Sri Lanka - Seventh (Mahaweli Transmission) Power Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 3599b-CE STAFF APPRAISAL REPORT SRI LANKA SEVENTH (MAHAWELI TRANSMISSION) POWER PROJECT January 21, 1982 Regional Projects Department South Asia Projects 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.  SRI LANKA SEVENTH (MAHAWELI TRANSMISSION) POWER PROJECT CURRENCY EQIJIVALENTS US$1.00 = SL Rs 18.5 SL Rs 1.00 = US$0.054 MEASURES AND EQUIVALENT 1 kilometer (km) = 0.6214 mile 1 kilovolt (kV) = 1,000 volts 1 megavolt ampere (MVA) = 1 million volt amperes = 1,000 kilovolt amperes 1 megawatt (MW) = 1 million watts 1,000 kilowatts 1 kilowatt hour (kWh) = 1,000 watt hours 1 gigawatt hour (GWh) = 1 million kilowatt hours ABBREVIATIONS AND ACRONYMS ADB - Asian Development Bank CEB - Ceylon Electricity Board CPC - Ceylon Petroleum Corporation DGEU - Department of Government Electrical Undertakings GSL - Government of Sri Lanka GTZ - German Agency for Technical Cooperation LRMC - Long-Run Marginal Cost MPE - Ministry of Power and Energy MASL - Mahaweli Authority of Sri Lanka PPAR - Project Performance Audit Report USAID - United States Agency for International Development. FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY SRI LANKA SEVENTH (MAHAWELI TRANSMISSION) POWER PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. 1. THE ENERGY AND POWER SECTOR ................................. A. Energy Resources ........................................ Hydro Power .................... 0...................... Traditional Fuels .................................... Petroleum ............................................ B. The Power Subsector ..................... ............... Sector Organization ............ .. .................... External Assistance . ................ ..... ........... Existing Facilities .................................. Development Program .................................. Access to Service and Status of Supply ............... Plant Maintenance .................................... Rural Electrification ........................ . ....... System Losses ........................................ Historical Consumption ............................... Load Forecast ........................................ fl. THE IMPLEMENTING AGENCY ........................... ..-... Lending Arrangements ...................................... Organization ...... ........ .................. Management and Staffing .................................. Management Systems ....................................... Training ................... 0............................... Local Authority Distribution Systems ..................... Audit ..................................................... Insurance .............................................. This report is based on the findings of an IDA mission comprising B.C. Davis and J.C. Ryan who visited Colombo in May/June 1981. This document has a restricted distribution and may be used by recipients only in the performance of their offial duties. Its contents may not otherwise be disclosed without World Bank authorization.  -2- Table of Contents (Cont'd) Page No. III. THE PROJECT . Objectives ............................................. Description ............................................... Project Cost .............................................. Project Financing Plan .................................... Engineering and Implementation ............................ Procurement ............................................... Disbursements ............................................. Land Acquisition .......................................... Risks ..................................................... IV. FINANCIAL ANALYSIS ......................................... CEB's Statutory Position ................................... Past Financial Performance ................................. Present Financial Position ................................. Billing and Collection ..................................... Revenues and Tariffs ....................................... Transfer of Assets from the MASL ........................... Financing Plan (FYs 1981-85) ............................... Future Finances ............................................ V. JUSTIFICATION .............................................. Approach ................................................... Economic Costs and Benefits ................................ Results .................................................... VI. AGREEMENTS REACHED AND RECOMMENDATION .....................  -3- Tables of Contents (Cont-d) Page No. ANNEXES 1. Power and Energy Balances (through 1990). 2. Generating Facilities. 3. Existing Transmission and Distribution Systems. 4. Load Forecast (through 1990) . 5. Organization Chart. 6. Reporting Requirements. 7. Project Description. 8. Project Cost Estimate . 9. Construction Schedule ................................ 10. Schedule of Estimated Disbursements ..................... 11. Income Statement (FY1976 through FY1980) ................ 12. Tariff Structure ................................ . 13. Income Statement (FY1979 through FY1988) ................ 14. Flow of Funds Statement (FY1979 through FY1988) ......... 15. Balance Sheets (FY1979 through FY1988) .................. 16. Power Sector Investment Program (FY1981 through FY1990) . 17. Assumptions for Financial Projections ................... 18. Economic Analysis ................................ 19. Related Documents and Information in the Project File ... MAP TBRD 16016R Seventh (Mahaweli Transmission) Power Project  A I~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ I  SRI LANKA STAFF APPRAISAL REPORT SEVENTH (MAHAWELI TRANSMISSION) POWER PROJECT I. THE ENERGY AND POWER SECTOR A. Energy Resources 1.01 Sri Lanka in 1981 had a population of 14.9 million and a gross national product of $250 per capita. Energy consumed in 1980 amounted to about 3.7 million toel/, of which 60% was provided by fuelwood, 13% by hydropower and 27% by imported oil. The country has no known reserves of coal, oil or natural gas, and its small deposits of peat are not significant. An Energy Assessment mission from the Bank visited Sri Lanka in June 1981 and its report will be published shortly. Hydro Power 1.03 Sri Lanka has an area of 25,332 square miles. Most of its precipitation comes from the Southwest monsoon from about May to September and from the Northeast monsoon from about December to March. Annual average rainfall varies from less than 40 inches in some northern parts of the island to more than 200 inches in places on the southwest slopes of the hills. Tlydro power potential totals about 6,600 GWh (1.7 million toe2/) per annum, or 2,500 MW at 30% load factor, mainly in three basins centered on the central highlands. They are the Mahaweli Basin in central Sri Lanka, the Walawe Basin to the south, and the Kehelgamu-Maskeliya Basin to the southwest. Some hydro power has already been developed in each of these basins. 1.04 Installed hydro generating capacity totals 369 MW out of a total installed capacity of 499 MW. Six more hydro stations are planned to bring the total hydro installed to about 1,100 MW by 1990. The present yield of firm energy is about 1,500 GWh per year; projected additions will increase this to about 3,240 GWh by 1990 (Annexes 1 and 2). Traditional Fuels * 1.05 Wood is the most widely used fuel. From such statistics as are available it appears that annual consumption of wood from the forests is between 3.8 and 5.4 million tons per year (1.5 - 2.2 million toe). To this 1/ toe = tonne oil equivalent = 10.2 x 106 kcal 2/ Primary equivalent based on 0.25 kgoe/kWh = 10,500 BTU/kWh = 2,646 kcal/kWh  -2- must be added 0.3 million tons per year (0.1 million toe) of fuelwood from rubber and coconut plantations. Petroleum 1.06 Exploration is taking place and it is expected that drilling will be started in 1981. Sri Lanka was recently classified as having favourable geological prospects for potential oil or gas discoveries, but the chances of substantial finds are thought to be low. 1.07 Ceylon Petroleum Corporation (CPC), a statutory corporation, is the sole importer and refiner; its refinery near Colombo has a capacity of 2.35 M tonnes per year. The refinery does not produce enough kerosene or diesel fuel to satisfy local demand and the