33770 E N E R G Y A N D M I N I N G S E C T O R B O A R D D I S C U S S I O N P A P E R P A P E R N O . 1 4 M A Y 2 0 0 5 Lessons from the Independent Private Power Experience in Pakistan Julia M. Fraser THE WORLD BANK GROUP The Energy and Mining Sector Board AUTHORS DISCLAIMERS Julia M. Fraser (JFraser@worldbank.org) is a Senior Financial The findings, interpretations and conclusions expressed in Analyst in the South Asia Energy and Infrastructure Unit of the this paper are entirely those of the author and should not be World Bank. attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. CONTACT INFORMATION To order additional copies of this discussion paper please contact the Energy Help Desk: +1.202.473.0652 energyhelpdesk@worldbank.org This paper is available online www.worldbank.org/energy/ The material in this work is copyrighted. No part of this work may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or inclusion in any information storage and retrieval system, without the prior written permission of the World Bank. The World Bank encourages dissemination of its work and will normally grant permission promptly. For permis- sion to photocopy or reprint, please send a request with complete information to the Copyright Clearance Center, Inc, 222 Rosewood Drive, Danvers, MA 01923, USA, fax 978-750-4470. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, World Bank, 1818 H Street N.W., Washington DC, 20433, fax 202-522-2422, e-mail: pubrights@worldbank.org E N E R G Y A N D M I N I N G S E C T O R B O A R D D I S C U S S I O N P A P E R P A P E R N O . 1 4 M A Y 2 0 0 5 Lessons from the Independent Private Power Experience in Pakistan Julia M. Fraser The World Bank, Washington, DC THE WORLD BANK GROUP The Energy and Mining Sector Board Copyright © 2005 The International Bank for Reconstruction and Development/The World Bank. All rights reserved CONTENTS FOREWORD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 ABSTRACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 ACKNOWLEDGEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4 ACRONYMNS AND ABBREVIATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4 SECTOR BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5 BANK SUPPORT FOR PAKISTAN'S PRIVATE POWER POLICY . . . . . . . . . . . . . . . . . . . . . . .5 1994 PRIVATE POWER POLICY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 CRITIQUE OF THE IMPLEMENTATION OF THE 1994 PRIVATE POWER POLICY . . . . . . . . .6 BANK GROUP INVOLVEMENT IN IPPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7 IMPACT ON WAPDA'S FINANCES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7 THE FALL OF THE IPP PROGRAM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 ORDERLY FRAMEWORK FOR IPP WORKOUT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10 RESULTS OF IPP WORKOUT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10 SITUATION TODAY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12 LESSONS LEARNED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12 Sector Reform and IPPs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12 Benchmark Pricing vs. Competitive Bidding. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13 Large IPP programs need to be carefully managed. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13 Due Diligence by Other Lenders. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14 Contingent Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14 Bank's Role in Dealing with Corruption Allegations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14 Renegotiations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 ANNEX 1: PAKISTAN PRIVATE POWER PROJECTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17 ANNEX 2: SUMMARY OF HUBCO LEGAL DISPUTES . . . . . . . . . . . . . . . . . . . . . . . . . . . .18 ii FOREWORD As part of the World Bank's ongoing work to identify barriers to increased investment in the power sector in developing countries this paper was produced as a case study on workouts for projects under stress. Pakistan's first private power project, the Hub Power Project, and its subsequent 1994 private power policy ­ both supported by the World Bank ­ were lauded by the international investment community. Pakistan succeeded in attracting over $5 billion in investment and contracting about 4,500 megawatts of private generation in record time. However, macroeconomic instability in the country and financial problems in the power utility revealed some of the shortcomings in the policy and its implementation. Unilateral attempts to terminate and re-negotiate IPP contracts led to a tumultuous three year workout period. 1 The Government, project sponsors and lenders all looked to the World Bank Group during this critical time as it was heavily involved in providing financing and guarantees to more than half of the IPPs under construction or operating in Pakistan at the time. The Bank Group was credited with facilitating an orderly resolution of the IPP disputes and helping to avert a wider Government default on IPP contracts which could have had macroeconomic implications for Pakistan. Several lessons that can be taken from the workout experience are highlighted in this discussion paper. Jamal Saghir Director, Energy and Mining Sector Board May 2005 2 ABSTRACT The discussion paper recounts the background to The World Bank Group played a pro-active role the IPP program, describes the "orderly framework" in facilitating the resolution of the IPP disputes, developed by the World Bank Group for the IPP necessitated by its large financial role in the IPP workout, and concludes with several lessons learned. program, and assisted in preventing the crisis from The 1292 MW, $1.6 billion Hub Power Project was exploding further. The work-out strategy called for hailed as a landmark in the field of infrastructure the Government to separate criminal allegations from finance at the time of financial close in 1995. It set an commercial disputes with the former to be resolved important precedent for the viability of private finance through the legal system and the latter through for a major infrastructure project in a developing amicable negotiation. Several important lessons can country. The complex suite of documentation developed be drawn from the Pakistan experience. Setting a bulk together with experience gained by Pakistan officials and tariff ceiling allowed Pakistan to alleviate its power institutions during its six years of project development shortage through private generation in record time; led to the adoption of a Private Power Policy in 1994. however, too much power was contracted with little 3 Under this policy, 19 independent private power regard for least cost expansion. The scale of private projects (IPPs) reached financial close in record time for investment in generation should be aligned with the an additional 3400 MW. (Four projects, totaling 435 country's state of development with respect to sector MW were subsequently terminated.) Pakistan earned reforms and also social, economic, political and high praise amongst international developers and institutional governance. In addition, solicitation of IPPs financiers and was a model for private sector should be on a competitive basis and staggered over a development in the power sector in the mid 1990s. It few years so that changes in international investors' was described as "the best energy policy assessment of country and contract risks could lead to in the whole world" by the US Secretary of Energy declining bid prices. Staggering IPP solicitation and following a trip to Karachi in September 1994. That scaling down large IPP capacity would also allow the same year, the Hub Power Project was named project utility to re-assess demand/supply conditions and adjust finance "Deal of the Year" by Euromoney Institutional the contracted capacity and completion timing for Investor. However, by 1998 the Government had issued subsequent IPPs accordingly. Since assumed future notices of intent to terminate 11 IPPs, representing two- country conditions at appraisal can be substantially thirds of private power capacity contracted, on alleged different from what