Document of The World Bank FOR OFFICIAL USE ONLY Report No: 84643–SB INTERNATIONAL DEVELOPMENT ASSOCIATION PROJECT PAPER ON A PROPOSED ADDITIONAL CREDIT IN THE AMOUNT OF SDR7.2 MILLION (US$11 MILLION EQUIVALENT) AND A PROPOSED ADDITIONAL GRANT IN THE AMOUNT OF SDR1.4 MILLION (US$2 MILLION EQUIVALENT) TO SOLOMON ISLANDS AND A RESTRUCTURING FOR A SUSTAINABLE ENERGY PROJECT FEBRUARY 13, 2014 Timor-Leste, Papua New Guinea & the Pacific Islands Country Department Sustainable Development Department East Asia and Pacific Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS (Exchange Rate Effective November 2013) Currency Unit = Solomon Islands Dollar (SBD) SBD1 = US$0.14 US$1 = SDR0.65 FISCAL YEAR January 1 – December 31 ABBREVIATIONS AND ACRONYMS AF Additional Financing CPS Country Partnership Strategy DMAC Debt Management Advisory Committee DMS Debt Management Strategy EIRR Economic Internal Rate of Return GEF Global Environment Fund IDA International Development Association KV Kilo Volt MVA Mega Volt Ampere MW Mega Watt NPV Net Present Value PPA Power Purchase Agreement RAMSI Regional Assistance Mission to the Solomon Islands SIEA Solomon Islands Electricity Authority SIG Solomon Islands Government SISEP Solomon Islands Sustainable Energy Project SIWA Solomon Islands Water Authority SOE State Owned Enterprise Vice President: Axel van Trotsenburg Country Director: Franz Drees-Gross Country Representative: Anne Tully Sector Manager: Michel Kerf Task Team Leader: Tendai Gregan ii SOLOMON ISLANDS SUSTAINABLE ENERGY PROJECT CONTENTS Project Paper Data Sheet…………………………………………………………… iv Project Paper I. Introduction………………………………………………………… 1 II. Background and Rationale for Additional Financing……………… 1 III. Proposed Changes…………………………………………….......... 5 IV. Appraisal Summary………………………………………………... 8 Annexes 1. Results Framework and Monitoring……………………………….. 15 2. Operational Risk Assessment Framework ………………………… 20 3. Economic Analysis………………………………………………… 23 4. Financial Analysis …………………………………………………. 30 iii SOLOMON ISLANDS SUSTAINABLE ENERGY PROJECT ADDITIONAL FINANCING AND RESTRUCTURING DATA SHEET Basic Information - Additional Financing (AF) Country Director: Franz Drees-Gross Sectors: General Energy Sector; Sector Manager/Director: Michel Energy Efficiency in Heat and Power Kerf/John Roome Themes: Urban Services and Housing Team Leader: Tendai Gregan for the Poor; Other Public Sector Project ID: P146816 Governance Expected Effectiveness Date: June 30, Environmental Category: B 2014 Expected Closing Date: June 30, 2017 Lending Instrument: Investment Joint IFC: No Project Financing Joint Level: N/A Additional Financing Type: Scale-up Basic Information - Original Project Project ID: P100311 Environmental category: C Project Name: Sustainable Energy Expected Closing Date: June 30, 2014 Project Joint Level: N/A Joint IFC: No Lending Instrument: Specific Fragility or Capacity Constraints [ ] Investment Loan Financial Intermediary [ ] Project Financing: IDA Series of Projects [ ] AF Project Financing Data [ ] Loan [ X ] Credit [ X ] Grant [ ] Guarantee [ ] Other: Proposed credit terms: Standard IDA terms. AF Financing Plan (US$m) Source Total Amount (US $m) Total Project Cost: 19.4 Co-financing: Borrower: 6.4 SIG Project Implementing Agency 6.4 Total Bank Financing: 13.0 IBRD IDA Credit 11.0 IDA Grant 2.0 New 2.0 Recommitted Client Information Recipient: Solomon Islands Government Responsible Agency: Solomon Islands Electricity Authority Contact Person: Norman Nicholls, General Manager Telephone No.: +677 38596 Fax No.: +677 39472 Email: Norman.Nicholls@siea.com.sb iv AF Estimated Disbursements (Bank FY/US$m) FY 2015 2016 2017 2018 Annual 6.0 4.0 2.5 0.5 Cumulative 6.0 10.0 12.5 13.0 Project Development Objective and Description Original project development objective: To improve operational efficiency, system reliability and financial sustainability of the Solomon Islands Electricity Authority (SIEA) through improved financial and operational management, reduction of losses, improved generator and distribution system reliability and improved revenue collection. Revised project development objective: To improve operational efficiency, system reliability and financial sustainability of SIEA. Project description: There are no changes to the descriptions of the three original Project Components, but additional activities are proposed under the project’s Component 1 (Strengthening Management) and Component 3 (Improving Technical Operations). The new activities focus on: (i) capital investments to strengthen SIEA’s largest power grid, Honiara, and improve the efficiency and reliability of power supplies; (ii) strengthening project management capability, particularly as it relates to the execution of capital works activities; and (iii) capacity building in several key areas: Power System Dispatch & Control, Power System Planning, integration of intermittent renewables and Independent Power Producers (IPPs), and transaction advisory services. Safeguard and