ASIAN DEVELOPMENT BANK PCR: PHI 30007

PROJECT COMPLETION REPORT

ON THE

LEYTE-MINDANAO INTERCONNECTION ENGINEERING PROJECT (Loan 1474-PHI)

IN THE

PHILIPPINES

May 2003

CURRENCY EQUIVALENTS

Currency Unit – Peso (P)

At Appraisal At Project Completion June 1996 May 2001 P1.00 = $0.038 $0.020 $1.00 = P26.00 P51.00

ABBREVIATIONS

AC – alternating current ADB – Asian Development Bank EA – executing agency EIA – environmental impact assessment EPIRA – Electric Power Industry Reform Act ERC – Energy Regulatory Commission HVDC – high voltage direct current NPC – National Power Corporation NPV – net present value POE – panel of experts TA – technical assistance TOR – terms of reference

NOTES

(i) The fiscal year (FY) of the Government and NPC ends on 31 December. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2001 ends on 31 December 2001.

(ii) In this report, "$" refers to US dollars.

CONTENTS

Page

BASIC DATA ii

MAP v

I. PROJECT DESCRIPTION 1

II. EVALUATION OF DESIGN AND IMPLEMENTATION 1

A. Relevance of Design and Formulation 1 B. Project Outputs 2 C. Project Costs 3 D. Disbursements 4 E. Project Schedule 4 F. Implementation Arrangements 4 G. Conditions and Covenants 5 H. Related Technical Assistance 5 I. Consultant Recruitment and Procurement 5 J. Performance of Consultants and Subcontractor 5 K. Performance of the Borrower and the Executing Agency 5 L. Performance of ADB 6

III. EVALUATION OF PERFORMANCE 6

A. Relevance 6 B. Efficacy in Achievement of Purpose 7 C. Efficiency in Achievement of Outputs and Purpose 7 D. Preliminary Assessment of Sustainability 7 E. Environmental, Sociocultural, and Other Impacts 8

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 9

A. Overall Assessment 9 B. Lessons Learned 9 C. Recommendations 10

APPENDIXES

1. Project Framework 11 2. Actual Disbursements – ADB Loan 1474-PHI 12 3. Status of Compliance with Loan Covenants 13

BASIC DATA

A. Loan Identification

1. Country Philippines 2. Loan Number 1474 3. Project Title Leyte-Mindanao Interconnection Engineering 4. Borrower National Power Corporation 5. Guarantor Republic of the Philippines 6. Executing Agency National Power Corporation 7. Amount of Loan $5.347 million 8. Project Completion Report Number PCR: PHI 733

B. Loan Data

1. Appraisal – Date Started 15 April 1996 – Date Completed 19 June 1996

2. Loan Negotiations – Date Started 30 August 1996 – Date Completed 6 September 1996

3. Date of Board Approval 30 September 1996

4. Date of Loan Agreement 18 November 1996

5. Date of Loan Effectiveness – In Loan Agreement 18 February 1997 – Actual 14 February 1997 – Number of Extensions 0

6. Closing Date – In Loan Agreement 30 November 1998 – Actual 15 May 2001 – Number of Extensions 4

7. Terms of Loan – Interest Rate variable – Maturity 15 years – Grace Period 3 years

8. Disbursements

a. Dates Initial Disbursement Final Disbursement Time Interval

9 July 1997 15 May 2001 46 months

Effective Date Original Closing Date Time Interval

14 February 1997 30 November 1998 21 months

iii

b. Amount ($) Category Original Amount Last Revised Amount Undisbursed Allocation Reallocated Allocation Disbursed Balance 01A a 3,600,000 655,278 4,255,278 4,255,278 0 01B b 919,900 (419,513) 500,387 500,387 0 01C c 129,300 26,873 156,173 156,173 0 02 d 697,534 (262,638) 434,896 0 434,896 Total 5,346,734 0 5,346,734 4,911,838 434,896 Note: Part I (Feasibility Study) was financed by a technical assistance grant from Asian Development Bank. a Consulting Services – Part II (Submarine Survey). b Consulting Services – Part III (Detailed Design). c Consulting Services – Part IV (Panel of Experts). d Unallocated.

C. Project Data

1. Project Cost ($ million equivalent) Item Appraisal Estimate Actual Foreign Local Total Foreign Local Total Part I: Feasibility study 0.562 0.013 0.575 0.498 0.007 0.505 Part II: Submarine survey 3.600 0 3.600 4.255 0.062 4.317 Part III: Detailed design 0.920 0 0.920 0.500 0.007 0.507 Part IV: Panel of experts 0.129 0 0.129 0.156 0.002 0.158 Contingencies 0.698 0.115 0.813 0 0 0 Total 5.909 0.128 6.037 5.410 0.079 5.489 Source: Asian Development Bank, National Power Corporation.

