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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF US$SO MILLION TO THE REPUBLIC OF INDONESIA FOR A DOMESTIC GAS MARKET DEVELOPMENT PROJECT Energy and Mining Development Sector Unit Infrastructure Unit East Asia and Pacific Region November 10,2005 Report No ID This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY EQUIVALENTS (Exchange Rate Effective - June 30,2004) Currency unit = Indonesian Rupiah Rp = US$1 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS AAA Analytical and advisory activity ADB Asian Development Bank AMDAL Analisis Mengenai Dampak Lingkungan Hidup (Analysis of Impacts on the Living Environment) bbl Barrel BPH MIGAS Badan Pengatur Hilir Minyak dan Gas (Oil and Gas Downstream Regulatory Body) BPK Supreme Audit Board CAS Country Assistance Strategy CFAA Country Financial Accountability Assessment CNG Compressed natural gas COZe Carbon dioxide equivalent ComDev Community development CQS CR Selection Based on Consultants' Qualifications Current ratio DO Development objective DSCR Debt service coverage ratio ECO Enviroilmental coordinating office EIAR Environmental impact assessment report EIB European Investment Bank EIRR EMP Economic internal rate of return Environmental Management Plan EO1 Expression of Interest EPC Engineering, procurement, and construction FMR Financial monitoring report FO Fuel oil FY Fiscal year GO1 Government of Indonesia GPN General Procurement Notice IBRD International Bank for Reconstruction and Development ICB International Competitive Bidding IFC International Finance Corporation IP Implementation progress IPO Initial public offering IT JBIC km KPKN LPG mmbtu mmcfd MOE NCB NGO NPV O&M PDO PGN PIU PMC PSC QBS QCBS RFP ROR RP. RVP SBD SBU SCADA SFR SO2 SPN TA tcf TGI TOR TSP VAT Information technology Japan Bank for International Cooperation Kilometer National Treasury Offices Liquefied petroleum gas Million British thermal unit Million cubic feet per day (gas) Ministry of the Environment National competitive bidding Nongovernmental organization Net present value Operation and maintenance Project development objective PT Perusahaan Gas Negara (Persero) Tbk Project implementation unit Project management consultant Production-sharing contract Quality-Based Selection Quality- and Cost-Based Selection Request for Proposal Rate of return Indonesian rupiah Regional Vice President Standard Bidding Documents Strategic Business Unit Supervisory Control and Data Acquisition Self- financing'ratio Sulfur dioxide Special Procurement Notice Technical assistance Trillion cubic feet PT TRANSGASINDO Terms of Reference Total suspended particulate Value added tax Vice President: Country Director: Sector Manager: Task Team Leader: Jemal-ud-din Kassum Andrew D. Steer Junhui Wu Noureddine Berrah

3 INDONESIA Domestic Gas Market Development Project CONTENTS A. B. C. D. STRATEGIC CONTEXT AND RATIONALE COUNTRY AND SECTOR ISSUES RATIONALE FOR BANK INVOLVEMENT HIGHER LEVEL OBJECTIVES TO WHICH THE PROJECT CONTRIBUTES... 3 PROJECT DESCRIPTION LENDING INSTRUMENT PROJECT DEVELOPMENT OBJECTIVE AND KEY INDICATORS PROJECT COMPONENTS LESSONS LEARNED AND REFLECTED IN THE PROJECT DESIGN ALTERNATIVES CONSIDERED AND REASONS FOR REJECTION... 6 IMPLEMENTATION INSTITUTIONAL AND IMPLEMENTATION ARRANGEMENTS MONITORING AND EVALUATION OF OUTCOMES/RESULTS SUSTAINABILITY CRITICAL RISKS AND POSSIBLE CONTROVERSIAL ASPECTS... 8 LOAN~REDIT c ~ N D ~ T ~ AND ~ N S COVENANTS... 9 APPRAISAL SUMMARY ECONOMIC AND FINANCIAL ANALYSES FINANCIAL ANALYSIS TECHNICAL FIDUCIARY SOCIAL ENVIRONMENT SAFEGUARD POLICIES POLICY EXCEPTIONS AND READWESS... 15

4 FOR OFFIcI[AE USE ONLY

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

6 ANNEXES Annex 1: Annex 2: Annex 3: Annex 4: Annex 5: Annex 6: Annex 7: Annex 8: Annex 8(A): Annex 8(B): Annex 9: Annex 10: Annex 11: Annex 12: Annex 13: Annex 14: Annex 15: Country and Sector or Program Background Major Related Projects Financed by the Bank andor other Agencies Results Framework and Monitoring Detailed Project Description Project Costs Implementation Arrangements Financial Management and Disbursement Arrangements Procurement Arrangements Clarifications Relating To National Competitive Bidding (NCB) Procedures An tic ormp ti on P1 an Economic and Financial Analyses Safeguard Policy Issues Project Preparation and Supervision Documents in the Project File Statement of Loans and Credits Country at a Glance Maps MAPS Overall Project Coverage and Other PGN Infrastructure Map of Greater Jakarta Zone (Zone 1) Map of Banten Zone (Zone 2) Map of Karawang Zone (Zone 3)

7 INDONESIA DOMESTIC GAS MARKET DEVELOPMENT PROJECT PROJECT APPRAISAL DOCUMENT EAST ASIA AND PACIFIC EASEG Date: November 10,2005 Country Director: Andrew D. Steer Team Leader: Noureddine Berrah Sectors: Oil and gas (100%) Sector Manager: Junhui Wu Themes: State enterprise restructuring and privatization (P); Infrastructure services for private sector development (S); Population management and environmental health (S) Project ID: PO77175 Environmental screening category: A Full Assessment Lending Instrument: Specific Investment Loan Safeguard screening cateeorv: S2 Y Y Y Project Financing Data El Loan 0 Credit 0 Grant 0 Guarantee 0 Other: For Loans/Credi ts/o thers : Total Bank financing (US$m.): 8 DEVELOPMENT ~ ~~ I I Total: I Borrower: Republic of Indonesia Responsible Agency: PT Perusahaan Gas Negara (Persero) Tbk. J1. K.H. Zainul Arifin No. 20 Jakarta, Indonesia, Tel: (6221) Fax: (6221) FY 2006 Annual $ 5.0 Cumulative

8 Project implementation period: Expected effectiveness date: March 3 1, 2006 Expected closing date: March 3 1, 2011 Does the project depart from the CAS in content or other significant respects? Ref. PAD A.3 nyes No Does the project require any exceptions from Bank policies? Ref. PAD D. 8 Have these been approved by Bank management? [s approval for any policy exception sought from the Board? Does the project include any critical risks rated substantial or high? Ref. PAD C.4 Does the project meet the Regional criteria for readiness for implementation? Ref. PAD 0.8 OYes HNo OYes UNO OYes UNO MYes UNO HYes UNO Project development objective Ref. PAD B.2, Technical Annex 3 Natural gas utilization expanded and air pollutant emissions reduced in West Java. Project description Ref. PAD B.3.a, Technical Annex 4 The project comprises two components:(a) Distribution Infrastructure Expansion to increase gas use in West Java and (b) Capacity Building to upgrade PGN s capabilities in management, infrastructure planning, marketing, distribution system safety and integrity management, etc. Which safeguard policies are triggered, if any? Ref. PAD 0.6, Technical Annex 10 Environmental Assessment (OP/BP/GP 4.01) is triggered Significant, non-standard conditions, if any, for: Ref. PAD C.5 Board presentation: None Loadcredit effectiveness: Dissemination of Financial Management Manual Covenants applicable to project implementation: None

9 A. STRATEGIC CONTEXT AND RATIONALE 1. Country and Sector Issues 1.1. Indonesia s proved reserves of natural gas, estimated at more than 2.5 trillion cubic meters (about 90 trillion cubic feet), are among the largest in the region. In 2003, gas production amounted to about 87 billion cubic meters (about 3 trillion cubic feet), of which 58 percent was exported, mainly to countries in the region. However, gas consumption by power and small and medium size industries as proportion of total energy consumption is among the lowest in the region. Until recently, the laws and regulations governing the hydrocarbon sector sanctioned the dominance of PT Pertamina s (Persero) and PT Perusahaan Gas Negara (Persero) Tbk (PGN). They also allowed the government to interfere in the sector in ways that inhibited efficient operation and limited participation of the private sector. Many of the issues the sector faced under the previous legislative framework have been addressed by the 2001 Oil and Gas Law and the 2004 implementation rules and regulations. The law and regulations created an environment conducive to the removal of the barriers to competition and private sector entry and to the development of the gas sector and the domestic gas market. However, the sector i s still facing the following interrelated issues that hamper the rapid development of a domestic gas market (see Annex 1 for details). 0 The structure of gas pricing in Indonesia is distorted and results in inefficient resource allocation. The price of natural gas in the domestic market is below its economic and market value reducing producers interest in developing this abundant resource for domestic use. The negative economic impact of this inadequate pricing system is compounded by the subsidized prices of petroleum products. 0 The implementation of the new Oil and Gas Law is proceeding slowly because of delayed issuance of the implementation regulations. The law has provided the basis for a progressive liberalization of the gas market. However, its implementation has been slow because of the delayed issuance of the implementing rules and regulations. The Bank engaged the government on this pressing issue and the implementation regulations were enacted on October 18, 2004 paving the way for effective implementation of the law. 0 PGN is not fully prepared to operate in the emerging competitive gas market. Under the new Oil and Gas Law, the three major segments of the oil and gas industry (production, transmission and distribution) will be unbundled, open access to network services will be allowed and eventually, a competitive gas market will be developed. To face these challenges, PGN is planning for (a) further restructuring including strategic partnership with private sector to increasingly meet new investment requirements from its financial resources and standings, a major objective assigned to it by the government; and (b) strengthening its management and operational practices and corporate governance to be ready to operate in the future competitive market. 0 Production-sharing contracts (PSCs) are not conducive to gas development. More than 90 percent of Indonesia s oil and gas is produced by the private sector, mostly by international oil companies. Private sector investment in the sector is almost totally governed by PSCs. The fiscal and nonfiscal terms of Indonesia s PSCs are mostly in line Statistics of DG MIGAS, provided by PGN. 1

10 with international practice. However, many existing contracts still do not have provisions for gas discoveries and therefore no predictable basis for forecasting the value to the producers of possible gas discoveries for domestic markets. 0 The transmission and distribution infrastructure is underdeveloped. The country s transmission and distribution infrastructure is underdeveloped and constrains the development and expanded utilization of this economically and environmentally attractive fuel. Progress toward a competitive gas market, as envisaged by the new Oil and Gas Law, requires further development of gas transmission and distribution systems The broad objectives of the Government of Indonesia s (GOI s) policy to reform the energy sector are: (a) efficiency and reliability; (b) transparency and competition; (c) minimization of the use of public funds; and (d) environmental soundness. GOI s strategy with respect to the above gas sector issues includes the following: 0 Phasing out of the subsidies and rationalization of energy prices. The prices of petroleum products in Indonesia are heavily subsidized. Prior to the recent increase in oil prices, the GO1 has implemented phased increases in fuel prices that led to a reduction in fuel subsidies and more rational energy product prices. Following a Presidential Decree in December 2002, the subsidies for all products-with the exception of kerosene-were to be fully eliminated by the end of However, the recent unprecedented surge in oil prices has again widened the gap between domestic prices and current international prices and increased the amount of fuel subsidies. The new government remains fully committed to addressing the oil product subsidy and gas pricing issues and to developing and implementing a rational gas pricing policy. Full removal of fuel subsidies will require more time than earlier planned and substitution of domestic gas for imported fuels will contribute to resolving this issue and benefit the economy and the environment. Recently the GO1 increased oil product prices between 9 and 25 percent which resulted in a weighted average increase of 12.5 percent. Establishment of an appropriate legislative and regulatory framework. Many of the sectoral issues have stemmed from the previous inadequate legislative framework governing the energy sector. In November 2001, the government enacted a new Oil and Gas Law. The law gave Indonesia its first modern legal framework to fundamentally reform the oil and gas sector, through (a) the gradual development of a competitive market; (b) the establishment of an implementing body for upstream activities and an independent regulatory agency for downstream activities; and (c) the unbundling of the traditionally vertically integrated oil and gas businesses. The issuance of the implementing rules and regulations on October 18, 2004 will likely speed up the opening of the oil and gas sectors to competition and further private investments. Restructuring of the Gas Sector. PGN has already unbundled its key transmission activities from its distribution operation. It associated with several strategic partners to create a gas transmission subsidiary, and listed, in December 2003, about 39 percent of its shares in the Jakarta and Surabaya stock exchange markets. Further restructuring of PGN to allow greater private sector participation in its operation and preparation for future sales of its shares and assets is under way. 0 Production-sharing contracts. The new law and regulations provide for a competitive environment under which all gas producers could have direct access to consumers. The 2

11 absence of a provision for gas discovery in the existing contracts will be resolved gradually, on a case-by-case basis. 2. Rationale for Bank Involvement 2.1. Bank involvement and assistance to PGN significantly contribute to adequate and effective implementation of the sound legal framework and policies developed with Bank support during the preparation of the project. During project implementation, the Bank will continue the ongoing policy dialogue and cooperation with GO1 and PGN on deepening the reform of the energy sector to ensure adequate implementation of the recommendations of the analytical and advisory and technical assistance activities jointly carried out to date. The project will focus mainly on (a) designing and implementing an effective gas pricing policy and, (b) further restructuring of PGN to bring its corporate structure in line with the new Oil and Gas Law. Appropriate policies in gas pricing and the restructuring of PGN must be addressed to improve the climate for high quality investments to develop gas use in the domestic market. The Bank s involvement would also assure that these two issues are addressed in a timely manner to meet the market needs according to international best practice and the government reform objectives. This would pave the way to further opening of the sector and attract private sector financing to meet the sizeable investment needs to develop it The development of a comprehensive gas pricing framework in relation to the cost of production, transmission and distribution of gas will improve the transparency of payment and allocation of the rent. The revenues generated by the development of natural gas from the field to the final users will allow the government and the regulator to make informed decisions in setting prices, taking into account efficiency and equity The GO1 has secured US$500 million from private investors to Pertamina for further field development and US$485 million from the Japan Bank for International Cooperation (JBIC) to PGN for a transmission project to increase gas supply to West Java. However, the government and JBIC agree that additional investment alone is not enough to develop the domestic gas market. The Bank s strong global knowledge and experience would be instrumental in addressing long term policy issues to develop and sustain the domestic gas market, It was agreed that the JBIC would rely on the Bank to address gas pricing issues to support its project. 3. Higher level Objectives to which the Project Contributes 3.1. The most recent full Country Assistance Strategy (CAS), approved by the Board on October 29, 2003 (Report No IND), focuses on assistance to Indonesia to overcome the low rate of investment and to improve the weak public service, two major impediments to reducing poverty. The objectives of the proposed project are fully consistent with, and give substantial support to, two of the five areas identified as essential to raise investment and improve (energy) services: fostering a competitive private sector and expanding Indonesia s infrastructure The development and implementation of a rational gas pricing policy will improve the efficiency of gas utilization, increase transparency, and create a more attractive environment for private sector participation, and thereby increase investment in the supply and utilization of 3

12 natural gas. The restructuring of PGN i s essential to ease entry into the growing gas market and to increase private investment in the gas sector. It will align PGN s corporate structure with the new law and recent regulations, and prepare it to operate in a competitive environment The physical expansion of the gas infrastructure under the proposed project will have a significant impact on alleviating infrastructure bottlenecks in Indonesia and improving quality of gas service in West Java. The project supports the reinforcement of PGN s distribution system to increase potential supply to about 550 mmcfd, more than three times PGN s gas sales in the region. B. PROJECT DESCRIPTION 1. Lending Instrument 1.1. The proposed project involves expansion of the gas distribution system in West Java and capacity building activities for PGN during the project s implementation period. Most of the loan funds will be used to procure goods for system expansion through International Competitive Bidding (ICB). Lending instruments such as SECAL and APL were considered but were rejected by the GOI. Based on its past cooperation with the World Bank, PGN selected a Specific Investment Loan as the most appropriate lending instrument. The variable-rate single currency loan selected by PGN during appraisal was confirmed by the Indonesian Delegation during negotiations. 2. Project Development Objective and Key Indicators 2.1. The proposed project would expand the use of natural gas in the West Java market. The objective is to improve economic efficiency and reduce pollution by substituting gas for more expensive and more polluting fuels, such as diesel, fuel oil and coal In addition, to achieve this objective efficiently and sustainably, PGN will carry out and prepare for implementation of ongoing studies focusing on: (a) rationalization of the natural gas pricing system to induce efficiency; and (b) restructuring of PGN to meet the requirements of the new law, ease market entry and increase private sector involvement. The major related projects financed by the Bank and other agencies are listed in Annex a a a a The key performance indicators, presented in Annex 3, focus on the following: An increase in utilization of natural gas; The reduction of air pollutant emissions; Finalization of the gas pricing study and development and implementation of a rational natural gas pricing policy according to a schedule acceptable to the Bank; and Finalization of the PGN s restructuring study and development and implementation of a restructuring strategy according to a schedule acceptable to the Bank. Project Components The project, described in detail in Annex 4, comprises two components: 4

13 Distribution Infrastructure Expansion: This component to be implemented by PGN includes: (i) construction of class 300 steel pipelines 4-16 inches in diameter with a cumulative length of about 185 km along with control valves and corrosion control facilities; (ii) construction of class 150 steel pipelines of 4 to 16 inches in diameter with a cumulative length of about 71 km, along with control valves and corrosion control facilities; (iii) installation of five off-take and two pressure regulation stations; (iv) installation of about 210 customer metering and regulating stations; (v) installation of a Supervisory Control and Data Acquisition (SCADA) system; and (vi) provision of radio and telecommunications equipment, information technology (IT) support, and emergency response equipment. The total cost of this component is US$ million including contingencies and value added tax (VAT), with IBRD financing of US$76.80 million. Capacity Building: This component, to be implemented by PGN, involves assistance to PGN in upgrading its capabilities and staff skills in financial management, infrastructure planning, gas marketing, gas utilization, distribution system safety and integrity management, and gas transmission and compression. The total cost of this component is US$6.20 million, with IBRD financing of US$3.00 million. The total cost of the project is provided in Annex Three of the issues mentioned in section A-1.1 will be addressed under the proposed project: Pricing. The Bank has provided funding to PGN under its power sector loan approved in June 2003 (Loan No IND) to conduct a study to develop a gas pricing policy to: (i) establish sound pricing and regulatory principles compatible with the government s reform and macroeconomic objectives to increase the market orientation of the sector, foster competition where feasible and safeguard consumers from monopoly abuses; and (ii) develop detailed transitional arrangements for a phased implementation of these principles in line with the implementing rules and regulations. The consultants for the study have been selected and the study is expected to be completed on or before March The important findings of the study will be used by PGN to prepare a pricing policy framework and gas transmission and distribution pricing principles and methodologies to be submitted to the government and the Regulator for review and consideration for approval2; PGN Restructuring. PGN has taken several actions to initiate unbundling of its structure (consistent with the Bank s recommendation in previous operations and the new Oil and Gas Law), to include strategic partners in its transmission operation, and to offer equity shares to the public through initial public offering (PO). The Bank, under its power sector loan approved in June 2003 (Loan No IND), is providing assistance to PGN to study alternatives to further its restructuring and be prepared to operate in the future liberalized market envisioned by the new Oil and Gas Law. The consultants for * The implementation of a rationalized pricing policy for most part falls under the purview of the newly established regulatory body. PGN will consult and closely coordinate with the regulatory body concerning the principles and implementation of the new pricing policy. As part the Pricing Study, the consultants will provide PGN with international experience on price setting, open access and other mechanisms to increase the market orientation of the sector. The experience will be shared and discussed with the regulatory body and should lead to informed decisions during the implementation of the agreed pricing policy. 5

14 the Restructuring Study have been selected, and the study is expected to be completed before the end of June The key findings of the study will be implemented under the proposed project, as part of the policy conditions discussed and agreed with PGN and concerned government agencies; and (c) Infrastructure. The proposed loan will finance the expansion of the gas distribution network. Although the amount of the loan is relatively small (US$80 million), the proposed project will have a significant impact in helping to alleviate gas infrastructure bottlenecks in Indonesia. The Bank s involvement in the project leveraged more than US$l.O billion of investment. This investment will expand substantially the gas infrastructure for development, transmission and distribution of natural gas, with potential supply of up to 550 mmcfd, or three times of current gas sales of PGN in the West Java region. 4. Lessons Learned and Reflected in the Project Design 4.1 The objectives of the Bank s previous gas distribution projects in Indonesia were to expand the physical network as well as to enhance the efficiency and the financial position of the implementing agency, PGN. Although these objectives were successfully achieved, ex post reviews of these projects stressed that gas pricing and further restructuring of PGN should be addressed to accelerate the development of the domestic gas market. The current project addresses these sectoral issues after the government passed the Oil and Gas Law and related regulations that paved the way for further opening of the sector to new entrants and for increasing its market orientation. 5. Alternatives Considered and Reasons for Rejection 5.1 The following alternatives were sequentially considered during the project design and preparation: Without Project Alternative. Prior to engaging in this important investment program, PGN considered a less aggressive strategy of converting small industries and businesses to gas, which entailed low growth of the Banten-West Java gas market and no expansion of its distribution system. The without project alternative has been rejected for three reasons: (a) the expansion of the gas market was in line with the government energy strategy to develop the domestic gas market because of its economic and environmental advantages over oil products and coal; (b) a market scoping study showed a strong preference of small industries and businesses for gas; and (c) expansion of the gas market would sustain the growth and strengthen the financial situation of the company and reduce the need for petroleum products subsidies. Choice of Gas Supply. Two alternatives were considered for gas supply: gas fields in South Sumatra, or small onshore and offshore fields in West Java. An Asian Development Bank (ADB) study found that delivering gas from the South Sumatra fields to the West Java market was preferable to relying on closer but limited and more costly to develop fields in West Java onshore and offshore. The gas reserves in the South Sumatra fields have been formally certified by a reputable international company at a level of 3.85 tcf in the Proven and Risk Adjusted categories. These reserves can supply up to 500 6

