Report No. PID10634 Project Name VIETNAM-Vietnam Guarantee Project (@) Region East Asia and Pacific Region Sector Power (100%) Project ID P067973 Borrower(s) SOCIALIST REPUBLIC OF VIETNAM Implementing Agency Address MINISTRY OF INDUSTRY Address: 54 Hai Ba Trung St., Hanoi, Vietnam Contact Person: Mr. Hoang Trung Hai - Minister Tel: 84-4-9349411 Fax: 84-4-9349412 Email: bqlipp-bcn@hn.vnn.vn Environment Category A Date PID Prepared September 24, 2002 Auth Appr/Negs Date June 24, 2002 Bank Approval Date October 8, 2002 1. Country and Sector Background The main sector issues were identified in the Bank's energy sector report: "Fueling Vietnam's Development " (April 1999) which has been discussed with the government and the Government's strategy to respond to these issues are outlined below : The four main challenges are first, the need for large sector investments to meet the growing energy demand. Energy demand has been growing 13 % faster than GDP during the last five years and continued expansion in energy and electricity supply and delivery infrastructure will enable rapid growth in the agricultural and industrial sectors to sustain economic growth. To meet the economic growth targets, electricity supplies will need to grow at about 70 % faster than economic growth rates. Second, though Vietnam is a resource rich country, it should strive to develop the energy sector along an environmentally sustainable path. Recent natural gas discoveries offshore provide an opportunity to make environmentally and economically beneficial energy use choices and the first offshore gas reserves will be piped ashore in 2002. Third, Vietnam has to invest almost 5.3 % of its GDP or twice that its ASEAN neighbors, in essential energy infrastructure. Fundamental reform of the energy tariffs with respect to both level and structure is required to ease immediate financing constraints and ensure long-term efficiency in the investment and resource utilization decisions throughout the economy. Since two thirds of the required investments will need to come from ODA, export credits and foreign direct investments, public financial resources and government guarantees for private investment should be selectively used. Fourth, attracting foreign private investment will require the creation of a enabling environment and legal framework. The Government needs to embark on restructuring and rationalization of the energy state owned enterprises, creating a regulatory system and developing a mechanism to coordinate policy and investment decisions in the energy sector. a. Need for large sector investments and for improvement in overall system efficiency: Over the past five years, electricity demand in Vietnam has increased at an average rate of 13-15 ; per annum. This increase is typical of countries which begin from very low levels of demand. To sustain an economic growth projection of about 6-8 t p.a. over the next 5 years, Vietnam needs to increase its electricity supplies at the rate of about 10-13 W per annum, calling for an investment of about US$ 8.3 billion equivalent over the period 2000-2005. This investment represents about 5 W of the projected GDP. Financing this increase in electricity supplies requires a strategy to first improve the efficiency of existing systems and second to maximize the inflow of external sources of capital within prudent limits, as well as increase the amount of self generated sectoral surpluses for investment. The Government is working towards these goals by : (a) promoting energy conservation and efficiency , (b) increasing and structuring electricity tariffs to raise internally generated surpluses; (c) involving the private sector in power "generation" and developing natural gas supplies; and (d) promoting equitization of distribution functions.b. Low Rural Access to electricity: Rural electrification is a critical element of the Government's program to eliminate poverty and redress imbalances in development. Ambitious rural electrification targets have been established and work towards meeting them has commenced. The key issues in rural electricity delivery and management are: (i) securing adequate resources for investments that are economically justified but financially unviable; (ii) defining and implementing methods for rural grid and off -grid management, maintenance and services that do not overextend central electricity providers and maximize local participation; and (iii) designing tariff structures that recover costs without distorting price incentives for local generation and for efficiency. The Government is addressing the above issues by: (i) issuing a Rural Energy Policy Paper and preparing national decrees for implementation of the rural electrification programs; (ii) nominating MoI to promote, coordinate and manage the renewable energy program for the country; (iii) working with the World Bank in designing investment projects for rural electrification that would address the issues noted above.c. Managerially and administratively weak sector institutions: Institutions in the Vietnam's energy sector are managerially and administratively weak. Much of this weakness results from inadequate staff skills and organizational systems required to deal with and operate in an increasingly commercial environment. The Government has recognized the problem, and is making slow but steady progress: (a) the government is focusing on staff training with a view of upgrading the skills base and also to familiarize senior government officials alternative models of governance and oversight; (b) the government has initiated plans for the