Papua New Guinea - Oro Smallholder Oil Palm Development Project

Document of The World Bank FOR OMCIAL USE ONLY MICROFICHE COPY Report No. P- 5367-PNG Type: (PM) BOYER, PHI/ X76229 / / ASTAG MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$27 MILLION TO THE INDEPENDENT STATE OF PAPUA NEW GUINEA FOR AN ORO SMALLHOLDER OIL PALM DEVELOPMENT PROJECT MAY 7, 1992 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURECY EOMIVALENT (January 1992) Currency Unit - Kina (K) Ki - US$1.0493 US$1 - KO.953 FISCAL YEAR GOVERNMENT OF PAPUA NEW.GUINEA January 1 - December 31 WEIGHTS AND NEASURES 1 kilogram (kg) - 2.2 pounds 1 metric ton (t) - 2,205 pounds 1 kilometer (km) - 0.62 mile 1 hectare (ha) - 2.47 acres AAAMIAIONS CDC - Commonwealth Development Corporation DAL - Department of Agriculture and Livestock FAO/CP - Food and Agriculture Organization/Cooperative Program HOPPL Higaturu Oil Palms Pty Ltd HTPL - Higaturu Transport Pty Ltd IDA International Development Association NES - Nucleus Estate and Smallholder OPIC - Oil Palm Industry Corporation PNG - Papua New Guinea PNGOPRA - Papua New Guinea Oil Palm Research Association STABEX - Export Earnings Stabilization System FOR OFFICIAL USE ONLY PAPUA NEW GUINEA ORO SMALDOLDER OIL PAIM DEVELOPMENT PROJECT Loan and Project Summary Borrowe: The Independent State of Papua New Guinea Beneficiaries: The Oil Palm Industr) Corporation (OPIC), and the Papua New Guinea Oil Palm Research Association (PNGOPRA) Ameant: US$27 million equivalent TeAs: Repayable in 20 years, including 5 years of grace, at the Bank's standard variable rate. Terms to eficiaries: US$6.0 million would be passed to OPIC and US$0.6 million to PNGOPRA on a grant basis. Financing Plan: Lo.al Forei Total --------US$ million---------- IBRD 10.4 16.6 27.0 Farmers 3.4 0.0 3.4 Governement of Papua New Guinea 5.0 1.4 6.4 Total1 1.. Economic Rate of Return: 12% on 76% of total project costs Staff Anraisal Reort: No. 8955-PNG IBRD No. 22171R This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE INDEPENDENT STATE OF PAPUA NEW GUINEA FOR AN ORO SMALLHOLDER OIL AIX DEVELOPMENT PROJECT 1. The following memorandum and recommendation on a proposed loan to the Independent State of Papua New Guinea (PNG) for US$27 million equivalent is submitted for approval. The loan would have a term of 20 years, including 5 yearr' grace, at the Bank's standard variable interest rate, and would assist the Government of Papua New Guinea to increase PNG's agricultural production and exports and to raise rural incomes and employment. 2. A"iculture. Agriculture accounted for about 27 percent of GDP in 1991 and 71 percent of non-mineral exports (13 percent of total exports). With about 85 percent of the population, encompassing the poorest segment of society, depending on agriculture for their livelihood, and the limited potential for mining to provide employment opportunities, most people will remain dependent upon the sector well into the next century. During the 1980s, the sector grew by less than 2 percent per annum - below the population growth rate - giving rise for great concern. The single most important cause of agriculture's poor performance is the sharp decline in world market prices for export crops, which has not been fully offset by the impact of economic adjustments on the agricultural sector. Other key constraints are high costs of production and low physical productivity of smallholders. 3. Smallholders constitute 95 percent of the agricultural population and account for virtually all the domestically produced food, which adequately meets the needs of the majority of the population. Tree crops account for almost all agricultural exports, the most important being coffee, palm oil, cocoa, and coconut products, and will continue to be the primary source of cash incomes for most of the rural population. Continued slow growth in agriculture would seriously impact on the welfare and living standards of the vast majority of the population. Effective policy action and investments will, therefore, be required to revitalize the sector so that it is able to provide broad-based income and employment and sustained development. Among the tree crops, oil palm has grown most rapidly in recent years. Introduced only 20 years ago, production grew rapidly under good prices and PNG's favorable climate, estate yields being among the highest in the world. Price declines since the mid-1980s have seriously eroded the profitability of the industry. Nevertheless, for smallholders, although yields are lower than those of estates, oil palm offers much higher income and returns to labor than any other major crop in PNG. 4. Goverment Strategy. The Goverment recognizes that restoring