Philippines - Power Transmission and Rehabilitation Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 10996-PH STAFF APPRAISAL REPORT PHILIPPINES POWER TRANSMISSION AND REHABILITATION PROJECT MICROFICHE COPY Report No.:10996-PH Type: (SAR) Title: POWER TRANSMISSION AND REHABIL Author: FERNANDEZ, C Ext.:80474 Room:D8043 Dept.:EAlIE June 3, 1993 Industry and Energy Operations Division Country Department I East Asia and Pacific Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CIRRENCY EQUIVALENTS (as of January 31, 1993) Currency Unit = Pesos (Pi) P I = US$0.038 US$1 = i26.0 WEIGHTS AND MEASURES b/d = Barrels per day (1 barrel = 159 liters) BTU = British Thermal Unit (0.253 kilo calories) GWh = Gigawatt hour (1,000,000 kwh) kg = Kilogram (2.205 pounds) knm Kilometer (0.62 miles) kw = Kilowatt (1,000 watts) kWh = Kilowatt-hour(860 kilo-calories) kV Kilovolt (1,000 volts) kVA = Kilovolt-ampere (1,000 volt-amperes) MMBOE - Million Barrels Oil Equivalent=0.144 MMTOE Million Tons Oil Equivalent MVA = Megavolt-ampere (1,000 kVA) MW = Megawatt (1,000 kilowatts) TOE = Tons of oil equivalent tcf = Trillion cubic feet Ton = Metric Ton (1,000 kilograms) TWh = Tera watt hour (109 watt-hours) ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank BOT Buiid-Operate-Transfer BTO Build-Transfer-and-Operate COA Commission on Audit DENR Department of Environment and Natural Resources DOF Department of Finance DOE Department of Energy ECC Environmental Compliance Certificate --A Environmental Impact Assessment EMB Environmemtal Management Board ERB Energy Regulatory Board EOIS Efficiency and Operational Improvement Study ESP Energy Sector Plan GDP Gross Domestic Product GCMCC Government Corporations Monitoring and Coordinating Committee GOP Government of Philippines IMF International Monetary Fund NEA National Electrification Administration NEDA National Economic and Development Authority OEA Office of Energy Affairs OPSF Oil Price Stabilization Fund NPC National Power Corporation PDP Power Development Plan PNOC Philippine National Oil Company RECs Rural Electrification Cooperatives FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY PHILIPPINES Power Transmission and Rehabilitation Project Loan and Project Summary Borrower: National Power Corporation (NPC) Guarantor; Republic of Philippines Amount: US$110 million equivalent. 20 years, including 5 years of grace, at the Bank's standard variable interest rate. Project Oblectives and Description: The main objectives of the proposed project are to alleviate power shortages in Luzon, through (a) a transmission system expansion and reinforcement program needed to bring power to Manila from the "fast track" generation plants and (b) the rehabilitation of the Bataan thermal generating plant. It will also improve the performance of the energy sector through the approval by the Government, in consultation with the Bank, of an Energy Sector Plan covering policies, institutions and implementing mechanisms. In addition it will ensure the financial viability of NPC to undertake a massive and long- overdue investment program and improve its institutional setup. The proposed project will have the following major components: (a) expansion of the transmission system in the Bataan/Batangas areas west of Metro Manila; (b) provision of goods and materials (conductors, insulators and supports) to reinforce the transmission system; (c).rehabilitation of the two units (Unit #1, 75 MW and Unit #2, 150 MW) of the Bataan oil-fired thermal power plant; (d) consulting assistance to prepare a master plan to develop the 500 kV extra high voltage (EHV) system and rehabilitate the Bataan thermal plant; and (e) improvement of NPC's institutional systems. Benefits and Risks: The project would ensure a stable power supply for Luzon, avoiding substantial economic losses estimated at $600-$800 million per year, while providing a base for improved institutional and fnancial operations within the sector. Although the Government is forcefully pursuing a large expansion of its power generation from the private sector, its implementation could be delayed on financial grounds. This risk is minimized by the number of projects and the diversity of the contractors. Should extensive delays occur the power supply situadon would continue to remain critical and the consequent curtailment of demand would have an adverse impact on the economy. The risk of delays in the implementation of the project's transmission program has been minimized by an advanced and effective procurement program being monitored monthly by the Bank. There is also a risk that tariffs would not be increased in the future. However, this risk is reduced because of the recent decisions of the Energy Regulatory Board approving the principles for NPC tariffs and because of the automatic tariff adjustments to be implemented. Moreover, the new administration in the Philippines has targeted energy problems as its top priority. This document has a restricted distribution and may be used by recipients only in the performance Of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Local Foreign Total ---- (US$ million) - - - - Transmission Expansion and Reinforcement 7.3 84.7 92.0 Bataan Power Plant Rehabilitation 3.5 22.5 26.0 Technical Assistance 0.3 1.4 1.7 Taxes and Duties 5.4 0.0 5.4 Base Cost (June 1992) 16.5 108.6 125.1 Physical contingencies 1.1 10.8 11.9 Price contingencies 1.1 6.7 7.8 Total Project Cost / 18.7 126.1 144.8 Interest during construction 0.0 15.0 15.0 Total Financin0 Reawred 18.7 141.1 159.8 Financine Plan: World Bank - 110.0 110.0 National Power Corporation 18.7 30.6 49.3 Japanese Grant 0.5 0.5 TOTAL 18.7 141.1 159.8 a/ Including taxes and duties equivalent to US$5.7 million. Estimated Disbursement: Bank Fiscal Year FY93 FY94 FY95 FY96 FY9,7 ------ (US$ million) ------ Annual 0.0 21.6 33.6 43.2 11.6 Cumulative 0.0 21.6 55.2 98.4 110.0 Economic Rate of Return: 11% Map: IBRD No. 20239  -~~~~~~~~~~~~~~~ xi PHILIPPINES Power TransmhIsion and Rehabilitation Project Table of Contents Paee No. Loan and Project Summary .............................................. i I. The Energy Sector Overview ......................1 Resource Endowment ..................... 1 Sector Institutions ..................... 