Philippines - Energy Sector Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 15657 IPLEMENTATION COMPLETION REPORT PHILIPPINES ENERGY SECTOR PROJECT (LOAN NOS. 3163-PH, 3164-PH, 3165-PH) May 23, 1996 Infrastructure Operations Division Country Department I East Asia and Pacific Region This document has a restricted distribution and may be used by recipients only in the perfornance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit Philippine Peso (P) P1.00 100 Centavos (ctv.) (end-July 1989) = US$ 1.00 = P 21.5 (end-Dec 1995) US$1.00 = P 26.2 WEIGHTS AND MEASURES kV = Kilovolt (1,000 volts) kW = Kilowatt (1,000 watts) kWh = Kilowatt-hour (1,000 watt-hours) MW = Megawatt (1,000 kilowatts) MWh Megawatt-hour (1,000 kilowatt-hours) GW Gigawatt (million kilowatts) GWh = Gigawatt-hours (million kilowatt-hours) FISCAL YEAR Republic of the Philippines January I - December 31 ABBREVIATIONS AND ACRONYMS BOT - Built-Own-Transfer BOOT - Build Own-Operate-Transfer DENR - Department of Environment and Natural Resources DOE - Department of Energy ECC - Energy Coordinating Council EMB - Environmental Management Bureau ERB - Energy Regulatory Board ERR - Economic Rate of Return GOP - Government of the Philippines JEximbank - Export Import Bank of Japan ICB - International Competitive Bidding IPP - Independent Power Producer NEA - National Electrification Administration NPC - National Power Corporation OEA - Office of Energy Affairs PNOC - Philippine National Oil Company PNOC-EDC - PNOC-Energy Development Corporation ROM - Rehabilitate-Operate-Maintain  FOR OFFICIAL USE ONLY Table of Contents Preface ....................................................i Evaluation Summary ................................................... ii PART I: IMPLEMENTATION ASSESSMENT A. Statement/Evaluation of Objectives. B. Achievement of Objectives .3 C. Major Factors Affecting the Project .6 D. Project Sustainability .8 E. Bank Performance .8 F. Borrower Performance .9 G. Assessment of Outcome .10 H. Future Operations .10 1. Key Lessons Learned .10 PART II: STATISTICAL ANNEXES ANNEX A: STATISTICAL TABLES ........................... 12 1 . Summary of Assessment .12 2. Related Bank Loans .15 3. Project Timetable .16 4. Loan Disbursements: Cumulative Estimated and Actual .16 5. Key Indicators for Project Implementation .18 6. Key Indicators for Project Operation .20 7. Studies Included in Project .22 8A. Project Costs .24 8B. Project Financing .25 9. Economic Costs and Benefits .26 10. Status of Legal Covenants .27 11. Compliance with Operational Manual Statements .30 12. Bank Resources: Staff Inputs .30 13. Bank Resources: Missions .31 ANNEX B: SECTOR SPECIFIC DATA .................................................. 33 1. Cumulative Actual and Planned Generating Capacity ......................................... 33 2. Phases of Power Sector Restructuring and Privatization ..................................... 34 APPENDICES A. Mission's Aide-Memoire .................................................. 35 B. Borrowers' Contributions to the ICR .................................................. 36 MAPS IBRD No. 21900: Energy Resources IBRD No. 21901: National Power Corporation Grid 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 wiihout World Bank authorization.   IMPLEMENTATION COMPLETION REPORT PHILIPPINES ENERGY SECTOR PROJECT (Loan nos. 3163-PH, 3164-PH, 3165-PH) Preface This is the Implementation Completion Report (ICR) for the Energy Sector Project (the Project) in the Republic of Philippines, for which US$390 million equivalent, was approved on February 1, 1990 and made effective on June 12, 1990. The Project provided for three Bank loans for: (a) the National Power Corporation (NPC) for US$200 million (Loan no. 3163-PH); (b) the Philippine National Oil Company (PNOC) for US$150 million (Loan no. 3164-PH); and (c) the Government of the Philippines (the Government) for US$40 million (Loan no. 3165-PH). Loan 3163-PH to the National Power Corporation closed on June 30, 1995 compared to the original closing date of December 31, 1994. The Loan is fully disbursed and final transaction took place on February 23, 1995. Loan 3164-PH to the Philippines National Oil Company was closed on December 31, 1995, compared to the original closing date of December 31, 1994. Apart from partial cancellation of some US$10.7 million equivalent, being earmarked for on-lending to Petron, the loan was fully disbursed and final transaction took place on April 15, 1996. Loan 3165-PH to the Republic of the Philippines was closed on April 30, 1996, compared to the original closing date of December 31, 1994. Some US$8.7 million equivalent was canceled and final transaction took place on February 3, 1996. The ICR was prepared by Ephrem Asebe, Consultant, EA31N, under the supervision of John Irving, Senior Power Engineer, Infrastructure Operations Division of the East Asia & Pacific Region, Country Department 1. It was reviewed by Mr. J. Shivakumar, Chief, Infrastructure Operations Division, and Mr. Walter Schwermer, Project Adviser. Preparation of this ICR was begun in October 1995 followed by an ICR mission in February 1996. It is based on material in the project file as well as data provided by the Borrower. The Borrowers contributed to the preparation of the ICR by stating their views as reflected in the mission's Aide-Memoire (Appendix A), and by preparing their own evaluation of the Project's execution (Appendix B). The Borrower agencies have also commented on this ICR, and their comments were taken into consideration when finalizing it.  IMPLEMENTATION COMPLETION REPORT PHILIPPINES ENERGY SECTOR PROJECT (Loan nos. 3163-PH, 3164-PH, 3165-PH) Evaluation Summary Introduction i. Bank involvement in the Philippine energy sector dates back to 1957. Bank lending in the sector was limited until 1981, at which time the Bank began lending to support various energy subsectors, including geothermal. In 1988, the Bank conducted a comprehensive Energy Sector Study in an effort to identify how the Government and the Bank could jointly work to address weaknesses in that sector, and The Energy Sector Project (1989) was conceived to support this effort. The Project involved eight beneficiaries and included three Bank loans totaling US$390 million to the National Power Corporation (NPC), the Philippine National Oil Corporation (PNOC), and four separate entities in the Government. Repayment will be over 20 years, including a five year grace period, at the Bank's variable interest rate. (paras. 1-3) Project Objectives ii. The Project had two distinct but complementary objectives. The first objective concerned the implementation of the energy sector development program, which had a number of facets: increasing sector coordination, adopting a least-cost development strategy, strengthening the pricing regime, encouraging private sector participation, improving environmental standards, and enhancing institutional development. The second objective was to finance a time-slice of the energy sector investment program for the period 1989-93. (paras. 4-6) iii. The objectives of the Project were extensive as their scope was sector-wide; however, they had been carefully thought out and were directly relevant to the Bank's Country Assistance Strategy. They were also responsive to the desire of the Government to explore alternative ways to manage the sector. The Project was demanding on all parties involved. (paras. 