Philippines - Transmission Grid Reinforcement Project

Document of The World Bank Report No. 14844-PH STAFF APPRAISAL REPORT PHILIPPINES TRANSMISSION GRID REINFORCEMENT PROJECT FEBRUARY 20, 1996 Infrastructure Operations Division Country Department I East Asia and Pacific Region  CURRENCY EQUIVALENTS (Fiscal Year January I to December 3 1) Currency Unit = Pesos (P) P I = USS0.04 US$1 = P25.0 WVEIGHTS AND MEASURES b!d Barrels per day (I barrel = 159 liters) BTU British Thermal Unit (0.253 kilo calories) GWh = Gigawatt hour (1,000,000 kwh) kg = Kilogram (2.205 pounds) km = Kilometer (0.62 miles) kW = Kilowatt (1,000 watts) kWh = Kilowatt-hour(860 kilo-calories) kV = Kilovolt (1,000 volts) kVA = Kilovolt-ampere(l,000 volt-amperes) MMIBOE = Million Barreis Oil Equivalent=0. 144 MMTOE Million Tons Oil Equivalent MVA = Megavolt-ampere (1,000 kVA) MW = Megawatt (1,000 kilowatts) TOE Tons of oil equivalent tcf = Trillion cubic feet Ton = Metric Ton (1.000 kilogramns) l'Wh = Tera watt hour (109 watt-hours) ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank BOT Build-Operate-Transfer BSBD Bank Standard Bidding Document CAS Country Assistance Strategy COA Cormmission on Audit DENR Department of Environment and Natural Resources DOE Department of Energy DOF Department of Finance DSM Demand Side Management EA Environmental Impact Assessment ECs Rural Electrification Cooperatives ECC Environmental Compliance Certificate EIIV Extra lligh Voltage (138 kV, 220 kV, 500 kV and 380 kV IIVDC) ENIB Environmental Management Board EOIS Efficiency and Operational Improvement Study ERB Energy Regulatory Board ESP Energy Sector Plan (1992) GCMCC Government Corporations Monitoring and Coordinating Committee GDP Gross Domestic Product GOP Government of Philippines HVDC Iligh Voltage Direct Current IMF International Monetary Fund IOD Investor Owned Distributors IPP Independent Power Producer JEXI.M Export and Import Bank of Japan LRNMC Long-run marginal cost NIERALCO Manila Electric Power Company NEA National Electrification Administration NEDA National Economic and Development Authority NLDC National Load Dispatch Center NPC National Power Corporation OEA Office of Energy Affairs Ol'SF Oil Price Stabilization Fund PD Project Director PD)P95 Power Development Plan 1995 PREO Privatization and Restructuring Executive Office PNOC Philippines National Oil Company PNIO Project Management Office PPA Power Purchase Agreement TA Technical Assistance TOR Terms of Reference TRANSCO Proposed name for NPC's Transmission Company USAID United States Agency for Intemational Development  i PHILIPPINES Transmission Grid Reinforcement Project Loan and Project Summary Borrower: National Power Corporation (NPC) Guarantor: Republic of the Philippines Implementing Agency: National Power Corporation Poverty: Not applicable Amount: US$100 million equivalent US$150 million (Currency Pool Loan) (Single Currency Loan) Terms: Currency Pool Loan: Standard variable loan payable in 20 years, including five years of grace at the Bank's standard variable interest rate; Single Currency Loan: Floating Rate single currency loan payable in 20 years including five years of grace at LIBOR base rate plus LIBOR total spread; Commitment Charge: Standard Financing Plan: See Para 4.6 Economic Rate of Return: 21% Map: IBRD No. 26879 Project ID #: 4571   PHILIPPINES Transmission Grid Reinforcement Loan Table of Contents Pane No. Loan and Project Summary ....................i 1. The Energy Sector and the Power Sub Sector .1 The Energy Sector ..1 The Power Sub Sector ..2 The Future Power Sector Framework .3 Need for Transitional Arrangements .3 Bank Support of the Sector ..5 Previous Bank Projects ..6 Rationale for Bank Involvement ..6 2. The Power Development Program .8 Power Market .8 Power Demand Forecast .8 NPC's Power Development Plan ..9 Power Pricg. .10 3. The Borrower .12 Overview ..12 Organization and Management ..12 Corporate and Operating Groups ..13 Technical Groups ..14 NPC Reform and Pnvatization ..15 TRANSCO . .15 NPC Holding Company ..16 4. The Project .17 Objectives .17 Project Description .17 Description of Project Components .17 Cost Estates. .18 Financing Plan ..18 Project Implementation .19 Monitoring and Supervision .19 Procurement.. 19 Disbursements .20 Environment and Resettlement .21  iii 5. Finance ..................... 22 NPC F inancial Performance ..................... 22 Tariffs ..................... 24 NPC's Financing Plan ..................... 25 Future Financing ..................... 26 Financial Sensitivity Analysis ..................... 29 Financial Rate of Return ..................... 29 TRANSCO Finances ..................... 29 Accounting and Audit ..................... 30 6. Project Justification ..................... 31 Economic Analysis ..................... 31 Project Risks ..................... 32 7. Agreements Reached ..................... 33 Agreements with the Government ..................... 33 Agreements with the Borrower ..................... 34 Condition for Loan Effectiveness ............................................. 35 ANNEXES Annex 1 Philippines Energy Production and Consumption 1984-2000 .34 Annex 2 Philippines Power Demand and PDP95 Generation Capacity Expansion Plan .35 For Interconnected Luzon Visayas EHV Transmission Grid .36 Annex 3 Summary of (i) Existing NPC Transmission and Subtransmission Facilities .37 (ii) Luzon Visayas Transmission Investment Projects 1994-2000 .38 Annex 4 NPC Restructuring and Privatization Program .39 Annex 5 Project Description and Implementation Arrangements .42 Annex 6 Covenant between PMO and NPC Engineering Division 50 Annex 7 Bank Supervision Plan ............................................. . 52 Annex 8 Project Costs (six tables) .53 Annex 9 Disbursement Schedule and Performance Indicators .59 Annex 10 Proforma Financial Statements for TRANSCO (4 tables) .............................................. 60 Annex 11 NPC's Financial Projections .............................................. 64 Annex 12 Economic Rate of Return .............................................. 68 Annex 13 Recommended Program to Enhance Load Dispatch Operations ........................................... 72 Annex 14 Environment, Land Acquisition and Resettlement .............................................. 73 Annex 15 Reallocation and Resettlement Policies & Guidelines .............................................. 78 Annex 16 Institutional Support to the Energy Regulatory Board (ERB) .............................................. 81 Annex 17 Summary of NPC Technical Assistance Components .............................................. 84 Annex 18 Documents in Project File .............................................. 89  iv CHARTS 1 - NPC Organization Structure, December 1994 ............. .. .................. 