1 Sector Issues and Reforms ......................................... 2 Previous Bank Projects. 7 Rationale for Bank Participation. 7 H. The Power Sub-Sector. 8 The Power Market. 8 The Power Crisis. 9 NPC's Power Development Program .10 Generation Program .10 System Losses .12 Transmission System .12 m. The Borrower .13 Organization and Management .13 NPC's Reform Program . 13 Training .14 Financial Policies .15 Financial Management .15 IV. The Project ......................................... 16 Background ........... 16 Project Objectives ............................... ............ 16 Project Description ............ 16 Cost Estimates ............ 18 Financing Plan ............ 18 Project Implementation ..................................... 18 Monitoring and Supervision ............ 19 Procurement ............ 20 Disbursements ............ 21 Environment ............ 21 This report is based on the findings of an appraisal mission consisting of Messrs. Claudio Fernandez (Principal Financial Analyst) and Darayes Mehta (Principal Power Engineer) who visited the Philippines in July 1992. The report was edited by Ms. Barbara Koeppel. Peer reviewers were Messrs. Rafael Moscote, Albert B. Gulstone and Jamil Sopher. The project was cleared by Mr. Callisto E. Madavo, Director EAI and Mr. Vineet Nayyar, Chief, EAIIE.  - iv - V Finances ........................ 23 Past anc Current Financial Performance . ........................... 23 Capital Expenditure Program ........................... 25 Overall Financing Plan ........................... 25 Foreign Exchange Exposure ........................... 27 Future Finances . ........................... 27 Financial Sensitivity Analysis ...................................... 29 Monitoring and Evaluation .29 VI. Project Justirication .30 Economic Analysis .30 Risks .30 VII. Agreements Reached and Recommendation .31 ANNEXES Annex 1 Energy Sector Plan Summary .33 Annex 2 Energy Production and Consumption .39 Annex 3 NPC's Demand (Sales, Generation, Peak Demand and Capacity) .41 Annex 4 NPC's Power Development Program .49 Annex 5 Transmission Facilities .51 Annex 6 Efficiency and Operational Improvement Study .53 Annex 7 NPC's Organization Chart .58 Annex 8 Project Cost .59 Annex 9 Bataan Plant Rehabilitation .62 Annex 10 Disbursement Schedule .65 Annex 11 Total Capital Expenditures .66 Annex 12 NPC's Financial Projections .69 Annex 13 Monitoring Indicators .72 Annex 14 Assumptions for Financial Projections .73 Annex 15 Economic Analysis .77 Annex 16 Tariff Structure .78 Annex 17 Transmission Master Plan - Terms of Reference .81 Annex 18 Documenits in Project File .84 MAP: IBRD No. 20239  I. THE ENERGY SECTOR Overview Resource Endowment 1.3 Unlike its ASEAN neighbors, the 1.1 Over the last decade, commercial energy Philippines is not well endowed with indigenous energy consumption in the Philippines increased at an average resources. New resources being developed (in addition rate of 2.3% p.a. from 83.4 million barrels of oil to coal and hydropower) are geothermal energy and oil equivalent (MMBOE) in 1980 to 104.5 MMBOE in 1990 which came into production in 1978 and 1979 (Annex 2, Tables I and 2). This was due to substantial respectively. Geothermal reserves are not yet fully increases in industrialization, the reduced share of evaluated, but could exceed 6,000 MW: 900 MW are agriculture on GDP and an overall growth in the already produced and about 800 MW more are expected economy of about 1.6% p.a. Between 1986-91, energy from projects under preparation or construction. Proven and GDP growth accelerated to 6.8% and 4% p.a. oil reserves amount to only 4 million tons and they have respectively. Most of the energy consumed (75%) was been declining since 1983. A recent discovery of natural and is derived from oil, but local oil production is gas offshore of Par:.- an may provide up to 8 trillion minimal (1.3% of the total) and this causes large cubic feet (tcf); however, substantial exploration is economic shocks when international oil prices increase needed to confirm the size of the deposit and its dramatically: For example, in 1991, due to the Gulf economic viability. The total potential coal resource is War, the cost of imported fuel increased by about 60% estimated at about 1,500 million tons (MMT), but most and the country registered a negative 1 % GDP growth. of it is low grade and expensive to mine. Hydro Annex 2 shows the Philippines' energy balance between resources are quite substantial, with a theoretical power 1980-2000. In 1991, the industrial sector accounted for potential in excess of 10,000 MW, but the better sites 51 % of total energy demand, followed by transportation, are too distant from roads and transmission lines, and with 32%. About 35% of total energy produced was their development has become uncertain given electricity (Annex 2, Table 1) and this figure is expected environmental concerns and guerilla activities in remote to rise to 38% by 2000. However, electricity generation areas. As a result, no single hydro project has been depends heavily on oil (55%), which entails considerable completed (other than one in Mindanao) during the last fmancial risk. Thus a move away from oil and further 12 years. About 40 run-of-river, small hydro projects development of indigenous energy are the only are being prepared under the Energy Sector Project significant prospects for limiting the rapid growth of oil (Loan 3163-PH) but those that are feasible would not imports. add more than 300 MW. Consequently, the most promising indigenous resource is geothermal energy. 