s_ V -9 t , M/ ' ('I Document of The World Bank FOR OFFICIAL USE ONLY MICROFICHE COPY Report No. 9810-PH Report No. 9810-PH Type: (SAR) SOPHER, J./ X80458 / D-8059/ AS2IE STAFF APPRAISAL REPORT PHILIPPINES RURAL ELECTRIFICATION REVITALIZATION PROJECT DECEMBER 23, 1991 Industry and Energy Operations Division Country Department I East Asia and Pacific Regional Office This document has a restricted ditrbution and may be used by rdpients ouly in the performance of their ofici duties. Its contents may so otherwise be dilosed witout Wodd Bank autfioIze.om Currency Equivalents (At Appraisal - March 1991) Currency Unit = Philippine Peso (i) US$1.00 = 28 i 1,000 = US$35.71 P 1 = 100 Centavos (Ctvs.) Weights and Measures bbi - Barrel m = Meter (3.2M8 feet) kn = Kilcrneter (0.6214 miles) kV = Kilovolt (1,000 volts) kVA = Kilovolt-Ampere MVA - Megavolt-Ampere (1,000 kVA) kVAr = Kilovolt-Ampere - Reactive MVAr = Mzgavolt-Ampere - Reactiv e (1,000 KVAR) KW = Kilowatt (1,000 watts) MW = Megawatt (1,000 kilowatts) SW = Gigawatt (1,000,000 kilowatts) kWh = Kilowatt-hours (1,000 watt-hours) MWh = Megawatt-hours (1,000 kilowatt-hours) GWh - Gigawatt-hours (1,000,000 kilowatt-hours) Abbreviations and Acronyms COA = Commission on Audits DENR = Department of Environment and Natural Resources ECC - Energy Coordinating Council ICB = International Competitive Bidding LCB = Local Competitive Bidding LIB = Limited International Bidding LRMC = Long Run Marginal Cost MERALCO = Manila Electric Company NEA = National Electrification Administration NEC-TS = National Electrification Comnunission - Technical Staff NEDA = National Economic Development Authority NPC = National Power Corporetion NRECA = National Rural Electnic Cooperative Assn. (U.S.A.) OECF Overseas Economicr Development Fund (Japan) PCB = Polychlorinated Biphenyls PER = Project Evaluation Report PIP - Performance Improvement Program REC = Rural Electric Cooperative REMP = Rural Electrification Master Plan SOP = Statement of Operating Policy USAID - United States Agency for Intemational Development NEA's Fiscal Year - January 1 to December 31 FOR OFFICIAL USE ONLY PHILIPPINES Rural Electrificaton Revitalization Project LOAN AND PROJECr SUMMARY Borrower. National Electrification Administration (NEA) Guarantor. Republic of the Philippines Beneficiaries: About 54 Rural Electric Cooperatives (REC) spread nationwide Amount: US$91.3 million equivalent Lending Terms: Repayable over 20 years, including five years of grace, at the Bank's standard variable interest rate. Relending Terms: NEA would relend the Peso equivalent to the RECs on terms and conditions established periodically for the sector (currently, twenty years, including three years of grace, at 12% per annum interest). Project Objectives: The proposed project aims at: (i) enhancing NEA's effectiveness as the core agency for the sector through its use of sound processes for prior- itizing investments, supervising the implementation of schemes, and fi- nancing the RECs; (ii) encouraging needed reforms among the RECs through the judicious application of conditionality, (iii) improving the reliability of electricity supply in rural areas by financing a portion of NEA's 1992-95 investment program; and (iv) providing technical assis- tance and training for NEA and the RECs. Project Description: The proposed project consists of: (a) an institutional development com- ponent that includes mainly (i) technical assistance and training to be provided under the proposed project, and (ii) NEA's application of discipline to itself through the use of systematic investment and financ- ing strategies, and to the RECs through conditionality attached to its future loans; and (b) an investment component that consists of specific subprojects from NEA's 1992-93 investment program, including: (i) core system rehabilitation, (ii) distribution system extensions to ca- pture productive loads as well as residential connections, and (iii) sys- tem improvements, aiming to improve the reliability of service. Beneflts: The main benefit of the proposed project would be the improvement in the quality of life in rural areas through the widespread availability of electricity for productive and household uses, with women being prima- ry beneficiaries. This should, in turn, facilitate a broadening of eco- nomic opportunity in provincial towns and rural areas in agriculture and small scale industry. This document has a restricted distribution and may be used by recipients only in the performance of their oflicla7 c ties. Its contents may not otherwise be disclosed without World Bank authorization. - ii - Risks: The proposed project is ambitious, and may exceed the capacity of the RECs to meet implementation schedules or furnish counterpart funds. The project was designed to enable the dropping of subprojects should any REC's absoiption capacity be exceeded. Rate of Return: 36% Estimated Costs: /a Local Foreign Total -------------US$ Million---------- REC Distribution Systems 8.2 63.4 71.6 Support Facilities 2.0 12.0 14.0 Training and Technical Assistance 1.0 5.0 6.0 Administration 1.0 0.0 1.0 Base Cost 12.2 80.4 92.6 Physical Contingency 1.2 8.1 9.3 Price Contingency 3.3 6.7 10.0 Total Project Cost 16.7 95.2 111.9 Interest During Construction 3.0 3.6 6.6 Total Financing Requirements 19.7 98.8 118.5 Financing Plan: Local Foreign Total ------------US$ Million------- IBRD 4.1 87.2 91.3 USAID Parallel Financing 1.0 8.0 9.0 NEA 6.0 3.6 9.6 RECs 8.6 0.0 8.6 Total 19.7 98.8 118.5 Est. Disbursements: FY92 EY93 FY94 FY95 FY96 FY97 ..*---------- --- (S ilo)------- ----------(S flin Annual 2.0 6.0 15.0 35.0 28.0 5.3 Cumulative 2.0 8.0 23.0 58.0 86.0 91.3 /a Including duties and taxes of about US$4.3 million equivalent. - iii - PHILIPPINES Rural Electrification Revitalization Project Staff Appraisal Report Table of Contents Ena LOAN AND PROJECr SUMMARY ........................................ -i - 1. THE RURAL ELECTRIFCATION SE.CTOR ..-.......................... - A. Background ................................................ 1 - B. Integrated Program for Sector Revitalization ....... ..................3 - C. Recent Remedial Activities . ...................................... -3- D. Bank Strategy ............................................. 5 - E. Rationale for Bank Involvement . .................................. -6- 2. THE BORROWER ............................................... -7- A. Background ................................................ 7- B. NE 's Role ............................................... -8- C. Organization and Management . ..................................-. - D. Staffmg ............................................... -9- F. REC Performance Monitoring .................................... -10- F. Accounting Systems and External Auditing ........ ...................- 10- G. Taxes ................................ 10- H. Security and Insurance Arrangements ............................... 10- 3. THE ELECTRICITY MARKET ........................................ -11- A. REC Markets ................................................-11- B. Recent Trends in Rural Electrification .............................. 11- C. Recent Trends and Forecasts for Project RECs ....... ................ 13 - D. Fu.ture Studies and Improvements in Load Forecasting .................. - 14 - __ ........ osv: ~ sport ~s pzop.cd by Muurs~ Jml S~pbc. ~tie~a U~ OlMi~ Ki~eu a4 Ald ift4 wo~stdtePi~pnat~a~ta ~ r~i~ a~ W .rriw ~viWl~ M.u~ laaysmiwb~api ~nd~cr 1cit u@~mn~nn W."Mta h owstw~ent~ei. ii on Atn dZIdsr n ~er.~s Divsiw,a ~nt y.prmz.)u.atn.a etr our - iv - 4. THE PROJECr . ................... 15 - A. Investment Programming and Project Preparation . . 15 - B. Project Objectives .................... 16- C Project Description .............. .....- 16 - D. Projet Design and Engineering .. 17 - E. Techuical Asistance and Training .. 18 - F. Project Cst ..19. 0. Project Fmancing Plan ..20 - HL Procurment ..21- L Dhbursement .-23- J. Project Implementation .24 - K REC Operational Performance .. 24 - L Project Monitoring .. 2 - M. Environment .. 25 - N. Project Benefits .. 25 - 0. Project Risks .. 26 - S. FINANCE AND TARIFFS ................................-.....- 27 - A. National Electrification Administration ..- 27 - B. Rural Electric Cooperatives ..- 36 - C REC Tari .- 38-- 6. PROJEC EJUSTIFICATION ........................................... -41 - A. Economic Evaluation of REC Investment Programs .- 41 - B. Rates of Return on REC Investment Programs .-42- 7. AGREEMENIS TO BE REAC-HED AND RECOMMENDAfTON .43 - A. Agreements to be Reached .343 B. Recomnmendation ............ 44 - Annexes 1.1 NEAr Statement of Operating Policy (without annexes) 2.1 Current Organization Chart 2.2 Transitional Organization Chart 2.3 Staffing Profile (Feb. 1991) 3.1 Annual Formation of RECs 3.2 REC Sales and Customers 1981-1990 3.3 Recent Trends and Forecasts of Sales and Customers for 50 Project RECs 4.1 Project Description 4.2 Outline of Evaluation Reports 4.3 Project Cost Estimates 4.4 Procurement Arrangements 4.5 Disbursement Schedule 4.6 Implementation Schedule 4.7 Generic Performance Improvement Programs 4.8 Schedule of Supervision Activities and Missions 5.1 Histozical Balance Sheet (1986-90) 5.2 Historical Income Statement (1986-90) 5.3 Fnancial Implications of the Bail Out Plan 5.4 Financial Projections (1991-2000) 5.5 Assumptions to Financial Projections 5.6 REC Bulk Supply Costs and Retail Rates (1985-90) 5.7 Tariffs of 50 Project RECs 6.1 Methodology for Evaluating Investments 6.2 Long Run Marginal Cost of Bulk Supply 6.3 Rates of Return of Proposed REC Projects 7.1 List of Documents in Project File Map IBRD 23207 - Service Areas of RECs Included in the Proposed Project 1. THE RURAL ELEC:IRFICATION SECTOR A. Background 1.1 The Philippine rural electrification program was launched in 1960. It gainod momentum in 1969 when the National Electrification Administration (NEA) was established to serve as the core institution for the sector. In 1971, when the first Rural Electric Cooperative (REC) was energized, various investor owned distribution companies were serving about 170,000 consumers located outside the major cities; by late 1990, the number of provincial elec- tricity consumers had surpassed 3 million, or about 50% of potential connec- tions. The vast majority of connections (about 90%) are residential consum- ers, many paying about P 100/month to consume about 40 kWh/month or less. In 1990, about 1,296 cities and towns and 21,051 barangays (93% and 60% of the totals, respectively) were electrified. Sector Structure 1.2 The Government institutions serving the rural electrification sector include: (i) NEA, which is responsible for formulating and implementing sector policies and for financing distribution investments for the nation's 120 RECs, and (ii) the National Power Corporation (NPC), which is responsible for all but very modest generation facilities and most transmission systems nation- wide, and wholesales power to the RECs and other distributors. Distribution for provincial urban centers and most rural areas is provided by the 120 mem- ber-owned RECs. The Manila Electric Company (MERALCO), an investor-owned company, distributes electricity to rural areas surrounding Metro Manila. NEA reports to the Department of Environment and Natural Resources (DENR), and has direct links with the other major energy sector institutions through its seat on the Energy Coordinating Council (ECC). Historlcal Context 1.3 From the early 1970s until about 1983, international bilateral as well as multilateial funding sources provided substantial finance for rural electrification (about US$20-30 million per year)to NEA. Foremost among these sources was the United States Agency for International Development (USAID), which provided much of the impetus behind the formation of the cooperative system and considerable finance for some of the early projects. Japan's Over- seas Economic Cooperation Fund (OECF) was also a major financier of the pro- gram during the early period. At that time, Government policy emphasized in- creasing the number of connections, regardless of the economic merits of mak- ing the investments. Because NEA was lending long term at below market rates, it met its operating expenses not from revenues but from excess capital and subsidies. Moreover, as NEA's policies were designed to keep electricity rates down, the RECs deemphasized maintenance and training in favor of new in- vestments, for which funds were freely available. As long as funds for cap- ital investment continued flowing abundantly, the system seemed to be healthy. -2- 1.4 In mid 1983, forwign funding for the rural electrification program abruptly r^n dry. By 1984, NEA's loan releases to the RECs dropped to about US$2-4 million per year. At that point, the serious institutional weaknesses of NEA and the RECs became evident, and their functional and financial capa- btlities deteriorated steadily thereafter. 