90 2 - Phases of NPC Restructuring .................................. 91 3 - Proposed NPC Structure ................................. 92 4 - Project Management Office Organization ............. .................... 93 5 - TGRP Project Management Arrangements ................................. 94 MAP: IBRD No. 26879 .............................. 95 This report is based on the findings of an appraisal mission consisting of John Irving (Senior Power Engineer), Jarnil Sopher (Principal Financial Analyst), Enrique Crousillat (Energy Economist), Sumila Gulyani (Resettlement Specialist), Jack Fritz (Enviromnental Engineer) who visited the Philippines in June 1995. Peer Reviewers were Messrs. Rafael Moscote, Arun Sanghvi, Anil Malhotra and Alfonso Mejia. The project was cleared by Mr. Callisto E. Madavo, Director EAI, and Mr. J. Shivakumar, Chief EAIIN. Contributions were made to the preparation of the report by Darayes Mehta and Martin Edmonds with overall coordination of its production by Ms Kajal Jagatsing.   1. THE ENERGY SECTOR AND THE POWER SUBSECTOR The Energy Sector expected to provide an increasing share of generation, rising from 29% in 1994 to about 46% by 2000. 1.1 Country Setting. The Philippine archipelago comprises over 7,000 islands with a population of 1.4 Resource Endowment. Unlike some of its about 66 million. The largest island is Luzon, about ASEAN neighbors, the Philippines is not well 104,000 sq. km., with a population of about 38 endowed with indigenous energy resources. New million; Mindanao is next with 94,000 sq. km. and 14 resources being developed (in addition to coal and million people. The only other island with an hydropower) are geothermal energy and oil, which appreciable population density is Cebu in the central came into production in 1978 and 1979, respectively. Visayas region. Philippine electricity networks are Geothermal reserves are not yet fully evaluated, but substantial, and there is scope for optimization by could exceed 6,000 MW; 900 MW are already interconnection; however the terrain is rugged with produced and another 800 MW are expected from ribbons of development along island perimeters. Most projects under preparation or construction. Proven oil of the other islands are small, so that efficiencies of reserves amount to only 4 million tons and have been scale are difficult to realize and electricity supplies are declining since 1983. The recent discovery of natural generally expensive. The nine largest islands, with gas offshore of Palawan is substantial, and could 95% of the population, have been until recently served provide up to 4 trillion cubic feet; further exploration by seven separate grids (five in the Visayas alone). is needed to confirm the size of the field and determine While Luzon and the eastern Visayas could be its economic viability. Potential coal resources are interconnected by 1998, interconnection of the western estimated at about 1,500 million tons, but most of this Visayas and Mindanao is not yet economically coal is low grade and expensive to mine. Hydro justifiable. resources are quite substantial, with a theoretical power potential in excess of 10,000 MW, much of 1.2 Energy Consumption. Commercial energy which is in Luzon. In general, the better sites are consumption in the Philippines increased from 93.7 distant from roads and transmission lines, and their million barrels of oil equivalent (MMBOE) in 1984 to development has been hampered by intermittent 141.7 MMBOE in 1994 (Annex 1), a faster rate guerrilla activities and the need to formulate (4.4% p.a.) than overall economic growth (2.9% p.a.). environmental policies; no major hydro project has This was due to substantial increases in been completed in the last decade. industrialization and a reduced share of agriculture in GDP. In 1994 the industrial sector accounted for 51% 1.5 Energy Sector Institutions. Until 1986, all of energy demand, followed by transportation, with primary energy sector institutions fell within the ambit 32%. Most of the energy consumed (75%) was and is of the Ministry of Energy. The Philippine National derived from imported oil, which contributes to large Oil Company (PNOC) served the retail market for economic shocks when international oil prices increase coal and oil-based products in addition to its primary dramatically. activity as a developer and converter of primary energy resources. The National Power Corporation 1.3 About 35% of energy produced in 1994 was (NPC) was the monopoly generator and supplier of electricity, and this figure is expected to rise to 43% electricity at the wholesale level. Its customers by 2000. A serious power crisis over 1988-93 caused included some 85 industrial consumers, together with substantial power outages and was partially 15 investor owned distributors (IODs) including the responsible for low economic growth during this Manila Electric Company (MERALCO), and about period. With the crisis over, annual GDP growth is 120 member-owned rural electric cooperatives (RECs) expected to increase from 4.5% over 1990-95 to 5.5% providing service to consumers at the retail level. The over 1995-2000. As a consequence, during the Ministry of Energy was neither directly nor indirectly remainder of the decade, yearly energy consumption is involved with the distribution utilities. The Energy expected to rise by 8.1%, with indigenous sources Regulatory Board (ERB), an agency of the Office of the President, ensured IOD adherence to government  -2 - policies through its authority to regulate their rates. The Power Subsector The National Electrification Administration (NEA), then an agency of the Ministry of Human Settlements, 1.8 Privatization of Generation. A serious power enforced government policy on the RECs by setting crisis struck the Philippines in 1988; the Government their rates and serving as the conduit for concessional responded by eliminating NPC's monopoly on power borrowings. generation and transmission and devolving responsibility for most new power generation to the 1.6 In 1986 the Government disbanded the private sector. Over 1988-91 the Government created Ministry of Energy; its research functions were an enabling environment for independent power assigned to the newly created Office of Energy Affairs producers (IPPs) by rewriting exclusionary laws, (OEA), while PNOC and NPC both were assigned to articulating new policies, simplifying clearance the Office of the President. To improve coordination processes, and restructuring the energy department among Government energy agencies, the Government and the sector regulatory framework. By mid-1995, created the Energy Coordinating Council (ECC) in the private sector was actively developing 35 1989; the Executive Secretary chaired the