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Project Number: 49450-023 November 2019

Pacific Renewable Energy Investment Facility Federated States of : Renewable Energy Development Project

This document is being disclosed to the public in accordance with ADB’s Access to Information Policy.

CURRENCY EQUIVALENTS

The currency unit of the Federated States of Micronesia is the dollar.

ABBREVIATIONS

ADB – Asian Development Bank BESS – battery energy storage system COFA – Compact of Free Association DOFA – Department of Finance and Administration DORD – Department of Resources and Development EIRR – economic internal rate of return FMR – Financial Management Regulations FSM – Federated States of Micronesia GDP – gross domestic product GHG – greenhouse gas GWh – gigawatt-hour KUA – Utilities Authority kW – kilowatt kWh – kilowatt-hour MW – megawatt O&M – operation and maintenance PAM – project administration manual PIC – project implementation consultant PUC – Utilities Corporation TA – technical assistance YSPSC – State Public Service Corporation

NOTE

In this report, “$” refers to United States dollars unless otherwise stated.

Vice-President Ahmed M. Saeed, Operations 2 Director General Ma. Carmela D. Locsin, Pacific Department (PARD) Director Olly Norojono, Energy Division, PARD

Team leader J. Michael Trainor, Energy Specialist, PARD Team members Tahmeen Ahmad, Financial Management Specialist, Procurement, Portfolio, and Financial Management Department (PPFD) Taniela Faletau, Safeguards Specialist, PARD Eric Gagnon, Principal Procurement Specialist, PPFD Teresita Leono, Associate Project Officer, PARD Mairi MacRae, Social Development Specialist (Gender and Development), PARD Lyailya Nazarbekova, Principal Counsel, Office of the General Counsel Manisha Pradhananga, Economist, Economic Research and Regional Cooperation Department Peer reviewer Dae Kyeong Kim, Senior Energy Specialist (Smart Grids), Sustainable Development and Climate Change Department

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page PROJECT AT A GLANCE MAP I. BACKGROUND 1 II. THE PROJECT 1 A. Rationale 1 B. Project Description 4 C. Value Added by ADB 5 D. Summary Cost Estimates and Financing Plan 5 E. Implementation Arrangements 6 III. DUE DILIGENCE 8 A. Technical 8 B. Economic and Financial Viability 8 C. Sustainability 9 D. Governance 9 E. Poverty, Social, and Gender 10 F. Safeguards 11 G. Summary of Risk Assessment and Risk Management Plan 11 IV. ASSURANCES AND CONDITIONS 12 V. THE PRESIDENT’S DECISION 12

APPENDIXES

1. Design and Monitoring Framework 13

2. List of Linked Documents 16

Project Classification Information Status: Complete

PROJECT AT A GLANCE

1. Basic Data Project Number: 49450-023 Project Name Renewable Energy Development Project Department/Division PARD/PAEN Country Micronesia, Federated States of Executing Agency Department of Finance Borrower Government of the Federated States of and Administration Micronesia

Country Economic https://www.adb.org/Documents/LinkedDocs/ Indicators ?id=49450-023-CEI Portfolio at a Glance https://www.adb.org/Documents/LinkedDocs/ ?id=49450-023-PortAtaGlance

2. Sector Subsector(s) ADB Financing ($ million) Energy Renewable energy generation - solar 15.00 Total 15.00 3. Operational Priorities Climate Change Information Climate Change Information1 Addressing remaining poverty and reducing inequalities CO2 reduction (tons per annum) 2,533 Accelerating progress in gender equality Climate Change impact on the Low Tackling climate change, building climate and disaster resilience, and Project enhancing environmental sustainability Making cities more livable ADB Financing Strengthening governance and institutional capacity Adaptation ($ million) 0.75 Mitigation ($ million) 14.20 Sustainable Development Goals Gender Equity and Mainstreaming SDG 7.2 Some gender elements (SGE) SDG 13.a Poverty Targeting Household Targeting 4. Risk Categorization: Low . 5. Safeguard Categorization Environment: B Involuntary Resettlement: B Indigenous Peoples: C

. 6. Financing Modality and Sources Amount ($ million) ADB 15.00 Sovereign Project grant: Asian Development Fund 15.00 Cofinancing 0.00 None 0.00 Counterpart 0.51 Government 0.51 Total 15.51

Currency of ADB Financing: US Dollar

1 The project reduces greenhouse gas emissions. However, it does not fall under the eligibility criteria for climate mitigation finance as defined by the joint multilateral development bank methodology on tracking climate finance, which notes that not all activities that reduce greenhouse gases in the short term are eligible to be counted towards climate mitigation finance. Accordingly, greenfield fossil fuel projects are excluded, and climate mitigation finance is considered zero.

Source: Asian Development Bank This document must only be generated in eOps. 25102019114026771417 Generated Date: 07-Nov-2019 14:51:02 PM N O R T H P A C I F I C O C E A N FEDERATED STATES OF MICRONESIA RENEWABLE ENERGY DEVELOPMENT PROJECT

Ulithi YAP Fais Colonia Gaferut Ulul Murilo West Fayu Fayu Namonuito Nomwin Ngulu Minto Reef Olimarao Pulap CHUUK Weno Oruluk STATE OF Puluwat Pakin KOSRAE Nama POHNPEI Losap Ant Pulusuk Namoluk Lukunor KOSRAE Etal Ngatik STATE OF YAP Tofol STATE OF POHNPEI

STATE OF CHUUK YAP SUBPROJECTS

Rumung

Proposed Solar Installation Sites 5 2 around Yap Sports Complex Maap

KOSRAE SUBPROJECTS Kilometers km

Solar Sites Open Ground Solar Site N Wanyaan Kosrae International Airport

National Capital Kanif Lelu State Capital Colonia Tofol International Airport Yap International Airport Reef/ State Boundary Battery Energy Storage System International Boundary Ngoof Malem Boundaries are not necessarily authoritative. 192658 19FSM ABV

This map was produced by the cartography unit of the Asian Development Bank. Magachgil The boundaries, colors, denominations, and any other information shown on this Walung Households and Power House map do not imply, on the part of the Asian Development Bank, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries, colors, denominations, or information.

