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Monday, June 7, 2010

Pakistans ENRON - IRAN oil pipeline

Swaminomics declared last week that India must forget the proposed Iran-Pakistan-India gas pipeline because of the outrageously high cost of Iranian gas. Some readers have asked, “Why is Pakistan willing to pay the Iranian price, and go ahead with the project minus India?” 

Answer: The pipeline is going to become Pakistan’s Enron. It will drive Pakistan towards bankruptcy and be aborted, just as Enron drove the Maharashtra government towards bankruptcy and was aborted. 

Iran and other Gulf producers have long linked the price of gas to that of oil. This was acceptable for decades when oil prices, and hence linked gas prices, were subdued. But oil shot up from $14/barrel in 1995 to a peak of $150/barrel in 2008, and it is still around $75/barrel today. 

Iran and Pakistan have agreed on a gas price linked to 80% of the Brent crude oil price. This would have been fair in 1995 but not any longer as oil is up from $14/barrel to $75/barrel. 

In a recent interview with Newsline magazine, former Pakistan petroleum secretary Gulfraz Ahmed declared bluntly, “I am now appalled to know that the present negotiations are in the region of 80% of Brent crude.” He adds, “We need this gas urgently, but on the other hand, not at this price.” 

He recalls that his original negotiation in the 1990s was for a gas price of $2.05/mmbtu (million metric British thermal unit) from Iran. But the new gas deal implies a price of $8/mmbtu if oil is $60/barrel. If oil goes up to $100/barrel — very likely in the next year or so — the gas price will soar to $13/mmbtu. And if oil returns to its 2008 level of $150/barrel — entirely possible when the Iran-Pakistan pipeline is completed in 2015 — gas will cost a mind-boggling $20/mmbtu, or 10 times as high as originally negotiated in the 1990s. 

The cost of 5,000 MW of power to be generated from the gas will rise correspondingly. If oil costs $100/barrel, the linked gas price will translate into an electricity price of around Rs 7.50/ unit. Remember that Enron had to be closed when its price rose to just Rs 4.25/unit: the Maharashtra government said this would empty its coffers. 
When Pakistan begins generating power with Iran gas in 2015, oil could be as high as $150/barrel. If so, the corresponding cost of electricity will be Rs 11/unit. Producing power at that price will be economic suicide. 

Why has Pakistan got itself into such a trap? Well, don’t be surprised: many Indians still want to join this project. Politicians and strategy wonks can be so fascinated by projects with political appeal that they forget commercial sense. The Left Front is dying to join the project just to spite the US. Pakistan too has foreign policy wonks who see the pipeline as a way to kick the US and display solidarity with Islamic neighbours, oblivious of the suicidal cost. 

When Enron proposed its 2000 MW plant in India, this was seen as a fabulously strategic project, worth paying a premium for. At the time the state electricity boards were bust, and India had a terrible power shortage. In this energy desperation, the Enron project was grasped eagerly and cleared at record speed, notwithstanding warnings about the cost. Many hoped this strategic deal would open the gate for dozens more foreign investments. 

Fifteen years later, Pakistan also has a terrible power shortage. It too suffers from energy desperation, and so is eagerly grasping a massive power project based on Iranian fuel, ignoring warnings from its own experts about the cost. 

Gulfraz Ahmed mentions a third reason for Pakistan’s behaviour: lack of negotiating skills to understand the risks of a 40-year deal with an unfavourable pricing formula. This happened in Enron’s case as well. In both cases the negotiators failed to realize the risks of a contract linked to world oil prices (which could shoot up) and denominated in dollars (the electricity price shot up every time the rupee declined). 

Critics of Enron shouted “corruption”. More than 20 cases were filed against the project but all were dismissed by the courts — there was no hard evidence. However, many Indians remained convinced that money had changed hands because Indian politicians are so obviously corrupt. I predict that the Iran gas deal will also be widely condemned as corrupt in Pakistan once the high cost of electricity becomes patently obvious. 

Corruption charges are a distraction. The Enron fiasco was caused by a combination of energy desperation, incompetent negotiation, and fanciful notions of strategic importance. Pakistan faces a similar fiasco for the same three reasons.

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