User:Kalnirna

THE ‘REAL’ LEARNING COST OF DABHOL

The Background

The Enron Power project backed by Bechtel, GE and other international companies is under discussion once again as the country faces an acute dearth of power and fuel. It was one project that was far ahead of its times and therefore may have had to face the brunt of the lopsided leadership in India back then. It was easy to drive away foreign investors, however this step opened the eyes of rest of the world that Indian market would not be an easy target, as it was way back in the 1860s when the British opened shop here by way of their East India company. Enron was likened to be an East India company in the offing, by some myopic visionaries in the nation in the year 1991-92. It was therefore impossible to gain trust in the eyes of the masses. Much of facts about the project have been documented well by analysts and off-the panel economic advisors of the nation.

The very fact that 12 years later Indians are reminded of the fact that they had shut their doors on a good opportunity to solve the power crunch and enable quality living for the masses is evidence enough of the success that Enron could have met in the country. May be we have learnt the lesson, but far too late!

Therefore an analysis on how much the country has had to pay in learning such a costly lesson is really important. Today, with Indians opening their doors wider to foreign investment in different fields of business, nevertheless with their microscopic scrutiny, the situation has changed. We find that foreign investors too are analyzing closely, whether India is truly a ?ripe? market. They have laid down theories of Indian market behavior and segregated the country from rest of the world in terms of its unpredictability and stringent norms, laid out with hardly a vision.

Developer I: The cost that went into learning from Enron, was not merely in the form of the economic loss of the Government and the masses, but also in terms of standard of living, production, and on the whole the ?quality of life? that was shut out for Indians in the real sense of the word. Therefore the project even today remains priceless.

Technocrat There is one more angle to the cost. Maharashtra, while increasing installed capacities of MSEB's power stations had experienced that the industrial development has always followed the capacity addition programme in the state. The policy makers realized that the subsidized electric supply to then agricultural and domestic consumers cannot be totally eliminated and can be continued only if there is increase in industrial consumption which would be possible only if large number of industries are confident of Maharashtra's power capacity addition programme. The failure of capacity addition programme, industrial recession in the last decade has deteriorated the ability of SEB to provide subsidized power supply to agricultural and domestic consumers.

Merchant Banker: The general equation today is that the masses are unaware of the fact that the Government of Maharashtra had a solid team to back them when they were contracting with Enron. There was another factor in play in 1991-92: the ?who-needs-who? equation back then was different from what it is today. It was in fact so one sided that enron could get away with anything. That was another impression in the minds of the masses.

Developer I: Enron-GE-Bechtel project was in fact the first large scale foreign investment that the country would have had in many years. It would have given rest of the world a confidence in the Indian market, which seems to be severely fluctuating even today, despite the nearly over-turned foreign investment scenario. Enron-GE-Bechtel would have been the first major foreign investor in the country, and probably the largest in the history of the country and therefore it was like the equity of the promoters and needs to valued much higher.

Let us analyse the cost, for instance the gas project - at today?s fuel prices probably at a gross level at least 55 to 60 percent of the cost of fuel is the cost of power. This is under nobody?s control. It was said that Enron was putting its own gas into the pipeline. In fact Enron had no gas to be put into the pipeline. The gas contracts were to be entered into with the Government of Oman or Abu Dhabi directly with the Government of Maharashtra, Enron never had anything to do with them.

Back to calculating the costs ? at today?s fuel prices the gas ? fire equation could be 50 percent of the power cost is the cost of the fuel. This remains unchanged. 30 to 40 percent of the remaining 50 is debt, which comes mainly from the country?s major debt organizers which is IDBI backed by several other banks. These are bodies who charge usurious interest rates as high as 19-21 %. They never wanted to support the investors they were not on the side of the Government either, they had the support of the Government of Maharashtra, instead of helping the investor they went ahead to fill their coffers. They had no reasons to charge those exorbitant rates. What they said was that, the rates would be low for GE and for Enron. But the combination of GE-Enron is a different entity and therefore it will have a higher interest rate. And the Government supported their view. The remaining 30 percent was equity. Let us assume they over charged on equity, but how much can you overcharge in the presence of a range of commissions, the eye of the commerce ministry, the law ministry, the Munde Committee, and so on. Let us be generous and say that they overcharged by 10 percent. A 10 percent overcharge on 15 percent equity comes to 1.5 percent at the end of the day. Let?s take a look at the round numbers that were offered ? which were Rs 2 to Rs 2.50, which comes to 1.5 paise per rupee, which is so negligible. Is that the overcharge that brought down the project? Clearly, it is not the overcharge.

