Cambodia - Phnom Penh Power Rehabilitation Project

Document of The World Bank Report No. 14378-1R STAFF APPRAISAL REPORT CAMBODIA PHNOM PENH POWER REHABILITATION PROJECT SEPTEMBER 5. 1995 Infrastructure Operations Division Country Department I East Asia and Pacific Region  Currency Equivalents (At Appraisal - January 1995) Currencv Unit = Riel ) US$1.00 R 2,600 R 1,000 US$ 0.40 Weights and Measures km Kilometer (0.6214 miles) kV = Kilovolt (1.000 volts) kVA = Kilovolt-Ampere MV = Megavolt-Ampere (1,000 kVA) MVAr = Megavolt-Ampere reactive kWh Kilowatt-hour (1,000 watt-hour) GWh = Gigawatt-hour (1,000,000 kilowatt-hour) MW = Megawatt (1,000 kilowatt) Abbreviations and Acronyms ADB = Asian Development Bank CAS = Country Assistance Strategy CIF Cost Insurance Freight EDC = Electricite' du Cambodge ERP = Emergency Rehabilitation Project FAO = Food and Agriculture Organization of the United Nations GDP = Gross Domestic Product ICB = International Competitive Bidding ICR Implementation Completion Report IDA International Development Association IPP = Independent Power Producer JICA = Japan International Cooperation Agency LPG = Liquefied Petroleum Gas LV = Low voltage MEF = Ministry of Economy and Finance MIME = Ministrv of Mines, Industry and Energy MOC = Ministry of Commerce MOP = Ministry of Planning MV = Medium voltage NCB = National Competitive Bidding PCB = Poly Chlorinated Biphenols PHRD = Policy and Human Resources Development fund PMU = Project Management Unit PPA = Power Purchase Agreement ROW = Right of Way SOE = Statements of Expenditures UNDP = United Nations Development Programme UNTAC = United Nations Transitional Authority in Cambodia UJNV = United Nations Volunteer Government Fiscal Year January I - December 31  CAMBODIA PHNOM PENH POWER REHABILITATION Credit and Project Summary Borrower: The Kingdom of Cambodia Implementing Agencies: Electricite du Cambodge (EDC) Ministry of Industry, Mines and Energy (MNiIvE) Beneficiaries: Electricite du Cambodge (EDC) Ministry of Industry, Mines and Energy (MIE) Poverty: Not applicable Amount: SDR 25.8 million (US$40 million equivalent) Terms: Standard IDA terms with maturity of 40 years. Commitment Fee: 0.50% on undisbursed credit balances, beginning 60 days after signing less any waiver. Onlending Terms: The Credit, less an amount equal to US$6 million equivalent, will be on-lent to EDC within three months after it has been established as an autonomous juridical entity, at a variable interest rate equal to LIBOR plus one-half of one percent, with repayment over 17 years, including a grace period of five years, and foreign exchange risk being borne by EDC. Financing Plan: See para. 3.21. Economic Rate of Return: 21.5% Map: IBRD No. 26880 Project ID Number: KH-PA4032   CAMBODIA PHNOM PENH POWER REHABILITATION Contents Page No. I. The Energy Sector .......... 1 A. Overview ................................1 B. The Power Sector ................................3 C. Power Sector Strategy ................................5 D. Past Bank Group Involvement in the Sector ................................6 E. Rationale for Bank Involvement ................................6 II. The Beneficiary 8.........8 A. Background ...........................8 B. Organization and Management ............................9 C. Financial Management ............................11 D. Capital Requirements ............................. 12 E. Commercialization and Corporatization ............................ 13 III. The Project ......... 14 A. Objectives ...................... 14 B. Description ...................... 14 C. Cost Estimates ...................... 17 D. Project Implementation ...................... 17 E. Environmental and Social Issues ...................... 19 F. Financing Plan ...................... 20 G. Procurement ...................... 21 H. Disbursements ...................... 22 IV. Finance ....................... 23 A. Past Financial Performance ....................... 23 B. Financial Outlook ....................... 25 C. Tariffs ....................... 26 D. Financial Projections .................. 27 V. Project Justification .................. 30 A. Economic Analysis .................. 30 B. Project Risks .................. 31 VI. Agreements and Recommendation ........................ 32 A. Agreements . ....................... 32 B. Recommendation ........... 33  ANNEXES 1 Power System Indicators and Installations ............................. .................. 34 2 Power Demand Forecast and Expansion Requirements ........................................ 37 3 Power Sector Reform ............................................... 48 4 EDC's Organizational Chart ............................................... 49 5 Project Design and Implementation Arrangements ............................................... 50 6 Project Implementation Schedule ............................................... 57 7 Su munary of Project Cost Estimates and Financing Arrangements ........................ 59 8 Disbursement Schedule ............................................... 61 9 Bank Supervision Plan ............................................... 62 10 Key Project Performance Indicators ............................................... 63 1 1 Environmental Retrofit and Safety Program ............................................... 64 12 Land Acquisition and Compensation.70 13 Technical Assistance ............................................... 78 14 EDC Finances ............................................... 95 15 Economic Justification ............................................... 105 16 List of Documents in Project File ............................................... 110 Map ..111 This report is based on the findings of an appraisal mission which visited Cambodia from January 23 to February 3, 1995. The mission was comprised of Messrs./Mmes. Enrique Crousillat (Mission Leader, EAIIN), John Irving (Power Engineer, EAIIN), Sumila Gulyani (Resettlement Specialist, ASTHR) Emilia Battaglini (Economist, IENPD) and P.T. Venugopal (Financial Analyst, consultant). Other important contributions to project preparation were made by Lars Lund (Resettlement Specialist, ASTHR), Yaacov Ziv (Environment Specialist, ASTEN) and Peter Cordukes (Financial Analyst, IENPD). The report was reviewed by Messrs. Hernan Garcia (IENPD) and Robert Taylor (EA21E) as peer reviewers. Mines. Hamideh Keyhani, Theresa Gamulo and Bobbie Brown assisted in the processing of the report. It was cleared by Messrs. Callisto E. Madavo, Director, EAI, and J. Shivakumar, Chief, EAIIN.  I. The Energy Sector A. Overview 1.1 The Kingdom of Cambodia, with an area of 180,000 km2 and a population of around 10 million, is one of the poorest countries in the world: per capita gross domestic product (GDP) is US$200. The largest city is Phnom Penh, the capital, with a population of about 800,000. After a long period of war and political disruption, the Government has made impressive progress on the macroeconomic front; high inflation has been brought under control, the exchange rate stabilized and growth has been relatively strong -- official data show real GDP growth of 4.1% in 1993 and 4.0% in 1994. This improvement is associated also with the introduction of market reforms and the political security provided by a United Nations intervention that allowed the election and establishment of a coalition government, business activities to increase and foreign investment to begin flowing into the country. Nevertheless, progress is threatened by a breakdown of basic infrastructure, including the power supply, which was virtually destroyed in past years. 1.2 All the commercial energy used in Cambodia is imported. Based on customs collections, imports estimated for 1993 were 75,000 tons (t) of fuel oil, 126,000 t of diesel, and 88,000 t of petrol, for a total of 289,000 t. Kerosene and liquefied petroleum gas (LPG) are also imported, although in smaller quantities. About 40% of fuel goes to industry and transport, 35% to electricity generation and 25% to agriculture. It is estimated that 75% of petroleum products are consumed in Phnom Penh and the surrounding areas. 1.3 Until now, no fossil fuels have been developed and little is known about the extent of resources. However, experts generally agree the country could have a significant amount of natural gas and a modest amount of oil. There is considerable interest in oil prospecting and three exploration contracts are currently under implementation through production-sharing agreements: the Government is a joint venture partner with the license operator. Licenses are issued by the Department of Geology of the Ministry of Industry, Mines and Energy (MIME). Oil is imported through the ports of Phnom Penh and Sihanoukville. Diesel and fuel oil are imported by the Ministry of Commerce (MOC) for use by Electricite' du Cambodge (EDC) and other generating facilities. Some municipalities also purchase diesel from the private sector to generate electricity. Private oil companies import fuel for the transport sector. Oil products for both EDC and private companies are delivered to the MOC storage facility in Phnom Penh. 1.4 Rural energy is produced largely from wood and charcoal (approximately 88% of the population lives in rural areas). FAO and UNTAC estimate that wood is harvested at the rate of 6 to 8 million cubic meters per year and that 90% is used for fuel. Rice husks are also used as an energy source. 