2. Financing Plan ($ million equivalent)

Item Appraisal Estimate Actual Foreign Local Total Foreign Local Total ADB TA Grant 0.562 0.013 0.575 0.498 0 0.498 ADB TA Loan 5.347 0 5.347 4.912 0 4.912 NPC 0 0.115 0.115 0 0.079 0.079 Total 5.909 0.128 6.037 5.410 0.079 5.489

ADB = Asian Development Bank, NPC = National Power Corporation, TA = Technical Assistance. Source: Asian Development Bank, National Power Corporation.

3. Project Schedule (completion dates)

Item Appraisal Estimate Actual a Part I Feasibility Study 31 July 1997 19 February 2000 Part II Submarine Survey 30 June 1997 5 August 1997 Part III Detailed Design 30 April 1998 30 September 2001 Part IV Panel of Experts (Feasibility Study Review) 31 July 1997 16 August 1998 Part IV Panel of Experts (Detail Design Review) 30 April 1998 14 July 2000 a Dates for Parts I-III are determined by receipt of the final reports, and dates for Part IV are determined by the contracts.

iv

D. Data on Asian Development Bank Missions

No. of Specialization of Name of Mission Date Persons Members a Project processing 15 April-19 June 1996 5 a, b, b, b, c Review 10 March 1997 2 a, c Review 20 June 1997 3 a, b, b Review 21-22 January 1998 2 a, c Review 24 August 1998 2 a, b Review 23-25 November 1998 2 a, b Review 1-5 March 1999 1 b Review 13-15 October 1999 1 a Review 16-22 February 2000 2 a, b Review 14-16 June 2000 1 a Project Completion b 13-14 November 2002 3 b, c, d a a = financial/energy specialist, b = engineer, c = energy specialist, d = financial specialist. b The PCR Mission consisted of Toru Hayakawa, Financial Specialist; Yongping Zhai, Senior Energy Specialist; and Geoff Brown (Staff Consultant), Engineer. v

I. PROJECT DESCRIPTION

1. The objective of the Leyte-Mindanao Interconnection Engineering Project (the Project) was to plan and design an interconnection between the Leyte and Mindanao electricity transmission grids (the Interconnection) to reduce the costs of electricity generation by allowing more efficient dispatch. As the Luzon and Leyte grids are already interconnected, the interconnection would link the three regional grids of the Philippines, namely Luzon, Leyte (Visayas), and Mindanao, thus establishing an integrated grid and allowing reserve electricity generation capacity to be shared by the three regional grids. Pre-feasibility studies 1 had indicated that, given the planned length and capacity of the Interconnection, a high voltage direct current (HVDC) system, using technology similar to that used for the interconnection between Luzon and Leyte, was required. The Interconnection, as envisaged at appraisal, included 384 kilometers (km) of 350 kilovolt (kV) HVDC transmission lines, 31 km of HVDC submarine cable, and 37 km of alternating current (AC) overhead transmission lines. 2 In addition, converters, cable terminals, and electrode stations3 were needed as well as substation expansions to enable connection to the two existing AC grids.

2. The Project consisted of four parts. Part I was a comprehensive feasibility study of the Interconnection. Part II was a detailed survey of the proposed submarine cable route. Part III included detailed engineering design and preparation of tender documents for the construction of the Interconnection. Part IV comprised a review of the feasibility study, survey and detailed design (Parts I to III) by a panel of experts (POE). The POE review was considered necessary because of the technical complexity of the Interconnection. The project framework, included in Appendix 1, was formulated assuming that a loan for the construction of the interconnection would follow.

II. EVALUATION OF DESIGN AND IMPLEMENTATION

A. Relevance of Design and Formulation

3. The 1995 transmission master plan study4 and several in-house studies indicated the technical and economic viability of the Interconnection. During appraisal, a staff consultant was engaged by the Asian Development Bank (ADB) to review these prefeasibility studies. Based on data provided by the National Power Corporation (NPC), load growth assumptions between 12.7% and 15.5% per annum were considered. The staff consultant estimated the net present value (NPV) of benefits from the Interconnection between $87 million and $346 million, depending on the load growth. These benefits were expected to arise from optimization of Mindanao’s hydropower plant operation, increased reliability of the Mindanao system, reduction of standby and spinning reserve electricity generation, and exchange of energy during periods of shortfall or surplus in electricity generation.

