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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Projects Department East Asia and Pacific Regional Office Document ot The World Bank FOR OFFICIAL USE ONLY STAFF APPRAISAL REPORT INDONESIA FOURTEENTH POWER PROJECT May 25, 1984 Report No IND 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 autborization.

2 CURRENCY EQUIVALENTS Currency Unit - Indonesian Rupiah (Rp) US$1 = Rp 1,000 Rp 100 = US$0.1 Rp 1 million = US$1,000 GOVERNMENT OF INDONESIA AND PLN FISCAL YEAR (FY) April 1 - March 31 WEIGHTS AND MEASURES 1 metric ton = 1,000 kiiograms (kg) 1 liter (1) = barrels (bbl) 1 kilometer (km) = miles (mi) 1 kilovolt (kv) = 1,000 volts (v) 1 megavolt-ampere (mva) = 1,000 kilovolt-amperes (kva) 1 kilovolt-ampere (kva) = 1,000 volt-ampere (VA) 1 megawatt (MW) = 1,000 kilowatts (kw) 1 gigawatt hour (GWh) = 1 million kilowatt hours (kwh) ABBREVIATIONS BAKOREN - National Energy Board BAPPENAS - National Development Planning Board BWI - Beka-Worley International of New Zealand DGEP - Directorate-General of Electric Power, Ministry of Mines and Energy EHV - Extra High Voltage JABOTABEK - Jakarta, Bogor, Tangerang and Bekasi area LNG - Liquified Natural Gas LRMC - Long Run Marginal Cost MIS - Management Informacion System LSME - Ministry of Mines and Energy MONENCO - Montreal Engineering Company cf Canada/UK PCR - Preece, Cardew and Rider of the UK PERTAMINA - National Oil and Gas Company PLN - National Electricity Authority PMAS - Project Management Advisory Service PUSDIKLAT - PLN's Center for Education and Training RE - Rural Electrification SEKNEG - Central Procurement Committee

3 FOR OFFICIAL USE ONLY INDONESIA FOURTEENTH POWER PROJECT STAFF APPRAISAL REPORT Table of Contents LOAN AND PROJECT SUMMARY Page No. I. ENERGY SECTOR AND ELECTRICITY SUBSECTOR Energy Resources Natural Gas... 1 Coal... 1 Hydroelectric... 2 Geothermal... 2 Institutions in the Energy Sector Bank Role and Strategy... 3 The Electricity Subsector... #... 4 PLN's Organization PLN's Facilities PLN's M4arket... 5 Long-Term Development Plan... 5 Bank's Earlier Operations and PLN's Performance... 6 II. THE POWER MARKET AND THE DEVELOPMENT PROGRAM... 7 Present Consumption and Access to Service. 7 PLN's Installed Capacity.. 7 Power Market Survey.. 7 Projection of PLN's Sales. 8 Long-Term Development Plan.. 8 III. BENEFICLARY... 9 Status, Responsibilities and Organization.. 9 Growth and Constraints.. 10 Management Development.. 11 Planning.. 11 Project rianagement.. 11 Management Information System.. 12 General Management.. 12 Manpower Development.. 13 Accounting and Budgeting.. 14 This report was prepared on the basis of the appraisal carried out by V. P. Thakor (Senior Power Engineer) and J. Chang (Financial Analyst) during November/December 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.

4 - ii - Page No. Billing and Collection Audits Insurance IV. THE PROJECT...o Project Objectives Project Description Suralaya Steam Power Plant Coal Supply... 0* 17 _ Transmission and Distribution Distribution Hydro Studies Cost Estimate -... o Financing Plan Engineering and Construction Procurement Implementation Schedule Disbursement Monitoring and Reporting o Ecology V. FINANCIAL ANALYSIS Past Results Present Position Fuel Prices Tariff Issues o..o...oo oo.. e 26 Financing Policy Performance Monitoring Fiuture Performance Asset Revaluation Corporate Taxes.. 33 VI. JUSTIFICATION o... o... O.. 33 Demand Growth and Need for the Project... o Least Cost Solution... o V.. 33 Distribution Economic Rate of Return Risks VII. AGREEMENTS REACHED AND RECOMMENDATIONS o... 35

5 - iii - ANNEXES MAPS 1. PLN's Investment Program 2. Growth of PLN's Consumers and Sales 3. PLN's Sales Projections 4. Peakload, Production and Installed Capacity - PLN Region: Java 5. Peakload, Production and Installed Capacity - PLN Region: Outside Java 6. Organization Charts for DNE and PLN 7. PLN's Performance Indicators 8. Growth of Captive Power in Indonesia 9. Scope of Distribution Project Proposal 10. Hydro Projects proposed for Engineering and Design Studies 11. Cost Estimate Table 1 Suralaya Units 3 and 4 Table 2 Distribution 12. Implementation Schedule for Suralaya Units 3 and Implementation Schedule for Distribution Projects 14. Disbursement Schedule for the Bank Loan 15. PLN's Financial Statements - Past Financial Results and Forecasts 16. Notes and Assumptions for the Financial Forecasts 17. PLN's Fuel Consumption Statistics 18. PLN's Tariffs 19. Financial Sensitivity Analysis 20. Generating Capacity Requirements in Java 21. Calculation of the Internal Economic Rate of Return (IERR) Table 1 Suralaya Units 3 and 4 Table 2 Jabotabek Distribution Project 22. Documents in the Project File IBRD 12453R4 IBRD 17207R

6 INDONESIA FOURTEENTH POWER PROJECT Loan and Project Summary Borrower: Beneficiary: Amount: Terms: Onlending Terms: Project Description: Republic of Indonesia Nationial Electricity Authority (PLN) US$210.0 million equivalent (including the capitalized front end fee) Repayable in 20 years including 5 years' grace, at the standard variable interest rate The proceeds of the loan will be onlent from the Government of Indonesia (GOI) to PLN for 20 years including a grace period of 5 years; the onlending rate will be equal to the Bank's standard variable interest rate plus no less than a quarter percent for administration charges. The GOI will bear the foreign exchange risk. The project supports the twin objectives of the expansion of power supply facilities in Indonesia to meet the demand and the development of alternate sources in the energy sector by the construction of 2 x 400 MW coal fired units 3 and 4 at Suralaya steam power plant in West Java. It also includes expansion of the distribution facilities in East and Central Java and in the Jabotabek (Jakarta, Bogor, Tangerang and Bekasi) area. About 400,000 residential consumers in urban and rural areas will receive supply. Simultaneously, the project will address the institutional development needs of PLN. Consulting services for hydropower and transmission development are also included. There is a risk of delay in the Suralaya project due to a delay in finalizing the critical steam generator contract or constraints on local funds. Suitable agreements have been reached with the Government and PLN to reduce these risks. There is no unusual risk associated with the distribution component of the project.

7 Cost Estimate:/a (US$ million) Local Foreign Total 1. Suralaya Units 3 and Distribution in East and Central Java and Jabotabek areas Consulting services for (a) Transmission lines (b) Hydro studies Total Base Cost Physical contingencies Price contingencies Total Project Cost /b Interest during construction Bank loan Others Front end fee on Bank loan Total Financing Required (US$ million) Financing Plan Local Foreign Total Ci) IBRD: Loan 2214-IND Proposed loan Cii) Suppliers' credit (iii) GOI/PLN /c Total Estimated Disbursement: FY85 FY86 FY87 FY88 FY89 FY US$ million--- Annual Cumulative Rate of Return: 28Z for Suralaya units 3 and 4 and 20% for the Jabotabek distribution, which together constitute 86% of the project costs. /a The costs are net of taxes and import duties as PLN is exempt from them. /b Inclusive of US$294.4 million for Suralaya Unit 3, for which US$54 million was provided under the Twelfth Power Project (Loan 2214-IND). Total project cost net of Suralaya Unit 3 is US$362.3 million equivalent. /c Comprises interest during construction.

8 I. THE EvMERGY SECTOR AND ELECTRICITY SUBSECTOR Energy Resources 1.01 Indonesia is richly endowed with energy resources including oil, natural gas, coal, hydropower and geothermal energy. Oil and natural gas now account for almost all of total commercial energy consumption. While undiscovered oil reserves are estimated at billion barrels, proven resources are 9.5 billion barrels. Unless massive new reserves are discovered, production capacity is unlikely to increase beyond 1.9 million barrels per day. GOI has therefore adopted a policy of promoting alternative indigenous energy sources- Natural Gas 1.02 The estimated natural gas reserve is 69 trillion cu ft (TCF) - of which 85% is non-associated and can be developed independently of oil. However, reserves are generally located away from population and industrial centers. The Arun field in North Sumatra has 17 TCF and Natuma in the South China Sea, 35 TCF. Production of natural gas reached 998 million cu ft in Half of this was exported as LNG to Japa%,from Arun and Badak. LNG production is expected to double by 1985 to 15 ' million tons per year and to reach 28 million tons by Gas pipelines have been laid to domestic steel and fertilizer factories and domestic consumption is expected to increase by 15% every year. Coal 1.03 Indonesia's coal reserves are believed to be as high as 20 billion tons, mostly located in West and South Sumatra and Kalimantan. While production is currently about 450,000 tons per year, major increases are planned by GOI. Coal will become the major source of fuel for the power sector as major thermal plants come on line in the 1980s. Work started early in 1982 on a 3.0 million ton per year mine at Bukit Asam in South Sumatra and on a 0.6 million ton per year mine at the nearby Muara Tiga coal field. Muara Tiga has reserves to permit an increase in production to 2.5 million tons per year by A program to raise the coal production at Ombilin in West Sumatra to 1.3 million tons per year is also being implemented by GOI. In addition, in 1981, GOI entered into a number of production-sharing agreements with private foreign and Indonesian joint-venture companies for exploration and exploitation of Kalimantan coal reserves. Exploration is now in progress. 1/ 1 TCF of gas = 24.7 million tons of oil equivalent. 2/ 1 ton of LNG = 1.2 tons of oil equivalent.