15 mmcfd of gas for at least 20 years. The option of transmitting gas from South Sumatra to West Java was selected. 5.2 Expansion of the Distribution System. PGN considered alternatives for the expansion of its distribution system by taking into account (a) the capacity of the existing system; (b) the location and demand of potential consumers (demand nodes); (c) the quantities and input locations of gas (supply nodes); and (d) severe constraints on the right of way in highly urbanized areas. The latter reduced the number of alternatives for expansion to two, mainly differentiated by the pipeline diameters along the same routes to satisfy a demand of 500 mmcfd in the first case and a demand of 800 mmcfd in the second case. The first option would have required further reinforcement of the system after 5-7 years to meet the full potential demand of 800 mmcfd by It was rejected because it was less cost effective and would have entailed greater temporary negative environmental and social impacts. C. IMPLEMENTATION 1. Institutional and Implementation Arrangements 1.1. PGN will be responsible for the implementation of both components of the project. It has established a project implementation unit (PIU) with overall responsibility for managing and coordinating all aspects of the project. The PIU will be supported by PGN s central departments Funds for this project will be borrowed by the Republic of Indonesia and on-lent to PGN in the currency of the loan, in line with current government policy and on the same terms and conditions plus an additional administrative fee not exceeding one percent (1%). A Subsidiary Loan Agreement is expected to be finalized between the GO1 and PGN for this purpose, as a condition for loan effectiveness Institutional and implementation arrangements are provided in Annex 6. Financial management and disbursement arrangements, discussed and agreed with PGN, are detailed in Annex 7. Procurement arrangements, discussed and agreed with PGN, are detailed in Annex Furthermore, PGN has agreed to hire (a) a project management consultant to assist in the design and engineering, procurement, construction supervision, inspection of materials and works, and testing and commissioning, as well as overall project management related to the distribution component; and (b) a long-term technical advisor to assist in customer conversion and connection, system integrity management and technical skill development and enhancement. 2. Monitoring and Evaluation of Outcomes/Results 2.1. PGN maintains a statistical system with sufficient data to monitor most of the outcomes of the project such as gas sales and number of consumers converted to gas. Major pollutant and greenhouse gas emissions will be calculated according to a methodology agreed with PGN and summarized in Annex 3. Results indicators such as progress of construction work and progress on the restructuring and pricing studies, will be monitored by the PIU and reported in periodic progress reports to be submitted to the Bank. 7

16 3. Sustainability 3.1 PGN has taken several actions to ensure the sustainability of the project by contracting gas supplies from different sources, preparing a customer conversion and ramping-up program, and committing to the implementation of gas sector reforms (including rationalization of gas pricing system) to ensure optimal use of resources and further opening of the gas market. Appropriate measures to mitigate the minor social and environmental impacts associated with the proposed and linked projects have been developed by PGN and agreed by the Bank. These will ensure the social and environmental sustainability of the project, the safety of the workers, PGN staff and the population during the construction period and the operation of the system. 4. Critical Risks and Possible Controversial Aspects 4.1. The project s overall risk is expected to be modest. Risk Risk Minimization Measure To Project Development Objective Gas supply lower than The gas source for this project is estimated at total proven and risk-adjusted reserves of about expected tcf, which would be sufficient to maintain a supply of 500 mmcfd for at least 20 years. PGN has signed a 12-year gas purchase contract with Pertamina, the gas supplier, for 250 mmcfd, which could deplete only 1 tcf of the above-mentioned reserves. PGN also signed a contract with Conoco-Phillips for 400 mmcfd to increase supply to West Java. Customer conversion slower A study on development of the gas market has been undertaken by PGN s marketing than planned. department, and a gas sale ramp-up plan was prepared at the Bank s request. According to the study, more than 500 industrial customers who were surveyed expressed interest in switching to gas. The demand of these customers is more than 600 mmcfd. However, because a lead time of about 12 months is required for consumer conversion, the Bank suggested, and PGN agreed, start customer preparation as soon as possible prior to project appraisal. The objectives of energy price rationalization not achieved because of lack of government commitment Inherent risks arising from weaknesses in country control environment and financial accountability systems. To Component Results a) Insufficient counterpart funds available. b) Construction not completed on time c) Procurement delays Overall Risk Rating The government is committed to reforming the energy sector, rationalizing the energy pricing system, and phasing out subsidies on the prices of oil products. Actions already taken, especially the enactment of the implementing rules and regulations in October 2004 and the important increase of oil products prices in 2005, are clear indications of the government s commitment. Continue country dialogue to expedite public financial management reforms and introduce project specific measures such as enhanced financial reporting and additional payment validation procedures. PGN has secured financing from the JBIC for the transmission pipelines. It has enough cash from its recent IPO to cover the capital cost not financed by the Bank. PGN has a demonstrated management capability to plan and implement large infrastructure projects. The transmission component is well prepared and its construction commenced in Preparation of the distribution component is also progressing well. A project management consultant (PMC) is being hired to help PGN prepare and manage the project, and construction will be outsourced to qualified engineering, procurement and construction (EPC) contractors. A procurement committee has been established. PGN committed to assign a core team full time to procurement tasks and to speed up the hiring of the PMC. Risk Rating - H (High), S (Substantial), M (Modest), N (Negligible or Low Risk) 4.2. The project i s not expected to face any controversial aspects. I RiskRating N M M S N M M M 8

17 5. Loadcredit Conditions and Covenants 5.1, Concerning pricing, PGN shall: (a) (i) Prepare a draft gas pricing framework based on the findings and recommendations of the Gas Pricing Study carried out under the Java-Bali Power Sector Restructuring and Strengthening Project; (ii) not later than March 31, 2006, furnish to the Bank for its comments said draft gas pricing framework; and (iii) promptly after receipt of said comments, finalize said draft, taking into account said comments, and submit it to BPH MIGAS (downstream regulator) for review, amendment, if needed and consideration in view of adoption; and (b) (i) Prepare draft methodology and implementation rules for transmission and distribution tariffs based on the findings and recommendations of the Gas Pricing Study carried out under the Java-Bali Power Sector Restructuring and Strengthening Project; (ii) not later than September 30, 2006, furnish to the Bank for its comments said draft methodology and implementation rules for transmission and distribution tariffs; and (iii) promptly after receipt of said comments, finalize said draft, taking into account said comments, and submit it to BPH MIGAS and other concerned authorities for review, amendment, if needed, and consideration in view of adoption Concerning the restructuring plan, PGN shall: (c) (i) Prepare a draft set of procedures and implementation plans for Third Party Access consistent with the regulations of the Republic of Indonesia No. 36 of 2004 regarding downstream business activities of oil and natural gas, which draft set shall include a standard contract form to be entered into with all users of PGN s transmission and distribution network; (ii) not later than December 31, 2005, furnish to the Bank for its comments said draft set of procedures and implementation plans; and (iii) promptly after receipt of said comments, finalize and adopt said set of procedures and implementation plans, taking into account said comments (d) (i) Prepare a draft time-bound restructuring plan based on the findings and recommendations of the Restructuring Study carried out under the Java-Bali Power Sector Restructuring and Strengthening Project; (ii) not later than March 31, 2006, furnish to the Bank for its comments said draft plan; and (iii) promptly after receipt of said comments, finalize said plan, taking into account said comments, and thereafter implement said plan in accordance with its terms Concerning the investment program, PGN shall: (e) Review with the Bank annually, commencing September 30, 2005, its rolling three-year investment program, and thereafter take all measures required to ensure a rational investment program Concerning the financial performance, PGN shall: (f) Generate sufficient revenue from its internal sources equivalent to at least 25 percent of its average three-year capital expenditures. 9

18 5.5. shall: (8) Demonstrate that a reasonable forecast of its revenues and expenditures for each fiscal year would produce sufficient net revenue to be at least 1.5 times its estimated debt service requirements. (h) Not incur any debt, if after the incurrence of such debt the ratio of debt to equity shall be greater than 75/25 during and 70/30 thereafter. Concerning the financial management issues and financial monitoring report, PGN (i) Furnish to the Bank an FMR, in substance satisfactory to the Bank, on a quarterly basis. The first FMR shall be furnished to the Bank not later than 45 days after the first quarter after the effective date, and thereafter at quarterly intervals not later than 45 days after the end of each quarter Concerning the audit and accounting, PGN shall: 5.7. (j) Have its annual financial statements duly audited by public accounting firms appointed by its shareholders in shareholders general meetings, in accordance with the provisions of its articles of association and prevailing laws and regulations in Indonesia. (k) Furnish to the Bank as soon as available, but in any case not later than six months after the end of each fiscal year audited the following: a certified copy of the audited financial statements of PGN audited by the above auditor, including the auditor s opinion on such statements, and management letters issued by the statutory auditor. Such audited financial statements shall include appropriate disclosures in the notes appended thereto on the amounts of Bank funding utilized during the period under audit, and copies of project related internal audit reports issued to its management by its internal audit department, as well as other financial information as the Bank shall deem necessary. Concerning the environmental and social aspects, PGN shall: (1) Undertake the implementation of the project in accordance with the project s Environmental Management Plan, the Environmental Monitoring Plan, and the Land Acquisition and Resettlement Policy Framework, all in a manner satisfactory to the Bank Concerning the project implementation unit, PGN shall: (m)maintain until completion of the project, a PIU, staffed with qualified and experienced officers, and provided with adequate funds and other resources as shall be necessary to accomplish its objectives Concerning the monitoring project performance, PGN shall: (n) Maintain policies and procedures adequate to enable it to monitor and evaluate on an ongoing basis, in accordance with the indicators set forth in para. 2.3 under section B (Project Description) the project objective achievements. (0) Prepare an annual report on the above monitoring results and review it with the Bank three months after completion of each report Concerning the progress report, PGN shall: 10

19 (p) Furnish to the Bank not later than March 31 in each year, commencing March 31, 2007, and until completion of the project, annual progress reports on the implementation of the project. D. APPRAISAL SUMMARY 1. Economic and Financial Analyses 1.1. Cost Effectiveness. A least-cost study on expansion of the gas distribution network in West Java was undertaken by PGN during the project preparation. The study considered different scenarios and configurations of the distribution system expansion to achieve the optimal expansion plan to meet the future gas demand in the region. The proposed project is part of the least-cost plan to expand the distribution system for West Java region to supply up to 800 mmcfd of natural gas by This demonstrates the cost-effectiveness of the project Cost-Benefit Analysis. In addition, a cost-benefit analysis (without considering environmental externalities) was carried out to estimate the economic internal rate of return (EIRR) of the proposed project. The EIRR was estimated at 20 percent, if benefits were valued at prevailing tariffs (base case), and at 59 percent, if benefits were valued at future market value of displaced fuels. Net present values (NPV) at 12 percent are US$169 million in the first case and US$1,152 million in the second case. Sensitivity and risk analyses were carried out to assess the robustness of the economic viability of the project in relation to the major perceived risks, such as increase in investment cost, delay in construction, reduction in benefits, and slow progress in consumer conversions. The sensitivity and risk analyses indicate that changes in the important variables will not fundamentally affect the economic viability of the project. Details are provided in Annex Financial Analysis 2.1 PGN s Financial Performance and Current Financial Position. Overall, PGN s financial position in the past has been sound, including during the regional financial crisis. PGN s current financial position based on 2003 audited financial statements is presented in Annex 9 and summarized below: (a) Revenues and Expenditures. In 2003, PGN generated a total revenue of US$425 million, comprising: (i) US$350 million (82.4 percent of the total revenue) from sales of natural gas through its distribution networks; (ii) US$74 million (17.4 percent of the total revenue) from fees earned for gas transmission services; and (iii) less than US$500,000 (less than 0.2 percent of the total revenue) from sales of liquefied petroleum gas (LPG); (b) Assets. PGN s total assets in 2003 were about US$l.08 billion, including current assets of US$418 million. Cash and cash equivalent represented 54 percent of its current assets, and short-term investments represented an additional 19 percent. The large cash account was the result of proceeds from the multilateral or bilateral loan borrowing, a US$l50 million Eurobond issue, and a December 2003 public offering of about 39 percent of its shares; (c) Liabilities. PGN s long-term debt in 2003 was about US$330 million, mostly consisting of two-step loans, owed to the government for the funds borrowed from the ADB, JBIC, European Investment Bank (EIB), and World Bank for its capital expenditures; and 11

20 (d) Equity. PGN s total equity in 2003 was about US$390 million. 2.2 PGN s Future Finances. Under the new Oil and Gas Law, PGN lost its self-regulated quasi-monopoly on gas transmission and distribution and, as the market progressively opens, will operate in an increasingly competitive market. The newly established Regulator will determine and regulate the tariff for natural gas distribution and transmission services. Further, the new law allows direct access of gas suppliers to consumers, creates a healthier environment for competition and provides for a more efficient operation of the sector in the future. It, however, has the potential to increase competitive pressure on PGN and reduce its current profit margin. For this reason, PGN s financial forecasts are based on mutually agreed assumptions about growth scenarios for natural gas demand, constraints on PGN s planned investment program, and pressure on its expected profit margin for gas distribution and transportation activities. Table A9.6 (Annex 9) provides a summary forecast of PGN s financial performance for , including estimated income statements, balance sheets, and cash flow statement. Initial, unaudited figures for 2004 indicate that PGN is on track to achieve its development and financial objectives. Revenues increased by more than 20 percent as expected through the sale of nearly 300 mmcfd of gas and the transportation of another 420 mmcfd. Consequently, PGN had an operating income of US$113 million, total income before taxes of US$74 million, and after taxes of US$55 million. Going forward, PGN needs to monitor their expansion plans carefully so that any adverse changes can be quickly mitigated with adjustments in their expansion plans. 2.3 The financial performance covenants described in C 5.4 (f), (g) and (h) were determined taking into account the critical areas that warrant closer monitoring of PGN s future finances. 3. Technical 3.1. The project has been designed and will be built in accordance with international standards and best practice to assure adequate security of supply, operational flexibility, and safety of operations. It will be provided with modem facilities for gas flow and pressure control, gas dispatch, gas flow measurement, gas quality monitoring, corrosion protection, IT support, and radio and telecommunications instrumentation PGN has implemented two gas distribution projects with Bank support and two gas transmission projects with ADB financing. It developed a reliable database of material and construction costs, which is being regularly updated. The project costs are considered realistic and take into account recent variation in and escalation of prices of goods and services. The physical and price contingencies are based on PGN s experience and are similar to those found in other developing countries in the region The capacity building component of the project will upgrade PGN s capabilities in distribution system safety and integrity management up to international standards. 4. Fiduciary 4.1. PGN became a partially public company following listing of about 39 percent of its share in December The company has successfully completed a due diligence process of its internal processes, including financial management processes, that is normally associated with an PO. It is also subjected to the financial reporting and auditing discipline normally applied to 12

21 publicly listed companies in Indonesia, which is relatively more rigorous than those applied to state-owned enterprises or government agencies The financial management assessment for this project has concluded that overall, financial management risks are moderate and that it would be appropriate to accept the entity annual audited financial statements for Bank purposes, with appropriate disclosures on the use of the Bank funds. To mitigate risks associated with this project, several measures have been suggested in an action plan agreed with PGN, including the adoption of quarterly FMRs, external audits by leading private sector accounting firms, and strengthened procedures for validating and approving payments to contractors. With the implementation of this plan, the financial management arrangements for this project would be acceptable. Results of the financial management assessment and agreed arrangements are provided in Annex A procurement capacity assessment has been carried out and concluded that PGN has adequate experience and capacity to carry out the procurement activities related to the proposed project. The procurement risk i s rated as average. However, given the size and complexity of procurement packages, as well as the relatively tight implementation schedule, external assistance (part of the project management consultant s services) will be provided to PGN during the entire procurement cycle, including preparation of bidding documents, bid evaluation, and contract execution. A brief summary of the procurement capacity assessment and more details on the procurement arrangements are provided in Annex 8 and the report is available in the project files. Clarifications relating to National Competitive Bidding (NCB) providers and an anticomption plan are attached in Annexes 8(A) and 8(B). 5. Social 5.1. There will be no involuntary resettlement and no impact on indigenous people or cultural property under the project. The adverse environmental and social impacts of the project are minor. The gas pipelines of the project will be built primarily in largely urbanized or industrial areas, all alongside existing roads. Businesses, residents and other facilities along the roadsides could suffer some temporary (up to one day) disruption caused by construction activities. In addition, there could be increased risk of pedestrian injury from traffic accidents during construction because of physical obstruction or removal of walkways. To minimize these disruptions, PGN has standard operating procedures and prevention and mitigation measures in place. It also agreed to compensate any affected businesses for loss of income according to the Land Acquisition and Resettlement Framework agreed with the Bank during project preparation, In addition, PGN has a strong commitment to social responsibility and has supported the communities along its transmission and distribution right-of-way. In 2002, a Master Plan for Community Development was drafted to provide corporate guidelines on community development (ComDev) programs. In conducting its ComDev program, PGN has worked closely with universities, nongovernmental organizations (NGOs), and local governments, These institutions will help PGN assess local need and play important roles in project implementation and in monitoring social outcomes The proposed project will expand the supply and utilization of natural gas and further competition in the domestic energy market and stimulate small industry development. During the project construction period, short-term employment opportunities for local unskilled labors 13

22 will be created, and the revenues of local small businesses may increase temporarily, because of expenditures on the part of construction workers. The project will also create permanent jobs in the project areas Consultation with the public at the local level is an important component of Indonesia s AMDAL (Analisis Mengenai Dampak Lingkungan Hidup) process. During the project preparation, PGN convened three public consultations in Jakarta and several consultations in project affected areas with representatives from most of the stakeholder groups: government agencies, property owners, local businesses, NGOs and academia. During the project implementation, consultation will be governed by the AMDAL and Environmental Management Plan (EMF) processes. Subcomponents of the project will be screened by PGN s project team with the support from the environmental coordinating office (ECO) in order to determine their status under Indonesia s AMDAL requirements and the World Bank s safeguard policies and procedures. For all the subcomponents and activities to be conducted under the project, public consultation will be further carried out at the local level in the subdistricts where the project activities will take place, as required by Indonesia s AMDAL process In general, the social project team of the PIU will be responsible for monitoring the project performance in terms of social development outcomes. The project team leader will receive copies of quarterly and special reports on general construction progress and any construction problems that may affect the local environment and community. In addition, PGN s ComDev programs and external institutions involved in the programs will help the project team monitor the social development outcomes. 6. Environment 6.1. Based on the Environmental Impact Assessment Report (EIAR) prepared by PGN with the assistance of local and international consultants, the project (classified A because of its link to the JBIC transmission project) is not expected to have any significant impact on natural habitats, forests or protected or sensitive areas. None of the impacts from the construction or operation of the pipelines is likely to be sustained or irreversible. The major negative environmental impacts will be temporary interference with the traffic in the project area and some temporary air and water pollution, as well as the removal of vegetation during the construction of the project. None of them, however, is likely to be major, sustained or irreversible The proposed project will provide important positive environmental benefits. Natural gas is regarded as the cleanest fossil fuel, producing considerably lower amounts of particulates or oxides of carbon, nitrogen, sulfur, and other emissions per unit of energy provided than other fossil fuels. Most of the targeted consumers are currently using other fossil fuels. So ambient air quality should improve and, in some cases, the air quality within factories should improve, with direct health benefits for the workers. In addition, Indonesia s greenhouse gas emissions will be reduced. 6.3 The proposed project is linked to a transmission project financed by the JBIC. Preparations for the construction of the JBIC project are well under way with construction planned to commence in first quarter of The EIAR was prepared and approved by the Ministry of the Environment (MOE) in It has been discussed and approved by the JBIC, 14