4. At the time of the Board approval of the Project in 1996, it was anticipated that, should the feasibility study show the Interconnection to be viable, ADB would finance its construction.

1 An initial feasibility study was undertaken in 1984, then updated in 1993. 2 In the recommended project design, the voltage is 250 kV and the submarine cable route length is 23 km. There is 170 km of overhead HVDC line on Leyte and 313 km of overhead HVDC line, including 29 km of electrode line, on Mindanao. The design also includes 20 km of 230 kV and 9 km of 138 kV AC lines on Mindanao. 3 The converter stations are needed for conversion from AC to direct current power and vice versa. An HVDC system normally uses the ground as a system conductor, and the electrode stations provide the connections from the system to the ground. 4 Completed for the National Power Corporation by consultants from United States and Argentina. 2

However, during the loan appraisal mission fielded in late 2001 for the proposed Transmission Interconnection Reinforcement Project (TIRP), which included the Interconnection, the Government informed the ADB that it had decided to defer the construction of the Interconnection. The investment would be financed by the concessionaire of the transmission company to be set up under the Electric Power Industry Reform Act (EPIRA), which was legislated in 2001 to restructure the power industry. The postponement of the interconnection was technically justified by the lower than expected electricity demand growth in Mindanao, due to the Asian economic crisis, and the construction of a coal-fired power plant (200MW) in Mindanao. These developments were not foreseen at the time of the Project approval in 1996.

B. Project Outputs

5. The following documents were prepared under the Project: (i) feasibility study report, (ii) least-cost transmission expansion plan, (iii) oceanographic report, (iv) marine survey report, (v) marine environmental impact assessment, (vi) design report, (vii) bidding documents – converter stations and substations, (viii) bidding documents – submarine cables, and (ix) bidding documents – substations.

6. In addition, NPC has produced a number of documents relevant to the Interconnection, including (i) route survey and detailed transmission line design, (ii) transmission line environmental impact assessment, and (iii) compensation and resettlement plan.

7. These documents collectively represent a comprehensive design of the Interconnection, as a two-pole5 250 kV transmission line, using state-of-the-art technology. They will form a valuable starting point for future detailed design and construction of the Interconnection, irrespective of whether such a project is developed by the Government or the private sector.

8. Although the capacity and configuration of the Interconnection was finalized on the basis of the best available data at the time of the design, the data is now out of date and, further, the electricity industry is being restructured in line with the EPIRA. Therefore, while proceeding with construction of the Interconnection in the future, the data and forecasts from the various studies prepared under the Project should be updated in order to determine the optimal capacity and configuration of the Interconnection under current conditions.

9. In addition, the study identified an alternative site for the cable landing point in Leyte, which might be preferable to the one for which survey data are available. Due to limitations of survey data that could be collected at that time, this cable landing point was not fully defined. The draft tender documents, therefore, require the submarine cable contractor to undertake a prelay survey, which would provide the additional data necessary to make a final decision on the issue.

5 HVDC interconnections can have one- or two-pole configurations. In a two-pole configuration, each pole operates as a separate circuit using the ground as the return path. A two-pole interconnection has higher availability than a one-pole system, since the interconnection would still operate at approximately 50% capacity following the loss of one pole. 3

C. Project Costs

10. The appraisal estimated costs and the actual costs of the individual project components are given in Table 1. Aside from the foreign exchange costs financed by ADB, NPC financed the local costs of the Project, which mainly consisted of the costs of counterpart staff, transportation, and office space.

Table 1: Estimated and Actual Project Costs ($)

Item Appraisal Estimate Actual Foreign Local Total Foreign Local Total Part I: Feasibility study 561,736 13,264 575,000 497,757 7,269 505,026 Part II: Submarine survey 3,600,000 0 3,600,000 4,255,278 62,143 4,317,421 Part III: Detailed design 919,900 0 919,900 500,387 7,307 507,694 Part IV: Panel of experts 129,300 0 129,300 156,173 2,281 158,454 Contingencies and 697,534 115,254 812,788 0 0 0 Counterpart Fund Total 5,908,470 128,518 6,036,988 5,409,595 79,000 5,488,595 Note: Counterpart Fund from Executing Agency is allocated to each project part at a pro rata basis. Source: Asian Development Bank, National Power Corporation.

11. The foreign cost of Part I of the Project was financed by a technical assistance (TA) grant6 to NPC funded by the Japan Special Fund and the foreign costs of Parts II-IV of the Project were funded by a TA loan from ADB’s ordinary capital resources. All local costs for Parts I-IV were funded by NPC. The borrower, and the executing agency, of the TA loan was NPC, and the loan was guaranteed by the Republic of the Philippines.

