Philippines - Energy Sector Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY L-A/. 316-3 I^M 3/49q L -N. 3'S Report No.P-5199-PH MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS FOR THREE PROPOSED LOANS IN AN AGGREGATE AMOUNT EQUIVALENT OT US$390 MILLION AND CONSISTING OF US$200 MILLION TO THE NATIONAL POWER CORPORATION US$150 MILLION TO THE PHILIPPINE NATIONAL OIL COMPANY (BOTH WITH THE GUARANTEE OF THE REPUBLIC OF THE PHILIPPINES) AND US$40 MILLION TO THE REPUBLIC OF THE PHILIPPINES FOR AN ENERGY SECTOR PROJECT NOVEMBER 22, 1989 This document has a restricted distribution and may be used by recipients only in the performance of their ofricial duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Philippine Peso (P) US$1.00 = P 21.5 P 1.00 = 100 centavos (ctv.) (as of July 1989) FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES (metric s;stem) MT - Million tons TOE = Tons of oil equivalent m Meter (3.2808 feet) km Kilometer (0.6214 mile) kV K Kilovolt (1,000 volts) kW = Kilowatt (1,000 watts) MW = Megawatt (1,000 kW) GWh = Gigawatt hours (one million kWh) MVA m Megavolt ampere (one million volt-ampers) ABBREVIATIONS AND ACRONYMS EHB Environmental Management Bureau ERB - Energy Regulatory Board Eximbank - Export-Import Bank of Japan ICB - International Competitive Bidding LCB - Local Competitive Bidding LIB = Limited International Bidding NEA = National Electric Administration NPC National Power Corporation OEA = Office cf Energy Affairs PNOC = Philippines National Oil Company PNOC-EDC - PNOC-Energy Development Corporation PNOC-PETRON - PETRON Corporation of PNOC REC = Rural Electrification Cooperatives  FOR OFFICIAL USE ONLY PHILIPPINES ENERGY SECTOR PROJECT Loan and Project Summary Borrowers: Republic of the Philippines National Power Corporation (NPC) Philippine National Oil Company (PNOC) Guarantor: Republic of the Philippines - for the loans to NPC and PNOC Other Beneficiary Office of Energy Affairs (OEA), Energy Regulatory Agencies: Board (ERB), Environmental Management Bureau (EMB), National Electrification Administration (NEA), PNOC-Energy Development Corporation (PNOC-EDC), and PETRON Corporation. Amount: Three loans amounting to aggregate of US$390 million equivalent, consisting of a loan to NPC of US$200 mil- lion, a loan to PNOC of US$150 million, and a loan to the Republic of the Philippines of US$40 million. Lending Terms: Three loans repayable over 20 years, inc]uding five years of grace, at the Bank's standard variable interest rate. On-lending Terms: The Government would pass on US$17.8 million of the proceeds of its loan to OEA, ERB ar.d EMB as budgetary contributions, and would make US$22.2 million available to NEA as an equity contribution. PNOC would on-lend US$147.0 million equivalent to PNOC-EDC and PETRON on the same terms as the World Bank loan, with PNOC-EDC and PETRON bearing the foreign exchange risk. Financing Plan: IBRD US$390 million Export-Im'ort Bank (Ex.mbank) of Japan US$150 million Committed loans from foreign sources US$1,170 million Internal cash and other financing US$1,799 million Total US$3,509 million Economic Rate of Return: 17Z Staff Appraisal Report: Report No. 8049-PH Maps: IBRD 21900 and IBRD 21901 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.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON THREE PROPOSED LOANS, ONE LOAN TO THE NATIONAL POWER CORPORATION, A SECOND LOAN TO THE PHILIPPINE NATIONAL OIL COMPANY, BOTH LOANS BEING GUARANTEED BY THE REPUBLIC OF THE PHILIPPINES, AND A THIRD LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR AN ENERGY SECTOR PROJECT 1. The following memorandum and recommendation on three proposed loans for an aggregate of US$390 million is submitted for approval. The proposed loans would be extended respectivelv to the National Power Corporation (NPC) in the amount of US$200 million, the Philippine National Oil Company (PNOC) in the amount of US$150 million and the Republic of the Philippines in the amount of US$40 million, at the Bank's standard variable interest rate with 20 years' maturity including five years of grace. The Republic of the Philippines will guarantee the loans to NPC and PNOC. The NPC loan, together with a US$150 million equivalent parallel financing arrangement from the Export-Import Bank of Japan (Eximbank), will finance investments in the power sector. PNOC will onlend to its subsidiaries, the Energy Development Corporation (PNOC-EDC), and PETRON Corporation (PETRON), US$147 million, and the balance of US$3 million will be used by PNOC itself on institutional strengthening. The loan to the Republic will be allocated to the Office of Energy Affairs (OEA), Energy Regulatory Board (ERB), and the Environmental Management Bureau (EMB) in the form of budgetary support, and to the National Electrification Administration (NEA) in the form of equity contribution. 2. Background. The Philippine economy is going through a major restructuring and reorientation. During the 1970s, economic growth was rapid but distortions in the incentive systems produced inefficient patterns of investment, slow growth in employment, high rates of inflation and low levels of domestic savings. Heavily dependent on imports and foreign capital, the economy did not adjust well Lo the external shocks of the Post-1979 period and experienced declining growth rates, a deteriorating balance of payments and a large accunmulation of external debt. Political instability and a global recession led to a payment crisis, forcing the Government to embark on a major stabilization effort in 1983. Overall, the stabilization program has been successful and has provided a basis for a healthy recovery, starting with impressive growth rates of 5.7% and 7.OZ for 1987 and 1988, respectively, and a good outlook for continued growth over the next several years. 