9 -2- Hydroelectric 1.04 Indonesia's total hydroelectric resources are large but development is limited by their geographic distribution relative to demand. The greatest potential (over 35%) lies in Irian Jaya where the demand is less than one percent of total domestic demand, while Java, which accounts for 80% of the current demand, has less than 10% of the total potential. Existing hydroelectric installations aggregate to 1,312 MW; they are located mainly in Java (489 MW), Sumatra (612 MW), and Sulawesi (181 MW). Schemes with an aggregate capacity of about 1,500 MW are currently under construction. PLN assisted by Nippon Koei of Japan has carried out a systematic countrywide resource survey using funds from IBRD Loan 1365-IND, which has led to an inventory of hydroelectric sites, which is being followed up with various prefeasibility and feasibility studies of the promising hydroelectric sites; prefeasibility studies of 21 such hydro schemes and feasibility studies for five schemes are also being financed under Loan 1365-IND. In addition, prefeasibility studies for 20 sites and feasibility studies for 6 sites will be financed under Loan IND. Geothermal 1.05 Surface manifestations of geothermal energy are found on all islands except Kalimantan, but only a few sites have been investigated and only one, Kamojang in West Java, has been delineated. It is believed that potential reserves may approach 10,000 MW distributed as follows: Java 5,500 MW; Sulawesi 1,400 MW; Sumatra 1,100 MW; other islands 2,000 MW. GOI, in collaboration with the Government of New Zealand, initiated development of Kamojang field in The first 30 MW generating set was commissioned for commercial operation in January 1983; the twelfth power project (Loan 2214-IND) provides for the expansion of the station by 110 MW. In 1982, PERTAMINA (The National Oil and Gas Company) entered into a joint operation contract with Union Geothermal, a subsidiary of Union Oil of California, for development of the Salak field in West Java. Exploration is in progress. GOI has announced its intention to lease other sites to successful bidders, to accelerate the development of geothermal energy. Institutions in the Energy Sector 1.06 The principal agency responsible for the implementation of GOI policies in the energy sector is the Ministry of Mines and Energy (MME). IME was established in 1978 to coordinate all activities in the energy sector and control the three state enterprises responsible for the execution of GOI policies in the energy subsectors; PERTAMINA for oil and gas, P.N. BATUBARA for coal and PLN for electricity. Other ministries and agencies are also involved in the sector: for example, Public Works primarily deals with hydropower resource surveys, Agriculture oversees forestry products, and the National Atomic Energy Commission is responsible for nuclear development. In order to ensure appropriate coordination of energy policy an inter-ministerial National Energy Board (BAKOREN) to oversee sectoral development was established. It is also proposed to establish an energy planning unit in the MME; a decision for its establishment is expected soon.

10 -3- Bank Role and Strategy 1.07 The Bank has been actively involved in some of the sectoral developments described above. During 1981, at the invitation of GOT the Bank/UNDP carried out a detailed assessment of the Indonesian energy sector, identifying policy options and analyzing investment priorities to provide a framework for technical assistance and advice to GOI on institutional aspects. The results have been incorporated in a report (No. 3543, November 1981) entitled "Indonesia: Issues and Options in the Energy Sector." This report confirmed earlier findings that alternatives for oil must be developed quickly for electricity generation, and recommended that this strategy should be extended to industry, transportation and households. It further pointed out that subsidized oil prices, weak institutions, manpower shortages and a lack of detailed energy sector planning were the chief obstacles to rapid substitution of oil Subsidized petroleum product prices caused serious distortions in the economy by failing to reflect the opportunity cost of these products. The effects of this have been to favor the use of oil over other competing fuels, to promote domestic consumption over exports and, because the degree of subsidy between oil products was uneven, to distort demand between individual petroleum products. The Bank has had a continuous dialogue with GOI on the question and has highlighted the consequences of this policy through its economic and sector work. In 1983, the Bank prepared a study entitled "Indonesia-Selected Issues of Energy Pricing Policy" (Report No IND) to analyse the policy options and their implications. In the last three years, OI has taken bold steps to increase the domestic price of petroleum fuels, the last being in January 1984, increasing average prices by 35%, which followed increases of about 60% each in January 1982 and These have now eliminated the differential between average domestic prices and the average economic price. Currently the prices for aviation fuel and regular gasoline are 125% and 150% of international levels, the prices of diesel and fuel oil are slightly above the international levels whereas the price for kerosene is about 64% of the international level (Annex 17, Table 3). The weighted average of domestic prices is now about the same as the average international price of a comparable bundle of petroleum products. The coal pricing issue was addressed under the Bukit Asam project (Loan 2079-IND), wherein it was agreed that Bukit Asam coal would be priced at no less than 80% of the international price for comparable coal The Bank is also providing assistance for institutional development in the energy sector. Under the seventh power project (Loan 1513-IND) a consultant, PA International of the UK, designed a management information system for all activities of the Directorate General of Electric Power (DGEP) which will be implemented during the next three years. In addition, a ilumber of assistance efforts have been devised for PLN in such important areas as planning, construction, accounting, manpower development and training, and are mostly financed with Bank funds (para. 3.05). Furthermore, in the coal subsector, various steps are being initiated for institutional and manpower development under Bank-assisted projects: the Bukit Asam Coal Mining Development and Transportation Project (Loan 2079-IND) and the Coal Exploration Engineering Project (Loan 2153-IND).

11 1.10 The magnitude of investments necessary to implement GOI's policy of diversification of energy sources is large. The Bank has estimated that the annual investments in the energy sector will increase from about $1.27 billion in 1980 to about $10 billion (at 1980 levels) in the year About half of these will be directly in the electricity subsector. The Bank's lending strategy for energy is to continue its support for the investment program in the electricity and coal subsectors during the next few years with a focus on steps to strengthen the institutions and develop manpower resources. Additionally, future projects may be developed in city gas/lpg production and natural gas utilization to assist GOI's energy diversification policy. Studies for gas/lpg production and natural gas utilization are being financed under the Fifth Technical Assistance Project (Credit 898-IND). The Electricity Subsector 1.11 The electricity subsector is regulated by MME through the DGEP. It comprises (a) PLN, (b) captive plants installed by private parties for their own use, (c) some small municipal franchises, and (d) a small number of cooperatives which were set up to provide electricity in certain rural areas remote from PLN supply systems. Legislation was enacted in 1979 to provide for private and cooperative franchise participation in the electricity sector. PLN's Organization 1.12 PLN is a public corporation (Perum) constituted under Presidential Decree No. 18 of 1972, with responsibility for the generation, transmission and distribution of electricity and the planning, construction and operation of electricity supply facilities. PLN is managed by a board of directors headed by a President Director, who is appointed by the President and is accountable to the Minister of Mines and Energy. The President Director has authority for all day-to-day operations of PLN. The board currently includes five other directors with functional responsibility respectively for planning, construction, operations, finance and administration. Operational responsibility devolves to 17 regions, and responsibility for major construction to 14 project managers. Also reporting to the board are several staff units responsible for power research, education and training, management services, an audit unit called the Corporation Inspectorate, and the Java system operation and control unit. OLN's Facilities 1.13 PLN is the dominant executive agency in the electricity subsector. In 1983, it had 3,253 MW of installed generating capacity - 1,356 MW of steam (oil fired), 787 MW of gas turbines, 502 MW of diesel, 578 MW in hydroelectric and 30 MW of geothermal (para. 2.02). PLN also operates over 8,000 km of transmission lines at 70 and 150 kv and about 35,000 km of distribution lines, the bulk of which are in Java. Java now has a fully interconnected grid at 150 kv. By early 1985, a 500 kv system covering West and Central Java will be commissioned; it will be extended to East Java by 1987.

12 -5- PLN's Market 1.14 A study to assess potential demand in Java (which presently accounts for about 80% of total electricity consumption) was undertaken in by Preece Cardew and Rider Consultants (PCR) of the U.K. financed under Credit 399-IND. It showed that the underlying demand was so large that PLN's sales growth would be limited only by its ability to supply until about 1990; only thereafter would it be limited by growth of the market itself. From 1976/77 to 1981/82, PLN's sales increased annually by an average of about 21%. The sales growth in 1982/83 slowed to 16%, partly due to economic recession and part'y due to budgetary constraints which slowed down the program of connection of new consumers. Long waiting lists for new service connections and the relatively low level of electrification are such as to sustain a high rate of growth of sales; the system is still supply constrained. The present projections are that PLN's sales will grow at an average rate of 19 to 20% p.a. for about five years and then gradually slow down to about 16% p.a. (para. 2.06). Long-Term Development Plan 1.15 PLN follows a practice of preparing a long term development plan to cover the projected requiremuents of generation, transmission, distribution and other facilities. The latost plan reviewed by the Bank in December 1983, covering the development period 1983/84 to 1993/94, shows generating capacity increasing from 3,253 MW in 1982/83 to over 14,000 MW in 1993/94. The major growth will be achieved by the construction of coal fired thermal, hydro and geothermal plants, reducing the share of oil-based electricity generation from 81% currently to about 27% in 1993/94 (para. 2.07). It is a balanced program which supports a vital part of the GOI's objective of reducing the domestic usage of oil. The total investment for the program is estimated to be about $21.0 billion in constant 1983 prices; the investment requirements will rise from $1.0 billion in 198zj83 to $2.5 billion in 1993/94 (Annex 1). While the demand for electricity exists and PLN appears capable of expanding its organization to implement such a program, a major constraint may develop in mobilizing the required finances ic the macroeconomic situation does not improve within the next 2 or 3 years. The program objectives will therefore have to be kept under continuous review, though the development targets have been approved by the Government. The Bank is proposing a detailed review of the PLN's investment program in 1984/85 (para. 2.08) In order to achieve the objective of rapid electrification and ensure soundness of the development program, the Bank has the following agreements with the GOI and PLN, which will be continued in the proposed loan: (a) PLN will prepare, review with the Bank and implement a customer connection program each year; (b) PLN and GOI will review annually with the Bank PLN's development plan and investme-.t budget to enable the Bank to express its views on the priorities and the balance among the generation, transmission and distribution investments; and