Exception to Policies Safeguard policies triggered: Environmental Assessment (OP/BP 4.01) [ x ]Yes [ ] No Natural Habitats (OP/BP 4.04) [ ]Yes [ x ] No Forests (OP/BP 4.36) [ ]Yes [ x ] No Pest Management (OP 4.09) [ ]Yes [ x ] No Physical Cultural Resources (OP/BP 4.11) [ ]Yes [ x ] No Indigenous Peoples (OP/BP 4.10) [ ]Yes [ x ] No Involuntary Resettlement (OP/BP 4.12) [ ]Yes [ x ] No Safety of Dams (OP/BP 4.37) [ ]Yes [ x ] No Projects on International Waterways (OP/BP 7.50) [ ]Yes [ x ] No Projects in Disputed Areas (OP/BP 7.60) [ ]Yes [ x ] No Is approval of any policy waiver sought from the Board (or [ ]Yes [ x ] No MD if RETF operation is RVP approved)? Has this been endorsed by Bank Management? [ ]Yes [ ] No Does the project require any exception to Bank policy? [ ]Yes [ x ] No Has this been approved by Bank Management? [ ]Yes [ ] No Conditions and Legal Covenants: Financing Agreement Description of Date Due Reference Condition/Covenant v FA, Schedule 2, Section V (1) The Recipient shall use its Monthly throughout Project best efforts to ensure that implementation. SIEA shall maintain its accounts receivables at levels not exceeding 60 days sales revenue at all times, including receivables from state-owned enterprises and other government entities, except as may otherwise be agreed with the Association. PA, Schedule, Section IV (1) The Project Implementing Monthly throughout Project Entity shall maintain its implementation. accounts receivables at levels not exceeding 60 days sales revenue at all times, including the receivables from state- owned enterprises and other government entities, except as may otherwise be agreed with the Association. PA, Schedule, Section IV (2) The Project Implementing No later than November 30 of Entity shall, no later than each year during Project November 30 of each year implementation. during Project implementation, prepare an annual rolling corporate plan with financial forecasts covering at least five (5) years, and have such plans discussed among the Project Implementation Entity’s Board, Management and the Association. vi I. Introduction 1. This Project Paper seeks the approval of the Executive Directors to provide Additional Financing (AF) in an amount of SDR8.6 million (equivalent to US$13 million) to the Solomon Islands for scaling up the Sustainable Energy Project (Project P100311, IDA Grant No. H415-SB, approved by the Board on July 28, 2008, hereafter referred to as “SISEP”). The proposed AF would consist of an additional credit in an amount of SDR7.2 million (equivalent to US$11 million) and an additional grant in an amount of SDR1.4 million (equivalent to US$2 million) to scale up SISEP by supporting distribution network upgrades in the capital city, Honiara, and providing technical assistance to complement the proposed physical investments. 2. This Project Paper also seeks approval from the Executive Directors to revise the Project Development Objective.. 3. The project restructuring associated with the AF will incorporate the following modifications: (i) adding new activities; (ii) raising the safeguards category from C to B; (iii) extending the closing date by 3 years from June 30, 2014 to June 30, 2017; and (iv) modifying the results indicators. II. Background and Rationale for Additional Financing 4. Project Background. The original IDA Grant of SDR2.5 million (equivalent to US$4 million) was approved by the Board on July 8, 2008 and became effective on June 25, 2009. As of November 30, 2013, disbursements were US$3.69 million (92 percent). Due to implementation delays, the original closing date of the Grant was extended by 18 months from December 30, 2012 to June 30, 2014. 5. Project performance. After initial delays in its earlier phases, project implementation is progressing well and the project is expected to achieve its original development objectives within the current financing envelope. The project has been performing consistently as Moderately Satisfactory in its development objectives and implementation ratings for the last 15 months. The project has been in compliance with the legal covenants, Bank procurement and financial management policies, as well as with safeguard policies. Audits are current and there have not been any significant audit qualifications on the most recent audits. Progress under each of the three components is summarized below. 