RESTR ICTE D CIRCULATING COP?Y 3TO BE RETURNED TO REPORTS DESIK R e p o r t N 0. TO-199 IN GENERAL FILES This report was prepared for use within the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT MIBORO HYDROELECTRIC PROJECT OF THE ELECTRIC POWER DEVELOPMENT COMPANY, LTD. December 22, 1958 Department of Technical Operations CURRENCY EQUIVALENTS U.S. $1 * 360 Yen 1 Yen z .278 U.S. cents I million Yen * U.S. $2,778 1 billion Yen - U.S. $2.78 million .: LIST OF' CONTENTS Page No. Summary I. INTRODUCTION 1 II. THE COMPANY 1 III. THE EROJECT 4 Description of the Project 4 Present Status and Construction Schedule 5 Estimated Cost of the Project 6 Unit Construction and Generation Costs 6 Thermal Alternative 7 IV. FINANCIAL 7 Power Prices 7 Financial Structure of EPDC 8 Past Earnings 9 Capital Flxpenditures and Sources of Funds 9 Forecast of Income Sources and Application of Funds 11 Future Earnings 11 Interest and Debt Service Coverage 11 Future Capitalization 12 V. CONCLUSIONS 12 LIST CF ANNEXES Annex 1 - EPDC Condensed Balance Sheets Annex 2 - EPDC Funded Debt as at March 31, 1958 Annex 3 - EPDC Income Statements Annex 4 - EPDC Forecast of Statements of Sources and Application of Funds Annex 5 - Calculation of Generation Cost for Miboro Annex 6 - Basis for the Calculation of Thermal Alternative Annex 7 - Imported Equipment and Services Summa rv This Report contains an appraisal of the Miboro Project, which is being built by the Electric Power Development Company, Inc., (EPDC), and has been proposed to the Bank as the basis for a $10 million loan. The Bank loan would be in conjunction with a $30 million bond issue to be sold abroad by the Government of Japan. ii. The Miboro Project, a reservoir-controlled hydroelectric instal- lation, will have a capacity of 215 MW. It will generate annually about 545 million kwh. The entire production of Miboro will be bought by the Kansai Electric Power Co. Construction of the Miiboro dam will also add about 220 million kwh per year to the production of existing Kansai downstream facilities. iii. The Project is part of a Program which EPDC is carrying out to add by 1962 almost 2 million kw of hydroelectric peaking power to the national power facilities, at an estimated cost of about 340 billion yen ($950 million). iv. The cost of the Project is estimated at 37.2 billion yen ($103 million). The net cost of energy from the Project at the end of the transmission line is estimated at 5.50 yen/kwh (15.3 US mills). This cost is reasonable and the project is economically acceptable. v. The activities of EPDC in the past are open to some questions with regard especially to the effectiveness of its management and to the economic justification of some of the facilities which have been construct- ed. More recently, however, the quality of EPDCts management has shown considerable improvement, and so has the planning of future expansion. vi. As to the engineering and operating services EPDC is capably staffed and the construction of the Project is properly organized, vii. EPDC has only recently begun the operation of the first of its completed facilities. It is its policy to determine prices for the bulk sale of power so as to earn a return of 6% on the investment. As more of the new facilities come into operation, the financial position of EPDC is likely to improve and it is expected that after the present program is completed in 1962, a substantial amount of the cost of future expansion will be met from self-generated funds. Debt service coverage should gradually improve from 1.2% at present to 1.4% in ten yearst time. viii. The Project is suitable for a $10 million Bank loan with a term of 25 years and a period of grace of 3 years. YiIBORO HYDROElECTRIC PROJECT - JAPAN I. INTRODUCTION 1. This report contains an appraisal of the Miboro Project, which is being constructed by the Electric Power Development Company, Inc. (EPDC) on the Sho River on the main island of Japan. It is based on information submitted to the Bank by the Japanese Government and by EPDC on various occasions in the past and on the findings of a Mission which visited Japan in November and December 1958. 2. The Miboro Project is estimated to cost the equivalent of $103 million. The Bank has been requested to consider a loan of $10 million equivalent to assist in the financing of the Project. Most of the pro- ceeds of the proposed Bank loan would be used to cover the cost of locally manufactured equipment and materials and local labor. About $1.7 million would be used to cover imported equipment and foreign ser- vices. As in previous loans to Japan, the Japan Development Bank (JDB) would be the Borrower and would in turn relend to EPDC. 3. The Bank loan is to be in conjunction with a $30 million bond issue to be sold abroad by the Government of Japan. The yen equivalent of the proceeds of the issue would be relent by the Government of Japan to EPDC and, like the Bank loan, would be applied against expenditures on the construction of the project. 