India - Private Power Utilities Project (BSES) for Bombay Suburban Electric Supply Limited

Cocument of The World Bank International Finance Corporation FOR OFFICIAL USE ONLY Report No. 9499-IN IFC/T-1095 STAFF APPRAISAL REPORT INDIA PRIVATE POWER UTILITIES (BSES) PROJECT FOR BOMBAY SUBURBAN ELECTRIC SUPPLY LIMITED MAY 15, 1991 The Wnrld Bank Asia - Country Department IV (India) Transport and Energy Operations Division International Finance Corporation Department of Investments, Asia II Division 1 ls 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/IFC authorization.  CURRENCY EQUIVALENTS (As of February 1991) Currency Unit Rupees (Rs) Rs 1.00 Paise 100 US$1.00 = Rs 19.00 Rs 1.00 - US$0.0526 MEASURES AND EQUIVALENTS 1 Meter (m) 39.37 inches (in) 1 kilo-Ampere (kA) 1,000 Amperes 1 Kilometer (km)3 1,000 meters (m) = 0.8214 miles (mi) 1 Cubic Moter (m ) _ 1.31 cubic yard (cu yd) = 35.36 cubic feet (cu ft) 1 Ton (t) 1,000 kilograms (kg) = 2,200 pounds (lbs) 1 Kilocalorie (kcal) 3.97 British Thermal Units (BTU) 1 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 Kilowatt-hour (kWh) 1,000 watt-hours 1 Megawatt-hour (MWh) = 1,000 kilowatt-hours 1 Gigawatt-hour (CWh) 1,000,000 kilowatt-hours ABBREVIATIONS AND ACRONYMS AEC - Ahrmedabad Electricity Company LIC - Life Insurance Corporation BEAG - Bombay Environmental Action Group LRMC - Long Run Marginal Cost BEST - Bombay Electric Supply and Transport LSHS - Low sulphur heavy stock EHEL - Bharat Heavy Electricals Ltd. H?CB - Maharashtra Pollution Control Board BOOT - Built, own, Operate and Transfer MRTP - Monopolies and Restrictive Trade BSES - Bombay Suburban ELectric Supply Company Practices CEA - Central Electricity Authority MSEB - Maharashtra State Electricity Board CESC Ltd. - Formerly Calcutta Electricity Supply NEERI - National Environmental Engineering Corporation Research Institute CHD - Chairman Managing Director NGO - Non-Government Organization OCL - Develcpment Ccnsultants Limited NHPC - National Hydroelectric Power Corporation DESU - Delhi Electricity Supply Undertaking NOx - Nitrogen oxide (subscript NOx) DOC - Department of Coal NPTC - National Power Transmission Corporation DOEF - Department of Environment and Forests NTPC - National Thermal Power Corporation DCP - Department of Power P-R - Project Completion Report DTEPG - Daharu Taluka Environmental Protection PFC - Power Finance Corporation Group REB - Regional Electricity Board EIA - Envirormentat Impact Assessment REC - Rural Electricity Corporation ERR - Economic Rate of Return SEB - State Electricity Board ESP - Electrostatic Precipitator SEC - Surat Electricity Company FAC Fuel Adjustment Charge S02 - Sulphur Dioxide (subscript SOZ) FGD - Flue Gas Desulphurization TCE - Tata Consulting Engineers GM - General Manager TCS - Tata Consultancy Services GOI - Government of India TDP - Tribal D^velopment Plan GOM - Government of Maharashtra TEC - The Tat lectric Companies IciCt - Industrial Credit and Investment THE ACT - Electric-cy Supply Act of 1948 Corporation of India THE LICENSE - Bombay Suburban Electric License 106l - Industrial Development Bank of India TPP - Thermal Power Plant IFCI - Industrial Finance Corporation of India tpy - tons per year IPR - Industrial Policy Resclution UP - Uttar Pradesh LCB - Local Ccmpetitive Bidding UTI Unit Trust of India Guarantor's and Borrower's Financial Year: April 1 - March 31 (In this report FY.. refers to the Guarantor's and the Borrower's fiscal year, which runs from April 1 of the previous year to March 31 of the indicated year; for example FY92 would mean the fiscal year from April 1, 1991 to March 31, 1992).  FOR OFFICIAL USE ONLY INDIA PRIVATE POWER UTILITIES (BSES) PROJECT Lo n/Investment and Proiect Summarv Borrower: Bombay Suburban Electric Supply Limited (ESES; the Company). Guarantor: IBRD Loan: India, acting by its President. The Government of India (GOI) would charge a guarantee fee of 2.75Z p.a. on the principal amount of the IBRD Loan withdrawn and outstanding. IBRD Loan: US$200 million equivalent. Terms: Repayment over 20 years. including five years of grace, at the IBRD standard variable interest rate. IFC Investment: A Loan: US$50 million equivalent (for IFC's own account); B Loan: Up to US$18 million equivalent (for the account of participants). Terms: A Loan: Fixed interest rate of 10.75Z p.a. Front-end fee 1S. Commitment fee 1 p.a. on the undisbursed balance. Repayment in 20 semi-annual installments of US$2,500,000 due from September 15, 1996 through March 15, 2006. B Loan: Syndication fee: 0.50? of the amount syndicated payable to IFC. Administration fee: US$2,500 per participant in IFC's B Loan, payable semi-annually to IFC; however, the total Administration fee not to exceed US$15,000 annually. Other terms to be negotiated. Overall maturity of 15 years, including five years of grace. The maturity of the B Loan is expected to be shorter than the maturity of the A Loan; in that event, the repayment installments of the A Loan will be adjusted so that the aggregate repayments for the A Loan and B Loan are approximately US$6,800,000 per year. Foreign Exchange and Interest Risks: The interest rate risk on the IBRD loan, and the foreign exchange risk on IBRD loan and IFC investment will be borne by the Borrower. Mortgage and Security: IBRD loan and IFC investment wili be secured against first charge on all of BSES's assets, subject to certain prior charges on current assets in favor of working capital lenders, pari passu with other senior lenders. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  -ii Prolect Objectivest The Project's objectives are to provide additional generation, transmission and distribution capacity to meet increasing electricity demand in the Borbay area, maintain good service quality provided to BSES's consumers, support GOI's endeavors to increase private sector participation in the supply of power, and assist BSES in its transformation from a distribution company to an integrated power utility which operates generation, transmission and distribution facilities. Project Description: The Project comprises: a) a power plant comprising two 250 MW coal-fired units located at Dahanu, including a flue gas desulphurization plant (FGD) as mandated by GOI's environmental clearancl; b) two double circuit 220 kV transmission lines of about 105 km, to transmit power from Dahanu to BSES's license area, and three 220/33 kV receiving stations; and c) strengthening and extension of BSES's 33 kV and 11 kV subtransmission and distribution system. Estimated Cost: a/ Local Foreign Total Project Components ----------us$---------- I. Dahanu Thermal Power Plant b/ 238.8 134.1 372.9 II. 220 kV Transmission Lines and Substations 23.0 23.1 46.1 III. Strengthening and Extension of BSES's Subtransmission and Distribution System 57.9 - 57.9 Total Base Costs 319.7 157.2 476.9 - Physical Contingencies 22.4 8.0 30.4 - Price Contingencies 12.5 14.3 26.8 Total Contingencies 34.9 22.3 57.2 Total Project Cost 354.6 179.5 534.1 Working Capital Margin and Debenture Issue Expenditures 1 6 - 12.6 Interest During Construction (IDC) - IBRD and IFC Loans - 63.2 63.2 - Other 43.4 - 43.4 Total - IDC 43.4 63.2 106.6 Total Financing Required 410.6 242.7 653.3 ==Wu=== YD =XX=_== 0==u3- a/ Including taxes and duties of about US$42.3 million. h/ Includes the FGD plant as mandated by GOI's environmental clearance. On account of the low sulphur content of Indian coal and the use of a 275 meter stack, the project would meet GOI, GOM and World Bank ambient air quality standards without arr FGD plant. Nevertheless, GOI required the installation of an FGD plant as part of its environmental clearance but is now reviewing whether to amend the said clearance. If GOI decides to amend the clearance to remove the FGD requirement, IBRD and IFC would not have any objection.  -iii- Financing Plan: (US$ million) Internal Accruals 65.6 Special Reserves 47.5 Fully Convertible Debenturess - First Issue 47.5 - Second Issue 69.6 Long Term Loans: - Indian Financial Institutions 155.1 - IBRD 200.0 - IFC Investment (A Loan) 50.0 - IFC Syndication 18.0 Total 653.3 Estimated Disbursements: IBRD/IFC Fiscal Year FY92 FY93 FY94 FY95 FY96 FY97 -(------- (US million) ------------------- IBRD Loan: Annual 46.5 38.0 68.2 22.4 22.4 2.5 Cumulative 46.5 84.5 152.7 175.1 197.5 200.0 IFC Investment: Annual 17.2 19.2 19.3 6.9 5.4 - Cumulative 17.2 36.4 55.7 62.6 68.0 - Rates of Return: Economic : 222 (The proposed project); 25? (1990-2000 time-slice of the Western Region Interconnected Development Program). Financial: 15? (The proposed project). Benefits: (a) Technical: The project would increase generating and transmission capacity in the Bombay area and would help to maintain BSES's good service quality. BSES's losses will be decreased following the strengthening and extension of the distribution network. (b) Institutional: Bank Group's participation would encourage greater private investment in the development of the power sector in India by mobilizing private savings for the sector. Risks: (a) Technical: The physical project components, which are based on conventional technology, do not represent unusual technical risks. The Bank Group is satisfied that all necessary measures to mitigate the environmental and social effects of the project will be implemented.  -iv- Environmental groups sought at. injunction to stop the project on the grounds that it posed undue ecological risks. This generated risks of cost overruns and loss in revenue. However, following recent rejection of the injunction request by the Supreme Court of India, it is unlikely that the case would be reopened. Possible institutional risks include the inability .f BSES to effectively manage the implementation and operation of the project. To minimize this risk, BSES has engaged competent consultants to manage the project. Furthermore, BSES's reorganization and strengthening efforts will be closely monitored. (b) Financial: BSES has been gran:ed permission to accumulate certain special reserves required in accordance with the financing plan of the project and assurances were obtained fron. GOI that it would ensure that GOM would permit BSES to collect special reserves during the operations stage as well, including special reserves for repayment of debt. With the approval of these special reserves, the project is financially and economically viable even without GOI's new policies on private investments in the power sector being enacted. The promulgation of the new incentives would generally enhance BSES's financial position. Increases in BSES's fuel costs or in Tata Electric Companies' (TEC) tariffs would be passed on to BSES's consumers as allowed under the Electricity (Supply) Act.  INDIA PRIVATE POWER UTILITIES (BSES) PROJECT Table of Contents Page No. I. SECTORAL CONTEXT ................ ........ . 1 Overview . . . . . . . . . . . . . . . . . . . . . . . 1 Organization of the Power Sector.. . . . . .* . . 3 Private Utilities .. . . . . . . . .......... ..4 GOI Strategy in the Power Sector . . . . . . . . 6 Bank G-oup Strategy in the Power Sector . . . . . . . . . . . . . . 7 Bank Group Participation.. . . . .* . . . 8 II. THE BORROWER.. . . . . . . . . . . . . . 9 Introduction ...................... . . . ... 9 BSES's Activities . . . . . . . . . . . . ... . . 10 Ownership.. . . . 11 Organization and Management .11 Maintenance. ..i... 12 Accounts and Audit 12 Billing and Collections . . . . . . . . . . . . . . 2 Insurance . . . . . . .. . 13 Income Tax .. . . . . . . . . . . 13 Dependence on TEC and MSEB . .......... .. .. . . .. 13 This report is based on the findings of a joint IBRD and IFC appraisal mission to India in February 1991. Mission members from IBRD were Messrs. A. Ceyhan (Senior Power Engineer), C.K. Teng (Financial Analyst) and Mrs. M. Manzo (Energy Specialist); and, from IFC Messrs. D. Lilaoonwala (Investment Officer) and H. Riddle (Chief, Environmental Unit). Mr. S. Guggenheim (Anthropologist) contributed to the report. The report has been reviewed by Messrs. J. Besant-Jones (Principal Energy Economist), E.W. Moore (Consultant) and T. Storm van Leeuwen (Senior Financial Analyst) of IBRD, and R. Gale (Principal Regional Economist) and D. Fenton (Principal Engineer) of IFC. The report was endorsed by Messrs. H. Vergin (Director, Asia, Country Department IV - India) and J.F. Bauer (Chief, Transport and Energy Operations Division, Asia, Country Department IV - India) for IBRD, and Messrs. J. Kassum (Director, Department of Investr.ants - Asia II) and A. Tharmaratnam (Divisional Manager, Division I, Department of Ini'estments - Asia II) for IFC.  -i i.- ~ ~ ~ ~ ~ t8e III. THE PROJECT.. . . ........ . . . 14 Project Objectives .. .......... . . . .. . ... . 14 Project Description ....... .. ...... . . . . . . . . 14 Cost Estimates . . . . . . . . . . . . . . . . . . * . . . 15 Basis for the Estimates . . . . . . . . . 15 Project Financing ........ ..... . . . . . . . . ... 16 Project Implementation Schedule ..... . . . . . . . . . . . 17 Status of Engineering and Project Management . . . . . . . . . . 18 Procurement . . . . . . . ....... . . . . . . 19 Disbursements from the IBRD Loan . . . . . . . . . . . . . . . . 20 Security Arrangements ....... . . . . . . . . . . . . . . . 20 Fuel Supply for the Dahanu Thermal Power Plant . . . . . . . . . 21 Water Supply .... . . . . .. . .. . 22 Land Acquisition .... . . . . . . ..... ........ . 22 Environmental and Social Aspects . . . . . . . . . .. . .. . 23 Project Benefits .... . . . . . . . . . .. .. . . .. . . 29 Project Risks . . . ... . . 30 Project Monitoring and Supervision . . . . . . . . . . . . . . . 30 IV. FINANCIAL ANALYSIS ..... ........... . 30 Special Reserves and Approved Institutions Status . . . . . . . . 30 Past and Projected Financial Performance . . . . . . . . . . . . 31 Financial Internal Rate of Return.. . . . . . . . 32 Sensitivity Analyses.. . . . . . . . . . . . 33 V. ECONOMIC ANALYSIS.. . . . . . . . . . . . ..33 Western Region Market Profile... 34 BSES Market Base ...... . . 35 Least-Cost Analysis . . 35 Program Analysis . . . . . . . . . . . . . . . . . . . . . . . . 36 Project Economics ...... . . . 37 VI. AGREEMENTS AND RECOMMENDATION. . . . . . . . . . . . . . . . . . 38 Agreements Reached between IBRD, and GOI and BSES . . . . . . . 38 Agreements Reached between IFC and BSES . . . . . . . . . . . . . 39 Recommendation . . . . . . . . . . . . . . . . . . . . . . . . . 