Sri Lanka - Fifth Power Project

DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Not For Public Use FILE COPY Report No. 21-CE REPUBLIC OF SRI LANKA APPRAISAL OF THE FIFTH POWER PROJECT (POWER TRANSMISSION AND DISTRIBUTION) OF THE CEYLON ELECTRICITY BOARD March 14, 1973 Public Utilities Division Asia Projects Department This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS US$1 . Sri Lanka Rupees (Rs) 11.19 1/ Rs 1 US$0.089 Rs 1 million - US$89,365 UNITS AND EQUIVALENTS 1 kilometer (km) - 0.6214 miles (mi) 1 kilovolt (kV) 1,000 volts (V) 1 megavolt-ampere (MVA) - 1,000 kilovolt-amperes (kVA) 1 megawatt (MW) = 1,000 kilowatts (kW) 1 gigawatt hour (GWh) - 1 million kilowatt hours (kWh) ACRONYMS AND ABBREVIATIONS ADB - Asian Development Bank DGEU - Department of Government Electrical Undertakings FEEC - Foreign Exchange Entitlement Certificate GNP = Gross National Product FISCAL YEAR January 1 - December 31 1/ The Sri Lanka rupee is tied to the Pound Sterling at Rs 15.60 per Pound. Consequently, the rate towards the US Dollar has been floating with the Pound since June 1972. The cross-rate has been about Rs 6.8 per US Dollar in recent months. The Foreign Exchange Entitlement Certificate (FEEC) rate, applicable to most non-food imports, is the official rate plus 65Z (55% until November 1972).  SRI LANKA CEYLON ELECTRICITY BOARD APPRAISAL OF THE FIFTH POWER PROJECT (POWER TRANSMISSION AND DISTRIBUTION) TABLE OF CONTENTS Page No. SUMMARY AND CONCLUSIONS ............................... i I. INTRODUCTION .......................................... 1 II. THE SECTOR ............................................ 2 Economic Background ...... ...................... 2 Sector Organization ....... ..................... 2 Existing Facilities . . ............................ 3 Power Market and Load Growth ..... .................. 3 The Development Program .... . 4 III. THE BENEFICIARY ....................... 4 Management Consultants' Study ..... ................. 5 CEB's Organization .................................... 5 Accounts .............................................. 5 Operations ........................................... 6 Insurance ............................................. 6 IV. THE PROJECT .... 6 Description of the Project ........................... 6 Project Cost Estimate .................... 7 Foreign Exchange Entitlement Certificate (FEEC) ....... 7 Engineering and Construction ........................... 8 Procurement and Disbursement ................. 8 Ecological Aspects ..................... 9 V. JUSTIFICATION OF THE PROJECT .......................... 9 This report was prepared by Messrs. K. Stichenwirth and C. K. Chandran and is based on the findings of a mission to Sri Lanka in July 1972.  -2- Page No. VI. FINANCIAL ASPECTS ..................................... 10 Past Record and Present Position .......... ............ 10 Accounting, Billing and Collection .. .................. 11 Transfer of Assets .................................... 11 Tariff and Dividend Limitation Covenant ............... 12 Audit .. ...................................... 13 Subsidiary Loan ....................................... 14 Future Finances ....................................... 14 VII. AGREEMENTS REACHED AND RECOMMENDATIONS ................ 15 ANNEXES 1. Existing Generating Facilities of CEB 2. The Existing Transmission and Distribution System 3. Energy Generation and Sales - Actual and Forecast 4. Detailed Description of the Project 5. Project Cost Estimate 6. Schedule of Disbursement of the Credit 7. Income Statements 1970 - 1977 8. Sources and Applications of Funds 1972 - 1977 9. Balance Sheets 1970 - 1977 MAP IBRD 10199 (R)  SRI LANKA CEYLON ELECTRICITY BOARD APPRAISAL OF THE FIFTH POWER PROJECT (POWER TRANSMISSION AND DISTRIBUTION) SUMMARY AND CONCLUSIONS i. This report appraises a Project consisting of extensions to the transmission and distribution facilities of the Ceylon Electricity Board (CEB). The Project includes the construction of 490 miles of transmission and distribution lines with associated substations, and distribution facili- ties for Colombo. ii. The estimated cost of the Project is US$9.8 million equivalent, including US$6.0 million in foreign exchange. An IDA Credit to cover the foreign exchange component of US$6.0 million is proposed. iii. The facilities provided through the proposed Project are needed to properly serve the expected market and are the most economic among the alternatives proposed. iv. The Credit would be made to the Government of Sri Lanka and re- lent to CEB at 7-1/4% interest and for a term of 20 years with three years' grace. The CEB, created by the 1969 Ceylon Electricity Board Act in con- sultation with the Bank, is a Government-owned corporation, responsible for generation, transmission and distribution of electric energy throughout the country. It has the engineering capability to handle design and construction of the work involved under the Project and will be responsible for its im- plementation. Procurement financed through the proposed credit would be carried out in accordance with Association guidelines. v. With the agreements reached during negotiations, the Project is suitable for an IDA Credit of US$6.0 million equivalent.   SRI LANKA CEYLON ELECTRICITY BOARD APPRAISAL OF THE FIFTH POWER PROJECT (POWER TRANSMISSION AND DISTRIBUTION) I. INTRODUCTION 1.01 This report. covers the appraisal of a Project for extensions of the Ceylon Electricity Board's (CEB) transmission and distribution network. These extensions are necessary to fully utilize the power soon to become available when two projects being constructed with Bank assistance are commissioned in 1974. 1.02 The Government of Sri Lanka has requested an Association Credit to finance the foreign exchange cost of the project amounting to US$6.0 million equivalent. The Project's total cost is estimated at US$9.8 million equivalent. 