4. The YNiboro Project forms part of the program of construction of a number of hydroelectric power plants, which EFDC started in 1952 and which is scheduled for completion in 1962. Total capacity to be provid- ed by the program amounts to 1,931 Mn, with an annual average energy generation of 5,843 million kwh. The present estimate of the total in- vestment required for the program amounts to about 340 billion yen. As of October, 1958, a total of 736 W had been commissioned, with an annual energy generation of 3,282 million kwh. All the other projects in the program are under construction. The investment in the program amounted to 172 billion yen as of M'arch 1958. II. THE COMPANY 5. EPFC was established in 1952 as a development corporation whose stock is owned almost entirely by the Government. Its main purpose, as stated in the Electric Power Development Law, is to develop power re- sources. It is not intended as a competitor of the nine privately-owned power companies and it is required to sell to them in bulk all power generated in its installations. For this reason the question of power market for the production of EPDC does not arise as such. The construct- ion program of EFDC is coordinated at Government level with that of the private power companies. 6. In the Electric Power Development Law and in the Statutes of EPDC, the Government has retained direct and effective contro7 of the policies of EPDC and of its management. MITI (the vinistry of Laterrational Trade and Industry) has responsibility for directing and supervising the activities of EPDC, although the authority for the appointment to top -2- EFDC management is vested in the Cabinet. EPDCts construction program mentioned in paragraph 4, consists exclusively of the development of hydroelectric power sites in the islands of Honshu,, Hokkaido and Kyushu. All the more important projects in the program are designed for peaking operation at low plant factor. 7. In the post-war period development of large reservoir-controlled hydroelectric installations has been necessary to firm up the capacity of existing run-of-river installations and to provide large amounts of firm hydro peaking capacity in the winter time to supplement high efficiency thermal units which constitute the major part of capacity additions to the privately-owned systems and are designed for base-load operation. 8. In view of these considerations, EPDC was assigned in 1952 a number of the large hydroelectric sites which had been under preliminary consideration by the private power companies. The current program con- sisting of sixteen projects or groups of projects was put under con- struction by EPDC almost simultaneously. This was done without much regard to the capability of EPDC, to the necessity of carrying out com- plete engineering investigations, to the establishment of reliable cost estimates or to economic value of the projects. As a result, severe difficulties were encountered in the course of construction which often involved changes in design, with resulting delays in completion and increases in cost. The program, which had originally been scheduled for completion in 1960, is now expected to be completed by 1962. The original cost estimates for the largest projects have gone up as much as 50% and 60%. 9. EFDC has been able to overcome most of the physical difficulties. While the projects will make a valuable contribution to the overall systemd requirements, the economic justification of some of them is doubtful because of their high cost. Since all projects in the program are in advanced stages of construction, to question them now would be rather academic. 10. The initial preoccupation of EPDC in accomplishing its engineer- ing and construction mandate at practically any cost has lately been broadened to include an awareness of the economic significance and limi- tations of its work. Efforts are being made to achieve better cost- control supervision on construction yards, better utilization of the equipment available and a more detailed design and cost appraisal of projects, which results in the establishment of more realistic estimates of cost prior to construction. Above all, they have begun to attach more importance to the operational and financial soundness of the pro- jects. 11. This shift in emphasis from construction to operation of facilities inevitably brought with it a reappraisal of the projects which had been under consideration as the basis for the continued expansion of EFDC after the present program will have been completed in 1962. The necessity for the reappraisal is based mainly on the high cost of developing firm hydroelectric power in the country and on the resulting danger that, how- ever valuable such power may be for system operation, its cost could -3- easily become so high as to destroy its market. 