profitability to the agriculture sector is an essential and pressing development priority. At the macro level, the Goverment responded promptly to the steep fall in the terms of trade, and the drop in export income caused by closure of the large Bougainville copper mine and isolation of the North Solomons province. Measures taken include a 10 percent devaluation in 1990, exempting rural wage payments from minimum wage requirements, waiving export taxes, and a moratorium on interest payments on existing agricultural loans. -2- Prices paid to tree crop smallholders have been maintained to some extent through the operation of the well managed commodity price stabilization funds, with the assistance of STABE-backed loans to the funds, and through an adjustment to the formula for sharing palm oil export income between smallholders and estates. For the future, cost recovery targets for Government investments are to be modified to ensure adequate returns to farmers, and achieve recovery at levels comparable to other countries. The Government has also taken measures to increase smallholder productivity by creating autonomous corporations to provide more effective research and extension services for the major tree crops. 5. Lessons Learned. The Bank's experience worldwide indicates that oil palm in a nucleus estate setting is well suited to smallholders, and if the fruit is marketed through the nucleus estate, provides an ideal opportunity for cost recovery. The Bank Group has supported three projects for oil palm development in PNG: the New Britain Smallholder Development Project in 1969 (Credits 137 and 175-PNG), the Popondetta Smallholder Oil Palm Development Project in 1976 (Ln. 1333-PNG), and the Nucleus Estate and Smallholder (Milne Bay) Project in 1985 (Ln. 2608-PNG). The three projects have had a marked development impact on the regions where they are located. An Impact Evaluation Report (No. 3070, 1980), and a Project Performance Audit Report (No. 7001, 1987) considered the first two projects successful. The ongoing Milne Bay Project has been successful in its physical oil palm and infrastructure development, but with the depressed international prices, the nucleus estate company is seeking a revision of its financial structure and debts. PIG smallholders have demonstrated their competence with oil palm and have received very good income and returns to labor while prices were high. Until recently credit recovery has been excellent, and oil palm smallholders continue to enjoy better financial returns than other tree crop farmers during the current time of low prices. 6. Ongoing agricultural sector work, including a review of all Bank- financed agricultural projects in PNG, provides additional major lessons: (a) that maintaining an appropriate macro-economic policy environment and incentives framework will be essential for the sustainable development of tree crops and other tradeables; (b) that institutional (including land tenure), infrastructure and human resource constraints are the three most critical impediments to sector development; and (c) that ensuring entrepreneurial and commercially oriented management would be fundamental to developing comercial production systems. These points are recognized in the Bank's strategy for the agriculture sector. The design of the project has benefitted from these lessons. 7. Bank Strategg and Rationale for Involvement. The Bank maintains a close macro-economic dialogue with the Goverment. The recent Country Zoonomic Report (PNG: Competitiveness, Growth and Structural Adjustment; Report No. 10319-PNG, March 31, 1992) notes that the recent structural adjustment program represents a substantial achievement given the magnitude of the problem. The report warns, however, that overcoming the pervasive lack of international competitiveness in the non-mining sectors will require concerted policy actions. The Bank is (a) assisting the Government in formulating measures to address sector constraints, through sector and economic work; -3- (b) providing funds to finance discrete investments in selected areas of agriculture or related to agriculture; and (c) supporting conditions for long term growth in the economy through balanced interventions in other sectors, particularly education, health and infrastructure. The proposed project fits well with this strategy. 8. Proect Obiectives. The projcet would increase PNG's agricultural production and exports, provide employment opportunities, generate incomes for poor farmers in Oro Province, and protect the habitat of the world's largest butterfly, which is an endangered species. 