Report and Recommendation of the President to the Board of Directors

Project Number: 41504-01 November 2010

Proposed Multitranche Financing Facility Papua New Guinea: Town Electrification Investment Program

CURRENCY EQUIVALENTS (as of 25 October 2010)

Currency Unit – kina (K) K1.00 = $0.38 $1.00 = K2.63

ABBREVIATIONS

ADB – Asian Development Bank ADF – Asian Development Fund CSO – community service obligation EIP – electricity industry policy EIRR – economic internal rate of return FAM – facility administration manual FFA – framework financing agreement FIRR – financial internal rate of return MFF – multitranche financing facility OCR – ordinary capital resources PCA – procurement capacity assessment PDP – power development plan PMU – program management unit PNG – Papua New Guinea PFR periodic financing request PPL – PNG Power Limited PPP – public–private partnership

WEIGHTS AND MEASURES

km – kilometer kV – kilovolt MW – megawatt MWh – megawatt hour

NOTES (i) The fiscal year (FY) of the government ends on 31 December. (ii) In this report, "$" refers to US dollars

Vice-President C. Lawrence Greenwood, Jr., Operations 2 Director General R. Wihtol, Pacific Department (PARD) Director S. Ra, Pacific Operations Division, PARD Team leader A. Maxwell, Energy Specialist, PARD Team members E. Brotoisworo, Principal Safeguards Specialist, PARD A. Gill, Country Specialist, PARD

R. Kesterton, Energy Specialist, PARD S. Lee, Senior Social Development Specialist, PARD R. Nagpal, Senior Counsel, Office of the General Counsel N. Sapkota, Safeguards Specialist, PARD A. Woodruff, Young Professional (Economics), PARD Peer reviewer D. T. Bui, Senior Energy Economist, Southeast Asia Department In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page PROJECT AT A GLANCE

I. THE PROPOSAL 1 II. THE INVESTMENT PROGRAM 1

A. Rationale 1 B. Impact and Outcome 3 C. Outputs 3 D. Investment and Financing Plans 4 E. Implementation Arrangements 6

III. GRANT ASSISTANCE 7 IV. DUE DILIGENCE 7

A. Technical 7 B. Economic and Financial 7 C. Governance 8 D. Poverty and Social 8 E. Safeguards 9 F. Risks and Mitigating Measures 9

V. ASSURANCES 10 VI. RECOMMENDATION 10 APPENDIXES 1. Design and Monitoring Framework 11 2. List of Linked Documents 14

I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on a proposed multitranche financing facility (MFF) for Papua New Guinea for the Town Electrification Investment Program. 2. The proposed investment program will improve power supply in provincial urban centers through replacement of high-cost diesel power generation with sustainable renewable energy power generation. The investment program will include (i) construction of about six run-of-river hydropower plants1 to supply provincial centers, (ii) construction of transmission systems to connect provincial centers, and (iii) capacity building within the power utility and communities. Project preparatory technical assistance (TA) was used in project preparation.2

II. THE INVESTMENT PROGRAM A. Rationale 3. In Papua New Guinea (PNG), grid-connected power is largely restricted to the main urban areas. Less than 10% of the population has access to electricity.3 In provincial urban centers not connected to the main power grids, a relatively low percentage of urban residents are connected,4 and distributed power is rarely available outside the provincial urban centers. The supply of power to business and industry in the provincial urban centers is unreliable, with regular power outages5

and demand that at times exceeds generation capacity. As a result, many large businesses in the provinces self-generate using diesel generators, at high cost. Lack of access to affordable, reliable power is limiting economic growth in provincial centers.

4. PNG has a total of 580 megawatts (MW) installed generation capacity. PNG Power Limited (PPL), the national state-owned corporatized power utility, manages generation of about 300 MW, including the two main grids (Port Moresby and Ramu grids) and 19 geographically isolated independent power grids servicing provincial centers. The remaining 280 MW consists of power that is self-generated by industrial facilities, including mines, and private sector generators. The majority of provincial centers are supplied entirely through diesel generation, resulting in high generation costs.6 The poor development of provincial power is due to (i) difficult geographical conditions; (ii) maintenance issues; (iii) high initial investment costs for hydropower resulting in reliance on diesel generation, which has low upfront costs but higher life cycle costs; and (v) the single national tariff structure, which serves an investment disincentive. The current regulatory framework provides power tariffs that allow full cost recovery by PPL; however, in the absence of adequately funded community service obligations (CSOs), the national uniform power tariff creates a disincentive for investment in high-cost regional centers. The ongoing policy reform proposes to address this through (i) a CSO policy,7

1 While hydropower is generally the least-cost renewable energy alternative, other sources may be considered.

(ii) an electricity trust fund under the draft electricity industry policy (EIP), and (iii) split tariffs to reflect higher

2 Asian Development Bank (ADB). 2008. Technical Assistance to Papua New Guinea for Preparing the Power Sector Development Project. Manila (TA 7113-PNG, approved on 8 August).