I. BACKGROUND

1. On 22 June 2017, the Board of Directors of the Asian Development Bank (ADB) approved 1 the Pacific Renewable Energy Investment Facility. The facility will finance renewable energy projects in ADB’s 11 smallest Pacific developing member countries. 2 It has an overall estimated cost of $750 million, including ADB financing of up to $200 million. Upon approval, the Board delegated authority to the President to approve loans and/or grants to each targeted country for qualifying projects.

2. The facility will provide a grant to the Federated States of Micronesia (FSM) for the Renewable Energy Development Project. The project will finance investment in renewable energy generation facilities in the FSM states of Kosrae and Yap—bolstering energy security and reducing reliance on fossil fuels for power generation in these states. Project investments will include (i) solar photovoltaic capacity and mini grid and solar home system investments for Kosrae Utilities Authority (KUA) in Kosrae and (ii) the installation and integration of photovoltaic capacity and a battery energy storage system (BESS) for Public Service Corporation (YSPSC) in Yap. The project will also support institutional strengthening and capacity building in KUA and YSPSC, as well as for Pohnpei Utilities Corporation (PUC) in the FSM state of Pohnpei.

II. THE PROJECT

A. Rationale

3. Macroeconomic context. The FSM has a population of about 105,000 spread across the western , comprising more than 600 islands. It is made up of four island states: Pohnpei, Kosrae, Chuuk, and Yap. The gross domestic product (GDP) is about $334 million. All petroleum products and a very high proportion of foods are imported. The FSM’s heavy dependence on imported petroleum fuels makes the country highly vulnerable to petroleum price volatility and shocks.

4. The FSM is a former United Nations Trust Territory of the Pacific Islands, administered by the United States until 1994. The FSM entered a Compact of Free Association (COFA) with the United States in 1986, ensuring 15 years of development aid during its transition to full sovereignty. The COFA provided large external financial transfers to support the operations of the Government of the FSM and substantial public sector investment at the state level, including in energy infrastructure. However, because of lack of adequate maintenance budgeting and practices, the infrastructure is now in poor condition. In 2003, the United States and the FSM entered into an Amended COFA under which the FSM would receive transfers of $92.7 million per year for 20 years, ending in 2023.

5. The FSM economy grew in 2018 by 0.8%, but this growth was driven largely by the fishing industry, which has attracted substantial increases in domestic revenues from fishing licenses sold to foreign fleets. The FSM’s economy has otherwise been stagnant, and significant development challenges remain. Development partner support has focused on achieving

1 ADB. 2017. Report and Recommendation of the President to the Board of Directors: Proposed Facility for the Pacific Renewable Energy Investment Facility. . 2 The , the Federated States of Micronesia, , the , Nauru, , , Solomon Islands, , , and Vanuatu.

2 medium-term fiscal sustainability to ensure that sufficient resources are available when cash transfers under the COFA expire in 2023.

6. Electricity demand and access. In 2018, electricity use in the FSM among various consumers were as follows: residential 20%, commercial and industrial 35%, and government 28%. The largest amount of electricity is used for air conditioning (especially in the government sector) and lighting. Pohnpei has the highest peak load of 6.6 megawatts (MW); peak loads in other states are as follows: 2.7 MW in Chuuk, 2.3 MW in Yap, and 1.2 MW in Kosrae.3 System losses averaged 17%, which is a high value that indicates likely widespread unreported and unbilled consumption.

7. Overall demand for power in the FSM is expected to increase by 60% from 2018 to 2037, from 67.0 gigawatt-hours (GWh) to 107.0 GWh per annum, due to population growth, increased economic activity, and expansion of power service to currently unserved populations. Demand from the Yap main grid is expected to increase by 56%, from 11.2 GWh to 17.6 GWh by 2037, while demand on the Kosrae main grid is expected to increase by 49%, from 6.0 GWh to 9.0 GWh over the same period.

8. Electricity generation in the FSM is based almost completely on fossil fuels. Only a small amount (about 9%) is generated from solar, wind, and small hydropower generation. About 76% of households in the FSM have some form of electrification. However, access rates vary widely among states, with Kosrae and Pohnpei having an electrification rate of about 95%, Yap 87%, and Chuuk only 27%.

9. The FSM spends about $40 million annually on imported fuels (about 12% of GDP). This represents more than half of the aggregate sectoral grants the nation receives from the United States under the COFA, and nearly 15% of nominal GDP—making energy the costliest sector of its fragile economy.

10. The high cost of power generation in the FSM is a constraint on economic growth and a burden on household and state budgets. Energy balance modeling was conducted to determine least-cost generation options for Kosrae and Yap’s main grids, consistent with the objectives of the FSM’s energy master plans. The resulting analyses are the basis for the proposed investments in Kosrae and Yap, and deliver least-cost generation to meet current and near-term load growth consistent with renewable energy generation development pathways in both states.

11. The project’s development was coordinated with other development partners and the FSM state utilities, facilitated by the national government’s Department of Resources and Development (DORD), and guided by the FSM energy master plans. DORD has requested ADB to fund investments in Kosrae and Yap, whereas the World Bank and the European Union (through the Secretariat of the Pacific Community) have pledged investments to support the FSM energy master plans’ targets in Pohnpei and Chuuk.

12. Sustainability of the utility companies. Each state of the FSM is served by its own state- owned utility company that rely primarily on diesel fuel for power generation and serve the majority of their customers on each state’s main island with peak load ranging from 1.2 MW in Kosrae to 6.6 MW in Pohnpei. These utilities also provide water and sanitation services to their states’ populations. Their commercial and financial performance, and thus their long-term viability, is broadly acknowledged as a threat to the sustainability of sector capital assets and provision of

3 Castalia Strategic Advisors. 2018. Energy Master Plans for the Federated States of Micronesia. Sydney (April).

3 utility services to the FSM’s economy and population. While each of the FSM’s state-owned utilities has its own unique characteristics, they all share many similar challenges and are in the same need of institutional strengthening and reform.