equitization of communes and districts. The change process is likely to be slow, but positive steps and actions have been initiated.d. Lack of a Comprehensive Legal and Regulatory Framework: Given that the structure and commercial arrangements in the power sector are evolving rapidly and the participation of the private sector is relatively new, the legal and regulatory framework has not developed adequately to respond to these changes. The creation of a credible regulatory entity and a enabling body of regulations for tariff, investment oversight, and rural electrification are key priorities. The Government is giving due importance to achieving developing the needed framework and with ESMAP and ADB assistance, it is currently engaged in the (a) drafting of an Electricity Law and (b) the development of an -2 - institutional mechanism to perform the regulatory functions.The Project is consistent with the Bank Group's strategy in the sector, the mainstay of which is to promote reform, deregulation, and private sector investment. The Government has indicated its commitment to reforming the sector, and works towards: (i) promoting energy conservation and efficiency; (b)increasing and structuring electricity tariffs to raise internally generated surpluses; (c) involving the private sector in power generation and developing natural gas supplies; and (d) promoting equitization of distribution functions. To meet increasing power demands, the Government invited private investors to bid for this generation Project under a competitive bidding framework. The Bank has supported the Government strategy of seeking private sector participation in power generation, and its support has been instrumental in ensuring a transparent framework for such private sector participation. The Phu My 2-2 BOT Power Project is the first infrastructure project to be implemented by the private sector through competitive bidding process in the country.The Project is a combined-cycle power plant to be fired with domestic natural gas and is a part of the least-cost power generation expansion plan in Vietnam. It would help avoid power shortages and secure significant economic benefits for the country. By enabling the Government to shift costs to the private sector, and reducing the need for public investment in the sector, this Project would help make available scarce public resources for poverty alleviation and social development needs. The Project will represent one of the largest foreign direct investment in Vietnam and should help pave the way for attracting additional private capital investment flows for infrastructure development in Vietnam. 2. Objectives The principal objectives of the Project are to (a) enable Vietnam meet its increasing power demands in a cost-effective and reliable manner, (b) mobilize private sector financing for a large infrastructure project and (c) promote Government's reform efforts by (i) demonstrating a competitive and transparent framework for private sector participation; (ii) promoting commercial discipline; and (iii) paving the way for further private participation in the sector. The proposed Project consists of a 715-MW gas-fired combined-cycle power station to be developed, owned, and operated on a Build-Operate-Transfer (BOT ) basis by Mekong Energy Company Limited (BOT CO.), a wholly owned subsidiary of the private sponsor consortium of EDF International (EDFI), Sumitomo Corporation and TEPCO International. Under the Power Development Project (CR 2820-VN), the Bank has partially financed the first phase of the Phu My 2 power project as a public project, and has provided technical assistance support for the development of the second phase as a BOT project. IDA Partial Risk Guarantee (PRG) of up to US$75 million in support of commercial debt financing was offered as an option in the competitive bidding to select private developer consortium for the Project, which concluded in April 1998. The EDFI-led consortium was awarded the Project in January 1999. The winning proposal included the IDA PRG as a critical core component of the financing of the Project.This operation would be the first IDA Guarantee in Vietnam. 3. Rationale for Bank's Involvement Over a period of several years, the Bank has actively assisted the Government in formulating a policy to promote private power development in a transparent and competitive manner. Vietnam has only limited access to -3 - the international loan and capital markets because of its IDA country status with non-investment grade sovereign credit rating (B1 by Moody's). It is therefore, mainly dependent on multilateral and bilateral funds for financing infrastructure development. Some oil and gas exploration projects with high and quick returns and foreign exchange revenues have been financed by sponsor equity of international oil and gas companies. However, such corporate balance-sheet funding is normally not available for lower-return infrastructure projects such as power generation projects. The limited-recourse debt financing for infrastructure projects has been extremely difficult in Vietnam, due to developing but untested legal and regulatory frameworks to deal with complex contractual arrangement, perceived lack of creditworthiness of the Government and various agencies serving as contractual counter-parties, foreign exchange convertibility/transferability risks as well as unfamiliarity of Government bodies towards private project finance and resulted long delays.The IDA Guarantee would assist the debt financing and therefore the actual implementation of the Project, and would encourage