3 Provinces not connected to the main power grids have an average access rate of 2.9%. 4 In the provincial centers assessed under the TA for Preparing the Power Sector Development Project, the urban

electrification rate was 24% to 57%. 5 For example, PPL estimates that load shedding in West New Britain is currently around 50%. 6 Power generation costs in some provincial centers exceed $0.8 per kilowatt-hour. 7 ADB is assisting the establishment of the CSO policy through ADB. 2009. Technical Assistance for Pacific Private

Sector Development Initiative Phase II. Manila (TA 7430-PNG, approved on 10 December).

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generation costs. The projects selected for the investment program are financially viable under the current national tariff system. PNG has significant underutilized indigenous renewable energy sources, particularly hydropower. The investment program will support development of renewable energy sources, including hydropower plants, in about six target provincial centers to (i) improve reliability and quality of power supply in order to stimulate economic growth; and (ii) replace diesel generation, thereby reducing power generation costs and creating incentives to improve access rates. 5. The investment program supports the Government of PNG’s strategic priorities in the energy sector. Activities in the PNG power sector are currently governed by the Electricity Industry Act 2002. The government has recently prepared the draft EIP,8 which is expected to be approved in 2010. It proposes various policy measures, including (i) facilitating competition and contestability in the electricity industry, including the private sector; (ii) up-scaling rural electrification through CSOs; and (iii) enhanced technical regulation. The proposed development of the power sector in each province is detailed in the PPL 10-year power development plan (PDP). 9

The PDP lists the status of current infrastructure and proposed investments over a 10-year time frame. The PDP provides a road map of priority hydropower developments in the provinces to reduce reliance on diesel generation and improve service delivery. The investment program will support implementation of the PDP.

6. The government has recognized a number of key policy constraints in the power sector and is currently undertaking a number of reforms that will be supported by the investment program.10 The investment program also supports (i) the PNG country strategy and program 2011–2015 of the Asian Development Bank (ADB),11 which prioritizes energy as a key area of support; (ii) the national program of priority hydropower developments listed in the PDP; and (iii) the Papua New Guinea Development Strategic Plan 2010–203012

priority of replacing diesel generation with hydropower.

7. PNG’s development partners have been consulted extensively during development of the investment program. The development partners have recently focused on policy support in the energy sector and development of small off-grid power supply projects with direct poverty alleviation benefits. The Pacific Islands Applied Geosciences Commission provided support for a number of energy sector issues in PNG, including consultation regarding the draft national energy policy and draft rural electrification policy through the Pacific Islands Energy Policy and Strategic Action Planning. The World Bank, with support from the Global Environment Fund, has been supplying rural teachers in the Western Province with solar lighting kits. It has also launched a regional Sustainable Energy Financing Project, designed to provide financing support to the energy sector in a number of Pacific countries, including PNG. 8. The implementation capacity of key institutions has been assessed and capacity strengthening activities developed, focusing on (i) financial management of PPL, (ii) procurement capacity for PPL, (iii) development of public–private partnership (PPP) options for consideration under tranche 2, and (iv) capacity of communities to manage improved power

8 A draft rural electrification policy has also been prepared, but has yet to receive broad endorsement. 9 Government of PNG. 2009. PNG Power National and Provincial Ten Year Power Development Plan 2009–2018.

Port Moresby (July). 10 Details of the proposed reforms are provided in the Sector Assessment (Summary): Energy (accessible from the

list of linked documents in Appendix 2). 11 ADB. 2010. Country Strategy and Program: Papua New Guinea, 2011–2015. Manila. 12 Government of PNG, Department of National Planning and Monitoring. 2010. Papua New Guinea Development

Strategic Plan 2010–2030. Port Moresby. (March).