13. Broadly speaking, none of the FSM’s state-owned power utilities are able to generate sufficient revenue to cover their full costs: tariffs are generally sufficient to cover current operating costs, but not capital replacement. Additionally, there is a high degree of cross-subsidization of areas of operation (primarily subsidization of water and sanitation services at the expense of power operations – a problem that is particularly acute in Pohnpei). The consequences of this include inadequate budgeting for maintenance, leading to premature dilapidation of plants, diminished operating efficiency, and reduced service reliability. These problems are compounded by limitations to the utilities’ ability to attract and retain sufficient numbers of experienced skilled personnel at all levels of operation.

14. Barrier to private sector investment in the energy sector. The environment in the FSM is not conducive to private sector investment in the power sector. This is largely because of the financial distress (and corresponding low creditworthiness) of the FSM’s state-owned utilities, and also the fundamental reality of the high country risk, small market and small project size, and high transaction costs. These factors combine to limit the level of interest of prospective investors, and increase the cost of commercial capital for any investment in this sector.4

15. Proposed solutions. The project will increase renewable energy generation in Kosrae and Yap, and will achieve about 30% renewable energy contribution in the first year of the project’s operation in these states, which is in line with the FSM national energy targets. The project will also increase access to electricity in Kosrae with the electrification of Walung Village.

16. Following its Nationally Determined Contributions under the Paris Agreement, the FSM has committed to reduce its greenhouse gas (GHG) emissions from the 2000 baseline level by 28%, i.e., to reduce emissions from 150,000 tons per annum to about 108,000 tons per annum of carbon dioxide equivalent by 2025. The project thus contributes to the FSM’s efforts to fulfil its international commitments on climate change mitigation, while supporting the FSM National Vision Statement for Energy.5

17. Alignment with development strategies. The project supports the implementation of the FSM energy master plans in the states of Kosrae, Pohnpei, and Yap (footnote 3). The master plans were developed under World Bank technical assistance (TA) and completed in April 2018 for each of the FSM’s four states and the FSM nation as a whole to support the FSM National Vision Statement for Energy to “improve the life and livelihood of all FSM residents with affordable, reliable and environmentally sound energy” (footnote 5).

18. The project is aligned with ADB’s Strategy 2030.6 It addresses remaining poverty and reducing inequalities by creating jobs and provides electricity to currently underserved communities. It strengthens the governance and institutional capacity of the power utilities. The project will tackle climate change, build climate and disaster resilience, and enhance

4 FSM Petroleum Corporation operates as an independent power producer selling power to PUC, but this is a quasi- commercial investment. FSM Petroleum Corporation is a publicly owned national corporation, and entered into this arrangement as a response to acute power shortages on Pohnpei in 2014. 5 Government of the FSM, DORD. 2012. Page 10. 2012 Energy Policy: Volume I. Palikir. 6 ADB. 2018. Strategy 2030: Achieving a Prosperous, Inclusive, Resilient, and Sustainable Asia and the Pacific. Manila.

4 environmental sustainability. It is included in ADB’s country operations and business plan for 11 small Pacific island countries, 2020–2022.7

19. Lessons learned. In Yap, ADB previously financed the Yap Renewable Energy Development Project, which installed 825 kilowatts (kW) of wind generation, 300 kW of rooftop solar photovoltaic generation, 2.5 MW of diesel generation, and an integration and control system.8 The project was completed in 2018. It was rated successful, and demonstrated the Yap utility’s capacity to manage project implementation and achieve targets within budget as well as its ability to cope with delays caused by exogenous factors. The project will build on these investments and further decrease Yap’s reliance on diesel for power generation and reduce its contribution to the FSM’s total GHG emissions.

20. Processing under the Pacific Renewable Energy Investment Facility. The project is included under the Pacific Renewable Energy Investment Facility (footnote 1), which aims to improve regional energy security in the Pacific region. The facility was approved to cover renewable energy investments and supporting infrastructure. The project qualifies to be approved under the Pacific Renewable Energy Financing Facility because (i) its scope includes renewable energy generation and supporting energy sector infrastructure, (ii) the FSM is one of the 11 eligible Pacific developing member countries, (iii) the project is identified in national energy sector planning documents as a priority investment (footnote 3, footnote 5), and (iv) the project has been classified category B for environment.

B. Project Description

21. The project is aligned with the following impact: sustainable social and economic development of the FSM promoted through the provision and utilization of cost-effective, safe, reliable, and sustainable energy services, per the FSM National Objective for Energy (footnote 5). The project will have the following outcome: sustainable generation and utilization of renewable energy in Yap, Kosrae, and Pohnpei increased.9

22. Output 1: Solar photovoltaic and mini grid in Kosrae installed. The project will finance 1.15 MWp of solar photovoltaic capacity connected to the main grid and solar–diesel hybrid mini grid and solar home systems in Walung village.

23. Output 2: Solar photovoltaic and battery energy storage system installed with system integration upgraded in Yap. The project will fund a 1.95 MWp of ground-mount, 300 KWp rooftop solar photovoltaic capacity, 800 kW/800 kilowatt-hours (kWh) of BESS, and the existing renewable energy integration and control system upgrade.

24. Output 3: Pohnpei Utilities Corporation strengthened. The project will support PUC to (i) reform the systems and processes required for efficient utility operation, (ii) develop PUC management and staff to provide for sustainable operations as a commercial entity, (iii) support PUC management in representation to its board and government on policy-related and policy-dependent actions, and (iv) assist PUC management in designing and overseeing special projects and identifying resource requirements and sources for them.

