Papua New Guinea - Upper Ramu Hydroelectric Development Project

RESTRICTED FILE COPY Report No. 1 C 9E 4 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE TERRITORY OF PAPUA AND NEW GUINEA FOR THE UPPER RAMU HYDROELECTRIC POWER PROJECT WITH THE GUARANTEE OF AUSTRALIA April 8, 1971  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE TERRITORY OF PAPUA AND NEW GUINEA FOR THE UPPER RAMU HYDROELECTRIC POWER PROJECT 1. I submit the following report and recommendation on a proposed loan in an amount in various currencies equivalent to US$23.2 million, to the Administration of the Territory of Papua and New Guinea ("the Admin- istration") for the Upper Ramu hydroelectric power project. The loan, to be guaranteed by Australia, would be for a term of 25 years including 5 years of grace and bear an interest rate of 71-4. PART I - HISTORICAL 2. New Guinea, a UN Trust Territory and Papua, an Australian dependency, are administered as one political and economic unit by Aus-tralia. The Territory, as the area is now referred to, received little attention from the more developed powers until the end of World War II, in the course of which its strategic importance became apparent and the interior of the islands wqas opened up. The task of development is, however, formidable. The indigenous population is divided by tribe and by language; roads hardly exist and the topography makes communica- tions of any sort difficult. Three quarters of the adult population is illiterate and only about one-third of children attend school. The pro- portion receiving higher education is much lower. 3. In 1963 the Australian Government asked the Bank to send a general survey mission. The first Bank economic report on Papua and New Guinea, produced in 1964 as a result of that mission, provided the framework for the Territory's first five-year Development Program (FY 1969-73). In 1966 the Australian Government requested the Bank to lend to the Territory. A second Bank economic mission visited the Ter- ritory in 1967 and the loans and credits made since then (which are summarized in Attachment I) were identified by it. 4. A loan was made in 1968 for telecommunications, the improve- ment of which is essential for efficient administration of the Territory and further development of the market economy. In 1969 and 1970 IDA credits were made to the Administration for smallholder oil palm and beef cattle ranching projects, both of which crops are new to the Territory where they do well. In 1970 the first Bank Group assistance to highways in the Territory, a Bank loan and IDA credit, was given for improvements to and further engineering on the highlands highway. Supervision missions in 1970 found that the execution of the telecommunications and agricul- tural credit projects is satisfactory. The rate of disbursement of the loans and credits, however, continues to be slow due to the shortage of accounting staff in the Administration, which is taking steps to remedy the situation. The first disbursements under the highway credit and loan which became effective in 1970 were made in March 1971.  - 2 _ 5. Reports on the Flamu hydroelectric scheme, prepared in 1967 by the Commonwealth Department of Works and by the Snowy Mountains Authority, recommended that the construction of the project be deferred for five years. The reports also concluded that Stage I of the whole project, comprising five 15 MW units, a storage dam and transmission lines, should be split into two phases, the second phase consisting of a dam and two 15 MW units to be comissioned about 1978/79. Accordingly the Bank agreed to consider financing the first phase of the project with a possible Bank loan scheduled for FY 1971. Upper Ramu Stage II would add 180 ITI at a future date not yet determined. PART II - THE COUNTRY Political 6. The Report of a Select Committee of the House of Assembly on Constitutional Development recently published recommends that "programmes be developed with the view that the Territory may become internally self-governing during the life of the 1972-76 House of - Assembly". The Report was debated and accepted by the House of Assem- bly and the Australian Government is firmly committed to granting some form of self-government to the Territory within the next few years. At present the Territory's budget is supported by Australia; further- more expatriates, largely Australian, fill most of the senior positions in government and in the private sector. The prospect of a measure of autonomy in the near future underlines the obvious need for development of the Territory's indigenous resources. Uncertain career prospects arising from the loom of self-government are thinning the ranks of the Administration faster than local recruitment is able to find replace- ments and the smoothness of the transition to self-government evidently depends on the training of able and technically qualified indigenes. Economic 7. A report "Current