6. Component 1: Strengthening Management. A new Solomon Islands Electricity Authority (SIEA) General Manager and an independent Board Member were appointed in March 2010. SIEA replaced its first Commercialization Manager (Chief Financial Officer) in April 2011, following the departure of the first incumbent from that position in January 2011. In early 2013, SIEA renewed the contracts of the GM, CFO and Independent Board Member that have supported the transformation of SIEA. 7. Component 2: Financial Operations. Over the past two years there has been a dramatic turn-around in the financial performance and sustainability of SIEA — both of which are key objectives of the project. In 2011 SIEA was in financial crisis and close to insolvency, with severe cash-flow problems and with poor and inconsistent information available to management. This resulted in a threat from SIEA’s fuel supplier to curtail 1 deliveries and risked power rationing across the capital city and the nation. However, by the end of 2011, SIEA had improved its cash flow position by focusing on key aspects of the commercialization program that SISEP supports: (a) Ministry of Finance brokered an agreement between SIEA and the Solomon Island Water Authority (SIWA), SIEA’s largest single customer and debtor, to have 100 percent of SIWA’s debt paid by March 2012; (b) SIEA addressed metering deficiencies and fraud at large commercial/industrial consumers; and (c) SIEA implemented improved financial controls and reports and replaced the General Ledger System. 8. Component 3: Technical Operations. The Project has already delivered significant improvements to customers through improved power system reliability and efficiency. SIEA’s operational performance has also improved via changes in the scheduling of generator maintenance to reduce power disruptions and via increased generator efficiency. The annual total length of time that a customer is without power in Honiara, taking into account all planned and unplanned outages (SAIDI), has fallen from a very high 51,840 minutes (864 hours) in 2007 (prior to the project) to 7,430 minutes (124 hours) in 2012. Over the same period, the number of times in a calendar year that a customer can expect to experience an interruption in power supply (SAIFI) dropped from 816 times to 155 times. However, additional improvements are required in generation supply and in parts of the network to further reduce the number of minutes and the number of times in a year that a customer is without power. 9. The improved financial performance of SIEA is enabling it to both plan and seek financing for capital investments across the country, including in its largest market and cost center – the Honiara grid – where 90% of the country’s power is produced and consumed. Thus, after decades of underinvestment due to its hitherto poor financial position, a significant program of capital investment in generation, transmission and distribution infrastructure is planned for 2013-16 to improve generation, transmission and distribution quality, network efficiency and reach of services. Strengthening system reliability and reducing system losses are key priorities over the medium term. This requires that SIEA successfully, efficiently and effectively implement major capital works projects – new generation and upgrades to the distribution network – that will dramatically improve power system reliability. Other critical activities for SIEA include: (a) development and review of least cost power system capacity expansion and investment plans; (b) completion of a cost of service and tariff review in 2014; and (c) further improvements in collection and reduction in non-technical losses. 10. The project has been in compliance with the legal covenants, Bank procurement and financial management policies, as well as with safeguard policies. Audits are current and there have not been any significant audit qualifications on the most recent audits. 11. Key lessons from the original Project will be applied to the new AF operation. First, to improve the sustainability of investments, local capacity building efforts and attention to social / environmental management will be enhanced, including through the preparation of the ESMF and the provision of technical assistance under the AF. Second, the proposed AF will help address SIEA’s financing needs by contributing to the debt financing component of SIEA’s identified capital expenditure program from 2013 – 2016 (approximately US$50 - US$70 million). SIEA has never had access to commercial bank loans before. The turnaround in the financial position of SIEA in 2012, which the original project facilitated, has resulted in commercial financiers expressing interest in debt financing of SIEA’s capital 2 investments. The proposed additional credit and grant would make it easier for SIEA to access commercial loans by reducing the overall amount needed and by providing additional comfort regarding the financial sustainability of the sector through continued World Bank engagement. 