Enron Case Study (1)

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INTERNATIONAL BUSINESS Page 1

Date: February 17

th

, 2012

SUBJECT

INTERNATIONAL BUSINESS

TOPIC

ENRON CASE STUDY

T.Y.B.COM – B.B.I

SEMESTER VI

ST. ANDREWS COLLEGE OF ARTS,

SCIENCE & COMMERCE (B.B.I)

GROUP NO: 6

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ACKNOWLEDGEMENT

It gives us immense joy and pleasure to acknowledge the help of all the

people who have helped us complete this project.

Our group owes more than it can say to the experience and the guidance

of our College Principle Dr. Marie Fernandes and the excellent faculty

and staff of St. Andrew’s College, Bandra.

We are greatly indebted to our BBI Prof. Shirley Pillai for her

enthusiastic support and co-operation as also for her constant

encouragement throughout the making of this project.

A special thanks to our friends and above all to our families for their

unceasing love, support and encouragement. Their wisdom has helped us

through the highs and lows of completing this project.

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DECLARATION

We the students of St. Andrew’s College of T.Y.B.COM (B.B.I) – 6th

Semester hereby declare that we have completed the project on

“ENRON CASE STUDY” for the subject International Business in the

academic year 2011-2012. Information submitted is true and original to the best of our knowledge.

Group Members

Name Roll. No Sign

1] MILTON GRACIAS 8225 2] ALSTON PEREIRA 8248 3] JEYSON BARBOZA 8249 4] VICKY RAMESH 8250 5] CLIFFTON KINNY 8251 6] HEINRICH KINNY 8252 7] KEVIN DSOUZA 8253

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CERTIFICATE

I __________________________ hereby certify that the following students of St. Andrew’s College of T.Y.B.Com (B.B.I) – 6th Semester have completed the project on “ENRON CASE STUDY” for the subject

International Business in the academic year 2011-2012. The information is true and original for the best of my knowledge.

Group Members

Name Roll. No Sign

1] MILTON GRACIAS 8225 2] ALSTON PEREIRA 8248 3] JEYSON BARBOZA 8249 4] VICKY RAMESH 8250 5] CLIFFTON KINNY 8251 6] HEINRICH KINNY 8252 7] KEVIN DSOUZA 8253

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INDEX

TOPIC PAGE NO.

BACKGROUND 6

ABSTRACT 7

INTRODUCTION 9

IN QUEST OF POWER 10

THE POWER FACTOR 13

ENRON AND CORRUPTION 16

CONCLUSION 18

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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 MSEB’s 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 2001 the problems continued and

in April the board of DPC authorized the management to terminate the contract any time it chooses. Today the first

phase of the plant is idle and the second is still not completed, Enron’s part of DPC is for sale and a deadline for bids is

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Abstract

The case 'The Enron Saga' outlines the problems faced by Enron in starting its operations in India-the legal, political and economic forces

at play during the early 1990s. The case is an example of how Enron surmounted the different hurdles and

made the project viable under the then prevailing business environment

in India. The case outlines the various events from the time the

MoU was signed till the final clearance. The case is a good example of the strategy adopted by Enron to make the project a success.

It also draws a comparison with Cogentrix, which failed to take off under similar conditions as faced by

Enron. The case also touches the various options available to Enron and the MSEB to sustain the project under the prevailing circumstance of

MSEB defaulting on payments.

The case helps them to understand how an effective strategy can overcome the various political, legal and economic hurdles. The case

also shows how the political and legal environment influenced the approval of the project thus proving advantageous to Enron. From the case, the students are expected to understand the various factors (mainly the external environment) that should be taken care of before entering an

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The case is a good example of the role of ethics in business. One of the teaching objectives is that a foreign (not local) company can drain away large amounts of profits if the contract that is signed is not fair. To avoid this, it is important to regulate the entry of companies to negotiate a fair deal.

The rate of return is not important in the power sector; the single most important factor is the price at which one gets the power. This can be lowered if there is competitive and transparent bidding. It is also important that the state boards are run on a competitive basis.

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Introduction

In 1996, Rebecca Mark, CEO, Enron Corporation, managed to wrest the controversial Dabhol Power Company (DPC) from the jaws of death. Five years later (2001), the survival of DPC was at stake. Both DPC and the Government of Maharashtra (GoM) have been accused of corruption and economic insanity. With the controversy regarding the price of

power still raging and the latest payments crisis that the Maharashtra State Electricity Board (MSEB) faced, both Enron and GoM were desperately looking for a solution.