7- 10) Implementation Experience and Results iv The Project substantially achieved its objectives, despite initial problems reconciling the least-cost development objectives with increased private sector participation (particularly regarding NPC) and reshaping the geothermal drilling program. The time-slice of the 1989-93 investment program had to undergo some revisions to induce the Independent Power Producers (IPPs) to participate in the fast-track generation program in 1991-93. This development, while costly to the sector, proved critical to ending the power crisis and, in so doing, restored the economic health of the economy as a whole. Moreover, as the number of IPPs increased and the power crisis eased, NPC was able to negotiate more favorable contract terms. Encouraged by such results, the Government accelerated the program for the privatization of NPC's various operations in its 1992 Energy Section Action Plan (ESAP). The role of NPC was thus redefined. Its role would no longer be as a generator of power, but as a purchaser of power (mainly on a take-or-pay basis) and as an operator of the transmission system. (paras. 11 - 13)  iii v. PNOC benefited from a small technical assistance component to facilitate privatization of its subsidiaries. PNOC-EDC (PNOC-Energy Development Corporation) received a substantial amount of the loan proceeds to conduct geothermal exploration. After disappointing results in Luzon, PNOC-EDC shifted its focus to Leyte, and with the support of two subsequent Bank loans, is successfully exploiting Leyte's geothermal resources. Petron successfully upgraded two facilities at its refi.nery under the Project. (paras. 13, 18 and 19) vi. The management of the country's energy sector changed significantly under the Project. In 1992, the defunct Department of Energy (DOE) was restored to give the energy sector cabinet-level representation. Further changes saw the folding of Office of Energy Affairs (OEA) into DOE and a substantial reorganization of DOE itself. While these institutional changes did not in themselves result in the improvements in sector-wide coordination as envisioned under the Project; nevertheless, the power crisis served as a catalyst in bringing the Philippine entities together to solve the problem. The Project also enhanced the efficiency and capabilities of entities in the sector by funding several topical studies in the sector, by upgrading hardware and software, and by providing additional staff training. The Energy Regulatory Board (ERB) acquired new capabilities to discharge its responsibilities with respect to inspecting and enforcing conformity to standards of metering equipment, petroleum products, etc. ERB also acquired computer hardware and software under the Project. The Environmental Management Bureau (EMB) also enhanced the skills and tools it needed to monitor the environmental impact of energy projects. The Project also succeeded in providing stop-gap technical assistance to National Electrification Administration (NEA) and the rural electrical cooperatives, in advance of a subsequent Bank project. (paras. 13 and 20) vii. Project sustainability. Project sustainability appears likely. The country's power crisis has been resolved, the macro situation has stabilized, and the energy sector looks set to enjoy orderly energy growth with cost optimization. Moreover, a number reforms in the pipeline will act to carry forward the process of orderly energy growth. (paras. 30-33) viii. Project costs and financing. Due to NPC's decision to enter into BOT arrangements with IPPs to increase generating capacity, and because of PNOC-EDC's poor results in prospecting for geothermal developments in Luzon, total project costs were only about US$2.6 billion, or 80% of the original planned. The Bank disbursed US$373 million through its three loans, or 96% of the full amount. The original closing dates of these loans were extended by 6 to 16 months (see Preface, Annex A: Tables lb, 4a-c, 8A and 8B). JEximbank, which was providing parallel financing, is expected to disburse about US$62 million by end-1996, against US$150 million which was made available. (para. 14) ix. Factors affecting project objectives. The major factors affecting the achievement of Project objectives were mainly those subject to the control of the Government or the implementing agencies, and the risks associated with exploration. At the Government level, the main factors affecting the achievement of Project objectives included tradeoffs between the pursuit of a least-cost or a fast-track strategy, the politicization of tariff adjustments, the weak financial position of NPC, and delayed budgetary allocations to ERB and EMB. NPC's failure to revalue its assets also contributed to its financial problems, and its organizational weakness compounded them. PNOC- EDC tended to be overly optimistic, both in planning for the number of wells to be drilled at geothermal sites in Luzon and in estimating the power capacity from the geothermal steam these were to provide. The original program had to be revised drastically downwards mid-way through the project cycle and the geographical focus had to be shifted to Leyte, a move which helped utilize the loan allocation. (paras. 22-29)  iv x. Bank and Borrower performance. Bank performance through all stages of the project cycle was satisfactory. This performance was particularly noteworthy regarding the design of the Project, the assistance rendered to NPC during its financial crisis, and the close working relationship with PNOC-EDC. Overall, the Borrowers also performed satisfactorily. However, NPC's failure to deal with its financial weaknesses and its absorption in pursuing private investment, led to problems and delays, especially at the on-set. PNOC-EDC's optimism over geothermal potential also impacted Project performance. (paras. 34-38) xi. Project outcogm. Overall, the Project outcome was satisfactory. The matrix in Annex A, Table IB outlines the core factors and justifies this assessment. (para. 39) Summary of Findings, Future Operations and Lessons Learned xii. Findings: (a) The Philippines provides an example of how, under the right conditions, private investment in power generation can be forthcoming and how market forces help secure contracts with fair terms for both sides. In due time, most of the commercial risks should be borne by private investors, and the power development program should suitable accommodate independent power production. Such programs will be useful to investors, and further benefit would be derived by periodic market surveys of energy demand and growth. (paras. 32 and 43) (b) A focal point is necessary within a government to conduct energy policy. It should be the center for planning, guidance, monitoring, coordination and strategy development. (para. 13) (c) Those institutions which manage the environmental and regulatory aspects of the energy sector would gain a better appreciation of their tasks and discharge them more effectively with greater exposure to external developments and expertise. (para. 13) (d) Until petroleum prices and power tariffs are deregulated and operate in a competitive climate, their determination and adjustment should be a transparent process. (paras. 