12. Improvements achieved under the original project can be attributed to a combination of factors, in particular: (a) improved corporate governance, with appointments to SIEA Board now being carried out under State Owned Enterprises Regulations (2010); (b) improved financial management and internal audit functions within SIEA; and (c) commercialization of SIEA, including a sharper focus on collections, reducing costs, improving customer service, improving plant maintenance and availability, and reducing electrical losses. Sustainability of these improvements, and therefore their development impact, will depend crucially on the degree to which institutional reforms and capacity building have become embedded in SIEA and are further consolidated and advanced. SIEA Board and management recognize that existing reforms need to be consolidated and that further institutional strengthening is required. During 2012 and 2013 the SIEA Board approved a corporate restructuring that has: (a) established an internal audit group focused on meter reading, billing reconciliation, and reducing theft/meter by-pass; and (b) created a capital projects management team charged with the planning, oversight and delivery of new capital projects. The Government continues to demonstrate strong support for improved SOE performance and sustainability, including: (a) supporting the on-going implementation of the financial restructuring plan for SIWA, SIEA’s single largest customer; (b) ensuring that electricity bills of government entities are paid in a timely manner; and (c) re- establishing Community Service Obligation (CSO) payments to utilities, to partially offset the losses they incur in providing to some customers services whose costs exceed the revenues that can be collected under the existing tariff scheme. Rationale for Additional Financing 13. The proposed AF would enable SISEP to be scaled up in the areas of improving management and technical performance, both of which will help address demands for improved reliability and efficiency of electricity services. The PDO has been simplified to sharpen the focus of the project. The implementing agency and all fiduciary mechanisms will remain unchanged under the AF operation. 14. The rationale for the AF is to scale-up the underlying project to improve the reliability and efficiency of electricity supplies to Honiara, the largest city in the Solomon Islands and its commercial center. The AF builds on the success of the original project, which has been pivotal in improving the commercial sustainability of the national power utility, and is a logical next step, as the utility now seeks to undertake long-overdue investments in the electricity system that will improve service to customers. The project will make a significant contribution to improving the reliability of electricity supplies in Honiara, the country’s largest city, which is both the political and commercial capital, and where 90% of electricity is generated and consumed. Since a national uniform tariff is being used, and given the weight of Honiara in determining that tariff, these improvements will have a large impact on the affordability of power across the country. 15. The four network investment sub-projects to be financed by the AF address critical weaknesses in the Honiara distribution network and in doing so seek to improve reliability of supply on the Guadalcanal grid. For example, the addition of a third 12.5 MVA 3 transformer at the Lungga Power Station benefits all customers on the Guadalcanal grid by providing sufficient redundancy in transformer capacity at the primary power station (Lungga) so that if one of the three transformers has a fault, the other two have sufficient capacity to allow all that station’s power to be exported. At present, if one of the existing two transformers at Lungga power station tripped, the other transformer would not have the capacity to allow the full export of power generated there – and in that event, there would be major power supply interruptions across the city or a complete blackout of the city grid. The number of people to directly benefit from the proposed investments funded by the AF is estimated to be 68,000. 16. The project will support inclusive economic growth. Sustained and inclusive economic growth is essential for Solomon Islands to make progress in reducing poverty and fostering shared prosperity. In recent years, economic growth was driven by the recovery from the sharp economic decline during the civil conflict (“tension”) in 1999-20031 and the unsustainable growth of the logging sector. Per capita incomes have now reached pre-tension levels, suggesting that post-conflict recovery will no longer be a determining factor in Solomon Islands’ economic growth rate. In addition, the output of the logging sector is projected to decline significantly in the coming years. As in most developing countries, a reliable and cost-efficient power supply is one of the key ingredients for private sector growth. While SIEA, with support from the Bank, has been able to restore its financial and operational viability, power supply in Honiara has become less reliable as a result of increased demand and insufficient investment in the power system. Frequent power-outages result in significantly increased cost to businesses and in productivity losses, including through down-times during power outages, damage to equipment from power fluctuations, and the need for businesses to maintain and operate costly generator based backup systems. The proposed AF would help to address the most severe bottlenecks in the distribution system. This would help to ensure a more reliable power supply for businesses in Honiara, and thus represent an important improvement in the business environment for private sector growth. It will also provide the basis for expansion of the power grid to peri-urban areas. These areas have seen rapid population growth due to high rates of migration from rural areas, have a high incidence of poverty, and currently have little or no access to electricity. 