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PP RUEHCHI RUEHPW
DE RUEHBI #0077/01 0631022
ZNR UUUUU ZZH
P R 031022Z MAR 08
FM AMCONSUL MUMBAI
TO RUEHC/SECSTATE WASHDC PRIORITY 6048
INFO RHMFIUU/DEPT OF ENERGY WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHNE/AMEMBASSY NEW DELHI 7261
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UNCLAS SECTION 01 OF 05 MUMBAI 000077 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
DEPT OF ENERGY FOR COURTNEY GILLESPIE, MARK GINSBURG, TOM CUTLER, GIULIA BISCONTI, PDAS K.FREDRIKSEN 
DEPT OF TREASURY FOR STEPHANIE SEGAL 
DEPT OF COMMERCE FOR ART STERN 
DEPT PLEASE PASS TO EXPORT IMPORT BANK FOR JESSICA FARMER AND RAY ELLIS 
DEPT PLEASE PASS TO USTR FOR ADINA ADLER AND CLAUDIO LILIENFELD 
DEPT PLEASE PASS TO EEB PETER HAYMOND AND BRENDA HAENDLER 
 
E.O. 12958: N/A 
TAGS: ENRG EINV ECON IN
SUBJECT: CAN ULTRA MEGA POWER PROJECTS RE-KINDLE U. S. INTEREST IN 
POWER GENERATION IN INDIA? 
 
REF: 2006 New Delhi 6313 
 
MUMBAI 00000077  001.2 OF 005 
 
 
Summary: 1. (U) The Indian Power Ministry is touting the 
attractiveness of ultra mega power projects (UMPPs) of 4,000 MW 
of station capacity at a single location.  The government is 
taking the lead role in obtaining the necessary clearances, 
land, domestic fuel linkages, and an assured market for these 
projects to boost investor confidence and reduce risk 
perception.  Despite this, there has been muted foreign interest 
in UMPPs.  Our interlocutors engaged in the Indian power 
industry cited payment security concerns as the main factor 
deterring foreign participation in UMPPs.  A relatively low 
return on equity (ROE) on the projects, and imported coal 
linkages, were other concerns cited as possible reasons for the 
low foreign interest.  Nitin Johar who works for Tata Power's 
UMPP at Sasan dismissed many of these concerns.  He pointed out 
that UMPPs have three layers of payment security built into all 
their power purchase agreements which assure prompt and regular 
payment.  He also claimed that the ROE from UMPPs is much higher 
than commonly perceived.  Despite Johar's claims, reported 
problems at Reliance Power's Sasan UMPP will hardly inspire 
global confidence to invest in an industry that is still haunted 
by the Dabhol debacle.  End Summary. 
 
Power Shortages Compel Promotion of Large-scale Projects 
-------------------------- 
 
¶2. (U) Currently, India has an installed capacity of 140,000 MW 
of power.  The country's per capita consumption of electricity 
is around one-sixth of the world average.  In addition, India 
suffers from a 12 percent power shortage during peak hours and 
analysts estimate that a doubling of power generation capacity 
is needed within the next six years to sustain an annual GDP 
growth rate of 7-8 percent. 
 
¶3.  (U) To address the country's crippling power shortages, the 
federal Power Ministry has promoted large-scale power projects 
of 4,000 MW station capacity at a single location.  These ultra 
mega power projects (UMPPs) are expected to generate cheaper 
power of around three to four cents per kilowatt-hour as against 
the current average cost of nearly seven cents per kilowatt-hour 
of power.  At the same time, they can meet the power 
requirements of a number of states through the transmission of 
generated power on regional and national power grids.  Spread 
across India, they will be located either at the pithead (near a 
coal mine) of an assigned coal block, or along the coast to 
facilitate easy coal imports. 
 
¶4. (U) The UMPPs, implemented through 
Public-Private-Partnerships, are to be awarded to a private 
domestic or foreign developer through a tariff-based competitive 
bidding process based on the lowest tariff quoted.  The 
government's initial participation in these projects is aimed at 
enhancing investor confidence, reducing risk perception and 
ensuring favorable private sector participation.  In the 
preliminary pre-bidding stage, shell companies formed to 
implement the UMPPs work under the government-owned Power 
Finance Corporation to obtain all clearances and will acquire 
land for the project.  Around 27 clearances are needed before a 
power project can be commissioned.  In addition, the shell 
companies draw up power purchase agreements with the power 
distribution licensees of the states that will procure power 
from the completed projects.  This ensures that the successful 
bidder has an assured market to buy power at the tariff quoted. 
 