1.5 NEA's review conducted in 1988 indicated that a large propirtion of RECs faced serious operational and financial problems. Only 22 RECs were con- sidered to be well managed and financially viable (A rating); for another 24, financial viability was considered within reach if they made some operstfonal and coxiercial adjustments (B rating). Of the remaining 71, some 40 needed substantial remedial action (C rating) and the remaining 31 were considered either beyond rescue, or salvageable only with great difficulty (D rating). REC distribution losses averaged 251 (technical losses averaged about 171 and non-technical, about 8X), but were in some cases as high as 45-501. Theft of electricity remained common, and maintenance was inadequate throughout the REC system. The Government's past emphasis on expanston of electrification with- out sufficient regard for cost, combined with its use of the RECs to implement costly and economically unjustifiable alternative generation and rural devel- opment programs, had left many RECs with precarious financial prospects. Generally, the burdens of past mistakes weakened the RECs' prospects for im- proving their financial health. In many cases, the RECa' financial problems could be directly related to managerial weaknesses and interference by highly politicized Boards in their internal affairs. Even if the RECs as a group could have been provided with financial relief, some 25-30 among them faced limited future prospects on account of franchise areas that are inherently too costly to serve. 1.6 Throughout its history, NEA performed poorly as both a lender and a provider of technical support to the RECs. It has been unable to implement programs for the RECs' operational and financial improvement, largely because its already scanty technical staff has been spread too thin. NEA's financial condition is poor; in 1987-1989, its collection efficiency averaged only 36X. In late 1990, NEA had on its books some P 4.3 billion (about US$150 million) in loans to finance uneconomic mini-hydro and dendro thermal investments, and an undetermined smaller amount of loans for social programs for which it has had negligible prospects for repayment. Overall, NEA had questionable pros- pects for repaying some P 11.4 billion (about US$407 million) of past loans raised from foreign lenders and from the Government. 1.7 NEA's weaknesses derived from (i) the past emphasis on expansion without adequate regard for the financial viability of the RECs; (ii) heavy investments in ill-conceived alternative generation projects; (iii) numerous amendments to its charter to broaden its responsibilities; and (iv) a tech- nical capacity that was too thin to support the breadth of those activities. These problems led to a lack of clarity regarding NEA's role, and its conse- quent lack of direction. This lack of a clear focus inhibited NEA from acting as an effective core agency for the sector. -3 B. Integrated Progam ibr Sector Revitalization 1.8 In February 1989, the Bank conducted a detailed review of the rural electrification sector. The findings are given in a report entitled An Znta. ,rAeed PraM to Revitalize the Sectgr (Report No. 8016-PH; November 9, 1989). The study found that, because of their depth and breadth, the sector's problems cannot be addressed piecemeal; rather, an integrated program that addresses the issues comprehensively should be implemented in systematic fash- ion. The report made the following broad recommendations: (a) per'Atlongl LficleicS. The RSCs need to implement integrated mea- sures to remedy: (i) excessive system losses; (ii) inadequate main- tenance and unsatisfactory commercial practices; (iii) deteriorated core systems; and (iv) obsolescent managerial and technical skills. (b) Invastment Stratgg.. NEA and the RECs need to develop a strategy that focusoe, in the medium term, on investments for: (i) rehabili- tation with infill connections, &nd (ii) expansio-n in selected areas of hlgh consumer density close to existing networks. (c) jrlcLg. NEA should adjust the RECs' pricing formula to include: (i) incentives to control operating costs, (ii) funds for future investment, and (iiI) incentives for efficient consumption patterns. (d) Restructuring of the RECs. NEA should encourage RECs willing to implement operating, investment, and pricing reforms by assisting them to: (i) depoliticize their boards through the addition of non- elected members of known professional competence, and (ii) restruc- ture their finances by rescheduling or canceling loans that are deemed not to be repayable. (e) Restructurlng of NEA. NEA needs to reorient itself to the role of lnterested lender. As such, it needs to streamline its activities by dropping a number of functions that are not directly related to electricity distribution in rural areas, while strengthening func- tions that relate to programming, formulation, and administration of loans and direct engineering services that enable the RECs to imple- ment investment projects. On the financial side, NEA needs to: (i) get relief from past loans and other liabilities that it lacks the capacity to repay; and (ii) implement a workable strategy for financing the RECs that includes pricing of new loans at levels ade- quate to cover costs (including provisioning against potential for- eign exchange risks), and application of appropriate conditionality. C Recent Remedial Activities 1.9 Shortly after presentation of the Sector Study ze the Government, NEA's managesmnt took the lead in trying to implement its provisions. The organizational restructuring of NEA and the RECs, as well as the redefinition of their interrelationships, can only be formally accomplished through an amendment to N8A's charter. NEA has already prepared a draft of an acceptable -4- new charter and is currently seeking sponsorship for the bill in both houses of Congress. Meanwhile, the Government and NEA have already begun implement- ing many of the key recommendations of the Sector Study: (a) The Covernment has agreed to a financi_l restructuring plan, under which it would relieve NEA of responsibility for P 11.4 billion in questionable loans (para. 1.6) over the next two years (pare. 5.6). (b) In November 1991, NEA's Board approved a Statement of Operating Policy (SOP) (Annex 1.1), which addresses the main policy issues to be covered formally in the amended charter. The SOP indicates Inter all& NEA's intent to confine its activities to lending and services related to electricity distribution in rural areas, and to use con- ditionality as the primary means of developing discipline among the RECs. The SOP has attached: (i) a draft new charter for NEA; (ii) a Financing Strategy for the sector; (iii) a Loan Policy Manual to govern NEA's lending operations; (iv) generic Performance Im- provement Programs (PIP), from which operational conditionality attached to future loans to the RECs can be derived; (v) guidelines for formulating and evaluating REC investments; and (vi) a schedule of fees to be charged for support services not directly related to NEA's loan generation activities. In addition, the SOP refers to the development of a Tariff Policy Hanual, which will detail NEA's policies with regard to the RECs' electricity rates. The annexes to the SOP were finalized and presented to the November 1991 meeting of the NEA Board1l. At negotiations of the proposed loan, NEA agreed that it will not amend, abridge, or repeal the SOP, any annex there- to, or the Tariff Policy Manual, without prior consultation with the Bank. NEA Board adoption of the Tariff Policy Manual would be a condition of effectiveness of the proposed loan. (c) NEA has made progress toward depoliticization of the RECs by chang- ing managers and reorganizing Boards to the extent allowed under its present charter. NEA has already appointed General Managers for about 54 RECs in the past two years; and in about 12 of those cases, NEA has reduced the Boards to advisory status. (') While some of the NEA appointees have been more effective than oth- ers, the operational and financial performance of the RECs has been steadily improving during this period. For example, aggregate sys- tem losses have declined from 25X in 1988 to 21X by the end of 1990; during the same time, collection efficiency improved from 88X in 1988 to 901 by the end of 1990. And the most significant improve- ment has been recorded at RECs being managed by NEA appointees. (e) In late 1990, NEA's Board adopted an electricity pricing formula for the RECs that includes a provision for self financing of investment. Since then, it has successfully persuaded about 100 RECs to intro- duce substantial tariff increases. NEA expects the remainder to I/ The Loan Policy Manual was amended in December 1991 to include accept- able long term financial performance targets for the RECs (para. 5.30). - 5 - increase their tariffs to the extent required for financial viabili- ty within the next few months. (f) NEA has developed an investment program for 1991-95, composed of in- vestments with a minimum economic rate of return of 15X. That ih- vestment program forms the basis of the proposed project. The pro- pos.d loan would finance the justifiable investments for some 54 of the 120 RECs; NvA expects to finance the justifiablo investments of the remaining 50-55 viable RECs with funding from OECF and USAID. (g) NEA has completed the development of generic PIPs (Dara. 4.24) and has already begun tailoring them for specific RECs in cornection vith the evaluation of futuie loans to those RECs. (h) NEA has recognized tnat it will face a major logistic problem as a result of the expected substantial growth in the amount of materials and equipment it wi:l be procuring on behalf of the RFC3. It has, therefore, asked the Bank's agreement to finance from the Energy Sector Prc'ect (Loan 3165-PH) technical assistance to develop sys- tems and pzocedures for materials handling at its central and Re- giona] warehouses. Iucing the diagnostic phase of that consultancy, NEA would determine whether it will need assistaniice for implementing the systems to be develojed (para. 4.19). 1.10 In conjunction with the revitalization program, NEA and the RECs need substantial resources for institutional development. In particular, they need equipment, tools, fixtures, computers, and training. To accommodate the urgency of this requirement, a US$5.3 million institutional development com- ponent was included in the Energy Sector Project. Also, USAID provided NEA with a US$4.6 million technical assistance grant Inter alla for: (i) the first phase of a Rural Electrification Master Plan (REMP); (ii) upgrades to the accounting at NEA and about 43 RECs; and (iii) the development of systems and procedures for operations and maintenance, commercial practices, and pricing for those same RECs. Consultants being financed by the USAID gra were mobi- lized in June 1990. Under the proposed project, USAID is plannirg co finance the extension of that technical assistance (para. 4.9) so that the remainir.g RECs may also benefit from similar institutional development efforts. D. Bank Strategy 1.11 The progress made by the Government and NEA in recent months set the foundation for the full scale implementation of the revitalization program. Through its agreement to the financial restructuring or NEA, the Government signalled its commitment that this sector needs to be served by healthy insti- tutions. The conditions attached by the Government to that restructuring are designed to institutionalize NEA's new role as an Interested lender. NEA has invested considerable effo.t in developing the tools to become more effective (i) as a lender to the RECs, and (ii) as the agent for instilling operational and financial discipline among its borrowers. Thus, the Bank's objective for the sector is to support with finance, conditionality, and technical assis- tance, the measures needed to ensure that rural households and enterprises can -6 - *njoy grid supplied *lectric service of high quality at reasonable cost. In particular, the Bank should focus on supporting; (a) economically Justifled znvg#utmnrA, which hove been formulated and developed according to a sound planning methodology; (b) the continued institutAonal devylogment of NEA and the & Z[, through appropriate technical assistance and training; (c) the de- velgoomnt of greater go.rationa1 and financial discioline amon the RECs, through tho use of tailored PIPs as conditionality to NEA's loans; and (d) K tionalii of SEC irGlL, through the implementation of a sound policy framework provided in the Tariff Policy Manual. Previous Balnk Involvement In the Sector 1.12 The Bank's only previous loan to NEA (Loan 1547-PH; US$60 million; 1978) financed mainly electricity distribution investments that were initiated during 1980-82. The project was completed in 1983, and an audit was prepared (PPAR No. P-5372; June 1985). The project largely met its objectives; how- ever, (i) some start up difficulties in procurement were encountered, and (ii) the RECs' financial performance