actually emerges, it is important that corruption and/or technical grounds. Perceptions by the a transparent bidding process is followed to be more project sponsors of excessive coercion, harassment and politically sustainable. Finally, while the risk of re- heavy-handed legal and other actions initiated by the negotiation can be minimized by competitive bidding Government to renegotiate tariffs or cancel contracts and transparent contracts, this risk cannot be wholly contributed to Pakistan's fall from grace in the eyes of avoided. All parties have to recognize that re- the international private sector community. A turbulent negotiation is reasonable provided it is done in a three year work-out period followed where most mutually acceptable manner. contracts were ultimately re-negotiated which coincided with the period when Pakistan was brought to the brink of financial collapse.1 Following Pakistan's nuclear tests and the subsequent imposition of economic sanctions in May 1998, Pakistan's economic and balance of 1 payment situation deteriorated rapidly and foreign investment slowed to almost nothing. Within just a few weeks, the stock market declined by 40%, the free market rupee depreciated by more than 25% against the US dollar, and official reserves declined to less than 2 weeks of imports. In early 1999, Pakistan signed an agreement with the Paris Club for rescheduling of $3.3 billion of public and publicly guaranteed debt repayments. ACKNOWLEDGEMENTS This paper draws on previous analytical work and internal memoranda prepared by Bank staff and consultants in the Energy Network and the South Asia Energy Unit. Valuable comments were received from several colleagues, including Penelope Brook, South Asia Energy Sector Manager, Tjaarda Storm van Leeuwen, Lead Financial Analyst, Middle East and North Africa Energy Unit, of the World Bank and from Apinya Suebsaeng, Senior Manager, Credit Review and Portfolio Division, and Denis Carpio, Chief Evaluation Officer, Operations Evaluation Group of the International Finance Corporation. In particular, the author acknowledges Mr. Carpio's contribution to the description of lessons learned described in the abstract. 4 ACRONYMS AND ABBREVIATIONS GOP Government of Pakistan IBRD International Bank for Reconstruction and Development IFC International Finance Corporation IPP Independent Power Project JEXIM Japan Export-Import Bank KESC Karachi Electricity Supply Corporation kWh kilowatt hour LTCF Long Term Credit Fund MIGA Multilateral Investment Guarantee Agency MW Megawatt PPA Power Purchase Agreement PPIB Private Power and Infrastructure Board PSEDP Private Sector Energy Development Project Rs. Rupees WAPDA Water and Power Development Authority SECTOR BACKGROUND Beginning in 1987, Pakistan requested assistance from (PSEDP I), with the objective of continuing to (i) assist the World Bank to increase private sector participation the Government in mobilizing additional private sector in the energy sector. An initial framework of incentives resources; and (ii) build on the institutional and policy to attract private investment in the energy sector was framework established to facilitate private sector put in place in 1988 which addressed the following participation in the energy sector. constraints: Although the international development community had · The absence of a comprehensive policy framework come to realize that the role of the public sector concerning incentives, fiscal treatment, repatriation needed to be redefined and reduced, no other low- of profits and capital, availability of foreign income country had made private investments a corner exchange, and pricing; stone of its energy policy. This strategy was a reflection · The lack of long term financing for projects with long of hard economic realities: a non-sustainable fiscal gestation periods and economic life; and deficit; a serious balance of payment situation; and the · The inadequacy of the institutional arrangements for inability of the public sector to mobilize the funds the review, negotiation and approval of private required to make the investments needed to keep pace sector projects. with power demand (which was growing around seven 5 percent per year). However, even if sound demand In July 1992, the Government of Pakistan (GOP) management policies had reduced the growth of adopted a Strategic Plan for power sector privatization. electricity demand below seven percent, the Under this plan, the Water and Power Development Government's strategy to rely increasingly on private Authority (WAPDA), the main electric utility in the investment in power was relevant as budgetary country, would be unbundled into separate generation, resources were needed to meet Pakistan's pressing transmission and dispatch, and distribution companies social needs. PSEDP I and II were designed to support and gradually privatized. The private sector would be the implementation of a program of agreed measures invited to construct and operate new thermal that consisted of: (i) policies for the promotion of generation plants, and an independent regulator would private sector investment in energy; (ii) creation of a be established. vehicle to provide long-term financing for private energy projects; and (iii) establishment of new institutions for the evaluation, negotiation, and BANK SUPPORT FOR PAKISTAN'S PRIVATE approval of private energy investments. POWER POLICY PSEDP I and II represented a major shift in the Bank's In support of this policy, the World Bank approved the power sector lending policies in Pakistan. They US$150 million Private Sector Energy Development embedded the lessons drawn from Bank lending to Project (PSEDP 1) in June 1988. Its objectives were to: government utilities, as reflected in the Policy Paper (i) assist Pakistan in mobilizing, from the private sector, entitled "Bank Lending for Electric Power" (1993). The the resources required to meet the anticipated deficit in Projects, however, were demanding as they required power supply; (ii) establish incentives to encourage inter alia: (i) the Government and its agencies to learn private sector participation; and (iii) establish an and adapt policies to enable private sector transactions institutional framework required to facilitate private in power; (ii) the creation of three new entities, namely sector transactions in energy on a sustainable basis. the Private Power and Infrastructure Board (PPIB) ­ the The Second Private Sector Energy Development Project "one stop shop" ­ in charge of negotiating the (PSEDP II) was approved in November 1994 for contractual framework (referred to as the Security US$250 million. It replenished the Long Term Credit Package) on behalf of the Government; WAPDA Private Fund (originally known as the Private Sector Energy Power Organization (WPPO) in charge of negotiating Development Fund) established under the first project the power purchase agreements (PPA); and the Private Energy Division (PED) of the National Development resources, and to integrate these measures with the actions Finance Corporation (NDFC) in charge of taken by the Government to deregulate the economy and administering the funds under the two Bank loans increase reliance on the private sector. The result was a (referred to as the Long Term Credit Fund - LTCF); and new policy for private power ("Policy Framework and (iii) the power utility, WAPDA, to abandon its virtual Package of Incentives for Private Sector Power Generation monopoly on power generation, and adjust its activities Projects in Pakistan"), promulgated in March 1994 (hereto including purchasing power from plants it did not own. referred to as the 1994 Private Power Policy), which incorporated the original policies introduced in 1988 The $1.6 billion, 1292 MW Hub Power Project (Hubco) together with subsequent modifications. The 1994 policy was the first private power project in Pakistan. It was was hugely successful in attracting the private sector. GOP hailed as the project finance "Deal of the Year" by issued Letters of Support to 34 projects for more than Euromoney Institutional Investor in 1994, and later in 9,000 MW under the expectation that less than 50% of the 