39  -ili- ANNEXES 1.1 All-India: Electricity Supply and Demand and Energy Consumption by Main Consumer Category 1.2 Comparison of Average Tariffs 1.3 Previous Loans and Credits to Indian Power Sector 2.1 BSES Electricity Sales and Consumption Pattern 2.2 BSES Corporate Organization Structure 2.3 BSES Project Management Structure 2.4 BSES Power Purchase from TEC 3.1 Project Description 3.2 Project Cost Summary 3.3 Project Implementation Schedule 3.4 Engineering and Management Consultants Employed by BSES 3.5 Procurement Arrangements 3.6 Procurement Schedule 3.7 Schedule of Disbursements for IBRD Loan and IFC Investment 3.8 Statement of BSES's Secured Borrowings 3.9 Main Characteristics of the lb Valley Coal 3.10 Executive Summary of the Environmental Assessment Document 3.11 Environmental Monitoring Plan and Ongoing Additional Baseline Studies 4.1 BSES's Income Statements 4.2 BSES's Balance Sheets 4.3 BSES's Statements of Sources and Uses of Funds 4.4 Estimation of Financial Internal Rate of Return 4.5 Sensitivity Tests 4.6 Main Assumptions for Financial Projections 5.1 Western Region Power and Energy Demand 5.2 Western Region Interconnected Power System 5.3 Estimation of Consumer Surplus 5.4 Western Region Expansion Program -- Summary of Assumptions 5.5 Results of Sensitivity Analysis of Western Region Program 5.6 Energy Dispatch from Dahanu Thermal Pcwer Plant to the Western Grid 5.7 Estimation of the Project's Economic Internal Rate of Return -- Summary of Assumptions 5.8 Results of Sensitivity Analysis for the Proposed Project 5.9 Evaluation of Combinied Cycle Alternative 6.1 Documents in Project File MAP No. IBRD 22938  INDIA PRIVATE POWER UTILITIES (LSES) PROJECT I. SECTORAL CONTEXT Overview 1.01 The principal challenge facing the Govermment of India (GOI) in the power sector for the 19909 is to improve the balance in sector development between efficiency improvement and supply expansion. This will require GOI to ensure that the sector's institutional development, including financial reforms, keeps pace with the physical expansion of power supplies. Even with more efficient utilization of the installed capacity, electricity demand is proiected to increase by 7 to 92 a year through 2000 and to continue to be supply constrained. To meet a higher proportion of demand and improve the quality of supply, GOI plans to install an additional 80,000 MW of capacity by the year 2000 at a cost of about US$150 billion. This is equivalent to between 252 and 302 of expected allocations under the Eighth and Ninth Plans. These enormous investment requirements would place great pressure on GOI's finances and pose many managerial and technical challenges for GOI and the State utilities. During the finalization of the Eighth Plan, these estimates are likely to be reduced due to the acute shortage of public funds. Nonetheless, the investments still represent a sizeable expansion. To satisfy this level of investment GOI recognizes that it must harness more resources and managerial skills from the private sector. 1.02 At present, India's power systems have an installed capacity of over 62,000 MW (Annex 1.1). This makes India's system comparable to those of France, the United Kingdom, and all the power systems in Sub-Saharan Africa combined excluding the Republic of South Africa. The per capita consumption of electricity in India (about 270 kWh per year) is one of the lowest in the world. In FY90, India's systems generated 245,000 GWh -- about 70% from coal stations, 25% from hydro stations, and 5Z from gas, oil and nuclear stations. Public supply has expanded quickly: in FY81 installed capacity was only 30,000 MW and generation was 104,000 GWh. Even so, India faces a shortage of peaking capacity of about 27Z, and approximately 1OX of total energy demand is left unserved. 1.03 The quality of electricity supplies also remains unsatisfactory. Interruptions and reductions in supply and voltage are common. The poor quality and unreliability of public supplies cause consumers to purchase costly back-up generating capacity which uses scarce liquid fuels. Furthermore, technical and commercial losses are about 21% of net generation. Approximately 75Z of total supplies are provided by the State Electricity Boards (SEBs) and 20% are provided by GOI-owned utilities -- principally the National Thermal Power Corporation (NTPC) and the National Hydro Power Corporation (NHPC). Private utilities, which are among the largest and most dynamic utilities in developing countries, provide less than 5X of public supplies in India. They have a combined capacity of some 2,500 MW and are presently undertaking projects that will soon add 1,200 MW to capacity, on top of the 1,000 MW commissioned since 1986. Private captive generation, which does not enter into the above statistics, is extensive, particularly in industry. It is estimated to be about 15% of public supplies.  2 1.04 In parallel with expanding supply, the sector has made some encouraging efficiency gains. For example, plant load factor has increased from 442 in FY81 to 552 in FY90. This means tha' every 1 kW of capacity now provides 1,031 kWh (272) more electricity per year than in FY81. In addition, the rate of coal consumption by power stations has been cut by about 1OZ since FY81. It now requires 720 tons of coal to generate 1 GWh, compared with 802 tons in FY81. This saves aDnroximately 13 million tons of coal annually (about 8z of the sector's total consumption) and Is worth about US$300 million/year. These improvements reflect a strengthening of plant ma....-nance and operations and are commendable in view of the deteriorating quality of coal the sector is receiving. A significant institutional gain is the one- third reduction in the ratio of employees to consumers at the power utilities. This ratio has declined from 29 employees per 1,600 consumers in FY81 to 19 employees at present. Many of the efficiency and institutional improvements may be attributed to the rapidlv expanding shares of NTPC and the private utilities in India's power system since FY83. These utilities have a much better performance than the SEBs. 1.05 Retail tariffs have increased slightly since FY821 in constant price terms. They also increased slightly as a proportion of long run marginal costs (LRMC) from about 50% to less than 60% of LRMC. Increases in real costs (particularly for fuel and wages) have largely neutralized the increases in efficiency and real tariffs. In the meantime, tariff differentials among consumer groups have widened. Industrial consumers have taken the brunt of the increases over the last ten years and their tariffs are now close to, or in cases even above, LRMC in most states. The rise in self supply of power needs by industries is attributed to this trend as well as to poor service quality. Agricultural tariffs, on the other hand, actually have fallen in absolute terms and now cover less than 102 of their supply rosts. The large financial burden agriculture already imposes on the power bystem is increasing. Partly as a result of this subsidization, agriculture's share in total consumption has grown from about 15% in FY81 to 23X in FY90, and this rise is expected to continue throughout the 1990s (Annex 1.1). A similar situation applies to the case of residential uses of electricity. 