7 ADB. 2019. Country Operations Business Plan: 11 Small Pacific Island Countries, 2020–2022. Manila. 8 ADB. 2013. Report and Recommendation of the President to the Board of Directors: Proposed Loans to the Federated States of Micronesia for the Yap Renewable Energy Development Project. Manila. 9 The design and monitoring framework is in Appendix 1.

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25. Output 4: Efficient project management delivered and implementing agency capacity developed. The project will finance project implementation consultants (PICs) (a firm) to help manage the project and serve as the owner’s engineer for the delivery of outputs 1 and 2.

C. Value Added by ADB

26. The project is aligned with the FSM’s energy master plans (footnote 3) prepared under a TA grant provided by the World Bank. Project activities are being coordinated with those under the World Bank’s Sustainable Energy Development and Access Project and the European Union’s European Development Fund 11, both of which prioritize energy access objectives identified in the master plans.10,11 The preparation of the project included feasibility assessments for outer- island electrification in ; the output of this feasibility study work is being shared with the World Bank and the European Union to support their investments in Chuuk State.

27. The expansion of solar photovoltaic generation in Yap and the integration of BESS on the Yap power system, at the level of renewable integration that this project will achieve, is an example of ADB financing of technology innovation, and builds on the experience of the recently completed Yap Renewable Energy Development Project (footnote 8). It leverages investments in that project’s integration and control system to expand YSPSC’s use of intermittent renewable energy sources.

28. The institutional strengthening consultant support in PUC (output 3) was developed under recent ADB TA (footnote 12) and has been extensively coordinated with the United States Department of the Interior’s Office of Insular Affairs, which manages implementation of COFA infrastructure grants. The Office of Insular Affairs has made the implementation of meaningful institutional strengthening and reforms of PUC a condition for further allocations of COFA infrastructure grant resources for investment in PUC’s electricity operations.

29. PUC suffers most acutely from poor commercial performance and threats to its long-term viability. At the request of PUC’s board of directors, ADB mobilized TA to diagnose the root causes of PUC’s poor performance and to develop an institutional strengthening and reform program.12 The recommended reform program was presented to PUC stakeholders in February 2019. PUC’s board of directors passed a resolution in May 2019 to implement the recommended reforms. The project will support commencement of these reforms under output 3.

30. To address the commercial and financial performance gaps of KUA and YSPSC, and in parallel with the implementation of the project, ADB will deliver the TA for Capacity Building and Sector Reform for Renewable Energy Investments in the Pacific (footnote 12) that supports the institutional strengthening of PUC (output 3). (Note: while not a beneficiary of the proposed project, Chuuk Public Utility Corporation is currently receiving support under the referenced TA.)

D. Summary Cost Estimates and Financing Plan

31. The project is estimated to cost $15.51 million (Table 1).

10 World Bank. Projects and Operations. Sustainable Energy Development and Access Project. http://projects.worldbank.org/P165183?lang=en. 11 European Commission. 2015. The Federated States of Micronesia: European Union National Indicative Program for the Period 2014–2020. Brussels. 12 ADB. 2017. Technical Assistance for Capacity Building and Sector Reform for Renewable Energy Investments in the Pacific. Manila.

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32. Detailed cost estimates by expenditure category and by financier are included in the project administration manual (PAM).13 The project will finance physical investments for KUA and YSPSC in solar photovoltaic generation capacities, battery energy storage, integration and control systems, and remote settlement electrification. It will also finance PICs for DORD to build capacity and deliver project management unit support, as well as consultants for institutional strengthening in PUC.

Table 1: Summary Cost Estimates Amounta Item ($ million) A. Base Costb 1. Solar photovoltaic and mini grid in Kosrae installed 5.05 2. Solar photovoltaic and battery energy storage system installed with system integration upgraded in Yap 6.84 3. Pohnpei Utilities Corporation strengthened 0.74 4. Efficient project management delivered and implementing agency capacity developed 1.10 Subtotal (A) 13.73 B. Contingenciesc 1.78 Total (A+B) 15.51 a Includes taxes and duties of $0.51 million. Such amount does not represent an excessive share of the project cost The government will finance taxes and duties of $0.51 million (noncash contribution). b In mid-2019 prices as of July 2019. c Physical and price contingencies, and a provision for exchange rate fluctuation, are included. Source: Asian Development Bank estimates.

33. The government has requested a grant not exceeding $15.0 million from ADB’s Special Funds resources (Asian Development Fund) to help finance the project.

34. The summary financing plan is in Table 2. ADB will finance the expenditures in relation to the delivery, installation, and integration of solar photovoltaic generation capacity, battery energy storage, integration and control system upgrades, institutional strengthening and capacity- building consultant support, and project implementation and administration support. The government has agreed to provide counterpart financing in the form of exemption of taxes and duties.

Table 2: Summary Financing Plan Amount Share of Total Source ($ million) (%) Asian Development Bank Special Funds resources (Asian Development Fund grant) 15.00 96.7 Government of the Federated States of Micronesia 0.51 3.3 Total 15.51 100.0 Source: Asian Development Bank estimates.

E. Implementation Arrangements

35. The Department of Finance and Administration (DOFA) is the project’s executing agency and DORD is the implementing agency. The PICs will be hired (under output 4) to support DORD throughout the project and build capacity within DORD for management of development partner-

13 Project Administration Manual (accessible from the list of linked documents in Appendix 2).

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financed projects. In addition to their role as owner’s engineer in overseeing the execution of contracts under outputs 1 and 2, consultants will support a dedicated project management unit within DORD and will coordinate with KUA, YSPSC, and PUC on project delivery in their respective utilities. The project steering committee, chaired by DORD and comprising DOFA and the three affected state-owned utilities, will coordinate project implementation and will convene bid evaluation committees comprising DOFA, DORD, and the respective utilities. ADB will be an observer to all deliberations of the project steering committee.

