Themes > Current Issues
11.01.2001
C.P.
Chandrasekhar
That
the Enron-led Dabhol Power Project (DPP) was an enormous blunder is
now obvious to all. Not only has the Maharashtra State Electricity
Board (MSEB) been driven to near-bankruptcy, but a shadow hangs over
the completion of the $1.87 billion Phase II of the project. According
to reports, lenders meeting at New York may have threatened to stop
disbursement of $400 million in debt needed to complete the dominantly
credit-financed second phase. Their reticence stems from the crisis
facing the MSEB, leading to non-payment of dues totaling Rs. 262 crore
to the Dabhol Power Company (DPC).
MSEB's inability to pay stems primarily from the fact that the revenue it earns from sale of Enron power is far less than what it pays out to DPC. According to one estimate, DPC accounts for just 6 per cent of power sold by the MSEB, for which the latter pays as much as 33 per cent of its revenues. According to the terms specified in the power purchase agreement signed with Enron, the price the MSEB pays amounts to the value of power that can be generated by DPC at 90 per cent capacity utilization, with the price of each unit of such power being computed on a cost-plus basis, where the plus is a predetermined rate of return in dollar terms. The price (which includes a capacity charge and a variable cost companent) equals at current costs Rs. 4.80 per unit compared with the Rs.2.03 figure worked out in 1993, with 1995 as base year. This increase is partly due to the fact that the price of naphtha, which is the fuel used by the project to generate electricity, currently stands at around $300 a tonne as compared with the $180 price which prevailed at the time when the PPA was signed. Further, the rupee has also depreciated during the interim from Rs. 32 to the dollar to close to Rs.47 to the dollar. Since these cost increases can, as per the PPA, be passed through to the price, the burden falls completely on the MSEB.
But that is not all. The MSEB has not been lifting the full complement of power that can be generated by the DPC at 90 per cent capacity utilization. That is because there are cheaper sources from which it can acquire the power to service the demands placed on it currently. In fact, the Maharashtra Electricity Regulatory Commission has issued a directive requiring the MSEB to source power from the cheapest suppliers first and then move on to others producers in order of cost. In the event, estimates of the amount of power being lifted by the MSEB from Dahbol vary between 35 and 60 per cent of the power generated by the DPC. This has meant that the actual price payable per unit of power sourced is much higher than the Rs. 4.80 mentioned above. For example, the price per unit paid in October last year has been estimated at Rs. 7.80. In that month, MSEB's dues to the DPC stood at Rs. 300 crore, while its revenues amounted to around Rs. 900 crore. In December, the state's Electricty Minister informed the Legislative Council that the MSEB had purchased power from the MSEB at Rs. 6.91 per unit between May 1999 and September 2000. Not surprisingly the Board has found itself in a position where it is unable to meet its financial commitment to DPC, precipitating a crisis situation.
The Dabhol crisis, which makes the central government accountable for MSEB's dues to DPC, has forced the government to reconsider its plan to provide sovereign guarantees for three other power projects – the 3960 MW Reliance-SEAP promoted Hirma project, the 1800 MW LNG-fired Ennore project and the 2000 MW Pipavav project. But it is not just the system of providing guarantees that has been challenged. The encouragement given by the PPA system to the use of fuels other than the much cheaper coal is also proving unsustainable. The National Thermal Power Corporation (NTPC) has shelved its plan to set up a 2000 MW liquefied natural gas (LNG) power station in Mangalore, since the tariff for power generated by the project is likely to be in excess of Rs. 4 per unit, making it unaffordable, in the view of NTPC, for the State-owned Karnataka Power Transmission Corporation Ltd. Interestingly, Enron has argued that the cost of power supplied by it would fall substantially in the wake of the switch over to LNG as fuel, when a terminal for the purpose and a regassification plant are commissioned at the end of 2002. In short, the government's policy of pushing through a dominantly private-led expansion of power generation based on fuels other than coal with the aid of a range of unprecedented concessions to private operators has collapsed.
This failure is however not just a reflection of an erroneous power policy, but an indictment of economic reform itself. We must recall that the terms on which the Enron-project was launched involved the provision of a sovereign guarantee that protected the group of investors led by Enron against three adverse consequences: first, the likelihood that demand for power produced by it would fall short of levels warranted by the size of the project; second, the likelihood that costs could rise, as they have in the wake of recent increases in oil prices; and third, the likelihood of a depreciation of the rupee against the dollar.