3. The energy sector faces a number of challenges as the country refocuses its efforts on sustained economic growth. First, energy demand, which had consistently declined during 1979-85, has erperienced a growth of about 40% during 1986-88; this indicates an immediate need for the expansion of energy supply capabilities, particularly power generating capacity. Second, the productive capacity of the energy sector, which was adversely affected by the limitations imposed by the stabilization program on investment and maintenance expenditures, was further reduced by a Government decision in 1986 to mothball the 620 MW nuclear power plant. Third, erratically  - 2 - fluctuating international energy prices have introduced considerable uncertainty regarding the economics of domestic energy and the development policy of the energy sector. Fourth, the Government's decision in 1986 to abolish the Ministry of Energy has substantially weakened the coordination of energy sector activities, and, tn particular, has created a bottleneck in planning and timely implementation of development, pricing and operations decisions. 4. To assist the Government in addressing these issues, the Bank carried out an Energy Sector Study in 1988, which concluded, inter alia, that the country should redirect its energy strategy toward rapid development of geothermal resources. The study also developed specific recommendations regarding investment, pricing, finance, operational efficiency and sector coordination. The Government is now seeking the Bank's assistance to implement an action program aimed at pursuing these recommendations e.s well as further policies in privatization, energy regu.ation, energy demand management and environmental monitoring of the energy sector. 5. Rationale for Bank Involvement. The energy sector, especially the power subsector, is viewed as a key bottleneck to sustaining the economic recovery, begun in the last two years. The sector impinges on economic growth in three ways: first, the present generating capacity is insufficient to meet increasing electricity demand; second, the sector is so capital- intensive that it is likely to drain a large portion of the economy's resources; and third, the high cost of energy in the Philippines adversely affects the international competitiveness of the country's industrial sector. Therefore, a comprehensive plan to develop productive capacity while increasing the efficiency of resource allocation, utilization and mobilization is crucial to the sector. The changes agreed under the proposed project are fundamental in nature and wide ranging in scope. These qualitative changes will help create an environment for optimizing returns on investment in the energy sector. Further, through its past operational involvement and in the course of preparing the Energy Sector Study, the Bank has developed a constructive relationship with various sector entities which has been important in facilitating coordination among them. Consequently, the Govern- ment, with the assistance of the Bank, prepared a comprehensive statement of its strategy in developing the country's energy supply with due regard to strengthening the technical capabilities of the sector entities, fuller development of domestic resources, increasing efficiency and improving competitiveness within the energy sector. The policy component of this strategy, which has been translated into a detailed action plan (SAR, Annex 3.2), fits well into the Bank's overall strategy for the country for revitalizing economic growth and improving the efficiency of public corporations. The investment component of the strategy supports the Govern- ment's macro-economic objectives by providing much needed investment funds in order to meet the increasing energy needs for economic recovery. 6. Project Objective, Description and Implementation. The proposed project would help finance the first phase of a reoriented development strategy for the Philippines energy sector aimed at minimizing the cost of energy supply. The components of this strategy are: (a) a least-cost investment program wnich has been agreed upon by all participating agencies;  - 3 - (b) development of a sector-wide capability to plan and coordinate policy and project implementation in the energy sector; (c) encouragement of private sector participation through joint-ventures, build-operate-and-transfer schemes, etc.; (d) consolidation of regulatory activities into an integrated system for monitoring the quality of service and consumer prices of petroleum, coal and electricity; (e) implementation of long-run marginal cost pricing for electricity; (f) development of technical capabilities to assess, manage and monitor the environmental impact of energy projects; and (g) implementation of measures to improve operational efficiency of the power sector by reducing electricity losses and rehabilitating aging plants. 7. The proiect would comprise components from the least cost investment program for the 1989-93 period, including: (a) NPC's investments in generation and transmission amounting to US$2,722 million; (b) PNOC's investments in geothermal resource appraisal arnd development, and debottle- necking of refinery facilities amounting to US$741 million; (c) a US$26 million component of the National Electrification Administration's (NEA) rehabilitation and loss reduction program; and (d) the institutional strengthening programs of the Office of Energy Affairs (OEA), the Energy Regulatory Board (ERB) and the Environmental Management Bureau (EMB). The total investment program which would qualify for partial financing under the sector project is US$3,509 million, of which the foreign cost component is about US$2,455 million. In order for the pa:rticipating agencies to utilize effectively other sources of financing, flexibility has been provided to