Document of The WorldBank

FOR OFFICIALUSE ONLY Public Disclosure Authorized

ReportNo: 22157

vIPLEMENTATIONCOMPLETION REPORT (03370;29820)

ONA

LOAN Public Disclosure Authorized IN THE AMOUNTOF US$150 MILLION

TO THE

ISLAMICREPUBLIC OF PAKISTAN

FORA

PRIVATE SECTORENERGY DEVELOPMENT PROJECT

May 11, 2001 Public Disclosure Authorized

EnergySector Unit South Asia Region

This documenthas a restricteddistribution and may be usedby recipientsonly in the performanceof their official duties. Its contentsmay not otherwisebe disclosedwithout World Bank authorization. Public Disclosure Authorized CURRENCY EQUIVALENTS (Exchange Rate Effective December 31, 2000) Currency Unit = Rupees (Rs.) Rs I = US$ 0.02 US$ 1 = Rs 58.15

FISCAL YEAR July 1 June 30

ABBREVIATIONS AND ACRONYMS

APL Asia Petroleum Limited CDC Commonwealth Development Corporation of the United Kingdom COD Commercial Operations Date COFACE Compagnie Francaise d'Assurance pour le Commerce Exterieur (France's export credit agency) DFID Department for International Development (UK) EAD Economic Affairs Division, Ministry of Finance ECAs Export Credit Agencies ECO Expanded Cofinancing Operation ESBI Electricity Supply Board International (Ireland) EPC Engineering, Procurement and Construction FSA Fuel Supply Agreement GOP Government of Pakistan HUBCO Hub Power Company Limited IA Implementation Agreement ICB International Competitive Bidding IDC Interest during Construction IFC International Finance Corporation IPP Independent Power Producer IRR Internal Rate of Return JBIC Japan Bank for International Cooperation JEXIM The Export Import Bank of Japan (now referred to as Japan Bank for International Cooperation. KESC Karachi Electric Supply Company kW Kilo Watt kWh Kilo watt hour LOI Letter of Intent LOS Letter of Support LTCF Long Term Credit Fund (the "Fund", formerly known as the Private Sector Energy Development Fund)

Vice President: Mieko Nizhimizu Country Director: John W. Wall Sector Director: Alastair J. McKechnie Team Leader: Tjaarda P. Storm van Leeuwen Task Leader: Julie M. Fraser FOR OFFICIAL USEONLY

MMCFD Million Cubic Feet per Day MITI Ministry of International Trade and Industry of Japan MOF Ministry of Finance MOU Memorandum of Understanding MPNR Ministry of Petroleum and Natural Resources MW Mega Watt (one million watts) MWP Ministry of Water and Power NEPRA National Electric Power Regulatory Authority NDFC National Development Finance Corporation (Administrator of the LTCF) O&M operations and maintenance ODA Overseas Development Administration (UK) OGDC Oil and Gas Development Corporation PED Private Energy Division of NDFC PPA Power Purchase Agreement PPC Private Power Cell PPIB Private Power and Infrastructure Board PRG Partial Risk Guarantee PSEDP Private Sector Energy Development Project PSO Pakistan State Oil QAG Quality Assurance Group RPPL Rousch (Pakistan) Power Limited SACE Sezione Speciale per l'Assicurazione del Credito all'Esportazione (Italy's export credit agency) SEPCOL Southern Electric Power Company Limited SNGPL Sui Northern Gas Pipelines Limited UPL Uch Power Limited USAID United States Agency for International Development WAPDA Water and Power Development Authority WPPO WAPDA's Private Power Organization

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.

PAKISTAN Private Sector Energy Development Project

CONTENTS

Page No. 1. Project Data 1 2. PrincipalPerformance Ratings 1 3. Assessmentof DevelopmentObjective and Design, and of Quality at Entry 2 4. Achievementof Objective and Outputs 6 5. Major FactorsAffecting Implementationand Outcome 13 6. Sustainability 17 7. Bank and Borrower Performance 18 8. LessonsLearned 24 9. Partner Comments 29 10. AdditionalInformation 35 Annex 1. Key PerformanceIndicators/Log Frame Matrix 42 Annex 2. Project Costs and Financing 43 Annex 3. EconomicCosts and Benefits 45 Annex 4. Bank Inputs 46 Annex 5. Ratingsfor Achievementof Objectives/Outputsof Components 48 Annex 6. Ratings of Bank and BorrowerPerformance 49 Annex 7. List of SupportingDocuments 50 Annex 8. BeneficiarySurvey Results 51 Annex 9. StakeholderWorkshop Results 52 Annex 10. Reviewof Sub-Projects 54 Annex 11. Borrower'sContribution 72

NOTE: The main text is identicalfor the intensive learning ICRspreparedfor the Pakistan Private Sector Energy Development Project (Ln. 2982) and thefollow-on, Second Private Sector Energy DevelopmentProject (Ln. 38)2). Theflrstproject was extended to be co-terminus with the second, and the loan agreement 2982-PAK was amended to match that of Ln. 3812-PAK. In particular, the implementationprogram as well as theproceduresfor and terms and conditions of subloans under theflrst Project were amended to be consistent with the second Project. Therefore, whie two separate ICRs areproduced; the text is identical while the project data, ratings, and statistical annexes are specificfor each project.

Various sections of this report draw extensivdy on previous analytical work and internal memorandaprepared by Bank staff and consultants in the Energy Network and the South Asia Energy Unit on the Pakistan energy sector portfolio, the dialogue on the power sector reformprogram, and the privatepowerprogram during 1998-2000,in additionto the report by M. Gerrardtitled "Financing Pakistan's Hub Power Project:A Review of Experiencefor Future Projects" datedAugust 1997, sponsoredby the Project Finance and Guarantees Department.

Project ID: P010313 Project Name: PRIVATE SECTOR ENERGY DEVELOPMENT PROJECT Team Leader: Julia M. Fraser TL Unit: SASIN ICR Type: Intensive Learning Model (ILM) of ICR Report Date: May 11, 2001

1. Project Data

Name: PRIVATE SECTOR ENERGY DEVELOPMENT L/C/ITFNumber: 03370; 29820 PROJECT Country/Department: PAKISTAN Region: South Asia Regional Office Sector/subsector: PT - Thermal

KEY DATES Original Revised/Actual PCD: 10/22/87 Effective: 10/26/88 03/16/89 Appraisal: 12/10/87 MTR: Approval: 06/29/88 Closing: 12/31/94 11/30/98

Borrower/lImplementingAgency: Government of Pakistan/National Development Finance Corporation Other Partners: The Export Import Bank of Japan, Government of Italy, Government of France, US Eximbank

STAFF Current At Appraisal Vice President: Mieko Nishimizu Wilfred Thalwitz Country Manager: John W. Wall Hans Eberhard Kopp Sector Manager: Alastair J. Mckechnie Ibrahim I. Elwan Team Leader at ICR: Tjaarda P. Storm Van Leeuwen ICR Primary Author: Julia M. Fraser; Marc L. Heitner; Peter A. Cordukes

2. Principal Performance Ratings (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory,HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest,N=Negligible)

Outcome: U Sustainability: UN Institutional Development Impact: N Bank Performance: U Borrower Performance: U

QAG (if available) ICR Quality at Entry: U Project at Risk at Any Time: Yes 3. Assessment of Development Objective and Design, and of Quality at Entry 3.1 Original Objective: 3.1.1 Until 1988, the Bank had been involved in Pakistan's power sector primarily through lending to the two govermmentutilities, the Karachi Electric Supply Company (KESC) and the Water and Power Development Authority (WAPDA). In 1988, economic growth remained constrained due to severe power shortages. It was estimated that during the Seventh Five-Year Plan (1989-93), 6,300 MW of additional generating capacity would be required, of which the public sector would only be able to construct 4,000 MW. Hence, it was proposed that 2,300 MW be built by the private sector during the Seventh Plan and, similarly, an additional 2,400 MW during the Eighth Plan (1994-98). 3.1.2 The objectives of the first Private Sector Energy Development Project (PSEDP 1), approved in June 1988, were to: (i) assist Pakistan in mobilizing, from the private sector, the resources required to meet the anticipated deficit in power supply; (ii) establish incentives to encourage private sector participation; and (iii) establish an institutional framework required to facilitate private sector transactions in energy on a sustainable basis. The Second Private Sector Energy Development Project (PSEDP I), approved in November 1994, replenished the Long Term Credit Fund (originally known as the Private Sector Energy Development Fund) established under the first project (PSEDP I) with the objective of continuing to (i) assist the Govermmentin mobilizing additional private sector resources; and (ii) build on the institutional and policy framework established to facilitate private sector participation in the energy sector. 3.1.3 The objectives were clear and were not modified during project implementation. The objectives were also consistent with the Govermment'sstrategy to encourage a greater role for the private sector in energy. However, the power shortage on which the private power program was predicated was due in large part to policy and institutional failures. Looking back, low average prices of electricity, cross subsidization of residential and agricultural consumers, weak payment discipline and widespread theft of electricity (unaccounted for electricity was estimated to be as high as 35 percent rather than the officially recorded 26 percent) exaggerated the shortage of electricity supply.

3.1.4 In many respects, the agenda for reform outlined in the strategy was well ahead of its time. Although the international development community had come to realize that the role of the public sector needed to be redefined and reduced, no other low-income country had made private investments a corner stone of its energy policy. This strategy was a reflection of hard economic realities: a non-sustainable fiscal deficit; a serious balance of payment situation; and the inability of the public sector to mobilize the funds required to make the investments needed to keep pace with power demand (which was growing around seven percent per year). However, even if sound demand management policies had reduced the growth of electricity demand below seven percent, the Government's strategy to rely increasingly on private investment in power was relevant as budgetary resources were needed to meet Pakistan's pressing social needs. The Projects were designed to support the implementation of a program of agreed measures that consisted of: (a) policies for the promotion of private sector investment in energy; (b) creation of a vehicle to provide long-term financing for private energy projects; and (c) establishment of new institutions for the evaluation, negotiation, and approval of private energy investments.

3.1.5 These two Projects were innovative and represented a major shift in the Bank's power sector lending policies. The Projects embedded the lessons drawn from Bank lending to govermnent utilities, as reflected in the Policy Paper entitled "Bank Lending for Electric Power" (1993). The Projects, however, were demanding as they required inter alia: (a) the Govermmentand its agencies to leam and adapt policies to enable private sector transactions in power; (b) the creation of three new entities - (i) the Private Power and Infrastructure Board (PPIIB)in charge of negotiating the contractual framework (referred to as the Security Package) on behalf of the Government; (ii) WAPDA Private Power Organization (WPPO) in

- 2 - chargeof negotiatingthe power purchaseagreements (PPA); and (iii) the PrivateEnergy Division(PED) of the NationalDevelopment Finance Corporation (NDFC) in chargeof administeringthe fundsunder the two Bank loans (referredto as the Long Term CreditFund -LTCF or the Fund);and (c) the power utility, WAPDA,to abandonits virtal monopolyon powergeneration, and adjust its activitiesincluding purchasingpower fromplants it did not own.

3.2 Revised Objective: n.a.

3.3 OriginalComponents: 3.3.1 In refiningand implementingthe privatesector energy strategy,the Govemmentrelied primarily on the adviceof the Bankand a consultingfirm (withthe US Agencyfor IntemationalDevelopmnent support). Threeconstraints to greaterprivate sector energy investments were identified: (a) the absenceof a comprehensivepolicy frameworkconcerning incentives, fiscal treatment, repatriation of profits and capital,availability of foreignexchange, and pricing;(b) the lack of long term financingfor projectswith long gestationperiods and economiclife; and (c) the inadequacyof the institutionalarrangements for the review,negotiation and approvalof private sectorprojects.

3.3.2 An initial frameworkof incentivesto attractprivate investment in the energy sectorwas put in place in 1988 whichaddressed these constraintsunder the PrivateSector Energy Development Project (PSEDPI). In additionto these incentives,a new lendingfacility-the PrivateSector Energy Development Fund which was later renamedthe LongTerm CreditFund (LTCF or the Fund)--wasestablished under PSEDPI to financeprivate energyinvestments. The Fund providedlong term subordinateddebt financing up to 23 years, includingeight years grace -tenors which werepreviously unavailable in Pakistanbut necessaryfor power and otherenergy projects with long economiclives. The Fund was createdto bridge the gap in the financialintermediation system of Pakistan.The purposeof this arrangementwas to provide securityand comfortto commerciallenders to encouragethem to financethe projectsas well. The Fund is administeredby the NationalDevelopment Finance Corporation (NDFC) on behalf of the Government.

3.3.3 Duringthe preparationand appraisalof PSEDPI, it was thoughtthat private sectorresources for financingthe energysector needed to materializemore or less immediatelyin orderto avoid jeopardizingthe achievementof the objectivesof the SeventhPlan which,in turn,necessitated the immediateestablishment of the Fund as a functionalunit of an existingfinancial institution. It was to act as the focal point for mobilizingfinancing from bilateral and multilateralagencies and, as its financial strengthsdeveloped, gradually seek commercialloans in the market,securing them againstthe strengthof its balancesheet. The Governmenthad designatedNDFC to administerthe Fund althoughthe latter's operationswere to be structuredto allow for possibledetachment from NDFC at a later date. As such the Fund was set up as a self-containedunit withinNDFC-the PrivateEnergy Division-which was expected to reach its own independentdecision as to the technicaland financialviability of subprojectspresented for financing,after they had been approvedby PrivatePower Cell of the Ministryof Water and Power (MWP). Duringthe appraisalof PSEDPII, it was recognizedthat the Fund'scontinued presence in NDFC was leadingto its bureaucraticabsorption as anotherarm of the public sector,and as such, the processof detachingthe Fund from NDFCwas to begin with the effectivenessof PSEDPII. In fact,this was made a dated covenantalthough no real progresswas made in detachingthe Fund fromNDFC. In addition,no additionalresources were mobilizedfor the Fund beyondthose provided by the initial financiersof PSEDP I and II.

3.3.4 Duringthe negotiationfor the Hub Project(the sole subprojectfinanced under PSEDPI) and the preparationof PSEDPII, the Governmentrecognized the need to fine-tunethe incentiveframework to take

- 3 - into accountthe feedbackreceived from privateinvestors and the internationalfinancial community. Refinementsin the frameworkwere also neededto make Pakistanintemnationally competitive in attracting financialresources, and to integratethese measureswith the actionstaken by the Governmentto deregulate the economyand increasereliance on the privatesector. The resultwas a new policy for privatepower ("PolicyFramework and Packageof Incentivesfor PrivateSector Power Generation Projects in Pakistan"), promulgatedin March 1994 (heretoreferred to as the 1994Private Power Policy), which incorporatedthe originalpolicies introduced in 1988together with subsequentmodifications as detailedin Box 1 below. The above policy,which was supportedunder the SecondPrivate Sector Energy Development Project (Ln. 3812-PAK),was successfulin attractingan additional19 privatepower projects, totaling over 3,000 MW.

Box 1: Salient Featuresof 1994 Policyand Packageof Incentives for PrivateSector Power Generation

. Bulk Tariffof USO 6.5/kWh"(to be paid in Rs.) for sale of electricityto WAPDA/KESC,with indexationmechanism for fuel price, US and Pakistani inflation,exchange rate, O&M costs, and others;

. Fiscal Incentivesconsisting of: exemptionfrom corporateincome tax, customs duties, sales tax, and other surchargeson importedequipment;

. StandardizedSecurity Package which includesa model ImplementationAgreement, Power Purchase Agreementand Fuel Supply Agreement;

. Creationof a Private Power Board, so as to facilitateone windowoperation; and

• Financialincentives to facilitate the creationof a corporatesecurities market in the country,including permissionfor power generationcompanies to issue corporatebonds and shares at discountedprices, and establishmentof an IndependentRating Agency. a/ Thebulk tariff was later reduced to USe 6.1/kWhwith the eliminationof theforeign exchange risk insurancescheme.

Source: Pakistan Energy OptionsStudy, ReportNo. 14025-PAK,June 15, 1995

3.3.5 PSEDP I and II each consisted of two components: (i) investment sub-projects and (ii) institution building. They provided for the financing of subordinated debt to private energy companies, together with technical assistance to govemment entities implementing the private power policy. They were successful in mobilizing considerable cofinancing for the Long Term Credit Fund as reflected in Table 1 below.

-4 - Table 1 Long TermCredit Fund Co-financingFunds Mobilized for PrivateEnergy Projects under PSEDP I and PSEDPII (US$million equivalent)

PSEDP I PSEDPll Ln. 2982 Ln. 3812 TOTAL

IBRD 150 1,3 250 2 400

JEX4I 150 3 250 400

Govemmentof Italy 49 3 50

Governmentof France 29 3 10 3 39

US Eximbank 12 3 97 4 110

Bankof China _ 80 4 80 TOTAL 390 687 1,077 (Thesefigures do not include otherdebt and equity mobilizedfor the sub-projectsfinanced underPSEDP I and I.) Of which$4 millionis for technicalassistance. Of which$6 millionis for technicalassistance. Fundsused exclusively for the 1292MW Hub Power Project. 4Funds contributedexclusively for the 586MW Uch Power Project.

3.3.6 The Bankand JEXIMeach contributedUS$400 nillion to the LongTerm Credit Fund,and other bi-lateralagencies together contributed over US$600million equivalent. Five sub-projects(one pipeline and four powerprojects) were financedunder PSEDPI and II. It was anticipated-giventhe Fund'sceiling of 30 percentfinancing per subproject-thatPaldstan would be able to mobilizeat least US$1.9billion under PSEDPI and US$1.2billion under PSEDPII, targetswhich werevastly exceededin realityas overallprivate sector investments in powerover 1990-99have been in excessof US$5billion (four out of twentyprivate power plantsutilized LTCF financing).ccc 3.3.7 Recognizingthe complexityof projectfinance, the two loansalso providedfor a considerable amount of technicalassistance to two newunits: (i) the PrivatePower Cell (PPC),located in Islamabad,to evaluateand negotiateproposals on behalfof the Government(PPC was convertedin 1994into the Private Powerand InfrastructureBoard - (PPEB),a "singlestop investmentwindow" with full responsibilityfor negotiatingpower investments); and (ii) the PrivateEnergy Division (PED), a unit of the National DevelopmentFinance Corporation(NDFC), located in Karachi,and entrustedwith the administrationof the LTCF. 3.3.8 In all, the designof the projectwas consistentwith its objectives.

3.4 Revised Components:

-5 - 3.5 Quality at Entry: 3.5.1 The Quality AssuranceGroup (QAG) made a post-approvalQuality at Entry assessmentof PSEDPII in mid-1997as part of a QAG review of SouthAsia PrivateSector Infrastrcture Development Operations. QAG rated the Projectas fully satisfactoryon accountof its many innovativeand groundbreakingfeatures that have been a model for other countries. Thereport recognized the "pioneer" featuresof thesetypes of operations"not only for the countrybut for the Bank",and that these funds "can be valuableinstruments for encouragingprivate participation in infrastructure"provided there is strong governmentcommitment to reform. Their importancein helpingto developlocal capitalmarkets was also recognized.

3.5.2 However,the QAG panel did not identifyflaws which have been presentin the financialstructure of both PSEDPI and II from the outset. Most notably,in arrivingat their "fullysatisfactory" assessment, the QAG panel remarked that "the appointmentof competentfund managers...[is] an importantfactor in the success." In fact, the LTCF has neverbeen managedas a fundand doesnot have the operational structuresto respondto events. Thepanel failedto notice the substantialasset/liability mismatches in the Fund,which could then have been partiallyoffset through conversion to a singlecurrency loan. In addition,the panel did not recognizethat NDFCwas essentiallyinsolvent and dependentupon the LTCF for liquidity,a weaknessin NDFCwhich shouldhave been apparentat the time.

3.5.3 Whilethe panel commentedupon the delaysin convertingLTCF to an "autonomous, commerciallyoriented" entity, evennoting that the fulfillmentof this covenantwas alreadymore than two and a half years overdue,the panel shouldalso have identifiedthe absenceof a realistic "sunset"plan for LTCF. In reality,the outline for the futureof the Fund was vague,and there was no work undertakento advisea more suitablestructure or developa timelineto implernentation.The QAG panel, similarto the Bank'sappraisal teams, did not includea financeexpert (as distinctfrom a financialanalyst) to examine the financialstructuring aspects and implicationsof the Projects.

3.5.4 With hindsight,the Projects,while being highly innovative, were a high-riskactivity that has now tumed out to have significantshortcomings. Other weaknesses at entry identifiedby QAG resultedin a much larger negativeimpact than foreseenat the time of the QAGreview. Theseincluded: (i) inadequate analysisof IPPs' impacton WAPDA'sfinances, (ii) inadequatereview of the Government'sthermal power policywhich may have revealedthe need to limitthe amountof new capacity;(iii) not enoughemphasis on social consequencesand affordabilityof privatepower generation; and (iv) no technicalspecialist on the team to focus on locationof IPPs and choiceof technology.Under the circumstancesand in retrospect,the Projectsare rated unsatisfactoryin terms of qualityat entry.

4. Achievement of Objective and Outputs 4.1 Outcome/achievement of objective: 4.1.1 Althoughoriginally intended to financeseveral subprojects, PSEDP I focusedon one very large transaction- the 1,292MW Hub Powersubproject. (Annex 10 describesthe five subprojectsfinanced under PSEDPI and II.) The Hub transactionrequired over six yearsfrom the detailedfeasibility study (April 1988)to financialclosure (January1995). This subprojectpaved the way for private power projects internationally,and the complexdocumentation it generatedis usedto this date as a referencefor such transactionsworldwide. Furthermore,the transactionalso involvedfor the first time the utilizationof a new Bankinstrument for power projects,the PartialRisk Guarantee,under which the Bankbackstops

- 6 - certainundertakings given by the GovermmentThus, the LTCF loan of US$616million enabledthe mobilizationof anotherUS$1.2 billion in the form of equityand debt. Subsequently,under PSEDP II, three more powerplants were partiallyfinanced by the LTCF involvingapproximately 1,100 MW with a total investmentcost of US$1.3billion. LTCF,which was initiallyintended to also supportsubprojects otherthan powerplants, helped finance a pipelineconnecting an oil storagedepot with the Hub power plant. More importantly,the frameworkwhich evolvedunder the Bankprojects enabled the financingand constructionof an additional16 powerplants involving an additionalgenerating capacity of 2,350 MW with a total investmentcost of almostUS$2.5 billion. Thus,the physicaloutcomes are consistentwith the initial targetsfor private powerset underthe SeventhPlan (2,300MW) and the EighthPlan (2,400MW).

4.1.2 In the case of NDFC,the administratorof LTCF,and PPIB, the one-stopshop for private investors,solid expertise was developedin privatepower transactions although most of the qualifiedstaff subsequentlyleft. While Pakistancreated institutional capacity to approveIPPs, WAPDAdid not develop the institutionalcapability required to managetheir new commercialcontracts.

4.1.3 Unfortunately,the implementationof the privatepower program under PSEDP I and II experienced difficultieswhich negativelyimpacted the Projects'ability to achievetheir objectivesand/or sustainable results. (PSEDPI is included in the analysisof the 1994private power program, even though it was designedprior, since the implementationprogram, evaluation criteria, as well as the procedurefor and tenmsand conditionsof subloanswere amendedto match that of PSEDPII.) Implementationdifficulties includedthe following:

* The selectioncriteria under the 1994Policy enabled the implementationof many subprojectswhich are not consistentwith the least-costexpansion program in terms of (i) capacity(too small giventhe systemsize and requirements);(ii) fuel selection(excessive relianceon importedfuel oil, as opposedto domesticnatural gas althoughat the time gas allocationfor powerwas difficultto secureand overallgas reserveswere thoughtto be on the decline3); and (iii) technology(too many dieselsets and steam turbines,as opposedto efficientcombined cycle plants). The 1994 IPP Policydid not providean incentivefor projectpromoters to reducecosts, and the tariff for virtuallyevery IPP reachedthe bulk tariff ceiling set underthe Policy,regardless of technology.This resultedin relativelyhigh project costs with a high proportionof "soft"costs (i.e.project development costs and fmancingcosts). In addition,the incentivesprovided by the 1994 Policy,particularly the price of electricityand the Government'sguarantees, proved with hindsightto be too generousas reflectedin the overwhelmingresponse from the privatesector. Although GOP had intendedto review the bulk tariff annually,it neverdid so.

* The pace of the privatepower program was faster than the restructuringand privatization of WAPDAand the creationof a suitableregulatory system. The mix of privategeneration and monopolypublic sector transmission/distribution, and the introductionof private powerunder the 1994IPP Policy(see para. 3.3.4),has renderedthe sectorvulnerable to financialshocks and externalevents such as changesin fuel prices. While the Bank promotedmeasures for sectormanagement and restructuring,as well as public sector policy reforns, includingintroduction of pass-throughmechanisms for cost of fuel and power purchased,they werenot implementedat the intendedpace. The delaysin sector reformsadversely impacted the efficiencyof both WAPDAand the IPP program,and left the sectoroverly vulnerable to economicdownturns.

- 7 - * The demandfor power increasedat a slowerpace than anticipatedresulting in excess capacityin the systemfor which WAPDAhas to pay capacitycharges under long term powerpurchase agreements (PPAs). Despitethe Bank'scaution to limit the new policy to about 2,000 MW of additionalcapacity and the adviceto switch to a competitivebidding process thereafter,GOP issuedLetters of Supportto projects for more than 9,000 MW. Ultimately,19 IPPs totalingabout 3,100 MW reachedfinancial close. (This figuredoes not includeHub, which was negotiatedprior to the 1994Policy.)

* A new governmentin 1997alleged that privatepower transactions involved corruption money,and took legal and othermeasures against subproject sponsors. This resulted in costlydelays in the comrnissioningof some of the power plants,renegotiations of contracts,and reductionsin saletariffs. While most IPPswere willingto renegotiate tariffs,given the precariousfinancial condition of WAPDAand Pakistan,the Government'sapproach was perceived to be heavy-handedand coerciveand nearly led to governmentguarantees being calledand a financialdefault by Pakistan. These perceptions also destroyedinvestor confidence in Pakistan,and foreigninvestment flowed to a trickle exacerbatingthe recenteconomic crisis.

• The institutionalframework has demonstratedthat it is capableof processingan impressivenumber of transactionsover a short period. Unfortunately,NDFC, PPIB and WPPOwere subjectto considerablepolitical interference, and a high staff tumover at the manageriallevel (betweenfour and eight ManagingDirectors in eachof the three organizationsover an eight-yearperiod). In addition,most of the key staff in NDFC and PPIB, who had developedsignificant expertise under the implementationof PSEDPI and II, are no longeremployed by these agencies. Furthermore,one unit or anotherwas sidelinedthrough political decisions at varioustimes throughout implementation.

* The financialframework for LTCF is in a stateof flux - which is exacerbatedby NDFC "capturing"the Fund to the extent that it is dependenton the LTCF for its own liquidity needs. (NDFC is currentlyinsolvent and wouldnot be in a positionto remit fundsheld on depositon behalfof LTCF withoutliquidity assistance from the State Bank of Pakistan.) The Bank had alwaysperceived NDFC to act as LTCF administratoron a temporary basis. The alternativesrealistically available for the futureoperation of the LTCFhave diminishedover time due to: (i) the absenceof an identifiedpipeline of viable infrastructureprojects in the energysector that would realisticallyreach financialclose in the next few years;(ii) reducedinvestment appetite for Pakistan,and (iii) the deteriorating conditionof NDFC. In the end, the Bankagreed with the Governmentthat creatingyet another financial"institution" would be inconsistentwith the Government'scurrent strategy,supported by the Bank, to consolidatethe financialsector. However,no agreementwas ever reachedon the futuremanagement and ownershipof the LTCF.