23 and was disclosed to the public following the AMDAL and JBIC's disclosure procedures. The approval of MOE was reconfirmed in December 2003, and copies of the EIAR, the EMP and the minutes of discussions held between the JBIC and PGN were provided to the Bank during the preparation of the proposed project. The EIAR and the process are considered as adequate. 7. Safeguard policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP/GP 4.01) H 0 Natural Habitats (OPIBP 4.04) 0 H Pest Management (OP 4.09) 0 H Cultural Property (OPN 11.03, being revised as OP 4.11) 0 H Involuntary Resettlement (OPIBP 4.12) 0 H Indigenous Peoples (OD 4.20, being revised as OP 4.10) 0 H Forests (OPIBP 4.36) 0 H Safety of Dams (OP/BP 4.37) 0 H Projects in Disputed Areas (OPIBPIGP 7.60)3 El Projects on International Waterways (OPIBP/GP 7.50) 0 El 8. Policy Exceptions and Readiness 8.1. The project is in compliance with all Bank policies and procedures. There are no policy exceptions The project meets the readiness criteria for implementation: 0 Institutional arrangements for project implementation (PGNPIU) are in place. International consultants (project management consultant and long-term technical collaborator) for project preparation and implementation have been appointed and contracts to be financed under the proposed project through retroactive financing are being negotiated; 0 The conceptual design is completed. Detailed cost estimates are available. The project implementation plan including detailed schedules has been prepared and submitted to the Bank; 0 A procurement committee for the project has been established by PGN. A detailed procurement plan has been prepared and finalized during appraisal. The bidding process will start once the project management consultant i s appointed; and 0 The Gas Pricing and Utilization Study and PGN Restructuring and Privatization Study are financed under the Bank Loan No IND, and the first results are expected by December 2005 and February 2006 respectively. By supporting the proposed project, the Bank does not intend to prejudice the final determination of the parties' claims on the disputed areas. 15

24

25 Annex 1: Country and Sector or Program Background INDONESIA: Domestic Gas Market Development Project Indonesia has one of the largest natural gas reserves in East Asia, roughly 20 percent of the region s total. Estimates put the total proved reserves at about 2.56 trillion cubic meters. However, the domestic gas infrastructure is remarkably underdeveloped. In fact, Indonesia s gas consumption by power and small and medium size industries as proportion of total energy consumption is among the lowest in the region. This reality is particularly relevant since the country s oil reserves are declining, and the environment is deteriorating because of the use of petroleum products and coal to meet the country s industrial and power sector needs. Given its ample gas resources, Indonesia can stem this depletion and degradation-thus gaining significant economic and environmental benefitsif it moves faster to develop its natural gas sector and to expand the supply and utilization of this fuel for the domestic gas market. Indonesia needs to address the main issues impeding the development of the gas sector and prepare a coherent and sustainable gas sector strategy to increase the use of this fuel substantially in the country. The following briefly discusses the substance of the issues facing the sector, the government s strategy to address them, and the Bank s interventions to help the government in its efforts. Pricing The flawed natural gas pricing structure is the first and the most important obstacle to gas development. However, the gas pricing issue cannot be addressed in isolation from the major issue of petroleum product pricing subsidization. Therefore, the government agreed to give priority to phasing out the subsidies of petroleum product first, and then begin to address the gas pricing issues. The prices of petroleum products in Indonesia are significantly below the economic cost of supply and thus are heavily subsidized. In fact, the domestic price of several products is even below the cost of production. The Bank, under the Indonesia Oil and Gas Sector Study, provided a detailed analysis and recommendations for phasing out the subsidies for the five important petroleum products, while at the same time protecting the poor and avoiding disruptive macroeconomic impacts. Since 2001, the government has taken major steps to reduce these subsidies considerably. However, soaring oil prices in late 2003 and 2004 negated all the progress made to date and the ballooning subsidies regained the attention of the government and the country and are now considered as one of the highest priorities of the new government. Promotion of gas and the implementation of a rational gas pricing policy became a central part of the strategy to reduce reliance on oil products and phase out subsidies to create a fiscal space for funding the development of the lagging areas. 17

26 Legal Framework Many of the oil and gas sector issues in Indonesia stemmed from the legal framework, which was in place until the end of 2002: (a) Pertamina had a supervisory function on the activities of the private companies operating in upstream segment of the industry and was, at the same time, supposed to compete with them, entailing a clear conflict of interest, and (b) it enjoyed (and still does) a virtual monopoly over a huge market in downstream petroleum activities. These issues led to inefficient operation and non-optimal exploration and production of oil and gas. They heavily contributed to the slow development of the gas domestic market. Indonesia clearly needed new and transparent Oil and Gas Law (and the associated regulations) to improve sector efficiency, to provide incentives for greater utilization of gas in the domestic market and to provide incentives for greater participation of the private sector in downstream activities. With substantial inputs from the Bank and ADB, the government prepared a comprehensive draft law and implementing regulations in early The law, enacted in 2002, opened the sector to competition, increased transparency and provided incentives for further involvement of the private sector. The law explicitly eliminates the conflicting roles and functions of Pertamina, by removing its supervisory functions and transfening these to an upstream supervisory agency. Pertamina s monopoly has been eliminated although de facto its monopolistic position continues given its market dominance. However, it will need to improve its efficiency and compete with new entrants to keep a market share in the sector. With respect to the gas sector, the new law provides for (a) third party access to the transmission and distribution pipelines (to the extent they are willing to pay the regulated tariff); and (b) a new regulatory body (BPH Migas) for all downstream activities, including regulating the transport fees for transmission and distribution pipelines, the gas price for household and small commercial entities, and the open tendering for new transmission and distribution investment. PGN Restructuring Prior to the enactment of the 2002 Law, Pertamina was the only upstream supplier of gas for the domestic market-either from its own concession areas or, as the government s sole agent, from the concession areas of other production-sharing contractors. Further, until 1998, Pertamina was also the only transporter of gas. In 1999 the government authorized PGN to also transport gas to meet the increasing demand; particularly by the small to medium-size industrial consumers (Pertamina still continues to be the supplier to the large industries such as steel, fertilizer, power and cement). Under the new law, PGN will ultimately operate in a competitive environment, including allowing third party access to its transmission and distribution network, to provide gas producers direct access to consumers. PGN (a) began to unbundle its structure, both functionally and geographically, and (b) took several steps to secure private capital, including joining with several strategic partners for its gas transportation business and listing about 39 percent of its shares through an PO. However, to meet the law s requirements, PGN needs to further its restructuring and increase the transparency of the accounts of its different subsidiaries to implement third party access, a prerequisite for the development of a competitive gas market. 18

27 Production-Sharing Contracts More than 90 percent of Indonesia s oil and gas is produced by the private sector, mostly by international oil companies, and governed by production sharing arrangements. Although the fiscal and nonfiscal terms of Indonesia s PSCs are comparable to PSCs in other countries, one issue is that many existing contracts still have no provision for gas discovery and therefore no predictable basis for forecasting the value to the producers of possible gas discoveries for the domestic market. The government has not yet began to address the issues relating to the existing contracts, considering that any change in terms and condition of the contracts need to be mutually agreed. With respect to new contracts, provisions of the new law and regulations aim at creating a competitive environment that provides producers direct access to consumers. The issue of absence of gas discovery provisions in the existing contracts can only be resolved gradually, and on a case-by-case basis. Infrastructure The issues discussed above hampered the development of an adequate gas infrastructure and constrained the development of the domestic gas market. Given the economic and environmental benefits of gas and Indonesia s declining oil reserves, it is essential to expand the gas infrastructure. The government s strategy fully supports market based expansion of the gas infrastructure with greater involvement of the private sector. 19

28 Annex 2: Major Related Projects Financed by the Bank and/or other Agencies INDONESIA: Domestic Gas Market Development Project Table A2.1 Bank-financed Sector Issue Natural gas market development in Jakarta-Bogor (West Java) and in Medan (North Sumatra) Natural gas market development in Surabaya and other towns in the vicinity (East Java) Fuel subsidies, oil-gas legislative framework Power sector restructuring and preparation of domestic gas sector restructuring Other development agencies Gas sector regulatory environment Natural gas market development IPDO Ratings: HS (Highly Satisfactory), Project Gas Distribution Project (completed 7/1994) Gas Utilization Project (completed 12/ 199 8) Second Policy Reform Support Loan (completed 12/1999) Java-Bali Power Sector Restructuring and Strengthening Project Implementation Progress (IP) HS S S S Development Objective (DO) HS ADB Gas Transmission and Distribution Project JBIC South Sumatra to West Java Gas Transmission Project I :Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) I S S S These projects are briefly reviewed as follows. a. Gas Distribution Project (Ln ZND) completed in July 1994 at a total cost of US$89 million. It covered development of gas market and expansion of distribution infrastructure in the cities of Jakarta and Bogor in West Java and in Medan in North Sumatra, and PGN s institutional development. Zt was recognized as having been exceptional throughout the project cycle by the Operations Evaluation Department in its Annual Review of Evaluation Results, The performance covenants under the project were exceeded in all cases. b. Gas Utilization Project (Ln ZND) completed in December 1998 at a total cost of US$119 million. It covered development of gas market and expansion of distribution infrastructure in Surabaya and twelve other towns in its vicinity in East Java, and in Medan in North Sumatra in parallel with the upgrading of Indonesian expertise to manage this process. Until the onset of Asian financial crisis (July 1997), project implementation was rated as highly satisfactory. All targets were either achieved or 20

29 surpassed. Thereafter, despite the crisis, the project was satisfactorily completed in December c. Grissik-Duri Gas Transmission Project, with ADB support, completed in 1998 at a total cost of US$530 million. It consisted of a 28 inch diameter, 536 km long high-pressure gas transmission pipeline from gas fields near Grissik in South Sumatra to the oil fields near Duri in Central Sumatra, along with ancillary facilities, for the transport of 300 mmcfd natural gas for enhanced oil recovery at Duri. Despite the Asian financial crisis, the project was completed on schedule and within the estimated cost. d. Grissik-Singapore Gas Export Pipeline Project, with ADB support, completed in 2003, at a total cost of US$470 million. It comprised a 28 inch diameter, 485 km long highpressure gas transmission pipeline from gas fields in South Sumatra to a power station in Singapore, along with ancillary facilities, for the export of 150 mmcfd natural gas. This project was also completed on schedule and within the estimated cost. Lessons learned and reflected in project design The objectives of the Banks previous gas distribution projects in Indonesia were to expand the physical network as well as to enhance the efficiency and the financial position of the implementing agency, PGN. Although these objectives were successfully achieved, ex post reviews of these projects made it clear that the pricing of natural gas, and the corporate structure of PGN, also needed to be addressed in order to accelerate the development of the domestic natural gas industry. The current project addresses these sectoral issues after the government passed the Oil and Gas Law paving the way for further opening of the sector to new entrants and increasing its market orientation. 21

30 Annex 3: Results Framework and Monitoring INDONESIA: Domestic Gas Market Development Project Table A3.1: Results Framework Natural gas utilization expanded and air pollutant emssions reduced in West Java. PGN s gas sales in the region bmcfd): Year Gassales Cumulative number of consumers converted to gas: Year Number Maior air Dollutant and greenhouse gas emissions reductions (1000 tons Der vear) so* NO, TSP COze 0 1,323 1,653 Component One: 1. West Java gas distribution network expanded Maior milestones of the distribution uroiect: Banten supply man line completed by October 2006; Banten reticulation mains completed by mid-2007; Component Two: Capacity Building of PGN 2. PGN restructured and its financial management, operation and planning capability strengthened. Maior milestones for TA comuonents: not later than June 20, 2006, PGN restructuring plan adopted Safety and Integrity Management System set up and operational by mid-2009 PGN s capacity enhancement in targeted areas achieved by mid-2009 PGN s gas transmission and distnbution operations further restructured before the end of the project. 3. Third Party Access 4. Rationalized gas pricing policy implemented. ote: Estimates of Emis not later than June 30, 2006, procedures and implementation plan of Third Party Access adopted by PGN. not later than March 31,2006, the framework for an economic and efficiency pricing as provided by the Gas Pricing Study under loan no 4712-IND will be developed by PGN and submitted to the Bank for comments. not later than June 30,2006, the framework (pricing policy) should be submitted by PGN the Ministry of Energy and Mining Resources for adoption. not later than September 30,2006, draft methodology and implementation rules for transmission and distribution tariffs developed and submtted to the Bank for comments. not later than December 31, 2006, methodology and implementation rules presented to BPH Migas for consideration in view of adoption. n Reduction Indicators. 22

31 Natural gas is the cleanest fuel among all the conventional fossil fuels. According to the market analysis by PGN, the gas supply from the proposed project will substitute for oil to be consumed mainly by industrial consumers in the project region. The emission reduction is therefore estimated by the difference between the air pollutants from burning gas and oil. The simple and widely accepted method to calculate pollutant emissions is to multiply emission coefficients of pollutants by energy to be consumed. The emission coefficients of pollutants used here are from different sources as below: e e e SO2, NO,: Sasmojo et al, 1997, the ALGAS Study Report for Indonesia. TSP: Energy Technology Characterizations Handbook, US Department of Energy, 1983 C02: Revised 1996 IPCC Guideline Reference Manual. 1 Emission Type Oil Gas SO2 (kg/mmbtu) NO, (kg/mmbtu) TSP (kg/mmbtu) COZ (kg/mmbtu)

32 I m o g 2 m o g 2 m o g 2 cc ir: WcoNZ mwm cc ir: W W N C mwm- cc v: W " N 5 mwm w w I w w w oooc a. a.

33 w w w w w c 0 * E Y.I e,.i Y E.I -.I t? & 3.I u.i & 3 M e 25

34 Annex 4: Detailed Project Description INDONESIA: Domestic Gas Market Development Project Background PGN s natural gas marketing and distribution operations in Banten and West Java account for about 50 percent of its gas sales. These operations are spread over six districts, namely, Banten (recently upgraded to province status), Jakarta, Bogor, Bekasi, Karawang and Cirebon. About 163 mmcfd natural gas is being supplied by PGN to industrial, commercial and household consumers in these areas. The distribution system spans urban and industrial areas from Cilegon in the west of Banten to Purwakarta and Cirebon in the east of West Java. It comprises supply mains, feeder mains and distribution pipelines with a cumulative length of 1575 km (840 km steel pipe and 735 km PE pipe); 9 off-take stations; 97 pressure regulation stations; and about 450 industrial meter stations, 850 commercial and 61,000 household meters installed at customers premises. About 30 percent of the pipelines are more than 20 years old and about 50 percent are years old. The system is designed for a pressure regime of 16 bar/4 bar/o.l bar. (Household consumers are supplied through 0.1 bar pipelines.) It is provided with corrosion control, pressure and flow control, gas measurement and gas quality monitoring facilities. The gas control and dispatch is handled manually. Given adequate supply and pressure, the system is capable of distributing about 240 mmcfd natural gas. The system receives about 100 mmcfd of natural gas from Pertamina s offshore and onshore fields in West Java, 55 mmcfd from BP s fields offshore West Java and 10 mcfd from Ellipse s onshore field in Jatirarangon in West Java. The gas from Pertamina and Ellipse fields is supplied through a Pertamina owned and operated 24 inch diameter, 220 km long transmission line from Cilamaya to Krakatow. This pipeline runs through the middle of the distribution system, offloading gas into the system at load locations. The input pressures have been as low as 50 percent of the design level and, therefore, the system has not been operated at design level pressures. The gas from BP s fields offshore West Java is carried to the shore by subsea gathering lines, owned and operated by BP, beaching at Muara Karang and connecting with PGN s distribution system. Natural gas utilization in Banten and West Java in 2004 is about 705 mmcfd, of which power generation accounts for 370 mmcfd, steel manufacturing for 65 mmcfd, fertilizer production for 57 mmcfd, cement for 26 mmcfd, petroleum refining for 17 mmcfd, general industries for 165 mmcfd, commercials and households for 3 mmcfd and compressed natural gas (CNG) for vehicles for 2 mmcfd. PGN supplies general industries, commercials, households and CNG stations (CNG stations are Pertamina customers, with gas carried by PGN), whereas the rest are supplied by Pertamina. 26

35 ~ According to PGN s surveys, the unmet demand of the existing consumers is about 44 mmcfd, the demand of consumers on the waiting list amounts to about 317 mmcfd, and the estimated demand of potential consumers is about 297 mmcfd. The existing and potential demand (on fuel substitution basis) would amount to 826 mmcfd including about 168 mmcfd being supplied to existing consumers. Before the sharp increase in oil price experienced lately, the prices of industrial diesel oil and fuel oil were at about 75 percent of the world market levels. Thus the price of natural gas for consumers in general industry, and depending on the type of the contract, was in the range of percent and percent of the price of industrial diesel oil and fuel oil respectively. This advantage is likely to increase with the elimination of subsidies. The reserves, deliverability and status of development of the fields supplying West Java in the medium term are summarized in Table A4.1. Table A4.1: Gas Reserves and Supplies Location On and offshore West Java Offshore West Java Corridor Block South Sumatra Pagerdewa- Prabumulih South Sumatra Rimau Block South Sumatra Jatirarangon West Java Operator Pertamina BP Conoco- Phillips Pertamina Medco Ellipse Energy Reserves tcf P P P P P P P1P P P P P P1 1.0 P2 1.5 P3 2.2 P P P Plateau Rate mmcfd 450 declining to can increase to Status of Development Producing Producing Partly developed Partly developed Partly developed Developed Earliest Likely Delivery Producing Producing Producing August 2004 I Recipient 350 to Pertamina customers in West Java 250 to Pertamina customers in West Java 23 mmcfd to Pusri Fertilizer in Palembang, South Sumatra PGN 10 27

36 On the basis of contracts under operation and ongoing negotiations, the availability of supply to PGN for its customers in Banten and West Java i s projected in Table A4.2. Table A4.2: A contract for 250 mmcfd supply from Pertamina s fields in South Sumatra has been signed; it is due to commence in mid Pertamina is preparing to develop these fields and PGN has commenced preparations for the construction of a transmission pipeline from South Sumatra to West Java to carry this gas to PGN s distribution system in West Java. Contracts for supplies from Pertamina fields in West Java and BP fields offshore West Java are expiring in 2011 and 2009, respectively. However, Medco has offered to supply 100 mmcfd from 2012 from its fields in South Sumatra, which will be transported by the South Sumatra-West Java transmission pipeline, BP has offered to supply 65 mmcfd from 2010 from its fields offshore West Java, and Ellipse has confirmed 30 mmcfd additional supplies from its fields in Jatirarangon in West Java; contracts for these supplies are being negotiated. The project, formulated on the basis of the above-mentioned demand and supplies, includes the following components: a) expansion of PGN s gas distribution infrastructure in Banten and West Java; and b) Technical Assistance (TA) to PGN to enhance its expertise in gas marketing, distribution and transmission. The project is also linked to a gas transmission project to bring gas from South Sumatra to West Java region financed by the JBIC. Recently, PGN has entered into a contract with Conoco-Phillips for purchase of 400 mmcfd gas from Corridor block in South Sumatra, to increase the supply and further develop the West Java gas market. Its plans for transportation of this gas from South Sumatra to West Java and supply to new consumers are being finalized. This contract ensures adequate supply to the West Java market up to 800 mmcfd. 28

37 A. Expansion of PGN s gas distribution infrastructure in Banten and West Java It will mainly support gas sales to industrial consumers in Banten and Jakarta-Bogor, which account for more than 60 percent of the demand in West Java. It will be a part of PGN s overall plan for the expansion of its distribution infrastructure in West Java. The expanded system will receive gas supplies at Bojonegara, Muara Karang from Pertamina fields in South Sumatra and BP fields offshore West Java, respectively, and through Pertamina transmission pipeline in West Java. In addition, the gas from Bojonegara will be carried into the distribution system as far as Serpong by a 24 inch diameter pipeline operating at 37 bar pressure. This would enable the distribution supply mains, emanating from the Bojonegara-Serpong pipeline to operate at 25 bar pressure, efficiently enhancing the system capability. Pipelines will be laid to bring additional gas supplies into the system, to augment the capability of sections where consumer demand has outstripped the distribution capacity, and to provide connections to new consumers. The expanded system will operate at pressure regime of 25 bad16 bar/4 barl0.l bar and, under certain conditions of input and output; it will have the capability to distribute about 600 mmcfd of natural gas. The system will be designed and built in accordance with international standards and best practices and it will be in full compliance with Indonesian national standard. It will be provided with modern facilities for gas pressure control, flow control and dispatch, corrosion control, gas flow measurement, gas quality monitoring, IT support, radio and telecommunication. A computerized SCADA system will be installed to monitor and control distribution system gas pressures and flows at the input points and at strategic locations, which will enable efficient utilization of system capacity and will enhance safety and reliability of operations, A system safety and integrity management program will be developed under the proposed project. It will include a) verification of compliance of the system with Indonesian national standard, b) planning and establishment of a database and IT system to assist in safety and integrity evaluation, c) risk assessment, and where warranted, identification and undertaking of mitigation measures. System control and emergency response philosophy will be reviewed to determinate and establish appropriate response arrangements. (See following section) The main elements of the distribution system expansion plan are as follows: Class 300 steel pipelines of 4 to 16 inch diameter of a cumulative length of about km along with control valves, fittings and corrosion control facilities. Class 150 steel pipelines of 4 to 16 inch diameter of a cumulative length of about 71.4 km along with control valves, fittings and corrosion control facilities. Five off-take and two regulating stations. 29