13 - 6 - (c) The Government will provide sufficient funds to finance PLN's capital expenditures as reviewed and agreed with the Bank. Bank's Earlier Operations and PLN's Performance 1.17 Since 1969, for a total of thirteen projects, the Bank Group has provided $1,869 million for power generation, transmission and distribution facilities. Four distribution projects (Credits 165-IND and 334-IND, and Loans 1259-IND and 2056-IND) rehabilitated and expanded the distribution facilities in the greater Jakarta area. Nine power projects (Credit 399-IND and Loans 1127-IND, 1365-IND, 1513-IND, 1708-IND, 1872-IND, 1950-IND, IND, and 2300-IND) -nere undertaken to help PLN expand electricity generation capacity in Java, to provide a strong all-java 500 kv grid, to reduce system transmission and distribution losses and to introduce a program of mini hydro development in Sumatra. PPAR's on the first two projects (Credits 165-IND and 334-IND) have been issued and the lessons learned from these operations have been applied to subsequent operations. They relate mainly to timely appointment of consultants, effective supervision, and lending as late as possible in the project cycle. PCR for the third and the fourth power project has been completed and tl-e PPAR for them is under finalization PLN's implementation capacity has grown vastly since the Bank's early association with it. All Bank financed projects have been or are being implemented as designed and have generally been within the estimated cost. However, delays of the order of six months to two years in implementation have been experienced compared to the appraisal estimates (paras and 1.20). Growing size and complexity of the projects coupled with cumbersome Government procedures for the award of contracts, opening of letters of credit, budget approvals etc. have been responsible for most delays. It is also relevant to note that the implementation schedules for the Bank financed projects have generally been optimised to international standards with little slack to accommodate procedural delays The earliest generation project (Credit 399-IND) covering 2 x 100 MW units at Muara Karang was completed about two years behind schedule. The subsequent extensions of this plant (Loan 1127-IND and 1365-IND) were completed about one year late. Extension of the Semarang power station by a 200 MW unit (Loan 1513-IND) was about 18 months behind the appraisal schedule; the construction of a new coal/oil fired station with 2 x 400 MW units (Loans IND and 1872-IND) is about ten months late for the first unit and about six months late for the second unit Two large hydro projects at Saguling (700 MW) and Cirata (500 MW) are being funded by Loans 1 50-IND and 2300-IND. Physical progress of construction at Saguling was poor at the start but is now proceeding satisfactorily. Completion of the Saguling dam is expected close to the appraisal target though the commissioning of the power station will be delayed by about six months due to landslide problems in the power house area and delay in tunnel constructions. The start of construction of the main civil works of Cirata project (Loan 2300-IND) was delayed by four months due to delay in the Government approval of the Consultants contract for construction supervision, though all major construction contracts were awarded in time.

14 1.21 Progress of implementation of transmission and distribution covered by the eleventh power project (Loan 2056-IND) is satisfactory. Also the progress of various components of the twelfth power project (Loan 2214-IND) such as Kamojang Geothermal, the loss reduction program and mini hydro projects is satisfactory; however, the impltmentation of Suralaya Unit No. 3 is delayed due to financing constraints (para. 4.16). II. THE POWER MARKET AND THE DEVELOPMENT PROGRAM Present Consumption and Access to Service 2.01 The per capita electricity consumption in Indonesia in 1983 was only about 115 kwh, which is almost a third of that in Thailand and the Philippines. Only about 10% of all households have electricity; the degree varies from about 12% in Java, to about 10% in Kalimantan and Sulawesi, 8% in Sumatra and 6% in the other islands. PLN's share of total electricity production which was about 50% until 1977/78, grew to 67% by 1982/83. In Java, PLN now accounts for about 74% of the market. PLN's total sales in 1982/83 were 9,101 GWh out of which 7,217 GWh (79.3%) were in Java. PLN's Installed Capacity 2.02 PLN's total installed capacity by end 1982/83 was 3,253 MW, out of which 2,458 MW (76%) was in Java. Nearly 81% of the capacity uses petroleum fuels. Table 2.1 shows the breakdown of the generating capacity in Java and outside Java. Table 2.1: PLN'S GENERATING CAPACITY (MARCH 31, 1983) (MW) Type Java Outside Java Total (X) Steam (oil) 1, , Gas turbines Diesel Hydro Geothermal 30.0 _ , , Power Market Survey 2.03 A detailed power market survey for Java carried out in (para. 1.14) concluded that growth in the short and medium terms depended on the rate at which PLN could build up supply facilities. After detailed review of the various aspects, including the necessity of rapid growth in PLN's

15 - 8 - institutional capability, an agreement was reached between the Bank and GOI in 1978 on the sales forecasts to be adopted in Java for planning purposes up to Also, as a necessary instrument of meeting its sales targets, PLN agreed with the Bank that it would prepare, discuss with the Bank and actively implement each year a consumer connection program consistent with its improving capabilities. As a consequence, the number of consumers grew from 1.2 million in 1976/77 to 3.8 million in 1982/83 and sales grew from 3,082 GWh to 9,101 GWh in the same period, which is a compound rate of growth of over 21% for consumers and 20.0% for sales. Annex 2 gives the details. The sales growth in Java for the same period was from 2,500 GWh to 7,217 GWh, an average rate of 19.3% p.a In the tenth powt. project (Loan 1950-IND), PLN agreed to build its own expertise for the power market survey and demand forecasting. It has set up a section for this purpose which is assisted by Preece Cardew and Rider (PCR) of the U.K., who were the consultants for the Java study in Work on surveys and building up of an information system commenced in mid- 1983, in which the headquarters as well as the wilayahs (regions) are involved. The demand forecasts on short and medium term will be constructed by microsurveys and the long-term projections will be reconciled with macroeconomic projections. This effort is expected to lead to the first set of revised projections by the end of 1984 which will then be updated annually An agreement has been reached with the Government that it will furnish to the Bank by December 31, 1984, procedures to ensure coordination of relevant departments and agencies such as PLN, MNE, BAPPENAS, etc. in providing policy guidance to PLN's power market survey group and reviewing and approving forecasts prepared by them, so that such demand forecasts form the basis of PLN's long-term planning. Projection of PLN's Sales 2.06 During the appraisal of the proposed project, the Bank mission reviewed the forecasts for Java based on the preliminary information compiled by the power market survey group of PLN, assisted by PCR. Forecasts for electricity sales in Java for short and medium terms were constructed with the available data of (a) connection program of residential consumers; (b) waiting list of industrial consumers; (c) program for changeover of captive generation to PLN supply and (d) an assumption of an average GDP growth of 5% p.a. It was concluded that the sales in 1983/84 are likely to fall short of PLN's forecasts on account of a slowdown in the connection program due to budgetary constraints and material shortages as well as general economic recession. However, it was concluded that the unsatisfied potential demand contributed by factors (a), (b) and (c) was still large and a high rate of growth in demand would continue if supply facilities are suitably expanded. Annex 3 shows the projections which are considered reasonable. Long-Term Development Plan 2.07 During the appraisal of the proposed project in December 1983, PLN's development plan (para. 1.15) was reviewed, taking into account the latest status of ongoing projects. The generation programs for Java and other

16 - 9 - islands are summarized in Annexes 4 and 5. Table 2.2 summarizes the expected generating capacity in 1993/94. Annex 1 contains the corresponding investment requirements. Table 2.2: PLANNED GENERATING CAPACITY IN 1993/94 (MW) Type Java Outside Java Total X Steam (a) Oil 1, , (b) Coal 4, , Gas turbines Diesel - 1,580 1, Hydro 2,614 1,432 4, Geothermal ,230 4,267 14, The physical features of the investment program in Java and the balance between generation, transmission and distribution facilities are fully justified. Also PLN should be able to implement the program substantially, given the necessary financial resources if it continues to maintain the impressive progress of its institutional growth. The same confidence cannot be extended to the proposed investment in the rural electrification program, which is not based on sufficiently detailed studies. Also the investment program outside Java has not been reviewed in depth by the Bank for its optimality. It is proposed to carry out a detailed review of PLN's investment program in 1984/85 to address these and other issues such as role of captive generation and rural energy needs. III. THE BENEFICIARY Status, Responsibilities and Organization 3.01 The borrower of the proposed loan would be the Government of Indonesia (GOI) and the beneficiary would be PLN, the wholly government-owned public utility in Indonesia PLN was established in 1961 as a department in the Ministry of Public Works, after the consolidation of three Dutch-owned electricity corpanies. In 1972, PLN was constituted as an autonomous public agency under ':M (para. 1.12). MME's and PLN's headquarters and regional organizational charts are given in Annex 6.