9. ProJect Descrintion. The proposed six-year project would be an expansion of the ongoing Popondetta oil palm NES scheme, and include the following components: (a) Smaltholder Oil Palm Development: (I) planting about 6,500 ha of oil palm in two areas of Oro Province, Popondetta and Kokoda; (ii) strengthening extension services; and (iii) building and maintaining agricultural roads (450 km) and social infrastructure; (b) ffg Rad I=MRvn: upgrading and maintaining sections of the national road from Popondetta to Kokoda (59 km); (c) Environmental Prtection: protecting an endangered butterfly species and its associated ecosystem; (d)Institutional Strengtbning: strengthening (1) the capacity of the Department of Agriculture and Livestock (DAL) for policy formulation and project preparation in the tree crop subsector; (ii) the management of the Oil Palm Industry Corporation (OPIC); and (iii) oil pals research; (e) Technical Assistance to OPIC; and (f) studies in the tree crop subsector. The total cost of the project is estimated at US$36.8 million equivalent with a foreign exchange component of US$18.0 million (49%). A breakdown of project costs and the financing plan are shown in Schedule A. Amounts and methods of procurement and disbursement are shown in Schedule B. A timetable of key project processing events and the status of Bank Group operations in Papua New Guinea are given in Schedules C and D, respectively. A map is also attached. The Staff Appraisal Report, No. 8955-PNG dated May 7, 1992, is being distributed separately. 10. Project Implementation. OPIC would be responsible for implementing smallholder oil pals development and overall project coordination, assisted by national and provincial project coordination committees. The Government would lend funds to smallholders through Higaturu Transport Pty Ltd (HTPL), the state-owned company which is responsible for the purchase and transport of smallholder crop, and which would administer smallholder loan accounts on behalf of the Government. The Departments of Environment and Conservation, and of Works would be responsible for environmental protection and infrastructure, respectively. Higaturu Oil Palms Pty Ltd (HOPPL), the nucleus estate company, would be responsible for producing planting materials, processing smallholder crop, and marketing oil palm products; and the Papua New Guinea Oil Pals Research Association (PNGOPRA) would be responsible for oil palm research. 11. Project Sustainability. From the experience in PNG, an assessment of the institutional needs of the tree crop sub-sector, and taking into account the effects of the current recession in agriculture, the following points have been incorporated in the design of the proposed project to ensure its sustainability: (a) continued strong extension for the new project participants and the Popondetta mature phase smallholders, to ensure that satisfactory yields are achieved and maintained; (b) provision of credit accompanied by grant support for the poor farmer target group; and (c) a :rengthening of institutional capacity for sub-sector planning and amagement. 12. Areed Actions. During negotiations, assurances were obtained from Government regarding: (1) the monitoring by DAL of the application of the smallholder oil palt pricing formula; (ii) the upgrading of HOPPL's effluent treatment facilities and solid waste disposal; and (iii) the staffing of key project management positions in OPIC and for butterfly conservation. Con3itioi of loan effectiveness would be: (1) the signature of the Financial Managemen Agreement between the Government and HTPL, satisfactory to the Bank, regarding smallbolder credit arrangements; (ii) the signature of the Subsidiary Agreement between the Government and OPIC, satisfadtory to the Bank, regarding OPIC's funding; (iii) the appointment of OPIC's General Secretary, Project Accountant and Field Project Manager; and (iv) the establishment of the National Oro Project Management Committee and the Provincial Oro Project Coordination Committee. Conditions of loan disbursement would be: (1) for the butterfly conservation component, that the Department of Environment and Conservation has employed a conservation project manager and a principal research officer; and (ii) for the research support component, (a) signature of the Subsidiary Agreement, satisfactory to the Bank, between Government and PNGOPRA; and (b) that HOPPL is current with payments of research ceases to PNGOPRA. 