38 0 210 customer metering and regulating stations. 0 SCADA for pressure and flow control, and monitoring. 0 Radio and telecommunications equipment, IT support and emergency response equipment. B. Capacity Building of PGN Skill Development PGN s origins are in gas distribution. Its basic capability and expertise in distribution engineering was established through training and TA in the 1980s and 1990s under two Bankfunded projects. However, in recent years PGN has been heavily involved in the development of transmission systems in Sumatra, delivering natural gas to Duri and exporting gas to Singapore. In this process, a significant number of PGN s experienced and senior staff have been converted to gas transmission planning and operations and transferred to the subsidiary company for the operation of the transmission system. PGN, therefore, needs to replenish its expertise in distribution engineering, taking into account the new methodologies, tools and software to improve operational performance. PGN also plans to enhance its capabilities in transmission engineering and planning of new transmission projects. Specifically, the proposed project aims at (a) enhancing PGN s expertise in infrastructure planning, gas marketing, gas utilization, distribution system safety and integrity management, gas transmission and compression operations, and (b) providing on-the-job and specialized training to enhance staff skills. The areas involved are briefly outlined as follows. Infrastructure Planning (a) Modeling, design and optimization of large scale distribution networks and transmission systems taking into consideration medium and long-term demand and supply projections, operational constraints, security of supply and safety aspects; (b) distribution and transmission system control concepts and techniques; (c) selection of appropriate software for pressure and flow analysis of the distribution system; and (d) determination of appropriate SCADA and emergency response systems. Gas Marketing (a) Cost-benefit analysis of large industrial customer conversion; (b) demand forecasting; (c) development of market for off-peak hours and spot gas availability; (d) marketing of gas for large industrial users, that is, power generation, fertilizer and cement manufacture, petrochemicals and cogeneration (e) contracting for the large-scale gas sale or purchase and for interruptible supply; and (0 managing marketing through outsourcing. 30

39 Gas Utilization (a) Conversion to gas firing (advice in selection and installation of equipment); (b) combustion engineering, design and specification of high-capacity gas burning and control equipment; (c) standby arrangements, for example, dual fuel firing equipment; (d) combined heat and power, and gas air conditioning systems; and (e) safety assurance and emergency response arrangements in gas utilization. Distribution System Safety and Integrity Management PGN is planning to strengthen its capabilities in the areas of system safety and integrity management. It intends to make a number of fundamental changes to its safety and integrity management system and introduce new methodologies and techniques to maintain the integrity of existing and future assets throughout their design life and beyond. The areas where strengthening is required include the following: Survey of the distribution system to ascertain compliance with National Safety Standard and registration of status with the Regulator. Risk assessment and design and implementation of mitigation measures where prescriptive compliance cannot be achieved. Clearance and registration of above measures with the Regulator. Monitoring techniques, risk assessment techniques and their application, defect assessment and repair methodologies. Required organization to strengthen integrity management. Design of an appropriate safety and integrity management framework. Planning and establishment of an electronic database and IT system to assist in safety an integrity management. Review and updating of standard operating procedures including establishment of compliance survey frequencies and risk assessment methodologies. Review of system control and emergency response philosophy, determination of appropriate equipment and response arrangements. Gas Transmission and Compression This component would include: (a) operating policies, procedures, guidelines and manuals; (b) reliability centered maintenance procedures and schedules; (c) operation and Condition monitoring systems; (d) risk assessment and mitigation measures; (e) IT systems to monitor performance; and (f) SCADA instrumentation system operation and maintenance (O&M) procedures. 31

40 Staff Skills Enhancement PGN requested assistance to provide basic skills to new entrants, upgrade the skills of existing staff in the company s core businesses during the coming high growth years. Specifically, the training will be designed to meet PGN s medium- and long-term requirements for the following: Providing new entrants with a basic level of knowledge and competency; Providing new entrants and existing staff with basic and advanced levels of knowledge and competency; Introducing the staff to the latest best practice, latest methods and tools to improve safety, integrity and efficiency of operations; Ensuring that lack of skilled human resources would not constrain the implementation and sound operation of ongoing and future projects; and Developing PGN s training capability to sustain this process and to minimize costs. The skills are to be upgraded through on-the-job training, in-house and overseas courses and attachments with appropriate organizations. Technical Collaboration PGN intends to carry out the proposed capacity building program through a long-term collaboration with a suitably qualified organization. The proposed collaboration will be characterized by a close involvement and cooperation between PGN and the Consultant to ensure that the needs and objectives of PGN are met in a flexible manner within the program outlined and taking into account the actual requirements of the PGN s staff. Implementation schedules and procedures will be developed throughout the duration of the collaboration and will be closely monitored. Financial Capacity Building Currently, the Finance Department includes about 40 professional staff, out of which about 10 have master s level MBA equivalent degrees. They intend to upgrade the skills of the 10 master s level staff as well as a select high potential group of the remaining employees. PGN proposes the following broad themes for the financial TA component: a. Executive Training. To upgrade staff skills in budgeting, retailing, financial modeling, analysis, and forecasting; and, corporate finance, financial markets, and investor relations. Their aim is to have staff gain applied skills in a short duration through intensive workshops related to the above subjects. PGN plans to have staff participate in overseas training programs as well as customized programs delivered in Indonesia; b. Distance Learning. PGN also plans to utilize the many distance learning programs that are related to finance that can be accessed through the internet; c. Technology Upgrade. PGN currently uses an Oracle based platform to handle basic financial activity and to integrate their various field offices. A critical bottleneck is that ledgers such as billing and trade receivables are still mostly done manually, whereby 32

41 impeding the real time flow and analysis of information. They plan to upgrade these systems as a part of the TA component. PGN has assured the Bank that this proposal i s to address a short-term need, and will not be in conflict with the current Bank financed study that is under way to evaluate the overall information technology (IT) systems for PGN, to be implemented after their corporate restructuring; and d. Advisory Support. PGN proposes to hire an in-house financial advisor to provide support during the next several years when their expansion plan will be at its most critical stage and sound financial monitoring and management will be very important. The Bank project is linked to the Japan Bank for International Cooperation (JBIC) gas transmission project from South Sumatra to Banten-West Java (US$485 million) The system is designed to receive natural gas at Pagerdewa in South Sumatra and transport it by a 70 bar, high-pressure pipeline to Bojonegara in Banten. It will have compression facilities at the inlet to boost the gas pressure from 30 bar to 70 bar. It will have a free flow carrying capacity of 450 mmcfd, which could be enhanced to 550 mmcfd with on-line compression. From Bojonegara the gas will be carried to Serpong by a 37 bar trunk line, feeding the distribution system en route through farm taps and off-take stations. Initially, the system will carry 250 mmcfd gases for PGN from Pertamina s fields in South Sumatra to PGN s distribution system in West Java. The system will comprise the following: 0 a 32 inch diameter, 270 km long steel pipeline from Pagerdewa to Labuhan Maringgai in South Sumatra; a 32 inch diameter, 110 km long steel subsea pipeline from Labuhan Maringgai to Bojonegara in Banten; gas compression facilities at Pagerdewa at the inlet to the transmission system; a gas receiving terminal at Bojonegara with an initial capacity of 250 mmcfd; and a 24 inch diameter, 70 km long trunk line from Bojonegara to Serpong near Jakarta. Preparations for the construction of this transmission system have commenced, it is expected to be completed by mid

42 Annex 5: Project Costs INDONESIA: Domestic Gas Market Development Project Table A5.1 Components Local Foreign Total US$ US$ US$ Project Cost by Component and/or Activity million million million A. Infrastructure (a) Pipelines including corrosion control facilities (b) Customer metering, regulating stations and service lines (c) Offtake metering stations and regulation stations (d) SCADNGas Management System (e) Detailed engineering and site supervision (f ) Inspection and certification (g) Special tools & equipment Subtotal B. Technical Assistance (a) Long Terms Technical Collaboration Services (b) Skills Development (c) Financial Technical Assistance Subtotal C. Building and Land Subtotal Total Baseline Cost Contingency Physical Contingencies Price Contingencies Subtotal VAT (10%) so oo 1.oo Total Project Costs /I Interest during construction Front-end fee Total Financing Required / Identifiable taxes and duties are US$10.4 million and the total project cost, net of taxes, i s US$104.3 million. Therefore, the share of project cost net of taxes is 90%. 34

43 Table A5.2: Financing Plan (US$ million) Investment Component PGN IBRD I Total I Foreign I I Local I Total Capacity Building Foreign Local Total Interest During Construction Foreign 7.40 I 7.40 I Local I Total Front-end Fee Foreign Local Total 0.20 I Total Foreign I Local I I Total

44 Annex 6: Implementation Arrangements INDONESIA: Domestic Gas Market Development Project PGN will have the overall responsibility for the implementation of the project. Having successfully completed two Bank and one ADB financed gas infrastructure expansion projects, PGN has a demonstrated management capability to plan and implement large infrastructure projects. Its strategy of outsourcing project activities, as far as possible, has been time-tested and has enabled it to efficiently complete expansion projects without significant increase in staff. For the proposed project it intends to follow the same strategy. The project implementation will be managed by a project implementation unit (PIU) with direct responsibility for the infrastructure expansion, customer attachment, gas sales ramp up and enhancement of distribution system safety and integrity management in West Java. The detailed planninghpecifications, preparation of procurement documents, quality control, construction supervision, safety assurance, and progress monitoring will be outsourced to a project management consultant (PMC); detailed engineering, procurement of materials, as far as possible, and construction will be outsourced to engineering, procurement, construction (EPC) contractors; certification of materials and works will be entrusted to independent inspectors; and technical collaboration with an appropriate organization will be arranged to assist in enhancing PGN s capabilities and skills in planning, engineering and generation activities (see Annex 4). Additionally, all procurement processing will be overseen by a Procurement Committee comprising experienced staff of PGN. The detailed roles and responsibilities of the organizations and entities involved are described below. 1. Project Implementation Unit: The PIU has been established specifically for the project by PGN Board of Directors Decree No. 0177OO.W12/UT/2004 dated September 27, It is located at the PGN head office in Jakarta and reports to the PGN s Board of Directors through the Director of Operations. The PIU s overall responsibilities include coordination of internal and external parties to ensure smooth project preparation and implementation including preparation of the project implementation plan and schedule; coordination of design, engineering, procurement, construction, environmental, social and customer attachment activities; preparation and implementation of gas sales ramp up plans; enhancement of distribution system safety and integrity management. It will also be responsible for monitoring implementation progress, reporting and evaluating project outputs and outcomes. At least ninety full and part time staff have been assigned to work for the PIU. 2. The PIU organizational structure is given at the end of this Annex. It includes basically three levels of management: a. the PIU is headed by a Project Coordinator, who will oversee the overall project preparation, implementation and various controls. The project coordinator reports to PGN s Director of Operations; 36

45 b. the head of PIU will be assisted by five managers-project Control Manager, Finance and Administration Manager, Project Manager, Procurement Manager and the General Manager SBUl (Strategic Business Unit 1). The Managers will be supported by full and part time professionals to perform their respective responsibilities, while the General Manager SBUl will deploy existing staff in the SBU to undertake customer connection and integrity management programs. c. specific task managers have been appointed for construction and logistics, quality control and safety-health-environment-resettlement, administration and contract management, finance, procurement control, procurement administration, system safety and integrity management, customer connection, and so forth. 3. Procurement Committee. A Procurement Committee has been established by PGN Board of Directors Decree No W91/UT/2004 dated June 8, 2004, comprising 20 members from various departments including planning and engineering, legal, accounting and budgeting, treasury, corporate review and business development, and project units. The committee, chaired by the Project Procurement Manager, will be responsible for: a. preparing procurement and bidding documents; b. developing evaluation criteria for prequalification and evaluation of bids; c. providing clarifications on procurement and bidding documents including Request for Proposals (RFPs) and TOR and preparing Minutes of Clarifications; d. conducting public bid opening and preparing Minutes of Bid Opening; e. evaluating submitted bids and preparing minutes of evaluation and evaluation reports; f. liaising with PGN President Director about the bid evaluation process and contract award recommendations; and g. contract award notification. In performing its duties, the Committee shall: a. share the procurement and bidding schedule with relevant project managers; b. have support, as needed, from PGN s department and staff to carry out its duties; c. have budgetary support from PGN. 4. Project Management Consultant. An external consulting firm will be hired through a competitive selection process to provide assistance in various aspects of project management, including but not limited to the following: a. project design and engineering; b. preparation of bidding documents; assistance in bid evaluation, contract award and finalization; c. construction supervision; quality control; cost control; schedule control; d. contract management; e. environmental management and social aspects; f. testing and commissioning; and g. training of PGN staff in project management. 37

46 5. Engineering and Procurement and Construction (EPC) Contractors. Suitably qualified contractors will be engaged through competitive selection for detailed engineering, procurement of materials and equipment, and construction of pipelines and stations. 6. Third Party Inspector. An external consultant will be hired, through competitive selection, for independent inspection and certification for goods and works. 7. Long-Term Technical Collaborator. A qualified international consulting firm will be hired and retained throughout the project implementation period to provide, among others, the following services related to customer connection, gas transmission and distribution system integrity management, O&M, as well as skill development or enhancement: a. b. C. d. e. f. review of system design and planning, and assessment of capabilities within the planning division and identification of areas for strengthening; advice on gas marketing and utilization for large industrial users (such as power generation, fertilizer and cement manufacture, petrochemicals and cogeneration) covering: cost-benefit analysis for conversion to gas, technical solutions for conversion, selection and installation of equipment, combustion engineering, design and specification of high capacity gas burning and control equipment, standby arrangements (for example, dual fuel firing equipment), and safety assurance and emergency response arrangements in gas utilization; development and implementation of an Operations and Integrity Management System (OMS) to ensure safety of personnel and the public and to achieve target levels of availability, through improved O&M practices; development of a system control philosophy and SCADA system specification including software, hardware, instrumentation and telecommunication requirements. The SCADA system will be procured under the project; provision of training, including an assessment of the skill needs of the existing staff and the design and implementation of a comprehensive training program in gas distribution and transmission engineering and operations for efficient project implementation and subsequent system operation; advice and technology transfer to PGN to ensure the establishment of the latest and most appropriate systems, methodologies, software and equipment for the efficient operation of gas distribution and transmission assets and maintenance of system safety and integrity for the design life of the infrastructure and beyond, For further details see the project implementation plan in the project file. 38

47 PGN PIU Organization Chart Notes: Project Coordinator is also coordinating the associated transmission lines (financed by JBIC); West Java Gas Distribution Optimization Team facilitates customer attachment; Project Control Manager is in charge of project control, budget monitoring and control and project management information system; Finance and Administration Manager is in charge of financial management, internal control, accounting, project documentation; Project Manager is in charge of construction quality. He will be assisted by three managers plus two external consultants - a PMC for project management and construction supervision and a Third Party Inspector for factory inspection of goods and safety inspection; Procurement Manager will serve the Chairman of the PGN Procurement Committee for this project and will also be assisted by PMC; SBU1-PGN s Strategic Business Unit No. 1, a permanent unit responsible for sales and customer services for West Java region (covering the distribution network financed under the project); About 90 full- and part-time staff has been assigned to support various managers. 39

48 Annex 7: Financial Management and Disbursement Arrangements INDONESIA: Domestic Gas Market Development Project Overall Summary of Financial Management Assessment The Financial Management assessment for this project was completed in April 2004, including an assessment of financial management capacity at the implementing agency as well as an analysis of financial management risks. The Domestic Gas Market Development Project will involve an expenditure of US$ million, of which US$8 million is expected to be funded by the Bank through a Specific Investment Loan. The project includes two main parts, the larger part (total size US$ million) will be for priority investments (including associated engineering, management and inspection services) in a gas distribution pipeline system for PT Perusahaan Gas Negara (Persero) Tbk. or (PGN), the partially state-owned gas utility, to help expand gas utilization in West Java; and the other part (amounting to US$6.20 million) comprises capacity building for PGN to support restructuring and institutional strengthening. Both components will be implemented by PGN. It is anticipated that loans under this project will be on-lent by the Republic of Indonesia as Borrower to PGN under a subsidiary loan agreement. PGN has been the recipient of several loans from both the Bank and other bilateral and multilateral agencies, including ADB, Japan Bank for International Cooperation (JBIC) and European Investment Bank (EIB) in the past, and is familiar with donor requirements with respect to financial managemente4 The most recent IBRD loan granted to PGN is a small component embedded in the Java Bali Power Sector Restructuring and Strengthening Project approved in PGN was till recently a fully state owned limited liability company (Persero) and became a public company following its Initial Public Offering in December PGN is now about 40 percent owned by the investing public and 60 percent owned by the GOI. The company has successfully completed a due diligence process of its internal business processes, including financial management processes, that are normally associated with initial public offerings. It will also henceforth be subjected to financial reporting and auditing disciplines that are normally applied to publicly listed companies in Indonesia, and which are relatively more rigorous than those applied to state-owned enterprises or government agencies. This is expected to have a beneficial impact on PGN s financial management capacity, as was apparent during the financial management assessment carried out. However, some weaknesses may arise specifically from the age and limited capability of the accounting system in use at PGN, and this may impact maintenance of essential financial The Gas Distribution Project (Loan 2690-IND) approved in May 1986 in the amount of US$34 million; the Gas Utilization Project (Loan 3209-IND) approved in July 1990 in the amount of US$86 million; a PPF of US$2 million in August 1996 to prepare a new project but the project was dropped out; plus a US$6 million TA under Java-Bali Power Sector Restructuring and Strengthening Project (Loan IND) approved in June Except for the US$6 million, which is ongoing, all other loans have been closed. 40

49 controls in a decentralized setting, for instance with respect to controls over customer collections and bank reconciliation and procedures to validate payments. PGN may also be influenced to a degree by the weak control environment in Indonesia, as determined by the Country Financial Accountability Assessment report (April 2001) completed by the Bank, and the slow pace of financial management reforms at this level. Overall, financial management risks have been assessed as moderate. To mitigate these risks with respect to this project, several measures have been suggested in an action plan agreed with the Borrower, including the adoption of quarterly FMRs, external audits by leading private sector accounting firms, and strengthened procedures for validating and approving payments to contractors for project activity. With the implementation of this plan, the financial management arrangements for this project would be acceptable. Project Organization proposed PGN has established a project implementation unit (PIU) for the project at its head office in Jakarta. The PIU is headed by a Project Coordinator to oversee the overall project implementation. The Project Coordinator is assisted by several managers-project Manager, Procurement Manager, Project Control Manager, Finance and Administration Manager, and General Manager SBU1. All the managers will be supported by functional task managers plus other full and part time professionals, while the General Manager SBUl will deploy the existing staff in the SBUl to undertake customer connection and integrity management program. The Project Coordinator will act as a central contact with the Bank during the period of project implementation, and will report to PGN s Director for Operations. For project financial accounting, a project accounting unit will be set up at the Jakarta Head Office. This unit will be staffed by one full time experienced accounting personnel from within PGN. Processing of payments under this project will be undertaken and approved by appropriate trained staff in the Head Office Treasury section that have prior experience in processing payment verification for PGN project activities financed by donors. Book keeping will be integrated with PGN s existing accounting system, though FMRs required for this project will be generated on stand alone applications by the Accounting and Budget Division. Impact of Procurement Arrangements on Financial Management A procurement capacity and risk assessment for this project has been completed and the risk has been assessed as Average. The procurement packaging has the following features that are relevant from the financial management perspective: a. Works procured under this project, would include customer connection (installation) services. Four packages covering two geographical areas with an aggregate amount of about US$3.82 million are expected to be procured through National Competitive Bidding (NCB) procedures. b. Goods procured under this project (aggregate value US$74.06 million) will comprise the largest expenditure category, and would include, supply and distribution of mains, offtake and regulator stations, customer meter and regulating stations instruments for pressure and flow control and monitoring, Radio and telecom equipment, IT support and 41

50 emergency response equipment, as well as special tools and equipment for O&M. The goods will also include the associated installation services. All packages will be procured through ICB procedures based on supply and installation arrangements, except for a few small contracts for O&M tools. ICB Contracts estimated to cost US$200,000 or above per contract and all direct contracting (if any) will be subject to prior review by the Bank. c. Consultant services are expected in the following areas: project management (including procurement services), third party inspection, and long-term technical collaboration, finance, and PGN staff skill enhancement. All these services will be provided by consulting firms. Consultancy services will total US$10.57 million. Those contracts with firms estimated to cost at or above US$lOO,OOO per contract, all Single Source contracts, and contracts with individuals above US$50,000 will be subject to prior review by the Bank. Given the large size and nature of individual packages likely for both goods and works, it is anticipated that a substantial part of the fund flows may involve prior review of procurement. Many packages would involve direct imports and hence will involve Special Commitments, where there will be an opportunity for scrutiny for supporting documents by the Bank prior to payment. Given PGN s robust financial situation, the balance locally procured transactions would not require a Special Account, and such expenditure will be reimbursed to PGN based on reimbursement applications approved by PGN Project Management and Ministry of Finance. Internal Controls and Risk Analysis A detailed analysis of risks arising from the country situation, the proposed project entity (PGN) and the specific project is attached as Table A7.1. A summary of the main findings follows. 42

