Philippines - Fifth Power Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 4388 PROJECT COMPLETION REPORT PHILIPPINES: FIFTH POWER PROJECT (CREDIT 296-PH AND LOAN 809-PH) March 16, 1983 East Asia and Pacific Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   FOR OFFICIAL USE ONLY PROJECT COMPLETION REPORT PHILIPPINES: FIFTH POWER PROJECT Table of Contents Page No. Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .(i) Basic Data Sheet . . . . . . . . . . . . . . . . . . . . . . . . . .(ii) Highlights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (iii) I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . 1 II. Project Description .... . . . . . . . . . . . . . . . . . . 2 III. Project Implementation and Cost . . . . . . . . . . . . . . . 4 IV. Financial Performance . . . . . . . . . . . . . . . . . . . . . 8 V. Institutional Performance and Development . . . . . . . . . . . 12 VI. Project Justification .... . . . . . . . . . . . . . . . . . 13 VII. Conclusions and Lessons Learned . . . . . . . . . . . . . . . 15 ANNEXES 1. Transmission Subprojects: Appraisal Estimate vs. Actual . . . 17 2. Data of Major Contracts ..19 3. Comparison of Appraisal Estimate and Actual Cost . . . . . . . 21 4. Actual Expenditures .. . ..... ..... 22 5. Actual Disbursement vs. Appraisal Estimate . . . . . . . . . . 23 6. NPC: Income Statements . . . . . . . . . . . . . . . . . . . . 24 7. NPC: Comparison of Financing Plan with Actual Performance. . . 25 8. NPC: Sources and Applications of Funds . . . . . . . . . . . . 26 9. NPC: Condensed Balance Sheets. . . . . . . . . . . . . . . . . 27 10. NPC: Actual and Forecast Sales in Provincial Areas of Luzon. - 28 11. Project Costs and Benefits. . . . . . . . . . . . . . . . . . . 29 12. Main Undertakings in Loan Documents . . . . . . . . . . . . . . 30 13. Letter from NPC . . . . . . . . . . . . . . . . . . . . . . . . 31 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   - i - PHILIPPINES: FIFTH POWER PROJECT PREFACE The Project comprised the construction of the second 150 MW unit at the Bataan thermal power station and various transmission lines and substations in Luzon, and consultant services to the National Power Corporation (NPC). A credit of US$10.0 million (296-PH) and a loan of US$22.0 million (809-PH) were made on April 3, 1972 and became effective on June 30, 1972. The final disbursement from the credit was made on April 10, 1975 and from the loan on July 1, 1980. The Project Completion Report (PCR) was prepared by the East Asia and Pacific Regional office on the basis of the appraisal report, super- vision reports and other documents in the Bank's files, a completion report prepared by NPC, and a project completion mission to the Philippines. A copy of the draft report was sent to the Borrower (NPC) and to the Government of the Philippines for comment. Comments were received from NPC, and are reproduced at Annex 13; they have been taken into account in finalizing the report. The project has not been subjected to audit by the Operations Evaluation Department.   - ii - PHILIPPINES - FIFTH POWER PROJECT BASIC DATA SHEET KEY PROJECT DATA Appraisal Actual or Actual as 2 of estimate estimated actual appraisal estimate Project costs (IS$ million) 48.0 68.3 142.1 /a Loan/Credit amount (US$ million) 32.0 Date Board approval 03/21/72 Date effectiveness 06/30/72 Date physical components completed 06/30/75 01/31/78 Proportion then completed (X) 40.0 /b Closing date 06/30/76 07/01/80 Economic rate of return (X) Financial rate of return (1) 152 Negative I/c Institutional performance Satisfactory Agronomic performance Number of direct beneficiaries (year ....) CUMULATIVE DISBURSEMENTS FY71 FY72 FY73 FY74 FY75 FY76 FY77 FY78 FY79 FY80 Appraisal estimate (USS million) 13.5 26.1 32.0 32.0 32.0 32.0 32.0 32.0 Actual (US$ million) 0.5 3.5 11.4 19.1 24.8 27.8 30.8 31.8 Actual as 1 of estimate 3.7 13.4 35.6 59.7 77.5 86.9 96.2 99.4 Date of final disbursement 07/01/80 Principal repaid to (mo./day./yr.) (US$ million) 12/31/82 - 6.7 MISSION DATA No. of Man-days Specializations Performance Types of Mission Date persons in field represented /d rating /e Trend /f problems / (mo./yr.) Identification 01/70 2 28 Eng/FA Preparation Appraisal 05/71 2 49 Eng/FA - Subtotal 77 Supervision 1 02/73 2 1 Eng/FA - Supervision 2 07/73 2 42 Eng/FA 1 2 N/S Supervision 3 12/74 1 7 Eng/FA 1 2 N/S Supervision 4 11/75 2 66 Eng/FA 1 2 M,T Supervision 5 07/78 2 28 Eng/FA 1 1 F,M,T SuPervision 6 04/79 2 7 Eng/FA 1 1 F,M,T Supervision 7/ Supervision 8 Supervision 9 Supervision 10 Supervision 11 Supervision 12 Supervision 13 Supervision 14 Supervision 15 Subtotal 178 Total 255 OTHER PROJECT DATA Borrower National Power Corporation Executing agency Borrower Fiscal year Calendar Name of currency (abbreviation) Pesos (P) Currency exchange rate: Appraisal year average US$1.00 - P 6.50 Intervening years average US$1.00 - P .22 Completion year average US$1.00 = P 8 Follow-on project: Name Sixth Power Project Loan/credit number 1034 Loan/credit amount (USS million) 61.0 Date Board approval 07/02/74 /a Delay in project completion, revaluation of various foreign currencies, extended scope of consultant services for design. /b Procurement delays and consequences of design changes. 7c Increased costs of fuel oil and cost overrun on project. 7T Eng - engineer; FA - financial analyst. 7T 1 - problem-free or minor problems; 2 - moderate problems; and 3 - major problems. 7? 1 - improving; 2 - stationary; and 3 - deteriorating. Tg F - financial; M - managerial; T - technical; P - political; and 0 - other.   - iii - PHILIPPINES: FIFTH POWER PROJECT HIGHLIGHTS The project formed part of the Government's four-year development plan for Luzon and had as its principal objective the expansion of the availability of electric power through extension of the transmission system to facilitate connection of further rural electric cooperatives, and the augmentation of NPC's generating capability to improve reliability of service. The project was successful in achieving both of these objectives, as evidenced by the growth of energy sales in provincial Luzon, which advanced at an average of almost 10% per year between 1976 and 1978 without deterioration in the reliability of service (para. 6.02). Facilities constructed under the project have operated satisfactorily since entry into commercial use (para. 3.17-3.18). However, all components of the project were completed late, the transmission component particularly so (para. 3.01- 3.03). Changes in the design of various project components and slow procurement procedures were the principal causes of delay. Largely as a consequence of this slippage, there was a considerable cost overrun, especially on the local currency element (para. 3.11) even though some of the transmission components included in the original project concept were eventually executed by another agency or transferred to a subsequent project (para. 2.03). The project also aimed at institutional development of NPC, and in this it was partially successful. A number of measures were initiated to help strengthen NPC's general management, planning (para. 5.02), collection of receivables (para. 4.10) and audit (para. 4.12), although some of these did not come to fruition until well after project completion. NPC's financial condition was under considerable pressure during the period of project construction as a result of the rapid rise in fuel costs (para. 4.02) and the burden of debt service associated with its substantial development program (para. 4.08). Tariffs did not keep pace with the increase in NPC's costs and, as a result, NPC was unable to meet the rate of return target of-8% covenanted with the Bank (para. 4.05). For the same reason the latest estimate of the financial rate of return to the project is negative. The financial rate of return is, however, an inadequate measurement of the justification of the project (para. 6.05), which is still considered to have been the least-cost solution available at the time of appraisal to meet the load growth forecast for the project area (paras. 6.03-6.04).   I. INTRODUCTION 1.01 Since 1957, the Bank has made nine loans to the power sector in the Philippines amounting to US$290.2 million equivalent, including seven loans amounting to US$218.2 million to the National Power Corporation (NPC). The first loan to NPC (183-PH, US$18.4 million, 1957) helped finance the Binga Hydroelectric Project and the second (297-PH, US$33.5 million, 1961) financed the Angat Hydroelectric Project. The third loan (325-PH, US$3.3 million, 1962) was used to finance the third unit of the Maria Cristina hydroelectric power plant, located in Mindanao. The fourth loan (491-PH, US$12.0 million, 1967) was used for the construction of a thermal power plant (75MW) at Bataan, Luzon, and addition of a fourth unit at Maria Cristina hydropower plant. These projects were completed without major problems and have been operating satisfactorily. Credit 296-PH/Loan 809-PH, which is the subject of this report, was made to NPC in 1972 to finance the Fifth Power Project. The sixth loan (1034-PH, US$61.0 million, 1974) is helping to finance the construction of the 100 MW Pantabangan hydropower plant and the expansion of the transmission system of the Luzon grid, which is expected to be completed in May 1982. The seventh loan, which is the Bank's latest operation with NPC (1460-PH, US$58.0 million, 1977) is financing the expansion of the transmission system in Luzon and construction of a load dispatching center, and is expected to be completed in 1984. 1.02 Bank Group lending to the Philippines power sector has also included: (a) a loan to the National Electrification Administration (NEA) for US$60 million in 1978 to help finance the 1979/80 portion of the rural electrification program; and (b) a commitment by the International Finance Corporation (IFC) equivalent to US$12 million in 1967 to the Manila Electric Company (MERALCO). 1.03 The Fifth Power Project was identified during a Bank mission that visited Manila in January 1970. The Bank advised NPC that appraisal of the project would be contingent upon the implementation of a substantial rate increase in that year and upon satisfactory progress on the proposed NPC legislation designed to avoid delays in the implementation of future rate increases. Although the rate increase, implemented in late 1970, was well below expectations, the project was appraised in May/June 1971 and the loan credit agreements were signed on April 3, 1972. 1.04 Main undertakings and compliances with loan documents are shown in Annex 12.  