17 PLN's major policies and programs - including its investment plans, budgets and tariffs - are subject to review by a supervisory board, established in 1981 and chaired by the DGEP, and ultimately to approval by GOI. PLN is also bound by a number of GOI procedures affecting all public sector enterprises. Growth and Constraints 3.04 Over the past years PLN has grown impressively from a department of a Ministry, unable to meet even half the country's demand and leaving industries and commercial establishments to install their own captive power plants, to become the largest public utility in the country. During the period 1971/72 through 1976/77, growth of PLN's sales averaged about 12% p.a., whereas captive plants grew at a higher rate of 15% to 20% p.a. Since 1977/78, PLN has connected new consumers at an average rate of about half a million every year, and its sales increased annually by an average.rate of about 20% for the period 1976/77 to 1982/83. Performance indicators such as the number of consumers per employee and the energy sold per employee improved. Transmission and distribution losses were reduced and standards of reliability of supply improved. Annex 7 gives some of the performance indicators for PLN for the period 1977/78 to 1982/83 which illustrate this trend. The growth of uneconomic captive plants in the country also declined rapidly during this period (Annex 8) Inevitably, such rates of growth have caused considerable strain on PLN's management. Areas in which a need for strengthening has been recognized as a condition of maintaining the rate of growth are summarized below: (a) Management development: the need for a more comprehensive corporate management system and planning process. Also identified is the need to strengthen PLN's engineering and project management capabilities, including project preparation, design, progress supervision, cost control and procurement arrangements; (b) Manpower development: the need for improved manpower planning and enhanced training facilities, including managerial training; and (c) Accounting and budgeting: the need to rebuild the accounting system to provide accurate and timely information, and develop the budgeting system into a useful tool of management control During the past few years, considerable attention has been given to improvements in PLN's management and institution. Technical assistance is either already underway or planned, in many cases with the support from the Bank; these are discussed in the paragraphs below.

18 Management Development 3.07 The Bank has many technical assistance programs included in its ongoing projects with PLN. These programs, as summarized below, are designed to support PLN's effort to deal with its management problems which can be grouped into four major areas, viz., planning, project management, management information system and general management. Planning 3.08 Through the years, weakness has been identified in the coordination of PLN's overall planning activities. The planning process for its development program has not been supported by complementary demand analysis and PLN's own manpower and financial planning. To address this problem, PLN set up a corporate planning unit in 1981 and a market survey unit in 1982 with Government agreeing to provide necessary policy guidelines and data to PLN for improving the quality of the survey results (para. 2.04). Further institutional improvement in the market survey area is included under the proposed project (para. 2.05). As agreed under the eleventh power project (Loan IND), PLN prepares a rolling 10-year financial forecast and financing plan based on its long-term investment program (para. 5.15). The manpower development planning issue was addressed under the twelfth power project (Loan 2214-IND) (para. 3.18) The corporate planning unit, which was established to improve the coordination of planning activities among various departmental and regional units, is not yet operating as it should, mainly because of a shortage of trained staff to effectively take up the responsibility. PLN has prepared a program for the training of its senior technical staff which was reviewed by the Bank and found generally satisfactory. Details are being developed. Project Management 3.10 Since PLN has undertaken a number of large thermal and hydro projects, delays have been occurring in their implementation. The weaknesses identified in this area include: (a) undefined and fragmented responsibilities; (b) inadequate monitoring of progress; (c) inadequate financial control of expenditures and project costs; (d) lack of uniform design standards; and (e) long delays in procurement and disbursement actions. Under the eighth power project (Loan 1708-IND), the Bank financed a Project Management Advisory Services (PMAS) assignment which specifically addresses all aspects of project management. The project cost and progress reporting system recommended by the PMAS is now being implemented. The directors of construction and planning of PLN and a number of their managers completed in 1983 a program of familiarization with current project planning and control techniques organized by the consultants in the UK. PLN has recently set up a Central Project Services Group in the Directorate of Construction to monitor the progress major projects and liaise with field organizations. A project liaison officer is being designated for each of the major projects. Various other steps have also been initiated.

19 Responding to the slowdown in the pace of disbursements on earlier loans, during early 1982 a system of monitoring of disbursement performance of Bank loans on a monthly basis was established to enable the Management to identify the causes of slippages and to take timely remedial steps. The system is not yet working satisfactorily. The preparation of the monthly statements is not on time and has been unduly delayed recently due to the transfer of responsibility for them from the Construction to the Finance Directorate. These delays are expected to be a short-term phenomenon and should improve once the new staff become familiar with the procedures involved. Other external factors causing disbursement delays involve complex and lengthy procedures for the approval of contracts, issue of letters of credit etc. These factors apply to other sectors as well, and the Bank has taken up these matters with the Government Under the twelfth power project (Loan 2214-IND), PLN was expected to prepare an action plan by January 1984, to improve the efficiency of procurement administration, for which responsibilities are fragmented and expertise in certain specialized areas is weak. During the appraisal of the proposed project, the question of reorganization of PLN's departments for more effective project implementation capability was discussed. In view of the various deficiencies discussed in para. 3.10, it was agreed with PLN that, in the interest of integration of expertise and optimum use of scarce skilled manpower, PLN should aim to unify project formulation, engineering, design, procurement, and construction monitoring under an Engineering Services Center. PLN has formulated plans for such a reorganization which are acceptable to the Bank. An action plan for the implementation of these proposals has also been agreed, according to which the Engineering Services Center will be set up by March 31, 1985 and suitably staffed thereafter. Management Information Systems 3.13 Currently, PLN is developing information systems in the following areas, some of which are being developed with Bank financing: (i) operation; (ii) project management (eighth power project); (iii) finance and accounting (eleventh power project); and (iv) personnel and manpower development (twelfth power project). These sub-systems will be integrated into a general management information system for PLN. Also the new system will be made compatible with the sector management information system which is now being implemented by MME (para. 1.09). In all these works, local counterpart staff assignment has been emphasized in order to ensure the transfer of know-how, and effective maintenance of the system by local staff once the systems are installed for operation. General Management 3.14 PLN's present highly centralized system is characterized by a preference for "consensus" decision making with a practice of strictly hierarchial communication and very limited horizontal coordination. The consequences are a heavy and growing workload on senior managers and overdependence by regions and projects on decisions from headquarters. In 1981, MME initiated a move to encourage PLN to introduce a management by objective system based on greater delegation of responsibilities from senior to junior

20 staff, and from headquarters to regional offices. For this purpose, PLN introduced a system of targets and objectives for monitoring regional performance. The Bank has given, and will continue to give full support to these initiatives. Under earlier projects, the Bank and PLN agreed to use performance indicators to monitor PLN's overall performance; these indicators included, among others, sales, system losses, consumers' connections and financial targets. This mechanism, together with PLN's internal monitoring schemes, should serve as a useful tool for improving and measuring its performance. Manpower Development 3.15 As of March 31, 1983, PLN had a staff of about 40,000 employees; about 24,000 are employed on the permanent payroll. PLN has no difficulty in recruiting staff at levels up to technical high school, but less than 3% of the staff have full university degrees. There is an urgent need for manpower development, particularly when GOI and PLN are seriously planning to limit PLN's reliance on foreign consultants To address the manpower problem, PLN established a separate department for education and training. This department, known as Pusdiklat, plays an important supporting role and manages six training centers with a staff of over 200, including about 50 trained instructors. During the period 1980/81 through 1982/83, a total of 6,500 employees were trained under various programs; about 4,750 received training from PLN's own training centers and the remainder from programs arranged by suppliers, consultants and overseas utility companies The ninth power project (Loan 1872-IND) provided for an advanced training school for training in the operation of thermal power plants at Suralaya, with a facsimile digital training simulator. Additionally, training was also arranged overseas in the fields of system protection, design of thermal stations and their special maintenance problems, and in extra-high voltage (500 kv) practices. Under the tenth power project (Loan 1950-IND), on-the-job training was arranged in the country with the help of consultants in selected areas, e.g., civil works contract administration, power system planning and operation, and power market surveys. These programs have been proceeding well PLN's training program was reviewed in 1982 in the context of overall staffing requirements in the decade ahead. The twelfth power project (Loan 2214-IND) includes a large training component ($25.0 million) to reorganize and enlarge the entire manpower development, training and personnel management functions for middle and lower level staff. It also provides for starting five more training centers, improving job performance evaluation systems and introducing inhouse management training. Expatriate assistance involving about 30 man-years has already begun, with the assistance of Pacific Engineers and Construction Company of Taiwan.