12. Additional works were identified under Part I due to (i) the revision of the cable route following a review by the POE, (ii) the need to rework the system planning study and the economic analysis to take account of the lower electricity demand projections following the 1997 Asian economic crisis, (iii) the extension of the scope of the feasibility study to include training for NPC in the measurement of electromagnetic fields and a study on the impact of harmonics7 on the operation of the Interconnection, and (iv) the decision to extend the study to look at the advantages and costs of a two-pole link. However, as the related additional costs were too high to be financed by the TA grant under Part I, this was treated as a minor change in scope of Part II using contingencies of the TA loan and savings from Part III.

13. The cost of Part III was lower than the appraisal estimate. This was due to the facts that (i) the feasibility study was more comprehensive than envisaged at appraisal, requiring less work for detailed design, and (ii) construction tender documents were not issued.

14. Cost overrun in Part IV was mainly caused by an additional meeting in Oslo attended by two members of the POE to finalize the cable route, and was funded from the loan contingencies. Overall, there was no total cost overrun for the Project.

6 ADB. 1996. Technical Assistance to the Philippines for Leyte-Mindanao Interconnection Engineering. Manila. 7 Harmonics are small magnitude, high frequency voltages and currents superimposed on the standard 50 Hertz AC wave. They are caused primarily by nonlinear electrical loads, and generated during conversion of electric power between alternating and direct currents. 4

D. Disbursements

15. The actual disbursement schedule of the TA loan is given in Appendix 2. As expected at appraisal, there was a high level of disbursements early in the Project due to the large upfront payment made for the high value of the submarine survey contract. Overall, disbursement of the loan was delayed, reflecting the project delays (para.16).

E. Project Schedule

16. The Project was not completed until May 2001, almost 3 years after the originally scheduled completion date of November 1998. In fact, ADB did not receive copies of some final documents until September 2001. The main causes of project delays were (i) the inability of NPC to provide updated data required for the draft feasibility study in a timely fashion, (ii) the delay in the delivery of survey data due to nonpayment of earlier invoices, (iii) the decision to include a least-cost electricity generation planning study to provide NPC with improved data on which to base the economic and financial feasibility studies, (iv) the decision in August 1998 to update all planning studies and to incorporate them in the 1998 Power Development Plan data, (v) the decision to commission a second marine survey (arranged and funded by NPC) to investigate alternative routes to the one investigated in the survey commissioned under Part II of the Project, and (vi) NPC’s decision in June 2000 to change the voltage from 350 kV to 250 kV and the configuration of the link from one-pole to two-pole.

17. The high estimated costs of the Interconnection and the technical complexity of the design also generated some delays. All parties wanted to ensure that the final design would be optimal and that any decision to proceed would be based on robust and up-to-date information. The decision taken in 1998 to revise all planning studies was driven by concerns from the possible impact of the 1997 Asian economic crisis on the economic and financial viabilities of the Interconnection.

F. Implementation Arrangements

18. Part I of the Project (funded by a TA grant) was undertaken under a contract with ADB, while Parts II and III (funded by a TA loan) were completed under a contract with NPC. However, ADB appointed a single consultant (the Consultant) for both contracts under a common selection process. Payments to the Consultant for Part I were made by ADB from the TA account, while payments for Parts II and III were made from the loan account after receipt of loan withdrawal applications from NPC.

19. With the agreement of the borrower, members of the POE (Part IV) were appointed by ADB in accordance with standard procedures for the selection of individual consultants. ADB negotiated the contracts on NPC’s behalf with the consultants but the contracts were between NPC and the consultants, as the payments to members of the POE were made from the loan account.

20. The arrangement worked reasonably well. However, timely processing of payment invoices by NPC was a problem, and all consultants eventually relied on ADB to intervene for them on this matter. The most serious issue that arose was a delay in making the mobilization payment and first progress payment for the marine survey work. This delay was caused by an NPC requirement for a board resolution before payments could be made from the loan account; the necessary resolution was not passed until June 1997, 4 months after payments were due. Processing of disbursement applications by ADB was however satisfactory. 5

G. Conditions and Covenants

21. A summary of NPC’s compliance with loan conditions and covenants is in Appendix 3. All covenants, except the requirement to provide a project completion report, have been complied with, although compliance with some covenants was late. Apart from the requirement to submit a cost-based tariff proposal, there was no other financial covenant included in the loan agreement because of the engineering nature of the Project.