4.1.4 On balance,the physicaltargets set outunder the two Projectshave largelybeen achievedresulting in investmentstotaling some US$5 billion. However, the outcomeof both Projectsis rated unsatisfactoryas the related economic,financial, institutional and technicalaspects fell short of expectationsand, therefore, negativelyaffected the Projects'development outcomes.

4.2 Outputs by components: 4.2.1 Macroeconomic Impact: Under the 1994Private Power Policy, the Governmentguaranteed the

-8 - availabilityof foreignexchange and paymentobligations of the state-ownedpower offtakers(WAPDA or KESC)and the state-ownedfuel suppliers(PSO or OGDC). WhileWAPDA was in good financial conditionat the tine of both appraisals,several developments led to the deteriorationof its financial performance,as a result of which it faced difficultiesin meetingits obligationsto IPPs whichrequired on-timecash payments. These developmentsincluded: (i) front-loadedIPP tariffswhich are indexedto the US Dollar,combined with a 45 percentdevaluation of the Rupee;(ii) a declinein electricitydemand due to low economicgrowth which led to a temporaryover-capacity in generation;(iii) poor collectionrates from govermnentcustomers which accountfor 30 percentof WAPDA'ssales; and (iv) wideningtariff cross subsidiesthat play againstindustrial and commercialconsumers, who have installedtheir own captive capacity.

4.2.2 In addition,Pakistan's federal system and narrowfiscal base makesit proneto typesof behavior--e.g.government arrears and unpredictableincreases in fuel taxes-that makescost recoveryfor power supplymore difficult. The IPP programalso put pressureon the country'shistorically precarious balanceof paymentsposition. Foreigndebt serviceobligations related to the IPPs are estimatedat about US$500million per annum in additionto the foreignexchange cost of importedfuel, O&Mand repatriation of profits. The country'sforeign exchange reserves fell to less than US$400million in Novernber1998, recoveredto US$1.5billion around March 1999,and has subsequentlystabilized to about US$0.6billion in 2000 (equivalentto aboutthree weeksof imports)--whichhas seriouslyjeopardized the Govermment's abilityto honor its obligationsin providingforeign exchange. Lastly,the Governmentis exposedto large contingentliabilities under the ImplementationAgreements (IAs) signed with the IPPs whichwere not sufficientlyaddressed by the Governmentor the Bank. The Governmentdid not establisha systemfor managingcontingent liabilities even when confrontedwith the real possibilitythat governmentguarantees underthe LAscould be calledas a result of politicalevents of defaultas definedunder the agreements. Conclusion: unsatisfactory.

4.2.3 Financial Impact: Both PSEDPI and II have generatedfinancial stresses for the borrowerdue to the fact that there is a completecurrency mismatch between the liabilitiesand the ultimatesource of revenues(domestic power consumers).In principle,this risk canbe mitigatedif the ultimaterevenue sourceis itself linkedto foreigncurrency, such as for electricitysales to exportrelated industries.In the case of PSEDPI, the foreignexchange risk on the loanswhich fundedthe LTCFwas assumedby the Goverrmnentas the loan to Hubcowas made in Rupeeterms. For PSEDPI the foreignexchange exposure is not only againstthe WorldBank lending,which has been on currencypool terms,' but also to loansfrom other donorsdenominated in ItalianLira, French Francs and JapaneseYen. In the case of PSEDPII, the Rupeeforeign exchange risk was passedon to the IPP, as the varioussub-loans were made on Dollar terms, who in turn were able to pass on a substantialpart of the foreignexchange risk to WAPDAby indexingthe tariffsin Dollars. However,for the LTCF, this givesprotection only againstDollars while the indebtednessis in a mix of currencies.

4.2.4 Overall,PSEDP I and II have exposedthe variousparties, most particularlyPakistan, to substantialforeign exchange exposures, not only betweenthe Rupeeand Dollarbut also betweenthe Dollar and the Yen and the Euro. Furthermore,there has been a persistentfailure to recognizethe CurrencyPool rather than Dollardenomination of the WorldBank loans in LTCF accounts.!Despite this, the experience of the LTCFhas been relativelyfortuitous in that the Dollarhas been strongagainst the Yen and the Euro over the term of the loansto date,which has counterbalanceddepreciation in the Rupee. With the movementof exchangerates over the term of the Projects,the LTCFhas experiencedforeign exchange loss and gains on an annualbasis. However,it is noteworthythat in 1998,the LTCF realized foreignexchange losses of some$75 million. In additionto the currencyexposure, the Projectsalso presentPakistan with

-9- interest rate exposure. The interestrates for the loansmade by the LTCF underPSEDP I and II are fixed for sometime and then are referencedto the Bank'sborrowing rate, which is an averageof longtern rates and adjustsgradually with time. This createsa mismatchwith the loans fromother donors which are a mixture of fixed and floatingrates.

4.2.5 Lastly,WAPDA was not able to absorbthe financialimpact of the new IPPs and, togetherwith GOP, resortedto negotiatingtariff reductionsbefore many wereeven commissioned.The total cost of power purchasedon a per kilowattbasis increasedrapidly due to Rupeedepreciation, increases in fuel prices, and lower than anticipatedplant load factors. The termsof the PowerPurchase Agreements allowedIPPs to pass throughfuel costs and to indexvarious components of the energyand capacity paymentsagainst exchange rate variationsof Rupeeto US Dollarand US inflationrate. However, WAPDAwas unableto pass these escalatedcosts on to its retail consumersor to improveits efficiencyof operationssufficiently to mitigatethe financialimnpact of the IPPs. The slowdownin electricitydemand growthexacerbated this situationas mostIPPs were commissionedover a two to three year period. Conclusion:unsatisfactory.

4.2.6 SectorPolicies: The 1994Policy was highly effective in attractingsignificant private power investmentto Pakistanand, as a result,load sheddingdue to insufficientgeneration capacity has been largelyeliminated. Nevertheless too many subprojectswere givenletters of support(34 subprojectsfor 9,000 MW) and too much capacity(3,150 MW) was contracted,despite the Bank'scaution to cap the amount at 2000 MW. Ratherthan proceedthrough competitive bidding for privatepower, Pakistaninstead set a tariff ceiling for investorsin an effortto acceleratethe privatepower program which provedvery successful. The ceilingprice set in the 1994Policy (US06.1/kWh as an averagefor the first ten years and USO5.5/kWh over the life of the projecton a levelizedbasis) wascompetitive with levelizedprices in other developingcountries at the time, includingIndonesia, Philippines and India. Theseprices were not determinedcompetitively, and someof the comparativecountries, similar to Pakistan,ranked low on intemationalindices of corruption.

4.2.7 The 1994 Policyled to many projectsbeing supportedwhich were too smalland not suitably locatedto systemrequirements. In addition,a biddingmechanism for IPPs couldhave resultedin lower prices and promotedtransparency (although higher prices are also due to limitedgas availability,so that most projectscould not use efficientcombined cycle technology). Projects which receiveda Letterof Support,were supposedto reach financialclose within one year, however,the Govemmentwas not able to devoteequal attentionto eachof the sponsorgroups. This led to extensionsbeing granted for several projects. Moreover,the basis on which projectswere selectedand accordedattention was not transparent and subjectto politicalinfluence which led to perceptionsof corruptionby successivegovernments.

4.2.8 In all, the 1994Policy led to far more subprojectsand investmentin IPPsthan GOP couldhave anticipated. Powershortages were eliminated,but the cost of the surpluscapacity has been taxing WAPDA'sfinancial position. With the benefitof hindsight,there were flaws in the Policythat subsequentlybecame apparent to GOP and led to its revisionin 1998,which did much to addressthe shortcomingsin the 1994 Policy. It providedfor competitivebidding for new subprojectsneeded after 2003. Additionalcapacity needs by 2008 wereestimated to be 5,000-8,500MW. The new policy was designedto attractbids for hydro and indigenouscoal-fired plants for which feasibilitystudies had already been prepared. No subprojects,however, have been approvedunder the new policy althoughPPIB is preparingprequalification and biddingdocuments for severalhydro subprojects. Selectionwill be basedon price with restrictionson front-endloading of tariffs. Conclusion:unsatisfactory.

- 10 - 4.2.9 PhysicalDevelopment: Hub was the first IPP and was built on time and withinbudget. The total cost was US$1.6billion (US$1,238per kW), of which "soft"costs absorbedUS$520 million, mostly interestduring construction and financingcosts. Developmentcosts-mostly legal costs- requiredabout US$81million. The originalfinancing for Hub includedUS$615 million from the Fund (US$386million underPSEDP I, includingIBRD financingof US$146million, and US$230million under PSEDP II, includingIBRD financing of US$110million). The Hub project absorbedall the financingavailable under PSEDPI. The additionalfunding provided under PSEDP1I (approved six yearsafter PSEDP1), together with a PartialRisk Guarantee,secured the completionof the financingplan for Hub. The subprojecttook almost 10 yearsto developand build. This experienceleads to the conclusionthat the first IPP in Pakistan shouldhave been a smallersubproject, which couldhave been more easily financed. Nevertheless,it did demonstrateto GOP how limitedrecourse subprojects could be preparedand provide a good learming experiencefor NDFC,PPIB, the Bank, commerciallenders, developers, and the lawyers.

4.2.10 The next three power plantsfinanced through PSEDP II-Rousch, SouthernElectric, and Uch-were all approvedunder GOP's 1994Power Policy. The APL Pipelinesubproject, which provided fuel to Hub, was also financedunder PSEDP II. All the power subprojectswere delayed,from 20 months (for Rousch)to over two years (for Uch),resulting in cost increasesof over 20 percentin eachinstance. The finaltotal cost per kW was similar,ranging from US$1,310for Uch (gas-firedcombined cycle plant), US$1,342for SouthernElectric (diesel plant) to US$1,396for Rousch(oil-fired combined cycle plant). The originalproject cost of betweenUS$1,030 and US$1,200per kW (not includingstandby financing) for these three projectswas more or less in line with the assumedproject cost of US$1,000per kW underthe 1994Policy. (However,starting in about 1997,capital equipment costs for combinedcycle plants dropped to about US$450to US$600per kW.) The APL pipelinesubproject was completedfive monthslate but US$10million below initial estimates.Conclusion: satisfactory.

4.3 Net Present Value/Economicrate of return: 4.3.1 Giventhe nature of PSEDPI and II, neitheran overalleconomic rate of return(ERR) or financial rate of returnwere estimatedat the time of appraisalsince subprojects were not identifiedin sufficient detail. However,the LoanAgreements specified as part of the evaluationand approvalcriteria that the investmentsubprojects must be "technically,economically and financiallyviable" to the satisfactionof the Bank -withoutdefining specific hurdle rates. While the economicanalysis contained in the appraisal reportsprepared by NDFC for each subprojectis rather weak(no ERR was calculated),sufficient analysis was providedon the technicaland financialfeasibility of the subprojects.Financial feasibility was justified based on adequatedebt servicecoverage ratios, project rates of returnand equityrates of retum. The Bank (and IFC in the case of the Uch Project)carried out economicanalysis of both the Hub and Uch projectsas part of the due diligenceof the partialrisk guaranteeoperations and an estimatedeconomic rate of return was calculatedas 18.3percent and 20 percent,respectively. Revised economic and financialrates of return were not calculatedfor each sub-projectas the requireddata was not accessiblefrom the privatepower companies. However,given the extendeddelays in plant commissioningfor Rousch,Southern Electric and Uch, the correspondingincrease in projectcosts, and the reductionin tariff for each of the four power sub-projectsnegotiated by WAPDAduring 1998-2000(see paras 5.2.2 and 6.1.1), one can deducethat the revised rates of return,both economicand financial,have decreasedsince sub-projectappraisal.

4.4 Financial rate of return: 4.4.1 See Section4.3 above.

- 11 - 4.S Institutionaldevelopment impact: 4.5.1 The Bank was instrumentalin creatingthree agencies: (i) the PrivatePower Cell (PPC), subsequentlyconverted to the PrivatePower and InfrastructureBoard (PPIB);(ii) the PrivateEnergy Division(PED), a unit of NDFC in chargeof administeringthe LTCF;and (iii) the WAPDAPrivate Power Organization(WPPO). All three benefittedfrom technical assistance under the project(funded by USAID, DFID and the Bank) and gained considerableexpertise in IPPs duringthe past 12 years. However:

* PPIB carriedout its mandateto act as a singlewindow, but its performancewas adversely affectedby politicalinterference resulting in frequentmanagerial changes and organizationalinstability. To ensureits autonomy,staff costs were coveredin its initial two yearsunder PSEDPII (subsequentlyextended to three years). Thereafter,PPIB was to receive 0.25percent of the intermediationspread charged on the sub-loansto cover its costs and ensure its independencefrom budget transfers. AlthoughPPIB has received some limitedfunds from the LTCF on an ad hoc basis, the mechanismhas not been finalizedin part due to confusionas to the amountPPIB was owed as a resultof ambiguouslanguage in the loan agreements. To date, PPIBhas reliedon the application and other fees chargedto IPPsto meet its budgetaryneeds, but this is not sustainablesince new projectson which to earn additionalfees are not forthconing. While the allocationof 25 basis pointswas, in hindsight,excessive and wouldhave greatlyexceeded PPIB's needs if the full amountwas made available;the balancewas retainedin the Fund, and as the Fund was held on depositwith NDFC,was ultimately used by NDFCfor its own liquidity needs.

* The PrivateEnergy Divisionof NDFCcarried out appraisalsof private sectorsubprojects, and negotiatedlong term, subordinatedloans on a limitedrecourse basis in accordance with the AdministrationAgreement (1989) and the OperationalGuidelines (1994). As lenderon record,it collectsthe debt servicedue from the projectcompanies and monitors loan and projectperformance. Debt service and other fees receivedare held on depositby NDFCon behalfof the Government.Although NDFC was one of the betterdevelopment financialinstitutions when the projectswere appraised, its financialcondition has steadily deterioratedto the pointwhere it is now, not only illiquid,but insolvent. As a result, NDFChas not alwaysbeen ableto transferthe full amountdue to the Governmentto repay the underlyingloans whichfinanced the LTCF. (The Governmentmet the differencesfrom othersources.) Whilethe Governmenttook stepsin mid-1999to protect the assets of the Fund by instructingNDFC to depositreflows into the National Savings Scheme,this Schemeno longeraccepts institutional deposits and alternativearrangements have notbeen made to date. Moreover,notwithstanding agreements to that effect,the Governmentdid not spinoffthe LTCF fromNDFC and convert it into a fully operational, autonomous,commercially-oriented financial institution. Finally, while significant capacitywas built throughtraining of PED staff in projectfnance transactions,NDFC has recentlylet go most of the seniorstaff resultingin a loss of institutionalstrengthening that was achievedunder the Projects. In hindsight,issues regarding the futureof LTCF shouldhave been sortedout prior to approvalof the PSEDPII.

• WPPO,which was entrustedwith coordinatingwith the differentunits of WAPDAduring the negotiationsof IPPs, was formallydeprived of this functionunder the 1994 Policy. However,in practiceit has continued,on and off, to negotiatePPAs and the applicable

- 12 - tariff since that time. WPPO aiso suffered from continuous turnover in its senior management and never fully developed the capacity to implement and monitor the PPAs signed.

4.5.2 In all, the three entities never enjoyed managerial autonomy, so that their decision making process was heavily influenced by political considerations. Given the uncertainties surrounding them and the lack of transparency, the institutional objectives of the project have not been fully attained.

5. Major Factors Affecting Implementation and Outcome 5.1 Factors outside the control of governmentor implemertingage"cy: 5.1.1 The finalization of the security package and mobilization of the financitg for the Hub Power Project, the sole sub-project financed under PSEDP 1, was delayed by almost four years due to unforeseen events such as: (i) the Gulf war which suspended most of the development activities for almost fourteen months (1990-91); (ii) the withdrawal of two of the main contractors which made it necessary to reconstitute the construction consortium (1990); (iii) the occasional losses of continuity that attended six changes in government in Pakistan which at times required renegotiation of key agreements; and (iv) the declaration of interest on loans illegal by the Federal Shariah Court in Pakistan (an issue that took some seven months to resolve). These delays led to an escalation of around US$ 150 million in the turn-key contract price. In addition, the senior lenders insisted on higher contingencies and standby financing amounting to around US$100 million. This necessitated new loans from the Bank and [EXIM to replenish the Fund, and PSEDP II was approved at the end of November 1994. Therefore, while PSEDP I became effective in October 1988, Hub did not reach financial close until December 1994. Based on the experiences of Hub, the Government announced a new set of incentives in 1994 and introduced streamlined approval procedures and standardized agreements. This allowed the subsequent IPPs, including the sub-projects financed under PSEDP II, to reach financial closure in a relatively short time for project finance transactions. Therefore, factors outside the control of government had a significant effect on project implementation for PSEDP I, but not PSEDP II.

5.2 Factors generally subject to government control., 5.2.1 The Government, through the Private Power and Infrastructure Board (PPIB). was responsible for implementing the private power policy and the tariff structure but failed to review the policy and tariff on an annual basis as was the original intention. The 1994 Policy should have been amended in light of changing circumstances such as the reduction in load growth and the subsequent fall in the cost of power plant equipment. In hindsight, the Govemmert should have placed a cap on the number of letters of support issued, and the tariff offered should have been reduced when it became apparent that the response from the private sector was exceptionally high. In retrospect, the percentage of letters of support which was expected to result in a completed project was underestimated.

5.2.2 Starting in 1998, the Government through the PPIB issued seven Notices of Intent to Terminate on grounds of cozruption and two on technical grounds which represented about two-thirds of private power capacity contracted (including two sub-projects financed under PSEDP II). Whatever the substance of the Government's allegations of corruption--such allegations are difficult to prove generally and no evidence was produced in court--these actions were largely perceived by the developers as means to delay the completion of IPP projects under the 1994 Policy and to extort tariff concessions given WAPDA's cashflow problems, political pressure not to increase retail tariffs, as well as the shortage of foreign exchange available in the country. IPPs expressed frustration at being called to appear before no fewer

13 - than a dozenIPP Committeesconstituted by the Governmentin an attemptto negotiatelower tariffs. The differentincarnations of the IPP Committeecomprised, at varioustimes and combinations,representatives of the AccountabilityBureau, PPIB, WAPDA,Ministry of Financeand independentlocal businessmen, among others. None of thesecommnittees proved effective as no clear authorityto negotiatewas delegated. In the end, one-on-onenegotiations with WAPDAcombined with interventionat the highestgovernment level, resultedin severalIPPs agreeing to tariff reductions. Separately,the Hub PowerCompany was accusedof corruptionin securingthe amendmentsto the PowerPurchase Agreement which resultedin a court mandatedreduction in the capacityprice to be paid by WAPDA. Furthermnore,changing governmentssought to placethe blame for the perceivedhigh cost of privatepower on previous governments,and as a result,the IPP programbecame highly politicized. The handlingof corruption allegationscontributed to the erosionof investorconfidence in Pakistanand has reflectedadversely on GOP. This has had a substantialnegative impact on the outcomeof both PSEDPI and H.

5.2.3 Lastly,each of the institutionsinvolved in the privatepower program (PPIB, NDFC and WPPO) were adverselyaffected by politicalinterventions. These contributed to the high turnoverof officialsand undernined the autonomyof the concemedinstitutions with adverseimplications for the outcome.

5.3 Factorsgenerally subject to implementingagency control: 5.3.1 The actionsof WAPDAto delaycommissioning of IPPs and securetariff reductionsin return for pernitting the plantsto comnmenceoperations contravened at leastthe spiritof projectdocuments signed with the subprojectsponsors. The resultis that tariff reductionshave been obtainedand WAPDAhas been able to delay paying capacitycharges, but the overallsubproject costs have risen by 20-30 percent(except for HUBand the APLpipeline subproject which were completedon time) which affectedreturn on equity as the constructionrisk had been assumedby the IPPs. This resultedin the three IPPs financedunder PSEDP11 to be commissionedbetween 14 and 30 monthsbehind schedule,as well as the Government assumingmore risk to the three subprojectsas LTCF contributedto meetingthe cost overruns.

5.3.2 In addition,WAPDA alleged corruption charges against Hubco and preventedthe companyfrom pursuinginternational arbitration through injunctions sought by WAPDAin the localcourts. On June 14, 2000 the SupremeCourt of Pakistanupheld, in a 3-2 decision,that the disputebetween Hubco and WAPDAis not subjectto arbitration,ruling that the disputecenters around alleged criiinality and therefore,as a matterof publicpolicy, it shouldbe resolvedwithin Pakistan in accordancewith local laws. Hubco filedpetitions in the SupremeCourt seeking a reviewand reversalof this judgmnent.The matterwas resolvedin a SettlementAgreement signed by Hubcoand WAPDAon December17, 2000 which lowered paymentsto Hubcoby WAPDA,provided for corruptioncharges and lawsuitsto be resolvedor withdrawn by March 31, 2001, and reaffirmedthe validityof the contract.These factors have substantiallyeffected the outcomeof the Projects.

5.3.3 NDFC and PPIBplayed key roles in the implementationof the policiesand in selection,appraisal, and financingof the subprojects.However, the frequentchanges of key personnel,the politicalnature of appointments,and at times interferenceby GOP hinderedtheir effectiveness. The failure of NDFCto provide agreedfunding under GOP's directions for PPIB's operationspreoccupied PPIB managers. More recently,the financialproblems of NDFC's own accountoperations have jeopardizedits abilityto administerthe LTCF as it has used the Fund's cash assets for its own liquidityneeds, and has in effect "captured"the Fund. In addition,the politicizationof the IPP programduring 1998-1999prevented PPIB and NDFCstaff fromtaking decisionsfor fear of retributionwhich furtherfrustrated the resolutionof issues. This has negativelyaffected the outcomeof the Projects.

5.4 Costs andfinancing:

- 14 - 5.4.1 Strict comparisonsof appraisalestimates of projectcost and financingwith actual costs are not very meaningfulgiven the project designwhere the LongTenn CreditFund createdunder the project,was intendedto catalyzefinancing for private sectorsub-projects which, for the most part, were not identifiedin detail at the time of appraisal. The Hub projectwas the only subprojectidentified at the time of appraisal for PSEDPI and II, and the APL Pipelinesubproject was identifiedduring PSEDP H appraisal.

5.4.2 UnderPSEDP I, total project cost was estimatedto be US$1,893million equivalent. Theproposed Bank loan of US$150million, together with loansand grantsfrom bilateralaid agencies,amounting to US$415million would finance the Fundand consultingservices. The remainingUS$1,328 million was to be providedby the private sector,comprised of US$470million (25 percent)equity and US$858million (45 percent)in local and foreigncommercial loans and suppliers'credits. Under PSEDPII, the estimated total cost of the Projectwas about US$2,388million of whichUS$11 million was for technicalassistance and US$2,377million for subprojects. The Hub Power Projectwould account for US$1,832mnillion and the APL pipeline,US$100 million. The remainingUS$445 million would be for power subprojects.

5.4.3 In reality,PSEDP I and II led to the financingof fiveprivate energy investmentsin Pakistan,for a total cost of over US$3 billion. Table 2 below comparessubproject appraisal estimates (as preparedby NDFC) with actualcosts. (Annex 10 providesadditional details on eachof the subprojects.)It shouldbe noted that with the exceptionof the Hub subprojectand the APL pipeline,which werecompleted within budget,the other three subprojectsexperienced cost overrunson the orderof 20-30percent.

5.4.4 Given the incentivestructure under the 1994Policy, the capitalcosts per kW of the subprojects wererelatively high, largelydue to high "soft"costs (i.e. sponsor/projectdevelopment costs, interestduring constructionand other financingfees). Not includingstandby financing, the estimatedcost per kW for the fourpower projectsfinanced under the two loans(Hub, Uch, Rouschand SouthernElectric) was estimated to be US$1245,US$1200, US$1090 and US$1035,respectively. Using actualfigures, the cost per kW for these same projectswas approximatelyUS$1205, US$1365, US$1395 and US$1325,respectively. In addition,the percentof "soft"costs for the Hub and Uch projectswere about30 percent(including II percentand 7 percent,respectively, for projectdevelopment costs). The "soft"costs for the Rousch and SouthernElectric projects were more modestaround 14 percentand 17 percentrespectively, including 3 percentfor project developmentcosts. As a comparisonto the Uch and Rouschplants which used combinedcycle technology,the 360 MW combinedcycle power plant in Bangladesh,which was competitivelybid in 1997,has a total estimatedcost per kW of US$510,including "soft" costs of 17 percentand projectdevelopment costs of 4 percent. However,these priceswere obtainedat a time when world marketprices for this type of equipmentwere at an all time low, and manufacturerswere introducing new combinedcycle technology. Equipment prices have sinceincreased in large part due to increased demandin developedcountries, notable the USA.

- 15 - Table 2 Project Cost and FinancingPlan (Comparisonof NDFC Subprojects: Appraisal Estimatesvs. Actual) (amounts are in US$ million)

HU8ai APL Rousch SEPCOL Uch lTechnical Assistance TOTAL ap pi sa l apasalactua acua araisawacia appaisal actual apprasal actualappraisal actual appraisal actual SubordinatbdDebt - PSEDPI _._ IBRD 148 116 _ _, 4 1 150 117 Cobancib 240 198 240 198 O_e 18=s== 0 18 TOTAL 306 330 0 0 0 0 a a 0 0 4 1 390 331 11% Si*Ow*atedDebt - PSEDPIf 110 so 20 20 70 120 35 35 5 _ 5 6 4 248 234 IWMIRCoIsnde 120 58 0 0 70 49 0 0 182 175 372 282 06.13' __ = _ 12 8 30 ____ OD TOTAL 230 108 20 20 140 181l 35 43 187 2101 8 41 618 so6 18%

Tobd s Dt 816 438 20 20 140 181 35 43 187 210 _w ___ 100 29%

21 -Njr ePR _ _ 1 .___.....2401484 ______1175 _.____1175 3153t1 22111

_ ,0~CdAeniaec - - - -1 -1 - - ______X t1 C"Agwdes______492 462 46 47 22 25 163 138 713 7 137 14t 35 40 172 1SO LG ABans 84 75 40 30 _2 _ 195 _ OTAL 816 883 40U 183 1S8 57 65 34 326 - - 4 129W 42%

_E_u_y372 372 35 35 127 188 26 53 160 185 722 813 25%

Ote -- - - - owe______8 55 11 6 __ _ 196 3%

GAWDTOTAL 1860 1556 95 85 450 S7! 120 147 690 73 10 5 3225 31061 % I rla litiacl pt 9for Hubwii $2 mo,of slanyfinanc: US$40rMilon under tfe BarksECOguarantee; US$20 mllon underthe JEXIM guaantee; $25 mwff i u U derte bloradebt fadiy, sod $2S,milIn undvPSEDP I am 1. V' tOInal fI plan tUf i hcbi US mllln Oftady financdng,$30mn i equy*sadby and$16 mlain eathundr the IFC B LoanFaciy andtheWold Bank Guaranee FaIy. Th Rg en h Vieactua! ahmn are a sinc i financil ucufing hs n t be c Inludes apabton_ tert chrd.. 4i Indude evnueduuivgwon*uct, ;riudatedn damagescaims. 6. Sustainability 6.1 Rationale for sustainability rating: 6.1.1 The sustainabilityfor both PSEDPI and II is unlikely. Whilethe IPP programmoved aheadquite aggressively,the reform of WAPDAis proceedingat a much slowerpace than originallyenvisaged and only startedin earnestin 1998. In fact, there was no cross conditionalitybetween PSEDP I and II and other Bankprojects in the Pakistanpower sector. The economy,and hence the demandfor power,did not grow as anticipated,and too muchprivate power was contractedunder the 1994Policy. Thegeneral economicweakness of Pakistan,which has necessitatedIMF programsand reschedulingof commercial debt, places futureIPP foreignexchange transfers at risk-althoughthe recordof governmentsin facilitatingthese transfers has been good, even at the low point of relationswith IPPs-and any future calling of govemmentguarantees and accelerationof IPP debt couldtrigger Pakistandefault with uncertain politicaloutcomes. Also,the entireenergy sectorwas jeopardized by the poor financialperformance of WAPDAand KESC, which resultedfrom the failure(i) to achieveefficiency improvements through restructuringand privatization(which would have improvedmeter reading and billing and reduced electricitytheft); (ii) to receiveregular tariff adjustments;and (iii) of government,particularly at the provinciallevel, to pay for electricity.Furthermore, WAPDA had difficultyhonoring its commitmentsto the IPPs which necessitateda lengthyrenegotiation process on tariffs. Underthe circumstances, particularlyas long as an excess of capacityprevails, there could be furtherpressures on the twenty private generatorsto reducetheir tariffsand/or on the commerciallenders to restructurethe IPP debt. Notwithstandingthe above,WAPDA has now made substantiveprogress in implementingthe reform programsince 1997/98and has renegotiateda lowertariff from the majorityof the IPPs that has brought somerelief to theircashflow problem. However,the IPP crisishas contributedto the lack of confidencein Pakistanby potentialinvestors needed to tumaroundthe financialperformance of the power sector. This leads to the conclusionthat unlessthe powersector reform is filly implemented,the frameworkis unsustainable. 6.1.2 The institutionalframework created under the projectdoes not appearsustainable, unless the Governmenttakes drasticmeasures, given: (i) the lack of securefunding for PPIB, (ii) the insolventstate of NDFCwhich has, in effect, capturedthe reflowsof the LTCF,(iii) the reluctanceof the Govemmentto address the futuremanagement and structureof LTCF; (iv) the limitedability of WAPDA'sPrivate Power Organization(WPPO) to effectivelymanage its commercialrelationship with the IPPs; and (v) the delay in reforning WAPDAand restructuringthe sector. The financialdifficulties faced by NDFC as a financial institutionseverely jeopardizes the sustainabilityof the Fund sincerecent indicationsare that NDFCis dependentupon the Fund for incomeand liquidity.The Govermmentis yet to decideon the use of such funds or to implementsatisfactory safeguard measures to prevent the reflowsfrom being held hostageby NDFC. On the positiveside, there is currentlyprogress on the implementationof the powersector reforms, includingthe financialrestructuring of WAPDAand KESC,but there is still someway to go to fully restore the financialviability of the sector.