II. PROJECT DESCRIPTION Original Project Description 2.01 The original project description for the NPC Fifth Power Project included the following items: (a) Generation (i) construction of Bataan No. 2 steam power plant (150 MW) including a boiler, turbine-generator, associated electromechanical equipment and extension of the power house; and (ii) three 75MVA transformers and extension of the switchyard. (b) Transmission. The transmission program for Central Luzon, Lagunas-Batangas, Ilocos, Zambales and Southern Luzon regions consisting of: (i) 317 km of 230 kV lines and 90 km of 115 kV lines; (ii) 440 km of 69 kV lines and 586 km of 34.5 kV and 13.8 kV lines; (iii) 8 large substations (245 MVA) at 230 kV and 115 kV; and (iv) 16 load-end substations (95 MVA) at 69 kV. (c) Advisory Services (i) follow up review by management consultants of accounting systems and procedures, reporting systems and staffing requirements and a review of the current value of fixed assets; (ii) engineering consultants to improve technical operations and to prepare long-term power development plans for Luzon; and (iii) feasibilty studies of possible hydroelectric schemes on the Chico River in Northern Luzon of about 450 MW capacity and 1,600 GWh output, for peaking duty, and on the pumped storage scheme at Caliraya (300 MW initial capacity). Changes to the Project 2.02 The scope of the project remained essentially the same as envisaged at appraisal with the exception of works for the transmission program (para. 2.03) which had to be reduced substantially owing to cost overruns.  - 3- only minor changes were introduced in the generating component as follows: (i) two 125 MVA, 240/13.8 kV main transformers were installed instead of three 75 MVA, 240/13.8 kV; (ii) location of the fuel tanks, boiler feed water pumps, demineralizing water treatment plant house, and compressed air plant were modified; and (iii) a demineralizing and pretreatment plant was incorporated as an added safety feature in case of future change in the properties of the present well water. 2.03 The main changes made to the transmission program during implementation were: (i) the originally planned route for the 230 kV transmission line was changed after survey and also the originating point of the line was changed from Caliraya hydroplant to the Malaya thermal plant. This resulted in an increase of 36 km in the total length of the line; (ii) additional transformer capacity at high voltage (230 kV and 115 kV) from 245 MVA to 315 MVA; (iii) construction of 34.5 kV (67 km) and 13.8 kV (519 km) lines was transferred to the National Electrification Administration (NEA); and (iv) the following parts of the transmission components were transferred and financed under the Sixth Power Loan: (a) switching equipment and steel structure for 230 kV and 115 kV substations; (b) 117 km of 69 kV lines; (c) nine load-end substations at 69 kV with a total capacity of 95 MVA; and (c) power line carrier equipment and relays. 2.04 A comparison between the original estimates and actual lengths of transmission lines is shown below. Details are shown in Annex 1. Transmission lines (kV) 230 115 69 34.5 13.8 Total Original (km) 317 90 440 67 519 1,433 Actual (km) 353 90 294 - - 737  - 4 - Parts of the 115 kV and 69 kV transmission lines were built using materials supplied from Japanese reparations which did not involve withdrawal from the Credit or the Loan. III. PROJECT IMPLEMENTATION AND COST Project Execution 3.01 The project was completed 31 months behind schedule as shown below: Completion date Delays Project item Original Actual (months) Generation June 1975 July 1977 25 Transmission June 1975 Jan. 1978 31 The 150 MW Bataan thermal unit was connected to the grid in February 1977, but entered into commercial service in July 1977, two years behind schedule. 3.02 Delay in implementation of the expansion of the thermal power plant resulted in part, from NPC's insistence on prequalification of suppliers of electromechanical equipment. The Bank had indicated early in 1972 that this requirement was not necessary. Nevertheless, NPC went ahead with prequalification of suppliers (see para. 3.05) and did not award the contracts until late 1973. Completion of this component was also held up by delays in execution of civil works and late deliveries of the main power transformers due to strikes in the manufacturer's country. 3.03 Major delays in the implementation of the transmission component were caused by: (a) changes in the design of the transmission projects prepared by NPC following a revision of the consultants; (b) changes in the location of some substations because of the need for supplying electricity to some important industries which had not been contemplated in the original plan; (c) rerouting of several transmission lines; and (d) delays in the delivery of some materials and factory strikes in the country of origin of the goods.  -5- Procurement 3.04 Preparation of bidding documents and procurement of equipment and materials were in accordance with the Bank guidelines, and no significant problems were reported in relation to contract awards. 3.05 At appraisal it was expected that the major equipment contracts would be awarded before the end of 1972. Subsequently, however, NPC stated that prequalification of prospective suppliers was required by Philippine law in a public bidding for Government contracts. Also, NPC wished, as a matter of policy, to avoid rejection of bids through post qualification. The prequalifying process delayed calling for bids for about six months. Further delays occurred because government regulations in force at that time required all publicly-bid or negotiated contracts with values exceeding P 2 million to be submitted to the NEDA Contracts Review Committee for review and subsequent endorsement and approval by the President. This contributed to delays beyond NPC's control. NPC itself was slow in dealing with the procurement process. As a result, the main electromechanical equipment contracts were not awarded until late 1973. Award of Main Contracts 3.06 A total of 13 manufacturers of turbo-generating equipment were invited to submit tenders in December 1972. Only six bidders submitted tenders. They were: Fuji Electric Co. (Japan), Mitsubishi Electric Co. (Japan), Brown, Boveri & Cie. (Switzerland), Ansaldo Meccanico Nucleare (Italy), Franco Tosi S.p.A. (Italy) and General Electric (USA). The contract was awarded to Fuji Electric Co. in October 1973. 