Research Project on India
Why do you think Enron was willing to shoulder the risk of making such a significant investment in India? What long run benefits did the company forsee? Do you think these benefits compensated for the risks involved?
India is a developing country with an underdeveloped economy. Since independence in 1947 India had a number of restrictions on foreign investments and it imposed number of trade barriers in the form of high import duties. However by the 90s India opened its doors to foreign investors.Former prime minster, Narsimha Rao requested Enron to make an investment in India in the form of an independent power project. Enron accepted the request and then begins the Enron saga. Enron was assured 16% return on investments. The rate of return after the agreement worked out to be 32%. Usually return on investment in the US would have been around 8%. The higher rate of return was attributed to risk associated with establishing a power plant in India. Considering the uncertain electricity market in the U.S, I would not agree that risk in India was too much.Also when the government of India was assuring the rate of return where was the risk?
The reason why Enron was so keen on setting up an LNG plant was that they had an LNG processing unit worth $4 billion in Qatar and they wanted a strong market like India to buy the output that was produced in Qatar. That is why although the Dabhol power plant was not economically feasible Enron was still interested in setting up a power palnt in India. Secondly the west coast where the power plant was located was close to the Gulf states,as a result cost of shipping LNG would be very low.
Next Enron thought that power availability would set up new industries in the region and increase the economic growth rate of the country.As a result purchasing power of India would increase which would result in outflow of precious foreign exchange. Not only this but growth potential would position Enron well in the global market place.
Enron did see many long run benefits:
Firstly after the success of a power project in a developing country like India,Enron would gain a very high image amongst other developing countries ie they would be able to capture energy markets in other countries as well.Thats what happened!!After the deal was struck with India Enron had power projects coming up in countires like Brazil, Bolivia, China etc.
Secondly the profits that Enron would earn would be extremely high compared to the cost.The main reason being cheap and freely available labour to run and maintain the plant.
Last but not the least, gaining access to business in India, the worlds largest democracy, Enron would be able to develop long term relationship which means that after its success once, India would ask them to set up more such projects which would be a benefit to no one else but Enron.
The "benefits" Enron was expecting were low cost of production, very high rate of return on investment in other words a good amount of profit, a successful global image and long term relationship with India.
The "risk" associated with investing in a country like India was very high. First of all the thought of investing in a developing country like India which has an unstable and a downward moving economy was a big risk itself, dealing with corrupt political officials was another issue. Plus selling liquefied natural gas to consumers who mostly use energy generated through burning of coal was a difficult approach because they were not sure if consumers would buy energy at approximately 4 times higher price than what was available in the domestic market.
I think Enron did not get the benefits it was expecting because of the risks associated with investing in India. There were chances of them earning a huge amount of profits. Enron struck a deal to generate 2450mega watts of energy (450mega watts higher than the original plant) at 22.6% less than the original price.Inspite of this cut Enron would have earned a very high rate of return on investment while simultaneously cutting the prices. In reality if everything worked out well they would be making profits which would not be possible abroad. But; because of the political instability the Enron power project did not last too long out and they had to return back.
Do you think Enron was right to build a risk premium into its original pricing of the Dabhol project? Should the company have foreseen that this might have been perceived as cost padding?
Yes, I think Enron was right to build a risk premium into its original pricing of the Dabhol project.Rebecca Mark was absolutely correct when she said,"In India you are suppose to have a 20% import duty on equipment.but when it comes right down to it,very common in a project is that it doesn't end up being 20% but whatever the customs inspector wants it to be on the day you get there. So you have to price that risk in."In a poor country like India bribery and corruption are the most common practices.No one is satisfied with whatever is given to them officially so they have to bank on unofficial practices to satisfy their needs and wants.Enron just did that it took all the risks (mentioned) into consideration and quoted the price.Afterall Enron was interested in doing business and not charity where its main goal was profit so it was justified to build a risk premium.
But;the risk premium was too high. Enron was asking for 4 times higher price than what was sold by domestic producers. Secondly the energy that they were trying to sell was a very new concept for the indian consumers. Basic common sence tells me that if iam trying to sell a new product in a new country I should sell it at a low price. Enron was doing just the opposite, instead of selling energy at an affordable rate it was trying to reach a peak which was next to impossible. Enron was too confident of the move it was making and therefore ultimately it did not get anything but dissatisfaction from its client (India).
What lessons about the requirements for successful investments in India can other foreign companies draw from Enrons experience with the Dabhol project?
The effects of Enrons collapse have been felt across the spectrum of financial,social and ethical circles and around the world. Enrons lessons as interpreted by economists,sociologists and everyday people have possibly changed the attitude of investors all over the world. Some of these lessons include:
Diversification of investments is important.Investors should be wary not to get carried away by substantial movements in the market, rather set a limit with a reasonable profit or loss.The Enron collapse has also allowed many to see that emotion exerts incredible influence on the markets.
In the information age, companies and consumers become more dependent on the information of the product. Belief in the integrity of information allows companies to maximize the true benefit of the information age. With the very nature of information being questioned, information based companies are finding it harder to sell their services to the consumer.
Enron tried to accomplish too much too quickly using "time is money" philosophy. It depended on the political system to get its way. Investors when investing in a foreign country should try to adapt to the host country's working environment and not stick to their system of working.
Investors should try to explore the local resources rather than importing new raw materials. Enron's high cost of importing and using LNG that was a contrast to other sources of fuel was detrimental to its success.
Is former US Ambassador William Clark right when he claims that, in the end Dabhol incident sent the right kind of signals about foreign investment in India? What kind of signals do you think it sends about investments in India?
Yes, Mr.William Clark is right when he claims that, in the end Dabhol incident sent the right kind of signals about foreign investment in India. The following are the signals Enron sent for investments in India:
First, political instability: The government of India has always made efforts to make money for themselves personally rather than for the nation as a whole, which means the level of corruption is quite high in India which the investors need to keep in mind.
Secondly, India does not follow the policy of "time is money". Investors have to be prepared for delay in completion of the projects. A lot of time is spent in sceduling meetings with the necessary officials, going thorugh negotiations and then finally striking the deal.
Lastly, I would like to say that investors should try not to be the first ones in launching their product or service. I would first want to see the results of others and then make my decision. Enron was the first company to make an independent investment in India. It was on the basis of trial and error that they carried out their operations. Now, after the whole thing other investors in India as well as abroad have learnt lessons from Enron but Enron unfortunately didn't have anyone to take lessons about the methods of working in a country like India.
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