1.2 It is expected that recovery of the Philippine economy will increase GDP growth from 3.5% p.a. between 1990-95 to 5.6% p.a. between 1995- Sector Institutions 2000. Thus, during the decade, energy consumption is expected to rise by 6.4% p.a., and it is thought that 1.4 The Energy Coordination Council (chaired indigenous sources will provide an increasing share by the President's Executive Secretary) and the Office of (from 9% to 15% for geothermal and from 5.5% to Energy Affairs (OEA -which reported to the Office of 7.9% for coal). Nevertheless, 70% of the energy the President) were responsible for coordinating the consumed will still be imported by 2000 (Annex 2, energy sector from 1987-92. These institutional Table 2). arrangements did not succeed in this task nor in providing adequate sector investments and supervision. The recent establishment of the Department of Energy (DOE), under Republic Act 7638 of December 9, 1992, is a major step to improve conditions; it has been operating since February 1993, replacing the Energy  -2 - Coordinating Council and OEA. DOE has been given a Administration (NEBA), responsible for financing and comprehensive mandate for policy formulation, planning providing related technical support to the RECs. To and supervision in the sector. Also, it will be involved strengthen the Government's supervisory role during the at the Cabinet level in decisions to solve the present current power crisis (para. 2.6), die DOE Secretary will energy crisis and is expected to strengthen private sector be the chairman of NPC, PNOC and NEA. Other participation in power supply (para. 2.11 and 2.14). institutions critical to the sector are: (a) the Department of Finance (DOF), which approves local or foreign 1.5 The DOE law establishes policies to borrowing and recommends budgetary contributions; (b) promote environmentally sound development and the National Economic and Development Authority conservation of resources, as well as indigenous energy, (NEDA), which approves the country's planning privatization and increased private sector participation in (including large energy projects) and (c) the all energy activities. It also aims to reduce dependence Environmental Management Bureau (EMB), under the on oil-fired plants. The DOE secretary is an ex-officio Department of the Environment and Natural Resources member of the National Economic and Development (DENR), which has the authority to approve the Authority (NEDA), and is supported by four bureaus: (a) environmental impact assessment (EIA) and provide the the Energy Utilization Management Bureau, for environmental compliance certificate (ECC) required for monitoring and assisting with demand management, the construction and operation of power projects. conservation, the efficient use of energy resources, and the development of nonconventional energy systems; (b) 1.7 Power Develonment Stratewv. The the Energy Resources Bureau, for formulating policies Philippine economy depends greatly on petroleum and helping develop energy resources; (c) the Energy imports and requires a substantial increase in its power Industry Administration Bureau, for creating regulatory, capacity. Concerned with the need to conserve petroleum financial and fiscal policies related to energy supply and use energy optimally, the Government strategy caUs entities and for approving non-price regulatory matters for: (a) an environmentaly sound and sustainable power and (d) the Energy Planning and Monitoring Bureau, for development plan; (b) large private sector participation developing and monitoring energy plans and demand in energy projects; (c) improvements in sector efficiency; forecasts and incorporating national environmental goals (d) reduced dependency on oil-fired plants; (e) increased into energy programs. A five-member Council of use of geothermal resources and (f) improved demand Advisers on Energy Affairs from the private sector was management and conservation. This strategy is supported also established to advise the President on energy by the Bank and sector reforms (para. 1.8-1.27) and is programs and private sector initiatives. consistent with Bank policies to promote satisfactory sector improvements, adequate regulatory systems (para. 1.6 PracticaDly aUl 140 companies and utilities 1.13) and the provision of services and private sector in the energy sector are private (investor or member- participation (para. 1.14). owned). Power distribution, in particular, is managed almost completely by investor-owned entities which Sector Issues and Reforms include the following: (a) MERALCO (Manila Electricity Company), a private utility that distributes 1.8 Since 1991 the Philippines has been about 60% of the total electricity to Metro Manila; (b) experiencing a very serious power crisis which poses a 12 private or municipal utilities that retail electricity in grave threat to its economic development and stability. different cities and (c) about 120 member-owned rural The crisis results in substantial outages -6 to 10 hours electrification cooperatives (RECs), which distribute and per day in Luzon and Mindanao and drastic curtailments manage retail power sales in rural areas. There are, in supply. This hurt industrial production and the however, three very large government corporations in development of new industrial and commercial activities. the sector: (a) the National Power Corporation (NPC), Thus, unemployment is rising and economic losses are which sells power in bulk to power utilities and is mounting, estimated at US$600-$800 million per year by responsible for power generation and transmission; (b) the Bank or about 1.5% of GDP (using 50.'kWh as the the Philippines National Oil Company (PNOC), cost of unserved energy) and at US$1-1.3 billion by the responsible for developing indigenous hydrocarbon and business community. Necessities are jeopardized-not geothermal resources and refining and selling petroleum only because of a lack of electricity for reading, cooking products and (c) the National Electrification or entertainment--but because other key services that  - 3- depend on electricity (such as traffic management, implementation by end of 1993 are as follows: (a) a total pumped water and sewerage), are also disrupted. The fuel cost adjustment mechanism to compensate for power crisis resulted from minimum investment in variations in fuel prices and the cost of purchased previous years (practically no addidonal power capacity energy, which would make future tariff adjustments was added between '986-92), due to delays for several largely automatic (para. 5.14); (b) a restructured tariff years in obtaining environmental approvals for power that introduces demand charges to reduce peak demand plants, slow procurement and the mothballing of the and (c) exchange rate adjustments (paras. 