36. The implementation arrangements are summarized in Table 3 and described in detail in the PAM (footnote 13).

Table 3: Implementation Arrangements Aspects Arrangements Implementation period February 2020–February 2023 Estimated completion date 28 February 2023 (physical completion) Estimated grant closing date 31 August 2023 Management (i) Oversight body Project steering committee comprising one member each from the Department of Resources and Development (chair), Department of Finance and Administration, Kosrae Utilities Authority, Yap State Public Services Commission, Pohnpei Utilities Corporation, and ADB (as observer) (ii) Executing agency Department of Finance and Administration (iii) Implementing agency The FSM’s Department of Resources and Development, with dedicated project management unit consultant support provided by the project implementation consultants Procurement International 1 contract $11.89 million competitive bidding Single-source 1 contract $0.31 million selection Consulting services - two contracts 1. Project implementation consultants, Quality- and cost- 31 person-months $0.87 million including project management unit based selection with (international), support 90:10 quality: cost 24 person-months weighting (national) 2. Supplemental management and Quality- and cost- 29 person-months $0.74 million operations consultants based selection with (international) 90:10 quality: cost weighting Advance contracting Advance contracting for consultants and engineering, procurement, and design contractors Disbursement The grant proceeds will be disbursed following ADB’s Loan Disbursement Handbook (2017, as amended from time to time) and detailed arrangements agreed between the government and ADB. ADB = Asian Development Bank, FSM = Federated States of Micronesia. Source: Asian Development Bank.

37. Procurement of goods and works will be conducted in accordance with ADB’s Procurement Guidelines (2015, as amended time to time). Recruitment of all consultants will follow ADB’s Guidelines on the Use of Consultants (2013, as amended from time to time).

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38. The single-source selection for output 2 will be awarded to Vergnet SA, the supplier of the Hybrid Wizard master control module procured under the Yap Renewable Energy Development Project (footnote 8).14

39. The Government of the FSM has delegated consultant selection to ADB, with review and consent by the project steering committee at each important milestone. ADB will manage consultant recruitment for outputs 3 and 4.

III. DUE DILIGENCE

A. Technical

40. The project design considers the least-cost approach to meeting forecast demand using proven and commercially available technology. The design is coordinated with the related World Bank-funded project in KUA. Both KUA and YSPSC are familiar with the operation of photovoltaic arrays. Capacity building is included where new technology is introduced, such as battery energy storage systems (in both utilities) and hybrid power systems mini grid operation in KUA. The project design considers climate change impacts.

B. Economic and Financial Viability

41. The project is found to be economically viable, with an economic internal rate of return (EIRR) of 8.5% for the Kosrae main grid investments and 6.7% for the Yap main grid investments, above the 6.0% minimum required EIRR for ADB investment projects in poor and remote areas. The main benefits are fuel savings and reduced GHG emissions. The economic costs of GHG emissions were valued according to ADB’s Guidelines for the Economic Analysis of Projects (2017) using the social cost of carbon and calculated based on the annual fuel usage multiplied by the carbon dioxide emission per unit of diesel burned (2.7 kilograms/liter).15

42. The Walung settlement electrification on Kosrae was assessed using cost-effectiveness analysis rather than cost–benefit analysis, as this component serves very poor and remote areas where benefits are difficult to value. Project costs were compared with supplying the same benefits by the next best alternative—a 100% diesel-powered mini grid. Alternative costs include the capital cost of diesel generators and ancillary equipment; the powerhouse and distribution system; and operation and maintenance (O&M) and fuel costs. These costs were compared against the costs of the proposed solar-diesel-battery mini grid and solar home systems investment. The cost-effectiveness ratio favors the project over the next best alternative, with a per kilowatt-hour cost of $1.88 versus $1.94 for a 100% diesel-powered mini grid. Therefore, the project uses an economically cost-effective method to provide access to electricity for the Walung settlement.

43. A sensitivity analysis of the EIRR and economic net present value to key risk parameters was conducted under the following scenarios: (i) an increase in capital costs by 10%, (ii) an increase in O&M costs by 10%, (iii) a decrease in benefits by 10%, and (iv) a delay of project commencement by one year. Results show that the overall project is economically viable across

14 The Hybrid Wizard system is a proprietary system supplied by Vergnet SA; only Vergnet SA can perform the necessary modifications to the system’s master control module to integrate additional renewable energy capacity. 15 United States Energy Information Administration. Frequently Asked Questions. How much carbon dioxide is produced from US gasoline and diesel fuel consumption?

9 all sensitivity parameters. The Yap main grid subproject is sensitive to a 10% reduction in benefits and delay by one year. The Kosrae main grid subproject is viable across all sensitivity parameters.

44. The project is not financially viable, with an overall project financial internal rate of return of 1.0%, which is below the WACC of 1.7%. However, the project’s annual benefits outweigh annual expenditure.16 A financial sustainability analysis carried out by projecting the financials of both YSPSC and KUA, incorporating the project, demonstrates that the annual incremental benefits of the project resulting from fuel savings (between $0.4 million and $0.5 million in Yap, and between $0.2 million and $0.3 million in Kosrae) are far greater than the incremental O&M cost ($39,000 in Yap and $24,000 in Kosrae). Only the up-front capital cost cannot be recovered through the annual benefits, hence the low financial internal rate of return.

45. The impact of the project for customers of both utilities will be a reduction in tariffs (all else being equal). In Yap, the benefits of the project through fuel savings reduce the cost recovery tariff from $0.56/kWh to $0.47/kWh, although depreciation and increasing fuel prices increase the tariff to $0.50/kWh by 2027. In Kosrae, the cost recovery tariff reduces from $0.52/kWh to $0.38/kWh, although depreciation and increasing fuel prices bring the tariff to $0.44/kWh by 2027.