Perception of Payment Risk Deters Foreign Investors, but UMPP 
Operator Says Perception is Unjustified 
----------------------- 
 
¶5.  (U) Power Ministry Director Sanjay Chadha, at a recent 
 
MUMBAI 00000077  002.2 OF 005 
 
 
seminar in Mumbai, claimed that since UMPPs guarantee reliable 
fuel supply, timely environmental clearances, and payment 
security, foreign investors will flock to bid for the projects. 
However, contrary to government expectations, there has been 
limited foreign interest in these projects.  So far, three UMPPs 
of the planned 10 have been awarded and all have been secured by 
private domestic companies.  Tata Power was awarded the Mundra 
project in Gujarat and Anil Ambani's Reliance Power secured the 
Sasan project in Madhya Pradesh and the Krishnapatnam project in 
Andhra Pradesh. 
 
¶6.  (SBU) Chetan Modi of Moody's who was earlier engaged in the 
Indian power sector believes that foreign investors, haunted by 
Dabhol, will never venture into the power sector in India.  Most 
power distribution companies who buy power are still state-owned 
and operated, and are not financially sound, he continued.  The 
risk of payment default for power is therefore very high, 
especially since the UMPPs are not backed by a sovereign 
guarantee, Modi maintained.  Ramya Venkataraman from McKinsey 
pointed out that the federal government had helped state-owned 
electricity boards pay off their outstanding dues to 
government-owned National Thermal Power Corporation and Coal 
India in 2000-01, even though it had not provided a sovereign 
guarantee in these cases.   Nitin Johar, the Associate Group 
Head - Finance of the Coastal Gujarat Power (the company 
implementing Tata Power's Mundra UMPP), stated that the federal 
government will never guarantee any project after the Dabhol 
controversy.  Contradicting Modi's belief of a payment default 
risk, Johar pointed out that the power distribution companies of 
Gujarat, Maharashtra, Haryana, Punjab, Andhra Pradesh, 
Karnataka, Chhattisgarh, Delhi, and Kerala, currently pay for 
procured power on the first day of billing.  He explained that 
the power industry has an in-built reward system for timely 
payment.  State Electricity Boards (SEBs) and private power 
distribution companies get a 2.25 percent discount on monthly 
billing in case of early payment (before 30 days).  This works 
out to an annualized discount of 26 percent which is a 
significant early payment incentive, he added.  Power providers 
are assured of prompt and timely payment and so are willing to 
offer this monthly discount, he continued. 
 
Three Layers of Payment Security Built into Power Purchase 
Agreements 
----------------------- 
 
¶7.  (U) Johar also explained that there are three layers of 
payment security built into the power purchase agreements 
between the UMPP provider and private or state-owned power 
distribution licensees (procurement companies) of the states 
buying power from the project.  First, the power distribution 
companies have to provide the UMPP provider with a rolling 
letter of credit of 1.1 times the projected monthly billing.  In 
case the distribution company does not pay within 30 days, then 
the UMPP provider can draw this letter of credit and secure 
payment for the first month of payment default.  There is also 
an escrow account establishing irrevocable claim of receivables 
of power distribution licensees, he continued.  All incremental 
receivables of these distribution companies over their operation 
and maintenance costs, flow into this account and can be 
accessed in case of a default.  According to Johar, this default 
escrow account mechanism blocks the company's cash flows and 
"forces" them to pay.  (Comment: The escrow account mechanism 
enables a direct transfer of funds owed by the power procurement 
company to the power provider.  As the defaulting power 
procurement company has no control over the escrow account, this 
mechanism prevents a Dabhol-like situation from re-occurring 
where the Maharashtra State Electricity Board refused to pay for 
the Dabhol power.  End Comment).   Finally, if the owed dues are 
not cleared within 90 days, the UMPP provider can sell 75 
 
MUMBAI 00000077  003.2 OF 005 
 
 
percent of the electricity that is otherwise supplied to the 
defaulting distribution licensee to third parties, including 
industrial consumers.  UMPP providers can sell this power at a 
much higher tariff and can actually earn more money if the 
default persists, Johar noted.  Ron Somers, the President of the 
U.S. Indian Business Council, said that while the open access 
system of selling power to third parties looks good on paper, it 
has never been tested.  He also pointed out that the three-tier 
payment security mechanism was implemented five years ago as 
part of the electricity sector reforms implemented to attract 
foreign investment, but foreign investors are still reluctant to 
invest in this industry. 
 