5.14). nuclear plant. Under the "Electric Power Crisis Act of 1993," the President has been given special powers to 1.12 NPC has also introduced major solve the energy crisis including facilitating tariff insdtutional and operational improvements. These increases, speeding-up project approvals and improving include: (a) streamlining its structure by halving the technical salaries in the sector. number of top managers, which eliminated 17 vice presidents and about 20 department managers and 1.9 Inadequate policies prevented Bank lending reduced the staff from 16,056 to 14,256 between 1991- to the Philippines for several years until 1988-89, when 92. Further reforms and streamlining of NPC's the Bacon Manito Project (Loan 2969-PH) and the management and organization are being implemented by Energy Sector Project (Loan 3163-PH) initiated reforms DOE; (b) rationalizing functions and providing for to improve sector coordination and planning, improve greater decentralization (particularly for maintenance, environmental monitoring, enhance the technical watershed management and accounting); (c) introducing capabilities of sector institutions and facilitate private standardized bidding specifications, establishing a power development. Despite these reforms, a serious contracts committee and delegating responsibilities for power and financial crisis and prolonged outages in all procurement to the regional managers; (d) establishing regions highlighted the need for further reforms and programs and targets to improve combustion efficiency; improvements. Therefore, since 1991, the Bank has been (e) improving project implementation and (f) pursuing discussing these issues and a paper recommending sector better internal audits and rotating staff who exercise improvements'/ was submitted to the new Government critical financial functions. In addition, an Efficiency in July 1992. and Operadonal Improvement Study (EOIS) has been contracted by the Bank to identify and implement further 1.10 Tehe Energv Sector Plan. Sector reform institutional improvements (para. 3.7). Improved and improvements are the highest priority of the new supervision and management by objectives are also being administration. Prior to Board presentation!, the implemented by the Government Corporatons Government approved an Energy Sector Plan (ESP) to Monitoring and Coordinating Committee (GCMCC), chart the course of actions it will take to unprove sector which is directed by a board that includes key cabinet operations. The ESP lays out policies and defnes members. It sets targets, performance indicators and improvements in all areas of concern as well as their incentives to improve the efficiency and effectiveness of completion schedule; these, along with the status of Government corporations. At the end of the year, the implementation, are shown in Annex 1. Implementing GCMCC judges compliance with agreed targets and the the ESP is cridcal to ensure adequate power supply and staff within the best-ranked Government corporations are donor support for the large outlays required. Agreement given bonuses of up to 10% of their salaries. was reached at negotiations that the Govermnent. NPC and the Bank would exchanae views on the 1.13 Regulatory Framework. Under the DOE implementation of the ESP. law, an adequate framework has been established for regulating the sector. This includes DOE setting policies, 1.11 Some key actions of the ESP have already deciding on non-price regulations, implementing them been implemented, particularly the establishment of the and supervising Government corporations in the sector. Department of Energy. Also, ESP's actions to improve In addition, the regulatory system has been strengthened, NPC's finances include a tariff increase to yield an 8% and the Energy Regulatory Board (ERB) is now rate of return on revalued assets in 1993 (para. 5.14) and responsible for approving tariffs (by public hearings) and other tariff actions already approved by NPC's Board. regulatng energy prices under clear rate-of-return These actions, which are being reviewing by the Energy criteria. ERB has just decided on the validity of two Regulatory Board (ERB) and scheduled for previous tariff increases (February 1991 and January  4- 1992) which had been previously enjoined and referred costs for unused capacity. The additional power by the Supreme Court to ERB for a decision. ERB generation already contracted for with the private sector authorized NPC to recover these with prospective effect, amounts to more than 60% of the present generating setting jurisprudence and criteria for future tariffs capacity. Moreover, NPC's Board has approved a policy regarding the rate base, the rate of return level, the to offer as BOT contracts practically aU the new power assets revaluation and the allowed expenses in the rate of generation plants (except multipurpose hydro plants), and return. Further, the ERB approved that the shortfall in bids for large coal plants are underway. Given the revenues of previous years will be collected in future limited commercial financing available to the Philippines bills. To perform effectively, ERB needs to increase the it would be desirable to provide some official financing number of qualified staff, receive support from advisors for the private sector, but there are three important and irain its staff on tariff analysis and regulatory constraints First, the Foreign Borrowing Act prevents systems. Grant financing for regulatory advisers is also the Government from guaranteeing official loans that being sought. Although the ERB is placed benefit a private sector investment in priority administratively within DOE, it is a quasi-judicial, infrastructure. Second, the generation investments autonomous body that has adequately managed oil prices needed are quite large (US$1.1 billion per year). Third, (maintaining a surplus in the Oil Price Stabilization Fund limits exist on the amount that can be onlent by (OPSF)) and approved adequate tariffs for private power Government banks, which serve as financial utilities. intermediaries. Thus, mechanisms must be created to allow some official financing to facilitate private 1.14 Private Sector Partic-iation. The projects. To this end, the Bank is supporting studies to Philippines is one of the developing countries