Council; generation projects for some 4,000 MW of new OEA served as its secretariat, and PNOC, NPC and capacity; the largest was the 1,000 MW Sual Power NEA were its permanent members. Since the ECC Plant in northern Luzon. With IPPs sponsoring most had no legal authority to make or enforce decisions, new projects, the structure of the electricity subsector the Government created the Department of Energy will have changed from near 100% public in 1991 to (DOE) in 1992, and placed PNOC, NPC and NEA nearly 90% private in 1998. Consequently, the under its control. The Secretary of Energy became the Philippines will have progressed further than any other ex-officio Chairman of PNOC and NPC; he was also developing country in devolving responsibility for legally empowered to serve as the Chairman of NEA electricity generation to the private sector. unless the President chose to appoint someone else - as he did over 1992-95. The DOE Secretary is an ex- 1.9 Power Sector Reforms. In 1994, to assist the officio member of the National Economic and Government in formulating its power sector strategy, Development Authority (NEDA). OEA was folded the Bank conducted a study of the power sector, into DOE and most of OEA's staff were transferred entitled 'Structural Framework for the Power Sector" into the Department's key positions. A five-member (Report No. 13313-PH, November 30, 1994). The Council of Advisers on Energy Affairs from the study found the organizational framework of the sector private sector was also established to advise the sound. It identified institutional weaknesses, President on energy programs and private sector particularly within DOE and ERB and recommended initiatives. Under the new arrangement, ERB that they be remedied through capacity building, continues to report to the Office of the President and training, and realignment of responsibilities. Power its regulatory scope has been extended to cover NPC sector reform placed a heavy burden on ERB's and the RECs, in addition to the investor-owned regulatory capabilities, which needed to be utilities. strengthened to cope with: (a) the rapid increase in IPP involvement; (b) inter-agency shifts in organizational 1.7 DOE is organized into four bureaus: (a) the responsibilities, and (c) freer interaction between Energy Utilization Management Bureau, which suppliers and consolidated distributors. The study monitors and assists with demand management, recommended forming a separate government-owned conservation, the efficient use of energy resources and company to own and manage and operate the development of non-conventional energy systems; (b) transmission system. The study also recommended the Energy Resources Bureau, which formulates that NPC and the distribution companies be policies and helps develop energy resources; (c) the restructured and responsible agencies strengthened to Energy Industry Administration Bureau, which creates capture the benefits expected from privatization; the regulatory, financial and fiscal policies related to realization of these benefits depends on the energy supply entities and approves non-price development of competitive markets for electricity at regulatory matters; and (d) the Energy Planning and both the supply and, especially, distribution ends of Monitoring Bureau, which develops and monitors the industry. The Government is in broad agreement energy plans and demand forecasts and incorporates with the Bank's recommendations; a summary of the national environmental goals into energy programs.  - 3 - Government's planned phases for restructuring and (d) To facilitate distribution subsector reform, privatization is given in Figure 1. 1 overpage. NEA would be encouraged to lend to the IODs with at least the same priority it has traditionally The Future Power Sector Framework accorded RECs. NEA would be empowered to provide guidelines and assist the distributors 1.10 The Government's framework for the future themselves to formulate the consolidation structure of the power sector is set out in the draft framework. Omnibus Electric Power Industry Code, which is expected to be submitted to the Congress in early (e) ERB would remain a quasi-judicial agency for 1996. It includes arrangements for a transitional regulating mainly the tariffs of all companies that period, and aims to rationalize roles of the agencies qualify as electric utilities. The approach to participating in the sector. Its main features are: regulation would rely primarily on market forces and thereby limit the interventions of the (a) DOE will serve as the policy maker for the regulator. ERB's span of jurisdiction would be sector. It would formulate rules within which the altered to include the power to award franchises, regulator would adjudicate, accredit IPP thereby bringing franchising and certification proposals, and maintain a comprehensive, up-to- activities under the same organization. date inventory of all power developments nationwide. 1. 11 The aforementioned roles of the sector agencies, underpinned by the passage of the Omnibus (b) For as long as is needed to privatize its law, are expected to continue improving the activities, NPC would limit its role to being an environment for private development of power sector owner and, to a lesser degree, operator of its facilities. The Government introduced a draft generating facilities. It would retain lead Omnibus Bill in the Philippines Congress in early responsibility for developing hydropower projects, 1995; that bill lapsed when the congressional session and would be one of a number of suppliers of ended in June 1995. Since then, several variations of thermal electricity, all competing on an equal the bill have been introduced in Congress. The commercial footing. In the near term, until DOE Government has indicated that it would either decide to develops the needed capabilities, NPC would sponsor one of those bills or introduce a bill of its own retain responsibility for power sector planning by April 1996. At negotiations agreement was reached under contract to the Energy Department. Also in that (a) the Government will conduct an annual review the near term, until the distribution subsector has of the progress achieved in carrying out its program for been reformed to create distributors in which restructuring and privatizing the power sector, suppliers have confidence, NPC would continue exchange views with the Bank with respect to its future as the wholesaler of electricitv and manage and implementation and take all measures necessary for operate the subtransmission networks. such implementation; and (b) not later than July 30, 1996, the Government will present to Congress for (c) A new national transmission company consideration a proposed Omnibus Power Industry (TRANSCO) would be