1.5 The organizational framework of the energy sector was changed when the current administration took office. The MIME was established in 1993 with the following  -2- responsibilities: (a) planning, formulating policy, regulating and auditing the energy sector; (b) generating and distributing electricity; and (c) coordinating energy projects (including donor activities). EDC is the main government entity and the largest organization in the sector. However, the private sector is substantially involved in supplying various energy forms. Energy sector participants and ownership are summarized in Table I. 1. Table 1.1 Energy Sector Participants Phnom Penh Provincial Towns Rural Electricity EDC (generation and Nominally EDC but Some villages have distribution) and actually under local own generators and private sector management and lead acid batteries to wholesalers. control. supply domestic lighting. Petroleum Gas stations and Gas stations and Small retailers in retailers served by retailers served by villages. private oil private oil companies. companies. Local Government electricity suppliers company for power purchase fuel from station use. private companies. Charcoal Individual wood Individual wood Only local charcoal cutters, charcoal cutters, charcoal burner. burners adjacent to burners adjacent to forest, small forest, small distributors. distributors. Wood Wood cut by Wood cut by Local cutting. villagers, transported villagers, transported to wholesaler in to town, small Phnom Penh, small distributors. distributors. Energy Sector Policy 1.6 The Government's ultimate objective is to rebuild the country, sustain its development, and realize full economic potential. To achieve this, its energy policy aims at: (a) providing an adequate supply of low-cost energy throughout the country; (b) ensuring a reliable, secure electricity supply at prices that facilitate investment; (c) encouraging exploration and environmentally and socially acceptable development of  -3- energy resources to supply needs of all sectors; and (d) encouraging the efficient use of energy and minimizing environmental effects resulting from energy supply and use. While this policy addresses medium- to long-term issues, short-term Government objectives focus on restoring an adequate energy supply as soon as possible. B. The Power Sector 1.7 Electricity supply, which was previously a function of the municipal councils in Phnom Penh and provincial cities, is now the responsibility of EDC, a nationwide utility reporting to, and operating under the supervision of, the MIME. 1.8 Electricity is generated through small isolated thermal systems that are mostly diesel fired. By far the largest is in Phnom Penh, where consumption accounts for more than 85% of the national total. At the national level, electricity use was approximately 26 kWh per person per year in 1994, one of the lowest levels in Asia (average consumption among countries of the region is 815 kWh per capita, while in Thailand and Vietnam consumption per capita reaches 980 kWh and 110 kWh, respectively). In Phnom Penh, only 25 MW (of the total 71 MW installed capacity, including several very old plants) are available for normal operations and do not meet the city's demand, which is estimated at 55-60 MW. Thus, if Cambodia is to sustain moderate economic growth, Phnom Penh's power shortage needs to be resolved. To this end, part of the city's generating plants are being refurbished, and various new generating sets are being installed, with the support of several donors. However, this additional capacity of about 40 MW will be insufficient to meet future demand and provide a reliable supply. Thus, the Government decided to expand generation through direct private participation. A power purchase agreement for a 35 MW diesel plant was signed recently and generation additions beyond 1998 are being assessed. Sector indicators and further data on installations are given in Annex 1. 1.9 Approximately 60% of Phnom Penh's distribution network is underground. The system is old and needs to be renovated. Although the older 4.4 kV sections are being repaired, newer parts (15 kV which account for about 70% of the total) are also in poor shape and just minimally maintained. Therefore, the network is expected to suffer from interruptions, failures and high losses (currently around 35-40%) until it is rehabilitated. 1.10 At present, 148 wholesalers distribute low voltage (LV) power, obtaining a metered supply from EDC at the distribution substations and selling to approximately 43,000 individual customers. Although this arrangement relieves EDC from the usually cumbersome retail operation, it is also a main cause of high technical losses and financial problems (para. 2.11). This arrangement needs to be reviewed. 1.11 Power outages are so acute that economic activities and essential services (such as water treatment and pumping, telecommunications, etc.) are severely curtailed. As a result, many consumers have installed their own generating units (estimated to be above 100 MW) at high investment and operating costs. Obsolete equipment accounts for only  -4- part of the sector problems. EDC's financial situation constitutes another constraint. Although electricity tariffs are relatively high -- 245 and 350 Riel/kWh (9.8 and 14 US.cents/kWh) for wholesale and retail customers respectively -- steep production costs, high losses and a poor collections record have caused EDC to run a large cash deficit in past years, covered by the Ministry of Economy and Finance (MEF). 1.12 The sector's maladies go beyond its poor technical and financial performance. EDC is a very weak utility that lacks skilled management and technical staff, and is at the same time over-staffed. A large part of the problem stems from past policies which treated the power sector as a public service instead of a commercial operation. Consequently, the Government's role was not limited to making policy but included direct intervention in daily operations. This situation has yet to improve. The sector's new organization mandates that EDC will report directly to the MIME; thus apparently lacking the autonomy it needs to operate the utility efficiently. Also, it gives the MIME multiple roles -- as policy maker, regulator and operator -- that create a conflict of functions. The Government is aware of these problems and is committed to introducing reforms that will commercialize the sector and attract direct private investment (paras. 2.3 and 2.18). 1.13 The World Bank is executing a UNDP-funded technical assistance (TA) project for the power sector. It mainly offers support for management and training of EDC and MIME staff, including also initial efforts in identifying a viable organizational and regulatory framework, a medium-term investments study and formulating a human resources master plan. The effort has already made modest but significant progress toward improving EDC's management and considerably reducing its drain on public finances. Demand Forecast 1.14 If Cambodia is to achieve a moderate economic growth of 7.5% per annum, power demand would rise at a faster rate, particularly in Phnom Penh, where commercial and domestic consumption is expected to grow rapidly when suppressed demand picks up. A desegregated forecast of expected sales in Phnom Penh was prepared by EDC consultants from the present to the year 2009. Forecasts for the initial years in all sectors were based on energy survey data and, in the absence of reliable statistical information, on data from other Asian cities. The forecast takes into account estimated high levels of suppressed demand and real increases in GDP. 1.15 Forecasts indicate that residential consumption will continue to drive load growth, accounting for approximately 80% of total demand. A rapid increase in domestic customers is expected to occur in 1996 and 1997, as the system is rehabilitated and demand is met. Commercial load is also expected to grow rapidly over the next seven years as commercial development accelerates. While demand from the manufacturing sector may be insignificant initially, it is also expected to grow quickly in the latter years of the forecast. Growth in the government sector is expected to be modest both in terms of  -5 - customer numbers and average consumption. Energy and capacity forecasts are summarized below. Table 1.2 Phnom Penh Power Demand Forecast - 1994/2009 (in GWh) Year Residential Commercial Manufacturing Government Total 1994 78.6 7.3 2.0 7.7 95.6 2000 315.9 36.4 12.3 10.0 374.6 2009 586.1 65.5 79.7 11.8 743.1 Growth Rate I _ _ 1994/2000 26.1 30.7 35.4 4.4 25.6 2000/2009 7.1 6.7 23.0 1.9 7.9 1.16 Early high growth rates are explained by the large amount of suppressed demand, currently estimated at 40% of gross generation. However, these will drastically decline after 1996 as new generating capacity is made available. Peak demand, including suppressed demand, is expected to increase from 55-60 MW at present (of which only about 25 MW is met) to around 70 MW in 1998, 100 MW in 2001 and 160 MW by the year 2009. Detailed results of the power demand forecast are presented in Annex 2. C. Power Sector Strategy 1.17 The Government has issued an energy sector position paper that proposes to enact a new power sector law favorable to private participation and to establish EDC as an autonomous corporation possessing a separate juridical personality. IDA and other donors are supporting the Government efforts in implementing a power sector strategy aimed at: Re-establishing an adequate supply of electricity nationwide, as soon as possible; Strengthening the sector's managerial and implementation capability, to ensure the effectiveness and sustainability of current and future operations; Creating the appropriate environment needed to promote a sustained, efficient and environmentally sound growth and operation of the sector, open to competition and private sector participation. To this end, it will address short-term and medium-to-long-term issues associated with investments, institutions and reforms. The Government is aware of the need to proceed in all areas, since it would not be productive to install new facilities unless measures are taken to improve EDC's financial and technical performance. The following measures are being launched with assistance of the donors community and the private sector:  -6- Supporting investments.. Phnom Penh's generation capacity will be expanded and the distribution system rehabilitated with assistance from the ADB, Japan International Cooperation Agency (JICA) and IDA and direct private investment; the rehabilitation will be supported by the proposed project. In addition, ADB is supporting investments for power generation in the provincial towns of Siem Reap and Sihanoukville. The Government is also seeking private investment for similar efforts in other provincial towns. Strengthening institutions. The present management support system for EDC (provided through UNDP technical assistance) will be continued and its billing and revenue collection system improved. EDC will also receive donor support (from ADB and IDA) to establish project implementation units, including an environmental unit, and staff training. :Reforming the sector. IDA is supporting MlME's preparation of an Electricity Act and statutes to establish EDC as a separate juridical entity. Further IDA support will include TA for defining a suitable structure for the sector and the utility, and setting up an appropriate regulatory framework, including the establishment of a regulatory authority for the sector (para. 3.8). 