51 Overall Inherent Risk Table A7.1: Summary of Risk Analysis Risks 1 Assessment5 I Summaly Comments 1 1. INHERENT COUNTRY RISK Substantial Public Sector Accounting Auditing Arrangements Banking System Substantial Moderate Moderate Substantial CFAA diagnostic completed in 2001 rated country control environment as weak. White paper has been prepared by government to address issues. New Finance, Treasury and Audit laws passed by Parliament but implementing regulations are yet to be issued. Minimal progress in implementing other CFAA recommendations. National accounting continues on a single entry basis with a semi manual system. Public sector accounting standards under development. Implementation of these standards will be taken up in the next few years. The Supreme Audit Board (BPK) now has legal mandate for audit as SAI. Institutional Development Plan for BPK under implementation. Banking sector restructuring under way. Central Bank now independent and responsible for supervision and regulation of commercial banks. 1. Implementing Entity Organization 2. FundsFlow 3. Staffing 4. Accounting Policies and Procedures. Information systems. Reporting and monitoring. 5. Internal Audit 6. External Audit OVERALL CONTROL RISK Low Moderate Moderate Moderate Moderate Low Moderate Financial health of PGN is generally good and the outlook for the next few years is good, following recent capital raising exercises. Solvency is not a serious concern. PGN organization has been recently restructured. Implementation will need to be managed carefully and may need time to stabilize routine functions. PGN flow of funds operates a network of commercial banks for its operations, and has a central treasury function. Budgeting system for operating revenues, expenditures and capital expenditure is in place. Accounting skills and experience mix at head office (Jakarta) is adequate. Financial Accounting ahs so far used a 10-year-old computer system, not networked or integrated nationally. Accounting policies and procedures well documented. Stand-alone systems used in field offices. A modern and integrated Oracle based accounting package is under implementation in year Accounting division is also responsible to prepare and administer operating budgets. Independent internal audit function exists, reporting to President Director, and operates under an annual work program. PGN uses public auditing firm as auditor (Ernst and Young Indonesia), in line with capital market regulations. Audits are up-todate. Auditors will henceforth be appointed at shareholder meetings. Assessment scale: High, Substantial, Moderate, Low. 43

52 Risks I Assessment 1 Brief Comment Mitigation of the organization not adequately supporting project financial management. Project works imvlementation Risk of contracted project civil work and services not meeting required quantity and quality. ReceiDt of vroiect goods Risk of goods received not meeting contracted specifications or quantities. Pavment validation Risk of the payment verification systems allowing erroneous payments. Disbursements, Fund Flows Risk thatfundflows are not adequately authorized before being disbursed. Project monitoring and revortinq Risk of lapses in implementation not being promptly identified. Accounting Risk offinancial transactions being recorded inaccurately, incompletely or not according to acceptable standards. Audit Risk of project audits not meeting acceptable auditing standards. Substantial Moderate Low Substantial Moderate Low Moderate Low Risks arise from the pressures of executing and accounting for a large capital expenditure plan in the next few years, estimated US$4.2 billion from 2004 to This risk applies for installation of procured equipment. PGN procedures provide for joint verification and testing of procured goods. Documentary support and trails under current procedures needs to be strengthened. Procedures for Special Commitments (likely for more than 50% of expenditure) are well established. PGN has prior project management experience. Inaccuracies may arise because of shortcomings in the old computer system. Risk will arise only if existing private sector auditors are replaced by those of unacceptable quality. Project accounting to be retained at head office in Jakarta, and full-time staff to be placed for this, suitably trained in preparation of FMRs and related Bank requirements. PIU to be managed by a dedicated organization. External project management consultants to be hired to assist in contract management. Use of turnkey contracts where possible. Certificates of Origin and Inspections will be requested under Letters of Credit imports. More stringent documentary trails will be required to support payments. All projects will be processed at head office Treasury. Banking Letters of Credit for imported goods will be encouraged. Procedures to be agreed in project manual. All packages (except consultancies) are expected to be above prior review threshold. Preparation of withdrawal application would be decentralized to PGN. Quarterly reporting (FMRs) on project progress will be implemented. Internal audit coverage of project activities will be requested. Project financial accounting will be integrated with PGN s own accounting package. FMR reporting quarterly will be generated on a stand-alone basis, but annual PGN financial statements will be acceded. PGN is likely to continue use ofprivate ~ sector for audit of its own financial statements under local capital market regulations. 44

53 Strengths and Weaknesses The financial management organization for this project has the following strengths: a. Accounting staff at Head Office in Jakarta is experienced accountants with the skills needed to support project financial accounting. In year 2003 the Company made a global offering of equity shares in the Company. These shares are now listed on the Indonesian Stock Exchanges. The Company has also issued long term Guaranteed Notes that were listed on the Singapore Exchange in This exposure to the rigors of reporting to local (and international) capital markets will be helpful in further strengthening PGN s financial management capacity. The use of FMRs as a basis for disbursements, and the use of Direct Payments for large transactions that are subject to prior review, will also facilitate better internal control by allowing an integrated review of procurement, implementation, financial and disbursement information; and b. The financial management organization at PGN has adequate segregation of responsibilities, for instance between procurement, approval of budgets, treasury management, collections and bookkeeping. Accounting systems, policies and procedures are also well documented. The primary weakness that is apparent relates to the semi manual accounting systems used by the Company. The computer system currently used for financial accounting (Foxpro software) is a decade old technology. Many important accounting processes are therefore done outside the core accounting system with standalone applications, including management accounting, maintenance and reconciliation of subsidiary ledgers, financial consolidation and preparation of financial reports. It is apprehended that these limitations of their accounting package will weaken the exercise of financial controls over operations. There is no costing system in operation, though occasionally stand-alone applications are done centrally using spreadsheet packages. However, we have been informed that a modern and integrated Oracle based accounting package is under implementation in year Fund flows and disbursement The fund flow mechanisms proposed is as follows: a. Method. Funds for this project will be on-lent to PGN by the GO1 as the Borrower. The terms and conditions for this on-lending will be agreed with the Bank before negotiations, and will be in the currency of the loan, in line with current government policy. The onlending terms are expected to be at nominal interest rates that are at or near local commercial borrowing rates. A Subsidiary Loan Agreement is expected to be finalized between GO1 and PGN for this purpose, as a condition for loan effectiveness. It is envisaged that payments for the procurement of goods will be made using Special Commitments and banking Letters of Credit for all imported goods where commercial practices for processing payments will apply. For TA consultancies and locally procured packages, PGN will prefinance and seek reimbursement from the Bank. Such 45

54 reimbursement applications will be submitted by PGN through the National Treasury Offices (KPKN) after approval by Ministry of Finance in line with existing government regulations. A Special Account is not considered necessary for this project. b. Disbursements based on FMRs. It is envisaged that except for cases that require special commitments, applications for reimbursements from the Bank will be submitted quarterly to the Bank, and will be supported by approved quarterly mmrs in formats agreed with the Bank. Project Financial Management Arrangements Organization. For purposes of project financial management the following staffing structure i s proposed: a. Payment processing. Payments will be initiated by the PIU staff at Head Office. Payments will be verified for payment by existing staff at Treasury department of PGN Head Office under PGN s existing administrative systems and procedures. Payment requests under Special Commitments for loan funded activities will be authorized by Project Manager, validated by PGN Treasury and sent to Bank with full supporting documents. b. Accounting. Data entry into the accounting system will be undertaken by existing staff at Head Office Accounting. Project Financial Accounting for purposes of quarterly reporting will be done by a full time senior staff, which will have the task of extracting relevant accounting information from the accounting system, preparing FMRs, preparing Reimbursement Applications and correlating information in financial, procurement and implementation reports in the FMRs. Staff in this position will be with at least a graduate (Sl) degree in accounting and will have at least 5 years prior experience in PGN. Suitable training will be provided by the Bank to the accounting staff in the preparation of m s. Accounting policies and procedures to be followed for project financial accounting will be the same as those followed for PGN financial accounting, and will essentially comprise Indonesian Accounting Standards consistently applied, with the exception that F MRs will be based on cashbased accounting, not accrual based, so that these are consistent with records at Loan Administration at the Bank. Expenditure commitments will however be monitored and fixed assets acquired under this project will be capitalized in PGN s books. Further, procedures will be specified and agreed with PGN management to strengthen ex ante controls over authorization of payments based on an improved documentary trail, including independent evidence acceptable to the Bank of work completed under project contracts, of goods delivered in quantity and quality as contracted, and demonstrated evidence of checks on full compliance with contracts. Audit arrangements Bank policy requires that auditors of Bank financed projects are acceptable to the Bank. Following PGN s privatization in year 2003, its audit arrangements are therefore subject to the capital market regulations in Indonesia, as mandated by the Capital Markets Supervisory Board 46

55 (Bapepam). PGN s financial statements are currently audited by Ernst and Young Indonesia. Under this regime, so long as the company s shares remain listed at the Stock Exchange, company auditors will be appointed at Shareholders meetings each year under regulations governed by the local capital market regulations. Auditors so appointed are required by law to be private audit firms that are licensed by the Ministry of Finance and accredited with Bapepam. Such audited financial statements are now also required to be submitted to the BPK for their review. In this situation, it is proposed that the Bank accepts the existing arrangements for the appointment of auditors by Company shareholders, subject to an assurance from PGN Management that so long as this project is under implementation, the Bank is given an opportunity to place before its management and shareholders the objections the Bank may have, if any, to the appointment of the selected auditors. The Bank will also consider completing independent peer reviews of audit firms appointed by PGN to help determine their acceptability. It is further proposed that the annual audited financial statements of PGN are accepted by the Bank as compliance with the financial management policy and loan covenants, provided that total expenditure under this project is separately and adequately disclosed in the annual financial statements of PGN. Project implementation controls will be verified by the company s Internal Audit Department. PGN will also be required to submit to the Bank copies of the management letters issued annually by the external auditors, as well as the annual internal audit reports, Entity financial statements of PGN (consolidated) with appropriate disclosures on use of Bank funds in the notes to accounts, audited by external auditors duly appointed by PGN Shareholders. 30th June of following year I I - I FMR: Reporting and Monitoring To facilitate project monitoring and control, a set of FMRs will be required from the project on a quarterly basis. These reports will comprise information on procurement activity, implementation progress, sources and uses of funds and a forecast of funds required for the project. The detailed formats for these have been developed and agreed with the Bank. The first such reports will be required to be submitted no later than 45 days after the end of the first quarter after effectiveness, and thereafter every quarter not later than 45 days of the quarter-end. Disbursements will also be report-based, as explained above. Action Plan The financial management arrangements as outlined herein are considered acceptable for the purposes of the project, subject to the satisfactory completion of the action plan summarized in Table A

56 Table A7.2: Action Plan 1. Organizational Assign 1 accounting staff for project Finance arrangements accounting on a full time basis. (PGN) Director, PGN 2. Audit PGN Management undertaking that audit Finance Director, PGN Before negotiations Before negotiations 3. Project implementation Project Director, PGN Before negotiations Supervision arrangements Specific supervision arrangements recommended for this project are the following: a. Review of quarterly FMRs, comprising procurement, physical progress and financial information will be conducted quarterly jointly with task team and will be an important supervisory step. b. Review of annual audited financial statements of PGN to identify any accounting or accountability issues that may arise. c. Achievement of any financial covenants in financing agreements will be monitored. d. The Bank may occasionally conduct ex post procurement reviews and financial reviews of the transactions under this project. e. Review of annual internal audit reports and external audit management letters, including follow up of matters arising. 48

57 A. General Annex 8: Procurement Arrangements INDONESIA: Domestic Gas Market Development Project Procurement for the proposed project would be carried out in accordance with the World Bank s Guidelines: Procurement under ZBRD Loans and IDA Credits dated May 2004; and Guidelines: Selection and Employment of Consultants by World Bank Borrowers dated May 2004, and the provisions stipulated in the Legal Agreement. The various items under different expenditure categories are described in general below. For each contract to be financed by the Loan or Credit, the different procurement methods or consultant selection methods, the need for prequalification, estimated costs, prior review requirements and time frame are agreed between the Borrower and the Bank in the Procurement Plan. The Procurement Plan will be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. Procurement of Works. Works procured under this project would include customer connection (installation) services. The procurement will be done using the Bank s Standard Bidding Documents (SBD) for all ICB and National SBD agreed with (or satisfactory to) the Bank. Four packages covering two geographical areas respectively (one for Banten and Greater Jakarta, and the other for Bekasi and Karawang) with an aggregate amount of about US$3.97 million are expected to be procured through NCB procedures. Procurement of Goods. Goods procured under this project would include (a) supply and distribution mains of 4 inch to 16 inch diameter with a cumulative length of around km; (b) five off-take and two regulation stations; (c) 210 customer meter and regulation stations; (d) SCADA for pressure and flow control and monitoring; and (e) radio and telecom equipment, IT support and emergency response equipment, as well as special tools and equipment for O&M. The goods will also include the associated installation services. All packages will be procured through ICB procedures based on supply and installation arrangements, except for a few small contracts for O&M tools. The Bank s SBD will be used for all ICB. Procurement of Non-Consulting Services. Not expected. Selection of Consultants. Consultant services are expected in the following areas: project management (including procurement services), third party inspection and long-term technical collaboration. All these services will be provided by consulting firms. No short lists of consultants are expected to be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. All consultants will be selected through Quality and Cost-Based Selection (QCBS) or Quality-Based Selection (QBS) procedures except for small training packages where Selection Based on Consultants Qualifications (CQS) procedures would be more appropriate. Operating Costs. No operating costs will be financed by the Bank loan. Others. Not expected. 49

58 B. Assessment of the agency s capacity to implement procurement Procurement activities will be carried out by PGN. The PIU established for the project will be staffed by at least 90 (full and part time) people. In addition, PGN has established a 20-member Procurement Committee (comprising managers and staff from all relevant departments, most of them with practical international procurement experience acquired through previous Bank financed projects or training). An assessment of the capacity of the Implementing Agency to carry out efficiently the procurement activities related to the project has been carried out by Bank procurement staff in accordance with relevant Bank procedures and guidelines and based on findings of the preparation mission in December 2003 and preappraisal mission in April The assessment report is available in the project files. The main risks associated with procurement for this project are identified as follows: (a) corruption and collusive practices-perceived to be a nation wide issue. Though no specific cases have been reported under PGN sponsored procurement, given the perceived high country risk and general weak procurement environment in Indonesia, the issue still warrants particular attention during the implementation of this proposed project; and (b) tight implementation schedule and procurement delays. PGN has entered into a gas supply agreement under which PGN will start to receive gas in end-2006 on a take or pay basis through the gas transmission pipeline to be built under JBIC financing. This agreement imposes a very tight implementation schedule on three subcomponents of the gas distribution network to be financed by the Bank (the Banten distribution mainline, greater Jakarta distribution mainline, and the new off-take substation). Although it is feasible to complete these subcomponents, every effort should be made by PGN and relevant parties (including the Bank) to avoid any major delays in procurement and physical construction. Preparation of the bidding documents is on the critical path of the procurement schedule. Based on the following assessment, the overall project risk for procurement is rated as average: a. PGN has received from the Bank 3 loans (including the ongoing US$6 million TA component under the Java-Bali Power project), and several loans from ADB, JBIC and others under which procurement activities were carried out without major problems. PGN has extensive experience in international procurement and several of its procurement staff has attended training sessions organized by the Bank and ADB. b. An external consulting firm will be hired to assist in project implementation and management, including preparation of prequalification and bidding documents, bid evaluation, contract negotiation, contract management, cost-schedule-quality control. c. The project is a specific investment loan with a clearly defined scope. A sound procurement plan has been prepared (covering the entire project period) with detailed procurement and construction schedule. Most of the packages will be based on a supply and installation (or EPC-engineering, procurement and construction) arrangement. Basically, all packages will be procured under ICB and subject to Bank prior-review (including Regional Procurement Advisor and Operations Procurement Review 50

59 Committee). There would be four NCB works packages (installation services). Consultant firms will be hired through QCBS or QBS with Bank prior review. d. Following the listing of 39% of its shares on stock exchanges in December 2003, PGN is expected to have a more open disclosure policy and be subjected to higher scrutiny from its shareholders. Government interference in its business is expected to be less than before. Its accounts are audited by a reputable international firm; and e. There is no record or report on PGN for misuse of funds under the Bank or other donor funded projects. Nonetheless, the overall perceived country risk in Indonesia is high, C. Procurement Plan The Borrower, at preappraisal stage, developed a draft Procurement Plan for project implementation which provides the basis for procurement activities. The plan has been finalized by PGN and approved by the Bank. The finalized plan is available at PGN PIU and the Bank project s file. It will also be available in the project s database and in the Bank s external website. The Procurement Plan will be updated in agreement with the Bank annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. D. Frequency of Procurement Supervision In addition to the prior review to be carried out from Bank offices, the capacity assessment of the Implementing Agency has recommended two supervision missions to visit the field to carry out post review of procurement activities. E. Details of the Procurement Arrangements Involving International Competition 1. Goods, Works, and Non Consulting Services Table A8.1 contains a list of contract Packages that will be procured following ICB, NCB and Direct Contracting. 51

60 1 4 Table A8.1 IFB No. Procure- Comments (Description) ed Cost ment Bid- Method Post) ICB No 12/22/05 No I t IFB Prior Supply mainline Installation IFB-2 ICB Prior 02/02/06 Supply Distribution Mainline Installation IFB-3 Offtake station I 8.98 ICB No Prior 03/02/06 Supply 82 No I Installation IFB-4. SCADA and ICB No 1 No Prior 03/28/06 Supply telecommunication Installation IFB-5 IFB-6a Procurement of pipes for service-lines Metering & regulating stations (Banten) ICB ICB IFB-6b Metering & regulating ICB No Yes stations (Greater Jakarta & Karawang) IFB-7 IFB-8a IFB-8b IFB-9a IFB-9b Special O&M tools & equipment Construction of Branch lines (Banten) Construction of Branch lines (Greater Jakarta & Karawang) Customer installation (Banten) Customer installation (Greater Jakarta & Karawang) I 1.23 I 1 90 ICB/NCB/ Shopping ~~ NCB NCB NCB NCB No I No Prior 01/05/06 Prior 02/10/06 Prior /06 Prior 08/15/06 Prior 03/10/06 ~ /06 No Post No I 1 09/20/06 No I No Post I 09/20/06 9 Supply only Supply only Supply only Consultant to define the details; Multicontracts. Small Works Contract Small Works Contract Small Works Contract Small Works Contract Note: ICB Contracts (goods) estimated to cost at or above US$200,000 per contract and all Direct contracting (if any) will be subject to prior review by the Bank. Works contracts estimated to cost at or above US$1.5 million per contract will be subject to Bank prior review. Given the tight schedules for IFB;1,2, 3, retroactive financing arrangements have been agreed for these packages. 52

61 2. Consulting Services 1 2 Ref. Description of Assignment No. 1. Project management consultant (PMC) 2. Long term technical collaboration services 3. Third party inspection 4. Skill enhancements 5. Financial TA Estimated Selection Review by Expected Comments Cost ($'m) Method Bank Proposals (Prior/ Submission Post) Date 5.45 QCBS Prior 02/07/05 Retroactive financing 3.50 QBS Prior 05/26/05 Retroactive financing 1.62 QCBS Prior 11/23/ /05/06 Not Bank Financed 1.oo 05/05/06 Not Bank Financed b. Consultancy services estimated to cost at or above US$lOO,OOO per contract and all Single Source selection (if any) of consultants (firms), and US$50,000 for individuals (if any) will be subject to prior review by the Bank. c. The project management and long-term technical collaboration consultants need to be engaged in advance of Bank loan approval and signing. It was agreed during appraisal to request Board approval for retroactive financing. d. Shortlists comprising entirely national consultants: No short lists of consultants are expected to comprise entirely national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. However, in the event this becomes necessary, the ceiling should be US$400,000 per contract. Bank Prior Review Thresholds Expenditure Category 1. Goods (including supply and installation) 2. Works 3. Consultant services Contract Value Procurement Method Contracts Subject to Prior Threshold (US$) Review (US$) >=500,000 ICB >=200,000 >= 100,000 NCB < 100,000 Shopping <5,000,000 NCB >= 1,500,000 >=200,000 QCBS, QBS >= 100,000 (firms) <200,000 CQS >=50,000 (individuals) 53

