ASIAN DEVELOPMENT BANK PPA: PAK 17003

Transcription

1 ASIAN DEVELOPMENT BANK PPA: PAK PROJECT PERFORMANCE AUDIT REPORT ON THE KESC FIFTH POWER (SECTOR LOAN) PROJECT (Loan 925-PAK) IN PAKISTAN October 2001

2 CURRENCY EQUIVALENTS Currency Unit Pakistan Rupees (PRe/PRs) At Appraisal At Project Completion At Operations Evaluation (August 1987) (November 1998) (May 2001) PRe1.00 = $ $ $ $1.00 = PRs PRs PRs ABBREVIATIONS ADB Asian Development Bank CADPAD computer-assisted distribution planning and design DFID Department for International Development EA Executing Agency EIRR economic internal rate of return FIRR financial internal rate of return IPP independent power producer J EXIM Export-Import Bank of Japan KESC Karachi Electric Supply Corporation OEM Operations Evaluation Mission PCR project completion report PDP power development program PPAR project performance audit report PPTA project preparatory technical assistance SCADA supervisory control and data acquisition TA technical assistance TOR terms of reference WAPDA Water and Power Development Authority WEIGHTS AND MEASURES GWh (gigawatt-hour) 1,000 megawatt-hours kv (kilovolt) 1,000 volts kva (kilovolt-ampere) 1,000 volt-amperes km kilometer kwh (kilowatt-hour) unit of electrical energy MVA megavolt-ampere MVAR (megavolt-ampere reactive) 1,000,000 units of reactive power MW (megawatt) 1,000,000 watts MWh (megawatt-hour) 1,000 kilowatt-hours V volt VA (volt-ampere) unit of apparent power NOTES (i) (ii) The fiscal year (FY) of the Government and KESC ends on 30 June. In this report, $ refers to US dollars. Operations Evaluation Department, PE-574

3 BASIC DATA KESC Fifth Power (Sector Loan) Project (Loan 925-PAK) Project Preparation/Institution Building TA No. TA Name Type Person- Months Amount ($) Approval Date 411-PAK Power Development and Tariff Study ADTA , Aug PAK Tariff Study on WAPDA/KESC ADTA , Dec 1986 Integration 869-PAK Karachi Electric Supply Corporation Power Expansion PPTA 4 75,000 6 Apr 1987 Key Project Data ($ million) As per ADB Loan Documents Actual Total Project Cost Foreign Exchange Cost Local Currency Cost ADB Loan Amount/Utilization ADB Loan Amount/Cancellation 1.6 Amount of Cofinancing Key Dates Expected Actual Fact-Finding 23-Apr-6 May 1987 Appraisal Aug 1987 Loan Negotiations 9-14 Nov 1987 Board Approval Dec Nov 1988 Loan Agreement Jan Dec 1988 Loan Effectiveness 21 Mar Feb 1990 First Disbursement 5 Nov 1990 Project Completion 31 Dec Sep 1997 Loan Closing 31 Dec Dec 1997 Months (effectiveness to completion) Key Performance Indicators (%) Appraisal 2 PCR 2 PPAR 3 Financial Internal Rate of Return for sector >50 Economic Internal Rate of Return for sector >50 Borrower Executing Agency Government of the Islamic Republic of Pakistan Karachi Electric Supply Corporation ADB = Asian Development Bank, ADTA = advisory technical assistance, EIRR = economic internal rate of return, PCR = project completion report, PPTA = project preparatory technical assistance, PPAR = project performance audit report, TA = technical assistance, WAPDA = Water and Power Development Authority. 1 In currencies totaling $100 million equivalent. 2 Sector estimates using a time-slice approach for all the Karachi Electric Supply Corporation (KESC) investments. 3 Because of an approved reduction in project scope, the Project as finally implemented was of insufficient size to achieve envisaged sector targets at appraisal. The EIRR for 11 kilovolts feeder subprojects ranged from 24 percent upward and the EIRR for the transmission component is calculated at 27.2 percent.

4 Mission Data Type of Mission No. of Missions No. of Person-Days Fact-Finding 1 36 Appraisal 1 50 Project Administration Inception 1 12 Consultation 3 26 Review 6 37 Special Review 3 43 Loan Administration 1 7 Power Sector 1 1 Project Completion 1 27 Operations Evaluation The mission comprised T.M. Hutton (Evaluation Specialist and Mission Leader) and D. Gianelly (International Consultant).

5 CONTENTS Page BASIC DATA EXECUTIVE SUMMARY SYSTEM NETWORK ii iii vii I. BACKGROUND 1 A. Rationale 1 B. Formulation 1 C. Purpose and Outputs 2 D. Cost, Financing, and Executing Arrangements 2 E. Completion and Self-Evaluation 2 F. Operations Evaluation 3 II. PLANNING AND IMPLEMENTATION PERFORMANCE 4 A. Formulation and Design 4 B. Achievement of Outputs 4 C. Cost and Scheduling 5 D. Procurement and Construction 5 E. Organization and Management 6 III. ACHIEVEMENT OF PROJECT PURPOSE 6 A. Operational Performance 6 B. Performance of the Operating Entity 8 C. Financial and Economic Reevaluation 10 D. Sustainability 11 IV. ACHIEVEMENT OF OTHER DEVELOPMENT IMPACTS 12 A. Socioeconomic Impact 12 B. Environmental Impact 12 C. Impact on Institutions and Policy 12 V. OVERALL ASSESSMENT 13 A. Relevance 13 B. Efficacy 14 C. Efficiency 14 D. Sustainability 14 E. Institutional Development and Other Impacts 15 F. Overall Project Rating 15 G. Assessment of ADB and Borrower Performance 16 VI. ISSUES, LESSONS, AND FOLLOW-UP ACTIONS 16 A. Key Issues for the Future 16 B. Lessons Identified 17 C. Follow-Up Actions 17 APPENDIXES 18

