Document of The World Bank FOR OFFICIAL USE ONLY Report No. 5484-IN INDIA KCERALA STATE POWER PROJECT STAFF APPRAISAL REPORT May 22, 1985 Power and Transportation Division South Asia Projects Department 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. CURRENCY EQUIVALENTS Currency Unit Rupee (Rs) Rs I = Paise 100 US$ 1 = Rs 12.0 Rs 1 = US$ 0.083 Rs 1 million US$ 83,333 MEASURES AND EQUIVALENTS 1 Kilometer (km) = 1,000 meters (m) = 0.6214 miles (mi) 1 Meter (m) = 39.37 inches (in) 1 Cubic meter (m3) = 1.31 cubic yard (cu yd) = 35.35 cubic feet (cu ft) 1 Hectare (ha) = 10,000 m2 = 2.471 acres (ac) 1 Kilogram (kg) = 2.2046 pounds (lb) I Ton (t) = 1 metric ton = 2,200 lbs 1 Kilocalories (kcal) = 3.968 British thermal unit (Btu) I Kilovolt (kV) = 1,000 volts (V) 1 Kilovolt-ampere (kVA) = 1,000 voLt-amperes (VA) 1 Megawatt (MW) = 1,000 kilowatts (kW) = 1 million watts 1 Gigawatt hour (GWh) = 1,000,000 kilowatt hours (kWh) 1 toe = ton of oil equivalent = 10 million kilocalories ABBREVIATIONS AND ACRONYMS CEA - Central Electricity Authority C&AG - Controller and Auditor Ceneral of India cwc - Central Water Commission GOI - Government of India GOK - Government of Kerala IBRD - International Bank for Reconstruction and Development IDA - International Development Association KSEB - Kerala State Electricity Board NHPC - National Hydro-Electric Power Corporation NPP - National Power Plan NTPC - National Thermal Power Corporation REC - Rural Electrification Corporation REB - Regional Electricity Board SEB - State Electricity Board SRPS - Southern Region Power System FISCAL YEAR APRIL 1 - MARCH 31 FOR OMCIAL USE ONLY INDIA KERALA STATE POWER PROJECT Table of Contents Page No. LOAN AND PROJECT SUMMARY ... .................................... i-iii I. SECTORAL CONTEXT ..... : .......................... ........ 1 Commercial Energy Resources ............................. 1 Supply and Demand of Electricity - India ................ 2 Supply and Deamdn of Electricity - Southern Region ...... 2 Organization of the Power Subsector .... ............. 3 Pricing and Resource Mobilization ..... ............. 3 Power Subsector Planning ................................ 4 Management and Operations ............................... 4 Bank Group Participation in the Past .... ............ 5 Bank Group Strategy in the Power Subsector .............. 6 II. THE BENEFICIARY ......................................... 7 Organization ................................. 7 Personnel and Staffing .................................. 7 Operation and Maintenance ..... ...................... 8 Planning ................................................ 8 Training ................................................ 9 III. THE PROJECT ............................ .... .......... 10 Project Setting ...................... ................... 10 Project Objectives ...................................... 10 Project Description ..................................... 11 Project Costs ........................................... 11 Project Financing ....................................... 13 Project Engineering .................... ................. 13 Project Implementation and Construction Schedule ........ 14 Procurement ............................................. 15 Disbursements ....................... .................... 17 Water Rights ............................................ 17 Land Acquisition and Resettlement ........... .. .......... 18 Environmental Aspects ....... ............................ 18 Project Operation ..................... .................. 18 Project Monitoring .................... .................. 19 Project Risks ........................................... 19 This report is based on the findings of an appraisal mission to India in December, 1984. Mission members included Messrs. A. Sanchez, Senior Engineer, J. Sopher, Senior Financial Analyst, and W. Jones, Economist. Mr. R. GoodLand assisted in the assessment of the environmental impact of the project. This docunient has a resticted distribution and nay be used by recpients only in the performance of their oficial duties. Its contents may not otherwise be dislosed without World Bank authorizaon. Page No. IV. FINANCE ............ o****....*o**-................. 20 Introduction o .* *0*....- ** ...... . .... ...- ** *........... * ... 20 Financial Management .... ... .. ... ............... ... *. 20 -Financial Organization ..... ..... .. ........... . .......... 20 Accounting System ......... .......................................... 21 Audit of Accounts .......******...........*.... ... ...... 22 Data Processing .... ............................... ...... 22 BilLings and Collections .... * *....... .................... 22 Insurance ............................................. 23 Income Taxes ................................... *.*.................. ?3 Financial Performance ...... .... ..... . .................... 23 Past and Present Financial Performance .................. 23 KSEB's Tariff ....................................... . .... . 28 Future Finance ... ................................ ......... 29 Rate of Return ........................................................ 31 Financial Recovery Program .............................. 33 V. PROJECT JUSTIFICATION AND ECONOMIC ANALYSIS .. 35 Least Cost Analysis ......... .. ........... ..35 Internal Economic Rate of Return . 36 Justification for Bank Involvement. 37 VI. AGREEMENTS AND RECOMMENDATIONS .......................... 38 Recommendation .... .... . ............ ... . ..... .. 40 Page No. ANNEXES 1 Power Supply Position - All India ....................... -41 2 Power Supply Position - Southern Region ................... 42 3 Power Supply Position - Kerala .......................... 43 4 Organization Chart of KSEB .............a................ 44 5 Detailed Project Description, Cost Estimate by Nature of Expenditure, and Detailed Cost Estimates .............. .... 45 6 Implementation Schedule .................... .... * ........ 53 7 Suggested Terms of Reference for the Institutional Development Components .. ....... ..... ..... .... ..... . .... 54 8 Schedule of Estimated Disbursements ....................... 63 9 Proposed Reorganization of the Finance and Accounting Cadre . ...... **........................................................ 64 10 Annual Financial Statements ............................. 65 11 Economic Analysis .......................................... 88 12 Related Documents in Project File ....................... 93 IBRD No. 18738 INDIA KERALA STATE POWER PROJECT LUAN AND PROJECT SUJhMRY Borrower: Incia, acting by its President. Beneticiary: Kerala State Electricity Board (KSEB). Amount: US*176 million. Terms: kepayment over 20 years, including five years. grace, at the applicable rate of interest. RelendinZ Tenms: C-overnment of India (GOI) to Government of Kerala (GOK): As part of Central assistance to States for aevelopment projects on terms and conditions applicable at the time. GOK to KSEB: (a) BanAl loan: Repayment over 20 years, inclucing tive years' grace, at GOK 's interest rate applicable at the time (currently 13.5X per annum) for its lending to KSEB, not less than the current Bark interest rate of 9.29Z per annum; (b) GOK loan: Repayment on GOK,s terms and conditions for its lending to KSEB, as applicable at the time. GOI voula bear the foreign exchange and interest rate risks. Proiect Description: Tbe project-s main objectives are: (i) to assist in meeting the electricity demand in the State of Kerala and the Southern Region of India through the construction of a 180-MW hydropower station; (ii) to improve the performance and efficiency of the existing system turough the reinforcement of the distribution networks in the major cities of Cannanore, Kozhiuode, and Cocchin and through the installation of reactive power compensation equipment; and (iii) to strengthen KSEB's managerial, commercial, ana financial practices through an institutional development program. The project provides for the construction, on the lower Periyar River in the Idukki District, of c powerhouse housing three generating units each of tU-NW capacity, and the construction and installation of about 415 km of 220-kV double circuit transmission lines, additional transmissiou substations of 1,180-HVA capacity, 760 NYAR of reactive power compensation devices, additional distribution substations (110-kY, 1l-kV) ot 270 IVA capacity, and the associated aistribution cables ana lines, switching stations, - ii- and distribution transformers. There are no extraordinary technical risks associatea with the project. Geological investigations have contirmed the excellent rock formation in the area. KSEB has staft experienced in supervision and execution of vorks similar to those required under this project, ana co,nsultant support will be proviaed for those areas in which KSEB's experience is limited. Estimated Cost: J (USA millions) Item Local Foreizn Total Power Station 84.4 34.0 118.4 Transmission Lines 20.2 2.5 22.7 Substations 25.6 2.3 27.9 Reactive Power Compensation Equipment 15.2 20.3 35.5 Distribution Works 36.2 12.0 48.2 Institutional Development 1.7 1.5 3.2 Base Cost 183.3 72.6 255.9 Physical Contingencies 12.9 3.9 16.8 Price Contingencies 42.1 18.5 6U.6 Total Project Cost 238.3 95.0 333.3 Interest during Construction: Bank - 4U.2 40.2 Other 26.3 - 26.3 Total Financing Requirements 264.6 135.2 399.8 jJ Including about USa59.1 million in taxes and duties. -i.iv Financint Plan: (US4 millions) Local Foreign Total IBID 81.0 95.0 176.0 GOI - 40.2 40.2 GOK loans to KSEB 76.6 - 76.6 KSEB internal resources 1U7.0 - 107.0 Total 264.6 135.2 399.8 Estimated Disbursements: (US millions) Bank FY FY86 FY87 FY86 FY89 FY90 FY91 Annual h92 31.2 45.4 47.9 32.7 9.6 Cumulative 9.2 40.4 85.8 133.7 166.4 176.0 Rate of Return: About 13Z. Appraisal Report: No. 5484-IN, dated May 22, 1985. INDIA KERALA STATE POWER PROJECT STAFF APPRAISAL REPORT I. SECTORAL CONTEXT Commercial Energy Resources 1.01 India's commercially exploitable energy resources consist of coal, oil, gas, hydro, uranium and thorium. Of the nonrenewable resources, coal is the most abundant. Reserves of thermal coal have been estimated at slightly more than 100 billion tons, of which 25 billion tons are proven. Although reserves are ample, the quality of coal produced is generally low and is deteriorating. Proven and probable petroleum reserves comprise approximately 530 million tons of oil and 390 million toe of natural gas. Despite recent increases in domestic production, India still imports about one third of its oil requirements, which in 1983/84 cost the equivalent of 40% of its merchandise exports. The Government has therefore given high priority to oil and gas exploration and, at the same time, has implemented measures to restrain the rapidly growing demand for oil products, in particular middle distillates; the Government has also generally limited the use of gas to premium markets, such as petrochemicals and fertilizer. However, delays in the construction of infrastructure for gas transport have resulted in substantial volumes of associated gas being flared. India's hydroelectric potential is about 100,000 MW. At present, only 13,000 MW have been developed, 4,700 MW are under construction, and a further 23,000 MW are being studied for future development. The country's uranium reserves could support a modest nuclear program (8,000-10,000 NW), and its thorium reserves are enough for a large breeder program. India's nuclear power generating capacity is currently 3,000 MW. 1.02 Planning the best use of India's indigenous energy resources for power generation raises a number of issues. First, the high ash content of coal, which can reach 50%, increases transport costs, as well as power station capital and operating costs. The development of pithead stations, which is constrained by pollution limitations and the availability of cooling water, only helps to alleviate the transport problem. Thus, priority is being given in Bank lending to the coal sector to more selective mining and improved coal preparation. Two studies included in the Dudhichua Coal Project (Loan 2393-IN) are designed to address problems of coal transport: one study will examine ways of improving the linkages between the sources of supply and demand, and the other will concentrate on improvements in handling and transportation facilities. Second, there is a need for a coherent policy on the utilization of gas, and this has become more urgent with the recent increases in estimated reserves. A Bank study planned for 1985 will focus on, among other things, the potential for the economic use of gas in power generation. Third, the prominent role of hydro in regional least-cost development plans prepared in 1982 has led GOI to emphasize the need to accelerate its development; however, progress has been slow owing to the time required to resolve water rights and environmental issues, the limited technical resources available for the simultaneous preparation of a large -2- number of schemes, and the lack of financial resources of States with the greatest hydro potential. Supply and Demand of Electricity - India 1.03 Approximately 50% of India's electricity is generated from coal, 40X from hydro, and the rest from oil, nuclear power, and natural gas. Although a number of large thermal projects are planned for the short term, the share of hydro is expected to increase in the long run. Electricity losses have risen slowly but steadily over the last few years and now exceed 26% of gross generation. The deteriorating quality of coal has been at least partly responsible for this trend, with coal stations' own consumption now approaching 10% of gross generation against a desirable 5. Distribution losses are also higher than is desirable owing to inadequate planning and insufficient investment. Although system losses are lower than in several cozntries in the region, they need to be reduced. Under its lending program, the Bank has supported measures designed to reduce losses and will continue to do so. However, such measures need to be State specific, reflecting the particular circumstances of each State. 