Why Enron cut its Price

It looks as though the Enron drama is going to have a happy ending. Many details of the re-, negotiation are secret, but certainly the total project cost has been stashed, its size has been expanded, and the levelised power tariff may plummet to just Rs 1.89 per unit, against the earlier Rs 2.62 per unit. Some other clauses have changed, so the effective tariff cut may be less, but will remain huge.

This proves, first, that the original deal was highly overpriced; and, second, that canceling the contract (as demanded by the Swadeshi Jagran Manch and Left parties) would, have been stupid. It would have meant heavy cancellation charges and a power shortage in the state. Instead the state will now have abundant power at a cheap price, the best possible outcome.

One clarification: Phase I of the project, cleared by the Pawar regime, has not really been renegotiated at all (Enron said this was not possible since it had entered into irrevocable contracts with its subcontractors). What the recent talks did was to negotiate an expanded Phase II at a very low rate, bringing down the overall rate.

Enron has lost face and credibility by slashing its price. Why did it not simply pocket compensation and walk off? I have found some answers by talking to international experts and leafing through the Middle East Economic Survey.

Enron has a reputation for pursuing high-risk, high-return ventures. Other risk-averse investors avoid a liberalising country till its reforms succeed. But risk-takers. like Enron rush in early, knowing the risks are high but so, correspondingly, are margins. The bargaining power of foreign investors is extremely high in the early days of reform, when few others are willing to come in, and the government. is inexperienced in handling giant infrastructure deals.

This was the case when, in 1992, Enron offered to set up a 2015 MW power plant costing $ 3 billion. At that time Messers Narasimha Rao and Manmohan Singh were touring world capitals pleading for foreign investment, and getting a sceptical response. So Enron’s offer not only looked dazzlingly large, it also promised to increase India’s credibility and catalyse other foreign investments. This was one reason for weak-kneed negotiation by the Maharashtra State Electricity Board (MSEB), despite many ex-pens protesting that the cost and tariff were much too high. Many believe kickbacks were also involved, but no evidence of this as been unearthed.

While only Phase I was approved by MSEB, it was understood that this would be followed by a much larger Phase II based on liquefied natural gas (LNG). Now, LNG is not available off the shelf. It is necessary to develop a gas field, liquefy the gas, arrange for a series of LNG tankers, and build an expensive regasification facility at the receiving point. So, Enron’s power business is an extension of its gas business.

Having got the Dabhol deal ht> 1994, Enron set about finalising LNG supplies. It struck a deal with Qatar for a giant LNG venture of 5 million tonnes per year, intending to sell roughly half to India and half to its project in Israel. This was not easy. Qatar had already established an earlier joint venture with Mobile l. This gave Mobil the right to block any new LNG deals in Qatar until reached a volume of 10 m.t. per year. To get a waiver from Mobil, Enron had to offer Qatar an especially sweet deal.

Enron proposed a joint venture in which it would have 40 per cent equity and Qatar 60 per cent. Enron undertook to arrange the entire financing including Qatar’s equity t stake. This was expensive for Enron, but made the proposal sweet) enough for Qatar to get Mobil-W waive its rights. However, Mobil’s waiver was subject to condition like.

  • Enron could not export to the lucrative Mediterranean area save Israel/Jordan.
  • Gas exports to India would be inventures where Enron had equity, participation.

Then the BJP-Shiv Sena came to power in Maharashtra, and cancel led the Dabhol project in July. This left Enron in a fix. Its onerous commitment in Qatar now looked like becoming a financial disaster. Enron claimed it could survive the cancellation. But, as the Middle East Economic Survey notes,” There is much scepticism in industry circles…. the high cost of building the downstream facilities in Qatar and Israel would be productive.”

This made it imperative for Enron to reach a negotiated settlement with Maharashtra, even if&’ meant slashing margins and tariffs, At stake was not simply Dabhol by its much bigger venture in Qatar.

The tables had really turned. In 1992, India was semi-bankrupt and in a very weak bargaining position. But by mid-1995 Enron was trapped into huge commitments in Qatar, and so India was in a powerful bargaining position. Besides, the global price of power equipment has crashed in 1995 (as often emphasised by Mr S Gurumurthy) making it easier to cut capital costs.

Enron agreed to change the fuel from diesel to naphtha in Phase I, but (contrary to press reports) this will not change the price materially -the main benefit is less pollution. By 1999 Enron hopes to complete Phase II, and switch the whole complex to LNG soon afterwards.

This will enable it to run its Qatar tar operation profitable. Enron also wants good relations with a country in which it sees a big long-term future. Still, its decision to slash its Dabhol price cannot be fully understood without looking at its problems in Qatar.

What do you think?