Opposition to the project stemmed from the sheer absurdity of this arrangement. A sovereign guarantee of this kind, it was argued, went against the very logic of private initiative, which presumes that private investors would make their investments based on an assessment of likely returns and the risks associated with realizing them. This would ensure that investments are directed into activities, projects and technologies where risk-adjusted returns appeared to be the maximum. They would also ensure that the risks involved in choosing between alternative scales, technologies and fuels would be taken into account when investment decisions are made. Given that the ‘Enron terms', which foreclosed such influences on the investment decision, were being given the okay by a Congress-government that had launched on a reform programme in which investment decisions were to be influenced not by state support and subsidy but by market forces, the whole exercise seemed to be suspect. Allegations that non-economic considerations were entering into the making of the decision and that Enron was using the opportunity to inflate capital costs and earn an even higher return were other arguments advanced against the project.
Such allegations were used by the BJP-Shiv Sena combine to oust the Congress through an election fought, inter alia, on the promise that the Enron deal would be scrapped. When voted to power, however, the committee of ‘experts' set up the BJP-Shiv Sena government, and subsequently the government itself, not only ensured that the project would go through, but added a second phase which would take the size of the project from 740 MW to 2184 MW. The terms for purchase of power from both phases of the project were worked out in advance.
It is now clear that other considerations aside, the BJP's desire to go along with Enron, despite its early opposition, was related to its effort to present itself as reform-friendly. It was clear then and has remained so since, that projects like Enron were a part of the reform agenda, and would have been pushed even if non-economic considerations did not play a role. This emerges from the arguments advanced in favour of the project and the terms being offered to it by different governments and by economists outside government supporting the reform agenda. First, since a limit on capital expenditures by the State in order to restrict the fiscal deficit was seen as imperative, a much larger role for the private sector in financing investment in the country was seen as inevitable. Second, it was argued, since utilities like services were non-tradables, import was ruled out even with liberalization, making investments within the country necessary if growth was not to be stalled by infrastructural bottlenecks. Third, it was presumed that the domestic private sector was not in a position to mobilize on its own adequate sums of capital for infrastructural investments, rendering foreign investments in these areas crucial. The officially-sponsored India Infrastructure Report made a case for attracting large sums of foreign investment into the area, and argued that financial liberalization and financial incentives were crucial to realize this goal.
Given these presumptions, the profit-guarantee and terms being offered to Enron were seen as a signal of India's commitment to making the country an attractive and reliable host to foreign investment, and opposition to the Enron project was even presented as anti-national by some advocates of reform. These arguments were, of course, those advanced publicly. But there was also a larger reform agenda hidden behind the case being advanced in favour of the Enron project.
It was widely accepted then and is accepted even now that much needs to be done to improve the functioning of the State Electricity Boards. Inadequate investments, poor maintenance and huge transmission losses plague most SEBs. For the reformists, however, what was most galling was the fact that for these and other reasons, such as the need to price electricity keeping in mind other developmental and distributional objectives, the SEBs were burdened with financial losses. Their prime problem was to ensure that these losses were wiped out, independent of the means by which that occurred. Combined with their obsession with attracting foreign investment at any cost, this resulted in a specific power reform programme. Privatisation, consequent to the break-up of the electricity boards into generation, distribution and transmission segments, as well as freedom to set prices were seen as the essential ingredients of such a programme. An unstated presumption was that if the SEBs were required to buy power from private providers at ‘economic' prices and bound by legal guarantees to meet the financial commitments involved, they would be forced to raise tariffs to cover ‘costs'. Thus, projects commissioned on terms like those offered to Enron were seen as a means of forcing the state governments to dismember the SEBs and to change their pricing practices in keeping with the reform agenda.
What was missed in this perception was the fact that in a democratic polity, policies to restructure the power sector can be pushed through only if all stakeholders find them reasonable. In state after state, the efforts to push through World Bank-inspired reforms in the power sector have proved difficult if not impossible to implement. Agricultural consumers are unwilling to accept higher charges when huge subsidies and tax concessions are handed over to industry. Domestic consumers see power as a facility that the state must provide at reasonable prices to all. And many among the rich who believe even the present rates are unreasonable find ingenious methods of bypassng the metering system. This makes nonsense of the the effort to use private enterprise in general and foreign investment in particular as the excuse to increase tariffs to levels that could cover up the problems in the present system.
Using the Enron-type strategy in the name of reform only compounds the problem. It is obvious to all that there are no markets working here nor is their any reduction in the fiscal burden. Enron's profitability is being protected by a government guarantee. And implementing that guarantee for a high cost project like DPC is only increasing the fiscal burden on the State.