established to serve as Code, which proposed legislation it shall certify as an owner, developer, and operator of extra high administration bill. The Government further indicated voltage (EHV) networks, providing all suppliers that (a) it expected the Omnibus Electric Power with non-discnrminatory access to the EHV Industry Code would be enacted by the end of 1996, system. To ensure adequate and timely service, and (b) by June 1996, it would provide the Bank with a TRANSCO would submit its investment program report detailing progress with respect to NPC annually to ERB for approval. To ensure that its privatization, distribution subsector reform, and charges are fair, its cost-based rates would be rationalization of load dispatch. subject to regulation. Within TRANSCO, a national dispatch entity will be created, with the Need for Transitional Arrangements rules for dispatch initially made by a technical committee consisting of representatives of parties 1.12 The recommended framework for the power to existing power sales contracts, with advice from DOE and ERB.  FIGURE 1.1 SUMMARY OF DOE PHASES OF RESTRUCTURING AND PRIVATIZATION Phase 1: Strengthen and restructure industry. Phase 2: Evaluate results, implementfurther restructuring and Phase 3: Move into final structures anid competitive privatize. environments. Time Frame: 1994-1998 (4-5 years) Time Frame: 1998-1999 (2 years) Time Frame: 1999-2004 (4-5 ycars) Objectives: Strengthen all sectors and participants in the Objectives: Evaluate results and industry performance; set final Objectives: Achieve full restructuring and decentralized industry; restructure generation and transmission; establish restructuring goals, adopt policies that accelerate participants' planning; establish fully coordination and arrangeien1cts and prepare induistry for increased growth into new structure and responsibilities; privatize effective competition in gcneration, retail sales and competition, privatization and decentralization. generation. resource planninig; monitor competitiveness and industry perfomiance. Major Activities: Major Activities: Major Activities: l1 Unbundle generation horizontally and vertically Ol Conduct key evaliation (e.g., competitive conditions; success E Implement programs determined by assessing I I Unhundle transmissioni of utility IRI', coordinationi arrangeintiits aiid regulatory development of the industry under dhe resticturinig anud [1 Unbundle hydroelectric to l-lydro Authority programs privatization initiatives El Decentralize planning responsibility E Make structural goal adjustments; re-visit workability of E Extend practices such as retail wheeling and retail 0 Establish operations coordination arrangements "English" model in Luzon; improve coordination arrangements sales competition n Rationalize pricing El Privatize Generation: sell Mindanao and Visayas subsidiaries; El Adopt incentive regulatory schemes proven to be 0 Strengthen distribution sector select and implement final Luzon generation privatization plan effective El Promote private participation in generation El Expand retail wheeling E Monitor competitiveness, market behavior, and the |l Strengthen regulatory and policy agencies 0 Implement policies to accelerate utilities' adoption of new potential for market dominance E0 Streamline NPC through additional subsidiaries; rationalize structure staffing levels Major Results: Major Results: Major Results: El NPC power supply subsidiaries in Mindanao, Visayas and El Adjustments to structural and ownership goals E Full finctioning of all utilities inder decentralized Luzon 0 Adjustments to regulatory oversight and policy programs decision making |0 NPC national transmission subsidiary responsible for El Improved iRI' and coordinated utility planning 0 Competitive generation markets transmission, dispatch and operations coordination of planning E Enhanced operations coordination; full economic dispatch on 0 Competitive retail sales markets from national perspective all grids E Widely practiced, state of the art IRP E RP Hydro Development Authority U Privatized generation E Innovative regulatory incentive programs D Integrated resource planning by all utilities El Increased competition: generation and retail sales 0 Efficient inter- and intra-grid coordinated operations E Coordination arrangements to achieve efficient operations and 0 Improvements in structure and performance of distribution planning sector El Transparent, unbundled prices E0 Increased private participation in generation 0 Regulatory programs that improve distribution performance wid rationalize structure E Improved regulatory and policy capabilities El Streamline NPC  - 5 - sector cannot be- fully implemented until NPC is sector study recommended the formation of a separate restructured and the distribution utilities combined to government-owned company to own and thereafter form stronger units. As shown in Annex 4, NPC has operate and maintain the transmission system; an already been reorganized into profit centers (Chart 2, important first step toward this objective would be for page 91), and has already taken substantial steps NPC to organize its transmission activity into an toward: (a) giving autonomy to transmission autonomous profit center. Eventually, this would be operations; (b) separating the costs of generation from followed by its incorporation as an NPC subsidiary, transmission; and (c) decentralizing the structure of its which would then be spun off after passage of the generation activities. These transitional arrangements, Omnibus law. While providing finance to strengthen rooted in decisions of the NPC Board rather than the transmission system, the project supports the steps legislation, are satisfactory until the Omnibus Code is leading to an independent transmission company. passed. However, they do not yet accord transmission activity the independence necessary to operate 1.15 Load Dispatch and Power Wheeling. To separately from the rest of NPC. sustain the transmission operation, wheeling charges need to be levied to cover the costs of equipment, 1.13 For the time being, NPC has effectively operation and maintenance, interest and taxes, and assumed a monopsony role as purchaser from IPPs and yield a surplus sufficient to enable self-financing of a a monopoly role as reseller of electricity to distributors. reasonable proportion of new investments. Further, the These roles have been instrumental to Government- operation must be supported by a modem, private sector collaboration in addressing the recent transparently operated generation dispatch facility. power crisis. Ultimately, the IPPs should be able to The Bank has supported considerable effort by NPC in deal directly with the distributors, making NPC subject this area under