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delivery. The MFF was selected as the preferred financing modality as the MFF (i) provides long term support to the implementation of the PNG Power 10 Year Development Plan, (ii) reduces commitment charges, (iii) reduces transaction costs compared to individual project financing, (iv) enables staged construction to match human resource availability within implementing agency, and (v) establishes a platform for ongoing dialogue and support regarding sector reform. The government and ADB have entered into a framework financing agreement (FFA), which sets out the roadmap, strategic context, policy framework, investment program, and the financing plan. The FFA also records the assurances and conditions in crosscutting themes covering safeguards, governance, anticorruption, financial management, procurement, and project selection. Financing will be extended under the MFF subject to the (i) submission of periodic financing requests (PFRs) by the government; (ii) compliance with the project selection criteria; (iii) execution of the related loan and project agreements for each tranche; and (iv) fulfillment of terms, conditions, and undertakings set forth in the FFA. Each PFR will be accompanied by a list of projects identified for financing under the MFF.13

B. Impact and Outcome 9. The impact of the investment program will be improved economic conditions in target provincial centers not connected to the main grids. The outcome of the investment program will be improved utilization of reliable, clean power by PPL to about six provincial urban centers. C. Outputs 10. The outputs of the investment program will be (i) about six renewable energy projects, including hydropower plants, put into operation by PPL; (ii) transmission systems constructed and operated by PPL; (iii) capacity building undertaken for the implementing agency and project beneficiaries; and (iv) efficient project management services rendered by the project management unit. Tranche 1 projects will support isolated provincial center grids, including:

(i) Divune Hydropower Plant, consisting of a 3 MW run-of-river hydropower plant, located in Northern Province. The project will include (i) 3-meter-high concrete gravity diversion weir; (ii) 2.6 kilometers (km) of buried low-pressure pipeline; (iii) a powerhouse; (iv) an 85 km, 22 kilovolt (kV) transmission line; and (v) upgrading and construction of the 6.1 km access road.

(ii) Lake Hargy Interconnection, consisting of an approximately 150 km, 66 kV transmission line connecting Bialla to Kimbe, West New Britain, accessing approximately 1 MW of spare generation capacity from the Lake Hargy Hydropower Plant, and connecting about 3 MW of biomass power (methane recovery) from palm oil plantations along the alignment.

(iii) Ramazon Hydropower Plant, consisting of a 3 MW run-of-river hydropower plant, located in Autonomous Region of Bougainville. The project will include construction of (i) a concrete weir; (ii) a 5 km buried pipeline; (iii) penstock; (iv) powerhouse; (v) a 50 km, 33 kV transmission line; and (vi) a 5.3 km access road.

11. The investment program will improve access to energy in urban areas through (i) improved quality and reliability of power to urban residential, commercial and industrial customers; and (ii) increased generation of power to allow PPL to increase connections to urban residential, commercial and industrial customers. The low rate of residential access to electricity

13 Framework Financing Agreement and Periodic Financing Request for Tranche 1 (accessible from the list of

documents in Appendix 2).

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outside provincial centers is a significant social issue (non-urban households rarely have access to electricity). The investment program will establish key transmission links along main population corridors, which will facilitate increased connectivity of the population outside the main provincial centers.14

This will address a key investment hurdle for provincial governments, who are responsible for rural electrification.

D. Investment and Financing Plans 12. The total cost of the investments under the PDP between FY2011 and FY2016 is estimated at $550 million equivalent. The investment program, which will support the section of the PDP targeting supply of power to provincial centers not connected to the main grids, is estimated to cost $150 million equivalent and will be implemented over 6 years. Tranche 1 will cost about $71.6 million equivalent, including taxes, duties, physical and price contingencies, interest, and other charges. The investment plan is summarized in Table 1.

Table 1: Investment Program ($ million)

Item Amount A. Investment Program 1. Base Costa a. Renewable energy generation 78.20 b. Transmission 39.60 c. Capacity development 0.30 d. Project management 11.50

Subtotal (A1) 129.60 2. Contingenciesb 15.10 3. Financing Charges During Implementationc 5.30

Subtotal (A) 150.00 B. Tranche 1 1. Base Cost a. Renewable energy generation 31.70 b. Transmission 24.00 c. Capacity development 0.30 d. Project management 5.30

Subtotal (B1) 61.30 2. Contingencies 7.40 3. Financing Charges During Implementation 2.90

Subtotal (B) 71.60 a In May 2010 prices. b Physical contingencies computed at 15% for civil works and 5% for transmission lines. Price

contingencies computed by year and expenditure based on cumulative domestic and foreign price inflation.

c Includes interest and commitment charges. Interest during construction for ADB loan(s) has been computed for the ordinary capital resources loan component at the 5-year forward London interbank offered rate plus a spread of 0.3% and for the Asian Development Fund loan component at 1% per annum. Table 1 is based on current estimates and financing terms may vary for subsequent tranches. Commitment charges for an Asian Development Bank loan are 0.15% per year to be charged on the undisbursed ordinary capital resources loan amount.

