Philippines - Leyte-Luzon Geothermal Project

GLOBAL ENVIRONMENT FACILITY 13033 -pA Republic of the Philippines Leyte-Luzon Geothermal Project Project Document May 1994 .' THE WORLD BANK  GEF Documentation The Global Environment Facility (GEF) assists developing countries to protect the global environment in four areas: global warming. pollution of international waters, destruction of biodiversity, and depletion of the ozone layer. The GEF is jointly implemented bythe United Nations Development Programme. the United Nations Environment Programme, and the World Bank. GEF Project Documents - identified by a green band - provide extended project- specific information. The implementing agency responsible for each project is identified by its logo on the cover of the document. Global Environmenit Coordination Division Environimlent Department World Bank 1818 H Street. NW Washington. DC 20433 Telephone: (202) 473-1816 Fax: (202) 522-3256  CURRENCY EQUIVALENTS (as of December 31, 1993) Currency Unit = Pesos (P) rP 1 - US$0.036 US$1 = P27.6 WEIGHTS AND MEASURES GWh = Gigawatt hour (1,000,000 kwh) MWe = Million Watts of energy. kWh = Kilowatt-hour (860 kilo-calories) TWh = Tera watt hour (109 ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank BOO Build-Operate-Own BOT Build-Operate-Transfer BTO Build-Transfer-and-Operate DENR Department of Environment and Natural Resources DOE Department of Energy ECO Expanded Cofinancing Operation EDC Energy Development Corporation EOIS Efficiency and Operational Improvement Study ERB Energy Regulatory Board ESMAP Energy Sector Management Assistance Program GEF Global Environment Facility GET GEF's Global Environment Trust Fund JEXIM Export and Import Bank of Japan NPC National Power Corporation OPSF Oil Price Stabilization Fund PNOC Philippine National Oil Company RECs Rural Electrification Cooperatives FISCAL YEAR January 1 to December 31   PHILIPPINES LEYTE-LUZON GEOTHERMAL PROJECT Grant and Prolect Summary Source of Funds: Global Environment Trust Fund Grantee: Republic of the Philippines. Grant Recipients: The Philippines National Oil Company's Energy Development Corporation (PNOC-EDC) and the National Power Corporation (NPC) AmuQitsa: SDR 21.6 million equivalent (US$30 million), US$15 million to NPC and US$15 million to PNOC. Terms: Grant Cofinanciers: (a) The World Bank; (b) The Japan Import and Export Bank (JEXIM); (c) three BOT contractors for the power plant; (d) Eurobonds for the converter station with the support of an ECO operation from the Bank; (e) the Swedish Agency for International Technical and Economic Cooperation (BITS) Objectives: The grant would provide financial support for the Leyte-Luzon Geothermal project, reducing its cost and making financially more attractive the use of environmentally preferable geothermal energy for power generation. The Project would also support the following objectives: (a) meet the rapidly increasing demand for power in Luzon using indigenous and environmentally superior geothermal energy; (b) strengthen the energy sector by implementing institutional, planning and financial improvements recommended by the ESP; (c) support the large ongoing private sector participation in power generation, and facilitate it by extending the national grid; (d) strengthen NPC's capabilities in environmental and social impact analyses; (e) introduce ECO cofinancing in the Philippines; and (f) ensure the financial viability of NPC and PNOC for undertaking a long-overdue investment program. Financing Plan: Local Foreign Total ---- US$ million ------ GET Grant PNOC 15.0 15.0 GET Grant NPC 15.0 15.0 IBRD-PNOC 114.0 114.0 IBRD-NPC 113.0 113.0 Energy Sector Loan (3163-PH)-On going works 13.3 13.3 JEXIM-PNOC 114.0 114.0 JEXIM-NPC 56.0 56.0 BOT-Contract 63.9 556.5 620.4 ECO-Supported Bond Issue-NPC 100.0 100.0 BITS Grant for Converter 26.6 12.4 39.0 PNOC Internal Cash Generation 71.7 20.3 92.0 NPC Internal Cash Generation 9.2 32.7 41.9 ---------------------------------------------------------------- TOTAL FINANCED 1/ 171.4 1162.2 1333.6 1/ Totals may not add due to rounding. Economic Rate of Return: 11% Poverty Category: Not applicable. Map: IBRD No. 25290   REPUBLIC OF THE PHILIPPINES LEYTE-LUZON GEOTHERMAL PROJECT 1. Country/Sector Background. Power demand growth in the Philippines has been uneven, largely following variations in GDP growth. In the last two years, it was severely restricted due to supply constraints; still, power sales increased 6.2% p.a. between 1986-92. Once adequate power supply is restored 1994 due to substantial new capacity added, sales are expected to rise by an average of 9% p.a. until the year 2000. In absolute terms, annual per capita consumption for power is very low (371 kWh)--equal to just a couple of weeks of per capita use in developed countries. Even considering the effect of energy conservation programs and conservative estimates of GDP growth, the peak demand is expected to double by the year 2000 to 8,260 MW. This will require substantial investments, sound financial policies and increased private sector participation. 