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Huaneng Power International’s decision announced last month to invest in the controversial Three Gorges dam has been followed this month by a plan to acquire a stake in four Chinese power plants. The swift sequence of events lends credence to the perception that the company’s investment in the financially troubled dam is governed more by political considerations than economic common sense.

Huaneng, China’s largest independent power producer, is run by Li Xiaopeng, son of former Chinese premier and staunch champion of the Three Gorges dam, Li Peng. When Huaneng announced it will pay US$30 million for a 3-per-cent stake in Three Gorges Power – a spin-off company of the corporation building the dam that will seek a domestic listing next year – investment analysts were reassured by the small size of the holding. "If analysts are happy with the [Three Gorges] project, then why do they keep emphasizing the purportedly small investment size?" the South China Morning Post wondered earlier this month.

Other analysts speculated that Huaneng, which is listed on the New York, Hong Kong and Shanghai exchanges, was positioning itself in advance of the sell-off of some of China’s state-owned power plants – that it was prepared to lose a little money now in anticipation of gaining access to a treasure trove.

Angello Chan of Lehman Brothers investment house told the South China Morning Post that Huaneng would be rewarded for buying into the Three Gorges project despite expected low returns and fears that serious environmental, technical and human-rights concerns surrounding the project might deter some investors. (For an overview of the concerns, see A decade of the dam: 10 years, 10 problems.)

"If the cost for Huaneng in the China power market involves [Huaneng’s] decision to take a stake in the Three Gorges project, its overall rate of return could be compensated through other measures as we have seen in the past," Mr. Chan was quoted as saying. "Under current circumstances, [they could be] lower acquisition prices for State Power Corp. assets in the upcoming asset sale programme."

Beijing recently outlined a plan to split the State Power Corp. into small power companies and electricity carriers, to break the corporation’s monopoly on the generation and supply of power. The official Xinhua news agency reported last month that the power-sector reorganization is to be completed by the end of this year.

Huaneng Power International has agreed to pay US$400 million for stakes ranging from 44 per cent to 70 per cent in three power plants (one in Shanghai and two in Jiangsu province). It will also acquire the assets and debts of a fourth plant, in Zhejiang province. The deal "could signal broader moves afoot in China’s electricity industry," the Asian Wall Street Journal said. "For one thing, it marks a thaw in the government’s freeze on publicly listed companies acquiring power-generating assets."

The newspaper quoted Dennis Zhu, chief of investment banking in China for J.P. Morgan & Co., which was an adviser on the deal, as saying: "Before this transaction, there was not much movement – either buying or selling. It’s representative of major changes in that sector." Mr. Zhu contended that official approval for Huaneng’s recent acquisitions did not hinge on the Three Gorges investment.

Wall Street Journal reporter Peter Wonacott noted, however, that Huaneng’s power-plant transaction "followed a smaller deal [to buy a piece of the Three Gorges dam] that might have brought the company some government goodwill."

Reuters news agency says that while Beijing’s blueprint for market-oriented reforms has aroused some interest outside China, "a more foreign investor-friendly power regime may take years to implement."

"Overseas power firms have long been wary of moving into China, largely due to a murky regulatory climate and inconsistent tariff scheme that makes investment returns tough to predict," the news agency said. Citing reports that some local governments in China have breached tariff contracts signed with foreign power firms in recent years, Reuters quoted China utilities analyst Ingrid Wei of ING Barings as saying: “These kinds of risks are unlikely to be removed any time soon.”

Grainne Ryder, a power-sector analyst and policy director at Toronto-based Probe International (which publishes Three Gorges Probe) says investors should be nervous about power deals that rely on political whim. "In China, where the state is committed to protecting the market for its own pet power projects, such as the Three Gorges dam, and where the newly privatizing industry is driven by cronyism and state decree, private investors are going to be in the dark about the viability of their investments."

This is how U.S. power giants got into trouble during the past decade, she says: Companies such as Enron discounted the political risks associated with state monopoly deals that offered guaranteed risk-free revenues and later collapsed in financial and political turmoil. Enron’s failed investment in the Dabhol gas-fired power plant in Maharashtra, India, is a case in point: Enron has seen none of the $26 billion it was guaranteed in return for its initial $3-billion investment regardless of how much power the state power authority could actually sell to its customers.

Then there were the billion-dollar power deals made by U.S. companies such as Mission Energy and General Electric Co. with friends and family of Suharto in Indonesia that came unstuck when the new Indonesian government reneged on the overpriced power-purchase contracts.

"Investors see state power plants coming up for sale in China and they’re attracted – they want to be on the inside track – but they should beware the risks," Ms. Ryder cautions. "The experience in Asia is clear: Political deals can quickly turn to dust and are no substitute for clear rules and market-based investment decisions."