21 Lack of trained staff is also a major constraint in PLN's accounting areas. PLN has made an effort to recruit qualified and experienced accountants to fill more senior posts. In early 1983, a senior accountant was transferred from the Ministry of Finance to PLN as Deputy Director, Accounting; another accountant has recently been recruited. PLN is in the process of preparing a crash program of training in accounting practices and procedures under an Asian Development Bank (ADB) loan. They are also preparing a program for overseas training for certain accounting/finance staff in areas of financial projections and planning, tariff setting, etc., which will be included in the program for the training of senior technical personnel (para. 3.09). Accounting and Budgeting 3.20 PLN's present accounting system follows generally accepted principles and normal utility practices (para. 5.01). But this system, which was originally installed in the early s, needs redesigning and restructuring because it has become increasingly ineffective due to the increased complexity and volume of accounting transactions. In addition to the Bank-assisted general consultancy services described below (para. 3.22), PLN will carry out interim measures and undertake several studies, supported by ADB financing, to improve its property accounting and reporting system and electronic data processing applications As a state company, PLN's budgets are subject to review by a supervisory board and Government's approval (para. 3.03). PLN's internal procedures for budget preparation and monitoring actual expenditures are not very effective. Coordination among various departmental units and between regional offices is also weak. PLN's management has begun reviewing the current procedures and identifying areas for improvement Under the eleventh power project (Loan 2056-IND), funds have been provided for consultancy services to assist PLN in setting up a more appropriate accounting system, and to strengthen procedures for budgetary control. The assignment will also cover a financial management information system utilizing computer facilities for accounting and financial reporting. The consultants (Pamintori in association with Coopers & Lybrand, Australia) started their work in early 1983 and are expected to complete the assignment by the end of Billing and Collections 3.23 Bills are prepared on a monthly basis. Computer billing is utilized at the computer center at the headquarters in Jakarta. Collection performance is generally satisfactory. The receivable position of general consumer accounts has been kept at about one and one-half months of the yearly billing. However, collections from some Government users (including Army users and local governments) have not been promptly settled as required under the previous Bank loans The Government is aware of the unsatisfactory payment performance by Government users. In 1983, the MME issued instructions jointly with the

22 Ministries of Finance, Defense, and Home Affairs to expedite payments by Government users to PLN. Outstanding Government accounts receivable were reduced from over one year in 1981/82 to about five months of billing in 1982/83; this is still not considered satisfactory. In order to further reduce the arrears, during the appraisal of this project BAPPENAS agreed that adequate funds will be provided in the budget for Government departments and entities and local governments to pay their bills to PLN; PLN was requested by BAPPENAS to provide the estimated amounts. During negotiations, an agreement was reached with the Government which would require that amounts owed to PLN by all Government users in aggregate are less than two months of total billings for such users. PLN would be required to keep collection data for Government users adequately disaggregated so that the source of any overdue payment problems could be identifed. An action plan to bring down the outstanding accounts receivable to within two months billing was also agreed with the Government and PLN during negotiations. Audits 3.25 PLN's accounts are required by its charter to be audited by Government auditors. The audits are carried out following generally accepted auditing practices and standards. The audit reports are acceptable to the Bank, but are subject to delays as a result of the problems affecting PLN's accounting system. In 1983 special efforts were made to expedite the closing of all regional accounts; PLN was able to complete the consolidated accounts for audit, as prescribed by its charter, six months after the close of the fiscal year 1982/83. The audited accounts with report were submitted to the Bank in December PLN has also taken measures to train its local accounting staff and begun to prepare plans to computerize large districts to expedite accounts processing. PLN is expected to be able to complete its accounts as required under the law. To be in line with the Government's auditing requirements for all public corporations, it was, therefore, agreed during the negotiations that the Bank's existing audit covenant will be modified from six months to nine months after the close of the fiscal year for submission of audited accounts with reports. PLN, however, will be required to submit its unaudited accounts to the Bank for early review at the time it is required to submit them for Government audit PLN has an effective internal audit group reporting to the President Director which carries out various special investigations in addition to keeping general accounting matters under review. Insurance 3.27 PLN carries motor vehicle insurance, transit and marine insurance on equipment and materials in transit. Fire and other hazards are selfinsured. In view of the geographical spread of PLN's assets, any single loss would be relatively small by comparison with total assets and operations, and this policy has been accepted by the Bank. However, some very large sized projects are under implementation now which would result in a greater concentration of assets in certain locations than in the past. Therefore GOI/PLN propose to intitate a review of the risks and adequacy of the self insurance procedures.

23 IV. THE PROJECT Project Objectives 4.01 The project supports one of the major elements of the GOI's energy policy of diversification away from oil in the generation of electricity, by supporting the construction of the coal-fired generating plant at Suralaya. The Bank has been involved with the development of this major thermal generation project since its conceptual stages and has had an active involvement in the optimization of the techn cal and organizational aspects. The Bank's support for the project will ensure timely implementation of generation as well as distribution facilities, which are urgently needed, in the current environment of resource scarcity. The project also supports further improvements and consolidation of PLN's skills in planning, construction and management, in which the Bank can play a constructive role. Appropriate instituticnal support is being orovided for this purpose. Of particular note is the extension of the institutional strengthening effort in the areas of financial performance and engineering. Financial performance measures and objectives adopted in the context of the project (paras and 5.23) and structural changes to be made in the organization of engineering and related functions (para. 3.12) represent significant steps forward for the utility. Project Description 4.02 The project comprises the following: (a) Construction of 2 x 400 MW coal-fired thermal unit nos. 3 and 4 at Suralaya in West Java. (b) Extension of the distribution network in Jakarta, Bogor, Tangerang, Bekasi (referred to as Jabotabek area), East Java and Central Java. (c) Consulting services for detailed engineering and construction supervision for the construction of transmission lines and substations in Java and for engineering and design of hydro projects (paras 4.06 and 4.11). Suralaya Steam Power Plant 4.03 The feasibility study for the Suralaya Steam Power Plant in West Java was financed under the fourth power project (Loan 1127-IND) and completed in The construction of the first two 400 MW units was financed under the eigth and ninth power projects (Loans 1708-IND and 1872-IND). The first unit is scheduled to be commissioned in October 1984 and the second unit in June The twelfth power project (Loan 2214-IND) provided funds for conr sulting engineering services for detailed engineering and construction supervision for units 3 and 4 and also for auxiliary equipment for unit 3, excluding the turbine generator and steam-generator islands. Units 3 and 4 will be coal-fired only, unlike units 1 and 2 which are coal and oil fired.

24 Coal Supply 4.04 Coal for the first two units will be provided from the Bukit Asam Coal Mining and Transportation project now under implementation (Bank Loan 2079-IND) which will have a capacity of 3.0 million tons per annum. The coal for units 3 and 4 is expected to be provided from indigenous sources. Exploration in the Muara Tiga area, adjoining Bukit Asam, has already proven mineable reserves of over 100 million tons, which are in excess of the requirements of Suralaya units 3 and 4, over their life of 30 years. A feasibility study for the mine development financed by the Bank Loan 2153-IND is in progress. Also explorations are in progress in other parts of Sumatra and Kalimantan (para. 1.03). The Government proposes to develop indigenous production as shown in Table 4.1, which will be adequate to meet coal requirements for power generation and other users. Table 4.1: INDONESIAN COAL PRODUCTION ('000 tons) Mine Ombilin ,010 1,110 1,310 1,660 1,810 Bukit Asam ,190 2,960 3,035 3,035 3,035 Others ,400 2,800 5,000 7,250 10,750 Total 950 1,985 4,600 6,870 9,345 11,945 15, In the event of a delay in the development of indigenous coal production, it would be possible to meet the coal requirements of Suralaya by imported coal. Currently, a task force set up by the GOI is looking into this possibility for the anticipated deficit in the period. During negotiations, an understanding was reached with GOI, that it will submit to the Bank satisfactory plans to supply adequate coal for the operation of Suralaya units, either by indigenous production or imports, at least two years prior to the commissioning of unit 3, i.e. by June 30, 1986, and thereafter GOI will implement the agreed plan, in order to ensure adequate and timely coal supplies to all the four units at Suralaya. Transmission and Distribution 4.06 Early in 1981, using funds out of Loan 1365-IND, PLN commissioned Beca Worley International (BWI) of New Zealand to review and report on the adequacy of its transmission and distribution program till 1987 to match the ongoing program of construction of new generating facilities in Java, North Sumatra and South Sulawesi (referred to as JASUSS area). BWI's report submitted in April 1982, identified additional requirements for transmission and distribution projects. This has resulted in a number of projects addressing distribution requirements such as Bank Loans 2056-IND and 2214-IND for

25 Jabotabek area and loss reduction; distribution in the cities of Semarang, Yogyakarta, Solo, Malang, Surabaya and Medan plus North Sumatra Transmission and Distribution projects financed by ADB; and the Bandung Distribution project financed by Kuwait and Abu Dhabi Funds. In 1983, PLN's planning department reviewed the ongoing program for the balance between generation, transmission and distribution development in Java and formulated proposals for transmission and substation requirements up to The proposed project provides for the services of consulting engineers for detailed engineering and construction supervision for assisting PLN in designing and implementing the transmission development program. Distribution 4.07 East and Central Java: The BWI study (para. 4.06) identified the requirements in Java for the extension of the 20 kv distribution system to form a backbone network. PLN established distribution planning units in each of its regions in late 1982, and entrusted them with the task of formulating detailed proposals for the expansion of the distribution networks based on survey of areas, demand potential and consumer connection targets. The regional offices in East, Central and West Java have carried out such studies in 1983 for the period 1984/85 to 1988/89. They have formulated proposals, prepared cost estimates and subjected them to financial analysis for ranking. The proposed project includes schemes in East and Central Java which meet the financial viability criteria and can be implemented in the two year period Requirements for West Java up to 1987 are fully covered by the ongoing projects funded by other agencies Jabotabek Area: The Bank has been involved in the reinforcement and expansion of the distribution system in the city of Jakarta and the surrounding areas, referred to as Jabotabek region (para. 1.16). The first two operations covered only Jakarta city; the fifth and eleventh operations (Loans 1259-IND and 2056-IND) extended the scope to the Jabotabek region, covering an area of about 5,700 sq kms and a population of over 10 million. This area contributes about 40% to the total electricity sales of PLN In 1979/80, SOFRELEC of France, the engineer associated since 1970 with the rehabilitation and expansion program in Jabotabek area, carried out a feasibility study of the requirements of the area during the period PLN's planning department has updated these studies in 1983, to identify the requirements beyond the scope of Loan 2056-IND, which will be completed by mid-1985, up to 1988/89. The proposed project includes the estimated requirements for one year after mid Combined Scope: The scope of the distribution component of the project involves the following construction activities:

26 East Java Central Java Jabotabek kv lines (km) (overhead) (underground) V lines (km) 1, , Distribution substations (No.) 839-1,022 (MVA) _ 4. Service connections & meters 183,091 91, ,816 Annex 9 gives a breakdown of the program in terms of physical quantities required in different areas. Hydro Studies 4.11 A nationwide study of the hydro potential of the country (para. 1.04) identified approximately 1,300 schemes amounting to a hydro potential of 78,000 KW in power and 410,000 GWh in annual energy. Preliminary screening led to 130 schemes considered suitable for further investigation. Loan 1365-IND provided funds for a prefeasibility study of twenty-one schemes and feasibility studies for five of these. Nippon Koei are presently working on the feasibility studies; the work will be completed in The proposed project provides funds for continuing this work i.e. engineering and detailed design of feasible projects. Annex 10 gives the major features of the five projects under study, three of which are in Sumatra, one in Java and one in South Sulawesi. Cost Estimate 4.12 Annex 11, Tables 1 and 2 give the detailed cost estimates for the Suralaya units 3 and 4, and the Distribution component of the project respectively. All costs are based on December 1983 prices; physical contingencies are at about 10%. The price contingencies, calculated on the basis of the following inflation factors, amount to 18% of the base cost plus phyical contingencies: Year & after Foreign Local Table 4.2 summarizes the project cost estimate. The costs are net of taxes and duties since PLN is exempt from them.

