wb-phu my 2 phase 2 power project

CURRENCY EQUIVALENTSExchange Rate Effective January 1, 2002 Currency Unit = Dong D DI = US$0.000067 US$1 = D15,000 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS ADB Asia

Document of The World Bank

FOR THE PHU MY 2 PHASE 2 POWER PROJECT

IN

THE SOCIALIST REPUBLIC OF VIETNAM

August 29, 2002

Energy Sector Development Unit

East Asia and Pacific Region

CURRENCY EQUIVALENTS

(Exchange Rate Effective January 1, 2002)

Currency Unit = Dong (D)

DI = US$0.000067

US$1 = D15,000

FISCAL YEAR

January 1 - December 31

ABBREVIATIONS AND ACRONYMS

ADB Asian Development Bank LLA Land Lease Agreement

BOT Build-Operate-Transfer LTSA Long Term Service Agreement

BP British Petroleum MECO Mekong Energy Company Ltd

BR-VT Ba Ria - Vung Tau MOI Ministry of Industry

CAS Country Assistance Strategy MPI Ministry of Planning and InvestmentCOD Commercial Operation Date MW Megawatt

DOSTE Department of Science Technology and O&M Operation and Maintenance

Environment of Vung Tau City PMPGC Phu My Power Generation CenterDSCR Debt Service Coverage Ratio PPA Power Purchase Agreement

EDF Electricite de France PRG Partial Risk Guarantee

EDFI EDF International PV Petro Vietnam / Vietnam Oil and GasEIA Environmental and Social Impact Corporation

EPC Engineering, Procurement, and SEIER System Efficiency Improvement,

Construction Equitization and Renewable ProjectERR Economic Rate of Retum SFR Self-Financing Ratio

EVN Electricity of Vietnam RFP Request for Proposals

GSA Agreement for the Sales of Natural Gas TEPCO Tokyo Electric Power Co.

IL Investment License TSA Technical Services Agreement

IPP Independent Power Producer UDEC Urban Development ConstructionkWh Kilowatt-hour Cornpany of Ba Ria - Vung Tau ProvinceLIBOR London Inter-Bank Offered Rate WSA Water Supply Agreement

Vice President: Jemal-ud-din Kassum Country Manager/Director: Andrew Steer

Sector Manager/Director: Mohammad Farhandi Task Team Leader/Task Manager: Anil Malhotra/Suman Babbar

VIETNAM VIETNAM PHU MY 2 PHASE 2 POWER PROJECT

CONTENTS

A Project Development Objective

Page

B Strategic Context

1 Sector-related Country Assistance Strategy (CAS) goal supported by the project 2

3 Sector issues to be addressed by the project and strategic choices 9

C Project Description Summary

D Project Rationale

2 Major related projects financed by the Bank and other development agencies 23

E Summary Project Analysis

F Sustainability and Risks

G Main Effectiveness Conditions

H Readiness for Implementation

Annexes

Vietnam Phu My 2 iPhase 2 Power IPlroject

Project Appiraisal foclmemlt

East Asia and Pacific Region

EASEGDate: August 29, 2002 Date: August 29, 2002 Team Leaders: Anil Malhotra /Suman Babbar

DevelopmentLending Instrument: IDA Partial Risk Guarantee Poverty Targeted [ntervention: No

Guarantee Amount (US$ m*Hon): US$75 million

* It is envisaged that ADB will be the Guarantor of Record for the proposed commercial Loan

Facility

* Total financing requirements of US$480 million include stand-by financing of US$80 million

Proposed coverage: The IDA Partial Risk Guarantee (PRG) would provide coverage for debt service

default caused by a breach of contractual obligations of the Government of Vietnam under the BOT Contract or Government Guarantee entered into between the Government and Mekong Energy

Company Ltd (MECO)

Project sponsors: EDF International (56.25%); Sumitomo Corporation (28.125%) and TEPCCInternational (15.625%)

Nature of underlying financing: A syndicated commercial bank loan guaranteed by IDA

Guarantee loan amount: Up to US$75 million

Final maturity: 16 years from financial close

Grace period: 32 months (8 months after commissioning)

Amortizatiom: Quarterly installments structured to meet the project revenue profile

Expected effectiveness date: September 2002

A Project Development Objective

1 Project development objective: (see Annex 1)

The principal objectives of the proposed Project are to: (a) enable Vietnam meet its increasing powerdemand in a cost-effective and reliable manner, which will contribute to sustainable economic growth andpoverty alleviation; (b) mobilize private sector financing for the infrastructure sector; and (c) promoteGovemment's reform efforts The latter by (i) paving the way for further private participation in thesector through a competitive and transparent framework similar to that developed for the proposedProject; and (ii) promoting commercial discipline through contractually defined arrangements

The proposed Project consists of a 715-MW gas-fired combined-cycle power station in the Phu My PowerGeneration Center (PMPGC) to be developed, owned, and operated on a Build-Operate-Transfer (BOT)basis by Mekong Energy Company Ltd (MECO), a limited liability company incorporated in Vietnam bythe private sponsor consortium of EDF Intemational (EDF1), Sumitomo Corporation and TEPCOIntemational (TEPCI) Under the Power Development Project (CR 2820-VN), the Bank has partially

financed the first phase of the Phu My 2 power project as a public project, and provided technicalassistance support for the development of the second phase as a BOT project IDA Partial Risk Guarantee(PRG) of up to US$75 million in support of commercial debt financing was offered as an option to thebidders during the competitive bidding to select a private developer consortium for implementing theproposed Project under a BOT structure After evaluation of the bids received, the EDFI-led consortiumwas awarded the mandate for the development of the proposed Project in January 1999 The price ofelectricity from the proposed Project will be approximately US cents 4 l/kWh on a levelized basis, which

is competitive with those offered by Independent Power Producer (IPP) plants in Asia The winningproposal included the IDA PRG as a critical core component of the financing for the Project

The proposed Project is part of the national least cost power generation investment plan It would bebased on combined cycle technology using domestic natural gas and thereby have minimal environmentaland foreign exchange impact It would help reduce power shortages and secure significant economicbenefits for the country By enabling the Government to shift investment costs to the private sector, thisProject would help free scarce public resources for other critical uses including poverty alleviation andsocial development It is path breaking in terms of attracting substantial private capital investment flowsfor infrastructure development and being the first internationally competitively bid BOT project inVietnam This would be the first IDA Guarantee in Vietnam

2 Key performance indicators: (see Annex 1)

The following performance indicators will measure the impact of the proposed Project on the sector andthe economy:

(i) completion of the Project according to schedule;

(ii) efficient operation of the plant according to the agreed operating regime (availability, thermalefficiency); and

(iii) overall increase in power supply and reduction in power shortages

B Strategic Context

1 Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1)

Date of latest CAS discussion: September 3, 2002 (Document No IDA/R2002-0150[IFC/R2002-0174])

The proposed Project is in full compliance with the Bank's Country Assistance Strategy (Report 24621)which sees the Bank Group's role in support for infrastructure being guided by three emphases, one ofwhich is a high priority being given to mobilizing private sector involvement The energy sector hascontributed substantially to economic growth Its continued development is essential to sustainingindustrial growth and employment generation The report "Fuelling Vietnam's Development: NewChallenges for the Energy Sector" ( April, 1999) identifies the key issues and lays out a strategy for thesector First, IDA lending will shift towards extending access in rural areas Second, IDA will supportprograms to increase the efficiency in the entire energy chain and assist in creating creditworthyinstitutions, improvement in corporate governance as well as rationalization of sector management Third,IDA's focus will shift towards mobilization of external financial resources for the sector to enable thecountry to meet its energy demands, providing assistance that will facilitate private participation in theenergy sector This will include advisory services for putting in place a trnsparent and independentregulatory framework and for promoting private participation in distribution and development ofrenewable energy resources

The policies and programs that the Government proposes to follow in the sector are in consonance withthe Bank's policy guidelines for the power sector IDA's involvement in Vietnam's power sector isintended to assist the sector's staged transition to a commercial structure and operating environment aswell as the development of an efficient and viable energy system This involvement, commenced underthe first four power credits, under which IDA is helping the Government in: (a) strengthening the existinginstitutions including those responsible for rural electrification; (b) implementing commercialmanagement practices and structures; (c) developing a credible legal and regulatory system; and (d)facilitating the entry of private capital and operators in the sector In addition, IDA's involvement isinfluencing the optimal utilization of scarce resources, as well as fostering energy efficiency and goodenvironmental management practices Sustained involvement in the Vietnamese power sector, through theproposed Project, would help consolidate reform efforts and institutional restructuring initiated underearlier projects

The proposed Project is consistent with the CAS focus on the promotion of private involvement ingeneration activities, catalyzing private finance for meeting the growing energy demands of the economyand promoting sector reform In turn, the CAS is organized around the three broad objectives of theGovermuent's Comprehensive Poverty Reduction and Growth Strategy (CPRGS as the PRSP in Vietnam

is called): (a) high growth through a transition to a market economy; (b) an equitable, socially inclusive,and sustainable pattern of growth; and (c) adoption of a modern public administration, legal andgovernance system The proposed Project supports all three of these objectives

2 Main sector issues and Government strategy:

Backzround: The energy sector can provide the essential underpinning to future economic growth in

Vietnam Today; it contributes over a quarter of the total foreign exchange earnings from oil and coalexports Energy demand has been growing 13-15%, faster than GDP during the last five years Continuedexpansion in energy and electricity supply and delivery infrastructure will enable rapid growth in theagricultural and industrial sectors and sustain economic growth It can help alleviate poverty by providingenergy access to the poor and mitigate environmental degradation by encouraging the shift fromtraditional to commercial energy, as well as making appropriate fuel choices in expanding supplies Newchallenges have emerged in the energy sector requiring structural and institutional reforms that are bothmore difficult and more complex