deficits are imported. Kerosene is sold on the local market at a price lower than either the cost of importing it or of producing it locally. Furnace oil, a blend of residual and distillate used among other purposes to fuel CEB's steam power station, is produced by CPC in greater quantity than the local market can absorb and the surplus is exported. Gasoline is sold at a high price to help offset the cost of subsidizing kerosene.l/ 1.08 Data from CPC given in Table 1.1 indicate that refined imports have been rising rapidly in recent years to meet increasing demand for kerosene and diesel fuel. Table 1.1: CONSUMPTION OF PETROLEUM PRODUCTS (Tonnes 000's) 1973 1974 1975 1976 1977 1978 1979 1980 Crude imported 1,753 1,526 1,465 1,447 1,530 1,444 1,444 1,861 Refined imports 33 20 6 20 78 168 312 102 Exports 770 555 630 655 682 576 608 731 Consumption 1,016 991 841 812 926 1,036 1,148 1,232 Value of consumption US$ million at current prices 23 81 68 73 93 105 172 295 1/ Prices in effect on June 2, 1981 were: Kerosene 17.68 Rs/IG Furnace Oil 19.50 Rs/IG Auto diesel 27.00 Rs/IG Gasoline 45.50 Rs/IG Heavy Diesel 25.80 Rs/IG  -3- B. The Power Subsector Sector Organization 1.09 Sri Lanka's first public electricity supply was made available in Colombo in 1895 by Messrs Boustead Bros. The business was soon taken over by United Planters Co., who extended it and in 1899 built the Colombo electric tramways. In 1902, the Colombo Electric Tramways and Lighting Co. Ltd. was formed and provided electricity supply until 1927 when the Department of Government Electrical Undertakings (DGEU) was established to control the utility, which had by then been purchased by the Government. DGEU was succeeded in 1969 when the Ceylon Electricity Board (CEB), a statutory corporation, was established with responsibility for the generation, transmission and distribution of electricity. CEB supplies power direct to consumers and also sells in bulk to local authorities who retail to their own consumers. The Ministry of Power and Energy is responsible for supervision of CEB's policies. 1.10 CEB has in the past been responsible for the development of generating capacity and is now building the Canyon (60 MW) hydro station. For the next several years hydro generating capacity will be developed by the Mahaweli Authority of Sri Lanka (MASL) an agency established uiider the Ministry of Mahaweli Development, having responsibility for the implementation of the Accelerated Mahaweli Program. As they are completed, the Mahaweli generating facilities will be transferred to CEB for operation. During the next ten years some 580 MW of additional hydro capacity will be developed in this way at Victoria, Kotmale, Randenigala and Rantembe (Annex 1). External Assistance 1.11 Sri Lanka has in the past obtained external financal assistance towards the foreign exchange costs of its development program. The Bank Group has made available for power developments the following loans and credits, totalling US$112.9 million: (a) Loan 101-CE (US$15.9 million) to GSL in 1954 to help finance the 25 MW expansion of the Laksapana hydroelectric scheme. (b) Loan 209-CE (US$7.4 million) to GSL in 1958 to help finance construction of a 25 MW thermal plant at Kelanitissa, Colombo. (c) Loan 283-CE (US$14.1 million) to GSL in 1961 to help finance a 25 MW expansion at Kelanitissa.  -4- (d) Loan 636-CE (US$21.0 million) to CEBI/ in 1969 to help finance the 90 MW Maskeliya Oya Stage II project, a 25 MW gas turbine, and management consultancy and engineering services. US$4.5 million of this loan was cancelled when the gas turbine was not purchased. (e) Credit 372-CE (US$ 6.0 million) to GSL in 1973 for reinforcement and extension of CEB's transmission and distribution systems. (f) Credit 1048-CE (US$ 19.5 million) to GSL in 1980 for the Sixth Power Project to provide further reinforcement and improvement of CEB's transmission and distribution systems. (g) Further, the Bank Group made available Loan 653-CE/Credit 174-CE (US$29.0 million) to GSL in 1969 for the multi-purpose (irrigation and power) Mahaweli Ganga Development of which the 38 MW Ukuwela power station formed a part. 1.12 Six projects have been completed satisfactorily while that under Credit 1048-CE is at an early stage. Project Performance Audit Reports (PPAR) have recently been prepared for three of the above projects. That for Loan 653-CE/Credit 174-CE, which was for both irrigation and electricity, concluded that although implementation was seriously delayed, the agricultural and power benefits turned out to be much greater than expected at appraisal; the benefit of power generated was much increased by the rise in petroleum prices in 1973 and afterwards. The PPAR report on Loan 636-CE, for the 90 MW New Laksapana hydro station, concluded that the project had been well conceived and constructed; it was built at low cost, and its timing was fortunate in that it was almost complete at the time of the 1973 oil crisis. A significant institutional advance under Loan 636-CE was the establishment of CEB as a public corporation, replacing the Department of Government Electrical Undertakings. Despite a promising start, CEB has not developed as well as expected and both the Sixth (Credit 1048) and the proposed projects are seeking to promote significant advances in CEB's management. The PPAR report dealing with Credit 372-CE concluded that the project met its major objectives; the extensions to the transmission and distribution system built under it, though completed late, enabled full use to be made of the Ukuwela and New Laksapana hydro stations. 1.13 The Sixth Power Project is about a year behind schedule. Effectiveness of Credit 1048-CE was postponed about 6 months because of a delay in arranging cofinancing, and further delays arose owing to the complexities of making procurement decisions, and because of changes of 1/ CEB was established in June 1969.  -5- senior staff in CEB. At negotiations IDA was assured that CEB would adopt quicker procurement procedures and such delays would be avoided in future. 1.14 CEB's management shortcomings were noted in the appraisal of the Sixth Power Project and in the PPAR report on the Fifth Power Project. A review of CEB's managerial performance and methods, financed under Credit 1048-CE, has been carried out by consultants, and action is being taken to restore management systems, provide support to senior management, and implement comprehensive training programs for all types of staff (paras 2.09-2.11). 1.15 The Asian Development Bank (ADB) has provided finance for construction of the Bowatenne and Canyon hydro stations and for rural electrification. GSL has arranged bilateral financing of hydro generation components of the Mahaweli program as follows: - Sweden (Kotmale), U.K. (Victoria) and the Federal Republic of Germany (Randenigala). The construction of hydro generating facilities at Samanalawewa has been postponed until the early 1990's. Existing Facilities 1.16 CEB's existing generating, transmission and distribution facilities are described in Annexes 2 and 3. CEB's present installed capacity is 499 MW, all interconnected on one system. In addition there are privately owned generating stations, most of them less than 500 kW but ranging as large as 5.75 MW in CPC's refinery at Sapugaskande and 6 MW at the urea factory. The transmission and distribution system comprises 569 miles of 132 kV line with 17 substations, 214 miles of 66 kV lines with 9 substations, about 3,250 miles of 33 kV, and about 750 miles of 11 kV lines. The system control and load dispatching centre is at Kolonnawa, and all important plants and switching centers can communicate by means of power line carrier. Development Program 1.17 Of recent years detailed planning has not usually extended more than four or five years ahead, but in mid 1981 CEB prepared a detailed development plan to meet its generation requirements over the next 15 years. The plan has not yet been officially adopted by GSL. The proposed hydro program shows additions to the end of this decade bringing the installed capacity to about 950 MW with a firm energy capacity of 3,170 GWh. In the first four years of the next decade, additions to hydro capacity of 1,000 MW and 2,000 GWh are proposed. To complement the hydro, some hundreds of megawatts of thermal plant will be needed between 1985 and 1994. 