6 EXECUTIVE SUMMARY At project formulation, there was an urgent need for investment in the transmission and distribution systems of the Karachi Electric Supply Corporation (KESC). The network had not kept pace with generation expansion, was heavily overloaded, and prone to power failures. Transmission and distribution losses were around 18 percent, and future growth in demand for electricity threatened to increase loss levels in the absence of expanding transmission capacity and upgrading the existing distribution network. The Asian Development Bank (ADB) formulated the Project as a sector loan to finance part of a three-year time-slice of KESC s power development program for the period FY The purpose was to develop the transmission and distribution systems to absorb new generation from Bin Qasim, and to address problems of system losses, load management, and distribution efficiency. ADB s loan was expected to play a catalytic role in mobilizing funding needed for the Project and KESC s overall development program. The project scope included (i) upgrading and expansion of transmission lines and substation capacity, (ii) rehabilitation and expansion of the distribution system, (iii) upgrading of the system control and protection facilities, and (iv) consulting services for project implementation and to assist with computerization of KESC s technical and financial operations. Selection and formulation of specific subproject proposals for implementation were part of the implementation consultants terms of reference. Subproject proposals were subject to ADB approval. Appraisal was completed in August A decision at loan negotiations in November 1987 to defer further loan processing until KESC s financial position was stronger meant that ADB s loan was not approved until 24 November The Project was completed in December 1997 with an overall delay of six years. The delay was caused by (i) the need for KESC to comply with key financial covenants before the loan could be declared effective; (ii) suspension of ADB s loan from March 1991 to October 1992 because of a deterioration in KESC s accounts receivable; and (iii) the need to update subproject proposals, which moved the physical start for the transmission component to July The final project cost of $277.4 million was 29 percent lower than the appraisal estimate of $389.8 million. Total disbursements under ADB s loan in various currencies equivalent to $100 million amounted to $98.4 million (35 percent of the total project cost). An undisbursed balance of $1.6 million was canceled. Savings on the appraised project cost were induced by a decision to reduce the project scope, particularly with regard to distribution, and defer some components to ADB s KESC Sixth Power (Sector Loan) Project. ADB s loan financed 69 percent of the foreign exchange costs compared with an estimated 53 percent at appraisal. The balance of foreign expenditure was financed by the Export-Import Bank of Japan. The local currency portion of $134.8 million was financed by the Government of Pakistan. Overall investment expenditure on KESC s power development program was PRs17.2 billion during FY , and PRs36.8 billion during FY Investment expenditure was largely to expand generation at Bin Qasim. Total expenditure under the Project was PRs9.4 billion, or 17.4 percent of KESC s total investment expenditure for the extended program period FY Of the PRs9.4 billion, 71 percent was spent on transmission improvements and the balance on distribution expansion (primarily) and upgrading. The Project at appraisal was technically well designed and appropriate for achieving its purpose. The performance of implemented subprojects has been satisfactory as attested by financial and economic internal rates of return that range from 16.5 percent to more than 50 percent. 5 5 Using the time-slice approach adopted at appraisal, the recalculated financial internal rate of return is negative and the economic internal rate of return is 1.6 percent. Because of the reduced project scope and inefficiencies that developed elsewhere in KESC s system, the time-slice results do not reflect the viability of individual project components nor overall project performance.

7 The decision to downsize the scope of the distribution component meant the Project was insufficient in scale to achieve an overall improvement in KESC s operating efficiency and financial position. KESC s transmission and distribution losses increased from 18 percent in FY1987 to 34.3 percent in FY1998 and caused KESC s profit performance to move from weak to negative. A first year loss of PRs0.5 billion was reported in FY1996. By FY1998, KESC became financially insolvent. Transmission and distribution losses continued to increase, and by FY2000 reached 40.2 percent, with an associated net loss of PRs12.8 billion. Contributing to the decline in KESC s financial performance was the rising cost of fuel and power purchases, and increasing loan interest. Escalating nontechnical losses estimated at over 40 percent of transmission and distribution losses, also contributed to KESC s overall financial deterioration, as did a problematic environment affecting revenue collection. The negative aspects associated with implementation delays, the failure to reduce KESC s overall transmission and distribution losses, and the subsequent financial insolvency of KESC tend to overshadow successful achievements at the subproject level. The positive impact of the Project was the completion of the transmission component to meet the availability of additional generation from Bin Qasim, without which power shortages would have been worse, and transmission losses higher. Subprojects for distribution rehabilitation, although insufficient in aggregate to meet sector targets and reduce overall KESC s transmission and distribution losses, were individually successful. Distribution expansion targets were also met and helped spur economic growth. Of the five evaluation criteria applied to judging the success of this Project, the rationale for the Project remains highly relevant. On the criterion for efficacy, the Project succeeded in its prime purpose to develop transmission to absorb new generation from Bin Qasim, but failed to effect an overall reduction in system losses. Because of the dominance and primary achievement of the transmission component, an assessment rating of at least partly efficacious is warranted. The financial and economic rates of return attest to the individual viability of subprojects, but not to their overall impact to improve the operational efficiency of KESC. The Project is, therefore, assessed partly efficient. The sustainability of the transmission benefits is assessed likely, while the sustainability of distribution subprojects is assessed less likely in the absence of investment in upgrading to match load growth. Institutional and other development impacts were negligible in terms of strengthening KESC s computer-based management systems, but under the broader socioeconomic aims of reducing load shedding and expanding distribution coverage, achievement was significant. New connections, for example, were increased by 74 percent from 0.8 million in FY1987 to 1.4 million in FY1998. Taking these evaluation judgments into account, the Project s overall rating is partly successful. KESC s recovery from financial insolvency is dependent on restructuring toward a more commercial and competitive orientation, external funding support including equity, and policy changes relating to the tariff setting and revenue collection from government departments and public sector enterprises. The operational viability of subprojects is dependent on improved load control facilities, staff training in technical skills, and enhancing technical efficiencies in the distribution network. Continued government attention, together with investment support, is also required to reduce nontechnical losses, which are currently estimated to be around 18 percent. Three key issues for the future are identified: (i) Consumer Charges. Consumer affordability and KESC s financial performance are negatively affected by the actual tariff paid by consumers, which is twice KESC s reported average revenue tariff. The difference is made up of a surcharge paid to the Government. As affordability of the actual tariff paid by consumers is a cause of political resistance against increasing tariffs, the issue of what is an appropriate level of surcharging needs to be urgently addressed, in light of KESC s insolvency and the severe constraints imposed on KESC s selffinancing capacity.