was uneven. In 1989, a US$22.2 million component of the Energy Sector Project (Loan 3165-PH) was allocated to NEA to support rural electrification investments. NEA has performed well so far, experiencing only minor procurement delays at the outset; however, project construction has only just begun. Also, because the Government wan the Bor- rower under the Energy Sector Project and NEA received its allocation from the proceeds under a Subsidiary Loan Agreement, NEA has encountered problems with the operation of the Special Account. The proposed project will benefit con- siderably from the effort spent under the Energy Sector Project to develop procurement documents; this should mitigate some of the early delays and inef- ficiencies related to procurement. The recent REC tariff increases combined with the PIPs should address the RECs' uneven financial performance. Finally, since NEA will be the Borrower of the propoied loan, it can manage the Special Account as needed. E. Rationale for Bank Involvement 1.13 Through the Rural Electrification Sector Study, the Bank helped develop a comprehensive, integrated program to address the issues facing the sector. Moreover, when the study's findings were discussed with all relevant agencies of the Government in September 1989, the Bank helped in developing a consensus that the program needs to be implemented broadly and comprehensive- ly. In the past eighteen months, the Bank has offered guidance and technical support for NEA's efforts to implement the program. The proposed project af- fords the Bank the opportunity to continue its close involvement with imple- mentation of the program by supporting it financially. Moreover, because of the Bonk's unique understanding of the issues, it is positioned to strike a balance between the divergent interests of the Government's electric power, plannUig and finance establishments. Finally, the proposed project will af- ford tne Bank the opportunity to continue providing high level technical ad- vice for all phases of the revitalization program. - 7 - 2. THE BORROWER A. Background 2.1 The Borrower of the proposed loan will be NEA. The loan proceeds will be onlent to finance investment programs of about 54a of the 120 RECs currently under NEA's jurisdiction. 2.2 NEA's charter (Republic Act No. 6038; June 1969) gives it two pri- mary responsibilities. First, NEA is the core agency for implementing the Government's rural electrification policy. Second, it is responsible for providing support to the RECs in realizing their electrification objectives. To meet these responsibilities NEA performs two functions: (i) financing of investments in electricity distribution networks in provincial towns and vil- lages and rural areas; and (ii) providing technical. assistance and operating guidelines to the RECs. Over the years, NEA was given a number of other roles and granted additional powers through a series of amendments to its charter. Among these secondary responsibilities are: (i) supervision of the RECs' tech- nical and managerial activities; (ii) regulation of the RECs' electricity charges; (iii) execution of the Government's alternative generation policy; and (iv) implementation of certain social programs un-elated to electrifica- tion. The NEA charter also provided for the organization of RECs to construct and operate electricity distribution networks throughout the country'. 2.3 NEA's past poor performance has primarily been attributable to: (i) a loss of institutional focus, resulting from the wide rar.ge of NEA's man- dated activities; (ii) constrained resources, resulting from the Government's V Originally, 50 RECs were slated to receive financing from the proposed loan; four RECs with small investment programs were added at negotia- tions (Bohol I, Cebu II, Tarlac I and Iloilo I). While their investment programs and circumstances had been appraised, some of the data needed for this appraisal report, specific to those RECs, was not readily available. jv The RECs are organized as non-stock, non-profit membership corporations to distribute electric power in designated and predominantly rural fran- chise areas, where they essentially act as regulated monopolies. The RECs are granted the general powers of a corporation and the members elect a Board of Directors,for periods of between 2 and 4 years, to ex- ercise those powers. The Officers of the RECs are drawn from the Board. Directors can be elected to an unlimited number of terms. The Directors also appoint a General Manager to be responsible for executing the poli- cies set by the Board. All households and enterprises within the fran- chise's jurisdiction are eligible to become members of the REC. Members contribute a one time statutory established fee of P 5. These membership fees represent the REC's paid-in capital. -8- decision that NEA should borrow foreign exchange and onlend pesos at highly concessional rates; and (iii) overwhelmed staff, as a result of having to perform many tasks that did not build on resident experience and often exceed- ed their technical capabilities. These problems were articulated in the Bank's rural electrification sector study. B. NEA's Role 2.4 Following discussion of the sector study, the Government decided to reorient NEA towards its original responsibilities while reducing the scope of its other activities. The Government felt that the RECs could, ln extremls, obtain technical support from other sources; however, no other institution could lend to the RECs, generally weak institutions delivering essential though capital intensive services. Thus, NEA neads to reorganize to play the role of "interested lender" (para 1.8). This reorganization will require that NEA (i) upgrade its lending activities; (ii) shed other activities that do not relate directly to lending or provide support for the RECs capacity to deliver electricity service; and (iii) charge fees for services that are not endemic components of loan origination or administration. This reorganization will be formalized through Congressional approval of an amendment to its charter; in the meantime, the SOP establishes the framework for this new role. 2.5 Currently, NEA provides the RECs with a number of services that are not directly related to loan formulation or administration, but which are deemed essential to the RECs' capacity to function effectively. Foremost among these are (i) procurement, (ii) materials handling, and (iii) project engineering. The procurement function is currently being strengthened through a consultancy being financed by USAID, while the materials handling function will be strengthened with technical assistance being financed by the Bank under the Energy Sector Project (para. 4.19). NEA's retention of consul- tants, according to terms of reference and procurement procedures acceptable to the Bank, to provide technical assistance effort in the area of materials handling is a condition of effectiveness of the proposed loan. NEA's project engineering service is considered adequate, given the present scope of its activities. C. Organization and Management 2.6 NEA is a wholly Government owned corporation. NEA's powers and responsibilities are exercised by the Chairman and four other individuals ap- pointed to the Board of Administrators by the President of the Philippines. Board members are appointed for six year terms. They meet periodically (usual- ly monthly) to establish the policies for NEA and to set its overall direc- tion. Responsibility for NEA's day-to-day management is left to the Adminis- trator, who serves as NEA's chief executive officer and also an ex-officio member of the Board. The Board is also responsible for regulating REC tar- iffs. The National Electrification Commission - Technical Staff (NEC-TS) is a separate unit that advises the Board regarding the adequacy and appropriate- ness of REC electricity charges (para. 5.31). - 9 - 2.7 NEA's Administrator is assisted by three Deputy Administrators, each heading a major group within the organization. The Technical Services Group is responsible for: (i) project engineering; (ii) materials handling and warehousing; (iii) construction, and operation and maintenance; and (iv) al- ternative energy systems. The COOP Development Group is NEA's primary organi- zational link to the RECs, and provides them services in the areas of institu- tional strengthening, performance monitoring, and management systems support. The Finance and Administrative Group performs all of NEA's own finance, ac- counting and loan administration functions as well as providing the general administrative and personnel related services. NEA's current organization chart is presented in Annex 2.1. 2.8 The current organization has two major weaknesses. First NEA has a poor history of loan administration and collections. Second, NEA has not until recently taken seriously the investment planning function and still has not developed a loan programming function. In anticipation of its change in focus, NEA has recently developed a transitional organizational structure (Annex 2.2) to enable it to (i) implement a disciplined financing strategy, and (ii) encourage operational and financial discipline among the RECs. As a first step, NEA created a new Accounts Management Department to execute lend- ing policies, formulate conditionality, supervise project implementation and monitor REC operational performance. In addition, this unit will have respon- sibility for formulating the Evaluation Reports that will serve as the basis for NEA's future lending to the RECs (para. 4.8). As a second step, NEA will delegate a number of its activities to its field organization; these include warehousing, some aspects of REC monitoring, and major repair and maintenance. Finally, a Strategic Planning unit will be formed to set common objectives for all of NEA's units, and to coordinate their activities. D. Staffing 2.9 NEA presently employs about 870 staff, most of whom are located at its headquarters. A staffing profile is shown in Annex 2.3. Most of the incumbents in professional grades have technical jobs in electric utility operations, construction, project engineering, procurement, accounting and administration. Few of the professionals are experienced in financial opera- tions, financial analysis, loan programming, or loan administration. 2.10 Following discussion of the sector study, NEA asked if it could supplement its weak capabilities in these latter areas by retaining a bank or a major financial institution, under a technical assistance to be financed from the Energy Sector Project, to provide on-the-job training to NEA staff and supervisory services in the loan processing and administration functions over the next few years. NEA's retention of consultants, according to terms of reference and procurement procedures acceptable to the Bank, to provide assistance with NEA's loan administration function is a condition of effec- tiveness of the proposed loan. - 10 - E REC Perfonnance Monitoring 2.11 The newly established Account Management Group will have the over- all responsibility (with day-to-day assistance from NEA's field organization) for monitoring the performance of the RECs and will tie this review and evalu- ation directly to NEA'a willingness to make future loans. An a condition of borrowing from NEA, the RECs will be required to implement PIPs (para. 4.24); these will provide NEA with a basis for monitoring each REC's implementation of meaningful activities related to its own circumstances. NEA will continue to require that the RECs have their accounts audited; over time, it will re- duce the scope of audit services being provided to the RECs, and requiro that the REC. employ private certified accountlng firms, where possible and appro- priate, for the conduct of the financial audit. F. Accounting Systems and External Auditing 2.12 NEA uses a manual accounting system, which is a dual entry, accrual based adaptation of the procedures followed by all Government institutions. With some modifications, the system is acceptable (para 5.17). NEA has an in- ternal auditing group that establishes internal controls and conducts its own review of NEA's books. Its accounts are also audited annually by the Commis- sion on Audits (COA), the government's official auditor. In addition to au- diting NEA accounts, COA performs management and compliance audits of the organization. During negotiations NEA agreed to furnish to the Bank by Sep- tember 30 of each year, its annual financial statements certified by an ac- ceptable auditor. To facilitate the Bank's supervision efforts, NEA provided an understanding that it would furnish the Bank with its unaudited financial statements by May 15 of each year. G. Taxes 2.13 In 1986, NEA lost the tax exemptions that were built into its char- ter. It is currently liable for income taxes (levied at 35X of taxable in- come) and other smaller taxes, and make arrangements with regard to customs duties on a case-by-case basis. H. Scurity and Insurance Aangements 2.14 All NEA loans are secured by first mortgages on materials and equipment released to the RECs. In addition, the RECs must obtain NEA's ap- proval before assuming other debt obligations. NEA is required to insure all its property. It has generally complied with this requirement; however, NEA has not undertaken a rlsk management assessment to determine the appropriate- ness of its coverage. In the past, NEA has required that the RECs insure their respective assets but few have complied because of the high premiums. Under the proposed project, NEA will be expected to comply with the insurance provision included in the general Conditions; this condition could be met by NEA's enforcing the RECs' compliance with its existing insurance requirement. - 11 - 3. THE ELECTRICITY MARKET A. REC Markets 3.1 Most of the 120 RECI were created during the 1970s (Annex 3.1. They now provid, electricity to about 1,300 towns (931 of the total), and serve more than three million consumers. To a degree, the expression "Rural Electrification" inaccurately depicts the markets they serve; they cover the entire Philippines, including major cities other than Manila, Cebu, Davao and Batangas; provincial urban centers; as well as towns and truly rural areas. 