revise the list of investments to be financed by the loan on an annual basis, from within the overall agreed sector investment program and to seek optional financing packages while pursuing Bank's ptocurement guidelines. The World Bank and Eximbank loans to NPC and the World Bank loan to PNOC may also be utilized to finance the shares of NPC and PNOC in investments in joint ventures and other schemes with the privatf sector provided that Bank procure- ment guidelines are followed. Retroactive financing up to US$23 million is recommended to cover expenditures on eligible goods and services incurred after April 30, 1989. OEA would supervise the timely implementation of the development strategy and consolidate the monitoring activities of the invest- ment program. A Project Implementation Committee, with members from all participating agencies, will be established to monitor the implementation of project components. Components, notably from PNOC and NPC investment programs and totalling around US$100 million, are already at an advanced stage of design and bidding preparation. 8. A breakdown of the project costs and the financing plan are shown in Schedule A. Amounts and methods of procurement and disbursement, and Lhe disbursement schedule are sho-.n in Schedule B. A timetable of key project processing events and status of Bank Group operations in the Philippines are given in Schedules C and D, respectively. Two maps are attached. The Staff Appraisal Report, No. 8049-PH, is being distributed separately. 9. Agreed Actions. During negotiations, agreements and understandings were reached that: (a) the Government will implement the proposed energy policy and its corresponding action plans according to a schedule agreed with the Bank; (b) NPC and PNOC will conduct, in consultation with the Bank, an annual review and update of their investment plans for the forthcoming year  - 4 - and the following four years; (c) NPC will implement no later than December 31, 1990 the first phase of a marginal-cost pricing system; (d) NPC and PNOC will maintain catisfactory financial performance in accordance with the financial covenants agreed with the Bank; (e) no later than June 30, 1990, NPC and PNOC will prepare training programs for their staff in engineering, operations and maintenance, and management; and (f) PNOC will appoint independent international consultanto to assist in geothermal assessment and implementation of the petroleum component of the proposed project. During negotiations, the Government confirmed the understanding that to improve environmental assessment of energy projects, the Department of Environmental and Natural Resources will be invited to provide input at an early stage of project preparation. The Government confirmed also the understanding that a Project Implementation Committee will be established prior to the date of loan effectiveness. 10. Environment. All investments financed under the project will be eyscuted with due concern for their environmental impact. Environmental impact assessment reports will be prepared by the implementing agencies for each subproject after the completion of the feasibility study and prior to design and bidding preparation. The Bank will review each environmental impact study before agreeing to the use of IBRD resources for the corresponding subproject. The subsequent compliance certificate to be issued by EMB on completion of each subproject will also be reviewed by the Bank. In addition, the project would assist the Government in (a) rationalizing environmental monitoring activities by establishing clear roles for NPC, PNOC and the newly formed EMB; and (b) strengthening the institutional and technical capabilities of the EMB to carry out its monitoring tasks. The Bank is expected to play a major role in the design and implementstion of the streamllned environmental monitoring system by reviewing the current practices and assisting the Government to establish a coherent program of action. Benefits 11. Risks. The project provides for development of 610 MW of geothermal resources, 1,650 MW of power generating capacity and substantial expansions in transmission and distribution systems during 1989-93. The physical risks in the achievement of this capacity is small, limited to the low probability that the steam reserves in the Luzon fields to be commissioned during this period could turn out to be smaller, after field appraisal, than presently estimated on available geoscientific data. However, there are two areas of concern regarding the implementation of the project and disbursement of the loans. First, there is an overall concern with regard to the implementation capability of various agencies in view of the fact that most of the agencies have not had significant investment projects during the last five years; this risk has been minimized by careful preparation of implementation schedules, creation of a Project Implementation Committee and a plan for project super- vision by the Bank. Sezond, there is some uncertainty with regard to the availability of other scurces of financing and therefore with regard to the disbursement schedule of the loan. By design, the proposed mode of operation provides that for certain items the beneficiaries may search for other sources of financing while minimizing the cost by using International Competitive Bidding. As a result, the Bank loan may be disbursed more slowly  - 5 - or faster than scheduled depending on the availability of other financing sources. 12. Recommendation. I am satisfied that the proposed loans would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loans. Barber B. Conable President Attachments Washington, D.C. November 22, 1989  Schedule A PHILIPPINES ENERGY SECTOR PROJECT Estimated Proiect Costs and Financing Plan Project Costs Local Foreign Total ------------