1999, selected as the "Deal of the Decade" by the projects would make it to financial closure. Including same magazine since it was "still one of the landmark Hubco, 20 IPPs with a total installed capacity of about project financings in the last 10 years." The Hub Power 4,500 MW reached financial close, of which four totaling Project occasioned many "firsts" for Pakistan, the Bank 435 MW were later terminated. The total investment was and the international financial markets. For Pakistan, it about US$5.3 billion, of which 25% was financed by 6 was the first private infrastructure project and the first foreign equity. An estimated US$3 billion was financed with limited recourse financing. For the Bank, it was the first foreign exchange debt with an average maturity of 10 private infrastructure project, Bank-financed years. Roughly 85% of the foreign debt or 66% of total infrastructure fund (the LTCF) to support private debt was from official sources. projects, partial risk guarantee under the Expanded Co-financing (ECO) program, ECO guarantee with Despite the problems in the IPP program (discussed below), another institution (JEXIM), and the use of the ECO Pakistan was successful in attracting foreign capital in a program to support a private project. For the financial quick, efficient manner. While the first IPP, Hub Power, took markets, it was the first major private infrastructure almost eight years to reach financial close, the IPPs under project in a sub-investment grade developing country the 1994 policy closed on average in two years. The to be financed by international commercial banks on a reasons for its initial success included: (i) having a clear limited recourse basis, the first international equity framework as documented in the 1994 Private Power offering (global depository receipt) and underwriting for Policy; (ii) establishing an indicative bulk tariff in the policy a developing country infrastructure project under with indexation mechanisms for fuel and inflation; (iii) construction, and the first stock market floatation of a attractive fiscal incentives; (iv) standardized security single power station under construction.2 package; and (v) creation of a "one stop shop" for investors. (See Box 1 below for a description of the salient features of the 1994 Policy.) 1994 PRIVATE POWER POLICY Although the complex suite of documentation3 negotiated CRITIQUE OF THE IMPLEMENTATION OF THE during the Hub Project laid the foundation for the model 1994 PRIVATE POWER POLICY agreements under the 1994 Private Power Policy, the Government recognized the need to fine-tune the incentive In hindsight, the selection criteria under the 1994 Policy framework to take into account the feedback received from enabled the implementation of many subprojects which private investors and the international financial community. were not consistent with the least-cost expansion Refinements in the framework were also needed to make program in terms of: (i) capacity and location (too Pakistan internationally competitive in attracting financial small given the system size and requirements and not M. Gerrard, "Financing Pakistan's Hub Power Project: A Review of Experience for Future Projects", August 1997, sponsored by the Project 2 Finance and Guarantees Department, World Bank. About 200 separate original project agreements and documents were drafted and negotiated as part of the Hubco project. In addition, many 3 documents had to be drafted and negotiated twice as the circumstances changed, i.e. changes in government, sponsor group, or construction group. suitably located to system requirements); (ii) fuel 1994-96 when Pakistan's IPPs were contracted. selection (excessive reliance on imported fuel oil, as Nonetheless, the public and political perception was opposed to domestic natural gas although at the time that the cost of private power is too expensive ­ an gas allocation for power was difficult to secure and important factor when it came to re-negotiation. overall gas reserves were thought to be on the decline); and (iii) technology (too many diesel sets and steam Another contributing factor to the implementation turbines, as opposed to efficient combined cycle plants). problems of the 1994 Policy was the slow pace of the One could argue that had the implementation of the restructuring and privatization of WAPDA and the 1994 Policy been limited to about 2,000 MW ­ as creation of a suitable regulatory system in comparison advised by the Bank Group ­ WAPDA may have been to the speed with which the private power program was better able to absorb the capacity charges under the implemented. The mix of private generation and long term power purchase agreements, despite the fact monopoly public sector transmission/ distribution, and that demand for power increased at a slower pace than the introduction of private power under the 1994 IPP anticipated resulting in excess capacity for several years. Policy rendered the sector vulnerable to financial However, there was no clear mechanism for GOP to shocks and external events such as changes in fuel prioritize projects. The basis on which projects were prices. While the Bank promoted measures for sector selected and accorded attention was not transparent management and restructuring, as well as public sector and subject to political influence which led to policy reforms, including introduction of pass-through 7 perceptions of corruption by successive governments. mechanisms for cost of fuel and power purchased, they Rather than proceed through competitive bidding for were not implemented at the intended pace. The private power, Pakistan instead set a tariff ceiling for delays in sector reforms adversely impacted the investors in an effort to accelerate the private power efficiency of both WAPDA and the IPP program, and program. This proved very successful in terms of projects left the sector overly vulnerable to economic downturns. being able to reach financial close in a relatively short period as mentioned earlier. The ceiling price set in the 1994 Policy (US cents 6.1/kWh as an average for the first BANK GROUP INVOLVEMENT IN IPPS ten years and US cents 5.5/kWh over the life of the project on a levelized basis) was competitive with levelized prices in IBRD provided partial risk guarantees to two projects: other developing countries at the time, including Indonesia, Hub Power Co. for US$240 million (reduced to Philippines and India.4 US$137million) and Uch Power Ltd. for US$75 million; IFC provided A- and B-loans as well as equity to five Some people alleged that by setting a tariff ceiling, the projects for about US$378 million; and MIGA Policy did not provide an incentive for project promoters extended guarantee coverage to three projects for a to reduce costs. The assumed project cost under the total of US$31 million. In addition, Government of 1994 Policy was US$1,000 per kW, but starting about Pakistan provided subordinated loans to four projects 1997, capital equipment costs for combined cycle through the IBRD-financed Long Term Credit Fund for plants dropped to about US$450 to US$600 per kW. about US$210 million. In total, the World Bank Group Pakistan's gas-rich neighbor, Bangladesh, was able to was involved in 11 of the 16 IPPs or 88% of the total contract a 360 MW gas-fired, combined-cycle plant at IPPs in terms of megawatts (see Annex 1). around this time for less than 3 US cents per kWh through a competitive tender. Although not a fair or accurate comparison, this was used as an example by IMPACT ON WAPDA'S FINANCES Pakistan authorities that they had paid too much. In fact, subsequent analysis revealed that the price in WAPDA's operating cost structure was transformed by Bangladesh and Pakistan were broadly comparable increasing purchases of power from IPPs. With plant after adjusting for various factors, including difference load factor assumed at 60%, the share of power from in fuel cost and technology costs available during IPPs increased from about 20% in FY97 to 46% in It is worth mentioning that these prices were not determined competitively, and some of the comparative countries, similar to Pakistan, 4 ranked low on international