1.18 In the short-term, these efforts will mean revising the sector's institutions and financial relationship with the Government (with respect to autonomy and subsidies) as well as altering arrangements, such as with wholesalers. In the medium-to-long term, actions in these areas will create the structural and regulatory conditions that will promote competition and direct private sector involvement. The project includes a TA component to support the strategy (paras. 3.7-3.8). D. Past Bank Group Involvement in the Sector 1.19 There have been no previous direct IDA operations in the power sector in Cambodia. However, the ongoing IDA credit for the Emergency Rehabilitation Project (ERP) contains an infrastructure component, including an addition of 10 MW generating capacity in Phnom Penh. Two main lessons have been learned from this ongoing operation. First: public entities' implementation capacity is extremely weak; and Second: local ownership is an essential condition to guarantee an effective implementation of projects. These lessons have been incorporated in the preparation of the project. Accordingly, a TA component will be provided to strengthen EDC's implementation capability, and the project has been designed in close coordination with EDC staff, including an early preparation of bidding documents.  -7- E. Rationale for Bank Involvement 1.20 The policies and programs pursued by the Government and supported by the project are substantially in compliance with the Bank's policy for the power sector. The project fits well with the IDA's Country Assistance Strategy (CAS, Report No. 14465- KH) presented to the Board on June 8, 1995. As discussed in the CAS, the Bank's support to Cambodia for the next year will focus on: (a) assisting the Government to strengthen its capacity in setting clear priorities and implementing development programs; (b) carrying out further analytical work; and (c) supporting critical measures that will have a significant and quick impact within each sector. The project is consistent with all of the above mentioned approaches. 1.21 Public participation in the power sector is justified because of the critical situation of power supply and the widespread impact of the sector on economic development and public welfare. Cambodia's investment requirements in power are large (above US$170 million in the medium-term, para. 2.17). While IDA can only finance a fraction of these needs, its participation in supporting urgent distribution investments will help fill a critical gap and at the same time will provide enough confidence to help attract funds for generation from public and private sources. The Government has stated clearly its interest in reforming the power sector, attracting private participation, and strengthening its institutions. Through its involvement in financing EDC's program, IDA will be able to play a key role in helping the Government in the initial stage of reform, and over time help the Government effectively address issues relating to: (a) power sector regulation, restructuring and commercialization; (b) institutional strengthening; (c) investment planning and resource pricing; (d) environmental discipline; and (e) establishment of a land acquisition and compensation policy.  II. The Beneficiary A. Background 2.1 The beneficiary of the proposed credit will be Electricite du Cambodge (EDC), a public utility responsible for generating, transmitting and distributing electricity throughout Cambodia. EDC was formed in 1958 when three private companies were nationalized--Compagnie Franco-Khmire d'Electricit6 (CFKE), Compagnie des Eaux et Electricite (CEE), and Union d'Electricite d'Indochine (UTNEDI). Its name was later changed to Electricite de Phnom Penh (EDP) to reflect the company's supply of power only to that city; recently it was changed back to Electricite du Cambodge, as it was given nationwide responsibilities. In practice, EDC uses private contractors to plan, construct, operate and maintain power systems outside Phnom Penh, and provides technical support to the provincial electricity operations as required. 2.2 EDC is a wholly state-owned utility, operating under the direct responsibility of the Ministry of Industry Mines and Energy (MIME), supervised by the Secretary of State for Energy. It is required to coordinate with the MEF on all aspects of operations concerning financial issues and with the Ministry of Planning (MOP) on the amount of energy to be generated and fuel requirements. EDC directly supplies 1,658 customers, broadly categorized as follows: Table 11.1 EDC's Customers Customer Number % of Total % of Total Category Consumption Revenue Wholesalers 148 50 42 Government 556 35 41 Embassies 66 4 6 Direct customers 888 11 11 Total 1,658 100 100 a' Wholesalers directly serve about 40,000 residential and commercial customers. 2.3 The Government is committed to reforming the power sector so as to achieve more efficient operations and development. To this end, an Electricity Act is being prepared that is expected to be presented to the National Assembly this year for enactment by June 30, 1996. The law is expected to establish clear principles for operating the power industry and defining the functions and powers of each entity. It will create an autonomous regulatory body, define the role of an independent public utility and a broad system of licenses for power services, and will also establish principles for setting electricity tariffs. It is designed to encourage private sector involvement and contains provisions for independent power producers (IPP) and, for the long term, a competitive  -9 - end use power market with transmission lines designated as common carriers. As a result, EDC's functions and responsibilities will have to be revised and adapted to the future sector structure. Annex 3 presents, within a time frame, a set of ongoing and agreed actions for sector reform, including legal measures and complementary technical support. B. Organization and Management Structure 2.4 EDC is managed by a director (appointed by MIME), who reports to the Secretary of State for Energy. The organization has seven sections (generation and transmission, distribution, commerce, administration, projects, planning and corporate finance), each headed by a deputy director (see Annex 4 for an organizational chart). The last three were recently created to address the utility's project investment needs and are headed by expatriates employed under a UNDP-funded Bank-executed Technical Assistance Project; they have been at EDC since July 1993. This project involves the three expatriates and 10 United Nations Volunteer (UNV) specialists who support EDC in technical areas. The TA project has concentrated on urgent rehabilitation needs of the power system in Phnom Penh and Sihanoukville, training, investment planning, computerization of billing and accounting systems, and initial efforts to re-organize EDC. Assistance was also given to MIIME to introduce energy planning skills and develop and reorganize the sector as a whole. The TA project is funded through July 1995 by the UNDP and the experts are to continue for another year, with the support of the Asian Development Bank and the project. This TA has already accomplished modest but significant progress in: (a) improving EDC's management decision process and planning for the distribution system; (b) adjusting tariffs; and (c) improving EDC's collections--by 20%. Thus, its drain on public finances has been considerably reduced. Personnel and Training 2.5 The devastation caused by 20 years of military conflict and political strife, together with the effects of a centrally planned policy which treated the power sector as a public service instead of a commercial operation, have had a negative impact on EDC's staff and management capability. EDC's staff amounts to 1,177 employees. Generally, its managers and other staff are weak. Many senior staff have only a limited appreciation of management principles in a market economy. Moreover, most staff are inadequately trained and poorly motivated because of extremely low salaries; this will continue until realistic salaries are paid. Responsibilities are poorly defined, and authority and reporting processes are not clearly established. Consequently, staff often do not understand the extent of their responsibilities and do not know to whom to report. There is also evidence that EDC is over-staffed. It has 34 customers to each employee, a ratio much lower than in neighboring countries (in Thailand, PEA's ratio is 265 customers per employee). Further, it does not have the power to hire the professionals it needs or fire redundant or  - 10- inefficient employees; instead, it can only redistribute the existing work force within the utility. 