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May 22, 2001

Enron Locked in Contentious Battle over Indian Project 

By Will McNamara
Director, Electric Industry Analysis 

[IMAGE][News item from Reuters] The Indian federal government is optimistic 
that Enron Corp. (NYSE: ENE) and the Maharashtra state government will 
resolve their wrangle, which has jeopardized the U.S. energy giant's $2.9 
billion power project. Indian lenders want their federal government to 
intervene after a threat by Enron Corp., the country's largest foreign 
investor, to walk out of a giant power project has put the loan of the Indian 
groups in jeopardy. Local lenders including the Industrial Development Bank 
of India and the country's largest commercial bank, State Bank of India, 
stand to lose billions if Enron pulls out the deal. On May 19, Enron took a 
major step toward pulling the plug on the project by issuing a notice to 
terminate its contract to sell power to the Maharashstra state. 

Analysis: This news item is significant for two reasons. First, Enron's 
ongoing troubles in India are causing other power companies to also scramble 
from their investments in the country or avoid India altogether. This comes 
at an unfortunate time for the undeveloped country, as it was hoped that the 
investment from Enron and other companies would provide a significant 
financial boost to India's energy infrastructure. Second, it is rather ironic 
that Enron, which has gained an earnings boon from its wholesale and trading 
activities in the United States, has faced financial challenges overseas by 
following the one business strategy that it has mostly avoided in this 
country: owning hard generation assets. 

By way of background, Enron was first approached by the Maharashtra 
government back in 1992 regarding the joint development of a new power 
project to serve the western part of India. In the mid-1990s, Enron broke 
ground on the 2,184 MW project on India's western coast (near Bombay, which 
is the capital of Maharashtra) that reportedly will be the largest natural 
gas-fired power project in the country upon its completion. Some reports 
suggest that it is the largest natural-gas plant in the world. The plant is 
in the midst of its first operational phase (with 750 MW up and running) and 
is scheduled to begin its second phase (1,444 MW) in June. The company that 
owns and operates the power project is Dabhol Power Company, in which Enron 
holds a 65-percent interest (the state of Maharashtra owns the other 35 
percent). Under terms of the contract, the state of Maharashtra agreed to 
purchase the totality of power produced at Enron's plant.  

However, problems began to surface over the last six months or so, heightened 
by Maharashtra's recent default on payments to Enron. Dabhol Power has been 
criticized for charging 7.1 rupees per kilowatt-hour, compared with the 
market's average of 1.5 rupees (for conversion purposes, $1 equals 46.93 
rupees). Citing what it claimed were high costs charged by Dabhol, the state 
of Maharashtra reportedly refused to pay for any power produced from the 
second phase of the Dabhol plant. At last count, the state government owes 
Enron approximately $48 million for power transactions completed last 
December and January, and could owe $607 million if the contract is 
terminated. 

Citing payment defaults by the state of Maharashtra and non-cooperation from 
both the state and federal government in India, Enron issued a preliminary 
notice to terminate future power sales from its Dabhol plant. Enron also 
declared a state of force majeure, a legal strategy that allows a company to 
break a contract for reasons beyond their control. In response, Indian 
leaders-driven by valid concerns about the financial repercussions that a 
broken contract would have-are requesting the country's federal government to 
intervene and prevent any break in the contract. Lenders such as the State 
Bank of India, the country's largest commercial bank, also plan to fight 
Enron on its plans to rescind the contract.  

As noted, Enron's problems in India are causing a damaging domino effect for 
the undeveloped country. Being the international energy giant that it is, 
Enron probably won't suffer too much if it does indeed terminate its contract 
with the Indian government, and perhaps can find another buyer in the country 
for the power produced by the Dabhol plant. Enron also has reportedly pulled 
out from all of the other projects in India in which it had once planned to 
invest, including Metgas (a liquefied natural-gas pipeline) and India-based 
projects led by Enron Broadband Services and Enron Oil & Gas. This ongoing 
divestiture in India should reduce the company's risk exposure related to the 
country's instability. 

On the other hand, the failed contract will most likely do a fair amount of 
damage to the energy market in India, which is already perceived as a less 
than lucrative country in which to develop power projects. Some reports have 
indicated that India received only $2.6 billion in foreign investment in 
2000, representing three times less than Singapore, a country representing 
only one-fourth of the economy of India. Any deterrent toward further power 
expansion in India would exacerbate concerns about the country's ability to 
meet growing demand for electricity. 

Further, at least four foreign power companies (Cogentrix of the United 
States, EDF of France, Powergen of the United Kingdom, and Daewoo Corp. of 
South Korea) already have pulled out of the Indian energy market. At the same 
time, many domestic companies also have postponed their own power projects as 
a result of legal obstacles. In addition to a tainted reputation, Indian 
leaders also stand to lose financially as well, as loans given to the Indian 
government reportedly are not covered by any guarantee (unlike overseas 
lenders who are protected by guarantees).  

Enron's announcement that it intends to terminate the contract has triggered 
a "cooling period" that will last for six months, during which time the 
Indian federal government will continue trying to convince Enron to maintain 
its end of the contract. Interestingly, in early May Enron said that it had 
"no immediate plans" to sell its stake in the Dabhol power project and added 
that it would make no move on the plant until the payment disputes with the 
state of Maharashtra are resolved. Other statements made by Enron Chairman 
Kenneth Lay have suggested that the company might continue to own the Dabhol 
project and proceed with the completion of the second phase, regardless of 
any payment that Maharashtra may or may not make. Given the sharp increase in 
demand that is expected in India, it would make sense for Enron to want to 
retain its majority ownership of the power plant and work a deal to sell its 
power to another Indian buyer.  

Enron has been fairly consistent with regard to its strategy of not owning 
hard assets on any long-term basis. Typically, Enron has accumulated 
infrastructure in various commodities (e.g., electricity generation, natural 
gas, bandwidth) in order to ensure that it can provide a product where the 
customer wants it. However, once Enron has established itself within that 
commodity, all it really needs is access to the infrastructure, rather than 
outright ownership, so divestiture has typically followed. The company might 
have perceived the Indian market to offer unique opportunities, due to the 
lack of infrastructure across the country. However, now it appears that 
Enron's majority ownership in the Dabhol plant may be causing more for the 
company than the assets are worth. 

The possible termination of the Dabhol contract with the state of Maharashtra 
would mark the third sales deal that Enron has broken in recent months. Most 
recently, the company announced that it is bowing out of $43.5-billion 
project to route Qatari gas to the United Arab Emirates and has sold its 
stake in Dolphin Energy to UAE Offsets Group for an undisclosed amount.  

In addition, Enron is being sued by a group of California universities over 
the schools' claim that the company breached a four-year contract, signed in 
1998, to provide power at a 5-percent discount to the utility rate frozen by 
California's 1996 deregulation law. Scheduled to expire in 2002, the deal 
between Enron and the California university system included a peak power load 
of 350 MW and is estimated to be worth about $500 million. Although Enron 
cited problems associated with California's energy crisis, once in court the 
company disclosed that the contract with the California universities no 
longer represented an economic business strategy and that the company was 
actually losing money on the contracts (although it would not confirm a 
specific amount). 

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