Many Indian power projects have attracted attention in recent years - mostly for the wrong reasons. Not Dabhol II. The financial close of the deal - sponsored by Enron, Bechtel and GE Capital Structured Finance - could herald the beginning of a raft of other independent power project (IPP) financings in India.

Phase II was one of the world's largest IPP financings last year and India's largest non-recourse financing. The financing of Phase II also marks a coming together of Indian financial institutions, Belgian and Japanese export credit agencies and a host of commercial banks in what was the largest cross-border transaction to be executed in India  - the $1.082 billion in debt was the largest external commercial borrowing sanctioned by the Ministry of Finance to date and the 2,184MW plant marks the financing of the largest gas-powered IPP in the world. 

The deal also took India into the league of liquiefied natural gas (LNG) importing countries and demonstrated its ability to support LNG projects. Furthermore, the project had the distinction of being the first LNG terminal financed on the basis of multiple suppliers of LNG: a 20-year agreement with the Oman LNG company to buy 1.6 million tonnes of LNG per year and 480,000 tonnes more from Abu Dhabi Gas Liquefaction under a separate 20-year deal.

Enron International's chairman and chief executive officer Joseph Sutton says of the project: "It was a truly remarkable accomplishment. The project clearly demonstrated Enron's and India's ability to support large infrastructure projects. Financial close of the second phase also realized one of Enron's key goals - that of bringing natural gas to the West Coast of India."

Enron's example should help other IPP's in gaining a better understanding of how to evaluate risks, structure deals and get to grips with regulatory issues. "How many companies would have offered to build a hospital in the area, increasing its public relations and community activities, and the patience to park someone outside the ministry until the work got done," says Ines da Silva, vice-president in the project finance department at Citibank.

Financial close of Phase II took just over a year, quite an achievement given the withdrawal at that time of US Exim due to American sanctions in the wake of nuclear tests carried out by India. Enron, as it has done throughout the deal process, responded quickly and innovatively by sourcing a part of the equipment from Japan and Europe. US Exim's loan was replaced by a $433 million loan from Jexim/MITI and $91 million from OND, the Belgian ECA.

Raj Pande, a partner and head of White & Case's India practice in Singapore, which advised the senior lenders and export credit agencies on the deal, says: "The speed with which financial closure was achieved can only be described as breathtaking, this was despite political and economic tremors being felt across Asia and India which created a lack of confidence among the financial community on lending to emerging markets as a whole. Phase II's completion has been positive not just for Enron, but for power developers throughout the region; it has boosted confidence in the marketplace for project financing and syndicated loan transactions as a whole."

Although many may regard Phase II as a single project, it is in fact four separate projects rolled into one including: a 1,444MW power plant; a 5mmtpa regasification facility; construction of a 135,000 cubic metre LNG vessel; and the development of associated port facilities including fuel jetty, navigation channel and breakwater. As expected the hurdles and challenges for such a complex deal were numerous and included changes to the original banking consortium, contentious inter-creditor issues, negotiations on voting rights, project insurance and LNG vessel financing complications, to name but a few.

Enron intended to use ABN Amro, Bank of America and CSFB for Phase II, but market conditions and Bank of America's merger with NationsBank forced change. Bank of America wanted to reduce its exposure in emerging markets and subsequently pulled back to a co-arranging role.

Also, due to the limited appetite of foreign banks for emerging market risk at that time, the $497 million uncovered offshore tranche had to be raised as a club deal. However, a wide cross-section of banks joined the deal confident in the sponsors, particularly Enron.

Although US dollar funding was in short supply, India's legions of overseas residents came to the country's rescue and pumped in billions via the Resurgent India Bonds scheme. This boosted dollar coffers of Indian banks. The State Bank of India and Canara Bank were able to lend US dollars for the first time to a project finance venture in India; a total of $225 million was sanctioned.

Among its many innovative funding features was the split into two stages of the commercial funding. About $145 million was raised in a pre-financial close syndication which was conducted by CSFB and this considerably improved the prospects of the subsequent general syndication.

Raising the funding was a challenge. But what surprised market observers was the competitive pricing obtained by Enron for these funds. As Sanjay Bhatnagar, CEO, Enron Pvt Ltd in Bombay says: "Overall we were happy with the financial package, the cost of debt was competitive, the OND loan came in at 5.66%, and Jexim's loan at 5.85%, this reflected the project's sound fundamentals and proper structuring. The key lessons we took away from Phase II were that structuring the project well and having sufficient flexibility to deal with externalities was essential."

The deal also involved financing the tanker for shipping LNG from the Middle East to Dabhol. While lenders viewed LNG vessel financing as asset-backed financing, deploying an LNG vessel to another project was not easy due to highly limited spot trades in the industry. Concerns about payment security for the lenders therefore needed to be addressed to ensure uninterrupted fuel supply to the project.