¶8.  (SBU) In a separate discussion, McKinsey's Venkataraman 
opined that the lack of foreign interest in UMPPs could be due 
to a misapprehension about the project's payment security 
mechanism.  "The perception of payment risk may deter foreign 
companies from bidding for UMPPs", she added.  Venkataraman 
agreed with Johar and claimed that domestic investors are 
"comfortable" with the level of payment risk associated with all 
power projects, not only UMPPs.    Sunali Rohra of McKinsey 
pointed out that while foreign companies are not bidding for 
power projects, they are still investing in the Indian power 
sector through infrastructure funds.  So they are therefore 
indirectly endorsing the viability of the project, she continued. 
 
ROE, Imported Coal and Ambiguous PPAs Are Other Obstacles for 
UMPP Investors 
------------------------------------ 
 
¶9.  (SBU) Udai Kotak of Kotak Securities (no relation to the 
company's founder) and Parag Baduni from IL&FS Investment 
Managers believe that UMPPs offer a 14-15 percent return on 
equity (ROE) (the after-tax profit of a company as a proportion 
of its equity, expressed as a percentage).  In contrast, 
merchant power projects (MPPs) can earn a 20-22 percent ROE by 
supplying power to the grid to meet peak load demand, they 
noted.  (Note: Merchant Power Plants are not tied to any power 
purchase agreement.  They compete for customers and absorb the 
full market risk.  In an energy deficient state, these MPPs can 
sell power when demand is highest to earn high tariffs.  End 
Note).  Johar however claimed that UMPPs can earn more than 
14-15 percent ROE, which he points out is the assured return for 
all negotiated power projects.  He maintained that UMPP 
providers take on more risk as the project is based on the 
lowest tariff quoted as against other power projects where the 
tariff is negotiated.  As UMPPs assume greater risk, the rewards 
necessarily have to be more than the assured ROE of 14-15 
percent, he argued.  (Comment: Although not explicitly stated, 
Johar's remarks indicated that the ROE for Tata's Mundra UMPP is 
estimated to be more than 14-15 percent.  End Comment). 
Operating MPPs have other risks like problems with coal 
sourcing, infrequent operation as power is not supplied on a 24 
hour basis, and transmission problems of connecting with the 
power grid, Johar continued.  McKinsey's Ventkataraman argued 
that MPPs were "small play" and "serious" power companies would 
prefer to venture into "big play" UMPPs. 
 
¶10.  (SBU) Kotak also noted that UMPPs run on imported coal need 
to have a dedicated supply source of overseas coal.  The price 
of imported coal factored into the price tariff quoted at the 
time of bidding for the project may be much lower that the price 
of imported coal when the project is commissioned.   Bidders for 
UMPPs based on imported coal therefore have to tie up a reliable 
coal source outside India before bidding to ensure a steady and 
reliable coal supply, he continued.  Many bidders are not 
equipped to buy mines or mining leases overseas, he added. 
Venkataraman concurred and added that if a bidder for an 
imported-coal fuelled-UMPP did not have access to a coalfield 
 
MUMBAI 00000077  004.2 OF 005 
 
 
and was dependent on the market price of coal, he was taking a 
huge risk. 
 
¶11.  (SBU) Manjushree Ghodke, the Deputy General Manager 
(Economic Cell) of Larsen & Toubro, stated that the 
government-drafted agreements that form the basis of the 
public-private-partnership for infrastructure projects, 
including power projects, often lack clarity.  These ambiguously 
worded agreements fail to inspire investor confidence, she said, 
and are responsible for the poor foreign participation in 
infrastructure projects.  She suggested that the government 
appoint a legal consultant to draft these agreements to make 
them user-friendly, clear and transparent. 
 