2. The private sector has become a principal player in the energy sector. Exploration for hydrocarbons is exclusively with the private sector; and, oil refining and distribution are carried out by two private companies (CALTEX and Pilipinas Shell Petroleum Corporation) in addition to Petron (the oil subsidiary of state-owned PNOC) . However, the Government sold 40% of Petron shares to Aramco in March 1994 and will sell another 20% to Petron's staff and the public by mid-1994. PNOC, one of the largest corporations in the Philippines, was created in 1973 as a holding company for several energy subsidiaries (oil refining, coal, geothermal), which were established to ensure the country's oil supply and to develop indigenous resources. After Petron's privatization, the main activity of PNOC would be to develop geothermal energy through its subsidiary PNOC's Energy Development Corporation (PNOC-EDC). In the power sector, practically all distribution is in the private domain. This includes: (a) MERALCO (Manila Electricity Company), a private utility in Metro Manila that distributes about 60% of the country's total electricity; (b) 12 private utilities that retail electricity in different cities; and (c) about 120 member-owned rural electrification cooperatives (RECs), which distribute power and manage retail sales in rural areas. There are also two state-owned corporations in the sector: (a) the National Power Corporation (NPC), which sells power in bulk to power utilities and is responsible for power generation and transmission, and (b) the National Electrification Administration (NEA), responsible for financing and providing related technical support to the RECs. Under the Energy Sector Plan (ESP), the Government is studying options for NPC's gradual privatization, which is likely to require several years, given constitutional, regulatory, commercial and financial constraints and the need to analyze options broadly identified by a USAID-funded study. It is in this context that the Bank is currently conducting a sector study on the Power Sector Structure, which will be completed by mid-1994; after this, detailed transactional studies will be conducted. The Government's present strategy of steadily increasing the private sector role in power generation and operational management is adequate. 3. With regard to incremental investment in power generation, NPC's Board of Directors is sucessfully implementing a policy to bring the private sector into the development of all new power plants (except multi-purpose hydro), and has entered into 35 contracts with private companies to construct, finance and operate power plants under Build-Own-Transfer (BOT), Build- Transfer-Operate (BTO), Rehabilitate-Operate-Lease (ROL) and other schemes. About 27 of these projects will be in operation by end of 1994. Total power generation contracted with the private sector amounts to about 5,000 MW, about 80% of the incremental capacity between 1993-99. To support such vast private sector investments, ways and means are needed to improve planning systems to ensure an optimal integration of private and public efforts. 4. The Power Crisis and the Project. Over the 1991-93 period, the Philippines experienced an acute power shortage; this posed a grave threat to its economic recovery because it translated into prolonged outages that  hampered industrial and commercial activities. As a result, unemployment increased and economic losses may have reached almost US$1 billion a year. Solving this problem became a national priority but conventional power supply projects (coal, geothermal and hydro) take about three-six years to be completed and could not provide relief in the short term. Thus, the Government launched a "fast-track" generation expansion program based on combustion turbine or diesel-engine driven systems which were contracted as BOT/BTO projects with the private sector. While these plants are operationally more expensive than base- load plants, they were the only power sources that could be commissioned within one or two years. These plants played a crucial role in meeting the Philippines power deficiencies and will meet peak system requirements in the future, but they are not a cost effective way to meet base- load power needs. However, by using geothermal energy in Leyte and substantially interconnecting the country's power systems, the proposed project provides a more cost effective option for Luzon. In addition, it is environmentally preferable to other thermal options. In any case, the substantial private participation already achieved has transformed the sector (de facto) and addressed the issues of adequately contracting and dispatching the power needed. These issues are being studied by consultants under the Leyte-Cebu Geothermal Project. 