The MSEB was not able to lift even the first phase supply fully. It was caught in a vicious circle with high fuel prices leading to low off take of Dabhol power into the grid. This in turn caused the unit capacity cost to rise. In October 2000, the price of Dabhol power touched Rs. 7.09 per kWh, due to the high price of fuel and the worsening exchange rate. In January 2001, responding to Business World's query on the state

government's stand, Padmasinh Patil, energy minister, GoM, said, "We will set up a review committee shortly. There are complex issues to work out".

Analysts felt that the possibility of Enron selling out or invoking penal clauses in its contractual agreement with MSEB, to exit could not be ruled out.

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In Quest of Power

In June 1992, a team of officials of the Government of India (GoI)

toured the USA with the aim of inviting power producers in the USA to invest in India.1 Prior to this, the government drew up a list of projects in which the private sector could participate.

In addition to the coal based projects, (Refer Exhibit II) there were two or three gas-based projects in the list. The Enron Corporation showed interest in setting up a power station in India based on the import of Liquefied Natural Gas (LNG).

On 15 June 1992, a team of officials from Enron Corporation arrived in New Delhi. On 18 and 19 June, the team visited over half a dozen

potential sites in Maharashtra and on 20 June 1992, the MSEB signed a Memorandum of Understanding (MoU) with Enron. The MoU specified that the MSEB would buy electricity and/or capacity from Enron which would build, own and operate (but not transfer) a plant of about 2000-2400 MW capacity.

The power station would be built near Dabhol in the Ratnagiri district, about 300 km south of Mumbai. The MoU also specified that the MSEB agreed that there was a need to set up a 2000 MW plant to be run on LNG. The "electrical power purchase contract” would be a contract for 20 years and would be structured to achieve a price of US $ 0.073/kWh (Rs. 2.34 per unit at the then prevailing exchange rates)."

At the price quoted by Enron for a unit, MSEB would be paying a sum of US $ 1300 million (Rs. 400 crores) every year for the total capacity of 2000 MW. The total payments for 20 years would be around 35 billion US dollars.

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In India the power sector was dominated by Central and State government owned organizations. In most of the cases, any State Electricity Board (SEB) was the sole generator, transmittor and

distributor of power. Power was generated by Central Utilities such as NTPC, NHPC, Nuclear Power Corporation, Damodar Valley

Corporation and NEEPCO; State Electricity Boards which were state-owned utilities; licensees such as BSES and CESC and Independent Power Projects (IPPs).

Transmission and distribution was mostly in the hand of SEBs with the sole exception of Orissa where power distribution was in the hands of the private sector. In 2000, India's power generation capacity stood at around 96600MW (Approx. 478 billion units).3 The major portion of the capacity was set up by SEBs (58%). This was followed by centrally controlled plants which contributed 34%. IPPs started contributing to installed capacity only as recently as 1996.

Central Utilities dominated the Indian power generation sector. Even after the new power policy of 1991came into effect, their share in power generated, as well as new capacity added, did not diminish significantly.

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This was largely due to the failure of IPPs to take off. Central Utilities included Powergrid Corporation of India, Power Finance Corporation of India, Rural Electrification Corporation and Power Trading Corporation of India.

To meet the growing shortage of power, the government encouraged private (including foreign) participation in the power sector. The new power policy permitted 100 per cent foreign owned companies to set up power projects of any capacity and type (coal, gas, hydel, wind or solar). An Independent Power Producer (IPP), after getting government

approvals for its specified plant size, could generate power and sell it to the respective SEBs under a Power Purchase Agreement (PPA).

Licensees were predominantly private companies that generated and distributed electricity to urban areas...

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The Power Factor

The MoU between Enron and MSEB was signed prior to the

examination of the terms and conditions and implication of the project. Among the parameters that should have been examined were the capital cost of the plant (on which the price of electricity depends), the type of fuel to be used, the location of the plant etc.

An autonomous organization, the Central Electricity Authority (CEA) was supposed to examine these aspects. In July 1992, the CEA examined the MoU and pointed out that the price agreed on was a "departure from the existing norms and parameters notified by the Government." It also pointed out that “denominating the price in US dollars was also a

departure from the existing norms." According to the CEA, the price that had been agreed upon was "considered high."

In July 1992, the Government of India asked Enron to submit a break-up of the project costs and the return on equity that was assumed. Enron wrote back stating, “…We advice you against auditing project costs and predetermining return on equity.”...