Source: Asian Development Bank estimates. 14 Extension of the distribution grid will be financed separately through government-financed CSOs, partially funded

through the electricity trust fund. A grant-financed project is proposed to assist energy access (see section III).

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13. The government has requested an MFF for an amount up to $120 million equivalent from ADB's ordinary capital resources (OCR) and Special Funds resources to help finance a part of the investment program. The government will be contributing $30 million to the MFF, including all local taxes and duties. The MFF will consist of two tranches, subject to the government's submission of related PFRs, execution of the related loan and project agreements for each tranche, and fulfillment of terms and conditions and undertakings set forth in the FFA. 14. The first tranche of the MFF will comprise a blend of (i) a loan from OCR of $40.9 million (OCR loan), and (ii) a loan from Special Funds resources of SDR10,565,000 equivalent ($16.4 million) (Asian Development Fund [ADF] loan), which will finance 80% of the total cost of tranche 1. ADB loan proceeds will be made available by the government to PPL under a subsidiary loan agreement15

. The government has provided ADB with (i) the reasons for its decision to borrow under ADB’s London interbank offered rate-based lending facility based on these terms and conditions, and (ii) an undertaking that these choices were its own independent decision and not made in reliance on any communication or advice from ADB. The government will provide counterpart funding of $14.3 million equivalent, including all local taxes and duties ($5.9 million). The financing plan for the investment program is in Table 2.

Table 2: Financing Plan ($ million)

Source Total % Investment Program Asian Development Bank (ADF and OCR) 120.00 80.00 Government of Papua New Guinea 30.00 20.00

Total 150.00 100.00 Tranche 1 Asian Development Bank (ADF) 16.40 23.00 Asian Development Bank (OCR) 40.90 57.00 Government of Papua New Guinea 14.30 20.00

Total 71.60 100.00 ADF = Asian Development Fund, OCR = ordinary capital resources. Source: Asian Development Bank estimates. 15. The financing terms for each tranche will be specified in the PFR for each tranche.16 Interest and other charges during construction for all tranches are to be capitalized for the ADF and OCR loans and such other terms and conditions set forth in the loan and project agreements. Tranche 2 is intended to be implemented by 1 January 2013, with physical completion by 31 December 2016.17

16. The government has requested that ADB consider providing additional resources from its ADF resources for subsequent tranches. It is understood that the provision of any such additional ADF financing will be accompanied by a corresponding reduction of the available OCR financing, so that the total financing provided by ADB will not exceed the MFF amount of $120 million equivalent. Any additional ADF allocation will be subject to (i) the general availability of ADF resources from time to time, (ii) Papua New Guinea's access to such

15 ADB loan proceeds (ADF and OCR) will be relent by the government to PPL on the same terms and conditions as

the loan agreements between ADB and the government, primarily due to the significant social benefit of the investments.

16 Transportation and insurance are eligible for financing under the loans. 17 Indigenous Peoples Planning Framework (accessible from the list of documents in Appendix 2).

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resources pursuant to ADB’s then-applicable Graduation Policy18 and the requirements of the ADF donors, and (iii) the availability of such resources to Papua New Guinea pursuant to ADB’s then-applicable policy on performance-based allocation of ADF resources.19

17. ADB will explore and pursue viable cofinancing opportunities (e.g., from the Japan International Cooperation Agency and European Investment Bank) during the implementation of the investment program and the preparation of subsequent tranches. ADB’s analysis of the sustainability of PNG’s external debt shows that PNG will remain at moderate risk of external debt distress over the medium term after the investment program. External debt burden indicators will be well below their indicative thresholds under the baseline scenario, but some vulnerability to further terms-of-trade shocks and slower economic growth will continue. 18. Two of the projects under tranche 1 are considered to be eligible for carbon financing under the Clean Development Mechanism (CDM). 20

PPL is proposing to pursue a CDM program of activities to develop small hydropower plants in PNG. The ADB technical support facility is providing assistance to PPL and the Future Carbon Fund has initiated discussions to purchase carbon emission reduction credits.

E. Implementation Arrangements 19. The implementation arrangements are summarized in Table 3 and described in detail in the facility administration manual (FAM).21

Table 3: Implementation Arrangements Aspects Arrangements Implementation period January 2011–December 2016 Estimated project completion date

Physical completion of the MFF is on 31 December 2016. The estimated completion date of tranche 1 is 31 December 2013.