3.2 The spread of end user sales among all the RECs and the other dis- tributors of electricity for 1990 is given in Table 3.1. Table 3.1: SPREAD OF NUMBER OF CONNECTIONS AND NPC BULK SALES - 1990 onnnmectni GWH X Conna X GH (000) RECs 3,185 3,621 52X 161 MERALCO 2,305 13,381 401 58X NPC Industrial and Other Utilities 596 5.927 lOX26X TOTAL 6,086 22,929 1001 1001 3.3 Size, whether expressed in numbers of connections or in GWh sales, varies greatly among the RECs. In 1989, 25 RECs (or 221) had less than 10,000 connections, while 9 RECs (or 81) had more than 50,000 and accounted for 181 of total REC sales. The RECs also vary widely with regard to residential consumption per customer and total sales per customer, reflecting the differ- ent degrees of development in various regions. In 1989, consumption per cus- tomer was less than 33 kWh/month in 29 RECs, while it exceeded 100 kWh/month in 16 RECs. Those 16 RECs accounted for 401 of total REC sales. The average of total sales per consumer was 77 kWh/m'-cn (compared with 500 kWh/month for MERALCO), and the average sales to residential customers was 36 kWh/month (compared with 170 kWh/month for MERALCO). B. Recent Trends in Rural Electrification 3.4 The number of the RECs' connections (Graph 3.1) grew very rapidly during the late 1970s (from 176,000 in 1974 to 1.44 million in 1980), reflect- ing the Government's ambitious policy of total electrification of the coun- tryside. Progress remained vigorous until 1983, but then slowed sharply, owing to (i) lack of funds, (ii) the higher costs of electrifying increasingly remote areas, and (iii) NEA's mandate to channel investments into activities - 12 - other than distribution (e.g., alternative generation). The number of connec- tions increased by only 4X per year during 1985-90, as against 11.3X per year during 1981-85. Thus, the Government's total electrification objective was postponed repeatedly. Table 3.2 indicates the progress of electrification since 1980, as well as NEA's current objective for 1995. Table 3.2: PACE OF ELECTRIFICATION IN REC SERVICE AREAS (1980-90 and 1995 Est.) 1980195 1990 1995 12. x 1 I2.X. N.,. X N2.1. x (Est.) Towns 934 77X 1,255 921 1,301 93X 1,382 1001 Barangays 10,955 361 19,009 551 21,317 611 24,063 691 Connections (000) 1,441 30X 2,649 46% 3,185 541 3,948 661 3.5 Total REC sales increased by 7.51 per year during 1981-85, and by 9.01 during 1985-90. During the early eighties consumption per customer actu- ally declined, reflecting (i) the high pace of connection, which added many small consumers, and (ii) the severe economic recession of 1983-85. Since then, with the slower pace of new connections, increases in consumption per customer became the prime determinant of sales growth. This is illustrated in Graph 3.1 below. GRAPH 3.1 - CUSTOMERS & AVG. CONSUMPTION THOUSANDS KWHIMONTH 3500. 80 3000- 2500 -60 2000 40 1000 220 0 0 194 76 1978 1990192 198 196 1988 199 YEAR NO. CUSTOMERS -4- KWHIMONTH - 13 - 3.6 The evolution of the shares of total REC sales by customer category is illustratei in Graph 3.2. Further details on demand trends are given in Annex 3.2. GRAPH 3.2 - REC SALES BY SEC-T-OR 1981 198 1,400 GWH 2,6 5 5 GWH C. Recent Trends and Forecasts for Project RECs 3.7 Past trends for 1981-90 and sales forecasts for 1991-96 for each of the 50 RECs participating in the proposed project are given in Annex 3.3. These forecasts are based on separate evaluations of incremental demand from (i) existing customers, (ii; new connections along existing lines (add-ons); and (iii) connections being made in newly electrified areas. These trends are summarized in Tables 3.3 and 3.4 as follows: Table 3.3: SALES TRENDS FOR 50L PROJECT RECs - 1981-90 AND 1996 (Est.) 1981 198 192s 1996 (Est.) Total Sales (GWh) 890 1,157 1,844 2,991 Purchases 1,084 1,454 2,285 3,392 Loss Ratio 18X 20X 19X 121 Connections (000) 941 1,392 1,651 2,007 Consmptn. per conn. (kWh/mo.) 946 832 1,117 1,490 ,A Excludes the four RECs added to the project at negotiations. - 14 - Table 3.i4: GROWTH TRENDS AT 51O PROJECT RECs - 1981-90 AND 1991-96 (Est.) 1981-85 1985-go 122Q929 Totel Sales 6.78% 9.76X 8.4% Purchases 7.61% 9.47% 6.8% Connections (000) 10.27% 3.48% 3.3X Conumptn. per conn. (kWh/mo.) -3.17% 6.07X 4.9% New Connections (No./year) 112,605 51,881 59,365 Add-ons 38,460 Extensions 20,904 La Excludes the four RECs added to the project at negotiations. D. Future Studies and Improvements in Load Forecasting 3.8 The methodology for deriving the demand forecast (defined in Annex 6.1, in the context of a general discussion of NEA's overall planning meth- odology) that provides the basis for the proposed project represents a consid- erable improvement over NEA's past practices, and the aggregate forecast it- self, while reasonably conservative, is acceptable for appraisal purposes. However, NEA can (and should) further improve its methodology for load fore- casting at the REC level. In particular, NEA and the RECs need to sharpen their understanding of the dynamics of consumption in newly electrified areas and thereby refine their market analysis for specific extension schemes. These market analyses need to focus on factors such as demographic trends, economic activity, and infrastructure development. This new emphasis or. mar- ket analysis is adequately reflected in the Investment Guidelines, which was approved by the NEA Board as an adjunct to the SOP. NEA will receive the help needed to upgrade its load forecasting methodology through the technical as- sistance being provided under the proposed project (para. 4.9). - 15 - 4. THE PROJECT A. Investment Progamming and Project Preparation 4.1 Between 1971-83, NEA channeled to the RECs about $20-30 million per year in loans from official foreign sources. Donor enthusiasm for NEA and its programs began waning in 1981, and declined steeply as of 1983. From 1984-89, NEA's most significant lending did not support the RECs' capital expansion; rather, the Government provided 9 500 million for a Relending Program, whereby NEA financed the efforts of 25 floundering RECs to meet their arrears to NPC. In 1989, based on a 1987 study conducted by Price Waterhouse and Co. and the National Rural Electric Cooperatives Association International Ltd. (NRECA), USAID made available about US$13 million to support (i) the rehabilitation of networks in eighteen of the leading RECs, and (ii) technical assistance aimed at upgrading the accounting, operations and maintenance, commercial practices and financial performance of those RECs as well as the 25 participating in NEA's Relending Program. This USAID financing is expandable to $40 million, and future phases of the project would include, Inter alla, parallel financing of the technical assistance and training being provided under the proposed project. Also in 1989, the Bank provided NEA with $22.2 million under the Energy Sector Project to support (i) the rehabilitation requirements of 12 RECs, (ii) power supply upgrades for eight other RECs, and (iii) substantial institutional development for NEA, itself. The USAID and Bank financed pro- jects were intended to serve as forerunners to future lending. 4.2 Previously, NEA used en ad hoc approach to investment programming. Az NEA received materials and equipment, they were allocated to RECs based on plans for increasing the number of consumer connections. Under the ongoing USAID and Bank financed projects, the recipient RECs were chosen from among the best performers in the country; and the schemes being financed, once se- lected, were anaiyzed to ensure that their economic rates of returns were satisfactory. During 1990-91, NEA greatly improved its investment planning methodology. The framework for an annual planning exercise, together with an outline of the methodology to be followed and the criteria for evaluating and prioritizing investments, are set out in the Investment Guideline that is an annex to the SOP. It provides for the RECs to furnish plans that are prepared according to prescribed formats, taking account of constraints that had been advised by NEA. The process provides for substantial discussion between NEA and the RECs, and consideration of investments within a REC specific and a Regional context. Ultimately, NEA aims to refine the current process by (i) delegating greater responsibility for data gathering and analysis to the RECs, and (ii) developing procedures for verifying the data provided by the RECs. During negotiations of the proposed loan, NEA agreed to (i) conduct jointly with the Bank an annual review of its investment program for the next five years and its investment accomplishments for the last two years, and (ii) adopt any mutually acceptable adjustments. 4.3 The proposed project identified by NEA for Bank financing involves schemes included in the 1992-95 investment plans of some 54 RECs; construction of any scheme to be financed by the proposed loan will have to begin before - 16 - the end or 1994. The RECs that would be financed under the proposed project were chosen at random; they represent a cross section of all RECs based on geographical distribution, operational and financial performance, and future prospects. The methodology used for formulating Bank financed investments is the same as is being used in connection with other donors; and NEA intends to apply loan terms and conditionality on a source neutral basis. B. Project Objectives 4.4 The proposed project aims at supporting the revitalization program by (i) enhancing NEA's capability to function as an effective core agency for this sector through its application of sound strategies for evaluating and solecting investments, supervising the implementation of schemes, and financ- ing the RECs; (ii) encouraging operational and financial reforms among the RECs through NEA's judicious use of conditionality; (iii) improving the avail- ability of reliable electricity supply in rural areas by financing a portion of NEA's 1992-95 investment program; and (iv) providing for NEA and the RECs technical assistance and training needed for institutional development. C. Project Description 4.5 The proposed project consists of two urgently needed ccmponents: (i) an institutional development component aimed at restructuring NEA and the RECs, and (ii) an investment component aimed at providing urgently needed new facilities or upgrades to existing facilities: (a) The InstitutlonaL Development Component would be implemelited through (i) application of conditionality on NEA's future loans to the RECs; and (ii) office equipment, technical assistance and training to be provided under the proposed project, including a provision to complete the REMP that was begun with USAID financing. (b) The Inyestment ComDonent consists of specific schemes from NEA's 1992-95 investment program, and was structured to enable the Bank to monitor all aspects of NEA's project cycle. Activities being financed under this component include: (i) system rehabilitation and reinforcements, including needed upgrades to substations, feed- er lines, secondaries, branches, and service drops as necessary, aimed at improving the reliability of power supply and customer service; (ii) connection of prospective consumers within a reason- able distance of existing lines; and (iii) economically justified distribution system extensions. 