H. Related Technical Assistance

22. A completion report for Part I of the Project provided as a TA grant (2653-PHI, footnote 6) was prepared as a separate document. Main findings of the TA completion report are given below.

23. The feasibility reports produced by the TA were of high quality. They established that the Interconnection was technically feasible and that its economic benefits would be high, although those were evaluated on the assumption of a vertically integrated electricity industry. While some of the work was undertaken in the Consultant’s home office, there was a high level of interaction between the Consultant and NPC through intensive communication. In addition, the POE mechanism facilitated transfer of knowledge to NPC by enhancing the skill and experience of its staff in preparing this type of technically complex project.

24. The TA is only rated as partly successful although its outputs were of high quality, because of the Government’s decision not to defer the construction of the Interconnection, thus not utilizing these outputs.

I. Consultant Recruitment and Procurement

25. Recruitment of the Consultant, for Parts I-III of the Project, and the recruitment of each member of the POE were undertaken by ADB in accordance with its Guidelines on the Use of Consultants.

26. The Consultant had initially submitted an expression of interest in association with a firm that was not acceptable to NPC, due to problems in another project. The Consultant submitted a revised proposal with another associate firm that was acceptable to NPC.

J. Performance of Consultants and Subcontractor

27. The performance of the Consultant, POE members, and the marine survey subcontractor was considered satisfactory. Project delays were generally caused by factors outside their direct control. It is likely that some of the Consultant’s additional work could have been avoided had the Consultant looked at a wider range of options (para. 28) earlier in the implementation of the Project. However, the Consultant explained that the terms of reference (TOR) and NPC’s initial reluctance to examine alternative options, required this inefficient approach.

K. Performance of the Borrower and the Executing Agency

28. As NPC was initially reluctant to consider alternative options, the Consultant had to carry out considerable additional work, which increased the overall cost of the Project. This was 6 particularly apparent in the June 2000 decision to change from a 350 kV one-pole link8 to a 250 kV two-pole link, based on a recommendation of the POE. This required changes to the design report and the draft tender documents, which would have been avoided had the final decision on the configuration been taken at the completion of the feasibility stage. While this was driven by a desire to maintain the project schedule, NPC was nevertheless unable to avoid delays caused by the need to comply with its internal and the Government’s approval procedures.

29. However, the eventual project output was acceptable in spite of the need for prelay survey to finalize the site of the northern cable landing point. Taking into account NPC’s limited experience in managing projects with such a high level of technical complexity, the performance of NPC is rated as partly satisfactory.

L. Performance of ADB

30. ADB was more closely involved in project implementation than usually due to its role in the appointment of consultants and the administration of the TA contract on behalf of the Executing Agency (EA). Aside from the recorded review missions, ADB communicated frequently with NPC and the consultants through the POE mechanism and informal meetings. Furthermore, ADB’s engineers found the Project technically challenging and were able to provide valuable inputs. However, ADB should not have accepted NPC’s limiting the alternatives considered under the Project (para. 28).

31. ADB was supportive of the work of the POE. It is believed that this support had a significant impact on extent to which the POE reports were taken into account by both the Consultant and NPC. The positive impact of the POE on the final project design might not have occurred without this support.

32. Overall, the performance of ADB is rated as satisfactory.

III. EVALUATION OF PERFORMANCE

A. Relevance

33. The Project was designed to examine the technical feasibility and the economic and financial viability of the Interconnection. It was implemented on the basis that, should the Interconnection prove technically feasible and economically and financially viable, it would proceed with construction and be financed by ADB.

34. As the Government decided to defer construction of the Interconnection (para. 4), the main objective of the Project has not been achieved. Nevertheless, as the construction of the Interconnection is an imperative for completing the national grid that would allow the full operation of the wholesale electricity spot market, it is expected that the Interconnection will be built eventually. The Project is still evaluated as relevant.

8 The original design had one-pole converter stations but a two-pole overhead line and two undersea cables. This arrangement increased the expected availability of the system (footnote 5) and reduced the cost of a subsequent upgrade to a two-pole system. 7

B. Efficacy in Achievement of Purpose

35. The primary purpose of the Project was to assess the technical feasibility of the Interconnection and its economic and financial viability, and this was achieved. The Project demonstrated convincingly that the Interconnection was technically feasible. Extensive economic and financial analyses demonstrated that the Interconnection was economically viable and that, based on the assumption of a vertically integrated electricity industry, the Interconnection was financially sustainable. Moreover, the Project has allowed technology transfer. Therefore, the Project is rated as efficacious.