12. Until recently EPDOC planned their expansion after 1962 with a ten- tative program which would have involved continued investment of the order of magnitude of the present rate of investment (about 50 billion yen a year). In the reappraisal three basic criteria were applied: - economic priority of sites in view of cost of power obtainable. - redesign of sites to obtain higher plant factor. - provision of a reasonable proportion of expenditures from funds generated internally. 13. The new program for completion subsequent to 1962 is not yet de- fined in detail but will involve a rate of expansion not to exceed the investment of 30 billion yen per year. The relative features of the revised program for the period 1962-1968 compared with the original are shown in the following table: 1962-1968 Total Annual Construct- Construct- Construct- Capacity Energy ion Cost ion Cost ion Cost IV ivilillions 1lillions US$/kw USO/kwh/yr. - _ kwh Yen __ Revised Program 1,113 4,093 158.9 397 10.8 Original Program 2,257 5,570 274.3 338 13.7 14. The revised program shows a reversal of the trend followed in the early years by EPIC, which consisted of building large capacity peaking plants with low utilization of capacity. It shows a reasonable concern with the economic factors which should form the basis of power expansion planning in Japan. It indicates the start within EPDC of proper manage- ment action. While these proposals are not yet firm, both the President of EPDC and responsible MITI officials have stated their support of the proposed action. 15. While these developments are promising, the question of the sound- ness of EFDCTs future operations and expansion clearly depends on the exercise of proper management. The present attempt of EPDCts manage- ment to have more direct and complete control over the study and formula- tion of the Companyts policies and program should be encouraged. Persons who are familiar with the problems of the Company should be appointed as top officials and their term of office should be such that reasonable continuity of management policies will be assured. This has not been the case in the past. 16. The Government has made it clear that it has no intention of re- linquishing or relaxing its control of EPDC. However, this would not be necessary. If the formation of a strong and competent management echelon at the head of EPDC should be accomplished, it would be advantageous to have MYITI exercise close permissive control over the Company. This would be a far better arrangement than the one followed in the past, where the -4 - Government control, instead of being permissive, consisted in formulating EPrC policies and programs, a task for which MITI and other government departments are not properly equipped to unidertake. The Minister and other high officials of MITI indicated that they favor the above change in policy. 17. Letters and statements of policy obtained during negotiations give the Bank reasonable assurance that in the future EPDC s operations will continue to improve. On this basis there is a good prospect that the Company's economic and financial policies will also improve. 18. The Companyts organization for engineering, construction supervision and power plant operation is capable. A good many of the senior EPDC staff in all departments were originally on the staffs of the power com- panies and the quality of personnel in EPLC is to a large extent compar- able to that of the power companiest staff. 19. EPDC, however, still suffers from over-staffing and staff efficiency is not as good as it could be. The management is aware of these problems and is trying to improve the situation. III. THE FROJECT Description of the Project 20. The ]Yiiboro Project consists of a rock-fill dam with impervious clay core, an underground powerhouse with an installed capacity of 215 MW in two units and of a step-up substation. 21. The dam is located at Shirakawa on the Sho river, near the west coast of the main island of Japan. The height of the dam will be about 130 meters and its volume about 8 million cubic meters of rock-fill and clay core. It will impound about 330 million cubic meters of useful water storage. The head on the generating units will be 192 meters. The units will discharge into a tailrace tunnel about 8 km long through which the water will be returned to the main stream of the Sho river just upstream of the intake for an existing power plant owned by the Kansai Power Company. Annual energy generation by the Miboro Station under median hydro conditions will be about 545 million kwh. 22. River regulation by the Miboro dam will improve the operation of existing downstream installations owned by the Kansai Electric Power Co. This will result in a net additional output of about 220 million kwh/year, and in an increase in winter peaking capability of the existing installa- tions of about 60 MW. 23. According to Japanese law, the Kansai Electric Power Company must compensate EPDC for these benefits by paying to EPDC part of the cost of the dam. The exact amount of compensation and the terms on which it will be paid will be determined at the conclusion of construction. On the basis of present estimates EPDC calculates that Kansai will pay as com- pensation the sum of 9,379 million yen. The payment to EPDC will probably be in twenty annual installments, free of interest. Kansai is in general -5- agreement with these provisional calculations. The entire production of 1iiboro will be sold to the Kansai Flectric Power Company at a price based on the actual cost of the project when completed. A preliminary agree- ment has already been signed by EPDC and Kansai. 