27 Table 4.2: SUMMARY PROJECT COST ESTIMATE Foreign cost as US $ million or Rp billion % of Item Local Foreign Total total 1. Suralaya units 3 & 4 including consulting services Distribution in East Java, Central Java and Jabotabek areas Consulting services (a) Transmission lines and substations (b) Hydro studies Total base cost Physical contingencies Price contingencies Total Project Cost Interest during construction Bank loan Others Front end fee on Bank loan Total Financing Required The total project cost of US$656.7 million is inclusive of US$294.4 million for Suralaya Unit No. 3 which was assisted in the Twelfth Power Project (Loan 2214-IND). The total project cost net of Suralaya Unit 3 is US$362.3 million. Financing Plan 4.15 The financing plan for the project would be as shown below.

28 U`S$ million Source Foreign Local Total % IBRD (a) Loan IND /a (b) Proposed loan /b Supplier's credit for Suralaya steam generators GOI/PLN 67.4/c /a Loan 2214 provides funds for detailed engineering and construction supervision for Units 3 and 4 and procurement of equipment other than main boiler and turbine generator islands for Unit 3. /b Including capitalized front end fee. 7-c Comprises interest during construction PLN initially intended to finance the turbine generators for Suralaya units 3 and 4 through suppliers' credit as well. However, the Bank was asked to finance them when it became apparent that these could not be accommodated within the export credit ceiling imposed by the Government for PLN. As the Government's sectoral export credit allocations were imposed in the interest of prudent debt management and were consistent with the overall borrowing strategy endorsed by the Bank, it was agreed to finance the turbine generators from the proposed loan At negotiations, an assurance was obtained from the Government to provide necessary funds to PLN for financing the project. The proceeds of the Bank loan will be onlent by GOI to PLN under a subsidiary loan agreement satisfactory to the Bank. The signing of this subsidiary agreement would be a condition of the Bank's loan effectiveness. The onlending rate would be equal to the Bank's standard variable interest rate plus no less than a quarter percent for administration charges. GOI will bear the foreign exchange risk in line with its policy applicable to all public corporations in Indonesia. Engineering and Construction 4.18 The Suralaya extension will be carried out by PLN, -Ath the assistance of MONENCO Associates of Canada/U.K., who are also the engineers for the ongoing work on the first two 400 KW generating sets. MONENCO was appointed in April 1982 for detailed engineering and supervision of construction of units 3 and 4, the services being financed under the twelfth power project (Loan 2214-IND). They are associated with a local consulting firm of PT Central Development Enterprise. The total cost of engineering services is UK B12.7 million and Rp 4.0 billion. The contract includes a provision for the transfer of knowhow and training of PLN's personnel in Indonesia as well as overseas.

29 The engineering and construction of the distribution component of the project will be carried out by PLN's own distribution staff in the wilayas (PLN's regions). The staff in Jabotabek area is already implementing the ongoing program of the expansion of distribution network (Loan 2056-IND) and is sufficiently experienced and adequate for the proposed program. Adequate staff is also avail-able in the East and Central Java Distribution Divisions to undertake the proposed program. All procurement will be centrally carried out by PLN's staff at the head office. Procurement 4.20 Except for concrete poles required for distribution which will be procured by local competetive bidding, all other equipment and services financed under the proposed Bank loan shall be procured by international competetive bidding (ICB), in accordance with the Bank's procurement guidelines. Qualifying domestic manufacturers would be eligible for a preference in bid evaluation of 15% or the import duty, whichever is lower. The Bank financed items will include (a) turbine generators and ancillary equipment for Suralaya units 3 and 4; (b) structural steel work and cladding, ash and coal handling plant, electrical equipment, transformers and miscellaneous equipment for Suralaya unit 4; (c) equipment for distribution; and (d) consulting services. Consultants will be engaged in accordance with the Bank guidelines Procurement arrangements are summarized in the Table All bidding packages for goods financed by the Bank and estimated to cost over US$1,000,000 equivalent would be subject to the Bank's prior review of procurement documents, which covers all the foreseen contracts. Implementation Schedule 4.23 Annex 12 gives the implementation schedule for Suralaya units 3 and 4 and Annex 13 shows it for the distribution component of the project. The commissioning dates for Suralaya units 3 and 4 are June 1988 and March 1989 respectively. The construction of the distribution facilities included in the project is scheduled to be completed by the middle of The implementation schedule for the Suralaya units is based on the award decision on the contract for steam generators by June 30, 1984; proposals for them have already been received and are under evaluation. Since this is the critical step for the timely implementation of the project, signing of this contract will be the condition of the effectiveness of the proposed loan. Disbursement 4.24 The Bank loan would be disbursed against: (a) 100% of the foreign cost of directly imported equipment and materials; (b) 100% of local expenditures ex-factory of locally manufactured items; (c) 70% of the cost of other items procured locally (ex-shelf); (d) 70% of the cost of concrete poles; and {e) 100% of the expenditures for consulting services. No disbursements will be made for expenditures prior to the loan signing.

30 Table 4.3: PROCUREMENT ARRANGEMENTS (US$ millions) Procurement Method Total Project element ICB LCB Other N.A. cost A. Suralaya Units 3 and 4 1. Steam generators and a ancillary equipment 2. Turbine generators and other equipment (133.4) /b (133.4) 3. Site preparation, civil works and buildings 4. Consulting services and training (28.6) (28.6) 5. Construction expenses and administration B. Distribution 1. Equipment (75.0) (10.0) (85.0) 2. Installation C. Technical Assistance (16.5) (16.5) Total (208.4) (10.0) (45.1) (263.5) /a By supplier's credits, following GO- procedures. Proposals are currently under evaluation. lb Figures in parenthesis indicate financing from the Bank loans (Loan IND and the proposed loan) Annex 14 gives the disbursement schedule for the proposed Bank loan as well as the Bankwide profile of disbursement for power projects. The disbursement of the loan for this project is estimated to be faster than the average Bank profile because of the distribution component, for which all procurement financed by the Bank loan will be completed within the first three years. Monitoring and Reporting 4.26 Satisfactory procedures for progress reporting on the project have been agreed. Quarterly progress reports will be received for Suralaya as well as the distribution project.

31 Ecology 4.27 Design of the Suralaya steam power plant has taken into account the requirement that the environmental impact of the operation of the plant at its fully developed capacity of 3,100 NW should not exceed accepted norms. In particular, the following steps have been taken Air Quality. Electrostatic precipitators with a particulate removal efficiency of 99.5% are provided to prevent ash and dust particles from polluting the environment. A stack height of 200 meters has been selected to ensure that the ground level concentration of sulphur dioxide and nitrogen oxides will not exceed the limits laid down by the US Environmental Protection Agency regulations Water Temperature Rise. The layout and design of the circulating water system will ensure that the residual impact upon the ocean and its life forms is minimal. Dispersal of the thermal plume from the sea outfall has been modeled and found to be within acceptable limits Liquid Chemical Effluent. Plant liquid chemical effluents will be held in a neutralization basin and treated prior to discharge into the circulating water discharge channel where they will be rapidly diluted before entering the Sunda Strait Distribution projects will be designed and carried out in accordance with current technological practices and will cause minimum disturbance to the environment. No safety hazards are foreseen. V. FINANCIAL ANALYSIS Past Results 5.01 When PLN was established, there was no accounting system and procedures in operation, and accounts were not properly recorded. Under the Bank's first lending operation (Credit 165-IND, 1969), consultancy services were financed t.o assist PLN in setting up an accounting system and preparing a balance sheet and operating budget (para. 3.20) The growth in PLN's operation has been impressive, but its financial performance has been uneven. PLN's detailed financial statements for the period 1977/78 through 1983/84 are given in Annex 15. Highlights of its operation are summarized in Table After the May 1980 tariff adjustment, PLN's operating income improved to Rp 31 billion in 1980/81 from an operating loss of Rp 21 billion in 1979/80. Since then, PLN's operating income has been declining steadily to Rp 2 billion in and to a loss of Rp 11 billion in 1982/83. Over the period 1980/81 to 1982/83, operating revenues increased by an average of 38% p.a., while operating expenses rose by about 48% p.a. The latter increase was