C. Sustainability

46. The risk to financial sustainability is substantial. To overcome the sustainability risks to the project, and to ensure that YSPSC and KUA are able to allocate sufficient resources for operation, maintenance, and eventual capital replacement, measures must be taken to allow these utilities to increase their revenues; and reform of both utilities’ tariff regimes is necessary. Covenants have been included in the grant agreement, including the review of utilities’ revenue requirements, revision of tariffs, and attainment and maintenance of an operating ratio of at least 1.0 by the end of 2020 for KUA and YSPSC. These measures will also be supported through the TA for Capacity Building and Sector Reform for Renewable Energy Investments in the Pacific (footnote 12).

D. Governance

47. Institutional framework. The executing agency has experience in implementing ADB projects as pertains to financial reporting and oversight. However, the implementing agency lacks such experience and does not possess sufficient in-house resources or systems to manage the project’s administration effectively. To mitigate the risk that this poses, the project will create a project management unit within DORD, staffed by persons recruited under the PIC contract (output 4).

48. Financial management. The assessed pre-mitigation financial management risk is substantial because of its potential impact, although the risk of its occurrence is considered low. The implementing agency has been serving as the implementing agency for the World Bank’s Sustainable Energy Development and Access Project grant and is supported by a Central Implementation Unit established within DOFA to support the implementation of multilateral development partner programs benefitting the FSM. A financial management action plan has been discussed and agreed with executing and implementing agencies.

49. Procurement and implementation risks. The FSM has a well-established public procurement system at the national and state levels, which is governed by the Financial Management Regulations (FMR) established at the national level, and closely followed by the

16 In most years, except if major capital replacement is needed in that year.

10 state-level finance units. The FMR cover all key aspects of a public procurement system including policies, institutional framework, guidelines, processes and procedures, administration, and financial management of the procurement system. In practice, the FMR also serve as a procurement manual for staff handling the procurement of goods, services, and works for government-funded projects.

50. The main weaknesses of the FMR are identified as (i) limited experience in the implementation of externally financed projects, (ii) the small number of procurement staff, (iii) the lack of a nationwide specialized or accredited procurement training program for procurement staff, and (iv) the lack of a manual containing detailed procedures for procurement and project management for projects financed by multilateral agencies.

51. The inherent procurement and implementation risks will be mitigated by (i) training provided by ADB’s Procurement, Portfolio, and Financial Management Department on ADB procedures for the procurement of goods, works, and consulting services; and (ii) advance recruitment of PICs (delegated to ADB) which is included in the procurement plan.

52. Integrity and anticorruption. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government and DOFA. The specific policy requirements and supplementary measures are described in the PAM (footnote 13).

E. Poverty, Social, and Gender

53. The main beneficiaries of the project are the 11,000 residents of Yap and 7,000 residents of Kosrae who will enjoy reduced power costs and decreased local environmental pollution through the reduction of diesel combustion; and in Kosrae’s Walung village, the provision of formal electricity for the first time. Imported diesel accounts for about 80% of power generation on Yap and 95% on Kosrae. Renewable energies have the potential to decrease tariffs, increase service reliability, and decrease emissions of local environmental pollutants (and thus decreased morbidity). Reduced costs and increased access both contribute to increased economic activity and opportunities for productive activities.

54. The provision of social services, such as health and education, is also expected to improve on Yap and Kosrae through a consistent power supply. The project will also benefit the population on Pohnpei through the improvement of PUC’s commercial performance and long-term viability and ability to deliver reliable utility services.

55. This project is classified as having some gender elements overall, particularly in the installation of the Walung hybrid mini grid, which would increase electricity access—boosting productive and income-generating activities among women. Women are also expected to benefit from improved access to social services such as health facilities and consistent water supply from a resilient energy supply as they bear the responsibility of caring for their families. To provide direct gender benefits and enhance the utilities’ operations, the project will help YSPSC and KUA develop and begin implementing a gender strategy to broaden the available pool of technical and trade expertise by attracting and retaining more females to those roles.

11

F. Safeguards

56. In compliance with ADB’s Safeguard Policy Statement (2009), the project’s safeguard categories are as follows.17

57. Environment (category B). Two initial environmental examinations and environmental management plans were prepared by transaction technical assistance consultants in accordance with the Yap State Environmental Protection Agency Regulations, the Kosrae State Code, Kosrae Regulations for Development Projects, and ADB’s Safeguard Policy Statement. No significant environmental impacts will result from the implementation of the overall project. During implementation, the PICs will support project management units in YSPC and KUA to (i) review and update the initial environmental examinations, (ii) monitor contractor compliance and manage environmental impacts, and (iii) report on environmental monitoring. DORD will submit environmental reporting to ADB semiannually.

58. Involuntary resettlement (category B). A draft land acquisition resettlement plan has been prepared by transactional technical assistance consultants. The resettlement plan is for the acquisition of an identified site on Yap and to facilitate necessary easements for power distribution on Kosrae. The draft resettlement plan will be updated after the detailed engineering design. No subproject is expected to involve physical displacement or relocation of people. During implementation, the PICs will support project management units in YSPC and KUA to monitor compliance with the resettlement plan. DORD will submit environmental reporting to ADB semiannually.

59. Indigenous peoples (category C). Transaction technical assistance consultants’ due diligence confirmed that no indigenous communities will be impacted by any of the subprojects analyzed. The beneficiaries in the project sites are not discriminated against because of their language, skin color, or traditional practices. All project outputs will be delivered in a culturally appropriate and participatory manner.

G. Summary of Risk Assessment and Risk Management Plan

60. Significant risks and mitigating measures are summarized in Table 4 and described in detail in the risk assessment and risk management plan.18

Table 4: Summary of Risks and Mitigating Measures Risks Mitigation Measures Project financial management delays or The project implementation consultants will establish a errors. The implementing agency lacks project management unit in the implementing agency and substantial experience in managing provide capacity building to ensure efficient project development partner-financed projects, implementation and prepare the implementing agency for and may be unable to perform financial future externally financed projects. management functions efficiently. Asset lifetime not achieved because of O&M training of hybrid power systems for KUA and YSPSC poor maintenance caused by limited staff will be included in the contractor’s scope of work. experience in O&M of the new assets installed under the project. Delayed operation caused by the delays DORD and KUA will coordinate with the World Bank and of the World Bank-financed battery energy ADB to ensure synchronized project implementation.