1.04 Over the past two decades, the consumption of electricity has grown approximately twice as fast as total commercial energy consumption and now accounts for more than 30X of the latter. However, supply has not kept pace with demand and shortages have been prevalent throughout the country. During the last five years, shortages have on average been equivalent to about 13% of electricity requirements. The principal sectoral shares of total electricity consumption are: industrial, 56%; agricultural, 191; and domestic, 12%. Agriculture's share has grown steadily owing to increased electrical irrigation pumping made possible by rural electrification and encouraged by heavy subsidies. Total consumption has grown at an average rate of 10% per annum during the past two decades, and the Central Electricity Authority (CEA) has forecast growth of 9% per annum between 1984/85 and 1989/90. Actual growth will depend on the allocation to power in the Seventh Plan and the performance of utilities in fulfilling the Plan. Supply and Demand of Electricity - Southern Region 1.05 The Southern Region comprises the States of Andhra Pradesh, Karnataka, Kerala, and Tamil Nadu, and the Union Territories of Pondicherry and Lakshadweep Islands. As of July 1984, the installed capacity in the Region was 9,685 MW, consisting of 3,407 MW (351) of thermal power, 6,043 MW (62%) of hydropower, and 235 MW (3%) of nuclear power. Installed capacity is expected to reach 25,100 MW by 1994/95, representing an average increase of 10% per year. In the period 1980/81 through 1984/85, electricity consumption grew at an average rate of about 9% per year, reaching an estimated 39,700 GWh in 1984/85; peak demand grew by about 7% per year, to 6,420 MW, in the same ,eriod. However, these rates of growth underestimate real demand growth because of the progressive severity of supply constraints. These constraints are expected to prevail into the coming decade despite the planned growth in installed capacity. Over the period 1984/85 to 1994/95, energy requirements are expected to increase at an average rate of about 10% per year to 101,840 CWh, and peak demand to increase by about 11% per year to 18,200 MW. Kerala's present installed capacity of 1,011 MW, which consists entirely of -3- hydropower, is adequate only in years with average or above-average rainfall. During recent dry years, KSEB has had to introduce selective power cuts and load staggering. Electricity losses in Kerala are estimated at 20% of total generation, and although losses are relatively low compared with other States in India, further reductions are possible and desirable. The proposed project is expected to result in a reduction in system losses of between 3% and 5X in 1989/90. Organization of the Power Subsector 1.06 Responsibility for the supply of electricity is shared between the Central and State Governments. The State Electricity Boards (SEBs) and the Regional Electricity Boards (REBs) are controlled by States; the Central Electricity Authority, the National Thermal Power Corporation (NTPC), the National Hydro-Electric Power Corporation (NHPC), and the Rural Electrification Corporation (REC) are controlled by the Central Government. SEBs were instituted under the Electricity (Supply) Act, 1948 (the Act), to promote the development of the power subsector and to regulate private licensees. Although SEBs are supposed to be autonomous in managing their day-to-day operations, in practice they are under the control of State Governments in such matters as capital investment, tariffs, borrowings, pay, and personnel policies. As a first step towards national integrati'Jn, the SEBs have been grouped into five regional systems, each coordinated by an REB. Coordination responsibilities include overhaul and maintenance programs, generation schedules, inter-State power transfers and concomitant tariffs. CEA was created in 1950 to develop national power policy and to coordinate the various agencies involved in supplying electricity. It is responsible for the formulation of countrywide investment plans for approval by the Central Government, development of integrated system operation, training of personnel, and research and development. It maintains operational, economic, and financial data at both the Central and State levels, and provides consulting support to SEBs. NTPC and NHPC were incorporated in 1975 by COI to construct and operate large power stations and associated transmission facilities. They sell bulk power to the SEBs for distribution. NTPC has had marked success and has grown rapidly. In contrast, NHPC is still struggling to establish a role for itself. The States own most hydro sites and are reluctant to relinquish these sources of comparatively inexpensive energy to the Central Government. REC was established in 1969 to coordinate rural electrification and provide financial and technical expertise for SEB schemes. At present, REC finances more than half of total rural electrification investment. Pricing and Resource Mobilization 1.07 Through the 1983 amendments to the Act, GOI has set a financial objective for the SEBs in which they are required to produce an annual return of at least 3% on their historically valued net fixed assets, after meeting operating expenses, taxes, depreciation and interest. The 3% return would represent, in terms of the Bank's conventional method of calculation, a rate of return on historically valued assets in the range of 10% to 13%. The Bank considers this objective to be a reasonable minimum but the investment requirements of a number of SEBs are such that higher returns would be desirable in order to achieve reasonable cash generation. Although, in some -4- cases, higher returns may be possible through reclassification of consumers, substantial improvements will only be achievable through tariff increases. SEB tariffs do nor adequately reflect marginal costs. An analysis of 1981 tariffs indicated that they were on average only 52Z of long run marginal cost (LRMC); industrial tariffs were almost 90%, domestic 36Z, and agricultural only 27%. While there may have been improvements since 1981 and adherence to the stipulated rate of return will further improve the overall level of the tariff, the structure is still distorted. State-specific financial programs are needed to provide both a higher return on investment and a simpler, efficient and affordable tariff structure. Such programs will be addressed t4rough the Bank's lending to individual SEBs. In contrast, NTPC's tariff Is approximately equal to its LRMC. Power Subsector Planning 1.08 Due to rapid demand growth, GOI at present allocates about 20Z of public in%estment to power development. In order that the subsector should be developed in the most economic manner, the Bank encouraged GOI to prepare a least-cost National Power Plan (NPP), which was completed in September 1982. Although this plan, which is actually a collection of five regional plans, represents substantial progress, further refinement is needed. In particular, there is a need for integration of the regional plans and greater coordination between planning in power and other sectors. Since it will not he possible to achieve full national integration immediately, the Bank will continue to ensure that each Bank-tinanced project forms a part of an up-to-date regional least-cost development plan. In due course, the sources of supply considered should be widened to include the option of importing from neighboring regions. This approach would eventually lead to integrated planning at a national level. To facilitate integration, GOI has agreed, under the Rihand Power Transmission Project, to undertake a study on the long-term development of a national transmission system. A problem has arisen in the coordination of the long-term NPP with the national five-year plan and shortcr-term budgets. Owing to the lack of resources, fewer projects have been included in the five-year plan than in the NPP and, as a result (if underestimation of project costs and delays in project implemertat.ion, still fewer have been executed. Consequently, the shortage of power has become more and more acute and, over the next decade, India expects its power deficit to increase severalfold. In the past this deficit has undermined rational pLanning by encouraging emphasis on the rapid expansion of supply rather than on least-cost development. Furthermore, it has prompted overinvestment in captive plant, leading to excessive use of high-value petroleum products in power generation. In addition to supporting COI's etforts Lo increase the supply of power, the Bank will continue to stress to GO! the role of pricing in eliminating the deficit and the importance of integrating planning and pricing. Management and Operations 1.09 SEEs' organization and management practices have not kept pace with the expansion of supply. Quality of service, reliability, and financial performance are the principal areas of concern. In general, SEBs have high quaLity engineering staff, but lack experienced personnel in the areas of financial planning and control. The relatively poor status and pay of these -5- personnel exacerbate the already significant pay differential between the public and private sectors and makes it difficult to recruit competent staff. Management practices are generally outmoded and inadequate. The SEBs' inefficient accounting systems are an example. At present, accounts are maintained principally to track cash receipts and expenditures, and there is little use of accounting information for managerial purposes. GOI has decided that a new and uniform accounting system should be installed in all SEBs. After initial delays, implementation is now proceeding. 1.10 In the area of operations, one of the main concerns has been the poor performance of thermal plant. Factors that have contributed to this situation are inadequate maintenance (due to capacity shortages), deficiencies in plant manufacture, lack of spqres, and the poor quality of coal; in general, these problems have been recognized by the relevant authorities and corrective steps are being t=ken. GOI is currently preparing a rehabilitation program for thermal plant. Until this program is compiled, the Bank will, whenever appropriate, include a thermal rehabilitation component under each of the loans made to the SEBs. Bank Group Participation in the Past 1.11 The Bank has made 18 loans for Indian power projects amounting to US$1,983 million, and 17 IDA credits totaling US$2,409 million. Seventeen projects financed under the following loans and credits have been completed: ten generating projects, the Beas Project (Credit 98-IN), the first four transmission projects (Loan 416-IN, Credits 242-IN, 377-IN and 604-IN), and the First and Second Rural Electrification Projects (Credits 572-IN and 911-IN). The Fourth Transmission Project (Credit 604-IN) was completed in 1983, and the Second Rural Electrification Project in 1984. The Singrauli (Credit 685-IN), Korba (Credit 793-IN), and Ramagundam (Credit 874-IN and Loan 1648-IN) Thermal Power Projects are in advanced stages of implementation. The credit for the Second Singrauli Thermal Power Project (Credit 1027-IN) and the credit/loan for the first stage of the Farakka Thermal Power Project (Credit 1053-IN and Loan 1887-IN) were approved in May and June 1980. Korba II (Credit 1172-IN) was approved in July 1981, RAmagundam II (Loan 2076-IN) in December 1981, and the Third Rural Electrification Project (Loan 2165-IN) in June 1982. The Upper Indravati Hydro Project (Credit 1356-IN and Loan 2278-IN) and the Central Power Transmission Project (Loan 2283-IN) were approved in May 1983, and the Indira Sarovar Hydroelectric Power Project in May 1984. The Second Farakka Thermal Power Project (Loan 2442-IN) was approved in June 1984, and the Trombay IV Thermal Power Project (Loan 2452-IN) in June of the same year'. The Third Rural Electrifica_ion Project is about a year behind schedule. The first five units of the Singrauli Project and the first two units of the Korba project were commissioned on schedule. The Farakka and RamAgundam projects are proceeding satisfactorily, the first unit at Ramagundam having been commissioned four months ahead of schedule. The Third Trombay Project (Unit 5) (Loan 1549-IN) was first synchronized in January 1984, about a year behind schedule; time was lost mainly because parts for the boiler were not delivered on time, and because of delay:. in its construction. 