6.2 Transition arrangement to regular operations: 6.2.1 The Bankhas recommendedthat the Govenmmentreplaces NDFC as the Administrator,given its inabilityto effectivelymanage the Fund,and to put in place an interimarrangement to monitorthe current portfolioof assets. Unfortunately,the Governmenthas not yet made suitablearrangements to safeguard the assetsof the Fund or address its future.

- 17 - 7. Bank and Borrower Performance Bank 7.1ILending: 7.1.1 Bank performanceduring project preparation of PSEDPI can be consideredunsatisfactory. In many ways,the projectwas highlyinnovative and challengingin that it soughtto assist the Governmentin undertakingbuild-own-operate projects using limitedrecourse financing - a financingtechnique that had been seldom,if ever, used in developingcountries until then for large scale infrastructureprojects. It requiredthe creationof a PrivateSector Energy Development Fund (laterrenamed the LongTerm Credit Facility- LTCF),and the developmentof GOP institutionsto appraiseand supervisesubprojects, and managethe Fund (the PrivateEnergy Division of NDFC) and developand administera privatepower policyon behalfof GOP (initiallythe PrivatePower Cell whichsubsequently became the PrivatePower and InfrastructureBoard -- PPIB). However,insufficient thought was given to the financialaspects of the Fund and to its future. In terms of Bankprocedure, appraisal of both Projectswas carried out directlyby the EnergyOperations Division Manager. High levelsenior managementattention may have led to inadequateattention being givento dissentingviews duringthe reviewprocess.

7.1.2 Despiteits innovation,in retrospectthe Projectmay have been too large. Althoughseveral subprojectswere identifiedas potentialcandidates for LTCF fundingduring appraisalof PSEDPI, all the proceedsof the first loan and a portionof the proceedsfrom the secondloan were devotedto financethe Hub subprojectand the related pipeline. Given the slow progressin bringingthe Hub project to financial closure,the Bankshould have at leastconsidered ending its involvementin the project. Furthermore,this large projectrequired many sponsorsand lenders,leading to excessivelycomplex arrangements and decisionmaking processes.

7.1.3 The Bank not only playeda coordinatingrole on behalfof cofinanciers,but also playedthe role of "broker"to help resolveissues between the Governmentand the Hub projectsponsors. Theseroles were viewed by most stakeholdersas invaluablesince the projectwas pioneeringand the sectoralinitiative was new for Pakistan. Withoutthe Bank'scontribution as unofficialleader of the cofinanciersand confidanteof the Government,development of the Hub projectcould have presentedinsurmountable problems to the Govermmentand sponsors. The downsidewas that someparties viewed the Hub project as a "Bank project",especially as the Bank actedlike a promoterrepresenting sponsors, lenders and government.In hindsight,Bank involvementwent far beyondwhat was prudentfor a developmentbanker and exposedthe Bank to conflictsof interestand reputationalrisk.

7.1.4 Insufficientattention was devotedduring appraisal of PSEDPII to the affordabilityof private power in Pakistan. In 1994when PSEDPn was approved,WAPDA's average tariff was approximately Rs. 1.45/kWh(US¢4.5/kWh). The levelizedtariff recommendedunder the 1994Policy at US¢6.5kWh for the first 10 years increased,taking into accountlosses at 24.2 percent,to US08.6/kWh. Thus, the issue wherebyWAPDA would lose implicitlyUS04. l/kWh boughtfrom IPPs was acknowledgedbut not addressedthrough the loan. This issue wouldhave been appropriatelyaddressed had the Governmentmore vigorouslypursued the power sectorreform program early on and allowedWAPDA to treat the cost of purchasesfrom IPPs as a pass-throughin its tariffs.However, it is highlyunlikely that tariff increasesof this magnitudewould have been politicallyor sociallyacceptable, or even commerciallysustainable.

7.1.5 Lastly,the Bankrequired through covenants under PSEDP II (and as amendedunder PSEDPI) that the Governmentoffer concessionsto IPPs whichwould be deemedexcessive by today'sstandards,

-18 - includinga provisionwhereby the applicabletariff willbe suchthat it yieldsa returnon equityof 25 percent aftertax, providedthat it does not exceedthe avoidablecost of WAPDAwhich at the time was set at US06.5/kWh.In retrospect,the Bankshould not have encouragedsuch a provisionin its loan covenants on what was essentiallya cormmercialmatter.

7.1.6 Underthe circumstances,the performanceof the Bank at appraisalis rated as unsatisfactoryfor PSEDPI and II.

7.2 Supervision: 7.2.1 As a practicalmatter, it is difficultto assess separatelythe supervisionefforts of PSEDPI and 11 since the Loan Agreementfor PSEDPI was substantiallyamended to match that of PSEDPR and its closingdate was extendedto be co-terminuswith PSEDPII. In generalterms, the supervisioneffort focusedto a very large extenton the review,preparation, appraisal, and negotiationsof specificIPP transactions,as opposedto ensuringthat the frameworkfor invitingprivate power, and the related institutions,perform in accordancewith expectations.This is also apparentfrom the staffingprofile of supervisionmissions. In addition,the exceptionalsuccess of the IPP programin mobilizingprivate finance createda diversionfor management,both in the design and supervisionstages, lessening their attention on the reformof the sectoritself (whichwas to be implementedunder a separateBank project and by a separatetearn). On the credit side,the Bankwas very innovativeand forcefulin overcomingthe difficulties of seeingthrough the IPP programonce it ran into troublestarting in 1998,and worked in a coordinated fashionwith both IFC and MIGAwhich were also involvedin PakistanIPP projects. In addition,the consolidationof the Bank teamsworking on the IPPsand sectorreform issues has been beneficial.

7.2.2 Acceptableaudited financial statements for the LTCF and the varioussubprojects were submitted to the Bank as requiredin the legal agreements.Except in the lasttwo yearsof implementation,NDFC submittedthese reportsin a timelyfashion. The last two annualaudited statements for the LTCFwere delayedby over a year due to severalchanges in NDFCs management,which left the organizationwithout a permanentNDFC Chairman in a positionto call Board meetingsto endorseand sign the accounts. In fact,the audit for the last fiscal year is yet to be received. The Bankfollowed up on the delaysin an appropriatemanner and there were no accountabilityissues raised in the auditsreceived. Compliancewith the Bank'sprocurement and environmentaland resettlementsafeguard policies was a conditionunder the subloanagreements between the LTCF and the subprojectcompanies. Each subprojectmet the Bank's safeguardpolicies applicable at the time. SinceNDFC did not have the capacityto ensurecompliance, the Banktook the lead in reviewingand clearingthe Environmnentaland SocialSoundness Assessment reports preparedby independentconsultants, financed by the sponsors,for each of the five subprojects.Until the loansare repaid,the Lenders'Engineer is responsiblefor monitoringenvironmental compliance. As such, supervisionmissions did not includeenvironment or socialdevelopment specialists. Accordingto informationavailable, each subprojectis operatingwithin the environmentalstandards as per Bank guidelines. Exceptfor the Rousch subprojectwhere seven households were resettled, no other personswere resettled. Table4 (see page 35) providesadditional information on environmentaland resettlementaspects for each of the subprojectsincluding land acquisitionand peopleaffected, if any.

7.2.3 The supervisionmissions initially focused on the Hub projectand securingits financialclosure which also requiredarranging the financingfor the relatedAPL fuel oil pipeline. (It shouldbe notedthat gaps were discoveredin the supervisionrecords during the period 1992-95which correspondswith the intensiveperiod during which the Bank was focusedon closingthe Hub project.) The Bankmade exceptionalefforts to enable the closureof Hub, including:(i) the identificationof the sponsorsfor the pipeline,and helping arrangefor its financing;(ii) the use of IBRDfunds underLTCF for mobilization paymentsto contractorsprior to financialclose; and (iii) the initial utilizationof the ECO Guarantee

- 19- instrumentdesigned to protectcommercial lenders against certain political risks (afterthree yearsof preparation,the Bankand JEXIMprocessed parallel guarantees of US$240million and US$120million, respectively).The Hub guaranteewas the first partialrisk guaranteeextended by the Bank and the lessons were subsequentlyincorporated in the Board paperon "Mainstreaniingof Guarantees",which streamlined processingof the product. In April 1996,the Bankapproved a similarguarantee in the amount of US$75 millionfor UchPower Limited."

7.2.4 Whenthe Hub project ran intotrouble with the Governmentin 1998 and Hubco'smanagement was accusedof corruption,the Bank'sposition was conflictedgiven its manyroles (i.e. as guarantorto the commerciallenders, indirect lender to the projectcompany, lender to WAPDA,and advisorto the Government).On the one hand,the sponsorsand lenderswere lookingto the Bank to supportthe project and intervenewith the Governmenton theirbehalf, in lightof whatthey viewedwere politicallymotivated chargesand which they consideredwere unfounded and drivenby the desireof GOP/WAPDAto reduce Hub'stariff. The Governnent,on the other hand,was seekingthe Banks assistancein pursuingthe corruptioncharges and loweringof tariffswhich WAPDAcould not afford to pay withoutpolitically infeasibletariff increases.Ultimately, the Bank assistedin developingan orderlyframework for resolving the IPP disputes,and facilitatedmeetings between Hubco and the Government,at their request,to reach a mutuallyagreed settlement which was ultimatelyconcluded without the Bank'spresence.

7.2.5 Overall,there was insufficientattention paid to the institutionaldevelopment aspects of the projects. Significantcovenants affecting institutional objectives that werenot compliedwith includedthe following:

* EstablishingLTCF as an autonomous,commercially oriented financial institution was includedas a loan covenantunder PSEDPI. In addition,it was agreedthat a studyto that effectwould be conductedin 1989,and its recommendationwould be implernented subsequently.However, this was postponedby GOP, with the concurrenceof the Bank and cofinanciers,until the first subproject(Hub) was launched. Therefore,a covenantto reconstitutethe Fund alongthe aboveprinciples and to appointa boardof directorsand managingdirector for the LTCF was includedunder PSEDPII. (It is notedthat this was statedas a conditionof effectivenessin the Staff AppraisalReport (SAR), althoughthe Minutesof Negotiationreveals that it wasincluded in the Loan Agreement. It is unclear why the SAR was not updatedto reflectthis changein condition.) In addition,consultants were to be appointedto formulatea frameworkfor the operationof LTCF as a administrativelyand financiallyautonomous institution. While the board and a managing directorwere appointed, their powers were (rightly)questioned by NDFC,which was still operatingthe Fundunder an AdministrationAgreement with the Government.Both the Governmentand the Bank werepreoccupied with the detailsof the subprojectsand did not give priorityto addressingthe spiritof the covenant.

* For the first time in 1999,the Banksupervision team includeda financialsector/capital markets specialistin an attemptto focuson achievingan autonomous,commercially orientedlong termcredit fund, to reassessthe need to createa separatefinancial "institution",and to exploreoptions for the Fund to achieveits objectivein line with the Bank'scurrent financial sector policy dialogue. Althoughthere were severalfalse startsin attemptingto engagethe Governmentin a discussionon a termsof referenceto exploreoptions for the futuremanagement, ownership and structureof the Fund,the Governmentdid not meetits commitmentto conductthis study. Duringthe final

- 20 - supervisionmission, it was agreedthat the loan conditionto establishthe LTCF as an autonomous,commercially oriented entity could not be fulfilledin the near term, given the unfavorablemarket conditionsfor privateprovision of infrastructurein Pakistan. In addition,the saleof existingassets is hinderedby the overalladverse investmnent climate in the country. In exchangefor a waiverto this covenant,the Governmentagreed to submit to the Bank an alternative,interim arrangemnent for the Fundwhich includeddetails on the matterin which the assets of the Fund shallbe safeguardedand a processunder whichthe Bank shallbe consultedas to the ultimateuse of the LTCF funds. However,no plan has been submittedto the Bank, and so no satisfactoryagreement was ever reached.

* An amount equivalentto 0.25 percent(25 basis point)of the proceedsof the intermediation spreadcharged on subloanswas to be made availableto PPIB to cover the cost of its servicesunder the Projectand to ensureits financialautonomy. However,the first partial paymentwas not made to PPIBuntil 1998/99since NDFC, the Ministryof Financeand PPIB couldnot agree on the interpretationof the covenantto ascertainwhether or not amountswere due to PPIBin the early yearsof projectimplementation. While the Bank agreedto fund an additionalyear of PPEB'sincremental staff costs throughDecember 31, 1997under PSEDPII, it declinedfurther requestsand ultimatelyfacilitated a common understandingbetween MOF, NDFC and PPIB to enablean annualpayment to be made to PPIBto cover its reasonableexpenses, subject to the amountnot exceeding25 b.p. of the intermediationspread.

* Governmentapproval of the securitypackage for the fueloil pipelinefor Hub is statedto be a conditionof effectivenessin the Staff AppraisalReport for PSEDPII. In the Loan Agreement,it is presentedas a dated covenant. One shouldnote that the subproject,three years aftercommissioning, has not reachedtechnical financial closure since the ImplementationAgreement was neversigned. The US$20million subloan has, however, been fully disbursedand repaymentsto the LTCFhave begun.

7.2.6 Lastly,the "highlysatisfactory" rating of supervisionmissions for PSEDPI and II during 1995-97 was misplacedand focusedtoo much on the apparentsuccess of GOP'spolicies in attractingIPPs and privateinvestment to Pakistan. It was only in FY99that PSEDPII receivedan "unsatisfactory"rating in termsof attainmentof DevelopmentObjectives.

7.2.7 Underthe circumstances,the Bank'soverall supervision effort for both PSEDPI and II is rated as unsatisfactory.

7.3 OverallBankperformance: 7.3.1 Overall,the Bank seemedto havebeen too involvedin promotingspecific transactions (to the extent that it even helpedfind partnersin someinstances), especially the Hub subprojectand the related pipeline. It did not pay enoughattention to the mannerin which the Governmentwas implementingits 1994 PrivatePower Policy. The Bank oughtto have reactedwhen it was clear that too many lettersof supportwere being issuedand when it was apparentWAPDA was takingon excessiveobligations with IPPs, and that less than optimalprojects were being selected. The early lack of focus on the impact on WAPDA'sfinancial situation and the covenantsrelating to PPIB and LTCF also contributedto an unsatisfactoryoutcome. Therewere managementshortcomings during preparation, appraisal and early supervisionof the Projects. The responsiblemanagers were too closelyinvolved in promotingprojects, and seniormanagement failed to pursueadequate quality assuranceand ignoredwaming signs. Early supervisionwas entrustedto looselymanaged long term consultants.In addition,Pakistani authorities

-21 - alleged malfeasance against a former Bank staff closely associated with the Projects in the context of the Hub subproject, which led to an internal investigation. It was only after 1998 that substantial management attention, both in Washington and the field, was accorded to the supervision efforts of the projects and to the underlying structural problems in the sector once it became clear that the current sector condition was unsustainable and threatened the macroeconomic stability of the country (FY99); by that time, the damage was done.

Borrower 7.4 Preparation: 7.4.1 The institutions responsible for managing GOP's policy and negotiating agreements on its behalf (PPIB) and for administering the LTCF (NDFC) were government-owned bodies that performed satisfactorily during project preparation and development. Creation of PPIB under PSEDP II was a sound decision, and PPIB was effective in carrying out its role for GOP in the implementation of the 1994 Private Power Policy. However, it is now apparent that both PPIB and NDFC's effectiveness were undermined by changes of government that reduced their independence and decision-making during implementation. The Bank sought, unsuccessfully, to prevent this from happening through covenants in the PSEDP loans.

7.5 Governmentimplementation performance: 7.5.1 (i) PPIB: PPIB reputedly performed well initially, and all parties -- NDFC, WAPDA and private power developers -- praised the quality and effectiveness of its staff. However, over time better salaries and opportunities in the private sector attracted many of its best professionals especially with some of the IPPs. A Special Assistant to the Prime Minister headed PPIB after its formation in August 1994, and this enabled it to obtain prompt government decisions and approvals. Subsequently, with changes in government -- the Ministry of Water and Power controlled PPIB at various times and then the Ministry of Investment -- its authority and reputation were reduced. For example, some sponsors questioned the transparency and impartiality of the process by which letters of support were granted. PPIB, to its credit, does not seem to have taken a prominent role in GOP measures adopted by GOP/WAPDA to delay commissioning of IPP generators and actions aimed at forcing renegotiation of IPP tariffs. Overall, PPIB's implementation performance is rated satisfactory.

7.5.2 (ii) WAPDA - WPPO: WAPDA's Private Power Organization (WPPO) was originally set up to negotiate tariffs and power purchase agreements. It also managed the integration of private power supplies into its system. Most of these functions were taken over by PPIB from WPPO in 1994 when it assumed full responsibility for negotiations with private sector subproject sponsors. When the financial problems of WAPDA emerged in 1997, WAPDA and the Government began to dispute the PPAs and discredit IPPs through allegations of corruption. Several IPPs faced delays due to WAPDA's failure to provide transmission inter-connections on time. WAPDA sought to delay commencement of IPP operations by refusing to cooperate with them during plant testing and commissioning. This led to significant start up delays for several IPPs and contributed to undermining international investor confidence in the country. Both GOP and WAPDA have alleged that their consent to the Hubco PPA was obtained improperly and corruption was involved. To date, no evidence has been provided to the courts to support these allegations, and both sides have mutually agreed to drop pending legal cases. In hindsight, it is apparent that WAPDA was not fully committed to purchasing power from IPPs or to reformiingitself

7.5.3 During implementation of PSEDP nI,WAPDA's financial performance began to deteriorate significantly. Prior to 1994, WAPDA had achieved good financial performance and had consistently maintained a high level of self-financing although this can at least be partly explained by low costs of old hydro plants, such as Tarbela, shown in WAPDA's financial statements. However during implementation of the project, a serious decline in WAPDA's finances occurred. WAPDA was not able to reduce its costs,

- 22 - reducetheft of electricity(except when the army took responsibilityfor meterreading and billingin 1999), recoverrevenues from provincial governments and governmententities, and obtain GOP/NEPRAapproval for tariff increasesneeded to maintainits financialviability. One of the principalconsequences is that WAPDAhad difficultymeeting its powerpurchase obligations to IPPs. WAPDA'sfinancial crisis was predictable,yet the managementwithin WAPDA at that time remainedcomplacent as financesdeteriorated and poor qualityservice led to lossof customergoodwill. Overall,WAPDA's implementation performance is rated as highly unsatisfactory.

7.6 ImplementingAgency: 7.6.1 NDFC: The PrivateEnergy Division(PED) of NDFCperformed in a satisfactorymanner during the early years of implementationin processingthe appraisaland approvalof subprojects,but was subsequentlyfound to be unsatisfactory.While PED was staffedwith well qualifiedpersonnel, the autonomyof the PED and the abilityof its staffto undertakedecisions was often frustratedduring 1998-2000when the privatepower programwas highly politicized. Subsequently,most of the PED's senior staff have left. The financialcondition of NDFCjeopardized its abilityto fulfillits functionsas administratorof the LTCF. Furthermore,the compensationarrangements for NDFC,in additionto their accessto LTCF funds (by virtue of the LTCF accountbeing held on depositat NDFC),made it extremely unlikelythat NDFC wouldfacilitate the creationof an alternativearrangement. The deteriorationin the financialcondition of NDFC commencedsome time beforethe approvalof PSEDPI and continuedthrough the last decade,largely as a resultof Governmentintervention and directedlending. NDFC's abilityto continueto administerthe Fund is tied to its own future,which is in questiongiven its insolventstate. It is unclearthat NDFCwould be in a positionto remit fundsheld on depositon behalfof LTCF without liquidityassistance from the State Bankof Pakistan.NDFC and GOP failedto act on the establishmentof LTCF as an autonomous,commercially oriented institution. Following the loss of confidenceby private investorsin Pakistan,the Bank has agreedwith GOP that spinningoff the LTCF as a separatefinancial institutionis no longerwarranted. However,concerns remain about how surplusesgenerated by the Fund and reflows fromdebt servicepayments by the IPPswill be used by GOP.

7.7 OverallBorrower performance: 7.7.1 Theborrower and the implementingagencies (i.e. NDFC and PPIB)were fully committedto the project and this is evidencedby the successin completing19 IPPsunder the 1994policy in additionto the Hub project Beneficiariesof the LTCF,without exception, praised the role of LTCF in providing long-termsubordinated loan flmdswithout which their subprojectscould not have been financed. However, the Governmentand WAPDAwere criticizedby IPPs for politically-motivatedobstructions and delaysin the past two yearswhich led to substantialcost overrunsfor severalIPPs and contributedto the overall declinein foreigninvestor confidence in the country.

7.7.2 WAPDA'scommitment as the powerpurchaser was muchmore problematicin 1998/99. GOP/WAPDAvigorously pursued the renegotiationof tariffsthrough corruption allegations and impeded completionof severalIPPs by not providingthem with inter connectionfacilities or the approvalto run their plantsuntil lowertariffs were agreed. WAPDAwas ultimatelysuccessful in securingtariff concessionsfrom about a dozenIPPs, all of whichhad yet to be commissionedin 1998/9as these were the plants over wbich WAPDAhad the most leverage. Significantly,no IPP (otherthan Hubco)which had achievedcommercial operations prior to this time, concededto WAPDA'sdesire to reducetariffs.

7.7.3 Lastly,the Governmentshould have reducedits commitmentsfor new IPPs once it becameaware that an excessof generatingcapacity was developing.In all, the performanceof GOP and its agencies (NDFC and WPPO)is deemedunsatisfactory.

- 23 - 8. Lessons Learned 8.1 The followingare some of the lessonslearned from PSEDPI and II.

8.2 SectorReform and IPPs. The Bankmobilized over time an impressiveamount of resourcesfor the power sectorin Pakistanand helpedeliminate power shortages.The IPP program,unprecedented both in conceptand scope,elicited an enthusiasticbuy-in both withinand outsidethe Bank. The Bankpromoted measuresfor sectormanagement and restructuring,as well as public sectorpolicy reforms, which were generallyright and timely. The Government,however, failed to have them implementedat the intended pace. While failuresin sectorreforms did not precipitatethe financialcrisis of WAPDA,they compounded it, crippledthe efficiencyof both WAPDAand the IPP program,and left the sectoroverly vulnerable to economicdownturns. The debatewithin the Bankon whethersector reforms should precede private investmentin powergeneration or whetherprivate investment acts as a catalystfor sectorreform is unresolved;however, there is a strong consensusthat privateinvestment is not a substitutefor reform and that private investmentin generationshould not takeplace in front of reformswhich at a minimum address distributionefficiency and tariff policies. OnceIPPs start to operate in a power system,it would be preferablefor an integratedutility sector to be unbundled,so that competitionfor the marketcan be introducedand, over time, generatingplants can be operatedon a competitivebasis. Thisfurther market developmentis anticipatedas part of the ongoing power sector reformprogram, but detailsare yet to he determined.In addition,automatic indexation formulae shouldbe in place to protect thepurchasing utilityfrom changesin fuel costs, currencydevaluation, and the cost ofpurchased power.

8.3 By supportingthe establishmentof PPIBand WPPOto implementthe 1994IPP policy,and by givingemphasis under that policy on the use of governmentguarantees, it may have had the unintended effect of enablingvested interest in the sector(WAPDA and the SectorMinistry) to "captureand stall" the implementationof the structuralchanges envisaged by the Governmentin the 1992Strategic Plan for the privatizationof the PakistanPower Sector, i.e. the unbundlingof the WAPDAPower Wing and the introductionof competitionin the market. After substantialdelays, the first phase of the power sector reform programis now nearing completion(i.e. restructuringof WAPDA'spower wing into 12 corporate entitieswith the remainingWAPDA responsible for hydelgeneration, with the NationalTransmission and DispatchCompany initially operating as a singlebuyer). The singlebuyer model has risks in terms of preservingthe role of the sectorministry in investmentdecisions, possibly shielding financiers of generation projects frommarket risks and govermnentinterference in electricitywholesale trading. The current NEPRAAct envisagesthat generatorsover time will be able to enter into bilateralcontracts with distributioncompanies. The institutional/regulatoryframework which is now being finalizedis being designedso as to not hinderthe ultimatecreation of a competitivewholesale market.

8.4 BenchmarkPricing vs. CompetitiveBiddinz. Ratherthan proceedthrough competitive bidding for private power,Pakistan instead set a bulk tariff ceilingfor investorsin an effortto acceleratethe private power programnand reducetransaction costs in orderto quicklyaddress the blackout situationfacing the country. This was a very successfultactic in attractingforeign investors, but too many projectswere approvedand the selectionprocess was not transparent. In fact, it is likelythat someprojects for which Lettersof Supportwere issued,and indeedsome of thosewhich ultimately reached financial close, benefitedfrom politicalsupport since no clear criteriaexisted to determinewhich projectsto prioritize when the Governmentwas facedwith negotiatingproject agreements with almost80 potentialIPP developers. In addition,setting prices rather than biddingallowed for inefficiencies(e.g. projectswhich were too small and not leastcost) and corruptionopportunities on non-priceissues (e.g. securingthe attendantfuel suppliesand WAPDA'stransmission investments). Furthermore, setting the ceilingprice for

- 24 - power which,in hindsight,was too high led to perhapsinflated costs. However,competitive biddingfor IPPs combined with incentives for providing least cost power could have resulted in lower tariffs, prevented too many and suboptimal projects being developed, and promoted transparency.