4.6 The proposed loan would finance the purchase and installation of materials and equipment as well as services for the following endeavors (de- tails in Annex 4.1): - 17 - (a) REC Distributio2 Systems (i) construction of forty 69/13.2 kV substations of 5, 10 or 20 MVA each at about 25 RECs, and upgrading of about 15 substa- tions at about six other RECs with the addition of a total of around 550 MVA of transformer capacity; (ii) construction of about 4,300 km of 13.2/7.6 kV three phase and single phase primary lines, and about 2,500 km of 220/110 volts secondary lines and installation of about 21,000 distri- bution transformers with a total capacity of around 450 MVA at about 54 RECs; (iii) service materials for connection of around 400,000 consumers, including service connections, meters and some 1,600 low ten- sion capacitors (around 100,000 kVAr) at about 54 RECs; (b) SupRort Facilities (i) support equipment, including tools; services vehicles; and testing, office and communication equipment for about 54 RECs, and computers for the remaining RECs; (ii) infrastructure and support facilities for NEA, including re- gional offices, buildings at zonal repair centers, a training center, a workshop, and warehouses, and the equipment needed for those facilities (including Inter alia computer hardware, mobile substations, etc); and (c) Training and Technical Assistance. Consulting services and train- ing to assist NEA and the RECs in project execution, operation and management (including upgrading of technical and financial skills). D. Project Design and Engineering 4.7 The design of rural electric networks in the Philippines is based on the single phase system used in the United States. Over the years, NEA and the RECs have gained the necessary competence to perform most of the design functions themselves. Because NEA's past policies gave expansion of distribu- tion lines priority over maintenance and repair of existing system, the condi- tion of many lines has deteriorated to the point where consumers suffer low and often fluctuating voltage levels and repeated power interruptions. NEA's emphasis has now shifted to quality of services and the operational and finan- cial viability of the RECs. Therefore, some modifications have already been introduced into the design and engineering of recent works. Still, to reflect the lessons of past experience, further action is needed--including, more de- tailed mapping, and adjustments to design and operations--to reduce system losses and raise the system power factor. 4.8 The facilities included in the proposed Project would be construct- ed in the service areas of various RECs, spread throughout the country (Map - 18 - IBRD 232 .7) To (i) assexs the viability of the selected schemes, (ii) con- sider the Impact of these investments on the RECs, and (iii) strengthen the RECs by addressing operational and financial weaknesses through the applica- tion of PIPs, NEA will prepare a Project Evaluation Report (PER) for each REC. An outline for these reports is shown in Annex 4.2. Before negotiations, NEA furnished ten satisfactory PERs to the Bank; during negotiations, NEA agreed to provide the remaining PERs to the Bank according to an agreeable schedule. It further provided an understanding that it would complete 20 more by March 31, 1992 and the remaining 24 by September 30, 1992. Each PER will include a section on environment; where there are no environmental issues, this will be so stated in the PERu. E. Technical Assistance and Training 4.9 The technical assistance and training program included in the pro- posed project would consist of three main components: (a) Strengthening the PlannIng Ca2abilit.les of NEA and the REC. NEA's current planning methodology is adequate for now, when many RECs have a backlog of justifiable investments. However, the initial planning exercise has revealed the need to focus more on load fore- casting, network mapping and design and the definition of technical parameters. More importantly, future plans will need to rely more heavily on inputs from the RECs themselves, with ground truthing to be performed by NEA. To accomplish this, the planning capabilities of NEA and RECs need to be strengthened, and the network requiire- ments for the medium term need to be established. (b) Extendin, tg all RECs the Institutional Asslstance Being Provided to the Beneficlaries of the Ongoing USAD Proglect. This includes (i) developing accounting manuals, and providing training to the users; (ii) adjusting existing budgetary systems to enable the more effective management of REC operations; (iii) introducing a comput- erized billing system adaptable to an integrated information sys- tem; (iv) recommending adjustments to existing rate setting proces- ses based on the provisions of the tariff manual (para. 5.38); and (v) developing training to meet managerial, operational, mainten- ance and administrative needs. (c) Znal Maintenance Centers. This technical assistance would include the design, preparation of specifications for the purchase of equipment and tools, and training during start-up operations for NEA's seven major repair and maintenance centers (para 4.23). 4.10 Altogether, implementation of this technical assistance and train- ing program is expected to require about 200 person-months of consulting for the preparation of documents and manuals, field training, courses and study tours. USAID, which would parallel finance (para 4.12) this project compo- nent, is preparing the scope of work and terms of reference for these activi- ties based on discussions with the Ban*. Procurement with regard to this component would follow USAID procedures. - 19 - F. Project Cost 4.11 The Project's estimated cost, including physical and price contin- gencies as well ax duties and taxes, in about US$112 million (based on March 1991 prices). This includes US$95.2 million of foreign exchange, and US$16.7 million in local costs (including US$4.3 million in taxes and duties), Phys- ical contingencies of 10 are assumed for equipment, materials and services, based on previous experience with rural electrification projects. Price con- tingencies for foreign costs are assumed at 3.6X per year throughout the pro- ject Implementation period, and for local costs at 11 for 1991, and 10 each year thereafter. The cost estimates are summarized in Table 4.1, and detailed in Annex 4.3. IahJ PROjCr COI SUMMAY LOC L FOREIGN TOTAL WCAL FOREIGN TOTAL FOREIGN (Pe (PO (Poe (U8$ (USS (US$ EXCHANGE Millll) Mllion) Mllo ) Millin) MUllon) Milon) COST (%) REC D19TRIBUTION SYSTEMS RehabilIlsUon 115.0 1034.0 1,149.0 4.1 36.9 41.0 90.0 Addon 13.0 13.0 1930 0.6 6.4 7.0 91.4 Expans_on 97.0 5620 659.0 3.5 20.1 23.6 352 Subtota 230.0 1,776.0 2,006.0 .2 63.4 71.6 68&6 SUPPORT FACIMIES REC Q00 1258 1258 0.0 4.5 4.S 100.0 Mobie Subtation 0.0 70.0 70.0 Q0 2.5 2.5 100.0 Zond Repir Center 560 7Q0 126.0 2.0 2.5 4.5 5S6 NEA 0.0 70.0 70.0 0.0 2.5 2.5 100.0 Sub-total 560 335.8 391.8 2.0 12.0 14.0 857 TRANING & TECH- 28.0 140.0 1680 1.0 L0 6.0 83 NICAL ASSISTANCE ADMINISTRATION 280 0.0 280 1.0 0.0 1.0 0.0 TOTAL BASE 342.0 2,251.8 2,593.8 12.2 80.4 92.6 86. Pbhal Con nedcle 34.2 22S2 259.4 1.2 al 9.3 87.1 Pric Contlugenchs 117.0 2353 352.3 3.3 6.7 10.0 67.0 Total 493.2 2,7123 3,2055 16.7 952 111.9 85.1 INTERUT DURNG 99.0 119.0 21U0 3.0 3.6 6.6 S46 CONSTRUCrION TOTAL FINANCING 592.2 2,831.3 3,423.5 19.7 93J 1U.S 834 REQURED - 20 - G. Project Financing Plan 4.12 The total financing requirement, including interest during con- struction (IDC), amounts to US$118.5 million, including US$19.7 million in local funds and US$98.8 million in foreign exchange. A proposed Bank loan of US$91.3 million equivalent would finance about 88X of the foreign exchange re- quirement and 20X of the local cost, together representing of about 851 of the total net of local taxes and duties and IDC. The proposed Bank loan of US$91.3 million would be lent to NEA for 20 years, including five years of grace on repayment of principal, at the Bank's standard variable interest rate. USAID has indicated a willingness to finance in parallel the training and technical assistance component amounting to US$9 million and representing about 91 of the foreign exchange requirements and about 5X of local currency requirements. At negotiations, NEA agreed that it will arrange a satisfactory amendment to the USAID Project Agreement, not later than May 31, 1992. The remaining US$18.2 million, which represents about 161 of the total financing required (including duties and tares and IDC), would be covered by NEA (US$9.6 million or 8.11 of the total) and b.y the RECs (US$8.6 million, or 7.31 of the total). This financing plan is summarized in Table 4.2. Should the cost of materials and equipment purchased for foreign exchange increase substantially, the scope of the project would be reduced correspondingly; cost overruns in local currency would be borne by NEA and the RECs. Table 4.2: PROJECT FINANCING PLAN (US$ million) LOCA', FOREIGN TOTAL Proposed IBRD Loan 4.L 87.2 91.3 USAID Parallel Financing 1.0 8.0 9.0 NEA 6.L 3.6 9.6 RECs 8.b 0.0 8.6 TOTAL 19.7 98.8 118.5 4.13 An on-lending agreement between NEA and each of the beneficiary RECs would need to be signed before NEA orders geods and equipment on their behalf. The amount of the onward loan would be based on the CIF/ex-factory cost of equipment and material, custom duties and taxes, if any, in-country transportation (on a cost plus basis), plus an add-on of 51 to cover NEA's cost of materials handling. Where NEA takes responsibility for civil and erection works, the loan amount would also include a provision to cover those costs based on an estimate of either the contract price or force account char- ges (para. 4.20). NEA has been asked to bring to negotiations a draft of a generic on-lending agreement for the Bank's review and comment. NEA would bear the foreign exchange risk (para 5.12). The parameters of onlending are discussed in paras. 5.15 and 5.22 (a). At negotiations, NEA agreed that it will furnish to the Bank a copy of each on-lending agreement not later than one month following its signature. - 21 - H. Peocurement 4.14 the followin, specific procurement arrangements, summarized in Ta- ble 4.3, are expected to be followed for the various project components: Tble 4.: PROCUREMENT ARRANGEMENTS (USS Milion) iTEM ICB LCB OTHER NA TOTAL REC DlS1RIBMION SYSTEMS Lne Equipment & Materials 582 58.2 (51.1) (51.1) Subsatio Equipment & Materals 23.0 23.0 (20.2) (202) Construction Wors 5.0 5.0 (4.3) (43) SUPPORT FACILITIES Equipment 93 1.4 3.5 14.2 (&2) (1.2) (3.0) (12.4) Construction Works 3.0 3.0 (2.3) (23) TRAINING AND TECHNICAL ASSISTANCE 73 7.3 (1.0) (1.0) NEA Overheads and Other Expenses 1.2 1.2 Total 90.5 4.4 15.8 1.2 111.9 (79-5) (3.5) (83) 0.0 (91.3) ICB: International Competitive Bidding LCB: Local Competitive Bidding Other: Limited International Bidding, International or Local Shopping, Force Account, and Consultant Services NA: Not Applicable: administrative expenses. No.te: Figures in parenthesis are the amounts proposed to be financed by the Bank and exclude taxes, duties and some local charges. 4.15 The following has been agreed with NEA with regard to procurement procedures and limits: (a) Goods: Contracts value at US$200,000 equivalent or more for mate- rial and equipment needed for the project, amounting to US$79.0 million in the aggregate, would be procured on the basis of Inter- national Competitive Bidding (ICB) according to Bank's Guidelines for Procurement. Local suppliers competing for the supply of goods - 22 under ICB would have a preference of 15 or the applicable customs duty, whichever is less. Purchases of minor quantities of materi- als, tools, and equipment not exceeding US$200,000 per contract (except for spares), or US$3,500,0C) in the aggregate, could be procured according to either LIB, LCB procedures acceptable to the Bank, or direct contracting (in the case of spares). In addition, purchases of minor quantities of materials not exceeding US$50,000 per contract and not exceeding US$1,400,000 in the aggregate could be procured using shopping procedures. To meet the implementation schedule, procurement of the equipment, materials and support com- modities would be split in three tranches over 1992 and 1993. Each tranche would include separate packages to be procured under ICB (Annex 4.4). (b) Works Civil works, mainly the construction of small buildings or the erection of substations and distribution lines, amounting to about US$8.0 million, would be widely scattered throughout 40 prov- inces, and numerous sites. The small size and geographical disper- sion of these works, often in remote locations and with sometimes difficult peace and order situations, are unlikely to attract for- eign contractors; and in some instances, even reliable local bid- ders may not seek these jobs. Moreover, the project aims to en- courage the RECs to participate in project implementation to the greatest extent possible. For theseh reasons (i) about 30X of the works, consisting of building and substation construction, would be procured under LCB procedures acceptable to the Bank, and (ii) the remaining 70X, consisting construction of distribution lines and consumer connection, would be accomplished through force account, and not financed by the Bank. The RECs' capacity to use force ac- count over the years has been satisfactory. (c) Consultant Servlces: Bank financed consultants would be selected and employed according to the Bank's Guidelines for the Use of Con- sultants. While USAID would be financing the vast majority of con- sulting expenditures for training and technical assistance, the proposed loan includes a small provision (US$1,000,000) to finance unanticipated, highly specialized consultancies that are consistent with the project's objectives, and which may arise in the course of project implementation. In the latter years of the Project, any portion of that provision that is expected to remain unused would be reallocated to other project components. 