1.12 A performance audit conducted in 1980 for the Second Power Transmission Project (Credit 242-IN) concluded that the project has succeeded -6- in helping the nine beneficiary SEBs extend their transmission systems and meet their growing power requirements. Utilization of generating capacity in these SEBs has exceeded the appraisal forecast. The upgrading of the SEBs' financial management practices that began under this project will continue under subsequent projects. The audit highlighted the difficulties of supervising a project consisting of many widely scattered subprojects, and of effecting institutional improvements in the absence of a close working relationship between the Bank Group and the beneficiary SEBs. Bank Group Strategy in the Power Subsector 1.13 Over the last ten years the Bank Group has assisted GOI in substantially expanding its centrally owned generation capacity. In the past two years, however, Bank Group lending has been broadened to encompass SEB-implemented projects in order to support GOI's policy of accelerating hydro development and improving project implementation, operational efficiency and financial performance in the SEBs. Specific objectives of Bank Group assistance include: (a) the better use of existing facilities--through transmission projects improving regional interconnections and through rehabilitation of plant, particularly of thermal power stations and distribution networks: these measures will improve the efficiency of energy use and reduce system losses, thereby helping to minimize system capital and operating costs; (b) institution building--although the Bank will continue to maintain an interest in Central institutions, its efforts will be broadened, as noted above, to encompass individual SEBs, where substantial efforts are needed to strengthen management, operations, and finances and to ensure the successful implementation of commercial accounting; (c) improved planning-particularly by extending the scope of planning from the State through the regional to the national level and through greater integration of planning with other sectors in the economy, both those that consume electricity and those that supply other forms of energy; and (d) improved resource mobilization from electricity consumers- the principal vehicle for this has been and will continue to be financial covenants in relation to beneficiaries; however, the Bank will also continue to stress the importance of relating tariffs to the economic costs of supply. -7- II. THE BENEFICIARY Organization 2.01 The Kerala State Electricity Board (KSEB) was organized in 1957 according to provisions of the Electricity Supply Act. It serves as the principal producer, distributor and retailer of electricity within the State of Kerala. Legally, KSEB is an autonomous organization reporting to the Water and Power Department of the Government of Kerala (GOK). In fact, while KSEB enjoys considerable independence in managing its day-to-day affairs, GOK strongly influences decisions relating to pricing, staffing, and planning. 2.02 KSEB's Board is responsible for establishing its internal policies and for ensuring that management conducts day-to-day affairs in accordance with those policies. The Board consists of seven members, four of whom serve as full-time senior managers (the Chairman, Technical Member, Vigilance Member, and Accounts Member) while the remaining three, who are appointed for one year at a time by GOK, serve as ex-officio members. Normally, the ex-officio members are distinguished members of the community at large who are charged with representing the consumer, including industry, commerce and the public. The Board is an effective working body. The Members are assisted by a Board Secretariat. 2.03 KSEB's organization structure is shown in Annex 4. This structure is characterized by broad delegation of functional responsibilties to numerous local offices spread across a wide geographic area. KSEB has met the demands of its substantial growth either by overlaying new organizational units atop a basic structure or by expanding existing units. To date it has not conducted a major review of either its organization structure or its managerial procedures and practices, to evaluate whether these are appropriate and responsive to KSEB's present or expected future needs. KSEB's rules sometimes limit the authority of local managers to Fulfill their responsibilities; also, the autonomy that local managers must exercise requires greater capabilities and qualifications than originally envisioned. Anomalies of this sort should be corrected through regular organization and management reviews. Accordingly, the proposed Project contains a provision for consultants to conduct a comprehensive Organization and Management Study and assist with implementing its acceptable recommendations, according to terms of reference and a schedule agreeable to the Bank (para 3.10 and Annex 7). At negotiations, KSEB provided an undertaking that, by December 31, 1985, it will retain consultants acceptable to the Bank to conduct a comprehensive Organization and Management Study, and assist with implementing its recommendations. Personnel and Staffing 2.04 Since 1982, COK has maintained a hiring freeze at KSEB. New personnel can be recruited from without only if KSEB has a vacancy, and can prove that no present employee possesses the requisite skills. Otherwise, vacancies must be filled through redeployment. Consequently, during the past two years, KSEB's number of sanctioned posts has changed only nominally, and its vacancy rate has been negligible. Table 2.1 shows KSEB's staffing as of March 31, 1984, distributed according to skill. -8- Table 2.1: KSEB Staff - Allocated by Required Skills (As of March 31, 1984) Sanctioned Strength Percent Management and Administration 389 1 Engineers 2,008 6 Technicians and Technical Support 14,767 42 Clerical 9,253 27 Operation and Maintenance 5,200 15 Laborers 3,200 9 Total 34,817 100 2.05 The activities of KSEB's employees are specified in job descriptions and are conducted according to specified procedures and policies. These administrative devices have been developed over many years specifically for KSEB and are not tied to personnel practices which govern COK civil servants. As KSEB's activity is expanding rapidly, a review and update of these practices would be one of the objectives of the proposed Organization and Management Study (para 2.03). Operation and Maintenance 2.06 Operation and maintenance of the system are generally satisfactory. Preventive maintenance and inspection for generation, transmission and substation facilities have been conducted regularly according to standard practice. Due both to cash flow limitations and the network's size, periodic inspections and preventive maintenance of the distribution system is conducted on a selective basis with corrective maintenance being provided as needed. KSEB expects to regularize its periodic inspections and preventive maintenance of the distribution system as cash flow constraints are relaxed. Planning 2.07 Since decisions concerning major systems expansions are made by GOI based on regional considerations, KSEB's own planning activities are limited to (i) preparation of load forecasts for the State, to be furnished to CEA for integration into its forecasts for the region; (ii) identification and preparation of feasibility reports on future power generation schemes; and (iii) planning of the high tension transmission and substation facilities. Distribution works have so far been executed piecemeal as needed, and systematic long-term planning of major distribution systems will be introduced only in the context of the proposed Project. KSEB's planning function needs to be strengthened by (a) developing a more accurate and detailed eata base, (b) integrating physical, financial and organizational considerations into its expansion planning; and (c) using modern tools of analysis, such as data processing facilities. These needs are being addressed by the proposed Project. -9- Training 2.08 Due to severely constrained cash flow, KSEB has had to curtail its training (para 4.16). It has expressed an eagerness to revive these activities in conjunction with the proposed project. Consequently, funds have been included in the cost of the proposed project for training, based on a preliminary assessment of needs prepared by KSEB. At negotiations, GOK agreed that KSEB would develop a detailed training program acceptable to the Bank not later than June 30, 1986. -10- III. THE PROJECT Project Setting 3.01 The proposed Project will be located in the State of Kerala (Map 18738), whose power system is interconnected through a 220 kV line to the rest of the Southern Region Power System (SRPS). The SRPS comprises the states of Andhra Pradesh, Karnataka, Kerala and Tamil Nadu and Lhe Union Territories of Pondicherry and the Lakshadweep Islands. A second interconnection, at 400 kV, is planned for 1990 under a Bank financed project, the Second Ramagundam Thermal Power Project. As of July 1984 the SRPS had a total capacity of 9,685 MW, of which 3,407 MW were coal-fired steam plants, 6,043 MW were hydro and 235 nuclear. Peak demand in the SRPS grew between 1980/81 and 1984/85 at an annual rate of about 6Z; however, this rate of growth underestimates real demand growth due to the progressive severity of supply constraints. These constraints are expected to prevail into the coming decade despite the rapid planned growth in instaLled capacity, estimated to reach 25,100 NW by 1994/95. Annex 2 shows the power supply position for the Southern Region. The integrated operation of the SRPS is controlled by the Southern Regional Electricity Board which is responsible for: (i) daily, weekly and seasonal scheduling of the generation of the individual power stations; (ii) scheduling their maintenance; and (iii) preparing the power exchange tariffs, for approval by the member SEBs. The role of the Board is however constrained by the lack of sufficient capacity of the interstate lines and by the prevailing regional shortages of capacity which impede optimal integrated operation. The completion of the ongoing Ramagundam Thermal Power Project and its associated 400 kV transmission lines is expected to partially remove these constraints. Kerala's system is entirely hydro and has an installed capacity of 1,011 MW, which is sufficient only in average or above average hydrological years. However, KSEB has had to introduce selective power cuts and staggering during recent dry years. Annex 3 shows the projected supply and demand for electricity in Kerala to 1994/95. Due to the lack of adequate stand-by reserve, not to mention spinning reserve, to the configuration of the system and to the nature of the loads, voltage regulation of Kerala is poor. Furthermore, the observed power factor is only 0.82. KSEB, as other SEBs, has traditionally given low priority to distribution works, and the construction or upgrading of networks is undertaken only when there are resources left after funding generation and high tension transmission or when pressure from consumers becomes politically unacceptable. Electricity losses in Kerala are estimated at 20% of the total generation and, although they are relatively low when compared to other States in India, further reductions are possible and desirable. It is expected that through the works contemplated under the project, losses will be reduced by 3% to 5% by 1989/90. The general objectives of the Project have been evolved to address these problems. Specific project objectives are developed below. Project Objectives 3.02 In addition to the primary objective of increasing the installed capacity in Kerala and the SRPS, the Project will help to: (a) make more intensive use of India's hydropower potential; (b) improve the performance -11- and efficiency of the existing system; and (c) strengthen managerial, commercial and financial practices of KSEB. Project Description 3.03 The proposed Project will include the following components: (a) construction of a run-of-the-river 180 MW hydropower station consisting of a diversion dam, intake, head race tunnel, penstocks and a powerhouse equipp2d with three Francis-type units of 60 MW each; (b) construction of 413 km of 220 kV double circuit transmission lines and the associated substations (1180 MVA) to feed the load centers of Cannanore, Kozhikode and Cochin; (c) installation of 760 MVAR of reactive compensation to improve the system's power factor; (d) reinforcement of the secondary transmission and distribution networks (110 kV to 11 kY) in the three major cities of Kozhikode, Cochin and Trivandrum, including the installation of about 270 MVA of additional distribution substations and the associated distribution cables and lines, switching stations, and distribution transformers; (e) provision of training, technical assistance, and consulting services to implement parts (a) to (d) of the project; and (f) implementation of an institutional development program, including acquisition of data processing facilities and consulting and training services to KSEB for: (i) design and implementation of an information system, including a commercial accounting system, for management and planning; (ii) an organization and management review, together with subsequent implementation of its recommendations; (iii) preparation of a comprehensive fixed asset inventory; and (iv) preparation of a study leading to a simpler and more efficient tariff schedule for the Board. Annex 5 gives a more detailed description of the works contemplated in the Project. Project Costs 3.04 Table 3.1 shows a summary of project costs. The total cost of the Project including physical and price contingencies (but excluding about US$59.1 million equivalent of taxes and duties) is US$274.2 million -12- equivalent, of which US$95.0 million (352) represents the foreign exchange costs. Interest during construction adds another US$66.5 million to the financing required. The Project costs are based on May 1985 forecast prices level and are derived from actual December 1984 prices for similar works, adjusted for estimated inflation. Physical contingencies of 10% on civil works and 5% on mechanical and electrical equipment have been allowed, amounting to about 7% of the base cost. Physical contingencies for civil works are in line with the advanced status of design, the degree of knowledge of the site geology and the relatively simple nature of the works to be executed. The excavations for the head race tunnel, already under construction, have confirmed the excellent regional geology revealed during the execution of the neighbouring Idukky underground scheme. Price contingencies for the local cost, amounting to about 24Z of the base cost, are based on an expected annual inflation rate of 8.5% between 1985 and 1990. Price contingencies for foreign costs were assumed to be 8% for 1985, 9% for 1986-87, 7.5% for 1989, and 6% thereafter. Quantities were obtained from designs at tender level. Unit prices for civil works are based on recent quotations received in Kerala for similar works and or. actual tender prices for the headrace tunnel of the Lower Periyar Station. The cost of major electrical and mechanical equipment has been obtained from proforma quotations furnished by manufacturers while that of miscellaneous equipment is based on recent purchases of similar elements by KSEB. The cost of consulting services is based on an estimated total of 450 man-months, of which about 300 man-months