13 and 25) xii. Future operatin. DOE has mapped out a comprehensive restructuring of the energy sector, to consolidate the gains made so far regarding institutional strengthening, generation and transmission, coordination, and to prepare for an eventually restructured and competitive environment. (para. 40) xiii. Key lessons learned. To the lessons inherent in the findings above, the following should be added: (a) Effective supervision is critical to project success, and projects could benefit from more innovative approaches. Supervision could be made into a more proactive exercise, for instance, by considering supervision as part of an ICR exercise and trying to apply any lessons learned during the course of the project, where they would be of immediate use. (para. 45) (b) For the Bank, a feature of a sector loan as distinguished from a subsector individual project loan is the dialogue at the macro policy and central level, which is important too. A judicious and overlapping mix of both types is desirable.  IMPLEMENTATION COMPLETION REPORT PHILIPPINES ENERGY SECTOR PROJECT (Loan nos. 3163-PH, 3164-PH, 3165-PH) PART 1: IMPLEMENTATION ASSESSMENT A. Statement/Evaluation of Objectives 1. Background. Bank involvement in the Philippine energy sector dates back to 1957. Bank lending in the sector was limited until 1981, at which time the Bank began lending to support various energy subsectors, including geothermal. In 1988, the Bank conducted a comprehensive Energy Sector Study in an effort to identify how the Government and the Bank could jointly work to address weaknesses in that sector. The findings of the Study proved very useful in assisting the Government in devising its Statement of Energy Policy (1989) and in formulating an agreed strategy for a five-year, least-cost development program for the sector. 2. The Energy Sector Project (1989) was conceived to support this development program, and also drew heavily on the work of the Energy Sector Study. The Project provided for three Bank loans totaling US$390 million for: (a) the National Power Corporation (NPC) for US$200 million (Loan no. 3163-PH); (b) the Philippine National Oil Company (PNOC) for US$150 million (Loan no. 3164-PH); and (c) the Government of the Philippines (the Government) for US$40 million (Loan no. 3165-PH). There were four beneficiary agencies in the Government: the Energy Regulatory Board (ERB); the Environmental Management Bureau (EMB) within the Department of Environmental and Natural Resources (DENR); the National Electrification Administration (NEA); and the Office of Energy Affairs (OEA), which was later subsumed into the Department of Energy (DOE) in 1992. 3. Repayment will be over 20 years, including a five year grace period, at the Bank's variable interest rate. The Government passed on US$17.8 million of the proceeds of its loan to EMB, ERB, and OEA as budgetary contributions, and made US$22.2 million available to NEA as an equity contribution. PNOC on-lent US$147.0 million to PNOC-EDC and Petron on the same terms as the Bank loan, with PNOC-EDC and Petron bearing the foreign exchange risk. 4. Project Objectives. The Project had two distinct but complementary objectives. The first objective concerned the implementation of the energy sector development program. This program aimed at (a) developing a sector-wide capability to increase energy resources and coordinate policy implementation; (b) adopting a least-cost development strategy for energy development; (c) strengthening regulatory activities for rational consumer energy pricing and improving product and service standards; (d) encouraging private sector participation through joint ventures and other schemes; (e) improving environmental standards and monitoring in areas of high energy use or resource development; and (f) enhancing the technical capabilities of sector institutions. 5. The second objective was to finance a time-slice of the energy sector investment program, for which each of the beneficiary institutions prepared its respective five-year investment program. Of the planned total of investments of US$3,509.2 million during the period 1989-93, the proposed expenditure of NPC was the highest (77.6%), followed by PNOC (21.1%), NEA (0.8%),  2 EMB (0.3%), DOE (0.1%) and ERB (0.1%). Bank loans under the Project were to provide 11.1% of the total investment. Loans from JEximbank were to finance a further 4.2%, and would be disbursed under a parallel financing arrangement with the Bank. The balance of 84.7% was to be financed through internal cash generation and from additional borrowings. 6. Project Components. The Project was to finance, inter alia, imported equipment and materials required for geothermal field development, power plant construction, power transmission and distribution, rural electrification, modernization of office and laboratory equipment of sector institutions, training, technical assistance, and a number of studies. In terms of physical work, the Project was to finance the development of 610 MW of geothermal resources, 1,650 MW of power generation capacity, and substantial expansion in transmission and distribution systems. In terms of policy and institutional reform, the Project was designed to redirect the country's energy development strategy. 7. Evaluation of Objectives. The objectives of the Project were the result of extensive dialogue between the Government and the Bank on issues raised by the Energy Sector Study. They were conceived subsequent to the election of a new Government in 1986, which was seeking alternative ways to manage the sector, and which abolished the Ministry of Energy in an effort to avoid concentrating too much power in the hands of a single Minister. The objectives were manifest in the Government's Statement of Energy Policy, which recognized that projects in the energy sector had intricate linkages with each other and with the sector as a whole and, further, that such linkages had implications to the overall health of the country. The sector institutions involved in the Project recognized that for their components to be viable, the sector program as a whole would have to succeed. 8. The Project was by nature complex, demanding and optimistic. It encompassed a wide range of policy and institutional issues, and included three IBRD loans and one JEximbank loan involving eight separate beneficiaries. Moreover, the implementation capabilities of these institutions were not initially known, as most of them had no recent experience handling sizable investment projects. In addition, the availability of additional sources of financing for the entire sector investment program was uncertain (para. 5). The BOT arrangements which came into vogue subsequent to the approval of the Project added to its complexity. In practical terms, NPC had little control over the choice and siting of BOT plants, and had to react quickly to accommodate changes to such plans. Also, because BOT financing arrangements incorporated new risk considerations, it was difficult to assess the long-term economic viability of this privatization policy. These factors could alone or together impact on the timely implementation and disbursement of the Bank loans, and were outside of Bank control. 