24. The line needed for the transmission of Miboro power will be built jointly by EPDC and Kansai, on the basis of an agreement recently signed between them. The transmission facilities are not included in the Bankts project. Present Status and Construction Schedule 25. Engineering work on the Miboro Project dates back several years. Construction of a dam at this site had been under consideration by Kansai before the site was assigned to EPDC in 1953. EPLC then started a complete program of borings and adits at the site, which confirmed the existence of a serious fault running parallel to the river. The problem of treating the fault and the related problem of choosing a suitable type of dam in view of known site conditions were studied in detail over a period of about three years in cooperation with several well-known American consultants and with the U.S. Bureau of Reclamation. These studies resulted in the choice of the type of dam now being built, and of the method for treating the fault. 26. Construction of the project started in May 1957. By December 1958 the projoct was about 40% complete. The construction camp is well organized, and the operation of rock quarries, clay borrow pit and the placing of these materials are run efficiently. A supervisory force furnished by George Atkinson & Co., of San Francisco has been retained by EBDO to advise their Japanese contractors on construction techniques. The amount of storage already available and the capacity of the two diversion tunnels, makes the possibility of damage fro-, exceptional floods during construction very remote. 27. The underground power station and related service turnnals have been almost com-pletely excavated. About one-fourth of the lengt'h7. of the tail- race tunnel has also been excavated either on full section or on a pilot section. The geology encountered in the segments of the tailrace tunnel so far excavated was found worse than expected and it was necessary to employ steel shoring to a much greater extent than had been planned. There is -. possibility that poor rock conditions will be found in the remainder of' the tunnel. 28. Treatment of the main fault under the dam is being continued on the basis of heavy grouting without excavating the fault itself, according to the advice of the Bureau of Reclamation. It cannot yet be ruled out that grouting may not be sufficient to solve the problem. 29. The tailrace tunnel and the main fault constitute therefore the two major areas of physical contingency in the project. Even if very bad conditions were encountered EPDC could successfully complete the project without too much difficulty. -6 - 30. Initial operation of both units is scheduled for the middle of 1961 and completion of wsrk on the project for the end of 1961. On the basis of progress to date and of the organization at thle site, this schedule is realistic. 31. Contracts for civil works and equipment purchases have been awarded to Japanese firms on a domestic competitive basis. Construction equip- ment has come from the pool owned by EPDC. Payments under the Bank loan for expenditures outside of Japan will cover spare parts for foreign con- struction equipment and technical services. (Annex 7) Estimated Cost of the Proiect 32. The Yiboro Project is estimated to cost 37.2 billion yen (equiva- lent to about $103 million). A breakdown of the estimate is as follows: Millions of Yen Land Acquisition and Compensation 5,646.5 Site Preparation and Access Facilities 520.0 Construction Equipment 1,402.4 Construction Facilities 1,314,9 Dam and Waterways 17,779.0 Power House 1,710.5 Electrical and Mechanical Equipment 3,719.5 Engineering, Construction, Supervision and Overhead 2,h5290 Subtotal 34,751.8 Less: Residual value of construction equipment and construction facilities 1 Z5,6 Net Subtotal 23,156o2 Contingency (2.4%) 783.4 Interest during Construction 3.330-3 Total 37,269.9 33. The estimate is up-to-date and much of it is based on contracts already awarded. The allowance for contingencies is small but it must be borne in mind that the project is already about 40% completed. If un- expected difficulties are encountered in the sealing of the fault, the completion of the tailrace tunnel, and in the rernaining part of the com- pensation and expropriation proceedings, the total cost of the Project could exceed 37.2 billion yen. There is a good prospect, however, that the Project will be completed