previous operations, and under the to market forces as both purchaser and seller. In their Power Transmission and Rehabilitation Project (Loan current fragmented state, distributors other than 3626-PH), has financed consultants to assist NPC in MERALCO have insufficient levels of demand to completing a master plan for transmission expansion, attract the attention of the IPPs or absorb the market and studies of economic dispatch and wheeling risk under PPAs. The recommended structural charges. The proposed project would strengthen the framework to consolidate distributors into viable role of the National Load Dispatch Center (NLDC) to commercial entities cannot work unless the distribution manage generation dispatch operations and facilitate subsector has been thoroughly reformed. Until then, a the application of wheeling charges. Further, a parastatal supplier will need to retain the ability to buy Japanese Policy and Human Resource Development electricity for resale to the unconsolidated distributors, (PHRD) grant (US$550,000) has been secured to and the backbone transmission company will need to finance studies and other technical assistance aimed at operate and maintain the subtransmission networks strengthening ERB's capacity to evaluate NPC's tariff while the distributors need to minimize their losses and applications as part of its mandate to regulate the improve their reliability. Under the Rural sector (Annex 16). Electrification Revitalization Project (Loan 3439-PH) the Bank is financing a consultant's study that would 1.16 NPC Institutional Capacitv. During the last guide distribution subsector reform. The Bank expects few years, NPC has suffered from considerable to support that study's recommendation by financing organizational problems. With Bank assistance, a additional subtransmission development in support of Japanese PHRD grant was secured in 1992 to develop the proposed Small Cities Electrification Project. approaches to strengthen NPC's efficiency through the Efficiency and Organizational Improvement Study Bank Support of the Sector (para 3.12). After NPC's Board decided in 1994 to divest and corporatize its various operations, the TA 1.14 Independent Transmission. To provide the was redesigned and currently supports NPC's IPPs with unbiased access to an efficient transmission preparation for privatization. system, the EHV transmission network must be strengthened and extended to serve the system's 1.17 Distribution Utilities. The largest of the IODs, growing load. More importantly, management of the accounting in 1994 for about 3,000 MW of demand transmission system should be independent of the and 60% of nationwide consumption, is MERALCO. interests of any supplier or distributor. The Bank's As a condition of effectiveness under the Leyte-Luzon  - 6 - project (Loan No. 3746-PH), in November 1994, NPC Previous Bank Projects signed a ten-year supply contract with MERALCO agreeing to the amnount of power to be purchased each 1.20 The Bank had only limited involvement with year and the conditions of supply (para 2.5). This NPC over 1978-88. Since then, the Bank has made agreement was required because MERALCO is five loans to NPC, with the most recent (Loans 2700- expected to be the other significant purchaser of power PH and 3746-PH) to finance the Leyte Geothermal from IPPs. To complement the reforms in generation, project, receiving Board approval in October 1993 and the Bank's sector study recommended that the RECs June 1994. Two of the earlier loans-the Bacon and IODs be consolidated into some 15 medium sized Manito Geothernal Project (Loan 2969-1-PH) and the (based on current demand, between 100 and 500 MW) Energy Sector (Loan 3163-PH}-closed in December distributors. This reform, which would need to focus 1995. Further, US$55 million was recently canceled on technical issues that involve different borrowers, from the Power Transmission and Rehabilitation would be addressed in a subsequent operation. Project (Loan 3626-PH) to reduce the scope of work in response to changes in IPP development projects. 1.18 Environmental Management. The Each of the earlier three loans has encountered Government's policy is to achieve sustainable implementation delays, largely due to NPC's development by enforcing environmental guidelines and preoccupation with its chronic generation shortfall requiring that each project obtain an environmental problems. NPC and the Bank have identified other clearance certificate based on a satisfactory important reasons for these delays, and addressed them environmental impact assessment. The technical in the ongoing Leyte Geothermal Project. The lessons capabilities and equipment of the Environmental learned are incorporated in specific corrective Management Board have been upgraded under the measures including: (a) appointment of project Energy Sector Project (Loan No. 3165-PH) through directors under a new vice presidency; a Project training and the acquisition of modem laboratory and Management Office was established in October 1994 monitoring equipment. Over the last few years, the to manage the responsible design groups in the Bank has sought to upgrade NPC's capacity to develop Engineering Department, as well as outside and implement projects that are environmentally and consultants; (b) strengthening NPC's procedures to socially acceptable, an important strategic objective of deal with environment and resettlement issues; (c) Bank support for the Philippines power sector. training in the implementation of Bank procurement procedures, and (d) standardizing bid documents to 1.19 Demand Side Mana_ement. In a further ensure a uniform approach in evaluating and awarding response to the power crisis, the Government initiated contracts. The proposed project will strengthen NPC's several programs' to reduce power demand, including: capabilities in project preparation and execution, and (a) introducing demand charges in the bulk tariff; (b) making better use of modem technology and project encouraging the use of energy-efficient lighting in the management software. commercial and industrial sectors; (c) replacing inefficient street lights; (d) requiring energy audits of Rationale for Bank Involvement large industrial consumers; (e) setting efficiency standards for electrical appliances; (f) launching 1.21 Although of Bank financing has been modest energy conservation campaigns particularly for lighting relative to NPC's overall needs in recent years, the and air conditioning; and (g) creating within ERB a Bank's broad involvement in the Philippine power working group to develop a regulatory framework for sector has enabled it to provide considerable strategic demand side management. This capacity building guidance to the sector in general and to NPC in