The Enron episode has in fact proved that the reform programme undertaken on the grounds that subsidies need to be eliminated and the fiscal burden on the government reduced is a complete farce. Vivek Monteiro, the Secretary of the Maharashtra State Committee of the Centre of Indian Trade Unions has been quick to point out that in the name of eliminating subsidies the government has ended up providing a huge subsidy to Enron. The PPA requires the government to find the resources to pay DPC. Even assuming demand is equal to that supplied by DPC at 90 per cent capacity utilization, and the price per unit is at Rs.3.25 per unit, distribution and transmission losses would alone take the price to Rs. 4.25 a unit. Taking account of the fact that the average price recovered per unit sold by the MSEB works out to only Rs. 2, the government has to provide the MSEB with and additional Rs.2.25 per unit to meet its dues to the DPC. Since, just putting in place a project commissioned on the Enron terms has proved inadequate to either reduces distribution and transmission losses or raise the tariff, the subsidy remains in place, though it accrues not to the MSEB but to Enron whose profits are protected. In Monteiro's view if Dabhol Phase II is commissioned the subsidy amount needed to protect DPC's dollar profits would work out to more than the total agricultural subsidy.
In sum, an initiative that was launched as part of the ideology of reform has ended by defeating the grounds on which the reform process is commonly advocated. The question that remains is why the subsidy that is finally being paid is being offered to Enron. It is known that among the major creditors who have lent Enron huge sums on the strength of the government's guarantee are a host of Indian banks and financial institutions. If a similar credible guarantee had been provided to an Indian firm, it could have accessed the same sources to earn similar profits, which may not have been repatriated abroad in equal measure. What benefit the policy has offered in terms of attracting foreign investors who could deliver more than India corporates to the country is by no means clear. And the fact that the policy has only worsened the crisis in the power sector and elsewhere in the economy has even begun to affect the credibility of the sovereign guarantee that the government has offered. As noted earlier, creditors have sat up and started questioning the feasibility of Phase II.
But the crisis cannot be easily resolved. What is damaging is that the manipulative advocates of reform have carried the process to an extent where redressing the obvious blunder could prove costly. Under the prevailing terms and conditions, if the government opts to pull back its commitment to backing Dabhol Phase II and purchasing all the power it generates, it would have to pay compensation to the tune of Rs. 35,000 crore. Reforms are irreversible, even if disastrous, only because those who devise them ensure that they can be reversed only at prohibitive costs. If the ideal capitalism that the advocates of reform celebrate actually ruled, all those who backed the project, including the "disinterested" economists who defended it, would have been penalized. Unfortunately, it does not.
MSEB's inability to pay stems primarily from the fact that the revenue it earns from sale of Enron power is far less than what it pays out to DPC. According to one estimate, DPC accounts for just 6 per cent of power sold by the MSEB, for which the latter pays as much as 33 per cent of its revenues. According to the terms specified in the power purchase agreement signed with Enron, the price the MSEB pays amounts to the value of power that can be generated by DPC at 90 per cent capacity utilization, with the price of each unit of such power being computed on a cost-plus basis, where the plus is a predetermined rate of return in dollar terms. The price (which includes a capacity charge and a variable cost companent) equals at current costs Rs. 4.80 per unit compared with the Rs.2.03 figure worked out in 1993, with 1995 as base year. This increase is partly due to the fact that the price of naphtha, which is the fuel used by the project to generate electricity, currently stands at around $300 a tonne as compared with the $180 price which prevailed at the time when the PPA was signed. Further, the rupee has also depreciated during the interim from Rs. 32 to the dollar to close to Rs.47 to the dollar. Since these cost increases can, as per the PPA, be passed through to the price, the burden falls completely on the MSEB.
But that is not all. The MSEB has not been lifting the full complement of power that can be generated by the DPC at 90 per cent capacity utilization. That is because there are cheaper sources from which it can acquire the power to service the demands placed on it currently. In fact, the Maharashtra Electricity Regulatory Commission has issued a directive requiring the MSEB to source power from the cheapest suppliers first and then move on to others producers in order of cost. In the event, estimates of the amount of power being lifted by the MSEB from Dahbol vary between 35 and 60 per cent of the power generated by the DPC. This has meant that the actual price payable per unit of power sourced is much higher than the Rs. 4.80 mentioned above. For example, the price per unit paid in October last year has been estimated at Rs. 7.80. In that month, MSEB's dues to the DPC stood at Rs. 300 crore, while its revenues amounted to around Rs. 900 crore. In December, the state's Electricty Minister informed the Legislative Council that the MSEB had purchased power from the MSEB at Rs. 6.91 per unit between May 1999 and September 2000. Not surprisingly the Board has found itself in a position where it is unable to meet its financial commitment to DPC, precipitating a crisis situation.