with large establish an Infrastructure Development Fund which private sector participation in the energy sector. With the could help finance or guarantee priority infrastructure exception of a handful of municipal utilities, all power investments by the private sector. distribution and retailing is done by private utilities or rural electrification cooperatives. Energy exploration is 1.16 A USAID-funded study (by Price private and oil refining and distribution are carried out Waterhouse) identified several privatization options for by two private companies (CALTEX and Philippines NPC. However, additional studies are required to Shell Petroleum Corporation) in addition to Petron (the evaluate the impact of these alternatives, as wen as the oil subsidiary of PNOC) which will be privatized in implementation procedures, since there are important 1994. The privadzation of Petron would include the sale constitutional, fmancial and borrowing constraints that of one third of its shares to a foreign oil company, must be resolved to ensure a successful privatizadon and another third would be sold to PNOC's employees and that the large investments needed would be implemented the public and the Government expects would retain thereafter. Thus, the present strategy of steadily about 35% of the shares. This privatization is supported increasing the private sector role in power generation by the Bank and is expected to repeat the successful and operational management is appropriate. Although experience in the privatization of 70 other Government regional fractionalizing of NPC seems politically corporations. expedient, a better alternative would be that NPC continues to be responsible for national transmission, 1.15 With 15 contracts signed and several others some residual power generation and the overaU dispatch under negotiation with the private sector for the of power, with power generation becoming fully construction, financing and operation of power plants competitive under improved BOT/BTO bidding using Build, Operate and Transfer (BOT) or Build, procedures. In accord with the ESP, a decision on NPC Transfer and Operate (BTO)3L systems, the Philippines privatization will be taker. .qy end of 1993. In the is a pioneer in private sector participation in power interim, ways are needed to il prove policies, reduce the generation. These contracts involves a total capacity of uncertainties and risks faced by the private sector and about 2,600 MW (Annex 4, Table 2). In the future, the encourage even wider private participation. Aeement proliferation of BOT contracts under take-or-pay was reached at neotiations that no later than December conditions may result in complex dispatch problems and 31. 1993 NPC would imnlement improved rules and difficulties in allocating he reserve and spinning costs of procedures to facilitate private sector Darticiation in capacity. DOE is establishing a planning system to avoid ener geeneration. including standardized bidding either low supply and outages or excessive supply and documents sadisfactorv to the Bank.  -5- 1.17 Power Pricing and Finacgial 1.19 Distribulion Tariffs. Retail power tariffs Improvements. Although the NPC Board had the in the Manila area, which are indexed with NPC tariffs power to approve tariffs, the increase in March 1991 and the exchange rate, have provided MERALCO a rate was suspended by the Supreme Court -which led to of return higher than 8%. The power tariff subsidize NPC's financial crisis (para. 5.4). In addition, the consumption below 50 kWh/month through relatively January 1992 increase, although implemenied, was also higher rates for large industrial and commercial users. submitted for an ERB judgement. However, ERB has Under the Rural Electrification Revitalization project, now determined that both tariff increases were justifled substantial tariff increases have been approved for RECs, and it furthe. approved an additional tariff incrcase of many in the order of 40%-50%. These tariffs are PO.O57/kWh from January 1992 onward (which would generally uniform for all consumers, regardless of have provided a 10% rate of reiurn to NPC, higher than voltage level, resulting in a cross subsidization to low the 8% covenanted by the Bank); these tariff increases voltage consumers. NEA is introducing tew guidelines would be recovered for one year, beginning April 1993. to improve the structure and level of REC tariffs. In addition, ERB clearly defined the asset base and the expenses allowed for the rate of return (the major 1.20 0 Pricing. The Government has targeted contention in the previous two tariff increases), which a full deregulation of oil prices for 1996 to improve will avoid future legal challenges on these matters. The competidon, upgrade oil production and refinery increases would result in additional revenues facilities and depoliticize the adjustment of oil prices. (P0.1 8/kWh from April 1993 and an additional The deregulation will require changes in the legal and P0.03/kWh from July 1993), increasing NPC's net regulatory frameworks, the establishment of new income from a negative P2.9 billion in 1991 to P 1.6 financing mechanisms for crude oil purchases, and the billion in 1992 and P6 billion in 1993. Now, under elimination of the "baggage of the past" (including legal DOE law, all energy prices will be approved by the cases pending at the Supreme Court). In order to achieve ERB. Moreover, to avoid delays in adjusting tariffs for a successful deregulation, steps are included in the ESP, costs that are beyond NPC control and to depoliticize including energy pricing, industry cost studies and the such increases, an automatic monthly total fuel cost measures already taken by ERB to ensure adequate rates adjustment was approved by the NPC Board and its of return to the oil companies. In the meantime, it was implementation is pending ERB approval. This will important to maintain appropriate prices for oil products. index NPC tariffs with fuel prices and other costs This was achieved during the last two years, when prices representing about 82% of NPC's operational were above intemational levels and resulted in a expenditures (for oil, coal, steam and purchased energy). substantial OPSF surplus. To ensure the continuation of NPC's Board also has approved and the ESP has these policies, the Government is supporting legislation endorsed a similar indexation to compensate for the requiring automatic adjustments of oil prices when the increase in loan principal resulting from exchange rate OPSF fund reaches minimum or maximum liquidity variations; this will be implemented when the exchange levels; also, ERB is considering indexing wholesale oil rate surpasses the base exchange rate of P28/dollar used prices with Singapore price indexes for petroleum for NPC's budget in 1993 (para. 5.14). products (expressed in pesos eqtuivalent). This would allow automatic monthly adjustments in oil prices. 