1.18 At negotiations, it was agreed that the following steps would be taken to put CEB's planning on a workable footing. The new General Manager should make planning a matter of high priority for his personal attention. A corporate planning department should be formed to plan generation and  -6- transmission and their associated capital expenditures. The same group should play a leading role in the preparation of one year and five year operational budgets and capital budgets. The group will be required to produce, by the end of 1982, a comprehensive development plan for generation, transmission and distribution. The plan will extend 15 years ahead and will be reviewed and updated annually. At negotiations an assurance was obtained that CEB will prepare such a plan by the end of 1982 to be endorsed by GSL and submitted to the Association. 1.19 CEB requires an effective planning unit to pursue a number of pressing problems, including: (a) the immediate addition of a diesel power station, which is necessary if energy shortages in 1984 and 1985 are to be minimized (Annex 1). (b) the timely commissioning of Victoria: in particular the impounding of the 1984 monsoon rains is of primary importance and CEB must make every effort to avoid delay. (c) the energy shortages likely in 1982, 83 and 84: programs to minimize their impact, by means of economies and demand management, have to be worked out in advance. (d) the need for one or two coal fired generating stations toward the end of the present decade: sites need to be selected and secured very soon. 1.20 In order to optimize the management and operation of the Mahaweli resource, as well as the planning of future construction, it is expected that CEB and MASL will cooperate closely, perhaps forming a joint planning unit. An immediate planning requirement is an exhaustive hydro identification and ranking study. CEB has requested GSL to have this performed and financed by the German Agency for Technical Cooperation (GTZ), who have done similar service to other countries. The planning unit will establish and maintain its mathematical models and computer programs in Colombo, so that forecasts and plans can be updated as needed, and suggested changes from any quarter can be readily and fully evaluated. Services required to assist CEB in establishing its planning department will be funded from CrediL 1048-CE. Access to Service and Status of Supply 1.21 The total energy generated by CEB's power stations in 1980 was 1,668 GWh, about 89% of it hydro. CEB supplied about 208,000 consumers, including 218 local authorities who distributed electricity to another 226,000 consumers, making the total number of consumers about 434,000. Of these, about 333,000 were domestic. This suggests that at present only about one household in eight has an electricity connection. Rural electrification has  -7-- been extended to over 2,000 of a total 25,000 villages (para 1.27), but electricity consumption per head was less than 100 kWh in 1980. The majority of households use firewood for cooking and kerosene for lighting. 1.22 The Bowatenne hydro station was commissioned in 1981 and Canyon is scheduled to be commissioned in 1982. Victoria and Kotmale are to come on line in 1984 and 1985. To prevent shortages of capacity and energy before the new hydro becomes available it was necessary to install additional thermal plant. Three 20 MW gas turbines were installed in late 1980 and early 1981. A second group of three 20 MW gas turbines was installed late in 1981. 1.23 Further generation will be needed in addition to the six gas turbines to supply the forecast energy needed in 1984, 85 and 86, and it is expected that CEB will order 80 MW of diesel generators in 1982 for installation in 1983 (para 4.15). 1.24 In the months of May through August 1980 there was load shedding to the extent of about 50 GWh (about 3.5% of annual sales), made necessary by lower than average rainfall, poor availability of steam units, and the breakdown of one hydro unit at New Laksapana. Only one of the gas turbines was in service before the end of 1980 because of ordering and construction delays. CEB entered 1981 with its hydro reservoirs only 2/3 full, and load shedding was again inevitable. It was started in February and continued into June, with the loss of an estimated 69 GWh of sales. Toward the end of the period, supplies to the general public were off for 8 hours per day, and 16 major public corporations were shut down to husband the little water remaining in the reservoirs. Plant Maintenance 1.25 The maintenance of CEB's transmission and distribution system has been adequate although unsystematic. Less satisfactory are the distribution lines of some of the local authorities, where for many years only the barest maintenance has been done and more consumers have continually been added to existing lines so that voltages at peak times are well below acceptable levels. The largest of the local authority undertakings, Mt. Lavinia, near Colombo, with about 14,000 consumers and serving a population of about 250,000, was taken over by CEB in 1979. 1.26 Maintenance of CEB's generating stations was done reasonably well in the past, but has deteriorated in recent years. Adequate systems exist for keeping plant history and maintenance records but in many stations they are not kept up to date. There is no planned maintenance schedule for each station to permit management to check easily that all items of plant are provided for and have duly been serviced. These deficiencies were particularly evident at the Kelanitissa steam plant, but efforts are now being made to restore this station to a reasonable level of reliability.  -8- Rural Electrification 1.27 The first rural electrification schemes were undertaken in the early 1960s. Sri Lanka has about 25,000 villages and CEB had provided service to about 2,000 of them by the end of 1979. Some of the local authorities who buy in bulk from CEB have extended their lines into nearby villages, adding to the extent of rural electrification. By the end of 1984, an additional 1,150 villages will be connected under a Rural Electrification project financed by ADB and GSL at a total cost of US$ 31.8 million. 1.28 The ADB project is expected to introduce some significant improvements in the handling of rural electrification: (a) the rural electrification force in CEB will be expanded and empowered to scrutinize and monitor the formulation and implementation of all new schemes and to implement the ADB Project. CEB has agreed to appoint a Project Manager for rural electrification and to establish a Load Promotion and Monitoring Unit; (b) economic analysis and discounted cash flow calculations will be employed in the feasibility analysis of rural schemes; (c) CEB will arrange installment financing of house wiring and connection charges. System Losses 1.29 Before 1976, energy losses on CEB's system were less than 12%, but they have since been rising and are currently reported in excess of 16%. Moreover, these figures do not include losses in the retail operations of the local authorities, who buy in bulk about 25% of the energy sold by CEB and distribute it at low efficiency. Analysis suggests that an acceptable level for overall losses would be about 13% of gross generation. In future, substantial blocks of energy will have to be generated thermally every year making better control of losses even more important. It is CEB's intention to establish a cell within the planning group to monitor and control losses. Funds for this will be provided under the project (Annex 7). Historical Consumption 1.30 Growth in consumption of electrical energy over the period 1961 to 1980 has averaged 9.5% p.a., ranging from 17.8% in 1966 to 3.3% in 1974. From 1972 to 1977 there was a period of weaker growth, but it appears that a rate higher than the long term trend is now being established. 1.31 The short and long term annual growth rates for each class of consumer are summarized in Table 1.2. Energy sales since 1961 are analyzed in Table 1.3.  -9- Table 1.2: ANNUAL GROWTH IN ENERGY DEMAND Local Domestic Industrial Commercial Authorities Total 1961-801/ 8.8 11.2 7.8 8.6 9.5 1961-65 3.6 14.5 3.8 7.4 8.7 1965-70 6.5 18.3 6.2 10.7 13.0 1970-75 7.6 8.7 8.1 5.9 7.8 1975-80 16.9 4.5 12.4 10.3 8.4 1977-78 11.2 13.9 7.9 8.6 11.4 1978-79 28.6 7.0 24.5 7.6 11.8 1979-80 30.1 3.0 14.8 17.0 11.4 Table 1.3: ENERGY SALES BY CATEGORY 1961 1965 1970 1975 1978 1979 1980 Domestic 15.5 12.8 9.5 9.4 10.3 11.9 13.8 Industrial 33.3 41.1 51.8 53.9 50.7 48.5 44.9 Commercial 21.7 18.0 13.3 13.5 14.0 15.6 16.1 Local Authorities 29.5 28.1 25.4 23.2 25.0 24.0 25.2 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Load Forecast 1.32 CEB compiles an annual energy sales forecast from forecasts of the consumption of each class of consumer within each of CEB's geographical divisions. In so doing, historical trends are considered for each of the 23 areas which together make up the divisions. Due weight is given to known prospective loads such as housing schemes, industrial parks, commercial areas, individual industries, commercial properties, and rural electrification schemes. For longer term forecasting, correlation and regression analyses are used. All consumers are divided into three categories, and growth rates are related to gross domestic product, to value added in mining and manufacturing and export processing, and to population. 1/ 1980 sales are as estimated without load shedding.  -10- To accommodate deviations from the trend, upper and lower limit estimates are made. 1.33 CEB's power and energy forecast of August 1981 is summarized in Table 1.4 and is shown in greater detail in Annex 4. Table 1.4: ENERGY AND POWER DEMAND FORECAST 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 Energy Sales GWh 1446 1795 2001 2196 2451 2816 3101 3364 3662 3987 4342 Increase % 11.4 24.1 11.5 9.7 11.6 14.9 10.1 8.5 8.9 8.9 8.9 Generation GWh 1728 2112 2354 2584 2884 3313 3648 3958 4308 4691 5108 Peak Demand MW 382 447 498 546 610 698 769 834 908 989 1077 The energy sales figure for 1980 is an estimate of what consumption in that year would have been if there had been no load shedding (the actual was 1396 GWh), and this is used as the base for the forward projections. Because of load shedding in 1981 the actual figure for 1981 will be less than that shown, by an estimated 69 GWh. The figures do not provide for supplying an extension to the Ceylon Cement Corporation's factory, which will install its own generation to supply about 90 GWh per year. The large increase from 1980 to 1981 and the strong growth forecast for the following four years are supported by evidence of contracts signed and construction in progress. 1.34 The heavy load shedding experienced in 1980 and 1981 may have repercussions on some of the planned enterprises included in the forecast. Some slippage in the construction, commissioning and building up to full scale operation of new industrial and commercial ventures can be expected. CEB and GSL may be expected to try to reduce demand by promoting energy savings in the operations of Government industries and the private sector, by raising tariff demand charges and even by shutting down uneconomic operations in critical periods. These and other measures may cause growth in demand to lag behind CEB's projections. For purposes of generation and transmission planning, however, CEB's forecast is appropriate. 1.35 The growth of sales by class of consumer is summarized in Table 1.5. It is forecast that growth in domestic consumption will be depressed by the recent increases in tariff and by the fuel surcharge, and will fall from its very high rates of recent years back to about 11% for the remainder of the decade. Similarly, the rate of growth in consumption by local authorities, whose consumers are mainly domestic and commercial, is expected to be somewhat less than in recent years, and is taken to be about 10%. 1.36 Small and medium industries, defined as taking less than 1,000 kVA, ave projected to have an underlying growth from 1980 to 1984 of 6%, to which is added the Greater Colombo Economic Commission's forecast for each year;  -1 1- for 1985 and thereafter 8% growth is used. Consumption by large industries is forecast to increase by 13.9% per year on average up to 1985. This is explained mainly by the considerable number of projects expected to come to fruition in 1981-83. The underlying growth for the period 1980-83 was taken as 4% p.a., and after 1983, 8% was applied. 1.37 Commercial consumption is forecast to continue to grow rapidly in the years up to 1986, as it has in the recent past. Up to 1986 an underlying growth rate of 11% is expected, and to this is added the individual consumptions of the expanded airport at Katunayake, the substantial loads to be fed at the Urban Development Authority's developments in Colombo, and the new Parliamentary complex at Kotte. After 1987 a rate of 10% is estimated for all commercial consumers taken together. Table 1.5: AVERAGE ANNUAL GROWTH OF ENERGY SALES Actual Forecast 1977-80 1980-85 1985-90 Domestic 23.0 11.0 11.4 Small and Medium Industry 7.6 13.2 8.0 Large Industry 8.2 13.9 8.0 Commercial 15.6 13.0 17.1 Local Authorities 11.0 9.8 9.8 Railways - - 5.7 All Classes 11.5 14.3 9.0 II. THE IMPLEMENTING AGENCY Lending Arrangements 2.01 GSL will be the recipient of the proposed credit (US$36 million equivalent) and will onlend the proceeds to CEB, the implementing agency for the project (para 4.18). A similar arrangement was made under the earlier sixth power project (Credit 1048-CE).  -12- Organization 2.02 CEB was established by the CEB Act, No. 17 of 1969 (1969 CEB Act) as the successor to the Department of Government Electrical Undertakings (DGEU) and is responsible for the development and coordination of the generation, supply and distribution of electrical energy in Sri Lanka. While CEB is a public corporation the 1969 CEB Act does not endow it with fully autonomous powers and the government has reserved to itself a substantial role in important policy matters and in particular tariffs, capital investment, borrowing and the appointment of the Chairman and the General Manager. The conditions of service of all CEB staff are subject to GSL regulation. CEB is also subject to the provisions of the Finance Act, No. 38 of 1971 (1971 Finance Act) which regulates the finances of all public corporations in Sri Lanka. 2.03 CEB is a corporate body governed by a seven-member Board; members serve a five-year term and may be reappointed. Board members are appointed by GSL - four with experience in either engineering, commerce, administration or accountancy, and the others representing local authorities, industry and the Ministry of Finance - and may be removed at any time. The Chairman is appointed from amongst the Board members. The present Chairman is also the Secretary, Ministry of Power and Energy. 2.04 CEB's organization structure was designed by consultants, Urwick International Ltd., in the early 1970's under Loan 636-CE. While some modifications have been made in recent years including the addition of two posts of Additional General Manager, the original pattern is basically unchanged. Changes are now contemplated as part of the general management improvements now taking place in CEB (para 2.08). They would strengthen the decentralization of CEB's operations while retaining key controls in Colombo. The assurance obtained under Credit 1048-CE that CEB will submit to IDA, in advance, any proposal for major change to CEB's organizational structure is repeated under the proposed project. Management and Staffing 2.05 While the Chairman is responsible through the Board for policy matters and close liaison with government, the General Manager is CEB's Chief Executive Officer. He is responsible for the overall direction and control of CEB's day-to-day business. The present General Manager was recently promoted to the post and is an experienced and long-serving engineer. He is presently assisted by an Additional General Manager, four Deputy General Managers and a Finance Manager. With the exception of the Finance Manager, who is not fully qualified in matters of finance but is a competent and long-serving administration officer, all top management posts are filled by engineers. The Commercial and Personnel Managers, Chief Internal Auditor (vacant), and the Legal Officer all report directly to the General Manager. CEB's present senior management structure is set out in Annex 5. Below this  -13- level, CEB operations are decentralized and are controlled at plant (for generation) and divisional level. Each of the seven operating divisions into which Sri Lanka is organized is headed by a Divisional Manager, who is a qualified engineer; the divisions are further divided into areas which are the primary units for systems maintenance, meter reading and consumer services. 