Despite a growing demand/supply gap in the natural gas market, Indian average gas prices have remained stubbornly low due to rate controls in the fertilizer and power sectors.

"The state is preventing gas producers making the most of demand in India. National Thermal Power Corporation, for instance, is refusing to pay a BG India-led consortium higher rates for gas from the Panna-Mukta-Tapti fields, although there are specific contractual reasons for this," says a foreign banker. According to the source, BG India is attempting to charge all its customers $5.15 per million BTU, currently the highest rate for gas in the India market.

LNG projects, with higher operational costs than domestic gas plays, are therefore having to be particularly cautious about prices paid for gas destined for sale in India. Bankers have already noted that Shell sold its first supply of gas from its new Hazira terminal at a loss. Conversely, Petronet (currently the only other LNG importer) has fared better and sourced supply from Qatar's RasGas at $2.53 per million BTU. The delivered cost (transport included) is about $3.2 per million BTU. Factoring in Petronet's own profit margin, the company has been able to secure profit making contracts for all its current throughput.

Petronet is thus ploughing on with its two LNG projects, the expansion of the Dahej LNG terminal to 10 million tonnes per year and the greenfield receiving terminal at Cochin, which will have an initial capacity of 2.5 million tonnes. Prosad Dasgupta, director of finance at Petronet, expects tenders for the chartering of additional LNG tankers, and the EPC contracts for both projects, to be awarded by September. Dahej and Cochin are scheduled to be commissioned in June 2008 and March 2009, respectively.

Dasgupta also confirms that supply for the Dahej expansion will come from RasGas, the Qatari exporter. But the all important question of price, has still to be negotiated.

Competition to LNG

LNG importers are facing increased competition from domestic sources. The discovery of new domestic gas reserves in the KG basin and the decision to bid out fields to the private sector will lead to a surge in domestic production. Reliance Industries (RIL), recently received approval to begin production of natural gas from its field in the Bay of Bengal. "The company plans to initially produce about 40 million cubic metres per day," says a banker, "but its not yet clear when first production will reach consumers."

Petronet aside, it is unlikely that further LNG import projects will emerge in the near term, because of both this competition and uncertainty over prices. But while LNG importers are likely to be discouraged by market conditions in the short term, the medium- and long-term outlook is much more promising. "Apart from the long-term demand/ supply outlook, the cost of competing fuel sources, notably coal, is increasing with new environmental regulations. Building new coal-fired power plants in the western half of the country is already uneconomic because of the cost of hauling coal from the main deposits found in the eastern half," says Rajat Misra, assistant vice president, project advisory and structured finance at SBI Capital Markets.

Misra adds that domestic upstream projects are being funded in the normal manner, with equity and corporate funds rather than project debt. BG India and its consortium partners, Oil and Natural Gas Corporation and RIL, for instance, are putting forward approximately $500 million for development and expansion of the Tapti gas field, offshore Mumbai.

But a source in Singapore says both international and domestic banks have RIL's pipeline projects in their sights. In April, the State of Andhra Pradesh granted RIL permission to lay natural gas pipelines between Hyderabad and Goa. "The company has drawn up plans to lay pipelines in other parts of Andhra Pradesh and eventually the rest of the country, following on from the discovery of gas in the KG basin," says the banker.

International lenders are regular providers of corporate debt to Reliance Industries, which is not expected to seek non-recourse debt for the pipeline assets. ABN Amro, BA Asia, BTM, Calyon, DBS and HSBC are currently in the market with a $250 million, five-year term loan for the company. The borrower comfortably raised $350 million in March through another five-year facility that was led by ABN Amro, BTM, Calyon, DBS, ING Bank and Standard Chartered. The loan carried an all-in yield of 90bp over Libor or Euribor.

In contrast, most of Petronet's funding needs for the $225 million Dahej expansion will be met by the domestic debt capital markets, says Dasgupta, although he expects a residual portion to be funded by Indian banks. The company had considered a two-stage bond program worth IRP11 billion ($255 million) in late 2004, to repay the loan funding the Dahej project's first phase.

Dasgupta would not be drawn on why the bond program has been delayed, but he says the issue is now planned for late this year. Dasgupta expects the ADB to provide a $67 million credit enhancement guarantee for the bond.

Power constrained

An expanded menu of gas supply alternatives is welcome news for the power sector. Many existing gas-fired power projects are currently unable to operate at full capacity because of fuel constraints. Indian financiers say some plant utilization rates have fallen below 60% for lack of fuel. Worse, a large number of generation projects have not been able to reach financial close due to gas supply concerns. Another source adds that key lenders, including Power Finance Corporation and ICICI, will be increasingly cautious about funding gas-fired power projects until new supply starts flowing.

Difficulties in securing gas have added to power shortages. To alleviate a power crisis in one particular state, Maharashtra, the government is working to find a resolution to the ongoing dispute surrounding the Dabhol power and LNG project. The plant and LNG terminal have not been operational since May 2001, when the Maharashtra State Electricity Board (SEB) stopped buying power from the project, after a dispute with Dabhol Power Company (DPC) over electricity tariffs.