8.5 Le IPP programsneed to be carefullymanaged. The IPP programwas "cuttingedge" and perhapsahead of its time given the country'sstate of development(in termsof social,economic, political, and institutionalgovernance), and may have been betterbeing piloted before encouraging wider use. A power systemcan accommodatea smallIPP programwithout major financialdislocation. Indeed, adding IPP capacityto a slow reformingsector can be a catalystfor reform. However,project economicsstill matterif the govermnentis assumingsome risk and severallessons emerge from the Pakistanexperience includingthe need to: * tailor public financial support and guarantees to facilitate an efficient investment program. Pakistanwas successfulin limitingBank supported political risk guaranteesto only two large projectsand in providingsubordinate debt underPSEDP I and IIto only fourlarge or mediumsize IPPs. However,all of the 20 IPPs receivedgovernment support underImplementation Agreements whereby the governmentbackstopped the payment obligationsof WAPDA/KESCand the state-ownedfuel suppliers. It is doubtfulwhether any IPPs could havebeen financedin Pakistanwithout government guarantees since perceptionsof Pakistan'srisk had limitedfinancing to terms of 18-36months. Nevertheless,such supportshould have been limitedonly to projectsof clearpriority that couldbe affordedby the country.

* limit the size of thefirst IPP to enableready substitutionif a key participantdrops out and allowthe Bank to take a more hands-offrole in the detailsof the transaction.The 1,292 MW, US$1.6billion Hub PowerProject was the first IPP transactionin Pakistanand the first subprojectfinanced under PSEDP I and II. The projectemanated from two unsolicitedoffers which weresubsequently consolidated and requiredsix yearsto reach financialclose. The difficultieswith the projectcan largelybe attributedto its size. The Hub subprojectabsorbed the full provisionfor PSEDPI (US$146million) as well as a significantshare of PSEDPII (US$130million including the financingof the associated fuel oil pipeline). The Bankalso provideda US$240million partial risk guaranteeto commerciallenders in orderto closethe financingplan. In addition,the Bank playeda vital role in brokeringthe transactionand assistingthe partiesin negotiatingkey agreements,including commercial agreements to whichthe Bankwas not a party. However,this approachlater backfiredas the Hub sponsorsexpected the Bankto play a key role in resolvingtheir disputewith the Government- a rolethe Bank was ill-equipped to perform as it was a conflictedplayer in as much as the Bank is also an advisorto the Government.Until Pakistanhad developeda track recordof GOP contractual performanceand successfulimplementation of powerprojects in the power sector,the Governmentshould have concentratedits effortson modest-sized,and as a consequence, more easilyfinanceable projects.

* have an efficientfuel supply policy particularly the rational use of natural gas (electricity generationis usuallyone of the highest valueuses of gas) and allowIPPs to procurefuels in competitivemarkets, both foreignand domestic.

* create capacity to manage IPP contracts. While Pakistan created institutional capacity to approvenew IPPs, and the creationof PPIB as a "one stop shop"for investorsis widely

- 25 - creditedas a key advantagein preventingbureaucratic delays, WAPDA did not put in place an effectivecontract management unit to managetheir commercial contracts with the private sector. Furthermore,WAPDA was conflictedas the sole buyer, systemoperator and competingpower generatorwhich arguesfor unbundling,at least, transmission.

ensureefficient plant dispatch. Sincefuel is the main elementof WAPDAand IPP costs, the power systemneeds to be operatedto ensurethat the plant with the lowestvariable operatingcost is dispatchedfirst, subjectto transmissionconstraints, and that undue preferenceis not givento any plant, publicor private. WAPDA'scurrent dispatch facilitiesdo not fully recognizeall relevantfactors.

8.6 Due Diligenceby OtherLenders. Given the overallgovernment guarantees provided through the ImplementationAgreements, it appearsthat privatesector lenders, export credit agencies and eventhe IFC and the Bank primarilyrelied on the risk allocationframework as containedin the securitypackage, and discountedthe potentialcountry, macroeconomic and sectorrisk. The partiesmay have also drawnundue comfortfrom the Bank Group'sinvolvement in the 1994 PrivatePower Policy. The lesson is that one cannotfully rely on the risk mnitigationmeasures provided in the securitypackage when the underlying economicsof the projectare compromisedby an unsoundmacroeconomic situation in the country.

8.7 Procurement.Most IPP projectswhich gainedLetters of Supportunder the 1994 Policy, and which were interestedin seekingsubordinated financing under the Long Term CreditFund, were not ultimatelyable to avail themselvesof the Fund due to procurementrestrictions. Any applicationof LTCF financing(utilizing the Bank or JEXIMfunds) had to meetBank procurementguidelines. Of the five subprojectsfinanced by the Bankthrough the LTCF, one (SouthernElectric) selected the EPCcontractor throughlimited international bidding and four sub-contractedvarious items of the EPCcontract through intemationalcompetitive bidding (ICB) which were to be procuredwith Bankfunds. However,Bank procurementguidelines existing at the timedid not fit well with the philosophyof build-own-operateand limitedrecourse projects. As a result,the Bankhad to includespecial procurement provisions in the Loan Agreementfor the Hub and APL pipelinesubprojects, including allowing equipment and works estimated to cost up to US$29million to be procuredunder contracts awarded with due considerationsof economy and efficiencyand in accordancewith soundcommercial practices. RevisedBank procurement guidelines now allowproject outputcosts (ratherthan input costs),such as the electricitytariff chargedby the power station,to be subjectto intemationalcompetitive bidding (rather than the underlyingequipment procurement),which opens the way for Bankfinancing of virtuallyall costs (soft and hard) during constructionor for refinancingafter completion of construction.International competitive bidding upstream (i.e. for the IPP concession on the basis ofprice) leads to greater transparency, reduces the risk of corruption, and allows more flexibility for Bankfinancing.

8.8 ContingentLiabilities. Under Implementation Agreements signed with IPPs, the Government guaranteedthe paymentobligations of the state-ownedpower offtaker (WAPDA or KESC) and the fuel supplier. In addition,GOP guaranteedthe availabilityand convertibilityof paymentsin foreignexchange. While foreigninvestments have manybeneficial effects, they also entailat somepoint the repatriationof profits and the servicingof foreigndebts. The capacityof a countryto meet thesenew obligationsis necessarilyrelated to its capacityto increaseforeign exchange eamings through exports. Particularlyin the case of the powersector, where investrnentsin excessof US$5billion were made, the incrementalforeign exchangeoutflow is on the orderof US$800million per annum,equivalent to eight percentof Pakistan's exports. The Bank did not investigatethe matteruntil 1995in the contextof the due diligenceprocess for the Uch partialrisk guarantee. The analysisconcluded that undermost scenarios,Pakistan would have seriousdifficulties in meetingthe incrementalforeign exchange obligations. Furthermore, given that

- 26- contingentliabilities also arise in the case of oil and gas development,Pakistan ought to put in place, possibly at the CentralBank, a monitoringsystem for contingentliabilities.

8.9 FinancingIssues. It is imperativeto assess infrastructurefund projects on an holisticbasis, includingthe financialimplications beyond the energysector. The focusof the Bankin this case would seem to have been on the constructionof powerplants and the productionof electricity.Little or no attentionwas given to the significantrisks accumulatedthrough the financingstructure, nor to the overall abilityof the Pakistaneconomy to bear the very significantbalance of paymentsburden createdthrough the projects. Theserisks, if properlyaddressed at the outset,may have led to the overallrationale of the projectsbeing questioned.The oversightin this regardextends also to the QAG who failedeven to address these issuesin the Qualityat Entry Review. Thepreparation/appraisal team should includea capital markets/finance sector specialist to ensure that all thefinancing issues associated with creating an infrastructurefund are properly addressedat the outset.

8.10 Insufficientcare was lent to the role of LTCF as a quasi-financialintermediarv. The Long Term Credit Fund was createdwithout any measuresto ensure that its variousassets and liabilitiesare matched (i.e. in terms of currencyand interestrate structure). Furthermore,the implementingagent has not until recentlybeen requiredto prepareany type of cashflow projectionsor assetlliabilitymanagement - which shouldbe standardfunctions for a fund manager. As a result,the LTCFhas sufferedexcessive volatility in profitability.These weaknesses stem froma lackof attentionto detailin the design of the project (onlendingterms, assetand liabilitymanagement, etc.) and an absenceof a mechanismto allow for the accommodationof a varietyof outcomes. The LTCF is withoutsuitable guidelines in terms of its financing structureand withoutthe capacityor mandateto respondto significantchanges in circumstances. Moreover,given the terms of the AdministrationAgreement signed between NDFC and the Govermment, there wouldnot appearto have been a fullunderstanding as to how the managingagents would ever have the incentivestructure to behavein the fashionrequired for the projectto be a success. For example, NDFC not only eamed a significantfee by administeringthe LTCF in additionto receivingother fees under the subloans,but also was able to use the LTCF money held on deposit withNDFC to shore up its own liquidityneeds (at one point, the LTCF constituted25 percentof NDFC'stotal deposits). It mustbe recognizedthat a project of this naturerepresents a relativelylong chain of interdependentprocesses, the overallstrength of the project is only that of its weakestlink.

8.11 Enforcementof Covenants.When two materialcovenants remained unfulfilled well past the dates stipulatedin the LoanAgreement, namely establishing the Fund as an autonomous,commercially-oriented financialinstitution and finalizingthe securitypackage for the APL pipeline,the Bank essentiallyhad no leverageto enforcethe covenants. Suspensionof disbursementswas not a viable optionsince (i) the funds were disbursedfor the APL pipelineprior to the covenantdate for finalizingthe securitypackage and (ii) the Bankcould not suspenddisbursements for other subprojectsdue to noncompliancewith the LTCF covenantsince these funds werecommitted to privateentities which had nothingto do with the Government'scommitment to spin off the Fund. In hindsight,both of these conditionsshould have remainedconditions of loan effectiveness,as originallyindicated in the StaffAppraisal Report, or other remediesshould have been designed.

8.12 Corruptionallegations. Whencorruption was allegedin someof the sub-projects(especially Hubco),the Bankfound it difficultto respondgiven its multipleroles (i.e. advisorto the Government, lender to WAPDA,indirect lender to IPPsthrough the LTCF, and guarantorto commerciallenders through the partialrisk guarantees).In the case of the fourIPPs financedunder PSEDP I and II, and in particular the Hub and Uch projectsfor whichthe Bankalso providedpartial risk guarantees,the Bank was a party to the private sectortransaction and was looked upon by both the Governmentand the privatesector as

- 27 - having a positiverole to play in resolvingthe dispute. StandardBank practice would dictate that the Bank not get involvedin commercialdisputes; however, the Bankhad a responsibilityto act once the partialrisk guaranteeswere underthreat of beingcalled by the lendersas a resultof whatwas perceivedto be governmentevents of default. The difficultyfor the Bankwas in tryingto maintainan "honestbroker" role in a situationwhere differentparts of the BankGroup often played conflicting rotes: IFC as a lenderto IPPs was tryingto mitigateits reputationalrisk vis-a-visits syndicatedB loans;the ProjectFinance Group in the Bankwhich was focusingon mitigatingcalls to the Bank'spartial risk guarantee;the country economicteam and energyteam were concernedabout the macroimpact and were advisingthe Government on the reformagenda. Furthermore,IPP sponsorsapplied pressure on the Bankthrough their Executive Directors,govermments and legislators,whereas the Govermmentapplied pressure on the Bankto live up to its zero tolerancepolicy on corruptionand requestedassistance in theircorruption investigation. Their argumentfor Bankassistance centered on the Bank'searlier, pervasive role in puttingthe Hubcodeal togetherand approvingthe documentation,in additionto beingthe mainadvisor to the Govermnentin developingthe IPP Policy. In all, this pushedBank staffand managementto play a moreproactive role than may have otherwisebeen the case. However,despite the variedinterests of the WorldBank Group in the dispute,the Bank'soverall objective remained the developmentof Pakistanand this objectiveguided the Bank decisionmaking.

8.13 Initially,the Bankhad advisedthe Governmentto separatethe commercialand criminalissues in an attemptto bringthe perceptionof an orderlyframework to resolvingthe IPP disputes. WAPDAwas facing severecashflow problems and was not in a positionto honorits paymentobligations under the PPAs. In addition,the country'sforeign exchange reserves were dangerously low whichjeopardized the Government'sobligation under the ImplementationAgreements to convertrupees into foreign exchange. SomeIPPs indicateda willingnessto renegotiatein recognitionof the country'sdifficulties, but not under duressand coercivetactics. However,separating the commercialand corruptionissues proved difficult to do in practicein the case of Hubco,where the Govermnent/WAPDAwas of the view that the original commercialterms were fraudulently obtained. Ultimately,both Hubcoand the Govermment/WAPDA requestedthe Bankto act as a facilitatorin resolvingthe disputesince attemptsby the partiesto renegotiate the commercialterms werecontinuously bogged down in corruptionallegations and refutations. Overall, the lessonleamed is that govermnentsand governmentalagencies should be encouragedto pursue corruptionstrictly according to law and internationallyrecognized due process,and in the meantime contractualobligations should be honored. 8.14 Renegotiations.Renegotiating concession agreements is not unusualin the privatesector, particularlywhen prevailing conditions substantially change (e.g. externalmacro shocks). However, negotiationswill more likelyresult in a promptand mutuallyacceptable solutions when they occurin a commercialatmosphere, free of coercion.

-28 - 9. Partner Comments (a) Borrower/implementing agency.

COMMENTS BY NDFC ON PRIVATE SECTOR ENERGY EVAELOPMENT PROJECT I & IJ (LN 2982-lPA AND 3812-PAK) INTENSIVE LEARNING IPLEMIENTATION COMPLETION REPORT (DRAFM)

Note: The cornuents hereunder are restricted to NDFC related components of the ICR.

4. Achievement of Objective and Outputs 4.1.4 The Bank's ICR has rated the oucome of both the Projects as unsatisfaetory on the basis that the related economic, financial, istitutional and technical aspects fell short of expectations. Although the related conndc expectstions did not materiarie to the level perceived, however, development of financial, institutional and technical aspects was not entirely insignificant. We consider that duo cognizanc. needs to be taken of the sizeable investmett in the power se

4.2.3 & 4 Flusial Impact: The Bank hax highlite.d the currncy mismatch, which leaves PSEIP-I&l1 exposed to adverse exchange raite movements. It needs to be roted thxt while for P$IP-1 tbis aspect was totally ignored, however, in PSDP-1I the excbhange risk fbr USS miovement to Pak Rxpee was coefd. The ae in the structuring of PSEDP-II demonstates a learning curve. Although, he find is still exposed to exchange risk of currencies oth than TS $. in ftre, this exchange risk exposre could be assessed in detil and appropriate mitigants could be exercised. With regards to interest rate a reasonable level of cushion is available between the- Wted average interest ates of the borrowing vis-&-vis on lepding to the investmenpt enterpises. As such, the financial impact could be rated as moderate rather than urisatisfactory.

4.2.6 to 4.2.8 Sector Policies: It needs to be acknowledged that the general economic scenaio of a country play a pivotal role in achievement of targeted obJtcfiveaSgoals Ik case am antiocp*ted/targted ecooomic development would have materialized, it would hive ecorplnertteid the Sector Poliies inated by te:0?.. It was unfortunate That economic development was not able to keep up the pace with the sector rembrins or energy policy initiated by the GoP. 43 Not Present Value/Economic rate of return: Since Hubco was conceved on the basis that it should remain in the least cost pln, terfore, NDFC's apraisal rdportp covored ERR. However, the other IPPs were not part of leat cost generaidon plan, therefore, necessity for computation of ERR was fet neither by NDVC nor thV Bank. With regards to financial rates of retarns, NDFC's appraisal included an in-depth financial analysis, including MR calulaos of dte sub-procts. Tis stands vali fbr the restreuturing proposals for Rousch and Sepcol submitted to the Bank for its approval. I

-29 - 4.5 lntjtUttalUd deV4lPIent impact:.The ICR is citroal of NDFC' s apetite of LTCE funids. iveit nes to e kit was the wae ib Administration Agrcemenit (AA), whichallowed thi*s situat to happen. Perthet f the AA, I4FC VaS required to ii a sertacco for the Fund Sn this requirenent WAS cmplied with, however, rired tt as not foused towards monitoring: of thisia6d6nt.

The isue relating to security of future rpaYmnerns fom. borrowing com*panes is somehow resolved ini view of "peifcinruc sfroM 'OF (dtd December 20). ccrigy aLCF eositAcWthsbe opne ithEEtNB: 3where llfuture repaynts fo LTF to b depst .It,ma be more appropite itf dx Fnd's icome is deposited with more than one b1nk. Wbilst it may be t t xa certain provisining fis required for the Fund's prast ear s due to N 'scu0rent ffrnancill Dstandin, howeverl the perfortnaxce obligations ~f OlP are in. no way d towrd th co4iajcs.I short Xthe s llaw as. the: abec of Qsepameters policy framework for depl;oyment of LT refoWS, as this could have been eaSIlY estakblished prior to makng PSEDP4I eftilva. The ICR has also critiied1F for l g ost o te seo tf of PED. While someof thesenio:r O rof FE havele Fhweer,theeertise, ved i gcneti :is such that it has ot crateW c.he learn curveofove a decade hja eabled i)staff to y POs to Thte mostiorat featur, whihpealedin PEI-pwas07th 0disseminatn Iof (knolge and expertis bythe enisto their uio u t iS oo on ave to cotr that insional obectiv haVe nOt bn ie.

5.,3.3 Bank has comend tha fixlue: of NtFCt poide gred fundng uder Go's dietIofor PPIB's peratio preoccupi It tnay be rl6ld thate

N4DPC was not the 'decision i by fr el i Ue o , C

6 JSUtiablt (.1.2): It has bensttdf ht fianl Sdiffclte faed( bLyNE)C sevrly jeopri1zes te ustanailty o Fud. OPasow esabished an rralgeint: (refer DScto 4.; alo and asa rsut re.net f LC orwr ilntb under cnro yisf FC. thTiherefoe O se is f that are with C over last few yars Eta t of a rk for fture deplgoymen, utiization and hedging of Funds inomeanopmentthedstinDbilyty.

The other najor: risk of LTCF's sustinabity is abilt of LTCF borrwsk to nake payments inatime, which amjong other, things is4alodpnet o Wapda's prorac in terms ofmeetingiiitsPayienit obigations. I view f sttlmntti Agreemets, ther overall situatilon hais improved altho'ugih we unertad h* agra deal ofwork is yet to be done towarsimpovemnt of inaiol-W'd healh f he t*o power utilities.

2

-30 - 7.6 Implemenatifg Agency (7.61. NDFC): It bas been stated that NDFC and GOP failed to act on the establishment of LTCF as an autonomous, commercaluy oriented instituon. As far as ND)FC is concerned., this job was, ever entrusted to N1FC. However, NDFC did provide its input (for instance ih prepaiatn of TOIs for appointment of conaultants) whenever the World Bank or GOP requested it. 7.7.3 Whilc cetegorizing NDFC's perfo9uance as unsatisft.i the ICR did not-take due cognizance of NDFC's contribution in overall loan stztoa of sub-projects during all phases (pre anid post financial close) of the projects.

ICR ANNEXURE Annex- 10. A. Hub Power Project, Para 7: It has beef stated that construction was completed in two years (1995-1997). The conssruton period for tho project was 47 months from Efifctive Date (RD). The RD for tho prposes of TfC was December 12, 1992, however, due to delay in financial close and delays in payments to the oontators, Ilubco and the contractors agreed an extenion ottiie wheeby the period for project's completion was computed from Apxil 30, 1993 With 47 mOiths cinstruction period the trgeted conmpletion was March 31, 1997. Commercial operations were ofitially declared on hMh 331, 1997 i.e. on schedule.

Annex- 10. B. The Asia Pipeline Ltd (APL) Project Para 9: It has been stated that APL still owes approxirnately USS I million to PS orn account of extcess tariff charged between November 1996 and July 1 99. Tbe actual liability of APL towards PSO is of Rs. 447 million, which at the current chnse ri6e f RAs. 61 to US$ 1 tranisltes to approximately US$ 7.328 million.

-31 - COA(MMNS.&Y WAPDA ON INTENSWE WLAPNUNGfi"3LMENTATION COMOPLTION REPORT (DRArIr)

PRiVATE SECTOR ELERGYDEVELOPMENT PROJECTS & r7 (LX2992AND 312-P)

TORt FO]R COzNT DY WABDA Our commentfs se esbioted to tbe WAPDA - related cortponewns of the report

VjTR ODUTORHEMARKS

As a esult of due digence aried out by S. We difer with the perfbrmanre zating of - aatistory' pcrtlzig to W:APTA inzlud1ng WPPOC DesPie cons_zmta, in4uding in*-quaM saport fmm tho Bank itaeU WA?DA performed SSALOIY. HAi upon the Por secot reatructnr g prowaxne and ecency iraptovoeent mesxure8, we can safety btccast a fineciauy viable fiimr for WAPIA and its succe5sors0 in our : tsessmenthoe XPPs: p io is very much sasiable. WAPDA's self-assesSed trrng rxgmeding implemotntation of£PSEDP-I and I is satisfctxy PAR4WISE COMMNTS

- '1NSZ7XUTIONAL OBJECTIVES ILlVH NOT BEEN FIPJLLY A(PARA 4.1A4)

As fr as WAPDA is concemed. a ceeofelece samds ereatd in the ftan of WPhs :inwtinzin Is otr only capable of handlng the preseit IPPs bu is liIela to uejbrherow of fbrtign ivesftment during next 25 years, as envisaged by us-

*-VAPD - 's F1X NCE4L PERFORMAArCB ILS ]BENVPOOR'?- (PARAS 4.1-1, 4.1.3 AND 4.2.5)

WADAs financial position sutands iproved- The total revenne oaUection tuargt fisr lY o00o - 2001 isLover RupeS 165 Billion. The target for teperiod July 2000 to Mhrch2091 bas already been exceeded. Systemn losses oM a igh leVel of 42% were reduced to2 273% in FY l9 Ths taxget for the current isoal standsaset at 2,4.5% The cxrrn Agaves indicate that the t:at stens aJchieved. WAPDA's developnt programme ix back oa fist trfck. Development budget for the 1-Y 2000 - 20301 is over Us. 20 bilon- Gbazi Barots, and ChashmAa Hydro Project are now on schedule. Psyables position is

-32 - Public Sector recevables remain a source of con**rr. The recervables ex:cludig Ohose frim RESC as of riov stand at Rs. 23 biloa. Hisor!call balloonodkVp Bg= of receivables bowe been n0ht-sizcd by wrxting off the eacesm. Posiio on publc sctor receivbles is improving, albet sb-*4r. Tb. proscur q-atum ofr-eevables fromzEsc is to the tune of Rs. 13 Billion. WAPDA is makng fbllowiug effiots fow recovery a. Meatin with Finance Division GOP aft regularly beig h}ld for paym&entVdnedtion at sourc* of the oufttading electrcity duos of the publc sector consumers- b Matter was t*keu up with the Chief xrcctiv. of Pakistan in meetin$p held on -une 29% 2000 and August 10, 2000. As per certain decisions amotmla payable by ite public secr consumets weta deducted at source tnd for the i receivables continuous liaison is being kept with the inistry ofFinance c. To resolvc the currnt bixg disputes the procedure for payrens vitim 90 days was evolved and all fhe provincai/fedet governmt depme ere infozmed to implement. d Meeting hold with the Govenors of NWF" and Sindla for recovery of outstading dectricity cues including against FATA Meetns beld with Governor of Puxiab to expedite the recovery. e. Mectimg held in inist of Finance on Apra 12. 2Q01 wherein all concerned were instucted to clear the ontstanding eaectricty bins- f. The Matter is corninuously being ken up With KBSC / Mnitry of Fi3ance for the payment of the outtmnding KESC electicity dues.

WAPDA has never dcfaulted on payment to IPPs even at the lowest poit of its relatosbhip with IPPs. Presenty the 1994 Policy crop of IPPs alongwitb }IUBCO and KAPCO are ejoying troublc free relations with WA.PDA.

Tho World Bsak, itscwbas through its energy secr mission in San-Feb. 2001, owprssed atiefaction about th progress o- the =arix of agrement and action imder its loan No. 3746-PAX fog Power Sector rana. Almost all acevities roqoired of WAPX)A mad GOp are on the dot The Woxid Bank through lett dated Marob 20. 2001 addxessd to Secretory Water and Power on the sabject of. Energy Secto NCssion bas projeced a financially viable artre for WAPDA and its successors.

We, therefore, take an exception to the poor rating about the liran=al perfbrmance of WAPDA. 'W"APDA RESORIzD ro A'.EGsoTJ4ATVG .TARIF WiTH M4NY WPS BEFfORE THEIUR COMMIWZSSIONIG'? (PAIRA 4-2~.5)

It is correct that WAPDA faced diffculty to absorb the financial impct of new IPPs due to the reason tht LOS were issued for capacity ir excess of regpireqat arid trxff inereasealadjustreafr as demanded by. WAPDA were not aproved by the Govemert.

- 33 - lowever. it is macOZrct tba WAPDA resorted to negotiating tariff reductions due to itr ~nanoil prolems.The IPPs requestd WAD to h ate iststing / cmanissipring of the pte de tactualuk-ents and in mettm agteed to negoiations of taf WAPO s con i proves coect Afrom tdh fact tat ithe two AES projects we tix(:0ly coaniioned and acepted wiho'ut any tariff reductons- They a being ptaid regularly and are eMfpying good %UfrlatL wh W-.P On t other had the commissioning of the plant of lt IPPa who signed MOtU were delayed even after signing MOU agnd allowtag relaxstions in test speciffcatifos. Negoatia;ons were a win-qKu sitation fr both parties.

*'WPZPO SUFEE iFROM' TUNOXR IN 17'S.E'~ ZO. MA2'A GEM EINT'v? (Al .

The rate of turnover in WPPO might have been high owevem it did not adversely in4act perfo-narwe as there Was contdriny of coxxnand at the level of Chaiman rescltnX in a uniform poli&r.

* 'WFPO IVEWR ADRVELOPED FULL CAPACI2Y TO L&UPILE&tNT AND MO,TMOR- PPAs? (PAA 4.5.1)

WPPO bas all tho ncessary invenbory of sldlls. adoquate level of governance, exceptona support frm enior most management in W*P and a. team of highly qalifie&,and de&iated pv*:iqIals. WPPO has ween x=cceslly maintainng continuous trouble-fee irelatio 13?tf P , resolution of disputes

. 'IPPs FI4CD DEL4YS DUE TO FAIUAE TO PROVrDE INTfPERCO2VNEWCTF ON 7Mg'? (PARAS 1.3.IL,75.2 & JANNEX-i)

Intarconnection to WAPDA System was provided before schedule in case off 1UIC[ ad SEPCOL. Thus HU1CO Plat stod cxmrssiioned ahead of is scheddle. The dWIy in COXM f_g~ hin SuPCOL was not due to dela m: intconnetion- Actually SEPCOL could not met with the tecical pi n as evidenced by its tbiteen unsw=ess*il spels of testing betore ecbieving commercial operution. It coul atn. cs operadon. only ater relaxatio on th-e t-chnical paramersanted by WAPDA as a qvid- pro-quo forrevision oftai

in case of ROUiSCH and UCK the delayed coinissioning can also not be attri-bted to any fault of WAPDA. Rather it was their own itea pmblems that led to delay.