Graph Energy Sector in Vietnam

* Hydrop e U Coal-fred thermal C Oil-fired themnal | fIndustrial sector

o Gas btirbine (Gas) * Gas turbine (DO) 1 Diesel "Agricultural sector

Electricity Consumption & Generation In 1990-2000

|_- - Generaton (GWh) i Consumpbon (GWVh) X Power losses (%)|

The major sector issues and the Government's strategy to deal with them are described in more detailbelow:

a Need for large sector investments and improvement in overall system efficiencv: Over the past five

years, electricity demand in Vietnam has increased at 13-15 % per annum This increase is typical ofcountries which begin from very low levels of demand In 2000, the electricity sector in Vietnam had aninstalled capacity of 6195 MW but the available capacity was only 5814 MW It had a system reservemargin of about 8 % in the dry season leading to considerable load shedding and brownouts Whileelectricity losses have been lowered from the early nineties when a quarter of all power generated waslost, the power loss rate still stands at 15.5 % The average per capita consumption in Vietnam was only

309 kWh - one of the lowest in the region and about one seventh of neighboring Thailand Load demandforecasts were prepared under three alternative scenarios which indicate that additional generationcapacity of 6000-8500 MW would need to be installed over the next decade Demand - supply gap isexpected to widen further in the absence of capacity additions The proposed Project is a part of the leastcost investment plan in all the three scenarios The Government has recently decided that, in addition topublic power generation projects, it would invite private investors to bid for generation projects up to 20

% of total system capacity In addition, discussions are ongoing for the creation of a Greater Mekong Gridfor power trade among the countries in the region, but it is unlikely that in the short or medium term, anymajor import of power can be expected into Vietnam to meet its power shortages

To sustain an economic growth projection of about 6-8% p.a over the next 5 years, Vietnam needs toincrease its electricity supplies at the rate of about 10-14 % per annum, requiring an investment of aboutUS$ 7.5 billion equivalent over 2000-2005 This investment represents about 5% of the projected GDP.Financing this increase in electricity supplies requires a strategy to: (a) improve the efficiency of existing

increase the amount of self generated sectoral surpluses for investment Fundamental reforms of theenergy tariffs will be required to ease financing constraints and ensure long term efficiency of investmentand resource utilization decisions in the entire economy Electricity efficiency has two components:supply side and demand side efficiency Inefficiencies in transmission and distribution include lowsystem power factors, transformer inefficiencies, poor quality cables and lack of system optimization.System losses, about 15.5 % in 2000, need to be reduced to 10% A wide ranging demand sidemanagement program would improve load management for large energy users, introduce buildingstandards, industrial audits to improve lighting and motors and design more efficient public lighting.These measures could reduce demand by about 700 MW and save US$400 million by 2010 TheGovernment is working towards these goals by: (a) promoting energy conservation and efficiency, (b)increasing and structuring electricity tariffs to raise internally generated surpluses; (c) involving theprivate sector in power generation and developing natural gas supplies; and (d) promoting privatization/equitization of distribution functions.

Table 1 Load Demand Forecasts 2000-2020

Source: PDP-5 and Bank Staffestimates

b Low rural access to electricitY: Rural electrification is a critical element of the Government's program

to eliminate poverty and redress imbalances in development Ambitious rural electrification targets havebeen established and work has commenced About 20 million people in Vietnam, representing about 4million households, still have no access to electricity Electricity consumption patterns are also skewed,with urban dwellers who account for about 20% of the population accounting for over 80% of the totalresidential consumption Expansion of rural electricity access is crucial for two reasons First, electricityaccess will make it possible to improve overall welfare levels by providing reliable lighting sources,improved health care and services Second, by providing electricity for irrigation and other productiveactivities (e.g weaving, etc.) the productivity and incomes of rural residents can be increased The keyissues in rural electricity delivery are: (a) securing adequate resources for investments that areeconomically justified but not financially viable; (b) defining and implementing methods for rural gridand off-grid management, maintenance and services that do not overextend central electricity providersand maximize local participation; and (c) designing tariff structures that recover costs without distortingincentives for local generation and efficiency The Government is addressing the above issues by: (a)issuing a Rural Energy Policy Paper and preparing national decrees for implementation of ruralelectrification programs; (b) nomninating the Ministry of Investment (MOI) to promote, coordinate andmanage the renewable energy program for the country; and (c) working with the World Bank in designinginvestment projects for rural electrification that would address the issues noted above

c Barriers to renewable energy: Decentralized electricity production from renewable energy sources can

be economically viable However, the scale of applications is too small to obtain any significanteconomies of scale in production or sales or justify establishing the necessary infrastructure to assure

sustainability Work done to prepare the Renewable Energy Action Plan (REAP) identified the followingmajor barriers: (a) lack of policy and institutional mechanisms; (b) insufficient information aboutrenewable energy technologies, their cost and performance, available to stakeholders at all levels; (c) fewcommercial businesses provide renewable electricity equipment and services; (d) lack of credit forrenewable energy suppliers, developers of community mini-grids and grid-connected projects, orhousehold purchase of systems; (e) unavailability of high quality technology; and (f) inadequate resourcedata The Government is gradually realizing the potential of renewable energy for decentralized electricitysupply and has embarked, with assistance from the Bank, on a programmed approach to renewable energydevelopment by (a) nominating MOI as the central agency for promotion and coordination of renewableenergy programs and (b) developing a renewable energy action plan (REAP), in consultation with localagencies and donors, which lays out a policy framework and long term program However, much workand capacity building still needs to be undertaken.

d Managerial and administrative capacitv of sector institutions: Institutions in the Vietnam's energy

sector are managerially and administratively weak Much of this weakness results from inadequate staffskills and organizational systems to operate in an increasingly commercial environment Moreover,Vietnamese government agencies and power enterprises have been unable to decentralize decisionmaking to front-line staff and exercise administrative/ management oversight without interfering, ortaking it over themselves Consequently, there has been a lack of autonomy and associated responsibility

in most energy sector institutions, resulting in low productivity The Government has recognized theproblem, and is making slow but steady progress: (a) allowing more decentralization of investmentdecisions, authorizing Electricity of Vietnam (EVN)'s management board to decide on investments under

$40 million; (b) training government staff, to upgrade their skills and to familiarize senior officials withalternative models of governance and oversight; (c) initiating plans for the equitization of communes anddistricts; and (d) commissioning a commune-based utility model to develop local management In the pastfive years, EVN has grown into an effective utility and its performance indicators, both physical andfinancial, place it among the top utility performers in the region

e Financial sustainability of the power sector: It is estimated that investments of the order of US$ 1.2-1.5

billion per year - about 5 % of GDP - would be required for this decade (Table 2) Financing thisinvestment requires a strategy to increase significantly the inflow of external capital within prudent limitsand the amount of self generated surpluses in the public utility EVN available for investment in the sector.EVNs financial performance, since its creation in FY95 to date, has been satisfactory on the strength ofhigh demand growth and rapid expansion of the Vietnamese economy The strong performance wasreflected in EVN's financial ratios: from FY96-98, the operating margin averaged 17% and the self-financing ratio (SFR), 36%.The regional financial and social crisis of FY97/98 severely constrainedaccess to extemal financing and revenue sources to support Vietnam's development However, EVNsustained its satisfactory financial performance and strong results largely due to the continued robustdemand for power During the period FY98-00, the operating margin averaged 14% and the SFR, 34%.Reflecting EVN's growing reliance on external long-term debts to finance capital expansion, the debtservice coverage ratio (DSCR) has been declining in recent years from its peak of 38 in FY98 to 3 inFY00 Sustained financial viability of EVN, in view of its investment needs, is critically dependant on thelevel of power tariffs in the country

Table 2 Investment Needs of the Power Sector 2000-2020 (Base Case)

Source: PDP-5 and Bank staffestimates

Retail electricity tariffs, currently uniform across Vietnam, are set by the Government, and wererationalized and have been raised periodically since March 1992 Currently, the average tariff is about D728/kWh, inclusive of the 10% value-added tax (VAT) The most recent estimates of Long Run MarginalCost (LRMC) for delivery to the consumer is in the range of VND 1125/kWh (US cents 7.5/kWh) Theachievement of an average tariff of US cents 7.0/kWh is the development objective of IDA's ongoingtariff and sector dialogue with the Government and key to satisfactory financial performance of EVN andits compliance with financial covenants, as well as sustainable health of the power sector TheGovernment, however, recently delayed the planned tariff increase to US cents 5.6/kWh scheduled to beeffective on October 1, 2001 due to concerns regarding negative economnic impact of the global economicslowdown after the September 11 attacks Given EVN's sizable investment plans over the next decade tomeet critical power shortage, and the associated increase in projected borrowing, the Government hasrecognized that it would be essential to implement the required increases in power tariff in a phasedmanner to achieve satisfactory fitancial performance of EVN, compliance with financial covenants andfinancial sustainability of the power sector

In 2001 and 2002 there has been some slippage in the financial performnance of EVN, as a planned tariffincrease scheduled for October 2001 was postponed due to the Govermment's concems about globalrecession following the events of September 11 The Government has recently re-committed itself to aprogram of increasing tariffs periodically in order to meet an SFR of 30% and DSCR of 1.5, covenanted

under on-going IDA power projects During negotiations on the System Efficiency Improvement, Equitization & Renewables (SEIER) project in May 2002, State Bank of Vietnam (SBV) provided the

Implementation Plan proposed by the State Pricing Committee and approved by the Prime Minister onMay 24, 2002 The Implementation Plan provides for the following schedule:

The Government recognizes that increased tariffs are required to secure financing for this project, and forcontinued IDA and ADB financing of the sector The Government has also agreed to the first increase to5.6 cents/kWh as a condition of effectiveness of the SEEER project (For a detailed analysis of thefinancial performance and projections, refer Annex 6.)

f Minimizing pollution and environmental degradation: A large share of the energy consumed by

Vietnam's population comprises traditional energy sources, such as, fuel wood, charcoal, coal briquettes,rice and straw A rapid shift is required from these traditional sources of energy to modern energy,

including electricity Recent natural gas discoveries offshore provide an opportunity to makeenvironmentally and economically beneficial energy use choices The Government has recognized thefuture importance of natural gas and has already signed contracts for the commercial development of asignificant offshore gas field The development of renewable forms of electricity supply can also play arole in minimizing pollution and environmental degradation.