Now look at the other side, the most important cost of fuel ? 20 percent of import duty on import of fuel. The other costs include customs? duty on cost of fuel, service charge on services availed. Our calculations show that almost Rs 800 crore were paid to the Government of Maharashtra by way of various taxes, duties, customs. And this amount would have been an everlasting flow into the coffers of Government of Maharashtra and the Government of India, on the basis of cost of imported fuel and its imported fuel agreements. The absurdity of the situation was that the Government is making more money than the equity promoters, because of the usurious rates.

Merchant Banker: Talking of overcharge, not many people understand what overcharge actually means and entails. How you look at appropriate charge, overcharge or undercharge on equity capital which is ?risk capital? by definition is basically that one has to see the alternatives, that is to say, with the same capital what are the other options available. Especially in 1991-92 our risk factor was much higher as India was like ?junk bonds? in those days. There was hardly any gap in perception and reality and if there was a gap, it was a reverse gap. The reality was more risky as compared to the perception. One needs to see how many projects have come, during this, after this and before this project. How many power projects have been completed with international participation ? hardly any. The few that started with international partners also teamed up against the foreigner along with their local partner.

People generally correlate what happened to Enron with greed, stupidity and scams that followed later- that is post Dabhol. One needs to ascertain carefully that whatever happened to Enron is independent of the events that occurred after it. One cannot jumble up cause and effect relationship. Enron cannot have been the ?effect? events that followed its exit. It is indeed absurd to think so. Public fury was raised against Enron, by the media backed by selfish and short sighted policy makers and a nation building endeavour to uplift the lives of the common Indian man managed to fall prey to public fury.

Developer I: Enron was not part of the opposition agenda, which blindly condemned the ruling party?s steps to better the lives of the common man. They retorted in words like ?we will throw you into the Arabian Sea, ?Return of the East India Company,? these are inflammatory words that have no base of reality but they serve a political agenda, as a result they shocked themselves with the political outrage that followed. Enron was actually made a ?scapegoat? of the unstable political situation, in more calmer waters, the project would have easily slipped through, but it was not so destined in 1991-92 when the Indian political scene was undergoing a major upheaval. The Government also lost the arbitration money. What good did it serve anyone?

Technocrat It is rather surprising to note that there is no substantial change in the power as well as energy fuel situation which was existing in 1992 and today after a lapse of nearly 12 years. In the early nineties, the capacities at MSEB’s thermal stations were not being utilized fully due to inadequate and deteriorating quality of domestic coal The capacity of the only one Uran gas power plant was not being utilized fully due to inadequate gas supply. Central Electricity Authority – an apex statutory authority of Govt of India had indicated that there is no possibility of supply of domestic gas for a new power plant. Due to restrictions on westward water diversion for Koyna hydro power station, there was no likelihood of substantial addition to the hydro generation. Maharashtra was therefore looking for power generation based on a new and cleaner source of fuel and addition to the states’ energy resources especially to meet the demands of a large number of industries who had requested for power assurance after announcement of the Economic liberalization policy in 1991,

Merchant Banker: The financial community believed that here was a brilliant structure created by Enron where all foreseeable risks were at rest and they got insulated in the structure and despite that with all the currency raise, interest raise, fuel pricing raises etc and whole range of 15 other risks were identified and insulated. Even the informed financial gurus expected that there was at least 15 to 20 percent per dollar returns. This rate of return is such a myth the fact is however that Enron-GE-Bechtel would have been lucky to get a 10-12 percent return on investment. All those who believed in such an absurdity fail to remember that you need to wait at least 10-12 years in a power project, before you get your first paisa returned. Then between the years 10 and 15 that the investor starts getting a decent return and it is only between the years 20 and 25 provided the Government contract is still valid that he can look for a high rate of return. But when this last 25 years return is averaged over the first 25 years of return only then can the investor can look for some good returns. All of this is however subject to the fact that: if the project lasts for 20 years, if those high rates of return at the back end are allowed to go through, and many more such ifs? the fact remains is that no investment banker, worth his salt would today recommend a private player to invest in an infrastructure project like Dabhol in India, because they know deep down in their heart that this was a tragedy of their country and not such a great deal for the investor.

Developer I: The question that now arises is that then why did the investor do it? Neither of the investing foreign companies are na?, yet they went for it. Everybody who comes in the country for the first time has to pay a price if you are willing to pay that price and you are willing to defy your returns for the next 10 or 15 years then all the doors will be open and you will have many more opportunities and that is the belief that the foreigners had and these are the very beliefs that we have slammed the doors on. Therefore today foreign investors are wary of investing in infrastructure projects. This is the dilemma that the Government of India has to wrestle with. How do you convince the foreign investor? Another way of putting it is that ?if you fool me once, shame on you. If you fool me twice, shame on me.? Now what the Government of India is trying to do is that it is trying to fool the foreign investors for the second time and it is not going to be easy.