3.07 Out of 13 prequalified manufacturers of steam generators, only 4 submitted bids: Mitsubishi Heavy Industries Ltd. (Japan), Babcock Atlantique (France), Franco Tosi S.p.A (Italy) and Sulzer Bros., Ltd. (Switzerland). The contract was awarded to Mitsubishi in November 1973. 3.08 The contract for the remaining equipment for Bataan No. 2 was awarded to Gruppo Industrie Elettro Mecchaniche per Impianti all'Estero (GIE), Italy in November 1973. Fourteen manufacturers had been prequalified, but only five bidders submitted tenders. 3.09 The contracts for the transmission system were awarded between 1974 and 1975. The 69 kV transmission equipment and materials were procured on a supply basis only, rather than a turnkey basis as had been originally scheduled. 3.10 Countries of the main contractors and suppliers are listed below and Annex 2 contains a breakdown of suppliers for the main project components.  -6- Country of Contract supplier Turbine generator Japan Steam generator Japan Electromechanical equipment Italy Civil works, Bataan No. 2 Philippines Materials & equipment, 230 kV Japan Power transformers Italy Substation equipment Switzerland & Japan Project Cost 3.11 The total project cost exceeded the appraisal forecast by about US$20.2 million equivalent (or 42.1%). The project as actually executed cost US$68.3 million, of which US$36.5 million represented the foreign component, including the cost of materials obtained from Japanese Reparations. If construction of 34.5 kV and 13.8 kV lines and some substations and communication equipment had not been omitted from the project, the cost overrun would have been higher. The comparison of appraisal estimate and actual costs is detailed in Annexes 3 and 4 and summarized below (in US$ million): Appraisal Actual Local Foreign Total Local Foreign Total Generation 3.80 16.70 20.50 3.91 20.46 24.37 Transmission 9.20 9.30 18.50 18.70 11.33 30.03 Consulting services 1.13 1.70 2.83 9.14 2.71 11.85 Contingencies 1.89 2.30 4.19 - - - Total 16.02 30.00 46.02 31.75 34.50 66.25 Interest during construction - 2.00 2.00 - 2.00 2.00 Grand Total (US$ million) 16.02 32.00 48.02 31.75 36.50 68.25  - 7 - 3.12 The actual cost of generation component of the project exceeded the original estimate by 19% (local 3% and foreign 22%). Despite deletion of the 34.5 KV and 13.8 KV lines the cost overrun for the transmission component was much higher. While the foreign currency costs of that component rose about 22% only, the local costs were more than twice the original estimate. These cost overrun resulted mainly from: (a) a two-year delay in the completion of the project; (b) revaluation of the yen and of the currencies of different countries where the equipment was purchased; (c) increased length of the 230 kV transmission lines (36 km) and changes in the design of the transmission project; (d) increases in the prices of cement and reinforcing steel procured locally and in the minimum wage rates which affected the domestic costs. 3.13 The cost of consulting services was about four times the original estimate mainly because of substantial increase in the scope of their work and employment over a longer period resulting from revisions of the design of the transmission subprojects. Also the preparation of NPC's long range power development program involved more detailed studies than envisaged originally. Disbursements 3.14 The Credit of US$10.0 million was fully disbursed by April 10, 1975 as against the original date of June 30, 1973. The final payment from the loan was made on July 1, 1980, more than five years behind schedule and the loan account was closed on that date. An amount of about US$181,000 was cancelled from the loan. 3.15 Because of project delays, the Bank extended the Closing Date from June 1976 to June 1978 and twice thereafter to enable NPC to complete the withdrawal of funds from the loan. The final Closing Date for the loan was July 1, 1980. A summary of estimated and actual credit/loan disbursements is shown in Annex 5 and a comparison of original and final allocation of proceeds of the Credit/Loan by categories is shown below:  - 8 - ALLOCATION OF CREDIT AND LOAN PROCEEDS (In US$) Category Original Final I General Facilities Civil works 300,000 Equipment, material & supplies 15,700,000 16,085,309.29 II Transmission facilities, equipment, material, supplies and erection 9,000,000 10,891,635.90 III Consulting services 1,700,000 2,842,386.89 IV Interest & other charges on the loan accrued on or before August 31, 1977 2,000,000 2,000,000.00 V Unallocated 3,300,000 Total 32,000,000 31,819,332.08/a /a Balance of US$180,667.92 was cancelled. Performance of Consultants, Contractors and Suppliers 3.16 In general, the performance of the consultants, contractors and suppliers that participated in the project, was satisfactory. Some delays in the delivery of materials and equipment were justified. Operating Performance 3.17 From the date it entered into commercial operations, the Bataan No. 2 power plant has performed satisfactorily, with an average plant factor above 75%. A number of changes were made