Case Questions-Political Risk and Dabhol
Analyze the Case issues etc. and present the brief analysis in your report. Along with providing detailed answers to the following questions. 1. Critically analyze and comment on the contractual operational risk management/mitigation arrangements that underpinned the original Dabhol Power Project. Ans. The various risk which underpinned the DPP are as follows - Currency Risk:
The Power purchase agreement (PPA) also took care of the currency risk. The final price of Dabhol power was in USD and for MSEB it was dependent on the USD-INR rate. Thus, the currency risk for DPC was removed and it was borne by MSEB. All these factors’ risk was borne by the MSEB, central government and state government. Financial Risk:
Enron negotiated a highly profitable deal for DPC whereby the real post-tax IRR of 26% to 32% while the projected IRR of project was 16%. This amounted to annual excess payments of between USD 15.9-20.4 million from MSEB. Political Risk:
Political insurance was obtained from (Overseas Private Investment Corporation) OPIC for the coverage of equity stakes and loans bought and obtained respectively by the DPC promoters. Environmental Risk:
There were certain environmental hazards like pollution of sea water and thereby affecting the fishing communities. The diversion of water to the plant and thereby non availability of water to villages earlier having 24 hour water supply previously. The land that was acquired to the project was mainly farmland and that resulted in relocation of many families. These were not completely settled by DPC. All these environmental risks aspects were raised as objections by individuals posting letters to the company when it published a notice in the newspaper. But DPC falsified the fact and reported that it did not receive any notices.
2. Assuming that the measures for mitigating operational risks that underpinned the Dabhol power project were a problem, discuss how Enron may have demonstrated “credible commitment” to the Dabhol power project. Ans. We can judge Enron’s “credible commitment” to the Dabhol Power Project on account of the following actions: To allow Dabhol to proceed, Enron needed to secure some 150 federal and state approvals, resolve many legal issues and deal in principle with complicated federal and state taxes. Enron, achieved all these with exceptional speed. Enron ran advertisements of the project showcasing the benefits that were associated with the project. Thus it developed a suitable environment from public support when it the project was cancelled by the state government. 80% of the state and 65% of the nation wanted the project the resume because of the publicity. Enron International chief, Mark, suggested a re-negotiation with the State Government proposing new tariff revision and PPA and even offered a stake of 30% to the State. In this negotiation, it was ready to use domestically produced naphta and LNG in the place of distilled fuel that it was importing. That would lower the cost of production and benefit MSEB.
3. Suggest approaches to manage risks in an unstable political and institutional environment associated with non-recourse/limited recourse finance. Ans. One of the major methods by which the political risk could be avoided was to include the government in the deal, but in India the political conditions are so unpredictable that DPC held a major risk close to it by including the Government. Certain approaches which can be used to mitigate the political and institutional environment are as under:
Political Risk Insurance or Insurance by World Bank:
The Enron was aware of the financial credibility of India in the international market, so they should try to bring the financing from World Bank, Inter-American Development Bank or some other multilateral financing agency. Insurance policy covering a number or political risk types, these are provided by many insurance companies against expropriation,...
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