8 (ii) (iii) Policy Reforms. Reflective of the differential between the tariff paid by consumers and the net tariff to KESC, electricity revenues paid to the Government exceed the revenues of KESC and are currently around PRs28 billion ($450 million equivalent) per annum. The surcharge paid to the federal and Sind governments is in effect a monopoly rent, but at the cost of lower investment and reduced availability of electricity in the Karachi area possibly by as much as 40 percent. The situation poses a policy dilemma of continuing to support a monopoly structure, which suppresses expansion and thereby reduces the benefits of electricity to households and businesses that would otherwise prevail. Perpetuating support to a system that extracts high monopoly rents but leaves insufficient revenue to meet operating expenditures and provide a normal return on investment is also a governance issue. A closer look at restructuring is warranted. With the right balance on incentives, both power expansion and overall tax revenues to government can be larger than is the case at present. Future policy reforms affecting electricity surcharges need to bear in mind investment requirements so that revenue flows sustain and expand development. Privatization. Privatization of KESC is unlikely before mid-2002, and may not result in a full divestment of the Government s holding. The present management practice is to support only essential investment in the interim period up to privatization. In this regard, the lessons of the Project are of paramount importance. The present level of technical losses of around 22 percent will escalate without adequate attention to upgrading the distribution system. Continuing expansion by way of new connections without upgrading existing overloaded distribution facilities will also further exacerbate power outages. Urgent attention to and continued investment in upgrading the distribution network prior to privatization are, therefore, recommended. The key lessons derived from the Project are (i) the critical importance of scale and timing for upgrading distribution systems to improve overall system efficiencies; (ii) the need for ADB to be more circumspect in appraising sector loan objectives and the likelihood of achieving them, particularly where target achievements depend on the availability of local funding and the capability of the power utility; and (iii) the need to replace KESC s nonfunctional and obsolete computer system for identifying and selecting distribution feeders for upgrading in order to reduce distribution losses. For follow-up, ADB is encouraged to take into account lessons identified and ensure that future sector loan projects are reviewed bearing in mind that the impact of changes in project scope can be critical for the achievement of project purpose. The Government should take immediate measures aimed at (i) providing KESC with support for upgrading the distribution system so as to contain and reduce technical losses until privatization; (ii) developing policies backed with financial support, which clarify how KESC will meet the demand for new connections in the interim period; and (iii) restructuring the electricity tariff so that the operations of KESC are financially sustainable. KESC should (i) continue to develop effective recovery mechanisms for dealing with nontechnical losses, outstanding customer accounts, errant staff, and contractors; (ii) in consultation with the Government, take steps to contain further increases in distribution losses; (iii) initiate a project to install capacitors on its low-voltage feeders; and (iv) take immediate steps to improve the technical skills of its staff to meet upgrading, servicing, and connection standards.

