crore)