5. It is also important to continue ongoing efforts to strengthen the regulatory authority and to improve energy efficiency and demand-side management. These efforts have already succeeded in introducing efficient lighting schemes, rating of electrical appliances, conducting energy audits, applying strict conservation measures at public offices and, given the high price of electricity (more than twice the average in Washington D.C.) in promoting other energy conservation measures. Power demand charges to reduce peak loads will be introduced under the project and further actions are being studied by the Bank's Energy Sector Management Assistance Program (ESMAP). 6. Institutional Issues. While a severe three-year drought, which seriously curtailed hydro capacity, was in large part responsible for the power shortages, poor institutional performance also contributed to the crisis: Environmental approvals for new power projects were substantially delayed and financial and institutional weaknesses in NPC prevented it from making needed investments. Moreover, NPC's finances deteriorated severely in 1991 when costs rose sharply due to a large currency devaluation and higher oil prices (resulting from the Gulf War). The Supreme Court decision to stay a pari passu tariff increase added to NPC's financial difficulties; as a result, the Government needed to contribute about US$135 million to NPC. In 1991-92, the Corporation's cash situation was also jeopardized because it was required to pay oil taxes that were not included into its tariffs (pending an appeal to the Supreme Court). However, the final Court decision (May 1993) reconfirmed that NPC is exempt from such taxes and will allow it to recover about US$400 million in overdue tax refunds over the next few years. NPC's equity was also increased by the Congress in 1993, mainly by a P3 billion infusion from the surplus in the Oil Price Stabilization Fund (OPSF). Further, NPC agreed to a reform program whose implementation streamlined its structure, reduced the number of vice-presidencies from 26 to nine between 1991-93, and eliminated more than 2,000 staff. NPC is also establishing targets for improving project implementation, internal audits and controls, and rationalizing and decentralizing functions (including a plan to establish separate units for Luzon, Visayas and Mindanao). Under the Electric Power Crisis Act of 1993, the President was given special powers to solve the power crisis; these include facilitating tariff increases, speeding-up project approvals, and increasing technical salaries in the sector. A comprehensive management audit ("Efficiency and Operational Improvement Study") was completed in October 1993 and its recommendations would be implemented under the project (para. 16). 7. The Energy Sector Plan (ESP). Sector reform is the highest priority of the new administration. As a result of its dialogue with the Bank, in January 1993, the Government prepared and approved the ESP, which charts a course of action to improve the operations of the energy sector as a whole. The ESP sets out measures and implementation schedules in all areas of concern, particularly for sector coordination, regulatory development, private sector  participation, power and oil pricing, environmental management, energy conservation, operational efficiency and project implementation. The Government would implement the ESP and annually review with the Bank the progress achieved. Some of the plan's key measures have already been introduced, such as establishing the Department of Energy (DOE) and initiating actions to improve NPC's finances, including automatic increases to the cost of purchased fuel and energy. These measures would ensure an adequate financial performance in future years. 