9 I. BACKGROUND A. Rationale 1. The Asian Development Bank s (ADB s) loan complemented a sector loan approved in December 1986 to the Water and Power Development Authority (WAPDA), 6 and was intended to help mobilize funding to meet investment requirements of the Karachi Electric Supply Corporation (KESC). Increased generation capacity of 630 megawatts (MW) to meet the forecast demand for electricity was planned from Bin Qasim (formerly Pipri) by Under KESC s overall five-year power development program (PDP) FY , a further increase in generation from Bin Qasim of 210 MW and West Wharf of 200 MW was also planned. To meet this increase, an expansion in transmission capacity was needed to carry the additional power to distribution load centers. Reinforcement of the existing transmission system; upgrading of KESC s power management system to more effectively deal with load fluctuations; and the upgrading, relocating of transformers, and installation of capacitors on the distribution network were also necessary to contain the potential for future increased losses. 7 B. Formulation 2. The Project was formulated to help meet the foreign exchange costs of a three-year time-slice, FY , under KESC s five-year PDP. 8 System requirements were initially studied under ADB technical assistance (TA) in 1982, 9 and reviewed under Canadian assistance in Recommendations for upgrading KESC s transmission and distribution facilities to satisfy demand requirements through 1992 were made under ADB project preparatory technical assistance (PPTA). 10 Fact-finding was completed in May, and appraisal in August At loan negotiations in November 1987, it was decided to defer further processing until KESC s financial position strengthened. Such strengthening, to enable compliance with ADB s financial covenants, was achieved through changes to the fuel adjustment charge, reduction in accounts receivables from seven to three months, and a 29 percent increase in the base tariff (para. 29). An ADB mission to update and reaffirm ADB s appraisal was completed in September 1988, and ADB s loan in currencies totaling $100 million equivalent was approved on 24 November in support of a total project investment of $389.8 million. ADB s loan was made in coordination with major aid agencies. 12 The Borrower was the Government of Pakistan, and the proceeds were relent to KESC under a subsidiary loan agreement. 6 Loan 824-PAK: WAPDA Tenth Power Sector Project, for $150 million, approved on 18 December KESC s transmission and distribution losses were around 18 percent, and a little more than half of these were attributed to bottlenecks in transmission, and excessively loaded feeders in distribution. 8 KESC s five-year PDP provided for a total investment of $1.3 billion (approximately PRs23.4 billion) for (i) increasing generation capacity at Bin Qasim (4 x 210 MW units) and West Wharf (1 x 200 MW unit), (ii) expansion and rehabilitation of the transmission system, (iii) expansion and rehabilitation of the distribution network, and (iv) upgrading system protection and load despatch facilities. Total investment cost over the threeyear project period FY was estimated at $803.3 million (PRs14.5 billion). 9 TA 411-PAK: Power Development and Tariff Study, for $350,000, approved on 27 August TA 869-PAK: Karachi Electric Supply Corporation Power Expansion, for $75,000, approved on 6 April Loan 925-PAK: KESC Fifth Power (Sector Loan) Project. 12 Prior to loan approval, two meetings were held in Islamabad in September 1985, and in Washington, DC in July The aid agencies in attendance included the Canadian International Development Agency, Department for International Development of the United Kingdom, Kreditanstalt für Wiederaufbau, and the World Bank. The aid agencies coordination meetings endorsed a core program of energy investments.

10 C. Purpose and Outputs 3. The overall purpose of the Project was to develop the transmission and distribution systems of KESC to meet increased generation from Bin Qasim, and address problems of system losses, load management, and system efficiency attributable to deficiencies in transmission and distribution. ADB s loan was expected to play a catalytic role in mobilizing the balance of donor and commercial funding needed for the Project and KESC s overall development program. The project outputs included (i) expansion and augmentation of transmission lines and substation capacity, (ii) expansion and rehabilitation of the distribution system, and (iii) upgrading of the system control and protection facilities. Selection of specific subproject proposals for implementation were made part of the implementation consultants terms of reference, and subject to ADB approval. Details of the PPTA consultant s recommendations for expanding and upgrading KESC s transmission and distribution facilities, which are the basis of subproject proposals, are provided in Appendixes 8 and 9 of ADB s appraisal report. Further details of the Project s outputs and expected impacts are provided in Appendixes 1 and 2. D. Cost, Financing, and Executing Arrangements 4. The estimated total project cost at appraisal was $389.8 million equivalent, with a foreign exchange component of $189.5 million. ADB s loan was to be used to finance 53 percent of the foreign exchange costs. Of the $89.5 million balance in foreign exchange cost, $12.2 million was expected to be financed by the Department for International Development (DFID) of the United Kingdom, $22.9 million by the Government, and $54.4 million by the Export-Import Bank of Japan (J EXIM). The local currency cost of $200.3 million equivalent was to be funded by KESC for $154.7 million, and J EXIM for $45.6 million. ADB s loan was drawn from its ordinary capital resources to the Islamic Republic of Pakistan, and relent as a subsidiary loan to KESC with provision for interest at 11 percent per annum (inclusive of a foreign exchange risk fee) and a repayment period of 25 years (including a grace period of four years). 13 KESC was the appointed Executing Agency (EA). An existing team of qualified full-time staff headed by a project manager, which had worked well under ADB s earlier loans, 14 was given the responsibility for implementation of the Project. E. Completion and Self-Evaluation 5. ADB s project completion mission inspected the Project in November 1998 and rated it partly successful. Rehabilitation and expansion of KESC s transmission and distribution systems were found implemented as envisaged, though with reduced scope and delays. The benefits of the Project were judged sustainable, but the delays in project implementation were such that the benefits were considered insufficient to improve KESC s overall performance. Using a time-slice approach, the financial internal rate of return (FIRR) was recalculated at 4.5 percent, and the economic internal rate of return (EIRR) at 5.7 percent. These lower-than-appraisal estimates 15 were attributed to high transmission and distribution losses, and the high cost of power purchases from independent power producers (IPPs). Transmission and distribution losses, instead of falling, were observed to have increased from 18 percent in FY1987 to 34 percent in FY1998. It was stated that the overall financial performance of KESC had deteriorated, though 13 The opportunity lending rate in local currency was 15 percent, and in dollars 6.5 percent (excluding foreign exchange cover). 14 Prior to ADB s loan for the Project, KESC had received nine ADB loans totaling $201.5 million and four TA grants totaling $0.68 million. 15 The appraisal estimates were 11.1 percent (FIRR) and 12.7 percent (EIRR).