1.06 With the power sector doubling in size every eight years or so, the combined financial losses of the SEBs have been steadily increasing, even though in real terms financial losses per unit of electricity sold have been checked or even have fallen somewhat. These losses have increased from US$1.3 billion in FY81 to US$1.8 billion in FY90. Losses of this magnitude materially affect public finances and, because of late payments to suppliers, create major financial problems for NTPC, NHPC, Indian Railways, Coal Inudia, and Bharat Heavy Electricals Limited (BHEL -- the largest local manufacturer of electrical equipment). As a consequence, GOI has recently been forced to earmark central transfer assistance to these entities, funds which otherwise would have been allocated to the budgets of the delinquent states. The situation in a few states, including Maharashtra is an exception. The Government of Maharashtra (GOM) has allowed the Maharashtra State Electricity Board (MSEB) and the private utilities operating in the state to function under a satisfactory regulatory and financial environment. As a result, MSEB 1 Using FY82 figures, from 40 Paise/kWh in FY82 to 47 Paise/kWh in FY90.  3 has become one of the most efficient and financially strongest of the SEBs. It has done this partly bv setting a remunerative level of tariffs. 1.07 Notwithstanding the efficiency gains secured by the SEBs in reLent years, there is urgent need for major improvement. Key constraints remain, for example, in the lack of financial autonomy for publicly owned utilities, and in the poor financial discipline of the utilities. Physically, these constraints cause India's power systevs to provide less power and power of a poorer quality, at higher cost, than they otherwise would be able to provide. The economic costs of shortages and poor quality supply are exacerbated by inefficient end-use of power. The latter result from P lack of commercial incentives in many markets and subsidized power prices. GOI is aware of these problems and has taken steps to alleviate them. 1.08 In response to the serious difficulties of the SEBs, GOI has relied increasingly on the central generating companies and private utilities for the expansion of supply. Since commissioning its first generating unit In FY83, NTPC has raised its capacity tenfold -- to about 10,000 MW. GOI recently set up the Power Finance Corporation (PFC) to finance those SEBs that are willing to undertake, with their state governments, needed financial and institutional reforms. GOI has caused the relatively more efficient central utilities (particularly NTPC) to improve cost recovery and ensure that priority projects are implemented on schedule. CMI has recently established the National Power Transmission Corporation (NPTC) to rationalize the construction and operation of India's bulk transmicsion systems. GOI also plans to establish Regional Tariff Advisory Committees. These committees will provide advice to state governments, SEBs and central generating utilities on the level and structure of tariffs needed to assure the financial viability of all agencies in the sector. GOI also plans to stimulate private sector involvement in power supply, in order to achieve the desired expansion of capacity, recognizing resource constraints and the continuing need to increase efficiency. To rap private sector potential for additional resource mobilization, in :;d-1990 GOI formulated a policy package containing incentives for potential local and foreign investors (para. 1.15). The package foresees amendments to the existing legislation which would remove many of the financial and .egulatory disincentives to private investment in the sector. GOI also is reviewing its fuel use policy for the sector. For example, 8,000 MW of gas-fired plant is to be added under the Eighth Plan. Organization of the Power Sector 1.09 Responsibility for electricity supply is shared between GOI and the States. Through the Department of Power (DOP) of the Ministry of Energy, GOI controls the Central Electricity Authority (CEA), NTPC, NHPC, the Rural Electricity Corporation (REC), and, through CEA, the Regional Electricity Boards (REBs). DOP also controls PFC and the newly-created National Power Transmission Corporation (NPTC). CEA's tasks are to develop a national power policy and coordinate sector development. Its effectiveness, however, is severely limited by shortages of financial and human resources. NTPC and NHPC are bulk supply utilities which sell power to the SEBs. NTPC provides about 13? of India's total power supplies, and has a track record of efficiency and financial strength. NHPC has yet to enjoy the same success and is developing relatively slowly. REC plans and finances most investments in rural electrification. The REBs coordinate dispatch and interstate power exchanges in each of the country's five regional power systems. The effectiveness of  4 the REBs presently is limited by their lack of statutory authority and by weaknesses in the structure of bulk power tariffs. This structure fails to provide incentives for rational interchanges of power within and among the regions. PFC mobilizes additional resources for the SEBs and pursues institutional strengthening of its borrowers through conditionality linked to financing. NPTC will coordinate the development and operation of transmission systems. Initially these will be systems associated with NTPC's and NHPC's power stations; later, systems owned by the SEBs also will be covered. 1.10 The States control the SEBs, which generate about 752 of electricity supplies and provide most of the distribution to final consumers. Although they are supposed to be autonomous, in practice the SEBs must obtain state approval for decisions on investments, tariffs, borrowings, salary and personnel policies. The SEBs are grouped into five regional interconnected systems. The activities coordinated regionally through the REBs include generation schedules, overhaul and maintenance programs, power transfers, and concomitant tariffs. The SEBs also license India's private power utilities and licensed local authorities. Private Utilities 1.1i At Independence, privpte utilities and licensed local authorities together provided about 80? of public electricity supply. The Electricity (Supply) Act of 1948 (the Act) created the SEBs and entrusted the Boards with primary responsibility for public powet supply. The Act also made the SEBs responsible for regulating private utilities. The Industrial Policy Resolution (IPR) of 1956 subsequently defined aspects of generation and distribution which were to be the exclusive responsibility of the states. All but the few remaining licensees consequently were taken over when their licenses expired. No new licenses have been granted since 1956. However, the IPR did not rule out expansion of the remaining licensees, or the possibility of joint ventures with the private sector when these could be shown to be in the national interest. Only five private utilities and one local authority remain; these provide about 5? of public supply. The private utilities are: Bombay Suburban Electric Supply Limited (BSES), Tata Electric Companies (TEC), Ahmedabad Electricity Company (AEC), Surat Electric Company (SEC), and CESC Ltd. (formerly Calcutta Electric Supply Corporation). 