8. Lessons Learned from Previous Bank Operations. Problems experienced in previous projects included delays in implementing required tariff increases, cost overruns due to project design changes, cumbersome contract award procedures and weak project management. We have endeavored to resolve these problems by assisting in establishing an improved regulatory framework and a system of automatic tariff increases linked to the cost of purchased fuel energy, by strengthening NPC's procurement processes and placing the responsibility for each project under a project director, and by using turnkey contracts rather than separate bids for each component. 9. Project Obiectives. The grant would provide financial support for the Leyte-Luzon Geothermal project, reducing its cost and making financially more attractive the use of environmentally preferable geothermal energy for power generation. The Project would also support the following objectives: (a) meet the rapidly increasing demand for power in Luzon using indigenous and environmentally superior geothermal energy; (b) strengthen the energy sector by implementing institutional, planning and financial improvements recommended by the ESP; (c) support the large ongoing private sector participation in power generation, and facilitate it by extending the national grid; (d) strengthen NPC's capabilities in environmental and social impact analyses; (e) introduce ECO cofinancing in the Philippines; and (f) ensure the financial viability of NPC and PNOC for undertaking a long-overdue investment program. 10. Project Description. The project includes the following components: (a) PNOC-EDC would develop a 440 MW geothermal energy field to expand Leyte geothermal capacity from 200 MW to 640 MW, including: (i) drilling about 65 additional producer and injector wells in Malitbog, Mahanagdong and Alto-Peak; (ii) contracting technical services for geothermal drilling; (iii) constructing steam gathering systems; (iv) constructing the related subtransmission systems in Leyte; (v) constructing a pilot reinjection plant for C02; and (vi) recruiting consultants to assist with project implementation; (b) PNOC-EDC would also enter into BOT contracts with private sector companies to construct and operate 440 MW geothermal power plants; and (c) NPC would (i) contract two high voltage DC (HVDC) monopole converter stations and related electrode stations at Ormoc and Naga, to be financed by a US$100 million Eurobond issue partly supported by an Expanded Cofinancing Operation (ECO) of the Bank; (ii) construct overhead transmission lines in Leyte (about 77 km at 230 kV); (iii) install a submarine cable (about 19 km at 350 kV, 440 MW) crossing the San Bernardino Strait (19 km) and linking the Leyte-Luzon lines; (iv) construct a twin circuit HVDC overhead transmission line from Ormoc to Matnog cable terminal (about 176 km at 350 kV) and from Cabacungan to Naga (about 256 km at 350 kV); (v) rehabilitate the Naga-Tayabas transmission line (about 205 km at 500 kV) ; (vi) recruit two advisers for strengthening its environmental and social engineering departments; and (vii) recruit consultants to design the Casecnan hydroelectric project and to support project implementation. To support the project the GET grant would partially finance the technical services for geothermal drilling and the pilot reinjection plant for PNOC, and the HVDC overhead transmission line and environmental advisers for NPC. Details of the project are provided in Annexes 1 and 2. 11. Prolect Implementation. NPC will implement the transmission component and PNOC-EDC will undertake the geothermal development component and contract with the private sector to develop the generation plants. PNOC-EDC has already signed three BOT contracts for power generation in Leyte that aggregate to 536 MW (for both Leyte-Cebu and Leyte-Luzon) . These energy conversion agreements use the same basic contract employed by NPC for other BOT projects, and were signed in September-October 1993 with Ormat Inc. (125 MW), Magma Power Company  (231 MW), and California Energy Company and CE Philippines Ltd. (180 MW), including 180 MW for Leyte-Cebu and 356 MW for Leyte-Luzon. Since the project construction will take five years, there is adequate time to contract the additional 100-140 MW BOT capacity. The BOO (build-own-operate) contract between NPC and PNOC-EDC to supply electricity was signed prior to Board presentation. The project preparation required considerable financial engineering by the Bank to complete a large financial plan for a complex project. In fact, the project financing would have not been feasible without Bank technical support and GEF financial assistance. The Bank's monitoring efforts would continue during project implementation, and would be supported by the project's consultants and periodic reports. The results of the pilot plant and the CO2 emissions would be reviewed by foreign consultants when the geothermal system is operating (Schedule D). 