13. Environmentl Asgects. The proposed project is expected to have an overall positive environmental impact. Water pollution levels would be reduced in the densely populated area around Popondetta through the upgrading of the effluent treatment plant of the HOPPL palm oil factory. The endangered, Queen Alexandra Birdwing butterfly would be protected from possible extinction through the promotion of conservation areas. Tree cover would be provided through the establishment of oil palm over large, degraded grassland areas, formerly covered with forest, and would prevent burning, restore soil fertility and control erosion. The clearing of degraded bushland and secondary forest would be done using chain saws to minimize soil disturbance and prevent soil erosion. Finally, herbicides would be used in small quantities in the grassland areas by trained personnel and would have no significant adverse environmental effects. 14. Povert.Alleviation. The proposed project would directly benefit about 3,250 poor smallholder families. 15. Role of Women. Women are involved in oil palm cultivation as an integral part of the family unit, and are responsible for food crop production in Oro Province. Vomen in the project area generally have some control on how the family income is spent, and therefore would benefit from the increased family income brought by additional oil palm. After consultations with women in the project area during preparation, specific provisions were made under the project for: (i) ensuring that land would remain available and readily accessible for food production; (ii) improved rural health and education - 5 - facilities; and (iii) under the conservation program, staff and facilities to identify and develop further economic opportunities for women. 16. Proisct Benefits. The proposed project would benefit about 3,250 smallhol4er families. Economic benefits would be derived from increased agricultural production and exports of about 30,000 tons of palm oil and kernels. Environmental benefits are expected under the project from the protection of the world's largest b-itterfly species and its habitat, upgrading effluent treatment, and the rehabilitation of degraded grassland areas. The economic rate of return is estimated to be 12% on 76% of total project costs. 17. Loka. The proposed project has been designed to build on existing infrastructure and services and no special agricultural risks have been identified. Effluent treatment would use an established technology and would be regularly monitored by the Department of Environment and Conservation. The primary financial risk is that declines in international commodicy prices below projected levels would result in poor financial returns to smallholders, inhibiting harvesting, and to the estate compary, jeopardizing its ability to process the crop profitably. Related to the financial risk, is possible slippage of offsetting macro policy implementation. Such slippage is a significant possibility as regards wage policy and competitiveness, especially during the coming years of rapid development of the country's mineral wealth. However, PNG has assembled a solid track record of macroeconomic stability since Independence, reinforced by its adjustment performance since 1989. Other potential risks would be: (a) poor field maintenance, low yields and even abandonment by the non- traditional oil palm farmers. This risk would be minimized by selection of village farmers, technical assistance and supervision by an oil palm extension team supported under the project; (b) the farmers would continue to practice shifting cultivation on forest land identified as important for the conservation of the endangered species of butterfly and its associated ecosystem. This would be addressed by promoting permanent conservation areas that would remain under traditional land ownership, but be subject to a ban on forest clearance; and (c) project Implementation may suffer from political difficulties and civil unrest, which affect various regions of the country from time to time. This risk would be mitigated by having the provincial authorities represented on the project's Provincial Coordination Committee, and by the inclusion of a significant social infrastructure component, designed after consultations with the farmees during project preparation. 18. Reommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Lewis T. Preston President Attachments Washington, DC Nay 7, 1992 -6- Schedule A PAPUA NEW GUINEA 0R0 SMALLHOLDER OIL PA= DEVELOPMENT PROJECT Estimated Costs and Financing Plan Estimated Costs:A/ Laci Foreign Toal --------US$ million---------- Smallholder Development Oil Palm Development 4.7 1.4 6.1 Extension Services 2.1 1.2 3.3 Agricultural Roads 2.7 7.5 10.2 Social Infrastructure 0.7 0.7 1.4 Subtotal 10.2 10.8 21.0 Main Road Improvement 0.5 1.0 1.5 Institutional Strengthening 2.6 1.1 3.7 Environmental Protection 1.2 0.8 2.0 Technical Assistance 0.0 0.3 0.3 Studies 0.0 0.2 0.2 Total Base Costs 11. 