g Pace of power sector reforn: The Government's vision for the sector and its strategy to bring about

greater efficiency and lower cost of electricity have been spelled out in Power Sector Policy Statement in

1997 which formed a part of the Transmission, Distribution and Disaster Reconstruction Project (CR

3034-VN) The principal elements of the phased sector reforms, both within EVN and at the level ofnationwide legal structure and administration,' include: (a) decentralization of management decisions atEVN, (b) improving efficiency in and corporatization of distribution entities, (c) commercialization oftransmission operations, (d) preparation of an Electricity Law and supporting secondary regulations, (e)introduction of private sector participation into power generation and small distribution franchises, and (f)improving regulatory procedures for tariff setting at levels that fully cover costs But pace of reform hasbeen slower than envisaged

The power sector in Vietnam began its current phase of market focused reforms in 1995 by theestablishment of EVN as a state-owned holding company operated under the State Enterprise Law and byremoving it from under the then Ministry of Energy This was done to separate government policy andadministration from business activities in the power sector Regional Power Companies (PC) in charge ofdistribution were formed as independent accounting units under EVN, separated from central generationand transmission business units Decentralization of authority in investment decisions for projects to EVNManagement Board started in 1999 Separate corporate charters for PCs providing for increasedmanagement autonomy were issued in 1999-2000 EVN and all PCs have had their accounts auditedannually by international auditors since 1997, and annual reports of EVN were publicly issued since 1999including their financial statements In January 2001, EVN introduced generation-transmission internaltransfer pricing for all EVN owned power plants as the first step to turn power plants into profit centers The reform plan envisages EVN as the key buyer of power generation over the short and medium term.Competition will be encouraged in upstream generation, with a 20% long-term target for privategeneration through the BOT schemes The 1992 amendment to the Foreign Investment Law and thefollowing 1993 decree introduced the concept of BOT schemes for infrastructure development, andvarious decrees issued in 1998 and afterwards amended and supplemented a number of regulations tofacilitate BOT projects Due to the innovative nature of such concepts in the country and the associatedlong and overlapping decision making process of government agencies, BOT development in Vietnamhas so far not been successful, with few projects being implemented However, the Government hasrecently issued Investment License (IL) for the 715 MW Phu My 2-2 Project and the 715 MW Phu My 3Project to international foreign developers The financial closure of these demonstration projects wouldfurther enhance the institutional capacity of the Government and agency officials and serve to encourageprivate participation for future projects

Given that the structure and commercial arrangements in the power sector are evolving rapidly and theparticipation of the private sector is relatively new, the legal and regulatory framework has not developedadequately to respond to these changes The current regulatory system for the power sector suffers fromtwo specific drawbacks: (a) the function of government oversight and regulation is not separated fromthat of sector ownership and management which have been vested in EVN's Management Board; and (b)there is no effective and credible body of sector-specific legislation and regulations The creation of acredible regulatory entity and a enabling body of regulations for tariff, investment oversight are key

to promote and implement the reform processes and the Bank has been assisting such reform effortsthrough a series of IDA supported projects and associated studies.

The thrust and pace of the power sector reform program was reviewed with both MOI and EVN duringmeetings held in early 2002 MOI confirmed that the Government is embarked on a serious and sustainedreform of the power sector in order to change from a "command and control" economy to a market basedeconomy Delays in implementation had occurred in the past due to the need to generate consensus withinand outside the Govermnent But now certain fundamental decisions regarding the future structure of thepower sector have been made and the pace of reforn was expected to accelerate These included, interalia: (a) the encouragement of competition in all sectors of the power industry; (b) a decision that onlytransmission would remain a government monopoly while generation and distribution would be subject tocompetition; (c) EVN would introduce competition in generation through creation of an internal powerpool and the introduction of power transfer pricing and in distribution through bulk power transferpricing; (d) an independent system regulator would be introduced into the system gradually; (e) therevised version of the Electricity Law would be shortly submitted to the Government; (f) MOI had alsodecided to prepare a number of decrees for promulgation even before the passage of the Electricity Lawincluding decree 45 on electricity usage (issued in August 2001) on energy conservation and saving;administration of penalties; inspection; safety; HV corridor right of way; tariff and regulation TheGovernment plans for EVN to restructure itself into a real holding company under the model of onemember limited liability company functioning under the Enterprise Law This reform would remove thedifferent treatment between public and private businesses and would create more transparent relationshipbetween EVN and its member companies and increase their autonomy Guidelines and schedules for therestructuring are being decided by the Government Since competition and diversified ownership areallowed in generation and distribution, EVN has already signed 11 Power Purchase Agreement (PPA)buying electricity from small-scale domestic IPPs with a total capacity of 575 MW and has beennegotiating PPAs with a number of other domestic investors Over the next five years, EVN plans tocreate joint-ventures with domestic or foreign companies to build and operate power plants, especially inhydropower EVN will also support IPPs selling electricity directly to customers, especially to rural areas.Internally, EVN has been applying transfer pricing between generation and transmission from 2001 inorder to give greater autonomy and long term incentives for generation power plants to improve theirefficiency, before moving to the next step of an internal power pool On distribution, EVN has recentlycompleted equitization of four enterprises under EVN and PCs and is now starting equitization indistribution, with the first fifteen joint stock companies in commune and one in district level as pilots for

a more ambitious program of equitization The Government has requested IDA assistance in therehabilitation and expansion of the rural network, in over 6000 communes, as part of Rural Energy HProject ($ 220 million, FY 2004) project which would entail the conversion of a number of thesecommunes into local distribution utilities as joint stock companies, leasing companies or co-operatives.The Government is currently engaged in: (a) seeking government approval of the Electricity Law anddecrees on tariffs, safety, grid code, etc which need to accompany the Electricity Law draft forsubmission to the National Assembly; (b) reviewing institutional mechanisms to perform the regulatoryfunctions and (c) developing a road map for continuing power sector reforms (see Annex 12 for details ofthe proposed power sector reform.)

3 Sector issues to be addressed by the proposed Project and strategic choices:

The proposed Project addresses the following main sector issues:

(a) Need for large sector investments to meet electricity demand:

The proposed Project is part of the country's least cost power development program (see Table 3), is asoundly conceived IPP and would clearly benefit the country by providing efficient and reliable power

and meet a critical gap in electricity supply The planned capacity additions by 2010 would provideelectricity generation of about 70,000 GWh with reserve margin of 34 % in rainy season and 22 % in dryseasons.

The proposed Project will be the first to be developed through competitive bidding under the policyframework for private BOT power projects Since the price at which the proposed Project would supplyelectricity to the grid of US cents 4.14/kWh (levelized) is competitive with similar projects in Asia andwell below tariff costs for other negotiated projects, it would also set the framework for further privatesector expansion in the power sector The gas-fired combined-cycle technology is appropriate andconsistent with the least cost expansion of the generation system for the southern part of Vietnam, giventhe existence of indigenous natural gas resources offshore If the gas-fired power plants using domesticgas are not developed, the country would have either to import fuel oil and diesel for meeting theprojected electricity demand in the region at a considerable higher cost and foreign exchange outflow ortransport coal from the Northern part of the country at a higher cost since additional infrastructure wouldneed to be created'

Table 3 Vietnam Generation Plan -2002-2007

(High case and including system reserve mnargins of average 25 %)

Source: World Bank estimates based on WASP HI study carried out by EVNfor PDP-V

' Based on an assessment carried out in 1997 comparative cost estimates of different plants were: (a)Gas fired combined cycle gas turbine -2.92 cents/kWh; (b) Coal fired steam turbine in the north-3.36cents/kWh; (c) Coal fired steam turbine in the south using coal transported from the north-3.93cents/kWh; (d) Fuel oil fired steam turbine- 5.64 cents/kWh and (e) Diesel fired gas turbine- 7.18cents/kWh

Since the private sector will have the responsibility for arranging all the finance for the proposed Project

in the form of both debt and equity, it will alleviate the fiscal burden on the Govenmment's budgetaryresources The Government would limit its direct extemal debt obligations as it would only provideguarantees of its own performance Most commercial and operational risks will be shifted to the privatesector and the plant will be operationally reliable as project revenues are entirely contingent on plantavailability and delivery of power at contracted levels

(c) ?tee of power se¢tor refoirm:

The proposed Project would also promote sector reform efforts by exposing Government agencies andstate-owned entities to rigors of contractual framnework required for internationally financed projects andencourage further commercialization of the sector IDA assistance has been instrumental to Vietnam indeveloping the private power generation framework and introducing competitive bidding in the selection

of private developer as an alternative to continuing public financing of generation projects In view of theongoing efforts under other Bank financed work, this project will not directly address the issue of the lack

of a comprehensive legal and regulatory framework which are being addressed through IDA's ongoingand new operations These include the early approval of the new Electricity Law by the NationalAssembly along with the decrees on the creation of a regulatory agency Government also plans tocomplete a power sector reforrn road map, through technical assistance from ADB, which will provide astage wise, time bound program for further structural and institutional changes in the sector The pace of

power sector reform will thus be further accelerated through future IDA operations as part of the Poverty Reduction Structural Credit II (FY 2003) and the Rural Energy Project II (FY 2004).