9. The objectives of the Project were in line with the Bank's Country Assistance Strategy (CAS). The CAS aimed to revitalize economic growth, improve the efficiency of public corporations, and accelerate privatization. The Project stands as an example of how the Bank was able to influence the direction of a sector far exceeding its relative financial contribution. 10. The Project was responsive to changes in the Government's priorities regarding macroeconomic strategy and sector policy reforms. The design of the Project afforded flexibility in financing components of the energy sector development program. Uncertainty with regard to the availability of other external sources of financing, especially the unsecured part, was recognized at the outset, and financing arrangements were so designed to allow the beneficiaries options in shifting around timings for World Bank/JEximbank financing, depending upon procurement policy  3 considerations. Accordingly, the loan agreements for PNOC and NPC prepared annual rolling investment and financing plans. B. Achievement of Objectives 11. Overall. The Project has substantially achieved its objectives, despite initial problems faced by (a) two sub-objectives with regard to introducing a least-cost power development strategy in the energy sector and encouraging greater private sector participation (especially with regard to NPC); and (b) the reshaping of the PNOC-EDC geothermal drilling program. 12. Macroeconomic policies. The Project contributed to the revitalization of the energy sector and improved the efficiency and capabilities of key sectoral entities (particularly NPC), all of which benefited the economic recovery of the country. These were important objectives of the Philippine CAS. 13. Sectoral and institutional policy objectives. The Project achieved its primary sectoral and institutional policy objectives, albeit, after initial delays. An examination of the separate sectoral and institutional policy components of the objectives follows: (a) Developing a sector-wide capability to increase energy resources and coordinate policy implementation. The Project sought to assist OEA in playing a coordinating role in policy planning. Until 1992, sector coordination was poor and important legislation often lagged. In that year, the defunct DOE was restored to give the energy sector cabinet-level representation. This development allowed the Secretary of Energy to replace the President's Executive Council Secretary as chairman of the Energy Coordination Council (ECC), which exercised broad powers in the sector. A further development saw the OEA attached to the ECC and later transformed into DOE. DOE was reorganized into four bureaus to better deal with (a) monitoring and assisting with demand management, conservation and efficient use of energy resources; (b) formulating policies and helping develop energy resources; (c) regulating financial and fiscal policies related to energy supply entities; (d) developing and monitoring energy plans and demand forecasts; and (e) incorporating national environmental goals into energy programs. In order to handle these functions successfully, DOE needed to undertake a number of studies, provide additional training to staff, and purchase modem computers and other equipment. The Project provided financing to allow DOE to undertake these activities; however, due to substitutions of some studies and with the transformation of OEA to DOE, only about 72% of the funds allocated for these purposes under the Project were utilized. While these institutional changes did not in themselves result in the improvements in sector-wide coordination as envisioned under the Project, nevertheless, the power crisis served as a catalyst in bringing the Philippine entities together to solve the problem. (b) Adopting a least-cost development strategy for energy development. The Government chose to defer a least-cost development strategy while the country faced a power crisis in 1991-93, and while NPC was in financial distress. To alleviate the power crisis, the Government opted for a fast-track program to attract IPPs as mentioned above. Although these projects were not necessarily least-cost options from a sectoral viewpoint, they were justified by longer-term strategic considerations in the energy sector and by the immediate benefits they brought to the economy as a whole. Only after the crisis eased did it pursue policies driven by least-cost considerations. (c) Strengthening regulatory activities for rational consumer energy pricing and improving product and service standards. Tariff reform was to be accomplished by adopting price  4 adjustment mechanisms (fuel price, foreign exchange and power purchase) and by incorporating demand charges. However, such reform was initially delayed by international oil price increases caused by the Gulf War and by the power crisis, and later by NPC's financial difficulties. The tariff structure eventually adopted was revenue-neutral for NPC and was implemented in January 1995. Through an array of adjustments, it promoted energy efficiency by reducing peak power demand and by promoting the more uniform use of electricity during daylight hours. (d) Encouraging private sector participation through joint ventures and other schemes. The role of private firms in the energy sector increased dramatically during the course of the Project, especially with regard to generation. However, this achievement was not without cost. In order to induce the Independent Power Producers (IPPs) to participate in the fast-track generation program in 1991-93, the time-slice of the least-cost development program had to undergo substantial revision. Nevertheless, the execution of the modified strategy created more favorable conditions for attracting sufficient numbers of IPPs, which proved critical to ending the power crisis -- a development that greatly facilitated the economic well-being of the country. Moreover, NPC was able to secure better terms from the IPPs as it gained greater experience in negotiating with IPPs and, with the easing of the power crisis, as it was increasingly guided by market considerations and less by crisis management. Encouraged by such results, the Government accelerated the program for the privatization of NPC's various operations in its 1992 Energy Section Action Plan (ESAP). The role of NPC was thus redefined. Its role would no longer be as a generator of power, but as a purchaser of power (mainly on a take-or-pay basis) and as an operator of the transmission system. As of end- June 1994, NPC was involved in 15 private generation projects (BOT, ROM, etc.), with some 18 more in the pipeline. The aggregate capacity of 20 projects for which data are available is about 4,000 MW, with private sector investment estimated at about US$4.2 billion. These figures surpassed the expectations at appraisal of both the Bank and the Government. The further privatization of NPC appears on track. Over the medium- to long-term, NPC will transfer its generation assets to a holding company which will spin off each individual generating plant to the private sector. The transmission function alone will remain with NPC. Privatization efforts at PNOC-Petron have also progressed. While the Government owns 40% of the shares of the company and Saudi Aramco holds another 40%, the remaining 20% is owned by about half a million Filipino stockholders. Petron has sought the Bank's