2.06 CEB has had considerable difficulty in retaining experienced staff in recent years as many engineers and accountants have left for overseas or private sector posts offering substantially higher monetary rewards. Salary differentials for senior CEB staff do not adequately reflect the heavy additional responsibilities of such posts. The lack of experienced engineering staff in the 30-45 year range is particularly noticeable at CEB while qualified or part-qualified accountants are now extremely difficult to recruit. These problems appear to be common to many public sector enterprises in Sri Lanka. A number of key finance posts which were vacant at the time of appraisal have since been filled. 2.07 CEB's present manpower is about 11,000 against an authorized total of about 14,000. Manpower has increased as follows in recent years: Table 2.1: CEB MANPOWER May December 31 1975 1976 1977 1978 1979 1980 1981 1. Managerial, pro- fessonial and administrative staff 235 244 285 329 312 344 336 2. Technical and clerical staff 1,895 1,934 2,379 2,476 2,787 3,132 3,083 3. Labor Grades 6,050 6,308 6,712 6,918 6,849 7,037 7,669 8,180 8,486 9,376 9,723 9,948 10,513 11,088 Whilst CEB's staff is large in relation to the size of its operations and the number of consumers it serves, the rate of increase over the past six years has been held to an average of 5.2% per year, which is reasonable in view of an expanding program of works, a rural electrification program, undertaken by force account, and the need to cover a high turnover of skilled labor. Management Systems 2.08 Comprehensive management information, accounting and budgeting systems were introduced by CEB in 1973 following a study by consultants, Urwick International Ltd., financed under Loan 636-CE. While the systems are satisfactory and are relevant to CEB's operations, senior management is not utilizing the information system, and this has resulted in a lack of control of CEB's activities. Staffing difficulties in recent years have led to serious delays in the preparation of periodic management reports,  -14- particularly financial reports. Present IDA reporting requirements are outlined in Annex 6, but are not being achieved. Internal audit arrangements have never been satisfactorily established in CEB largely due to the inability to recruit a Chief Internal Auditor. 2.09 In view of the acknowledged weaknesses in CEB's present management arrangements, CEB agreed under the sixth power project (Credit 1048-CE) to implement a program of management improvements. To this end, Urwick International Ltd., were recalled to review the situation and, in particular, the status of implementation of their earlier recommendations and the effectiveness of management practices in certain specified areas and to recommend a program of measures to restore CEB's managerial effectiveness. 2.10 This short assignment is now complete: recommendations for the "restoration phase cover (a) general management advice, (b) restoration and further development (e.g. computerization) of CEB's systems, and (c) the introduction of management development and training programs. The restoration of management systems and the development of training (para 2.11) are most urgent tasks and CEB has recently appointed Urwick International Ltd., with their extensive background knowledge for this purpose. The appointment of a general management advisor requires a person experienced in power utility management and CEB will be discussing a number of options with IDA in the coming months. Funding is available under Credit 1048-CE for the restoration" program. Training 2.11 CEB operates a residential training center at Castlereagh for technicians which offers courses related to CEB's operations. Accommodation is limited and CEB is planning to develop non-residential technical training facilities in Colombo as a result of an earlier investigation by the National Rural Electric Cooperative Association, Washington, D.C., financed under the USAID program. Regular training programs are required to fit engineers for managerial positions; prior to assuming responsibility for operating facilities newly qualified engineers should receive six-months on-the-job training: at present this requirement is not consistently achieved. There is no program for progressive management development. Training programs are also required to familiarize accounting staff with CEB's financial operations and reporting requirements for financial control. CEB agreed under Credit 1048-CE to submit to IDA a satisfactory training program for all cadres of CEB staff by June 30, 1981, and thereafter to implement an agreed program. CEB has submitted an outline training program after discussions with IDA and following Urwick's recent report. This proposal will be developed to suit CEB's needs and provision is made under the proposed project to finance training expenditure.  -15- Local Authority Distribution Systems 2.12 While CEB supplies power directly to some 208,000 domestic, commercial and industrial consumers throughout Sri Lanka, another 226,000 consumers are supplied by local authorities which purchase power in bulk from CEB.The quality of local authority service to consumers is unsatisfactory (para 1.25). GSL planned that CEB should assume responsibility for the distribution facilities of the local authorities. CEB would take over all staff, assets and liabilities relating to electricity supply. In view of CEB's present managerial problems and the heavy additional burden such a transfer would place on CEB, including its financial position, the transfer is presently deferred and may not now proceed. GSL has confirmed this position (para 4.09). Audit 2.13 The present arrangements under Credit 1048-CE require CEB to submit (a) unaudited accounts to IDA within four months of the year-end (the time permitted by law for their submission to the Auditor General) and (b) the Auditor Generals report on the accounts within ten months of the year-end. CEB-s FY 1980 unaudited accounts were submitted for audit in May 1981, a considerable improvement on earlier years, but the final audit report is still awaited. The above arrangements are satisfactory and will be continued under the proposed project. Insurance 2.14 CEB has for a number of years borne its own insurable risks and has established an Insurance Reserve to which an annual contribution of 1/10% of gross fixed assets values is transferred from retained earnings. This arrangement is satisfactory.  -1.6- III. THE PROJECT Objectives 3.01 The main objective of the project is to supply efficieLitly, reliably and at minimum cost the output from the hydro electric power stations in the Mahaweli basin to the principal load centres in and around Colombo. In doing this CEB will establish the first elements of a 220 kV grid that will eventually cover much of the country. It was therefore essential to perform screening studies looking well into the future to ensure that a system will evolve that is flexible enough to accommodate any reasonable generation program. This meant considering how to handle the outputs from all major generation developments probable in the next twenty years, including such hydro electric potentials as Upper Kotmale, Uma Oya, Samanalawewa and Kukule, and possible coal fired stations at Colombo and Trincomalee. A secondary objective of the project is to inject power into the existing 66 kV system so as to enable it to function at acceptable levels of reliability, voltage control and energy losses. Description 3.02 The project consists of the following components (for details see Annex 7 and the map IBRD 16016R. (a) 126 km of 220 kV doable circuit transmission line and 38 km of 132 kV single circuit transmission line. (b) One new 220/132 kV substation, additions to three existing 132 kV substations, one new 132 kV switching station and additions to an existing 66 kV substation. (c) Replacement of circuit breakers with new ones of higher rupturing capacity. (d) Power factor correction equipment. (e) Power line carrier equipment. (f) Equipment for a loss reduction cell. (g) Vehicles, tools and buildings. (h) Engineering consulting services, technical assistance and training.  -17- Project Cost 3.03 The estimated cost of the project is Rs 1,412 million (US$76.3 million) including contingencies and customs duties. The estimated costs are summarized in Table 3.1 and shown in greater detail in Annex 8. Table 3.1: SUMMARY OF ESTIMATED PROJECT COST Description Foreign Local Total Foreign Local Total (Rs million) (US$ million equivalent) Transmission Lines 366 118 484 19.8 6.4 26.2 Substations 100 30 130 5.4 1.6 7.0 Transformers 81 7 88 4.4 0.4 4.8 Circuit Breaker Replacement 56 9 65 3.0 0.5 3.5 Other Equipment 31 17 48 1.7 0.9 2.6 Vehicles & Tools 4 - 4 0.2 - 0.2 Engineering/Training 30 4 34 1.6 0.2 1.8 CEB Supervision - 9 9 - 0.5 0.5 Sub Total 668 194 862 36.1 10.5 46.6 Contingencies Physical 63 19 82 3.4 1.0 4.4 Price 135 109 244 7.3 5.9 13.2 Project Cost before Duties 198 128 326 46.8 17.4 64.2 Customs Duties 224 224 - 12.1 12.1 TOTAL PROJECT COST 866 546 1,412 46.8 29.5 76.3 3.04 The cost estimates were developed by CEB and their consultants and are based on recent quotations updated where necessary to 1981 prices. Physical contingencies of 10% were allowed where applicable, and price contingencies amounting to 17.3% of the project cost were calculated using the following rates of escalation: 1981 1982 1983 1984 1985 Foreign % 9 8.5 8 7.5 7 Local % 23 17 14 12 10 Customs duties ranging from 5% to 50% on imported equipment and materials were allowed as applicable, amounting to 15.9% of the total project cost. The cost estimates are adequate.  -18- Project Financing Plan 3.05 It is anticipated that co-financing of the project will be arranged between IDA (US$ 36.0 million) and the Opec Fund (US$11.0 million). The combined amount (US$ 47 million) would cover 100% of the foreign costs (US$ 46.8 million) together with local training costs (US$ 0.2 million)1/ and represents about 62% of the total project cost (or about 73% excluding customs duties). CEB will be expected to meet all other local costs (US$ 29.3 million) from internal cash generation. The components proposed to be financed by IDA, the Opec Fund and CEB are identified in Table 3.2. A satisfactory arrangement for financing by the OPEC Fund is a condition of credit effectiveness. Table 3.2: PROJECT FINANCING PLAN US$ Equivalent Percentage (%) IDA Transmission lines 26.0 Transformers 6.0 Other Equipment, Vehicle & Tools 2.0 Consultancy/Training 2.0 36.0 47 OPEC FUND Substations 7.0 Circuit breakers (replacement) 4.0 11.0 15 CEB Local costs, excluding training 29.3 38 76.3 100 Engineering and Implementation 3.06 In view of the construction of a group of relatively large new hydro stations totalling about 580 MW in the Mahaweli Basin, studies of the transmission system were carried out by CEB and their consultants. They concluded that for the main link from Mahaweli to Colombo the optimum solution would be to complete two 220 kV circuits by the time Victoria was commissioned, with the intention of adding a third in due course. Since this 1/ IDA financing only.  -19- voltage had not previously been used in the country, they decided to employ consultants for this project, and engaged the firm which had already started designing the 220 kV substation at Victoria and the line from there to Kotmale. The cost of engineering for the lines and substations as far as evaluation of tenders is being financed from Credit 1048-CE. The balance of the consulting work comprising detailed design, contract supervision, inspection and testing, and supervision of construction will be financed from the proposed Credit. The contract provides for about 140 man months of foreign engineers' services at an average man-month cost (including fees, international travel, subsistence, allowances, and reimbursable foreign costs) of US$ 9,300. 3.07 The specification of the 220 kV lines will be essentially that developed for the line from Victoria to Kotmale, while the 132 kV lines will follow CEB's established practice. The areas through which the lines will pass have been surveyed by helicopter and then visited on land, and provisonal routes chosen. As soon as the contract is awarded the contractor will perform check surveys. It is expected that tenders will have been received and evaluated by end-March 1982. 3.08 The project will be constructed between September 1982 and slay 1984 (Annex 9). Completion by this date is necessary to permit the first generator in Victoria to come on line as scheduled in mid-1984. Procurement 3.09 The main part of the project will be constructed under the following contracts: (a) A single responsibility contract for the 220 kV and 132 kV lines. (b) A single responsibility contract for the new 220 kV substation, the new 132 kV switching station, and the modifications to the existing 132 kV and 66 kV substations; this contract will include the supply and installation of the reactive compensation equipment, and the installation (but not the supply) of the power transformers and the power line carrier equipment. (c) A supply contract for the power transformers. (d) A supply contract for the circuit breaker replacements. (e) A supply contract for the power line carrier equipment. 3.10 International competitive bidding in accordance with IDA's guidelines will be employed for the major contracts. Vehicles, equipment and materials  -20- 3.10 International competitive bidding in accordance with IDA's guidelines will be employed for the major contracts. Vehicles, equipment and materials not exceeding US$15,000 per item and US$150,000 in aggregate may be procured in accordance with local procedures, which are satisfactory. For materials and equipment tendered internationally, the standard domestic preference of 15% on the c.i.f. price, or the prevailing duty, whichever is less, will be applied in bid evaluation. Disbursements 3.11 The Credit will be disbursed against the following items: (a) 100% of the foreign expenditures for 220 kV and 132 kV transmission lines. (b) 100% of foreign expenditures for directly imported items, or 100% of the local expenditure (ex-factory) for locally manufactured items, or 65% for locally procured items (equipment and materials for power transformers, power line carrier, loss reduction program, and vehicles and tools). (c) 100% of foreign expenditures on engineering consultants. (d) 100% of expenditures on technical assistance and 100% of training. A schedule of estimated disbursements is provided in Annex 10. It is consistent with the proposed implementation period for the project (para 3.08) and provides for about 90% disbursements by project completion. The proposed credit would be fully disbursed by June 1985, some 3 1/2 years from project approval. Similar recent Bank Group projects have been disbursed over about 4 1/2 years, but CEB is confident that it can complete the project in a shorter period. Land Acquisition 3.12 No problems are foreseen. The site for the Biyagama substation has to be acquired but no difficulty is expected as the land is owned by GSL. Wayleaves for transmission lines are routinely acquired without difficulty. Risks 3.13 The project consists of normal electric utility work entailing no unusual risks and no particular difficulty is foreseen in its execution. Price contingencies in the estimate have been allocated to minimise the risk of cost overruns.  -21- IV. FINANCIAL ANALYSIS CEB's Statutory Position 4.01 CEB's finances are regulated by the provisions of the 1969 CEB Act and the 1971 Finance Act, which affects all public corporations in Sri Lanka. CEB is required, by Section 38 of the 1969 CEB Act, to operate in a commercial manner so as to ensure that revenues are sufficient to meet all outgoings, including depreciation and interest, and a reasonable proportion of development costs. CEB's statutory obligations were amended in two important respects following IDA approval of Credits 372-CE and 1048-CE. 1/ in 1973: (a) CEB is permitted to charge depreciation in its accounts based on a current valuation of fixed assets rather than the historic cost of such assets. (b) CEB's obligation to pay an 8% annual dividend on GSL's equity capital is waived each year until CEB has generated cash equivalent to a 30% contribution to the combined annual capital expenditure on electricity supply, including interest during construction, of CEB and any other body responsible for undertaking a joint scheme with CEB. Past Financial Performance 4.02 CEB's actual financial operations for the five years to FY 1980 are summarized in Table 4.1 below and are shown in greater detail in Annex 11. 