indices of corruption. BOX 1. Salient Features of 1994 Policy and Package of Incentives for Private Sector Power Generation · An indicative Bulk Tariff of US cents 6.5/kWha (to be paid in Rupees) for sale of electricity to WAPDA/KESC, based on annual plant factor of 60%. · A premium of US cents 0.25/kWh based on energy sold during the first 10 years of project operations was allowed to projects above 100 MW which were commissioned by end 1997. · Sponsors had to meet the following application procedure for bulk power tariffs: ­ The average tariff for the first ten years does not exceed US cents 6.5/kWh ­ The annual base tariff does not exceed US cents 8.33/kWh in the first year and US cents 6.66/kWh in any subsequent year; and ­ The levelized tariff for the life of the project does not exceed US cents 5.91/kWh (calculated based on a 10% discount rate). · The actual payment of tariff comprised two components, i.e. a "fixed" Capacity Price and a "variable" Energy Price. As the capacity price is assured as per terms of the Concession Agreements, there was no guarantee for purchase of a specified amount of power. ­ The capacity payment was paid on a monthly basis (Rupees/kW/month) whether the plant generated and 8 sold power or not, provided the plant was available to generate and sell electricity. It covered debt service, fixed operation and maintenance cost, insurance expenses and return on equity. A portion of the capacity fee was fixed throughout the contract life and another portion was subject to escalation for US and Pakistan inflation and exchange rate changes. For purpose of allocating the capacity fee into a per kWh basis (e.g. for determining the average tariff for any year), a plant load factor or utilization rate of 60% was assumed, independent of the actual plant utilization rate. ­ The energy price was a variable amount equal to a US$/kWh variable operation and maintenance component and a pass-through fuel cost component (subject to a maximum guaranteed heat rate/kWh or alternatively, a minimum fuel conversion efficiency rate to electricity) times the actual number of kWh sold during each month. The variable O&M cost was also subject to escalation. There is no guaranteed minimum amount of electricity to be purchased by WAPDA/KESC per month. · Fiscal Incentives consisting of: exemption from corporate income tax, customs duties, sales tax, and other surcharges on imported equipment. · Standardized Security Package which includes a model Implementation Agreement, Power Purchase Agreement and Fuel Supply Agreement. · Creation of a Private Power and Infrastructure Board (PPIB), to facilitate a "one stop" processing of IPP proposals. · Financial incentives to facilitate the creation of a corporate securities market in the country, including permission for power generation companies to issue corporate bonds and shares at discounted prices, and establishment of an Independent Rating Agency. aThe bulk tariff was later reduced to US cents 6.1/kWh with the elimination of the foreign exchange risk insurance scheme. Source: "Policy Framework and Package of Incentives for Private Sector Power Generation Project in Pakistan", March 1994, Government of Pakistan FY00 (Figure 1). Between 1996 and 2001, the share of contributed to the deterioration of its financial hydropower generation (with its low operating cost) performance included: (i) front-loaded IPP tariffs which declined from 47% to 29%; electricity tariffs in nominal are indexed to the US Dollar, combined with a 45 rupee terms increased by almost 60% but fell in real percent devaluation of the Rupee; (ii) a decline in terms; operating revenue increased by 13% per annum electricity demand due to low economic growth which while cash operating costs and debt service increased led to a temporary over-capacity in generation; (iii) by 20%; and the cost of private power reached 50% of poor collection rates from government customers which WAPDA's operating costs. Other developments which account for 30 percent of WAPDA's sales; and (iv) FIGURE 1. WAPDA Energy Generation and Imports received numerous messages that coercive tactics (e.g. arresting/interrogation of IPP company officers 70000 and sometimes family members) and threats of project Hydropower cancellation were being used in attempts to obtain Thermal 60000 Generation tariff reductions. On the other hand, Pakistani Wapda authorities were pressing the Bank to live up to its 50000 Imports zero tolerance policy on corruption, and in a specific h 40000 instance, alleged malfeasance against a former Bank GW staff member associated with one of the IPPs. 30000 20000 In July 1998, the Government through the PPIB issued seven Notices of Intent to Terminate on grounds of 10000 corruption and two on technical grounds which represented about two-thirds of private power capacity 0 1996 1997 1998 1999 2000 2001 contracted. Whatever the substance of the Years Government's allegations of corruption ­ such allegations are difficult to prove generally and no evidence was produced in court ­ these actions were 9 widening tariff cross subsidies that play against largely perceived by the developers as means to delay industrial and commercial consumers, who installed the completion of IPP projects5 under the 1994 Policy their own captive capacity. and to extort tariff concessions given WAPDA's cashflow problems, political pressure not to increase retail tariffs, As a result, WAPDA faced difficulties in meeting its as well as the shortage of foreign exchange available obligations to IPPs which required a discipline of on-time in the country. IPPs expressed frustration at being called cash payments. This was a new, harsh reality for WAPDA to appear before no fewer than a dozen IPP as previous cash flow problems were dealt with through Committees constituted by the Government in an the public sector debt circle where payment arrears attempt to negotiate lower tariffs. The different to/from other public sector enterprises were a way of life. incarnations of the IPP Committee comprised, at various times and combinations, representatives of the Accountability Bureau, PPIB, WAPDA, Ministry of THE FALL OF THE IPP PROGRAM Finance and independent local businessmen, among others. None of these committees proved effective as The Government was of the view that further increases no clear authority to negotiate was delegated. In the in consumer tariffs would be politically difficult if there end, one-on-one negotiations with WAPDA combined was no accommodation by IPPs to reduce their price with intervention at the highest government level, to WAPDA for power purchased. This was especially resulted in several IPPs agreeing to tariff reductions. so given its perceptions that IPP prices were out of line with the international market, that IPPs are very Separately, the Hub Power Company was accused of profitable, and that there may have been corruption corruption in securing the amendments to the Power in some of the transactions approved by the previous Purchase Agreement which resulted in a court elected government. Thus, in 1997 against a mandated reduction in the capacity price to be paid by worsening fiscal background and unwillingness to WAPDA. Hubco denied that corruption had taken place adjust retail tariffs, the government attempted to lower and considered the charges as a means to coerce the IPP payments through various committees of inquiry company to lower its tariff. Hubco sought assistance in and sponsor-by-sponsor negotiations. Not only was resolving its disputes with GOP and WAPDA through this unsuccessful, it created confusion and fears of international arbitration but was restrained from doing Government not honoring contracts. The Bank so through injunctions sought by WAPDA in the local WAPDA had an inherent incentive to delay the completion of projects since capacity payment obligations did not begin until a project 5 achieved commercial operations. courts. (A summary of Hubco's legal disputes is · Clarify income and other tax and foreign exchange summarized in Annex 2.) conversion issues related to IPP contracts.6 · Follow due process for settling tax and foreign Furthermore, changing governments