2.6 In order to improve EDC staff performance and develop its manpower potential, the ongoing UNDP/World Bank TA project (para. 1.13) has been providing training in: (a) management principles; (b) technical skills, for engineers and technicians; (c) English, for senior and middle management; and (d) study tours to visit foreign power utilities. The TA project also includes a technology transfer program whereby intemational experts provide on-the-job training to local counterpart staff. 2.7 To date, responsibility for staff training within EDC has not been assigned. However, a Human Resources Development Master Plan (para. 1.13) has been prepared and is being reviewed. Its key objective will be to develop a comprehensive program and schedule to train staff in the power sector. To this end, the Master Plan proposes 22 actions to: (a) expose the senior managers, middle-level managers and supervisors to modem utility strategies and practices; (b) train staff in technical activities; (c) address key business objectives such as collecting revenues and managing contractors; (d) provide a sound recruitment strategy across all areas; and (e) develop training needs analyses, performance appraisals and career development. The project will fund a limited part of the Master Plan elements. It is expected the effort will be complemented by other donor support. Operational Performance 2.8 The intemal turmoil of the past two decades left the infrastructure severely deteriorated, a problem aggravated over recent years by a lack of investment. Also, a lack of spare parts and a shortage of skilled technicians has resulted in widespread operational problems. Maintenance is inadequate and work is often substandard, although the quality is improving. Technical losses have been estimated at 15% of electricity generated, which is high, given the urban load base. Overall losses, including non-technical losses but excluding station use, are estimated to be in the order of 33%. For all the above reasons, EDC is able to meet only less than half of the estimated peak demand, and interruptions to supply are frequent due to a shortage of capacity, and a lack of maintenance and spare parts. Altogether, EDC's poor technical, commercial and financial performance is a cause of Government concern. This has caused it to propose a Performance Plan between MIME and EDC as a way of monitoring EDC's performance and introducing adequate efficiency incentives. Consequently, a two-year plan was agreed on August 9, 1995 a summary of which is incorporated in the key performance indicators in Annex 10. This Plan sets forth the principal technical, commercial and financial indicators and targets to be achieved by EDC, as well as the basic measures to be taken by MIME to assist EDC in realizing that achievement. It was agreed at negotiation that the Government shall take all action necessary to ensure the satisfactory implementation of the Performance Plan. 2.9 Consequently, growth in sales has been limited. Sales for the first eight months of 1994 totaled only 52.3 GWh, while annual sales were expected to reach 82.2 GWh. Also,  only about 67% of the units produced were billed. A new electricity pricing structure was introduced early in 1994, with different rates for electricity wholesalers and direct customers. This adjustment was aimed at reducing the wholesalers' margin while also keeping end-use tariffs at previous levels. Subject to adjustments for exchange rate fluctuations, the new tariff should permit EDC to almost break even, based on the production forecast. Wholesaling 2.10 EDC sells some fifty per cent of its energy to 148 wholesalers who are responsible for retail billing and collections relating to about 40,000 consumers. While this effectively puts the retailing function in the private sector, EDC has been unable to control wholesalers effectively. In addition to failing to maintain fully satisfactory collections from them, EDC is not able to enforce its authorized retail rate of Riels 350/kWh, it being reported that some wholesalers charge rates as high as Riels 600/kWh. EDC operates other parts of the LV network, supplying larger customers and those on the outskirts of the city. It directly supplies only 1,658 end-use customers, including government agencies, embassies and various residential consumers who, however, account for 50% of total consumption. 2.11 EDC is also ineffective in exercising control over new connections and maintenance of the low voltage distribution system. The consequent overloading caused by the wholesalers, inefficient installations, and their lack of maintenance are major causes of the high electrical losses in the system. The implementation of the distribution rehabilitation component of the project will entail the dismantling of wholesalers installations (i.e. great part of their installations would be replaced by a new low voltage network and consumer connections) and, hence, an opportunity to revise the current arrangement. As the distribution system is being rehabilitated, and the wholesalers are a main source of inefficiencies, it was agreed at negotiations that EDC will: (i) redefine the role of, or phase out, wholesalers prior to the initiation of the low voltage construction program; and (ii) prepare an action plan for the implementation of these measures not later than March 31, 1996. The implementation of these measures are included also as part of the Performance Plan agreed between MIME and EDC (para. 2.8). C. Financial Management 2.12 EDC operates under the direction and supervision of the MIME, and uses Government-prescribed financial accounting procedures. However, its financial management systems and skills are generally inadequate, especially with respect to the foreseen growth in generation and distribution capacity and the large number of customers the company is expected to inherit from the wholesalers (as it assumes their functions and increases gradually its number of direct customers from 1,658 to about 40,000). Until early 1995, the billing and accounting system was manual, thus slowing the processing of accounting information. Credit control, while relatively tight, was handicapped by a  - 12- cumbersome, slow system. To improve the process, a computer system was purchased under the UNDP Technical Assistance Project and made operational in early 1995. This new system, however, will require further upgrading to enable EDC to handle a larger number of customers. 2.13 Collecting money owed from Government agencies has proved very difficult. The MEF has made a preliminary agreement with EDC that it will pay the agencies' overdue bills. In addition, agreement has been reached with the Government that it will prepare, and agree with EDC, on an action plan to collect outstanding accounts receivable by February 28, 1996 (para 4.7). 2.14 Recent years were marked by rapid inflation and a corresponding devaluation of the Riel. Although fuel costs rose sharply, EDC did not significantly adjust its tariffs until early 1994. This situation was aggravated by its poor collection record and the large margin taken by wholesalers who purchased energy at 9.8 UScents/kWh and sold it to end users for 14-22 UScents/kWh. Consequently, large and increasing losses were incurred in five of the last six years and the Government covered the resulting shortfall. EDC's past financial performance and projections are discussed in Chapter IV. 2.15 Considerable improvements in technology, policies and practices are needed to obtain prompt and rational accounting results (that are consistent with generally accepted accounting practices). Thus, an upgraded computerized billing and accounting system must be adopted as soon as possible, along with a customer management system. The project will provide support in continuing ongoing efforts to implement such systems (para. 3.7). 2.16 EDC has no adequate internal audit procedures and is subject to only sporadic external audits carried out by the MEF. As EDC is commercialized, it will need to create formal internal and external audit procedures. Agreement was reached at negotiations that the Government will cause EDC to maintain its accounts in accordance with appropriate internationally accepted accounting principles and would submit to IDA the audited accounts and the auditor's reports within six months of the end of each financial year. D. Capital Requirements 2.17 Significant capital investment is needed to meet the high level of suppressed demand, estimated at approximately 112 GWh per annum. This is about equal to EDC's total estimated production for 1994. Investment requirements to re-establish a normal power service are estimated at US$170 million (World Bank report No. 12667). The Government is aware of the difficulty in mobilizing such amount. Therefore, in January 1994, MIME asked for expressions of interest for private sector investment in the electricity sector. The response was encouraging, and a Memorandum of Understanding was signed for new generation. A generation license was granted and a Power Purchase Agreement (PPA) was signed with a private consortium in September 1994 to install and  - 13 - operate 35 MW of new capacity at the C2 power station. After this successful experience, the Government moved to prequalify suitable contractors for IPPs for eight provincial towns. However, it is likely that private investors will not respond with much enthusiasm until a clear legal and regulatory framework, along with adequate guarantees, are in place. As these conditions are met, more than half of the sector's capital requirements would be covered by private sources (para. 4.17). E. Commercialization and Corporatization 2.18 The Government is committed to establishing EDC as a separate juridical entity. This would be a first step toward its commercialization and subsequent corporatization. Accordingly, EDC would be established as a separate utility to develop, generate, transmit and distribute electric power throughout the country according to its service