Papua New Guinea - Second Power Project

Report No. 327a-PNG FILE COPY Papua New Guinea Appraisal of the Second Power Project (Electricity Commission of Papua New Guinea) May 15, 1974 Asia Projects Department Public Utilities Division Not for Public Use Document of the International Bank for Reconstruclion and Development International Development Association This report was prepared for official use only by the Bank Group. IL may not he published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS Before September 9, 1973 A$ 1 - US$1.42 A$ 1,000 - US$1,420 A$ 1,000,000 - US$1,420,000 From September 9, 1973 A$ 1 - US$1.4875 A$ 1,000 ' US$1,487.5 A$ 1,000,000 - US$1,487,500 Weights and Measures Equivalent kW - Kilowatt MW - Megawatt (1,000 kW) kWh - Kilowatt hour MWh - Megawatt hour (1,000 kWh) GWh a Gigawatt hour (1 million kWh) kV = Kilo volt (1,000 volts) cro rs and Abbreviations Commonwealth - Commonwealth of Australia Territory - Territory of Papua and New Guinea Administration - Administration of Papua and New Guinea PNG - Papua New Guinea ELCOM - Electricity Commission CONWORKS - Commonwealth Department of Works Offshore - Overseas Onshore - Domestic ELCOM's Financial Year - Year beginning July 1 and ending June 30 (Unless otherwise stated, the year quoted in the text refers to the financial year.)  PAPUA NEW GUINEA PAPUA NEW GUINEA ELECTRICITY COMMISSION APPRAISAL - SECOND POWER PROJECT TABLE OF CONTENTS Page No. SUMMARY AND CONCLUSIONS ..... ................... i-ii I. INTRODUCTION ........ ................................ 1 II. THE ECONOMY AND THE POWER SECTOR .................... 2 The Country and its Economy ......... 2 Energy Resources ............. .............. ... 3 The Power Sector ....................... .. ..... 4 III. THE BORROWER AND THE BENEFICIARY .............. ...... 5 Elcom's Management and Organisation .. .......... 5 Existing Facilities ..... ....................... 6 Future Development Plans ...................... 7 IV. THE POWER MARKET . .................................. 7 V. THE PROJECT ............................... ....... 8 In-Service Training ..... .............. 8 Distribution Expansion ..... .................... 10 Foreign Exchange Shortfall of Loan 737-PNG ..... 10 Procurement and Disbursements ................ .. 11 Construction Schedule ..... ..................... 11 Consulting Services ............ . ...........e. 11 VI. JUSTIFICATION OF THE PROJECT ..... ................... 11 In-Service Training ............ .. .............. 12 Distribution Expansion ..... .................... 12 Foreign Exchange Shortfall of Loan 737 PNG ..... 12 This report was prepared by Messrs. E. A. Minnig (Power Engineer) and S. S. Scales (Financial Analyst).  -2- Page No. VII. FINANCIAL ASPECTS ...... ............................. 13 Past and Present Earnings ...................... 13 Present Financial Position ..... ................ 13 Sinking Fund ..........1 4......... 14 Insurance ........... ...................... 15 Audit .......................................... 15 Proposed Financial Plan ...................... . 15 Future Financial Position ..... ................. 16 VIII. AGREEMENTS REACHED AND RECOMMENDATION .... ........... 18 LIST OF ANNEXES 1.1 Diagram Economic Data - Chart (8026) 1.2 Gross National Product (Current Prices) 2. Diagram Organisation Chart - Chart (8027) 3. Power Plant as Installed June 30, 1973 4. Overhead Line Statistics at June 30, 1973 5. Supply Point Transformer Statistics at June 30, 1973 6. Distribution Substation Statistics at June 30, 1973 7. Future Development Plans 8.1 Generation, Sales and Maximum Demand 1964-1973 8.2 Generation, Sales and Maximum Demand 1974-1980 9. Consumer Statistics 1966-1972 10.1 Sales and Revenue per Tariff Classifications 1964-1968 10.2 Sales and Revenue per Tariff Classifications 1969-1972 10.3 Sales and Revenue per Tariff Classifications 1973-1976 10.4 Sales and Revenue per Tariff Classifications 1977-1980 11. Review of Economic Trends and Prospects in the Area to be served by Upper Ramu Hydroelectric Project 12.1 Diagram - Actual & Forecast Maximum Demand (MW) (Chart 8025) 12.2 Diagram - Actual & Forecast Generation (GWH) (Chart 8028) 12.3 Diagram - Actual & Forecast Sales of Energy (Chart 8030) 13. Distribution Expansion Program 1975-1978 14. Upper Ramu No 1 - Hydro Plant Cost Estimates 15 Diagram - Staff and Consumers (Chart 8029) 16. Training 17. Schedule of Estimated Disbursements 18. Schedule of Monthly Tariffs 19. Condensed Balance Sheets for 1970 thru 1980 20. Statement of Outstanding Debt - Repayment of Principal - 1973-1980 21. Source of Application of Funds for 1973 thru 1980 22. Construction Expenditure for 1973 thru 1980 23. Income Statements for 1970 thru 1980 24. Estimated Interest for 1973 thru 1980 MAP  PAPUA NEW GUINEA PAPUA NEW GUINEA ELECTRICITY COMMISSION SECOND POWER PROJECT SUMMARY AND CONCLUSIONS i. This report appraises the Second Power Project for Papua New Guinea and aims at helping PNG to strengthen and localize ELCOM. The project consists of two main items: a) technical assistance for ELCOM's in-service training program during the period 1974-79, and b) expansion of ELCOM's distribution network in 13 different centers. The project will also include financing to cover the cost over-run under the first power project (Loan 737-PNG) which is attributable to exchange rate adjustments. The estimated total cost of the project is US$17.25 million equivalent. A loan of US$10.8 million is proposed. ii. The loan was requested by the Commonwealth of Australia (Guarantor) on behalf of the Government of Papua New Guinea (Borrower) and the Papua New Guinea Electricity Commission (ELCOM) (Beneficiary). iii. ELCOM was established in July 1963 as a statutory corporation, with adequate powers to conduct its affairs in accordance with sound public utility practices. It was responsible to the Commonwealth Minister of External Territories through the Administrator, but the Minister and the Administrator have de facto transferred their powers relating to ELCOM to the cabinet of the newly formed PNG Government, and ELCOM now reports to the PNG Minister of Mines and Energy. PNG achieved self-government on December 1, 1973. It is expected to become independent in December this year. iv. The country's economy is based essentially on primary production. GNP growth declined from a previous annual rate of 11% between 1969 and 1971 to 2.1% in 1972. ELCOM's power market, being susceptible to changing and uncertain economic conditions, is projected to grow at a reduced rate of 8.6% as against 21% forecast in 1970 for the period 1969 through 1978. The factors contributing to the recession are the transient political situation and the uncertainties of the future. Because of this ELCOM has eliminated all add- itional generation expansion projects from its 1974-1980 investment program, since available capacity will meet forecast demand. Its expansion program, therefore, includes only the Upper Ramu No. 1 Hydro Project under construction (financed by Loan 737-PNG) and modest distribution facilities. v. ELCOM has a good record for reliable supply and service. Although the recession is affecting its growth, ELCOM's forecast financial position would continue to be satisfactory with an operating ratio varying between 59% and 65%; a net debt/equity ratio improving from 76/24 in 1976 to 73/27 in 1980; and internally generated funds after debt service financing 35% of capital requirements during 1974/79.  - ii - vi. ELCOM presently supplies power to 10 centers of population. It has a generating capacity of 70 MW consisting of 37.6 MW of hydroelectric plant and 32.4 MW of diesel. ELCOM is also responsible for the operation and maintenarnce of generating and distribution facilities at 142 centers owned by the PIG Government with a total capacity of 8.9 MW. Three of these centers situated in the area of the Upper Ramu hydroelectric project will be trans- ferred to ELCOM in 1976 and incorporated into the system. vii. ELCOM's management is able, and its staff is competent. It was the first organisation in PNG to appreciate the need to train local staff and it has had a training program in operation since 1964. At June 30, 1973, its operating staff totalled 1,247 of which 264 were expatriates. In addition it had 365 local apprentices, trainees and cadets under training. The degree of indigenisation (excluding apprentices, etc.) is now 79% as against 64% in 1970, with a target set for 1980 of about 98%. By then most of the 25 expatriates still considered essential would be in the more senior positions. viii. The proposed project would be a suitable basis for a Bank loan of US$10.8 million equivalent for a ?eriod of 20 years including a 5 year grace period.  PAPUA NEW GUINEA PAPUA NEW GUINEA ELECTRICITY COMMISSION SECOND POWER PROJECT I. INTRODUCTION 1.01 The Government of the Commonwealth of Australia on behalf of the Government of Papua New Guinea and the Papua New Guinea Electricity Commis- sion (ELCOM) has requested a Bank loan of US$10.8 million equivalent to finance the off shore cost element of salaries of expatriates exclusively engaged in training local staff (44%) modest distribution investments (21%); and the foreign exchange short-fall on Loan 737-PNG resulting from recent currency adjustments (35%). The principal element of the proposed loan would support a soundly conceived training program which would otherwise have to be curtailed since no alternative financing is in sight. 1.02 Under the UN Trusteeship Agreement (New Guinea) and the Common- wealth's Papua New Guinea Act, the Commonwealth was responsible for govern- ing and developing the Territory up to December 1, 1973. An Administrator, appointed by the Commonwealth Governor-General, administered the Territory with the assistance of an Executive Council (AEC). Originally self- government was anticipated in the mid 1970's and independence in the 1980's. The Commonwealth has accelerated the time-table, and self-government was achieved on December 1, 1973. Papua New Guinea is expected to become indepen- dent in December this year. A legislature has been elected, a Government formed, and the functions of the AEC have been taken over by the Cabinet. 1.03 ELCOM was established as a Statutory Corporation on July 1, 1963, when it took over the functions of the Administration's Electrical Under- taking Branch. On establishment, nine separate electric supply systems, each serving a center of population, were transferred to ELCOM. The present number of 10 will increase to 13 when the Supply Systems at Mt. Hagen, Kainantu and Kundiawa are transferred to ELCOM in 1976 on the com- missioning of the Upper Ramu No. 1 Hydroelectric Scheme (Loan 737-PNG). ELCOM also operates and maintains generation and distribution facilities at 142 other centers owned by the Government, with funds provided by the Government. In time these would be transferred to ELCOM, if transfer does not impose any financial burden on ELCOM. 1.04 As a result of the present transient political situation, business and industrial activity has appreciably slowed down throughout the country. Current power market growth is predicted at an average annual growth rate of only about 8.6% over 1974-1980 as against 21% forecast in 1970 over 1969-1978. Actual results in 1973 were about 25% below the 1970 forecast. Business is waiting for the situation to stabilize and for the new Government to clarify and publish its economic policies. This climate of uncertainty, the declared policy of the new Government to replace expatriates with indigenes, and the announcement of its intent to issue its  - 2 - own currency, is expected to result in the departure of a great number of the non-indigenous population. 1.05 Progress on the Upper Ramu No. 1 Hydroelectric Project financed through Loan 737-PNG is satisfactory. The present estimated A$ cost of the project still corresponds to the original estimate althougn it exceeds the original est mated US$ costs by 27% at today's exchange rates. This corresponds to a shortfail in the foreign currency elenent financed by Loan 737-PNG of about US$3.8 million equivalent or about 16%. The project is still economically justified even with the changed economic situation (paras 6.01 - 6.06). 1.06 This report was prepared by Messrs E. A. Minnig (Power Engineer) and S. S. Scales (Financial Analyst) from information prepared by ELCOM, economic data provided by the Territory Office of Programming and Co-ordination, and information obtained during a supervision mission in June/July, 1973. II. THE ECOhsOMY AND THE POWER SECTOR The Country and its Economy 2.01 Papua New Guinea extends over 800,000 sq miles of tropical seas north of Australia. The eastern half of New Guinea and the three largest islands - New Britain, New Ireland and Bougainville - comprise most of the land surface of 180,000 sq miles (about 475,000 km2). It is an area of unusual diversity with extremely rugged mountain ranges, wide valleys, large river systems, extensive jungles, and vast swamps. 2.02 Population in mid-1972 was estimated at about 2.58 million, of which 2% or about 50,000 are non-indigenous. The rate of growth of the indigenous population between 1969 and 1972 has been 2.7% p.a., but growth of the non-indigenous population, because of changing economic conditions and forthcoming independence, changed from net increases of 2,026 in 1969; 4,478 in 1970; and 3,024 in 1971, to a net decrease of 5,286 in 1972 accelerating to a decrease of 5,485 for the first six months of 1973. Population density averages 14.3/sq mile (5.4/sq km) but ranges from 1.5 to 60 according to district. 