sought to place the exchange issues. blame for the perceived high cost of private power on previous governments, and as a result, the IPP program The third step was to set a negotiating strategy became highly politicized. The poor initial handling of for different groups of IPPs within the context of corruption allegations contributed to the erosion of investor sustainability: confidence in Pakistan, and foreign investment flowed to a trickle exacerbating the wider economic crisis in the country. · Review actions undertaken in consultation with legal and technical advisors and determine suitable strategy. · For IPPs without allegations of fraud or corruption or ORDERLY FRAMEWORK FOR IPP WORKOUT without Notices of Intent to Terminate (NITs) or other legal actions pending: The Bank Group's strategy was to avert a Government ­ Resolve outstanding contractual issues default by facilitating an orderly resolution of the ­ Negotiate voluntary tariff reduction immediate disputes and preparing for a permanent · For IPPs where the government considers that 10 solution to the underlying causes of the IPP problem credible evidence of fraud etc. is not available: through providing support for the implementation of ­ Stop investigations the power sector reform. One of the basic tenets of the ­ Inform IPPs of this strategy was to persuade the Government to separate ­ Withdraw NITs criminal allegations (i.e. corruption, bribery, kick-backs) ­ Negotiate voluntary tariff reduction from the commercial issues (i.e. tariff level, liquated · For IPPs where the government considers that there damages owed, etc). Following the issuance of Notices is credible evidence against them: of Intent to Terminate, the Bank Group assisted the ­ Quickly complete investigations Government in adopting the so-called "Orderly ­ Conclude standstill agreement Framework for IPP Negotiations" in late 1998 to ­ Respond to the Companies' and Lenders requests prevent further deterioration in the situation. The for further information concerning the alleged immediate step was to conclude voluntary standstill defaults to facilitate consultation by the Companies agreements valid for a period of 30 to 45 days so that as to the cure and mitigation of defaults and allow a meaningful dialogue could commence on all relevant lenders to exercise their rights in accordance with issues without the IPP companies and the lenders being the Implementation Agreements under a threat of termination of the agreements and ­ Initiate legal action against individuals without government notices giving rise to further and/or sponsors defaults and legal proceedings. ­ If necessary conclude second standstill agreement ­ Negotiate voluntary tariff reduction The second step was to ensure a fair and just implementation of the IPP contracts whereby the Bank staff regularly monitored progress in the implementation Government would: of the Orderly Framework which was one of the key aspects of the Bank and IMF structural adjustment programs. · Honor existing contractual obligations. · Seek a conducive environment for IPP personnel and their families. RESULTS OF IPP WORKOUT · Refer routine disputes including interconnection issues to the technical committee consisting of The financial difficulties of WAPDA were exacerbated by negotiating agency (e.g., PPIB, WAPDA or KESC), IPP too many IPPs coming on stream simultaneously at a time company, and independent engineers/advisors. when demand did not grow as anticipated. This resulted The Central Bureau of Revenue did not accept the position of IPPs that they were given a certain lower tax rate under the IPP Policy. Several 6 IPPs also reported problems with the timely conversion of Rupees into foreign exchange. in excess generating capacity that, in the minds of most only a small portion of costs on which they could Pakistan officials, they neither needed nor could afford. negotiate ­ essentially return on equity and the operations and maintenance cost. Since only 20% of To bring some relief to the cash-strapped power utility, investments were financed through equity, this left little the Government vigorously pursued the renegotiation room to maneuver in the negotiating room as project of tariffs with IPPs. WAPDA also delayed commissioning sponsors could not offer reduction in interest rates of several IPPs by not providing them with without lender consent. (In fact, the results of all interconnection facilities or the approval to run their negotiations were subject ultimately to lender consent.) plants until lower tariffs were agreed, saving significant Lender groups' contribution to the workout often amounts of money in the process. (It should be resulted in capitalization of interest and/or debt mentioned that not all delays were a result of WAPDA payments during the early years, and in a few cases, a actions and, in some cases, WAPDA was inadvertently more extensive restructuring of the amortization profile helped by the IPPs themselves when they failed to meet the revised anticipated cash flows. technical performance tests.) It is interesting to note that lenders only agreed to these Once the Orderly Framework was accepted by the measures in projects where the plant was delayed in Government, the basic principles for IPP renegotiation achieving commercial operations ­ and therefore had were: (i) contracts are a starting point for negotiation incurred significant cost increases (a large component 11 and (ii) negotiations must be by mutual agreement of which was interest during construction costs). without coercion. Stand-still agreements were signed Lenders to Hub Power, which had been in commercial for all projects which were issued Notices of Intent to operations for a couple years, continued to receive Terminate which prevented the companies and/or timely debt repayments throughout the dispute period lenders from undertaking untoward legal steps to and did not agree to restructure the debt to provide protect their rights under the agreements. Importantly, further tariff concessions. It should be noted that Hubco WAPDA also assumed sole responsibility for was able to meet their debt payment obligations negotiations addressing the concerns by some IPPs that throughout the workout period despite the fact that the parameters were forever shifting with each new IPP WAPDA was not paying the company the full tariff. The committee that was appointed. WAPDA was ultimately company had built up a rather large amount of cash in successful in securing tariff concessions from about a their accounts since they were prevented from dozen IPPs, all of which had yet to be commissioned as distributing dividends due to a court imposed order. these were the plants over which WAPDA had the most Hubco was therefore able to draw on this cash to meet leverage. Significantly, no IPP (other than Hubco) which its debt obligations. had achieved commercial operations prior to this time, conceded to WAPDA's desire to reduce tariffs. The Hubco case was different from the rest of the IPPs since it did not fall under the 1994 Policy. Government Available data on roughly half of the IPPs which officials alleged that the PPA amendments, which renegotiated their tariff reveals that the average substantially increased the price of electricity produced decrease in the levelized tariff was about 10%, ranging during the first years of plant operation, were corruptly from 7-8% to as much as 16%. In exchange for these obtained or otherwise fraudulent. In parallel with legal tariff concessions, the term of their power purchase proceedings related to the dispute playing out in the agreements was extended from around 20 years to 30 local courts (see Annex 2), Hubco, the Government years, agreement was reached with WAPDA on the and WAPDA held various meetings during 1998-2000 commercial operations date allowing IPPs to begin in an attempt to resolve their outstanding issues. At the receiving revenue, and all legal disputes were resolved. request of both Hubco and GOP, the Bank facilitated many of these meetings in an attempt to resolve the There was little scope for IPPs to dramatically lower disputes in a neutral environment. Almost two and a their