Ravi Suri, head of structured finance at ABN Amro in Delhi says: "As the project was based on LNG, a payment security mechanism had to be structured because this was the first time that LNG was being supplied to a sub-investment grade country. Historically, LNG sales have been to state-owned entities in creditworthy countries like Japan and South Korea."

Insurance for the project had to cover both the consultation and operations period, insurance cover during the operations period was again a first in India and resolved by the sponsors organising re-insurance for both periods. ABN Amro's Suri says: "The challenge here was that international banks could not take risk on Indian insurance companies. They needed to go to reinsurers which complicated the deal. Although a precedent did exist for obtaining this 'cut through' for the consultation period, obtaining the same for the operating period was done for the first time in India."

Numerous inter-creditor issues also had to be resolved. The two phases of the project had to be integrated as one with a common security package. Phase II structuring demanded lenders in both phases to be packaged as one group, they had therefore to become comfortable in sharing collateral and receiving equal ranking in the security package.

However, offshore lenders for Phase I had a Government of India counter-guarantee which they did not want to share with Phase II lenders. Phase II was financed on the basis of an escrow from the Maharashtra State Electricity Board (MSEB) backed by a State Government of Maharashtra guarantee. However, Maharashtra's status as a creditworthy state, and standard termination rights clauses in the contract forcing the state government to buy the plant in case of payment default, brought comfort to lenders.

Phase I lenders were also taking construction risk on Phase II, a mitigating factor in this case, was the benefit of lower tariff-based LNG after completion of Phase II.

Another potential hurdle was how to ensure existing lenders from Phase I had the same voting rights in Phase II. Complications arose because US dollar lenders were to be repaid earlier than rupee lenders, which meant that during the first eight years, as outstanding US dollar lenders' loan balances fell, their voting rights also diminished.

But as Raj Pande says: "All these issues were resolved amicably through negotiation and understanding of each others' viewpoints, the project succeeded because everyone had a common goal and pulled together."

Not every project can be a Dabhol, so where does India go from here and what can the government do to instill greater confidence in international investors?

The experience of the last six years is now embodied in the following government reforms designed to streamline procedures and ensure tighter management of state finances. Many of these intiatives are being implemented and include structural reforms of SEBs. The SERC (State Electricity Regulatory Corporation) has been created as an independent body to set power tariffs, making the process less political, while a strong and independent regulator is expected to instill greater confidence in investors.

International competitive bidding on the basis of lowest tariff is also being introduced for state-based projects together with a 10-year tax holiday and duty free import of capital equipment.

A mega-power policy initiative will come into force for thermal projects above 1000MW and hydro projects above 500MW. The Indian government will obtain all project clearances and permits for these projects on behalf of promoters. These larger projects are expected to benefit from economies of scale and incentives, meaning lower tariffs for the consumer.

A bankable security package has also been promised. The Power Trading Corporation (PTC) has been set up to buy power from IPP's and then sell that power to state electricity boards (SEBs). A tripartite agreement between the Reserve Bank of India, the PTC and the state government will be signed, ensuring payment to the PTC by the SEBs.

The World Bank has funded projects in Orissa State to push forward the privatisation of transmission and distributions a major step towards Western-style efficiencies. The process is now being replicated in other states.

Jagannatha Kumar, of ICICI is upbeat about developments and future prospects. "The success of Phase II financing of Dabhol has certainly catalysed activity in the sector," he says. "Since then, ICICI has achieved financial close for one more project, with more to follow. While the Central Government is playing a facilitative role in resolving impending problems, further success will be a function of how each state can address issues relating to the health of SEB's and offer adequate comfort to lenders and investors."

Confidence has also risen among international observers after the Neyveli project, one of the seven fast-track power projects, achieved financial close in November 1999. "Achieving financial close on Phase II and Neyveli, should give encouragement to other sponsors. It demonstrates that these transactions are capable of being closed as international banks have managed to find a solution to the variety of structural problems thrown up by these deals in India," says Bimal Desai, a partner in Allen & Overy's Major Projects Group.

The key problem in India remains unsolved - until consumers are encouraged to pay an economic price for the electricity they consume, and receivables due from the sale of power are aggressively collected, the SEB's will continue to bleed. No amount of creative structuring by lenders will solve that problem.

However, change is coming and lessons learnt from projects such as Enron's are being turned into value-adding policy initiatives: proposals for securitization of SEB power receivables are under consideration. At present such receivables at present total more than Rs21,000 crore ($3.3 billion).

Indian financial institutions have come a long way in limited recourse financing in the last four years. In a scenario where projects were taking a long time to close, financial close of this project, despite its complexities, is considered a major milestone for the Indian project finance business in general, and for the power sector in particular.