1.18 NPC's Board has also approved a tariff restructuring to implement demand charges in line with 1.21 Environmental Management. The its long-run marginal cost and achieve a better price for Government's policy is to achieve sustainable demand and energy charges, while providing a lifeline development by enforcing environmental guidelines and rate for utilities that serve low-income consumers. requiring that a satisfactory environmental impact Establishing charges for maximum demand is supported assessment (EIA) be prepared for power projects. by the ESP and would be implemented under the project However, many power projects were halted or suffered (para. 5.14). Fu.-ther improvements would require the inordinate delays (three years) during the time that implementation of time of day rates for large consumers environmental decisions or approvals from the (once normal power supply is restored) and the Department of Environment and Natural Resources equalization of rates (at the same voltage levels) among (DENR) were being secured. This occurred due to industries and utilities. institutional deficiencies, stringent, environmental guidelines and the convoluted process to obtain the  - 6- environmental approval and acceptance from the efficiency standards for all power intensive appliances communities involved. Agreement has now been reached are being implemented and test results will be used to to separate the technical and enviro;. ntal analyses and label appliances by mid-1994; (e) an ongoing approval (by DENR) from the stial and political Technology Transfer Energy Management program approval which will be handled by the Regional would continue to finance energy conservation programs, Development Councils and NEDA. The technical document energy savings and disseminate relatea capabil4qy and equipment of the EMB are being upgraded information; (f) studies are being completed by several under the Energy Sector Project (Loan 3165-PH) donors and the Bank on further energy conservation and through training and the acquisition of modern demand management and (g) demand charges will be laboratory and monitoring equipment. DENR will also introduced to MERALCO and all other utilities by need to employ more environmental specialists and December 1993 (para. 5.14). review its stringent environmental guidelines. The Bank has completed a sector study ("Toward Improved 1.24 OneratMonad Mantance. The present Management of Environmental Impacts," May 10, 1993) energy crisis (para. 2.6) is in part due to lack of proposing recommendations to improve the adequate maintenance, insufficient spare parts and lack environmental analysis and find a balance between the of qualified technical staff. The problem has been power supply requirements and the resistance of most exacerbated by power shortages which have forced NPC communities to having power plants in their backyards. power plants to operate for long periods without Since a key concern for power projects is their social scheduled maintenance. Maintenance practices, acceptability, the President has given instructions to especially with regard to procuring essential spare parts NEDA, DOE, DENR and NPC to identify sites for when they are needed, must be improved. Thus, future power plants whicb would be .re management contracts with the private sector have been environmentally and socially acceptable. signed for several plants (Ambuklao, Naga and ten power generating barges). 1.22 Enerm Conservation and Demand Management. The Philippines is already implementing 1.25 Ogerational Efficiency. NPC's programs for energy conservation and demand transmission losses, net of station use, are just 3.5%, management. These include: (a) using DOE audits of which is satisfactory. However, to improve operational energy-intensive industries to demonstrate savings to efficiency in the power sector old NPC plants would be similar companies (for example, large commercial and rehabilitated (to increase the reliability of power industrial establishments already use highly efficient generation). Because most t'ermal plants are very old fluorescent lights); (b) using industrial loans to purchase (their average age is 23 years), some may have to be more efficient motors; (c) carrying out energy audits (by retired within the next 5-10 years. Also management private companies), fnanced by part of the cost savings contracts are being considered for another two large and (d) adopting strict conservation measures at public plants in 1993. Further, MERALCO and the RECs will offices. ESMAP is currently studying further measures be requirea to reduce excessive distribution losses by to be implemented, but given the Philippines's very low upgrading the system's capacity and enforcing stricter per-capita power demand and the limited use of controls on metering and biUling. Between 1989-92, electiicity, the power demand reductions are expected to MERALCO reduced electricity distribution losses from be moderate. 