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World Affairs








  Mihin's brand new plane through a web... Excise spotlight on Gymkhana Club

Central Bank hand revealed as oil hedge boils over

CPC Chief Asantha De Mel (second from right)
flanked by representatives of the banks involved
 in the hedging (inset) Mahinda Rajapakse,
Sarath N. Silva, A.H.M. Fowzie and Nivard Cabraal

By Sonali Samarasinghe

Even as allegations of massive cheating including personal benefits, all expenses paid trips abroad and bank jobs for relatives pummel the players in the oil hedging scam, Sri Lanka is set to lose up to a colossal 400 million dollars, over 15% of the country's foreign reserves, on what amounts to a government wagering contract that has left financial experts aghast.

The cost of the hedge exceeds the cost of the Norochcholai Coal Power Plant. Indeed it is money the cash strapped government can ill afford to lose. US$ 400mn can supply the entire country free fuel for 45 days; fund the war for three months; provide the entire population a monthly subsidy of Rs. 2300 for one year.

Erosion of Forex reserves

What is shocking, says one analyst, is that our foreign exchange is whittled down from US$ 3.5bn to US$ 2.5bn due to the intervention by the Central Bank to maintain rupee stability of which USD 1.16 billion is committed for Iran oil payments. He warns that if we lose USD 400 million, the US Dollar/Rupee rate may rise from 110 to 125.

As events unfolded earlier this month revealing no proper cabinet appraisal, CPC board appraisal of the hedge or legal advice had been obtained before the CPC plunged head first into the alleged payola, angry professionals lashed out at CPC Chairman and Managing Director Asantha de Mel for his part in the deal.

SC guns blaze

Last Friday the Supreme Court now emerging as the only beacon of justice and fair play in the country, struck again as it intervened in the oil hedging scam, declaring all hedging agreements signed without cabinet and board approval and without referral to the Attorney General, null and void.   

The Supreme Court was giving order in two Fundamental Rights Applications FR 535/2008 filed by Attorney At Law Kamal Gunasinghe and FR536/2008 filed by Attorney At Law G.G. Arulpragasam last Wednesday (26) respectively by Laugfs Chairman Wegapitiya and by Ven. Thiniyawala Palitha Thero, UNP MP Ravi Karunanayake and Ravi Jayawardene, legal coordinator of Corruption Watch - a body of professionals formed to combat bribery and corruption.

The applications inter alia called to suspend Asantha De Mel as chairman CPC, to reduce the price of petroleum and petroleum related products in keeping with global prices, and to prevent the CPC from making any payment to the banks on the hedging deals until the final determination of the case.

The apex court Friday held in both cases the petitioners' rights were violated under the constitution. The Petitioners were represented by Attorney Uditha Egalahewa.

Settlement attempted

Interestingly enough before court commenced Counsel for Minister Fowzie, Faiz Mustapha, PC was to suggest a settlement of sorts approaching Counsel and asking if the Petitioner would agree to waive interim relief as prayed for in the applications and send the matter back to cabinet where a formula can be derived. Gunasinghe's client had not agreed to the proposed settlement.

The Bench comprising Chief Justice Sarath Silva and Justices Sripavan and Ratnayake in the former application held that the Chairman of the CPC had acted illegally and willfully without any cabinet approval and also without any sanction from the board of directors of the CPC and without consulting the Attorney General or obtaining any other legal opinion. Therefore all agreements were held to be null and void.

Infamous press brief

Neither was the Chief Justice pleased about the infamous press conference called by Asantha De Mel on November 10 where he stated a default of any payments to the banks would be as good as a sovereign default.

"Even though the CPC has to pay this marginally higher price, the country as a whole does benefit from the lower world prices. CPC is committed to make the payments as and when they fall due. There is no question of defaulting on these payments. A default by CPC will be as good as a sovereign default, which could have serious consequences to the country and its growth prospects.," he said at a press conference convened by Standard Chartered Bank at the TransAsia Hotel.

 The foreign bank and its foreign CEO, Clive Haswell even sent out notices on SCB letterheads and went so far as typing out a statement to be read out by government official and CPC Chairman, Asantha De Mel. A turn of events so distasteful, in conflict and a violation of all norms it was not to go unnoticed by the Chief Justice.

Speech writing

CPC Chairman Asantha De Mel who was present in court Friday and represented by Ikram Mohamed PC admitted to court the media briefing was summoned by the SCB using their own letterheads.  

Irritated by the tenor of the threat and his comments that the government could not back out of paying the banks as it would affect the sovereign guarantee of the country, the Chief Justice summoned before him Asantha De Mel who was present in court. De Mel then admitted that not only was the conference convened by the SCB but that they had even prepared his press statement.

The court held De Mel was no longer suitable to hold the position of Chairman any longer and suspended him with immediate effect.

Judiciary as Executive

But the Chief Justice did not stop there. In what can only be termed a slight usurpation of the Executive role, he ordered Petroleum Minister A.H.M. Fowzie to be removed and another more suitable appointment made by the President.

Faiz Mustapha, PC representing Minister Fowzie was to say that the Minister was innocent and acted in good faith and that he had got legal advice to do so. The Chief Justice immediately pounced on this statement asking 'Who is the lawyer who gave this legal advice. Name the person so he can be dis-enrolled.'

Fowzie removed

However no names were forthcoming even as the Chief Justice was critical of the conduct of Fowzie, pointing out that Asantha De Mel was an appointee of Fowzie's and that the Minister knowing that his actions were illegal and wrongful still defended him in parliament.

The Minister being a responsible officer justified the conduct of De Mel and that cannot be condoned, the Chief Justice said. Therefore he declared, it was the wish of the Supreme Court in terms of Article 44 of the Constitution for the President to take over the Ministry and appoint a suitable minister.

Reduction of prices

Dealing with FR Application 536/2008 where he again held the rights of the petitioners had been violated the Chief Justice made order with regard to the reduction of oil prices. He observed that the various taxes attached are to cover up the losses of hedging and this loss should not be the burden of the public.