62 Annex 8 (A): Clarifications Relating To National Competitive Bidding (NCB) Procedures INDONESIA: Domestic Gas Market Development Project 1. General The procedures to be followed for NCB shall be those set forth in Presidential Decree No. 80/2003 of the Republic of Indonesia with the clarifications and modifications described in the following paragraphs required for compliance with the provisions of the Guidelines for Procurement under ZBRD Loans and IDA Credits (the Guidelines). 2. Registration a. Bidding shall not be restricted to preregistered firms. b. Where registration is required, bidders: (i) shall be allowed a reasonable time to complete the registration process; and (ii) shall not be denied registration for reasons unrelated to their capability and resources to successfully perform the contract, which shall be verified through post-qualification. 3. Pre-qualification When prequalification shall be required for large or complex works (not for simple goods and works): a. eligible bidders (both national and foreign) shall not be denied prequalification, and b. invitations to prequalify for bidding shall be advertised in at least one widely circulated national daily newspaper a minimum of 30 days prior to the deadline for the submission of prequalification applications. 4. Joint Ventures A bidder declared the lowest evaluated responsive bidder shall not be required to form a joint venture or to subcontract part of work or part of the supply of goods as a condition of award of the contract. 5. Preferences a. No preference of any kind shall be given to national bidders. b. Regulations issued by a sectoral ministry, provincial regulations and local regulations, which restrict National Competitive Bidding (NCB) procedures to a class of contractors or a class of suppliers shall not be applicable to procurement procedures under the Credit or the Loan. 54

63 6. Advertising a. b. C. d. Invitations to bid shall be advertised in at least one widely circulated national daily newspaper allowing a minimum of 30 days for the preparation and submission of bids and allowing potential bidders to purchase bidding documents up to 24 hours prior the deadline for the submission of bids. Bid documents shall be made available, by mail or in person, to all who are willing to pay the required fee. Bidders domiciled outside the area, district, or province of the unit responsible for procurement shall be allowed to participate regardless of the estimated value of the contract. Foreign bidders shall not be precluded from bidding. If a registration process is required, a foreign firm declared the lowest evaluated bidder shall be given a reasonable opportunity for registering. 7. Bid Security Bid security, at the bidder s option, shall be in the form of a letter of credit or bank guarantee from a reputable bank. 8. Bid Opening and Bid Evaluation a. Bids shall be opened in public, immediately after the deadline for submission of bids, and if bids are invited in two envelopes, both envelopes (technical and price) shall be opened at the same time. b. Evaluation of bids shall be made in strict adherence to the criteria declared in the bidding documents and contracts shall be awarded to the lowest evaluated bidder. (c) Bidders shall not be eliminated from detailed evaluation on the basis of minor, insubstantial deviations. (d) No bidder shall be rejected merely on the basis of a comparison with the owner s estimate and budget ceiling without the Association s or Bank s prior concurrence. 9. Rejection of Bids a. All bids shall not be rejected and new bids solicited without the Association s or Bank s prior concurrence. b. When the number of responsive bids is less than three, rebidding shall not be carried out without the Association s or Bank s prior concurrence. 55

64 Annex 8(B): Anticorruption Plan INDONESIA: Domestic Gas Market Development Project This Anticorruption Action Plan is based on an examination of the overall project cycle, to identify where corruption is most likely to occur, and what mitigation measures are likely to be most effective. Because of the nature of the project, particular emphasis is given to procurement aspects. Potential risks of corruption are identified, and mitigation measures are identified below. Further details of specific control systems are outlined in Annex 7 (Financial Management and Disbursement Arrangements) and Annex 8 (Procurement Arrangements). The project manual will include more details concerning implementation of the elements of this plan, including relevant TORS. Corruption Mapping The corruption mapping matrix included below in this Action Plan identifies potential risks of corruption and specifies appropriate mitigation measures agreed by the PGN. Action Plan Specific mitigation actions are presented in the Corruption Mapping Matrix. The following provides a summary: (a) Enhanced Disclosure Provisions and Transparency. PGN will establish a filing system to maintain all the project related documents, including procurement documents, Whilst securing any information that must be kept confidential, the project will ensure that a wide range of important documents and information will be made public in a timely fashion. The World Bank s disclosure policy will be followed. In order to increase public awareness of the important measures, information concerning enhanced transparency and civil society oversight will be included in procurement advertisements. This will include, but not be limited to the following measures: 1. The PGN and the World Bank will each make publicly available, promptly after completion of a midterm review of a project carried out in accordance with this agreement, the midterm review report and the aide-memoire prepared for this purpose. 2. The PGN and the World Bank will each make publicly available promptly after receipt audit reports (financial or otherwise, and including qualified audit reports) prepared in accordance with this agreement, and all formal responses. 3. The PGN will (and the World Bank can): > make publicly available promptly after finalization all annual procurement plans and schedules, including all updates thereof; > make available to any member of the public promptly upon request all bidding documents and requests for proposals issued in accordance with the procurement provisions of this agreement, subject to payment of a reasonable fee to cover the cost of printing and delivery. In the case of requests for proposals, the relevant 56

65 documents will only be made available after notification of award to the successful firm. Each such document will continue to be available until a year after completion of the contract entered into for the goods, works or services in question; k make available to any member of the public promptly upon request all short lists of consultants and, in cases of prequalification, lists of prequalified contractors and suppliers; k disclose to all bidders and parties submitting proposals for specific contracts, promptly after the notification of award to the successful bidder or consultant, the summary of the evaluation of all bids and proposals for such proposed contracts. Information in these summaries will be limited to a list of bidders or consultants, all bid prices and financial proposals as read out at public openings for bids and financial proposals, bids and proposals declared non responsive (together with reason for such an assessment), the name of winning bidder or consultant and the contract price. In the case of the lowest evaluated responsive bidder is not awarded the contract, a concise explanation shall be given concerning the justification for the selection. Such summaries will be made available to the public, promptly upon request; > allow representatives of the end users of the goods or works being procured to attend the public bid openings, information concerning the selection process and TORS will be included in the project manual; > make publicly available and publish widely contract award information for all contracts for goods and works above USD100,OOO equivalent and all contracts for consultants above USD 50,000 equivalent, promptly after such award; and > make available, promptly upon request by any person or company, a list of all contracts awarded in the three months preceding the date of such request in respect of a project, including the name of the contractor or consultant, the contract amount, the number of bidders or makers of proposals, the procurement method followed and the purpose of the contract. It will be mandatory to widely disclose salient contract award information. The PGN already makes annual audit reports public, and will continue to do so in relation to this project. (b) General Stakeholder Oversight. With listing of roughly 40% of its shares on the Indonesia stock market since December 2003, PGN is subject to broad monitoring and scrutiny by the general public. PGN employs an external independent auditor. As outlined in the Corruption Mapping Matrix, specific measures will be taken to encourage representatives of stakeholder groups to oversee important aspects of the project. For example, invitations to observe the procurement process (such as bid opening and evaluation) will be sent to carefully selected, independent organizations related to the sector, such as university faculties and other institutions. Though the primary role of these observers is to observe the procurement process they may have a stronger technical capacity than the end-user representatives, therefore the PGN procurement team may 57

66 decide utilize them as a resource for technical advice. Information concerning the selection process and TORS of these independent observers will be included in the project manual. All observers to the procurement process must agree to respect the confidentiality of the process and must be free from problems related to conflict of interests. An Audit Committee will function at PGN, in line with GO1 regulations. Review of the project progress will be included in the Audit Committee agenda. (c) Mitigating Collusion, Fraud and Nepotism. Although opportunities for collusion and fraud may exist in any project, transparent and well-advertised procurement under the project with appropriate oversight will greatly reduce such risks. Additional safeguard measures will be in place, including procurement and project management assistance as well as training by an external consulting firm hired under the project. External project management consultants will be hired to assist in contract management and provide training to PGN staff, and there will be third party inspection of goods and services delivered. Independent consultants will sign off and certify progress before progress payments are made. To reduce the likelihood of abuse still further, audits of international standard will be held in accordance with current PGN practices. (d) Complaints Handling Mechanism. The new Keppres 80/2003 provides comprehensive complaints handling procedures. These procedures will be strictly followed under the project. A complaints database will be set up by PGN to monitor the response to complaints and follow up actions. Details concerning the complaints handling mechanisms to be employed are given in Attachment A. (e) Sanctions and Remedies. Clear sanctions and remedies are an important final step in the effort to fight corruption. This program will not tolerate corruption. When fraud and corruption in any aspect of project implementation is suspected, project management must immediately arrange an independent investigation. If the results of the investigation confirm the occurrence of fraud and corruption, administrative action will be taken against any PGN staff who are involved. Further, if the results of the investigation confirm third party involvement in fraud and corruption, then the parties involved, including consultants, contractors and vendors must be blacklisted by PGN. Cases must be reported to the Bank and also referred for criminal prosecution in accordance with government regulations. Substantiated allegation of a criminal offense must be reported to the police and other relevant authorities. 58

67 TABLE AS (B).l CORRUPTION MAPPING MATRIX Corruption Mapping I Level of I Opportunity for I Mitigation Action Area I Risk I Corruption Procurement Stage Procurement Planning Packaging, cost estimates, procurement or consultant selection methods, scheduling Low Packaging in favor of local suppliers Mandatory review by the Bank of Procurement Plan; packaging and procurement methods to be based on economy and efficiency. As currently planned, majority of procurement will be done through ICB. For the anticipated NCB packages (for installation services), the clarifications of NCB procedures following Keppres to be acceptable to the Bank will be included in the Legal Agreement. Majority of procurement packages will be based on supply and installation arrangements with prequalification. Procurement Notice (GPN), Special Procurement Notice (SPN), Request for Expression of Prequalification and Sl Prequalification Consultant short listing would reduce transparency and limit competition *t listing Process Medium I Prequalification in favor of the preferred contractors. the preferred consultants. The Bank advertising procedures will be strictly followed; Advertisements will be published in two nationwide newspapersone in English (Jakarta Post) and the other in Bahasa Indonesia. Prequalification document shall be prepared based on the Bank guidelines. Clear and adequate qualification criteria defined in the prequalification documents and followed in evaluation. Bank prior review is required for all prequalification evaluation reports. PGN will make available to public promptly upon request the list of prequalified contractors. PGN to provide all the names who expressed interest, criteria and justifications for shortlisting, plus other supporting information. Bank review to ensure the shortlist is reasonable and justified. PGN to make available to public promptly upon request the consultant shortlist. Bidding Process Bidding documents and Request for Proposals (RFPs) Medium Delay in preparation or issuance of bidding documents or RFPs (which may indicate lack of capacity or poor institutional setup). Bidding document or RFPs and evaluation criteria shall be prepared based on Bank guideline. 59

68 Corruption Mapping Area Bid or proposal evaluation and contract award recommendation Risk Medium Corruption Delay in evaluation process that would benefit exclusive bidders or consultants; Bid or proposal rejected for reasons unrelated to the capacity of bidders in carrying out the contract or services; False information provided by bidders or consultants. Mitigation Action Procurement Plan will include specific milestones for bid evaluation, which will be monitored by both PGN PIU and the Bank; External project management consultant will assist in bid evaluation; Bank would declare misprocurement for unjustified extension to bid validity; Bank will not issue no-objection to unjustified contract awards; Bank or GO1 disclosure procedures to be enforced. These include, inter alia: - make publicly available promptly after finalization all annual procurement plans and schedules, including all updates thereof; - make available to any member of the public promptly upon request all bidding documents and requests for proposals issued in accordance with the procurement provisions of this agreement, subject to payment of a reasonable fee to cover the cost of printing and delivery. In the case of requests for proposals, the relevant documents will only be made available after notification of award to the successful firm. Each such document will continue to be available until a year after completion of the contract entered into for the goods, works or services in question; - make available to any member of the public promptly upon request all short lists of consultants and, in cases of prequalification, lists of prequalified contractors and suppliers; - disclose to all bidders and parties submitting proposals for specific contracts, promptly after the notification of award to the successful bidder or consultant, the summary of the evaluation of all bids and proposals for such proposed contracts. Information in these summaries will be limited to a list of bidders or consultants, all bid prices and financial proposals as read out at public openings for bids and financial proposals, bids and proposals declared non responsive (together with reason for such an assessment), the name of winning bidder or consultant and the contract price. In the case of the lowest evaluated responsive bidder is not awarded the contract, a concise explanation shall be given concerning the justification for the selection. Such summaries will be made available to the public, promptly upon request; - allow representatives of the end users of the goods or works being procured to attend the public bid openings; - make publicly available and publish widely contract award information for all contracts for goods and works above USD100,OOO equivalent and all contracts for consultants above USD 50,000 equivalent, promptly after such award; and - make available, promptly upon request by any person or company, a list of all contracts awarded in the three months preceding the date of such request in respect of a project, including the name of the contractor or consultant, the contract amount, the number of bidders or makers of proposals, the procurement method followed and the purpose of the contract. Bank or GO1 complaints handling and sanctions policies to be - enforced. Substantiated allegation of a criminal offense must be reported to the police and other relevant authorities. 60

69 Corruption Mapping Area Contract negotiations and finalization Overall procurement Project Implementati Contract execution, supervision and audit Level of Risk Medium Medium Medium Opportunity for Corruption Contract price negotiations; Collusion and nepotism in awarding contract Risk of kickbacks; collusive practices in contract awards; lower quality of goodskervices. Goods and services delivered at lower than specified quality or quantity; construction delays; cost overruns; kickbacks from contractors-suppliersconsultants to project staff. L Mitigation Action 0 Bank will require detailed explanations and justifications if final contract price differs from that proposed at the evaluation report; 0 Mandatory disclosure of contract award information. 0 Enhanced disclosure, complaints handling and sanctions or remedies as defined in Keppres ; 0 Independent, external observers acceptable to the Bank will be invited by PGN to attend all important steps of the bidding process, including bid opening and evaluation. Though the primary role of these observers is to observe the procurement process they may have a stronger technical capacity than the end-user representatives, therefore the PGN procurement team may decide to utilize them as a resource for technical advice. Information concerning the selection process and TORS of these independent observers will be included in the project manual. All observers to the procurement process must agree to respect the confidentiality of the process and must be free from problems related to conflict of interest; Enhanced capacity for procurement and contract management (assistance by external consultants, training); Enhanced control system (internal and external): as a publicly listed company, PGN is now subject to more scrutiny by stakeholders; Project management system includes cross-support and cross-checking mechanisms to reduce and minimize corruption opportunities; Enhanced Bank supervisions (almost all packages are subject to prior reviews). External project management consultants to be hired to assist in contract management and provide training to PGN staff; Clear testing and acceptance procedures to be specified in the contracts and to be followed; Third party inspection of goods and services delivered; Internal and external auditors are in place; The project is an integrated part of PGN s ongoing priority investment which has a firm completion date; delays will cause take or pay penalties; PGN will be accountable to shareholders, including BPH Migas, for adhering to the Master Plan, including timely project completion at the expected quality and cost. The PGN and the World Bank will each make publicly available, promptly after completion of a midterm review of a project carried out in accordance with this agreement, the midterm review report and the aide-memoire prepared for this purpose. The PGN and the World Bank will each make publicly available promptly after receipt audit reports (financial or otherwise, and including qualified audit reports) prepared in accordance with this agreement, and all formal responses. 61

70 Annex 9: Economic and Financial Analyses INDONESIA: Domestic Gas Market Development Project This annex provides the methodology, assumptions and results of the cost-benefit analysis of the project. 1. Cost-Effectiveness Analysis During project preparation, a least-cost study was carried out by PGN for the gas distribution network expansion in Banten, Greater Jakarta, Beksi, Karawang and Bogor of West Java region, covering The study is based on detailed gas distribution network simulations for different scenarios and configuration of gas pipelines. It considered (a) the capability of the existing systems; (b) the location and demand of potential consumers (demand nodes); (c) the quantities and important locations of gas supply (supply modes); and (d) severe constraints on rights-of-way in highly urbanized areas. In addition to the total system costs (both investment and operation costs), technical constraints, such as load factors, line-pack requirements, security of supply, safety of operation, minimum pressures and customer attachment to achieve required ramp-up rates in accordance with good industry practices were considered. The proposed project is part of the least-cost distribution system expansion plan for West Java region, to supply up to 800 mmcfd of natural gas by This demonstrates the cost-effectiveness of the proposed project. 2. Cost Benefit Analysis A cost-benefit analysis was also carried out to estimate the ERR of the proposed project. Economic Costs The economic costs of the project include (a) total investment costs for gas transmission pipelines (partly financed by the JBIC) and for gas distribution network (partly financed by the Bank); (b) O&M costs related to the transmission and distribution facilities; (c) expenditures for gas purchases; (d) cost associated with gas losses incurred during transmission and distribution, and (e) conversion investment costs to be undertaken by customers for fuel switching. All the costs exclude taxes and duties and financing costs. The conversion factor is considered as 1.0 when estimating the economic costs from financial costs because the distortions in the exchange and wage rates in the overall costs are not significant enough to justify the use of shadow prices. Detailed assumptions considered in the analyses are as follows: The investment costs for the transmission and distribution components of the project are estimated at US$ million and US$ million, respectively, as shown in following tables; The annual incremental O&M costs are assumed to be 2 percent of the investment costs for transmission and distribution components of the project; Gas losses are assumed to be 2 percent of the annual quantity of gas received from producers; 62

71 0 Under the gas purchase agreement between Pertamina and PGN, Pertamina will sell the gas to PGN at the inlet of the transmission line for US$2.00 per mmbtu for the first year, and the price is indexed at 2.2 percent for the ensuing years. Although this reflects a financial cost, it is assumed to be the average incremental economic cost (AIC) of the exploration, development and production, given the proximity of this value to the AIC calculated for Indonesia as part of the Bank s sector analytical work in 2000 (that is, US$ per mmbtu). This gas purchase price will be used to estimate the gas purchase costs for the project; and 0 Customer conversion costs were estimated by PGN at about US$10.3 million. Table A9.1: Investment Cost of the Transmission Component Item 1.a am 1.n a a a 1.a 1.a 1.a 1.a 1.a 1.a 1.a o.a 1.a a 1.w am a w 0.03 iav Table A9.2: Investment Costs of the Distribution Component Components A. Infrastructure B. Technical Assistance C. Building and Land D. Physical 08% E. Price Contingency F. VAT (10%) Total Project Cost Note: The infrastructure ir Economic Benefits Financial Costs Conversion Local Foreign Total Factor million) oo 1.oo 1.oo 0.87 tis table includes the section of distribution line to be finance Economic Price Local Foreign Total (million (million (million US$) US$) US$) by JBIC (base cost of US$7 million). Benefits of the project (cash flow from sales of gas by PGN) are estimated based on the assumption that the economic value of gas is equal to the future market prices of oil products to be replaced by gas. Oil product prices are based on the Bank s projection of oil price during appraisal at US$26 per bbl. Other benefits of the project, such as energy efficiency and product 63

72 quality improvement due to switching from oil products to gas, as well as environmental benefits of substituting cleaner gas for oil products, were not considered in the estimate. Detailed assumptions are as follows: 0 The volume of gas sales: Although the carrying capacity of the transmission is 450 mmcfd and the capacity of the distribution system is 550 mmcfd, the evaluation of the project benefits was based on the gas purchase agreement signed between PGN and Pertamina. According to the agreement, Pertamina will supply gas to PGN beginning in June 2006 according to the following schedule: 150 mmj3tu for the first year, 200 &tu for the second year and 250 mmi3tu from the third year up to It is assumed that after 2018, the gas supply will remain at 250 mmcfd level and the price will be the same as that in PGN has already secured other sources to supply the West Java market of which about 160 mmcfd could be distributed by the system expanded under the project. According to PGN s gas market survey, the fossil fuels to be replaced by gas from the proposed project are fuel oil (18 percent), automotive and industrial diesels (72 percent and 10 percent, respectively). The prices of fuel oil and diesel are estimated at US$3.74 per &tu (fuel oil), US$6.23 per mmbtu (automotive diesel) and US$6.03 per mmj3tu (industrial diesel) based on the Bank s recent long-term forecast of crude oil prices available at appraisal: US$26 per bbl. Economic Internal Rate of Return The base case ERR is estimated at 20 percent, if benefits are valued at the current gas sales tariff, and 59 percent, if benefits are valued at future market prices of displaced fuels, with an NPV at 12 percent of US$169 million in the first case and US$1,152 million in the second cases shown in Table A9.4. Sensitivity Analyses Sensitivity analyses were carried out on the base case to further examine the robustness of the economic viability of the project in relation to the major perceived risks, such as increase of investment cost, delay in commissioning of the project, reduction of project benefits and slow progress of consumer conversions. The sensitivity and risk analyses indicate that even in case of important increase in investment cost, delay in commissioning and reduction in benefits, the EIRR remains higher than 12 percent, indicating the robustness of the economic viability of the project. The major results of the cost-benefit analysis are summarized in Table 9A.3. Base case Investment costs Delay in commissioning Reduction of project benefits Gas sales in first five years Changes ERR (%) NPV (US$ million) n.a (%) year (%) % of base case

73 i 7 5 gg= 00 L C I- Y.P ~ ~~.~6+octmctoooooooooooooooooo ~ ~ ( r ) 0 + ~ ~ ~ 4 fff =o:~:oooooooooooooooooo~ g 0 ~ N 0 ~ o ~ d 2.- ~ 0 g ~ g o o o o o o o o o o o o o o o o o o ~ E30N~N ~ 65

74 Risk Analysis To complement the above detednistic analysis, risk analyses have been carried out using a probabilistic approach to assess the impact of the perceived risk factors that affect the economic return of the project. Four broad categories of risks have been considered in the analyses: 0 Demand risk. Demand risk is related to the slow sales ramp up. It is not perceived as a major risk factor in the long term because of the low penetration rate of gas among the industrial and commercial consumers in the market. However, a lower than expected sales ramp up rate during the first few years of the operation of the project could impact the economic viability of the project. 0 Cost risk. Higher-than-estimated project investment cost usually results from (a) higher equipment and materials prices: The major equipment and materials will be procured through ICB. Prices could therefore be affected by market fluctuation; and/or (b) Construction cost overrun: Cost overrun during the construction period is a common phenomenon for many infrastructure projects. Its is caused by a number of factors, in particular, delays in construction because of interface problems between different contractors, unforeseen site conditions, and inadequate project management. 0 Project performance risk. Poor performance could be caused by (a) low reliability of the pipelines and gas supplies and (b) inadequate maintenance and poor management. Both of them would eventually reduce the output of the project; therefore reduce the project s benefits. Based on the foregoing considerations and extensive sensitivity analyses, four variables have been selected as the crucial risk variables because of the significant impact on the project economic viability. Table A9.5 presents the selected variables, the assumed value ranges and probability distributions attached to them based on past Bank experience. The risk analysis was carried out with the Crystal Ball software, which uses Monte Carlo simulation technique. The spreadsheet employed for the risk analysis is based on the base case cost-benefit analysis (see Table A9.4). The results, based on 5,000 simulations, are summarized in Table A9.6 and Figure A

75 No. Variables Probability Changes Probability Distribution (YO) Expected ERR Standard deviation Minimum Maximum Coefficient of variation Probability of negative outcome The expected EIRR, based on weighted average of all simulated combinations, is 19.9 percent and the probability of negative outcome is nil, which shows that the results of the economic analysis is robust. 67

76 Figure A9.1 Risk Analysis Risk Variables Report 80% Risk Variable No. 1 60% 40% 20% 0 Yo %- 40% 30% 20% 10% 0% Risk Variable No %1 1 60% Risk Variable No. 3 Distribution Dela Probabilit distribution: DISCRETE 40% 20% 0% Risk Variable No. 4 40% 30% 20% 10% 0 Yo!