in the boiler (high pressure preheater) since its performance during the acceptance tests was lower than that guaranteed by the manufacturer. The supplier made the necessary modifications at no cost to NPC, and extended the guarantee on that part of equipment for another year. 3.18 All other project components have also been operating satisfactorily. IV. FINANCIAL PERFORMANCE Operating Results 4.01 NPC's operating results during the period of project implementa- tion (1972-77) (see Annex 6) were slightly better than expected at the time  -9 - of appraisal. Net income quadrupled from P 24 million in FY71/72 to P 103 million at the end of CY77. During this period average revenue per kWh sold increased from 5,2 centavos (8 US mills) to 14.68 (19.5 US mills) while operating costs per unit sold increased from 1.9 centavos to 11 centavos. Operating income, however, was only sufficient to meet the rate of return targets agreed with the Bank in FY73, when NPC achieved 6%. Thereafter, NPC was unable to achieve the agreed level of 8% on revalued net fixed assets (see Table of Key Indicators). TABLE OF KEY INDICATORS Fiscal year June June June June June Dec. Dec. 1972 1973 1974 1975 1976 1976 1977 Revenue per KWh Sold (Centavos) Appraisal 5.17 5.38 6.05 6.27 5.78 - - Actual 5.20 5.62 8.11 9.48 11.91 10.99 14.67 Rate of Return Appraisal 4.6 6.4 8.2 8.0 8.9 - - Actual 7.5 6.0 5.5 7.7 5.9 7.4 4.11' Times Debt Service Covered by Cash Generation Appraisal 1.3 1.5 1.9 1.7 1.8 - - Actual 1.9 1.3 1.5 3.5 1.7 3.3 0.7 Debt/Equity Ratio Appraisal 48/52 52/48 57/43 60/40 61/39 - - Actual 40/60 47/53 31/69 31/69 26/74 58/42 60/40 4.02 The principal reason for NPC-s failure to meet the rate of return covenant was that tariff increases were not sufficient to match increases in costs. Although NPC introduced a fuel cost adjustment clause about mid-1973 which fortunately enabled it to pass on increases in costs of fuel oil, increases to cover higher costs of other operating expenses including depreciation were permitted by Government too infrequently and too late to enable NPC to meet the financial performance targets agreed with the Bank. These increases were made in July 1974 (20%) and November 1976 (35%). 4.03 Under the rate of return covenant in the Loan Agreement, NPC agreed to revalue its assets "once every four years or more frequently in accordance with sound and consistently maintained methods of valuation, acceptable to the Bank." It was also agreed that consultants would be employed to carry out the revaluations; the first of which was to be completed for FY72 by October 31, 1972. The consultants selected for this assignment by NPC carried out revaluations as of June 1972 and December 31, OED Note: See also item 3-A on page 2 of Annex 13.  - 10 - 1976. The results of these revaluations were recorded in NPC's books in the years immediately following their completion. In the intervening years, NPC adjusted its rate base using suitable price indexes which had been recommended by the consultants. During the years 1972-77, NPC's average net fixed assets in service were revalued about 90%. Over approximately the same period, the Philippine consumer price index doubled. This suggests that the consultants' revaluation led to adjustments to NPC's rate base which reasonably approximated the change in the general level of prices. 4.04 NPC's overall depreciation cost rates have shown some fluctuation from one revaluation to the next. To some extent this is attributable to changes in the mix of components in each asset category. But besides this, one of the valuation study recommendations both in 1972 and 1976 was the adoption of revised rates of depreciation based on revised asset lives. The changes proposed have led to some inconsistency in the accounting for depreciation expense. However, they would not have been sufficient to materially affect NPC's financial performance. Nevertheless, the Bank has suggested to NPC that it give due consideration to the need for maintaining consistent depreciation rates and only revise them on the basis of long-term operating experience. 4.05 While NPC's rate of return performance in most years was not much below the agreed level of 8%, it is now apparent that the agreed level was set too low to provide NPC with an adequate level of self financing mainly because of the unexpected increase in working capital requirements. The Bank recognized this when processing the Seventh Power Loan and renegotiated the covenant to include a provision for the borrower to consult with the Bank to establish rates of return higher than 8% by June 30, 1979. However, so far NPC has not been willing to agree any rate higher than 8%. The issue of the 8% rate of return covenant has been the subject of frequent discussion and correspondence between NPC and the Bank. However, both parties are agreed as to the need for NPC to mobilize a greater proportion of the resources required for its development program from its own customers, and targets for this have been adopted for the years 1983 through 1986 in the context of the negotia- tions for the Second Structural Adjustment Loan. Although expressed in terms of a reducing dependence, and eventual elimination, of government equity contributions, their achievement will also imply an improvement in NPC's rate of return. Satisfactory progress will be a condition of Bank preparedness to consider further lending to NPC.!