private participation into the power and other infrastructure sectors where such has been very difficult. By guaranteeing the contractual obligations of the Government and its agencies for the Project, the IDA PRG would mitigate sovereign and political risks for commercial lenders and thereby facilitate the mobilization of long-term debt capital necessary to implement the Project and offer competitive tariffs. The IDA Guarantee would allow for allocation of only non-commercial risks to the Government and commercial risks to the sponsors, unlike sovereign borrowing where the Government takes on all the risks. The IDA Guarantee would not create any additional liabilities for the Government other than limited non-commercial risks already undertaken in the project agreements. Following the Sponsors' request for a Guarantee, and in keeping with IDA's 'lender of last resort' role, BOT CO. was asked to maximize other possible sources of finance such as export credits and multilateral programs without a government counter-guarantee with a view to minimizing IDA support for only the balance of the financing. The IDA Guarantee will help catalyze the largest limited-recourse project finance commercial debt package to date for Vietnam IDA PRGs, compared with IDA credits, are particularly suited to help governments transition from public to private finance through political risk mitigation and effective risk sharing with project sponsors and lenders. The IDA Guarantee, by catalyzing commercial finance, would reduce the amounts of fund resources required by governments for critical infrastructure investments such as the Project and enable the Government to free more resources to meet other social projects.The IDA Guarantee, in a limited but significant way, has contributed to the sector reform dialogue in terms of helping to establish an enabling and sustainable framework for private power projects by raising the awareness of the stakeholders in the Government toward the need for sector reform. 4. Description The proposed Project consists of a 715-MW gas-fired combined-cycle power station to be developed, owned, and operated on a Build-Operate-Transfer (BOT) basis by Mekong Energy Company (BOT CO.), a wholly owned subsidiary of the private sponsor consortium of EDF International (EDFI), Sumitomo Corporation and TEPCO International. 5. Financing -4- Total ( US$m) BORROWER $0.00 IBRD IDA ASIAN DEVELOPMENT BANK $75.00 IBRD GUARANTEE $75.00 EXPORT CREDIT (UNIDENTIFIED) $190.00 FOREIGN PRIVATE COMMERCIAL SOURCES (UNIDENTIFIED) $140.00 Total Project Cost $480.00 6. Implementation The Project will be implemented by Mekong Energy Company (BOT CO.), a private company incorporated under the laws of Vietnam by the Sponsors. The Government, coordinated through MOI, has negotiated and will finalize the various project agreements. EVN will purchase the Project's power capacity and output for resale to users through its distribution PCs. PV will supply gas fuel to the Project. The Government, through MPI, will provide necessary assurances and guarantees to the Project. 7. Sustainability The sustainability of the Project will be underpinned through a combination of the following factors: (i) economic benefits to the Government from the Project with a competitive tariff and which would help to address needs for increased power generation capacity to sustain economic growth; and (ii) private sector operation backed by firm financing commitments and commercial and financial benefits to the Sponsors. 8. Lessons learned from past operations in the country/sector Learning from the experience with IPPs in other countries, certain safeguards have been incorporated in the Project design with respect to mitigating sectoral and macroeconomic risks. 9. Environment Aspects (including any public consultation) Issues : The Project is an expansion of the Phase 1 of Phu My 2 power project financed by IDA under the Power Development Project (CR 2820 of February 1996), for which an EA was previously prepared by IDA. The Project does not involve any land expropriation or resettlement. Under the RFP of the Project, the Sponsors were required to produce an environmental impact evaluation report with respect to the facility in accordance with World Bank Guidelines and the Laws of Vietnam. The Sponsors and their consultants have completed a detailed EA in accordance with World Bank Guidelines and submitted such to the Bank for review. The EA will be publicly disclosed and discussed in Vietnam. A copy of the EA will be released through the Bank's InfoShop in October 2001. 10. Contact Point: Task Managers Anil Kumar Malhotra /Suman Babbar The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: 84-4-9346600 (Hanoi); 202-473 2029 (Washington) - 5- Fax: 84-4-9346597 (Hanoi); 202-477 0218 (Washington) 11. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop Note: This is information on an evolving project. Certain components may not be necessarily included in the final project. This PID was processed by the InfoShop during the week ending September 27, 2002. -6- . 84-4-93494 12 Email: bqlipp-bcn@hn.vnn.vn Environment Category A Date PID Prepared September 24 , 20 02 Auth Appr/Negs Date June 24 , 20 02 Bank Approval Date October 8, 20 02 1. Country. and TEPCO International. Under the Power Development Project (CR 28 20-VN), the Bank has partially financed the first phase of the Phu My 2 power project as a public project,. The Project is an expansion of the Phase 1 of Phu My 2 power project financed by IDA under the Power Development Project (CR 28 20 of February 1996), for which an EA