consent to prepay the entire loan proceeds of US$20 million, which it had utilized for upgrading two facilities. PNOC-EDC also sought greater private sector participation by attracting IPPs into BOTs to convert over 600 MW of steam to electricity from fields in Leyte. This steam resource was partly identified by the current Project, and is being exploited by the Bank-financed Leyte-Luzon Geothermal Project (Loan no. 3747-PH) and the Leyte- Cebu Geothermal Project (Loan no. 3702-PH). The Project also advanced privatization efforts at PNOC, which utilized a small technical assistance component to facilitate privatization of its subsidiaries. (e) Improving environmental standards and monitoring in areas of high energy use or resource development. This involved the modernization of environmental monitoring facilities and capabilities in response to energy developments. The Project succeeded by and large in enhancing the quality and competence of the EMB. It is now better equipped, and its personnel better trained with consultant assistance, to carry out its various functions. However, EMB was only able to utilize 75% of its allocation, as delays at the Department of Budget prevented the timely release of funds under the Project. (f) Enhancing the technical capabilities of sector institutions. The Project improved the technical capabilities of ERB staff by financing their participation in various local and foreign  5 training courses, conferences and seminars, and by supporting technical assistance in regulatory procedures, price and tariff determination, and related subjects. ERB acquired new capabilities to discharge its responsibilities with respect to inspecting and enforcing conformity to standards of metering equipment, petroleum products, etc. ERB also acquired computer hardware and software under the Project. The Project financed technical training for staff at NEA, as well as at the Rural Electrical Cooperatives (RECs) which NEA oversees. Such training allowed the RECs to upgrade and rehabilitate critical transformer/substations and distribution equipment. It also laid the groundwork for a broader development agenda for the RECs, which was addressed under the subsequent Rural Electrification Revitalization Project (Loan no. 3439-PH). 14. Financing objective. The total investment program under the Project was to be financed from four sources: (a) World Bank loans (with JEximbank parallel financing); (b) other committed loans (including from bilateral sources); (c) other uncommitted loans; and (d) internal cash generation. While adequate financial mobilization from external sources was largely realized (primarily due to interventions by IPPs under BOT contracts), counterpart financing for the Bank component from internal cash generation was found wanting, particularly with regard to NPC. This development was not anticipated by the Bank in its appraisal in 1989, at which time the Philippine economy and the energy sector were both growing by 5% annually. Howeve'r, this situation changed dramatically as a series of events unfolded which impacted the sector in general and NPC in particular: the lack of a replacement for the Bataan nuclear power plant and the breakdowns of badly maintained thermal plants, combined with the effects of the drought, which precipitated a period of extended brown-outs; the Gulf War, the increase in international oil prices, and Peso devaluation, which impacted on both NPC's costs and revenues; and NPC's asset undervaluation and the political unpopularity regarding tariff increases, which further compounded NPC's abilities to increase revenues. As a result, NPC became in technical default of its loan covenants and was unable to attend adequately to its investment program. All of this coincided with (and contributed to) the country's power crisis. These problems caused a delay in the effectiveness of the JEximbank loan until October 23, 1992, and the extension of its closing date until December 31, 1996. While the Bank has been able to disburse 95% of its loan to NPC, JEximbank disbursements have been slow, but Jeximbank is expected to disburse about US$62 million by end-1996, against US$150 million which was made available. 15. Physical objectives. The overall physical objectives of the Project were substantially achieved. The physical objectives of the sector program in geothermal exploration, power generation and transmission were substantially achieved, albeit, with an increased focus on fossil fuel-based generation. 16. NPC. The construction of the Palimpinon II (2x2OMW) four modular geothermal power plant commenced on May 13, 1992. All four units became operational between February 1994 and May 1995. While the cost of Palimpinon 11 was originally estimated at US$80.2 million, the eventual cost totaled US$105.1 million, reflecting increases associated with implementation delays and exchange rate losses. The procurement of 69kV transmission line materials for Luzon, Visayas, Mindanao, and the Small Island grid have been completed, and some transmission lines in Luzon and Visayas have already been erected and energized. The US$200 million Bank loan for these purposes has been fully disbursed. The remaining transmission system construction will be financed by JEximbank (70%) and by NPC's internal cash generation (30%). 17. The contract for the rehabilitation of the Ambuklao hydroelectric plant was terminated effective November 1, 1991 to encourage private financing. The rehabilitation is now  6 being effected under an ROL agreement by a consortium including MERALCO Industrial Engineering Services Corporation, Morrison-Knudsen Corporation, Mindanao Shipbuilding Corporation, and J.G.S. International Corporation. 18. PNOC-Petron. PNOC-Petron successfully upgraded two facilities at its refinery under the Project. The Gas Oil Desulfurizer Unit (GODU) was commissioned on April 23, 1995 and the LPG treating facilities were completed on February 25, 1995. During the performance test-run, the GODU operated with a sulfur product of 0.12 wt % based on a 1.33 % feed sulfur content. The LPG produced yield has increased by 13%, equivalent to a 400 barrels per day increase in LPG production, but this was below 1990 projections. 19. PNOC-EDC. PNOC-EDC drilled 38 of the 76 geothermal exploration wells in Luzon, but the results were disappointing, as large geothermal reserves in commercial quantities were not discovered. Priorities then shifted to Leyte, where 28 of the wells had been drilled. The target commission dates were postponed, while completion of resource assessment and development strategy targets were met between one and two years later than scheduled. Despite these delays and the lack of commercially viable geothermal resources in Luzon, PNOC-EDC has continued exploiting geothermal resources in Leyte under two subsequent Bank-funded projects, and in new BOT ventures. 20. NEA. The Project provided for the rehabilitation of 12 RECs and financed an additional eight substations and 21 power transformers and substation packages. 