tariffs since the investment in plant and equipment half years after the first allegations of corruption were had already been made and projects were close to made, Hubco, the Government and WAPDA agreed to completion. In addition, by this stage in project a settlement whereby, inter alia, the tariff level was implementation, sponsor groups had direct control over reduced and all criminal and civil cases were disposed. SITUATION TODAY needs to be conceived and implemented as part of a sensible broader reform framework. For a relatively Relationships with IPPs have normalized, contracts are large power system such as in Pakistan, it would be being honored, and WAPDA is paying IPPs in accordance preferable for an integrated utility sector to be with the terms of the PPAs. Nevertheless, all things are not unbundled, so that the power market can be operated necessarily quiet on the IPP front. While there are no in a transparent manner, competition for the market longer high profile disputes, the implications of the cost can be introduced and, over time, generating plants of IPP power on the financial viability of the power sector, can be operated on a competitive basis. In addition, and the question of what customers should be asked to automatic indexation formulae should be in place to fund through tariffs,7 remain hot topics in discussions protect the purchasing utility from changes in fuel costs, regarding ongoing power sector reforms in Pakistan. This currency devaluation, and the cost of purchased power. being said, however, it is generally accepted that the IPPs were critical in meeting a severe capacity constraint, and By supporting the establishment of Private Power and that IPPs and private sector financing have a role to play Infrastructure Board (the one-stop shop for investors) in meeting the investment gap in the power sector. Since and the WAPDA Private Power Organization (WPPO) the resolution of the IPP crisis, Pakistan has made the to implement the 1994 IPP policy, and by giving right decisions regarding reform. However, a daunting emphasis under that policy on the use of government 12 challenge remains in implementation. guarantees, it may have had the unintended effect of enabling vested interest in the sector (WAPDA and the sector ministry) to "capture and stall" the LESSONS LEARNED implementation of the structural changes envisaged by the Government in the 1992 Strategic Plan for the The following are some of the lessons learned from the privatization of the Pakistan Power Sector, i.e. the Pakistan experience. unbundling of the WAPDA Power Wing and the introduction of competition in the market. After Sector Reform and IPPs. substantial delays, the unbundling of the power sector is almost complete (i.e. restructuring of WAPDA's power An impressive amount of resources for the power sector wing into about 14 corporate entities, with the in Pakistan was mobilized over time and helped remaining WAPDA responsible for hydropower eliminate power shortages. The IPP program, generation and the National Transmission and Dispatch unprecedented both in concept and scope, elicited an Company initially operating as a single buyer). The enthusiastic buy-in both within and outside the Bank. assignment of all IPP contracts to WAPDA's successor The Bank promoted measures for sector management companies once restructuring was complete was and restructuring, as well as public sector policy foreseen in all PPAs/implementation agreements. reforms, which were generally right and timely. The Although the load dispatch center needed upgrading Government, however, failed to have them and market operating rules could be refined, the implemented at the intended pace. While failures in dispatch rules were well established (based on lowest sector reforms did not precipitate the financial crisis of variable costs) and generally respected, despite some WAPDA, they compounded it, crippled the efficiency of reports of WAPDA's own plants being favored. both WAPDA and the IPP program, and left the sector However, the main issue was WAPDA's inability to pay overly vulnerable to economic downturns. the IPP capacity charges due to its weak financial position. The main effect of the delays in WAPDA's There is a strong consensus that private investment is restructuring/privatization has been, however, that not a substitute for reform, and that significant private expected efficiency improvements, including restoring investment in generation should not take place in front the financial health of WAPDA's successor companies of reforms which at a minimum address distribution failed to materialize even today and investments in efficiency and tariff policies. Private sector participation upgrading the transmission and distribution system It is noted that capacity charges, which were front-loaded, have declined over time since most IPPs have been in operation for several years. 7 Consequently, the cost per kWh generated have generally declined as well. have not always been made. This remains an accommodate a small IPP program without major impediment to attract fresh private capital in the financial dislocation. Indeed, adding IPP capacity to power sector in general and for new generating a slow reforming sector can be a catalyst for reform. capacity in particular. However, project economics still matter if the government is assuming some risk and several lessons Benchmark Pricing vs. Competitive Bidding. emerge from the Pakistan experience including the need to: Rather than proceed through competitive bidding for private power, Pakistan instead set a bulk tariff ceiling tailor public financial support and guarantees to for investors in an effort to accelerate the private facilitate an efficient investment program. power program and reduce transaction costs in order Pakistan was successful in limiting Bank supported to quickly address the blackout situation facing the political risk guarantees to only two large projects and country. This was a very successful tactic in attracting in providing subordinate debt under PSEDP I and II to foreign investors, but too many projects were approved only four large or medium size IPPs. However, all 16 and the selection process was not transparent. It is IPPs received government support under likely that some projects for which Letters of Support Implementation Agreements whereby the government were issued, and indeed some of those which ultimately backstopped the payment obligations of state-owned reached financial close, benefited from political power utilities and the state-owned fuel suppliers. It is 13 support since no clear criteria existed to determine doubtful whether any IPPs could have been financed in which projects to prioritize when the Government Pakistan without government guarantees since was faced with negotiating project agreements with perceptions of Pakistan's risk had limited financing to almost 80 potential IPP developers. In addition, terms of 18-36 months. Nevertheless, such support setting prices rather than bidding allowed for should have been limited only to projects of clear inefficiencies (e.g. projects which were too small priority that could be afforded by the country. In and not least cost) and corruption opportunities on addition, both private as well as public investment in non-price issues (e.g. securing the necessary fuel generation should be consistent with an economic least supplies and WAPDA's transmission investments). cost power supply plan. In hindsight, the Government should have restricted the number of projects under the bulk tariff scheme, have an efficient fuel supply policy particularly the moved to competitive bidding and staggered rational use of natural gas (electricity generation is solicitation over a few years so that changes in usually one of the highest value uses of gas) and allow international investors' assessment of country and IPPs to procure fuels in competitive markets, both contract risks should have led to declining bid prices. foreign and domestic. This also links to the concept of Staggering IPP solicitation and competitive tendering least cost power mentioned above. It should be noted, would also have