2.03 At the time of appraisal of Loan 737-PNG in 1970, the Gross Monetized Sector Product (GMSP) was forecast to increase on average at 10% for 1969-1973 compared to an average growth rate of 12% achieved since 1966. In 1970, however, self-government was not expected before 1975 and independence not before the early 1980's. Papua New Guinea has now achieved self-government and it is expected to become independent at the end of this year. Because of the transient political situation there is a general slowdown of business and industrial activity, since prospective investors found that they had to deal with two governments, one in Canberra and one in Port Moresby. Together w-ith this, but also because of the uncertainty of the PNG Government's future plans, plus the Government's intention to  drastically reduce the number of expatriate public servants and to issue a PNG currency, an increasing exodus of expatriates is anticipated. 2.04 Faced with these uncertainties GMSP projections are continually being revised. The Bank's May 1972 Economic Mission forecast a growth rate of 9% p.a. from 1973 to 1978; a revised forecast prepared in September, 1972, by the Territory Office of Programming and Coordination estimated a growth rate of 6.7% p.a. for the same period. 2.05 Papua New Guinea has a dual economy; a large indigenous subsistence sector based on traditional agriculture (41% of GNP) and a modern monetized sector which includes export oriented plantation agriculture, Government operations and services and lately, mining (58.0% of GNP). GNP which had grown at the rate of 11.1% per anntm between 1969 and 1971 declined to a rate of 2.1% in 1972. Per capita GNP rose from US$217 in 1969 to US$295 in 1971 and then receded to US$293 in 1972. Since mid-1971 the economy has in fact, been passing through a recession, and real GNP declined by 4%. This slowdown is attributable to the political factors already mentioned, a general decline in world market prices of PNG's major export crops (copra, cocoa, rubber, palm oil and coffee) and to a sharp drop of investment outlays after the completion of the Bougainville Copper Mine. However, export prices have started to recover, and when the political situation has stabilized, long term prospects for PNG's economic development will be more favorable; one indication is the obvious interest shown by other countries and industries in the development of the country's natural resources (hydro and copper). 2.06 The recent economic recession is reflected in ELCOM's energy sales which have fallen substantially below predictions. Historic growth rates during the period 1964 to 1970 were 25.4% for the Upper Ramu Service Area (to be served by the project financed under Loan 737-PNG) and 19.2% for its other service areas. In 1970 these were forecast to continue at the high rates of 25.8% and 18.9% respectively during the period 1970/78. However, the latest forecast (June 1973) projects growth rates of only 8.6% for the period 1974/80. In 1973 per capita consumption of electricity amounted to 322 kWh, which includes the energy produced by Bougainville Copper Ltd. Excluding this enclave project, per capita consumption would have been about 100 kWh. Further details on the economy and the power market are given in Annex 1. Energy Resources 2.07 Papua New Guinea has a vast hydro potential totalling some 11,000 MW at sites each capable of producing 300 MW or more. Recent investi- gations have concentrated on two rivers (i) Purari River flowing into the Gulf, of Papua (potential 7,200 MW, 6,100 MW firm; and about 53,000 GWh per annum) and (ii) Musa River flowing into Oro Bay in NE Papua (potential of 400 MW and about 2,800 GWh per annum). Japan and Australia have shown an interest in developing and utilizing some of this energy potential to support power intensive industry, mainly metallurgical, but it is unlikely that any devel- opments will materialize before the late 1980's. The changing world energy situation may accelerate the development of PNG's hydro resources.  - 4 - 2.08 There are no known economic deposits of coal. Prospects for oil and gas of commercial value are considered favorable following an off-shore gas strike in the Gulf of Papua and further prospecting is under way. Fuel imports in 1972 totalled about A$ 12.8 million, of which ELCOM's share for electricity generation was about 5.7%. Tae Power Sector 2.09 Virtually all power facilities were destroyed during World War II. The Commonwealth Department of Works (COMWORKS) was made respDonsible for reconstruction, and in 1957 the Territory Administration accepted this responsibility by creating the Electrical Undertaking Branch. On July 1, 1963, ELCOM was established and assumed full responsibility for nine centers. ELCOM was also required to provide services at 128 other centers owned by the Administration. 2.10 The centers presently served by ELCOM and their population (1970) are: Port Moresby (56,200); Lae (24,300); Rabaul (20,300); Madang (11,200); Goroka (7,900): Samari (2,200); Wewax (8,945); Kavieng (2,140); Kokopo (537). In October 1972, Kieta-Arawa (755), which is the headquarters for the Bougainville Copper Ltd., was added to ELCOM's system, and on com- pletion of the Upper Ramu Hydroelectric Scheme (45 MW) in mid 1976, Kundiawa (1,590); Kainantu (1,200); and Mt. Hagen (3,315) will be transferred to ELCOM by the Government. The locations of these centers together with the Administration centers are shown on the attached map. 2.11 Outside the centers served by ELCOM (now 10) and by the Administra- tion (now 142), private generating equipment is generally installed by missions and plantations. The largest private generating facility is owned by Bougainville Copper Ltd. (135 MW in three oil-fired steam units), which also sells power to ELCOM for distribution in Kieta-Arawa. A small hydro plant with an installed capacity of 5.5 MW is owned by Placer Development Ltd. near Baiune to the south of Lae. This company, previously engaged in gold mining operations, has virtually ceased mining activities and now sells about two-thirds of its output to ELCOM for distribution in Lae with which it is connected by a 66kV transmission line. ! 2.12 As of June 30, 1973, the installed capacity and generation in 1973 in Papua New Guinea were as follows: Installed Capacity (MW) Annual Generation % of Total Hydro Thermal Total GWh Generation ELCGM 37.6 32.4 /a 70.0 202.8 23.6 Administration - 8.9ka 8.9 19.0 2.2 Bougainville Copper - 135.0/b 135.0 587.0 68.8 Placer Development 5.5 - 5.5 36.0 4.2 Other Private - 3.5A 3.5 10.0 1.2 TO.AL 43.1 179.8 222.9 854.8 100.0 /a Diesel. /b Oil-firea steam thermal.  -5- Of all power generated in the Territory in 19;?3, ELCOM's share amounted to about 24%. III. THE BORROWER AND THE BENEFICIARY 3.01 The Borrower would be the Government of Papua New Guinea, the Guarantor Australia, and the Beneficiary ELCOM. A Guarantee Agreement would be entered into between the Bank and Australia, a Loan Agreement between the Bank and the Government of PNG, and a Project Agreement between the Bank and ELCOM. 3.02 Various Ordinances governing the use of water for agriculture, forestry, mining, conservation, water supply and power generation contain conflicts which neither the Commonwealth nor the Territory Administration wanted to change while the Territory was moving rapidly towards self govern- ment as they considered the changes should be made by the newly elected Government. In the interim, and as a condition of Loan 737-PNG ELCOM was provided with all the rights to use land and water necessary for its operations. 3.03 To safeguard ELCOM's interests a default condition was negotiated under Loan 737-PNG whereby the Bank could suspend or cancel the loan should legislation be enacted which would materially and adversely affect ELCOM. This default condition has been incorporated in the loan documents of the proposed loan. ELCOM's Management and Organisation 3.04 ELCOM has an able management, and its staff is competent in both operation and planning. It is governed by a full-time Commissioner and five part-time Associate Cormissioners who were appointed by the Commonwealth Minister of External Territories. With self-government, the Commissioners will in future be appointed by the PNG Cabinet on the recommendation of the PNG Minister of Mines and Energy. Senior staff are appointed by the Commis- sioners, and their terms and conditions of employment are determined by the Minister. However, in the present transitionary period, ELCOM is required to consult with the Public Service Board (PSB) before renewing expatriate contracts. Although empowered to process ELCOM's proposals the PSB submits them to the Cabinet for decision because of implications on other statutory authorities. As contracts expire and the terms of new contracts remain undecided the Commission risks losing staff essential to operations, and because of this, it was agreed during appraisal that the Cabinet would consider ELCOM's proposals expeditiously. As a result ELCCM was permitted to extend existing contracts by two years. Nevertheless, ELCOM lost 56 ex- patriates during the past 6 months and has been unable to recruit replacements. Recruitment efforts for operational staff are currently underway in Malaysia and the Philippines. Contracts to be offered to new staff will, however, be subject to the Public Service Board's guidelines.  - 6 - 3.05 Wnen the last loan was considered in 1971, assurances were obtained that ELCOM would consult with the Bank before making appointments to the positions of General Manager, k.ss stant General Manager (Finance and Administration) and Assistant General Manager (Engineering). This covenant has been repeated. 3.06 At June 30, 1970, ELCOM's staff totalled 1,556 of which 388 were expatriates, 677 local staff and 491 iocal apprentices, trainees and cadets. At June 30, .973, staff totalled 1,612 of which 264 were expatriates, 983 locals, ana 365 local apprentices, trainees and cadets. Of the local staff 221 were seconded by ELCOM to administration owned Centers. The degree of indigenisation (excluding apprentices, trainees and cadets) is now 79% as against 64% in 1970, with a target set for 1980 of about 98%. By then, only about 25 expatriates are expected to remain. Annex 2 shows ELCOM's present organisation chart. 3.07 ELCOM was the first organisation in Papua New Guinea to appreciate the need to train local staff. It built and staffed its own Training School and provided courses in power plant operation for mechanics, electri- cians, linesmen and also for clerical staff. It is currently sponsoring 97 high school graduates as cadets to the University of Papua New Guinea (Port Moresby) and to the Technical University of Papua New Guinea (Lae) to receive education as lawyers, economists, civil, mechanical, and electrical engineers, and as surveyors. At the peak in 1972, 517 locals were under training. The cost of training reached a high of A$ 670,000 in 1970 (US$750,000 at then prevailing exchange rates) representing nearly 15% of revenues. During negotiations of Loan 737-PNG the Administration agreed to proviile ELCOM with at least A$ 90,000 annually up to 1978 towards the cost of training, because after completion of their courses some trainees find employment in the private sector, whilst others are seconded to Administration owned Centers. This covenant in the Loan Agreement of Loan 737-PNG has been repeated. 3.08 ELCOM's foresight in training has given it a good start towards implementing the government's policy of accelerated indigenisation. Existing Facilities 3.09 To serve its present centers, which are not interconnected because of the transmission distance involved, ELCOM had available at June 30, 1973 a total of 70 MW of generating capacity of which 38 MW was hydro and 32 MW diesel. Annex 3 lists the individual power plants with their installed capacity. Annex 4 lists ELCOM's transmission and distribution facilities and Annex 5 provides supply point transformer statistics whilst Annex 6 gives distribution substation statistics. 3.10 Existing facilities are adequate, and because of the rapid drop in the growth rate, generating facilities, especially in Port Moresby, are at the moment excessive. Plant is generally well maintained and service interruptions are few and not related to design defects or poor operations.  -7- Future Development Plans 3.11 Investigations are proceeding on a continual basis to ensure that when the need arises, new generat:ing facilities can be built economically and with the least possible delay. ELCOM's consultants, Commonwealth Department of Works (COMWORKS), are currently investigating several alter- native hydro sites which could supplement the Upper Ramu Project should ELCOM be called upon to serve the demand of potential mining developments. Further details of ELCOM's future development strategy are given in Annex 7. IV. THE POWER MARKET 4.01 The tables below showing ELCOM's average annual growth rates and load forecasts demonstrate the changed market situation. Detailed information is given in Annexes 8 thru 12. Table I 1970 Forecast 1970 Forecast Current Forecast Actual 1973 for 1973 for 1978 for 1978 Generation (GWh) 227.0 291.9 734.5 342.6 Sales (GWh) 204.8 265.3 657.0 308,1 Maximum Demand (MW) 44.7 60.7 145.9 68.3 Table II Average Annual Growth Rates in % Actual Forecast Appraisal 1970 Current Appraisal 1963/70 1969/73 1970/73 1969/78 1974/80 Generation 19.4 17.1 12.5 21.0 8.6 Sales 20.7 18.0 12.8 20.9 8.5 Maximum Demand 16.8 15.1 11.7 21.0 8.8 4.02 The current sales growth projections average 8.5% per year for the period 1974/80 as against 20.9% forecast in 1970 for 1969/78. Actual results in 1973 were about 25% below the 1970 forecast. In view of this, ELCOM has eliminated all generation expansion projects from its 1974/80 investment program since available capacity would meet forecast demand. 