The Hindu Business Line : Clean Development Mechanism and Dabhol — Potential for significant value generation

AS FAR back as April 1993, the World Bank evaluated the Dabhol project and concluded that it was `not economically viable, and thus could not be financed by the Bank'.

A lot has happened since the project was cleared and counter-guarantees executed with a speed and efficiency one does not generally associate with the Indian system.

To quote a prominent political figure:

"From the speed with which the memorandum of understanding was signed it seemed as if Enron came, it saw, and it conquered". Implementing and running the project have been a totally different story altogether.

Concrete moves are on to revive the project, the latest being the approval given by a US bankruptcy court to GE and Bechtel to acquire a significant part of Enron's equity in DPC for around $20 million in a two-stage process.

After the acquisition of a controlling stake of around 52 per cent in DPC, GE and Bechtel are in a better position to protect the value of their investment in DPC. It is to be expected that the change in ownership of the beleaguered Dabhol Power Company (DPC) will raise its price tag to around $800 million, including the cost of restarting the project, that is.

"Now that GE and Bechtel have a majority stake in DPC, their bargaining position has been strengthened. They are now in a much better position to call the shots in the sale process.

"For quite some time, the two US-based companies have been informally arguing in favour of a formula which entails selling the entire equity for $300 million," said a source in the lenders' consortium.

As far as the potential `acquirers' are concerned, the Reliance and Tata groups have already indicated their interest in DPC, and the former had in fact submitted a bid of $25 million for Enron's stake, which was rejected by the US backruptcy court on the ground that the Reliance group did not have any locus standi in the matter.

To arrive at a final bid `value', rational bidders typically consider a host of issues, including projected cash flows, value generated on account of various synergies with the existing operations, the strategic value of the assets — in terms of pre-empting competition, etc., and the bidder with the highest `value' (implying the one who is able to extract the maximum `value') typically bids a higher amount and wins.

Among the various avenues for generating value, interested bidders would be well advised to consider the potential for generating revenue from the sale of carbon accruing on account of reviving and operating the DPC.

Preliminary calculations indicate that the net present value of what is essentially hot air could pay for the acquisition of a controlling interest in the project.

Can Dabhol revival be based on CDM?

Stepping back from legal controversies, the revival of Dabhol would seem to be a fit case to be registered under the clean development mechanism (CDM) of the Kyoto Protocol. In fact, it could perhaps turn out to be the greatest success story of the CDM.

Consider: On the one hand, you have smoke-belching, coal-fired power plants struggling to meet demand, and, on the other, a state-of-the-art combined-cycle gas turbine project lying in a mothballed state.

Would it not be an exemplary example of the effectiveness of the CDM if revenue proceeds from carbon credits accruing from running the project could be used to restart it? Structured suitably, this `hot air' could generate a sizeable revenue stream.

Way forward

Lets us assume the project consists of two parts:

Part 1: The construction and physical implementation — this is complete and has limited (if any) scope for CDM-linked benefits.

Part 2: Project revival. Though the project has to be implemented, the revival process could be developed under the CDM. The all-critical `additionality' arguments in support of the project are that:

The revenue from CERs (certified emission reductions) would enable a quick resolution of the current stalemate. It would help bridge the gap (partially) of the price per unit of electricity that the project `owners' are willing to sell at and the price that the main customer — the Maharashtra State Electricity Board — is willing to pay.

The CERs would help make the project economically viable under the current (revised) economic scenario.

The revenue from CERs could be used to reach a quick settlement with the equity-holders — GE, Bechtel, and others.

To begin with, the project's revival would certainly lead to a reduction in anthropogenic emissions of greenhouse gases (GHGs) that are additional to any that would occur if the project were not revived. The alternative would be generating electricity from sources with higher emission levels — pithead coal-fired power plants, being among the lowest-cost options in India.

Value of the CERs

A back-of-the-envelope calculation tends to suggest that the value one is looking at certainly seems very attractive. Considering a pithead coal-fired power plant to be the baseline scenario, the revenue potential from sale of CERs at an estimated price of euro 5/CER would be as shown in the Table.

Assuming a price of euro 5/CER, the net present value (NPV) of future cash flows from the project on account of sale of CERs alone would amount to a whopping euro 289 million! To put this in prospective, euro 280 million is more than 10 per cent of the capital cost of the project! The process for registration will undoubtedly be controversial and subject to a great deal of scrutiny but the value in question is significant.

It would be advisable for potential bidders wanting to exploit this opportunity, to tread the CDM project development process carefully; the slightest slip could jeopardise the process and turn the expected revenue into, yes, just hot air!

Suitably structured, most, if not all new power plants should be eligible for generating carbon credits. The key issues being (1) the GHG emissions per MWh of power generated should be lower than the grid average, and (2) demonstration of the fact that it is not a "business and usual" project.

It may also be pointed out that this holds true, not only for new projects, but also for retrofits and technology upgradations.

(The author is partner at CarbonWatch, a carbon finance consultancy focussed on assisting Indian corporates develop their CDM strategies. The views expressed are personal.)