21. Economic Rate of Return. The economic rate of return for the project has been computed at 13.5%. This computation did not follow the methodology used in the SAR. The earlier methodology did not make allowance for the role of independent power production, which has become very prominent in the interim, and therefore would likely overestimate the value of the project's benefits. Because of this new phenomenon, NPC's investment streams have focused on lower return rehabilitation/retrofitting of old plants and transmission networks, and not on new generation capacity. The 13.5% ERR assumes that the economic value of a kWh of electricity sold to the distributors at high voltage terminals, after transmission in the main grids, is US7cents/kWh (in 1994 terms). This, in fact is approximately the amount currently being realized through existing tariffs. This ERR of 13.5%, without having to bring into reckoning "consumer surplus," is indeed satisfactory. While it is somewhat lower than the 17% computed at appraisal, a value comparable to the appraisal estimate would have been likely had the original methodology been followed. C. Major Factors Affecting the Project 22. The major factors affecting the achievement of Project objectives were mainly those subject to the control of the Government or the implementing agencies, and the risks associated with exploration. 23. Factors generally subject to Government control. The main factors affecting the achievement of Project objectives at this level included tradeoffs between the pursuit of a least-cost or a fast-track strategy, the politicization of tariff adjustments, the weak financial position of NPC, and delayed budgetary allocations to ERB and EMB. 24. In its drive to end the power crisis (power outages and brown-outs of the late 80s and early 90s), the Government was anxious to attract private interest in fast-track power generation,  7 even assuming some commercial risks itself. It accomplished this by supplying fuel at its own cost to IPPs, by providing counter-guarantees on NPC guarantees for take-or-pay contracts, and by offering incentives for power production above contracted quantities. At first, the IPPs installed mostly gas turbines. These were favored because of their low gestation time and relatively lower capital costs; however, their operational costs were relatively high as typifies peaking facilities used for base load generation. Relieved from the pressures of the power crisis, NPC was able to introduce competition in the selection of IPPs and choose lower generation cost through longer lead-time projects, thus achieving much lower generation costs. 25. The politicization of tariff reform brought to the forefront a controversy concerning NPC's exemption from fuel taxes. These taxes were assessed and collected at P2,950 million in 1992, but not refunded (as was the normal practice) in view of the controversy. The Supreme Court eventually ruled in favor of the exemption, greatly facilitating NPC's financial recovery. 26. By 1991, NPC's financial situation had deteriorated to the extent that its rate of return was just 3% against the covenanted 8%, and the debt service ratio dropped to 0.9, the lowest level since 1985. As a result, NPC was in technical default of loan covenants as stipulated by the Energy Sector Project and the Bacon-Manito Geothermal Project (Loan nos. 29690-PH and 29691- PH). NPC's situation was, in part, precipitated by factors beyond its control, including the devaluation of the Philippine Peso in 1990, the catastrophic droughts in Mindanao, and the upsurge in oil prices caused by the Gulf War. However, NPC contributed to its travails by its failure to disclose its true financial condition during 1987-90, when it resorted to a limited revaluation of its assets and depressed its rate base. Had it carried out a full revaluation -- as was done subsequently with consultants in 1992-93 -- the drastic remedies administered through a reform program in 1992 might not have been necessary. At present, NPC's financial condition is satisfactory; however, to maintain its financial health, NPC must remain vigilant. NPC, in its own evaluation of the Project, states this as a key lesson learned. 27. Factors under the control of the implementing agencies. Factors relating to NPC were partially addressed in the previous paragraph, as they interrelated with Government actions, but other factors exclusive to NPC affected the achievement of Project objectives. For one, NPC's organizational weakness led to its fighting "brush fires" under exigencies of power outages and brown-outs, diluting its attention from construction and expansion projects. Implementation delays (in procurement, engineering design, and right-of-way acquisitions) in the course of the Project became endemic with NPC, a feature from which it is now recovering. 28. While other implementing agencies did not face this range of problems, the encountered delays in start-up and implementation, owing to their unfamiliarity with Bank procurement procedures and with .he preparation and evaluation of bid documents. 29. PNOC-EDC tended to be overly optimistic, both in planning for the number of delineation/development wells to be drilled at geothermal sites in Luzon and in estimating the power capacity from the geothermal steam these were to provide. The original program had to be revised drastically downwards mid-way through the project cycle and the geographical focus had to be shifted to Leyte (which proved a fruitful move). It seems advisable, in planning for delineation/development of uncertain prospects and providing for funds, that probability assessment techniques be used (e.g., Monte Carlo).  8 D. Project Sustainability 30. Project sustainability appears likely. At the macro level, the economy has been recovering. The country has resolved the power crisis and appears to have learned from this experience. This resolution also allowed Project objectives to come back into play. The energy sector looks set to enjoy orderly energy growth with cost optimization. The DOE, since its restoration in 1992, and with renewed authority over the various entities in the energy sector, has been framing pragmatic energy policies and medium- to long-term plans. The Medium-Term Energy Plan (1993-2000) was initiated in 1993 and was updated as the Philippine Energy Plan (1994-2010) in 1994. DOE is also cognizant of emerging issues, such as demand side management and energy conservation. It is also mindful of the financial implications and timing of new capacity additions by IPPs. Such prudence is important, as a mismatch between guaranteed purchases of power and NPC's forecasts of sales growth or readiness to receive supplies could be financially costly, but power outages must be avoided in the end. 31. A number of reforms in the pipeline would carry forward the process of orderly energy growth, including: (a) restructuring NPC and privatizing its various generation plants; (b) developing an independent transmission company (NPC may be wholly assuming this function) which will provide IPPs with open access to the power market and thus introduce competition among power suppliers; (c) deregulating energy pricing (targeted for end- 1996); (d) strengthening the capabilities of NPC's BOT Center to ensure competitive private investments; and (e) developing adequate projects suitable for private participation. NPC's latest effort to reward and promote good performance, its Productivity Enhancement Program, should also contribute to sustainability. 