12. The project cost is estimated at US$1266.9 million, with a foreign exchange component of US$1095.5 million (86% of the total) . The total financing required, including interest during construction, is US$1333.6 million and includes two proposed Bank loans, for a total of US$227 million equivalent (17.0 of total): US$114 million to PNOC and US$113 million to NPC. A GET grant of US$30 million equivalent (SDR 21.6 million, 2.2% of the total) to the Government is recommended to make the geothermal alternative more competitive with a least-cost coal plant. Subsidiary grant agreements would be signed with NPC and PNOC each for US$15 million equivalent, to be withdrawn for specific components pari passu with the project implementation (Schedule B and Annex 4). 13. The remaining financing would be provided by: (a) internal cash generation of US$133.9 million (18.8% of the total excluding the BOTs), of which US$92.0 million would be from PNOC and US$41.9 million from NPC); (b) JEXIM would jointly finance US$170 million with the Bank (US$114 million for PNOC and US$56 million for NPC, 12.7% of the total), which would review project procurement and the awarding of contracts; (c) a Eurobond issue bonds for US$100 million (7.5%) to finance the converter stations, to be supported by an Expanded Cofinancing Operation (ECO); (e) a grant from the Swedish Government of about US$39 million equivalent (2.9%); (f) three BOT contracts for the generating plants totalling US$620.4 million, or 46.5% of the total) and (g) US$13.3 million (1W) of ongoing geothermal exploration being carried out under the Energy Sector Project (Loan 3164-PH). Advance contracting has been used for the transmission components, to better define the large investment and financing needed and to ensure the timely procurement for the project. Retroactive financing of up to SDR 2 million (10t of the proposed grant) is included for project expenditures incurred after August 1993. To facilitate disbursements a special account of US$2 million equivalent would be opened on terms and conditions satisfactory to the Bank. A breakdown of costs and the financing plan are shown in Schedule A. Amounts and methods of procurement and disbursements, and the disbursement schedule are shown in Schedule B. A timetable of key processing events and the project supervision plan is shown in Schedule D. A map is also attached. 14. Project Sustainability. In developing and implementing the ESP, the Government has provided a sound environment in which the sector can grow and strengthen its organization, planning and finances. NPC has already taken important steps that will require greater responsibility and accountability from regional managers; also, it established Project Directors, improved its procurement systems and would substantially increase staff salaries, allowing it to hire and retain competent staff. In turn, these actions will improve project implementation and plant maintenance. NPC's revised tariff structure, and particularly the approved system of automatic adjustments to purchased fuel and energy costs, will ensure adequate resources to cover its operation and debt service and help finance the large investment needed in the power sector. PNOC-EDCs operation and maintenance of renewable geothermal resources (under previous projects) has been satisfactory and is expected to continue as such. The joint action envisioned between PNOC-EDC and private BOT contractors will ensure that the power generated under the project will be reliable. 15. Rationale for GEF Involvement. The use of geothermal steam for power generation, followed by re-injection of the exhaust liquids into the ground,  has considerable environmental advantages over other fossil fuels in terms of reducing CO2 emissions (and other gasses responsible for global warming), sulphites, particulates and NOX. Therefore, the project would help reduce global warming, since CO2 emissions from alternative coal-fired plants are about 10-15 times greater. The grant would also strengthen NPC's social engineering and environmental management departments, which are critical for the adequate implementation of its future power investments. 16. The GEF grant would help develop critically needed energy in the Philippines and support a source that is indigenous and environmentally superior. Although the grant is small in the context of a project that totals US$1.2 billion, it was critical for the investment decision and influenced the Government in its choice of geothermal over the least-cost coal alternative (Annex 3). Due to high transmission costs, the project's cost of US