effort is supported by a grant from the Bank's particular. The 1992 Energy Sector Plan (ESP), Institutional Development Fund. formulated by the Government in consultation with the Bank, outlines a series of actions for reforming the energy sector, while the Bank's Power Sector Study provides a strategic framework for restructuring and privatizing the sector. The Government has moved a long way toward laying the foundations for reform and DOE circular November 6,1995, directb d electric uties to submit has succeeded in adding a large number of IPPs to the DSM plans to ERB every two years begining January 1,1996. grid. It has now begun to concentrate on privatizing  - 7 - NPC and separating transmission from generation 1.23 The policies and programs pursued by the activities. These latter actions represent the most Government are in accordance with Bank policies and difficult aspects of the ESP. guidelines for power sector reform and the reform program is progressing satisfactorily. The project is 1.22 The Bank's continued financial involvement consistent with the Country Assistance Strategy (CAS, and technical assistance would help the Government Report No. P-5967-PH dated January 6, 1994) and implement critical projects and the remaining stages of with the CAS presented to the Board in conjunction power sector restructuring. Indeed, bearing in mind the with the proposed project. It will support the significant penalty charges that NPC is liable to pay to Government's efforts to move from the current the owners of the Sual IPP (estimated at US$0.5 economic recovery into a period of sustained growth. million/day for capacity not used), successful As discussed in the CAS, it is proposed that the Bank's implementation of the project is of vital importance to support to the Philippines should address long-term NPC. The Bank's presence in the power sector would development issues designed to enhance competition also help ensure satisfactory and timely completion of and upgrade infrastructure. The relevant priority areas the reform process that the Government has for Bank assistance include strengthening undertaken. The proposed project specifically supports infrastructure to ensure that the full benefits of new reorganization of NPC's transmission activities generation capacity reach the public. This requires including (a) setting a timetable for establishing an focusing the Bank's supervision effort on measures autonomous profit center for transmission leading to its being taken to improve private business environment eventual corporatization and privatization; and (b) and in strengthening policy/project providing a framework of procedures-a Grid implementation-all of which are embodied in the Code-for implementing optimal load dispatching. proposed project.  2. THE POWER DEVELOPMENT PROGRAM Power Market recent ADB financed TA'. This study involved: (a) a review of NPC current load forecasting procedures; (b) 2.1 NPC's power systems in the Philippines are reviewing forecasting interfaces between NPC and organized into-and managed as-three major regions: other organizations; (c) developing recommendations (a) Luzon in the north, the largest power system where for improving the forecasting methodology, and (d) the capital Manila is located, includes over 4,880 km training NPC staff. The study also developed of transmission lines and about 12,000 MVA of integrated resource planning procedures incorporating installed substation capacity; (b) Visayas in the center Demand Side Management (DSM) techniques, which including the main islands of Leyte, Cebu, Panay and are estimated to achieve a reduction of about 750 MW Negros has about 2,700 km of transmission lines and of growth in total demand by 2000 provided new 2,700 MVA substation capacity, and (c) Mindanao in policies are implemented by the Government. the south has about 4,220 km transmission lines and 2,750 MVA substation capacity. The Luzon and the 2.4 The basis for forecasting used in NPC's Visayas regions account for 85% of power sales and successive Power Development Plans (the most recent will be interconnected under the Leyte Geothermal being PDP95), utilizes the National Economic and projects by 1998. The Mindanao interconnection, Development Authority's (NEDA) targets for currently in planning, is expected to be commissioned economic growth. These targets are generally shortly thereafter. optimistic and correspond to a high growth scenanro. NEDA's most recent GDP growth rates average about Power Demand Forecast 6% a year through 2000. The Bank and the ADB have used a more modest forecast for the medium term 2.2 Past Trends. Sales of power in the Philippines based on a GDP growth rising from 4.2% in 1994 to grew at an annual rate of 7% during the 1970s, but fell 5.5% a year thereafter. NPC's regional forecasts, off considerably during the 1980s. Growth in demand based on a demand elasticity between 1.2 and 1.5, generally follows GDP variations, reflecting greater show increases in demand of about 9% annually. industrialization, higher living standards, and an increasing number of households connected to Table 2.2 electricity. During the 1988-93 power crisis, annual NPC MEDIUM TERM LOAD GROWTH electricity sales held constant for three years, then grew Generation Sales Peak by 15% after economic recovery commenced in 1993. | Year GeWetion Sales e Peak NPC's actual growth over 1985-94 in 1995 33518 31067 J 8.3% 5359 generation-about 7% of which was lost in - 1996 36812 34149 9.9% 5884 1997 40656 37428 9.6% 6497 transmission and energy consumed by generators-s 1998 43373 39783 6.3% 6911 summarized in Table 2.1. 1999 46618 42777 7.5% 7431 Table 2.1 2.5 To provide some degree of protection in forecasting its sales NPC has entered into sales Generation Sales Peak agreements with its customers; these establish Year 18757 17140 4% 3037 minimum levels of contracted energy and demand. 