1.12 BSES is a distribution company serving the northern suburbs of Bombay. The Bombay Electric Supply and Transport Ltd. (BEST), the only remaining local authority, is a municipal corporation which supplies the southern areas of Bombay. TEC, AEC and CESC generate at least some of the powez they distribute. SEC is in charge of distribution in the town of Surat in the State of Gujarat. At present, BSES and BEST purchase their power from TEC. However, with the proposed project BSES will be generating some of its power from its 500-MW thermal power station by 1995. Unlike the SEBs, the remaining private utilities have been alio4ed by their respective state governments to operate autonomously and in a technically and financially viable manner. They have not suffered from the institutional and financial problems of the GOI-owned central entities because the powar they generate is largely fed Into their own distribution networks which _upply urban residential and industrial consumers. 1.13 The Act allows private power utilities and licensed local authorities to pass on all of their costs to consumers through tariffs. These  5 costs include depreciation (at 3.6Z p.a.) and interest plus special reserves as allowed by the State Government and plus profit equal to a 12Z return on their remunerable capital base. Special reserves, like depreciation, are charged on tariffs, thus increasing revenues. However, unlike cash costs, the special reserves are not paid out. The capital base comprises share capital and free reserves, but excludes the special reserves. The rate of return is currently set at 12? p.a. If a utility makes higher profits, it can retain only 20? of the excess. The private utilities maintain that the 12Z p.a. rate of return is inadequate. Their cost of borrowing is now 15? p.a. for long-term loans and 172 p.a. for working capital. In order to compensate for the lower return on capital base, GOI agreed to ensure that GOM will permit BSES to create special reserves through its tariffs (para. 4.01). 1.14 Tariff adjustments by private utilities are permitted annually and do not require state approval. Only 60 days notice by the licensee is required. The tariffs comprise a demand charge, a fixed component designed to recover the utility's fixed costs, and an energy charge for actual consumption, reflecting the utility'- variable cost of generation. The latter comprises a basic energy charge and _. fuel adjustment charge (FAC), reflecting the increases in the cost of fuel between two successive tariff revisions. In deciding on the amount and timing of their increases, the utilities also take into account economic and political factors (for example, the state of the economy in their area and the attitude of consumers and of the authorities). Petitions by consumers requesting stays of the increases are common, as common as the rejection of these petitions by the courts. BSES and BEST normally follow MSEB and TEC in raising tariffs (Annex 1.2). 1.15 Prospective Policy Adjustments. The serious institutional and financial problems of the SEBs and their inability to expand in line with demanc have prompted GOI to reassess the environment in which the private sectcr invests in public power supply. Several reforms were articulated in the new policies formulated by GOI in mid-1990. These reforms included: (i) an increase from 122 to 15? in the maximum allowable rate of return on the capital base for new investments; (ii) an increase in the allowed debt:equity ratio to 4:1; (iii) capitalization of the interest during construction at actual cost for the initial project as well as subsequent expansions; (iv) extension of the initial licensing period .rom 20 to 30 years and subsequent extensions for 20 years on each occasion; and (v) exemption from the clearance required under the Monopolies and Restrictive Trade Practices (MRTP) Act. 1.16 GOI is still considering an increase in the depreciation allowance which would permit the licensees not to use special reserves to bridge the gap between the debt redemption requirements and resource generation through depreciation and retained earnings, as laid down in the Act. The Act will also be amended to permit privately owned "generating cimpanies"2 to enter into contractual agreements for specified periods in order to sell power to the SEBs. The sale of power would be regulated through a two-part tariff, which would be determined in a manner so as to encourage efficient operations. Local and foreign investors would be required to provide at least 11? of the total project cost. The equity component would be at least 20? and the amount 2 The companies formed jointly by the private sector and GOI, NTPC, NHPC, or one or more State Governments or SEBs would also be considered "generating companies".  6 of financial resources to be obtained from the Indian Financial Institutions would not be more than 40Z of the total project cost. The companies also would be required to operate within the interconnected systems and to abide by the operational grid discipline to ensure optimal grid operation. 1.17 The above stipulations would serve to stimulate private sector interest in and mobilize additional funds for the power sector. However, it is not certain whether the SEBs would be able to pay for the energy bought from the "generating companies". GOI might not be suiccessful in attracting additional private investment in the power sector unless the SEBs improve their payment record, sinice the SEBs will be purchasing most of the power generated by the new ate power utilities. The new incentives also are likely to be incremert :i nature and to be sponsored by the states unevenly. The more progressivct- .'f.J, such as Haharashtra, already have a private sector presence an- encouraged the private utilities to expand by providing the incent-1 -; irmitted within the existing framework. Maharashtra undoubtedly will take the iead. Overall, it is difficult to predict how quickly private participation might increase. GOI-IBRD/IFC dialogue on the issue is under way. For BSLS, the incentives already provided by GOM within the existing legal framework are adequate to meet the financing needs of the project (para. 4.01). 1.18 The progress of reforms in the power sector has been temporarily interrupted by the change of administration and revisions in formulating the Eighth Plan. In an interim initiative before the policy changes are announced, GOI and several state governments have invited selected private investment houses to present proposals for build, own, operate and transfer (BOOT) generation projects. These projects fall within the provisions of the IPR (para. 1.11), which allows SEBs to enter into joint ventures with the private sector for projects believed to be in the national interest. New joint ventures of this type have not been launched however since the groups approached are waiting for the new legislation to be enacted. GOI Strategy in the Power Sector 1.19 The Five-Year Plan constitutes the only formal statement of India's energy and power policies. Under the Eighth Plar., the roles for energy conservation and the private sector in the supply of power are likely to be enhanced. The principal energy objectives are likely to be: (a) developing supplies at rates which will facilitate growth in other sectors and meet particular economic and social objectives assigned to the energy sector (for example, extending irrigation pumping and meeting the energy needs of the rural poor); (b) substituting indigenous energy for imported fuels wherever economically feasible; and (c) promoting rational and more efficient energy use. The objectives of the power sector are similar. The short-term objectives are likely to focus on easing supply shortages and improving financial discipline in the sertor. 