1.03 Four Bank loans for power development and one loan/credit for an irrigation/power project have been made as follows: (i) Loan 101-CE (US$15.9 imillion) in 1954 to help finance the 25 MW expansion of the Laksapana hydroelectric scheme; (ii) Loan 209-CE (US$7.4 million) in 1958 to help finance construction of a 25 MW thermal plant at Grandpas, Colombo; / (iii) Loan 283-CE (US$14.1 million) in 1961 to help finance a 25 MW expansion at Grandpas; (iv) Loan 636-CE (US$21.0 million) in 1969 to help finance the 90 MW Maskeliya Oya Stage II project, a 25 MW gas turbine and management consultancy and engineering services. US$4.5 million relating mainly to the gas turbine instal- lation were subsequently cancelled; and (v) Loan 653-CE/Credit 174-CE (US$29.0 million) in 1969 for the multipurpose Mahaweli Ganga Development project of which the 50 MW Polgolla power station forms a part.  -2- The last two projects are currently under execution and work is proceeding satisfactorily after some initial difficulties, mainly due to delays in placing major contracts and subsequent delay in the supply of generating equipment. The other power stations are in satisfactory operation and their output should be adequate to meet system requirements until early 1974 by which date the Maskeliya Oya project is scheduled to be commissioned. 1.04 CEB was established in July 1969 by the Ceylon Electricity Board Act No. 17 of 1969 to replace the Department of Government Electrical Under- takings (DGEU). Its operations have generally improved from a very low level of efficiency during the last two years, but further effort is requir- ed. In accordance with provisions of Loan 636-CE, Management Consultants are presently engaged in the field of accounting and internal reorganization of CEB to establish its technical and financial operations on more modern lines. 1.05 This report was prepared by Messrs. K. Stichenwirth and C. K. Chandran and is based on the findings of a mission to Sri Lanka in July 1972. II. THE SECTOR Economic Background 2.01 Sri Lanka covers an area of about 25,000 square miles and has a population of 12.7 million growing at 2.4% annually. Its per capita GNP in 1970 was estimated at US$120 by the Bank's economic mission. It has no large mineral deposits and its economy is largely dependent upon three agricultural products, tea, rubber and coconuts. Its per capita consumption of electricity, presently below 60 kWh, is among the lowest in the world. 2.02 In the 1960's there was no real economic growth due to exception- ally poor market conditions for its two principal exports, tea and rubber. The country now faces a difficult economic situation, mainly due to adverse balance of payments and serious unemployment. 2.03 Reversal of the economic decline will depend both on improvement of traditional exports and diversification of the economy. To this end, measures are being introduced to electrify and modernize tea estates and to develop new agricultural exports. New, export-oriented industries, based on local labor and available raw materials, are also being considered, with priority to be given to quick-yielding, labor-intensive and financially productive schemes. An adequate electricity supply is basic to all these initiatives. Sector Organization 2.04 Electricity supply in Sri Lanka was initially developed by a private company. In 1928 the Government purchased the assets of this company and transferred them to the Department of Government Electrical Undertakings (DGEU) which has since been, in effect, the national electricity authority  - 3 - of the country. The Electricity Supply Act, 1950, as amended in 1957, reserved all electricity generation and transmission to DGEU, which was the retailer of electricity in most places also, but permitted local authori- ties in some places to distribute and sell electricity. By 1969, DGEU's service area had been extended to practically all major towns; but it had by then become apparent that its organization was weak; it also lacked independent authority in overall policy planning, financing and personnel management. In an attempt to overcome these deficiencies, the Government passed legislation in July 1969 creating GEB as a single autonomous entity, responsible to the Minister for Public Works, Irrigation and Power, enabling financial policies to be introduced which would clarify the application of revenue and specifically provide for financing a reasonable proportion of the cost of development of electricity services. 2.05 CEB fulfills its operational responsibilities adequately but its financial management is weak and it does not have complete control of its system planning because decisions on multipurpose water resource develop- ment are made by other agencies. After these decisions are made CEB is given responsibility for design and construction of the development's power features. While the choice of developments has been acceptable (the Bank/ Association has assisted in their financing) the provisions for eventual transfer of the value of power assets to CEB is vague and to prevent CEB from having to assume an undue portion of such costs in the future, it was agreed during negotiations that the methodology for determining the same and the amount to be transferred should be acceptable to the Association (paragraph 6.07). Existing Facilities 2.06 Annex 1 shows the characteristics of CEB's eight existing power stations. These provide a total capacity of 261 MW. Five are hydro stations which together with the three thermal stations, generated a total of 833 GWh in 1971. Existing plant is well maintained and, together with generating capacity presently under construction (paragraph 2.10), should meet system requirements until the end of 1975. 2.07 The transmission and distribution system is described in Annex 2. The main transmission system at 132 KV has been well designed on the basis of network analyzer studies. It enables CEB's existing power stations to be operated as an integrated power system. The system has been planned to facilitate expansion, mainly at 132 KV and 33 KV. Power Market and Load Growth 2.08 In the early 1960's, the overall demand increased at an average annual rate of 10.3%. However, during the economic slowdown in 1968-71, the annual demand growth rate fell to about 9% (Annex 3). At the same time, the industrial demand had been the most rapidly expanding sector of the power market, increasing at an annual rate of about 18% between 1961 and 1968, and about 11% thereafter. With the commercial and domiestic con- sumption maintaining a fairly steady low average growth rate of about 5.5%  -4- between 1961-71, industrial consumption increased its share of total sales from about one-third to more than half during 1961-71, becoming the most important factor in assessing future overall load growth. 