The court ordered the Secretary Treasury therefore  to temporarily take over the post of chairman CPC and to report back to court on December 15 with an account of what direct taxes are involved giving credit for that amount and ascertaining by what amount the price could be reduced. The court also observed the presence of UNP MP Ravi Karunanayake and directed him to help in arriving at a reasonable price for fuel in the context of the taxes imposed.

Timely judgment

While the Judgment comes at a time the public are crushed under massive petrol prices such judgments could have international repercussions for the government with a message that no deal signed with the government is safe from judicial intervention of the most drastic kind. Such judicial interference could result in an erosion of confidence in the investment and business market on the one hand but some analysts say it could also strengthen confidence in the system as contracts are tightly regulated and the possibility of graft rooted out.

Burden rolls away

But for Mahinda Rajapakse despite his bleats in cabinet last week that he will honour the agreements, a stark change from his protestations of two weeks ago, the judgment can come at no better time. Cash strapped and facing a depleted foreign exchange reserve Rajapakse will perhaps be secretly smiling.

Nivard master hedger

Be that as it may even as Asantha De Mel packs up his family photograph in a cardboard box and heads back home more details are emerging making it clear that the mastermind behind the disastrous hedging deals was neither De Mel nor the cabinet of ministers but rather Sri Lanka's wonder-boy and Governor of the Central Bank, Ajith Nivard Cabraal. Analysts say the hedge was akin to the CPC betting on a card pack where all the cards in their favour are removed from the pack.

De Mel is certainly not the only culprit in the deal as cabinet documents reveal, Sri Lanka's Central Bank, already in the eye of an economic storm and desperately seeking more foreign commercial loans, had a distinct hand in recommending the particular hedge to Cabinet.

Cabinet Memo

A Cabinet Memorandum was tabled early last year on January 13, 2007 by Petroleum Resources Minister A.H.M.Fowzie when crude oil traded at some USD 55 a barrel. The Paper was titled 'Introduction Of Oil Hedging For Maintaining Stability In A Volatile Global Oil Market.'

Approval was granted by cabinet on January 24 to the proposals in the final memorandum after consideration of the memorandum and the observations made by the Minister of Finance. What is important is that approval was granted as stated in the cabinet document, "to the proposals in the final paragraph of the memorandum to be implemented without delay as suggested by the Central Bank of Sri Lanka."  (See elsewhere for copy of cabinet approval)

In fact the Cabinet Memorandum was introduced four days after Central Bank Governor Nivard Cabraal by 'urgent' letter dated January 10, 2007 pushed the CPC to go for a hedging deal and that letter is damning.

This is what Cabraal wrote:

Dear Mr. De Mel

I refer to the telephone conversation I had with you yesterday, 9th January 2007.

As you are aware, the Central Bank of Sri Lanka was instrumental in promoting hedging as a means of purchasing petroleum and made a presentation to His Excellency the President and the Cabinet of Ministers on 6th September 2006. The Central Bank has also made available to the Ceylon Petroleum Corporation (CPC) certain technical details and options for hedging. However, we note that the CPC has so far not been able to enter into any form of hedging or other acceptable financing arrangement to ensure that Sri Lanka's petroleum bill will be at manageable levels in 2007.

As you may agree, petroleum prices have now reduced to about  US $55 per barrel, this may appear to be the opportune time to enter into suitable arrangements to hedge at least a part of our country's total requirements. Hence, in the interest of the national economy, I would urge you to take the necessary steps to ensure that expenditure on fuel prices will not cause undesirable effects on the macro-economy in 2007.

Yours sincerely,

Ajith Nivaard Cabraal

Indeed in Fowzie's Cabinet Memo last week dated November 17, 2008 he refers to the cabinet meeting of January 24, 2008 directing the CPC to engage in oil hedging 'keeping in  line with observation of the Central Bank.'

The cabinet therefore agreed to a zero cost collar instrument rather than a premium based hedge. UNP MP Ravi Karunanayake explains that this instrument incurs no cost to the country but the risks of a sharply falling price of crude had not been assessed correctly.

The issue is that while the CPC had received US$ 24.5 million from the banks on the hedging instruments on the upside - when the crude oil prices went up - it has so far paid out over US$ 38.5 million. The CPC will likely pay out up to over US$ 300 million to August 31, 2009 when the last of the several hedging contracts mainly with SCB and Citibank, but also with Commercial Bank, Deutsche Bank and People's Bank eventually terminate.


Under the zero collar hedge while there was a cap or restriction on the upside where the banks paid the difference up to 100,000 barrels, on the downside there was no cap but the CPC had to buy double the number of barrels, that is 200,000 barrels. Therefore even though the hedge according to De Mel was for one third of the country's oil requirements the way the Standard Chartered Bank had structured the hedge the CPC must buy double the quantity if prices go down.

UNP MP Dayasiri Jayasekera calls it absurd and lays the blame squarely at the feet of cabinet and the CB. 'Why didn't they ask to see a formula?' he queries.

Even though the Central Bank has commenced an investigation into the deals, sources say it's more of a red herring and does not absolve the regulator from liability as the contents of the Cabinet Memo squarely puts both the Central Bank of Sri Lanka and President Mahinda Rajapakse as Minister of Finance and Planning in the line of fire as movers and shakers in what could turn out to be the financial debacle of the decade.

Drastic drop

With almost a US$100 drop in oil prices from five months ago and prices poised to fall a further 15 percent at least despite oil producing countries deciding to reduce production to stem the sharp downward slide, it is now obvious that the Central Bank, Cabinet, Finance Ministry and the CPC lacked competence and dispensed with due process and due diligence as it waived aside legal and expert advise on the matter in its haste to sign on the dotted line.

Ironically it is now the banks that are laughing all the way to their vaults. The CPC hedging contracts were assigned with the Standard Chartered  Bank, Citibank, Commercial Bank, and on a smaller scale with Deutsche Bank and the People's Bank of Sri Lanka.