- WPPO DI D NOT COOPERAT:E i PIANT TESZTNG COI I YSSrONG-? (PARA 53:1)

As above

3

- 34 - - 'mE Qr ff$'TION4'LE FMzJTyOP W!vPro To R l M4NA E fl COMfnl4 kBAIPSI Twl?Pa - pA:A 6J.2Ew)

Nzot a-ee4 ,* 'UNLess 7wE POWZR SWCTO RBF0ORw is F1ZLY J7AfPLFJJZNTRD, THE FR OAis (NSV$TA1W

The Power Sctor zuform s am being =plemmtecL

* '4PVA 's i PLEAENTA2IONPIF ORMA NCE CAN PR.ASO 4$ IJ Yr UNI 4S75'A C TO.(N 7 3- WAPDA's i=V10MOO CapaWlity-egw4ic the P1I£P I &Eu7Ird,oud. II-t fUEsa. be iudzgd In. 1he bekdrop of lhe p ffiUa6c* _ofthe B-;2 itsaf and :*q: ntey level of the Pejeict- VqWihizd t* the bak jumlffX*IM*& &It .WL as un-satisfae*az7nd the self - .s..efA Ver1ro=mmceof B Bank o _t"_eft _ Ulm the ce it would 1ve beSe if W pcndbrm was

(b) Cofinanciers: None received. (c) Otherpartners (NGOs/privatesector): None received.

10. Additional Information 10.1 Please seeAnnex 10 for a summaryof the individualsubprojects financed under PSEDPI and IL. Table3 below providesa list of IPPs which achievedfinancial close under the 1994 PrivatePower Policy, includingdetails on technology,capacity, and date of commercialoperations.

-35- Table 3 PakdstanPrivate Power Projects (Projectswhich achievedfinancial close)

Name/Location Notes Technology Capacity Capacity Commercial Gross Net Oprations (MW) MW) Date

I AES Lalpir /a Steam 362 351.3* Nov. 6, 1997 Limited turbines on (achieved) Lalpir fuel oil

2 AES Pak Gen /a Steam 365 343.9* Jan. 2, 1998 (Pvt) Co. turbines on (achieved) Lalpir fuel oil

3 Altern Energy Flared gas 14 13 Apr. 30, 2000 Limited (estimated) Fateh Jang, Attock

4 Davis Energen Gas turbines 10.5 9.8 Dec. 31, 2002 (Pvt) Ltd. on flared gas (estimated) Fim Kassar, Chakwal

5 Eeshatech(Pvt) Coal 20 18 Terminated Ltd Kalar Kahar (Chakwal)

6 Fauji Kabirwala /d Combined 157 150* Oct. 21, 1999 Power Co. cycle on gas (achieved) Kabirwala, Dist Khanewal

7 Gul Ahmed /a /e Fuel oil 136.17 128.5* Nov. 3, 1997 Energy Ltd. (achieved) KorangiTown, Karachi

8 Habibullah Combined 140 126* Sep. 11, 1999 Coastal Power cycle on (achieved) Quetta natural gas

9 Japan Power Diesel 120 107* Mar. 14, 2000 Generation engineson (achieved) Off RaiwindRd, fuel oil Near Jia Baggo

10 KohinoorEnergy /a Diesel 131.44 126* Jun. 20,1997 Limited engineson (achieved) Raiwind-Manga fuel oil Road

- 36 - 11 Liberty Power Combined 235 211.9 Apr. 30, 2000 Project cycle on Daharki natural gas

12 NorthernElectric Steam 6 5.5 Jun. 30, 2003 Co. Ltd. turbines on Choa Saidan Shah, coal Chakwal

13 Power Generation Diesel 116 110 June 30, 2005 Systems engines on Patoki fuel oil

14 Rousch (Pakistan) lb Combined 412 355.1* Dec. 11, 1999 Power Ltd cycle on fuel (achieved) SidhnaiBarrage oil Punjab

15 Saba Power /d Steam 114 109 Dec. 31, 1999 CompanyLtd. turbineson (achieved) 9 km from fuel oil Sheikhupura

16 Sabah Shipyard le Fuel oil 288.6 273.6 Terminated Pakistan Ltd. Korangi, Karachi

17 SouthernElectric /b Diesel 115.2 112.1* Jul. 12, 1999 Power Co. engineson (achieved) Raiwind,Lahore fuel oil

18 Tapal Energy /d /e Fuel oil 126 125.5* Jun. 20, 1997 Limnited (achieved) West Karachi

19 Uch Power /a /b /c Combined 586 548* Oct. 18,2000 Limited cycle on low (achieved) Dera Murad btu gas Jamali

TOTALunder 3455 3224 1994 Policy

20 Hub Power Project /b/c Steam 1292 1200 Mar. 31, 1997 Tehsil Hub, turbines on (achieved) District Lasbela fuel oil

TOTAL incl. 4747 4424 Hub

/a IFC participation *Actual Initial Dependable Capacity /b PSEDF participation /c IBRD Guarantee /d MIGA participation /e PPA with KESC

Source: Private Power and Infrastructure Board, November 2000

-37- Tsble4 PSEFI ad I Retlemenutad Efroimt Asptwd Subpr

Nameof Retle*Met FMhvIniwlM$alt*Ha MARPor

A*quisio oflM PeopkeA ltede S_b-eoetbRqpt Ladm agw soak R t d Cmrg EuNhe-tvbl tspevn w meat by byWB adny a bpetLersLpeedrliuteius Sporn oter

Piv"e Goveat ea*uniem I ced Prperly col biyws

HUBCO 74(A acqAlcd717 Aaes NilD Smannualp g LeE&gw Feb.1993 Mvh 199 noC _mutal GOB fivnIb ud * Xits na

RPPL 144AmaGqmkd,No 7-boscoI m Monu"lbvbDgrt dlesEn r May1996 My31,1996 no dvmmta vWofP ,tiotof fomSlhmasma- wk aesvi sbotla Wnfu=c 22.Tbwwmtlw nuwin"Wdgfi1m skiaI basisand scowtmd Pi= LWM&&m rivkuintaoo cfcrASTHR*w= OmnglMP" r da edMay 17,1996 Mkowmm c I__ SEPCOL48 Acrts aqu No Nil Q(uarttr fom I=kEn hme June19S Nov.22, 1995

ideuew Lcoder OaBae. anqrd an mqwptw UCH . Am qur 616Acsr from NIL Mod*bbyocinrc L.*a EI= 1995 We August19i XoBf X WBO ACWUIfMO d *i 0 PC August1995 LandAcqwm smihmai qw* qs.yrevbedsut BEPA:Oct. 1995 LandACLc t Ad189. And .mqy'smtm subequntl operEnR~pmd cova*g won*y.dto the .u te nt actL

APL . 233.18Ah1osuof NIL Qu oPang rpot lcrw i*ws Oc 1993 SfPhAsubecive wbich167.7 Am s Aomco vandon1waldad 16. acquwdhem GOS eo"Ows 8g 0941995. n3Q6Aaison an ~~~~~~~~~~~~Aunecpo envkasnentaaspots AnuyA .62Amr

Nt: a PWsfpebel'rpJctddowtbe sa atWobeWl~crmssro artamthik i. WB - Wuda IPC la eidsulWIkac"Cmprainu MIA - lK*eettnetmpe BEPA= BshIUa ambI?tniAgme GOS - GwLdeSbneyqa pL COB - GwLdOfinu Endnotes

1. This figure does not include the 1,292 MW Hub Power Project which was negotiated prior to the 1994 Private Power Policy.

2. Of the $616 mnillion,$146 million was financed by the Bank under PSEDP I and $110 million under PSEDP II.

3. New gas fields were discovered in the late 1990s, and it is likely that additional gas resources will be made available to the power sector. In fact, studies have been initiated recently to convert existing IPPs to gas, including Hub and Rousch.

4. Under the terms of the PPAs, WAPDA pays a two-part tariff: (i) a capacity charge designed to recover debt service obligations, fixed O&M and equity regardless of generation output; and (ii) an energy charge, covering fuel and variable O&M, only for electricity produced.

5. It should be noted that there is a disconnect in the development objective (DO) rating for the first PSEDP between the last Project SumrnmaryReport (PSR) rating dated June 15, 1999 when PSEDP I was rated satisfactory, and this ICR where the DO is rated unsatisfactory. At the time of the last PSR, the summary DO rating was stated as satisfactory based on the Project meeting its first two objectives: mobilizing additional resources for private sector participation in the energy sector, and establishing an incentive framework to encourage such participation. However, the sustainability of the incentive framework was questioned in addition to the sustainability of the project's third objective, establishment of an institutional framework to facilitate the Government's dealings with the private sector.

6. The loan documentation is not particularly clear as to how the repayment amount is calculated, but this is reflected in the interest rates charged and is also the understanding of the various parties. It is also not clear to what extent the foreign exchange exposure was borne by the State Bank of Pakistan through its Foreign Exchange Risk Insurance (FERI) program or by the LTCF. FERI was discontinued in 1994 and since that time the Rupee foreign exchange risk has been borne by LTCF.

7. Currency pool has reflected approximately equal exposure to Dollars, Yen and Deutschmarks (Euros).

8. The loans made under PSEDP I and II would have been obvious candidates for conversion into Dollar denominated Single Currency Loans when the Bank made this option available in 1998.

9. The onlending rates are actually set against the higher of the Bank's lending rate or the US 1-year Treasury Rate.

10. The average bulk tariff set under the 1994 Policy of US06.5 kWh for the first ten years was reduced to US¢6.1 per kWh shortly after the Policy was announced following the abolishment of the foreign exchange risk insurance (FERI) scheme by the Government.

11. The ICR does not assess directly the guarantee aspects for the Hub and Uch projects. However, the project Finance and Guarantees Departrnent published an extensive discussion paper in 1997 on "Financing Pakistan's Hub Power Project: A Review of Experience for Future Projects", which is

- 40 - referencedin this docunent. ICR Guidelinesfor guaranteeoperations are currentlybeing formulated,and it is expectedthat a separateICR will be preparedfor the stand-aloneUch partialrisk guaranteeoperation.

-41 - Annex 1. Key Performance Indicators/Log Frame Matrix

Outcome/ ImpactIndicators:

I i I E_ lI *_

OutputIndicators:

End of project

-42 - Annex 2. Project Costs and Financing

ProjectCost by Component(in US$ millionequivalent)

-,.-._...... __...... _-~~~~~~~~~~~~~~~~~~~~~~~~~~~~ ...... Subprojects 1883.00 1555.00.. 83 TechnicalAssistance 4.00 0.80 20

Total BaselineCost 1887.00 1555.80

Total ProjectCosts 1887.00 1555.80 Total FinancingRequired 1887.00 1555.80

ProjectCosts by ProcurementArrangements (Appraisal Estimate) (US$ million equivalent)

1. Works 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) 2. Goods 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) 3. Services 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) 4. Miscellaneous 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) 5. Miscellaneous 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) 6. Mlscellaneous 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) Total 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00)

-43 - Project Costs by(Procurement Arran ements(Actual/Latest E0timate US$ million e uivale(

1. Works 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.75) (0.00) (0.75) 2. Goods 0.00 0.00 0.00 0.00 0.00 (94.18) (0.00) (0.00) (0.00) (140) 3. Services 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.79) (0.00) (0179) 4. Miscellaneous 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (1.40) _L (° °°) (1.40) 5. Miscellaneous 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (19.63) (0.00)1.6 6. Miscellaneous 0.00 0.00 0.00 | 0.00 | 0.00 (0.00) (0.00) 0.00) (0.00) (0.00) Total 0.00 0.00 0.00 0.00 0.00

______(94.18) (0.00) (22.57) (0.00) 116.75 Figures based on data provided from ICS "Figures in parenthesis are the amountsto be financedby the Bank Loan. All costs include contingencies. 2' Includescivil works and goods to be procuredthrough national shopping,consulting services, services of contracted staff of the project managementoffice, training,technical assistance services, and incrementaloperating costs relatedto (i) managingthe project, and (ii) re-lendingproject funds to local governmentunits.

- 44 - Annex 3: EconomicCosts and Benefits

- 45 - Annex 4. Bank Inputs (a) Missions: Stguyof !rojectCyclelt No.~Of Pesoi Anad Specialty

Month/Year Coun l _ Identification/Preparation

Appraisal/Negotiation 12/87 1 Economist 1 Power Engineer

03/88 Supervision 06/89 1 Economist HS HS I Power Engineer

07/90 1 Consultant HS S I Power Engineer

11/91 2 Energy Specialists S S I Power Engineer 1 Consultant

04/95 1 Private Sector Dev, Specialist HS S

08/95 1 Private Sector Dev. Specialist HS HS I Energy Specialist

04/96 1 Private Sector Dev. Specialist HS HS I Energy Specialist

08/96 1 Private Sector Dev. Specialist HS HS I Energy Specialist

04/97 1 Private Sector Dev. Specialist HS HS I Energy Specialist

04/98 2 Financial Analysts S S

ICR 03/99 1 Financial Analyst S S I Power Engineer I Consultant

-46 - (b) Staff.

Stag Of Pr*teaCY~IOC _ _ _ _ _ No. S~WRE u (USS*O) Identification/Preparation 28.9 67.6 Appraisal/Negotiation 56.5 138.5 Supervision 202.8 543.2 ICR 22.37 78.0 Total 310.57* 827.3* *Totals are Bank Budgetonly

-47 - Annex 5. Ratings for Achievement of Objectives/Outputs of Components (H=High, SU=Substantial,M=Modest, N=Negligible, NA=Not Applicable) Rating El Macro policies O H O SU OM O N * NA O Sector Policies O H OSUOM O N O NA El Physical O H * SU O M O N O NA O Financial O H OSUOM *N O NA O InstitutionalDevelopment 0 H O SU O M * N 0 NA ECEnvironmental O H O SU O M ON * NA

Social E Poverty Reduction O H OSUOM O N * NA El Gender O H OSUOM ONI * NA LI Other (Please specify) O H OSUOM O N * NA Q Private sector development O H * SU O M 0 N 0 NA E Public sector management 0 H 0 SU 0 M 0 N 0 NA LIOther (Please specify) O H OSUOM O N * NA

- 48 - Annex 6. Ratingsof Bank and BorrowerPerformance (HS=HighlySatisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory)

6.1 Bank performance Rating

O Lending OHS OS *U OHU a Supervision OHSS OU *u OHU Ol Overall OHS OS * u O HU

6.2 Borrowerperformance Rating

FOPreparation OHS OS * U O HU El Governmentimplementation performance O HS O S * U 0 HU El Implementationagency performance OHS OS * U O HU E] Overall OHS OS * U O HU

-49- Annex 7. List of Supporting Documents 1. Supervisionreports, including Form 590/ProjectStatus Reportsof PSEDPI and II (1990 - 2000) 2. Staff AppraisalReport for PakistanPrivate Sector Energy Development Project, Report No. 7226-PAK(June 10, 1988) 3. Staff AppraisalReport for PakistanSecond Private Sector Energy Development Project, Report No. 13006-PAK(October 28,1994) 4. Staff AppraisalReport for ProposedExpanded Cofinacing Operation to PartiallyGuarantee up to US$240Million of a SyndicatedCommercial Bank Loan of US$360Million Equivalent to The Hub PowerCompany, Report No. 9004-PAK(October 29, 1991) 5. Memorandumof the Presidentfor the ECO Partial RiskGuarantee for the Hub PowerCompany (October28, 1994) 6. Loan Agreement(Ln. 2982-PAK)for the PrivateSector Energy Development Project (August 8, 1988 as amended) 7. Loan Agreement(Ln. 3812-PAK)for the SecondPrivate Sector Energy Development Project (December20, 1994 as amended) 8. Policy Frameworkand Packageof Incentivesfor PrivateSector Power GenerationProjects in Pakistan,Government of Pakistan(March 1994) 9. Policyfor New PrivateDevelopment Projects, Government of Pakistan(July 1998) 10. Guidelinesfor the Operationof the PrivateSector Energy DevelopmentFund (modifieddate December 26, 1994) 11. AdministrationAgreement for the PrivateSector Energy Development Fund betweenthe Presidentof the IslamicRepublic of Pakistanacting throughthe Ministryof Financeand EconomicAffairs (the Govermnent)and NationalDevelopment Finance Corporation (January 14, 1989) 12. FinancingPakistan's Hub Power Project: A Review of Experiencefor Future Projects,by Michael Gerrard,RMC DiscussionSeries Paper,Number 118,August 1997 13. Memo from Director,Quality Assurance Group to Vice President,South Asia on "Post-Approval Qualityat Entry Assessment:Final Report"dated August 8, 1997

- 50 - Annex 8. Beneficiary Survey Results

- 51 - Annex 9. Stakeholder Workshop Results

Private Sector Energy Development Project

Stakeholders Workshop (February 16, 2000)

Participants (approximately 50): Donors: IFC, JBIC,World Bank Commercial banks: ANZ, Citibank GOP and GOP Agencies: MOF, MWP, EAD, NDFC, OGDC, PPIB, WAPDA Private Sector IPPs: AES, Fauji Power, Hubco, Japan Power Generation, Kohinoor, Rousch, Saba Power, Sepcol, Tapal, Uch.

1. The World Bank representatives opened the meeting by thanking the different parties for accepting the invitation. Following which, a brief presentation was made on the objectives of the workshop, the agenda, and possible topics for subsequent debate.

2. The NDFC representative made a presentation in which he first discussed the history of LTCF over 1985-2000. He subsequently noted that project activities were handicapped by the high turnover of staff in the different agencies of GOP involved with the Projects. He made a number of recommendations regarding the power sector (NEPRA should have been made operational prior to embarking on the IPP program; distribution could have been privatized prior to generation; resolution of tariff issues should have priority); and LTCF (LTCF ought to expand its activities to other sectors; GOP exposure is too high in large projects; balance sheet financing can be observed in one of the IPPs; procurement requirement can be cumbersome, particularly when they apply to a contractor selected through a negotiated process, who has to observe specific bid rules for the subcontracts). He concluded by advocating that LTCF reflows should be used to finance relatively high risk infrastructure projects (not necessarily in energy), and that the existing institutions be strengthened.

3. The PPIB representative first presented the salient features of the 1994 Power Policy and subrnitted inter alia that fixing the tariffs in advance reduced the scope of negotiations to a considerable degree and enabled the conclusion of 19 transactions over a two-year period. However, this prevented GOP to profit from the subsequent decline in the price of equipment. As a result of slow demand growth, the IPPs are not dispatched as anticipated, with the result that average tariffs are higher than what they should be - the higher tariff was also caused by higher fuel prices. While the developers were allowed to select the fuel, technology and location of their plants, this should be considered against the background of load shedding prevailing at the time. Furthermore, against an expectation of 1,500 MW worth of capacity which would close under the 1994 policy, in excess of 3,000 MW were awarded (the Government extending deadlines in some instances). Following a review of the 1995 Hydel and 1995 Transmission policies (which failed to bring projects), the PPIB representative discussed the 1998 Power Policy, which provides for the processing of solicited as well as unsolicited proposals. He concluded by stating inter alia that 1994 Power Policy's successful results can also be attributed to PSEDP; TA (legal) provided under PSEDP helped conclude transactions on a timely basis; PSEDP was essential in the creation of present institutional framework; salary cuts, downsizing and non payment of 0.25 basis points impacted PPIB adversely; PSEDP should help WAPDA resolve issues of WAPDA's high tariff and surplus capacity problems; World Bank did not display due diligence in forecasting load growth, resulting in the financing of excess capacity.

- 52 - 4. The WAPDArepresentative stated that the energy supplyand demandgap remains,except that the countryhas moved from an energy deficitto an energy surplus. That is becausethe tariff adjustments necessitatedby the commissioningof IPPsdid not take into accountthe impact on consumers.Hence, unless privategeneration results in a declinein generationcost, the wholeexercise would be futile. The World Bank oughttherefore to focus on how to reducecosts to stimulatedemand. This couldbe achievedthrough tariffsreform, or privatizationof distribution(provided that it results in loweringcosts). In balance, the 1994 Policywas effectivein eliminatingload shedding,and createdincentives to completeprojects on a timelybasis and to operatepower plants to high standards. Furthermore,WAPDA no longerhas to bear the costs of projectdelays. Lastlyforeign capital has been attracted,and tariffswill declineonce the senior debt is retired.On the otherhand, the WAPDArepresentative remarked inter alia that letters of intentwere issued withoutascertaining first affordabilityand justification; a high bulk tariff was promisedinstead of proceedingon the basis of price-basedbids; developerscould select the site,technology and fuel, whilethe tariff remainedthe same in all cases; tariffsare all indexed,and adjustmentsare a pass through,for which compensationis not coveredin the retail tariffs;developers are chargingfor debt serviceprovisions on a monthlybasis, whilepayments to lendersare due twice yearly;PPAs were issuedwithout WAPDA being consulted;and BOOT are preferableto BOO giventhat at the end of the PPA period,the countryhas paid the debt, and the shareholders,compensated.

5. The Hubcorepresentative stated that WAPDAwas afflictedwith lackingrevenue collection, theft and high lossesin its system. Underthe circumstances,insufficient attention had been givento the restructuringof WAPDA,the introductionof independentregulation, and the privatizationof generationand distributionassets. Furthermore,PPIB was emasculatedat somepoint, so that its effectivenessas an agent of reformshad been weakened. With respectto the WorldBank, the Hubcorepresentative noted the decisive contributionmade by the Bank to set up the institutionalframework, and provide a financialinstrument in Rs, togetherwith the PartialRisk Guaranteewhich allowed the containmentof certainrisks; on the other hand,he regrettedthat, followingclosure, unlike conumercial banks, the WorldBank has not establisheda monitoringsystem - more generally,there has been a drasticreduction in WorldBank involvementwhich precludedit from taking a proactiverole as facilitator(with the authorities);he also noteda lack of continuityin WorldBank staff concemedwith the Project.

6. The IFC representativenoted that the excess supplywas not unique to Pakistan,but was also apparentin CentralAmerica. A solutionthat could help both Pakistanand the IPP industrywould involve the implementationof a biddingsystem for energy,on a weeklybasis. This wouldlead to operational savings(because at presenttoo many plantsare being dispatchedat a low load factor),and doesnot require modificationof contracts. Hence, this representsa "WinWin" situationfor the country.

7. Subsequentlya generaldiscussion followed.

- 53 - Additional Annex 10. Review of Subprojects

Pakistan Implementation Completion Report - PSEDP I & II The Subprojects A. Hub Power Project

Background

1. TheHub Power Plant consistsof four generatingunits with a total installedcapacity of 1,292MW and burns residualfuel oil, suppliedby PakistanState Oil (PSO). A projectdevelopment company, the Hub River PowerGroup (HRPG) Limited, was formedcomprising five sponsorcornpanies: Xenel (Saudi Arabia),National Power (UK), Mitsui (Japan),Ishikawajima-Harima Heavy Industries(1I1), and K&M Engineeringand Consulting.The operating contractor is NationalPower (now IntemationalPower) of the UK. 2. At the time the Bank approvedPSEDP I, the pipelineof subprojectsavailable for LTCF financing includeda numberof power generationprojects. Of these,the Hub PowerProject was the most advancedin its negotiations.It becamethe first privatesector build-own-operate (BOO) power projectin Pakistan. 3. Work on developingthe projectbegan in summer1987 and a detailedfeasibility study was begun in April 1988. Constructionof the stationbegan on the basis of mobilizationfinance in December1992, which allowedconstruction to start prior to the financingpackage. The project'stotal financepackage becameirrevocably committed in September1994, by whichtime the projecthad sufferedtwo events causingsignificant slippage in its timetable: the Gulfwar (1990-91)and a Pakistancourt rulingon the applicabilityof ShariahLaw to the paymentof interest(1991-92). Financialclose was achievedin January 1995 - almosteight years after the initiationof projectdevelopment. See Table I below for key milestone activitiesin projectdevelopment.

Table 1: Key eventsand activitiesin projectdevelopment

Year Event

1987 Sponsorssubmit proposal Initialsite is selected

1988 Governmentissues letter of intentto projectsponsors Detailedfeasibility study is completed Bank approvesthe PSEDF Ministryof Waterand Power's Private Power Cell is established

1989 Implementationagreement between the governmentand Hubcoand power purchase agreement betweenWAPDA and Hubco are negotiatedand initialed NationalDevelopment Finance Corporation's Private Energy Division is established

1990 Fuelsupply agreement between Pakistan State Oil and Hubcois negotiated Re-tenderof turbineisland is effected

- 54 - 1991 Constructioncontract is signed Arrangerbanks are mandated ECO progran is approvedby the Bank

1992 Mobilizationfinance is arranged Constructionis started

1993 Commercialbank and ECO guaranteeterm sheets are signed Commercialbank due diligenceis completed

1994 Commercialbank debt is underwrittenand syndicated Equity is underwrittenand placed Bank and JEXIM approveguarantee facilities

1995 Financialclose

ProjectImplementation 4. The turnkeyconstruction contract was signedin July 1991following the reconstitutionof the construction consortium. The original construction consortium was led by Mitsui Co. of Japan and includedthree other Japanesefirms: (i) Ishikawajima-HarimaHeavy IndustriesCo. Ltd (EHI)for the supply of the boilers;(ii) Toshibafor the overallengineering and the supplyof the turbogenerators; and (iii) KumagaiGumi for civil works. The sponsorsselected British ElectricityInternational (BEI)' of the UK and CanadianUtilities Power (CUP)of Canadafor the operationsand maintenanceof the complex. Due to delaysand other variousreasons, Toshiba, Kumagai Gumi and CUP couldnot renew the validityof their prices beyondMarch 31, 1990 which requiredthe sponsorsto reconstituteits constructionconsortium. BEI acceptedfull responsibilityfor the operationsand maintenance,and CampenonBernard of Francewas selectedto replaceKumagai Gumi for civilworks. Followingthe Bank'sInternational Competitive Bidding procedures,Ansaldo GEE of Italy was awardedthe contractfor overallengineering and turbinegenerators (replacingToshiba). 5. Subsequentto the signingof the turnkeycontract in 1991,the sponsorsand the Government negotiateda revisedtariff that reflectedchanges that had occurredin the constructioncontract, the ternnsof finance,and exchangerates since December1989 (the date of the previoustariff agreement).The revised tariff adheredto the reopenersand indexationprovisions that were outlinedin the previoustariff agreement.

6. The contractorwas mobilizedin December1992, two years priorto financialclose. Mobilization financeplayed a crucialrole in maintainingthe project'stimetable for deliveringpower to the Pakistangrid and in avoidingthe potentialcost increasesthat wouldhave followedthe expirationof a tumkey contract price offer. It also createdunstoppable momentum to the projectdevelopment effort. Mobilizationfinance in the amountof about US$423million was advancedby (i) the Bankand the governmentsof Franceand Italy in the form of termloans throughthe LTCF;(ii) localbanks in the form of bridgeloans; (iii) the CommonwealthDevelopment Corporation through a term loan; and (iv) the projectsponsors through equity contributions.

7. The fourth and final unit of the Hub PowerProject was completedthree weeksahead of schedule on March 7, 1997. Commercialoperations were officiallydeclared, on schedule,on March31, 1997. The actualcapital cost of completingthe projectwas slightlybelow budget. The pipelineconnecting the station to the oil importterminal was comnmissionedin October1996, with an installedcapacity sufficient for a

- 55 - 2,000 megawattpower station. In terms of simplechronology, the time taken to developHub was eight years (1987-1995),while construction was completedin two years (1995-1997). ProjectCost and Financing 8. The total estimatedcost of Hub was US$1.8billion comprising:developmnent and start-upcosts of US$217million, a tumkey constructioncontract of US$1billion, financing costs of US$355million, and standbyfunds of US$221million. The projectwas completedwithin budget. All base loan facilitieswere drawn substantallyas envisagedin the financeplan, but no standbyloan facilitieswere drawn. 9. The initial financingplan was basedon equityprovided by sponsorsand investorsof US$372 million and borrowingof US$1.4billion. This comprisedsubordinated debt of US$601million (US$375 millionfrom PSEDPI and US$197million from PSEDP II) and seniordebt of US$738million. The senior debt includeda Bank ECO guaranteefacility for US$240million (including US$40 million of standby financingwhich was never utilized).See Table2 below.