11 no financial accounts or analysis of accounts was presented in the project completion report (PCR), and that KESC was unable to comply with ADB s financial covenants. Because the Project was implemented and operational at loan closing, no follow-up actions were recommended. Attention was drawn to the need to recognize in power projects that where the achievement of project objectives is a direct function of the level of inputs, the implications of reducing the project scope should be carefully assessed. Continuation of the sector loan approach was recommended for similar projects in ADB s other developing member countries. 6. The PCR assessment reliably evaluated the Project s implementation performance and the impact of delays on achieving technical efficiency improvements. However, for a sector loan, KESC s performance and policy reforms should have been evaluated as well Factors affecting KESC s declining financial performance were reflected in the PCR s FIRR recalculation although KESC s insolvency position was not mentioned. The recalculated EIRR of 5.7 percent was within ADB s then benchmark range of 4-10 percent for rating a project partly successful. Because the recalculation excluded KESC s investment in additional generation capacity for Bin Qasim units 3 and 4, and was based on projections after FY1998 for power generation that did not pertain to KESC s development program, the EIRR was overestimated. If recalculated with these adjustments, the EIRR would have been negative and would have caused the Project to be rated unsuccessful. In this regard, the PCR rating was misleading. F. Operations Evaluation 8. This project performance audit report (PPAR) reviews the findings of the PCR and presents the findings of the Operations Evaluation Mission (OEM) that visited the project area during 21 May-1 June Special attention is given to assessing the achievement of purpose; attainment of project and sector goals and intended developments from the Project; operational performance of KESC; and adequacy of design for meeting load expansion requirements, and avoiding and reducing system losses. Related to these aspects are planning issues for the intended privatization of KESC and environmental consequences of the Project s operations. The PPAR is based on the findings of the OEM taking into account a review of the PCR, the appraisal report and material in ADB files, two years of additional actual operational data, KESC s responses to OEM s questionnaire, and follow-up discussions with ADB staff, KESC s senior officials, representatives of other government agencies, electricity consumers, implementation consultants, and local equipment manufacturers. The assessment rating is based on ADB s four-category assessment rating system. 17 Copies of the draft PPAR were provided to the Government, KESC, and ADB staff concerned for review, and their comments were considered in finalizing the PPAR. 16 At appraisal, the Project was variously referred to as a sector loan or project. The concept of providing a sector loan for transmission and distribution improvements covering a large number of subprojects that depended on detailed engineering analysis and design before specifying specific material and contract requirements, made the need for a sector loan approach self-evident. Funding for each subproject was made conditional on detailed appraisal and ADB approval. The terms of reference for the consultants were, however, as for a project, and cost estimates included provision for physical and price contingencies, which was unusual for a sector loan. Apart from a requirement to complete a separate TA study to integrate the tariffs of KESC and WAPDA, there was no requirement to support and evaluate sector policy reforms. 17 In September 2000, a four-category assessment rating was introduced: unsuccessful, partly successful, successful, and highly successful. The previous rating system, used for the PCR, was based on a three-category system of unsuccessful, partly successful, and generally successful. The new evaluation system removed the benchmark assessment links to EIRR estimates and gave more emphasis to the achievement of project purpose.

12 II. PLANNING AND IMPLEMENTATION PERFORMANCE A. Formulation and Design 9. KESC s PDP covering FY formed part of the national Government s Seventh Five-Year Plan ( ) for sustaining economic growth. The Project s rationale (para. 1) reflected (i) investment requirements for power transmission and distribution to Karachi and its environs, (ii) the need to sustain investment expenditure on distribution upgrading, and (iii) ADB s assistance strategy for improving operational efficiencies and mobilizing cofinancing to meet investment needs. 10. The Project was structured from KESC s PDP to meet 49 percent of the total planned investment for the three-year time-slice FY (para. 2). The outputs were set against specific requirements for expanding and upgrading KESC s transmission and distribution systems, and were defined as a subset of KESC s PDP. Formulation and identification of project outputs were prepared on a least-cost basis. The OEM reviewed the feasibility and appraisal estimates for the PDP and Project, and found the technical solutions, system controls, and equipment specified appropriate for the projected load growth (Appendix 3). B. Achievement of Outputs 11. Appendix 1 compares the actual outputs under the Project with what was envisaged at loan approval. The outputs from expanding transmission capacity, reinforcement of 220-kilovolt (kv) transmission, and installation of capacitor banks were by and large achieved. Outputs for rehabilitating and expanding the distribution system were substantially smaller than envisaged, reflecting a cutback in available funding and a change to meet distribution expansion at the expense of upgrading the existing distribution network (Table 1). 18 Outputs for upgrading KESC s system control and protection were substantially deferred. Table 1: Distribution Expansion and Rehabilitation a Item Approved Actual 11 kv Distribution Reinforcement 487 km 566 km 0.4 kv Overhead/Underground Lines 1,500 km 766 km 11/0.4 kv Transformer Capacity MVA MVA Capacitor Installation 260 MVAR Nil km = kilometer, kv = kilovolt, MVA = megavolt-ampere, MVAR = megavolt-ampere reactive. a Comparative details for other project components are shown in Appendix 1. C. Costs and Scheduling 12. As a result of the reduced scope, the actual project cost of $277.4 million equivalent was 29 percent less than the appraisal estimate of $389.8 million. The foreign exchange cost of $142.6 million was lower by 25 percent, and the local currency cost of $134.8 million equivalent 18 As of May 2001, over 30 percent of the distribution equipment procured under the Project remained in KESC s stores unused. The main reasons for incomplete implementation are (i) the local authorities have restricted road excavation for cable laying, (ii) KESC is reluctant to install further copper conductor given the high levels of theft, and (iii) KESC staff do not have the knowledge required to use some of the materials.