Clever dick

For President Rajapakse however CPC Chairman Asantha De Mel remains a 'clever guy.' By what yardstick Rajapakse makes this judgment call is not immediately clear but nonetheless it is the Chief Executive's opinion aired liberally at the cabinet meeting two weeks ago, despite the CPC grappling with an economic crisis worsened by CPC tomfoolery under De Mel's chairmanship.

The CPC now not only owes huge amounts in foreign exchange to the banks it is also facing an internal crisis. It had an outstanding Iranian credit line bill of US$ 433 million as at October 31. (See box) Despite mounting public and political pressure it is unable due to the hedging contracts to lower local fuel prices even though a barrel of crude sunk to US$ 46 last Friday.

According to Former CPC Chairman Daham Wimalasena the CPC currently has financial commitments amounting to over USD 2.18 billion. Wimalasena scoffs at hedging saying he would have gone for more long term solutions rather than a short term fix like hedging which in any event should not be a risk undertaken by a government corporation. There has to be a plan, he says. "We need to increase our refining capacity. We are now importing most of our requirement in finished form." Wimalasena calls it a speculative venture at best.

Meanwhile the two member CPC team that clinched these deals comprising CPC Chairman Asantha De Mel and Deputy Manager Finance Lalith Karunaratne claim to be experts on hedging having according to De Mel quoted in several media reports traveled globally studying the subject.  

They however failed to read the expert global reports on energy and deduce correctly market fluctuation. Neither did they bother to assess the massive risk involved in the deals. Experts say there are different varieties of hedges with the CPC opting for the riskier zero collar option when it should have if at all gone with the premium based hedge. But this again is a matter of opinion with many in the industry sharply divided on the issue. 

Nonetheless even as the war budget for 2009 exceeds Rs. 177 billion with no end in sight the armed forces and the police and STF owe the CPC as at September 30 a massive sum of Rs. 8.66 billion while Mihin Lanka alone owes Rs. 665 million. Moneys owed to the CPC by government departments including the Ceylon Electricity Board tally well over Rs. 64 billion.

It is in this backdrop that the country has to now look at the hedging deal. It is obvious that Fowzie as the line minister and Asantha De Mel as the institutional head are culpable to a large degree for the fiasco together with the CB which pushed the deal.

However UNP MP Ravi Karunanayake points out that the government cannot abdicate itself from responsibility. From start to finish the government was involved in this, Karunanayake says. "On the one hand they are pretending to give subsidies for political gain but on the other hand it is the public who have to make massive payouts. The government is trying to pin the blame on Asantha De Mel. But what about the cabinet of ministers themselves and the Central Bank?"

"It was in fact the CB that had recommended the deal be implemented without delay," Karunanayake points out.  

Amidst allegations of wrongdoing CPC Chairman De Mel summoned before a Parliamentary Committee on Public Enterprises meeting last Tuesday (25) had not been his usual arrogant self.

Sources say government ministers in COPE like Education Minister Susil Premajayanth attempted to lasso De Mel and absolve themselves from blame as cabinet ministers who approved the zero collar option.  

The COPE meeting last Tuesday proved to be interesting with many revelations being made by both the CPC Chairman, its directorial board, and the additional secretary to the Ministry of Petroleum resources who were all present.

Be that as it may the Governor of the Central Bank, Nivard Cabraal made a presentation on 'maintaining stability in a volatile global oil market' sometime in 2006. Following this presentation the cabinet of ministers decided it was a subject that needed further studying and a seven member committee including officials from the CB, Treasury, Petroleum Ministry and Ministry of Power and Energy were appointed. They submitted their report on hedging on November 16, 2006 to the then Treasury Secretary P.B. Jayasundera. The report recommended to use zero cost collar as the hedging instrument with the upper bound based on market developments.

The additional secretary of the Petroleum Ministry present last Tuesday admitted to a committee of parliament that this high level committee was briefed on the subject of hedges by none other than the banks themselves. This is a clear case of conflict of interest.

Following the committee report, Fowzie was to table the cabinet paper which was blindly approved by cabinet with not so much as a squeak or call for the CPC to come up with a mechanism or formula that could be reviewed. This rubber stamping only goes to show Sri Lanka is today governed by a bunch of nincompoops.

What is even more shocking according to what transpired at a committee meeting of parliamentarians last week is that when Chairman Asantha De Mel referred the matter to his board, sources say the CPC directors admitted they too blindly wrote away their birthright by handing over all powers to go ahead with the hedge to both Asantha De Mel and Deputy Manager Finance Lalith Karunaratne.

Upon being asked by parliament why the duo did not get approval for the hedging contracts from the Attorney General, De Mel had replied that the deals had to be done quickly and there was no time to refer the AG. However he said the CPC had referred the contracts for a legal opinion to a private law firm, Nithya Partners.

Absurd as this sounds CPC had in fact paid legal fees to a private legal firm for a legal opinion while it bypassed the AG's Department due to expediency.

Private law firm used

However Senior Partner of Nithya Partners Aritha Wikramanayake told this newspaper his firm had only been given the master document for its perusal, that is the International Swaps and Derivatives Association (ISDA) and had neither seen nor was shown the hedging document.     

   Be that as it may UNP MP Dayasiri Jayasekera was heard to tell De Mel, "Asantha you were a good cricketer but this isn't a ball game and what you did is not cricket."

Meanwhile bigger fishes were swimming away. Parliamentary sources said Central Bank Governor Nivard Cabraal had ducked a meeting with COPE last Wednesday scheduled for 2 pm. Cabraal had called at 10.45 am canceling the meeting stating he was held up at the Presidential Office.


A parliamentary source said COPE now under a new Chairman, John Seneviratne operates on an ad hoc basis with government officials calling up the Chairman at any time to cancel inquiry dates indiscriminately - a procedure called into question by many of the opposition members including UNP MP Dayasiri Jayasekera.