1/ These conditions are repeated under the proposed Credit.  -22- Table 4.1: CEB INCOME STATEMENT (FY 1976 through FY 1980) (Rupees Million) 1976 1977 1978 1979 1980 Energy Sales (GWh) 996 1,042 1,161 1,298 1,396 Sales Revenue (Rs/kWh) 0.16 0.16 0.18 0.30 0.59 Operating Revenues 178 197 242 435 887 Less Operating Expenses and Depreciation 121 151 196 258 564 Net Income (before interest) 57 46 46 177 323 Interest (16) (25) (28) (43) (27) Net Income (after interest) 41 21 18 134 296 Operating Ratio a/ 53% 48% 47% 32% 46% Average Currently Valued Net Fixed Assets (ANFA) b/ 1,047 1,864 2,147 2,611 3,660 Rate of Return on ANFA 5.4 2.5 2.1 6.8 8.8 Contribution to CEB's Investment Program 37% 43% 16% 67% 58% CEB was required, under IDA Credit 372-CE, to maintain tariffs at levels sufficient to produce, from FY 1974, at least an 8% annual rate of return on currently valued net fixed assets in operation. In this respect CEB's financial performance through FY 1978 was unsatisfactory mainly as a result of unchanged tariff levels between April 1, 1972 and December 1, 1978. CEB has, however, satisfactorily revalued its fixed assets through FY1980 using agreed local indices. In the seven years FY's 1972 through 1978 whereas the average cost of energy (including depreciation) per kWh rose by 58% from Rs 0.11 to 0.17 CEB's average sales revenue per kWh rose by only 20% from Rs 0.15 to 0.18. Following a tariff increase on December 1, 1978, sales revenue rose to Rs 0.30/kWh in FY 1979. Except for an unexpectedly large (37 1/2%) movement in the indices used for fixed asset revaluation, the a/ Operating expenses before depreciation divided by operating revenues. b/ Following an initial valuation of CEB's fixed assets at January 1, 1972, subsequent revaluations of fixed assets, using local indices agreed with IDA, have been incorporated in CEB's accounts annually from FY's 1977 through 1980.  -23- covenanted 8% rate of return would have been achieved, the actual being about 7%. Operating expenses increased in FY 1979 by about 32%, much less than budgetted, bringing the average energy cost to Rs 0.20/kWh. Present Financial Position 4.03 In order to achieve the 8% rate of return required by IDA, CEB was required to make a further tariff increase as a condition of effectiveness of Credit 1048-CE. From October 1, 1980, GSL authorized CEB (a) to increase tariffs from an average Rs 0.30 to Rs 0.58/kWh and (b) to introduce a revised fuel adjustment surcharge on all consumers so as to recover automatically the monthly fuel cost of thermal generation (para 4.11). Following these revisions CEB's rate of return on revalued assets in FY 1980 was about 9% and is estimated at about 11% in FY 1981. This constitutes a very satisfactory turnaround of CEB's finances since FY 1978. 4.04 CEB's financial position as at December 31, 1980, based on unaudited accounts for FY 1980, was as follows: Table 4.2: CEB BALANCE SHEET (at December 31, 1980) (Rupees Million) ASSETS: Net Fixed Assets 4,643 Work in Progress 325 4,968 Current Assets 1,430 Less: Current Liabilities 373 1,057 Total Assets 6,025 LIABILITIES: Equity: GSL 677 Consumer Contributions 348 Revaluation Reserve 2,705 Retained Earnings 1,034 4,764 Loans 1,261 Total Liabilities 6,025 4.05 CEB's FY 1980 balance sheet indicates a highly satisfactory debt/equity ratio of 20:80 (debt service was covered 7.3 times by earnings). CEB's current ratio is a relatively high 3.3 times but this will fall to a more satisfactory level (about two times) in the 1980's. CEB will have to  -24- maintain a tight control over the level of consumer receivables (paras 4.06 - 4.10) and inventories.l/ Billing and Collection 4.06 CEB's billing and collection performance has been reasonably satisfactory in recent years. Under Credit 1048-CE, CEB's customer receivables on the last day of each month should not exceed the aggregate billings for the three months ending on the same day and this requirement is repeated under the proposed project. CEB has made considerable efforts to meet this target: the position at December 31, 1980 indicates receivables equivalent to 3.2 months billings compared to 3.6 months billings at end FY 1978. As CEB's revenues have quadrupled in this short period the present receivables position represents a commendable performance by CEB staff. 4.07 An analysis of consumer receivables at end FY 1980 is as follows: 1/ Under the Sixth Power Project CEB agreed to reduce inventories to a satisfactory level by December 31, 1982 and GSL agreed to ensure the timely availability of foreign exchange for inventories: materials management problems have already been reviewed by CEB's management con- sultants and action is being taken to improve controls. These conditions are repeated under the proposed project.  -25- Table 4.3: ANALYSIS OF CONSUMER RECEIVABLES (at December 31, 1980) Consumer Large Consumers Category a/ (over 50 kVA) Other Consumers Total No. % % No. % % No. % % months Bill- Receiv- months Bill- Receiv- months Bill- Receiv- out- ings ables out- ings ables out- ings ables stand- stand- stand- ing ing ing Private 2.3 24 18 3.7 25 28 3.1 49 46 Public Corporations 2.7 39 32 - - - 2.7 39 32 Government 3.1 6 6 14.7 1 3 4.1 7 9 Local Authorities - General 8.0 4 10 9.6 - - 8.8 4 10 - Street Lighting 16.2 1 3 - - - 16.2 1 3 Total 3.0 74 69 4.1 26 31 3.2 100 100 4.08 CEB has a separate unit to handle large consumers' accounts, which are maintained on a manual system. The above table indicates that CEB is maintaining a tight credit control over most large consumers, the exception being the 218 local authorities which CEB supplies in bulk and for street lighting. In the first three months of 1981 CEB managed to reduce local authority arrears by some Rs 6.5 million to about Rs 30 million, equivalent to some 7 months billings but the position is still unsatisfactory. 4.09 GSL agreed, under Credit 1048-CE to ensure the timely payment of future amounts owed by the local authorities to CEB together with arrears in accordance with an agreed program. At that time GSL was proposing to transfer the local authority systems to CEB and this led to a deterioration in the local authority arrears position. Arrears would have been settled as a part of the transfer arrangements. The transfer has now been abandoned. a/ Local authority billings are at pre-December 1978 tariffs by agreement between GSL and CEB. GSL is billed separately in respect of the tariffs increases, including the fuel surcharge, since December 1, 1978: the billings and receivables on this account are not included under the Government sector in this table but are shown under a separate debtor's account (paragraph 4.09).  -26- An assurance was obtained, therefore, at negotiations that, from October 1, 1981, the local authorities will pay the current CEB tariffs for bulk supplies and introduce retail tariffs which are sufficient to cover CEB's bulk supply charges and the local authorities distribution costs. Presently GSL is responsible for payment of increases in the local authority bulk supply tariffs since December 1, 1978, but to date has made payments to CEB only up to March 31, 1981. Arrangements are in progress to settle the remaining amount and the payment to CEB of the amount outstanding at September 30, 1981 is a condition of credit effectiveness. 4.10 The bulk of CEB's billings are of relatively small amounts and are maintained on computer. They constitute some 25% of CEB's billings by amount. Over 50% of such monthly accounts are for less than Rs 15. The difficulty of recruiting satisfactory meter readers poses a continuing serious problem for CEB and leads to some delays in billing and problems in collection. CEB is striving for improved performance in this sector. Revenues and Tariffs 4.11 The details of CEB's recent tariff structure are set out in Annex 12. CEB's tariffs were unchanged between April 1972 and December 1978 but since then two tariff increases have been made which have increased CEB's average tariff by about 260% from Rs 0.16 to 0.58/kWh (about 3 US cents).l/ In addition to raising tariff levels in recent years, which has enabled it to meet financial rate of return criteria, CEB has also made some structural improvements to its tariffs. Domestic consumers now pay higher block tariffs and non-domestic tariffs have been rationalized. Further, from October 1, 1980, CEB is recovering automatically the cost of fuel needed for CEB's increasing thermal generation by way of a surcharge on consumers' monthly bills. The first 200 units of domestic consumption (equivalent to a maximum charge of US$ 5) are exempt from the surcharge and this exempts over 90% of domestic consumers. 