Table 2: Summaryof OriginalFinance Plan Sourceof Financing Amount (US$ million equivalent) Base Standby Total Equity 372 SeniorDebt WorldBank ECO GuaranteedFacility 200 40 JEXIM GuaranteedFacility 100 20 COFACEGuaranteed Facility 45 MITTGuaranteed Facility 86 SACEGuaranteed Facility 195 CommonwealthDevelopment Corporation 37 Rupee facility 75 25 Subtotal 738 SubordinatedDebt PSEDPI322 53 PSEDPII 114 83 Subtotal 436

Total Base Financing 1,545 _ Revenue During Construction 63

Subtotal 1,608 Standby Financingd 221

Total Base + Standby 1,830 Figures are in end-1993dollar exchangc rates. In practicesources and applicationsof financeare in multiplecurrencies. bofwhich IBRD,$146 millionincluding standby financing. 'of which IBRD,$110 millionincluding standby financing Standbyfinance was not drawn

- 56 - 10. The financingplan was designedto mobilizethe longestmaturity and cheapestfinance terms possiblein orderto achieve an acceptabletariff throughoutthe projectlife. The major constrainton the ffnanceplan wasthe limitedand, in the case of the longermaturities, nonexistent availability of foreign-currency,commercial bank term loansfor privateenterprises in Pakistanwithout co-financier support. The availabilityof LTCF formeda fundamentalpart of the financingplan. The WorldBank participationwas essential to the banksjoining the project in syndication.PSEDP I and II, which included fundingfrom the WorldBank and JEX[M,in additionto fimdingfrom the governmentsof France and Italy, provided30 percentof project funding. Throughthe ECO partialrisk guarantee,the Banksupported 29 percentof seniorterm finance. 11. The actualcompleted cost of the projectwas aboutUS$1.6 billion' comparedto the original estimateof US$1.8million, as the standbyfinancing was not required. The basic financialstructure and amountsraised for the projectdid not vary significantlyfrom the estimatein the Bank's appraisalreport. The main deviationwas in the amountof subordinateddebt fundingfrom LTCFsince it fell from US$601 millionto US$445million, mainly due to the stand-byfacilities not being required. Seniordebt funding rose slightlyto US$742million. 12. The equitywas raisedfrom four sources:(i) the promotingsponsors, US$163 million; (ii) CommonwealthDevelopment Corporation (CDC), US$8 million; (iii) a local shareissue on the Karachi StockExchange for US$30 million;and (iv) Global and AmericanDepositary Receipts for US$170 million. 13. The seniordebt used comprisedseven facilities: (i) Underthe ECO guarantee,a syndicateof 34 banks providedUS $146 million; (ii) Underthe JEXIMguarantee, a syndicateof 19 banksprovided US$116 million; (iii) Underthe COFACEinsurance, a syndicateof sevenbanks providedUS$52 million; (iv) Underthe MMTIinsurance, a syndicateof 17 banksprovided US $99 million; (v) Underthe SACEinsurance, a syndicateof 18 banks providedUS $224 million; (vi) a loan fromCommonwealth Development Corporation (CDC) provided US $39 million;and (vii) A syndicateof nine Pakistanibanks and other institutionsprovided rupee facilityof US$66 million.

Tariff

14. The initialPower PurchaseAgreement (PPA), signed in August 1992,set out the tariff principles. Subsequently,an indicativetariff was agreedwith WAPDAon May 1, 1993with the understandingthat it wouldbe adjustedprior to financialclose. The tariff set at financialclose is referredto as the reference tariff. Thisreference tariff was indexedand adjustedon the commercialoperations date. In 1994, two amendmentsto the PPAwere signed;the first incorporatedthe indicativetariff and changedthe tariff schedulein the PPA. The secondamendment provided agreement on the referencetariff, granted Hubco the same concessionas otherIPPs on importduties, and made a changeto timing of foreignexchange adjustmentsto the tariff. The referencetariff establishedat financialclose has increasedin Rupeeterms due to increasesin fuel prices,inflation and devaluationof the Rupee.

15. The averagetariff for the first 10 years is USO6.54/kWh and US05.80/kWhon a levelizedbasis over the life of the project. The tariff payableby WAPDAhas a two-partstructure and is separatedinto capacityand energypayments. The capacitycharge was designedto generatesufficient cash both to service the debt and pay agreedfixed costs, togetherwith the returnon equity. It includedthe projectdevelopment,

- 57 - constructioncontract, and financialcosts. Theenergy price was a variablepayment depending on the net amount of energyactually dispatchedby WAPDA.It is composedof the actualcost of fuel (61%),fuel surchargeand taxation(34%), and variableO&M (5%). 16. The tariff is front-loaded.For the first two years,the front-loadingreflects: (i) the creationof the escrow,reserve, and collateralaccounts required by the financiers;and (ii) the ForeignExchange Risk Insurance(FERI), the insurancepremium paid to the State Bank of Pakistan. The tariff also reflectsdebt service. As the loans are repaid,the tariff willprogressively decrease from USg7.42/ kWh in 1999 to US¢5.63/kWh in 2005. The tariff will decreasefurther in 2015 to US05.47when the subordinateddebt has been repaid. 17. LTCF contributedto a lowerlevelized tariff sinceit was instrumentalin extendingthe overall maturityof debt finance.For the Hub project,the commercialbanks were willingto provide construction financewith maturityup to only twelveyears. The LTCF providedfor loan maturitiesof 23 years, nearly twice that of commercialbanks. The HubcoDispute 18. Followingaccusations of corruption,Hubco, the largestIPP operatingin the country,has been involvedin severaldisputes with WAPDAand the Pakistaniauthorities since mid-1998largely centering on the validityof the amendmentsto the PowerPurchase Agreernent and the levelof the tariff. Government officialshave allegedthat the agreementswith Hubcowere corruptlyobtained or otherwisefraudulent, in particularthe amendmentto the PowerPurchase Agreement that substantiallyincreased the price of electricityproduced during the first years of plant operation. 19. Hubcodenies that corruptionhas takenplace and considersthat these chargeswere being used to coerce the companyto lowerits tariff. Hubcohas soughtassistance in resolvingits disputeswith GOP and WAPDAthrough international arbitration but has been restrainedfrom doingso throughinjunctions sought by WAPDAin the local courts. (A summaryof Hubco'slegal disputesis summarizedin the box below.) At the requestof both Hubcoand GOP, the Bank facilitatedmeetings between the partiesto resolve the disputesin a neutralenvironment.

- 58 - Summary of Hubco Legal Disputes On May 8, 1998 a pro bono publico constitutionalpetition was filed in the Lahore High Court (LHC) against the Company. The Petitioner challengedthe decisionof the Governmentand WAPDAto enter into the Power Purchase Agreement(PPA) on the groundsthat the tariff was discriminatoryin favor of the Company. The Petition also accusesthe Government,WAPDA and the PPIB of havingacted malafide and fixed a tatiff which was unjustifiable. At the request of the Petitioner,the LHC issued interim orders,which were subsequentlyamended by the Supreme Court (SC), that prohibitedthe Companyfrom making distributionsfrom reserves as of December31, 1997 to shareholdersand restrictedthe fixed element of the tariff to a maximumof Rs. 845 million per month plus billing in respectof Energy PurchasePrice. Althoughdirected by the SC to disposeof the matterby the end of 1998,the petition has not been fixed for hearing so far. The petition is being contestedby the Company whichbelieves that it is without merit. In a related action on July 9, 1998,pursuant to the PPA, the Companyfiled a request for arbitrationin the InternationalCourt of Arbitrationof the InternationalChamber of Commerce(ICC for hearing in Londonseeking a declarationthat AmendmentNo. 2 to the PPA is valid and that WAPDAis bound by its terms. The Tribunalwas fully constitutedin mid-January 1999. The Tribunalfirst met on February22, 1999 but could not proceed as the Companywas restrainedby a Pakistanicourt order fromparticipating in the proceedings. Subsequentattempts to convenehave also proved abortivefor the same reason. On October 11, 1998 WAPDAalleged that the SupplementalDeed dated November 16, 1993 and AmendmentsNos. I and 2 of the PPA dated February24, 1994 and September17, 1994,respectively are void ab initio becausethey were said to have been procured by unlawful means. WAPDAis claiming in addition the repaymentof Rs. 16 billion allegedlyoverpaid. The Companyhas rejectedthe allegationsmade by WAPDAand has includedthese issues in the ICC Arbitration. The Companyhad issued notices to WAPDAunder the PPA which could result in the terminationof the PPA. Correspondingnotices had alsobeen issued in respect of the ImplementationAgreement (IA) and the Fuel SupplyAgreement (FSA). These noticescould lead to the terminationof the PPA and, as a consequence,of the IA which event would entitle the Company (and throughthe Companythe shareholdersof the Company)to compensationas set out in the IA. However,the operationof these noticeswere subsequentlysuspended by the SupremeCourt of Pakistanby an order passed on an applicationmoved by WAPDA. The operationof the notices continuesto be suspendedto date. In aid of its request for arbitration,the Companyfiled suit in the High Court of Sindhin November1998, requesting the Court to direct WAPDAto proceed to ICC arbitrationand restrain WAPDAfrom taking any proceedingsexcept ICC arbitration. In March22, 1999 WAPDAwas directedto proceed to arbitrationby the Court which was appealed by WAPDA. The AppellateCourt suspendedthe earlierorder and also restrainedthe Company from proceedingto arbitration. Challengesby the Companywere filed and hearingson that issue concludedin June 1999 and judgment was reserved. By an order on August 11, 1999 the Court stated that it would hear the Companyapplication with WAPDA'sappeal and also continuedthe restraint on the Companyto proceed with the ICC arbitration. The Company petitionedthe SupremeCourt against this order. The Company'spetition was convertedto an appeal on October27, 1999 and heard by a five memberbench of the SupremeCourt. On June 14, 2000 the Company'sappeal was dismissedby the SupremeCourt by a majority of 3 to 2 and the Company was restrainedfrom invokingthe arbitrationclause of the PPA for the purpose of resolvingits disputes with WAPDA through the agreed forum of ICC arbitration. On July 10, 2000 the Companyfiled petition in the SupremeCourt seekinga reviewand reversal of the majorityjudgment of June 14, 2000. (Source: summarizedfrom The Hub Power Company Limited, Annual Report 2000)

Settlement 20. In parallel with the legal proceedings related to the dispute playing out in the local courts, Hubco, the Govermmentand WAPDA held various meeting during 1998-2000 in an attempt to resolve their

-59- outstandingissues - often facilitatedby the Bank at the request of both parties. Throughbilateral discussion,the partiesfinally concludeda negotiatedsettlement, and on December17, 2000, a Settlement Agreementwas signedby the Governmentof Pakistan,WAPDA and Hubcowhich will resultin a tariff reduction. Underthe Agreement,the partiesagreed to reducethe levelizedtariff chargedby Hubcofrom 6.5 to 5.6 cents per kilowatthour by bringingdown the capacitypurchase price (CPP) from 4.45 cents to 3.36 centsper kwh. The CPP is the fixedcomponent of the tariff which is paid regardlessof whetheror not electricityis producedby the plant. The tariff reductioninvolves one elementof the CPP, "Project CompanyEquity (PCE)" as definedin the PowerPurchase Agreement. The initial assessmentreveals that the drop in the tariff will be largelyaccommodated through a reductionin the project equityrate of return from 18 percentto around 12-14percent. The SettlementAgreement affirms the PowerPurchase Agreementand the right to arbitrationin accordancewith the contract It was also agreedthat all criminal investigationswill be completed,and the partieswill meet and agree the mechanismfor the disposalof all civil and criminalcases. The Agreementis subjectto approvalby the FederalCabinet, WAPDA Authority,Lenders, the CompanysBoard of Directorsand the Companysshareholders approval in a generalmeeting. All actionsand approvalsare to be completedby March 31,2001. Under this Agreement,WAPDA undertook to closelycooperate with Hubcoto ensurethat the "Lendersconcerns regardingcurrent and future debt servicepayments are fully met." Lenderswill have to analysethe implicationsof the termsof the SettlementAgreement on futurecashflows, before detemining whethera restructuringof the debt is warranted. ProiectEvaluation 21. Hub was a landmarkproject in the world-widedevelopment of the EPPindustry and was a prototypefor IndependentPower Producers in Pakistan. It was necessaryto draft from scratch,then negotiateabout 200 separateoriginal project agreements and documents.In addition,many documentshad to be draftedand negotiatedtwice as the circumstanceschanged, i.e. changesin government,sponsor group, or constructiongroup. The documentsthat provedmost time-consumingwere the PowerPurchase Agreement,the InplementationAgreement, and the creationof LTCF. 22. However,the project'shistory is not simplyabout its development.More importantly,it provided the foundationto an entirepolicy initiative by both the Governmentof Pakistanand the Bank. In most other countriesthat have attemptedsuch a fundamentalreform - invitinglarge-scale private investment in whathad hithertobeen an exclusivelypublic industry- the reformhad been precededby the enactmentof enablinglegislation. In the case of the Hub project,the ImplementationAgreement assumed the role of this legislation,so the project sponsorsand the Bankbecame inextricably involved in the complexdiscussions that such a structuralreform involves. 23. The Hub PowerProject occasioned many "firsts"for Pakistan,the Bankand the international financialmarkets. For Pakistan,it was the first privateinfrastructure project and the first limitedrecourse financing. For the Bank, it was the first privateinfrastructure project, Bank-financed infrastructure fund (the LTCF)to supportprivate projects, partial risk guaranteeunder the ECO program,ECO guarantee with another institution(JEXIM), and the use of the ECO programto supporta privateproject. For the financialmarkets, it was the first majorprivate infrastructure project in a sub-investmentgrade developing countryto be financedby internationalcommercial banks on a limitedrecourse basis, the first international equityoffering (global depository receipt) and underwritingfor a developingcountry infrastructure project underconstruction, and the first stockmarket floatation of a singlepower stationunder construction. 24. Any delayscan be attributedto the project'snovelty, size, and complexityas well as to several force majeureevents. If allowanceswere made for time lost throughthe followingunforeseen events, then the activeperiod of projectdevelopment in terms of real time was closerto five years:

* the Gulf War (1990-91),

- 60 - * a Pakistancourt ruling on the applicabilityof the ShariahLaw to the paymentof interest (1991-92), * disruptioncaused by havingto reconstitutethe constructionconsortium following the departureof two of its memnbers(1990), and * occasionallosses of continuityattending several changes of governnent in Pakistan.

25. At the time the plant was placedunder WAPDA load dispatch,the outputcapacities and efficienciesof all unitsperforned at or aboveguaranteed levels. Throughoutthe first winterof operation (1996-97),the commissionedunits operatedat almostfull output. The station'scontribution to the reductionof load sheddingin Pakistanwas then widelyacknowledged. 26. However,starting in 1998,as WAPDA'scash flow problemsintenisified, WAPDA began to look to IPPs for tariff relief As the largestIPP, Hubcobecame a focus for the Sharif government.Over the last two years, there was a wideningperception by WAPDAand somegovernment officials, that the Hubco project was one-sided,unaffordable to Pakistanand that corruptionmust have been involved. 27. Hub, a truly pioneeringproject, was at one time seen as the flagshipprivate sectorproject in Pakistan,and laid the groundworkfor futureIPP developmentnot only in Pakistan,but other developing countriesas well. Subsequently,however, the Government'stactics in pursuingallegations of corruption, which wereperceived by the companyand its investorsas beinga fonn of organizedharassment aimed at reducingthe tariff, underminedforeign investor confidence in Pakistanand damagedthe country's reputation.Almost two half yearsafter the first allegationcharges were made, Hubco,the Governmentand WAPDAagreed to a settlementwhereby, inter alia, the tariff levelwill be reducedand all criminaland civil caseswill be disposed.

Endnotes "British ElectricityIntemational became National Power Intemational(UK). 2/ Given the use of over six currenciesin both the financing and procurementarrangements, the dollar equivalent is an approximation. 3' The financial difficultiesof WAPDAwere exacerbatedby madnyIPPs coming on stream simultaneously,at a time when demand did not grow as anticipated.

- 61 - B. The Asia Pipeline Ltd (APL) Project

Background 1. Asia PetroleumLtd (APL), createdin 1994,is owned49 percentby PakistanState Oil (PSO), a Government-ownedcompany involved in the distributionof petroleumproducts; 26 percentby Asia InfiastructureLtd (AIL),a Singaporecompany involved in projectdevelopment; 12.5 percent by Veco Engineersand Construction(VECO), a USA engineeringfirm; and 12.5percent by the Independent PetroleumGroup (IPG), a Kuwaitcompany involved in petroleumtrading. The companywas set up to build,own and operatethe pipelinecarrying residual fuel oil fromthe PSO-ownedPipri oil terminalto the Hub powerplant. The WorldBank was instrumentalin assemblingthe consortium,and ensuringthat the Hub powerplant would be suppliedwith fuel on a timelybasis. 2. It was intendedinitially that: (i) Promet,a Singaporecompany whose main shareholdersat the time were also AlL's, wouldbuild the pipeline;(ii) VECO,one of the sponsorswould be entrustedwith the operationand maintenanceof the pipeline;and (iii) IPG wouldsupply the crudeoil. Eventually,Promet built the pipeline,but otherarrangements were introducedfor the exploitationof the pipelineand the procurementof crude. 3. Given the need to providecomfort to the seniorlenders of Hub, the ImplementationAgreement (IA) and the Fuel TransportAgreement (FTA) were initialedin Washingtonin September1994; and the Engineering,Procurement and Construction(EPC) contract with Prometwas signed in January 1995,close to the conclusionof the SecurityPackage for Hub. Sincethen, negotiationshave continuedover the SecurityPackage for the APL pipeline,and a revisedversion of the IA was initialedin October1999. The issues whichremain to be settledare the transferof the right of wayto APL and the forcemajeure provisionsin the IA (i.e.events outside the controlof APL, suchas the conversionof Hub to naturalgas, changesin the tax regime,route changes,results of politicalevents etc.). As a result,the projecthas not yet reachedfinancial close from a projectsecurity interest point of view,although the fundshave been fully disbursed,and loansare being repaid.

Projectimplementation 4. The project consistsof an 82-kin, 14 inch insulatedresidual fuel oil pipelineand relatedpumping stationwith a capacityof 3.5 milliontons (MMT)per annum (of which 2.5 MMT were earmarkedfor Hub, and 1.0 MMT for anotherpower plant which was not built). 5. Theproject was expectedto be completedin 18 months,i.e. by June 1996. Due to delaysin the acquisitionof rightsof way, the projectwas completedfive months late, so that it beganoperating in November1996 (the first unit at Hub startedto operatein June 1996 and the fourth in March 1997). The pipelinewas certifiedby severalconsulting engineers and has been operatingsatisfactorily since its commissioning. ProjectCost and Financing 6. The cost of the projectwas initiallyestimated at US$95million - the pipelinewas eventually completedat a cost of approximatelyUS$85 million. The Projectwas financedthrough shareholder's equity(approximately US$35 million); a long term loan of US$20million under PSEDPI made available in January 1996 (priorto financialclosure); and short term borrowings(approximately US$30 million) arrangedthrough local commercialbanks.

- 62 - Tariff 7. The initialtariff was set at US$70,000/dayon a provisionalbasis. In July 1998,the tariff was revised to US$12.13/tonfor the first 1.5 MMTper annum,and US$8.49/tonfor any excess. The initial tariff was designedto allowthe companyto reach a returnon equityof 25 percent,which was subsequently reduced,by mutual agreement,to 16 percent 8. The tariff is equivalentto the standardroad hauling chargesprevailing in 1996 for a similar distance,expressed in Rupees. The relativelyhigh chargesare also explainedby the characteristicsof the residual fuel oil, which is viscous,hence costly to trawsportover long distances. 9. One shouldnote that APL has been able to retirethe short term debt (US$30million) out of its revenue. APL still owes approximatelyRs447 million to PSO on accountof excesstariff chargedbetween November1996 and July 1998,as well as storagefees. APL expectsto refinancethose chargesfollowing financialclosure. Evaluation 10. The Bankmade the transferof the rightsof way to APL, as well as the conclusionof the security package, conditionsof PSEDPII. The StaffAppraisal Report makes these a conditionof effectiveness.In the Loan Agreement(Section 3.05), they are subjectto a dated covenant(initial target date was January31, 1995). At the same time,it allowedthe disbursementof US$16million (subsequently increased to US$20 million)towards project execution, prior to the two conditionsbeing fulfilled. This action was deemed necessaryto allowthe pipelineto be built in time for the commissioningof the Hub powerplant (otherwise heavypenalties would have been claimedby the sponsorsof Hub). 11. As a resultof not reachingfinancial closure, the shareholdersof APL have not been able to draw dividends;the sharesof APL have not been listed on the KarachiStock Exchange; and the companyhas not been ableto initiatenew activitieseffectively (such as the distributionof CNG).

- 63 - C. Uch Power Limited (UPL) Background 1. The Uch Powerproject, jointly supportedby IBRDand IFC, is a 525 MW (586 MWISO rating)gas-fired, combined-cycle power plant, locatedin the Provinceof Balochistan,at an estimatedbase cost of $630 million. The projectuses low to medium-Btugas from the nearbyUch gas fieldwhich, becauseof its low energy content,has no othereconomic use exceptdedicated power generation.The project sponsorsare MidlandsElectricity (UK, 40%), Tenaska(USA, 30%),General Electric Capital Corporation(USA, 18%), Hawkins Oil and Gas (USA,9%) and Hasan Associates(Pakistan, 3%/O). The design, supplyand constructionof the plant was arrangedunder a fixedprice turnkeycontract with GE Power Systemsand Chineseequipment and engineeringfirms from Harbin, China for a EPC contractprice of US$347million. The plant is operatedby ESBI of Ireland. 2. UPL was incorporatedas a public companyon July 7, 1994. A Letter of Supportwas issuedby NDFC in March 1995. WAPDAagreed to purchasethe capacityand energy outputof the project from UPL undera 23-yearpower purchase agreement (PPA) signedon November23, 1995;similarly, OGDC agreed to supplythe gas under a 23 year Gas SupplyAgreement signed on November2, 1995. In addition, UPL enteredinto an ImplementationAgreement (IA) on November19, 1995under which the Government guaranteesthe paymentobligations of WAPDAand OGDC,and assuresthe performanceof the State Bank of Pakistanfor convertibilityand availabilityof foreignexchange. (The contractualframework was similar for all IPPs underthe 1994 PrivatePower Policy.) Financialclosure was achievedon May 17, 1996. Under the terms of the agreement,commercial operations were expected to begin on March 1, 1998. ProjectImplementation 3. Projectcompletion has been delayedby over two years due to technicaldifficulties by OGDCwith the gas facility,various disputes with WAPDAand GOP, and GE related equipmentproblems. Gas suppliesfrom OGDC, which were due to be providedby October1997, were not provideduntil June 30, 1999. Connectingthe plant to WAPDAtransmission system was delayedfrom August 31, 1997to January 10, 1999.Delays were also causedby the issuanceof a Noticeof Intent to Terninate (NIT)by the GOP in July 1998on groundsof corruption. (Thiswas one of sevenNITs issuedto IPPsby the GOP on groundsof corruptionin additionto two TerminationNotices on technicalgrounds. All IPPs deniedthe corruptionallegation, and the NITs were subsequentlywithdrawn following a settlementto lowertariffs.) All of these delaysled to the demobilizationof the contractorsfrom May to December1998 and again from August to November1999. In addition,the EPC contractorexperienced some technical difficulties in testingthe plant in early to mid 2000 which also delayedthe commercialoperations date. On April 18, 2000, UPL and WAPDAsigned a Memorandumof Understandingin which,among otherthings, (i) WAPDAagreed to use all reasonableefforts to achievethe CommercialOperations Date (COD)on or beforeJune 1, 2000;(ii) UPL agreedto lowerthe levelizedtariff; and (iii) the term of the PPA was extendedfrom 23 to 30 years. Commercialoperation was declaredon October18, 2000. UPL signeda WithdrawalAgreement and a SettlementAgreement on November3, 2000 with WAPDAand PPIBwhich, respectively,withdraws the Notices of Intentto Terminateissued by GOP and WAPDAand resolves differenceswith respectto liquidateddamages owed by eachparty. The sponsorsare in the processof negotiatingwith the EPC contractorand OGDCon liquidateddamage claims and finalizingthe financial restructuringagreement with the lenders. Project Costand Financing 4. The projectcost was estimatedto be US$630million (excluding US$60 rnillion in standby fimding). The financingwas basedon a 80:20debt:equity ratio amountingto total equity of US$130

-64 - millionand total debt of US$500million (see tablebelow). The US$313million of seniordebt was providedthrough a US$153million loan guaranteedby US Eximbank,an IFC 'A' loan of US$40million, an IFC 'B' loan of US$60 million,and a US$60million commercial loan supportedby an IBRDpartial risk guarantee. LTCF provideda US$187million subordinated loan, of which US$5million was provided by the Bank underLn.3812-PAK. 5. The cost of the projecthas now increasedby US$86million to aboutUS $716 milliondue to delaysin commissioningthe plant. Thecost ovemrnis proposedto be fundedprincipally by the equity investors(US$61 million), LTCF (US$42million in the form of capitalizedinterest), the Bank'sECO facility(US$15 million), and IFC (US$15million) - most of which was alreadyprovisioned for in the form of standbyfinancing. Originalvs. RevisedProject Cost and FinancingPlan Cost:USD million Orig. Rev. Funding:USD million Orig. Rev.

EPC Contract 347.0 355.2 IFC - A Loan 40.0 40.0 ProjectDevelopment 42.4 53.0 IFC -B Loan 60.0 72.0 Land 0.6 0.6 WB GuaranteedFacility 60.0 75.0 Spare Parts 12.0 11.2 US EximbankFacility 153.0 135.0 Insurance 11.0 12.8 LTCF 187.0 199.0 Start up, training& admin. 47.0 75.4 US Exim - $97.0 IDC & financialexpenses 140.0 207.8 Bank of China - $80.0 World Bank- $5.0 JEXIM - $5.0 Equity 130.0 185.0 LiquidatedDamages Rec'd 10.0 630.0 716.0 630.0 716.0

a/ Odginalfinancing plan does notinclude US$60 nillion of standbyfinancing, $30 millionin equity standbyand S15 nillion each underthe IFC B LoanFacility and the WorldBank Guaraeed Facility. Revisedfigues are estimatesas the financialrestucrngw has not yet beenfinalized. "Increasein LTCF fundingis throughthe capitalizationof interest. Tariff 6. The originaltariff agreed in the PPA was an averageof US¢ 6.05per kWh for the first 10 years and the levelizedprice was US¢5.58per kWh. In a Memorandumof Understandingsigned on April 18, 2000 betweenUPL and WAPDA,UPL agreedto a reducedaverage tariff of US¢ 5.77 over the first ten years and levelizedtariff of US¢ 5.13 over 30 years. ProiectEvaluation 7. The Uchproject was completedover two yearsbehind scheduleand has experiencedsimilar problemswith completionto other IPPs. As a resultof the delays,the projecteconomics have deteriorated significantly,which together with the reducedtarff, has necessitateda financialrestructuring of the Project The IRR on equityhas been reducedfrom 25 percentto about 10 percent. The project is currently in default (interestand principalpayments under the FinancingFacilities have been missed)and is operatingunder the terms of an InterimAgreement which provides for a standstillperiod during which lendershave agreednot to take any action againstUPL while the restruturing is being workedout. 8. The Uch Projectremains the cheapestof the four powerplants supported by the LTCF with a cost of US$1,169per kW. From the countrypoint of view,because of the use of low quality indigenous

- 65 - gas, this project is perhapsthe most economicamong all of the IPPs. The WorldBank and IFC playeda key role in financingthis project. IFCprovided US$115 million in A and B loans;World Bank's partial risk guarantee,US$75 million; and the LTCF,US$188 million. The combinationof these fundsprovided over 70 percentof the total loans for the Project.