2.09 During the appraisal, the Government's plans for industrial expan- sion over the next 4-5 years, which would have required annual generation increases of about 18%, were reviewed with CEB and representatives of the Ministry of Planning and Employment (concerned with the regulation of in- dustrial development) and were judged as too ambitious in the present eco- nomic situation of the country. In agreement with Government and CEB a growth rate of about 13% annually was adopted as reasonable for planning purposes. Although slightly higher than during the recent slowdown, this growth rate is based on expected additional sales to existing major indus- tries only, not taking into account planned new industry, the implementation of which is not assured at present. Domestic and commercial sales are not expected to increase above the low recent annual rate of about 5.5%; together with the industrial growth rate of 13% an overall annual increase of 10% is therefore projected (Annex 3). The Development Program 2.10 Two hydroelectric stations are now under construction, the 90 MW Maskeliya Oya Stage II station being financed under Loan 636-CE which is expected to be commissioned in early 1974 and the 50 MW Polgolla station due for commissioning in mid-1974. The power development program for the Second Five-Year Plan (1972-76) includes two new hydroelectric projects to be com- missioned by end 1975 and 1977 respectively. The first, Bowatenne, a 40 MW station associated with the Mahaweli Ganga multipurpose project but carried out by CEB, was appraised recently by the Asian Development Bank (ADB) and an agreement for its financing has been reached. The timing and the means of implementation of the second, the larger 120 MW station associated with the Samanalawewa multipurpose project, have yet to be decided but CEB's capital expansion planning makes provisions for both. The extensions of the main 132 KV system that are necessary for these projects will be largely provided by the proposed Project. III. THE BENEFICIARY 3.01 The 1969 Act under which the CEB was created (paragraph 2.04) does not endow the company with all the authority normally expected with an independent entity. Substantial Government role in important policy matters such as borrowing power, setting of tariffs, and appointment of the General Manager is provided for. The CEB has sole discretion only on matters of day to day management. This is in line with Government policy for control- ling important sectors of the economy.  -5- Management Consultants' Study 3.02 The transition from a Government department (DGEU) to an autonomous Board required total reorganization, establishment of a modern accounting system and proper transfer and valuation of assets. This task required con- sultants' assistance and, as a condition of Loan 636-CE the Government en- gaged management consultants (Urwick International) to render advice on these matters. The consultants' services were financed from the proceeds of the loan. 3.03 In the course of their work the consultants have encountered greater difficulties than expected when they began their assignment in 1970. Shortage of experienced CEB staff and the chaotic state of DGEU's records caused the consultants to fall considerably behind the originally estimated schedule (completion of the study by early 1971) and completion of the management study is now expected by mid-1973. In the meantime, the consultants' interim recommendations are being implemented step by step by the CEB. CEB's Organization 3.04 The CEB has a seven member Board whose members serve for a 5 year term and may be reappointed. They are all appointed by the Government; four with experience in engineering, commerce, administration or accountancy, one representing local authorities, one representing the industry and one the General Treasury. They can be removed at any time by the respective Ministers who nominate them. The Chairman, who is the only full-time member, is ap- pointed by the Government from among the Board members. He may be removed from office at any time by the Government. With Government approval, the Board appoints the General Manager who is the chief executive and responsible for the management of day to day affairs. 3.05 The organizational plan recommended by the consultants and now being implemented generally follows the pattern suggested by an earlier DGEU Reorganization Committee with the General Manager as chief executive assisted by deputies responsible for system planning, construction, operation and maintenance, administration and accounting. The proposed organization structure is basically sound. 3.06 The CEB has a total staff of 8,500. Though CEB's activities cover all aspects of power generation, transmission and distribution, the number of employees is high by normal standards. With the severe countrywide un- employment, however, it would not be reasonable to expect improvement in the near future. In the long run, however, CEB expects to normalize the employ- ment situation through attrition and retirement. Accounts 3.07 The consultants' progress in setting up the accounting system and undertaking the revaluation of assets has suffered from the problems described in paragraph 3.03. Due to a severe shortage of competent accounting staff,  -6- they have had to assume responsibility for supervising implementation of their recommendations. New accounting procedures have now been introduced and the staffing improved as much as possible. The asset revaluation study has been completed and the results incorporated in the 1971 balance sheet. During negotiations CEB indicated that the final consultants' report would be submitted to the Association not later than April 15, 1973. Operations 3.08 The CEB is moving towards developing the required technical and managerial skills but it has been handicapped during the past two years, during a crucial stage of development, by changes in key posts including that of the General Manager. This has resulted in the Chairman having to take temporary control of a number of operations including the construction supervision of the Maskeliya Oya Stage II project. 