will be local and 150 man-months will be expatriate experts, and includes fees, overheads, travel, and subsistence expenses. An amount of 10% of the base cost net of duties and taxes has been assumed for engineering and administration. Interest during construction has been added at an annual rate of 10.75Z for all Government loans. It has been assumed that no front-end fee will be charged. Annex 5 presents a project cost estimate by nature of expenditure, and a detailed project cost estimate. Table 3.1: Project Cost Summary Local Foreign Total Local Foreign Total (Rs Million) (Us$ MillionT Lower Periyar Power Station 1,013 408 1,421 84.4 34.0 118.4 Transmission Lines 242 30 272 20.2 2.5 22.7 Substations 307 28 335 25.6 2.3 27.9 Reactive Power Compensation 182 244 426 15.2 20.3 35.5 Distribution Works 435 144 579 36.2 12.0 48.2 Institutional Development 20 18 38 1.7 1.5 3.2 Total Baseline Costs 2,199 872 3,071 183.3 72.6 255.9 Physical Contingencies 155 46 201 12.9 3.9 16.8 Price Contingencies 505 222 727 42.1 18.5 60.6 Total Project Costs 2,859 1,140 3,999 238.3 95.0 333.3 Interest During Construction Bank - 482 482 - 40.2 40.2 Other 315 - 315 26.3 - 26.3 Total Financing Required 3,174 1,622 4,796 264.6 135.2 399.8 -13- Project Financing 3.05 The proposed Bank financing for the Project amounts to US$176.0 million equivalent, representing about 52% of the total project financing requirements, net of duties and taxes. The Bank loan will finance US$95.0 million of the foreign exchange cost and US$81.0 million of local costs. KSEB will finance US$107 million equivalent out of its internally generated funds, or 27% of the total financing required. GOK will provide US$76.6 million equivalent and GOI will finance about US$40.2 million of foreign currency representing interest and other charges on the Bank's loan. Assurances were obtained during negotiations that GOI is prepared to seek financing through suppliers' or export credits or commercial banks of about US$30 million, representing 85Z of the cost of the reactive power compensation equipment, the 66 kV gas insulated switchgear and the 110/66 kV cables for the distribution works. If this financing materializes, the Bank funds no longer needed for these items would be reallocated to other elements of the project. The Bank loan to GOI will be at the prevailing variable rate of interest and will be repaid over 20 years, including 5 year grace period. OI will make the Bank loan and other external cofinancing funds available to G0K as part of central assistance to States for development projects on terms and conditions applicable at the time. GOK will onlend the funds provided by COI, together with its own resources, to KSEB in accordance with the terms outlined in para 4.31. GOI will bear the exchange and interest risk and will finance any eventual cost overruns. Table 3.2 shows the proposed financing plan. Table 3.2: Project Financing Plan (US$ Million) Local Foreign Total IBRD loan 81.0 95.0 176.0 coi - 40.2 40.2 GOK loans to KSEB 76.6 - 76.6 KSEB internal generation 107.0 - 107.0 Total 264.6 135.2 399.8 Project Engineering 3.06 Project engineering is generally at the bidding level. The distribution and the reactive power compensation components need further detailing for tendering which will be done with the assistance of consultants (para 3.08). KSEB, with the assistance of the Central Water Comission (CWC) for the civil works and of CEA for the electro-mechancial aspects, have been developing the detailed engineering for the Project since 1982. Field investigations for the Lower Periyar station, however, began in 1971. In June 1984, KSEB appointed an independent Panel of Experts under terms of reference acceptable to the Bank to oversee the technical aspects of project design and construction. The Panel of Experts, met in August 1984 and approved the proposed power station layout with minor modifications which -14- have been accommodated as the design work progressed. The Panel will be retained until the completion of the Project. Project Implementation and Construction Schedule 3.07 KSEB will be the implementing agency for the Project. The Project will be executed over a period of about 7 years. The construction of the head race tunnel for the Lower Periyar Station began in August 1984. The three units are expected to be commissioned in May 1989, October 1989 and February 1990. The transmission lines, associated substations, and distribution works proposed under the project are scheduled to be completed around the first quarter of 1990. However, the lines Idukky-Lower Periyar (35 km) and Lower Periyar-Trichur (100 km) as well as the expansion of the 220 kV bays at Trichur need to be completed not later than June 1986 to enable the evacuation of power from Idukky Power Plant-Phase II. To achieve these targets, the contracts for major civil works and for supply of major equipment for the power station must be awarded during the first half of 1986. Materials and equipment for the transmission and distribution components should be ordered in January 1986. The proposed Project construction schedule is shown in Annex 6. 3.08 CEA and CWC will provide general engineering and consulting services to KSEB. In addition, independent consultants will assist KSEB in the preparation of detailed engineering for particular components as described below. The responsibilities of CEA and CWC will include, but will not be limited to, the preparation or review of tender documents, the preparation of technical specifications of major electro-mechanical equipment and of drawings for construction of the civil works, and the provision of general technical assistance during project construction. Both CEA and CWC have experience in similar projects as they have served as the engineers for most of the hydropower and irrigation schemes in India for several decades. KSEB has a cadre of well experienced construction and supervision engineers for the civil works who have been responsible for the construction of far more complex projects, for instance the Idukky scheme (780 MW), involving an underground power station and a variety of major dams. KSEB has appointed a Chief Engineer, Construction, for the Lower Periyar Station and a satisfactory organization for the implementation of this part of the project has been established. Another position of Chief Engineer has been created to coordinate and supervise the associated transmission and distribution works, for most of which KSEB also has extensive experience. However, KSEB has no substantial prior experience in selection, procurement or installation of reactive power compensation equipment, underground transmission and gas insulated switchgear. Consequently, KSEB has retained consultants to assist in: (i) refining the engineering of the proposed distribution and reactive power compensation elements of the Project; (ii) preparing their final technical specifications; (iii) evaluating tenders; (iv) supervising their construction and installation; and (v) providing general advice to KSEB as needed on other project related matters. It is estimated that about 100 man-months of consulting services will be required for this purpose. 3.09 Due to the involvement of several KSEB's organizational units and to the number of contracts to be executed under this Project, KSEB confirmed at -15- negotiations that it will create, before September 30, 1985, a Project Cell under the Chief Engineer (Planning) to: (a) coordinate project implementation; (b) serve as liaison with COI, CEA, CWC and the Bank; (c) monitor project execution; (d) prepare the necessary periodic reports for the Project authorities and the Bank; and (e) process disbursement applications. 3.10 KSEB will retain consultants under terms satisfactory to the Bank for the implementation of the institutional development program. It has been estimated that KSEB will need about 350 man-months of consulting and training services for the fixed assets inventory (100 man-months), management and organization review (50 man-months), implementation of commercial accounting and management information system (120 man-months), data processing implementation (30 man-months), and tariffs study (50 man-months). Annex 7 presents the suggested terms of reference for the services mentioned above. In vies of the interrelationship of these consulting services, KSEB agreed during negotiations for an undertaking to create a Steering Committee for the Institutional Development Program including key members of KSEB's staff to coordinate all technical assistance and training activities. The consultants would participate as needed in the Committee. KSEB agreed at negotiations for an undertaking that it will retain these consultants no later than December 31, 1985, with the exception of the consultants assisting with implementation of commercial accounting and those conducting the fixed-asset inventory, and valuation both of whom will be appointed not later than August 31, 1985. Procurement 3.11 Procurement arrangements for the Project are summarized in Table 3.3 -16- Table 3.3: Procurement Arrangements (Million of US$) 1/ Procurement Method Total Project Element ICB LCB Other N.A. Cost A. General Land 11.2 11.2 Site Preparation and Facilities 4.3 4.3 B. Civil Works Dam, Diversion Tunnel, and Intake 14.5 14.5 (8.7) (8.7) Head Race Tunnel (Under Construction) 25.5 25.5 Surge Shaft and Pressure Shaft 5.1 5.1 (3.1) (3.1) Powerhouse, Switchyard 7.3 7.3 (4.4) (4.4) Erection of Transmission Lines 5.6 5.6 (3.4) (3.4) Substations Yards and Bldgs 0.5 0.5 (0.3) (0.3) Civil Works for Distribution 1.8 1.8 (1.1) (1.1) C. Equipment and Materials T-G sets for Power Station 61.6 61.6 (36.4) (36.4) Gates and Stop logs 7.0 7.0 (6.3) (6.3) Step-up Transformers & 220 kV Switchgear for Powerhouse 4.1 4.1 (3.7) (3.7) ACSR Conductors 10.4 10.4 (9.1) (9.1) Power Transformers for Substations 17.8 17.8 (15.8) (15.8) Circuit Breakers & Other Misc. 8.8 8.8 (5.7) (5.7) Reactive Power Compensat. Eqpt. 23.0 23.0 (23.0) (23.0) Equip. & Material for Distribution 49.9 49.9 (35.1) (35.1) Other Equipment and Materials 41.4 41.4 (15.8) (15.8) D. Training and Consulting Services 4.1 4.1 (4.1) (4.1) E. Engineering and Administration 29.4 29.4 Total 204.4 84.2 44.7 333.3 (148.2) (23.7) (4.1) (176.0) 1/ Figures in parentheses indicate Bank financed portion. -17- All civil works contracts with an estimated cost of US$5 million equivalent or more and all contracts for suppLy of goods with an estimated cost of US$1 million equivalent or more will be subject to ICB, and the balance to LCB procedures acceptable to the Bank. Major local firms are expected to be competitive in the civil works and most of the equipment supply tenders. Foreign suppliers will not be precluded from participating in LCB. About 80% of works and services for the Project will be procured under ICB. Local contractors, competing under ICB will have 7.5% of preference margin for civil works and local manufacturers a 15% preference or the applicable duty whichever is less, for supply of goods. Consultants will be selected in accordance with the Bank's guidelines. All civil work contracts with an estimated cost of US$5 million or more equivalent will be subject to the Bank's prior review. All equipment contracts with an estimated cost of US$1 million or more equivalent will also be subject to Bank's prior review. Prior review will apply to about 90Z of the estimated cost of Bank financed elements. Other contracts will be subject to selective post-award review. Disbursements 3.12 Disbursements of Bank funds will be made against: (a) 100% of CIF price of imported goods; (b) 1002 of the ex-facr?ry cost of locally manufactured goods; (c) 50% of local expenditure for other items procured locally; {d) 100Z of consultants' services; and (f) 60Z of the civil works. Disbursements will be fully documented except for (a) payments under civil works contracts for one or more progress payments not exceeding Rs600,000 each, and (b) payments for locally procured items of equipment not exceeding Rs300,000 each. Such disbursements will be made against statements of expenditures (SOEs), the documentation of which will not be submitted to the Bank Group but retained for inspection by the supervision missions. The standard procedure for auditing SOEs will apply. Annex 8 shows the estimated disbursements schedule as derived from the construction program, considering the normal commercial payment term.s for the types of contracts envisaged for this project. The proposed Project contains a provision of up to US$i00,000 to finance retroactively certain consulting activities (paras 3.08 and 3.10) which will begin during the spring and summer of 1985. Since there is no information available on typical disbursement profiles for similar power projects in India (power station combined with transmission and distribution), no meaningful comparison can be made in that respect. However, the Project's disbursement profile fits closely a Bankwide blended profile for generation, transmission and distribution projects. The closing date will be September 30, 1991. Water Rights 3.13 The Periyar river is within the State of Kerala in its entire length. There are no pending water rights disputes or claims that can affect the Project's construction or operation. Furthermore, being a run-of-the-river scheme, the present flow regime of the river will not be materially altered. -18- Land Acquisition and Resettlement 3.14 The pondage created by the intake dam of the Lower Periyar Station covers, at full level, only 44 ha, which KSEB already owns. The land for the powerhouse and the associated switchyard is also in KSEB's possession. The expansion of most of the existing transmission substations will be feasible on land which KSEB already owns and, where this is not the case, the necessary land is being acquired. In order to minimize the space needs for the new distribution substations in the crowded and expensive centers of Cochin, Trivandrum and Kozhikode, gas insulated switchgear is being proposed. The