4.16 Bank financed procurement would follow Bank guidelines. According- ly, prior to tendering and award, the Bank would review all procurement docu- ments for goods valued at more than US$ 200,000 equivalent; this would cover 802 of the total value of goods. A sample of other contracts for goods and works - which would be of low value (para. 4.15 (b)) - would be reviewed by the Bank subsequent to their award. Bank staff have reviewed NEA's handling of local procurement, and confirm that this is acceptable. Also NEA has shown, under the Energy Sector Project (Loan 3165-PH), a record of good per- formance in preparing procurement documents and awarding contracts. - 23 - I. Disbursement 4.17 The proceeds of the proposed loan would be disbursed for materials and equipment, construction and erection works, commissioning expenditures, and consulting fees, as shown below: (a) 100X of the CIF expenditure of imported material for lines, substa- tions and support commodities; in the case of locally manufactured goods, 100l of ex-factory expenditure, and in the case of goods procured locally, 751 of the expenditure; (b) 851 of civil works related to expenditure for erection and commis- sioning, including civil works related to lines, substations, buil- dings and infrastructure facilities; and (c) 100% of total expenditure of consulting services, including inspec- tion of equipment and materials. These disbursements would be fully documented, except for minor expenditure for equipment, materials and civil works costing less than US$50,000. In such cases, disbursement will be made against a Statement of Expenditures (SOE), the documentation of which will not be submitted to the Bank but retained for review by visitirg Bank missions. To facilitate disbursements, a Special Account would be established on terms and conditions satisfactory to the Bank. The maximum amount that would be deposited in the Special Account would be US$5.4 million, representing an average of four months disbursement. During negotiations, NEA agreed to have its activities in relation to the Special Account, as well as the Statement of Expenditures being maintained for dis- bursement purposes, audited in conjunction with the audit of its annual ac- counts (para. 2.12). However, the Bank reserved the right not to make the initial deposit into the account unless it is maintained in a commercial bank that allows NEA to have direct access to the funds therein. 4.18 Disbursements are expected to be concluded by December 31, 1996, one year after the expected completion of the project. The additional year would allow adequate time for releasing contractors' retentions and processing withdrawal applications. In addition, as power distribution investments fol- low a dynamic process, the pattern of expenditures would be monitored closely so that any undisbursed funds could be applied to suddenly arising justifiable schemes that meet the objectives of the proposed project, following consulta- tions with the Bank. An estimated schedule of disbursements together with a comparison with the standard country disbursement profile is given in Annex 4.5. For the first four years, the expected disbursements for the proposed project follow the standard profile for the Philippines. However, although that standard profile indicates an 8-year period for full disbursements, the proposed loan is expected to be disbursed within six years given (i) the time- slice (1992-95) definition of the project, (ii) the satisfactory performance of NEA regarding procurement in the previous projects, (iii) the fact that all equipment and materials being procured under the project are ready made, and (iv) no major civil works are required for installing goods that are purchased under the project. Moreover, the earlier Rural Electrification Project (Loan 1547-PH) was fully disbursed within five years. - 24 - J. Project Implementation 4.19 While the RECs will be responsible for implementing schemes within their service areas, NEA will supervise all of the proposed project's con- struction activities. In the past, NEA has shipped materials and equipment to the RECs as soon as possible after receipt of those goods at NEA's central warehouse. This piecemeal approach to releasing goods to the RECs has led to difficulties in ensuring that agreed schemes were actually built; the RECs were under great pressure from prospective consumers to put the goods to use as soon as these were received rather than wait for the complement needed for a given scheme to be assembled in its entirety. Under the Energy Sector Pro- ject, NEA will be shipping goods as they arrive to warehouses strategically located to serve groups of RECs. At those warehouses, the goods ordered for each REC will be stored, and released only when the full complement needed to implement committed schemes has been assembled. NEA would then monitor close- ly implementation of the promised scheme. This approach will also be followed for the proposed project. The RECs will only acquire liability for the onward loans from NEA with the release to them of blocks of materials and equipment. 4.20 Once the materials and equipment have been released, the RECs will be responsible for their storage and for execution of the construction works. In general, substation and the backbone distribution networks would be built by independent contractors. The RECs would use force account to erect lateral lines from the backbone. In order to perform these tasks, the LECs are being equipped with the necessary tools and construction equipment under the USAID Project and the Energy Sector Project as well as under the proposed Project. 4.21 NEA's engineering department would participate in acceptance tests, commissioning, and review and approval of as-built stake-sheets. The construc- tion period for each scheme would range between 6 to 18 months, depending on the scope of the works. An overall implementation schedule, outlining the key dates for procurement and construction activities, is shown in Annex 4.6. The proposed Project is expected to be completed by June 30, 1996. 4.22 To ensure effective coordination and monitoring of activities among NEA's departments and between NEA and the RECs, NEA has appointed an appropri- ately qualified Project Director, who is responsible inter alla for managing project implementation. K REC Operational Performance 4.23 In the past, some RECs have developed notoriously poor records for operation and maintenance of their facilities and for commercial discipline. The training and technical assistance program included in the proposed Project (para. 4.5), addresses some of those weaknesses by imparting needed knowledge and capabilities to the RECs, while enhancing NEA's capacity to supervise REC operations. NEA is also developing repair shops and testing facilities in its zonal maintenance centers. Tools and equipment for these activities have been provided under the Energy Sector Project and more are still being provided under the proposed Project. These centers would provide the RECs with various q5 specialized services (e.g. meter calibration, transformer rewinding), for which NEA would be remunerated (para. 5.14). 4.24 An conditionality related to its on-lending, NEA would seek the RECs' agreement to implement three year PIPs, specifically tailored for each REC, aimed at their implementing specific measures to (i) reduce non-power costs; (ii) reduce technical and non-technical losses; and (iii) improve col- lection efficiency. A generic program of typical measures has been prepared by NEA and reviewed by the Bank (Annex 4.7). This generic program is an ad- junct to NEA's SOP. L Project Monitoring 4.25 Project implementation would be monitored by NEA. NEA will furnish to the Bank quarterly progress report that cover the status of procurement, contract execution, physical progress, project costs, disbursements and admin- istration of the proposed project. It would also provide an annual report on the operating performance of the RECs. This annual report would discuss Inter alla for each REC: (i) system losses; (ii) collection efficiency; (iii) non- power cost; (iv) the customer per employee ratio; and (v) realization of its financial performance targets (para. 5.30). The Bank would also supervise project implementation through field missions; a tentative schedule for super- vision activities and missions is summarized In Annex 4.8. Following the com- missioning of schemes, NEA would require that the RECs provide Project Comple- tion Reports detailing their implementation experience. These reports would be furnished to the Bank upon request. Finally, following completion of the proposed Project, NEA would furnish to the Bank a Project Completion Report, summarizing the project's execution, initial operation, actual project cost and benefits, NEA's and the RECs' performance, and the realization of the project's objectives. M. Environment 4.26 The proposed project is not expected to pose environmental prob- lems. The rehabilitation and system reliability components involve adjust- ments to systems already in place. While the system extension and power sup- ply reliability components do envision some new works, these involve low volt- age networks that would follow existing infrastructure in thinly populated areas. Where substations are to be upgraded, NEA has indicated that trans- formers containing PCB will be disposed of safely. In general, the technical standards followed by the RECs were adapted from those used in the United States, where environmental impact has been a key concern; still, NEA will arrange for preparation of ar Environmental Impact Assessment wherever net- works are extended through forests or wetlands. N. Project Benefits 4.27 The main benefit of the proposed project would be the improvement in the quality of life in rural areas through the widespread availability of - 26 - grid supplies of electricity for household and commercial uses, with women being the primary beneficiaries. This should, in turn, facilitate a broad- ening of economic opportunity in provincial towns and rural areas in agricul- ture and small scale industry. These benefits would be realized as a result of the following features of the proposed project: (a) The lnstitutional and trainIng comRonent is expected to: (i) improve the operational performance of the RECs through the PIPs, which should result in a lower cost of service. (ii) improve financial performance of the RECs and NEA through more disciplined investment and lending criteria and a more appro- priato tariff policy, which together should enable the sec- tor's institutions to become more effective at delivering their service. (iii) improve the methodology being used by NEA and the RECs for planning and network design, which should enhance the quality of service while lowering the cost of supply. (b) The Investment cogmonent is expected to: (i) meot the growth in demand of existing and new customers, and Improve the quality of electricity supply in the service areas of the project RECs. (ii) provide a more convenient source of energy as comparad with kerosene lamps or diesel motors, and enable the use of life enhancing electric appliances for newly connected customers. 0. Project Risks 4.28 NEA and the RECs are generally weak organizations that will be at- tempting to implement ambitious investment programs. In that sense, they may confront problems in meeting implementation schedules or raising counterpart funds. In addition, the RECs may not realize financial and operational per- formance improvements as quickly as desired. At appraisal, the Bank tried vigilantly to ensure that the proposed Project would not exceed the absorption capacities of NEA and the participating RECs. - 27 - 5. FINANCE AND TARIFFS A. National Electrification Administration Past and Present Financisl Condition 5.1 NEA's financial performance for 1986-90 is presented in Annexes 5.1 and 5.2 and summarized in Table 5.1: Table 5.1: NEA's Financial Performance (1986-90) (Million Pesos) 1986 1987 1988 1989 1990 Operating Revenue 263 284 340 306 297 Operating Expenses 231 438 443 473 344 Operating Income/(Loss) 32 (154) (103) (167) (47) Net Income/(Loss) 37 (243) (218) (84) (707) Adjusted Net Income/(Loss) 37 (233) (1,762) (670) (617) Total Assets 8,199 11,583 10,695 11,241 12,441 Long-term Debt 3,447 5,607 5,627 5,556 6,267 Retained Earnings 2 (231) (1,993) (2,663) (3,280) Current Ratio .94 .80 .74 .64 .73 Debt/Equity Ratio 70:30 75:25 88:22 91:09 93:07 5.2 Except for 1966, NEA has consistently incurred large financial losses. During 1987-90, NEA's operating revenue was insufficient to recover interest or other operating expenses. Since NEA accounts for interest revenue on an accrual basis and does not make provisions for doubtful accounts, the revenue claimed is substantially overstated. During the period, NEA's delin- quency rate on interest payments alone averaged about 45X per year; for prin- cipal and interest together, the delinquency rate is currently about 56X. In 1989 and 1990, despite large subsidies to offset interest on advances that previously had enabled NEA to meet its foreign debt service obligations, its financial losses exceeded twice its total revenues. 