17 ADB. Safeguard Categories. 18 Risk Assessment and Risk Management Plan (accessible from the list of linked documents in Appendix 2).

12 storage system for KUA, thus delaying the dispatch of the ADB-funded photovoltaic generation. Delayed project commencement The Federated States of Micronesia and relevant states because of land agreements, permits, have agreed to ensure that the implementation of approved and/or compensation payments delay environment and land acquisition and resettlement plans is done without delay. Ineffective operation and degradation of Consultant support will be provided under ADB’s technical the new assets as a result of either assistance for Capacity Building and Sector Reform for improper O&M, insufficient funding for Renewable Energy Investments in the Pacific to assist KUA maintenance, or low tariffs. and YSPSC to implement measures to improve O&M.a Ineffective project management and Consultant support will be provided under the project for slow implementation caused by the lack DORD to help implement the project, including progress of DORD experience in implementing ADB- monitoring, ensuring compliance, managing contracts, and funded projects disbursements. ADB = Asian Development Bank, DORD = Department of Resources and Development, KUA = Kosrae Utilities Authority, O&M = operation and maintenance, YSPSC = Yap State Public Service Corporation. a ADB. 2017. Technical Assistance for Capacity Building and Sector Reform for Renewable Energy Investments in the Pacific. Manila (TA 9425-REG). Source: Asian Development Bank

IV. ASSURANCES AND CONDITIONS

61. The government and DOFA have assured ADB that implementation of the project shall conform to all applicable ADB requirements, including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, financial management, and disbursement as described in detail in the PAM and draft grant agreement (accessible from the list of linked documents in Appendix 2).

62. The government and DOFA have agreed with ADB on certain covenants for the project, which are set forth in the draft grant agreement (Appendix 2).

63. As a condition for the disbursement of grant proceeds for the payment of withdrawal applications for contracts for goods or works, the government shall have concluded separate tripartite grant agreements, in form and substance acceptable to ADB, with each of (i) Yap State and YSPSC; (ii) Kosrae State and KUA; and (iii) Pohnpei State and PUC, providing for enforceability of the assurances and covenants set forth in the draft grant agreement.

V. THE PRESIDENT’S DECISION

64. The President, acting under the authority delegated by the Board through the approval of the Pacific Renewable Energy Investment Facility, has approved the grant not exceeding $15,000,000 to the Federated States of Micronesia for the Renewable Energy Development Project, from Special Funds resources (Asian Development Fund) of the Asian Development Bank (ADB), on terms and conditions as are substantially in accordance with those set forth in the draft grant agreement.

Appendix 1 13

DESIGN AND MONITORING FRAMEWORK Impact the Project is Aligned with Sustainable social and economic development of the FSM promoted through the provision and utilization a of cost-effective, safe, reliable, and sustainable energy services (National Objective for Energy) Data Sources Performance Indicators and Reporting Results Chain with Targets and Baselines Mechanisms Risks Outcome By 2023:

Sustainable a. Renewable electricity contribution YSPSC and Reduction in diesel generation and increased to 38% of generation mix in KUA annual use by power sector utilization of Yap and 30% in Kosrae (2019 baseline: reports offset by increase in renewable 19% in Yap and 8% in Kosrae) other sectors energy in Yap, b. Generation of solar energy increased by Kosrae, and 2,700 MWh per year in Yap and Local operators at Pohnpei 1,700 MWh per year in Kosrae Walung override increased (2019 baseline: 580 MWh in Yap and control system and 490 MWh in Kosrae) manually use diesel c. Diesel fuel consumption decreased by at generator least 0.92 million liters per year in Yap and Kosrae (2019 baseline: 4 million liters) d. CO2 emissions in Yap and Kosrae reduced by 2,533 tons per year (2019 baseline: 10,730 tons of CO2 emissions) e. Walung Village fully electrified (2020 baseline: none) f. YSPSC and KUA will achieve and maintain an operating ratio of at least 1:1 (baseline: to be determined) Outputs By 2023:

1. Solar 1.1. Additional 1,150 kWp of solar KUA annual Limited number of photovoltaic and photovoltaic commissioned and reports, project bidders because of mini grid in operational in Kosrae power system progress small size package Kosrae installed (2019 baseline: 345 kWp) reports and remote project 1.2.1. 60 kWp rooftop solar photovoltaic location installed on school building (2019 baseline: 0) Delayed integration 1.2.2. 30 kW diesel generator and 160 kWh of solar photovoltaic BESS installed (2019 baseline: 0) with the World Bank 1.2.3. 39 households connected to the BESS distribution network with priority to connecting 100% of households headed by womenb (2019 baseline: 0) 1.2.4. Nine SHSs installed outside of mini grid distribution network (2019 baseline: 0) 1.3. Three Workshops with KUA on workforce planning held and three workshops on gender strategy and institutional study held, with outreach to increase women in the utility sectorc (2019 baseline: 0)

14 Appendix 1

Data Sources Performance Indicators and Reporting Results Chain with Targets and Baselines Mechanisms Risks By By 2023:

2. Solar 2.1. Additional 300 kWp solar photovoltaic YSPSC annual Bidding packages photovoltaic and rooftops installed (2019 baseline: reports, project do not receive BESS installed 200 kWp) progress sufficient with system 2.2. At least 1,950 kWp ground mount reports competitive tender integration photovoltaic generation capacity offers upgraded in Yap commissioned and operational (2019 baseline: 0) Delay in securing 2.3. At least an 800 kW/800 kWh BESS lease for ground commissioned (2019 baseline: 0) mount solar 2.4. Control system is upgraded successfully photovoltaic site and outputs 1–3 are integrated into the YSPSC power system (2019 baseline: 0) I&C contractor 2.5 Workshops with YSPSC held on unable to integrate workforce planning, and three workshops project into YSPSC on gender strategy and institutional study power system. with outreach to increase women in the utility sector, with targeted human- Operators lose resource policy reforms, such as paid confidence in control maternity leave, flexible working hours, system and and anti-harassment policiesd manually override, (2019 baseline: 0) using more diesel fuel than projected.