77 Figure A9.2 PGN s Current Financial Position and Past Financial Performance Revenues and Expenditures. In 2003, PGN generated a total revenue of US$425 million (based on end-2003 exchange rate; US$1 = Rp 8,465), comprising (a) US$350 million from the sales of natural gas through its distribution networks, (b) US$74 million from fees earned for transporting gas through transmission pipelines, and (c) less than half of a million dollars from the sale of LPG. The cost of purchasing natural gas and LPG in 2003 was about US$231 million, representing 66 percent of the distribution revenue. The total operating expenditures (that is, transmission, distribution, general and administration) was about US$96 million, or about 23 percent of its total revenue. PGN s income from operation was about US$98 million, its total income before tax was US$89 million and after tax US$62 million. The revenues were generated from (a) selling an average of 250 million cubic feet per day (mmcfd) of gas through its 6 distribution network in West Java, East Java and Sumatra, (b) transporting an average of 306 mmcfd of gas through its three transmission pipelines, and (c) selling small volume of LPG. The average operating margin of gas sales through its distribution network in 2003 was about US$1.38 per -tu, and the average transportation fee charged was US$0.55 per &tu. Assets. PGN s total assets in 2003 were about US$l.08 billion, including a current asset of US$418 million. Cash and cash equivalent represented 54 percent of its current assets, and a short-term investment represented an additional 19 percent. The large cash account is the result of the proceeds from the multilateral or bilateral loan borrowing, a US$150 million Eurobond issue and a December 2003 public offering of about 39 percent of its shares. PGN has not revalued its assets because of significant tax implication of revaluation. However, in 2003, it revalued only that part of assets transferred to its wholly-owned subsidiary, the PT Transgasindo (TGI). 69

78 Liabilities. PGN s long-term debts in 2003 was about US$330 million, mostly consisting of two-step loans, owed to the government for the funds borrowed from the ADB, JBIC, EIB, and World Bank for its capital expenditures. In addition, PGN has issued two Euro bonds: (a) a US$l50 million in September 2003 (under regulation S), due in 2010 with an option to extend to 2013, and bearing an interest of 7.5 percent; and (b) a US$125 million in February 2004 (under 144A), due in 2011 with an option to extend to 2014, and bearing an interest of 7.5 percent. Both notes were rated B2 by Moody s. Shareholders Equity. Prior to 2003, its authorized capital consisted of 800,000 shares with a nominal value of Rp 1 million per share, of which 200,000 had been issued and fully paid. In November 2003, the shareholders approved the increase the company s authorized capital from Rp 800 billion to Rp 7 trillion and the decrease of the par value to 500 per share. Accordingly, 3.5 billion shares were fully paid. In December 2003, PGN received approval to sell about 38 percent of its shares through public offering. The stocks were listed in Jakarta and Surabaya stock exchanges on December 15, 2003, at Rp 1,500 per share. PGN s total equity in 2003 was about US$390 million. PGN s net cash flow amounted to US$65 million from operation activities, and US$372 from financial transaction, the latter mostly resulting from proceeds of borrowing, issue of Euro bond and the PO. PGN had also spent about US$250 million in 2003 toward its capital expenditures. PGN s end-2003 cash stood at US$227 million, a net increase of US$135 million during Table A9.7 below provides a summary of PGN s income statement and balance sheets for As shown above, the revenue from operation has been growing at about 15 percent per year, on average, during the period, reflecting both the increase in gas sales on average and in gas sale prices. The operating income has been growing on average at about 16 percent between 2000 and The net income before tax, however, has been fluctuating significantly as a result of the fluctuation in other income and charges, particularly foreign exchange fluctuation. The increase in current assets in 2002 and 2003 are largely the IPO and the bond issue (in 2003) despite the sale of TGI (in 2002). The Work in Progress increased in 2002 because the Grissik- Singapore pipeline was still under construction, and the net fixed asset almost doubled in 2003 when this pipeline became operational. Current liability increased in 2002 because of PGN s obligation to the Grissik-Singapore pipeline contractors, and the long-term debts increased because of the US$l50 bond issue. During the past 5 years, PGN has maintained a healthy current ratio (ranging from 1.5 to 4.4, but mostly above 2), a solid rate of return (ranging from 18 percent to 3 1 percent), and an acceptable debt service coverage ratio (ranging from 1.05 to 2.75 times). 70

79 At the time of appraisal, audited or consolidated financial information was unavailable for Therefore, preliminary year-end financial estimates from PGN were used to ensure that the overall financial performance trend remained as initially forecast for the year. PGN continued to expand their market as envisaged, and earned a total revenue of US$512 million (based on average 2004 exchange rate of US$1 = Rp 8,700), comprising (a) US$426 million from sales of natural gas from its distribution network, (b) US$86 million from transporting gas through PGN pipelines. Unlike in previous years, they did not have any income from the sale of LPG since PGN dropped this business line. These revenues were generated largely by selling nearly 300 mmcfd of gas, an increase of 50 mmcfd from the previous year. The transmission revenue was generated by transporting 420 mmcfd, of which nearly 80% was from Grissik to Duri in Northern Sumatara and the remainder to Singapore. The initial data indicate that PGN purchased a total of US$274 million in natural gas from suppliers, which makes up 64% of distributional revenue. The operating expenses were US$119 million, which is higher than initially forecast but was offset by a 40% reduction in the expected foreign exchange loss. Consequently, PGN had an operating income of US$118 million, total income before taxes of US$76 million, and after taxes of US$56 million. PGN s Future Finances With the implementation of the new Oil and Gas Law, PGN will face major challenges because: (a) it could loose its monopoly in the distribution segment; (b) it will gradually operate in a regulated competitive market; and (c) it will be required by law to provide third party access to its transmission distribution networks at regulated prices. Although the new law clearly creates a healthier environment for competition and provides for a more efficient operation of the sector in future, it has also the potential to negatively impact the level of PGN s profit margin. Although it is not possible, at this stage, to assess the impact of the pricing policy that will be in effect in the future, a sensitivity analysis indicated that a reduction in the sales price of gas by 5% will still enable PGN to maintain a healthy financial structure. If the price change was expanded to lo%, however, it will be difficult for PGN to comply with the World Bank loan covenants in some years. Additionally, future competition can also curtail PGN s ability to expand, especially at the pace that was initially envisaged by the company. The World Bank and PGN worked closely to develop a low growth forecast, reducing the total investments from US$4.4 billion to PGN s about US$2.2 billion from 2005 to 2010, or an average of nearly US$365 million per year (with an average of approximately US$440 million per year between 2005 and 2007). Under this scenario, PGN still expects to increase gas sales by 34% per year on average and stressed that it has already enlisted enough customers for more than 50% of their expected medium term gas supply. Nevertheless, PGN conducted sensitivity analyses by reducing sales by 10 and 30% and assessing the resulting financial implications. The results indicate that the financial situation remains robust and the company will still be able to maintain financial viability and meet the Bank loan covenants during most of the years. If future sales are reduced by lo%, PGN would still (a) adequately service its debt and meet the loan covenant; (b) be able to finance at least PGN audited financial statements were released just prior to Board presentation, and validates the overall direction of the company s financial performance. There were only minor variations between the unaudited and audited financial figures. 71

80 25% of its investments through internally generated sources; and (c) maintain a return on its assets that i s greater than 14% annually. A more substantial reduction of 30% in sales will still enable PGN to have a debt service coverage of no less than 1.46 and a self financing ratio of more than 25% except in the heaviest investment year (2006, when ratio is 20%), and maintain a higher than 11% return on assets during all the period. Despite the robustness of its financial situation, it is important that PGN management continues to carefully monitor the company s financial performance and take necessary actions to maintain financial viability in the event the expected sales would not materialize. Table A9.8 provides a summary of the forecast of PGN s future financial performance, including its estimated income statement, balance sheets and cash flow statement for After discussions with PGN and taking into account the critical areas that warrants closer monitoring with regard to PGN s future finances, it was agreed that the proposed loan would include the following financial covenants: To ensure satisfactory financial performance by PGN with respect to adequate level of revenues generated, PGN would be expected to produce, for each fiscal year, sufficient funds from its internal sources equivalent to about 25 percent of its average annual capital expenditures ; To ensure a sound capital structure and a prudent strategy on long-term borrowing, before PGN incurs any new debt, it would be required to demonstrate that a reasonable forecast of its revenues and expenditures for each fiscal year would produce sufficient net revenue to be at least 1.5 times its estimated debt service requirements (including the new debt); and To ensure adequate capitalization of the company, PGN is not expected to incur any debt, if after the incurrence of such debt the ratio of debt to equity shall be greater than 75/25 during and 70/30 thereafter. 72

81 m 4 m I E I 73

82 e f-4 H f-4 r? e N e a v1 e 8 Q e a 8 0.e Y 2 3 U c d"3nmci3n m 3 Y I 74

83 Annex 10: Safeguard Policy Issues INDONESIA: Domestic Gas Market Development Project The Environmental Impact Assessment Report (EIAR), prepared in 1998 before the project was postponed because of the financial crisis, was updated in 2003 and approved by the Ministry of the Environment (MOE) in December PGN provided the Bank with the EIAR, including an Executive Summary, as well as the letter of approval from MOE. The EMP was also updated in 2003 and approved by MOE. In July 2002, a public consultation was convened for the project in Jakarta. This consultative workshop was conducted with input from World Bank staff and consultants, and included participation of central, regional and local governments, as well as NGOs and community organizations. In April-May 2004, PGN, with international consultant assistance, prepared a revised Environmental and Social Impact Assessment and Environmental Management Plan (EIA-EMP) in English language, which serves as the summary report for the Bank and public review. An EMP has been developed based on the results of the environmental impact assessment (EIA). It identifies the important environmental impacts, and the procedures and measures to be taken to mitigate the adverse impacts. According to the EMP, PGN will establish a PIU with overall responsibility for coordinating and managing the project, and an ECO to oversee and support the monitoring and mitigating activities. The ECO will serve as the core unit for environmental management and monitoring. Its capacity will be strengthened under the capacity building program for environmental management proposed in the EMP. These arrangements are regarded as adequate. Attached i s the summary and introduction of the Environmental Impact Assessment Report. 75

84 EXECUTIVE SUMMARY 1. Introduction This Environmental & Social Assessment / Environmental Management Plan (EINEMP) has been prepared by PT Perusahaan Gas Negara [PT PGN (Persero) Tbk] as part of its preparations for the proposed Domestic Gas Market Development Project with the World Bank. Prior to the regional economic crisis, the Bank considered providing a loan to PGN for a transmission and distribution project to increase gas utilization in West Java. The original project design involved both construction of a transmission line from gas fields in South Sumatra to West Java and the extension of the gas distribution network in West Java. An Environmental Assessment Study for the then considered project was prepared by PGN. During the crisis, the project was postponed by the Bank and finally dropped. By the time project discussions resumed in November 2001, the Japanese Bank for International Cooperation (JBIC) had agreed to finance the Sumatra-Java transmission pipeline. The Government then requested a World Bank loan to expand the West Java gas distribution system under the proposed Domestic Gas Market Development Project. This summary synthesizes the full Environmental Impact Assessment (EIA) Report prepared by PGN based on detailed Indonesian environmental assessment analyses and studies, completed and approved by the AMDAL Commission (under the Ministry of Mining and Energy) in 1999 and updated and re-approved by the Central AMDAL Commission (under the Ministry of Environment) in November The EIA Report covers PGN s gas distribution expansion plan in West Java partly financed by the Bank and complies with the World Bank s environmental and social requirements (including operational policies on environmental and social safeguards). 2. The Project The proposed project aims at expanding the supply and utilization of natural gas, the cleanest fossil fuel, in Indonesia s domestic market to improve economic efficiency and reduce pollution resulting from the heavy reliance on fuel oil and diesel. The project consists of: (i) a gas distribution component to expand gas utilization in BantenWest Java region, and (ii) a capacity building component to strengthen PGN s (the project owner) financial, planning, engineering and management capability. The project is linked to a Japan Bank for International Cooperation (JBIC) financed gas transmission project to bring gas from South Sumatra to BantenWest Java region. The distribution project comprises: (i) construction of class 300 steel pipelines of 4 to 16 inch diameter (about 186 km) along with control valves and corrosion control facilities; (ii) construction of class 150 pipelines of 4 to 16 inch diameter (about 71.4 km) along with control valves and corrosion control facilities; (iii) installation of five off-take and two pressure regulation stations; (iv) installation of around 21 0 customer metering and regulating stations; (v) installation Referred to as PGN thereafter. 76

85 of SCADA system; and (vi) provision of radio/telecommunication equipment, IT support and emergency response equipment. The proposed Bank-financed project is linked to a JBIC financed transmission project. Project preparations are well underway with construction planned to commence in the second quarter of The EIA Report for the transmission project was prepared and approved by the AMDAL Commission in It has been discussed and approved by JBIC, and disclosed to the public following JBIC s disclosure procedures. A social assessment report and a Resettlement Action Plan (RAP) were prepared in 1998 to comply with AMDAL procedures and JBIC s requirements. The RAP was recently updated by PGN at JBIC s request. And its implementation is underway. 3. Indonesia s Environmental Legal and Institutional System - The AMDAL System Indonesian EIA is widely known by its acronym, AMDAL - Analisis Mengenai Dampak Lingkungan Hidup (literally, Analysis of Impacts on the Living Environment ). The Ministry of Environment (Kementrian Lingkungan Hidup, KLH - or LH) is responsible for national-level functions for environmental enforcement, including oversight of the AMDAL process. Regional Environmental Impact Management Agency (BAPEDAL - Badan Pengendalian Dampak Lingkungan Hidup) offices, directly as offices of local governments, have recently been given the principal role in AMDAL review and environmental management at the regional level. The AMDAL Process AMDAL requirements apply to most government and private sector projects. Carrying out an AMDAL study is the responsibility of the project developer or proponent, as are the mitigation and monitoring of the project s impacts. The types of activities subject to AMDAL are specified most recently in the Ministry of Environment Decree Number 17/2001, Types of Business and/or Activity Plans that are Required to be Completed with the Environmental Impact Assessment. A full AMDAL assessment involves a three-step process of studies and reports: ANDAL (Analisis Dampak Lingkungan - Analysis of Environmental Impacts); RKL (Rencana Pengelolaan Lingkungan -Environmental Management Plan), and RPL (Rencana Pemantauan Lingkungan - Environmental Monitoring Plan). From the perspective of a project developer, the AMDAL process involves up to seven steps: 0 project Identification screening 0 scoping, with Public Consultation 0 approval of the KA (TOR)-ANDAL 0 assessment, and preparation of the mitigation and monitoring plans 0 approval of the assessment, management, and monitoring plans 0 implementation, monitoring, and reporting. Development activities that are unlikely to have significant or widespread environmental impacts* are subject to a less rigorous and specific set of AMDAL studiesg: ~ * Kepmen 481/PU/1996 defines those activities requiring UKL/UPL in the public works sector, for example, and there are similar decrees in other sectors. 77

86 0 UKL (Upaya Pengelolaan Lingkungan -- Environmental Management Procedures), and UPL (Upaya Pemantauan Lingkungan -- Environmental Monitoring Procedures). These procedures are not subject to evaluation by an AMDAL commission. The less significant environmental aspects of these projects are to be covered within the Standard Operating Procedures (SOPS) of the implementing agency. Decentralization of AMDAL Review and Approval Law Number 22/1999 gave wide authority and responsibility to the Regions; they now must function on their own initiative to meet the interests of the local public and fulfill the potential of their region. The role of central government-the Ministry of Environment-is now only to give technical supervision, facilitate and promote, and set national standards related to environmental affairs, For AMDAL, the only projects subject to review at the national level are those involving defense and security, cut across more than one province, are in areas of dispute or borders with other countries, or that concern marine regions more than 12 miles from shore. For full-fledged AMDAL studies - ANDAL-RPL-RKL - evaluation and approval are undertaken and provided by an Evaluator Committee or AMDAL Commission chaired by the Deputy Minister of Environment. Their work is guided by the Guidelines for AMDAL Document Evaluation, BAPEDAL Decree Number 2/2000. The AMDAL Commission draws upon the expertise of all concerned government agencies, public sector organizations, universities, NGOs and the private sector. Each BAPEDALDA has its own local AMDAL Commission, to review ANDAURKURPL studies under their jurisdiction (and not subject to review by the national AMDAL Commission) and supervise the implementation of the AMDAL during construction and operation of the projects. According to BAPEDAL Decree Number 17/2001 (Types of Business andor Activity Plans that are Required to be Completed with the Environmental Impact Assessment), construction of onshore gas transmission pipelines of 50 km or more in length and having a diameter of 20 inches or greater, and all offshore gas transmission pipelines, require an EIA. Therefore, the proposed project required a full AMDAL assessment (equivalent to full EA in line with Bank requirements and procedures of category A projects). 4. Baseline Data The project region: The proposed distribution project would support construction of new pipelines and branch lines to extend PGN s gas distribution system in West Java (Greater Jakarta, and Provinces of West Java and Banten). PGN s existing distribution system in this region is readily divided into three Zones: Greater Jakarta (l), Banten (2) and West Java (3). The proposed project will be implemented in these three zones which are in general heavily urbanized or industrialized. There are no protected areas, or critical natural habitat sites in the vicinity. The proposed distribution pipelines will follow existing national, provincial and district roads and will not cross any culturally or socially sensitive areas. As set out in KEP-I2/MENLH/3/1994. lo Ibid l1 Kep. BAPEDAL, No. 09, Tahun 2000, Pedoman Penyusunan Analisis Mengenai Dampak Lingkungan Hidup. 78