17. The project complements other interventions by development partners . Other development partners are supporting other activities in the energy sector. For example: (a) Australia , the Pacific Regional Infrastructure Facility (PRIF) and the European Investment Bank are supporting the preparation of the Tina River Hydropower Project; (b) the Asian Development Bank is supporting remote islands electrification; and (c) bilateral agencies support household solar lighting in rural areas. 18. The use of IDA funds is consistent with the government’s debt management policy, which states that concessional lending should be used for economically and financially feasible activities, with grant financing used for other activities that have lower financial and economic returns. The use of IDA funds is justified in the this case for the following reasons: (i) economic and social returns from the proposed AF investments are high, given low electricity coverage in Solomon Islands and the critical role these investments would play in setting the stage for future coverage increases; (ii) the proposed 1 The 1998-2003 civil conflict, known locally as the "tension", emerged as a result of grievances between the local Guadalcanal landowners and migrants, predominantly from the most populous island of Malaita, drawn by economic opportunities. Violent clashes involving rival militant groups led to deaths, displacement, and the widespread destruction of property. 4 investments will help underpin economic growth by addressing a major infrastructure service bottleneck — unreliable and costly power supplies — that adversely affects economic activity and the delivery of social services such as education and healthcare; and (iii) the on- going involvement of IDA is enabling private sector debt financing of generation investments, as IDA’s on-going support to the energy sector is perceived by commercial lenders as a key factor in reducing the risks of commercial lending. 19. Country Partnership Strategy. The AF is aligned with the Government’s vision for sustainable, efficient, reliable and affordable electricity in Solomon Islands and supports the SIG’s energy sector policy. The AF supports the objectives of the World Bank’s Country Partnership Strategy (CPS) for the Solomon Islands 2013-2017 – discussed by the Board of Executive Directors on June 13, 2013 – and the two broad themes of the Partnership Strategy: strengthening economic resiliency and improving service provision. In line with the CPS’s strategic objectives under Outcome 5 (strengthening economic resiliency) the proposed AF promotes least-cost power supply, access to electricity services, and improved technical and financial operations of SIEA - all of which contribute to the twin WBG goals of reducing absolute poverty and boosting shared prosperity. 20. Alternatives to AF considered. Three alternatives to AF were considered for financing SIEA’s immediate capital expenditure needs. First, the option of using just internally generated cash to finance the scale up activities was considered. However, this source of financing alone is insufficient to cover the cost of SIEA’s large capital expenditure program. The second option considered the use of equity financing, in conjunction with commercial borrowing, i.e., the financing model used by most utilities. This option is being pursued for the first time by SIEA as well to finance the larger generation investments that are also required in the short term. The larger generation investments would be more likely to attract commercial lenders than the smaller distribution investments to be supported through the AF and, therefore provides a better opportunity for SIEA to test the possibility of accessing commercial loans. Third, consideration was given to preparing the scale up activities as a separate new project, but this approach would take more time and may result in a loss of momentum for SIEA reforms; it would also be less cost effective than using the AF instrument and would unnecessarily increase overall transactions costs for the SIG. Finally, the activities financed by this proposed AF are fully aligned with the PDO of the existing project. It was therefore decided to proceed with an AF operation for the proposed investments. III. Proposed Changes 21. PDO. It is proposed to amend the PDO to improve operational efficiency, system reliability and financial sustainability of the SIEA by deleting the part of the parent project’s PDO that describes project activities, i.e., “through improved financial and operational management, reduction of losses, improved generator and distribution system reliability and improved revenue collection”. 