properties for these distribution substations, planned to start *n 1988, is presently being identified and valued. No land acquisition is il olved for the transmission lines, since the Electricity (Supply) Act of 1948 does not require that KSEB acquire the land for the erection of the transmission towers. Compensation is only provided for trees cut; cultivation is permitted under the line and towers. No major resettlement of population is involved in the Project. Seventeen families displaced from the power station site, who KSEB claims were illegal settlers, have vacated the site but took their cases to court, a commission of enquiry was appointed and the Kerala High Court took up the issue on appeal. Although a decision on the amount of compensation to be paid is still pending, the amounts involved compared to project costs are considered negligible. Environmental Aspects 3.15 The Project has been cleared by the Department of Environment (COI). The proposed diversion dam will raise the water level permanently to the seasonal high flow level of the Periyar river up to the existing Neriamangalam power station some 4 km upstream. Since no reservoir will be created, water quality is not at issue, neither is fish migration in view of the existing dams upstream. Malaria and filaria have been eradicated from the entire State of Kerala for more than a decade and the risk of schistosomiasis is considered low due to the distances to potentially contaminating places (Tamil Nadu). The Project will pose almost no harm to forest land. Only some 40 ha as a narrow (few meters wide) strip will be affected on the right bank of the pondage for the Lower Periyar Station. For the power house, operation camp, adits, dumps, etc. a total of 127 ha will be deforested. As a compensatory measure, KSEB will finance the Kerala State Forestry Department to plant 127 ha of forest near Munar Village. KSEB reports that no rare or endangered biota will be affected. Jeep access roads to an average of every six towers will be built for construction of the transmission lines, this will be allowed to revert to forest and will be rendered unusable to avoid forest encroachment. Line maintenance (twice a year) is to be completed on foot. Project Operation 3.16 Th2 catchment area of the Periyar River at the proposed power station is 1053 km representing about 20Z of the total basin area. The river falls rapidly from its origin at elevation 1830 m to elevation 200 m at the power station site. The station will be located in the low land of the basin where the river enters the Lower Periyar Valley. The Periyar river is regulated -19- upstream of the station at the Idukky reservoir (1460 Mm3 live storage) and their waters are diverted into a neighboring basin through the Idukky power plant, leaving about 400 km of catchment area for Lower Periyar station. The inflows to Lower Periyar consist of the yield from the catchment downstream of Idukky reservoir plus the tail race regulated releases Ind spills of the Neriamangalam power station with a catchment area of 73 km . The average annual flow at Lower Periyar is 1,400 Mm of which about 802 occurs between June and September. Since there is daily regulation at Lower Periyar station, it will operate as a peaking plant in the dry season but as a run-of-river plant in the wet season. The average annual output is 604 GWh and the 90% dependable generation is 493 GWh. Proje:t Monitoring 3.17 KSEB agreed at negotiations to furnish quarterly progress reports covering physical works, consultants work, costs, disbursements, and administrative aspects of the Project. In addition there will be annual reports on the financial position and management situation of the Board, which will be monitored on the basis of targets agreed during negotiations (Table 4.3). Finally, assurances were obtained during negotiatioris that KSEB will arrange, in a manner satisfactory to the Bank, for periodic inspections of the works to be constructed under the Project in order to ensure their safe operation and proper maintenance. Project Risks 3.18 There are no extraordinary technical risks associated with the Project. The power station scheme does not involve any engineering technology beyond the limits of well known practices. Geological investigations and initial excavation of the headrace tunnel have confirmed the expected excellent rock formation prevalent throughout the area. Consequently, no special difficulties are expected for the tunneling works. KSEB has sufficient staff experienced in supervising and executing most of the works similar to those proposed in the Project and appropriate consultants support will be provided for those areas in which KSEB's experience is limited, to minimize any undue risks in this regard. -20- IV. FINANCE Introduction 4.01 The financial operations of the SEBs are regulated by the Act. In June 1978 and August 1983, the Act was amended to enable the SEBs to reorganize their finances along commercial lines. However, the SEBs continue to maintain extremely poor accounts, with inadequate financial staff implementing different accounting systems, most of which are fraught with ad hoc rules and procedures. Most SEB senior financial managers possess excellent qualifications; however, given the poor quality of raw data developed at field offices, they lack the resources to compile timely and reliable accounts. 4.02 Though more independent than many SEBs, KSEB's financial and commercial practices fit the typical profile. KSEB believes it should strengthen its accounting, financial, and commercial operations by increasing the number of financial managers while improving the qualifications and skills of staff responsible for maintaining accounts at KSEB's field offices; the Bank has made provisions in the proposed project to support these institutional development objectives (paras 4.07-4.08). 4.03 In developing the proposed project, KSEB invested considerable effort and retained consultants to assist with the financial preparations. Thus, KSEB was able to provide considerable details regarding the contents of accounts, based on professionally sound approaches to mitigating the questionable quality of raw data. Thus, even though the accounts contain some inaccuracies, the information is adequate for the Bank to draw sound conclusions from its financial analysis. KSEB needs to correct certain poor financial practices. The recommended corrective measures and financial targets comprise an integrated financial recovery program (para 4.36). The program is designed to encourage financial discipline and ensure sufficient liquidity for operational and investment requirements. A. Financial Management Financial Organization 4.04 KSEB's finance and accounting functions are headed by an Accounts Member, who is a qualified chartered accountant. He serves as a member of KSEB's Board and, de facto, as a chief financial officer. KSEB has decided that the fulfillment of those two roles requires another full-time incumbent and is currently recruiting another qualified chartered accountant to serve in the vacant post of Chief Accounts Officer (para 4.07). 4.05 At headquarters, KSEB has one Deputy Chief Accounts Officer and four Senior Accounts Officers. The Senior Accounts Officers are responsible for producing accounts and managing various accounting services. Most of KSEB's accounting data is compiled in the field in 145 account-rendering units, each of which is managed by one of 97 divisional accountants. The divisional accountants report to either the superintending engineer or the executive engineer who heads that particular office. Under KSEB's existing organization structure, accounting managers at headquarters have functional -21- responsibility for the output of the divisional accountants in the field but lack direct authority over, or direct communications with, them. 4.06 KSEB does not have enough accounting managers to verify the accuracy and comprehensiveness of accounting data compiled in the field. Moreover, the degree of autonomy that divisional accountants must exercise often requires higher qualifications and broader authority than is specified in their job descriptions. KSEB must strengthen its accounts and finance function by adding senior managers and upgrading the qualifications of its field personnel. 4.07 At appraisal, KSEB indicated that it would reorganize its finance department (Annex 9). As a first step, it would increase to four the number of Deputy Chief Accounts Officers and to ten the number of Senior Accounts Officers. Some of the new posts would be filled by internal promotion of staff possessing the necessary qualifications; the remainder would be filled by external recruitment. Forty-eight of the existing 97 divisional accountants are considered to have adequate qualifications, the remainder will be offered the opportunity to acquire specialized training or be replaced through natural attrition. This proposed reorganization is considered satisfactory as an interim measure, prior to the comprehensive organization and Management Study (para 2.03). At negotiations, KSEB provided an undertaking that it will conduct an interim reorganization of its finance department in a manner satisfactory to the Bank (Annex 9), and fill new senior financial managerial posts with adequately qualified people not later than December 31, 1985. Accounting System 4.08 Under the Third Rural Electrification Project (Loan 2165-IN), GOI agreed that the SEBs would implement a uniform system of commercial accounting by April 1, 1984. Because of delays in developing the new system, the Bank agreed that its implementation could begin on April 1, 1985. A new system was circulated to the SEBs and to the Controller and Auditor General (C&AG) for comments in the spring of 1984. At that time, GOI indicated its intention to notify the new system in the Official Gazette before April 1, 1985, after receiving the C&AG's comments. These comments were received only in January 1985 and were circulated to the SEBs in preparation for notification of the new system. The late receipt of the C&A.G's comments left GOI with insufficient time to translate the system into Hindi by April 1, 1985 (Indian Law requires that new regulations be notified in both English and Hindi); at negot_ations, GOI agreed that the new accounting system would be notified by Julyv 5, 1985. Even though the new system will be notified by July 15, 1985, KSEB will need more time than is being provided between notification and introduction to assure correct implementation of the new system; therefore, at negotiations, KSEB provided an undertaking that it will take all preparatory steps necessary to ensure that, by the beginning of the financial year 1986/87 (April 1, 1986), it will implement correctly commercial accounting according to the system to be notified by GOI. 4.09 Although the introduction of commercial accounting is expected to be delayed by one more year, KSEB needs to use that time to prepare for the -22- new system. Suspense accounts will need to be cleared (para 4.21); and fixed assets will need to be inventoried (para 4.22). In addition, KSEB's divisional accountants and their staffs will need extensive on-the-job and classroom training. New ledgers, code books and forms will need to be designed, printed and distributed. KSEB has asked that technical assistance be provided under the proposed Project to prepare for implementation of commercial accounting in the year before introduction and provide ongoing training and support during the first two years after introduction. Draft terms of reference for this technical assistance have been discussed at appraisal (Annex 7). At negotiations, KSEB provided an undertaking that by August 31, 1985, it will retain consultants to provide technical assistance, according to terms of reference and a schedule agreeable to the Bank, to prepare for and implement commercial accounting. The Bank is satisfied that, even before introduction of the new accounting system and implementation of this technical assistance, KSEB can maintain project accounts adequately. Audit of Accounts 4.10 KSEB's accounts are audited by the C&AG, who has satisfactorily completed the audit report for 1982/83. At negotiations, COK agreed that KSEB would furnish to the Bank its unaudited annual financial statements not later than nine months after the close of each financial year; and, not later than twelve months after the end of such year, its annual financial statements certified by the C&AG or an acceptable alternate, together with the auditor's report. KSEB currently has an an internal audit unit. In the past, the questionable quality of raw accounting data negated the potential benefits from having that internal audit unit. Nevertheless, KSEB recognizes the importance of this activity and will ensure that the Organization and Management Study (para 2.03) makes specific recommendations for strengthening it. At negotiations, KSEB provided an undertaking that would reorganize its internal audit unit, in accordance with acceptable recommendations of the Organization and Management Study, not later than December 31, 1986. Data Processing 4.11 KSEB's management believes that, to cope with its rapidly growing data base and information required for operations, it must computerize the handling of data, which until now has been collected and processed manually. Consequently, it is proposing to introduce comprehensive computerization, based on a consulting study. The Bank has reviewed the study's proposals and considers that it recommends a satisfactory beginning to the needed comprehensive computerization program which would be developed in parallel with the Organization and Management Study. Billings and Collections 4.12 In 1982/83 and 1983/84, KSEB's accounts receivable increased unsatisfactorily (para 4.24). KSEB believes this resulted, inter alia, from slow payment of the larger bills generated because meter reading became irregular as the number of consumers connected to the system grew. Therefore, the tariff notified in