Loan closure dates Tranche 1: 30 June 2014 MFF: 30 June 2017

Project management (i) Oversight body Town Electrification Investment Program Steering Committee

Chair: Department of National Planning and Monitoring Members: Departments of (i) Petroleum and Energy, (ii) Treasury, (iii) Environment Conservation, and (iv) Public Enterprises Independent Public Business Commission and PPL

(ii) Executing agency Department of Petroleum and Energy (iii) Implementing agency PNG Power Ltd (iv) Project Management Unit PNG Power Ltd, five staff Procurement International competitive bidding 6 contracts $47,148,792

National competitive bidding 1 contract $1,726,161 Shopping 2 contracts $171,000

Consulting services QCBS 1 contract $4,948,406 Retroactive financing and/or advance contracting

Under each tranche, ADB may, subject to its policies and procedures, allow advance contracting and retroactive financing of eligible expenditures under the MFF incurred prior to loan effectiveness but not

18 ADB. 2008. Review of the 1998 Graduation Policy of the Asian Development Bank. Manila. 19 ADB. 2004. Review of the Asian Development Bank's Policy on the Performance-Based Allocation of Asian

Development Fund Resources. Manila; and ADB. 2008. Refining the Performance-Based Allocation of Asian Development Fund Resources. Manila.

20 CDM will be explored for other projects under subsequent tranches. 21 Facility Administration Manual (accessible from the list of documents in Appendix 2).

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Aspects Arrangements earlier than 12 months before the date of signing of the related loan agreement; such retroactive financing and/or advance contracting is limited to up to 20% of the proposed individual loan.

Disbursement The loan proceeds will be disbursed in accordance with ADB’s Loan Disbursement Handbook (2007, as amended from time to time), and detailed arrangements agreed upon between the government and ADB.

ADB = Asian Development Bank, MFF = multitranche financing facility, PMU = Project Management Unit, PNG = Papua New Guinea, QCBS = quality- and cost-based selection. Source: Asian Development Bank.

III. GRANT ASSISTANCE 20. A proposed grant project—Improved Energy Access for Poor Communities—for $2 million is being prepared 22

to assist with improving access to energy for low income rural communities. Discussions are ongoing for cofinancing of the proposed grant assistance. The grant project will be submitted separately for Board approval, and may include the following:

(i) Component A: Trialing of power grid extension to low-income rural communities. Component A will (a) consist of bundling of power distribution projects to demonstrate the impact of targeted CSOs financing on access rates; and (b) target approximately 1,500 poor households in the Northern Province.

(ii) Component B: Trialing of community-based civil works contracts. A major barrier is the high cost of civil works to construct distribution systems, which is related to difficulties in attracting civil works contractors. The proposed grant will trial community-based civil works contracts for distribution systems.

IV. DUE DILIGENCE

A. Technical 21. The proposed projects have been assessed to be technically viable. For the hydropower design, all available stream flow data was collated to assess water resource availability. Where flow data was limited, correlated projections were made. Alternative designs have been assessed, e.g., glass-reinforced plastic penstocks have been recommended to (i) reduce initial costs, (ii) reduce maintenance, and (iii) reduce transport costs. Standard equipment of known design has been selected to (i) increase availability of parts, and (ii) standardize equipment. B. Economic and Financial 22. Economic aspects. A least-cost analysis of alternative generation options has indicated that tranche 1 projects represent the least-cost means of meeting forecasted growth in demand. The economic internal rate of return (EIRR) for each project exceeds the EIRR threshold of 12% (Divune Hydropower Plant 18.6%, Lake Hargy Interconnection 18.1%, and Ramazon Hydropower Plant 16.4%), and the projects are therefore economically viable. Analysis was undertaken to test the sensitivity of the EIRR to adverse changes in five major risk areas, (i) an increase of 10% in capital cost; (ii) an increase of 10% in operation and maintenance costs; (iii) a 10% decrease in benefits; (iv) a combination of (i), (ii), and (iii); and (v) a 2-year delay in project implementation. The analysis indicates that the EIRR remains robust under all