1.20 Specific investment objectives under the Eighth Plan are likely to include: (a) accelerating the completion of ongoing projects, particularly hydroelectric investments; (b) encouraging the construction of energy efficient and environmentally benign gas-based combined cycle plants; (c) rehabilitating existing plants; (d) improving the quality of coal supplies through better coal preparation; (e) increasing investments in transmission and distribution relative to investments in generation; and (f) continuing the  7 modest development of nuclear power. Less clearly defined are the organizational, institutional and financial strategies needed to achieve these investment objectives. Given the magnitude of the task at hand, it is essential that GOI and the state governments tackle the sector's financial problems with renewed vigor. GOI's recent initiative in forming the PFC is expected to begin yielding results under the Eighth Plan. In line with its operational policies, the PFC is entering into agreements with the SEBs under which the SBEs commit themselves to follow action plans to improve their operational efficiency and financial position as a condition for PFC lending. Although GOI is constrained in its ability to act unilaterally in the power sector, key initiatives it is likely to pursue will be to; (a) accelerate development of the relatively efficient GOI-owned utilities; and (b) promote more extensive private sector participation in power supply. 1.21 GOI's strategy toward public and private interests in the power sector is basically sound. However, in practice the results have not been encouraging. The public utilities require substantial efforts in order to strengthen their institutional development, planning, financial discipline, resource mobilization, pricing, and load management. Bank Group Strategy in the Power Sector 1.22 In recent past, IBRD followed a three-pronged btrategy in its lending operations in the power sector in India. As a means to effect sector- wide improvements, it supported agencies owned by GOI. It also supported a selected number of SEBs whose managements and state governments were committed to reforms. In addition, and in close cooperation with IFC, it provided support to existing private power utilitias to improve their financial and economic efficiency, and to encourage GOI to lower eutry barriers for new investors. IFC has approved loans to three of the five private utilities over the past two years. In dealing with both public and private utilities in India, IBRD and IFC are also promoting more comprehensive and vigorous analyses of environmental inputs in project design and improved implementation of project components which support the environment. Through syndications, IFC proposes to mobilize additional resources for the power sector. 1.23 IBRD's support for the central agencies has provided many opportunities for institutional strengthening. IBRD helped NTPC to grow into one of India's model utilities and in the process IBRD also helped to improve operational efficiency nationwide. However, GOIPs and our efforts to develop the power sector into an efficient and commercially viable part of the economy have fallen considerably short of the objective, mainly because of the SEB's weak institutional and financial performance. The pervasive nature of the sector's constraints and the relative autonomy of the states limit what can be achieved through involvement exclusively with central agencies. Beginning in the mid-1980s, IBRD emphasized direct involvement with state governments and SEBs, attempting to influence selectively the commercial orientation of the Boards. Tariffs and financial performance will continue to be key components of IBRD's sector strategy. However, these are also the areas in which progress is most difficult to achieve since the state governments at this time would rather provide additional financial support to the SEBs than impose unpopular tariff increases. 1.24 IBRD's close lending relationship with the SEBs has been successful in the case of the stronger SEBs, such as MSEB, which has shown  8 improved efficiency, financial performance, and willingness to innovate. It was always recognized that projects with institutionally and financially weaker SEBs would carry a correspondingly higher risk, as shown by the following actions which have had to be taken due to poor performance: (a) in 1989, the loan to Delhi Electric Supply Undertaking (DESU) was cancelled; (b) in April 1991, disbursements under the Uttar Pradesh (UP) Power Project were suspended; and (c) the SEBs in the States of Karnataka, Kerala and Himachal Pradesh have been advised that disbursements would have to be suspended unless tariff actions to meet the financial covenants are taken. Furthermore, in response to SEBs' continued poor payment records on their bulk power purchases which are now seriously straining NTPC's finances, IBRD hae alerted GOI and NTPC that our continued funding to their projects would no longer be possible unless actions to correct NTPC's finances are taken. In view of the severity of the sector's financial problems and the adverse repercussion on the fiscal deficit, IBRD will now have to apply the legal remedies available whenever the SEBs and central entities are unable to comply with the rate of return covenants and with their other commitments to the IBRD. 1.25 Due to the sector's institutional and financial problems, IBRD is at this time refraining from further commitments to central agencies, including proposed loans to NTPC (US$375 million) and to PFC (US$265 million) which had been fully negotiated and scheduled for FY91. Unless power tariffs are increased in real terms, bill collection is improved, and the management of the SEBs is strengthened, lending for power projects will be substantially reduced and will be limited to support for: (i) viable private sector investments in generation and transmission; (ii) the few better managed and financially stronger SEBs; and (iii) innovative, small scale developments such as mini hydro and cogeneration schemes. In addition, IBRD intends to continue its dialogue with NTPC and may finance the most critical components of this important agency's core investment program. 