(d) mmlzlmig poudoum amd euavlrommerma degeiadmton:

The proposed Project will provide power sector capacity additions based on natural gas which willdisplace existing power plants based on coal or fuel oil This will help in minimizing pollution andenvironmental degradation

C Poce l)oscrlpftn SUQMaTny

1 ]Proqect coimpoinemts: (see Annex 2 and Annex 3)

1-1 Project Summary:

The proposed Project consists of a 715-MW gas-fired combined-cycle power facility to be built, ownedand operated on a BOT basis to be constructed at the Phu My Power Generation Center (PMPGC) siteoperated by EVN and located in the Phu My Industrial Complex in Ba Ria - Vung Tau (BR-VT)Province, 70 km southeast of Ho Chi Minh City

The proposed Project will be implemented by Mekong Energy Company Ltd (MECO), a limited liabilitycompany incorporated in Vietnam and owned by the consortium of EDF International (EDFI) (equitystake: 56.25%), a wholly-owned subsidiary of Electricite de France (EDF); Sumitomo Corporation ofJapan (28.125%) and TEPCO International (TEPCI) (15.625%), a wholly-owned subsidiary of TokyoElectric Power Co of Japan (TEPCO) (Sponsors) EDF is one of the world's largest electricity utilitywith over 100GW of installed capacity and EDFI holds EDF's investments abroad with totalshareholders' equity and total assets amounting to FRF71 billion and FRF207 billion TEPCO is thelargest private electricity utility in the world and one of the largest companies listed on the Tokyo stockexchange Sumitomo Corporation is part of the Sumitomo Group which is one of the leading tradinghouses in Japan

The proposed Project will be implemented under a 20-year BOT Contract The Project will sell powerexclusively to state-owned EVN based on a 20-year Power Purchase Agreement (PPA) It will be fueled

by domestic gas supplied by state-owned Vietnam Oil and Gas Corporation or PetroVietnam (PV) under

a 20-year Agreement for the Sales of Natural Gas (GSA) The gas will be sourced from the Nam Con Son(NCS) Basin gas fields jointly owned by private developers of the gas fields and PV and will betransported onshore by the Nam Con Song gas pipeline under construction Raw water for cooling andother infrastructure services will be provided to the proposed Project under the infrastructure sharingarrangement with EVN; and potable and process make-up water will be supplied by BR-VT WaterSupply Company Land for the proposed Project will be leased by the Urban Development ConstructionCompany of BR-VT Province (UDEC) The proposed Project includes construction of a short 500kVtransmission line from the facility to the Phu My 500kV switchyard within the PMPGC, ownership andoperation of which will be transferred to EVN at commissioning Power generated will be evacuatedthrough the existing transmission system and the new 500kV transmission line, being constructed byEVN with financial support of Japan Bank for International Cooperation (JBIC) funding

The proposed Project will deliver power to EVN at US cents 4.14/kWh2 on a levelized basis over the life

of the Project, based on a 90 % plant availability and a plant load factor of 75% On an aggregate basisover the life of the contract, capacity charges constitute about 25%, O& M payments about 8% and fuelcosts about 67% of the tariff revenues The tariff for the proposed Project is consistent with the mostrecent Bank estimates of US cents 3.9-4.2 /kWh of LRMC for generation

Gas Supply Arrangements.

The proposed Project will utilize non associated natural gas from the offshore fields in Block 06-1 in theNCS Basin being developed under Production Sharing Contract of 35 years signed among ONGC of India(45%), British Petroleum (BP) (35%) and PV (20%) The gas field is under development and construction

of the platforms and sub-sea wellheads is expected to be completed by November 2002 In addition,natural gas from the associated gas fields of Bach Ho (owned by Vietsovpetro) as well as from otherfields in the Nam Con Son Basin will be available for dispatch to the Phu My power complex (see Annex

13 for details.) The transportation and fluid treatment facilities which include an offshore 370 krm 26"pipeline, a 30kn 30" onshore pipeline, a processing terminal at Dinh Co and a gas distribution centerlocated in the Phu My complex, are under construction by BP The pipeline is owned by BP (32.67%),

PV (51%) and Conoco (16.33%).The pipelines and the gas distribution center under construction by BPare expected to be operational by November 2002 BP will operate the pipeline for first 5 years (fromplanned completion of November 2002 to November 2007) PV will be the operator thereafter The Block06-1 owners and PV have executed a Gas Sales and Purchase Agreement which includes the gas price.The agreement has a provision for annual fixed escalation of 2 % The gas price agreed in the GSA ofthe Phu My 2-2 Project between PV and MECO includes, in addition to the well head price,transportation tariff and distribution fee to compensate the NCS gas project and pipeline developers fortheir respective investments

Summary Contractual Framework

The key project documents for the Phu My 2-2 Project, which include the BOT Contract between MOI and MECO, PPA between EVN and MECO, GSA between PV and MECO, Government Guarantee

between Ministry of Planning and Investment (MPI) and MECO, have been negotiated and the Project

received an Investment License from the Govermment on September 18, 2001 The BOT Contract

between MECO and the Govemment represented by MOI lays out the legal, regulatory and tax regime,defines the rights and obligations of each parties, and spells out consequences and remedies for the breach

of obligations or the occurrence of force majeure events Under the Government Guarantee between

MECO and the Government represented by WL, the Government guarantees the due and punctualperformance of obligations of each of the Vietnamese counter-parties of the key project agreements,including payment obligations (See Section 4-3 for details of contractual framework and discussion onrespective project contracts.)

1-2 Estimated project costs and financing plan: (See Anmex 3)

Total financing requirements for the proposed Project are estimated at approximately US$480 million,including stand-by financing of US$80 million The proposed Project will be financed through acombination of equity and debt comprising of Sponsor equity of US$140 million (Base Equity of US$100million, Stand-By Equity of US$40 million) and debt of US$340 mnillion (Base Debt of US$300 millionand Stand-By Debt of US$ 40 million) The equity /debt ratio would be 25%/75% for the base projectfinancing; and the contingent project financing would be on the basis of a 50%/50% equity/debt ratio It iscurrently expected that the debt facilities of US$340 million will be provided through: the IDAGuaranteed Loan of US$75 rmillion; ADB direct loan of US$50 million; political risk insurance (PRI)-covered loan with ADB as the guarantor of record of US$25 million; JBIC direct loan of US$150 millionand Proparco direct loan of US$40 million4 The IDA Guaranteed Loan is expected to have a maturity of

up to 16 years including a 2 year construction period with repayment starting 8 months after the

3The failure of MECO to achieve the financial closure within 12 months of its receipt of the IL would constitute an event of

default by MECO unless the parties agree to extend such period

4 While IDA PRG is supporting Phu My 2-2 power project, MIGA is supporting the subsequent Phu My 3 Project of the samecapacity as a co-guarantor along with ADB IFC in May 2001 informed EDFI (the principal sponsor) that they were not

proposing to participate in the financing

Commercial Operation Date (COD) The interest rate of the IDA Guaranteed Loan would be on a floating rate basis at a margin over US$ LIBOR5 Total debt for the proposed Project has been limited to a level which would ensure the projected average DSCR of 1.5 for the duration of the loans.

The sponsors have mandated a consortium of three international banks (ANZ Investment Bank, Societe Generale, and Sumitomo Mitsui Banking Corporation) to underwrite and arrange the IDA Guaranteed Loan and other loan facilities The bank consortium was selected through competitive bidding It is expected that the commercial loan facilities would be syndicated on a pro-rata basis as a single financing package.

i-3 JIroposed DA Gtrsinarmtee: (See the proposed IDA Guarantee Terms in Annex 11.)

The contractual structure of the transaction and the allocation of commercial, technical, and political risks among the parties is consistent with industry standards in a limited recourse project financing structure.

fabRe 4: ocatiom of ?roject RUsks

convertibility/transferabilit,y

Vietnam political force

law

Foreign political force

majeure" affecting MECO

Foreign political force

public sector entities

Natural Force majeure

sector entities

° Political force majeure events include: acts of war, blockade, embargo, strikes, changes in law, etc.

°° Natural force majeure events include: fire, earthquake, landslide, flood, etc IDA PRG covers only non insurable natural force niajeure risks

The proposed IDA PRG will provide coverage for loan default on debt service payments, of bothprincipal and interest of the IDA Guaranteed Loan, resulting from the Government's failure to meet its

payment obligations stipulated under the BOT Contract and Government Guarantee Commercial risks

such as construction completion and plant operation, as well as natural force majeure risks directly

affecting the proposed Project will be borne by MECO The IDA Guarantee excludes coverage of Government obligations arising in connection with Company events of default with respect to the proposed Proiect MECO will mitigate these comrnercial risks by employing competent contractors and

purchasing insurance for such comrnmercial risks Because of the limited degree of recourse the lenderswill have to the Sponsors, risks borne by MECO after financial close are also borne by the lenders

IDA PRG would cover the risks under the following key categories: (i) failure by the Govermnent tofulfill its payment obligations under its guarantee in relation to the purchase of power by EVN6, thesupply of fuel by PV, and payment obligations of other public entities.; (ii) inconvertibility of Dong into

US dollars, or restriction on transferability of funds for payment of debt services, etc.; (iii) political forcemajeure events adversely affecting the Project including changes in law; and (iv) expropriation

The IDA Guarantee Agreement will be entered into between IDA and the IDA Facility Agent Bank on behalf of the commercial lenders under the IDA Guaranteed Facility Under the Agreement, lenders will

be entitled to make a demand for that portion of any scheduled principal and/or interest payment whichhas fallen due and has not been paid by MECO as a result of the failure of the Government to pay certain

amounts due under the BOT Contract or the Government Guarantee for events covered under the Guarantee These could be with respect to both periodic payments and termination payments in the event

that the Project is terminated The IDA Guarantee may be called only after any debt service reserveaccounts have been exhausted In the case of a dispute, the IDA Guarantee would be callable only if theGovernment is obligated to pay and has failed to do so as provided under the dispute resolution provision

in the relevant agreement

In keeping with the policy on IDA Guarantees, the IDA PRG for the proposed Project is non-accelerable.

