ST-CMS ENERGY PLANS TO PURSUE ARBITRATION IN ITS

UNCLAS SECTION 01 OF 02 CHENNAI 001200

SIPDIS

SENSITIVE

SIPDIS

STATE FOR EB/CIP
USDOE FOR DAS DAVID PUMPHREY, TOM CUTLER
USDOC FOR MAC/ANESA/OSA/ASTERN/LDROKER
USDOC FOR USFCS/OIO/ANESA/JMATHESON/BORRE
USDOC FOR TD/AS/AC/BLOPP
DEPARTMENT OF ENERGY FOR TOM CUTLER, MIRIAM SALERNO

E.O. 12958: N/A
TAGS: EINV ENRG ECON PGOV IN
SUBJECT: ST-CMS ENERGY PLANS TO PURSUE ARBITRATION IN ITS
DISPUTE WITH TAMIL NADU ELECTRICITY BOARD

REF: 05 CHENNAI 02705 AND PREVIOUS


1. (SBU) SUMMARY: U.S. company ST-CMS Energy plans to
immediately begin arbitration proceedings to seek to resolve
its dispute with the Tamil Nadu Electricity Board (TNEB)
over the final capital costs of its 250 megawatt power plant
in Neyaveli, Tamil Nadu. This case is an unresolved legacy
issue, which Embassy and Consulate General Chennai have
raised many times with the GOI and the Tamil Nadu state
government. ST-CMS's decision to resort to arbitration will
not help the GOI's recent efforts to attract new foreign
investment in its power generation sector. END SUMMARY

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TNEB AND CEA CALCULATE LOWER CAPITAL COSTS
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2. (SBU) Mr. C.K. Lakshminarayanan, CEO of ST-CMS Energy,
and Mr. K.M. Manoj, Director of Business Development for the
company, met with Post's Pol/Econ officer on June 2, 2006 to
discuss the company's planned next steps in its dispute with
the Tamil Nadu Electricity Board (TNEB). They began by
expressing their disappointment with the calculation of
final capital costs made by TNEB and also with the
calculation of final costs made by the Central Electricity
Authority (CEA). The CEA, a Government of India agency, had
been asked to review the TNEB calculation and provide their
independent recommendation on final capital costs. Final
capital cost as calculated by both TNEB and CEA were not
only significantly lower -- by $28.9 million and $31.2
million respectively, or about 10% -- than ST-CMS'
calculations, they were also lower than the provisional
capital cost that TNEB and ST-CMS had agreed upon in
November 2005. The provisional and final capital costs as
calculated by the three parties are as follows:

TNEB/ST-CMS Agreed Provisional - $281.6 million
TNEB Final Capital Costs - $268 million
CMS Final Capital Costs - $296.9 million
CEA Final Capital Costs - $265.7 million

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ST-CMS MOVES THE COURT TO PREVENT A REDUCTION IN TARIFF
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3. (SBU) Because the agreement on provisional capital costs
achieved in November 2005 had hiked tariffs paid by TNEB for
power supplied by ST-CMS from 0.05 cents to 0.07 cents per
kilowatt-hour unit, an immediate concern to ST-CMS was that
TNEB would seek to lower tariffs based on the new, lower,
final capital cost figure. Accordingly, on May 19, ST-CMS
filed with the Madras High Court to enjoin TNEB from
lowering tariff rates for power supplied by ST-CMS. ST-CMS'
presentation to the court was heard on May 23. TNEB has yet
to present to the High Court on the issue.

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NEXT STEP - ARBITRATION
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4. (SBU) Lakshminarayanan and Manoj shared with Post their
pessimism about achieving any positive results through
continued negotiation with TNEB. Lakshminarayanan said that
the project's sponsors had made the decision to pursue the
arbitration provisions that are included in the Power
Purchase Agreement (PPA). Lakshminarayanan described to
Post the arbitration procedures outlined in the PPA which
include two stages of arbitration. In the first phase, the
parties engage in an informal dispute resolution process.
Each party selects an official representative and the two
try to reach a voluntary agreement. If this informal phase
fails to produce an agreement, the process moves to binding
arbitration overseen by the International Chamber of
Commerce in London. There each party chooses a
representative and they jointly choose a third. The results
of this arbitration are binding. Enforcement of the result
is accomplished through a motion to the Madras High Court in
Chennai.


CHENNAI 00001200 002 OF 002


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ST-CMS FEELS THEY HAVE A STRONG CASE
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5. (SBU) Lakshminarayanan and Manoj told Post that ST-CMS
feels it has a very strong case and that it will prevail in
arbitration. They base that confidence on their belief that
both the TNEB and CEA calculations of final capital costs
were completed in direct violation of Clause 4 of Addendum
#3 of the PPA. That clause permits a more favorable
treatment of currency valuation fluctuations occurring
during construction of the project than the treatment TNEB
and CEA used in their calculations.

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BACKGROUND AND COMMENT
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6. (U) BACKGROUND: ST-CMS operates a 250 megawatt lignite-
fired power plant at Neyveli located 220 kilometers south of
Chennai, the capital of Tamil Nadu state in southern India.
The facility was built with an investment of US$ 300
million, with $100 million being held by the Michigan-based
CMS Energy and New Jersey based ABB Equity ventures. The
facility started operations in December 2002 supplying all
of its power ouput to Tamil Nadu Electricity Board (TNEB),a
state-run power utility with whom the investors entered into
a power purchase agreement. Differences with TNEB over the
computation of capital costs resulted in a backlog of
payments. After considerable advocacy by Consulate General
Chennai and Embassy in New Delhi, the payments dispute was
sorted out in September 2005, with agreement on Provisional
Capital Cost and with determination of Final Capital Costs
left pending.


7. (SBU) EMBASSY COMMENT: The USG has raised several times
with the GOI CMS's difficulties in its ST-CMS project and
its potential decision to seek arbitration, including most
recently:
-- Commerce Assistant Secretary Bohigian with India's
Ministry of Power Secretary Shahi in New Delhi, January 10-
12;
-- Embassy Economic Ministry Counselor Lee Brudvig Secretary
Shahi, March 26;
-- Energy Secretary Samuel Bodman with Power Ministry Shinde
(April 22); and
-- Ambassador Mulford with Planning Commission Deputy
Chairman Montek Ahluwalia (May 12).


8. (SBU) This case is one of the remaining "legacy issues"
that, as we have told the GOI, needs resolution in order to
improve foreign investors' perceptions of India's investment
climate, particularly in the electrical power sector, where
India's Ministry of Power has been conducting road shows to
promote its "Mega-Project" capacity construction plans. The
GOI Power Minister and Secretary have limited formal
jurisdiction in this matter and could only influence the
Tamil Nadu government and Central Electricity Authority.
END EMBASSY COMMENT.

HOPPER