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The Peak Load

The project generated much controversy in Maharashtra. Of the two main opposition parties (the BJP and Shiv Sena) , the BJP was in the forefront of the opposition to the project on a number of grounds. Their primary contention was that the deal indicated corruption at the highest level. In January 1995, elections to the Maharashtra state assembly were announced. Enron was made a key issue in the elections. Gopinath

Munde, leader of the BJP, visited the Enron site and promised to throw "the project in the Arabian Sea". Business Line and Frontline carried long and detailed articles on the PPA, which had been kept secret up till then...

A Tripp

The MSEB's inability to pay DPC was rapidly emerging as a threat to the viability of phase II of the project which involved a generating capacity of 1, 400 MW and an LNG terminal of 5 million tons.

There was an increasing possibility that the dispute over phase I might end up in international arbitration, if MSEB failed to pay up and the state government refused to bail out the ailing MSEB. The PPA had provisions for arbitration in case a dispute could not be resolved through negotiations.

The DPC and the MSEB would have to work out alternative options as the project was unviable in its present form. Said Kirith Parikh, former director, Indira Gandhi Institute of Development Research (IGIDR), "Yes, the power from Enron is currently expensive, but a solution needs to be worked. Throwing the Enron project into the sea is not an

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"This case has highlighted to the people how even after 50 years of independence, political considerations outweigh the public interest and the interest of the state and to what extent the government can go to justify its actions and not only before the public but even before the courts of law."

- Bombay High Court's passing remark after dismissing a bunch of petitions that had challenged the legality of the Enron power project.

"Enron's India odyssey which started with the largest American FDI in India is ending in a whimper."

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Enron and Corruption

Right from the beginning, the project contract was questionable. The initial contract of the project was considered to

be suspiciously generous to DPC. Dabhol has been accused of corruption in the setting up of the project and in the

procedure regarding granting official clearance for the project. The World Bank has called this type of corruption

“state capture”. The US Government carried out an investigation about the questionable USD 6 million education

expenses used by DPC. However, the results showed that there was no bribery involved in the amount.

Enron and DPC have also been criticised about its accounting and auditing procedures. Arthur Andersen is accused of

allowing Enron to hide huge losses off the balance sheet. The auditors allegedly conspired in the manipulation of

accounts. Despite of this, no cases of prosecution have been made. Generally Enron has a bad reputation in its

corporate culture. According to a senator there is an “almost a culture of corporate corruption” in Enron, e.g. the

employees have told later that communicating the corruption to managers would possibly have caused reprisal

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CONCLUSIONS

The project was the focus of attention nationally and internationally because of the controversies surrounding the

project’s suspension. The Dabhol power project’s collapse came at an acutely embarrassing time for the Indian

government. Internationally, India had been carefully building the confidence and trust of the foreign financiers and

companies, as it needed to secure long-term economic growth.

The DPC debacle follows with a number of foreign investors pulling out of India, e.g. Electricite de France and

Cogentrix. Also Daewoo, PowerGen and National Power have previously experienced problems in India.

There are numerous reasons that made the project fail discussed in this paper. The points of failure were that the high

costs and that MSEB ran out of money, since its financial situation was not evaluated critically enough in the

beginning of the project. One other important factor that proved to be dreadful is that although DPC got decisions in

court in favour of them, there was no way they could enforce the decisions, so they could not get their money. The law

enforcement did not work as it should have which in turn was a result of many different causes.

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BIBLIOGRAPHY References:

The enron saga, rediff, http://www.rediff.com/money/enron1.htm

Government of Maharasthra guarantee,

http://www.altindia.net/enron/Home_files/Gom_gua.htm

Government of India guarantee,

http://www.altindia.net/enron/Home_files/goi_gua.htm

Independent Power Producers: A review of the issues,

http://www.indiainfoline.com/infr/spfe/inpp/

Power purchase agreement scans, http://altindia.net/enronPPA/

Human rights watch,

http://www.hrw.org/reports/1999/enron/index.html Consortiumnews http://www.consortiumnews.com/2001/123001a.html Guerillanews http://www.guerrillanews.com/human_rights/doc299.html Altindia http://www.altindia.net/enron/Home_files/doc/munde/intro.htm Democratic underground http://democraticunderground.com/articles/02/01/26_india_2.html

Jeff Rense Program http://www.rense.com/general18/enrons.htm

Corporate watch

http://www.corporatewatch.org.uk/news/labour_and_enron.htm http://www.icmrindia.org/casestudies/catalogue/Business%20Ethi cs/The%20Enron%20Saga.htm