In the event that the proposed Project is terminated as a result of a Government default, IDA could be

called on to make payments according to the original debt service schedule as provided for in the IDA Guaranteed Facility Agreement IDA would seek reimbursement of any and all claims and other expenses

it incurs under the IDA Guarantee from the Government under the Indemnity Agreement to be entered

between IDA and the Government IDA would reserve its rights to demand immediate reimbursementfrom the Government Consequently, there would be a clear financial disincentive for the Government tocause a call on the IDA Guarantee, particularly since any Government default would also cross-defaultother Bank loans or IDA credits to Vietnam, as well as other project loans, and could result in thetermiination of the Project and enforcement of security

1-4 Risks associated with IDA Guarantee:

As guarantor of the Government's performance, specific project risks covered by IDA under the PRG, arethe same as those undertaken by the Government under the Project Agreements The guarantee thereforedoes not pose any additional burden on the Govermnent The risk for IDA is the ability of theGovernment to reimburse IDA under the Indemnity Agreement This risk is the same as for any IDAcredit to Vietnam

The following principal underlying risks borne by the Government under the BOT Contract and Government Guarantee, which may trigger the IDA Guarantee, are worth highlighting:

6 The tariff structure consists of a Capacity payment and Energy charge The former would be payable based onplant availability with EVN being responsible for ensuring dispatch based on system demand

a) failure by EVN to pay for the purchase of power;

b) failure by PV to supply fuel and pay damages in the event of gas supply interruption;

c) inconvertibility of VND into hard currency or restriction on transferability of funds;

d) political force majeure events, including change in law;

e) natural force majeure events affecting public sector counter-parties; and

f) expropriation

(a) EVN ability to pay:

A major risk associated with the Project is the EVN's ability to meet its payment obligations under the

PPA to MECO As a single buyer of power in the country, EVN is the sole purchaser of power from all

generating plants including all IPPs including the proposed Project, and sells power through thedistribution PCs Because EVN is a state-owned enterprise and retail electricity tariffs are set by theGovernment, lenders perceive EVN's payment obligations as a political rather than commercial risk.EVN has been profitable and its financial performance since its creation in FY95 has been satisfactory,and its medium term financial outlook is acceptable to IDA provided that tariff levels agreed by theGovernment in May 2002 as a part of the SEIER project (paragraph E 2-2) are progressivelyimplemented according to the agreed schedule with the first 'increase in October, 2002 Under its

guarantee of the PPA, in the event of non-payment by EVN, the Government would be obligated to make

the payment to MECO Given the importance of EVN as a core of the country's power system; and thepriority status of the Project as an indispensable downstream gas utilization project for the upstreamdevelopment of the Nam Con Son gas chain, which is the single most important macro-project currentlydeveloped in Vietnam, the likelihood of a breach by the Government on its guarantee obligation isrelatively low (See Annex 6 for details.)

(b) PV ability to supply gas:

The proposed Project will consume approximately 0.85bcm/year and purchase all of its gas from PV Theproduction of already certified gas reserves alone (Block 09-1, Block 06-1 and Block 11-2) would reach5.4bcm/year by 2005, which is considered sufficient for the existing and planned power plants in theregion with combined capacity of 3,700MW when developed by 2004-2005 The proposed Project isexpected to use gas from Block 06-1 (Lan Tay and Lan Do gas fields) with current proven reserve of57bcm These gas reserves were estimated by BP and were verified by an independent consultant retained

by IDA There are other non associated gas fields in the Nam Con Son basin - Block 11-2 with reserves

of 20 bcm, Block 5-2 and 5-3 with reserves of 42 bcm and 13 bcm respectively In addition, theassociated gas fields of Cuu Long basin may be expected to provide adequate gas supplies for the nexttwo decades It needs to be pointed out that all offshore gas has to be sold to PV by the production sharingcontracts, and that PV is then responsible for providing gas to the downstream users in accordance withthe various GSA's PV is thus the gas integrator in the supply system

Gas from the Nam Con Son gas fields will be transported offshore by the Nam Con Son pipeline, which isbeing constructed by BP, partly financed by PV, and expected to be operative in the third quarter of 2002.The pipeline will have a nominal capacity of 7 bcm/year, and as a regional transporter can deliver gasfrom all the blocks in the Nam Con Son Basin when developed The offshore platforms, subsea wellheadsand the pipeline is presently under construction and is expected to be completed by November 2002.There could be a timing mismatch between the start of production of new gas fields and thecommissioning of new gas-fired power plants, which may lead to a gas surplus in 2002-2003 andtemporary shortage in 2004-2005 This risk would be mitigated by the fact that the Block 06-1, which isbeing developed by BP-led consortium to start producing gas in late 2002 with gas supply obligation to

PV of 2.7bom/year , could produce up to 3.6bcm/year if required by PV to meet short term gas shortage.

To provide the additional gas that may be required, PV could also accelerate the development of otherfields that have already been declared to be commercial

Under its guarantee of GSA," in the event of non-performance and non-payment of damages for

interruptions in supply, etc by PV, the Government would be obligated to make payment to MECO Thelikelihood of a breach by the Government on its guarantee obligation is low, given the importance of PVfor Vietnam's economy and the importance of existing and future contractual relationships of PV withforeign developers and financiers In addition, the displacement of diesel fuel with gas will save Vietnamapproximately US$1 million per day (See Annex 13 for details of gas reserves, supply and demand.)

(c) Foreign exchange inconvertfbility and non-transferability:

BOT Contract provides MECO with the right to convert VND into hard currency and the right to make remittances Under the Government Guarantee, the Government has guaranteed the convertibility and

transferability of VND into hard currency as required for project operations The power tariff is payable

by EVN to MECO in VND The gas price comprised of cost of gas, transportation charge and distributionfee is payable by MECO to PV in VND The Government guarantee provides for the conversion of VNDrevenues earned by MECO less amounts due to PV under the GSA (fuel expenses would account for 53%

to 79% of tariff revenue over the life of the Project) and local operating expenses (including tax) into USdollars in accordance with procedure defined in the Project Agreements and the availability andrernittance offshore of such US dollar amounts

The Government has been careful in providing foreign exchange convertibility guarantees to investors Afew precedents can be found in oil and gas projects The lack of foreign exchange convertibility guaranteefrom the Govemment has been one major reason for the lack of financing for private infrastructureprojects in the past The proposed Project has received such Government guarantee due to its priorityproject status as a part of the Nam Con Son gas development chain

Vietnam is current in all its debt service obligations, and the projected debt service burden is sustainable.Debt service stands at around 1 1 percent of exports of goods and services and 7 percent of GDP in 2001and is expected to fall in the medium-term Even a significant drop in the projected export earningsgrowth rate (e.g a halving of the growth rate) will not create a problem with servicing of external debt.Vietnam's external debt as a share of GDP and debt service as a share of exports compares favorably withother developing countries

Vietnam's stock of outstanding external debt stood at US$14.4 billion in 2001, equivalent to about 45percent of GDP and 94 percent of exports earnings About four-fifth of this debt is on concessional terms.Most of the remaining debt consist of those that accompany foreign investment flows into Vietnam.Concessional borrowing is unlikely to contribute to significant increases in Vietnam's debt service burdenover the next five years The Government has also formulated an action plan on debt monitoring and debtmanagement and issued supporting decrees and regulations

(d) Political force majeure:

This includes traditional political force majeure risks such as war, invasion, armed conflict, blockade,embargo, revolution, riot, act of terrorism In the event of Vietnam political force majeure that affect the

Project, if prior to commercial operation, MOI, under the BOT Contract shall pay to MECO compensation for delay; and if on and after the commercial operation, EVN, under PPA/BOT Contract,

shall pay the Capacity Charge to MECO Under the BOT Contract, a material change in law negatively

affecting the Project by a specific cumulative amount would lead to a supplemental tariff, compensation

8 PV had retained the services of PDC (UK) to assist them in the negotiation of the GSA ( with MECO) and toensure that Gas Sales and Purchase Agreement (with BP) and GSA were back to back agreements

payment, andlor exemption from the change in law The Government guarantees payments byVietnamese parties and this obligation is backed by the IDA PRG.

(e) Natural force majeure:

IDA PRG covers only non-insurable natural force majeure risks MECO would therefore seek insurancefor natural force majeure risks such as fire, earthquake, flood, storm, typhoon, etc In the event of naturalforce majeure events outside the fence that affects the public sector counter-party's ability to fulfill their

obligation under the Project Agreements, MOI, under the BOT Contract, shall pay to MECO

compensation for delay, if such events take place prior to commercial operation, and if these events take

place after commercial operation, EVN, under PPA/BOT Contract, shall pay the Capacity Charge to

MECO The Government guarantees compensation payments by the Vietnamese parties On the otherhand, the risk of natural force majeure events inside the fence affecting the ability of MECO to perform istaken by MECO, which will not receive any compensation

(f) Expropriation:

The expropriation or compulsory acquisition by the Government of the proposed Project would constitute

an event of default by MOI under BOT Contract and if not cured could lead to a termination with

compensation payable to the MECO

1-5 Selection of the Consortium:

The EDFI-led sponsor consortium9 was selected following international competitive bidding conducted

by the Government through MOI The Bank, through the Power Development Project (CR 2820-VN) as

well as PHRD and PPIAF grant funds, financed the technical assistance support to the Government for:(i) the formulation of bidding documents including draft project contracts, the evaluation of bid proposals;(ii) and the negotiation of the Project contracts MOI issued the Request For Proposals (RFP) to ten pre-qualified bidders in October 1997 After the approval of the IDA PRG program by IDA's Board ofExecutive Directors in November 1997, the Government in March 1998 requested IDA to provide an IDAPRG for the Project Subsequently, an IDA PRG of up to US$75 million in support of commercial debtfinancing was offered as an option to all the bidders in the bidding process Six strong bid proposals weresubmitted and opened in April 1998, where the IDA PRG was sought by five of the six bidders Theprices quoted by the bidders were considerably lower than prices obtained for other power projects in theregion Based on the evaluation criteria in the RFP, the first three bidders were ranked (led by EDF, AESand Tractabel respectively) and EDF consortium, the first ranked, was invited for negotiations in January

1999 Negotiation with the selected consortium was completed in September 2001 when an Investment License (IL) was issued The long time taken from selection of the consortium to the execution of the

Project Agreements and issuance of the IL was primarily because of the legal and commercial issuesencountered during negotiations and the novelty of such contractual arrangements in Vietnam Despitethe delay and the issues encountered, the overall process has been a model of transparency

2 Key policy and institutional reforms supported by the project:

The proposed Project supports and promotes: (a) efficiency in Vietnam's electricity sector through efficient power generation; (b) private investment with world-class professional expertise in constructionand operation management of generation facilities; (c) sectoral reforms by creating a more dynamiccontext for private sector participation and strengthening govenmment-IDA dialogue and; (d) actions to

cost-improve the sector's financial viability in order to service the PPA obligations.