Merchant Banker: In all markets, and particularly in emerging markets, in case of all projects and especially in capital intensive projects, which have a long gestation period fundamentally there are lots and lots of unforeseen risks which are basically discounted when you are coming out with the price. The track record of India when it comes to these type of projects is that it makes a great difference to see who is the promoter? That is to say can he manage the local environment?

This means that our local environment is not an ?open platform? or an easy one to adjust to even to most efficient players. Fundamentally they need to be conversant with the Indian mode of doing business and in the Indian environment. And if you don?t bring the most efficient player that means that eventually the cost is going to be high. And who is going to have to bear the cost? At the end of the day the Indian consumer will have to pay the cost. This is what decision makers in India do not possibly understand ? this is the biggest tax of ?misjudging? the foreign investor that the common Indian man has to pay and that too in the present scenario for poor returns.

Indians often concentrate on the Budget, saying that this is Mr Chidambaram?s Budget and so on? but the real ?tax? is on the quality of the project and the price that we pay plus the inflation. Many people even today are under the impression that now that Enron and everything is over, all is hunky-dory, and now that Government institutions have taken over the project, everything should be alright.

Technocrat: The technology, advance class gas turbines, method of construction, adopted in the project are unique and prove the test of time. Even today, after the lapse of a period of almost ten years, it is interesting to observe that the unique positive features of the Dabhol Project noted in the meeting convened by the then Finance Secretary GoI’s prove to be worthwhile (a) relatively early availability of power (b) high plant load factor (c) favourable psychological impact for foreign investment in the power sector (d) an alternative fuel source for Maharashtra (e) a fixed tariff with risk being borne by the company.

Developer I: The new syndicate that has taken over the project must issue a public document, making public the actual cost of this project up till now. Who received the money and who didn?t receive it is a separate discussion. We must calculate the entire cost of the project to the common man, whether it is Enron or some one else. Including the missed opportunity and including politically speaking the opportunity lost in not getting quality electricity. Kirit Parekh had done a research and his paper was published in the Editorial column of The Times Of India in 1995, it said ?the shadow cost of power,? which means the cost of not receiving one unit of power was in the neighborhood of Rs 13 to Rs 15. This is at a time when we were arguing whether the price of power per unit should be Rs 2.50 or Rs 2.80 look at the tremendous harm incurring to the State at that point. Today, 2003-05 a similar number has been put out by Mr Pachouri. He says the ?shadow cost of power? today is roughly Rs 28 to Rs 30. It is reasonable, because in the past 12 years and steadily rising inflation rate, which has indeed doubled. So today when the cost of a missing unit of power is almost Rs 30, isn?t it absurd to say that you could not afford to pay Rs 2.50 or Rs 2.80? Every industrialist today is generating capital power at Rs 7 per unit and when this power could have been made available at just around Rs 3 or Rs 4 just look at the loss that has occurred on such a huge scale. So let?s ask ourselves why we can?t pay that? Today Maharashtra?s data shows that 5 to 10 percent of consumers support the subsidized lives of the rest 95 to 90 percent of consumers. This was not true in 1992-93 when Enron had come into the country. In those days 40 percent of the consumers were paying and on an average 60 percent were subsidized. The present situation of 95 percent subsidized living and 5 percent of them supporting them is a totally unviable situation and this is a result of ?bad politics.? Calculate the tremendous loss that the missing unit of power has cost the entire nation, which could have doubled its productivity with its help. Today, we have to analyze the cost of power ? the upfront cost of power and the back-door cost as well, with respect to the tremendous subsidies that the foreign investors today are getting.

In 1993, journalist Sucheta Dalal took the issue to Court and by Court order the Enron issue was made public. Today 12-13 years later we have a freedom of information Act, we have a Government at the centre acting with much transparency, yet no reporter has asked for this data to be made public!

The mind set of Indian leadership seems to be ?we can do what we want.? But a foreigner has to make everything public. It is time that as a mature nation we had a way with a level played thing. If information is to be made public tell the public what you wanted to tell them in 1993.

The cost for Enron to re-start the project will be difficult to arrive at ? the cost of the existing plant is Rs 2.8 billion dollars, the cost of keeping the plant shut down for five years is roughly 2 billion dollars of debt multiplied by 15 to 18 percent of interest. The cost to the State of Maharashtra is 2400 mega watts (x) 360 days worth 24 hours a day plus units that were not produced plus Mr Pachouri?s Rs 30 per unit of power of all this put together is the cost of power to the State of Maharashtra. This figure could be anywhere between 300 to 500 billion rupees (that comes to around 70 million dollars to 116 million dollars). These are just the basic elements that go into calculating the present costs of power. The figures are so alarmingly high that most people find it comfortable to shove the mind-boggling figures aside and pretend as if they do not exist. The fact remains that they do. In fact a Trial Balance has to be drawn and made public and then can the viability of the power project be tested and ascertained fully.