But domestic lenders are now expected to seal a settlement with international lenders in the next two to three months, whereby GAS and Power Investment Company (GAPIC), an SPC set up by the Indian lenders to Dabhol, will buy out the foreign debt, which stands at approximately $600 million. DPC's domestic creditors include the Development Bank of India, State Bank of India and ICICI Bank, with domestic loans to the project totaling $1.3 billion.

The Indian government has facilitated the plan by approving a guarantee to domestic financial institutions to give domestic lenders greater comfort. One banker says international lenders have agreed to take a haircut of about a quarter of their original loan volume, but this was not confirmed by banks involved in the negotiations. GAPIC is expected to pay off the offshore loans by issuing bonds.

But while the take out of foreign debt would be an important step in the overall restructuring process, another key hurdle has still to be overcome before the project can be restarted, relating to the equity claims of General Electric and Bechtel, who now own 85% of Dabhol Power Corporation.

Assuming General Electric, Bechtel and the creditors can all agree a final settlement, DPC will require a small additional loan to fund its remaining capital expenditure needs. This capex relates to the power station's second phase and the 2.5 million tonne per annum LNG import terminal. The source says loan agreements could be concluded this year, assuming a restructuring package is in place in the next few months. SBI Capital Markets is advising the government on the debt restructuring.

Dabhol and other power projects will rely on local banks and development agencies for the vast bulk of their bank debt requirements. "Indian institutions are very competitive right now for all sorts of projects, not just power plants," says one international banker. "We hear of institutions agreeing to underwrite $500 million plus deals by themselves in order to lock others out. Domestic financial institutions are all the more competitive in the power sector, because of their relatively aggressive stance on projects with SEB [State Electricity Board] offtake."

The Jammu and Kashmir Power Development Corporation is currently seeking an IRP17.7 billion loan from domestic institutions for the 450MW Baglihar Hydro-electric Power Project in Jammu and Kashmir's Doda region. Nine banks and agencies including the Power Finance Corporation, the Rural Electrification Corporation, Union Bank of India, Central Bank of India, Indian Overseas Bank and Canara Bank are said to be participating.

Foreign debt take out

Although foreign banks are showing greater interest in Indian projects, no institution has participated in an Indian project loan in recent years. Instead, foreign loans have been gradually taken out by local debt. SBI Capital Markets, for instance, recently acted as lead arranger in a refinancing for ST-CMS Electric Co, which runs a 250MW, lignite-based power project at Neyveli (ABB is 50% shareholder in ST-CMS). "The original Euro loans were replaced by local currency loans leading to an improvement in all-in financing costs for the borrower," says Misra. Bank of America, ANZ Grindlays and ICICI were the arrangers of the original financing.

The creditworthiness of the SEBs remains an issue even for state owned Indian financial institutions. Therefore, there is particularly heavy competition amongst banks for projects that have offtake agreements with the stronger SEBs or with other types of offtaker. Both IPP sponsors and banks alike are looking for opportunities to do business with the privatized distributors. Misra notes that SBI Capital Markets is advising the government in the bid process for one such project, the 1,000MW Bawana project in Delhi. "The process of selecting a developer and finalizing all the necessary regulatory approvals will probably be completed in six to eight months and then financing discussions can begin," says Misra. Delhi's distribution system is one of only two fully privatized distribution systems in the country (the other being in the state of Orissa).

CLP Power Asia, one of the only foreign sponsors actively pursuing new projects in India, has also set its sights on projects within the privatized distribution market. "There are a number of greenfield schemes which we could participate in on a joint-venture basis. But these are mostly in the early development stage," says Richard McIndoe, managing director of the company.

New fuel – new power

McIndoe says the 2003 Electricity Act has boosted investors' confidence in the Indian electricity market as power producers now have greater flexibility to wheel power around to stronger offtakers. Encouraged by the Act, CLP Power Asia is not ruling out new projects with the State Electricity Boards, but is currently in the midst of planning for the expansion of its wholly owned, combined cycle, GPEC (Gujarat Paguthan Energy Corporation) facility. "We are planning to add 1,025MW to the power plant and will be looking to finance the project later this year," says McIndoe. The financing amount is expected to be between $400 million and $500 million. Construction is slated for early 2006.

Before CLP Power Asia approaches the bank market, the company needs to finalize equipment procurement and fuel supply arrangements. McIndoe would not specify which energy companies GPEC is in discussions with, but comments: "the emergence of new fuel supply alternatives is making this part of the planning process easier."

For long-term strategic reasons, foreign banks have been encouraged by their top management resuscitate their lending activities in India. Most foreign investors in the country's power market are expected to request at least a token foreign bank presence in their funding arrangements, particularly if they still depend on the SEBs for offtake. "Foreign sponsors are not going to want to rely on state-owned Indian banks in a dispute with a State Electricity Board. I expect foreign banks will therefore be involved in some deals."