C. Efficiency in Achievement of Outputs and Purpose

36. There were five components for achievement of outputs and purposes for the Project, which were whether the Project would (i) verify the technical feasibility of the Interconnection, (ii) verify its economic and financial viability, (iii) complete selection of its detailed submarine cable route, (iv) prepare its detailed design, and (v) produce the tender documentation for its construction. Though the completion of the Project was delayed by about 3 years and the site of northern cable landing is still to be confirmed by the prelay survey, all key components were successfully achieved, and the feasibility reports produced were of high quality. The Project is therefore evaluated as efficient.

37. The summary of the results of the economic and financial analyses of the Interconnection prepared under the Project is given hereunder for reference.

38. The economic analysis for the Interconnection was undertaken by using 1998 price level and a with-and-without project analysis framework. The benefits of the Interconnection were estimated under a vertically integrated electricity industry by comparing the least-cost electricity generation development plans to supply the forecast electricity demand in Leyte and Mindanao with and without the Interconnection. Without the Interconnection, electricity generation must be developed independently to meet the requirements of each grid. With the Interconnection, the electricity generation resources of the interconnected grids can be shared, and construction of some high cost electricity generation projects can be deferred. This leads to real cost savings. The analysis was performed by comparing the discounted economic costs and benefits associated with the expansion plans of the whole system over a period of 30 years from the commissioning of the Interconnection. It resulted in an economic internal rate of return of 21.9% and an NPV of $231 million, assuming a discount rate of 12%. The financial analysis for the Interconnection was undertaken by using almost the same evaluation framework as the economic analysis. The analysis calculated a financial internal rate of return of 21.6% and an NPV of $732 million, assuming a discount rate of 6%, the estimated weighted average cost of capital.

D. Preliminary Assessment of Sustainability

39. The Interconnection was not constructed despite the favorable results of the Project. The sustainability of the Project was therefore evaluated as unlikely. In addition, although the financial analysis for the Interconnection resulted in a high financial return (para. 38), it was made on the assumption of a vertically integrated electricity industry, which is not considered valid for assessing the sustainability of the Interconnection in an unbundled electricity industry, since it captures financial benefits that will not flow directly to the operator of the Interconnection.

8

40. Under the EPIRA, the electricity market is to be unbundled, and management of the transmission grid is to be contracted to a private concessionaire.9 It will be the responsibility of the concessionaire to assess the financial viability of the Interconnection and to arrange its financing should it decide to proceed with its construction.

41. Under the new industry arrangements, the Government will be required to produce an annual transmission development plan that will feed into a power development plan and a national energy plan. It is conceivable that such planning will confirm the findings of the Project and determine that construction of the Interconnection has high national economic benefit. However, in this event, construction of the Interconnection would proceed only if there were sufficient financial incentives given to the transmission concessionaire to finance the construction. The transmission concession will be a natural monopoly regulated by the Energy Regulatory Commission (ERC). Therefore, the extent to which the concessionaire would be able to recover the financial costs of constructing and operating a new interconnection from the economic beneficiaries would be dependent on regulatory policies and decisions made by the ERC. The performance-based regulation, which is being considered by the ERC, includes provisions to allow the concessionaire to effectively recover its investment through tariff adjustment.

E. Environmental, Sociocultural, and Other Impacts

42. The Project was composed of a feasibility study and engineering works, so environmental and socio-cultural aspects were not directly relevant to the Project itself, although they are relevant to the Interconnection studied by the Project. NPC undertook environmental impact assessments of the land-based portions in Leyte and Mindanao in 1997. As a part of the Project, the Consultant also undertook an environmental impact assessment of the submarine cable route and the sea electrode sites (all assessments assumed a 350 kV one-pole configuration). The Summary Environmental Impact Assessment of the proposed TIRP (para. 4), was circulated to the Board on 4 August 1999. A summary of the assessment related to the Interconnection is given below.

43. The decision to change from a 350 kV one-pole link to a 250 kV two-pole link would reduce the adverse environmental impact. The width of the overhead HVDC transmission line right-of-way would be reduced from 50 meters to 40 meters because of the lower transmission voltage. Electric and magnetic fields would be reduced because of the cancellation effects of the opposite polarity currents in the two poles. Furthermore, under normal two-pole operation, electrode currents are minimal, so the impact of the electrode at the Mindanao end10 on local marine life would be minimal.

44. In spite of the deferment of construction of the Interconnection, NPC is continuing to finalize the right-of-way negotiations for the overhead lines, except in the area of the landing point in Leyte, and this work is almost completed. The intention is to have a route finalized with negotiations and compensation complete before construction of the Interconnection commences. Nevertheless, problems may still arise, as squatters, tenants, and landowners may construct buildings and plant crops over the easement in the meantime.