Meanwhile renegotiations with the banks were in progress with the government wanting fresh terms backdated to November 1, stating, they will pay at US$75 per barrel as opposed to the US $ 100. With oil selling at less than US$50 per barrel, the government will still take a hit of about US$25 per barrel.

At a press conference on November 10, Asantha De Mel vowed to restructure the hedging arrangements with all banks that have entered into hedging arrangements to mitigate losses arising from lower crude oil prices.

Hedging 30 percent

"We are hedging 30 per cent out of the total oil imported and have negotiated with banks to mitigate losses every three to four months and have not defaulted any bills to these banks," he said, adding that Sri Lanka's total oil bill is around US$ 3 billion and the drop in international market prices would definitely be an opportunity for everybody, which has made arrangements to settle all bills on time.

He said due to the volatile nature of market prices, CPC has hedged around 35 per cent of its exposure. The balance is open to the market at the current lower prices. As a result, for current imports, our average price is only marginally higher than the market price.

At this infamous press conference De Mel was almost speaking on behalf of the banks as he reassured the media that the risks have been fully explained by all the banks. 'Downside risks are also given in a table, where based on different scenarios, possible payments from CPC to the banks are highlighted.'

No mis-selling

"As a result there is no question of mis-selling of these products by banks," de Mel was reported as saying in the state media. "Since starting our hedging programme, the different banks have explained to CPC the various downside risks associated with each product and we entered into these deals with full knowledge of these risks," he said as reported in the state media. 

Asantha supports his banking buddies

Little wonder De Mel felt obliged to support the international bankers. CEO  Standard Chartered Bank, Clive Haswell and his wife Alison are close family friends. De Mel's daughter Stephanie landed a job as an intern at the bank at about the time these products were being sold.

The question is was this job nicked at about the same time negotiations were underway on the hedging deal. The job, sources say is in the bank's Global Markets area and Forex room, a highly restricted space where it is said the petrol hedge was developed.

There are allegations that Chairman De Mel and another official from the CPC travelled to Singapore and Dubai several times in first and business class comfort and that the tickets were not only purchased by the banks, the CEOs of the banks joined them during these visits abroad. The former of these facts De Mel had confirmed to the Parliamentary Committee as well.

Funnily enough De Mel recently claimed during a press conference that he traveled globally to learn about hedging.

As this copy went to press The Sunday Leader had already attempted numerous times to contact both Asantha De Mel and Nivard Cabraal but they were unavailable for comment or response. Later De Mel told this newspaper he did not wish to comment on any matter.

But if government officials acted as employees of the bank for alleged personal benefit then the big wigs of the banks were squeezing out deals in order to rake in the big bucks themselves in terms of bonuses and extras.

Just as we saw AIG senior management use bail out funds to treat themselves to luxury spa treatments in the US, personal bonuses and incentives have driven traders to take great risk and even place clients in harms way.

Unjust enrichment

Meanwhile some employees of the said banks on conditions of anonymity said that the losses from these contracts started to build up in July 2008 but the banks failed to inform the CPC and or allegedly colluded with the CPC resulting in the CPC not exiting in a timely fashion and the banks raking in extensive and unconscionable profits.

The bottom line is this. The CPC is exposed to a loss of USD 400 million with the last of the hedging contracts ending only on August 31, 2009. Meanwhile the banks are pressurising the government to ante up under the deals even as cabinet resists and fundamental rights applications have been filed in the public interest calling on the Supreme Court to prevent the government from paying the banks until the final determination of the case.

The government is faced with a catch 22 situation as it grapples with endorsing the huge foreign exchange payments - some 15% of the country's reserves by the CPC to the foreign banks or face international repercussions.

SCB and Citibank had hedged these instruments with the New York Mercantile Exchange (NYMEX) which is a usual practice. The banks will claim to be making only a small profit on the instrument as it had re-hedged the instrument with a third party.  Therefore any default by the government will be perceived as default of sovereign debt - a claim some analyst say is poppy cock. There is enough evidence to prove the deals were mis-sold, they say. The government must stand firm.

But now in the face of Friday's judgment at least for the moment the government has space to breathe.

Unjust enrichment:  How the banks made unconscionable
gains to the detriment of the public

(1) The hedge was one sided in favour of the bank. There was no floor price for CPC to protect the down side risk but it contained a cap on the upside to protect the banks' risks.

(2) Any benefits derived by the CPC would be paid for only two months whereas the CPC had to pay benefits for a period of 12 months.

(3) CPC has to pay for double the quantity hedged on the downside whereas the bank pays only for the hedged amount.

(4) No clauses in contract to limit the risks on downside movements of oil prices and no floor levels established in the contract to protect CPC in case of sharp fall in prices.

(5) This structure was a zero cost collar option. But some experts opine the banks should have paid an upfront premium to CPC for entering into such transactions.

What is a hedge?

Involves taking an offsetting position in aderivative in order to balance any gains and losses to the underlying asset. Hedging attempts to eliminatethe volatility associated with the price of an asset by taking offsetting positions contrary to what the investor currently has. The main purpose ofspeculation, on the other hand,is to profitfrom betting on the directionin whichan assetwill bemoving.

Hedgers reduce their risk by taking an opposite position in the market to what they are trying to hedge. The ideal situation in hedging would beto cause one effect tocancel outanother. For example, assume thata company specialises in producing jewellery andit hasamajor contract due insix months, forwhich gold is one of the company'smain inputs. The companyis worried about thevolatility of the gold market and believes that gold prices may increase substantially in the near future. In order to protectitself from this uncertainty,the companycould buy a six-monthfutures contract in gold. This way, if goldexperiences a 10% price increase, thefutures contractwill lock in a price that will offset this gain.

As you can see, although hedgers are protected from any losses, they are also restricted from any gains. Depending ona company's policies and the type of business it runs,it may choose to hedge against certain business operations to reduce fluctuations inits profit and protectitself fromanydownside risk.

To avoid the volatility of import prices of oil, CPC decided in 2007 to hedge a part of its oil imports against high and volatile prices. Like an insurance policy, hedging is used to protect against unexpected negative events. This does not prevent the negative event from occurring, but if it does happen and if it is properly hedged, the impact of the event is reduced.