22 The grant design mission (5–16 April 2010) agreed on the proposed scope of works with the government.

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scenarios, with the exception that EIRR for the Lake Hargy interconnection and Ramazon Hydropower projects drops just below 12% under the “all of the above” scenario. 23. Financial aspects. The financial internal rate of return (FIRR) and financial net present value were computed at the May 2010 price level. The overall FIRR of tranche 1 projects is 9.6%, which exceeded the weighted average cost of capital of 2.4%. Tranche 1 is considered financially feasible. The financial viability of tranche 1 projects was subjected to sensitivity analysis. Sensitivity analysis shows that the FIRR is robust under various adverse conditions, including a (i) 10% increase in capital costs, (ii) 10% reduction in benefits, (iii) 2-year delay in project implementation, and (iv) case 1 and case 2 combined. C. Governance 24. Financial management. A financial management assessment was completed for PPL,23

including a review of the accounting and reporting system, internal and external auditing, fund disbursement, and information system. Control risk for PPL was rated as moderate, and was deemed to be lower than inherent risk due to the corporatized nature of PPL and its significant financial management capacity. PPL’s current financial management system was considered adequate, however, PPL does not have recent experience with international donor-funded loan projects. Specific training needs have been identified and incorporated into tranche 1 design.

25. Procurement capacity. A procurement capacity assessment (PCA) was completed for PPL. The PCA is included in the FAM (accessible from the list of linked documents in Appendix 2). The PCA indicated that PPL has significant procurement experience, including preparation of bidding documents and evaluation of technical proposals and monitoring contract performance. PPL has recent experience with procurement for large projects; however, it does not have recent experience with multilateral development bank procurement procedures. Targeted procurement training of PPL will be undertaken. 26. Anticorruption. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the Department of Petroleum and Energy and PPL. The specific policy requirements and supplementary measures are described in the FAM. 24

D. Poverty and Social 27. Potential poverty and social benefits and impacts on local communities have been analyzed. The investment program incorporates several strategies to enable communities to realize benefits and reduce poverty, including (i) improved access to power, both in towns and villages near hydropower sites; (ii) water supply connections to adjacent communities; (iii) employment during construction; (iv) skills training; and (v) inclusion in civil work contracts of minimum labor standards. The investment program is classified as effective gender mainstreaming. A gender action plan has been prepared, and includes (i) provision of HIV/AIDS awareness for men and women, (ii) equal pay for equal work by male and female workers, (iii) female participation in the labor force, (iv) female participation (30%) in community consultations, (v) skills training for village committees and households (minimum 50% female participation), (vi) the establishment of village power and water committees with at least 50% female participation, and (vii) capacity building of PPL.

23 In accordance with ADB. 2005. Financial Management and Analysis of Projects. Manila; and ADB. 2009. Financial

Due Diligence A Methodology Note. Manila. 24 Facility Administration Manual (accessible from the list of documents in Appendix 2).

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E. Safeguards 28. Environment. An environmental assessment review framework presents the general anticipated environmental impacts of the investment, selection criteria, and environmental procedures for subsequent projects. Initial environmental examinations have been prepared for each of the three tranche 1 projects. The main potential impacts identified include (i) waterway sedimentation, (ii) impacts on fauna during construction, and (iii) reduced streamflow. Adequate mitigation measures have been incorporated. A climate change adaptation risk evaluation was conducted and considered in infrastructure design. 29. Involuntary resettlement. A resettlement framework for the program provides guidelines for preparation of resettlement plans for subsequent projects. Tranche 1 does not involve physical displacement of people and structures, although it will acquire land for two hydropower sites. All land acquisition will be financed by the government. Displaced persons will lose part of their land, crops, and trees. A resettlement plan has been prepared for Divune Hydropower Plant, which involves acquisition of customary land. 25

The resettlement plan includes measures to compensate for affected land and assets and to assist displaced persons to restore and improve their livelihoods.

30. Indigenous peoples. An indigenous peoples planning framework provides guidelines to prepare indigenous peoples plans for subsequent tranches. Customary landowners at one tranche 1 site will lose part of their customary land, but are not expected to experience other adverse impacts. The landowners are expected to benefit from power connection and employment opportunities. An indigenous peoples plan has been prepared for tranche 1 project. 31. Tranche 1 has been classified as category B for environment, involuntary resettlement, and indigenous peoples. Social safeguard documents for tranche 1 projects have been disclosed on PPL's website. All safeguard documents will be disclosed on ADB’s website. The investment program will support capacity within PPL to manage safeguards. F. Risks and Mitigating Measures 32. Major risks and mitigating measures are summarized in Table 4. The risks of the investment program have been assessed and the benefits are expected to outweigh the costs.

Table 4: Summary of Risks and Mitigating Measures

Risks Mitigating Measures Lack of trust by the private sector in the grid power supply results in continuing self-generation.

Offtake agreements will be signed with major customers prior to connection to the grid.