- 66 - D. Rousch (Pakistan) Power Limited (RPPL) Background 1. Rousch (Pakistan)Power Limited was establishedpursuant to the Govermmentof Pakistan's1994 PrivatePower Policy to build, own and operatea 412-MWcombined cycle residual fuel oil fired power generatingstation at SidhnaiBarrage in SouthernPunjab. The plant, comprisingtwo gas turbinesand one steam turbine,has been designedto facilitateeasy conversionto a gas-firedfacility using indigenous pipelinequality gas. The plant has been designedand constructedby SiemensAG and SiemensPakistan with ESBInternational undertaking the operationof the plant. The sponsorsof the Projectare the Rousch Companies,Siemens Project Ventures BmbH (Germany) and ESBI (Ireland). 2. An ImplementationAgreenent (IA), PowerPurchase Agreement (PPA), and Fuel Supply Agreementwere all signedduring 1995with the financingagreements signed on March31, 1996.The Bank approvedRousch as an eligiblesub-project under Ln. 3812-PAKon May 31, 1996. The Govermmentof Pakistanacknowledged financial close at the end of July 1996,and construction commencedin September1996 with comnercial operationsscheduled for March 1998. ProiectImplementation 3. The March 1998commercial operations date (COD)was contingenton the Interconnection and TransmissionFacilities being made availableby WAPDAby August 1997. As a result of WAPDA delaysto provideinterconnection and subsequentrefusal to permit synchronization,(i) the EPC contractor sloweddown the pace of work and in July 1998began demobilization after initiatinga plant preservation program;and (ii) Rousch issuedNotices of Intentto Terminatethe IA and PPA on October28, 1998. Permissionto synchronizethe gas turbineswas finallygiven in February1999 with commercialoperations rescheduledto commenceby the end of September1999. However,technical difficulties with the heat recoverysteam generators delayed COD a further72 days. The Projectachieved COD on December11, 1999 - 21 monthsbehind schedule. 4. Despitecertification by the independentengineer, WAPDA did not acknowledgethe achievementof COD citingvarious technical difficulties and declinedto pay the capacitycharges. The ProjectCompany was of the opinionthat this was a strategyon the part of WAPDAto gain tariff reductionsand was aware,that in other IPPs, WAPDAhad successfullynegotiated tariff reductions, followingwhich invoicessubmitted by thoseIPPs were paid in a timelymanner. Therefore,Rousch negotiatedan acceptabletariff reductionwhich was documentedin a Memorandumof Understanding (MOU) withWAPDA dated January14,2000. Underthe termsof the MOU,(i) WAPDAacknowledged that COD was achievedon December11, 1999;(ii) the levelizedtariff was reducedfrom 5.5780/kWh to 5.188 0/kWh (iii) both WAPDAand Rouschagreed to withdrawtheir claimsfor liquidateddamages for delaysin commissioningand testing;and (iv) Rouschagreed to withdrawthe Noticesof Intentto Terminate the PPA and IA. ProjectCost and Financing 5. Theproject was estimatedto cost US$450million (excludinga US$50million standby facility). Financingwas providedfrom the LTCF througha subordinatedloan of US$140million equally provided by the Bankand JEXIM,in additionto a Rupeestandby facility equivalent to US$40million arrangedby NDFCon its own account. Exportcredit agencies from Germany(Hermes and DEG) and ANZ Bank and Siemens-guaranteedcommercial loans provided US$183 million in senior debt financing for the project. Equitycontributed by the sponsorsamounted to US$137million, including US$10 million in standbyfunding.

- 67 - 6. The delaysin projectcompletion led to additionalfinancing costs and also unbudgeted preservationexpenses, operations costs and companycosts. At the end of December1999, the finalproject cost was expectedto be US$575million, an increaseof US$125million over the estimatedcost. (More than 45% of the cost overrunswas as a result of additionalinterest incurred during the extended constructionperiod of 21 months.)This increasewas fundedby additionalequity from sponsorsof US$51 millionand an additionalUS$41 million from LTCF(US$12 million of which was in the formof capitalizedinterest) as part of a financialrestructuring agreernent. The remainderwas providedby the senior lenders. Agreementwas also reachedwith lenders,including LTCF, to extendloan maturitiesunder the refinancingpackage. The conditionsprecedent under the refinancingdocumentation were met in October2000 which enabledRousch to draw on the additionalLTCF facility.

Originalvs. RevisedProject Cost and FinancingPlan (December1999) Costs:USD million Orig. Rev. Funding:USD million Orig. Rev. ConstructionCosts 369.00 Commercial 137.00 148.28 369.00 Add'l Construction 23.40 Hermes 33.00 34.80 Costs O&M Costs 9.00 16.43 DEG 13.00 12.85 Overheads 5.20 20.97 WorkingCapital 10.50 FinancingCosts 50.80 94.51 Inventory 8.45 ExistingLTCF 140.00 140.00 Other 9.00 14.86 AdditionalLTCF 40.83 Net ProjectCosts 443.00 547.63 Float 14.31 Equity 127.00 187.88 Initial OperatingCosts 7.00 12.94_ 450.00 574.88 450.00 574.88

Of the total USS455miDlion original base projectcost, US$140milion was approvedunder LTCF which wasto be co-financed50:50 betweenthe Bank and JEXIM. Becausethe SecondJEXIM PSEDP n loanwas not in place at the time of the Rouschfinancial close, the Bank agreedto disburseits portionof the subloan(i.e. $70 tnillion)ahead of JEXIMwith JEXIMdisbursing its half after the Bank. As a result, the full $70 millionfiom the Bank wasdrawn down by the timeof financialrestructuring, but only US$49.3out of a total of US$70 uillionwas drawndown fromJEXIM. As the GOPwas in arrearsto 3EXTh4,JEXIM refused to aDlowthe remainingUS$20.7 million to be drawndown. Therefore,the Bank agreedto financethe remainingbalance of JEXIM'sportion to coveroriginal costs in additionto US$29million needed to meetthe cost overrunsto be financedunder LTCF as part of the refinancingfrescueplan. Floatis a cashbalance that has beencommitted by Sponsorsto providethe Companyin the formof equity,enabling it to meetthe first debt servicing. Tariff 7. The originaltariff agreedwas US¢5.98/kWhon a 10-yearaverage basis and US¢5.57/kWhon a levelizedbasis. The companyfinally resolved technical difficulties with WAPDAwhen it agreedto reduce the tariff in a Memorandumof Understandingsigned on January 14, 2000. This providedfor a revised tariff of US¢5.80/kWhon a 10-yearaverage basis and US05.19/kWhon a levelizedbasis. Project Evaluation 8. Theproject was one of the largerIPPs approvedunder the 1994policy guidelines- only Uch was larger.It was the only plant to use combined-cycletechnology buming fuel oil. After two years of operationon fuel oil, it was expectedto be ableto switchto gas. Thecompletion delays of about 21 months have increasedthe cost of the projectby US$125million. The cost overrunstogether with the reductionin tariff necessitateda financialrestructuring of the project. Additionalcapital requirements have been met

- 68 - mainly by the projectsponsors and throughsupplementary funding from LTCF. In addition,senior lenders have extendedthe finalmaturity of the commercialfacilities by three to six yearsand amendedthe amortizationprofiles to match the availablecashflow. Costper kW installedhas increasedfrom US$1,092 to US$1,395.The IRR on equity has been reduced from about 18 percentto about 6 percent aftertax due to the reducedtariffs and the increasedcosts arisingfrom delaysin completion. 9. No GOP allegationsof corruptionwere made againstRousch. Nevertheless,it doesappear that WAPDAcreated delays in providinginterconnection, permitting testing and commissioningof the plant, principallyto compelthe companyto renegotiatethe tariffs. 10. Rouschmanagers acknowledged the key role playedby NDFCILTCFin securingfunding for the Project.

- 69 - E. Southern Electric Power Company Limited (SEPCOL)

Background 1. SouthernElectric Power Company Limited (SEPCOL) was approvedby the Bankas an eligible sub-projectunder Ln. 3812-PAKon November4, 1996.SEPCOL received a letter of support from the GOP on August 3, 1994 and undertookto constructan IPP comprising5 x 23.4 MW diesel engines with a gross capacityof 117 MW operatingon residualfuel oil suppliedby PakistanState Oil company (PSO). The plant (at Raiwindnear Lahore)was suppliedand installedunder a fixed price turnkey contract for US$92.2million, by a consortiumled by ABB KraftwerkeAG (Germany)with SEMTPielstick (France)and ZelinPakistan (Pvt) Limited.The plant is operatedby B.C. HydroInternational Power DevelopmentCorporation (Canada). The projectis sponsoredlargely by overseasinvestors led by a subsidiaryof B.C. HydroInternational Transpower Corporation (Canada) which subsequentlywas partially acquiredby SNC LavalinEquity of Canada. 2. SEPCOLsigned a 22 year PPAwith WAPDAon November17, 1994and an Implementation Agreementwith GOP on November23, 1994.Financial closure was achievedon October25, 1995.The project was scheduledto begin commercialoperations on December28, 1997. Project lmplementation 3. Theproject startedtrial runs in December1997 and CommercialOperation Testing (COT) from January9, 1998. However,the plantcould not clear the ReliabilityRun Test (RRT) per PPA requirements.There were altogether11 successiveRRT/COT failures between January to April 1998. On July 9, 1998,GOP issued a TerminationNotice to SEPCOLon technicalgrounds which led to the demobilizationof the EPC Contractorfrom the site. Followingextensive negotiations, SEPCOL and GOP signeda WithdrawalAgreement on January8, 1999 throughwhich GOP withdrewits terminationnotice and the companywithdrew its case from internationalarbitration. After the signingof the Withdrawal Agreement,the projectcompany remobilized the EPC contractor,increased its efforts to preparethe plant for testing,and ultimatelyachieved commercial operations on March 10, 1999. 4. However,WAPDA refused to acceptthe resultsof the test and disputedthe commissioningof the plant. In orderto resolvethe dispute,the ProjectCompany entered into negotiationswith WAPDAand also submitteda revisedreduced tariff proposal. On July 12, 1999a Memorandumof Understanding (MOU)was signedbetween WAPDA and SEPCOLresolving all issuesregarding tariff and commissioning of SEPCOLPower Station. The salientfeatures of the MOU are as follows: (i) WAPDAaccepted commissioningof the plant as of March 10, 1999;(ii) the project offereda reductionin the tariff suchthat the levelizedtariff has been reducedto US¢ 5.19/kWhfrom the originalUS¢5.57/kWh; and (iii) the project life was extendedto 30 years from 22 years.

ProjectCost 5. The capitalcost of the projectat financialclose was estimateat US$121million. In addition, the sponsorsprovided US$5.8 million as a standbyprovision to meet contingencies.The projectwas financedby SEPCOLshareholders who have contributedUS$27 million as equity. SanwaBank (Japan) and ANZ-Coface(Paris) provided senior debt of US$57million; subordinated loans for US$35million were providedby LTCF.

-70 - 6. As a resultof the 14 monthdelay in projectcompletion, costs increasedto US$155million. Almosthalf of this increaserelates to additionalinterest during constructionand financingfees. The cost ovenrunis being financedby the sponsors(US$6 million), senior lenders/guarantors(US$22 million), and additionalfunding from the LTCF (US$7.8million).'

Originalvs. RevisedProject Cost and FinancingPlan Costs:USD million Orig. Rev. Funding:USD million Orig. Rev. ConstructionCosts 91.3 94.1 ANZ-CofaceCredit 35.0 35.0 OwnersCosts 6.8 9.6 SanwaBank Japan 22.0 22.0 Insurance 1.4 1.9 NisshoIwai Corp. 4.0 ContractMgtnt Fee 2.2 2.5 LTCF 35.0 42.8 Other 4.5 10.6 Equity 27.0 33.0 FinancingCosts 13.8 29.9 InitialWorking Capital 1.0 6.2 WorkingCapital 7.8 Other 2.0 10.3 121.0 154.8 121.0 154.9

While the Bank had provided its no objecion to financing part of the cost ovetnns from LTCF under PSEDP U, the project company could not meet all of the conditions precedent under the refinancing documents in time to allow funds to be drawn down under Ltd 3812-PAK Tfherefore,the Government agreed to allow NDFC to use the accumulated reflows to LTCF to meet the additional financing needs of SEPCOL. Includes interest income, liquidated damages payable by the contrctor and pre-operatng energy fees.

Tariff 7. Theoriginal tariff agreedin the PPA was US¢6.1/kWh on a 10-yearaverage basis or USO 5.58/kWhon a levelizedbasis. This tariff was reducedon July 12, 1999 in return for WAPDAdropping all disputesand agreementon the COD. Therevised tariff is US05.8/kWhon a 10-yearaverage basis and US¢5.20/kWhon a levelizedbasis. ProjectEvaluation 8. This project was the smallest(117 MW) of the four IPPs supportedunder the PrivateSector Energy DevelopmentProjects. With a high unit cost (US$1,342per kW), it is unlikelythat this sub-project wouldhave been a least-costproject for WAPDAalthough it fit withinthe criteriaof the 1994 Private PowerPolicy and the PSEDPLoan Agreement. The plant cost per kW is almostas high as the Rousch project,a combined-cycleplant, with highercost technology.There werealso seriousdifficulties experiencedin testingand commissioningthe plant which led to paymentsby the contractorof US$5.5 millionin liquidateddamages. Theproject was completed21 monthslate, and as a result,costs increased by US$34 millionor about28 percent. The overalldevelopment experience was not substantial consideringthe small size of the project,and the fact that dieselplants are normallysimple to installand a well proven technologycompared to more complex,combined-cycle plants. The estimatedIRR on equity has been reducedto 14 percentbased on the revisedtariff.

- 71 - AdditionalAnnex 11. Borrower'sContribution

GOVERNMENT OF PAKISTAN

PRIVATE SECTOR ENERGY DEVELOPMENT PROJECT I

BORROWER'S CONTRIBUTION

PREPARED BY

THE NATIONAL DEVELOPMENT FINANCE CORPORATION

- 72 - GiEN-SU?VN ,~ 39

NIO. 5 ()W/94* (Jovcrnttlent o RE C £ I V E C MINISTRY OF FINANC -EC)ONOMIC \FFATRS (ECONO-MIC AFFAI`RS DIIINt Telegs-zaui: EiCONOMIC Tcele E'CDIV No ()3-63-V iYalIdhe.1104,PK~A,-99Q1 SECTION OFFICER TELE:9201437

Subject: PRIVATE SECTOR ENEVRGY DEVLOPMENT PROJECTS I AND II ( Ln. 2982 and 3812-PAX) INTENSIVE LEARNING I1MPLEMENTATION COMPLETION REPORT:

Dear Mr. Wall,

Kindly refer the World Bank's letter dated March 16, 2001

regarding the above subject.

2. With regard to the Implementation Completion Report (ICR)

exercise for the above mentioned two projects, I am encloaing the

Borrowers ( Government of Pakistan) contribution to the ICR which has

been prepared by the National Development Finance Corporation (NDPC) and

has been approved by the Finance Divislon.

Regards.

Yours sinc,tely.

ADIL AgBAR )

Mr. John Wall, Country Director Pakistan & Afghanistan South Asia Region. World Bank Resldent Mission, ISLAMAEAD

- 73 - BORROWER'S SECTION OF PSEDP I&II Imnilementation Comniletion Renort - Borrower's Views

Introduction:

A World Bank mission visited Pakistan from February 7 - 17, 2000 to initiate the preparation of the Private Sector Energy Development Project I&II ("PSEDP I&l" or the "Project') Implementation Completion Report (ICR).

In this context the mission met with different parties and reviewed inter alia; i) the effectiveness of the institutional arrangements for the Projects implementation ii) the national policies underlying the introduction of private power, iii) the selection criteria for project eligibility, iv) the time frame for the implementation of selected projects, v) the financial and operational impact of introduction of private generation, and vi) the arrangements for Project operations.

GOP agreed to the mission's suggestion that NDFC take the lead role in drafting of the borrower's section of the ICR and that EAD would coordinate the writing of the report which would include inputs received from PPIB, Wapda, and other Project participants.

Methodoloav:

NDFC in consultation with EAD wrote to various Project participants falling in the following categories:

i) Main players such as MW&P Wapda, KESC, PPIB, LTCF, PSO, and OGDC and institutions collaterally related to Project such as State Bank of Pakistan, National Insurance Corporation of Pakistan. ii) Sub-Projects, which had availed LTCF funding. iii) All other IPPs which were reported by PPIB to have achieved Financial Close.

To foster a focused discussion, each stakeholder was requested to comment on specific aspects of the Project as well as to express views on its own area of operation and/its role in carrying out the Project.

The list of institutions approached questions addressed to them, the status of replies received and the questions addressed to them are summarized in Annex-I.

NDFC intended to complete the draft ICR within the time frame proposed by the WB, however, responses from different institutions were rather slow. Even after reminders, all institutions did not response.

Prolect Back-roundand ProiectObiectives:

In November 1995, GOP first announced its policy of encouraging Private Sector (PS) participation in the development of power generation in November 1985. Two years later the policy was further developed in consultation with the Bank and GOP announced a plan to increase PS participation in energy production. The plan's main premises included: (i) 5% projected annual growth rates for main sectors of the economy during the 7th and 8th Plan periods (1989 -1998); (ii) increase in energy consumption at 7% and 6% during the 7th Plan and 8th Plan periods respectively; and (iii) expected shortages of energy after allowing for realistic levels of investment by the public sector.

- 74 - The targetsfor incrementalproduction capacities to be financedthrough PS investmentin the energy sector during the 7th and 8thPlan periodsare sunnnarizedbelow:

7th Plan (1989-93) 8th Plan (1994-98) PowerGeneration 2,300 MW 2,400 MW Coal Production 2 m. tpa 3 m. tpa Natural Gas 132 MMCFD 200 MMCFD

A study undertakenby the WB, throughconsultants with a view to identifyconstraints that couldhinder the achievementsof thesetargets recommended: (a) Strengtheningthe institutionsresponsible for evaluationand approvalof PS proposals; (b) Creatinga vehicleto providelong term financingfor PS investments;and (c) Designinga frameworkof incentivesfor PS developmentof energy.

Based on these recommendationsthe GOP:

(a) Createdthe PrivatePower Cell (PPC)in the Ministryof Water & Power(MW&P) and the Water & PowerPrivate Organization (WPPO) within the Water and PowerDevelopment Authority (WAPDA); (b) approvedsetting up of a PrivateSector Energy Development Fund (PSEDF),to be administeredby the NationalDevelopment Finance Corporation (NDFC); (c) Formalizedand strengthenedthe schemeof incentivesfor PS investmentin the energysector.

Theseefforts of GOP were supportedand complementedthrough the WB's PrivateSector Energy DevelopmentProject I & II (collectively"the Project").PSEDP I was launchedin 1988 and to furtherbuild on the base developed,PSEDP II was launchedin 1994.

In 1988, the WB Board approvedPSEDP-I (Loan 2982-PAK) to provideUS$ 150 millionfor financing the Fund (PSEDF).The loan was co-financedto the extent of US$ 314 millionby USAID,Nordic InvestmentBank and the Govenmmentsof France,Italy, Japanand UK.

The specificobjectives of PSEDPI were:(a) mobilizingresources for confinancingprivate sector investmentsin energydevelopment to contributetowards the achievementof objectivesof the 7th and 8th Plans; and (b) settingup an institutionalfrmework to sustainPS investmentand operationin the energy sector.

GOP and the WB signedthe Loan 2982-PAKon August 1988which had followingkey features:

TotalAmount: US$ 150 million

ProjectComponents: Part A: InvestmentProjects earmarked for sub-projectmeeting the eligibilitycriteria for equipment,works and IDC.

Part B: Technicalassistance component of US$ 4.0 million for training and consultancyservices.

Closing: December31, 1994 (was extendedto December31, 1999)

- 75 - Utilization: The entirecomponent for the sub-projectswas utilized for Hubco.At FinancialClose of Hubcoa total amountof US$ 146million was sanctionedfrom Loan2982-PAK Hubcoutilized an amount of US$ 115.95million and as the Projectwas completedunder budget, Hubco cancelledthe balanceof US$ 30.05million from this loan.

The TechnicalAssistance Component was utilizedto the extent of US$ 0.83 milliononly.

PSEDF-I1objectives were: (a) to continueto assist the GOP in mobilizingthe additionalresources required to developthe energy sectorthrough the PS participation;and (b) to build on the institutionaland policy frameworkestablished to facilitatethe PS in the energy sector.

The US$ 250 millionLoan Agreement3812-PAK was signedin December1994 between the GOP and the WB. PSEDF-IIwas co-financedto the extentof US$ 436.58million by JapanEximbank, US Eximbank, Govemmentof France and Bankof China.

Amount: US 250 million

ProjectComponent: Part A: For sub-projects;sub-loans to meet the cost of goods,services and interestand other chargesaccrued during construction.

Part B: For institutionbuilding; cost of consultants'services, training and equipments.

a) to replenishthe PSEDF(LTCF) to providefunds to Hubco,APL and other eligibleprojects related to power generationand energyrelated infrastructure;

b) fund the continuedoperation of PPIB and LTCF; coveringstaff, consulting services, training, equipment& services;

c) fund other consultancyservices to:

i) assist GOP to outlinethe mandatefor PPIB its managementand reportingstructure; ii) to ensure formulationof LTCF as an autonomouscommercially oriented LTCF.

Closing: The loan was closedon October31, 2000.

Utflizaffon: Out of total availablefunds of US$ 250 million underLoan 3812-PAK,an amountof US$ 233 millionhas been utilized,canceling the balanceof US$ 16.73million.

Evaluationof Oblectives:

The Projectobjectives had definedspecific production goals for incrementalcapacities through PS for productionof power,gas and coal.The Projectalso soughtto build and strengtheninstitutional capabilities and developa policy frameworkto supportthe implementationof energyprojects in the PS.

- 76 - As the Project'sphysical targets were developed to complementthe overallnational energy plan for the 7th and 8th Five Year Plans therefore,they could said to be pragmaticand well foundedthough they were inherentlyconstrained by the successin achievingthe overallmacro-economic objectives. With respectto the institutionalobjectives and creationof a frameworkthese were an essentialcorollary for achievementof the physicalobjectives.

For facilitatingPS investorsin the powersector the Projectenvisaged strengthening the existingPPC in the MW&Pwhile in a similar arrangement,the Coal MiningCell (CMC),was proposedin the Ministryof Petroleumand Natural Resources(MP&NR) for the coal sector.No analogousarrangement was defined for the gas sector,perhaps because MP&NR was alreadyconversant with dealingwith privateinvestors. Also, while the WPPOwas establishedin Wapdano parallelbody was envisagedfor KESC.

The objectivesdeveloped for the Projectwere primarily based upon past rates of economicgrowth and increasein the energyconsumption, and may not have fully consideredthat as energy productionand distributionhistorically enjoyed direct and indirectindividuals subsidies, consumption levels may not supportproduction delivered at prices considerablyhigher than the past

Achievementof Oblectives:

As the principalProject executing agencies involved in actualimplementation on behalf of GOP were PPIB, Wapda(WPPO) and NDFC,their assessmentof the Project's outcomeare givenin this section.(The lettersof variousparticipants conveying their views on the Projectare availablein NDFC'sfile. Due to limitations of the sizeand the report'sstructure the replieshave been abridge and edited.) Given the Project's structure,it is not surpising that the views of variousgovernment controlled organizations are somewhatdissonant; they shouldnot be seen as representingGOP's comprehensiveand unifiedposition.

PrivatePower and Infastructure Board(PPIB):

PPIB has viewedthe PSEDPprogram as an overall success.The GOP with supportof the WB was able to developa policy frameworkwhich resulted in a large inflowof foreigninvestment in the energysector as well as establishingan enablinginstitutional framework. PPIB feels that it was able to successfully implementthe 1994Power Policy, which resultedin 19 IPPs with a combinedcapacity of 3,000 MW achievingFinancial Close, by acting as an effectiveinterface between the private developersand GOP/Wapda/PSO/OGDCL.

Followingthe 1994 PolicyPPIB also undertookimplementation of the 1995and 1998hydel policies, thoughneither of these could match the successof the 1994Policy.

Based on the benefits of long tenorsand Rupeerepayment facility available under the PSEDFsub-loans, PPIBbelieves that IPPs shouldhave been able to offer lowertariffs to Wapda.Also in PPIB's opinionthe Lendersshould have made a better assessmentof Pakistan'spower requirements thus avoidingthe present oversupplysituation.

On the questionof problemsfaced by IPPsin projectimplementation PPIB has observedthat generallythe developerscould have avoidedthese through better planning and execution.However, problems relating to foreignexchange availability, withholding tax, exchangerate parity couldhave been mitigatedto a great extent if a single institution,like PPIB,was authorizedto take decisionson behalf of GOP in coordination with the concernedgovernment agencies also keepingin viewthe contrtual obligationsunder the

- 77 - concessionagreements.

The major lessonof the Projectin PPIB's viewwas that adoptionof ICB processfor specificidentified projectswould have ensuredgreater transparency as well as competitivetariffs. Also, various factors influencingthe successof PSEDP, suchas cost of generation,projected demand and supply,financial and fiscal regimesprovided to investors,should have been carefullyevaluated.

The views expressedby PPIBhave been endorsedby the Ministryof Waterand Power.

Water and Power DevelopmentAuthority (Wayda):

The views expressedby Wapdaon the Projectare focusedon the tariff disputesthat emergedabout three years back with Hubco,and other IPPs as the Projectsapproached completion.

Commentingon the objectiveof PSEDP,Wapda expressed the viewthat it wasto bridgethe energy supply and demandgap throughprivate sectorparticipation at an affordableprice. This objectivewas achievedto the extent of 5000 MW additionalIPP capacitybeing availableto the NationalGrid, however,as the countryhas endedup with surpluspower the demandsupply gap has not been reallybridged suitably.

In Wapda's opinionwhile concentrating on "Supplyof Energy",affordable tariff for the utilityand the ultimateconsumers were ignored.Apart from the effectsof a recessionhit economy,the high cost of electricityhas resultedin the taperingof demand.

Summingup the lessonsof the Project,Wapda has asserted:"Unless the involvementof private sectorin energy sectordoes not reducecost of the product,the whole exercisewould prove futile."Looking to the future,Wapda feels that the main focus of WorldBank's PSEDPshould be on how to reducecosts of energyto stimulatedemand. Towards this end, Wapdahas made the followingsuggestions on future utilizationof fundsavailable in PSEDF:

a) promotionof tariff reforms,which could help in stimulatingdemand; b) meaningfulprivatization of the distributionsector with the objectiveof lowercosts finrly in mind; and, c) reductionof interestrate softeningthe termsof loans in the existingIPPs.

KarachiElectric SuPDlV Corporation (KESC):

KESC, the utilityresponsible for generationand distributionin Karachiand surroundingareas, had signed nine PPAs totaling over 2000 MW underthe 1994 PowerPolicy. Only three projectsachieved Financial Closeand two, with a combinedcapacity of 250 MW, reachedcommercial operations.

In KESC's view due to lower economicgrowth than envisagedunder the 1994policy the presentgeneration capacityand conmmittedadditions are likelyto be sufficientupto 2003. Due to dryingup of loan availability for its own generationprojects the IPPs helpedin reducingthe demand-supplygap in KESC's network during the years 1998 and 1999 and createda maintenancereserve for its stations.