4.03 The loads associated with certain projects presently under dis- cussion have not been included in the forecasts because of uncertainty whether they will be constructed before 1980. Inclusion of such loads could increase ELCOM's demand by 3 MW (8%) in 1974 and about 10 KM (17%) by 1976. These could be served by the Upper Ramu Project financed through Loan 737-PNG, investments would be minimal, consisting mainly of extensions to existing transmission facilities presently under construction.  - 8- 4.04 When ELCOM was established in 1963, it was serving 7,410 consumers, and arnual consumption per consumer was about 6,270 kWh. At June 30, 1973, the number of consumers served had increased to 22,853 and consumption averaged 9,050 kWh/consumer. Thus the average annual growth rate of con- sumers was 13.2Z for the period and of consumption per consumer about 4.2%. By 1980 it is estimated that ELCOM would serve about 33,700 consumers including consumers at Mt. Hagen, Kundiawa and Kainantu centers presently served by the Administration but scheduled for takeover by ELCOM on December 31, 1975. Average consumption per consumer in 1980 is estimated at 11,800 kWh, which is high reflecting the low degree of electrification (only about 7% of the population presently benefit from the use of electricity). Thus the forecast average annual growth rate of consumers from 1973 to 1980 is only 5.8% (despite the takeover of the three additional centers by ELCOM) and of consumption per consumer about 3.8%. 4.05 In 1973, of total sales of 204.8 Gwh, 26.5% were for domestic purposes; 56.2% for commercial and small industrial enterprises, 17.0% for larger industries, and about 0.3% for public lighting. In 1980 with forecast sales of 356.8 Gwh, 29% would be for domestic purposes; 55.6% for commercial and small industrial enterprises; 15% for larger industries; and about 0.4% for public lighting. The share of domestic load thus increases whilst that of commercial and industrial enterprises decreases reflecting again the changed political and economic situation. V. THE PROJECT 5.01 The proposed project aims at helping PNG to strengthen and localize ELCOM and consists of two main items: a) technical assistance for ELCCt's in-service training program during the period 1974-79, and b) expansion of ELCoM's distribution network. The project would also include financing to cover the cost over-run under the first power project (Loan 737-PNG) which is attributable to exchange rate adjustments. 5.02 In-Service Training. ELCOM's objective is to accelerate in-service training of local staff to permit an early and rapid reduction of expatriates. To achieve this two alternatives are possible: (i) the counterpart system, whereby a particular establishment function would be filled by a local and an expatriate. The duties of the expatriate, in addition to his functional duties, would be the training of his local counterpart: and (ii) the transfer of full responsibility to the local with one expatriate supervising and providing in-service training to more than one local. The first alternative is considered not only costly but ineffective, because locals are generally reluctant to press for responsibility and expatriates seldom take the time or the patience to properly train their local counterparts. The more effective their training, the sooner they lose their jobs. The second alternative has the advantage of clearly establishing the function and duties of the expatriate trainer, his term of employment is clearly defined, and the more effective he is, the greater the possibility of contract renewal. The effect on the local is also positive, because of increased motivation and pride. ELCOM rightly selected the second alternative; its foresight in having an  - 9 - intensive training effort underway allows it to do so. The diagram attached as Annex 15 shows its past manpower development, its forecast manpower requirements, and its targets for indigenisation. Annex 16 describes in detail its Training Center, the type of training provided and its future training plans. 5.03 ELCOM's plans for in-service training and the utilisation of expatriate staff can be summarized as follows, Locals Receiving Expatriate Staff In-Service Training Operational Trainers Total Technical Commercial Total 1974 141 99/a 240 98 64 162/a 1975 118 107 225 136 104 240 1976 89 91 180 112 95 207 1977 25 75 100 96 101 197 1978 25 50 75 105 116 221 1979 25 2 = 50 84 100 184_ 1980 25 - 25 - - - Man years 385 1038 /a Six months only. 5.04 The in-service training envisaged would cover a period of five years. The program provides for 385 trainer man years and 1038 trainee man years involving a total of 528 locals. Thus, by 1980 about 1/3 of local staff will have benefitted from this in-service training program. The ratio of trainers to locals would be about 1:3. Promising local tradesmen already trained or in training would be selected for in-service training as super- visors (Senior Artisans, Senior Power Station Operators, Technicians). Qualified technical and commercial officers would be promoted to more senior positions. Graduate cadets (engineers, accountants) would be given immediate responsibility at smaller centers. The necessary supervision and training would be provided by selected expatriates relieved of operational responsibility and administratively attached to the Education and Training Branch. To supplement and complement this effort it will be essential for ELCOM to continue its classroom training program. Accordingly ELCOM has agreed that (a) the Hohola Training School will continue to operate to meet ELCOM's requirements; and (b) any subsequent appointment to the position of Principal of the Hohola Training School be made only after prior consultation with the Bank. (The present Principal is well qualified, dedicated, and competent). 5.05 The technical assistance program will cost about US$7.8 million of which the Bank would finance the off-shore element of expatriates' salaries (US$4.7 million) which is basically the difference between the ex- patriate and local salary of equivalent grade and represents about 60% of the gross salary. It also corresponds to gross salaries including benefits reduced by expected expenditures in PNG for subsistence, housing, local taxes, etc. Since training provides long-term benefits, costs can reasonably  - 10 - be termed long-term capital investments and depreciated over a reasonable period (10 years is proposed). The costs associated with this program total A$ 5.26 million or about $5000/trainee tian year, a not insignificant amount, but justified in view of the subsequetit benefits to be realized. 