9 The concessionaire will have a 25-year contract with a 25-year right of renewal. It is expected to be selected during the second half of 2003. 10 At the Leyte end, the system would use the existing electrode constructed for the Luzon-Leyte one-pole interconnection. 9

45. Among other impacts of the Project, skill transfer to NPC was considered relevant and evaluated to be done successfully, because of the high level of interaction between the Consultant, the POE, and NPC (para. 23).

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS

A. Overall Assessment

46. The objective of the Project was to plan and design the Interconection. It was envisaged that the Interconnection would encourage further involvement of the private sector, including independent power producers, in the Philippines electricity market, because the Interconnection would expand the market for electricity generators. Under the Project, the Consultant found that the Interconnection was technically feasible and that the economic argument for constructing such a link was compelling. However, because the Government decided to defer construction of the Interconnection, the outputs from the Project has not been fully utilized.

47. The decision to defer the construction of the Interconnection was beyond the control of the Consultant, NPC, and ADB. The Project was implemented largely as conceived at appraisal, although completion was delayed by approximately 3 years. This delay was caused mainly the need to resolve technically complex issues and provide more robust project outputs.

48. While much of the design work was undertaken in the Consultant’s home office, the high level of interaction between the Consultant, the POE, and NPC stimulated on-the-job technology transfer and resulted in strengthening the skill and institutional capacity of NPC. Though many outputs of the Project, including engineering designs and skill transfer, were achieved and the Consultant’s work was reasonably successful, the Project and the related TA are rated as partly successful, because the outputs of the Project have not been utilized to construct the Interconnection.

B. Lessons Learned

49. The review by an independent panel of experts is very beneficial to technically complex projects. The POE had a significant impact in improving the quality and robustness of the project deliverables. As a result of the feasibility study review by the POE, both the submarine cable route and the configuration of the Interconnection were changed from that originally proposed, and the economic analysis supporting the Interconnection was strengthened.

50. The results of the prefeasibility study should be subject to further examination in the feasibility study in complex engineering project. As the preliminary study of the Interconnection conducted by NPC suggested one particular option, NPC was reluctant to include a comparative study to examine alternatives in the Consultant’s TOR, and ADB accepted this position. As a result, the Project experienced some delays and additional costs when the recommendation of the POE on the configuration of the Interconnection (para. 28) was adopted. ADB and EAs should be cautious not to limit technical alternatives to a minimum number, and to make TORs flexible enough to allow consultants to propose other alternatives that should benefit the projects, especially in complex engineering studies.

51. Appropriate financial incentives should be provided to private operators that do not directly benefit from high economic returns of projects. The Project demonstrated the difficulty experienced in many countries in implementing transmission extensions in an unbundled electricity industry. The problem arises because the transmission network service provider, 10 operating a regulated common carrier business, does not directly share the economic benefits of reduced electricity generation costs. Hence, within a regulated industry structure, there is a need to provide financial incentives to transmission operators to extend their networks to generate national economic benefits.

52. The proposed structure of the Philippines electricity industry, as envisaged by the EPIRA, is designed to address this issue. The Department of Energy is required to prepare an integrated power development plan, and the rules of the wholesale electricity spot market, which will provide financial incentives for the construction of economically efficient transmission extensions. These measures, together with good governance and the performance-based regulation in the electricity industry, should ensure that economically efficient transmission extension projects are able to proceed.

C. Recommendations

53. Further Action or Follow-Up. ADB should continue its policy dialogue with the Government to ensure timely implementation of the power sector reforms including selection of a private sector concessionaire for the transmission company and promulgation of performance- based regulations, which will be essential to ensure the viability and sustainability of the Interconnection.

54. Should a decision is made to proceed with construction of the interconnection in the future, the data and forecasts from the various studies prepared under the Project should be updated in order to determine the optimal capacity and configuration of the Interconnection under current conditions.

55. Additional Assistance. A TA to promote good governance and effective regulation in the electricity industry, proposed for 2003, should be pursued. Effective regulation will be necessary to ensure that the transmission concessionaire has financial incentives to proceed with economically efficient extensions.

56. Timing of PPAR Preparation. A project performance audit report is considered unnecessary, given the Government’s decision not to proceed with construction of the Interconnection at this stage.