32. Further, the allocation of risks between the Government and its entities on the one hand, and the private sector on the other, is being studied. This analysis will focus in particular on policies guiding guarantees and pricing. Limits on the overall use of guarantees, consistent with a realistic evaluation of the country's fiscal capacity and macroeconomic priorities, will be part of this initiative. 33. Finally, the Bank's CAS will support the strengthening of infrastructure to ensure that new generation capacity will benefit the public at large. The Bank's continued participation in the energy sector (as detailed above) is expected to reinforce the prospective policy thrusts that the Government is currently contemplating. E. Bank Performance 34. Preparation. Bank performnance with regard to Project preparation was satisfactory. Project identification was carried out in conjunction with the beneficiary institutions, and flowed from previous work with the same parties during the preparation of the Energy Sector Study. While the objectives of the Project were clear, the Project was necessarily complex, owing to the participation of eight separate beneficiaries, and its sector-wide scope. This complexity allowed for a degree of innovation with regard to Project design, and called for a great deal of effort on the part of Bank staff. Since the Project was financing only a time-slice of the investment program (of which there were many sub-projects), suitable sub-projects were selected from a rolling list which was prepared annually. The Project afforded additional flexibility by allowing the beneficiary institutions to seek alternative financing arrangements using Bank funds as a backstop. Since it was anticipated that some sub-projects would involve BOTs, an innovative mechanism for financing procurement was worked out for such cases, though never used, apparently due to the perceived burden of  9 complying with Bank procurement procedures. With regard to environmental considerations, the Bank reserved the right to review the Environmental Impact Assessment, and stipulated that it must be satisfied before the Bank could approve the use of loan proceeds for particular sub-projects. The geothermal development around Mt. Apo was excluded from the 1989-93 time-slice until an environmental assessment could be completed, but given the continuous protests by NGOs regarding the environmental impact of such development, it was subsequently dropped from consideration for Bank financing. 35. Appraisal. Bank performance with regard to appraisal was satisfactory, especially given the complexity of the Project. In fact, one Executive Director commented that the Project was a "well designed operation which is central to the Bank's Assistance to the Philippines." However, it should be pointed out that, between the first appraisal mission in July 1989 and the first supervision in June 1990, when Bank staff were concentrating on the loan approval process, the financial situation of NPC quickly deteriorated. While the Bank had recognized that NPC's finances were weak from the on-set, it had not fully appreciated the severity of its financial position, nor anticipated how vulnerable NPC was to the exogenous factors which quickly brought about its financial crisis (para. 14). However, the Bank was quick to adapt its supervision priorities and respond to NPC's financial crisis by providing strong support during the crisis that followed. 36. Supervision. Bank supervision was satisfactory. Given the complexity of the Project and the fact that there were eight Philippine entities involved (para. 8), supervision efforts focused on a few, key issues. With regard to NPC, the aim was on alleviating its financial problems, compliance with legal covenants, improving its efficiency, and encouraging private participation in generation and privatization. With regard to PNOC-EDC, supervision was more hands-on, with Bank staff involved in implementing sub-projects and in guiding the steps for BOT power generation. The DOE entities did not require much supervision given the relatively simple scope of their participation. F. Borrower Performance 37. Preparation. Overall project preparation by the Borrowers was satisfactory. Such preparation was in large part a follow-up on the Bank's Energy Sector Study (1988) and to the Government's Statement of Energy Policy, as the sector reforms embodied in the Project (e.g., privatization, least-cost development, economic prices, etc.) were set out in these earlier works. In such a framework, NPC, OEA and PNOC drew up action plans and investment programs which could be coordinated, yielding economies of scale and scope. However, NPC made overly optimistic assumptions about its internal cash generating capabilities, and this error, in combination with a number of exogenous factors, contributed to its financial distress -- and to subsequent problems with implementation and performance. 38. Implementation. The overall implementation performance of DOE, EMB, ERB, NEA and PNOC was satisfactory. In the case of NPC, Project implementation was unsatisfactory in the early years, due to its absorption in the pursuit of private investment, but improved with the easing of the power crisis and its own financial recovery. Project implementation problems included slow disbursement, procurement complications, delays in the availability of counterpart funding, and delays in acquiring rights-of-way. There was further a deferment in the effectiveness date of parallel financing by JEximbank, resulting in a delay in the implementation of the subproject, which is not expected to be completed until 1996.  10 G. Assessment of Outcome 39. The outcome of the Project was satisfactory. The Project substantially achieved its major objectives, given the changed environment, and is likely to achieve satisfactory development results with only a few shortcomings. Annex A Table lb provides a breakdown of the extent to which estimates in the SAR were realized. H. Future Operations 40. At the sectoral level, future operation would be greatly advanced by undertaking appropriate measures to improve the private business environment, strengthen policy formulation, and ensure efficient project implementation. The Bank has succeeded in shaping a favorable investment climate, despite its relatively minor resource commitment. Further, the Bank will continue its on-going dialogue with the Borrowers in the course of follow-on projects, further improving the operating environment. In addition, DOE has mapped out a comprehensive restructuring of the energy sector to be accomplished in three phases (Annex B, Table 2). Phase one (1994-98) is directed at strengthening all sectors and participants in the industry, restructuring generation and transmission, facilitating coordination, and preparing the industry for increased competition, privatization and decentralization. Phase two (1998-99) will focus on evaluating results and further restructuring and privatization. Phase three (1999-04) envisions moving into a completed restructured and competitive environment. With respected to the operating units of NEA, NPC and PNOC financed under the Project during Phase I, the associated measures should help guarantee proper maintenance of their respective operations. I. Key Lessons Learned 41. It would be trite to state that any commercial institution must maintain a continuous vigil