within this figure, Unit Constri ton and Generation Costs 34. The net cost of the Yiboro Project, after deducting the compensation payment for downstream benefits, will be about 28 billion yen ($78 million equivalent). This is equivalent to about $360 per kw, and to about 14 US cents per kwh per year. These costs are reasonable for seasonal reservoir- -7- controlled hydroelectric power in Japan. The production cost of Iiboro energy will be 4.85 yen/kwh (13.5 US mills/kwh) at the outlet from the generating plant, and about 5.5 yen/kwh (15.3 US mills/kwh) at the ter- minal of EIDC ts transmission line in the Nagoya area (Annex 5). Thermal Alternative 35. Two basic viewpoints are examined, that of the Company and that of the economy as a whole. These viewpoints differ mainly in their treatment of fuel cost. The cost of fuel to the Company is assumed to be the same as it would be for Kansai, as power from Miborb will flow into the Kansai system. This cost,including duties and taxes, is about 1 yen per 1000 calories (0.70 US cents per million BTU), whereas the cost of imported fuel for the economy excludes both duties and excise taxes and could be assumed at a conservative level of 0.72 yen per 1000 calories (50 US cents per million BTU). 36. From the point of view of the Company, the return on additional in- vestment in Miboro of about $70 million equivalent would be about 7%. (Annex 6) This is based on a 275 MW alternative modern thermal plant (equivalent to the Miboro capacity of 215 INW plus the increase in down- stream winter peak output of 60 NW) operating at full capacity for 5000 hours per year. In the calculation, hliboro is charged with the fuel cost involved in generating the additional energy needed to equal the output of the alternative thermal plant. It is assumed that this energy would be generated by the thermal plants now existing on the system. Under the same assumption, but taking a fuel cost of 50 cents per million BTU, annual savings would show a return of about 5.3% on the additional investments. 37. While these rates of return are lower than those yielded by similar calculations for installations of the private power companies recently financed by the Bank they are acdeptable. It will be noted that EPDCTs return of 6% on its total investment lies between the two figures. IV. FINANCIAL Power Prices 38. EPDC sells bulk power to six of the nine private power companies in Japan. The wholesale price is established for each river system in a separate power contract between EPDC and the purchaser. 39. The contract price for a given river system is computed so as to produce, under average hydrological conditions, revenues sufficient for EPDC to cover its operating and maintenance expenses, including deprecia- tion, and to provide an adequate return on the Companyts investment. It has been the policy of EPDC to set the rate of return at 6%, with only one exception. The Hokkaido Power Company pays a contract price based on a return of 5-1/2% for electricity generated by EPDCts four power plants along the Nukabira River. This reduced rate is inspired by con- siderations of general economic development of the island of Hokkaido and will only remain in effect until April 1960. From May 1960 on, the -8- price for power from the Nukabira plants will be established on the basis of a 6% return on the investment. 40. In the case of installations from which EFDC expects to receive payments for downstream benefits (as in the case of Miboro), the contract price is based on the net cost of construction, after deduction of the agreed amount of downstream compensation payments. 41. Power contracts specify the summer and winter volumes of energy delivery corresponding to average hydrological conditions. Provisions are made for retroactive price adjustments in Yay and November of each year, if actual deliveries in the previous half-year have deviated by more than 10% from the contract volume. The effect of these adjustments is that EPDC and the purchaser share, within agreed maximum and minimum price limits, both the risk of an abnormally low power production and the benefits accruing from an exceptionally favorable water flow. 42. Power contracts are rather short term and may be revised at period- ical intervals to reflect changes in operating costs. An entirely new contract is negotiated when a new plant comes into operation. 43. In the course of preliminary negotiations EPDC has agreed to an undertaking with the Bank that it will promptly establish and thereafter maintain prices which will provide alreasonable return upon the proper value of the total assets employed in its business". It defines this return to be at least 6% and states that, having regard to present con- tract commitments it expects to attain such a level by 1961. 