Economic Position and Prospects of the Territory of Papua and New Guinea" (EAP-8a) wvas circulated to the Executive Directors on September 9, 1969. A Basic Data sheet is at- tached. The economy of the Territory has so far been dependent on the production and export of a few agricultural commodities, particularly copra, rubber, coffee and cocoa. Only a minority of the indigenous work force is fully integrated into the monetized sector; the remainder depend in varying degrees on subsistence agriculture. The development program is directed toward drawing the local population into the cash economy and building up the infrastructure required to develop both agriculture and new manufacturing industries. Results in developing agricultural production have been encouraging and in FY 1969/70 ex- ceeded the program's projections by 12%. Tea production has been successfully introduced to the New Guinea highlands. Progress has been made in establishing the production by smallholders of tea, rubber, palm oil and livestock; and an oil palm project partly financed by IDA is expected to come into production in 1971. Indigenous entrepreneurs are slowly coming forward assisted by the Papua and New Guinea Develop- ment Bank which in the year to June 30, 1970 lent A$l.9 million to 1250 indigenous businesses.  8. The recent discovery of large copper ore deposits on Bougainville Island wqas a major turning point in the Territory's economic development. Mining operations by Bougainville Cbpper Pty. (a subsidiary of Conzinc Rio Tinto of Australia Pty.) are expected to begin in 1972. Output is to be at a rate of 30 million tons of copper ore per year to produce 'concentrates for export containing roughly 150,000 tons of copper, 500,000 oz. of gold and 1 million oz. of silver. The investment to estab- lish the operation will be in the order of A$400 million through FY 1971/72. The immediate effect of the mining project on the Territory's monetized sector was reflected in the 2h percent growth of Gross Monetized Sector Product during FY 1969/70, compared to an average annual growth rate of 13.5 percent over the preceding three years. The largest single growth factor was in private capital formation which rose by 156 percent in FY 1969/70 to A$132 million; over half of this increase was due directly to the Bougainville project. 9. The long-term impact of Bougainville and possible further mineral discoveries on the economic development of the Territory has not yet been fully assessed. Exports from the project are expected to start in FY 1972/73, valued at an estimated A$140 million which will represent over one-half of total exports projected for that year, and the Territ- ory's bplance of payments on current account is estimated to move from a deficit of around A$90 million in FY 1971/72 to a surplus of A$35 million in FY 1972/73. Internal revenue derived by the Administration from the project through FY 1974/75 is estimated at about A$70 million as compared to expected t6tal Admihistration' ependitures on the pr6ject in the range of A$84 million. 10. Despite the benefits of the Bougainville mine, the Territory will continue for many years to depend on Australian grants and other sources of external finance. Administration expenditure as a whole will outstrip local revenue by an estimated A$145 million in FY 1972/73 and A$157 million in FY 1974/75. The Australian Government is committed to continued aid at the present level but emphasizes the need to increase revenue raised in the Territory, which in FY 1970/71 amounted to only 43% of total Administration outlays, to meet the rising expenditures foreseen. As a step towards greater budgetary autonomy the support re- ceived from Australia has been divided betwe:en a direct grant towards recurring Administration expenditures and development aid and loans, and the emphasis, it is hoped, will shift from the direct grant in favor of development aid in future. Total non-military Australian aid in all forms during FY 1970/71 is estimated at A$126 million including A$14.5 million direct expenditure by Commonwealth departments in the Territory in the same year. The amount includes also A$11.6 million drawings on loans raised in the Australian capital market. 