While the legal and regulatory frameworks for private infrastructure investments are yet in a developingstage, the successful financial closure of the proposed Project would support the on-going improvement

of the BOT frameworks and legislation by the Government in recent years to alleviate legal/regulatorybottle necks for project financiers and facilitate private investment in the country.

3 Benefits and target population:

The target population is electricity consumers all over the country The proposed Project promisessubstantial economic benefits to Vietnam: (a) when commissioned, it would augment the supply ofelectricity, thus avoiding a major bottleneck to economic growth; (b) it would generate estimated savings

of about US$ 200-240 million annually by displacing less efficient or higher cost imported diesel fueledprojects; and (c) it will reduce the need for public investment in the power sector, thus enabling theGovernment to deploy more funds to meet poverty alleviation and other social needs The proposedProject would also (a) mobilize commercial credit for private infrastructure development; and (b) provide

an efficient, low-cost, and well managed electricity generation facility

4 Institutional and implementation arrangements:

4-1 Executing agency:

MIECO, the executing agency for the proposed Project, was established in September 2001, as a limitedliability company under the Vietnam laws MECO's shareholders are EDF International, Sumitomo

Corporation and TEPCO Intemational MECO is currently headed by a General Manager who is

responsible for all aspects of MECO's operations MECO would be able to draw upon the full scope ofEDF and TEPCO's utility generation expertise and support available from their corporate offices as

defined under the Technical Services Agreement (TSA) While EDF is the largest utility in the world,

TEPCO has the most extensive experience of operation of combustion turbines and combines cycle plantsincluding the equipment to be installed at the Phu My 2-2 power plant During construction and

operation, MECO will be staffed by experienced personnel from the shareholders including a TechnicalManager from EDF, Deputy Technical Manager from TEPCO and an Administration Manager fromSumitomo Corporation MECO has established a contractual and management structure with adequatetechnical and managerial capacity to construct and operate the plant and carry out its obligations under theEnvironmental Management Plan

4-2 Project management:

MECO would have an organization staffed with technically qualified and experienced personnel tooversee the construction and operation of the plant (paragraph 4-1) Its primary responsibility duringconstruction would be to coordinate with Vietnam counter-parties, carry out obligations under the ProjectAgreements and oversee the EPC Contract with EDF-CNET, anmengineering department of EDF and theEPC contractor for the Project The EPC Contract is a fixed price and date-certain contract, andguarantees equipment performance EDF-CNET has sub contracted the power island equipment(combustion turbines, heat recovery system and associated auxiliary plant and equipment) to GeneralElectric, one of the most experienced suppliers of such equipment EDF-CNET is experienced andcapable of handling the contract MECO has also retained TEPCO as the Owner's Engineer for technicaloversight of project implementation The Project will be operated and maintained by MECO with staffseconded from EDF and TEPCO who will have full access to staff and expertise of the parent companies

for the life of the BOT contract under the TSA MECO will also enter into a Long Term Service Agreement (LTSA) with GE Intemational (GE), equipment supplier, covering operation and maintenance support for the gas turbines and steam turbines LTSA will terminate after the first major inspection or

seven years from commissioning unless renewed by MECO

The lenders have appointed an internationally experienced engineering firm, PB Power of New Zealand,

as an Independent Engineer, which will be responsible for reviewing and monitoring the constructionand management of the Project on their behalf

4-3 Project contractual arrangements:

The contractual structure of the transaction and the allocation of commercial, technical, and political risksamong the parties are consistent with industry standards for limited recourse projects

Chart - Project Contractual Structure

Cont Liense + W SupH Gon ~~Government Aremt

IandGaane Lease

Agmeement

EDF/TEPCO |

'GEiII

Contractual arranEements with public sector:

Key Project Agreements with Vietnamese counter-parties are as follows:

(a) BOT Contract between MECO and MOI as the authorized state body appointed by the Government

for negotiation of such projects was executed on September 18, 2001 The BOT Contract defines the

rights and obligations of MECO and of MOI including termination and default provisions and lays out the

legal, regulatory and tax regime Under the BOT Contract, the Government grants MECO the exclusive

right to finance, construct, own and operate the power station on the site It assures MECO of investmentincentives and other beneficial treatments for the Project under laws and regulations of Vietnam,including a guarantee for free convertibility and transferability of foreign exchange; permission toestablish off-shore accounts; permission for the proposed Project to provide security to lenders; provisionfor lender step-in arrangements in the event of MECO default; and confirmation of certain preferential tax

treatments available to infrastructure projects The BOT Contract will terminate 20 years after the

commissioning date unless previously terminated in the event of default or force majeure At the end ofthe term or upon termination, MECO will transfer the ownership of the plant facility to MOI or itsnominee, free of charge The BOT Contract defines the termination events and specifies the

compensation to be paid in each case

(b) Power Purchase Agreement (PPA) between MECO and EVN is dated September 18, 2001 The PPA

provides for the sale of electricity to EVN on the basis of a two-part tariff payable in VND and consistingof: (i) Capacity Charge, with Fixed Capacity Charge (FCC) to cover debt service, taxes and capitalredemption/profit and Fixed O&M Charge (FOMC) to cover operating expenses; and (ii) Energy Charge

to cover Variable O&M Charge (VOMC) and Fuel Charge (FC) FCC, FC and portions of FOMC and

infrastructure sharing arrangement under which EVN will provide to MECO cooling waterintake/discharge facilities, site wide drainage system, natural gas and distillate delivery systems as well aspower supply for construction and start-up EVN is responsible for construction, operation andmaintenance of all common facilities and associated costs EVN and MECO will agree to price for suchservices to be recovered under Additional Charge component of tariff The tariff for the proposed Project

is subject to the following escalation from the bid date The FCC is indexed to the US$/VND exchangerate but is not escalated for any inflation Fixed and variable O&M costs are indexed for inflation based

on the relevant index (foreign inflation for foreign currency costs and domestic inflation for local costs)

In addition, the foreign costs would be indexed to US$/VND exchange rate The price of fuel is indexed

to the US$/VND exchange rate and escalates at a fixed rate of 2% per annum

(c) Agreementfor the Sale of Natural Gas (GSA) between MECO and PV was signed on September 18,

2001 All of the gas requirements of the Project will be supplied under the GSA with PV MECO will

have a 20-year obligation to purchase a minimum quantity of gas from PV The proposed Project isexpected to consume approximately 0.85bcm of gas per year and 17bcm over the term of the BOTcontract at 75% average load Gas price comprises of costs of gas at well head, transportation charge anddistribution charge Gas prices are paid in VND but substantially indexed to the US dollar The priceshave been established on the assumption that the gas delivered by PV is sourced from Nam Con SonBlock 06-1 Should the gas come from any other source, the gas price would be adjusted

(d) Water Supply Agreement (WSA) between MECO and BR-VT Water Supply Company was signed on

June 17, 2002 Potable and process mark-up water for the power station will be supplied by BR-VT WaterSupply Company, which is responsible for maintenance of pipelines and water meter Water price is set

by the BR-VT provincial government Water charges paid by MECO to the Water Supply Company will

be recoverable by MECO under the Additional Charge component of the power tariff

(e) Land Lease Agreement (LLA) between MECO (Lessee) and UDEC (Lessor) is dated September 18,

2001 LLA sets out the amount and location of land to be leased to the Lessee, rent free, for the term of the

BOT concession and provides for the "Certificate of Right to Use Land" to be issued to the Lessee TheLessee has the right of ownership to all works constructed on site and is entitled to mortgage the land for

mobilizing the financing for the Project LLA recognizes lender's step-in rights in case of MECO event of

default

6I Government Guarantee between MECO and MPI on behalf of the Government is dated September

18, 2001 The Government Guarantee guarantees the due and punctual perforrnance of responsibilities

and obligations of each Vietnamese counter-party to the MECO, including but not limited to payment

obligations in underlying documents The Govemment Guarantee covers the obligations under the BOT Contract, PPA, GSA, WSA and LLA The Government Guarantee also guarantees the availability,

convertibility and transferability of foreign exchange; permits off-shore accounts for project financing andrecognizes lender step-in rights in case of a MECO event of default The Guarantee for this Project isconsistent with such issued by MPI for the Nam Con Son gas project

(g) Investment License (IL) issued by MPI on behalf of the Govenmment is dated September 18, 2001 IL

sets out the terns of the license awarded to MECO and provides for the registration of the company

Contractual arrangements with private sector:

(h) Engineering, Procurement, and Construction Contract (EPC Contract) is between MECO, the

Project company and EDF-CNET which is an engineering department of EDF The EPC Contract scope

provides for turnkey completion for the entire power plant It is a fixed price, date certain contract with

completion schedule consistent with the COD in the BOT Contract, and incorporates guarantee for plant

performance The EPC contractor is liable for liquidated damages for delay (20%) and performnance(20%) with an aggregate cap of 25% of the contract value

(f) Technical Services Agreement (TSA) for Operation and Maintenance will be signed between MECO

and EDF/TEPCO Under the agreement EDF/TEPCO will provide technical services including hot linetechnical assistance, data on similar plants in operation in EDF and TEPCO, analysis of critical plantequipment performance data and recommendations on Operation and Maintenance of the plant, audit ofsupplier quality and procedures, analysis of major incidents and recomnnendations for future action

a) Long Tern Service Agreement (LTSA) is between MECO and GE, the equipment supplier It provides

for technical support for the first 48,000 hours of operation (nominally six years) or until after the firstmajor overhaul Under the contract GE will: (i) place a full time engineer at the site to provide technicalsupport; (ii)provide initial spares and management of the spares inventory for GE supplied equipment;(iii) provide online monitoring of GE plant; and provide operation data