5.3 NEA was initially organized as a Government corporation with autho- rized capital of P 1 billion. Several subsequent amendments to the NEA char- ter raised the authorized capital to P 5 billion. By the end of 1990, after the Government had already subscribed about P 4 billion of NEA's capital, NEA had virtually eroded that capital and was operating unsustainably. Its cur- rent ratio was less than .75, and its debt to equity ratio reached 93:7. NEA's cash flow depended on the Government's relaxing the requirement to repay advances. If commercial accounting practices were applied, many of NEA's out- standing loans and the interest receivable thereon would be deemed doubtful - 28 - and therefore written off. In addition, substantial inventories primarily of alternative generation equipment have negligible value. With expenses running far ahead of revenues, current liabilities outpacing current assets, and sig- nificant overvalued inventories, NEA is virtually insolvent. 5.4 These factors were discussed explicitly in the Bank's 1989 Sector Study. In its aftermath, the Government and NEA decided to implement a number measures to put the sector's institutions on a sound financial footing. These included: (i) reorientation of NEA to the role of interested lender, with the capability to act as receiver (para. 5.5); (ii) the financial re- structuring of NEA, and through NEA, the RECs (para. 5.6); (iii) the adoption of a coherent financing strategy and corresponding policies that will encour- age NEA and RECs to observe financial discipline, and thus sustain their sol- vency after being restructured (para. 5.10); and (iv) the adoption of sound electricity tariff policies (para. 5.38). Reorientation of NEA's Role 5.5 In NEA's new role as 'interested lender", it intends to act as a receiver in instances of REC defaults. NEA would therefore focus on the dis- position of failed RECs, possibly in altered form, rather than on rescuing those RECs largely for the benefit of entrenched interest groups. The capac- ity to act as a receiver will substantially alter in NEA's favor its power relationship with the RECs. Finandal Restructuring 5.6 On January 24, 1991 the Government formally agreed to implement a comprehensive financial restructuring of NEA. This will place NEA on a "clean books" basis, thereby enabling it to address the future development of the sector free from the financial burdens of past mistakes. Thiq restructuring plan is outlined in Annex 5.3. Under the plan the Government will: (a) Convert to equity about P 5.1 billion of advances made to NEA dur- ing the past seven years. (b) Assume the responsibility for all of NEA's foreign loan obliga- tions, as and when those obligations are due (as of December 31, 1989, these amounted to P 6.3 billion). (c) Enable NEA to write off numerous doubtful and uncollectible loans, or other over-valued assets. These include: (i) P 1.4 billion of loans to 25 remote island RECs with limited prospects for financial viability; (ii) P 1.9 billion of loans for inoperative alternative generating equipment nominally transferred to the RECs, but either not installed or commissioned; (iii) P 663 million of loans to RECs for operational alternative generation equipment; (iv) P 558 mil- lion, representing alternative generation equipment inventory on NEA's books; and (v) P 592 million of other doubtful assets and loans on NEA's books. - 29 - (d) Direct the RECs to transfer their alternative generation equipment to NPC. In addition, NEA will sell any alternative generation equipment in inventory and transfer the proceeds to the Government. 5.7 This restructuring program will cost the Government a total of about P 11.4 billion. Although this price tag is high in nominal terms, the fiscal implications are negligible; the Government has been aware, at least since discussion of the issue in the Sector Study, that NEA had no revenues corresponding to these liabilities, and therefore no hope of meeting them. Moreover, NEA and the RECs acquired these obligations as a result of intemper- ate decisions of the previous Government. No other entity can appropriately take responsibility for these liabilities. 5.8 This financial restructuring will have two major impacts on NEA: a) Reduction of NEA's Cost of Funds. Prior to restructuring NEA's cap- ital structure consists of P 11.4 billion in debt and 8 893 million in equity. After the restructuring, NEA's capital base will mate- rially change to P 6.2 billion of equity and no debt, giving NEA a 0:100 debt to equity ratio and a zero weighted average cost of funds. Moreover, NEA will be receiving up to US$40 million of fi- nance originating from USAID and US$22.2 million from the Bank's Energy Sector Project as equity, thereby increasing its equity cap- ital by about P 1.6 billion. Current NEA efforts to raise new debt will produce obligations beginning only in 1993. Thus, NEA's weighted average cost of funds is expected to remain below 2X for the foreseeable future. b) Healthy Cash Inflows for NEA. While the restructuring will result in cancellation of P 11.4 billion in loans to NEA, NEA will only forgive P 3.5 billion in loans to RECs, leaving about P 5.1 billion in REC loans for which NEA has no corresponding liability. Of that amount, about P 4.3 billion are current. The remaining P 821 mil- lion are in arrears, and NEA will be rescheduling these as a one time measure. While this rescheduling will give the mismanaged RECs more time to meet their obligations, the related interest rate will increase sharply from the present 3X to 71 range to 121. 5.9 Although the Government agreed to the financial restructuring, its implementation depends on: (i) the Government making the budget allocations needed to enable the agreed conversions of debt to equity; and (ii) NEA com- plying with conditionality attached by the Government. Those components of the restructuring that involve NPC's absorption of alternative generation assets and liabilities as well as the conversion to equity of some advances are expected to be implemented in 1991. Much of the remainder is due for implementation in 1992.Y The foreign exchange related obligations will be absorbed by the Government as and when they mature (declining amounts will mature through the year 2000). At negotiations, the Government agreed that it M NEA's write off of uncollectible loans requires Congressional authoriza- tion. NEA has already drafted and secured Administration support for the necessary legislation. . 30 - will make the annual budgetary allocations required to enable the timely im- plementation of NEA's financial rescheduling. The conditions imposed by the Government are consistent with those of the proposed project. Because of the Government's commitment to the financial restructuring, all analyses of NEA's future financial prospects will be formulated net of the bail-out plan. Financing Strtegy 5.10 In May 1991, the NEA Board approved, as an adjunct to the SOP, a new Financing Strategy. It includes: (i) treating loan funds as source neu- tral, and using the average cost of furids as the base for its onlending rate; (ii) rationalizing the costs to be recovered through the interest rate; (iii) arranging for provisions against potential foreign exchange losses; (iv) relieving NEA of the responsibility for lending to support financially non-viable RECo or economically non-viable projects; and (v) charging fees for other services that NEA considers it should provide but that are not directly related to loan formulation or supervision. This strategy, which also in- cludes financial policies to be followed by NEA, is acceptable to the Bank. Lending Policies and Procedures 5.11 NEA has compiled a Loan Policy Manual, which is also an adjunct to the SOP. The manual establishes (i) authorities and limits for lending, (ii) accountability for loan transactions, and (iii) a loan committee for evaluating proposed RZC loans. It includes financial objectives and appraisal criteria, and formalizes the role of the PIPs in developing operational tar- gets for the RECs. The Loan Policy Manual is acceptable to the Bank. Foreign Exchange Fund 5.12 NEA's financial distress was the inevitable consequence of the pre- vious Government's decision that NEA should borrow in foreign exchange and relend in pesos on concessionary terms. The Sector Study recognized that RECs lacked the capacity to borrow in foreign exchange or to implement indexed tariffs. To prevent such debilitating exposure from recurring, NEA estab- lished in December 1991 a Foreign Exchange Fund. This fund would operate much like an annuity account, with regular contributions being made to cover antic- ipated future payments. The amounts contributed would be set according to estimates of future foreign exchange losses based on expected rate variations between the Peso and the currencies of NEA's foreign borrowings. The contri- butions rate will be reviewed periodically to determine whether: (i) the fund balance is adequate, and (ii) the level of contributions is appropriate. As NEA intends to accumulate quickly a sizeable balance, starting with 1992 it will initially allocate about 35X of interest income from all loans to the fund. NEA's Board has already (i) approved the establishment of the fund, and (ii) instructed management to use the proceeds in the fund to purchase forward cover from the Government. At negotiations, the Government and NEA provided an understanding that resources allocated to this fund will be utilized only for the purpose of covering NEA against future foreign exchange losses. - 31 - 5.13 Under the Industrial Restructuring Project (Loan 3287-PH), the Gov- erNment agreed to provide borrowers of official loans with forward cover against foreign exchange risk. The fee for this cover is based on the differ- ence between the prevailing commercial rate for the currency being covered (or an acceptable proxy in case a commercial rate cannot be established) and the weighted average interest rate on peso time deposits of 60-91 days. This rate is adjusted quarterly, in line with the movement of the various reference rates. At negotiations, the Government agreed that it would provide NEA with cover against foreign exchange risk for a fee linked to the Weighted Average Interest Rate for 60-91 day time deposits. The Government emphasized that this decision was predicated on NEA's passing the cost of this cover to elec- tricity consumers; therefore, NEA would meet this cost while preserving the source neutrality of its lending by (i) appropriating a portion of its aggre- gate interest rovenues to the Foreign Exchange Fund and (ii) using the pro- ceeds that fund to purchase the requisite cover. Fees for Support Services 5.14 NEA has been offering a wide array of services to the RECs, includ- ing engineering and technical services, materials management, warehousing, training, and financial advisory and auditing services. The cost to NEA of these services is significant and should not be covered entirely from the interest rate being charged to the RECs. In connection to its new financing strategy, NEA has decided to: (i) cover the cost of services directly related to loan formulation and administration through the interest rate; (ii) charge for materials handling by adding an appropriate percentage (currently 5X) to the principal amount of corresponding loans; and (iii) levy direct fees for its other services. In connection with the SOP, NEA has developed a fee schedule for those other services, including training, major maintenance and repair, miscellaneous engineering, auditing, and corporate development. Onlending Rate 5.15 The Sector Study recommendedV that NEA formulate an onlending rate that would cover: (i) its average cost of funds, (ii) appropriate operating costs, and (iii) a provision to protect against anticipated foreign exchange risk. As onlending would be source neutral, (i) the onlending rate should be applied consistently to all new loans, and (ii) the provision for foreign exchange losses (para. 5.12) would be derived from all NEA loans to the RECs, not just those that arise from NEA's own foreign borrowings. NEA has included this interest rate formula in its financing strategy. Currently: (a) Based on the financial restructuring, NEA's current weighted aver- age cost of funds is OX, and should not exceed 2% for a number of years (para. 5.8). W Philippines Rural Electrification Sector: An Integrated Program to Revi- talize tbe Sector; Nov. 9, 1989; Rep. No. 8016-PH; Page 87, para. 6.35. - 32 - (b) NEA has rationalized the operating costs to be covered by the in- terest rate (para. 5.14). NEA's costs for these activities are currently estimated to equate to a spread of 61 to 8X. (c) By allocating 35X of all interest revenues to the Foreign Exchange Trust Fund at a time when its own foreign exchange exposure is min- imal, NEA expects to accumulate a sizeable reserve during the next three to five years. NEA's current interest rate of 12X complies with this formula. To manage the liability side of its balance sheet more effectively, NEA has decided that its new loans would carry a variable interest rate. The rate would be reviewed annually, and an adjustment would be applied following the review. 