44. The EPDC has also agreed to an undertaking with the Bank by which no new project should be initiated unless it would be able to earn a rate of return upon it "corresponding to the rate of return which might be expected to be earned upon other investments in Japan with a similar degree of risk". The Company advises the Bank that the application of this yardstick currently would require a return measurably higher than 6%. There is no test provided as to how the ability to earn a given rate is to be based, but presumably this would be governed to a consid- erable extent by the cost to the customer companies of equivalent power otherwise available to these companies from new projects. Financial Structure of EPDC 45. A summarized balance sheet of EPDC as at Ijarch 31, 1958 is given in Annex 1. The capitalization of the Company was approximately as follows: Billions of Yen _f Share Capital 46,10 27.7% Reserves .17 .1% Earned Surplus __°0 Total Equity 46.31 27.8% Long-term debt E72.2 Total 166.34 100.0% - 9 - 46. The share capital of EPDC is held almost entirely (99.6%) by the Japanese Government. The private power companies hold the remaining 0.4%. 47. A breakdown of the Company's funded debt as at March 31, 1958 is given in Annex 2. Borrowings from government sources accounted for over 94%o of the total debt. By far the largest part of this was in the form of 30-year loans from the "Trust Fund Bureau" of the Ministry of Finance, at an interest rate of 6.5%. The Trust Fund Bureau is the government's depositary of the reserves of the state postal savings and life insur- ance systems. Other borrowings from government sources included various U.S. counterpart funds, some at an interest rate of 4% and others at 3.3%. The only non-government borrowings of EPDC were 3 domestic issues of 7-year bonds at a nominal rate of 7%, for a total of 7 billion yen, or less than 6% of the Companyts funded debt. 48. The bond issues are secured by a general mortgage. The rest of the funded debt is unsecured. Past Earnings 49. EPDC did not begin selling electricity until three years after its establishment as none of the Companyts power plants had yet been com- pleted. EPDO is still largely at present a construction company, with more than half of total fixed assets represented by work in progress. 50. Summaries of income statements for the past two fiscal years are given in Annex 3. Net profits of 'PDC were 710 million yen in 1956/57 and 1,178 million yen in 1957/5g. As the Company is exempt from paying dividends until 1962 the management charged all but a small fraction of the profits to extraordinary depreciation, in order to avoid payment of corporate income taxes. This is permitted under the existing legislation which allows various industries, including electric power, to compute depreciation allowances, for income tax purposes, according to the de- clining balance method instead of the straight line method, thus enabling corporations to charge substantially larger amounts to depreciation in the early years of a plantts useful life. 51. Gross income before deduction of interest charges and extraordinary depreciation was 3,278 million yen in 1956/57 and 4,478 million yen in 1957/58. This amounted to a return of slightly less than 6% on the average investment in operation during the last two years thus conform- ing generally to the pricing policies of the Company as set forth in paragraph 39. 52. Non-capitalized interest charges were covered by gross income (before deduction of extraordinary depreciation which is, in effect, a profit) 1.23 times in 1956/57 and 1.36 times in 1957/58. This low cover- age, results from the Companyts high ratio of debt to equity. Capital Expenditures and Sources of Funds 53. Total construction expenditures of EPDC over the four years from April 1, 1958 to March 31, 1962 are estimated at Yen 197.5 billion (equi- valent to about $550 million) of which 37 billion yen for the Miboro Project. _ 10 - This is. an average of nearly 50 billion yen ($138 million) a year. The program would more than double the Companyts total fixed assets (includ- ing Work in Progress) from 171.6 billion yen at the end of March 1958 to 369 billion yen four years later. 54. From 1962 on, it is the stated intention of the management of EFDC and of the Ministry of International Trade and Industry to reduce the rate of the Companyts expansion from about 50 billion yen to about 30 billion yen a year. EFDC envisages spending a total of 182 million yen on capital account over the 6 years from April 1, 1962 to March 31, 1968, or an average of 30.3 billion yen ($85 million) a year. 55. Construction costs are expected to be met as follows: Billicns of Y 4 years from 6 years from Total April 1, 1958 April 1, 1962 (10 years) to March 31 1962 to March 31. 1968 Depreciation accruals 14.04 48.52 62.56 Retained Earnings 6oE 1.13 7.38 Total internal cash &eneration 20.09 49.85 69.94 Sales of share capital 55.10 52.30 107.40 Net increase in long term debt* 120.96 75.31 196.27 Downstream benefit payments 1.30 6.00 7.30 Total funds available 197.45 183.46 380.91 Construction costs 197.49 182.00 379.49 Increase in Working Capital (