1.26 IBRD will also continue to pursue the following key objectives: (a) assist the Indian power sector with development of a strategy to address in a uniform and co-ordinated way the environmental and sociological aspects of power development (including through a proposed loan to mini-hydro and alternative energy development which are likely to receive support from the Global Environment Facility); and (b) support developments requiring coordinated actions within and outside the power sector -- priority areas being improving coal quality and transport. Bank Group Participation 1.27 IBRD has made 31 IBRD loans (US$6.3 billion) and 18 IDA rredits (US$2.3 billion) for power projects in India (Annex 1.3). Twenty-seven projects have been completed: 20 for generation; 4 for transmission; and 3 for rural electrification. Ongoing projects include nine for generation (three of which are for hydro power plants); three for transmission; and seven which include a mix of generation, transmission and distribution. Five of the IBRD loans have been extended to one private utility (TEC), in 1954, 1957, 1979, 1984 and 1990. The implementation of Bank power projects in India has proceeded broadly according to expectations. However, loan and credit disbursements continue to show large outstanding balances (US$3,965.7 million, as of February 28, 1991). These are due primarily to the very long construction periods for generation projects compounded by frequent delays in procurement and in foreign exchange and import license clearances by the  9 various ministries, and the increasing number of projects under implementation. Undisbursed balances have been pushed up further by frequent cost under-runs on major equipment contracts. The latter are due to the softening of international markets in the mid-1980s and the rapid real devaluation of the Rupee. 1.28 IFC has made four investments totalling US$153 million to three of the five priva e power utilities in India. These investments were made in AEC and TEC in FY89, and in TEC and CESC in FY90. All the projects are progressing satisfactorily. 1.29 Bank Group participation in these projects has strengthened the financial performance of these borrowers, by bringing in additional financing and encouraging improvements such as the extension 3f operating licenses and the establishment of special reserves. Joint preparation of the proposed project by IBRD and IFC underscores the commitment of the World Bank Group to the development of private power supply in India. The association has been fundamental in advancing the Group's dialogue with GOI on regulatory and other constraints to extended private sector participation in public power supply (para. 1.15). 1.30 The Project Completion Report for IBRD's most recently completed private utility project in India, the Third Trombay Power Project (Loan 1549- IN) executed by TEC, rates the project a success, even though there wore cost increases and implementation delays, because an unsatisfactory contractor had to be replaced. The financial performance of the utility remained satisfactory throughout project implementation because GOM diligently allowed TEC to continue to collect the special reserves permitted under the Act. II. THE BORROWER Introduction 2.01 BSES is a corporate entity governed by the Companies Act of 1956. Its electricity distribution business is governed by the Indian Electricity Act of 1910, and the Electricity (Supply) Act of 1948. BSES is licensed to distribute electricity in the northern suburbs of Bombay. The Bombay Suburban Electric License, 1926 (the License), initially was granted by GOM to Messrs. Killick, Nixon and Company Limited. The License was assigned to BSES in 1930, and the management of BSES remained with Messrs. Killick, Nixon and Company Limited under a managing agency agreement. In 1970, the system of managing agency was statutorily abolished and majority control was transferred to the Life Insurance Corporation (LIC), General Insurance Corporation (GIC) and its subsidiaries, and the Unit Trust of India (UTI). The management of the Company was taken over by a professional Board of Directors comprising representatives from the LIC, GIC, UTI, GOM, and public shareholders. The License was,init5ally valid for 50 years. In 1976, GOM extended the License for 10 years on the condition that BSES install a 500 MW generation project in Maharashtra to meet the growing power requirements in the company's license area. By initiating actions to build the generation project, BSES got GOM to extend the License to 1993. 2.02 GOM has the option to revoke the License if BSES fails to comply with its terms and conditions. It is very unlikely that GOM will revoke the  10 License, given the growing requirement of power and prevailing power deficit in the state, and the emphasis on increased private participation in power supplies. Nevertheless, GOI agreed to ensure that GOM will extend BSES's license at least up to August 15, 2011, the maturity of the proposed IBRD loan. This is a condition of effectiveness for the loan (para. 6.03.a). Furthermore, GOI agreed to ensure that GOM will not take any actions that would adversely affect BSES's operational performance or financial position, including restricting BSES's license or supply area (para. 6.01.b.i). BSES's Activities 2.03 BSES has a solid customer base. This base has grown from about 1,700 consumers in FY30 to about 1.2 million in FY90. The largest consumer group is made up of residential users (872). It is followed by commercial (112) and industrial (2Z) users. Residen.ial users pur hase about 44Z of energy sold, industrial users 38%, commercial users l -, and other users 2% (Annex 2.1). BSES estimates that energy consumption in its license area is increasing by 7Z to 8Z a year. 2.04 BSES's record in the availability and reliability of electricity supply is good. This is primarily due to proper maintenance and upgrading of its distribution system. BSES's physical assets for electricity supply include an installed power transformer capacity of about 679 MVA. This capacity serves a maximum system demand of 618 MVA. BSES also has about 1,437 km of HT cables, 1,671 km of LT cables, 7 bulk supply receiving stations, and over 2,257 substations. The proposed project would help BSES to reduce its dependence on purchased power as demand grows over time. During the first full year of its operation the proposed Dahanu power plant would meet 40% of the requirements of BSES's license area. After ten years the plant would provide about 35Z of requirements. 2.05 In addition to electricity distribution, BSES has diversified into other areas of businesb. In 1966, it entered into the field of electrical contracting. The following year 4t entered into computer services. BSES's contracting business encompasses the installation of power stations and auxiliary equipment, and the construction of transmission lines for the SEBs, including contracts in Saudi Arabia and Bhutan. In FY90 contracting business accounted for about 5.82 of BSES's revenue. 2.06 BSES's Computer Service Department has computerized its billings to customers, inventory control, materials management, payroll, shares and fixed deposit accounting, and some aspects of project costing. With its experience in software development and the successful computerization of much of its accounting functions, BSES began marketing its services to other power utilities. To date, it has completed management information systems (MIS) work for the SEBs, private utilities, financi-l institutions and other corporations, including an assignment in the Middle East. Receipts from the computer services business amounted to about 0.5Z of BSES's revenue in FY90. Since these services are not regulated by the Electricity (Supply) Act, the profits associated with these services increase the returns to BSES shareholders.  