2I ZLZ Physical Contingencies 0.5 1.0 1.5 Price Contingencies 3.8 2.3 6.1 Total Proiect Costs IlI 1LA 26.1 Interest During 0.0 0.5 0.5 Construction Total Financing ReaUred 1.A 11A MA Financing Pan IBRD 10.4 16.6 27.0 Farmers 3.4 0.0 3.4 Govt. of PNG 5.0 1.4 6.4 Intal l I" I A/ Including taxes and duties estimated at US$1.1 million equivalent. -7- Page 1 of 2 PAPUA NEW GUINEA 080 SMALLM0LDER OIL PALM DEVELOPMENT PROJECT Procurement Methods and Disbursements (US$ million) Procurement method /a Project Element LCB Other,& NA Total Cost Civil Works 16.4 16.4 (14.7) (14.7) Vehicles, Furniture 0.8 0.2 1.0 & Equipment (0.8) (0.2) (1.0) O&M (Vehicles, Equipment, 3.2 3.2 Buildings, and Roads) (1.8) (1.8) Fertilizers 0.7 0.3 1.0 (0.6) (G.3) (0.9) Planting Materials 2.2 2.2 (2.2) (2.2) Herbicides, Tools 1.1 1.1 (1.0) (1.0) Salaries of Incremental 5.5 5.5 Staff (3.9) (3.9) Operational Expenses 1.8 1.8 (1.1) (1.1) Technical Assistance 0.5 0.5 & Training (0.4) (0.4) Studies 0.2 0.2 (0.0) (0.0) Smallholder Own Labor 3.4 3.4 (0.0) (0.0) Interest During Construction Lg 0.5 0.5 (0.0) (0.0) Total 12 2.1 1.2 U..& (16.1) (5.9) (5.0) (27.0) /.A Costs are inclusive of contingencies, duties and taxes and figures in parentheses indicate amounts to be financed by the Bank. ja! "Other" includes prudent shopping, force account and direct contracting. fg 7apitalized interest on smallholder loans during the 3 year grace period. -8- * Schedule B Page 2 of 2 Categoyg of expenditures (US$ million) to be financed (1) Civil Works 13.2 100% of foreign expenditures 90% of local expenditures (2) Vehicles, furniture, 0.9 100% of foreign expenditures equipment, and related 90% of local expenditures transport services (3) Agricultural inputs 1.7 100% of expenditures and related transport services (4) Planting materials 2.0 100% of expenditures (5) Salaries and travel 4.1 90% of expenditures in FY expenses for incremental 1993 and FY94; 75% in FY95, staff FY96, and FY97; and 25% thereafter (6) Rental of houses for 0.4 100% of expenditures DAL and DEC incremental staff (7) Maintenance of roads, 1.6 90% of expenditures in FY vehicles and equipment 1993 and FY94; 75% in FY95, FY96, and FY97; and 25% thereafter (8) Consultants' services 0.3 100% of expenditures (9) Training 0.1 100% of expenditures (10) Unallocated 2.7 .TIntel 2.. Estimated IBRD Disbursements (US$ million) BankF2 122& 1221 122 122Z 122 M 222 2=9. Annal 0.3 3.2 5.4 5.1 5.6 4.5 2.5 0.4 Cumulative 0.3 3.5 8.9 14.0 19.6 24.1 26.6 27.0 9 Schedule C PAPUA NEW GUINEA OR SMALLHOLDER OIL PALM DEVEIDPMENT PROJECT Timetable of Key Processing Eentg (a) Time taken to prepare: 5 years (b) Project prepared by: FAO-CP/CDC (c) First IBRD mission: Febr,uary 1989 (d) Appraisal mission departure: March 1990 (e) Re-appraisal: February 1992 (f) Negotiations: April 1992 (g) Planned date of effectiveness: October 1992 (h) List of relevant PPAR/PCR: 1976 PPAR No. 1400 and 1980 Impact Evaluation Report No. 3070 for Cr. 137/175- PNG; 1987 Project Completion Report for Popondetta Smallholder Oil Palm Development Project (Ln. 1333-PNG) - 10 - Scedule-D STATUS OF BANK GROUP OPERATIONS IN PAPUA NEW GUINEA A. STATEMENT OF BANK LOANS AND IDA CREDITS /a (as of March 31, 1992) Amount (US$ million) Loan/ Bank IDA Credit Fiscal Original Principal Undis- nuaber Yeur Borrower Purpose (less cancellation) bursed Thirteen loans and thirteen credits fully 175.02 113.77 disbursed 2265-PNG 1983 PNG Road Improvement 31.00 3.05 2475-PNG 1985 PNG West Sepik Provincial 9.70 2.64 2608-PNG 1986 PNG Nucleus Estate Smallholder 27.60 1.79 2722-PNG 1986 PNG Yonki Hydroelectric 28.50 3.70 2742-PNG 1987 PNG Transport Improvement 42.82 20.22 3051-PNG 1989 PNG Land Nobilization 19.60 16.02 3154-PNG 1990 PNG Third Telecommunications 17.20 14.04 *3218-PNG 1990 PNG Structural Adjustment 50.00 2.00 3289-PNG 1991 PNG Special Interventions 30.00 21.13 3290-PNG 1991 PNG Public Sector Training 20.80 - 19.80 Total 452.24A 113.77 104.39 of which has been repaid 100.83 5.72 Total now held by Bank and IDA 351 108.05 Amount sold 15.39 of which repaid 15.39 Total undisburseP Undis- * B. STATEMENT OF IFC INVESTMENTS (as of March 31. 1992) None SThe status of the projects listed in Part A is described in a separate report on all Bank/IDA- financed projects in execation, which is updated twice yearly and circulated to the Executive Directors on April 30 and October 31. * SAL, SECAL or Program Loan. MebOlye it-e IIA NEW GVINEA 1~ ORO SMALLHOLDER OIL PALM PAPuA DEVELOPMENT PROJECT NEW SMAUt.O~R Ot tLM ØLOCKS: GUINEA fø^ NucteusE. RC.OL MtM ES1ATEs A OFMEs AN cOR»iEs D~unia SECTTON 1OE UPGRAD N4T9RNAT~NA ØCKNDAP#E d'o s 10 is 2o SOLOMON SEA * 00 BHE AMB ET buuru ESTATESEVENE rr n n Bmay MT. LAMINGTON 147'5' Md ew