The 1994Policy allowed free choiceof site,fuel and technologyto developers.This led to IPPs choosing sites in proximityto KESC's own power stations,thus increasingthe vulnerabilityof the transmission system,and selectionof diesel enginebased plants, which allowedearly project completionbut from KESC's perspectivedo not offerbase load stability.Also, in KESC's view thoughthe 1994 Policywas

- 78 - simple,allowing an upfrontbulk tariff, and thereforeattracted investment, it sufferedfrom somebasic flaws suchas not requiringICB and permittingtariff adjustmentfor both inflationas well as Rupee depreciation.Other drawbacks of the privatepower program were that the large numberof incentives offered(government performance guarantees; tax and duty waivers)attracted private investors looking for windfallgains rushed to set up projectsand frequentlyadopted coercive tactics to -ensure early signingof agreements.

KESC has acknowledgedthat as a consequenceof the power sectorbeing an exclusivepublic sector domainmany distortionsand anomalieshad resulted. Onepositive effect of inductionof privategenerators is that now public sectorutilities are betteraware of marketrealities and competitionwith the IPPs is expectedto lead to bettermanagement of publicassets.

Oil and Gas DevelonmentCompanv Limited (OGDCL):

OGDCLhas limitedits commentsto its experiencewith the Uch PowerLimited (UPL) project. The Uch gas fieldhas been developedby OGDCLwith a financialoutlay of US $ 270 millionand is expectedto generaterevenues in the range of US$ 54 to 83 millionannually, depending on load factor achievedby UPL. Howeverthe continuedwrangling between WAPDA and UPL and UPL's problemswith its contractorsand lendersdelayed commissioning of their projectfor quite a while.

OGDCLhas emphasizedthat despitefulfilling all its contractualobligations UPL has refusedto acceptgas deliveries.

NationalDevelo_ment Finance Cor_or (NDFQ:

The formationof a separatedivision within NDFC for PS energyproject and its staffingby professional staff was one of the requirementsunder Loan No. 2982 PAY, The PrivateEnergy Cell of NDFCprovided a nucleusfor the new division,the PrivateEnergy Division (PED), setup in 1988.

Under the AdministrationAgreement signed between the GOP and NDFC in January1989, NDFC was designatedas the Administratorof the PrivateSector Energy Development Fund establishedthrough the proceedsmade availableby a nunber of internationalfunding agencies. In 1994PSEDF was renamedas the Long Term CreditFund ("LTCF"or the "Fund").During its initialyear PED benefitedfrom the trainingand technicalassistance provided by outsideconsultants as well as two residentconsultants financedby USAID.

As administratorof the LTCF,NDFC is responsiblefor appraising,approving financing, supervising and monitoringeligible PS Projects.

LTCF fundingfor powerprojects was only consideredafter the sponsorshad obtaineda Letterof Support (LOS);and executionof concessiondocuments between the Projectcompany and relevantcounter parties and satisfactorycontractual arrangements for equipmentand constructionwere conditionsprecedent for effectiveness.Therefore, basic premisewas that all partiesto theseagreements has carriedout their respectivedue diligenceand thereforeit was believedthat the Projects' operationalrisks had been reasonablymitigated. As such, it was expectedthat the Fund's borrowerswould be able to satisfactorily meet their obligationsto lenders,including LTCF.

It is noteworthythat as many as 20 proposalswere receivedby LTCF for fundingbut only five were financed.The high drop out is due to: (i) the procurementprocess; (ii) availabilityof alternativefinancing

- 79 - due to high marginsunder the 1994Policy; (iii) non-availabilityof fund for a periodbefore effectiveness of PSEDF-II;(iv) crowdingout due to high allocations/standbysfor Hubco.

LTCF has participatedin the fundingof IPP's which vary in terms of size(117-1200 MW), location,fuel (RFO, naturalgas, low BTU gas) and type (combinedcycle, steam,diesel). The Fund also participatedin the 82 Km residualfuel oil pipelineproject, which meetsthe entirefuel requirements of Hub Power Company.Todate LTCF has investedabout US$ 840million in five 5 projects.The total amountof investmentmobilized for theseprojects (including equity and commercialdebt) is approximatelyUS$ 3 billion.

Each of the sub-projectsare briefly discussedbelow:

Asia PetroleumLimited (APL):

The 82 Km Pipelinewith an annualcapacity of 3.63 milliontones runs fromthe Pipri Oil Terminalto Hub, Baluchistanand suppliesresidual fuel oil (RFO)to Hubco.The Pipelinehas been operationalsince November02, 1996 and has cumulativelypumped 4,777,287 metric tones of RFO upto March 31, 2000. LTCF provided$ 19.98million for the Projectand the companyhas been servicingits loanssatisfactorily throughproject revenues.

Hub Power ComDanvLimited (Hubco):

The 1292MW stearncycle project,based on residualfuel oil (RFO),has been in commnercialoperation since March 1997. The tariff payableto Hubcoby Wapdahas been under disputesince mid 1998. ConsideringLTCF's large exposureto this project(approximately $ 450m)an early resolutionof this disputeis imperativefor the Fund to maintaina positivecash flow.

Rousch(Pakistan) Power Limited(RPPL):

RPPL,a 412 MW (grosscapacity) combined cycle plant located at Abdul Hakimnabout 70 km. from Multan,is in operationfor almosta year now. The plant design,currently based on RFO,allows easy conversionto gas, which would improveoverall efficiency and profitability.LTCF has provideddebt facilityof US$ 180million to the Project.The initialtargeted Commercial Operation Date (COD)was March 1998,however, actual COD was achievedon December11, 1999.

SouthernElectric Power CompanyLimited (SEPCOL):

SEPCOLis a 117 MW dieselengines plant based on RFO to which LTCFhas disbursedUS$ 35 million. The Projectencountered serious problems during commercial operation testing and also facedthe threatof termination,however these issueswere resolvedand COD was achievedin March 1999.

Uch Power Limited(UPL): UPL is a 587 MW low BTU gas fired plant locatedat Dera MuradJamali, Baluchistan.LTCF financingcomnitinents for the Projecttotal US$187.00million, out of which approximatelyUS$ 7.00million rernains undisbursed. The Projecthas achievedCOD in October2000.

Project Contribution in Gas/Coal Sector; the Project succeeded in attracting a huge amount of private capital,albeit concentrationin powergeneration and enhancinginstitutional capacity for appraisingand finalizingproject proposals.

- 80 - DuringProject implementation the gas and coal sectorsappear to receivedinadequate attention. This would indicatethat perhapsthe relevantadministrative agencies were either initia1ly not consultedin the evolving the objectivesand/or there was a lack of sufficientfollow-up endeavor during the implementationphase. More involvementof MP&NRwhich is the controllingministry for the gas and coal sectorsmay have the achievementof the objectivesfor these sectors.

The implicationsof this are quite significantas a more balanceddevelopment of the energy sectormay have avoideda situationof over capacityof power,based on importedfuel, whilethere existsunmet demandfor gas. Thereforethe objectivesshould not have been treatedas mutuallyexclusive but inter-relatedi.e. developmentof one energy sectorshould have been linkedto simultaneousgrowth in other sectors.

PED/NDFCStaffing:

Over the yearsthe experienceand exposureof operatingin internationalenvironments have groomedPED' s professionalstaff to effectivelymeet the operationalrequirements of LTCF.The experiencegained by PED in financingof energy / infrastructureprojects is substantialwhich now encompassesboth appraisal and monitoringphases, PED officershave been exposedto workingon these transactionswith international lenders,sponsors and developerson "projectfinance" basis. Actingas administratorof the Fund,PED always remainedeffective in matchingthe variedrequirements of variousparties. PED staff has also gained experienceof workingwith technicaland legal consultantsof internationalrepute and a numberof major internationalsuppliers, contractors and operators.Furthermore, PED has gainedvaluable experience of workingwith a numberof co-financers,particularly the WB/JEXIM.

The experiencegained in PED equipsthe divisionto adventinto othersectors wherein private sector investmentis essentiallyrequired. With the existingskills today PED is fully gearedto; i) undertakeProject Financingon a non-recourseAimitedrecourse basis; ii) providefinancial advisory services; iii) develop financialmodels for energy/infrastructureprojects; iv) arrangefunds throughsyndications as a leadbank; v) act as an Inter-creditorAgent in internationaltransactions; vi) reviewand evaluatethe procurement aspectsin-line with the requirementsof the WB and other internationalmulti-lateral and bi-lateralagencies; vii) undertaketechnical due -diligence;viii) effectivelynegotiate project's agreementswith the Project companiesas well as other lendersto the Projects;ix) act as Fund Manager.

Although,PED has been able to retainmost of its trainedstaff, however, the currentscenario indicates that it may not be the case for long. In case no attemptsare made to up hold PED, which over the yearshas transformeditself into a stronginstitution, the human resourcesdeveloped will be lost, leavinga vacuum for future developmentsin energy/infrastructuresector.

Viewsof otherStake Holders:

The substantiveviews and commentsreceived from the other stakeholders are summarnzedbelow.

Hub PowerCompanV Limited (Hubco):

Hubcowhile appreciatingthe far reachingsignificance of the Projecthas suggestedthat there was a need for the establishmentof an effectivemonitoring program by the WB whichwould have enabledit to play a more proactiverole in resolvingthe problemsbeing faced by the IPPs. It has also opinedthat despitegood initialintentions GOP could not implementkey componentsfor the program,particularly those related to the introductionof marketreforms in the areasof transmissionand distributionof power,which has marred the successof the entireproject.

- 81 - Commentingspecifically on the designof the Project,Hubco expressed its reservationson three aspects, viz (i) the requirementto complywith WB procurementguidelines for the WB and Jeximtranches (ii) the tied nature of certain tranchesof the PSEDFand (iii) the unavailabilityof PSEDFfinancing for payment of soft costs.

With respectto disbursementssome teething problems were encountered in the initialstages resulting in agreeddeadlines being missed. However one operationalproblem which persisted was that disbursements were not pre-advisedby any of the co-financiersexcept USAID. This meant that beneficiarieswere not able to receive value date credits.

On the questionof effectivenessof PSEDFfunding in facilitatingFinancial Close, Hubco has unequivocallyacknowledged that withoutthe fundingmade availablethrough the PSEDFtheir project wouldnot have been materialized.It has also appreciatedthe cooperationextended by the variousGOP agenciesduring implementation of the Project.

Rousch (Pakistan) Power Limited (RPPL):

RPPL believesthe Project's contractualframework and the concessionswere adequateto give reasonable comfortto seniorlenders as well as projectpromoters/sponsors. Commenting on their experienceduring project's implementationwith variousGOP entitiessetup for PSEDF,RPPL feels that duringinitial years the three institutionsdeveloped by GOP (i.e. PED,WPPO/PPC/PPIB3) had worked largelyper the PSEDF frameworkand facilitatedIPP proposals.This is evidentfrom the fact that the RPPLproject was appraised,negotiated, and documentedin a professionalway, achievedtimely Financial Close and committedfunds were disbursedper agreedtime frameand procedures.This was achieveddespite PPC/PPIBnot being able to truly offerthe 'one window' facilityannounced in the GOP's policy.

Subsequently,however, as the sub-projectapproached completion, the companystarted facing a lot of hindrances.In RPPL's opinion,the govenmnentmachinery at that time triedto make the implementationof IPPs a politicallyoriented issue, which also influencedthe approachof these three institutions.

Commentingon the appropriatenessof optingfor LTCF fundingRPPL acknowledged that without a subordinatedloan, probably the Projecthave not materialized.PED/NDFC team played a vital role without compromisingon the basic principlesof creditappraisal and objectivesof PSEDP.PED/LTCF was conceivedto act as professionaland independentorganization, but with time it has increasinglybeen influencedby disparateconsiderations and is seen as wearingtwo hats, which has shakenthe confidenceof the offshorelenders and sponsors.LTCF being a lenderhaving its own Board of Directorsshould play an independentrole on comnercial curn developmentbasis.

On LTCF's financingrole in facilitatingraising of senior debt, RPPLconfirm that availabilityof LTCF loan helpedin givingcomfort to seniorlenders in makinga decisionto financethe Project,at reasonable cost and fees in a developingcountry. Particularly, LTCF's successfulfunding of Hubcoprovided confidenceto offshorelenders and sponsors.

RPPLsuggests that a more constructivestrategy for tariff reductionwould have been to approachthe sponsorsand lendersto work with the govemmentto mitigatethe impactof the powerpurchase agreements (PPA)on Wapda's cash flowsrather than impendingimplementation of projects.This would have avoided damaginginvestors confidence, developed over a periodtime, and also the Projectswould not have faced cost overruns,thereby reducing the cost of generation.

- 82 - Like Hubco,RPPL has also suggestedthat the WB shouldhave playeda more activerole in the PSEDP program.Another weakness pointed out was that the Projectdid not promotethe localengineering industriesor consultingfirms. RPPL facedproblems in hedginginterest rate risk and suggestedthat LTCF rates shouldbe linkedto LIBORinstead of US Treasuryor IBRDrates. The companyhas also suggested that greaterdecision making autonomy should be providedto the three GOP institutionsdeveloped for the Projectand compensationdesigned to discouragestaff turnover.

Asia PetroleumLimited (APL):

Givinga backgroundof the ventureAPL writesthat theirproject was establishedin the privatesector to constructa pipelinewithin a very limitedbut definitetime frameto fulfillthe HFO needs of Hubco, therefore,the companywas conceivedin an unconventionalmanner. Following actions were initiated by the WB, with the consentof GOP:

- Selectionof shareholderswho had a vestedinterest in the runningof the company;

- EPC contractwas awardedbefore signing of any agreementsespecially the IA, which has still not been finalized;

Recountingits experiences,APL has listed the followingproblems, possible mitigants, and lessonslearned;

- As the companywas unableto achieveFinancial Close and the fundstherefore, were not easily availablethe contractorwas alwaysin a positionto dictateterms. Healthy contractor-client relationshipwas very often missing.

The MP&NRgot into tanglesas this was the first time they were handlinga projectof this nature thereforetheir responseswere alwaysvery slow and createdhurdles for the Project.We feel that the sameGOP windowshould have been operativeas in the case of IPP thus eliminatingthe need of re-inventingthe wheel,which was alreadysubstantially developed in the Ministryof Water and Power.

The role of NDFC as an institutionwas no differentto what is normallyattributed to the Public Sectorentities. However, one redeemingfactor has been the attitudeof PED sectionwhereby most of the officialsdemonstrated a very commercialand skillfulapproach to the whole issue and inspite of constraintsthat they must have been faced with,things did moveand the Projectgot completed on time.

Any projectwhich requiredsubstantial investment, Financial Close shouldnot be a pre-requisite.

PSEDFlike fund definitelycan servea very meaningfuland rewardingpurpose.

NDFC shouldact as an independententity to administersuch funds and shouldnot be dependantto performwithin the practicedbureaucratic norms.

TaualEnerLv (Private) Limited (Non-LTCF Funded IPP):

Tapalconsiders the Frameworkfor the PSEDPwell conceivedand designedto encouragepower generation projectsin the PS. However,adding; there couldhave been a parallel and equalfocus on developingpower

- 83 - distribution also in the PS as reform in the power sector cannot be completed until the distribution sector is also privatized and able to control its losses and revenue leakages.

On their experience with various GOP entities setup for PSEDP implementation the company states that while they did not borrow from the PSEDF the general impression from those companies, which did borrow, was that while the various GOP entities created under the Project were well established there appeared an absence of common objectives between them. As an example, the PPIB was concerned with investment promotion and facilitation of IPP projects. In WAPDA the WPPO was more concerned with the cost of electricity under the PPA. WPPO was also rightly concerned, even in 1994 that the quantum of generating capacity being contracted from the PS appeared far in excess of projected demand. It was therefore trying to discourage a few projects. The PED in NDFC appeared more concerned with the viability of its investments and was therefore interested in maximization of revenues of its sub-projects, an objective directly in conflict with that of WPPO. PED was reporting through NDFC to the Ministry of Finance, as opposed to the PPIB and WPPO, which came under the administrative control of the Ministry of Water & Power. The fuel logistics and contracts were being coordinated by the Petroleum Ministry, which had its own priorities. The ministries did not see eye to eye on many issues, resulting in confusion and delays.

On the relative merits of a financial structure with LTCF funding vis-a-vis one without Tapal feels a blend of the LTCF with commercial debt would definitely have been a better package as their current loan is of seven-year maturity, which places a heavy debt servicing burden during the initial years of the PPA.

Based on their experiences with the PSEDP program the Tapal has suggested the following approach:

- To test the framework and policy, the first private generator should have been of much smaller capacity (approximately 200 MW) than Hubco.

After signing the first 1000 MW under the 1994 policy, the GOP should have switched to a competitive bidding system for subsequent capacity acquisitions, based upon pre-determined project parameters such as size, location, fuel and technology.

- A parallel focus should have been given to the privatization of distribution entities and strengthening of regulatory framework.

- Problems that arose in the implementation of projects should have been dealt on a commercial basis.

Assessment of World Bank Performance:

The WB played a major role in designing the framework and launching of the PSEDP. Subsequently through contacts with the Project participants and regular follow up missions the WB monitored the implementation progress. In addition to its own funding the Bank's participation encouraged other co-financiers to fund the program.

The assessment of the WB by the various Project participants presents a somewhat divergent view. While the GOP agencies have generally been reticent on the subject, Wapda's continued censure of the IPPs, with tacit support of other government agencies, can be seen as an indirect criticism of the PSEDP program and its protagonists. Though it should be recognized that this criticism has not been directed at the concept of private powerper se, but rather the perception that the tariff payable by utilities under the program is

- 84 - unaffordable.

On the other hand, someof the IPPs have calledfor a largerWB role in resolutionof their differenceswith GOP, evidentlyin the beliefthat this wouldbe to their advantage.This attitudewould appearto lend credenceto the perceptionthat the programsprinal objectiveswere promatationof the foreign investors/contractorsinterests.

LessonsLearnt:

Prior to invitingPS proposalsthere shouldhave been definedparameters for; i) the legislativeenvironment; ii) what is requiredfrom the Projecttechnically and commercially;and iii) what is finance-ablein the private sector.Wapda being the powerpurchaser should have identifiedthe specificationof availablesites, plant size, fuel type, mode of plant operation,provision of grid inter-connectionfacilities etc. Identification of these desiredparameters would have provideda meaningfulcompetition between the privatesector investors.

Beforeembarking on enlargingthe country'spower generationpool it may have been appropriateto plug the holes. The problemsof high line lossesand pilferageswere well known and past attemptsto addressthe issue had not met with any notablesuccess. In this scenario,accurate demand figures i.e. the need as well as the capacityto pay, could not be estimated.

Focuson a singlelarge projectas a 'first' was a risky propositionwhen the countryhad not gainedenough negotiatingexperience. This may have resultedin: (i) the GOP agreeingto multiplerisk coverageswhich only addedto the cost of the Projectresulting in a burdenbeyond the country's economiccapacity (ii) offeringa higherROI than meritedby technologicaland operatingrisk considerationand (iii) higher developmentalcosts which couldnot be off-set againstany tangiblebenefits for the country.

As eventshave show, in-deptheconomic and technicalappraisal is requiredfor a projectof this magnitude and far reachingimplications. Specifically: (i) more detailedwork on the BulkTariff Policymay have helpedin avoidingsome of its shortcomingslike offeringa premiumwhich encouraged relatively smaller diesel engineprojects not suitedfor base load requirements(ii) the impactof the Projectson the country's balanceof paymentwere not fully comprehended(ii) despitethe currentpressures for loweringtrade barriers,considerations of economiclinkages and indigenisationshould not be totallyignored in such Projectsas this adds to their politicalsustainability and ultimatesuccess.

It has been noted that numberof project'sparticipants influenced the timelyand successfulcompletion of the transaction.More the number of projectparticipants, (may it be the contactcounter-parties, contractors,co-financiers, members of the sponsorgroup), longer it will take the Projectto achieve FinancialClose. As such, for a smoother,timely and cost effectivetransaction, the ideal scenariois to have a limitednumber of projectparticipants.

Projectswhich entitledmulti-currency funding have experiencednot only delaysbut have also incurred additionalcosts on accountof hedgingfor the exchangerate movements.The preferredoption could be that all projectfunding should be denominatedin a singlecurrency preferably the same currencyas that of the TKC/EPC(Turnkey/Engineering Procurement Contractor) or at leastinto a currencywhich may be hedged readily.

For the success of the PSEDPProject it was a pre-requisitethat a suitableinstitutional framework is in-placeand sufficientadministrative resources are mobilizedto expeditethe necessaryproject agreements

- 85 - and approvals.Such a set-upshould have been availableprior to the commencementof first project (Hubco)development work, however,this wasnot the case.Hubco paved a way for an institutional developmentand by the time it was completed,a reasonablyutilitarian institutional framework was available.The continuityand availabilityof experts/specialistsdeveloped in these institutionswas essentiallyrequired for effective/smoothimplementation of projects.Unfortunately, as this institutional developmentwas in the public sector,therefore, no attemptswere made to retainthe human resources developedin these institutions.The lack of propercompensation and un-definedfuture career prospectus, forced significantnumber of professionalsto leave for bettercareer prospects. As such, thoughan institutionalframe was available,it was neverfully equippedand gearedto effectivelyrespond to the inherentchallenges of the transactions.

The PSEDPfunding was fromvarious co-financiers and was, therefore,in differentcurrencies. The World Bank commitmentand disbursementswere in US$,however, as the WB disbursesequivalent US$ from the pool of currencies,GOP is requiredto servicethe debt in respectivecurrencies from which WB has made disbursements.This has exposedthe PSEDPto exchangerisk. While structuringthe PSEDF-Ithis aspect was totallyignored, however, in PSEDF-IIthe exchangerisk for US$ movementto Pak Rupeewas covered,as under PSEDF-IIthe ProjectCompany liability is establishedin US$ with repaymentsin local currencyequivalent amount on the basis of exchangerate prevailingon the date of repayment.The change in the structuringof PSEDF-IIdemonstrate the learningcurve, however, the fund is still exposedto exchangerisk of currenciesother than US $. In future,it wouldbe essentiallyrequired that exchangerisk exposureshould be assessedin detail and appropriatemitigates are in place.

The overallconcentration remained focused on powergeneration and in the process the ancillary requirementswere ignored,which includeddevelopment and privatizationof power distributionsystern, affordabletariff and overall industrialgrowth. The imnplicationsare that, although,the electricityis available,the distributionsystem is inadequateto caterthe consumptionrequirements. The transmission losses are being passedon to the consumersin the form of excessivepower tariff.The availabilityof power,which shouldhave triggeredthe industrialdevelopment, did not help, as the power tariff is too high. Power sectorwas declaredan industryand variousconcessions were allowed,however, not enough incentiveswere offeredin other sectorsof the economyto facilitateaccelerated industrial development It is an establishedfact that developmentis a mellifluousactivity and is therefore,should not be restrictedto one sector of the economy.For a real successof PSEDPcoordinated efforts were/are required in all sectors of the economy.Optimal consumption of availablepower, efficient transmission and controlleddistribution losses will automaticallyreduce the tariff payableby Wapdato the IPPs,thus makingthe power affordable for the end consumers(industrial/domestic).

The financialstructuring engineered for the first PSEDPproject burdened the Projectwith substantivesoft costs such as, developmentcosts, legal costs and the lendersreserve requirements, in spite of the fact that variousguarantees were availableto the lenders.These soft costs were/area major contributingfactor in an inflatedtariff agreedfor Hubco.Being the first project,some of these costs couldbe justifiable,especially the legal/developmentcosts, however, the financialstructuring was adoptedas a model in other IPPs, which should not have been the case. On the basis of watertightsecurity arrangements the lenderscould have foregonetheir reserverequirements, thus allowinga relief on the tariff.Had Wapdaand the GOP continued to honortheir commitments,the lendersmay have agreedto provide suchreliefs on futuretransactions.

For the first PSEDPproject GOP had to allowseveral guarantees through the WB, JEXIMand other Export Credit Agenciesto the commerciallenders. All these guaranteeswere/are; i) back-stoppedby the GOP guaranteesand are thereforecontingent liabilities of GOP;and ii) for the politicalrisk cover.From 1988to 1996all the governmentswere supportiveof powerpolicy and therefore,with the passageof time

- 86 - the foreignlenders started to considerfinancing in Pakistanwithout guarantees for the politicalrisk cover. It was alwaysthe intentionof the GOP to minimizeguarantee exposure in such "ProjectFinancing" transactions.The consistencyin GOP's policiesencouraged the foreignlenders, during the period 1994to 1997,to financesome of the IPPs in Paidstanwithout seeking political risk guarantees.This was an encouragingsign and could have been en-cashedfor futuredevelopmental transactions in the privatesector, at an affordableprice. However, the changein GOP's attitudehas once again cautionedthe international communitynot to enter a third worldcountry without securing itself for the politicalrisks.

- 87 - Annex-I-A

List of InstitutionsApproached and Stastusof RepllesReceived

S.No. InstitutionName Replv/ Responded

1. National InsuranceCorporation No 2. Oil & GasDevelopment Corporation Yes 3. PakistanWater and PowerDevelopment Authonty Yes 4. State BankOf Pakistan Yes 5. Sui SouthemGas CompanyLimited No 6. The KarachiElectric Supply Corporation Yes 7. PrivatePower and InfrastructureBoard Yes

8. Asia PetroleumLimited(APL) Yes 9. Rousch(Pakistan) Power Company Limited (RPPL) Yes 10. SouthernElectric Power Company Limited (SEPCOL) No II. The Hub PowerCompany Limited (Hubco) Yes 12. Uch PowerLimited (UPL) No

13. AES Lal Pir Limited Yes 14. AES Pak Gen (pvt) Company No 15. AltemEnergy Limited No 16. DavisEnergen Lirrited No 17. Eeshatech(pvt) Limited No 18. Fauji KabirwalaPower Company Limited No 19. Gul AhimedEnergy Limited No 20. HabibullahCoastal Power (pvt) Company No 21. JapanPower Generation Limited No 22. KohinoorEnergy Limited No 23. LibertyPower Limited Yes 24. NorthemElectric Company Limited Yes 25. PowerGeneration Systems Limited No 26. SabaPower Company Liniited No 27. Sabah Shipyard(Pakistan) Limited No 28. TapalEnergy Limnited Yes

- 88 - Annex-1 -B

OuestionnaireAddress to the abovelisted Institutions

1.Adequacy of contractualframework and the concessions/policyto give comfortto seniorlenders as well as to the projectpromoters/sponsors for projectimplementation and operation.

2. Your company'sactual experiences with variousGOP entitiessetup for PSEDPimplementation. In your opiniondid these entitiesprovide adequate assistance to the IPPs at variousstages of approval, implementationand operations?How do you think this assistancecould have enhancedfor facilitating settingup of IPPs?

3. Appropriatenessof your decisionto avail LTCF subordinatedloan from PED/NDFCfor financingpart of the capitalcost. Was your loan requesthandled properly at variousstages of appraisal,documentation, disbursement,etc,. If there were shortcomingsobserved, how these couldhave been avoided?

4. LTCF subordinatedloan (togetherwith equity)was expectedto facilitateraising of senior debt, and at relativelylower cost and fees. Whathas been the actualexperience with the seniorlenders and exportcredit guaranteesas well as other guarantees?

5. Someof the IPPsexperienced a numberof problems.How do you think theseproblems could have been avoided?What do you considerwould have been the impact on capitalcost and generationcost if such problemswere resolved early?

6. What do you considerare the lessonslearnt from implementationof PSEDP,in particularthe implementationof yourproject?

- 89 -