Thus, hedging is not aimed at generating profits, but mainly protecting from losses that could arise from adverse price fluctuations.

Zero cost collar

Another type of hedge, the importer sets the maximum price, the high collar. In response, the bank sets the floor price, the low collar. If the market price is above the high collar price, the bank will pay the difference between the high collar price and the market price to the importer. If the market price is below the low collar price, the importer will pay the difference between the low collar price and the market price to the bank. In this case no premium is involved.

Despite a Treasury committee headed by an international hedging expert, Canada based Upali Arunajith recommending the crude oil cap, CPC disregarded this expert advice and went for a very one sided and risky variant of zero cost collar which has led to the current situation, say sources. CPC decided to work with local branches of foreign banks without the required oil hedging expertise instead of specialist global oil hedging firms recommended by the Treasury committee.

Asantha lost for words

Contacted by The Sunday Leader to ask about specifics, suspended CPC Chairman Asantha De Mel stated he will not make any comment to this newspaper.

Hedging instruments

As an example take the contract with Deutsche Bank effective for one year commencing July 2008. According to this instrument  the CPC could benefit if oil prices increased over US $ 112.50 per barrel. So the maximum benefit the CPC could receive on this document was limited to US$ 2.5 million. But if oil prices fell below US$ 102.5 then CPC had to pad the difference between the average market price and the floor level of US$ 102./50 without any limit on the maximum amount to be paid. So for the month of October the CPC would have to pay US$ 4.5 million and if oil prices remain the same the CPC will have to pay on this single contract a total of US$ 40.5 million. The total losses on all the contracts signed would therefore amount to about US$ 490 million according to the FR Application filed by Wegapitiya.

Mihin's brand new plane through a web of middle men

Chamal Rajapakse

By Ranjith Jayasundera

The recent cabinet decision to secure an aircraft for Mihin Lanka on a wet lease and give the airline another Rs 1.1 billion behind the back of parliament has raised fresh questions about the government's priorities and its competence to steer the country through the economic crisis.

In passing the cabinet paper, not a hum was heard on what the airline - fraught with US$ 3 million in debt with a loss of over US$ 1.5 million from its only year of operations - was thinking in paying US$ 1 million per month for three months to take an aircraft on lease for three months.

Should something go wrong, as is to be expected from both Mihin Lanka and any multi-million dollar venture graced by the Rajapakse Midas touch, Mihin stands a risk of doubling its existing debt.

The rushed November 11 Cabinet Paper No.2008/50 presented by Minister Chamal Rajapakse and endorsed the same day, is littered with mistakes and misleading statements. The first, ironically, is that throughout the paper, Mihin Lanka is referred to as Mihin Lanka 'Private' Limited, a reminder that the airline's roots as a personal flight of fancy by a Presidential coterie is still fresh in the memory of even the cabinet of ministers and those drafting the cabinet papers.

Actual owner

The Cabinet Paper also claims that the aircraft to be leased is both owned and operated by French-Dutch based Transavia Airlines. While the aircraft may be operated by this airline, records we have inspected - that are also in the possession of the Aviation Ministry - show that the brand new Boeing 737-800 is actually owned by two leasing companies, NBB Mallard Company Limited as well as Babcock and Brown Aviation Finance Limited.

The aircraft was initially ordered from Boeing by US based Delta Airlines, who in November 2006 sold the as-then uncompleted aircraft to these finance companies, who have in turn given the aircraft on lease to Transavia Airlines. These facts were confirmed when the aircraft was delivered to Transavia by a press statement by Babcock and Brown released on May 14.

It stated that Transavia "took delivery of one new Boeing B737-800 with a lease term of six years" and identified the aircraft by its serial number MSN 29650, which is also present in the Cabinet Paper. This very same press release also highlighted a lie in the report by the Technical Evaluation Committee (TEC) recommending the purchase of the aircraft.

In comparing the chosen aircraft to a different Boeing 737-800 proposed by another bidder, the TEC report highlighted the fact that the Transavia aircraft was fitted with a CFM56-7B26 engine and that the other aircraft was fitted with a CFM56-7B24 engine.

Factual flaws

The 7B26 on the Transavia offer, the TEC report said, "is more advantageous in the context of fuel consumption." There are two factual flaws to be highlighted here. The press release referred to earlier states clearly that MSN 29650 upon delivery for Transavia was "powered by CFM56-7B24 engines."

Further, available technical specifications for the engines and Boeing aircraft show that the CFM56-7B26 engine is for Boeing 737-900 aircraft and not those such as the 737-800 that were under consideration by the TEC.

An official from the CFM56 consortium pointed us to US government documents that showed that the fuel consumption of the two engine varieties was indistinguishable.

There is also further cause for suspicion in the way the deal has reached the government. As with any commercial transaction involving a Chinthana pet project, there is a middle man involved, in this case, a UK-registered company named Global Plane Search Limited and an obscure Czech charter airline named Travel Service a.s.

Global Plane Search (GPS) is a company founded in 2004 as an aircraft listing website, with just two shareholders and an issued share capital of 200 sterling pounds - around Rs. 40,000. In the company's four year history it has never declared revenue of over 29,000 pounds (Rs. 6 million).

Meagre figures

The 2007 financial statement filed by GPS with the UK's Registrar of Companies shows a profit after taxation for the company of just GBP 4,238 or under Rs. 1 million. The same financial statement showed that the company's fixed assets were of GBP 433 (about Rs. 85,000) in value.

Yet this is the company that is leasing a US$ 56 million aircraft to the Sri Lankan government at a cost of almost US$ 1 million per month. A visit to their web site (www.globalplanesearch.com) indicates that most of its revenue would accrue from the advertisements placed on the site around the multitude of aircraft listings. The website does not even keep commissions on aircraft sales that result through its listings, instead allowing potential buyers to contact sellers directly.