September 1982 was designed to accommodate a limited use of self-billing. Under KSEB's system, a consumer is assigned -23- to a billing category based on historical levels of demand and consumption. The consumer is furnished with billing cards to enable hini to remit paymnents monthly to one of KSEB's 500 section offices. Meter readers would then make readings and corrective billings on a regular basis. Many corrective readings are taken quarterly; all meters are required to be read semiannually. This system applies to all but high tension (HT) and extra high tension (EHT) consumers, whose meters are read every month by the Assistant Engineer in charge of the section office. KSEB believes that this system has been working satisfactorily and that collection of receivables has improved substantially since it was introduced. Until the Organization and Management Study is completed, the existing billing and collection systems do not need modification. Insurance 4.13 KSEB follows standard practices for insuring against partial or total loss of goods and equipment being procured under ongoing projects. For permanent installations, KSEB holds policies which conform, in terms of the nature and amount of coverage, to accepted utility practices in India. Income Taxes 4.14 SEBs are liable for income tax; however, KSEB has not incurred any income tax obligation, primarily because of the high proportion of debt in its capital structure and the allowances generated by its large investment program. Since it is projecting intensive capital expenditure between 1985/86 and 1994/95, KSEB is not likely to incur any income tax liability in the intermediate term future. B. Financial Performance Past and Present Financial Performance 4.15 KSEB provided audited accounts for the years 1981/82 and 1982/83. Additionally, it provided budget figures for 1983/84 and 1984/85. This summary of its past and present financial performance is displayed in Annex 10. Key financial indicators are summarized in Table 4.1. -24- Table 4.1: Key Financial Indicators 1981/82-1984/85 1981/82 1982/83 1983/84 1984/85 (Aud.) (Aud.) (Est.) (Bud.) Average Revenue (paise/kWh) 25.6 31.6 39.2 35.1 Rate of Return (Z)/1 15.1 9.9 7.4 14.6 Self-Financing Ratio (Z) -64.4 45.2 44.2 40.3 Debt/Debt Plus Equity (%)/2 95.9 96.1 96.4 90.2 Debt Service Coverage 0.4 1.7 1.9 1.3 Operating Ratio (Z) 62.2 70.2 77.0 62.1 Accounts Payable (months) 17.9 9.8 12.3 11.8 Accounts Receivable (months) 2.7 3.9 3.5 2.8 /1 Based on average Net Fixed Assets in Operation valued at historic cost. /2 Computed prior to adjustments for Suspense Accounts. If these adjustments are made, Debt/Debt plus Equity would equal about 98% in each 1981/82, 1982/83 and 1983/84. 4.16 KSEB self-financed a significant portion of its investment program in 1982/83 and 1983/84 and projects doing so again in 1984(85. However, KSEB arranged this self-financing by (a) ignoring its interest obligations on its extensive borrowings from GOK (para 4.18); (b) ignoring substantial taxes to GOK (para 4.19); (c) extending excessively its accounts payable (para 4.23); (d) postponing some maintenance expenditures; and (e) substantially cutting its training activities. In part, these measures were necessitated by the severe drought conditions that prevailed in 1982/83 and 1983/84, which reduced the amount of power available for sale. In order to limit the revenue shortfall, KSEB rationed power to HT and EHT consumers, who pay much less per kWh than LT consumers. Thus, in 1982/83 and 1983/84, KSEB's average revenue per kWh increased substantially more than its tariff. In contrast, assuming average hydrology for 1984/85, KSEB's average revenue per kWh would decrease by about 10% while its tariff has been increased by about 8%. As a consequence of both its commitment to self-financing and the negative impact of hydrology on revenues, KSEB's working capital decreased dramatically during the 1981/82-1983/84 period. Its debt/equity ratio for the same period of about 96/4 was computed without adjusting for suspense accounts; had proper adjustments been made, the debt/equity ratio wouli have been 98/2 during that period. Several provisions of the financial recovery plan are intended to eliminate the negative effects of KSEB's past reliance on financial expedients. 4.17 GOK Loans. GOK, like all other State Governments, follows a policy that whatever investment in the power sector is not financed from internal cash generation must be financed from loans. KSEB has borrowed significantly from a variety of Indian financial institutions; the balance of its borrowings has been obtained from GOK. While meeting its debt service obligations to all other lenders, KSEB has ignored responsibilities -25- associated with loans from GOK; meanwhile, GOK has not pressed KSEB for payment of these obligations. 4.18 GOK has financed KSEB primarily with "perpetual" loans. KSEB is not in default on repayment obligations; however, it is more than five years in arrears in paying interest on these loans. As of March 31, 1984, KSEB recorded arrears in interest to GOK of about Rs. 380 million, which are classified as current liabilities. KSEB cannot meet these arrears within the next year without jeopardizing its liquidity. Furthermore, because a maturity period or lack thereof is not specified in the notification of the "perpetual" loans, they may be called in whole or in part at the sole discretion of COK. The 1983 amendment to the Act specifies that a call on either the arrears in interest or the principal (or a portion thereof) of these "perpetual" loans, while subordinate to operating expenses and interest accrued during the current period, has priority over expenditures for investment. At negotiations, GOK provided an undertaking that it would subordinate repayment of both arrears in interest and principal repayments on all existing and anticipated "perpetual" loans to funds needed to implement Plan approved projects. Effectively, this undertaking endows the "perpetual" loans with the same characteristics as cumulative preferred stock. Thus, while GOK may consider capital provided in this manner as loans, the Bank may reclassify this capital as equity for the purposes of financial analysis. 4.19 Arrears for Taxes. During the past several years, KSEB has not remitted to GOK its taxes on operations.l/ In September 1984, these arrears in taxation amounted to Rs. 428 million. This obligation has been carried as a current liability and GOK had indicated that it expected KSEB to make payments against this amount as and when cash became available. In addition, GOK has cited these arrears as a reason for trimming the amount of its project loans to KSEB. KSEB cannot meet these obligations on a current basis and retain adequate liquidity. At negotiations, GOK provided an undertaking that it will subordinate repayment of these obligations to funds needed to implement Plan approved projects. As with "perpetual" loans,this undertaking enables the Bank to reclassify these obligations as equity for the purposes of financial analysis (para 4.18). 4.20 Intangible Assets. KSEB is carrying about Rs. 270 million on its balance sheet in an account entitled "Intangible Assets." These assets represent engineering work and some initial site preparation for projects which GOK has dropped from KSEB's investment program. The Act makes no specific provision for expensing such assets and, at present, KSEB does not expense them. At negotiations, KSEB provided an undertaking that it will expense extraordinarily the full amount of intangible assets in a manner acceptable to the Bank in a period of not more than eight years. 1/ These taxes are separate from Excise Taxes charged the consumer in addi- tion to KSEB's tariff and which are deposited to GOK at the time of collection. -26- associated with loans from COK; meanwhile, COK has not pressed KSEB for payment of these obligations. 4.18 COK has financed KSEB primarily with "perpetual" loans. KSEB is not in default on repayment obligations; however, it is more than five years in arrears in paying interest on these loans. As of March 31, 1984, KSEB recorded arrears in interest to COK of about Rs. 380 million, which are classified as current iiabilities. KSEB cannot meet these arrears within the next year without jeopardizing its liquidity. Furthermore, because a maturity period or lack thereof is not specified in the notification of the "perpetual" loans, they may be called in whole or in part at the sole discretion of COK. The 1983 amendment to the Act specifies that a call on either the arrears in interest or the principal (or a portion thereof) of these "perpetual" loans, while subordinate to operating expenses and interest accrued during the current period, has priority over expenditures for investment. At negotiations, GOK provided an undertaking that it would subordinate repayment of both arrears in interest and principal repayments on all existing and anticipated "perpetual" loans to funds needed to implement Plan approved projects. Effectively, this representation endows the "perpetual" loans with the same characteristics as preferred stock. Thus, while GOK may consider capital provided in this manner as loans, the Bank may reclassify this capital as equity for the purposes of financial analysis. 4.19 Arrears for Taxes. During the past several years, KSEB has not remitted to GOK its taxes on operations.l/ In September 1984, these arrears in taxation amounted to Rs. 428 million. This obligation has been carried as a current liability and GOK had indicated that it expected KSEB to make payments against this amount as and when cash became available. In addition, COK has cited these arrears as a reason for trimming the amount of its project loans to KSEB. KSEB cannot meet these obligations on a current basis and retain adequate liquidity. At negotiations, COK provided an undertaking that it will subordinate repayment of these obligations to funds needed to implement Plan approved projects. This representation protects KSEB's liquidity and enables the Bank to treat these obligations as equity for the pu-poses of financial analysis, based on considerations similar to those used in relation to "perpetual" loans (para 4.18). 4.20 Intangible Assets. KSEB is carrying about Rs. 270 million on its balance sheet in an account entitled "Intangible Assets." These assets represent engineering work and some initial site preparation for projects which GOK has dropped from KSEB's investment program. The Act makes no specific provision for expensing such assets and, at present, KSEB does not expense them. At negotiations, KSEB provided an undertaking that it will expen;e extraordinarily the full amount of intangible assets in a manner acceptable to the Bank in a period of not more than eight years. 1/ These taxes are separate from Excise Taxes charged the consumer in addi- tion to KSEB's tariff and which are deposited to GOK at the time of collection. -27- 4.21 Suspense Accounts. In its audited accounts for 1982/83, KSEB was carrying about Rs. 360 million in a Materials Suspense Account. This is an account for holding transactions only until the accounts department receives the necessary supporting documentation from all parties to the transaction. At KSEB, non-completion of this documentation has been a chronic problem and many items included under this heading should have been reallocated to other accounts years ago. KSEB estimated that about 75% of the assets classified under the Material Suspense Account have been used in capital construction, and therefore should have been reallocated to work in progress or gross fixed assets. The remainder is believed to have been expended in operations and maintenance and should have been included among KSEB's expenses in previous years. Similarly, KSEB has been carrying another suspense account entitled "Inter-unit Transactions" on its year-end balance sheet. As of September 1984, about Rs. 147 million were included in this account. KSEB believes that the amounts included in this account were used entirely for operations and maintenance and should have been expensed in previous periods. At negotiation, KSEB provided an undertaking that, following a review of the contents of these accounts, it will capitalize those items which can be identified as having been used in the construction of specific assets and recognize as an extraordinary expense those items which have been expended for operation and maintenance. The adjustments which are completed prior to March 31, 1986 will be made in KSEB's accounts for the financial year 1985/86; the remainder will be taken into KSEB's 1986/87 annual accounts. In total, these adjustments are believed to imply extraordinary losses of about Rs. 240 million. 4.22 Fixed Asset Accounting. KSEB's fixed asset registers do not accurately reflect its plant and equipment. Until the late 1970s, the fixed asset registers were not maintained comprehensively or systematically; since then, accounting practice has improved; but, the engineering records, from which the fixed asset registers are derived, still appear incomplete and out of date. The proposed project includes a provision for a comprehensive fixed asset inventory to be conducted by KSEB with assistance from consultants. Draft terms of reference for this consultancy were discussed at appraisal (Annex 7). This inventory has the dual objective of providing accurate financial records of KSEB's plant and equipment while updating the information needed for operation, inspection and maintenance of all facilities. At negotiations, KSEB provided an undertaking that it will, not later than August 31, 1985, retain consultants acceptable to the Bank to conduct a fixed-asset inventory 4.23 Accounts Payable. During the past four years, KSEB has stretched its current liabilities beyond acceptable levels. GOK is by far KSEB's largest creditor; however, a number of suppliers and contractors have significant due bills outstanding and could create difficulties if together they pressed for payment. Moreover, KSEB has exhausted the financial cushion afforded by delaying payments to creditors. At negotiations, KSEB provided an undertaking that, beginning in 1985/86, it will maintain its accounts payable at not more than the operating expenses and capital expenditure, net of those capital expenditures financed through suppliers' credits, incurred during the preceding two months. -28- 4.24 Accounts Receivable. In 1982/83 and 1983/84, KSEB encountered difficulties in collecting its revenues, resulting partly from consumer resistance to the September 1982 tariff increase and partly from the slower payment of larger bills issued according to the uneven pattern of meter readings and billings (para 4.12). To address this problem, KSEB changed its billing practices to enable consumers to remit payments against self-assessments and took legal action against numerous municipalities whose arrears had become excessive. KSEB affirms that both these efforts have been effective and that it expects to carry less than 3 months' accounts receivable at the end of 1984/85. At negotiations, KSEB provided an undertaking that it will maintain its accounts receivable at less than 2.5 months of sales in 1985/86 and less than 2.0 months of annual sales thereafter. 