Other external factors will act to prevent private sector expansion.

Demand growth will be monitored in target provincial centers.

Landowner disputes delay implementation. Adequate PMU staffing for consultation PNG Power reallocates human resources to alternative projects.

Additional staffing will be allocated to the PMU to ensure adequate human resources.

25 In 1989, ADB approved the Divune Hydropower Project, which failed to proceed, partially due to land ownership

issues. Early extensive consultation has indicated land ownership disputes are manageable and the site-specific plans have been designed to monitor the negotiation process. (ADB. 1989. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the Independent State of Papua New Guinea for the Divune Hydropower Project. Manila (Loan 0962-PNG, approved on 6 July).

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Risks Mitigating Measures Access to sites is cut by natural disasters such as floods or landslides.

The provincial governments will ensure access to sites remains open.

Shortage of civil works contractors. Construction companies may be reluctant to bid for projects.

The PMU will conduct outreach activities to potential bidders

Source: Asian Development Bank.

V. ASSURANCES 33. The government and PPL have assured ADB that implementation of the investment program will conform to all applicable ADB policies including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement as described in detail in the FAM and loan documents. The government has given ADB certain undertakings for the MFF, which are set forth in the FFA. Specific covenants agreed by the government with respect to individual tranches under the MFF are set forth in the loan agreement and project agreement for the respective tranches. In addition, the government and PPL have agreed to the following specific assurances with respect to tranche 1:

(i) Divune hydropower. PPL will ensure that off-take agreements are signed with additional commercial or industrial consumers for a minimum purchase of 6,000 megawatt-hours (MWh) per annum, or will confirm project financial viability, prior to release of tenders for construction of Divune Hydropower Project.

(ii) Ramazon hydropower. PPL will collect additional streamflow data prior to detailed design to confirm estimated flows.

(iii) Transmission civil works. PPL will allocate adequate counterpart financing and staffing to ensure construction of transmission lines in accordance with proposed project implementation schedules.

(iv) Maintenance. PPL will ensure that a maintenance program is established for each project and provide adequate financing for program implementation.

VI. RECOMMENDATION

34. I am satisfied that the proposed multitranche financing facility would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the provision of loans under the multitranche financing facility in an aggregate principal amount not exceeding $120,000,000 to Papua New Guinea for the Town Electrification Investment Program comprising:

(i) loans from ADB’s Special Funds resources, with interest and other terms to be determined in accordance with ADB's applicable policies relating to Special Funds resources, subject to conditions set forth in paragraph 16 of this report;

(ii) loans from ADB's ordinary capital resources, with interest and other terms to be determined in accordance with ADB's London interbank offered rate (LIBOR)-based lending facility; and

(iii) such other terms and conditions as are substantially in accordance with those set forth in the framework financing agreement presented to the Board.

Haruhiko Kuroda President

1 November 2010

Appendix 1 11

DESIGN AND MONITORING FRAMEWORK FOR THE INVESTMENT PROGRAM

Design Summary Performance Targets

and Indicators Data Sources and

Reporting Mechanisms Assumptions

and Risks Impact The economic condition of the population in the targeted provincial centers has improved.

Increase in PPL customers (business and industrial) by 20% in target provinces by the end of 2016 Reduced self-power generation by customers (business and industrial) by 20% in target provincial centers by the end of 2016 (measured in MWh)

PPL management system Chamber of Commerce member reports

Assumption Improved power supply will encourage private sector and improve economic conditions. Risks Private sector will not trust the grid power supply and continue to self-generate. Other external factors will act to prevent the private sector from expanding and benefiting from the improved power supply.

Outcome Improved utilization of reliable, clean power to six provincial urban centers

All indicators are relative to baseline of January 2010. Installation of 15 MW of additional hydropower capacity in target provincial areas by the end of 2016 Avoid production of an additional 100,000 tons of CO2 equivalent per annum by the end of 2016 Reduce power outages by 20% in target provincial urban areas by the end of 2016 Reduce fuel costs for PPL power generation by 60% in target provincial areas by the end of 2016

As-built drawings PPL fuel consumption records PPL monitoring database PPL financial reports

Assumptions Provincial governments continue to support projects Sufficient resources are allocated to operation of the hydropower sites. Risks Landowner disputes delay implementation PPL reallocates human resources to alternative projects

Outputs 1. Six renewable

All indicators are relative to baseline of January 2010. Generation of 60 GWh

PPL operational records

Assumptions PMU can locate sufficient qualified staff to implement projects.