3.09 Noticeable improvement has been made in the CEB's technical opera- tions and quality of service is improving. In order to be fully aware of system conditions at all times the CEB is implementing, as quickly as pos- sible, recommendations made by the consultants in regard to the equipping and commissioning of a central load dispatch center in Colombo. Insurance 3.10 CEB is presently permitted to accrue an insurance reserve by making annual contributions of 0.1% of the capital value of assets. This arrange- ment, however, does not automatically provide CEB with the foreign exchange required for damage involving extensive repairs and replacement of plant. The Government therefore agreed during negotiations to make promptly avail- able to CEB all foreign exchange required to repair or replace any asset of CEB in case of damage. IV. THE PROJECT Description of the Project 4.01 The Project will provide for the extension, during the period early 1974 to early 1976, of the CEB's transmission and distribution facilities by constructing: (a) 86 miles of 132 kV transmission lines and associated 132/33 kV substations; (b) 400 miles of single circuit 33 kV distribution lines and associated substations; and (c) 11 kV and low tension switchgear, distribution transformers, and ancillary equipment for the Colombo distribution system.  -7- Complete details of the project are given in Annex 4 and the location of the transmission lines is shown on the attached map. Project Cost Estimate 4.02 The project cost estimates are detailed in Annex 5 and summarized below: (in Rs million) (in US$ million) Foreign Local Total Foreign Local Total 132 kV extensicns 22.49 4.83 27.32 2.01 0.43 2.44 33 kV extensions 30.21 14.20 44.41 2.70 1.27 3.97 11 kV and low tension switchgear, etc. 8.84 1.08 9.92 0.79 0.10 0.89 Buildings and Quarters - 8.00 8.00 - 0.71 0.71 Engineering and Adminis- tration - 6.00 6.00 - 10.54 0.54 Customs Duties - 6.00 6.00 - 0.54 0.54 Contingencies: Physical 1.01 0.18 1.19 0.09 0.02 0.11 Price 4.59 1.85 6.44 0.41 0.17 0.58 67.14 42.14 109.28 6.00 3.78 9.78 4.03 The project cost estimate was prepared by CEB on the basis of experience gained during construction of transmission lines of the Maskeliya Oya Stage I project during 1967-1971. Cost estimates for erection of 132 kV and 33 kV lines were based on contract payments for similar lines during the period 1967-71, allowances of about 20% being made to cover cost increases which have taken place since that time. Costs of equipment are based on prevailing prices. All estimates take into account changes in exchange rates after the recent devaluation of the US dollar. 4.04 Local costs include customs duties applicable, which vary from 5% for transformers, insulators, etc. to 25% for steel towers, conductors and switchgear. An overall average of 20%, determined by the mix of equipment, has been applied to the total cost of imports. Although the 132 kV facili- ties had been estimated as accurately as possible, a 5% provision has been made for physical contingencies on both foreign and local costs of all 132 kV lines and equipment. For 33 kV and lower voltage facilities no physical contingencies have been included since any variations in cost are taken care of by marginally adjusting the volume of work to be constructed. Price contingencies have been provided separately for foreign and local components at 7-1/2% and 10% respectively. These provisions are adequate considering the short construction period of a little over two years. Foreign Exchange Entitlement Certificate (FEEC) 4.05 In order to improve the country's balance of payments position and to increase revenues for the Government's budget, a levy of 55% of the official  - 8 - exchange rate - the Foreign Exchange Entitlement Certificate (FEEC) - was in- troduced in May 1968 and has since been extended to most import categories. Effective November 13, 1972 the FEEC percentage was raised to 65%. This increase has also been taken into account. 4.06 During negotiations clarification was obtained that CEB is FEEC exempt for all imports financed under loans extended to it up to December 1, 1972; this applies also to future foreign exchange transactions based on such imports, for instance debt service on foreign loans and credits secured for the procurement of equipment and services. For imports financed under the proposed credit, CEB, though liable to FEECs, will pay them with the amortization of the Subsidiary '-oan (paragraph 6.15). In estimating the cost of the Project in both rupees and US dollars as well as converting future foreign exchange transactions to rupees in the financial tables of the several annexes, a rate of exchange of Rs. 11.19 to the dollar has been used as compared to the official rate of Rs. 6.78 in order to allow for the FEEC charge. Engineering and Construction 4.07 CEB plans to carry out the engineering, preparation of specifications and construction of the project using its own staff. CEB staff have gained sufficient experience in the execution of the Maskeliya Oya Stage I project and are performing similar work on the Laksapana-Polpitiya 132 kV lines and other 33 kV lines now under construction. This arrangement is satisfactory. 4.08 Engineering and preparation of specifications is underway and it should be possible to invite tenders by mid-1973. Field construction is planned to begin in January 1974 and to be completed by early 1976. Con- struction of the 12 mile, double circuit line linking the Polgolla station to the grid will receive the highest priority to coincide with plant com- missioning in mid 1974. Procurement and Disbursement 4.09 In the absence of indigenous sources of supply, all project equipment will have to be imported. Procurement of equipment will be made through international competitive bidding in accordance with Association procurement guidelines. 4.10 Customs duties provide for Commonwealth preferences of 25% on switch- gear and 10% on steel towers and conductors. However, in previous Bank-fin- anced projects, CEB evaluated bids and awarded contracts on a c.i.f. basis. The Government confirmed during negotiations that this practice would be continued for the Project. 