/ Financing Plan 4.06 NPC's capital expenditure for FY73-76 (See Annex 7) totalled US$160.8 million compared to US$168.8 million anticipated when the project was appraised, but substantial unforeseen increases took place in working capital amounting to about US$81 million over the period. Cash generation and borrowings provided about the planned level of funding. Commencing FY75, Government began the first of a series of subscriptions to NPC's capital. These contributions were required to finance the local costs of NPC's rapidly expanding construction program which included the country's first nuclear power plant at Bataan. To finance the latter, NPC arranged a $367 million bond issue through Eximbank, the proceeds of which were 1/ OED Note: See also item 10-D on page 5 of Annex 13.  - 11 - temporarily placed on deposit pending their use thus accounting for the substantial increase in working capital shown in the financing plan. 4.07 In addition NPC arranged a series of loans and bond issues totalling about US$900 million through the US Eximbank and a group of banks headed by Citicorp (USA) to finance the foreign costs of the Bataan nuclear plant. However, the arrangement of these funds did not reflect in NPC-s finances up to the end of the planned construction period for the Fifth Power Project, i.e., June 30, 1976. Financial Position 4.08 During project implementation, the level of NPC's debt equity ratio and debt service coverage was lower than the Bank's appraisal report projec- tions at least until 1977 (Annex 8 and 9). The debt/equity ratio which was 40/60 in FY72 rose to 60/40 in CY77 mainly due to the surge in NPC's borrowings to finance the Bataan nuclear project and other ongoing projects. By June 1976, the debt/equity ratio had declined to 26/74 due to conversion of government bonds and loans to equity (P 247 million). In addition equity contributions which began in FY75 accelerated in the following year to provide NPC with an additional P 900 million in new capital in the 2-1/2 year period to December 1976. However, because of the increase in NPC debt service charges due to additional borrowing discussed in paras. 4.06 and 4.07 and the coincident expiration of the grace period on a number of other large loans, debt service coverage declined dramatically in FY77. Until this decline, NPC had maintained an adequate level of debt service coverage and been able to meet the requirement for at least 1.3 times coverage in the Loan Agreement. Because of this serious deterioration in NPC's debt service position, the Bank introduced a new covenant in the Seventh Power Project Loan Agreement (Section 5.05) which required NPC to: (a) submit its ten-year development program and supporting financial plan to the Bank for review; (b) undertake new investment projects (i.e., in excess of $50 million) only after agreeing with the Bank that such projects form part of a least-cost program to be financed at reasonable cost as part of an appropriate financing plan; and (c) to limit medium- and short-term debt, i.e., debt maturing within five years to US$50 million equivalent. The debt service coverage ratio has subsequently recovered to above the covenanted level. 1/ 4.09 Under the debt service coverage covenant in the Loan Agreement for the Fifth Power Project, it was agreed that foreign debt would be valued on the basis of prevailing exchange rates. In partial compliance with this covenant, NPC revalued its foreign debt in 1973 and 1976 using the official rate of exchange between the US currency and the peso. While this procedure would have provided an appropriate valuation of foreign debt in US currency, 1/ OED Note: See also item 5 on page 3 of Annex 13.  - 12 - it would not have in the case of debts incurred in other currencies which NPC began to obtain from FY75. To ensure that NPC's debt is properly valued, the Bank has advised NPC that all foreign debt be valued at the end of each year using prevailing exchange rates as provided in the loan agreement and not just on the basis of periodic adjustmentL of the US$/peso exchange rate. Collection of Unpaid Electricity Accounts 4.10 Under the Fifth Power Project Loan Agreement NPC agreed to take steps to reduce unpaid electricity accounts as of June 30, 1973 and there- after annually to an amount equivalent to not more than the amount billed during the last three months of the year. .NPC introduced revised billing and collection procedures including discount for prompt payment, disconnection for nonpayment, and levy of interest charges on overdue accounts. Despite this change in procedures NPC did not consistently meet this undertaking until FY77. In the preceding years it did make arrangements with a number of its industrial customers, (e.g. cement companies) to pay off their arrears in monthly installments. This covenant was repeated in the Loan Agreements for the Sixth and Seventh Power Loans.i/ Audit 4.11 NPC's annual financial statements were audited each year by the Government's Office of the Corporation Auditor. In most years the audit reports were received within three months of the end of NPC's fiscal year except for FY76 when NPC changed its fiscal year from July 1/June 30 to the calendar year. On this occasion, the report was received about six months late. 4 12 The reports of the corporation auditor were generally satisfactory and contained comprehensive information supporting the auditor's opinions. Shortly after the loan was signed, however, the Bank questioned the independence of NPC's auditor with its general manager and the National Economic Development Authority primarily on the grounds that the auditor was engaging in executive duties. The Bank raised this question during processing of the Seventh Power Loan in the context of the auditor's preaudit functions. At negotiations for the Seventh Power Loan, it was agreed with Government that it would review its auditing procedures at NPC and implement a program to improve them in agreement with the Bank by September 30, 1978. Changes in the auditor's duties to reaffirm his independence were instituted effective January 1983. V. INSTITUTIONAL PERFORMLANCE AND DEVELOPMENT Organization and Management 5.01 Under the Fourth Power Loan (6491-PH), NPC engaged consultants to organize its management on a sound basis. Although the recommendations 1/ OED Note: See also item 6 on page 3 of Annex 13.  - 13 - of these consultants were implemented, the Fifth Power loan included a provision for a follow-up review by the consultants of the accounting systems, reporting procedures and staffing. During supervision of the project, Bank staff noted that the quality of NPC-s accounting and finance staff raised doubts as to their ability to use the systems which had been installed by the consultants to best advantage. It was also recorded that NPC management needed improvement to cope adequately with the rapid expansion of TPC s facilities. This expansion was facilitated by Presidential Decree No. 40 of November 7, 1972 which gave NPC responsibility for planning and operating all generating facilities in the country. In 1977, government decided to turn over to NPC the thermal power plants previously operated by Meralco. Fortunately this takeover process was not finalized until 1979, giving NPC time to make adequate preparations for the takeover by strengthening its organization and staff. 5.02 The strengthening of NPC's management by consultants under the Fourth and Fifth Power loans was continued with further reorganization of management staff, project implementation and planning systems under the Seventh power loan. Also, under that loon NPC agreed to establish and fill the position of Vice President Finance.-1 5.03 Under the guarantee agreement (Section 3.03) the Government agreed to submit to the Bank by December 31, 1972, a plan for the effective coordination of the planning of power development and its implementation among power suppliers. Although the Bank was not given any opportunity to comment on the proposed changes the enactment of the Presidential Decree No. 40 met the intent of the covenant in the Guarantee Agreement. NPC's Charter 5.04 NPC had a new Charter approved by the Government in September 1971 primarily because of legal difficulties in implementation of tariff increases. The new charter gave NPC power to fix its own tariffs. In practice, NPC has not been able to implement tariff increases approved by its board without first obtaining the approval of the President. The increases approved have not been sufficient to meet the 8% rate of return target since its intro- duction in FY74 (paras. 4.01 and 4.02). VI. PROJECT JUSTIFICATION 6.01 The project was part of the Government's four-year development plan for Luzon. It was intended to accomplish the objective of bringing electricity to as many inhabitants as possible, a process assisted by /1 Meralco (Manila Electric Co.) had 1,270 MW of thermal plant in 1972 to NPC's 615 MW of which only 75 MW was thermal. 1/ OED Note: See also item 8-B on page 4 of Annex 13.  - 14 - connecting as many of the provincial population to the national system of electricity supply as soon as possible. This objective was met by the extension of the transmission facilities making possible connection of the local private franchises and the rural electric cooperatives thus reducing the overall system cost of electricity supply in the country. Load Growth 6.02 Actual NPC energy sales in the 1972-78 period in the Provincial areas of Luzon were 10% lower than those estimated at appraisal as shown in detail in Annex 10 and summarized below: LUZON GRID - ENERGY SALES (GWh) 1972 1973 1974 1975 1976 1977 1978 Total Appraisal 1,370 1,650 1,930 2,110 2,400 2,630 2,930 15,020 Actual 1,377 1,608 1,718 1,989 2,269 2,182 2,362 13,505 Energy sales for 1977 decreased by 87 GWh from 2,269 GWh in 1976 to 2,182 GWh due to load shedding caused by lack of water in the reservoirs during the year and also because of the effects of the tariff increases in November 1976. The average price per kWh rose from P 0.1099 in 1976 to P 0.1468 in 1977 or an overall increase of 34%. Because of the reduction in the load growth, the delay in the completion of the Bataan No. 2 did not seriously affect the reliability of service. Least Cost Solution 6.03 At appraisal the additional thermal power plant at Bataan was considered to be the most econotic means of meeting the increased load expected in the Luzon grid. The size of the unit (150 MW) was also considered suitable in relation.to the combined capacity of the NPC-Meralco system. Development of domestic energy resources to serve the power sector was at that time at an early stage, with the exception of hydropower develop- ment. The latter, however, required a longer period of construction and, furthermore, there was no hydroelectric alternative of suitable size. Because of the low utilization factor (about 32%), small reservoirs and priorities for irrigation which characterized existing hydropower plants, a thermal power plant was the only solution capable of safely meeting the accelerating load growth. 