22. Components. Additional activities are proposed under Component 1 (Strengthening Management) and Component 3 (Improving Technical Operations) of the project. The new activities focus on: (i) capital investments (which are part of SIEA’s priority capital investment program for 2014 – 2017) in the Honiara power grid; (ii) strengthening project management capability, particularly the execution of capital works activities; and (iii) capacity building in several key areas. 5 23. Component 1, Strengthening Management. Capacity Building ($2.7 million, of which $2.0 million from the IDA Grant and $0.7 million from the IDA Credit). Additional financing under this component will finance the following: a) Technical Assistance and training on dispatch and control, system planning, integration of renewables and Independent Power Producers; b) Support to Owner’s Engineer (to mid-2017); c) Capital Projects Manager from 2014 – 2017; and d) Finance and Due Diligence Technical Assistance (legal officer, finance officer, and procurement officer for upcoming Power Purchasing Agreements, e.g., Tina River Hydro and/or Savo Geothermal). 24. Component 3, Technical Operations. Capital investments for improving the reliability and efficiency of the Honiara power grid ($10.3 million from the IDA Credit). Four priority network investments would be financed to enhance the capacity of distribution transformers, lines and substations on the Honiara grid in order to enable it to meet existing and growing power demand more efficiently, provide better quality and quantity of electric power for productive uses, and reduce power system losses. Specifically, additional financing under this component would finance the following: a) Upgrade of transformer capacity with an additional 5 MVA 33 kV/11 kV transformer, addition of a second 33 kV switchboard, and a New System Control Room and Dispatch at Ranadi; b) A12.5 MVA transformer and upgrade of switching arrangements at Lungga Power Station; c) New Zone Substation for transforming 33 kV/11 kV, with a 7.5 MVA transformer at Kola’a Ridge; and d) Relocation of the second power circuit to supply the residential area to the south of Honiara Airport (Feeder 12 area) by building a new overhead power line and an underground circuit around the airport that links the East Honiara Substation to the Feeder 12 area. 25. The estimated costs of AF activities and the sources of financing are set out in Table1 below. The IDA Credit ($10.3 million) will provide around 70% of the total cost of the four proposed network investments (total cost $14.6 million); the balance ($4.4 million) will be provided from SIEA’s retained earnings. IDA Credit and Grant ($2.7 million in total) will provide around 57% of the cost of the Capacity Building TA activities (total cost $4.7 million), while SIEA will contribute the balance ($2 million). 6 Table 1: Costs and Financing of SISEP AF Activities (US$ million) Component Site Sub-project IDA IDA Total SIEA TOTAL Credit Grant IDA TA and training on Dispatch & Control, System Planning, 0.7 0 0.7 0.3 1.0 integration of renewables and IPPs Owners Engineers (to SIEA 0 0.8 0.8 0.8 1.6 Component 1 mid- 2017) Capital Projects 0 0.6 0.6 0.6 1.2 Manager (2014-2017) Finance/Due Diligence TA (legal, finance, etc. 0 0.6 0.6 0.3 0.9 for upcoming PPAs) Sub-Total 0.7 2.0 2.7 2.0 4.7 Ranadi Upgrade of transformer capacity with additional 1 x 5MVA 33kV/11kV transformer and a second 33 kV Switchboard 2.3 0 2.3 1.0 3.3 New System Control Room/Dispatch centre 1.9 0 1.9 0.8 2.7 Lungga 1 x 12.5 MVA Power Station transformer & upgrade Component 3 switching arrangements 1.9 0 1.9 0.8 2.7 New Zone Substation for transforming Kola’a Ridge 33kV/11k, with 1x7.5 MVA transformer. 3.2 0 3.2 1.4 4.6 Feeder 12 load Feeder 12 relocation from Lungga area & 11 kV generation bus Honiara to East Honiara sub- Airport station 0.9 0 0.9 0.4 1.3 Sub-total 10.3 0.0 10.3 4.4 14.7 TOTAL 11.0 2.0 13.0 6.4 19.4 26. Project Financing. The total cost of the original Project and the additional costs with the proposed AF are presented in Table 2. Table 2: IDA Contribution by Component (US$ millions) Component Original Project Additional Revised cost Financing 1: Strengthening 1.8 2.7 4.5 Management 2: Improving Financial 0.7 0.0 0.7 Operations 3: Improving Technical 1.5 10.3 11.8 Operations Total 4.0 13.0 17.0 7 27. Retroactive financing of up to US$2,200,000 out of the proceeds of the Credit and US$400,000 out of the proceeds of the Grant may be made available for Eligible Expenditures paid prior to the signing of the Financing Agreement, but not before December 1, 2013. All expenditures under retroactive financing are subject to IDA prior review. 