Appendix 1 11

PROJECT FRAMEWORK

Design Performance Monitoring Mechanisms Assumptions Summary Indicators/Targets and Risks Sector Goals • Restructure and • Deliver adequate power • Annual project review • Political instability privatize National at affordable prices. missions • Economic stagnation Power Corporation • Improve system stability • Utility annual reports • Natural disasters (NPC) and reliability, reduce and statistics • Support independent system losses, and • Annual economic power producer promote least-cost statistics involvement. electricity generation • Project completion • Expand NPC’s expansion in an report transmission system. environmentally sound • Consolidate manner. distribution utilities. • Introduce demand side • Support energy management and conservation energy conservation programs. programs.

Purpose • Complete • Reduce power outages • Utility reports and • Lower levels of demand interconnection of the and improve system project completion growth three power grids. reliability. report • Market collapse • Improve power • Reduce overall reserve system reliability in margins. Mindanao. • Enable planning for • Facilitate additional larger units with lower least-cost electricity unit costs. generation expansion.

Project Components • Feasibility study of • Verify technical • Asian Development • Weak performance of the interconnection feasibility of Bank (ADB) review consultants project interconnection. missions • Ineffective review by panel • Detailed design of the • Verify financial and of experts (POE) interconnection economic viability of project interconnection. • Preparation of the • Complete detailed tender documents submarine cable route selection. • Make detailed design of interconnection. • Produce tender documentation for interconnection project.

Inputs • Consulting services • 51 person-months of • ADB review missions • Weak performance of consulting services • Review of feasibility consultants • 4 person months of study report by POE • Ineffective review by POE experts • Review of detailed • Total project cost of engineering design by $6.037 million POE • Review of tender documents by POE

12 Appendix 2

ACTUAL DISBURSEMENTS – ADB LOAN 1474-PHI ($)

Year Quarter Amounts Cumulative Annual

1997 1 0 0

2 0 0 3 2,936,346 2,936,346 4 193,157 3,129,503 3,129,503

1998 1 0 3,129,503 2 366,000 3,495,503 3 20,584 3,516,087 4 111,161 3,627,248 497,745

1999 1 0 3,627,248 2 19,937 3,647,185 3 0 3,647,185 4 151,988 3,799,173 171,925

2000 1 94,242 3,893,415 2 211,210 4,104,625 3 54,504 4,159,129 4 235,648 4,394,777 595,604

2001 1 210,461 4,605,238 2 306,600 4,911,838 517,061

Appendix 3 13

STATUS OF COMPLIANCE WITH LOAN COVENANTS

Reference in Loan Covenant Agreement Status of Compliance National Power corporation (NPC) shall carry 4.01 Complied with out the technical assistance (TA) with due diligence and efficiency and will perform all TA- related obligations as set out in the loan agreement.

NPC shall make available, promptly as needed, 4.02 Complied with the funds, facilities, services, equipment, materials, documents, and other resources required to carry out the TA.

NPC shall cooperate fully with the consultants 4.03 Complied with and make available all information and assistance as they may reasonably request.

NPC shall furnish to the Asian Development 4.04(a) Complied with Bank (ADB) copies of all documents relating to the TA prepared by the consultants.

NPC shall give consideration to all 4.04(b) Complied with recommendations by the consultants and shall exchange views with ADB on the implementation thereof.

NPC shall maintain records and accounts 4.06 Complied with adequate to identify the services financed by the loan and shall record the progress of these services.

NPC shall furnish financial information as is 4.07(a) Complied with reasonably requested by ADB.

NPC shall provide ADB with a project 4.07(b) Not complied with completion report not later than 3 months after completion of the TA.

NPC shall provide ADB with a set of audited 4.08 Complied with but late; accounts no later than 6 months after the end of submission dates were each fiscal year (FY). FY97 21 Sep 98 FY98 3 Sep 99 FY99 3 Jul 00 FY00 1 Aug 01 FY01 12 Jul 02

14 Appendix 3

Reference in Loan Covenant Agreement Status of Compliance

NPC shall ensure that the project director for the Schedule 5, Complied with TA shall be provided with a sufficient number of para. 4 suitably experienced and qualified staff to implement the TA adequately.

NPC shall assign suitably qualified counterpart Schedule 5, Complied with staff to assist the consultants. para. 5

NPC shall obtain all necessary clearances and Schedule 5, Complied with permits for the TA, including those related to the para. 6 submarine survey.

NPC shall submit to ADB an environmental Schedule 5, Complied with impact assessment (EIA) of the investment para. 7 project by 31 May 1997 and a summary EIA by 30 June 1998

NPC shall submit a tariff proposal that Schedule 5, Complied with but late accurately reflects its fixed and variable costs para. 8 and shall use its best efforts to ensure that the proposal shall be implemented by 31 March 1997.