As usual the government is at the bottom of a long pyramid of brokers, middle men and agents. Mihin Lanka's proposal came from GPS, which in turn is dealing with Transavia who operate the actual aircraft, and even Transavia is using the aircraft on lease from Babcock and Brown, who purchased it from Delta Airlines. There is money being made at every link in the chain all the way back up to the leasing company Babcock and Brown.

The terms of the wet lease envisage the aircraft being used for over 300 hours per month, roughly 10 hours per day. Even if Mihin Lanka doesn't use up this amount of flying time, this is the minimum amount that has to be paid under the lease agreement.

Flight schedule

The Sunday Leader has seen the flight schedule proposed by Mihin Lanka for the first quarter of 2009, and it envisages 336 hours per month of flight time on the basis that the aircraft will fly like a workhorse on three return flights a day five days a week, and two return flights a day on the remaining two days of the week, every day for those three months.

For the venture to be successful with the most elementary napkin math, the airline would have to earn the leasing cost of 10 flight hours per day or US$ 28,900, bordering on Rs 3 million, from its ticket sales and cargo revenue every day.

Repeated attempts by The Sunday Leader to contact sitting Mihin Lanka Chairman Raja Edirisuriya failed. He had told us earlier however that he was not involved in the aircraft acquisition process and would have to make do with whatever aircraft that process delivered.

The UNP has however warned that trying to re-launch Mihin Lanka on a plan to fly over 300 hours a month with one aircraft is a "clear cut prescription for disaster." Speaking to The Sunday Leader, UNP MP Ravi Karunanayake said there is no way the airline will fly this many hours in a month.

"That is where the corruption is," he charged. "Airline companies are so dead that you can get a wet lease today for just US$ 2,000 per flying hour." According to Karunanayake, the airline will peak at 270 flying hours per month.

Huge gamble

"If there is a minimum guarantee of 300 hours, then these 30 unused hours will be pure profit for the airline leasing the aircraft, and the tax payer is the ultimate loser." If the UNP MP is correct in his assessment, the amount Mihin Lanka could lose over the three year contract is US$260,000 or around Rs. 30 million. From such a perspective, the lease agreement bears a lot of resemblance to the CPC hedging agreement for which the Supreme Court on Friday blocked payments.

The UNP also predicts that Mihin Lanka will never get off the ground with this type of business plan. "If they are starting expecting to fly over 300 hours a month on a single plane this is wishful thinking at taxpayer expense. Chamal Rajapakse wanted three months to get the airline in order. If this is his plan, mark our words even if you give them a year they won't turn Mihin around," Karunanayake warned.

Due to the silence from Mihin, several questions remain unanswered, chief among which the question of what happened to the hundreds of millions of rupees doled out to Mihin Lanka by the Treasury this year, given that the company still owes BoC over Rs 1 billion, the CPC over 640 million and SriLankan Airlines over Rs 500 million.

The Cabinet Paper is also ambiguous on whether the requested Rs 1.1 billion is to be deducted from the Rs. 6 billion allotted to Mihin Lanka in the Cabinet Paper, or whether this is an additional handout.

Additional costs

The Rs 3 million lease price per day does not include the landing fees for the three airports to be visited every day as well as the other costs associated with running an airline. In any event, at the monthly price being paid, the airline would be able to buy the US$ 56 million aircraft in under five years if it were not a wet lease but a lease to purchase agreement.

Although the total cost of the lease for a three month period will amount to around Rs 300 million, Minister Chamal Rajapakse's Cabinet Paper asks for Rs 1.1 billion to restart the airline without mentioning what the remaining Rs. 800 million is to be utilised for.

The airline's own woes aside, had the cabinet tender committees done their homework they would have seen that the aircraft owner's parent company, Babcock and Brown, is having financial problems of its own under the current global crisis.

On November 20, the Sydney based Babcock and Brown asked the Australian Stock Exchange to halt trading of its shares until Monday, November 24, while it endeavoured to resolve what the company termed "a dispute with a bank which holds a deposit of material amount."

But on Monday, November 24, Babcock and Brown announced that two directors were resigning from the company's board and that trading in its shares was to be suspended until further notice. It was later revealed that the massive company owes a colossal sum of US$ 3.1 billion to a 25 member banking syndicate.

In trouble

One member of the syndicate, German Bank Bayerische Hypo-und Vereinsbank (HVB) is refusing to release to Babcock a deposit of GBP 70 million due to the outstanding debt. The Australian newspaper's business section on November 25 reported that Babcock and Brown "appears to be grinding inexorably towards administration and receivership."

It is quite possible that Mihin Lanka, Cabinet and the Aviation Ministry are quite oblivious to the possible effect that this company's possible collapse could have on Mihin's operations since the name of the true owner of the aircraft does not appear anywhere even once in the Cabinet Paper or any of the tender or technical committee reports.

With the world economy nose-diving so far as for its effects to cascade around the world, the question must be raised as to why our Mihin Lanka must obtain a brand new (2008 vintage) Boeing aircraft. The difference between this plane and slightly older craft given in the Technical Evaluation Committee has been found to be untrue and even if the TEC were misled into believing a falsehood about the engine configuration of the aircraft, it would only have taken a little bit of homework to uncover the true picture.

This will leave the question open in the public mind as to whether this airline requires a brand new aircraft for commercial reasons or, given the airline's past history, whether the President and his lackeys are just in search of a new, shiny "Air Force One" for their globetrotting.

Fresh start

The fresh start promised to Mihin Lanka's operations by its new Chairman Raja Edirisuriya has been put into serious jeopardy by a series of events that according to him are beyond his control. In order to break even - and not burn through another Rs 6 billion of taxpayer money - in the coming year, the rookie airline Mihin will have to fill up three return flights a day without skipping a beat.

If the new Chairman is serious about getting the airline back on track, he should look into the discrepancies in the procurement process for this aircraft, take an active role in acquiring aircraft for operations in the future and ask some serious questions about the viability of such multi-million transactions that will ultimately reflect on the balance sheet of the company he is heading.