5.06 Distribution Expansion. The modest distribution program covering the 13 new centers ELCOM will be servicing after 1975 is sufficient to meet ELCOM's needs through 1979. The program consists of 150 distribution trans- formers totalling about 15 MVA; 47 km of 11 kV and 22 kV primary distribution lines; 119 km of secondary distribution lines; about 8000 service connections; about 900 street lights; and about 9,000 meters (Annex 13 gives further details). The total cost of the distribution program is estimated at US$5.7 million of which the Bank would finance US$2.3 million. 5.07 Foreign Exchange Shortfall of Loan 737-PNG. The Upper Ramu Hydroelectric Scheme is presently under construction in the Highlands by ELCOM. The project consists of a run-of-the-river underground power station with an initial installed capacity of 4.5 MW. Included in the project are 320 miles of transmission lines linking centers previously served by small diesel units. At the beginning of 1976 the project will provide electricity for the favorably endowed Highland regions and constitute a major element in ELCOM's plan to establish a national transmission grid. Construction of the project is proceeding without any major difficulties. The project financed by Loan 737-PNG (US$23.2 million equivalent) is still within the original cost estimate as expressed in current A$ or in US$ using pre-March 1971 exchange rates. However, foreign exchange requirements expressed in US$ at current exchange rates are now estimated at US$27.1 million equivalent (Annex 14), an increase of about US$3.9 million of which about US$3.8 million is directly attributable to exchange rate variations. The existing loan agreement contains the usual covenant requiring the Administra- tion/Government to cover project cost overruns but the level of assistance to be given by Australia will be limited and diversion of funds to the Ramu Project would mean a shortfall elsewhere. Because the shortfall is not attributable to cost overruns but to other circumstances not foreseen (exchange variations) at the time of appraisal, the inclusion of US$3.8 million in the proposed loan to cover the shortfall would be reasonable.  - itb - 5.08 The table below suimrarizes the cost of the proposed project: A$ '000 USV0O0O On shore Off shore Total On shore Off shore Total I. Technical Assistance 2,104 3,156 5,260 3,111 4,700 7,811 II. Distribution Materials 791 1,250 2,041 t,169 1,851 3,020 Labor 383 - 383 567 - 567 Contingencies - Physical 117 125 242 173 185 358 - Price 197 210 407 292 311 603 Engineering and Overheads 769 - 769 1,138 - 1,138 III. Ramu Project Shortfall - 2 535 2,535 - 3,753 3,753 Total 4.361 7,276 11,637 6,450 10,800 17,250 The physical contingency of 10% on estimated distribution costs is ample to allow for increased quantities and unestimated items. The price increase contingency is based on an escalation of about 5% p.a. for local costs and for the cost of imported materials. Engineering and overhead represents about 20% of total costs, which given the large area served by ELCOM, is not un- reasonable. The proposed Bank loan would cover the off shore cost component of the project amounting to US$10.8 million equivalent. If there are any savings in the project, such savings would be cancelled. 5.09 Procurement and Disbursements. All procurement, except services, would be on the basis of international competitive bidding in accordance with the Bank's Guidelines dated April 1972. Disbursements for technical assistance would be on a reimbursement basis equal to 60% of expenditure by ELCOM on gross salary and benefits of expatriate trainer staff and would include retroactive financing for payments made after January 1, 1974 equivalent to about US$300,000. Disbursement of the distribution element would be made only for the actual c.i.f. cost of equipment and materials and for the off shore cost of services. Disbursements of the foreign ex- change shortfall of Loan 737-PNG would be made against contracts already approved and awarded. 5.10 Construction Schedule. Construction of the distribution system extension would be carried out in 1975 to 1979 by ELCOM's own force, which is capable of carrying out work of this nature. 5.11 Consulting Services. No consultants are required for the dis- tribution element of the project. ELCOM staff is capable and adequately trained for design, construction and supervision of transmission and distribution work.  - 12 - VI. JUSTIFICATION OF THE PROJECT 6.01 As the project contains three separate and distinct items, an overall economic evaluation has not been attempted. Each item is dealt with separately. In-Service Training 6.02 Accelerated indigenization is a government policy introduced to enable the local population to play a greater part in the economy and to encourage greater self reliance, independent of any financial advantages which this may involve. The benefits are difficult to quantify. The justification of this item of the project is based on the financial savings due to the salary differential between expatriate and local staff of equiva- lent grade and responsibility. To test this a discounted cash flow analysis was carried out over a period of 20 years of two cost streams, one representing ELCOM's cost without the proposed training (continued employment of expatriates) and the second representing ELCOM's costs with in-service training reducing the number of expatriates over time as local staff accept full operational respons.bility. The discount rate which equalized the two streams was found to be in excess of 48%. Distribution Expansion 6.03 This modest expansion covers the five years through 1979. Rehabil- itation, strengthening of existing systems and expansion are involved. A rate of return on this element of the project has not been estimated due to the problem of allocating incremental revenues to existing and new facilities. Foreign Exchange Shortfall of Loan 737-PNG 6.04 The Upper Ramu Hydroelectric project was planned for two stages: No. 1, a 45 MW run-of-the-river plant and No. 2, installation of two additional 15 MW units plus the construction of a storage dam to provide regulation for a firm output of 60 MW at the system load factor. 