11. These amounts, although substantial, fall short of the Territory's requirements which will increase with the approach of self- government and the concomitant need for and expectations of rapid econo- mic development. Australia itself faces the problem of financing a large domestic investment program, especially in infrastructure, to meet the needs of the expanding private sector. In the circumstances, it seems  appropriate that the Bank group should supplement the Australian effort in the Territory. Bank group lending, however, would not be a substitute for Australian assistance and, indeed, would be contingent upon its continuance. The imminence of self-government and the atten- dant denand for training of !ndigenes emphasizes the need for invest- ment in education and for rapid indigenization of institutions. The almost total absence of roads and telecommunications has also called for heavy expenditures in which the Bank group has assisted. Generation of electricity, hitherto on a local basis, requires major investment to utilize the abundant hydro resources available and to provide new indas- tries with the most efficient source of energy. In the next fiscal year I expect to present to the Executive Directors a loan and a credit for a second telecommunications project and a project to expand and improve the facilities at a number of ports. I may also present a further small loan for power. Meanwhile ex1oratory missions are planned to investi- gate bow the Bank group can best assist in education in the Territory and in establishing indigenoas businessmen and smallholders through the Papua and New Guinea Development Bank. Loans and credits are tentatively scheduled for education and agricultural credit in subsequent fiscal years. The Territory, which is a member of ECAFE, and is about to join the Asian Development Bank, should soon be able to begin drawiing funds also from that source. PART IlI - THE PROJECT 12. A report entitled "Appraisal of the First Phase of the Upper Ramu Hydroelectric Development Electricity Commission of Papua and New Guinea"' (PU-60) is being circulated separately. The proposed hydroelectric project is a run-ol-the-river, underground power station with an initial installed capacity of 4$ MIJT. Included in the project are 320 miles of transmission lines linking centers previously served by small diesel units (see Attachment II). The beneficiary -rill be the Papua and Hew Guinea Electricity CoTmission (ELCOG) anLd the Borrower, as in previous loans to the Territory, will be the Administration. 13. ELCOM, all the equity of which is held by the Adrinistra- tionl provides 80% of the electric power generated in the Territory; the remainder being provided by the Administration or small private plants. It owns all but 5.5$nW of the existing hydroelectric capacity (41.h NJ) and 18.0 Kt out of 27.6 NW diesel capacity in Papua and New Guinea. 1t. The most formidable task facing EIDON is the training of local staff to replace expatriates who are at present predominant in senior positions. Of the total staff of 1313 as of Jane 30, 1970, 335 were exoatrintes and 978 (including 508 trainees) from the Territory. The Loan Agreement includes a covenant whereby the Administration will grant an annual subsidy of 4$90,000 to ease the financial burden of EBOM'1s training program, which cost A$750,000 in 1969/70 and is estina- ted to cost $L60,Oo0 per arnum from 1972 onwards. EBLOM has engaged the State Electricity Commission of Victoria as consultants to review its organization and methods and it is hoped that this will lead to some ir4tovement in the present ratio of one employee per 20 consumers. The proportion of expatriates on the staff is expected to fall from the present level of 42% to 5% by 1977/78.  15. The construction of the Ramu hydroelectric project is designed to meet the steep increase in demand expected in the area to be served. This area, which accounted for 28% of total sales in FY 1970, comprises the highlands and the twio ports serving them, Lae and Madang. The rate of growth in demand of about 25% which is expected to continue up to 1977/78, reflects both a low starting base and the rapid pace of development. The highlands, opened ap by road connection with the coast only in the last decade, contain almost half of the total population of the Territory and are well sui-ted to cash crop production. Coffee, tea and forest products are being successfully developed and shipped out through Lae. A second access to the coast is planned by construction of a road to Madang. There is a shortage of skilled labor common throughout the Territory in the area and a difficulty in obtaining land, held tribally, for productive use, but these obstacles are receiving the attention of the Administration and should not seriously delay progress. industrial develop- ment is starting to gather speed in the two ports and the highlands and industrial customers accounted for 73% of total power sales in the project area in FY 1970 compared Twjith 50O% in FY 1964. 16. The economic rate of return expected on the investment in the project is 18% and the internal financial rate of return is over 17%. The appraisal mission visited each of the main centers to be served in order to test the reasonableness of forecasts of demand growzth and was satisfied in each case that development plans were in line with expec- ted demand. Rise in urban population, the establishment of new indus- tries and expansion of existing ones underpin ELCOM's projections. These projections were taken into account in examining the economic justification of the project. EICO0N's consultants examined the least cost alternatives, both thermal and hydroelectric, to the Ramu project. The alternative hydroelectric plant had a higher capital cost and the thermal plant, with lower capital cost had much higher running costs. On the basis of a realistic assessment of the possible range of values of the main variables, including a very modest increase in the price of oil, the rate of interest which equalized costs and benefits of the two alternatives was likely to lie between 13% and 23%. 