Sunset for Enron, sunrise for Maharashtra

Kandula Subramaniami

PENNSYLVANIA: Newspaper headlines over the past two days are related to the collapse of Houston-based energy giant Enron. A Reuters news story said the entire “financial world watched nervously on Thursday as America’s top energy trader, Enron Corp, teetered on the edge of collapse, fearing a strain on US banks that could send the global economic recovery back a step.”

The collapse has been so dramatic that shares in Enron, which till recently were ranked number seven on the Fortune 500 list of the biggest US corporations, slumped 85 per cent to an all-time closing low of 61 cents last Wednesday after a rescue deal by rival Dynegy Inc. fell apart.

The end came quickly because Enron had over-extended itself—and because investors and customers lost faith in its secretive and complex financial maneouvres. With legions of traders working out of a Houston skyscraper, the company put together trades so exotic that they mystified many a Wall Street veteran.

While there are many explanations to what went wrong, one analyst put Enron’s collapse as, “the company was borrowing too heavily to finance its assets: the classic case of debt trap.” In fact, surprise disclosures at Enron, including the admission that it had overstated earnings by almost $600 million since 1997 and kept huge debts off its books, led investors to rapidly lose faith in a company valued at almost $80 billion about a year ago.

Companies such as Enron operate in over 40 countries around the world, employing 21,000 people in operations ranging from marketing electricity and natural gas to delivering commodities such as metals, coal, pulp and paper. Now all these projects are in limbo.

At a conference organised at the Wharton Business school in Philadelphia on November 30, one CEO from an investment bank remarked that effects of this collapse would be felt over time as the extent of exposure of some of banks comes to the fore. Banks that lent billions to Enron will have to fight for a share in a bankruptcy court. Enron’s biggest lenders are JP Morgan Chase & Co. and Citigroup, which together have an estimated $1.6 billion in exposure.
Having said that, what are the lessons for developing countries as well as India from such collapses?

On April 25, 2001, The Financial Express carried a story stating that the investment problems in India concerning the Dabhol Power Company (DPC) in Maharashtra were falling into a pattern which Enron was streamlining globally.

Exactly a year back, in November 2000, Enron’s CEO Kenneth Lay indicated that the company had a lot of capital tied up in physical assets which, at least on a current basis, were earning a very low return on the capital invested.

Curiously, DPC started experiencing a payment crisis since November last year and has since streamlined its staff in India, and more recently expressed its interest to walk out of the project.

Though Union finance minister Yashwant Sinha has stated that the Enron crisis had created uncertainties over resolving the Dabhol crisis, the Indian government has to oblige.

It seems the company had decided to exit the project last year itself. The payment crisis seems to have given them a good “excuse” to do so.

The first attempt at rescue has come from domestic financial institutions, which are in the process of discussing a package to ease Enron out of the $2.9 billion DPC. After all, the Industrial Development Bank of India, State Bank of India, ICICI and other Indian lenders have lent directly or have guaranteed loans totalling $1.4 billion to Dabhol Power Company. If this is not done, these FIs can add another Rs 4,000 crore to their pile of non-performing assets.

Even if this does not work out, the terms of the counter-guarantee re-ensures DPC payment. As the assets are already on the ground, it would be in the governments’ best interest that FIs find a new buyer themselves.

The deal that Enron struck on DPC protects the company from every possible and conceivable angle. The tools of project finance are used to cover companies against risks arising out of businesses such as power.

While there is no issue on that, what protection does a state electricity board or a country have against such rapid change in a company’s fortune? What protection did the 1991 power policy offer to any of the state governments for such collapses?

While power purchase agreements insist on a lock-in period for the promoters, what is the protection if companies want to exit the power business or are forced into bankruptcy? Operating power plants is not on their priority list at that stage. They are not interested in running power plants and keeping a nation lit. They are there for business.

Developing countries, such as India cannot afford power being cut off suddenly due to changes in companies’ business fortunes or cycles. If they do, then the entire country stands to go out of business.
It is time all the states started thinking along this line.

The future of DPC and Maharashtra could well be out of the hands of Enron, but the story does not end there for the state. The mess that it has got itself in is proving difficult to unwind. After the collapse of Enron, the valuation of DPC will again undergo a change. It is now definitely a distress sale.

The collapse of Enron is not related to DPC directly, but Enron’s business strategy has raised doubts on their corporate ethics and governance in the US. The Madhav Godbole Committee exposed the project economics and stopped short of recommending a judicial probe. Probably, it is time to reconsider this report.

Time will tell how the drama unfolds in the US and India. Enron’s entry into India has been controversial; its exit may also be as controversial.

(The writer is on a sabbatical at the University of Pennsylvania, the US)