YSPSC fails to prepare and engage in workshops. 3. Pohnpei By 2023: Pohnpei Decision-making Utilities Utilities delays at the Corporation 3.1. PUC’s Operating Ratio of 1.0 maintained Corporation political level strengthened (2019 baseline: < 1.0) supplemental 3.2. Key energy policies adopted (2019 management baseline: not applicable) and operations 3.3. Capital investment planning procedures consultant improved (2019 baseline: not applicable) reports 4. Efficient By 2023: project management 4. Project implementation completed within delivered and budget and on schedulee (2019 Baseline: implementing not applicable) agency capacity developed Key Activities with Milestones 1. Solar photovoltaic and mini grid in Kosrae installed 1.1 Install solar photovoltaic in Kosrae power system 1.2 Install mini grid and SHS in Walung Village 1.2.1 Procure EPC contractor (Q3 2019–Q1 2020) 1.2.2 Award EPC contract (Q1 2020) 1.2.3 Contractor designs and orders equipment (Q2–Q3 2020) 1.2.4 Contractor mobilizes to Kosrae (Q4 2020) 1.2.5 Contractor installs solar photovoltaic, mini grid, and SHS (Q4 2020–Q1 2023)

Appendix 1 15

Key Activities with Milestones 1.2.6 Contractor operates, maintains, and hands over solar photovoltaic, mini grid, and SHS with manuals (Q1 2023) 1.3 KUA capacity building in solar photovoltaic and mini grid construction, operation and maintenance, gender, environmental, and social safeguards (Q2 2021–Q4 2022) 2. Solar photovoltaic and BESS installed with system integration upgraded in Yap 2.1 Install solar photovoltaic on Yap Sports Centre rooftops 2.2 Install ground-mount solar photovoltaic near YSPSC power station 2.3 Install BESS at YSPSC power station 2.3.1 Procure EPC contractor (Q4 2019–Q1 2020) 2.3.2 Contractor designs and orders equipment (Q2–Q3 2020) 2.3.3 Contractor mobilizes to Yap (Q4 2020) 2.3.4 Contractor installs solar photovoltaic and BESS (Q4 2020–Q2 2021) 2.3.5 Contractor integrates BESS with YSPSC power system (Q2 2020–Q3 2021) 2.3.6 Contractor operates, maintains, and hands over solar photovoltaic and BESS with manuals (Q4 2021) 2.4 Upgrade integration and control system for YSPSC power system to integrate outputs 2.1, 2.2, and 2.3 into YSPSC power system 2.4.1 Procure I&C contractor (Q4 2019–Q1 2020) 2.4.2 Design I&C philosophy (Q3 2020) 2.4.3 I&C contractor upgrades control system (Q4 2020–Q1 2021) 2.4.4 I&C contractor integrates outputs 1–3 (Q2–Q3 2021) 2.4.5 I&C contractor commissions YSPSC power system (Q3–Q4 2021) 2.5 YSPSC capacity building in solar photovoltaic and BESS design, construction, operation and maintenance; and on gender, environmental, and social safeguards (Q2 2021–Q4 2022). 3. Pohnpei Utilities Corporation strengthened 3.1 Recruit and select supplemental management and operations consultants (Q4 2019–Q1 2020) 3.2 Consultant mobilization to Pohnpei (Q1 2020) 4. Efficient project management delivered and implementing agency capacity developed 4.1 Recruit and select project implementation consultants (Q4 2019–Q1 2020) 4.2 Project implementation consultant facilitates workshops with KUA and YSPSC on strategies to develop medium- to long-term workforce planning and to develop and implement a gender strategy (Q3–Q4 2020) Inputs Asian Development Bank: $15.00 million (Asian Development Fund grant) Government of the FSM: $0.51 million (in kind, taxes, and duties) BESS = battery energy storage system; CO2 = carbon dioxide; EPC = engineering, procurement, and construction; FSM = Federated States of Micronesia; I&C = integration and control; KUA = Kosrae Utilities Authority; kW = kilowatt; kWh = kilowatt-hour; kWp = kilowatt-peak; MWh = megawatt-hour; Q = quarter, SHS = solar home system; YSPSC = Yap State Public Utility Corporation. a Government of the Federated States of Micronesia, Department of Resources and Development. 2012. Energy Policy: Volume I. Palikir. b 10% of Walung households are headed by women. c This will include preparation of a gender needs assessment of women’s reproductive, productive, and community needs; identification of, and recommendations to remedy, existing shortcomings in institutional policies; and examination of potential for supporting women’s groups and/or a women’s village committee. d Yap Human Resource Gender Policies outline measures that include equal employment, harassment policy, and maternity leave. An institutional study will be carried out, with the aim of supporting paid maternity leave, strengthening of the harassment policy, and equal employment and opportunities. e Project implementation consultants will include a gender and development analysis expert. Contribution to the ADB Results Framework: to be determined Source: Asian Development Bank

16 Appendix 2

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=49450-023-2

1. Grant Agreement 2. Sector Assessment (Summary): Energy 3. Project Administration Manual 4. Financial Analysis 5. Economic Analysis 6. Summary Poverty Reduction and Social Strategy 7. Risk Assessment and Risk Management Plan 8. Climate Change Assessment 9. Initial Environmental Examination: Kosrae 10. Initial Environmental Examination: Yap 11. Resettlement Plan

Supplementary Documents

12. Social, Poverty, and Gender Assessment 13. Financial Management Assessment 14. Financial Sustainability Assessment: Kosrae Utilities Authority 15. Financial Sustainability Assessment: Yap State Public Service Corporation 16. Procurement Plan 17. Procurement Risk Assessment