responsibilities as defined by law, statutes and regulations. It would operate as a commercial business, organize its production and operations according to market demand, pay taxes, and set its personnel and salary policies. IDA is currently supporting the Government in achieving this target through the provision of technical assistance for the preparation of EDC's articles of association and related constituent documents. According to the Government's plans, EDC would be expected to prepare, build, own, finance, lease and operate power generation and transmission facilities, as well as contract with third parties for, among other things, the purchase of power, and licenses for distribution and transmission. In addition, short-term Government plans consider expanding generation through the direct participation of independent power producers (IPPs), with EDC keeping direct responsibility for distribution and retail sales. Agreement was reached at negotiations that failure of any of the following events to take place by its respective specified date will entitle IDA to suspend Credit disbursements: that EDC will be established as an autonomous entity possessing a separate juridical personality with attributes, powers and responsibilities satisfactory to IDA not later than December 31, 1995; that the Electricity Act would be enacted not later than June 30, 1996, in form and substance satisfactory to IDA; and that an autonomous regulatory body for the power sector would be established not later than September 30, 1996. 2.19. EDC would have a Board of Directors which would be responsible for managing and operating the company through its Director General. The Board would be composed of members of the Government and the business community to reflect balanced expertise; it shall include at least one engineer, one accountant and one lawyer. Implementing the program will require external TA. Accordingly, the project will support the Government by providing consultancy services to define the best structure for the utility and the sector, as well as to prepare a plan to commercialize EDC and formulate a regulatory framework consistent with the proposed structure (para 3.7 and Annex 3). Further support will be provided by other donors through the services of a power utilities management expert who will advise the Board. Agreement was reached at negotiations that a duly qualified advisor to the EDC's Board will be recruited according to terms of reference agreed with IDA. Proposed terms of reference for these services are given in Annex 13.  III. The Project A. Objectives 3.1 The main objectives of the project, which has been designed to be consistent with the Government's power sector strategy (para. 1.17), are to support the rehabilitation urgently needed for Phnom Penh's distribution system as well as the Government's initial efforts to strengthen sector institutions. Also, the project would help create an environment in which the power sector can be developed and operated efficiently, including the involvement of the private sector. To this end, the project will finance priority investments and provide much needed TA. The project will be implemented along with other investment programs supported by the ADB and bilateral agencies from Japan and France, among others. B. Description 3.2 The project would include the following components: (a) Rehabilitation of Phnom Penh's distribution system comprising: (i) Construction of about 23 km of 1 15 kV transmission circuits around the perimeter of Phnom Penh to connect three new primary 11 5/22kV substations; (ii) Construction of about 100 cct-km of 22 kV underground and overhead lines, 300 km of low voltage lines, 40 MVA of distribution transformers, 20 MVAr power factor correction equipment and about 40,000 consumer connections; (iii) Provision of support facilities, including tools and equipment, communications for system operations, storage areas and logistics controls; and (iv) Improvement of environmental and safety conditions at existing power plants. (b) TA comprising: (i) Within EDC -- procurement and engineering, importation of management services, strengthening of commercial operations, setting up an environmental unit, implementing the land acquisition and compensation plan and training EDC staff, and  - 15 - (ii) Within MIME -- defining and implementing a new sector structure and regulatory framework; and training staff in energy planning. Rehabilitation of Phnom Penh Distribution System 3.3 An in-depth feasibility study undertaken by EDC's consultants financed by the Policy and Human Resources Development Fund (PHRD), determined that a new 115 kV transmission network is needed to connect the five power stations in Phnom Penh and to provide three points of supply to serve the city's 22 kV networks. The system was designed to allow for future upgrading in order to accommodate the expected electricity growth up to 2005 when demand is expected to reach about 130 MW. The 115/22 kV substations were designed to provide space to connect with a future 230 kV connection to Vietnam in the east and Sihanoukville in the south. The substations under the project would use standardized designs, consistent with practices utilized by neighboring countries. The 115 kV lines under the project would use 25m concrete or wood poles, constructed along roads, thereby minimizing right of way (ROW) requirements. 3.4 The distribution system would be constructed to operate at 22 kV, although parts could operate at 15 kV until the older equipment is phased out of service. Rehabilitation of the medium voltage (MV) system within the city will be completed with underground cable (as is now done) so as to minimize visual impact; outer urban areas will be reticulated with 22 kV overhead systems on 12m concrete poles. LV networks will be constructed with overhead bundled conductor cable systems, as was done under two recent pilot projects funded by other sources. Service connections will use concentric screened cables to reduce the incidence of illegal connections. New meters will be installed in prominent locations on all consumers' premises employing adequate mechanisms to make them tamper-free. Installation of the LV and consumer service systems will be carried out in conjunction with EDC's renegotiation of commercial arrangements with wholesalers responsible for providing domestic and commercial electricity services. Details on project design and implementation arrangements are presented in Annex 5. 3.5 The project will also provide for operations and maintenance equipment including communications equipment, vehicles, construction plant and erection tools. It will also expand EDC's computer facilities for: (a) project management, monitoring and control of implementation; (b) billing systems, to cover up to 80,000 consumers; (c) planning tools; and (d) other office equipment as required for commercial and engineering applications. Equipment Storage and Logistics Control 3.6 The project will support the preparation of a suitable site for receiving and storing equipment near the C3 power station site. It will contain outdoor storage facilities with handling equipment, and indoor facilities for management offices; meter testing facilities; and offices for construction and maintenance management.  - 16 - Technical Assistance 3.7 The TA component was designed to address the most pressing needs of the power sector. It aims to: (a) strengthen EDC's technical, managerial and implementation capabilities; and (b) support the Government's reforms to create a more autonomous, financially viable power sector open to the private sector. The following consultancy services will be secured to support EDC: (a) Engineering assistance to support EDC in the implementation of the project. This service will focus on strengthening the Project Management Unit (PMU) established within EDC to execute this and other projects to rehabilitate and expand its power networks. Engineering consultants will be required to: (i) help EDC prepare bidding documents for procuring materials and equipment; (ii) assist and train its staff in evaluating bids and managing contracts for each project component; (iii) arrange for the training of EDC staff in the areas of transmission and distribution construction management, supervision, and operations and maintenance; and (iv) provide technical advisory services as necessary to complete the project and operate the plant. Taken together, the services are designed to ensure that all aspects of project implementation are coordinated; (b) Management and computer experts, to strengthen commercial operations and computerize the accounting, billing and collection services to establish a sound basis for revenue; and (c) Experts to assess and define the scope for establishing an environmental unit within EDC and implement the project's land acquisition and compensation plan. 3.8 The TA component to support MIME will include: (a) consultant services to help identify the most suitable regulatory framework for the power sector (that can provide incentives for an efficient, reliable supply of electricity, attract foreign capital and promote efficient operations); (b) the services of a regulatory advisor to support the implementation and initial operations of the proposed regulatory agency (the Electricity Authority of Cambodia); (c) the services of an energy advisor to the Minister, to develop energy policy and implement MIAME's work program; and (d) a training program for MIME staff on energy economics, resource management, energy planning, and statistics gathering. Annex 13 presents a more detailed description of the TA package, including terms of reference and resources to be allocated. Agreement was reached at negotiations that consultancy services will be employed according to terms of reference satisfactory to IDA.  - 17 - C. Cost Estimates 3.9 The total financing required for the project (including capitalized interest during construction) is estimated at US$46 million equivalent, with a foreign exchange component of US$37 million equivalent (Details of the cost estimate are presented in Annex 7). Costs are based on December 1994 price levels. Physical contingencies have been assumed at about 10% of the base cost, considering that the project may change its scope as the detailed design progresses. Price contingencies are estimated on the basis of escalation factors of 5% for local cost components and 2.8% for the foreign ones, following Bank guidelines. Table III. 1 summarizes the cost estimates for the project. Table HI.1 Cost Estimates Component Riels Million USS Million Foreign as Local For. Total Local For. Total % of __________________________________ ______ _____ _______ Totals A. 115 kV Transmission System 115 kV Transmission Lines 604 3421 4025 0.24 1.37 1.61 85 115/22 kV Substations 2425 18225 20650 0.97 7.29 8.26 88 B. Distribution System Rehabilitation 22 kV Rehabilitation 4502 13505 18006 1.80 5.40 7.20 75 LV Construction and Consumer Services 7500 22501 30002 3.00 9.00 12.00 75 C. Operational and Construction Support Facilities Operational and Commercial Equipment 75 5125 5208 0.03 2.05 2.08 99 Stores and Logistics 103 1150 1253 0.04 0.46 0.50 92 Environmental Enhancement and Safety 83 735 818 0.03 0.29 0.33 88 D. Technical Assistance 749 6741 7490 0.30 2.70 3.00 90 E. Land Acquisition and Compensation 675 0 675 0.27 0.00 0.27 0 F. EDC Administration 400 0 400 0.16 0.00 0.16 0 Total Base Cost 17122 71403 88526 6.85 28.56 35.41 81 Physical Contingencies 1711 7141 8852 0.68 2.86 3.54 Price Contingencies 3265 7238 10505 1.31 2.90 4.20 Total Project with Contingencies 22098 85785 107883 8.84 34.31 43.15 79 Interest During Construction 218 6076 6293 0.09 2.43 2.52 l Total Project Financing 22316 91860 114177 8.93 36.74 45.67 80 D. Project Implementation 3.10 The Project will be implemented in accordance with a Project Implementation Plan. With the exception of the TA component for MIME, EDC will be responsible for implementing the project. It will obtain adequate consultant services for management, design and procurement activities, as well as for supervising construction. A project team, headed by the manager of the Project Management Unit (PMU), has been formed within EDC to coordinate and direct the project. The 115 kV transmission lines will be constructed and the 115/22 kV substations installed through single-responsibility turnkey  - 18- contracts. Because the transmission lines will be pole-mounted and routed along roads, ROW requirements will be minimal. EDC has already begun to secure land for substations. As the amount of land needed is relatively limited, the company has flexibility in its choice of location and can be sensitive to local conditions and future expansion requirements. Thus, the implementation schedule is unlikely to be affected by land acquisition and compensation obstacles (see Annex 6 for the implementation schedule). 3.11 The PMU will establish teams to supervise the construction of the MV and LV distribution works. Planning for the MV rehabilitation program will be linked to the commissioning of the 35 MW private plant at the C2 site; this will ensure that power can be evacuated without incurring contractual penalties. Planning for the LV construction will be coordinated with EDC's plans to phase out or change the role of the wholesalers. The work will be coordinated by the PMU project manager and several project engineers who have experience with construction under bilaterally-financed projects. Detailed surveys, the planning of routes, the selection of equipment and cost estimates will be made with criteria established by the staff and consultants. Monitoring and Reporting 3.12 Procedures for monitoring the physical works and financial reports have been agreed upon with EDC, which will furnish quarterly progress reports including updated charts based on the model used for the project schedule (Annex 6). These procedures are reflected in EDC's Project Implementation Plan. During the final year of implementation, IDA will draft Parts I and 3 of the Implementation Completion Report (ICR), no later than six months after the project is completed. EDC will review them and prepare Part 2 (the Borrower's perspective) within the next three months. Supervision Plan 3.13 The project will be supervised according to the plan presented in Annex 9. The main areas of focus will be: (a) EDC's investment plan and tariffs, to ensure these are consistent with macroeconomic changes; (b) compliance with financial covenants to assure EDC's financial health as it conducts a large investment program; (c) technical supervision and consulting studies, (d) compensation for the transmission line; and (e) reforms in the power sector. Bank missions will also help EDC with institutional development activities and provide advice on environmental and social issues when needed. Supervision of the project will require expertise in power engineering, management techniques, economics and financial analysis--all of which is available within the Bank. It is expected that two missions a year for three years will be needed, for a total of 35 staff weeks. Key project performance indicators that would be used for supervision are given in Annex 10.  - 19- E. Environmental and Social Issues 3.14 The project's overall environmental impact is expected to be positive, since an old, hazardous distribution system will be replaced, energy losses will be reduced and, consequently, a large number of inefficient generating units will cease to operate. In addition, the project will upgrade the existing power stations in Phnom Penh, improving their environmental and safety conditions. Except for compensation associated with the construction of the 115 kV transmission line and related substations, no other remuneration is envisaged, since all other project components involve existing power plants and distribution systems. Accordingly, the project has been classified in the B category. The preparation of an Environmental Action Plan for Cambodia is considered in IDA's work program for FY97. 3.15 EDC consultants assessed the project's environmental impact, focusing on: (a) route selection and effects of the proposed transmission line and associated substations; and (b) clean-up and safety at existing power stations. Social and environmental issues were key factors for the selection of the transmission line route and location of substations. Overhead 115 kV pole-mounted lines routed along roads will minimize ROW requirements. The layout design of the substations would be fairly flexible, and emphasis will be placed on aesthetic aspects in their setting and design. Line and substation designs will follow internationally accepted safety practices that have a proven record in the urban environment. Further, an environmental audit of power stations was carried out and the most essential clean-up and safety measures were included in the project (Annex 11). 3.16 The eventual replacement and disposal of obsolete equipment (such as PCB-filled transformers) and environmentally hazardous materials were also addressed. EDC carried out a survey on existing transformers and concluded that no PCBs are in service on the network. Land Acquisition and Compensation 3.17 The following components will involve land acquisition: two (out of three) grid substations and the 23 km transmission line. One substation site will need about 8,000 square meters of land and will affect nine households; the other will require 1,350 square meters of land for an access road and will affect four households. The ROW for the transmission line will affect 19 households, and the project as a whole will affect a total of 32 families, of which 15 houses will need to be relocated. 3.18 Minimizing the scale of land acquisition was one of the criteria in selecting the transmission route and location of sub-stations. The transmission line, which was initially set to cross the city, was re-routed and located further away so as to affect fewer settlements. Its pole mounted design also helped keep adverse impacts to a minimum. Further, given the medium voltage, the line will require a ROW of only about six meters, as the cross arm width is about three meters.  - 20 - 3.19 A detailed survey of the proposed route was completed and base drawings (scale 1:3000) indicate the structures and property affected by the line. In addition to the technical survey, authorities made a baseline survey of the affected population. Further, EDC has obtained the Government's clearance on a policy framework and plan for land acquisition and compensation. Agreement was reached during negotiations on a timetable for the Government's implementation of the Land Acquisition and Compensation Plan and on the regular monitoring of the plan's implementation (summary of the Plan and agreed timetable are presented in Annex 12). EDC's compliance with such timetable is also part of the Performance Plan agreed between MIME and EDC (para. 2.8). Implementation and Institutional Strengthening. 