6.05 A probability analysis comparing the project to the most economical thermal alternative was made at the time of original appraisal. Three values were introduced for the variables: load forecasts, capital costs for the hydro and thermal alternative, and fuel prices. The resulting mean value of the discount rate which equalized the present value of the cost streams was 17.6%. This analysis was repeated based on information available in July 1973. The resulting mean vaiue of the discount rate was 18.8%. If today's fuel costs were introduced into the analysis the discount rate would be at least 25%. 6.06 This surprising result is attributable to three factors: (a) .he basic cost estimate of the Upper Ramu Hydro Project expressed in Australian dollars made in 1970 proved to be  - 13 - accurate; thus a probability of I could be assigned to the hydro capital costs in the revised analysis; (b) fuel costs for the thermal alternative were, already in July 1973, higher than the most probable value assigned in the 1970 analysis; (c) because of the lower load forecast there is now no immediate need for existing diesel equipment to firm up output, thus saving fuel expenses in the earlier years which originally had to be allocated to the hydro cost stream. VII. FINANCIAL ASPECTS 7.01 ELCOM has a good record for reliable supply and service and its financial position has been sound. However, since 1971 ELCOM's market has suffered from business and industrial activity slowdown due to the transient political situation (para 2.03). ELCOM's financial forecasts have therefore been proje:ted conservatively. Past and Present Earnings 7.02 When ELCOM was established in July 1963 it became responsible for nine central supply systems. Its revenues were based on a tariff structure which remained unchanged until 1968. At that time the structure was revised to remove certain inequities and as a result revenue per kWH sold declined by about 7%. Partly for this reason, but mainly due to a substantial increase in expatriate staff for operations to cope with the rapid expansion of facilities (a growth of 3MW/year in the past increasing to about 14MW/year). ELCOM's rate of return fell from 8.4% in 1968 to 4.7% in 1969. This low return continued until a 5% tariff increase became operative in November 1970. On the basis of forecasts which incorporated this tariff increase, ELCOM agreed in 1971 in connection with the Loan 737-PNG to maintain tariffs suf- ficient to produce an annual rate of return of not less than 9% on its averaged net fixed assets in service in 1972 through 1976 and not less than 10% there- after. The slowdown in business and industrial activity starting in 1971 resulted in a rate of return of 7.3% for 1972 and 8.5% for 1973, compared to the 9% required by the Loan Agreement. Present Financial Position 7.03 ELCOM's financial position at June 30, 1973 was sound with net long term debt representing 73% of capitalisation; the value of current assets exceeding by four times the value of current liabilities; the Sinking Funds and Insurance Funds sufficiently liquid to meet the purposes of the funds; and internal cash generation covering debt service for the year by 2.3 times. 7.04 Condensed balance sheets as at June 30, 1970, through 1980 are shown in Annex 19. The estimated 1973 balance sheet shows ELCOM's current financial position. Gross plant of A$ 37.4 million consists of the original  - 14 - fixed assets transferred froa the Administration for a net value of A$ 5.8 million when ELCOM was estab;ished, subsequent additions at historic cost and plant taken over from the Administration during 1973 having a net value of A$ 0.9 million. Work in progress of A$ 13 million includes A$ 10.5 million in respect of the construction of the Upper Ramu hydroelectric Plant No. I and the Rouna hydroelectric Plant No. 3. 7.05 Tne current ratio of 4.1/1.0 (Including current maturities of long-term debt) is satisfactory. Cash on hand is adequate to meet normal working capital requirements. 7.06 ELCOM's capitalization at June 30, 1973 is sunnarized as follows: Equti ; A$ Million % of Total Administration's Equity 6.7 General Reserve 3.7 Insurance Fund 1.7 12.1 27 Net Long-Term Debt Local Currency Debt 30.0 Less Singking Funds (2.1) 27.9 62 Foreign Currency Debt IBRD Locan 737-PNG 4.5 Supplier Credit 0.5 5.0 11 32.9 73 45.0 100 7.07 Total equity represents 27% of capitalization. The Administration's equity represents the agreed value of the original assets transferred together with the value of A$ 0.9 million for plant at Kieta and Keravat transferred during 1973. 7.08 Long-term debt is detailed in Annex 20. The Administration's 1/ loans carry interest rates of between 5-1/8% and 7-3/4% and are repayable after periods of 20, 25 and 40 years. The IBRD loan of A$ 4.5 million is that part of Loan 737-PNG drawn to date to finance the Upper Ramu hydro- electric project. The loan should be fully withdrawn by the end of 1975. Other debt consists of supplier credits which will be repaid by 1977. Sinking Fund 7.09 Sinking funds have been established to repay Government loans upon maturity. As they complicate unnecessarily the servicing of debt, 1/ As from December 1, 1973 the Government of PNG took over the former Administration's equity and loans.  - 15 - future Government loans should require normal level debt service. ELCOM may desire to go further and substitute a similar method for servicing existing Government debt. In such an event, the arrangements made between ELCOM and the Government woull be discussed with the Bank. Insurance 7.10 ELCOM is accumulating an Insurance Fund to cover various risks from fire, explosion, and other damage and loss. The annual premia assessed by ELCOM's insurance consultant are properly charged as an operating ex- pense. The fund amounted to A$ 1.75 million, or US$2.6 million equiv- alent as at June 30, 1973. Apart from possible catastrophic loss, the forecast annual premia together with interest on the Fund's investments exceeds the forecast annual claims. However, after independence and the creat:ion of a new PNG currency, the Fund may not provide foreign exchange to pEy for replacement or repair of plant. The Borrower has therefore undertaken to use its best efforts to convert funds held by ELCOM in its insurance fund into currencies freely usable by ELCOM to replace or repair assets in the event of loss or damage. Audit 7.11 The existing Project Agreement requires annual audits by independent auditors acceptable to the Bank and audited statements within 4 months of the end of the financial year. This covenant has been repeated. The last audit was made by the Auditor General for the Common- wealth of Australia. This arrangement will likely cease when Papua New Guinea achieves independence. The new PNG Government is expected to establish a PNG Auditor General's Office to undertake, inter alia, ELCOM's annual audit as required by Sec. 23 of the Electricity Commission Ordinance. This was discussed during negotiations and it was agreed that, in the event the PNG Auditor General should not have