28. Safeguards. The Environmental category for the Project changes from Category C under the original project to Category B under the AF. The proposed new activities in the AF trigger BP/OP 4.01 Environmental Assessment. There is no land acquisition or involuntary resettlement arising from the proposed activities since activities will take place within the confines of existing facilities on land leased by SIEA. The project has an urban context and no Indigenous Peoples (IPs) as defined under OP4.10 were found in the project area of influence. Preliminary findings indicate that the proposed new sub-projects will cause no major social or environmental impacts, and the minor impacts that they will have can be readily mitigated and resolved. SIEA has prepared an Environmental and Social Management Framework (ESMF) for the Project, which was disclosed in-country for public consultations on October 29, 2013. The project files contain a summary of the Environmental and Social Safeguards Issues related to the Project, including results of public consultations. The ESMF complies with both World Bank OP4.01 and national environmental legislation. The updated ESMF was disclosed in-country and in the Infoshop on December 3, 2013. 29. Results Framework. Some changes are proposed to the Outcome and Intermediate Indicators to reflect: (a) the revised closing date; (b) reliability impacts of the proposed network upgrades; and (c) delivery of physical outputs funded by the AF. The revised results framework is presented in Annex 1. 30. Extension of Closing Date. The proposed additional credit and grant would require an extension of the closing date of the original project to June 30, 2017. The extension is sought in order to enable completion of the proposed new activities. IV. Appraisal Summary 31. Economic Analysis. The Project remains economically justified, following an assessment of the proposed new activities. The proposed priority capital expenditure investments for the Honiara power system create significant economic benefits because they render the system substantially more reliable and economic. Each of the four distribution network upgrades under the proposed AF generates a positive EIRR, which reaches a combined 17.6 percent for the four sub-projects, when additional generation capacity is assumed to materialize in the near future as envisaged under the overall SIEA investment plan.2 Tables below summarize the results of the cost benefit analysis and the sensitivity analysis; more details are provided in Annex 3. 2 SIEA’s capital investment plan calls for the installation of two additional 5 MW gensets to meet projected load growth. 8 Summary of Cost Benefit Analysis Distribution network upgrades Lungga Kola'a Ridge Ranadi Transformer Feeder 12 Transformer & Zone TOTAL & switchboard relocation switchgear Substation EIRR (%) 35.1% 17.0% 13.9% 32.6% 17.6% NPV of Net Benefit $2.75 $9.78 $4.39 $3.15 $20.06 ($ mill)* Switching Value for 103% 216% 75% 248% 140% cost increase (%) * calculated at 10% discount rate Sensitivity Analysis Distribution network upgrades Lungga Ranadi Kola'a Ridge Feeder 12 Transformer Transformer & TOTAL Zone Substation relocation & switchgear switchboard 20 per cent increase in capital costs EIRR (%) 26.9% 15.9% 12.6% 27.6% 15.8% NPV of Net Benefit ($ mill)* $2.21 $8.87 $3.22 $2.90 $17.20 3 20 per cent decrease in benefits from unserved energy reduction EIRR (%) 22.2% 15.1% 11.5% 26.7% 14.7% NPV of Net Benefit ($ mill)* $1.30 $5.92 $1.49 $2.27 $10.97 20 per cent increase in capital costs & 20 per cent decrease in benefits from unserved energy reduction EIRR (%) 16.0% 13.9% 10.3% 22.6% 13.1% NPV of Net Benefit ($ mill)* $0.77 $5.01 $0.32 $2.01 $8.11 * calculated at 10% discount rate 32. Financial analysis. The financial risks associated with the project have been assessed as minor given the strong financial position of SIEA, as a result of the improvements in collection and billing processes over the past two years. A sensitivity analysis of SIEA’s financial position, including the IDA Credits and other planned debts (concessional and commercial), indicates that SIEA will remain in a very strong position and will be able to service all its proposed debts under a range of scenarios, covering increases in costs, reductions in revenues and profitability, and the combination of increased costs and reduced revenues. The projected financial performance of SIEA following the implementation of the proposed capital expenditure program shows that total revenues, operating income and net profit will increase. Liquidity will remain high, with a current ratio well above 1 (lowest point is 17.2 in 2015). The debt to equity ratio exceeds 30:70 in 2014 (37:63), 2015 (31:69) and 2017 (31:69) before gradually falling over the remainder of the program. The profitability of SIEA is projected to increase gradually over the life of the program, with net profit margins increasing from 17% in 2013 to 47.1% in 2033. SIEA will therefore be able to 3 As there are no studies of the cost of unserved energy done in the Solomon Islands, a figure of US$1,000/MWh has been assumed in the economic analysis based on the lower end values estimated by studies from other developing countries. 