Environmental Clearance, Land Acquisition Bog Down Sasan UMPP 
---------------------- 
 
¶12.  (SBU) Johar told us that Tata's imported-coal based UMPP at 
Mundra in Gujarat will be completed nearly one and a half years 
ahead of schedule.  Work has already started and the project 
will be commissioned by March 2011 instead of the projected 
August 2012, he continued.  Reliance Energy's domestic-coal 
based UMPP at Sasan in Madhya Pradesh has not met with similar 
success.  The project had to be re-bid after global investor 
Globeleq Singapore exited and sold its stake in the project to 
its co-partner Lanco Infratech.  Anil Ambani's Reliance Power 
matched Lanco Infratech's original quoted tariff and secured the 
Sasan UMPP.  Tata Power had also bid for the Sasan UMPP but 
Johar stated that the winning tariff of INR 1.19 (around three 
cents) was "unrealistic" and admitted that "Tata would never 
have been able to match it."  (Note: Johar believes that 
Reliance Power had to secure the Sasan UMPP in order to obtain a 
"high price" for its initial public offering.  He claimed that 
the IPO was over-priced and noted that Reliance Power's 
projected energy capacity in 2012 will equal state-owned 
National Thermal Power Corporations current installed capacity 
and NTPC's shares are trading at around USD 5 as against 
Reliance Power's IPO price of USD 11.  End Note). 
 
¶13.  (SBU) The Sasan UMPP currently faces delays of 
environmental and forest clearances, and problems with land 
acquisition and allocation.  Johar told us that the project is 
located in the Singrauli coal belt of Madhya Pradesh where 
National Thermal Power Corporation already has several large 
power plants.  Environmental clearance is subject to incremental 
pollution caused by a new project, he pointed out, and the base 
level of pollution is already high in Singrauli due to the 
existing power plants in the area.  Johar however believes that 
land acquisition will be the bigger problem for the Sasan UMPP. 
So far no land has been acquired and media reports state that 
the government had even asked Reliance Power to reduce the land 
required for the project.  The government has touted the 
attractiveness of UMPPs by claiming responsibility for acquiring 
land and securing environmental clearances, but Johar admitted 
that despite these assurances, procedural delays are quite 
common. 
 
¶U. S. Equipment Too Expensive, Chinese Equipment Not IP 
Compliant or Without Adequate Capacity but Korean Equipment Just 
Right 
-------------------------- 
 
¶14. (SBU) Johar claimed that U. S. power equipment and 
technology is too expensive and is therefore unlikely to be used 
in a UMPP.  Tata Power is utilizing Korean technology for its 
Mundra UMPP.  Venkataraman's McKinsey, said that many power 
companies are considering using Chinese equipment for 
non-critical components of the power plants.  The move towards 
made-in-China critical power equipment may take another 4-5 
 
MUMBAI 00000077  005.2 OF 005 
 
 
years, she opined.  Johar, however, claimed that most Chinese 
power equipment suppliers were bound by technology transfer 
agreements so any sale to companies outside China was an 
intellectual property violation.   To get around the technology 
transfer agreement, these companies sell to Chinese shell 
companies who in turn sell to Indian companies, he added.  Johar 
also noted that the Indian companies who buy from the shell 
companies face a huge risk for if the shell companies are shut 
down for any reason then there will be no one to service the 
equipment and honor the contract.  There are a few Chinese 
companies who have their own technology but their equipment can 
be used only in smaller 600 MW power plants, he continued.  Tata 
Power is considering using this equipment for their smaller 
power projects but will not buy any "infringed" technology from 
Chinese suppliers, he maintained. 
 
Comment: 
------- 
 
¶15. (SBU) Public-private partnerships in ultra mega power 
projects were conceived to provide certainty to private 
investors and to reduce risk perception.  However, payment 
security for these projects, a cornerstone of power sector 
investment, still hinges on private and government-owned power 
procuring companies of different states adhering to the power 
purchase agreements signed with the private developer.  U. S. 
investors may be reluctant to place their faith on the 
state-owned power procurement companies given the financial 
crunch faced by most licensees and their poor track record 
(Enron, GE, Bechtel with Dabhol, and AES with Orissa).  Indian 
energy players, however, appear quite comfortable with the 
payment risk associated not only with UMPPs but all power 
projects.  The disparity between the two viewpoints indicates a 
possible lack of understanding or misperception about the 
current scenario in the Indian power sector and energy reforms 
implemented since Dabhol.  But as Tata Power Johar's said, you 
have to be prepared to face Indian terms and conditions if you 
want to invest in India.  End Comment. 
OWEN