6.04 The transmission subprojects in Southern Luzon were based on studies made by Electricite de France in 1965 and were considered to be the most economic proposals on the basis of the "present value comparisons" of the various alternatives analyzed.  - 15 - Internal Financial Rate of Return 6.05 The rate of return on the project had been estimated at appraisal at 15%. On the basis of actual investment costs, tariffs and operating expenses (in constant 1977 prices) a similar analysis to the calculation in the appraisal report shows a negative return (Annex 11). This difference from the appraisal forecast is due in part to the cost overruns on the project, but more importantly to the extremely large fuel oil price increases. These rose from about US$2.40/bbl in 1972 to US$34.00/bbl in 1981 which, if expressed in USe/kWh, is now higher (6e/kWh) than the present average power rate in the Luzon grid (4.55e/kWh). However, it is important to note that average power tariffs are not a true measure of the economic merit of the Project since these tariffs understate the value of the benefits accruing to the beneficiaries (consumer surplus). VII. CONCLUSIONS AND LESSONS LEARNED 7.01 The project was completed about 2 1/2 years late at a total cost of $68.25 million which is 42% above the appraisal estimate. The 150 MW thermal powerplant at Bataan financed under the loan/credit has operated satisfactorily. The transmission component of the project, however, was substantially changed; works with a foreign exchange cost of US$8 million were transferred and financed under the Sixth Power Project due to lack of funds under the Fifth Power Project and all subtransmission works at 34.5 KV and 13.8 kV were erected and financed by the National Electrification Administration (NEA)./1 7.02 The internal financial rate of return on the Project was negative due to the extremely large increases in the cost of fuel used by the plant (USc/6/kWh) and to a lesser extent to the cost overrun on the Project. These increased costs were greater than the increase in average power rates over the period 1977-1981. The increase in fuel costs could not have been foreseen. At the time of appraisal the addition of an oil-fired thermal unit was the least cost means of meeting the growth in the Luzon system and its construction was fully justified. 7.03 For a number of reasons, some beyond NPC's control, it was common for the award of contracts to be delayed well beyond the date stipulated in the tender documents. This caused not only delay in the completion of works, /1 NEA was made responsible in 1972 for coordinating and financing electricity supply in rural areas through electricity cooperatives.  - 16 - but equally importantly, cost overruns. The Bank has addressed this question to 1TPC, encouraging it to take the necessary steps as soon as possible to speed up its procurement procedures. NPC has eventually made some improvements in this matter. Additionally, revised government procedures for contract review and approval introduced in 1978 and 1981 will alleviate causes of delay external to NPC. 7.04 NPC's sales growth was not as rapid as expected (10% lower than projected) but this slower growth did not significantly affect its financial performance. NPC failed to achieve the 8% rate of return target agreed for FY74 and future years primarily because tariff increases were not sufficiently frequent to match increases in costs (other than for fuel). Up to 1976 its debt service coverage was adequate but at the end of 1977, NPC debt service coverage fell to unsatisfactory levels and self-financing was zero. The additional funds required during the project construction period were provided by the Government through additional equity contributions. 7.05 Because of NPC-s poor financial position at the end of 1977, the Bank took steps in the Seventh Power loan to address NPC's financial problems by including an undertaking to consult with the Bank on higher rates of return than 8% and measures requiring NPC to obtain the Bank-s agreement to any new investment projects (costing more than US$50 million), its financing plan and limitations on the level of short and medium term borrowing. 7.06 Todate NPC has not achieved an 8% rate of return, and this failure has become an important issue betwen the Bank and the Government of the Philippines. However, Government, NPC and the Bank are agreed on the underlying need to mobilize increased funding for NPC from its customers through higher rates. Appropriate measures to address this have been adopted in the context of the SAL II energy component and satisfactory progress should b,e a condition to the Bank preparedness to consider further lending to NPC.i 7-07 The measures included in the Project for strengthening NPC's organization and management were adequate at the time of the Bank's appraisal. However, if the Bank had known about the Government's plans to give NPC responsibility for all generation (which it did about six months after the loan/credit was signed), the Bank could have included measures for providing training for NPC staff in thermal plant operation and maintenance and assistance in planning and organizing the takeover of the Meralco plant. 1/ OED Note: See also item 8-B on page 4 of Annex 13.  PHILIPPINES NATIONAL POWER CORPORATION (NPC) FIFTH POWER PROJECT (CREDIT 296-PH/LOAN 809-PH) PROJECT COMPLETION REPORT Transmission Subprojects - Appraisal Estimate vs. Actual 230 kV 115 kV 69 kV 34.5 kV 13.8 kV Substations Appraisal Actual Appraisal Actual Appraisal Actual Appraisal Actual Appraisal Actual Appraisal Actual Subproject --------------------------------------------- (km)