4.,1 The schedule of disbursements, based on the program of project ex- ecution outlined in paragraph 4.08, is given in Annex 6. No disbursements would be permitted for expenditures made prior to signing of the Credit. Disbursements from the proposed Credit would be made for the c.i.f. cost of  - 9 - imported materials and equipment. Unused funds of the Credit would be cancelled unless there are grounds to apply them to related works. Ecological Aspects 4.12 The facilities to be provided by the Project do not pose any en- vironmental problems. The Colombo 11 kV distribution system is underground and only reinforcement of equipment would be involved; the 132 kV transmis- sion lines pass mostly through jungle areas and the 33 kV lines are short spurs in rural areas. V. JUSTIFICATION OF THE PROJECT 5.01 The facilities provided through the Project are required to satisfy economically the system's growing market requirements, which could not other- wise be met; to connect the Polgolla generating facility (Credit 174-CE/Loan 653-CE) presently under construction to the grid network, to improve the re- liability and quality of supply to existing consumers and to properly utilize the output from the Maskeliya Oya Stage II project (Loan 636-CE), also pre- sently under construction. In the light of consumers' demonstrated willing- ness to pay for the full costs of service and the absence of evident gross distortions in tariffs which would inflate demand, there is no ground for questioning the merits of the program to meet the system's groving market -requirements. The Project forms part of this program. No economic rate of return has been estimated for the Project because there is no way of iden- tifying the portion of the system expansion revenues properly attributable to it. 5.02 The existing 56 mile, 33 kV line from Habarane to Trincomalee, which serves an industrial complex en route, is now fully loaded. The first stage expansion of a Rare Earth factory at Pulmoddai, 37 miles from Trinco- malee, financed by the Asian Development Bank, is initially expected to require 1,000 kVA with an ultimate demand of 5,000 kVA. Conservative fore- casts for Trincomalee itself estimate a need for 7,000 kVA by 1976. Con- struction of a 132 kV line to Trincomalee is the most economic solution since an alternative 66 kV line would, in any case, have to be designed for later conversion to 132 kV to cater for loads in the area south of Trincomalee which are expected to develop shortly after the completion of the Project. 5.03 The 12 mile, double circuit 132 kV line linking the Polgolla station to the grid is required by mid-1974 to feed about 170 GWh of energy annually into the system. 5.04 Half of the main 33 kV extensions are intended to provide more reliable supply to centers presently connected by single circuit lines only. The rest would connect new centers of consumption as part of normal system distribution expansion.  - 10 - 5.05 In Colombo, the lack of 11 kV switchgear has led to a 33/11 kV substation lying idle while another is overloaded. Some of the switchgear to be procured under the Project would enable about 10 MVA of demand to be met immediately; the balance will upgrade existing low capacity switchgear. VI. FINANCIAL ASPECTS 6.01 CEB's finances are regulated in important matters, for instance depreciation procedures and dividend limitation, by the stipulations of the CEB Act. Furthermore, Loan 636-CE introduced the concept of a minimum 8% rate of return on average revalued net fixed assets in operation as a measure of financial performance, requiring asset revaluation from time to time and depreciation provisions based on these revalued assets. 6.02 In October 1971 the Government promulgated the 1971 Finance Act, the purpose of which was to establish financial regulations applicable to all public corporations in the country, consequently, also to CEB. This Act introduced stipulations requiring depreciation to be based on historic cost of assets rather than on revalued assets and also overruled the dividend limitation provision of the CEB Act. Application of these requirements would have resulted in lack of objective standards for measuring the ade- quacy of CEB's financial return and a reasonable internal contribution to investments would not have been assured. In discussions, Government and CEB recognized the need for rectifying the situation, and, consequently the Government waived the relevant sections of the Finance Act for CEB, in fact restoring CEB's financial basis as prevailing before promulgation of the Finance Act. Past Record and Present Position 6.03 The financial projections are based on unaudited 1971 figures which, for the first time in CEB's history, incorporate currently valued assets. These values are based on the asset revaluation study carried out by CEB's accounting consultants, Urwick International. The financial statements thus arrived at, and incorporated in Annexes 7 to 9, provide an acceptable basis for the financial projections. 6.04 CEB's capitalization as of December 31, 1971 was as follows:  - 1 1 - Rs million _ Equity Government Contributions and Reserves 816.0 /1 75 Long-Term Debt IBRD-Loans 156.2 15 Suppliers' Credits 78.6 7 Local Loans 32.7 3 267.5 25 Total Capitalization 1,083.5 100 /1 Including Rs 280.7 million revaluation reserve. Apart from the revaluation reserve, equity consists of the net value of assets transferred to CEB when it was constituted (RS 379.1 million) and retained earnings. The Bank loans were made between 1954 and 1969 for periods of 20-25 years, at interest rates of 4-3/4% to 6-1/2%. The terms of suppliers' credits average about 10 years at interest rates from 5.5% to 6%. The major portion of the local loans is composed of overdrafts (7% interest) from local banks which have been included in the long-term borrowings since they can be considered in effect a floating debt. Accounting, Billing and Collection 6.05 Once CEB's accounting system is reorganized and in full operation its management will have the control needed to assist it in carrying out its financial operations efficiently. 