3.20 Given that local agencies and EDC have little experience dealing with environmental and land acquisition issues, the project will provide TA for consultants to help EDC (a) define the scope of an environmental unit (to be set up within EDC); (b) implement the compensation plan, including the preparation of a Due Process Manual; and (c) further develop EDC's policy framework, procedures, and implementation arrangements for land acquisition and compensation (Annex 13). F. Financing Plan 3.21 Table III.2 below summarizes the expected financing sources for the project. IDA financing would account for about 88% of project costs, covering 100% of the foreign component (excluding interest during construction), and about 64% of the local component. The IDA credit of US$40 million equivalent would be at the standard terms for a 40-year term including a 1 0-year grace period. The Government would retain about US$0.8 million towards the TA for MIME. The balance would be fully passed on to EDC in two parts, the equivalent of US$6 million as equity contribution, and the remaining about US$33.2 million as a subsidiary loan. Agreement was reached at negotiations that the Government will enter into a subsidiary loan agreement with EDC, satisfactory to IDA, within three months after EDC is established as a separate juridical entity (para 2.18). It was also agreed that onlending will be in US$ at a variable interest rate equal to LIBOR plus one half of one percent, with repayment over 17 years, including a grace period of five years. Table m1.2 Project Financing II I ~~~~~~~~~~~~US$ Mfillion Source Local gForein I Total IlDA Credit 5.69 34.31 I 40.00 EDC Self Financing/Governnent Equity 3.24 2.43 567  - 21 - G. Procurement 3.22 With the exception of the provision made for local contractors and stores (para. 3.23), all contracts financed by the credit for works and goods would be awarded on the basis of International Competitive Bidding (ICB) according to IDA procurement guidelines. Annex 5 gives a summary of the procurement arrangements. 3.23 The credit will finance up to 100% of foreign and 70% of local components of the supply and installation contracts for the transmission line and substations awarded on ICB basis, which will be evaluated allowing domestic preference for contractors. The distribution component involving laying of underground cables and overhead main lines estimated at $5.9 million will also be subjected to ICB. Construction of storage facilities will be awarded on the basis of National Competitive Bidding (NCB) procedures acceptable to IDA with 100% of foreign and 70% of local components funded by the Credit. An amount of $500,000 has been allocated to encourage the development of local contractors for which special procedures will be followed. Local contractors who have the aptitude and capacity for the distribution components will be invited to register for training following advertisement in local newspaper. On completion of the training program conducted by EDC, a list of qualified contractors (minimum five) will be prepared for participating in the bidding process, following competitive bidding procedures. Bidding documents for such procedures will be reviewed by IDA prior to release to ensure that terms and conditions are equitable and fair. IDA will finance 70% of the costs for this pilot project. 3.24 In the evaluation of bids for goods following ICB procedures, a domestic price margin of preference equal to 15% of the CIF bid price of imported goods or the actual customs duties and import taxes, whichever is less, will be allowed for domestic manufacturers. Prior IDA review of bid documents and approval of contract awards will be mandatory for contracts for goods and works expected to cost the equivalent of US$0.5 million or more. This will cover about 90 % of total contract value. Consulting services financed by IDA will be awarded according to Bank guidelines for the use of consultants. Contracts exceeding US$100,000 for firms and US$50,000 for individuals will require IDA's prior review. Table III.3 summarizes the procurement arrangements for the project.  - 22 - Table m.3 Procurement Arrangements Project Component Procurement Method Total Cost ICB NCB Other Works Transmission & Substations 12.0 12.0 (11.5) (11.5) Distribution Construction 5.9 0.5 (a) 6.4 (4.0) (0.4) (4.4) Buildings and site works 0.5 0.5 (0.4) (0.4) Goods 20.2 20.2 (20.2) (20.2) Consultants 3.5 (b) 3.5 (3.5) (3.5) Total 38.1 0.'5 4.0 42.5 (c) (35.7) (0.4) (3.9) (40.0) (a) refers to pilot program for local contractors. In brackets: IDA funding (b) refers to engagement of consulting services. (c) excludes EDC's administration and compensation expenses. H. Disbursements 3.25 Disbursements for the distribution components are expected to begin in early 1996. The overall implementation period will be about four years from negotiations. The IDA credit would be disbursed against: (a) 100% of foreign expenditures for imported equipment and materials as well as related installation works; (b) 100% of local expenditures (ex-factory) for locally manufactured items and related installation works; (c) 70% of local expenditures for materials, equipment and related installation works; (d) 70% of construction of distribution works by local contractors (to cover the cost, net of taxes, for leased equipment and importation of foreign supervision); and (e) 100% of total expenditures for consulting services. Full documentation would be required for all contracts for goods and works valued at US$0.5 million equivalent. Disbursements for goods and works valued at less than US$0.5 million would be made on the basis of itemized Statements of Expenditure (SOE). The SOE limit for consultant's services would be US$100,000 for firms and US$50,000 for individuals. The documentation for SOE supported expenditures would be retained and made available for review by IDA supervision missions. A Special Account would be established at the National Bank of Cambodia to facilitate these payments. This account would be maintained in US dollars, with a limit of US$3 million equivalent. 3.26 Annex 8 gives the disbursement schedule for the IDA credit. The project is expected to be completed by June 30, 1999 and the closing date for the Credit would be December 31, 1999.  IV. Finance A. Past Financial Performance 4.1 At present, EDC's financial operations are an extension of the Government's. From year to year, the Government provides budgetary support to EDC in order to cover its losses and new investment needs. Essentially, EDC's activities in Phnom Penh are not large enough for the economy of scale that is needed. The prevailing power wholesale tariffs, at around 10 US cents/kWh, on the average, do compare with the tariffs at the higher end of the region. The coming years would see fast growth in power consumption. As EDC is established as a separate commercial entity, the objective will be to attain financial independence, and at the same time endeavor not to raise tariffs in real terms, although rationalize them in due time and, ultimately, reduce them. To allow EDC to begin its new commercial life without past financial burdens to the extent possible, the balance sheet has been reconstituted, subject to the approval of the Government, eliminating "inefficient" balances. This is further explained below. As EDC's business expands and sales revenues climb, EDC could quickly become self-sufficient in respect of cash operating costs and, soon thereafter, achieve full financial viability as measured by rates of return and other financial indicators. 4.2 Financial results of EDC's trading, restricted to its operations in Phnom Penh, for the period 1989-1994 are summarized in Table IV. 1. Detailed statements are given in Annex 14. Table IV.1 Summary Trading Results 1989-1994 (M Riels) Item 1989 1990 1991 1992 1993 1994 Total Revenue 436 1 181 5 957 17 289 16 891 24 277 Total Operating Expenses 686 1 485 6 293 15 598 29 830 34 789 Operating Profit -250 -304 -336 1691 -12 939 -10 512 Net Profit (- loss) -288 -361 -419 1 768 -12 878 -10 512 4.3 EDC's operating losses have risen from Riels 288 million (about $1 million) in FY1989 to Riels 10 000 million ($3.8 million) in FY1994, the first year in which depreciation was calculated on revalued fixed assets in service. Only in FY1992 was a profit made. Fixed assets in service at the end of FY1993 were valued at Riels 49,300 million ($19 million), thus a return of eight percent would have required an operating profit of Riels 3,900 million. Therefore, the shortfall for FY 1994 was about Riels 14,000 million ($5.4 million). EDC's increasing losses during the last four years are explained by: (a) a decline in real tariffs, which remained unchanged throughout great part of that period; and (b) an accelerated deterioration of its power generation capability caused by maintenance problems and old equipment. The slight improvement of 1994 was due to a rise in wholesale tariffs.  - 24 - 4.4 Estimated balance sheets for FY 1993 and 1994 are presented in Annex 14 and summarized in Table IV.2. The fixed assets are at valuation in 1994 prices with additions at cost.' Table IV.2: Summary Balance Sheets 1993-1994 (M Riels) Years Ending 31 December 1993 1994 Fixed Assets in Service 49,257 43,911 Total Current Assets 9,970 18,927 Total Assets 59,227 62,838 Total Owner's Funds 56,987 50,376 Total Current Liabilities 2 ,239 12,462 Total Equity & Liabilities 59,227 62,838 Valuation of Equity 4.5 The value of the owner's interest in EDC is determined largely by the value of fixed assets less any long term debt raised to finance them. In EDC's case, the book value of assets in 1993 was seriously below depreciated replacement cost and there was no long term debt. Fixed assets were revalued as at December 31, 1993 by EDC consultants, using a depreciation replacement cost approach. After allowing for the rundown nature of many system assets, the total value is put at almost Riels 50,000 million (approximately US$19 million). 4.6 The other main determinant of assets value is receivables and inventory. Whilst it is intended to incorporate EDC as a joint stock company with limited liability, EDC's accounts have been reconstituted as at the end of 1993. This included writing off about one third of recorded values, including a large but not known proportion of debtors' balances dated back to 1983, and capitalizing an amount of Riels 12,000 million recorded as payable to the Government. The current valuation of fixed assets has been brought to account, and the net result to value the owner's interest at that date, at almost Riels 57 000 million ($ 22 million). The whole of this is treated as equity. Given the precarious state of EDC's finances, there is no point in attempting to assess an appropriate mix of debt and equity. More properly, the aim should be to get EDC's profitability to the stage where EDC pays taxes and a dividend to Government and thereby makes funds available for reinvestment in other development projects. Agreement was reached during negotiations that, not later than June 30, 1996, the Government will record approval of EDC's reconstituted and duly audited balance sheet as at December 31, 1995. The balance sheet for FY 1993 is a reconstruction based on available information and does not include old, doubtful and obscure arnounts.  - 25 - Accounts Receivable 4.7 EDC sells almost 50 percent of its energy to wholesalers and bills them about 42 percent of its revenue. Collection performance is poor and worsening; between 31 December 1993 and 31 December 1994 collections were only 60 % of sales revenue. Accordingly, unpaid accounts are estimated to have increased by Riels 9,200 million (US$3.5 million) to Riels 14,700 million (US$5.7 million), approximately 7.3 months' revenue. Such position of trade receivables, even after reconstituting the balance sheet of EDC, is cause for serious concern. Government agencies are the primary debtors, followed by the Municipality, wholesalers and embassies. This issue was discussed with the Government. Agreement was reached at negotiations that the Government will take all measures necessary to assist EDC to collect the outstanding account receivables, and that EDC will reduce these to not more than three months of sales revenue by December 31, 1998, and to 2.5 months of sales revenue by December 31, 1999. Also, an agreement was reached that the Government will prepare, in coordination with EDC, a plan of action to achieve these results, satisfactory to IDA, not later than February 28, 1996. B. Financial Outlook Projected Financial Performance 4.8 Improvements in EDC's financial performance would require the following: (i) the capacity to meet demand for increased quantities of electrical energy; (ii) improved generating and distribution efficiencies; and (iii) tariffs to be adjusted to cost escalation. The capital investment program supported by multilateral and bilateral agencies and a first contract with an independent power producer will provide the necessary generating capacity by 1999-2000. The rehabilitation of the Phnom Penh's distribution network will also allow to reduce EDC's electrical losses from 1994's 24 % to 15 % during the same time, since the project is in fact a major loss reduction program. This improvement would be also complemented by a better collection performance made possible through the implementation of a modern billing and collection system. 4.9 The modernization of EDC's billing and collection system would allow EDC to take over -- or reach a new type of arrangement for -- wholesale distribution thus enabling the utility to capture progressively the large wholesale margin (paragraphs 2.11 and 2.12). Additional costs to be incurred to provide an efficient billing, collection and consumer accounting and management services should be minimized by redeploying existing staff. However, even after allowing for increased earnings in this manner, price adjustments will be necessary for some time and it is important that EDC review its rates regularly and not less often than annually. Projections of EDC finances indicate that average revenue yields per kWh sold expressed in dollar equivalent need to increase at not less than the average rate of international inflation during a period of five years. This would mean that rates should reflect real increases in oil prices and equipment, as well as variations in the exchange rate. Agreement was reached at negotiations that the Government will review  - 26 - not later than October 1, in each year, EDC's investment program and power tariffs in consultation with IDA. Financing Plan 4.10 Table IV.3 summarizes EDC's projected cash flows during the period 1995-2003. Based on the projected costs and revenues, internally generated funds are expected to cover about 45 % of total cash application requirements and about 70 % of projected capital expenditures. Details of the capital funds projected to be received are given in Annex 14. Table IV.3: Financing Plan 1995-2003 Item M Riels k$ @ Riels 3300 Sources of Funds Internal Sources Operating income + depreciation 336,598 101,999 Interest earned 30,291 9,179 Internally Generated Funds 366,890 111,179 Grants 228,238 69,163 Capital contribution 54,564 16,534 Long term borrowing 149,659 45,351 Capital Funds 432,461 131,049 Total Funds Available 799,351 242,227 Application of Funds Capital Investment 521,436 158,011 Debt Servicing Interest expense 63,857 19,351 Principal 53,986 16,359 Total Debt Service 117,844 35,710 Tax & Dividend paid 49,965 15,141 Change in noncash working capital 12,294 3,726 Change in cash balances 97,812 29,640 Change in Working Capital 110,106 33,365 Total Funds Applied 799,351 242,227 a. 1995-2003 Riels have been converted to dollars at a single representative rate. C. Tariffs 4.11 EDC's tariff structure includes a single energy rate with no demand charges. The tariff system contains rates in both Riels and US.Dollars. The Dollar tariff is higher than the Riel tariff and applies generally to foreign firms and embassies. The average revenue yield for FY 94 was Riels 292 per kWh (11.4 US.cents). Wholesalers paid Riels 239 for energy billed in Riels and Riels 449 for energy billed in US. Dollars. EDC billed most of its retail consumers at rates yielding between Riels 326 and Riels 350, but obtained from embassies billed in Riels 327, and from those billed in US. Dollars, Riels 546.  - 27 - 4.12 Through FY91 until early FY94 EDC's rates had remained unchanged. During that period average rates to wholesalers were Riels 119 per kWh and to end consumers Riels 170 per kWh. Consumers billed in dollars paid a constant value of $0.21 per kWh over the same period. 4.13 The wholesalers are known to charge retail rates considerably higher than the authorized retail tariff (para. 2.10). While this introduces unfair treatment to retail consumers, it is also an indication that consumers' willingness to pay may be higher than the retail tariff. While EDC is expected to improve its financial performance as: (i) its generating capacity is enhanced; (ii) energy losses are reduced; and (iii) collection record is improved, it does not necessarily follow that retail rates should be reduced as wholesalers' activities revert to EDC. A carefully designed plan for revising the structure of tariffs should be prepared before wholesalers' businesses are taken over, or a new arrangement is made, so that the required revenue will be progressively earned without granting reductions that may have to be reversed soon afterwards. The plan should reflect the financing requirements of EDC including the completion of its rehabilitation program in Phnom Penh and the expansion of its operations throughout the country, while keeping the long term objective of reducing real tariff levels (see para. 4.17). Given the structure of the consumer group, composed mainly of a large number of residential and small commercial consumers, and the relatively weak billing and collection system, it is not recommended that demand charges be introduced in the short term. D. Financial Projections 4.14 Revenue projections have been made based on the following: (i) the sales and load forecast; (ii) new generation, transmission and distribution capacities as they become progressively available in accordance with the capital investment program; (iii) the projected costs of supply and distribution; (iv) the progressive capturing of wholesale margins as the distribution system is rehabilitated; and (v) the effect of projected international inflation and exchange rates on investment and operating costs. A complete set of the assumptions used for these projections is given in Annex 14, including commercial conditions for the onlending agreement between the Government and EDC (para. 3.21). 4.15 The main determinants of future costs will be: (i) the investment program; (ii) fuel costs; and (iii) the contract(s) entered into with independent power producers. Given the Government's policy that future increments of generating capacity are to be built and financed by independent producers (para 2.10), the projections assume two further power stations being commissioned before 2003 to provide enough energy and adequate security of supply at times of peak demand. This results in high fixed costs per kWh delivered by the new stations in FYs 2002-2003 and a temporary reduction in profitability.  - 28 - 4.16 Including 2.5% per year international inflation and a similar devaluation of the Riel, average revenue yields are projected progressively to rise 136 % from Riels 292 in FY94 to Riels 689 in FY98, including a gradual capturing of the wholesale margin. The increase in projected dollar equivalents is 60 % by FY 2000. EDC's projected operating results are given in Annex 14, Table IV.4 presents a summary. Table IV.4: Summary Financial Projections to 2003 (Rls Billion) 1995 1996 1997 1998 1999 2000 2001 2002 2003 Energy Sales (GWh) 116.7 159.3 223.8 274.8 327.4 376.1 422.1 461.3 495.2 Average Revenue (Rls/kWh) 364 424 482 531 584 641 656 672 689 Operating Revenues 42.9 68.3 108.9 147.4 193.1 243.3 279.8 313.2 344.4 Operating Expenses 46.5 74.6 119.4 140.3 168.9 210.8 233.9 277.9 321.5 Purchased Power Cost - 41.6 81.9 87.0 122.3 155.9 172.4 211.8 251.2 Operating Profit -3.6 -6.3 -10.5 7.0 24.2 32.6 45.9 35.2 22.9 Net Income -4.3 -5.4 -13.2 -2.7 10.2 28.9 37.0 30.4 21.4 Current Assets 29.2 58.5 48.1 47.8 44.8 89.2 123.0 139.3 153.1 Total Assets 119.0 296.4 373.7 382.4 432.8 516.2 536.7 535.7 529.4 Current Liabilities 11.2 27.3 25.3 26.0 27.9 33.3 52.5 52.8 51.5 Long-term Debt (net) 0.4 42.9 135.4 146.0 149.7 136.2 122.7 109.2 95.7 Total Equity 107.4 226.2 213.0 210.3 255.1 346.7 361.5 373.7 382.2 Primary Ratios: Rate of Return on Ave. Fixed Asset in Service(