D Project Rationale

1 Project alternatives considered and reasons for rejection:

A number of studies have established that combined cycle electricity generation technology, fueled byindigenous natural gas, is the least cost option for base load power generation in Vietnam Natural gas is

an indigenous resource and constitutes the least cost, environmentally friendly fuel for power generation.EVN has already utilized the technology for its power plant in the location and is thus familiar with itsoperations

The proposed Project is being implemented in the private sector as it enables the Government to reapincreased efficiencies and reduce need for public sector investment for increasing power generation

2 Major related projects flnanced by the Bank and/or other development agencies:

(completed, ongoing and planned):

(PSR) Ratings

(Bank-financed rojects only)

Progress (IP) Objective

(DO)

Improve technical, operational, management and sector Power Sector Rehabilitation and S S

Rationalize power sector institutions; Commercialize Power Development Project (CR 2820-VN S Soperation of sector entities; Initiate appropriate legal and of February 1996)

regulatory frameworks; Initiate private sector participation

in generation; etc

Unbundle EVN's transmission and generation functions; Transmission, Distribution and Disaster S SImplement regulatory reforms; Induce tariff reforms; Reconstruction (CR 3034-VN of January

Explore financing of distribution from diversified sources; 1998)

Institutional strengthening and commercialization

Improve rural access; Strategy for rural electrification; Rural Energy Credit (CR 3358-VN of S SPromote renewable energy development; Local November 2000)

management and operation of rural grids; Creation of joint

stock companies for distribution; Institutional reform for the

creation of a creditworthy distribution sector

Improve overall system efficiency, Enhance energy sector System Energy, Equitization and S Sfor the poor; Sustain reforn of the power sector through Renewables

separation of generation, transmission and distribution by

institutionalizing transfer pricing, improving corporate

governance and equitization to develop a creditworthy

distribution sector

Other development agencies _

Asian Development Bank Power Distribution and Rehabilitation (LN

1368-VIE of June 1995)Central and Southern Vietnam Power andDistribution (LN281 87-VIE of November1997)

Japan Bank for International Cooperation (former Overseas Construction of Phu MY I Power; Pha Lai

Economic Cooperation of Japan) 2 Power Plant; Ham Thuan Da Mi Power

Plant (January 1994)Construction of Da Nhim Power Plant(March 1997)

Construction of 0 Mon Power Plant(March 1998)

Construction of [ ] transmission

sub-station for 500kV (to be signed)Swedish Intemational Aid Agency Construction of Song Hinh Power Plant

(1995)Construction of six substations for 1 00kV;

Extension of transmission substations for500kV (1998)

Upgrading distribution network in CentralArea tobe signed)

IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)

* Note: The "unsatisfactory " Development Objective (DO) rating for the two Vietnam projects has been upgraded

to " Satisfactory" as agreement was reached on a Tariff Implementation Plan at the negotiations for the SEIERProject in May, 2002 and implementation of this increase is a condition for the SEIER project credit effectiveness

3 Lessons learned and reflected in the project design:

The proposed Project design incorporates lessons from the experience in other countries regarding therisks encountered by the IPP programs These risks include (a) unconstrained addition to generationcapacity through IPPs; (b) affordability, i.e the utility's ability to pay for the electricity; and (c) nontransparent process for the selection of the developer There are, however, some significant contrastsbetween design of this Project and the IPPs in other countries which encountered problems:

(i) The proposed Project is the first intemationally competitively bid power project in the country As aconsequence of this competitive process, the Project has very competitive tariff of US cents 4.14/kWh

on a levelized basis (at 10% discount rate) This is consistent with EVN's LRMC for generation and wellbelow the average retail tariff of the utilities As the Project's debt is paid off the tariff in real terms willdecline over the life of the Project, increasing the Project's competitiveness over time It has also set abenchmark for the subsequent IPP projects, thus ensuring a least cost expansion of the system withprivate financing

(ii) Based on the latest power demand projections for Vietnam, the proposed Project is required to meetthe electricity demand even under the low growth scenario By 2005, over 2,900MW addition or 64%increase in generation capacity would be called for even in the low case, compared with 3,750MW or 83

% increase required in the high case The proposed Project is located in the PMPGC near Ho Chi MinhCity in an area where EVN estimates that electricity demand will grow at approximately 16% annually.Phu My 1 (860MW), Phu My 2-1 and its extension (626MW) combined-cycle power plants are currently

in operation at the PMPGC, and EVN plans to increase capacity of the PMPGC up to 3,700MW in thecoming years

(iii) The Government is aware of the implied macroeconomic risks of an unconstrained IPP-typeprogram, and intends to implement foreign private participation progressively to account for up to 20 %

of the total system capacity Currently, EVN has approved the purchase of electricity from small-scaleenclave IPPs established to service export processing zones and industrial parks under short termcontracts There are other small regional independent diesel power projects As regards projects under the

BOT framework, IL for the first BOT project - the 715 MW combined cycle Phu My 3 Project of BP-led

consortium (negotiated deal), was issued in June 2001 and for the proposed 715 MW Phu My 2-2Project in September 2001 It should also be noted that a few other private power projects were negotiatedwith foreign sponsors over years but failed to reach financial closure due to an inadequate framework forimplementing private projects in the country at such time

4 Indications of borrower commitment and ownership:

The proposed Project has been developed under the country's BOT infrastructure developmentframework The proposed Project is one of major downstream gas utilization projects indispensable forthe commercial success of the on-going upstream Nam Con Son gas development project which is to startproducing gas in 2002 The Government approved the proposed Project in December 2000 as part of theeconomically important and priority Nam Con Son gas chain project The Government has subsequently

issued an IL for the proposed Project in September 2001.

The Government in 1998 formally requested the Bank to consider the provision of an IDA Guarantee to

recently reiterated the importance of the IDA Guarantee to facilitate the financing and implementation ofthe Project.

5 Value added of Bank support in this project:

Over a period of several years, the Bank has actively assisted the Government in formulating a policy topromote private power development in a transparent and competitive manner Vietnam has only limitedaccess to the international loan and capital markets because of its IDA country status with non-investmentgrade sovereign credit rating (BI by Moody's; BB- by S&P and Fitch) It is therefore, mainly dependent

on multilateral and bilateral funds for financing infrastructure development Some oil and gas explorationprojects with high and quick returns and foreign exchange revenues have been financed through equity

by international oil and gas companies However, such corporate balance-sheet funding is normally notavailable for lower-return infrastructure projects with long-term pay back period such as powergeneration projects The limited-recourse debt financing for infrastructure projects has been extremelydifficult in Vietnam, due to developing but untested legal and regulatory framework, limited experience

of government agencies in dealing with complex contractual arrangement, perceived lack ofcreditworthiness of the country and foreign exchange convertibility/transferability risks, etc This hasresulted in long delays in reaching consensus decisions

By guaranteeing the contractual obligations of the Government and its agencies for the Project, the IDAPRG would mitigate sovereign and political risks for commercial lenders and thereby facilitate themobilization of long-term debt capital necessary to implement the Project and offer competitive tariffs.Unlike sovereign borrowing where the Government takes on all the risks (such as commercial borrowing

of PV with Government guarantee for its pipeline and other projects), the IDA Guarantee would allow forallocation of only non-commercial risks to the Government while commercial risks are born by thesponsors As IDA has a long term relationship with the country, its participation through the Guaranteewould also provide comfort to other financing agencies thereby assuring the successful financial closure

of the proposed Project and encouraging private participation in the power and other infrastructure sectorswhere it has been very difficult to mobilize private financing

Following the Sponsors' request for a Guarantee, and keeping the line of IDA's 'lender of last resort'role, MECO was asked to maximize other possible sources of finance including export credits with aview to minimizing IDA support MECO has maximized the amount of export credits and bilateralsupport for the Project, including US$150 million loan from JBIC through its Overseas Investment Loanprogram on a project finance basis In addition, ADB has approved the provision of an OCR (direct) Loanand a guarantee (where ADB is the guarantor of record) in the combined amount of up to US$75 million.The IDA Guarantee with the Government counter guarantee will provide comfort to other lenders andguarantors and help catalyze the largest limited-recourse project finance commercial debt package to datefor Vietnam The IDA Guaranteed Loan facility would have an overall term of 16 years including 2 yearconstruction period, the longest tenor to date for any non-concessional finance in Vietnam Given thevery competitive tariff of the Project, the long-term debt was critical for the viability of the Project.IDA PRGs, compared with IDA credits, are particularly suited to help governments transition from public

to private finance through political risk mitigation and effective risk sharing with project sponsors andlenders By catalyzing commercial finance, IDA PRG would reduce the amounts of fund resourcesrequired by governments for critical infrastructure investments such as the proposed Project and enablethe Government to free more resources for other projects in social sectors

The IDA Guarantee, in a limited but significant way, has contributed to the sector reform dialogue byhelping to establish an enabling and sustainable framework for private power projects and by raising theawareness of the stakeholders in the Government toward the need for sector reform

E Summary Project Analysis

1 Economic: (see Annex 4)

Cost Benefit Analysis: NPV=US$ 667 million; ERR = 24 %

The delivered cost per kWh was the key parameter for the evaluation of bids received under thecompetitive bidding process undertaken for the Phu My 2-2 Power Facility The proposed Project has anaverage tariff of US cents 4.07/kWh and a levelized tariff (at 10% discount rate) of US cents 4.14/kWh(both tariffs include the cost of gas) This price of energy is competitive compared to other recent IPPs

in Asia The benefits of the Project are from the final uses of electricity generated by the Phu My 2-2Power Project, development of a domestic natural gas resource, employment generation and additionalrevenues for the Government Additional benefits, not readily quantifiable, are the creation of a climateconducive to private participation in the provision of electricity in particular and infrastructure in general.The economic assessment of the proposed Project, taking into account prospective economic and powersector developments in Vietnam over the 22-year project cycle (2002-2024 including a 2-yearconstruction period) indicates that it will deliver net economic benefits under a considerable range ofadverse conditions The base case returns is an ERR of 24 % and a net present value of US$ 667 million(at a discount rate of 10%) The base case scenario is based on the following assumptions: (a) an annualincrement of 8% real rate is applied on average to the commercial tariff until assumed Willingness to Pay(WTP) ceiling of US cents 7.5/kWh is reached in 2006; (b) all new IPPs which will follow the Project areslightly more fuel efficient; and losses will be reduced from 15.6% to 10% at an annual rate of 6%