9 assume the proposed levels of debt, and the projected capital expenditure program is financially viable. For more details, see Annex 4. 33. On-lending of IDA Credit. On-lending of IDA Credit by the Government to SIEA has been determined under the framework of the government’s debt management policy. On- lending to State Owned Enterprises (SOEs) is regulated and rationed via the government’s draft SOE Borrowing policy and procedures. On November 13, 2013 the Minister of Finance wrote separately to the Bank and SIEA, confirming in-principle agreement to the proposed AF, with the government to on-lend IDA Credits to SIEA. 34. The IDA Credit will be on-lent to the SIEA on the following terms agreed to between the Government and SIEA: (i) loan denominated and repayable in Solomon Islands Dollars; (ii) interest charged on the principal amount withdrawn and outstanding from time to time at the rate of 4% per annum; (iii) payment of a commitment charge on the Un-withdrawn Balance at the rate payable by the Government, if any; and (iv) loan repayable over a period not exceeding 15 years from the date of the Subsidiary Agreement, inclusive of a grace period on the principal outstanding amount not exceeding one (1) year. The 4% on-lending rate was determined taking into account: (i) credit risk differences between the Government and SIEA; (ii) social and economic benefits arising from investments financed through the AF; (iii) potential exchange rate risk borne by the Government in deciding to on-lend a foreign currency denominated IDA Credit to SIEA in Solomon Dollars (SBD); and (iv) commercial rates of interest in Solomon Islands (which in 2013 range from 5 to 7 per cent per year on a 10 year loan) and the potential for IDA Credit to crowd out commercial debt. 35. On-granting of IDA Grant. The IDA Grant is to be passed on to SIEA by the SIG on a non-reimbursable basis. 36. Financial Management. The AF will use similar accounting and FM arrangements to those applicable to the original Project, but institute a more streamlined FM reporting regime to enable the project’s FM reporting obligations to be carried out as part of the entity’s annual audit. An updated FM assessment (see project files) confirms that SIEA has the necessary staff and systems in place to effectively manage the Project, inclusive of the scaled up activities, and that there are no significant pending FM issues. The new streamlined FM reporting regime is proposed because since the original project was approved in 2008 there have been significant improvements in SIEA’s FM processes and systems, which are reflected in: (i) the unqualified entity audit of 2012; (ii) 2012 entity audit being completed within the statutory time period after the end of the financial year; (iii) SIEA implementing a new and more robust billing and general ledger system, effective January 1, 2014. 37. Procurement. SIEA will continue to be responsible for procurement for the additional financing activities. An assessment of SIEA’s procurement capacity was carried out in the context of the proposed AF, and the following principal procurement risks were identified: (i) limited procurement and technical capacity; (ii) low participation by bidders and lack of local market capacity; and (iii) delay in implementation due to the complexity of procurement and lack of proper cost estimating, planning and contract supervision. The following mitigating measures will be implemented: (i) set up a project management team for project implementation; (ii) hire procurement and owner engineers to assist SIEA in preparing designs, technical specifications, bidding documents, and bid evaluation reports, and in contract supervision; (iii) develop a contract packaging strategy in order to attract more international bidders; (iv) use a design, supply and installation approach to address the 10 challenge of lack of local market installation capacity and logistics constraints; and (v) take into account lessons from previous ICB contracts in setting out qualification requirements, cost estimating and planning.4 The overall procurement risk is rated as substantial. 38. Procurement Arrangements. Procurement arrangements agreed for the original IDA grant will remain unchanged for the additional financing activities. Procurement of contracts to be financed from the proposed additional financing will follow the World Bank’s “Guidelines: Procurement under IBRD Loans and IDA Credits”, dated January 2011 (Procurement Guidelines); and “Guidelines: Selection and Employment of Consultants by World Bank Borrowers”, dated January 2011 (Consultant Guidelines). 39. Procurement methods and thresholds applicable to the proposed AF are set out below. Procurement Methods Procurement Thresholds Prior Review Thresholds Goods International Competitive ≥US$500,000 All contracts subject to prior Bidding (ICB) review Shopping