11 Ownership 2.07 As of FY91, BSES's share capital is owned by about 9,000 shareholders. Equity shares held by the Life Insurance Corporatioa (LIC) amount to 21.4Z of the total, while 19.9? is held by the General Insurance Corporation (GIC) and its subsidiaries. Eighteen percent is held by the Unit Trust of India (UTI), a mutual fund that raises funds from the public through sales of units and invests them in companies on a portfolio investment basis. Four percent is owned by other mutual funds, 8Z by other corporate bodies, and the balance 28.3? by private individuals (Table 2.1). The largest individual shareholding is 7Z. Table 2.1: BSES's Shareholders as of FY91 Percent of Shares Life Insurance Corporation (LIC) 21.4 General Insurance Corporation (GIC) and Subsidiaries 19.9 Unit Trust of India (UTI) 18.1 Sub-total 59.4 Other Mutual Funds 4.1 Other Corporate Bodies 7.7 Nationalized Banks 0.5 Individuals (About 9,000) 28.3 Total 100.0 2.08 Part of the financing for the proposed project will be raised through two issues of convertible debentures totalling Rs 2,500 million. The first issue of about Rs 1,000 million was made in April 1991. This comprised 8,000,000 debentures with individual face value of Rs 125. These debentures will be convertible one year later into five equity shares with individual face value of Rs 10, i.e., representing a premium of Rs 15 each. The issue was oversubscribed by about ten times. BSES is permitted to retain Rs 150 million out of the oversubscribed portion. As a result of the conversion of the first issue of debentures into equity shares in 1992, the number of individual shareholders is expected to increase to over 150,000 and the shareholdings of the insurance companies and UTI will drop from 59Z to about 51Z. Further reduction in the institutional shareholding is expected to occur after the project is completed. Organization and Management 2.09 BSES is managed by a Board of Directors. This board includes a Chairman-Managing Director (CMD), one director each from LIC, GIC, UTI and ICICI, one GOM representative, two directors nominated from private shareholders, and two functional directors. The present CMD has more than 30 years of experience in the electric utility business. He is assisted by two competent functional directors, one for Finance and one for Technical matters. 2.10 BSES's organization has been restructured with the assistance of management consultants satisfactory to IBRD and IFC (Tata Consultancy Services - TCS). This restructuring was done to meet expected demands during project construction and operation, and to respond to the company's needs for business diversification. The new structure largely reflects functional and business  12 responsibilities such as electricity generation and supply, electrical contracting and computer services, and financial affairs. In addition, BSES has created a Human Resources Development Department to oversee BSES manpower requirements, recruitment, training and vigilance. Two proactive divisions have been created to handle government liaison, environment%l issues, and external relations: the Environmental-Corporate Public Relations Division, and the local (at Dahanu) Public Relations Division. These divisions report to the Director of Generation and Supply. The Bank Group has reviewed the restructured BSES and is satisfied that its organization, staffing, and management system are adequate to properly oversee the implementation of the proposed project and to operate the power plant at a later stage (Annex 2.2). 2.11 To reinforce its capabilities in the design, engineering, implementation and management of the proposed project, BSES has retained a number of consultants satisfactory to IBRD and IFC (paras. 3.09 and 3.10). These consultants will be used to staff the Project Management Division, which will carry out overall supervision of the project. The structure and staffing of key positions in BSES's Project Management Division is satisfactory to IBRD and IFC. It is shown in Annex 2.3. 2.12 As of FY91, BSES had about 3,800 employees, about 600 of whom were professionals and 2,200 were skilled and unskilled support staff. The staffing is commensurate with the company's present business activities and the work to be generated in implementing the proposed project. Maintenance 2.13 In FY90, BSES allocated about 5O of its annual budget (Rs 254 million) to maintenance. This amount is satisfactory and is associated with a high level of service quality. BSES uses its own work force to carry out well established preventive maintenance routines on its electrical equipment and machinery. Key installations such as receiving stations, sub-stations, transformers and switchgears are maintained regularly throughout the year. The company also provides adequate resou.ces to carry out preventive maintenance of its distribution system, which consists mostly of underground cables. Accounts and Audits 2.14 BSES has a computerized accounting system which is adequate for its utility operations and other functions. An independent internal auditing unit reporting directly to the CMD reviews the accounts mainly for compliance with the Companies and Income Tax Acts. An external auditor completes BSES's audit of its annual report by July 31st of each year. BSES agreed to furnish its annual financial statements audited by auditors acceptable to IBRD and IFC, within 120 days after the end of each of its financial year. This will include annual audits of the Special Account and Statement of Expenditures (paras. 3.14 and 6.02.a). The audited reports for FY90 are unqualified and comply with the provisions of the regulatory acts. Billing and Collection 2.15 BSES has a computerized billing and collection system which efficiently serves the company's more than 1.2 million customers. Industrial consumers are billed monthly, and residential and commercial consumers  13 bi-monthly based on meter readings. BSES assesses a 32 to 42 penalty on residential consumers who fail to pay their bills within 15 days of receiving notice. Industrial consumers who fail to pay their bills and the penalty are disconnected. For residential and commercial customers, notice of disconnection is given following the second time the bill is not paid. If the bill is not paid within one month of notice, service is immediately terminated. The strict enforcement of collection policies combined with reliable service allows BSES to collect promptly from its customers. As of FY90, the company's receivables were at the equivalent of 45 days of sales. In other words, BSES has no problem with arrears. Insurance 2.16 BSES maintains insuran_e policies on its operating machinery and other assets on a cost replacement basis. These policies protect against fire, natural hazards, and machinery breakdown. BSES projects under construction are covered under marine, storage and erection policies based on their estimated contract values. BSE