over its financial position. However, considering the experience of NPC, this lesson bears restatement. Financial and commercial policies must be adopted with due consideration of their ultimate consequences. Exigencies of operation must not result in onerous financial conditions, as it could have long-term repercussions. It would be desirable that NPC study the implications of the several IPP contracts it has signed with take-or-pay clauses and high plant factors. While contract conditions must be honored, NPC should have a clear idea of the problems which may arise from such obligations, including the problems associated with coordination of the IPPs. 42. Privatization can succeed if implementing agencies are committed to the new policy paradigm, take bold but flexible steps, and institutions provide incentives for prospective participants (such as IPPs). In the design of future energy sector projects, policymakers and managers need to recognize how and when to modify (or abandon) conventional assumptions, and to apply a strategy that will introduce innovative solutions in a fast-changing global economic environment. For example, to resolve the power crisis, it was necessary drop the belief/paradigm that NPC should/could have a monopoly on the energy supply in the Philippines. This paradigm shift made private funding possible. 43. Private investment must be secured under competitive conditions to ensure that market forces help achieve least-cost solutions. Investors must be expected to bear all commercial risks. Where exigencies of circumstances, such as the pressing need for external capital/new technology, obliges governments or their agencies to assume some of the commercial risks, there  11 should be a thorough analysis of the long-term implications with objective, expert assistance, and then the terms of such offers should be negotiated on fair terms for both sides. 44. Bank guidelines for procurement have uniformly been appreciated by the Borrowers for their transparency and integrity of the processes involved, yet developing a mastery of these guidelines seems to be a protracted undertaking. Apart from the Bank educating concerned personnel of the Borrowers (even during appraisal), it may be worthwhile to require borrowers to maintain continuity of key personnel to handle procurement from loan to loan. 45. Given the complexity of the Project and the critical nature of the work which needed to be carried out during supervision, particularly regarding NPC's financial situation and implementation problems, the Bank could have undertaken more initiatives to make such supervision more effective. One approach would be to consider some of the topics during supervision that are normally considered during an ICR exercise (Borrower performance, Bank performance, Lessons Learned, etc.) so that supervision would become more of a proactive exercise and any lessons could be applied during the course of the Project, when they would be most useful. Moreover, a more judicious allocation of responsibilities among professional staff may be called for in order to cover as much ground as possible, with the possibility of rotating Task Managers.  I  12 IMPLEMENTATION COMPLETION REPORT PHILIPPINES ENERGY SECTOR PROJECT (Loan nos. 3163-PH, 3164-PH, 3165-PH) PART II: STATISTICAL ANNEXES ANNEX A: STATISTICAL TABLES Table 1: Summary of Assessment A. Achievement of objectives Substantial PiNegligible hk appllicable Macroeconomic policies 0 00 0 Sector policies 0 0 0 0 Financial objectives 0 0 0 0 Institutional development 0 0 0 0 Physical objectives 0 0 0 0 Poverty reduction O 2 O 0 Gender concems 0 O O 0 Other social objectives 0 O 0 Environmental objectives o 0 0 0 Public sector management O 0 0 0 Private sector development 0 0 0 0 Economic benefits Ql O B. Proiect Sustainabilitv Likely Unlikel Uncertain 1/ (V (/ (/ 0 0 0 C. Bank Perfofmance Hi2hlv Satsifactory SatisfactoQ Deficient (/) (/) (/) Identification 0 0 0 Preparation assistance 0 0 0 Appraisal 0 0 0 Supervision 0 0 0 D. Borrower Performance Hi1hly Sfifc Satsatr Deficient (/3 (/3 (/ NPC (Loan 3163-PH) Preparation O0 0 Implementation 0 0 0 Covenant compliance 0 0 0 Operation (if applicable) E 0 0 PNOC (Loan 3164-PH) Preparation 0 0 Implementation 0 G Covenant compliance 0 0 0 Operation (if applicable) 0 0 0  13 D. BorrowerPerformance Higly Safisfctory Satisfactory Deficient (I) (' (0 PNOC-EDC (Loan 31 64-PH) Preparation 0 0 0 Implementation 0 0 0 Covenant compliance 0 o Operation (if applicable) 0 Q O PNOC -PETRON(Loan 3164-PH) Preparation 0 0 0 Implementation 0 0 0 Covenant compliance 0 0 0 Operation (if applicable) 0 Q O DOE (Loan 3165-PH) (/) () (0 Preparation 0 Implementation 0 0 0 Covenant compliance 0 0 0 Operation (if applicable) 0 0 O ERB (Loan 3165-PH) (I) (I (/) Preparation 0 0 0 lmplementarion 0 0 0 Covenant compliance 0 Operation (if applicable) n 0 O NEA(Loan3165-PH) (/) (0 (I) Preparation 0 0 o Implementation 0 0 Covenant compliance Q 0 0 Operation (if applicable) o 0 0 EMB (Loan 3165-PH) (/) (I) (/) Preparation 0 0 0 Implementation 0 0 0 Covenant compliance Q 0 0 Operation (if applicable) 0 0 0 E. Assessment of Outcome Higly Satisfactory Satisfactory Deficient (0 (0 (0 0 0 0  14 Table lb: Summary of Assessment (Overview: Expectudons and Performance) SAR Actual Bank Bank estimates of project loan loan project costs costs amount utilized Beneficiary 1989-1993 1990-1995 Brower agency Core goals of ESP Results achieved SM $ 5M S M SM GOP OEA/DOE Lead & coordinate DOE under a full time Secretary in L3163- sector activities; Charge of Energy affairs created; PH 4.3 3.1 4.3 3.1 Carry out studies with Done, and findings used for policy expert help. ERB Raise professional Done, more remains to be done competence to regulate energy prices/inspection. 3.0 3.5 3.0 3.5 EMB Raise professional Done, but more remains to be done competence to safeguard the environment implementing energy projects 12.2 7.8 10.1 7.8 NEA Boost rural First-aid type assistance provided. electrification, where Revitalization of project is ongoing moribund pending a comprehensive revitalization project 26.5 i& 22.6 ,& Subtotal 440 f27 40 ,-7 NPC Adopt a least cost Energy crisis and financial woes of NPC L3163- development program in 1990-91 upset the program; but this PH) NPC over 1989-93 and accelerated private investments in power optimize generation - initial fast track projects investments/returns; were not cost effective, but subsequent invoke private ones were, mainly due to market participation, etc. competition and enormous interest in the Philippines. If NPC had been more alert in 1990, the financial crisis would have been mitigated and drastic steps of the Recovery program enforced by IMF with Bank support obviated 2722.0 2292.0 200.0 200.0 PNOC- PNOC-EDC Develop Steam Luzon did not keep its promises, so L314- Delivery in Luzon/ PNOC-EDC diverted attention to Leyte PH Visayas & Provide a where there has been success; and BOTs local economic will convert steam to electricity. resources for power generation, seek private, participation 466.0 265.0 133.0 118.0 Petron Upgrade quality of Done in all respects diesel oil/ increase LPG production/ privatize 29.0 37.0 14.0 20 PNOC Re-orient towards Largely done; PNOC-EDC will also be privatization of almost privatized in the coming two years. all its subsidiaries UQ U33