provided time to validate the however, that at the time the 1994 Private Power Policy economic and power demand growth expectations was conceived, Pakistan did not think it had a lot of based on updated developments. domestic natural gas available for power generation. Large IPP programs need to be limit the size of the first IPP to enable ready carefully managed. substitution if a key participant drops out and allow the Bank to take a more hands-off role in the details of the The scale of the IPP program was perhaps ahead of transaction. The 1,292 MW, US$1.6 billion Hub Power its time given the country's state of development (in Project was the first IPP transaction in Pakistan and terms of social, economic, political, and institutional entailed a complicated financing structure.8 The project governance), and may have been better being piloted emanated from two unsolicited offers which were before encouraging wider use. A power system can subsequently consolidated and required six years to The Hub financing package included seven senior debt facilities, most of which had a syndicate of commercial banks. There were more than 8 70 financial institutions represented in the financing structure (including 43 international commercial banks, 9 local banks, several export credit agencies, etc.) This was in addition to the sponsor group and contractors. reach financial close. The difficulties with the project state-owned power offtaker (WAPDA or KESC) and the can largely be attributed to its size. Until Pakistan had fuel supplier. In addition, GOP guaranteed the developed a track record of GOP contractual availability and convertibility of payments in foreign performance and successful implementation of power exchange. While foreign investments have many projects in the power sector, the Government should beneficial effects, they also entail at some point the have concentrated its efforts on modest-sized, and as a repatriation of profits and the servicing of foreign debts. consequence, more easily financeable projects. The capacity of a country to meet these new obligations is necessarily related to its capacity to increase foreign create capacity to manage IPP contracts. While exchange earnings through exports. Particularly in the Pakistan created institutional capacity to approve new case of the power sector, where investments in excess of IPPs, and the creation of PPIB as a "one stop shop" for US$5 billion were made, the incremental foreign investors is widely credited as a key advantage in exchange outflow is on the order of US$800 million per preventing bureaucratic delays, WAPDA did not put in annum, equivalent to eight percent of Pakistan's exports. place an effective contract management unit to The Bank did not investigate the matter until 1995 in the manage their commercial contracts with the private context of the due diligence process for the Uch partial sector. Furthermore, WAPDA was conflicted as the sole risk guarantee. The analysis concluded that under most buyer, system operator and competing power generator scenarios, Pakistan would have serious difficulties in 14 which argues for unbundling, at least, transmission. meeting the incremental foreign exchange obligations. Furthermore, given that contingent liabilities also arise in ensure efficient plant dispatch. Since fuel is the the case of oil and gas development, Pakistan ought to main element of WAPDA and IPP costs, the power put in place, possibly at the Central Bank, a monitoring system needs to be operated to ensure that the plant system for contingent liabilities. with the lowest variable operating cost is dispatched first, subject to location, transmission constraints, and Bank's Role in Dealing with Corruption that undue preference is not given to any plant, public Allegations. or private. WAPDA's current dispatch facilities do not fully recognize all relevant factors. When corruption was alleged in some of the sub-projects (especially Hubco), the Bank initially found it difficult to Due Diligence by Other Lenders. respond given its multiple roles (i.e. advisor to the Government, lender to WAPDA, indirect lender to IPPs Given the overall government guarantees provided through the LTCF, and guarantor to commercial lenders through the Implementation Agreements, it appears through the partial risk guarantees). In the case of the that private sector lenders, export credit agencies and four IPPs financed under PSEDP I and II, and in particular even the IFC and the Bank primarily relied on the risk the Hub and Uch projects for which the Bank also allocation framework as contained in the security provided partial risk guarantees, the Bank was a party to package, and discounted the potential country, the private sector transaction and was looked upon by macroeconomic and sector risks. The parties may have both the Government and the private sector as having a also drawn undue comfort from the Bank Group's positive role to play in resolving the dispute. Standard involvement in the 1994 Private Power Policy. The Bank practice would dictate that the Bank not get lesson is that the assumed future country conditions at involved in commercial disputes; however, the Bank had appraisal can be substantially different from what a responsibility to act once the partial risk guarantees actually emerges. When substantial changes do occur, were under threat of being called by the lenders as a all parties should recognize and accept that re- result of what was perceived to be government events negotiation may happen. (See further discussion on re- of default. negotiation below.) The Bank had to maintain an "honest broker" role in a Contingent Liabilities. situation where different parts of the Bank Group at times played conflicting roles: IFC as a lender to IPPs was trying Under Implementation Agreements signed with IPPs, the to mitigate its reputational risk vis-a-vis its syndicated B Government guaranteed the payment obligations of the loans; the Project Finance Group in the Bank which was focusing on mitigating calls to the Bank's partial risk governments and governmental agencies should guarantee; the country economic team and energy be encouraged to pursue corruption strictly according team were concerned about the macro impact and to law and internationally recognized due process, were advising the Government on the reform agenda. and in the meantime contractual obligations should Furthermore, IPP sponsors applied pressure on the be honored. Bank through their Executive Directors, governments and legislators, whereas the Government applied Renegotiating concession agreements is not unusual pressure on the Bank to live up to its zero tolerance in the private sector, particularly when prevailing policy on corruption and requested assistance in their conditions substantially change (e.g. external macro corruption investigation. Their argument for Bank shocks). However, negotiations will more likely assistance centered on the Bank's earlier, pervasive role result in a prompt and mutually acceptable solutions in putting the Hubco deal together and approving the when they occur in a commercial atmosphere, documentation, in addition to being the main advisor free of coercion. to the Government in developing the IPP Policy. In all, this pushed Bank staff and management to play a more Lastly, in the context of future IPP solicitations, it may proactive role than may have otherwise been the case. be useful to set out the principles of how the benefits However, despite the varied interests of the World Bank or burdens of future debt refinancing or restructuring Group in the dispute, the Bank Group's overall should be shared among the parties involved. Including 15 objective remained the development of Pakistan and such principles in future PPAs could: (a) facilitate the this objective guided the Bank's decision making. restructuring of debts in jeopardy situations, and/or (b) Overall, the Bank Group was recognized as playing a encourage IPPs to refinance debt in the event interest positive role in the resolution of the IPP disputes. rates fall substantially and refinancing could lead to significantly lower cost of debt to the benefit of the