The Dabhol crisis, which makes the central government accountable for MSEB's dues to DPC, has forced the government to reconsider its plan to provide sovereign guarantees for three other power projects – the 3960 MW Reliance-SEAP promoted Hirma project, the 1800 MW LNG-fired Ennore project and the 2000 MW Pipavav project. But it is not just the system of providing guarantees that has been challenged. The encouragement given by the PPA system to the use of fuels other than the much cheaper coal is also proving unsustainable. The National Thermal Power Corporation (NTPC) has shelved its plan to set up a 2000 MW liquefied natural gas (LNG) power station in Mangalore, since the tariff for power generated by the project is likely to be in excess of Rs. 4 per unit, making it unaffordable, in the view of NTPC, for the State-owned Karnataka Power Transmission Corporation Ltd. Interestingly, Enron has argued that the cost of power supplied by it would fall substantially in the wake of the switch over to LNG as fuel, when a terminal for the purpose and a regassification plant are commissioned at the end of 2002. In short, the government's policy of pushing through a dominantly private-led expansion of power generation based on fuels other than coal with the aid of a range of unprecedented concessions to private operators has collapsed.
This failure is however not just a reflection of an erroneous power policy, but an indictment of economic reform itself. We must recall that the terms on which the Enron-project was launched involved the provision of a sovereign guarantee that protected the group of investors led by Enron against three adverse consequences: first, the likelihood that demand for power produced by it would fall short of levels warranted by the size of the project; second, the likelihood that costs could rise, as they have in the wake of recent increases in oil prices; and third, the likelihood of a depreciation of the rupee against the dollar.
Opposition to the project stemmed from the sheer absurdity of this arrangement. A sovereign guarantee of this kind, it was argued, went against the very logic of private initiative, which presumes that private investors would make their investments based on an assessment of likely returns and the risks associated with realizing them. This would ensure that investments are directed into activities, projects and technologies where risk-adjusted returns appeared to be the maximum. They would also ensure that the risks involved in choosing between alternative scales, technologies and fuels would be taken into account when investment decisions are made. Given that the ‘Enron terms', which foreclosed such influences on the investment decision, were being given the okay by a Congress-government that had launched on a reform programme in which investment decisions were to be influenced not by state support and subsidy but by market forces, the whole exercise seemed to be suspect. Allegations that non-economic considerations were entering into the making of the decision and that Enron was using the opportunity to inflate capital costs and earn an even higher return were other arguments advanced against the project.
Such allegations were used by the BJP-Shiv Sena combine to oust the Congress through an election fought, inter alia, on the promise that the Enron deal would be scrapped. When voted to power, however, the committee of ‘experts' set up the BJP-Shiv Sena government, and subsequently the government itself, not only ensured that the project would go through, but added a second phase which would take the size of the project from 740 MW to 2184 MW. The terms for purchase of power from both phases of the project were worked out in advance.
It is now clear that other considerations aside, the BJP's desire to go along with Enron, despite its early opposition, was related to its effort to present itself as reform-friendly. It was clear then and has remained so since, that projects like Enron were a part of the reform agenda, and would have been pushed even if non-economic considerations did not play a role. This emerges from the arguments advanced in favour of the project and the terms being offered to it by different governments and by economists outside government supporting the reform agenda. First, since a limit on capital expenditures by the State in order to restrict the fiscal deficit was seen as imperative, a much larger role for the private sector in financing investment in the country was seen as inevitable. Second, it was argued, since utilities like services were non-tradables, import was ruled out even with liberalization, making investments within the country necessary if growth was not to be stalled by infrastructural bottlenecks. Third, it was presumed that the domestic private sector was not in a position to mobilize on its own adequate sums of capital for infrastructural investments, rendering foreign investments in these areas crucial. The officially-sponsored India Infrastructure Report made a case for attracting large sums of foreign investment into the area, and argued that financial liberalization and financial incentives were crucial to realize this goal.
Given these presumptions, the profit-guarantee and terms being offered to Enron were seen as a signal of India's commitment to making the country an attractive and reliable host to foreign investment, and opposition to the Enron project was even presented as anti-national by some advocates of reform. These arguments were, of course, those advanced publicly. But there was also a larger reform agenda hidden behind the case being advanced in favour of the Enron project.