1986 19263 17645 3% 3203 Under these arrangements, MERALCO and other large 1987 20995 19337 10% 3432 customers can arrange to take supply from IPPs for all 1988 22944 21180 10% 3684 r 1989 24087 22244 5% 3909 requirements over and above the minimum levels 1990 24799 22915 3% 3974 contracted with NPC. The ten-year contract with 1991 25437 23598 3% 4081 MERALCO, which also stipulates the conditions of 1992 25697 23958 2% 4295 1993 26614 24897 4% 4676 supply and the mutual obligations of both parties, 1994 30874 28687 15% 4858 2.3 Forecast Demand. NPC's load forecasting Long-Tern Power System Planning Study, Prepared for DOE and capability has been strengthened considerably under a ADB by SRC International Pty, Australia February 1995  - 9 - allows for an offtake of 2,971 MW in 1995 rising to 2.8 The viability of the PDP95 generation 3,605 MW by 2005. expansion plan will depend on the timely completion of a high capacity EHV grid interconnecting over 5,000 NPC's Power Development Plan MW of power station capacity in Luzon and Visayas. As shown in the Map (IBRD 2679), at that stage, the 2.6 PDP95 (summarized in Annex 2-Generation, EHV overhead transmission lines will extend over and Annex 3-Transmission) indicates that over the 2,000 km from the 1,000 MW Sual power station in next ten years, an average annual investment of about Northern Luzon via submarine cables and overhead P58.9 billion will be needed, about 70% of which will lines as far as the island of Panay in the Western be for generation, with the balance for transmission. Visayas.2 Beyond the year 2000, the grid is expected PDP95 shows generation projects in the Luzon- to extend a further 500 km south from Leyte by Visayas grid during the period 1994-2000 totaling overhead line and submarine cables to Mindanao, at 4,573 MW, most of which will be installed by the which time the main load centers and generating plant private sector. Of the 11,350 MW of capacity required in the Philippine archipelago will be fully over 2000-05, some 4,500 MW is expected to be interconnected. During its expansion, the grid will provided by arrangements between MERALCO and provide increasing opportunities to optimize the the IPPs planning to develop the Palawan gas resource. development of hydro and geothermal resources in the In formulating future PDPs, NPC will need to move Philippines, thereby minimizing power system reserve away from prescriptive planning for generation capacity as shown in Table 2.4. expansion, and instead encourage the private sector to propose alternatives. This would help move toward Table 2.4 indicative planning and increase competition in the SUMMARY OF RESERVE CAPACITY BY generation market. Ultimately the BOT law will need REGION PDP 95 to be changed to facilitate approval of priority projects Year Luzon Visayas Mindanao only after pre-qualification and the bid process. Such l MW Reserve MW Reserve MW Reserve changes would allow projects not included in the 1994 1995 35% 328 39% 823 54% respective PDP to be fully evaluated by appropriate 2000 3548 34% 1312 55% 614 25% entities. At negotiations, it was agreed that, no later 2005 4487 29% 1228 41% 666 17% than October I each year, the Government shall exchange views with the Bank and the Borrower on the 2.9 Load Dispatch. Optimal grid operation will necessary actions to carry out the agreed power require considerable enhancement of NPC's load development plan. dispatch system, which currently comprises three regional centers and five supervisory control and data 2.7 Fuel Mix. The fuel mix relating to PDP95 is acquisition (SCADA) systems; communications shown in Table 2.3. The share of coal in power systems will also need to be upgraded to meet the generation will increase from 7% in 1995 to 41% in telemetry requirements of the new load dispatch 2005, while the share of geothermal power will functions. The detailed planning of a national progressively decline from 27% in 1995 to 16% in economic dispatch system will take some time while a 2005 as most promising sites would have been Grid Code3 is being developed to cover conditions for developed. Gas- and hydropower-based generation will become significant contributors in the year 2000. 2 The principal components of the grid, running from north to south Table 2.3 will include: (i) about 500 lkn at 500 kV (3000 MW) double circuit PDP95 FUEL MIX overhead lines from Sual to and around the main load center in Manila, to Interconnect (at Naga) with (i1) about 300 km of 380 kV (880 MW) Fuel 1995 2000 2005 bipolar design (Initially operating monopolar) HVDC overhead lines Oil 49% 14% 9% extending to the southern tip of Luzon, thence via 18 In of submaine Imported Coal 3% 37% 36% cable and 300 km of overhead lines terminating near the 640 MW Subtotal Impgrted 52% 51% 45% ~~~~Leyte geothernua site. From Leyte the grid will continue through (Wi) Subtotal imported 52% 51% 45% about 100 km of 220 kV (200 MW) overhead lines and 40 kmn of Hvdro 17% 10% 13% undersea cables, thence proceeding another 200 km through to the Geothermal 27% 26% 16% Island of Cebu and connecting with the rest of Vsayas through the Local Coal 4% 8% 5% existing (Iv) about 200 km of 138 kV (100 MW) overhead lines and Locural Coal 4% 58% 21%_____ undersea cables lbindng the Islands of Negros and Panay Natural Gas 0 5% 21% A public document containing procedures and technical regulations Subtotal Local 48% 49% ________ appfled to al users of the transmission network embodying prlnciples  - 10- supply into the EHV system, the transmission interface where it would be exposed to continuing lahar arrangements throughout Luzon and Visayas are being excursions. finalized, and the physical aspects of EHV/HV metering, control, protection, and communications are 2.11 Subtransmission Development. Although the being evaluated. It will also be necessary to rationalize subtransmission systems properly belong with existing PPAs along more standard lines to reflect distributors, virtually all but MERALCO are too weak better the desired operating conditions for optimized and fragmented to manage these networks responsibly. power scheduling under the proposed new wheeling Until DOE's proposed distribution reform is well tariffs. For this purpose, NPC completed a study4 of advanced (para 1.12), NPC will not be able to shed the generation dispatching issues that will form the basis attendant technical functions or the commercial risk for a detailed design of the National Load Dispatch related to the financial performance of distribution Center (NLDC) to be housed in TRANSCO's utilities. Accordingly, NPC is strengthening the proposed headquarters in Manila. The study made a subtransmission networks to provide better service to number of important recommendations to improve the distributors and improve their chances of taking them design of existing PPAs and distribution supply over in the future. As shown in Annex 3, of the US$2 contracts, revise load dispatch scheduling procedures, billion planned investment under PDP95 in the Luzon- and complete further investigations during the course Visayas transmission systems, about US$650 million of this project to enhance the overall efficiency of load will be used to reinforce subtransmission. Under this dispatch operations. The study also identified a need project, the principal measures of the Visayas 138 kV to modernize many of the outstation transducers and transmission component are designed to address issues protection facilities to upgrade their capacity for higher of concern to NPC's customers in Cebu, Negros, and speed, accuracy, and reliability. During negotiations, Panay, which have recently been connected