87 The climate, air quality and noise emission: West Java has a tropical climate. Temperature and relative humidity are fairly uniform throughout the year. The rainy season is from October to the end of April and the dry season is from May to September. In zone 1, the annual mean rainfall is about 1850 mm with the highest monthly value at 425 mm in January and the lowest at 47 mm in July. In zone 2, the annual mean rainfall is about 1725 mrn with highest monthly value at around 300 in February and the lowest value at 56 mm in August. In zone 3, the annual mean rainfall is 1809 mm with the highest monthly value at 371 mm in January and the lowest value at only 26.5 mm in August. The air quality (S02, N02, CO, HC and dust) and noise level were measured in 1999 and remeasured in The results show that all the values of ambient air quality parameters measured meet the national standards in the project region. Noise emission levels were sometimes higher than the national standards during the busy traffic hours. Geology, morphology, topography, soils and hydrology: Principal geological features in the project areas include: Volcanic sediment (zone 1 ): consisting of andesine, lava, breccias, volcanic breccias and tuffs; Alluvial sediments (in zone 2 and 3): consisting of swamp and river alluvial sediments, in the forms of hunks, pebbles, sand, clay, and organic materials; Banten tuffs (in zone 2): consisting of tuffs, pumices and tuffs sandstones; Bunning pinang basals (in zone 2): in the form of a basal diabasic texture; Flood plain sediments (zone 3): consisting of sandy clay and humic clay; Tuffs sandstone and conglomerates units (in zone 3): consisting of tuffs sandstones, conglomerates and breccias; and Citalang formation (in zone 3): consisting of conglomerates, sandstone and breccia. In zone 1, the sloping is between 04% with land elevation of 0 to 1 meter above see level. Morphology units in zone 2 are river and coastal alluvial plains, sloping between O-5percent with land elevation of 0 to 15 m above sea level. Land in zone 3 crossed by the proposed pipeline routes is relatively flat and in the type of flood sediment, with elevation ranging between 0 to 5 meters. Typical soil types in the project areas include alluvial, latosol, podzolic and regosol soils, clay and other materials from volcanic eruption. Along road shoulders that will be used as the pipeline routes, the uppermost soil layer from 10 to 20 cm thickness typically consists of small stones. The second deeper layer from 40 to 50 cm thickness consists of soils, followed by a layer of ordered-stones of cm thickness, and finally reaching the original soils in the deepest layer. Analysis of soil samples in the project region shows that soil erosion rates are all in the tolerate range. Total numbers of water crossings on the proposed gas pipeline route are 10 in zone 1, 151 in zone 2 and 102 in zone 3. Most of the waterways to be crossed by the pipeline are streams with width below 3 meters (3 in zone 1, 82 in zone 2 and 55 in zone 3). Only 18 rivers are classified as big rivers (width above 10 meters). 7 of the big rivers are in zone 1, 6 in zone 2 and 5 in zone 3. The rest are small rivers (with width between 3 and 10 meters) and irrigation canals. The discharges of those big rivers range from 2.5 to 9 cubic meterskecond and their mean depth ranges from 0.7 to 2 meters. 79

88 Analysis of water samples in the project areas indicates that most of the parameters do not meet the highest water quality standards (class 1). Some, such as Total Suspended Solid (TSS) and Total Dissolved Solid (TDS) do not meet even lower quality standards (The Class II and Ill). Analysis also showed that there is no significant level of mercury in the study area and the highest values of lead were lower than the safe limit under class II and Ill standards. Analysis of water samples from zone 1 also indicated that surface water in the region contains higher level of Chloride (Cl), detergent, and BOD than national water standards. Chloride comes from natural abrasion along the body water, whereas high BOD level is caused by pollution from industrial wastes. People s daily activities alongside the river using detergent are responsible for higher detergent level. Biodiversity: A floristic survey along the proposed gas pipeline was conducted and 11 species were found, Most of them were shade or canopy-trees, planted in the sidewalks or on the shoulder of the roads. In the project area, roadside vegetation along the proposed gas pipeline route provides the only available habitat for wildlife. Accordingly, wildlife found in the area is limited and no protected species were found. Benthic communities in the river crossings are potentially vulnerable to temporary disturbance during construction of the pipelines. Other aquatic biota like plankton, nekton, and fishes are unlikely to be affected by the construction or any wastewater flows from the project. In general, the habitat quality for benthos organisms in the project areas is poor. The water bodies in the area are characterized by strong currents, and hard substance. Land use: Since the proposed distribution pipeline will be located along the shoulders of the existing roads, land use analysis focused on the land alongside the proposed pipeline routes. According to the updated survey carried out in 2003, major land uses in the project areas are 48% for settlements (27% for villages and 21 % for towns), 36% for industry, 14% for agriculture (including trees and crops) and 2% for tourism. Social-economy, governance, culture: In zone 1, the proposed pipeline will pass through the districts of Kedep, Bekasi, Tegal Gede (south Jakarta), and Cakung, Cilincing (north Jakarta). The pipeline route in zone 2 will pass through the districts of Tangerang, Serang and Cilegon city, all of which are within the recently created Banten Province. For zone 3, the project passes through the districts of Karawang, Cikampek, and Punvakarta, which are part of West Java Province. The population density of villages in the project areas is usually over 400 people/km2. The dominant occupations of local people living near the project route are industrial workers, traders, private employees and civil servants in the town areas, and farmers in the countryside. Along the road side, a lot of people also work as owners and/or employees of stores, shops and semi-permanent kiosks. The roads that the pipeline route follows include national-class roads (93.1 km), provincial class roads (106.3 km) and district class roads (49.2 km). At some points of the roads mostly along industrial estates, offices and trade centers, traffics are heavy, especially during the morning and evening rush hours. 5. Evaluation of Alternatives The following alternatives were sequentially considered during the project design and preparation: 80

89 Expansion of gas business versus business as usual : Prior to engaging in this important investment program, PGN considered to continue a business as usual approach entailing a less aggressive strategy of conversion to gas of small industries and businesses and therefore a low growth of the Banten-West Java gas market. The business as usual approach has been rejected for four reasons: (a) the expansion of the gas market was in line with the government energy strategy to develop the domestic gas market because of its economic and environmental advantages over oil products and coal; (b) a market scoping study showed a strong preference of small industries and businesses for gas; (c) expansion of the gas market would strengthen the financial situation of the company; and (d) without of the expansion of gas market, some energy consumers will continue to use oil and other dirty fossil fuels which will have more negative environmental impacts. Choice of gas supply: Two alternatives were considered for gas supply: gas fields in South Sumatra or onshore and offshore small fields in West Java. An Asian Development Bank (ADB) study found that, delivering gas from the South Sumatra fields to the West Java market was preferable to relying on closer but limited and more costly to develop fields in West Java onshore and offshore. The gas reserves in South Sumatra fields have been formally certified by a reputable international company (D&M), which has issued certification indicating 3.85 tcf in the Proven and Risk Adjusted categories. This level of reserve could easily support up to 500 mmcfd of gas supply for the economic life of the proposed project (20 years). The option of transmitting gas from South Sumatra to West Java was selected. Expansion of the distribution system: PGN considered alternatives for the expansion of its distribution system taking into accounts: (a) the capability of the existing system; (b) the locations and demand of the potential consumers (demand nodes); (c) the quantities and input locations of gas supply to the system (supply nodes); and (d) severe constraints on the right of way in highly urbanized areas. The latter reduced the number of alternatives for expansion to two, mainly differentiated by the pipeline diameters along the same routes to satisfy a demand of 500 mmcfd in the first case and a demand of 800 mmcfd in the second case. The first option would have required further reinforcement of the system after 5-7 years to meet the full potential demand of 800 mmcfd by It was rejected because it was less cost effective and would have entailed more temporary negative environmental and social impacts. 6. Likely Impacts and Mitigation Measures Positive impacts: the project will provide important positive environmental benefits as shown in following table. In addition, Indonesia s contributions to the global greenhouse gas emissions will be reduced. Traffic Soil Erosion Air and Noise Pollution Water Pollution Socioeconomic Table 6.1 Likely Positive Impacts of the West Java Gas Distribution Expansion Reductions in traffic of lorries and other vehicles delivering fuels to industries and other customers throughout the region, Construction is likely to help to stabilize drainages in some locations. Reductions in regional air emissions for all pollutants and greenhouse gases. Improved air quality within factories that convert to natural gas. Reduced dust and emissions from fuel delivery vehicles. Reductions in noise from traffic of lorries and other vehicles delivering fuels to industries and other customers throughout the region. There will be modest reductions in water use by fuel delivery vehicles and in maintenance of industrial combustion -y,r Creation of short-term employment for local unskilled laborers during the construction and temporary Increase in cash flow to the local economy, particularly the informal sector, due to expenditures from construction workers. Some modest long-term employment opportunities. General reductions in fuel prices, improved industrial efficiency, and improved competitiveness of industry in the region, with on-going stimulation of business opportunity and development. 81

90 Negative impacts: there will also be some negative impacts from activities funded under the project as shown in following table. But none of the impacts identified and addressed in this assessment are likely to be major, sustained, or irreversible. Most of these impacts will occur during the construction phase only. All can be mitigated to some extent through good environmental planning and practices. All of the negative impacts can be mitigated satisfactorily by applying PGN s established standard operating procedures (SOPS) for design, construction and operation as presented below. Table 6.2 Likely Negative Impacts and Mitigation Measures of the West Java Gas Distribution Expansion during Construction Phase Traffic meters, buttemporary disruption of access from street to markets, businesses, factories, restaurants, residences will occur. Also, temporary increases in traffic for delivery of materials, and slow down of traffic in work areas will occur. At crossing points, there may also be some temporary interference with roads and railways. Other There is some risk during construction to existing Underground underground utility infrastructure, such as water Infrastructure supply and cables. will be by hand. Soil Erosion There is likely to be some storage, spillage, and erosion of excavated soil on private land adjacent to the route. Potential release of hydrostatic testing water and waste solids generated during construction on private land adjacent to the route. Air and Noise Pollution Water Pollution Solid Waste Construction will produce fugitive dust from topsoil removal, trench excavation and backfilling, and from storage of excavated soil adjacent to the excavated pipeline trench. Noise from construction -vehicles and equipment, materials loading and offloading, pipe cutting and welding, pipe stringing, etc. -- may cause nuisance wherever the pipeline passes near to homes and businesses. Rain and other of water from trenches may become contaminated with lubricants from vehicles and equipment that eventually flows into public drainage ways or directly to waterways. Water from pigging and hydrostatic testing is likely to be released to storm water drains in urban areas, or directly into waterways. Vegetation removal during site leveling and preparation Removal of concrete surfaces in urban and industrial areas Release of hydrostatic testing water may contain spent welding rods, mill cuttings, stones, and rubble. time. This section must be backfilled within 24 hours, and backfilling must occur before the next section is opened. Contractors are required to maintain public safety and smooth traffic flow at project sites. Local traffic control authorities will be informed in advance. Temporary bridge will be in place when necessary. The public will be informed about the work schedule and The project will be mainly implemented in the dry season. Everv effort will be made in advance to check with local authorities and itilities, and virtually all digging for the pipeline construction The construction will be mainly conducted in dry season. If heavy rains occur during excavation, the trench and piled soil from it is to be covered with plastic tarps. During excavation along public roadways, removed soils will be placed into patch boxes. Proper compaction of the restored soil is monitored by PGN s work site inspectors. Release of hydrostatic testing will be well managed according to PGN s procedures. Excavation will be done by hand shoveling; The use of patch boxes for holding the excavated soil. Spray water on dry soil if necessary. The pipeline excavation and installation will not use motorized equipment, which could generate high levels of noise. The delivery by lorries of piping and construction materials will be twice each hour or less at any one location. The project will be mainly implemented in dry season; All the hydrostatic testing will be conducted under PGN s supervision. The point of water release will be controlled by temporary plastic draining pipes and the rate of water release will be controlled to minimize the impacts on receiving rivers; During the construction stage: (i) for small rivers (width of 4 0 m), an overhead crossing with an I-beam design will be used; and (ii) for big rivers (width >lorn), a steel bridge will be installed for holding and supporting the pipes. In addition, pipe bridges will be installed alongside with existing roads. Most of the excavated soil and other solid wastes will be back-filled on site. Excess soil and other solid wastes will be removed from the site in standard woody boxes. Permission will be obtained from local authorities or private landowners for disposal as landfill. Pigging process will be carefully managed to produce least amount of solid wastes. 82

91 Socioeconomic Businesses are likely to suffer temporarily due to physical obstruction caused by construction activities. Increased risk of pedestrian injury from traffic accidents during construction due to physical obstruction or removal of walkways. Construction will be carefully planned to minimize disturbance to the local businesses; Measurable losses and damages of local businesses caused by the project will be compensated; The contractors will be required to maintain public safety and smooth traffic by preparing and installing required signs; The contractors will also be required to coordinate with local authorities to maintain public safety. Table 6.3 Likely Negative Impacts and Mitigation Measures of the West Java Gas Distribution Expansion during Operation Air and Noise Pollution Safety and Risks of Accident Likely Negative Impacts Durina ODeration, emissions from aenerators and relea& of natural gas (predominantly methane [CH.,]) from offtake stations are very unlikely, but might happen (very low probability). The odorizing plants will be in isolated locations, so Injection of THT (tetrahydrothiophene) to the gas is unlikely to cause any nuisance. Natural gas is flammable and explosive, so the operation of any natural gas pipeline poses risks. Safety risks can arise from: pipeline damage, with resulting release of natural gas; leakage through valves and flanges; leakage through fittings and regulators; and release of THT at the odorizing plant, including leakage from THT storage drums Mltigation Measures The five off-take stations are isolated awav from human habitation. Pipeline and offtake stations will be designed according to standards consistent with international practices to avoid leak There will be systems to detect and react to leaking rapidly. During the course of project preparation, and distinct from the EA and EMP preparation, safety aspects of PGN's overall operations and specifically for the project have been jointly reviewed by Bank experts and PGN staff. The pipeline will be designed to ASME Class 4 standard consistent with densely populated urban areas. The entire West Java gas distribution system is designed for compliance with the Indonesian Pipeline Standards, which is the equivalent of the American Society of Mechanical Engineers (ASME) Code B31.8 Gas Transmission and Distribution Systems (1 989 edition). PGN also uses the latest edition of the ASME code, supplemented by specifications and standards from the Institute of Gas Engineers and British Gas. In addition, PGN has established procedures and specifications covering construction, commissioning, operation 7. Environmental Management Plan EMP Purpose and Objectives In accordance with the requirements of the World Bank's OP4.01 on Environmental Assessment, this Environmental Management Plan (EMP) has been prepared for the project. The purpose of the EMP is as follows: 0 Provide direction to owners, contractors, operators and environmental regulatory agencies on environmental protection measures that need to be implemented to eliminate or reduce environmental effects of construction and operation activities of the proposed project; Delineate the requirements for environmental monitoring and inspection activities of the project sites, including identification of the group or agency responsible for monitoring or inspection, type of monitoring or inspection to be undertaken, parameters to be tested, monitoring and inspection schedule, and reporting requirements; and Identify organizations or institutions responsible for managing the environmental program, which will ensure environmental protection measures are properly designed and implemented, undertake environmental monitoring, and prepare environmental reports for the project. 83

92 Institutional Roles and Responsibilities PGN currently incorporates Indonesian EA procedures (AMDAL) into project planning and implementation wherever required. For the proposed project, PGN will establish a Project Implementation Unit (PIU) with overall responsibility for coordinating and managing the project, including environmental issues and an environmental coordinating office (ECO) to oversee and support the monitoring and mitigation activities is being developed at PGN s central office in Jakarta. The ECO will serve as the core unit to be strengthened under the environmental management capacity building program proposed in the EMP. During the project preparation stage, as the proposed project will pass through more than one provinces, its AMDAL process is overseen by the national level AMDAL committee chaired by the deputy minister of the Ministry of Environment and the Director of Environment of the Ministry of Environment is the secretary of the AMDAL committee. During the construction stage, any issues of environmental and social compliance, monitoring, and reporting would continue to be under the authority of the PIU. The implementation of AMDAL will be contracted out to contractors. All contractors will be monitored to ensure full compliance with Indonesian legislation and the approved EIA (including EMP). PIU will report to provincial (level 1) and regional (level 2) BAPEDAL quarterly for the implementation of AMDAL of the subprojects carried out by contractors in the regions and the provinces. Once construction is completed, responsibility for any continuing monitoring and reporting work is under the authority of the General Manager of the Strategic Business Unit 1 (SBUl) of PGN. Again, the General Manager of SBUl will report quarterly to the regional and provincial BAPEDAL for the implementation of AMDAL of the gas distribution system in the region and province. Monitoring During the construction phase, impact monitoring and mitigation activities will be one of the primary responsibilities of Site Manager. He is based in the field, directly overseeing the contractors who are carrying out the excavation and pipe-laying work. He will also frequently meet with local government officials, and will be recognized as the primary contact should any complaints or issues arise. On a monthly basis, the Evaluation and Reporting Manager, under the Project Administration Manager, will visit each construction site to observe progress and assess any problems from a more central perspective. Possible environmental and social impacts to be monitored are listed in following table. 84

93 Table 7.1 Possible Environmental and Social Impacts to be Monitored During Construction Traffic Congestion and Disruption: - excavation procedures - traffic flow and public safety - disruption of access to residents 8, businesses Soil Erosion: - use of patch boxes for soil storage - proper back filling and compaction - proper disposal of excess soil - restoration to original conditions Air Pollution: - incidence of fugitive dust problems Noise: - noise levels to be measured in response to any public complaints Disturbance to Other Underground Infrastructure: - excavation procedures Water Pollution and Run-off: - controlled drainage of testing waters Solid Wastes: - proper disposal of excess soil - proper disposal of other inorganic solid wastes - proper disposal of organic solid wastes Socioeconomic Issues: - timely excavation to minimize losses of access to businesses - prompt and transparent resolution of claims for losses - prompt resolution of any incidents among personnel or between workers and the community. After construction is completed, the pipeline will be operated by the West Java Strategic Business Unit primary on-going environmental concern is the risk of leakage, fire and/or explosion. PGN has well established sound design and safety monitoring systems based on inspections, preventive maintenance and emergency response preparedness. These will benefit from Bank support under the project. Reporting Reports based on the monitoring of construction under the project will also be the responsibility of the PIU. The Site Managers will report through the Construction Manager. Construction Manager will then evaluate the report and convey it to the Project Manager. The Project Manager will be responsible for submitting quarterly and special reports on general construction progress and any construction problems that may affect the local environment or community. These are required under the RPL, the Rencana Pernantauan Lingkungan - the Environmental Monitoring Plan. They are submitted to the Central AMDAL Committee, from where they are then circulated to local environmental officials. The Project Manager will share these reports with all members of the ECO, as well as with the World Bank. Actual preparation of the Project Manager s reports will generally be done by the Evaluation and Reporting Manager. 85

94 In addition to the quarterly reports, prepared in Bahasa Indonesia in fulfillment of AMDAL reporting requirements, the PIU, with the support of the ECO will, prepare bi-annual environmental summary reports, to be submitted in English to the World Bank. This report would include: 0 a summary of significant mitigation measures, if any, undertaken during the previous six months; a description of any significant problems or successes in environmental mitigation during the period; and anticipated notable environmental or social events anticipated during the coming six months. In addition to these environmental management reports, it should be noted that PGN has standard procedures for reporting on safety and emergency response incidents. These include: 0 incidenvaccident reporting; 0 response in the event of incidents/accidents; and 0 gas escapes. PGN compiles accidenthcident statistics on a monthly and annual basis. This information is submitted to Directorate General for Oil and Gas (Bahasa: Direktorat Jenderal Minyak dan Gas or Dirjen MIGAS). For the duration of the World Bank loan, these reports will be summarized and included in the bi-annual environmental reports submitted to the World Bank. Thus the basic outline of the bi-annual reports on environmental monitoring for the project will include: Technical support to establish Environmental Coordinating Office (ECO) In order to establish firmly the ECO s capacity to support environmental efforts company-wide, a 5-year program of technical and capacity building support has been prepared by PGN as shown in following tables. The program will be fully funded by PGN. 86

95 Table 7.2 Training Program for ECO Environmental Introduction for Executive and SBU* = Strategic Business Unit Level B EIA certification is required for an EIA compiler and higher than level A. Level B certification is prerequisite for higher level training. The remain budget for Environmental Coordinating Office is expended for consultant (international and domestic), document procurement, and equipment (computer, etc) 87

96 No. Table 7.3 Training Schedule Year Title Public Consultation and Disclosure Three public consultations were undertaken by PGN in July, September 2002 and April Participants included the heads of both provincial and regency-level environmental planning boards (Bapedal Tingkat I and II) as well as a cross section of regional and local representatives of stakeholder groups: government agencies, local people, local businesses, NGOs, and academics. Major issues discussed include the implementation of EIA, the coordination with relevant authorities, impacts of the project on local communities, interests of local communities, gas market development, customer service, and safety issues during the project operation stage, etc. The scope of the proposed project (including pipeline routing and proposed location for offtake) has never been revised since April In addition, PGN also conducted the socialization with the local affected people in (a) Zone 1 (Greater Jakarta), which was held on September 28, 2004 at the Head of Bekasi District office; (b) Zone 2, on 13, 19, and 20 of August 2004 in Balaraja, Cikande, and Kramat Watu respectively: and (c) Zone 3, on September 29, 2004 at Wisma PGRl of Karawang. Informal interviews of local people on the roadside in various sites along the project route were conducted in Some 21 YO of the respondents were supportive of the project and thought it will be good for local development. About 12% felt that such a project would create too many negative impacts (mainly traffic problems). About two thirds (67%) were neutral. Respondents strongly suggested that construction work should be performed as fast as possible, so as to minimize disturbance on traffic. The project also was announced and publicized in the local and national newspapers. The next stage of consultation will occur during the final detailed design and planning that will follow confirmation of financing for the project through the loan agreement with the World Bank, As indicated in the informal public surveys carried out during the preparation of this EIA, the general impacts and disturbances of public works projects are well known. In the next stage, once the project is confirmed and specific customers and routes are confirmed, public consultations will be scheduled in the individual kecernatan (sub-districts) where the route would pass. 88