It was widely accepted then and is accepted even now that much needs to be done to improve the functioning of the State Electricity Boards. Inadequate investments, poor maintenance and huge transmission losses plague most SEBs. For the reformists, however, what was most galling was the fact that for these and other reasons, such as the need to price electricity keeping in mind other developmental and distributional objectives, the SEBs were burdened with financial losses. Their prime problem was to ensure that these losses were wiped out, independent of the means by which that occurred. Combined with their obsession with attracting foreign investment at any cost, this resulted in a specific power reform programme. Privatisation, consequent to the break-up of the electricity boards into generation, distribution and transmission segments, as well as freedom to set prices were seen as the essential ingredients of such a programme. An unstated presumption was that if the SEBs were required to buy power from private providers at ‘economic' prices and bound by legal guarantees to meet the financial commitments involved, they would be forced to raise tariffs to cover ‘costs'. Thus, projects commissioned on terms like those offered to Enron were seen as a means of forcing the state governments to dismember the SEBs and to change their pricing practices in keeping with the reform agenda.
What was missed in this perception was the fact that in a democratic polity, policies to restructure the power sector can be pushed through only if all stakeholders find them reasonable. In state after state, the efforts to push through World Bank-inspired reforms in the power sector have proved difficult if not impossible to implement. Agricultural consumers are unwilling to accept higher charges when huge subsidies and tax concessions are handed over to industry. Domestic consumers see power as a facility that the state must provide at reasonable prices to all. And many among the rich who believe even the present rates are unreasonable find ingenious methods of bypassng the metering system. This makes nonsense of the the effort to use private enterprise in general and foreign investment in particular as the excuse to increase tariffs to levels that could cover up the problems in the present system.
Using the Enron-type strategy in the name of reform only compounds the problem. It is obvious to all that there are no markets working here nor is their any reduction in the fiscal burden. Enron's profitability is being protected by a government guarantee. And implementing that guarantee for a high cost project like DPC is only increasing the fiscal burden on the State.
The Enron episode has in fact proved that the reform programme undertaken on the grounds that subsidies need to be eliminated and the fiscal burden on the government reduced is a complete farce. Vivek Monteiro, the Secretary of the Maharashtra State Committee of the Centre of Indian Trade Unions has been quick to point out that in the name of eliminating subsidies the government has ended up providing a huge subsidy to Enron. The PPA requires the government to find the resources to pay DPC. Even assuming demand is equal to that supplied by DPC at 90 per cent capacity utilization, and the price per unit is at Rs.3.25 per unit, distribution and transmission losses would alone take the price to Rs. 4.25 a unit. Taking account of the fact that the average price recovered per unit sold by the MSEB works out to only Rs. 2, the government has to provide the MSEB with and additional Rs.2.25 per unit to meet its dues to the DPC. Since, just putting in place a project commissioned on the Enron terms has proved inadequate to either reduces distribution and transmission losses or raise the tariff, the subsidy remains in place, though it accrues not to the MSEB but to Enron whose profits are protected. In Monteiro's view if Dabhol Phase II is commissioned the subsidy amount needed to protect DPC's dollar profits would work out to more than the total agricultural subsidy.
In sum, an initiative that was launched as part of the ideology of reform has ended by defeating the grounds on which the reform process is commonly advocated. The question that remains is why the subsidy that is finally being paid is being offered to Enron. It is known that among the major creditors who have lent Enron huge sums on the strength of the government's guarantee are a host of Indian banks and financial institutions. If a similar credible guarantee had been provided to an Indian firm, it could have accessed the same sources to earn similar profits, which may not have been repatriated abroad in equal measure. What benefit the policy has offered in terms of attracting foreign investors who could deliver more than India corporates to the country is by no means clear. And the fact that the policy has only worsened the crisis in the power sector and elsewhere in the economy has even begun to affect the credibility of the sovereign guarantee that the government has offered. As noted earlier, creditors have sat up and started questioning the feasibility of Phase II.
But the crisis cannot be easily resolved. What is damaging is that the manipulative advocates of reform have carried the process to an extent where redressing the obvious blunder could prove costly. Under the prevailing terms and conditions, if the government opts to pull back its commitment to backing Dabhol Phase II and purchasing all the power it generates, it would have to pay compensation to the tune of Rs. 35,000 crore. Reforms are irreversible, even if disastrous, only because those who devise them ensure that they can be reversed only at prohibitive costs. If the ideal capitalism that the advocates of reform celebrate actually ruled, all those who backed the project, including the "disinterested" economists who defended it, would have been penalized. Unfortunately, it does not.
© MACROSCAN 2001