both Renegotiations. the IPPs and the host country. Not having had at the outset such "rules of the game" could be one of the Initially, the Bank had advised the Government to reasons for the few incidents of debt refinancing or separate the commercial and criminal issues in an restructuring among the Pakistan IPPs. attempt to bring the perception of an orderly framework to resolving the IPP disputes. WAPDA was facing severe cashflow problems and was not in a position to honor its payment obligations under the PPAs. In addition, the country's foreign exchange reserves were dangerously low which jeopardized the Government's obligation under the Implementation Agreements to convert rupees into foreign exchange. Some IPPs indicated a willingness to renegotiate in recognition of the country's difficulties, but not under duress and coercive tactics. However, separating the commercial and corruption issues proved difficult to do in practice in the case of Hubco, where the Government/WAPDA was of the view that the original commercial terms were fraudulently obtained. Ultimately, both Hubco and the Government/WAPDA requested the Bank to act as a facilitator in resolving the dispute since attempts by the parties to renegotiate the commercial terms were continuously bogged down in corruption allegations and refutations. However, the Bank was not (and should not) be represented at the actual negotiating table as it is not a party to the contract. Overall, the lesson learned is that 16 ANNEX 1. PAKISTAN PRIVATE POWER PROJECTS PROJECT NAME/ NOTES TECHNOLOGY CAPACITY CAPACITY COMMERCIAL LOCATION * AND FUEL GROSS NET ** OPERATIONS (MW) (MW) DATE 1 AES Lalpir Limited /a Steam turbines 362 351.3* Nov. 6, 1997 Lalpir on fuel oil 2 AES Pak Gen (Pvt) Co. /a Steam turbines 365 343.9* Jan 2, 1998 Lalpir on fuel oil 3 Altern Energy Limited Flared gas 14 13 Apr. 30, 2000 Fatch Hang, Attock Combined cycle 157 150* Oct. 21, 1999 4 Fauji Kabirwala Power Co. /d on gas Kabirwala, Dist Khanewal 5 Gul Ahmed Energy Ltd, /a/e Fuel oil 136.17 128.5* Nov. 3. 1997 Korangi Town, Karachi 6 Habibullah Coastal Power Combined 140 126* Sep. 11, 1999 Quetta cycle on natural gas 17 7 Japan Power Generation Diesel engines 120 107 Mar. 14, 2000 Off Raiwind Rd, Near on fuel oil Jia Baggo 8 Kohinoor Energy Limited /a Diesel engines 131.44 126 Jun. 20, 1997 Raiwind ­ Manga Road on fuel oil 9 Liberty Power Project Combined cycle 235 211.9 Apr. 30, 2000 Daharki on natural gas 10 Northern Electric Co. Ltd. Steam turbines 6 5.5 Jun. 30, 2003 Choa Saidan Shah, on coal Chakwal 11 Rousch (Pakistan) /b Combined 412 355.1* Dec.11, 1999 Power Ltd Cycle on fuel oil Sidhnai Barrage Punjab 12 Saba Power Co. Ltd. /d Steam turbines 114 109 Dec. 31, 1999 9 km from Sheikhupura on fuel oil 13 Southern Electric /b Diesel engines 115.2 112.1* Jul. 12, 1999 Power Co. on fuel oil Raiwind, Lahore 14 Tapal Energy Limited /d /e Fuel oil 126 125.5* Jun. 20, 1997 West Karachi 15 Uch Power Limited /a /b /c Combined 586 548* Oct. 18, 2000 Dera Murad Jamali Cycle on low Btu gas TOTAL under 1994 3,020 2,813 Policy 16 Hub Power Project /b /c Steam turbines 1292 1200 Mar. 31, 1997 Tehsil Hub, District on fuel oil Lasbela TOTAL incl. Hub 4,312 4,013 * Four IPPs were terminated after reaching financial close: (i) Davis Energen (Pvt) Ltd. (gas turbines on flared gas, 10.5 MW); (ii) Eshatech (Pvt) Ltd. (coal, 20 MW); (iii)Power Generation Systems (diesel engines on fuel oil, 116 MW); and (iv) Sabah Shipyard (fuel oil, 288.6 MW) ** Actual initial dependable capacity /a IFC participation /b PSEDF participation /c IBRD Guarantee /d MIGA participation /e PPA with KESC Source: Private Power and Infrastructure Board ANNEX 2. SUMMARY OF HUBCO LEGAL DISPUTES On May 8, 1998 a pro bono publico constitutional has included these issues in the ICC Arbitration. petition was filed in the Lahore High Court (LHC) The Company had issued notices to WAPDA under against the Company. The Petitioner challenged the PPA which could result in the termination of the decision of the Government and WAPDA to the PPA. Corresponding notices had also been enter into the Power Purchase Agreement (PPA) issued in respect of the Implementation Agreement on the grounds that the tariff was discriminatory (IA) and the Fuel Supply Agreement (FSA). These in favor of the Company. The Petition also accuses notices could lead to the termination of the PPA the Government, WAPDA and the PPIB of having and, as a consequence, of the IA which event acted malafide and fixed a tariff which was would entitle the Company (and through the unjustifiable. Company the shareholders of the Company) to compensation as set out in the IA. However, the At the request of the Petitioner, the LHC issued operation of these notices were subsequently interim orders, which were subsequently amended suspended by the Supreme Court of Pakistan by by the Supreme Court (SC), that prohibited the an order passed on an application moved by 18 Company from making distributions from reserves WAPDA. The operation of the notices continues as of December 31, 1997 to shareholders and to be suspended to date. restricted the fixed element of the tariff to a maximum of Rupees. 845 million per month plus In aid of its request for arbitration, the Company billing in respect of Energy Purchase Price. Although filed suit in the High Court of Sindh in November directed by the SC to dispose of the matter by the 1998, requesting the Court to direct WAPDA to end of 1998, the petition has not been fixed for proceed to ICC arbitration and restrain WAPDA hearing so far. The petition is being contested by from taking any proceedings except ICC arbitration. the Company which believes that it is without merit. In March 22, 1999 WAPDA was directed to proceed to arbitration by the Court which was appealed In a related action on July 9, 1998, pursuant to by WAPDA. The Appellate Court suspended the the PPA, the Company filed a request for arbitration earlier order and also restrained the Company in the International Court of Arbitration of the from proceeding to arbitration. Challenges by International Chamber of Commerce (ICC for the Company were filed and hearings on that hearing in London seeking a declaration that issue concluded in June 1999 and judgment Amendment No. 2 to the PPA is valid and that was reserved. WAPDA is bound by its terms. The Tribunal was fully constituted in mid-January 1999. The Tribunal first By an order on August 11, 1999 the Court met on February 22, 1999 but could not proceed stated that it would hear the Company application as the Company was restrained by a Pakistani with WAPDA's appeal and also continued the court order from participating in the proceedings. restraint on the Company to proceed with the Subsequent attempts to convene have also proved ICC arbitration. The Company petitioned the abortive for the same reason. Supreme Court against this order. The Company's petition was converted to an appeal on October On October 11, 1998 WAPDA alleged that the 27, 1999 and heard by a five member bench of Supplemental Deed dated November 16, 1993 the Supreme Court. and Amendments Nos. 1 and 2 of the PPA dated February 24, 1994 and September 17, 1994, On June 14, 2000 the Company's appeal was respectively are void ab initio because they were dismissed by the Supreme Court by a majority of said to have been procured by unlawful means. 3 to 2 and the Company was restrained from WAPDA is claiming in addition the repayment of invoking the arbitration clause of the PPA for the Rupees. 16 billion allegedly overpaid. The Company purpose of resolving its disputes with WAPDA has rejected the allegations made by WAPDA and through the agreed forum of ICC arbitration. On July 10, 2000 the Company filed petition in the Supreme Court seeking a review and reversal of the majority judgment of June 14, 2000. The above is summarized from Hub Power Company Limited Annual Report 2000. In December 2000, the parties agreed to a settlement whereby inter alia the tariff level was reduced and all criminal and civil cases were to be dismissed. 19 20 THE WORLD BANK GROUP The Energy and Mining Sector Board The World Bank 1818 H Street N.W. Washington, D.C. 20433 USA