Page 1

1. How did Enron try to eliminate contract risks?

BACKGROUND Overview In May 1992 India invited Enron Corp to explore the possibilities of building a large power plant in Maharashtra and already the following month a memorandum of understanding was signed. In December 1993 Maharashtra State Electricity Board(MSEB) signed a power purchase agreement with Dabhol power corporation(DPC). The power plant was planned to be completed in two stages. In 1995 after the state elections, the new government scrapped the project, alleging corruption and high costs. Later, in the same year the project was renegotiated and MSEBs stake was much higher than it had been in the initial contract. In May 1999 the first phase of the power plant was ready and begun operating. Maharashtra government allies wanted to stop the project because in their opinion the power produced was much too expensive, and shortly thereafter they default on their payments to DPC.In JanuaryJune 2001, there were several exchanges between MSEB and DPC that have generated quite many sparks with threats to terminate the ongoing contract. It was said that the entire negotiations with Enron were an illustration of how not to negotiate, how not to take a weak position in negotiations and how not to leave the initiative to the other side. It was also an example of the perils of signing a contract in haste, a complete lack of transparency in negotiations in making a contract and of not properly analysing the implications of the deal. Financial structure The Dabhol Power Company was established in 1993 solely for the project. The designed project debt-equity ratio was 70:30, Enron being the sponsor of the $2.9 billion project. Lenders and insurers The project debt arrangements were done by four international financiers; ANZ Investment Bank, Credit Suisse First Boston, ABN-AMRO, and Citibank. US government owned Overseas Private Investment Corporation (OPIC) supplied the project $160 Mio loans and worth $180 Mio in risk insurances. The other US Governmental institute, The American Export Import Bank, had issued worth $300 Mio as direct loan. State Bank of India, ICICI, Canara Bank, Industrial Finance Corporation of India, and Industrial Development Bank of India participated the project as domestic lenders. In January 2001 Reuters reported that the combined loan and guarantee exposure of the domestic lenders was roughly Rs 62 billion equalling to about $1.4 billion. The Government of Maharasthra (GoM) state issued an unlimited guarantee for MSEBs payment dues. The GoMs guarantee was the first to be invoked before filing any cases against MSEB. Guarantee also implied that the guarantor was responsible for the legal or other failures of the guarantee or the Power Purchase agreement. The Government of India issued a counter guarantee over all of its current and future assets excluding the military assets. Equity investors Three major equity investors participated the project with the sponsor Enron; MSEB with 15% share, and General Electric (GE) and Bechtel with 10% share each. MSEB was to pick up to 30% of equity in Phase two but it failed to raise the funds and left to 15%. On January 24th in

JUNE. 5, 2006

Page 2

2001 the Cabinet Committee on Economic Affairs permitted Enron to enhance its stake in the project to $1119.9 Mio.

Indirect credit support The guarantees of both GoM and GoI have elements of indirect credit support in that by defaulting their obligations they would repel foreign investors. At stake is the prestige of the federal government in New Delhi and the state government of Maharashtra, which cannot afford to be seen to be violating a contractual agreement. Any incidents would affect Indias image as a suitable destination for foreign investment. In case of problems India will eventually lose many millions of dollars of potential foreign investment if playing domestic politics with the national economy.

Project structure In this study, we analyse the Dabhol power plant project, a project in India that has been a disaster for all of the parties involved, and especially for Enron and the state of India. We would try identify here the key contractual risks and how those were eliminated by Enron. The contractual risks that were identified in MoU between MSEB and DPC and the way those was suppressed and eliminated by Enron is elucidated in the following few paragraphs. Competitive Bidding: Competitive bidding is the essence of any business contract to arrive a most suitable deal. There was clear absence of competitive bidding and lack of transparency while the MoU was signed. The MoU was signed in the year 1992 when India was just economically liberalised and India govt was in welcome mode for any form of FDI to revive back its economic downturn. In this of course of their exercise of attracting FDI in power energy sector GOI landed up in dialogue with Enron for setting up a Power plant in Maharashtra. It all begun when in 1992, pursuing a policy of economic liberalization, the Congress (I) Government opened up the power and energy sector to foreign investment. In May-June 1992, on a three-week trip abroad, a senior GoI delegation met Enron officials who expressed interest in building a power plant in India.On June 15, 1992, Enron and GE representatives came to India and discussed with GoI officials. On June 17, 1992, the Enron team went to Maharashtra, surveyed the sites, met Maharashtra government officials and signed an MoU on June 20, 1992 to build Dabhol Power Project.Thus in less than three days, the MoU was signed between Enron and MSEB for a power project involving US Dollars 3.1 billion using entirely imported fuel (LNG) and with largely imported equipment which no one in the government had any experience or expertise and with a party whose history, business or accomplishments were not known. The Secretary, Energy, Government of Maharashtra (GoM) instructed the MSEB to finalise certain points so that a proper PPA could be signed in sixty days. This cleary points out that GOI was in a real hurry to get FDI and thus there was no chance that GOI could look into proposals of the other prospective companies who could have bid for the same project other than Enron. Thus lack of competitive bidding opened the Pandoras box and helped Enron to take an upper hand on the contractual obligations.