4.25 Security Deposits. Currently, KSEB collects two months' security deposits from all consumers. The Bank considers this practice satisfactory. KSEB's Tariff 4.26 The structure of KSEB's tariffs is extremely complex. Although the tariff specifies only nine major consumer categories, the majority of these are subdivided and many of the subdivisions are divided further. The essential elements of the HT and EST tariffs are a demand charge based on recorded kVA or 75% of the contracted load, whichever is the higher, and one or more energy charges depending on consumption per kVA. However the energy charges are subject to complex adjustments which depend (nonlinearly) on what proportions of the user's energy consumption is for factory lighting and housing colonies. The domestic tariff comprises a fixed monthly charge and a "slab-based" energy charge. The "slab" system charges consumers a regular monthly sum which depends on the consumption slab into which they fall, e.g. someone using between 21 and 30 kWh per month would pay an energy charge of Rs. 8.00. This system was designed to reduce the frequency of meter reading from monthly to quarterly. Other Low Tension (LT) tariffs include fixed charges, either flat rate or dependent on connected load, and energy charges which are also either flat rate or dependent on connected load. The overall effect is a very complex system of tariffs which is difficult for consumers to comprehend and difficult for KSEB to administer. The structure is not related to the underlying costs of supply. 4.27 In view of the complexity of the tariff, its difficulty of administration, and its divergence from the costs of supply, the project includes a study aimed at simplifying and improving the efficiency of KSEB's tariff. The study will include: (a) determination of the cost of supply for different categories of consumers based on the power expansion plan for the Southern Region approved by GOI; (b) determination of a "lifeline" consumption level and a corresponding affordable tariff; -29- (c) simplification of the tariff structure, with the objective of better reflecting the cost of supplying different consumer classes; and (d) preparation of a program acceptable to the Bank for gradually restructuring the tariffs as recommended by the study. At negotiations, KSEB provided an undertaking that, to perform the study, it would retain consultants, according to terms of reference acceptable to the Bank, not later than December 31, 1985. 4.28 GOK last increased KSEB's tariff in September 1982. The increase was intended to provide KSEB with about 30% more revenue. The tariff increase was designed to take effect in stages, so that about 60% of its effect was introduced in September 1982, a further 20% in April 1984, and the remainder in April 1985. In addition to tariffs, KSEB's consumers pay excise taxes which are related either to their consumption or their entire bill, depending on consumer category. Table 4.2 (page 30) presents a summary of average tariff realization per consumer by category for both 1981/82 and 1984/85. The average realization, including collections for excise taxes, across all consumer categories has been about 40 paise/kWh in 1984/85. For the purpose of comparison, the long-run marginal cost (strictly average incremental cost) of power in the Southern Region is estimated to be 56 paise/kWh in economic terms, equivalent to an average financial tariff of 70 paise/kWh, given a standard conversion factor of 0.8. Future Finance 4.29 KSEB's detailed financial projections for the period 1985/86-1994/95 are presented in Annex 10. Table 4.3 (page 30) summarizes the projected key indicators for each year during that period. 4.30 Financing Plan. KSEB's financing plan for the period 1985/86 through 1989/90, the period of execution of the proposed project, is presented in Table 4.4. KSEB would finance 30% of its investment program (including interest during construction) from internal cash generation. The proposed Bank loan would finance 20% of KSEB's investment program. The proposed Project is expected to comprise 38% of KSEB's investment program for the period. Table 4.2: Averase Conatner Charges for Electricity by Category for 1981182 and 1984/95 -------1981/82---- - - ------1984/85----- Aggre- Total Fixed or Aggre- Total Consumer gate Excise Pay- Demand Energy gate Excise Pay- Category Tariff Tax ment Charute Charge Tariff Tax .L. ment Domestic 35.82 2.47 38.29 14.50 30.00 44.50 3.00 47.50 Comercial 50.61 4.20 54.81 5.00 60.00 65.00 6.00L 71.00 Irrigation 15.17 1.20 16.37 8.00 12.00 20.00 1.20L1 21.20 Water Works 20.44 1.70 22.14 8.50 17.00 25.50 1.70 LI 27.20 Industrial LT 21.74 1.70 23.44 8.87 17.00 25.87 1.7011 27.57 High Tension 14.90 4.47 19.37 17.60 12.00 29.60 8.88L 38.48 Extra High Tension 8.14 2.44 10.58 14.61 9.76 24.37 7.31/2 31.68 Licensees 13.12 - 13.12 22.12 9.90 32.02 - 32.02 Public Lighting 71.00 - 71.00 12.00 175.35 187.35 - 187.35 LI 10 of the Energy Charge. L2 302 of Aggregate Tariff. Table 4.3: Key Financial Indicators 1985/86-1994/95 1985/86 1986/87 1987/88 1988/89 1989/90 1990/91 1991/92 1992/93 1993/94 1994/95 Average Revenue (paise/kIh) 39.7 45.5 50.8 56.0 61.8 66.4 73.1 74.5 77.3 82.6 Rate of Return (M)/1 12.9 13.0 14.2 14.5 13.2 12.8 14.1 13.8 12.1 11.3 Self-Financing Ratio (2) 17.2 31.5 27.1 34.8 30.0 29.2 29.1 33.9 43.3 57.8 Debt/Debt Plus Equity (2) 39.2 39.9 39.8 38.5 36.4 31.4 27.5 24.7 22.8 21.4 Debt Service Coverage 1.4 1.8 1.8 2.1 1.8 1.6 1.6 1.6 1.7 1.8 Accounts Payable (months) 4.4 4.5 4.6 4.3 3.4 3.6 3.4 3.3 2.9 2.9 Accounts Receivable (months) 2.5 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 LI Based on net fixed assets in operation, valued at historical cost average. -31- Table 4.4: KSEB's Financing Plan, 1985/86-1989/90 Rs. Million US$ Million Z Sources of Funds Internal Cash Generation 7,229 602 (less) Net Working Capital Incr. 137 12 (less) Debt Service 4,038 336 Cash Available for Investment 3,054 3,054 255 255 30 On-lent World Bank Loan 2,112 176 20 Other Loans/l 2,133 178 21 GOK Investment/2 3,017 251 29 Total Sources of Funds 10,316 860 100 Investment Program Kerala State Power Project 3,918 327 38 Other Projects 5,268 439 51 Interest during Construction 1,130 94 11 Total Application of Funds 10,316 860 100 /1 Principally from the Life Insurance Corporation, the Rural Electrifica- tion Corporation, the National Bank for Agriculture and Rural Develop- ment, or public debenture issues. /2 Consisting entirely of "perpetual" loans (para 4.18). 4.31 On-Lending. At negotiations, COK agreed to on-lend the proceeds of the Bank loan to KSEB for 20 years, including 5 years of grace on repayment of princi.pal, at the higher of (a) the interest rate applicable on its loans to KSEB at the time of drawdown, or (b) the Bank's current rate of 9.29%. Currently, COK's applicable rate is 13.5%. The rate had remained constant at 10.752 from mid-1981 until late 1984. GOK indicated that, while the applicable rate might drop below the current level, it would probably not fall below 10.75Z daring the period of project implementation. Rate of Return 4.32 During appraisal, financial performance targets similar to the contribution to investment eligibility criteria included in the Third Rural Electrification Project (Loan 2165-IN) were discussed with KSEB, GOK and GOI. GOK and KSEB indicated that the tariffs implied by these financial performance targets could be implemented without substantial difficulty. However, GOI objected to the principle of contribution to investment targets, indicating instead a preference for a rate of return approach that is -32- consistent with the August 1983 amendment to the Act. The Bank agreed with this approach under the Chandrapur Thermal Power Project. 4.33 At negotiations, COK agreed that, beginning with 1985/86, it would take all such measures as may be necessary, including adjustment of KSEB's tariff, to ensure that KSEB's total revenues in any financial year shall, after meeting: (i) all expenses properly chargeable to revenues, including operating, maintenance and management expenses; {ii) taxes on income and profits; (iii) depreciation; and (iv) interest payable on all debentures, bonds and loans; produce such surplus of not less than 3X of KSEB's net fixed assets in service at the beginning of that year. This measure of performance is identical to the financial performance requirement specified in the 1983 amendment to the Act. 4.34 At negotiations, COK confirmed that, for the purposes of evaluating com,liance with this agreement, the critical terms would be defined as follows: (a) "tota! revenues" means KSEB's revenues from the sale of electricity and other services, miscellaneous income, rural electrification subsidies, state electricity duties received, and suc:. other subventions received from GOK to cover extraordinary costs which are borne by KSEB and which should not reasonably be borne by its customers; (b) "expenses" means the cost of power purchased, fuel, o-erating, maintenance, management and administrative expenses, and all taxes and duties accruing during the financial year, other L.aan taxes on KSEB's income and profits; (c) "taxes on income and profits" consist of income taxes and other levies accrued by KSEB according to the provisions of any applicable legislation or regulation; (d) "depreciation" means a provision, based on KSEB's gross fixed assets in service at the beginning of the year, derived by using the straight line method in conjunction with the schedule of useful life of assets that was notified according to provisions of Section 68 of the Act, on April 3, 1985; (e) "interest payable on all debentures, bonds and loans" means all interest (whether paid or waided), including interest during construction, accrued by KSEB during the financial year, and all other charges on debt; and -33- (f) "net fixed assets in service" means, (a) the original cost of fixed assets, reduced by the aggregate of the cumulative depreciation taken on those assets, less (b) consumers' contribution for service lines, also reduced by the aggregate of the cumulative depreciation taken on that portion of the service lines which were financed by consumer contributions. KSEB has not received any rural electrification or other subsidies from GOK in recent years. The currently notified useful lives of assets are appropriate. The Bank considers these definitions to be acceptable. 4.35 Table 4.3 (page 30) shows the acceptable financial performance levels implied by Annual 3% surpluses computed according to this formula, re-expressed in terms of the Bank's definitions of rate of return and self-financing ratio. Based on the confirmed definitions, the minimum target of 3% would yield annual rates of return on historically valued net fixed assets in operaticn averaging 13.2% and annual self-financing ratios averaging 33% during the period 1985/86-1993/94. The debt/debt plus equity ratio, which is particularly low due to the reclassification of the "perpetual" loans as an equity equivalent (para 4.18), should be read only as an indicator of GOK's support for KSEB in periods of financial dififculty. FinanciaL Recovery Program 4.36 The measures discussed in the preceding analysis are needed to put KSEB on a sound financial footing. Taken together, these steps form a comprehensive financial recovery program. To recapitulate, KSEB would: (a) meet specified annual targets for: Ci) revenue surplus (para 4.33); (ii) accounts receivable (para 4.24); and (iii) accounts payable (para 4.23). (b) conduct a tariff study (para 4.27). (c) make adjustments to its accounts including: (i) expensing its intangible assets (para 4.20); (ii) clearing its suspense accounts (para 4.21); and (iii) conducting a fixed asset inventory (para 4.22). (d) upgrade its accounting and financial practices by: (i) strengthening its financial management (para 4.07); (ii) introducing a commercial accounting system (para 4.08); -34- (iii) providing intense training to its finance and accounts personnel (para 4.09); and (iv) strengthening its internal audit unit (para 4.10). Eurthermore, GOK would: (e) enable KSEB to meet financial performance targets (para 4.34); and (f) subordinate repayment of principal of "perpetual" loans and arrears in taxes and interest to funds needed to implement Plan approved projects (paras 4.18 and 4.19). -35- V. PROJECT JUSTIFICATION AND ECONOMIC ANALYSIS Least Cost Analysis 5.01 The principal element of the p-oposed Project is the Lower Periyar hydro scheme and, in relation to this, three particular decisions require economic justification. These concern the installed capacity, the number of units and the place of the scheme in the Southern Region's leazt cost development plan. The justification for the installed capacity of 180 MW is based on the trade-off between capital and operating costs of the Lower Periyar Station and system savings estimated by reference to alternative coal-fired generation. The Bank has reviewed this analysis and found it sati3factory; brief details are given in Annex 11. The choice between 2 and 3 wi_ts is reasonably finely balanced with capital and operating cost differences being partially offset by differences in generation during periods of turbine outage. Nn initial choice of 2 units might have reduced total system costs by $2.6 million. However, the advanced stage of engineeLing for 3 units makes this the more economic option. Even a one-month delay caused by changing the decision would increase total system costs by $3.3 million, thereby eliminating any possible benefit from choosing 2 rather than 3 units. In fact, a change to 2 units would probably delay the project by about six months. In order to analyse whether the scheme forms part of the Southern Region's least cost development plan studies have been carried out by CEA using the optimization model WASP-IlI. In all cases analyzed the earliest feasible implementation of the Lower Periyar scheme forms an integral part of the least cost development plan. The methodology and the assumptions employed, including the load forecast presented in Annex 11, have been reviewed by the Bank and found satisfactory. 