21% to 14% and the RECs from 26% to 22%. These losses should be graduaUy reduced to about 10%. Ilegal 1.23 The key for conservation is pricing power connections are partly responsible for such losses, since appropriately. Measures to achieve this have already there are practically no penalties fom making been implemented and prices are now slightly higher unauthorized connections or tampering with meters. To than marginal cost. Future actions on demar, correct the problem. The ESP is supporting crucial anti- management include: (a) DOE is mandated to create pilferage legislation which has already been introduced programs and incentives to conserve energy and its in Congress. Energy Utilization Bureau will establish policies for efficient energy use, monitor energy consumption and 1.26 Proiect Implementation. The process provide training and promotion in improved whereby NPC approves contracts has been slow. To technologies; (b) power utilities' losses will be reduced; improve and accelerate procurement, NPC has (c) a program is being developed to replace all public standardized bidding documents and specifications, lighting with efficient fluorescent lights and finance appointed project managers for each project md similar lights for residential consumers; (d) energy implemented a computerized monitoring system  7 (Artemis) for all investments. Implementadon project (Bacon Manito-Loan 2969). In 1988-89, two improvements should result from delegating the other projects were approved: One was for MERALCO's construction of new generation plants to the private power distrK-tion in Metro Manila and another was for sector under BOT/BTO contracts. To expedite future the Energy Sector (Loans 3163-PH, 3164-PH and 3165- projects, NEDA will approve by mid-1993 the total PH). These projects financed sector investments and power development program for the next few years and supported improved sectoral policies regarding DOE will establish maximum approval periodG from investment strategy, financing and coordination. They other agencies. are generally being implemented satisfactorily, but the completion of the Bacon Manito project would be 1.27 Staff S.es. Salary and benefits for delayed about one and a half years, and NPC recently NPC staff, as wtf as for employees in other had problems achieving the covenanted rate of return. Government corporations, have been reduced These problems have been factored into the design of the substantially since 1991, due to a law that standardized proposed project. salaries for all Government workers. As a result, many key technical and managerial staff have left (and new Rationale for Bank Participation ones will need extensive training programs), maintenance has been affected and hiring of qualified staff has 1.29 The Government requires strong support become difficult. Under the Power Crisis Act, the from the Bank to solve the country's power supply crisis President was given powers to raise NPC's salaries in the near term, and to establish sound sectoral policies based on comparisons with the private sector and a that would enable the large investments needed in the consultancy study will prowide recommendations in medium to long term. Ensuring adequate power supply August 1993. is the most critical problem in the country's economic development and is a priority for the Bank's lending Previous Bank Projects strategy for the Philippines. The proposed project would help alleviate a grave power supply situation, with the 1.28 From 1957-75, the Bank financed three private sector providing the additional generating hydro projects, two thermal plants, one transmission capacity, and NPC expanding and reinforcing its project and a rural electrification scheme. Three loans transmission system. Bank intervention in the power were also approved for coal, oil and geothei mal sector has been critical in defining improved policies and exploration. Project Performance Audit Reports were actions through the formulation of an Energy Sector Plan prepared for two projects with NPC (the fourth and and in strengthening NPC's finances, improving its seventh projects, PPAR No. 0980 and PPAR No. 8574). efficiency, promoting actions to enhance private sector The major problems identified in the PPARs were generation of power and establishing the DOE. Bank implementation delays and cost overruns due to project support is also critical to balance the country's need for design changes, cumbersome contract award procedures, energy development with sound environmental practices. and weak project management. Because of a These are crucial elements in the process of solving the disagreement on policies, the Bank discontinued lending ongoing power crisis in the Philippines and preparing the until 1988 when it approved a geothermal generation sector for a robust implementation of its energy program. Endnotes: 1/ 'Energy Sector Issues and Actions." 2/4 The ESP was approved by the Cabinet and the President on November 17, 1993. A revised implementation schedule was approved by the Cabinet on January 12, 1993. 2.4 In build-operate-transfer (BOT) projects, the private sector will build, finance, implement and operate (for 10-20 years) the project facilities and transfer them back to NPC after that period (BOT contracts can be extended). In build-transfer-operate (BTO) projects, the private sector will build, finance and construct power plants. After project compledon, the assets and liabilities will be transferred to NPC, but the contractor will operate the plant for most of its useful life under a renewable management contract.  -8 - II. The Power Sector The Power Market 2.4 The appraisal projections correspond to the Bank's estimated GDP growth of about 5.5% p.a. 2.1 Power generation in the Philippines is between 1994-2000. These result in a demand growth mainly the responsibility of NPC, but there is large and of about 8% p.a. in Luzon, 7.8% in Visayas and 8.5% increasing participation from the private sector. NPC in Mindanao. However, the Government targets a supplies power in bulk and at high voltages to higher GDP growth (7.5% p.a. for 1994-98 and 8.4% MERALCO and other private utilities, the rural between 1999-2005). Based on these projections, NPC electrification cooperatives and some large industries. prepared an alternative power demand, which, using a demand elasticity of 1.3 for Luzon and 1.5 for Visayas 2.2 Demand for power grew at an annual rate and Mindanao, forecasts a much higher demand for of 7% during the 1970s, 4.1% between 1980-85, and power than presented in this report: From 1993-98, it 6% between 1985-90. However, these average rates would average 9.4% p.a. in Luzon, 13.5% in mask uneven growth in demand, which closely follows Mindanao and 10.6% in Visayas. This does not variations in GDP growth. Power growth rates are considerably