6.06 Loan 636-CE requires that, by the end of fiscal 1970, CEB accounts receivable should not exceed three months' billing. This undertaking was not complied with in fiscal years 1970 and 1971 due to deficiencies in the billing system at that time and very slow payments on the part of public agencies. Over the past two years the Government has tried to speed up these payments, and has succeeded in part. The consultants also consider that, after correct- ing the accounting deficiencies, CEB will be in a position to comply with the three-month target. The undertaking in Loan 636-CE has therefore been retained. Transfer of Assets 6.07 As mentioned in paragraph 2.05, a number of future power stations are associated with multipurpose- projects constructed by agencies other than CEB. Current legislation makes no mention of the operational and financial aspects of these projects. The Association, therefore, introduced a covenant in the Agreement for Credit 174-CE providing for the transfer to CEB of the power assets in a manner mutually acceptable to the Government, the CEB and the Association, of the Polgolla station, upon its completion. As mentioned in paragraph 2.05, agreement was reached during negotiations that this stipula- tion be extended to all future multipurpose projects for which CEB assumes partial responsibility.  - 12 - 6.08 Furthermore, there are no regulations at present specifying the financial arrangements to be made for transfer of such power assets. The covenant agreed during negotiations (paragraph 6.12), includes 30% of the transfer value to be financed from CEB's own funds and 70% from other sources, for instance Government loans. Tariff and Dividend Limitation Covenant 6.09 Under the stipulations of Loan 636-CE, CEB is required to set tariffs at levels sufficient to cover operating expenses, debt service, adequate working capital and dividends, if any, on equity. To achieve this it must observe the following criteria: (i) before completion of the asset valuation study (paragraph 3.02) a reasonable portion of capital expenditures, defined as an average of 25% for 1970/71, would be financed from internally generated funds; and (ii) after completion of the asset valuation study, a minimum 8% return on the average current value of net fixed assets in operation would be earned to meet the above requirements, including a reasonable, but after 1971 unspecified, percentage of capital requirements. 6.10 Section 39(b) of the 1969 CEB Act (paragraph 3.01) limits dividend payments on CEB's initial equity only to an annual rate of 8%. No dividend limitation is provided for later equity. This situation could theoretically impair CEB's finances by lowering its internal cash generation below accept- able levels. Consequently, the covenants outlined in paragraph 6.11 establish the 8% rate of return as a reasonable earnings target and, in addition, in- troduce a 30% contribution to investment concept as a dividend limit. Unlike the interim 25% contribution for the 1970/71 period stipulated in Loan 636-CE (paragraph 6.09(i)) which was chosen because lack of earnings prevented a better target, the 30% now proposed assures proper internal financing of future capital investment. It can be reached with the recent 16% tariff increase and with a reasonable tariff policy in the future. 6.11 The following agreements were reached with the Government and CEB during negotiations: (i) CEB will be permitted to record its assets as currently revalued from time to time. The initial valuation will result from the valuation study as incorporated in the 1971 balance sheet. Depreciation, calculated on the useful life of assets, will be based on these revalued assets; (ii) a minimum 30% internal contribution to investment should be earned in 1973; from 1974 onward, a minimum rate of return of 8% on currently valued average net fixed assets in operation should be achieved;  - 13 - (iii) CEB will review tariffs annually and will include assess- ment of the asset valuation in a manner acceptable to the Association; (iv) dividend and other similar payments to the Government will be permitted only after a minimum 30% internal contribution to CEB's capital expenditures has been made in any given year; and (v) any shortfalls or overruns in the investment contributions will be taken into account in the following year. 6.12 The power investments in multipurpose projects for which CEB is responsible under the 1969 Act, in effect represent assets of CEB from the time they are made. In order to assure adequate self financing, they should, on an annual basis, be added to CEB's investments for determination of the base for measuring the 30% contribution target. The funds thus generated would be taken into account at the time of asset transfer and would thus limit debt incurrence by CEB to a maximum of 70% of the value of transferred assets. Consequently, the Government and CEB agreed during negotiations that the annual construction costs made for power facilities by agencies other than CEB will be included in the basis for determining CEB's 30% contribution to investment. The Government is charged with the responsibility of provid- ing CEB, in a timely manner, with the necessary data. 6.13 The rate of return of 4.8% forecast for fiscal 1973 is below the 8% rate of return stipulated in connection with Loan 636-CE. Sales increases have been significantly lower than expected when Loan 636-CE was made, and the asset revaluation study produce a higher rate base than anticipated. To provide an 8% return in 1973, a tariff increase of about 20% would be required but this would be inappropriate so soon after the 16% increase made in April 1972. Since CEB's financial standing is not seriously impaired by the low return for one year the 30% contribution to investment (paragraph 6.11(ii)), which can be achieved in that year even with the low return, will be suffi- cient. From 1974 onwards, the 8% return will be required and can be achieved. Audit 6.14 The law requires that public corporations in Sri Lanka be audited exclusively by the Auditor General who may, however, employ the services of any qualified auditor to act under his direction. This is a satisfactory arrangement, to which the Association agreed during negotiations. It was furthermore agreed that the Association will be provided with copies of the auditor's report within six months after the close of each fiscal year. In order to inform the Association as early as possible on CEB's finances, CEB agreed to send copies of the unaudited financial statements to the Associa- tion at the same time it furnishes them to the auditor.  - 14 - Subsidiary Loan 6.15 It was agreed during negotiations that the Government will re-lend the proceeds of the proposed Credit to CEB at 7-1/4% interest and for a term of 20 years with three years' grace. Future Finances 6.16 As indicated in Annexes 7 to 9, CEB's financial prospects are satisfactory. The financial projections take into account the tariff and contribution conditions mentioned above. 6.17 The forecast revenues are based on the sales expectations included in Annex 3 and discussed in Chapter II. They take into account the recent 16% tariff increase effective April 1972 and include a further 10% tariff increase in 1975 to ensure the stipulated 8% rate of return on average net fixed assets in operation, and to keep a reasonable ratio between internally generated funds and borrowings. 6.18 The projections of operating expenses are based on past experience. The cost of fuel takes into account prevailing prices and operation of thermal stations under dry-year conditions, which is conservative. 6.19 As explained before, the financing plan (Annex 8) aims at cover- ing about 30% of future investments from internal cash generation and about 70% from borrowings. The 1972-1977 forecast (Annex 8), however, shows about 55% internal coverage; this is due to the contributions to be made for the relatively large Samanalawewa project, the transfer of which will not appear in CEB's books before 1978. The borrowings would consist of the drawdown of Loan 636-CE, the Government Counterpart Loan for the proposed IDA-Credit (paragraph 6.15), and assumed Government loans (7% interest, 20 years amortization period) equivalent to 70% of the transfer value of the power components of multipurpose projects. The financing plan is satisfactory. 6.20 Within the financing plan described in paragraph 6.19, the Project would be financed about 30% by CEB's own funds, 60% by the proposed IDA Credit, and 10% consumers' contributions. 6.21 As shown in the Forecast Sources and Applications of Funds State- ment (Annex 8), annual debt service coverage by internal sources is expected to vary between 1.4 and 2.8, which is satisfactory, particularly since the low figure occurs only in 1973. Debt service coverage based on historical cash generation 1/ is not expected to fall in future below 1.5. It was agreed to repeat the covenant in Loan 636-CE permitting CEB to incur debt only if the maximum future debt service is covered at least 1.5 times by historical internal sources. 1/ Actual cash generation in the 12-month period before a debt is incurred.  - 15 - VII. AGREEMENTS REACHED AND RECOMMENDATION 7.01 During negotiations agreement was reached on the following: (a) the power assets associated with multipurpose projects, for which CEB is responsible, will be transferred to CEB upon completion in a manner mutually acceptable to the Government, the CEB and the Association (paragraphs 2.05 and 6.07); (b) the Government agreed to make insurance arrangements explicitly providing for catastrophic damage requiring foreign currency (paragraph 3.10); (c) bids will be evaluated on the basis of c.i.f. prices (paragraph 4.10); (d) tariffs will be set to earn revenues sufficient to cover 30% of capital expenditures in 1973, and from 1974 onward to achieve an 8% rate of return on currently valued average net fixed assets in operation (paragraph 6.11); (e) the appropriateness of the tariff level and of asset valuation will be determined once in every year (paragraph 6.11(iii)); (f) dividend and other similar payments to the Government will be made only after a minimum 30% internal contribution to investment has been allowed for in any given year; shortfalls and overruns in any particular year will be taken into account in the following year before making such payments (paragraphs 6.11(iv)(v)); (g) CEB will have its books audited by qualified auditors in an arrangement acceptable to the Association (paragraph 6.14); (h) the Government will relend the proceeds of the Credit to CEB (paragraph 6.15); and (i) CEB should not incur debt without the Association's concur- rence, unless its maximum future debt service is covered at least 1.5 times by historical cash generation (paragraph 6.21). 7.02 The proposed Project constitutes a suitable basis for an Association Credit of US$6 million equivalent. March 14, 1973   ANNEX 1 SRI LANK GOKLON EIECTRICITY BOARD (CEB) EXISTING GENERATING FACILITIES INSTALLED NAME OF STATION TYPE DATE OF COMMISSIONING CAPACITY Laksapana Hydro 1950-1958 50 MW Pettah Diesel 1956 6 mq Chunnakkam Diesel 1957-1967 14 MW Inglaiyagala Hydro 1958 10 MW Grandpas Thermal 1962-1964 50 MW Norton Bridge Hydro 1965 50 MW Uda Walave Hydro 1968 6 MW Polpitiya Hydro 1969 75 MW (Maskeliya Oya Stage I) TOTAL 261 MW Under Construction Maskeliya Oya State II Hydiro 1973 90 MW Polgolla Hydro 1974 50 MW TOTAL 140 MW Revised November 8, 1972   ANNEX 2 Page 1 of 3 pages SRI LANKA CEYLON ELECTRICITY BOARD The Existing Transmission and Distribution System The Transmission System 1. The CEB System operates at 132 kV, 66 kV, 33 kV and 11 kV. There are 400 miles of double circuit and 230 miles of single circuit 132 kV lines in operation. The 66 kV system is limited to about 70 miles of double circuit lines connected with the earliest developments. Some 2220 miles of 33 kV lines constitute the main distribution system, 11 kV being adopted only for about 400 miles in Colombo City. These lines are indicated in the map attached. 