32 Table 5.1: PLN OPERATING RESULTS, 1977/ /84 Fiscal year ended March 31, (Est.) Energy sales (GWh) 3,527 4,270 5,340 6,523 7,845 9,101 10,391 Operating revenues (Rp bln) Operating expenses (Rp bln) Operating income (Rp bln) Average revenue (RpIkWh) Net income (Rp bln) Rate of return (X) Self-financing ratio (%) Note: 1. Operating revenues do not include other net income, e.g. consumers' contribution. 2. Assets were revalued in 1975/76 and 1979/ Self-financing ratio computed on a three-year average (current plus 2 previous). mainly attributable to the increase in the fuel prices during this period (para. 5.09) Effective March 1984, the Government approved an electricity tariff increase of about 32%. As in the past three years, this latest tariff increase was intended only to absorb the fuel price impact on PLN's operating costs (para. 5.10), and it was again lagged behind the January 1984 fuel price increase by nearly two months leaving PLN to absorb about US$35 million in increased fuel costs in January/February As a result PLN is expected to incur an operating loss of about Rp 20 billion in ,-2 altlhough PLN is able to achieve a self-financing ratio (SFR) of about 1 5% 4/ (para. 5.23). The performance would have been better if the timing of the tariff increase had been synchronized with the increase in fuel costs. 3/ Based on April 1983 estimates. 4/ PLN has been able to meet the required interim targets of SFR in the past mainly because of: (a) high percentage of consumers' contribution and depreciation in PLN's internal sources; and (b) lower level of realized capital expenditure than originally projected.

33 Present Position 5.06 PLN's estimated balance sheet as of March 31, 1984 is summarized in Table 5.2 and is compared with the audited 1982/83 position Although PLN's operating results have been uneven in the past few years, its financial position at the end of 1983/84 indicates a comfortable margin in its debt/equity ratio. As required of all public corporations by the Government, PLN's assets have been revalued twice at four-year intervals; first in 1975/76 and then in 1979/80 (para. 5.27) Of the total assets in 1983/84, 68Z is estimated to come from equity financing, mainly from Government capital contributions; the remainder is from long-term debt (24%) and consumers' contribution (8%). Fuel Prices 5.09 Fuel cost accounts for nearly 60% of PLN's total operating expenses. Increases in fuel price (para. 1.08) have imposed upward pressure on PLN's costs. From 1978/79 to 1983/84, the average fuel price to PLN increased by almost nine times - from Rp 23/liter in 1976/77 to nearly Rp 200/liter in 1983/84, whereas PLN's average tariff increased by only about three times over the same period, from Rp 27/kWh to Rp 75/kWh As a result of the latest fuel price increases in January 1984, PLN's fuel cost in 1984/85 is expected to rise by an average of about 55%. To compensate for this increase in the fuel expense, the Government approved an increase in PLN's tariff by about 32Z over its 1983/84 level (para. 5.04). Tariff Issues 5.11 PLN's present tariff schedule comprises 17 consumer categories. For all except the smallest domestic class, two-part charges are applied, and for industrial and large commercial consumers time-of-day pricing is in effect. Provision can be made for surcharges to cover cost increases. Variation of surcharges requires the Minister's approval; alteration of the basic rate, however, requires Presidential approval. The present tariff structure and the history of past tariff increases are given in Annex The present basic rate schedule was introduced by PLN in May 1980 to structure its electricity tariffs according to the Long Run 2Iarginal Cost (LRMC) pricing principles, as agreed with the Bank under the seventh power project (Loan 1513-IND). However, since 1980, all tariff increases have been effected entirely through 7anges in the energy charges. The failure to adjust the demand charges - has distorted the tariff structure. 5/ "Energy charge" is the charge per kwh based on metered consumption of electricity. "Demand charge" is the fixed component of a customer's bill which is designed to recover the "capacity costs" (e.g. depreciation, finance charges) of the capacity the utility must keep to meet peak demands.

34 Table 5.2: PLN'S FINANCIAL POSITION, 1982/83 AND 1983/84 As of March (Actual) (Estimated) (Rp billion) Assets Fixed Assets Net fixed assets in service 1,268 1,633 Work in progress 1,907 2,410 Total Net Fixed Assets 3,175 4,043 Current assets Less: Current liabilities Net Other assets 1 1 Total Assets ,299 Liabilities Equity 2,428 2,902 Long-term debt 730 1,045 Other liabilities Total Liabilities 3,455 4,299 Current ratio Debt/equity ratio /a 22/78 25/75 /a Includes consumers' contribution but excludes revaluation surplus PLN has completed, as agreed under the thirteenth power project (Loan 2300-IND), a study of its cost and tariff structure. Based on the result of this study, and after consultation with GOI and the Bank, PLN is expected to design its tariff structure to better reflect LRMC of electricity supply (including peak hour characteristics). During negotiations, agreements were reached for PLN to review its LRMC periodically and to carry out an annual review of its tariff level based on its financial requirements and economic efficiency pricing. PLN will review the results of these studies with GOI and the Bank before the end of each calendar year.

35 Financing Policy 5.14 With negligible net income, PLN's major sources of internal funds have been depreciation and consumers' contribution. The remainder of PLN's investment program, which is not financed from internal funds, has been provided exclusively by GOI. Although PLN is authorized to borrow from local and foreign lenders and to issue its own obligations, the Government in practice secures all foreign borrowings on behalf of PLN as a matter of policy for all public corporations. PLN's local currency expenditures are customarily reimbursed in the form of equity contribution through the project budgeting (DIP) system. The foreign exchange expenditures are partly funded through equity and partly through the on-lending of foreign loans and credits secured by the Government; this latter financing has become increasingly important as illustrated in the following table. Table 5.3: FINANCING SOURCES FOR 1974/ /79 AND 1979/ / / / / /84 Billion Rp z Billion Rp Z Capital expenditures , Financed by: Net internal resources Borrowings , Equity , Total , Budgetary constraints facing GOI in recent years indicate that PLN would not be able to count on receiving the same level of Government equity as in the past. The Bank has been recommending that PLN's long-term objective should be to secure a significantly higher degree of leverage in its financing plan by increasing its external borrowings. The study of PLN's financing policy by the Government's three banking advisors (Lazard Freres, S. G. Warburg and Kuhn Loeb Lehman Bros.) also shares the view that future Government equity funding should be minimized when loan financing could be used instead. The possibility of a limited amount of funding through bond issues also needs to be considered. As agreed under earlier Bank loans, PLN has begun to prepare a rolling ten-year financial forecast based on its proposed development program and a financing plan covering the first five-year period as part of its corporate planning procedures. In addition, the Government has agreed to review annually with PLN and the Bank PLN's financial forecasts and financing plan. These covenants will be continued under the proposed loan. To improve PLN's financial planning capability, training of financial staff will also be included in the training program for senior technical staff (para. 3.09).

36 On the basis of the investment program given in Annex 1, the financing plan for the period 1984/85 through 1988/89 is summarized below: Table 5.4: FINANCING PLAN 1984/ / / /89 Billion Rp Z Capital expenditures 11, Financed by: Net internal sources 2, Borrowings 6, Equity 2, Total 11, The financing plan assumes that the equity funding from GOI during 1984/85 through 1988/89 could be expected to average about Rp 500 billion p.a. and that annual borrowings will increase from about Rp 1,000 billion p.a. during 1984/85 through 1986/87, to about Rp 1,500 billion p.a. during 1987/88 to 1988/89. The debt/equity ratio (excluding revaluation surplus) will increase from about 35/65 in 1984/85 to a level of 46/64 by 1988/89, and the annual debt service coverage ratio will remain at above 2.5 times throughout the period. This projected performance is satisfactory. Under earlier loans, the Government agreed to provide adequate funds to help finance PLN's capital expenditures (para. 1.16), and to facilitate PLN's access to all possible sources of required finance based on its financing plan (para. 5.15). These covenants will be continued. Performance Monitoring 5.18 Under earlier Bank loans, various measures have been adopted to monitor PLN's financial performance. The choice of monitoring measures varied as PLN's financial circumstances changed. During the financial recovery period, 1972/73 through 1976/77, a cost recovery covenant was used and a 100% revenue/cost ratio for 1978/79 with interim targets was set to ensure that PLN's operation would cover its full operating expenses. PLN achieved full cost recovery in 1976/77, three years ahead of the target year In 1976, PLN adopted cash generation targets using a three year moving average of self-financing ratio as a measure of financial performance. The quantification of the targets has been revised from time to time. The existing covenant (under the twelfth power project, Loan 2214-IND) provides for a target rate of 20% to be achieved in 1985/86 with interim targets set at 10% per year. These rates are subject to changes, in the event of