to the it was agreed that by June 30, 1996 the Government Visayas grid. Specifically, it will reduce losses and would investigate (a) the underlying inefficiencies in improve the quality of supply to about 11 RECs and economic load dispatch and draw up a time bound plan three IOD networks. These lines will be routed to for the elimination of said inefficiencies which plans facilitate private-sector development of four hydro sites should include specific steps for promoting competition in Panay (Timbaban 35 MW, Villasluga 30 MW) and in power, and (b) thereafter carry out said plan. Negros (Okoy 11.8 MW, and Sikopang 17.6 MW) that were investigated under the Bank's Energy Sector 2.10 Transmission Planning. NPC has recently Project (Loan 3164-PH). completed a Transmission Masterplan (TMP) study' for EHV transmission development. This work Power Pricing developed from a 1988 study that proposed HVDC inter-regional links between: (a) Leyte and Luzon 2.12 Under the DOE law, all energy tariffs require (1000 MW HVDC); (b) Leyte and Cebu (200 MW the approval of ERB. Moreover, to avoid delays in 230 kV AC), and (c) Leyte and Mindanao (400 MW adjusting tariffs for costs that are beyond NPC control, HVDC). The TMP study examined four options for and to depoliticize such increases, automatic monthly the northwestern 500 kV extension under the proposed total fuel cost and exchange rate adjustments were Bank project, and concluded that the proposed approved by the ERB in 1993 (para 5.14). The most extension was the optimal arrangement, taking into recent automatic increase was a fuel adjustment that account the potential for new hydro development at included provisions for cost increases in purchased Casecnan and San Roque, the likelihood of a 1,500 power, effectively indexing NPC's tariffs to fuel prices MW gas fired project in Bataan, and the uncertainties and other costs. These represent about 82% of NPC's of routing the line on the westem side of Mt. Pinatubo total operational expenditures (for oil, coal, steam and purchased energy), as well as increases in loan principal arising from exchange rate variations. In of good uility practice. A draft code is in preparation by the NPC November 1994 ERB also approved in principle the Nuclear Operations Group. first phase of changes in the bulk tariff structure to Econonic Dispatch Study, Power Technologies Inc. USA/ PROMON promote efficiency in the distribution sector. This Engenharis Brazil July 1995 introduced peak and energy charges, initially on a 5Transmission Masterplan Study, Power Technologies Inc. USA/ 'Yevenue neutral" basis. The final restructured tariff PROMON Engenharia Brazil April 1995 was cleared by ERB in March and implemented in  Luzon in May 1995 (thereby complying with a distribution franchise system and pay a rate for condition of disbursement under the Leyte-Cebu electricity that is only marginally higher than what project). ERB has approved a similar proposal for NPC charges MERALCO. About half of these (43) Visayas and hearings for Mindanao tariff restructuring can be considered large, with a load greater than are ongoing and expected to be completed during 1996. 3MW. In contrast, 61 large, medium, and higher voltage MERALCO customers pay tariffs about 40% 2.13 In its 1994 decision to allow NPC to higher than NPC's directly connected customers for restructure its tariff (para 2.12), the ERB also directed comparable (mostly 69kV) service, much of it drawn NPC to submit within one year a new structure that from the same transmission lines. This 40% difference would taken into account updated data for NPC's Long in tariffs represents the cross-subsidies MERALCO Run Marginal Costs (LRMC) of expansion. To this (and other distributors) must find to lower rates for the end, NPC will undertake a comprehensive study aimed lifeline block of residential consumption and all at developing a tariff strategy and proposing a new consumption in the Visayas and Mindanao. structure incorporating the following: (a) applying LRMC principles in the Luzon grid with a view to their 2.15 Distribution Tariffs. Retail power tariffs in introduction in the Visayas and Mindanao; (b) the Manila area, which are indexed with NPC tariffs introducing appropriate charges for wheeling and and the exchange rate, have provided MERALCO a ancillary services to be applied in Luzon, and rate of return higher than 8% based on an agreed level beginning in 1998 to the Luzon-Visayas inter- of losses expected to decline over the next five years. connected grid, and (c) removing existing cross The power tariff subsidizes consumption below 50 subsidies. During negotiations, it was agreed that NPC kWh/month through the application of relatively high would submit an application to ERB by October 31, rates for large industrial and commercial users. For 1996, for a new rate structure designed (a) to phase out the rural areas, in connection with the Rural subsidies between grids, (b) introduce Long Run Electrification Revitalization Project (Loan 3439-PH), Marginal Cost principles in the Luzon grid; and (c) substantial tariff increases have been approved for introduce appropriate charges and ancillary services in RECs, many in the order of 40-50% during 1991. the Luzon grid. These tariffs which appear to be adequate, are generally uniform for all consumers, regardless of 2.14 HV Consumers. NPC has 91 directly voltage level, and result in subsidies for low voltage connected medium and high voltage customers, largely consumers. NEA is introducing new guidelines to commercial and industrial users, which are serviced as improve the structure and level of REC tariffs and will exceptions to the regular geographically based provide the first step toward the implementation of DSM programs.  3. THE BORROWER Overview 3.4 The original 'Fast Track" projects involved rapidly constructed peaking plants that would be run at 3.1 In 1988 NPC expected that its existing load factors more appropriate to base load facilities; as generating capacity could meet demand projected a result, the energy they produced had a high cost through 1991, affording plenty of lead time to (averaging nearly US80/kWh). However, once new implement projects to provide additional capacity. capacity began coming on stream and the supply However, NPC's expansion program suffered because: situation stabilized, NPC introduced a transparent (a) several projects were delayed due to excessive time bidding process to solicit IPP proposals for larger needed to secure financing; (b) other projects were base-load plants. The reference price related to bids delayed by implementation problems; and (c) still other that were solicited from early 1993 to late 1994 projects, for which financing was available, were held dropped to an average of US5