personnel with the necessary qualifications to carry out the commercial audit, ELCOM would employ an independence firm of professional accountants to either assist the Auditor General in the audit or alternatively to provide the Bank with an independent commercial audit. Proposed Financing Plan 7.12 Annex 21 presents sources and application of funds for 1973-80. It is based on sales forecasts discussed in Chapter 4 and the income state- ments in Annex 23. A summary of .he proposed financing plan covering the six-year period 1974 through 1979 is shown below:  - 16 - A$ Million A$ Million % Funds Required Capital Expenditure 34.9 Deferred Charges In-Service Training 5.1 Working Capital Increase 1.3 Capitalized Interest 4.2 Total Requirements 45.5 100 Source of Funds Internal Cash Generation 42.8 Less: Interest charged to operations (18.5) Debt Amortization (3.0) Sinking Fund Contributions (2.7) Provision for employees benefits (1.9) Dividend (0.6) Net Internal Cash Generation 16.1 35 Borrowings IBRD Loan No. 737-PNG 12.4 Proposed IBRD Loan 7.2 Local Borrowings 9.8 Total Borrowings 29.4 65 Total Sources 45.5 100 7.13 Net internal cash generation would finance 35% of ELCOM's capital requirements. Borrowing detailed in Annex 20 would finance the remaining 65%, and would consist of the balance of Bank Loan 737-PNG, the proposed Bank loan of US$10.8 million equivalent or A$ 7.2 million, local loans of A$ 9.8 million of which A$ 8.8 million represents loans which the Admini- istration has already agreed to provide and estimated advances of A$ 1.1 million from consumers. A short-term bridging loan of A$ 3 million would be required in 1974 repayable in early 1975, and an additional A$ 1 million later in 1975 repayable in 1976. ELCOM has indicated that these funds would be made available by either the Government or the Bank of Papua New Guinea. Additionally ELCOM's present undertaking to provide a financial plan satis- factory to the Bank before committing itself to any future construction project costing in excess of A$ 10 million has been repeated in the proposed loan agreement. Future Financial Position 7.14 Revenues are based on forecast sales growth of 8.5% through 1980 (para 4.01). Projected operating expenses (Annex 23) assume that the cost of those expatriates wholly engaged in training during the five-year period from mid-1974 through mid-1979 would be deferred and written off over 10 years. On this basis, the 9% return required by the existing  - 17 - loan agreement would be achieved in 1974 and 1975. Subsequently, returns of 8.4%, 6.9%, 7.4%, 7.6% and 7.9% for 1976 through 1980 are forecast, which would be below the targets of 9% until 1976 and 10% thereafter set forth in the existing covenant. This forecast failure to meet the agreed returns results principally from the low rate of market growth adopted for this report; the agreed returns would be met should the additional load described in para 4.03 maternalize. Paradoxically, the financial situation is forecast to remain sound even with low market growth: the operating ratio would vary between 59% and 65%, the net debt equity ratio would improve from 76/24 in 1976 to 73/27 in 1980 and internal cash generation net of debt service would cover 35% of capital reuqirements during 1974-1979. Given these circumstances, the existing earnings test covenant has been continued in the proposed Project Agreement, recognizing that it may be waived for some years after 1975 provided ELCOM's financial situation for the year in question remains satisfactory to the Bank. The existing covenant preventing payment of dividends before July 1978 without the Bank's approval has also been continued. 7.15 The Administration agreed in connection with the last loan that in transferring any of its assets to ELCOM it would: (a) accept in payment therefor a suitable form of equity corresponding to the agreed value of such transfer; and (b) make available annually to ELCOM amounts sufficient to cover the losses on any power systems transferred. These undertakings were repeated in the proposed Loan Agreement. 7.16 Estimated gross assets in service are forecast to increase from A$ 40 million (US$59 million equivalent) at the end of 1974 to A$ 83 million (US$123 million) by 1976 after the Rouna No. 3 hydroelectric plant and the Upper Ramu hydroelectric plant No. 1 are commissioned (Annex 19). Sub- sequently investment in distribution accounts for the increased plant value to A$ 90 million (US$133 million) by the end of 1980. 7.17 Long-term debt net of sinking funds represents 77% of total capitalization in 1974 rising to 79% in 1975 then declining gradually to 76% in 1980. The current ratio drops from 4.1 in 1973 to 1.2 in 1974 due to the short-term bridging loan of A$ 3 million. Subsequently the ratio rises to 3.5 by 1978. The reduction to 3.2 in 1979 and 1980 reflects the beginning of the payment of dividends. 7.18 ELCOM's internal cash generation would cover annual debt service 1.9 times on average, a satisfactory coverage on a year to year basis. However, the existing covenant of Loan 737-PNG provides that ELCOM shall not incur any long-term debt, except as the Bank may otherwise agree, if its net revenue for the fiscal year next preceding the date of such incurrence shall be less than 1.5 times the maximum debt service requirement for any successive year-on all the debt of ELCOM including the debt to be incurred. The 1.5 times coverage, which is strict, was based on ELCOM's previously provided high market growth and high earnings. It cannot reasonably be achieved in the next few years unless loan growth (para 4.03) and increased revenues (para 7.14) materialize. ELCOM's net revenues would then exceed 1.5 times the maximum debt service for any succeeding year. In the circumstances the covenant was continued.  - t8 - VIII. AGREEMENTS REACHED AND RECONKENDATION 8.01 During loan negotiations agreement was reached on the fo}lowing points and appropriate covenants included in the legal documents for the proposed Loan: (a) an earning test (para 7.14); (b) debt control (para 7.18); and (c) training program (para 5.04). 8.02 The project is suitable for a Bank loan of US$10.9 million equivalent for a term of 20 years including a grace period of five years.  F'PU NW UIEPAPUA NEW GUINEA PAPA NW GINA ELECTRICITY C M ISO EC M ECONOMIC DATA EC) t -/340 1 0 / 1320 1 g o-_ _ 300 1.2 220 1.1 KWH/CAPITA./ t 1~~~~~~~~~~~~~~~~~~~~~~~~~~~~260 1. 1 7 0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~240 t1.2 iOOO GNPCPItCAAz 220 1.1 9~~~~~~~~~~~~~~~~.s- 00 20- 1.0 GWH PAPUA NEW GUINEA IN TOTAL 180 6 0.9 a 700 I KWH GENERATED/$ A GNP < / 3 600 140L8 0. W f _ G~~~~~~~~~~~~~~~~~~ROSS NATiONAL PRODUCT >500t '8 120 0.6 L3400 1 00-~ sss*|t _ R _~ 8 g 0.5 300 - SECToj~~~~ - - ~ 60 0.3 200= C _5 10