5.02 Other elements of the proposed Project comprise transmission lines in the Idukky Calicut corridor, a reactive power compensation program and distribution works in Trivandrum, Cochin and Calicut. The transmission lines are necessary to evacuate power from Lower Periyar and from Idukky Stage II. KSEB and CEA have considered different options for transmission development to a0hieve this, including schemes based on 110 kV, 220 kV and 400 kV. The Bank is satisft d that the proposed 220 kV configuration would form part of the system's least cost development. The choice of how much reactive power compensation to install has been based on minimization of the sum of costs arising from transmission losses, owing to power factor, and the capital and operating costs of compensation. Distribution plans have been prepared by KSEB and CEA in accordance with accepted but not state-of-the-art utility practices. While the Bank is generally satisfied with the proposed plans, the use of computerized distribution planning models and a more decailed geographic disaggregation of the load forecast might indicate that refinement is possible. As part of the proposed Project, KSEB has retained consultants to assist in finalizing the reactive compensation program and distribution plans (para 3.08). Subject to any modifications that may be identified at that stage the Bank is satisfied that the proposed reactive compensation program and distribution works will contribute to the least cost development of the system. -36- Internal Economic Rate of Return 5.03 Benefits of the four elements of the proposed Project cannot readily be separated from those of other investments in generation, transmission and distribution. Therefore, having established that the elements of the proposed Project form part of the least-cost expansion plan for the Southern Region it is appropriate to carry out a cost-benefit analysis on the entire plan in order to ensure that the expansion envisaged is desirable. For this purpose a 'time-slice' of the Southern Region's investment program, covering schemes to be commissioned in the period 1989/90-1995(6, has been analyzed. Capital costs of the investment program (covering generation, transmission and distribution) together with incremental operating and fuel costs are given in Annex 11. The benefits of the investment program relate mainly to the incremental consumption which it makes possible 1/. A minimum measure of benefit, which ignores consumer surplus, can be derived from the revenue generated by the incremental sales. In the absence of adequate class specific consumption conversion factors, the standard conversion factor (estimated to be 0.8) has been applied to convert financial revenue into a measure of economic benefit. On this basis the minimum internal economic rate of return achieved by the program is 4%. 5.04 However, this estimate is more a reflection of the inadequacy of tariffs than of the economic merit of the investment program which includes the proposed Project. The estimated minimum economic rate of return, 4%, is substantially less than the established opportunity cost of capital, and this is indicative of the fact that tariffs to consumers are presently less than LRMC (para 1.06). In reality the program will confer benefits in excess of those described above. There will be consumer surplus associated with the incremental consumption and typically there will be other external benefits. Consumers' reactions to the severe shortages of power experienced at present, and expected for the foreseeable future suggest that willingness to pay substantially exceeds present tariff levels. 5.05 In order to derive a more realistic estimate for the internal economic rate of return of the program it is useful to estimate a measure of consumer surplus, at least for industrial and agricultural consumers. Their willingness to pay will be related to the costs of autogeneration and diesel pumping respectively. Many consumers are presently observed to find these economic when public supply is not available. Annex 11 presents an estimate of diesel autogeneration costs at Rs. 1.12/kWh. It would, however, be unreasonable to assume that all consumers would be willing to pay this price for the whole of their consumption from the public supply system. Therefore, as a conservative measure, it has been assumed that the consumer surplus 1/ The program may also lead to benefits in terms of a reduction in the cost of meeting existing demand, particularly through fuel savings. However, the energy deficit is such that by far the greater part of the output available from plants in the program will lead to increased sales. Therefore, fuel savings resulting from the program are likely to be small and this element of the benefits has therefore been ignored. -37- attributable to incremental sales can be derived from an average of the cost of autogeneration and the prevailing tariff. Similarly for agricultural consumers the equivalent cost of diesel pumping has been estimated at Rs. 2.21/kWh and average willingness to pay has been estimated at halfway between the average agricultural tariff and this alternative cost. This more realistic measure of the benefit of consumption results in an internal economic rate of return for the program of 13%. However, it must again be stressed that this still represents a lower bound estimate as domestic consumer surplus and other external benefits, have still not been included. Justification for Bank Involvement 5.06 The Bank would be supporting OOI's efforts to: (a) accelerate the development of hydro; (b) alleviate power shortages in the Southern Region; (c) improve the quality of supply; and (d) reduce system losses. The Bank's involvement to date 14s already achieved significant improvements in project design and the Bank's continued involvement would: (a) contribute substantially to the institutional development of KSEB; (b) cause KSEB to undertake a comprehensive financial recovery program; and (c) through consultancy assistance for the reactive compensation and distribution elements of the Project, introduce KSEB to state-of-the-art planning techniques in these fields. -38- VI. AGREEMENTS AND RECOMMENDATIONS 6.01 The following agreements were reached at negotiations: (a) KSEB will develop a detailed training program acceptable to the Bank not later than June 30, 1986 (para 2.08); (b) KSEB will create, by Septembe- 30, 1985, a Project Cell (PC) under the Chief Engineer (Planning) to: (a) coordinate project implementation; (b) serve as liaison with GOI, CEA, CC and the Bank; (c) monitor project execution; (d) prepare the necessary periodic reports for the project authorities and the Bank; and (e) process disbursement applications (para 3.09); (c) GOI will notify the new uniform accounting system to be used by the SEBs by July 15, 1985 (para 4.08); (d) KSEB would as of April 1, 1986, implement commercial accounting according to a system to be specified by GOI (para 4.08); (e) KSEB will furnish to the Bank its unaudited annual financial statements not later than nine months after the close of each financial year; and, not later than twelve months after the end of such year, its annual financial statements certified by the C&AG or an acceptable alternate, together with the auditor's report (para 4.10); (f) GOK will on-lend the proceeds of the proposed Bank loan to KSEB for 20 years maturity, including 5 years of grace on repayment of principal, at GOK's applicable rate of interest on loans to KSEB at the time of drawdown (para 4.31); (g) GOK will take all such measures as may be necessary,.including, if necessary, adjustment of KSEB's tariff, to ensure that, commencing with the financial year 1985/86, KSEB's total revenues in any financial year shall, after meeting: (i) all expenses properly chargeable to revenues, including operating, maintenance and management expenses; (ii) taxes on income and profits; (iii) depreciation; and (iv) interest payable on all debentures, bonds and loans; produce such surplus as is not less than 3% of the SEB's net fixed assets in service at the beginning of such year (para 4.33). 6.02 Undertakings regarding the following items were received during negotiations: -39- (a) GOI will seek to finance about US$30 million equivalent, representing 85X of the aggregate cost of the reactive power compensation equipment, the gas insulated switchgear and tL2 110 and 66 kV cables for distribution, through suppliers' credits, export credits or commercial bank loans. If this financing materializes, the Bank funds no longer needed for these items would be reallocated to other elements of the project (para 3.05); (b) KSEB will create a Steering Committee for the Institutional Development Program including key members of KSEB's staff to coordinate all technical assistance and training activities (para 3.10); (c) KSEB will retain all consultants for the project not later than December 31, 1985, with the exception of the consultants being hired to assist with the introduction of commercial accounting and those conducting the fixed-asset inventory, both of whom will be appointed no later than August 31, 1985 (paras 2.03 and 3.10); (d) KSEB will conduct an interim reorganization of its finance department in a manner satisfactory to the Bank and fill new senior financial managerial posts with qualified people not later than December 31, 1985 (para 4.07); (e) KSEB will take whatever preparatory steps are necessary to ensure that, by the beginning of the financial year 1986/87 (April 1, 1986), it will implement correctly commercial accounting according to the system to be notified by GOI (para 4.08); (f) KSEB will strengthen its internal audit unit not later than December 31, 1986 (para 4.10); (g) KSEB will expense the full amount of intangible assets in a manner acceptable to the Bank in a period of not more than eight years (para 4.20); (h) KSEB will review the contents of the suspense accounts, and capitalize those items which have been used in construction while recognizing as an extraordinary expense those items wlhich have beein expended for operation and maintenance. These adjustments should be made in KSEB's accounts for the financial year 1985/86 (paras 3.10 and 4.21); (i) GOK will subordinate repayment of principal for "perpetual" loans and payment of arrears for both interest and taxes to funds needed to implement Plan approved projects; (j) KSEB will maintain its accounts payable at not more than the last two months' cash operating expenses and capital expenditure, beginning in 1985/86 (para 4.23); and -40- (k) KSEB will maintain its accounts receivable at less than 2.5 months of sales in 1985/86 and less than 2.0 months of annual sales thereafter (para 4.24). Recommendation 6.03 The proposed Prol4ct is suitable for a Bank loan of US$176.0 million equivalent. 1NDIA KENALA STATE POWER PROJECT Pover Supply Position - All India ----------Actual-------- Prov. ---------------------------------------Estimated----------------------------------------- 1980/81 1981/82 1982/83 1983/84 1984/85 / 1985/86 1986/87 1987/88 1988/89 1989/90 1990/91 1991/92 1992/93 1993194 1994/95 A. CAPACITY (MW) Installed Capacity 30,210 32,340 35,360 39,360 44, 500 48, 500 52, 800 57, 300 63, 100 71, 700 82, 450 92,900 103,100 110,100 117,500 Peak Availability 19, 240 20, 189 21, 504 22, 903 26,400 29,600 32,400 34, 800 38,000 42, 700 50, 100 56,400 63,900 69,700 76,200 Peak Demand 2/ 19,240 20, 189 21, 504 22,903 28,250 33,600 36,900 40,300 44,100 48,100 52,400 56,900 61,700 66,700 72,000 Surplus/(Deficit)/ - - - - (1, 850) (4,000) (4, 500) (5, 500) (6,100) (5,400) (2,300) (500) (2,200) 3,000 4,200 B. ENERGY (oMh) Energy Availability 104, 188 122,010 130,210 130,695 161,200 176,140 195,380 214, 530 234,410 260, 120 306, 120 348,000 398,410 440, 890 474,900 Energy Requirement j/ 104,188 122,010 130,210 130,695 161,200 184,260 202,060 221,220 241,780 263,820 287,450 312,330 338,630 366,330 395,400 Surplus/(Deficit) 2/ - - - - - (8,116) (6,680) (6,690) (7,370) (3,700) 18,670 35,670 59,780 74,560 79,500 Source: CU 1/ Appraisal miaSion's estimate for 1984/85. V Historic records of peak demands and energy requirements refer to those actually met. IIIDIA KRAIA STAT8 PW PROJECT Pover SUDDly Position - Southern Ren ion ---------Actual-------- Prov. ---------------------------------------,Estiasted
Groupe de la Banque mondiale · Staff Appraisal Report
India - Kerala State Power Project
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Groupe de la Banque mondiale
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Staff Appraisal Report
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Inde
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Banque mondiale