2. There are three main grid centers viz Kolonnawa, Polpitiya and Laksapana (see map). Kolonnawa is an important load center near Colombo and the other two are the major generation sources in the central hills. Norton Bridge hydroelectric and Grandpas thermal power stations are connected to Laksapana and Kolonnawa respectively through very short 132 kV double circuit lines. Each of the three grid centers referred to above have 132 kV double bus arrangements and are interconnected with each other. There are four 132 kV circuits between Polpitiya and Kolonnawa and two between Polpitiya and Laksapana. Two more 132 kV circuits are under construction between the latter points. At Kolonnawa and Laksapana there are 66 kV bus arrangements with inter-bus transformers; and, in the case of Kolonnawa, 33 kV bus bars as well. Kolonnawa and Laksapana are also interconnected at 66 kV through a double circuit line. Two of the four 132 kV circuits which connect Kolonnawa and Polpitiya and the 66 kV circuits which interconnect Kolonnawa and Laksapana are "teed off" to grid substations which feed the CEB's extensive 33 kV distribution network. 3. Apart from 132 kV and 66 kV interconnecting lines referred to above, there are a number of radial transmission lines to distant load centers. From Polpitiya, a double circuit 132 kV line runs due north to Anuradhapura, and on to Chunnakkam (Jaffna), the extension from Anuradhapura being strung on a single circuit. "Tee off" substations on this route are Habarana and Kilinochchi. A second radial 132 kV double circuit line runs south from Polpitiya to Galle, with "tee off" points enroute at Balangoda and Deniyaya. From Kolonnawa, a 132 kV double circuit line runs north along the coast to Bolawatta and Puttalam substations with a "tee off" to Sapugaskanda and a single circuit radial line runs south to Ratmalana substation. 4. 66 kV double-circuit radial lines connect Norton Bridge power station to Kandy in the north and Nuwara Eliya and Badulla in the east. An  ANNEX 2 Page 2 of 3 pages extension of the latter - a single circuit line from Badulla to Inginiyagala - has been constructed for future 132 kV operation, in line with the CEB's policy of relying on 132 kV for all future transmission lines extensions. This applies also to the single circuit 66 kV extension from Kandy to Kurnegala. The Distribution System 5. Except for the major load center of Colombo, which is served by a 11 kV network, distribution in Sri Lanka is through an extensive 33 kV network which now extends over 2220 miles. The system comprises mainly of single circuit lines. As the system expands alternative supply routes are being arranged to the more important points. In operation, however, these 33 kV routes are sectionalized by means of airbreak switches. All 11 kV lines are operated as radial lines. 6. The city of Colombo receives power from Kolonnawa at 33 kV. Three, 30 MVA, 132/33 kY, transformers installed there supply the normal demand of the city, with a 30 MVA three winding transformer 132/66/33 kV serving as reserve. 23 miles of 33 kV underground cables have been laid to four primary 33/11 kV substations designated A, B, C and D. The southern ring (A) serves a predominantly domestic market, whereas the central ring (B) serves a commercial area and ring C, the industrial market. The fourth, viz D, has not been commissioned mainly due to lack of necessary 11 kV switchgear. The system is adequate to supply about 120 MVA to the four substations. It would be seen from the table below that substation A, which at present meets the demand of the area covered by ring D, is already loaded up to its effective capacity. Primary Normal Substation Transformer Capacity Maximum Demand A 3 x 12.5 MVA 24.3 MVA B 3 x 12.5 MVA 18.25 MVA C 2 x 12.5 MVA 10.25 MVA D 2 x 12.5 MVA NIL 7. About 165 miles of 11 kV cables have been laid from the four primary substations to 196, 11/0.4 kV stepdown substations with an aggregate transformer capacity of 125 MVA. The circuits are arranged in the form of three rings (a fourth will be formed when primary substation D is comnis- sioned), with satellite substations connected by 11 kV loop circuits around the ring. The 11 kV ring circuits are isolated at convenient points and operated as radial feeders; the problems of load division among the feeders and complications of protective relaying dictate this arrangement, which appears to provide fairly satisfactory service. Each of the ring substations are equipped with two 500 kVA transformers, 11/0.4 kV with a third 500 kVA transformer being added to meet the load situation in a few cases. Installa- tions at the satellite substations vary from one to two, 500 kVA, or smaller size transformers. Many of the satellite substations serve individual industrial consumers or important commercial loads.  ANNEX 2 Page 3 of 3 pages 8. Prior to the commissioning of the primary substations A, B and C, the 11 kV switchgear had rupturing capacities of 80-100 MVA, corresponding to the low fault level obtaining at that time. Thereafter, and particularly with the recent increases in system capacity, it was necessary to increase the switchgear capacities to 250 MVA. About 80% of the 11 kV switchgear has since been changed over to the higher rating during the past few years. In rings A and C the changeover of switchgear has been completed. In ring B, switchgear at a few substations has been changed. The switchgear ratings of the remaining stations is barely adequate even at present and would be inadequate to meet system conditions, by 1973-74. 9. The low tension distribution network consists of radial feeders from the 11/0.4 kV substations to feeder pillars and distributor cables from such feeder pillars. Consumers service connections are provided from the distribution cables. The greater portion of the low tension distributor network consists of underground cables, but in some areas of the city a few overhead distribution lines also exist. November 14, 1972   SRI LANKA CEYLON ELECTRICITY BOARD ) ENiERGY GENERATION AND SAIES - ACTUAL AND FORECAST 1/ 2/ ACTUA17 FORECAdTS SALES 1)io6 1967 19ob 1969 1970 1971 1)7z 1573 1974 1975 197b 1971 Domestic and Commerciai 230 2 6 2 1 317 337 374 30 2? L .400 92 Industrial 178 224 204 29, 324 3c67 l45 49 530 5,9 67y 765 TOTAL 402 472 538 383 64,1 701 78 ( Wo5 9i.9 l1040 11L'1 1257 GFN2RATION (Requirement) 480 '61 o20 695 70 833 930 1003 1101 1206 13;-6 11458 Firm Hydro Energy - o)2 o92 111, 1200 13 0 ,1380 Available Thermal _nergry - - - - - - 330 330 330 330 330 330 TOTAL FItvi 3&'GY (Available) 1022 1022 1445 1530 1710 1710 Maximum Demand~t/ 193