13 by 33 percent. The nonspecific nature of details for the project scope also accounts for some of the cost variations. 19 Total disbursements under the ADB loan amounted to $98.4 million equivalent (35 percent of the total project cost). An undisbursed balance of $1.6 million equivalent was canceled. ADB s loan financed 69 percent of the foreign exchange costs, compared with 53 percent envisaged at appraisal. ADB s funding was largely applied to the transmission component. The balance of foreign expenditure was financed by J EXIM. The local currency portion of $134.8 million was financed by the Government. Anticipated cofinancing from DFID (para. 4), which was intended for upgrading KESC s system control and protection, did not materialize. The appraisal costs are compared with actual costs in Appendix The Project was deemed substantially complete in December 1997, six years later than envisaged at appraisal. There were three extensions on the loan closing date from 31 December 1992 to 31 December Implementation was slowed by (i) the need for KESC to comply with key financial covenants before the loan could be declared effective in February 1990; (ii) suspension of ADB s loan from March 1991 to October 1992 because of a deterioration in KESC s accounts receivable position; and (iii) the need to update, after loan suspension, final subproject proposals for the transmission component, which extended the physical start to July A comparison of the actual implementation schedule with the appraisal schedule is shown in Appendix 5. D. Procurement and Construction 14. Procurement was envisaged at appraisal to be undertaken in accordance with ADB s Guidelines for Procurement. Other than for distribution, contracts were to be awarded on the basis of supply, delivery, installation, and commissioning. For distribution components of the Project, contracts were to be on the basis of supply and delivery only, with KESC responsible for installation and commissioning. Summary details of contract awards are provided in Appendix 2 of ADB s PCR. 15. KESC reported that the international and domestic contractors and suppliers for the Project performed satisfactorily. Equipment and materials complied with KESC s specifications and had no significant defects. All equipment inspected at the subproject sites visited by the OEM was functioning satisfactorily. 16. Nevertheless, OEM s engineering inspection revealed that the design and quality of work undertaken by KESC for the distribution rehabilitation and expansion component were generally substandard. With appropriate design and quality, including proper connection practices, the reduction of technical losses by 4-5 percent through upgrading low-voltage lines and replacement and relocation of transformers could have been increased by an additional 1-2 percent. The installation of three-phase capacitor banks, if carried out, would have reduced technical losses by another 2 percent. KESC s method of design and construction of distribution lines, particularly for 400 volts (V) and 230 V, has still to catch up with accepted international practice. E. Organization and Management 17. Organization and management were consistent with agreed arrangements at appraisal and generally satisfactory, except for the need to extend the implementation period. Project implementation was satisfactory with respect to selection of consultants, awarding of contracts, and management by KESC. Recruitment of consultants was initiated in 1988, and a consortium of international and domestic consultants was contracted under an agreement concluded in August Because of the implementation delays, it was necessary to extend the 19 Consistent with the sector loan approach, detailed costings for subprojects were to be made during project implementation.

14 consultants period of assignment under several amendments until project completion. Performance of the consultants, whose activities were restricted to transmission, was of a high order. Engineering and progress reports were submitted promptly, and supervisory responsibilities over contractor activities and advisory assistance to KESC were discharged effectively. The supervisory responsibilities of the consultants and their contribution to institutional strengthening through improving technical efficiencies, employee skills, and computer systems were considered by KESC appropriate and helpful ADB provided adequate monitoring during project implementation with one inception mission, nine review missions (including three special review missions), three consultation missions, one power sector mission, and one project completion mission. Coordination and progress meetings were held during review missions with the Ministry of Foreign Affairs, KESC, and consultants to solve problems and minimize delays. 19. ADB s loan and project agreements included covenants relevant to improving KESC s operational performance and accountability. These included requirements for the following: (i) ensuring that the Project was managed by a project group, headed by a project manager from within KESC; (ii) all subprojects to be selected in accordance with criteria agreed with ADB; (iii) completing TA 835-PAK for a tariff study to integrate the tariff structures of KESC and WAPDA; (iv) reducing transmission and distribution losses to 15.5 percent by FY1995; (v) phasing out subsidies and complying with financial covenants; and (vi) submitting quarterly progress reports for execution of the Project. KESC s compliance with loan covenants is summarized in Appendix 5 of the PCR. All covenants had been complied with at project completion, except those relating to transmission and distribution losses and financial performance (paras. 24 and 27). 20 The consultants assisted with the preparation of bid documents for distribution procurement but were not involved in the supervision of contracts and work on distribution improvements.