Excise spotlight on Gymkhana Club

The Gymkhana Club

By Ruan Pethiyagoda

The Department of Excise has become entangled in a battle between the Gymkhana Club and a third party running a nightclub called Zetter on the club premises. In a series of seemingly partial moves, the Excise Department has moved to cancel the extended license issued to the Gymkhana Club for its poolside bar, and is considering the transfer of another commercial licence to the Zetter nightclub.

The Gymkhana Club is the parent club of the Colombo Cricket Club (CCC), Colombo Hockey and Football Club (CH&FC) and Queens Club.

The matter erupted when incumbent Gymkhana Club President, Ranjan Kanagasabai met with Excise Commissioner D.G.M.V. Hapuarachchi, and spoke to him regarding concerns that the Zetter nightclub operating at their new building on Maitland Place was doing so illegally and in violation of excise regulations.

It is learnt that Kanagasabai's concern was that since the management of Zetter was a non-entity in the eyes of excise, their allegedly illegal activities would ultimately impact the Gymkhana Club, which holds the license under which Zetter was operating.

No legal authority

At the Gymkhana Club President's meeting in early August with Excise Commissioner Hapuarachchi it transpired that Zetter did not have any legal authority to sell liquor on their premises, and according to documents The Sunday Leader has seen, Kanagasabai requested that the Excise Department act to terminate the illegal operations at Zetter.

However, no such action was ever taken by the Excise Department and Zetter continued to operate and sell liquor, collecting revenue to private limited companies Perera Developments and ASPIC Entertainment, whilst purchasing its liquor stocks privately from supermarkets and in the name of the Gymkhana Club license.

Excise had subsequently raided the Gymkhana Club premises on October 2, leading Kanagasabai to once again meet the Excise Commissioner and ask that the club not be held responsible for the actions of a private party, and asking that the Zetter nightclub be shut down instead of penalising Gymkhana.

Notwithstanding this request, Excise slapped a fine of Rs. 200,000 on the Gymkhana Club for illegally selling alcohol in violation of the terms of their license. Ironically, it was Kanagasabai himself in his capacity as Gymkhana President who informed Excise about the illegal activity taking place at Zetter, yet it was the Gymkhana Club and not Zetter that was taken to task by Excise.


In the meanwhile, the management of Zetter has paid several million rupees to another private party in order to transfer another liquor license for use in their premises. There are two problems with this transfer. The first is that under existing excise regulations, two separate licenses cannot be issued to the same building assessment number. Thus the current Gymkhana Club extended license and the new proposed Zetter license cannot co-exist.

Although money has changed hands, the Excise Department maintains that it has not been officially asked to facilitate a transfer of the license (see box).

Several members of the Gymkhana Club executive committee have told The Sunday Leader that they suspect that moves are afoot with the collusion of Excise to cancel their existing license in order to facilitate a transfer of Zetter's' new private license.

Kanagasabai replied the Excise Department's letter of demand on November 5, refusing to pay the Rs 200,000 fine, and asking why action is being taken against the club and not the operators of Zetter. Kanagasabai also revealed in his letter that Excise had seized the Gymkhana Club's extended license last August over some other offences committed by Zetter.

His letter states that after Excise seized the license, the Department had improperly released it not to any officer of the Gymkhana Club, but to a private individual, one Buwanaka Kollonne. Gymkhana had to then make arrangements to get their license back from Kollonne, and not from the Excise Department. Kanagasabai cited a letter that he had seen on the desk of the Excise Commissioner from Kollonne to the Department requesting that the license be released to him.

Asked for copy

The Gymkhana President asked Hapuarachchi "respectfully" to forward him a copy of the letter "along with an account of the events that led the Department of Excise to release the Gymkhana Club liquor license to a private individual."

The letter also set out some facts that Excise would be hard pressed to contradict in justifying their actions. "The Gymkhana Club has never requested that the Excise Department extend the validity of the said license to either allow for the serving or storage of liquor on the second floor of the building, where the Zetter nightclub operates," he states, putting the ball straight in the court of Excise to explain why the club is still being allowed to function.

Although the letter was not specific as to the laws being broken, it made clear that the management of Zetter was violating Section 18 of the 2001 Excise Ordinance, which states that "no excisable article shall be sold, or kept or exposed for sale, without a license."

In the letter Kanagasabai is clear that "the Gymkhana Club accrues no revenue from the sale of liquor at the said nightclub" and that the premises are managed by Perera Developments, and also that credit card payments are collected by Aspic Entertainment. "The club has never asked that any of our licenses be extended to the Zetter nightclub and has no intention of initiating such a request."

Request to take action

Kanagasabai further asked that unless Excise "has reason to believe that the sale of liquor by the operators of the Zetter nightclub is completely legitimate and in compliance with the law" that they move to "take any necessary action to prevent the sale of liquor" on the premises without prejudice to the areas legally prescribed for Gymkhana itself to sell liquor.

When we spoke to Kanagasabai, he confirmed that he had not received any response to the letter thus far.

Another fear that Gymkhana committee members have is the fact that default of VAT payments by the operators of Zetter would leave the club liable, and that the company could get away Scott free. The entire agreement with the nightclub as well as several other angles pertaining to the new building constructed at the Independence Square Roundabout have come under scrutiny since Ranjan Kanagasabai was elected President of Gymkhana earlier this year.

In the past few months, the club has had several of its accounts frozen by the Inland Revenue Department for non-payment of taxes, its electricity disconnected for non-payment of bills and its auditors, Ernst & Young, have, in a confidential report revealed that documentation is unavailable to verify over Rs 63 million in payments made by the club during the construction of the building and that a further Rs. 15 million worth of payments are "unidentifiable" in any manner at all.

Audit stopped

Ernst & Young have stopped their audit until the club forwards the necessary documentation to continue, and all indications are, according to committee members, that these documents are not available. Also, upon inspection it was found that several agreements are detrimental to the club, as their rental payments are a pittance.