Learning cost of Dabhol

Costs calculated over a span of 12 years (1991-92 to 2005) that the project was shut down (Base= 1998 prices)

2400000 x 365 x 24 = 21,02,40,00,000 (21024 x 106) x Rs 25 = 525600000000 (Avg cost of power per unit) = Rs 5256 x 108 = 5.26 x 109 = Rs 5.26 billion

5.26 bn x 12 = Rs 63.12 bn (109) = Rs 6.31 x 1012 = 6,312,000,000,000= 6312 x 109 = 63.12 lakh crore rupees

Therefore the total learning cost of Dabhol comes to: Rs 63.12 lakh crore

Merchant Banker: The costs may surely have been tallied by the IDBI or the Central Finance Ministry, and they may have dawned upon these high figures, which is roughly around Rs 684 lakh crore plus cost of arbitration.

Developer I: The Enron technology is still in good shape and has not gone waste. In GE they believe that every technology is updated and is essentially evolutionary. Today, you have 30-40 years old machinery all around the world working in good stead. The Enron engines have barely run, Phase I engines ran for 8-10 months, Phase II (Part B) was barely worked for three months. Part C of Phase II was ready to start tests, never even ran for a minute. It is as good as brand new. The question really is that despite the brand new engines what has really deteriorated sitting idle for five monsoons in the past four years? And this answer we will know in the coming six months.

Today installation of this plant will cost a lot higher. The cost would be more than double for the Government of India, irrespective of the fact, who is the player now. Today everything is open ended. And therefore it would be difficult to ascertain the actual cost of re-starting the Enron Project because once a contract is running for ten years. The cost is relatively lower, than that when it is shut down. Today Rs 30 per unit of power cannot cover the cost of what was lost when Enron project was allowed to go down the drain.

Unless we have a credible independent agency, to regulate the Government?s interests and that of the private investor, a ?fair play? will be difficult to arrive at. Most of the regulators that we have today are either retired bureaucrats who owe their livelihood to the ruling politicians, how can they ever oppose the politicians? Then the Electricity Act says that the State can issue orders to override the regulator, as and when it feels necessary, which again fails him from working as a fair regulator. A good regulator should be a genuine consumer advocate and a knowledge based individual with a vast world view like a retired economist, a retired professor at IIM, etc. or there could be institutional regulators like the Reserve Bank of India or SEBI. A good and honest regulator can always ensure that the learning curve of this project is flat as soon as possible.

If you want to look at bringing foreign investment for the power sector, let?s not get lost in the euphoria of Walmart and retail and Pantaloons, etc. those people come in here make their money in three to six months but power sector is a different ball game altogether. Here most people will not make returns for at least 10-12 years. They need to be freed from the Indian bureaucracy which survives on not making decisions. A different kind of investor who is willing to put in ten billion dollars and who is not asking for a single paisa returns for at least 10 years.

Merchant banker: The only foreseeable solution in the present situation is that we will go along like this pull on for the coming 50 years as we have been doing the last 50 years shirking the real problem because that?s how the Indian bureaucracy works. The cost will be borne by one who owns the utility share in the company, the investor and all those who are associated with the project, but all of these will have a return however deferred or little. The real cost however, will have to be borne by the ultimate consumer who will have no say in the project. He will think that things are better than they were yesterday. But not the fact that the best that could have come to him has not been done. It is a mutual benefit society, where degrees of benefits exchanged vary, sometimes really greatly. It is this difference is what determines the cost and quality of life.

Forces are working, the entry barriers are coming down, the tariff barriers are coming down and any smart Indian entrepreneur will adjust to such a situation and try and make sure that their benefits are optimum. For instance take the telecom industry or the insurance industry, or any of these structurally important industries, fundamentally outsiders were not allowed to contribute more than 25 percent of capital. All of these are capital intensive industries, for instance in the insurance industry, by definition the business plan says that for the first 10 to 12 years you are making losses. After that the returns slowly start coming in. at the same time the Indian entrepreneurs with the firm backing of the Indian politicians have realized that by pooling together decent capital resources they too can invest in such capital intensive project and prevent a foreigner from acquiring 75 percent share in what is due to them. For this they have worked hard for improving their efficiency and back-end technology and kept par with the foreign competitors, which is a positive sign. There is improvement in the parameters of production, they are trying for global benchmarking. All of this is true and seems to depict a rosy picture. But the hard fact is the actual cost that has gone in for arriving at this level of understanding and working. That is the true learning cost and in terms of Dabhol is exceptionally high ? nearly Rs 63.12 lakh crore.