5.16 Since no explicit cost was allocated to the Government's equity in NEA, this cost based onlending rute contains an implicit subsidy. This subsi- dy is justified because: (a) the 120 RECs that borrow from NEA are all financially and opera- tionally weak. Even with this the subsidized interest rate, nearly 100 RECs have recently had to implement substantial tariff in- creases merely to enable them !o be financially viable in 1991-92 (para. 5.34). (b) the RECs are regulated monopolies, with a limited selling price but costs that can increase without constraint; (c) given that the bulk of the RECs' customers are poor rural folk liv- ing below the pcverty line, their service has a social as well as a commercial value; (d) the RECs are unable to issue bonds or obtain investment funds from sources other than NEA, thereby limiting any possible impact of NEA's subsidized lending on the financial sector; (e) NEA's new Loan Policy Manual (para. 5.11) includes a provision for the rate to be reviewed annually, and adjusted as needed to take account of changes in NEA's cost structure. Thus, as the RECs im- prove their financial health, NEA would expect to lift the subsidy from its interest rate; and (f) albeit that its posted interest rate contains an implicit subsidy, the fees it plans to charge for services unrelated to lending should provide NEA with substantial additional revenues. Thus, notwithstanding the interest subsidy, NEA is projecting healthy financial performance through 2000 (para. 5.23). Changes In Accounting Procedures 5.17 The final element of NEA's new financing strategy is the adoption of changes in accounting procedures appropriate to NEA's new function as an - 33 - "interested lender,. Accordingly, NEA is seeking COA's approval to change its procedures to enable: (i) the ongoing provisioning and write-off of REC loans that are determined respectively to be doubtful and uncollectible; (ii) the provisioning for likely losses resulting from foreign exchange exposure on outstanding borrowings; (iii) the recognition of interest earned by NEA based on the status of the underlying loans; and (iv) the placement in a suspense account of the various components of the bail out plan as of year-end 1991. In addition, NEA indicated it would seek COA's permission to account for the Foreign Exchange Fund off its balance sheet, since this reserve is essentially a committed expense once the funds are allocated to the trust. Financing Plan 5.18 NZA's financing plan for 1992-96 (the 1riod within which project related expenditures are expected to be incurred) is summarized in Table 5.2. Table 5.2: NEA's Financing Plan (1992-1996) Pesos Millions Percent I. Internal Cash Generation (Net of Working Capital Needs) 7,746 53X II. Debt Service (Ex. Payments to Forex Fund) 1L294 -92X Cash After Debt Service 6,452 441 III. External Financing Proposed Loan 3,169 221 Other Foreign Exchange Loans 3,506 241 Foreign Grants 606 41 Government Contributions 900 6Q Total External Sources 8 181 Total Sources of Funds 14 63 1OOX IV. Loans and Investments REC Loans Disbursements 11,770 801 Purchase of Ass' 412 31 Contribution to Foreign Exchange Fund 980 71 Purchase of Short-term Securities 1,471lO Total Uses of Funds 14 633 lOOX 5.19 NEA's use of the funds for the period will be about P 14.6 billion, of which 801 represents loans to the RECs. By 1996, net contributions to the Foreign Exchange Fund will amount to P 980 million, or 71 of its cumulative financing requirement. NEA's remaining financing requirements are for its own - 34 - plant and equipment and the purchase of short-term securities. Combined, these represent about 13X of NEA's total use of funds for the period. 5.20 About 441 of NEA's investment program is expected to be financed from internal cash generation after debt service, and the remainder from: (i) external borrowings, (ii) foreign grants, and (iii) government equity con- tributions. The proposed loan represents about 22X of the total sources of funds. Government contributions, which represent only about 61 of total fi- nance, are intended to finance investments in remote, small island RECs. Ths V 606 million of grants from foreign sources includes the conversion to equity of NEA's US$ 22.2 million allocation from the Energy Sector Loan. The Govern- ment cannot make this equity infusions, nor can it make the conversions to equity implied by the financial restructuring of NEA, unless pending legis- lation to increase NEA's authorized capital to * 20 billion is passed. That bill has already been approved by the House of Representatives and is expected to be passed by the Senate before the end of its term in late February 1992. At negotiations, the Government and NEA provided an understanding that they will use their combi-ed best efforts to ensure that legislation to increase NEA's authorized capital to 0 20 billion is enacted by the end of 1992. S.21 NEA plans to raisa an unusually large part of its investment re- quirements from internal cash generation. First, NEA projects making sizeable provisions for doubtful loans and for foreign exchange losses, which do not involve cash outflows. Thus, even though NEA is projected to operate at break-even during 1991-96, it should generate significant amounts of cash from operations. Second, the financial restructuring will transfer most of NEA's external debt to the Government, thereby minimizing NEA's debt service re- quirements during the period. Finally, NEA is expected to collect on many of its existing outstanding loans, thus generating additional cash inflows against which it would have negligible outflows. Future Finance 5.22 Financial projections for 1991-2000, along with the detailed as- sumptions, are presented in Annexes 5.4 and 5.5. Key financial indicators and ratios for the period are summarized in Table 5.3. The projections are based on the following principal assumptions: (a) Starting with 1992, all new loans to the RECs will carry a 121 in- terest rate and an average maturity of 20 years. The lending rate should be increased to 131 in 1993 and to 141 in 1995 in order to keep consistent with the cost based onlending rate formula (para 5.15). Resched!'led loans will also carry an interest rate of 121 even though NEA will not be realizing loan origination expenses. NEA will not finance from its own account inherently non-viable RECs; instead, for a service fee, it will act as a channel for di- rect government financing of these and other projects of question- able viability that the Government chooses to implemer.t. (b) Beginning in 1992, NEA will charge fees for a number of its support services (para. 5.14). - 35 - (c) NEA will make appropriate provisions for doubtful accounts and for anticipated foreign exchange losses. Also, starting with 1992, NEA will contribute 35X of all interest revenues to the Foreign Ex- change Fund. The fund will be utilized to purchase foreign exchange cover from the Government at a cost assumed at 8X of NEA's out- standing foreign currency denominated borrowings (para. 5.13). (d) NEA will improve its collection rate from an initial assumed level of 652 in 1991 to 851 in 1995. These targets are attainable be- cause: (i) under the financial restructuring, many of NEA's shaki- est outstanding loans will he canceled, and (ii) the application of the investment guideline and strict credit evaluation criteria will largely eliminate investments in nonviable schemes. (e) The peso-U.S. dollar exchange rate is assumed to decline each year in relation to the differential between the local inflation rate and the international inflation rate. 5.23 NEA is projected to show a stable financial profile throughout the 1991-2000 period. NEA in expected to realize operating losses during 1991 and 1992, mainly because of the substantial loan loss provisions against its ex- isting portfolio of past loans that will be made during those years. In the following years, NEA's net income is projected to improve, from P 32 million in 1993 to a high of P 357 million in 1998. After 1998, net income stabiliz- es, partly because of the dampening effoct of increasing provisions for for- eign exchange losses on NEA's net income. Table 5.3: NEA's Projected Financial Performance (1991-2000) (in million Pesos) 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Interest Inco=e 301 461 642 965 1266 1590 1778 1917 2021 2100 Other Operating Revenue 48 138 202 206 194 234 270 275 295 317 Operating Expensos 337 443 585 763 999 1191 1258 1293 1435 1501 Operating Profit/(Losa) 34 174 273 418 470 644 800 910 891 925 Not Income/CLosa) (132) (11) 32 102 122 220 304 357 325 324 Operating Cash Flow 168 309 465 705 981 1282 1429 1527 1640 1707 Total Assets 7581 8808 9862 12218 14544 15904 16568 16837 16862 16794 Long-ter Debt 0 761 1722 3796 S746 6588 6878 6691 6016 6541 Retainod Earnings (2165) (2337) (2465) (2459) (2464) (2323) (2108) (1770) (1465) (1162) Contribution to Forex Fund 2 163 171 129 237 279 344 305 474 526 Foreign Exchange Fund Balanco 2 119 219 168 141 151 245 336 627 1032 Operating Ratio 82X 701 68S 70M 731 69S 651 61S 641 i5S Average Collection Rate 65S 701 75S 601 85S 852 865 8S1 851 651 Current Ratio 116.82 72.82 32.45 26.84 14.11 10.78 11.73 14.24 10.14 11.69 Debt/Squity Ratio 0:100 9:91 17:83 31:69 40:60 41:59 42:58 40:60 36:64 33:67 Debt Service Coverage "na" 40.72 9.26 5.99 4.22 3.20 3.30 3.71 2.87 3.10 Average Cost of Debt "De" 6.71 6.81 6.41 6.21 6.11 5.9S 5.71 5.71 5.61 Average Cost of Funds O0 Ox 12 1S 21 2S 21 2S 2S 2S Average Yield (Lending) 5.21 6.7X 7.71 9.31 10.11 1141 11.91 12.21 12.51 12.81 Return on Equity "neg" "nDg, 0.61 1.91 2.21 3.86 5.0S 5.61 4.91 4.71 Return on Assets "neg" neg" 0.5S 1.3S 1.31 2.1S 2.81 3.3S 3.01 3.01 - 36 - 5.24 NEA's cash flow should remain sound, because of: (i) the substan- tial amounts charged against income for "non cash items" (such as, foreign exchange and loan loss provisions); and (ii) the gradual increase in collec- tions. These factors enable NEA to increase operating cash flow sharply from about P 168 million in 1991 to almost P 1.7 billion in 2000. At the same time, debt will account for an increasing proportion of NEA's capital; debt service coverage is expected to drop to about 3 times by 2000. 5.25 To realize this healthy performance, NEA will have to manage its financial affairs prudently. The Financing Strategy provides for NEA to real- ize or exceed the following financial targets: (i) collection rates of 701 in 1992, 751 in 1993, 801 in 1994 and 851 in 1995 and thereafterW; (ii) a re- turn on total assets (after appropriate provisions for foreign exchange losses and doubtful accounts) of at least 0 through 1994 and exceeding 2.01 in 1995 and thereafter; (iii) a debt service coverage ratio exceeding 4.0 through 1996 and exceeding 3.0 thereafter; and (iv) a debt:equity ratio of less than 60:40. These targets are acceptable to the Bank7/. B. Rural Electric Cooperatives Past Financial Performance 5.26 Summary indicators of aggregate REC financial performance during 1985-89 are shown in Table 5.4 (page - 37 -). 5.27 Despite some improvements in system losses, load factor and collec- tion efficiency, the RECs overall financial condition deteriorated sharply during the 1988-89. Aggregate retained earnings and the RECs' net worth were negative throughout the period, and net losses were realized in each year except 1986 and 1988 (when the RECs as a group broke even). By 1989, the aggregate retained earnings deficit reached P 715 million, more than double the 1985 level. Because the RECs previously could not increase their tariffs as needed or otherwise increase their capital, their financial condition inev- itably worsened from year to year. Paid in capital from members amounted to only P 20.5 million in 1989, representing an increase of only i
Группа Всемирного банка · Staff Appraisal Report
Philippines - Rural Electrification Revitalization Project
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