These agreements were signed under the presidency of incumbent committee member and former cricketer Shammi Silva, a situation which has lead to severe divisions within the current committee with many members of the committee being against investigations into the club's past dealings.

The rental agreement with Zetter was more complicated. Perera Development, the company that runs Zetter nightclub was supposed to make a loan of over Rs 10 million to the club at 16% interest, in exchange for which the company was to be granted a lease to the Zetter premises for a fee of Rs 30 per square foot each month. The club's financial statements show that very little money has been received by Gymkhana.

Even more remarkably, despite the fact that Perera Development has not fully given the initially promised loan, some committee members allege that they continue to charge 16% interest in monthly installments to the club, in return for a financial facility that was never received.

Gained nothing

Thus in exchange for providing these rock bottom lease prices in the heart of Colombo 7, the Gymkhana Club itself has gained next to naught.

When all of these issues were raised at an emergency meeting of the club's past chairmen on Monday, November 3, a clear division arose between those present. The club's incumbent Secretary, Shiran Anthony and Immediate Past Chairman Shammi Silva took Kanagasabai head on at every turn.

The minutes of the meeting indicate that Silva chastised Kanagasabai for complaining to Excise about the illegal activities of Zetter.

Silva together with Secretary Shiran Anthony accused Kanagasabai of causing the problems with Excise by complaining about the illegal use of their license by Zetter. He said that he had met the Excise Commissioner, who had told him that the club was fined purely on the basis of Kanagasabai's supposed admission of guilt in committing an offence.

These statements were just the beginning of what was to become an evening of perverted distortions of the truth relating to the problems faced by the Gymkhana Club.

Interestingly enough, instead of making a 'request' to Kanagasabai for assistance in stopping Zetter's illegal sale of alcohol, the Excise Department has decided to target Gymkhana, without even a hint of investigation into the persons actually committing the crime of illegally storing and selling liquor.

Question of VAT

When Kanagasabai brought up the fact that Zetter is not paying VAT on their liquor sales, and that these VAT bills may eventually be landed on Gymkhana for millions of rupees, Secretary Shiran Anthony responded that Zetter is also not claiming input VAT on their purchases, proposing that the club could do so to save some money.

Anthony glossed over the fact that it is illegal to claim input VAT without actually paying the output VAT and that such a scam would just raise more alarm bells at Inland Revenue and bring the entire situation crashing down even harder on the head of the already financially beleaguered club.

On the same topic of VAT, when Kanagasabai highlighted that the club's accounts had been frozen out of owing Rs 11.4 million to the Inland Revenue Department, Shammi Silva again lashed out at the Chairman saying that the cheques had bounced since he had refused to sign several agreements that would have brought the needed money into the club accounts.

Kanagasabai did not have at hand the necessary documentation to show that out of the six dishonoured cheques given to the Excise Department, three of them were dated before he assumed the presidency of Gymkhana on July 30, 2008.

Dishonoured cheques

Thus the rejection of the cheques and the lack of money in the accounts cannot be pinned on Kanagasabai but the accuser, then Chairman Shammi Silva. The document we saw from the Inland Revenue Department gives the dishonoured cheque dates as June 30, July 15, July 30 and three other cheques after Kanagasabai took over.

By the time he assumed office however, the club had already issued Rs 1.476 million in dud cheques to the Inland Revenue Department.

When Kanagasabai tried to defend his integrity by pointing out that when the electricity to the club was disconnected on August 1, he personally gave Rs 800,000 to the club out of pocket to get the line reconnected, Silva again took him on blaming him for the disconnection in the first place.

He said that the electricity was disconnected to the club as part of the fallout from Kanagasabai 'carrying tales' to Excise about the crimes committed by Zetter. Electricity was disconnected on August 1, many days before Kanagasabai met the Excise Commissioner Hapuarachchi.

There is thus simply no way that the excise meeting could have affected the disconnection of electricity to the club.

Mathata Thitha

The internal politics of the Gymkhana Club and its finances aside, the most sordid part of this saga is that even under the Mahinda Chinthana's Mathata Thitha policy, the transfer of a commercial liquor license is underway to a privately run nightclub not even 100 metres away from St. Bridget's College.

The owners of some of Colombo's fledgling boutique hotels such as Tintagel, Casa Colombo and the Park Street Hotel, who have been unable to get liquor licenses for their properties despite even approaching the President directly, will likely have some inspiring things to say if the Excise Department were to allow a nightclub to run within jumping distance of a girl's school.

Zetter operation illegal - Excise

Excise Commissioner D.G.M.V. Hapuarachchi told The Sunday Leader that his department has never issued a license for the sale of liquor within the premises of Zetter. Asked whether the sale of liquor within these premises would be illegal, he replied "yes."

Hapuarachchi also explained that the reason that Gymkhana was being fined is that they are the party holding the license that is being exploited for the running of Zetter. "This was all done by the previous management of Gymkhana," he said asserting that the club as an entity must be held responsible.

He also said that no written request has been received for the official transfer of the other private license to the premises of Zetter, and that he can only consider questions emanating from the transfer when such a written request is received. "There has only been talk so far," the Excise Commissioner said.

Meanwhile The Sunday Leader learns that the financial transaction between the two parties for the transfer of the license is complete and over Rs. 2 million has changed hands through the deal.

Ask Shammi - Zetter Management

The former administrator of Zetter, Buwanaka Kollonne said that he is no longer involved in the operations of the nightclub, and that thus he cannot answer questions pertaining to the legality of its sale of liquor.

He asked that we speak to the club's Former President, Shammi Silva, also stating that Silva is now the owner of the Zetter nightclub.

Shammi Silva, however, when contacted, denied that he was involved with Zetter and declined to answer any further questions citing legal concerns.

The club suffers - Kanagasabai

Incumbent Gymkhana Club Chairman, Ranjan Kanagasabai refused to comment on the details of the issues with Excise and the missing money alleged by the auditors. "At the end of the day it is the club that loses out when all these things are happening," he concluded.

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