change the requirements for power plants well correlated to GDP growth but have been about within the next four years, (in the short-term, it will 2%-3% points higher; the difference is attributed to result in higher sales and revenues by maximizing the greater industrialization, higher living standards (which use of existing capacity), but in the medium-term it translate into the use of more appliances), and the would require much larger investments. NPC's direct increase in households connected to electricity. In fact, capital expenditures would not change considerably, power demand increased, although at a lower rate, even since, other than multipurpose hydro plants, all new during economic recessions: While GDP decreased by power generating plants are expected to be built and 14% between 1983-85, electricity sales increased 0.3% financed by the private sector (BOT/BTO projects). (Annex 3, Table 1). Most of the 1991 electricity Given the country's financial and infrastructure consumption of 23,599 GWh (76.8%) was in Luzon, constraints and the impact of demand management where Manila is located, while the two other large programs (para. 1.22), the appraisal is based on a more island-systems, Mindanao and Visayas, used 14.6% and conservative estimate. In any case, the power 8.6% of the total power supply. Due to the distances development program will be updated annually in involved and the cost of underwater cables, these consultation with the Bank (para. 2.09) and decisions to regional systems are expected to be interconnected only initiate new plants will also be made annually, based on after 1997; therefore, the demand and capacity are updated forecast. planned for each system independently. 2.5 To reduce power demand, the 2.3 NPC annually updates its demand forecast Government implemented several programs that model based on statistical analyses of population, involved: (a) implementing demand charges; (b) industrial and commercial growth, surveys of major encouraging commercial and industrial consumers to utilities and industries and the Government's estimate of use energy-efficient lamps; (c) replacing inefficient GDP growth. (See Annex 3, Table 2 for the main street lights; (d) requiring energy audits and energy assumptions for power demand). The report assumes reporting requirements from large industries; (e) that once the current unserved demand is met, increases publishing the efficiency performance of electric in power sales will stabilize. Power outages (seven appliances and (f) introducing conservation campaigns hours a day in Luzon in April 1993) are expected to be (particularly for lighting and air conditioning). To substantially reduced by mid-1994 with the completion fiirther promote conservation, ESMAP is preparing (in stages) and additional capacity from the new plants recommendations on cost-effective ways to reduce (particularly the "fast track" projects), adding 923 MW energy demand. However, the basic parameters for to Luzon (9 plants), 273 MW to Mindanao (3 plants) optimal electricity demand are already in place; these and 40 MW in Visayas (one plant)!'. Such a large include appropriate pricing policies (the second highest capacity (1236 MW) will substantially improve the retail power tariffs in Asia after Japan), and adequate system, which has had practically no increase in charges for electricity (based on long-term marginal capacity during the last five years. cost). The impact of conservation would be limited in  -9- the short term, because much of the population is low- the wet season (Pantabagan, Magat, income (per capita GDP was only $730 in 1990) and Angat, Lanau, Kalayaan, etc.). Power the annual per capita consumption is only 375 kWh, shortages were particularly serious in roughly the equivalent to the per capita electricity used Mindanao, which depends on hydro in a period of two weeks in the United States or power for almost 90% of its electricity Canada. supply. The drought reduced Mindanao's sales by 21% between 1990-92 and The Power Crisis halved the expected increase in sales in Luzon in 1992 from 6% to 3%. 2.6 The power crisis in 1991-92 posed a grave threat to the Philippines' economic recovery, and (b) Long delays occurred in obtaining if continued, to its economic and political stability. The approval for the Environmental Impact crisis resilts from substantial outages -4 to 10 hours Assessments (EIA) for power projects and per day in Luzon and particularly in Mindanao, which in issuing environmental clearance experienced one-third reduction in its power sales, certificates (ECC). During the last five (Figure 2.1). This adversely affected industrial years, not a single power project, other production and the development of new industrial and than combustion turbines, was approved commercial activities. Thus, unemployment is rising by the DENR. For example, although and economic losses are mounting, estimated by the coal plants are routinely constructed in Bank at US$600-$800 million per year, using CS0/kWh developed countries, this has proven very as the cost of unserved energy (1.5% of GDP). The difficult in the Philippines, and the business community estimates the loss at US$1-1.3 approval process for key coal projects billion. Necessities are jeopardized--not only because of totalling 1,700 MW has taken from three a lack of electricity for reading, cooking or to four years. The main problems are entertainment--but because other key services that institutional weaknesses in the depend on electricity (such as traffic management, environmental management process (para. pumped water and sewerage), are also disrupted. 1.21), weakness in NPC's enviromnental assessment capacity -particularly for community relations- and the lengthy MINDANAO POWEA SALES process needed to secure acceptance from -ffi0 ; _ _ _ _ _ _ _ NGOs and affected persons. 3W _ _----0> (c) NPC's financial performance during 1991-92 was inadequate, reducing internal cash generation and the amount - _ _ _ _ _ _ E available for power investments (paras. _ =- - _ _ _ _ -=5.3-5.7). (d) Plants were inadequately maintained - _ _ _ _ and/or rehabilitated. They experienced O _ IS VW vim VW| " V6,t e:/;frequent outages, partly because they are sv z rbn FCutel Itl l~ s