4.12 CEB agreed under Credit 1048-CE to carry out a study of long run marginal cost (LRMC) pricing with technical assistance from the Bank. This study should have been completed by December 31 1980 but staffing constraints in particular have led to delay and it was agreed to extend the deadline by one year to December 31, 1981. Preliminary results of the study were submitted at negotiations but further refinements are needed for the results to be useful for tariff restructuring. The study is now being revised and CEB gave an assurance during negotiations to implement any recommendations agreed after consultation with GSL and IDA. 1/ with the addition of the fuel surcharge this was equivalent to about - 6 US cents/kwh. in 1981.  -27- 4.13 An assurance was obtained at negotiations that CEB will continue, as previously, to review tariffs annually, before the start of each financial year to ensure that revenues are sufficient to meet operating expenses, including fuel and depreciation, and to produce at least an 8% rate of return on currently valued net fixed assets. While the presently agreed rate of return is 8%, in FY 1982 CEB will have to increase tariffs by about 50%, (equivalent to a 12% rate of return) in order to generate sufficient internal resources to meet the local costs of its approved investment program through 1985. This increase in tariffs is a condition of credit effectiveness. In FYs 1982 and 1983 such tariffs would produce a before-tax rate of return of 16% (para 4.16). From FY 1985 onwards further tariff increases will be required to enable CEB at least to maintain the covenanted 8% rate of return: the amount of such increases will depend to a great extent upon the size of CEB's future investment program. Transfer of Assets from MASL 4.14 The 1969 Act authorizes CEB to enter into "joint schemes" with other agencies for the generation of electricity. The Act does not detail the arrangements for the transfer and operation of assets created under such schemes. Subsequently, under Credit 372-CE, GSL agreed to ensure that CEB is sufficiently involved on the formulation of all future joint schemes, and that the power assets are transferred on completion to CEB on terms satisfactory to IDA. This was done in the case of the 38 MW Ukuwela hydro station constructed under the Mahaweli Ganga Stage I (para 1.11(g)). Most of the hydro-power development in the 1980's in Sri Lanka will be carried out under the Accelerated Mahaweli Program. CEB is not required to contribute to the costs of these schemes during the construction phase but ownership will be transferred to CEB on their completion. The need for adequate co-ordination between CEB and in the design and construction of these facilities was discussed in the context of the Sixth Power Project and again during negotiations for the proposed project. CEB is not represented on the MASL Board and such representation would require legislation. However, technical co-ordination between the two agencies is now satisfactory. GSL agreed during negotiations to ensure proper future co-ordination between CEB and any other agency involved in a joint scheme. Futhermore, in view of the major impact that the Victoria and Kotmale assets will have on CEB-s finances, GSL and CEB have agreed a satisfactory provisional basis for the transfer of these assets. Financing Plan (FYs 1981-85) 4.15 CEB's presently approved investment program through FY 1985, comprises the ongoing ADB-assisted Bowatenne, Canyon and Rural Electrification projects, the IDA-assisted sixth (transmission and distribution) and proposed seventh (Mahaweli transmission) projects, various small system augmentation works and the installation of a second 60 MW of gas turbines in FY 1982. GSL confirmed at negotiations that it has recently  -28- agreed to the inclusion of an 80 MW diesel project in CEB's investment program (para 1.23) and to contribute Rs 800 million in the form of Equity towards the cost of such a project. Furthermore, GSL has approached IDA for financial assistance towards the foreign costs of the project. 4.16 CEB has not, in past years, been liable to pay income tax. However, from April 1981 the basis of annual depreciation allowances used in the computation of tax liability has been changed. In future CEB will be entitled to claim a 12 1/2% depreciation allowance on newly commissioned assets over an eight year period as compared to the previous 100% allowance in the first year. Consequently, it is estimated that CEB may incur a tax liability totalling Rs 665 million in FY-s 1982/83 but thereafter the transfer of major hydro-stations will create tax losses to be carried forward to subsequent years. CEB is also liable to a Turnover Tax of 2% of its sales revenues, including those in respect of the recovery of fuel costs. 4.17 CEB's estimated financial requirements for the period FY's 1981 through 1985 and the sources of funds are as follows: Table 4.4: CEB FINANCING PLAN (FY 1981 through FY 1985) Rupees US$ Million Percentage Million Equivalent % Requirements a/ Capital Expenditure 7,979 431.3 100 Sources of Funds CEB Internal Cash Generation 7,084 382.9 (89) Less: Debt Service b/ (2281) (123.3) (29) Working Capital (1103) (59.6) (14) Contribution to Investment 3,700 200.0 46 IDA Credits 1,026 ) ) OPEC Fund 204 ) 119.0 ) 28 Other loans 973 ) ) Consumer Contributions 543 29.4 7 GSL Equity 1,406 76.0 18 Short-term loan bJ 127 6.9 1 7,979 431.3 100 a/ Includes sixth and proposed seventh power projects and proposed 80 mw diesel plant. b/ Rs 127 million short-term loan in FY 1984 is fully repaid in FY 1985.  - 29 - 4.18 The proceeds of the IDA credit of US$36 million will be made available to CEB by GSL at 12% interest for a 20 year period with 3 years grace. 1/ GSL will bear any foreign exchange risk in accordance with the 1969 CEB Act. The execution of an onlending agreement satisfactory to IDA is a condition of credit effectiveness. 4.19 To protect its future financial viability, CEB has agreed previously not to incur any long-term debt without IDA's prior agreement unless its maximum future debt service is covered at least 1.25 times by its most recent 12 months operating surplus before depreciation. This condition is repeated under the proposed Credit. Future Finances 4.20 Financial projections for the period FY 1979 through FY 1988 are set out in Annexes 13-16. Assumptions used to prepare the projections are set out in Annex 17. Salient features of CEB's future finances, which are satisfactory, are summarized in Table 4.5. The fluctuation in CEB's average revenue in future years (table 4.5, line 1) results from the operation of the present fuel adjustment clause. As part of the tariff review now being undertaken (paras. 4.11-4.13) base fuel costs will be included in the basic tariff to prevent fluctuations in consumer bills from month to month. 1/ CEB's commercial borrowing is negligible and loans are obtained towards foreign and local expenditures from GSL whose present lending rate is 10%. Inflation in Sri Lanka was, 1978-9%, 1979-16%, 1980-24%, and is forecast at 1981-23%, 1982-17%, 1983-14%.  -30- Table 4.5: SUMMARY OF CEB'S FUTURE FINANCES 1981 1982 1983 1984 1985 1986 1987 1988 1. Average Revenue a/ b/ (Rs/kWh) 1.15 1.69 1.94 1.91 1.76 1.82 1.73 1.92 (US cents/kWh) 6 9 10 10 10 10 10 10 2. Average Tariff b/ (Rs/kWh) 0.58 0.74 0.87 0.87 1.05 1.15 1.20 1.27 3. Average Cost of Energy Sold c/ (Rs/kWh) 0.71 1.18 1.41 1.20 0.91 0.91 0.78 0.92 (US cents/kWh) 4 6 8 6 5 5 4 5 4. Operating Ratio c/ 61 70 73 63 52 50 45 48 5. Rate of return on annually revalued (%) Net Fixed Assets d/ 11 12 10 9 8 8 8 8 6. Debt service coverage 6.4 7.1 4.2 3.6 1.9 1.5 1.8 1.7 7. Contribution to CEB-s Investment Program (%)e/ ---- 46 -- ----- 32