37 significant variation of PLN's capital expenditures and fuel costs. The necessity to build in adjustments to modify the self-financing targets indicates that this type of measure with the covenanted levels is less appropriate fzom the viewpoint of financial viability under PLN's circumstances now than six years ago Under the twelfth and the thirteenth power projects, the Bank raised the issue of adopting a ROR covenant as one of the measures to monitor PLN's financial performance. The advantages of adopting a ROR in PLN's case include: (a) ROR is not affected by non-operating revenues, e.g., consumers' contribution, and is therefore more related to consumption-based tariffs; (b) the value of assets in use can usually be established with reasonable certainty; (c) ROR is neutral as to the disposal of net cash flow; and (d) the lumpiness of PLN's investment program and the uncertainty in estimating its capital expenditure will have little effect on the ROR calculation While the Government and PLN agreed in principle to the advantages of adopting the ROR, it was agreed to postpone the decision until the study of PLN's finances by the Advisory Group (the Three Houses) was completed (para. 5.15). This study is now completed, with a similar recommendation to use ROR as the monitoring criterion. During negotiations, agreements with GOI and PLN were reached to replace the existing SFR covenant by a ROR covenant under the proposed loan. The ROR will be calculated on a revalued asset base (para. 5.28). The SFR will be included as one of the performance indicators and will be monitored regularly to ensure PLN's sound self-financing capability (para. 5.24). Future Performance 5.22 PLN's forecast financial performance for the period 1984/85 through 1989/90 is summarized in Table 5.5. Detailed projections are given in Annex 15, with notes and assumptions given in Annex In January 1984, the Government decided not only to remove the fuel subsidies, but increase the prices of diesel and residual fuel oil even beyond the international prices for resource mobilization. To compensate for the increase in PLN's fuel expenses, the Government approved a tariff increase of 32X effective March 1, 1984 (para. 5.04). With this tariff increase, PLN is expected to achieve an SFR of 15Z in 1983/84 and 13% in 1984/85 but incur operating losses in both years. During negotiations, GOI and PLN agreed to (i) take all necessary measures to ensure PLN's achievement of the minimum financial objectives of a 6% ROR in 1985/86, and an 8% ROR in 1986/87 and thereafter (para. 5.21); and (ii) by December 31 of each year, review the adequacy of PLN's tariffs to meet these objectives (para. 5.13). The

38 Table 5.5: PLN FINANCIAL PERFORMANCE 1984/ / / / / / / /90 Average tariff (Rp/kWh) Increase (X) Energy sales (GWh) 12,419 14,906 17,799 21,102 24,807 29,051 Operating revenues (Rp bln) 1,224 1,703 2,236 2,916 3,737 4,683 Operating expenses (Rp bln) 1,240 1,488 1,785 2,331 2,919 3,642 Operating income (Rp bln) ,041 Rate of return (X) /a Current ratio (times) Debt/equity ratio (%) /b 35/65 40/60 41/59 44/56 46/54 48/52 Self-financing ratio (%) /c Debt service ratio (timest /a On revalued rate base. /b Excluding revaluation surplus.,c On three year moving average (current plus two previous years). financial performance expected of PLN in 1984/85 is considered acceptable recognizing the facts that: (i) the removal of 6 ubsidy in fuel prices is in the larger interest of the sector (para. 1.08);- (ii) a larger quantum of electricity tariff adjustment immediately following the fuel price increase in 1984 was considered not feasible; and (iii) both GOI and PLN have now accepted the ROR as the financial performance criterion and have made strong commitments to achieve the agreed objectives The agreed ROR targets will result in improving PLN's self-financing ratio from 13% in 1984/85 to 18% in 1985/86, 25% in 1986/87, and to 30% in 1987/88, which are considered satisfactory. The SFR will be regularly monitored to ensure that PLN's self-financing capability will be maintained at satisfactory levels. It is also proposed to review the ROR and SFR targets for years beyond 1986/87, in light of the findings of the study of the longrun marginal cost of supply now in progress and a detailed review of PLN's investment program planned to be carried out in 1984/85 (paras.1.15 and 2.08) In addition to fuel price and tariff adjustment, two other factors, namely, energy sales and investment program, also significantly influence PLN's financial operation and projected performance. With the uncertain economic condition and the financing constraints now facing the country, it is 6/ The savings for GOI in terms of reductions in budgetary subsidy due to the January 1984 fuel price increase are estimated at about US$1.6 billion in 1984/85.

39 necessary to examine, from a conservative point of view, the outcome of possible changes in these factors and their implications on PLN's finances in the next two years. Given the recent fuel price increase and the tariff adjustment in 1984, a sensitivity analysis has been carried out for the following cases: Case 1: Base case (para. 5.22). Case 2: Slower energy sales growth in 1984/85 and 1985/86 than the base case. Case 3: Lower capital expenditures in 1984/85 and 1985/86 than the base case. Case 4: Combination of Cases 2 and 3. The aim is to compare these three cases with the Base Case with respect to the following indicators: (1) ROR; (2) SFR; and (3) external borrowings, assuming an equity contribution of Rp 500 billion p.a. in 1984/85 and 1985/86. The results are given in Annex 19 and summarized below: Tablie 5.6: FINL SENSfVIY ANALYSIS, 1984/85 AND 1985/86 Case 1 Case 2 Cse 3 Case / / / / / / / /86 Ave. tariff (RphkW TrrcreaseCZ) RR) SER CX) Borrowlngs (Rp bin) 1, , , , The Government currently assumes the exchange risk on the foreign debt borrowed to finance all public corporations and this policy is assumed to continue throughout the forecast period. The existing covenant binding PLN to a minimum 1.5 times coverage of future debt service each year will continue under the proposed loan to ensure PLN's prudent debt management. Asset Revai! atton 5.27 PLN's assets have been revalued periodically. The last detailed revaluation was done in 1979/80 as required of all public corporations under instructions of the Ministry of Finance. Net fixed assets were revalued using the Gross Domestic Investment Deflators as published by the Bureau of Statistics. The revaluation was recorded in the books and has been accepted by the Bank. Fixed assets acquired after March 31, 1979 are appraised at cost. On the basis of its 1979/80 revaluation results, PLN carried out a simple yearly revaluation, starting from 1980/81, to arrive at revalued net fixed assets in 1984/85.

40 However, it is necessary to carry out another detailed revaluation following similar lines as the last revaluation in 1979/80 and also taking into account the effect of currency devaluation. During negotiations, agreements were reached with PLN: (i) to prepare a report on the methodology of such a detailed revaluation, in consultation with the Government and the Bank, by December 31, 1984; and (ii) to carry out annual revaluation of its operating assets, accumulated depreciation, work in progress, and consumers' contribution for the purpose of ROR calculation, for 1985/86 and thereafter. The revaluation will be done on a memorandum account basis and need not be incorporated in PLN's books. Corporate Taxes 5.29 In accordance with the prevailing tax legislation, PLN is subject to corporate income tax. However, PLN has been exempted from income tax payments since 1980/81 for a period of five years. The exemption is an investment incentive and is also being applied to some other revenue earning public corporations in Indonesia. This status will be reviewed by GOI in 1984/85. PLN's financial projections do not assume income tax payment. In calculating the rate of return, however, any income tax payments will be taken into account. VI. JUSTIFICATION Demand Growth and Need for the Project 6.01 The forecasts for electricity sales of PLN in Java are given in Annex 3. The forecasts of peak demand, energy generation and installed capacity requirements are given in Annex 20. As discussed in para. 2.06, it is believed that a high rate of growth can be sustained at least through this decade. The experience of the last two years in which, even under severe recessionary economic conditions, a relatively high rate of growth in the electricity sales was maintained, supports the above view. Also the demand has not proved to be very sensitive to the price increases; tariff increased nearly threefold from 1979 to Therefore the demand growth is expected to continue to follow the trend indicated in the forecast-. If PLN's facilities are not expanded to meet the demand, a revival in the growth of uneconomic private generation would occur (para. 3.04) Based on the projects currently under implementation, the available capacity would not be able to meet the demand from 1988/8-. onwards (Annex 20). The deficit will increase to about 500 MW and 4,700 GWh, in 1989/90. Suralaya units 3 and 4 (800 MW, 4,800 GWh) woulc meet this need, with their commissioning schedule of June 1988 and March 1989 respectively. Least Cost Solution 6.03 The Java System Development Study for the period up to 1995 carried out by PCR with Bank assistance (Credit 399-IND) established a least cost sequence of expansion of generating capacity. PLN now has in-house capability

41 to periodically update the development plans. These studies show that the addition of two 400 MW units to the coal fired Suralaya steam power plant located in West Java is the least cost next step in the development program. This conclusion is valid for the prevailing coal prices ($55-60 per ton of Australian coal delivered to Suralaya or equivalent price of South Sumatra Coal) for discount rates up to 20%. A 500kV extra high voltage transmission network from Suralaya to Jakarta, Bandung and Ungarang (Central Java) is now under construction (Loan 1872-IND) and its extension to Krian near Surabaya in East Java is being taken up by the help of a German Credit (KfW). The output of Suralaya power plant will be, therefore, utilized fully to serve the demand in Java. Distribution 6.04 PLN needs to expand its transmission and distribution facilities rapidly to satisfy the large demands reflected in long waiting lists and to reach the supply to large unelectrified areas. However, it is necessary to keep a balance between generation, transmission and distribution facilities. The generating capacity in Java will increase from about 2,700 MW in 1983/84 to about 4,900 MW in 1987/88, needing the following investments in transmission and distribution, which are included in PLN's investment program (Annex 1). Cost in US$ millions (1983 prices) Year 1984/ / / /88 Transmission & substations Distribution Total The proposed project includes some of the distribution requirements of East and Central Java in the period and of Jabotabek area for one year period in 1986 as explained in paras to Economic Rate of Return The economic rate of return (IERR) of the investment program at the prevailing tariff is about 12%, which indicates that the prevailing tariff is close to the long run average incremental cost of supply. Additionally, the IERR for Suralaya and the distribution components are worked out on a segregated basis as discussed below Suralaya. The economic rate of return for Suralaya units is worked out by taking the capital, operation and maintenance costs for the project as well as the investment required in transmission and distribution network for transmitting its output to the consumers. The revenue to PLN at the prevailing average tariff of US 9.8 per kwh is taken as the benefit. On this basis the IERR works out to 28% (Annex 21, Table 1). The IERR will drop to 26% if the project costs escalate by 10%. The IERR is high because: (a) the project is one of the low cost elements of the investment program; and (b) some of the