12 Appendix 1

Design Summary Performance Targets

and Indicators Data Sources and

Reporting Mechanisms Assumptions

and Risks energy power plants put into operation by PPL 2. Transmission lines constructed and operated by PPL 3. Capacity building undertaken for implementing agency and project beneficiaries 4. The PMU renders efficient project management services

per annum of renewable energy by the end of 2016 Provide power and water connection to villages adjacent to power generation project sites Transmission of 60 GWh of power per annum to provincial urban areas by end 2016 Conduct capacity building training for PPL in procurement and financial management by June 2011 Conduct training for villages adjacent to project sites, including (i) maintenance skills for power and water supply (at least four volunteers per village, including at least 50% women); and (ii) power safety, household utility budget, and business skills training for each village at the project sites (at least 50% participation by women). PMU meets annual target contract awards and disbursements Conduct training activities for PMU staff and PPL management, including gender awareness training

PPL operational records As-built drawings PPL GIS database PPL customer database PPL customer database Facility administration manual

The government properly implements safeguard frameworks and plans. Risks Construction companies may be reluctant to bid for projects in the provincial areas, given political risks, mobilization issues and high demand from other projects Landowners block construction Access to sites is cut by natural disaster such as floods or landslides.

Appendix 1 13

Activities with Milestones Inputs All target performance dates are from loan effectiveness of each tranche. 1. Construction of renewable energy power plants 1.1 Finalize land acquisition of each project by the end of month 10,

including community project design consultations with a target of 30% female participation. The community consultation team will include at least one female member.

1.2 Finalize project detailed design by end of month 10. 1.3 Award civil works contracts and equipment packages by the end of

month 13. Civil works contracts will include requirements for (i) HIV/AIDS training for all contractors, and (ii) equal pay for male and female workers undertaking equal work. Contractors will be encouraged to increase female participation in the labor force.

1.4 Construct power and water connections to villages adjacent to power generation project sites by the end of month 18.

1.5 Establish a village power and water committee at each village connected to power and water for project design consultation, training and ongoing maintenance (at least 50% participation by women) by end of month 20.

1.6 Commission a renewable energy power plant by the end of month 30. 2. Construction of transmission systems 2.1 Finalize project detailed design by the end of month 10. 2.2 Award civil works contracts and equipment packages by the end of

month 13. 2.3 Commission transmission lines by the end of month 30. 3. Undertake capacity building activities 3.1 Conduct procurement training workshop for PMU and PPL by the end

of month 5. 3.2 Conduct financial management training for PMU and PPL by the end of

month 5. 3.3 Conduct training for villages adjacent to project generation sites by the

end of month 22, including (i) maintenance skills training for power and water supply at project sites; and (ii) power safety, household utility budget training and business skills training. At least 50% of participants at all training sessions will be women.

4. Establish PMU 4.1 Establish operational PMU by the end of month 3. 4.2 Finalize recruitment of PMU staff by the end of month 5, including a

community development and gender specialist. 4.3 Establish sex disaggregated baseline data and monitoring plan for

implementation of the gender action plan by the end of month 10.

ADB: $120 million Government: $30 million

CO2 = carbon dioxide, GIS = geographic information systems, MWh = megawatt-hour, MW = megawatt, PMU = project management unit, PPL = PNG Power Limited. Source: Asian Development Bank.

14 Appendix 2

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=41504-01-3

1. Loan Agreement

2. Project Agreement

3. Framework Financing Agreement and Periodic Financing Request for Tranche 1

4. Sector Assessment (Summary): Energy

5. Facility Administration Manual

6. Contribution to the ADB Results Framework

7. Development Coordination

8. Financial Analysis of Tranche 1

9. Economic Analysis of Tranche 1

10. Country Economic Indicators

11. Summary Poverty Reduction and Social Strategy

12. Gender Action Plan

13. Initial Environment Examination – Divune Hydropower Plant

14. Initial Environment Examination – Ramazon Hydropower Plant

15. Initial Environment Examination – Kimbe to Lake Hargy Interconnection

16. Environmental Assessment and Review Framework

17. Resettlement Plan – Divune Hydropower Plant

18. Resettlement Framework

19. Indigenous Peoples Plan – Divune Hydropower Plant

20. Indigenous Peoples Planning Framework

21. Risk Assessment and Risk Management Plan

Supplementary Documents 22. Climate Change Adaptation Risk Evaluation

23. List of Potential Renewable Energy Subprojects for Subsequent Tranches and Selection Criteria

24. Implementation Schedule for Tranche 1 and Investment Program

25. Procurement Plan