15 III. ACHIEVEMENT OF PROJECT PURPOSE A. Operational Performance 20. Operational performance is measured in terms of the Project s achievements relative to expectations at appraisal and changes in scope to (i) help meet the incremental demand for power between FY1992 and FY1998, (ii) expand transmission to relieve overloaded subtransmission systems and reduce load shedding, (iii) expand distribution and improve distribution voltage levels and system reliability, and (iv) reduce system losses. The adequacy of maintenance is also reviewed. Indicators of KESC s technical and financial performance are summarized in Appendix KESC s installed generation capacity was projected at appraisal to increase to 1,920 MW by FY1992, and its energy sales to 6,283 gigawatt-hours (GWh). The actual installed capacity was 1,738 MW, or 91 percent of the target. Actual sales were 5,492 GWh or 87 percent of the forecast. 21 Generation capacity was increased by a further 200 MW in FY1998 and old units retired to leave a total installed capacity of 1,756 MW. No further additions have been installed since The transmission reinforcement and expansion helped reduce transmission losses and the frequency of load shedding, and increase energy available for sales. However, insufficient attention to upgrading the distribution network in the face of growing load demand and a surge in nontechnical losses resulted in KESC s overall transmission and distribution losses almost doubling (Table 2). Indicator Table 2: Operational Performance Indicators Before Project (FY1987) Projected (FY1992) After Project (FY1998) Installed Capacity (MW) 1,008 1,920 1,756 Energy Sales (GWh) 4,130 6,283 6,489 Customers Served ( 000) 823 1,145 1,435 System Voltage across 11 kv Lines (kv) a Distribution Voltage across Low-Voltage 170/ /220 Lines (V) Transmission and Distribution Losses (%) kv = kilovolt, GWh = gigawatt-hour, MW = megawatt, V = volt. a Ideally, the measured voltage across 11 kv lines should be 11 kv +/ kv to reduce transmission losses to less than 2.5 percent. 23. For the distribution subprojects, rehabilitation and reinforcement improved feeder voltages from around 9 kv to 11 kv and helped offset overloading in low-voltage distribution. The installation of additional feeders from grid substations expanded the availability of electricity and resulted in 612,000 new connections for a 74 percent increase between FY1987 and FY1998. Voltage at residential and commercial connections was typically increased from V to the designed level of V. 22 Overall, electricity reliability decreased, however, with more frequent feeder trippings due to a mixture of imbalanced loads, increased loadings, and overall poor state of the distribution network In addition to own generation, KESC purchased power from WAPDA. In FY1992, power purchased from WAPDA amounted to 575 MW compared with 780 MW forecast at appraisal. 22 At lower voltage, appliances and machinery do not run at their design specification and burn out with continued use. 23 Reaching 700 per month over some 6, kv feeders.

16 24. The Project was expected to reduce KESC s overall transmission and distribution losses from 17.9 percent in FY1987 to 16.5 percent by FY1992, and to 15.5 percent by FY1995. Actual losses, which also include nontechnical losses, increased to 26 percent by FY1992, and to 34 percent by FY Several reasons explain this: (i) delays in rehabilitation of the distribution network, which as a result, accentuated the impact of ongoing load growth; (ii) reduced investment in distribution rehabilitation; (iii) canceling the installation of capacitors in the distribution system; (iv) poor design, construction, and connection practices; and (v) an increase in nontechnical losses. 25 The net effect was that the final project scope as implemented, was insufficient to achieve the project targets set for KESC s overall system. Appendix 3 discusses further the operational and technical performance of the Project and the KESC system. 25. Maintenance was not addressed at appraisal. The OEM observed from subproject sites and substations visited that maintenance for distribution operations generally failed to follow accepted international practice and was affected by shortages of equipment, particularly meters, fuses, transformers, and connectors. Discussions with KESC revealed the lack of a systematic approach to maintenance. B. Performance of the Operating Entity 26. At appraisal (FY1987 being the last available full-year accounts), KESC s financial performance was considered unsatisfactory, due largely to factors beyond its control. KESC reported an operating profit after depreciation and interest of PRs340 million, or 8.7 percent of total revenues. Liquidity was affected by a dividend provision of 85 percent of profit before tax, a high level of arrears from provincial government agencies, and a reluctance by the federal Government to approve tariff increases. Prior to approval of ADB s loan, the Government introduced several measures to restore financial viability. These included (i) reductions in the price of natural gas and fuel oil for generation, (ii) a revision of loan terms on government debt, (iii) implementation of recommendations to integrate the tariff structures of KESC and WAPDA, and (iv) a holiday period on dividend payments. 27. The main indicators of KESC s financial performance are summarized in Table 3 (see also Appendix 6). KESC s PDP for FY projected (i) a total investment of PRs23.4 billion, (ii) an increase in total operating revenue by 22 percent a year in nominal terms, (iii) an increase in operating profit before depreciation and interest by 20.8 percent per annum, (iv) a debt service ratio ranging from 1.8 to 3.1, and (v) a rate of return on historical assets increasing from 10 to 14.5 percent. Actual total PDP investment expenditure which, because of delays, did not include funding under the Project of PRs5.3 billion was PRs17.2 billion, or 74 percent of that planned. 26 Actual operating revenue increased at 16.8 percent per annum, and gross operating profit in FY1993 was PRs3.1 billion compared with PRs5.7 billion forecast. Except for FY1991, KESC s debt service ratio remained until FY1996 slightly above the loan covenanted level of at least 1.3, but not near as high as projected at 3.1 for FY1993. Because of a switch in accounting practice to value assets on a current basis, the OEM could not monitor the rate of return on historical assets. 28. Over the longer period FY1987 to FY2000, KESC s profit performance relative to operating revenue and return on equity moved from weak to negative. Net operating profit after depreciation and interest began to deteriorate after FY1990, reaching a first-year loss of PRs0.5 billion in FY1996, which increased to PRs12.8 billion in FY2000. Gross operating profit did not deteriorate until after FY1995 when the higher cost of fuel began to have a negative effect. After FY1995, interest costs also rose steeply, and KESC was unable to meet the full 24 Eighty percent of losses in transmission and distribution were identified at appraisal as due to distribution. 25 Transmission and distribution losses were 40.2 percent in FY2000, of which nontechnical losses were estimated at around 18 percent. 26 Total expenditure under the Project for FY was less than 1 percent of KESC s total PDP investment, and over the investment period FY was 17.4 percent.