17. The Territory Department of Health has reviewed the health hazards of the Ramu scheme and appropriate precautions will be taken to reduce the risk of malaria. The Administration has also undertaken to carry out a comprehensive ecological study before the second phase of the project is started. No villazes exist in the project area so no resettlement will be needed and no other ill effects on the environment are expected. 13. ELCON's financial position has deteriorated in the last three years due to tariff reductions and increases in costs and per- sonnel. The rate of return on net fixed assets in use in 1969/70 was 4.7%. This unsatisfactory position, will, it is expected, be corrected by a revision of tariffs which came into effect at the beginning of 1971. ELCOM has agreed to maintain -tariffs and take such other steps as shall be required to provide revenues sufficient to produce an an- nual rate of return of not less than 9% until 1975/76 and of 10% there- after.  19. Steps are also being taken to improve the financial structure of ELCOM. Conversion of Atiinistration loans of A$5.8 mil- lion into equity will help to improve the Commission's estimated debt/ equity ratio from 88112 at June 30, 1971 to 70/30 at June 30, 1972. The Bank's loan to the Administration is to be relent to ELCOM on the same terms and to rank pari passu with all existing debt to the Admin- istration. In addition, ELCOM undertook to seek Bank agreement before incurring any further long-term debt which would lift total future an- nual debt service over 1.5 times the net revenue at the time of incur- rence. EICOC must also obtain Bank approval of financing plans for projects estimated to cost over A$10 million. Finally, ELCOMI.has agreed not to declare any dividends before July 1, 1978. 20. ELCOMIs financial plan for the five-year period to FY 1975/76 provides for capital outlays of A$68.9 million and for an increase in working and other funds of A$4.7 million. The financial forecast indicates that ELCOM should generate sufficient cash from its operations to provide about A$25.5 million or 35% of the funds required through FL 1975/76. Ioans during this period amounting to about A$14.5 million would be sought from the Administration, which has been the principal lender in the past. Apart from the proposed Bank loan of A$20.7 million (US$23.2 million) finance in respect of foreign costs of two generating units, one hydroelectric, one thermal, will be re- quired in amounts equivalent to A1$9.4 million. Suppliers credits would be used to finance A$1.7 million of minor diesel plant leaving A$1.5 million to be raised from other sources. The financial position of ELCOM should be sound throughout the construction period of the project. The Administration has agreed to accept ELCOMI equity (rather than interest bearing loans, as in the past) in full settlement for power systems that may be transferred to ELGOM, and to subsidize any operating losses of such systems. 21. The proposed Bank loan would finance the 'off-shore' costs of the project amounting to US$23.2 or 68.5% of the total (US$33.9). Procurement would follow international competitive bid- ding. As in previous Bank Group operations in the Territory, which is part of the Australian monetary system, Australian procurement would be treated as a foreign cost and therefore eligible for Bank financing although it is not possible, at this time, to estimate what proportion of the total procurement will be in Australia. Local costs will be financed from internally generated cash or Administra- tion loans. It is expected that the Bank loan will be fully disbursed by June 30, 1976. PART II - LEGAL fNSPtUNEWTS AND AUTHORT'Y 22. The draft Loan Agreement between the Bank and the Admin- istration, the draft Guarantee Agreement between the Commonwealth of Australia and the Bank, the draft Project Agreement between the Bank and ELCOM, the Report of the Commiutee provided for in Article III,- Section 4 (iii) of the Articles of Agreement and the text of a Reso- lation approving the proposed Loan are being distributed to the  -7- Executive Directors separately. Modifications have been made to the General Conditions applicable to Loan and Guarantee Agreements to take into account the special nature of the Borrower as a dependent territ- ory of the Guarantor, and the potential control exercised over ELCOM by both the Guarantor and the Borrower. In addition to the covenants referred to in paragraphs 19 and 20, the Loan Agreement contains the provisions usual in power projects. 23. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART V - RECOMIIENDAT ION 24. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Washington, D.C. April 8, 1971.  Attachment I Bank Loans and IDA Credits made to Papua and New Guinea at February 28, 1971 Amount (US$ million) No0 Year Borrower Purpose Bank IDA Undisbursed 546 PNG 1968 Administration of the Territory of Papua and Telecommuni- 7.Q 6.1 lNew Guinea catior.s 137 PNG 1969 Administration of the Territory of Papua and New Guinea Agriculture 15 0.8 175 PNG 1970 Administration of the Territory of Papua and New Guinea Agriculture 5.0 4.4 204 PNG 1970 Administration of the Territory of Papua and New Guinea Highlways .5 .5 693 PNG 1970 Administration of the Territory of Papua and New Guinea HighwTays ___5 4_5 Total now outstanding 115 llO0 20.3 Amount sold 0.2 Total now held by Bank and IDA 1103 11O Total undisbursed lO16 9.7 20.3  Attachment II PAPUA AND NEM GUINFKA LOAN SUM4ARY Borrower: Papua and New Guinea Beneficiary: Electricity Commission of Papua and New Guinea Guarantor: Australia Amount and terms of loan: US$ 23.2 million equivalent, 7-1/4% 1976-96 Project: Upper Ramu Hydroelectric Development Project: construction of and equipment for the first phase (45 MNT) of stage 1. (US$ millions) Cost of Project: Local Offshore Total Acquisition of land .95 - *95 Preliminary works 1.45 .38 1.83 Civil works 4.38 8.81 13.19 Electro-mechanical equipment .66 3.75 4.41 Transmission lines and sub- stations .69 9.04 9.73 Consultants fees and ELCOM overheads chargeable to project. 2.5L 1.22 3.76 10.67 23.20 33.87 Estimates include allowances for contigencies (8%) and cost increases (16%) Financing of Project: IBRD loan - 23.20 23.20 Internal cash generation 10.67 - 10.67 10.67 23.20 33.87 Procurement Arrangements: International competitive bidding Construction period: August 1971 to September 1975 Consultants: Australian Commonwealth Department of Works and Preece, Cardew and Rider. Economic Rate-of Return: 18% April 8, 1971  Attachment III PAPUA AND 1T,hJI GUDIEA BASIC DATA v Area 475,366 sq. kilometers Population (mid-1970) 2,523,000 of which: Non-indigenous 48,960 Rate of Grouth (1960-70) Indigenous 2.8% per year Population Density (per sq.km) 5 Gross National Prcduct at Curre:it lviarkot Prices (FY 1969/70) Monetized Sector A$353.6 million Non-monetized Sector A$190 0 Trnl,lion Whole Economy A4306 million Annual Rate of Growth () Average FY's 1965/66 FY 1969/70 - 1968/69 Monetized Sector 13e5 23.7 Non-monetized Sector 1.7 0:,7 IThole Economy 8.2 1T C Per Capita GNP 1969/70 (rough estimate) Indigenes US$150 Non-Indigenes US$4,000 Gross National Product Monetized &iectc- at Factor Costtv (FYT196-t/65) A$240.2 million of which: Agriculture, Livestock, Forestry and Fisheries 30% Mining and Quarrying 1% Hanuf'acturing and Construction 16% Transport and Communications 8% Trade 12% Other Services 33% Percent of GNP at Current Market Prices- Whole Economy (FT 1969/70) Gross Domestic Investment 47% Gross National Savings 19% Import Surplus of Goods and Services 283 1/ Fiscal Year = July 1 - June 30.  _2- Money and Credit (A$ million) Average in Annual Rate of Increase FY 1969/70 FYis 1965/66 - 1969/70 Major Trading Bank Deposits 42.2 9.7% Loans, Advances, and Term Loans 27.2 30.5% Savings Banks D posits 415 12.6% Government Finance (A$ million): FY's 1968/69 1969/70 1970/71 1/ (Actual) (Actual) (ActualA- Administration Receipts: 149.6 204h.2 1955 of which: Internal Revenue 55.1 7_27 F3 .T Borrowing 7.2 34.5 h1.2 Australian Grant 87.3 97.3 70.8 Expenditures: 14965 20h.6 195.5 (Administration Investment Expenditures, National Accounts Series) (414) (49.9) Local Government Councils Current Exbpenditures 0.8 14 Capital Expenditures 2.3 Se2 Total 3.1 Revenues 3.1 4.6 Direct (Net) E.enditure in the Territory by Australian Commonwrealth Department and Instrumentalities 2/ 30.2 30.6 31.3 External Trade (A$ million) Average IAnnual Change FY 1969/70 FY's 1965/66 - 1969/70 Exports 71.1 13% (excluding re-exports) (22.7) of which: Coconut and Copra (30%) 21.0 0% Coffee (28%) 20.2 23% Cocoa (22%) 15.7 37% Forest Products ( 9%) 6X5 15% Inports 211.7 18% 1/ Not comparable with preceding years as it excludes allowances and other benefits to expatriate Administration officials (FY 1970/71 A$29.5 million) which are from now on directly appropriated by the Australian Govermnent. 2/ Including defense expenditures.  Balance of Payments (A$ million) FY's 1967/68 1968/69 1969/70 Trade Balance -69.0 -69.1 -125.1 Idet Invisible -38.1 -32.5 -34.9 Balance on Current Account -107.1 -101. -160.0 Net Capital Inflow 28.9 44.3 114.4 Other Items 78.2 57.3 45.6 Debt Service (Repayable in Australian Currency) Percent of Government Internal Revenue FY 1969/70 2.2% Current Exchange Rate: US$1 = A$0.893 A$l = US$1.12 (Official Parity) East Asia and Pacific Department April 8, 1971