JUNE. 5, 2006

Page 3

Assessment by competent & authorised entity: Any contract should be signed only after evaluluating it by completent and authorised entiny specially in case when a government in undergoing a contract with company that is stting up plan or manufacturing unit which would have direct impact on countrys economy, society and Environment. There was lack of initiative from GOI in opting for assessment of the project by competent authority and over dependence on Erons wisdom: As the entire signing of the MoU was done in a hurry so GOI didnt opt for an competent authority to evaluate the viability of project. It was after the singing of MoU the Maharashtra Government requested the World Bank to review the project although the then Finance Secretary felt that Enron would pre-empt the financing of other projects (and hence was not in favour).Though initially, Enron was convinced that the World Bank has full and scientific knowledge of the working of the Power Sector in India. But the World Bank found many irregularities in the agreement. The government had not provided an overall justification for the project and the MoU was one sided in favour of Enron. It encouraged the government to verify Enrons experience as an electricity generating company before proceeding with the project.The World Bank advised that the Enron Project is unviable as it did not satisfy the test of least cost power, was too large and was not justified by the power demands of Maharashtra.The World Bank thus clearly mentioned on April 30, 1993, that the project was not a least cost choice for base load power generation compared with Indian coal and local gas. Even imported coal is a better option as against imported LNG with the current environmental standards. Hence the World Bank emphatically vetoed the Project. It subsequently refused to finance the project. But GOI and GOM didnt give a serious consideration to the World Banks evaluation. They had more faith on Eronss wisdom than on that of the World Bank which made them accept Enrons disguise that World banks opinon can be changed which in term make GOI to accept their proposal of public relations firm to manage the media. This entire episode clearly signifies that assessment of the viability project was not first of all important to GOI and the exercise that was carried out by engaging World Bank in name of assessing viability was completely a eyewasher to the others as no action was taken GOI based on the recommendation by the World Bank. Even though no environmental impact assessment was carried out by the project authorities but still GOM of Maharashtra boasted about the environmental benefits that this project would bring to the society. Detailed, informative and transparent MoU: A a high value MoU like that was signed between MSEB and DPC should ideally pen down each and every details related to the project. But that was not followed here. The MoU did not provide specific details about the costs of the project that were required under the Indian Law. When CEA asked DPC for the detailed project costs to justify the rate of return, DPC replied that the tariff was guaranteed regardless of the capital costs and hence the request was irrelevant and did not furnish any information beyond the capital cost summary already provided .The MoU did not specify when the 20-year contract and its associated payments would begin, when power would be available or when the contract was signed. There was no provision to audit the project over time to ensure that the price MSEB paid to DPC was commensurate to the actual cost of electricity. The MSEB had agreed to a guaranteed minimum fuel purchase but the fuel supplier was not bound for the minimum fuel supply. The MSEB had not verified whether the price of fuel was economical. The PPA and dealings were also initially kept secret leading to the regrettable lack of transparency

JUNE. 5, 2006

Page 4

in public transactions. All these issues were never debated or discussed and thus never answered or atleast sought by Enron and hence lack of information never a risk for contract not getting signed. While Enron paid US$20 million as education gifts to MSEB officials and other Indian officials to hide these fallacies of the contract. Guaranteed payment and Currency exchange Risk: The tariff was denominated in US dollars insulating Enron from rupee-dollar fluctuations. Payment to DPC by MSEB were guaranteed by the State Government and counter guaranteed Central Government. This was a special consideration to Enron. In addition Enron was offered a guaranteed PLF-linked return on equity plus escalation in fuel, transmission and maintenance. This cost-plus structure is a departure from existing norms.Thus the Enron practically insured themselves of any losses that they may incur in the future. Legal Risk: Enron further secured themselves of any legal implication that might come up in future by agreeing appoint in the MoU that all disputes were to be settled under English Law in England. Knowledge about of the counter party: To gain most out of contract, the first and the foremost requirement is knowledge about the counter party, their history and their past projects. In this case there no details in the hands of MSEB, GOM or GOI about Enron as regards history, business or accomplishment. The World Bank encouraged the government to verify Enrons experience as electricity generating company before proceeding with the project. But the Indian officials were not too keen on doing that. Athough the project cost and power tariffs were high as compared to completed a similar sized plant in Teeside, UK, for less than half the price. The indian official overlooked the same due to some reasons. Enron had a clout with top US politicians and the US Government. It could count on their support who in turn might have influenced the Indian officials that if Enron pulled out of Dabhol project, the foreign direct investment (FDI) in power projects in India may dry up. This aside, the Indo-US relations may also suffer a setback. Thus Enron eliminated the risk of losing the contract due to Indian official being conscious and judicious about the reputation of the company and interested in knowing more about their past projects.

JUNE. 5, 2006