17 financial cost of its operations and debt servicing. By FY1998, KESC was financially insolvent. ADB s financial covenants to ensure (i) a current ratio of not less than 1, (ii) a debt service ratio of at least 1.3 times net revenues, and (iii) a self-financing ratio of at least 0.25 from FY1991 were not complied with. Table 3. Financial Performance of KESC (PRs billion) Fiscal Year Ending Gross Revenue Fuel Costs Other Operating Expenditure Gross Operating Profit a (1.7) 0.0 (0.4) (4.0) Profit Before Tax (6.8) (6.9) (7.4) (12.8) Appropriations b (1.2) (1.2) Net Fixed Assets Long-Term Loans Total Assets Performance Indicators Current Ratio c Debt Service Ratio d (0.5) (0.1) (0.4) (0.7) Self-Financing Ratio e <0 <0 <0 <0 Operating Expenditure/Revenue (ratio) Return on Operating Revenue (%) f (42.9) (31.0) (31.6) (51.1) Return on Equity (%) (449.8) insolvent Equity to Total Assets (%) (6.2) (12.4) (32.5) Average RevenueTariff (PRs/kWh) = near zero, kwh = kilowatt-hour. a Before depreciation and loan service costs. b Covering provision for dividends and tax. c Ratio of current assets to current liabilities. d Profit before depreciation and interest, and after tax and dividends divided by interest plus loan repayments. e Net sum of funds from internal resources divided by average capital expenditure. f Profit before tax divided by operating revenue. 29. Adjustments in KESC tariffs resulted in an average annual increase of 12 percent between FY1987 and FY2001 compared with an average inflation rate of 9 percent per annum. 27 Reflecting these adjustments, the average revenue per kilowatt-hour (kwh) increased 4.5 times from PRs0.93/kWh to PRs4.21/kWh. By way of contrast, the average unit cost, excluding depreciation and interest, increased 8.6 times from PRs0.55/kWh to PRs4.75/kWh due mainly to rising fuel costs and the higher cost of energy purchases from IPPs. Erosion of KESC s operating margin was also accentuated by the loss of operational efficiency resulting from growing system losses. Overall, KESC s weakening financial performance is attributed to (i) reduced investment and attention to improving system efficiencies, particularly in distribution; (ii) growing nontechnical losses; and (iii) insufficiency of the net revenue tariff to KESC (para. 55). C. Financial and Economic Reevaluation 30. At appraisal, the EIRR and FIRR were calculated taking into account all KESC investment additions (planned and under construction), including the Project, during the timeslice FY The investments included a planned increase in generation of 830 MW at 27 As measured by the national consumer price index to FY2001. The last tariff adjustment in March 2001 provided for an estimated average increase of 8 percent. The previous adjustment in 1998 provided for an average increase of 20 percent.

18 Bin Qasim 3, 4, 5, and West Wharf 1 and all rehabilitation and expansion works in transmission and distribution. The benefits included all incremental energy revenue up to FY1995, which was thereafter held constant through FY2015. Associated operation and maintenance expenditures, including fuel costs, were estimated up to FY1993 and thereafter held constant through FY2015. The base case EIRR of 12.7 percent and FIRR of 11.1 percent were sensitive to variations in energy sales, tariffs, fuel prices, and capital costs The PCR extended the completion year of the Project and repeated the approach adopted at appraisal, taking into account actual costs and revenues from FY1991 to FY The PCR s lower FIRR of 4.5 percent largely reflects differences in scheduling, accountability for capital invested, 30 and incremental sales. 31 The lower EIRR of 5.7 percent arises because of the same factors Reestimates of the time-slice calculations based on all investment additions from FY1987 to FY1998 are less than zero (FIRR) and 1.6 percent (EIRR). However, because of the reduced project scope to address system losses and subsequent insufficiency of investment in distribution upgrading to achieve an overall reduction in system losses for KESC, the time-slice approach is not an appropriate methodology for assessing the financial and economic viability of the Project. Estimates for typical individual subprojects visited by the OEM, which range from 16.5 percent to more than 50 percent for the FIRR, and from 23.7 percent to more than 50 percent for the EIRR, attest to the viability of the subprojects. Comparison of the subproject estimates with the time-slice estimates calculated at appraisal and in the PCR is shown in Table 4. Appendix 7 provides details of the methodology, assumptions, sensitivity, and workings underlying the FIRR and EIRR calculations. Table 4: FIRR and EIRR Estimates (percent) Item Appraisal PCR PPAR a FIRR >50 EIRR >50 EIRR = economic internal rate of return, FIRR = financial internal rate of return, PCR = project completion report, PPAR = project performance audit report. a For individual subprojects. D. Sustainability 33. The sustainability of reduced transmission losses, improved voltage reliability, and reduced outages depends on generation sufficiency and optimal load management. Generation sufficiency to meet load growth has been achieved through power purchases from IPPs and WAPDA. The transmission line capacity developed under the Project is sufficient to meet the 28 For example, a 10 percent increase in fuel costs without a corresponding increase in the electricity tariff reduced the appraisal FIRR from 11.1 percent to 6.0 percent. 29 The computation did not account for KESC s earlier investment in generation for Bin Qasim units 3, 4, and 5 from which incremental energy increases were derived. 30 Qasim generation units 3, 4, and 5 were commissioned in FY1990 and FY1991; Qasim 6 was commissioned in FY The PCR s projected incremental sales increased from around 800 GWh in FY1998 to 4,000 GWh in FY2001. The increase reflected energy increases not linked to KESC s investment additions but largely to forecast increases in the purchase of power from IPPs and WAPDA. Actual incremental sales attributable to the time-slice investments were around 800 GWh, and if used in the PCR would have resulted in a much lower FIRR and EIRR. 32 Another difference in the computation method involved the pricing of incremental sales. At appraisal, incremental sales were valued at willingness to pay. For the PCR, incremental sales were valued at the average tariff adjusted to economic prices (Appendix 7).