The robustness of the Project outcomes in terms of ERR has been tested against various parameters that

is expected to influence the outcome most negatively Those parameters are: (a) commissioning delay,(b) lower WTP and loss reduction, (c) slow reforrn, no escalation of tariffs, (d) higher investments inT&D, and (e) VND devaluation Sensitivity analysis on these risks indicate ERR outcomes in the range of

10 - 22% The economic assessment indicates that the Project is quite robust in delivering net economicbenefits under various scenarios The presented results can be regarded as a conservative, lower bound,measure of the true economic benefits realized by the proposed Project

2 Financial:

2-1 Projected financial performance of MECO: (see Annex 5)

MECO is a privately owned and operated company established to develop, construct and operate the715MW power plant It is expected that the construction of the power facility will take 24 months MECOwill have a single source of revenue from sale of electricity to EVN under a 20 year PPA Under the PPA,EVN will pay on a monthly basis a two-part tariff consisting of: (a) Capacity Charge with a fixedcomponent to cover debt service, taxes and capital redemption and a fixed operation and maintenancecharge to cover operating expenses and (b) Energy Charge to cover variable operation and maintenancecharges and a fuel charge The fuel charge payable to PV would be the largest category of expenses forMECO and would amount to about 53 % of the total revenues of approximately $200 million for the firstyear of operation Fuel price is projected to increase at a fixed 2 % per annum in accordance with theGSA MECO has projected the following project tariff breakdown

Table 5: Summary of Project Tariff Breakdown (US cents/kWh)

Project Operaton Fuel Charge All-in Tariff

Source: MECO projections

The Project demonstrates sound financial prospects in terms of income, cash flows and debt servicecapacity, with projected average DSCR of 1.5

The financial performance of the Project will be monitored inter alia through the review of the auditedannual accounts of MECO (Details of financial projections and assumptions are described in Annex 5.)

2-2 Projected financial performance of EVN: (See Annex 6)

EVIWs financial projections showed phased improvement in financial performance and compliance withfinancial covenants on the basis of the following assumptions: (a) gradual tariff increase in accordancewith the following schedule: (i) US cents 5.6/kWh by October 1, 2002; (ii) US cents 6 1/kWh by Apri 1,2003; (iii) US cents 6.6/kWh by April 1, 2003; and (iv) US cents 7.0/kWh by July 1, 2005; (b) energygeneration and sales which would follow EVN's Power Development Plan under the base case; (c) hydropower frequency at the rate of 65% adjusted flow; (d) gas at the Nam Con Son field available for powergeneration by FY02; (e) fuel price for coal and oil based on the State Pricing Committee's projections andthe gas supply contract with PV; (f) the VND against the US$1 would remain steady at VND 14,400during the projected period; (g) tax relief via exemption from the 32% profit tax levied on the incrementalrevenues derived from the tariff increases; (h) tax rebate of the 2.5% Government capital tax; and (i)relaxation of repayment terms on subsidiary loans by extending the repayment terns of three JBIC loansfrom 20 years to 25 years

A plan of action to facilitate the achievement of EVN's overall financial objectives and bring financialcovenant compliance to complement the phased tariff increases and cash flow relief has been developedwhich includes: (a) control of unit costs by improving operating efficiency and productivity; (b)implementation of the cost-based transfer pricing arrangements beginning FY02 in order to contain costs

at the PCs and subsidiaries; (c) more investment efficiency by limiting use of debt, better management ofconstruction projects; (d) equitization of some power plants by FY05; (e) greater reliance on independentpower producers (IPPs) and small power producers (SPPs); and (f) careful management and utilizationgovernment grants for rural electrification

The results showed that because of the delay in implementing the necessary tariff adjustment, EVN wouldnot be in compliance with the 30% SFR requirement from FY02-04 (i.e 14.7%, 20.6% and 28.5%,respectively) It would, however, achieve compliance in FY05 when the average tariff would have been at

US cents 7.0/kWh and SFR at 30% The DSCR would be slightly below compliance at 1.4 times in all the

years The financial projections were approved by the Govemment and although not fully satisfactory,IDA accepted the results, i.e the slow and phased improvement in financial performance, in view of thesizable amount of the price increases required and the impact of future foreign exchange devaluation,which otherwise would make it impractical to proceed faster.

During negotiations on the SEIER project in May 2002, SBV provided the Implementation Plan proposed

by the State Pricing Committee and approved by the Prime Minister on May 24, 2002 TheImplementation Plan provides for the following schedule:

The Government recognizes that increased tariffs are required to secure financing for this project and forcontinued ADB and IDA financing of the sector During the negotiations of the $ 225 million SElERproject (Board approval on June 25, 2002) it was agreed with the Government that implementation of atariff program including the implementation of the first phase increase would be a condition ofeffectiveness of the SEEER project

3 Technical:

The Project scope includes a gas-fired combined-cycle power facility with a contractual capacity of715MW consisting of combustion turbines, heat recovery equipment, steam turbine, all associatedauxiliary equipment and spare parts, circulating water supply and discharge systems, water treatmentsupply and storage systems, gas receiving and interconnection facilities and an electrical switchyard Italso includes the installation of electrical interconnection facilities between the plant and the EVN 500kVPhu My Complex Switchyard located at the PMPGC, which will be transferred to EVN for operationupon commissioning

The Project site location in the PMPGC and power station design have a number of features which makethe installation of additional capacity under the proposed Project attractive for power development,including the following: (a) it will be part of a 3700 MW PMPGC complex ; (b) Regional Load ControlCenter at near-by Ho Chi Minh City enhances system stability; (c) the power station will use domestic gastransported to the PMPGC; (c) ample cooling water can be obtained and site wide surface water drainagesystem is being completed as a part of the Phu My I project; (e) the site is accessible by the existingroads; (t) PMPGC is equipped with off-site facilities which are shared by power plants have been mostlycompleted, and the marginal investment is required for the proposed Project; (g) land adjacent to PMPGCwhich is a part of the Phu My Industrial Complex is mostly vacant and can be used during construction

In addition, minimal environmental and socio-economic impacts are anticipated primarily due to thetechnology (combined cycle), fuel type, and location

4 Institutional:

4-1 Executing agencies:

The proposed Project will be implemented by MECO, a private company established by the Sponsors andincorporated under the laws of Vietnam The Government, represented by MOI, has negotiated variousProject Agreements The contractual structure of the transaction is consistent with industry standards withrespect to allocation of commercial, technical and political risks among the parties in a limited recourseproject financing structure Major Vietnamese contractual parties are: MOI as authorized state body

guarantor under the Government Guarantee; EVN as power purchaser under the PPA; and PV as gas supplier under the GSA (See Section C 4-3 for details of the contractual framework of the Project.)

5 Environmental: Environmental Category: A (Full Assessment)

(See Annex 14)

5-1 The proposed Project is in compliance with all environmental requirements and standards of theGovernment of Vietnam and World Bank environmental policies, procedures and guidelines.'°

The proposed Project is an expansion of Phase 1 of Phu My 2 power project financed by IDA under the

Power Development Project (CR 2820 of February 1996), for which an EA was previously prepared An

EA has been prepared for this Project and has been approved by the Department of Science Technologyand Environment (DOSTE) of Vung Tau City on May 25, 2001 A public consultation process inaccordance with the policies and procedures of the Government of Vietnam was conducted in July 2001.Participants included Project Sponsors, preparers of the EA, 25 representatives of the local authorities(Provincial Environment Department, District Peoples Committee), environmental faculty of theUniversity of Ho Chi Minh City, and reporters of the Tan Thanh Radio Station According to the presentplans of the developer, the power station does not require any land expropriation or resettlement

The EA, EMP, and public consultation process have been prepared in a manner consistent with WorldBank requirements The EA Executive Summary was disclosed in Vietnam at Phu My IZ and Tan ThanhDistrict in December 2001 The EA was sent to the Infoshop and the Board in January 2002

Location and construction impact: The proposed Project will be located in the PMPGC site operated by

EVN adjacent to the Phu My Phase 1 Extension where land has already been cleared and leveled.PMPGC is located in the Ba Ria-Vung Tau Province in the Phu My Industrial Complex owned by theProvince and reserved for future development The environmental impacts are manageable, and theproject has all requisite environmental approvals from the Government of Vietnam, as well as meets theWorld Bank environmental guidelines Movement of men and materials for construction would beconfined to existing roads (No 1 and No 4 connected to Ho Chi Minh City) and/or shipped via the ThiVai River

Air Emissions: Potential harmful emissions from the Project are confined to NO, since the power station

would be fired almost exclusively on natural gas from the Nam Con Son gas fields The gas pipeline isnot part of the Project as it will supply fuel for all power stations located in the PMPGC In accordancewith the Government of Vietnam environmental regulations, an EA report for the gas pipeline wasprepared (December 14, 1999) and approved by the Ministry of Science, Technology, and Environment(MOSTE) on June 7, 2000 The level of emissions meets both Vietnamese emission standards and World

Bank environmental guidelines The cumulative impact on local air quality of the other power stations

currently under construction and/or operation, and the future power stations planned for the PMPGC sitewere studied as part of the revised EA and found to be in compliance with Government of Vietnam airquality standards when fired on gas

Water Effluents: The most significant issue is the discharge of heated cooling water Cooling water will

be withdrawn from a channel fed by both the Sao River, a tributary of the Thi Vai River and the Thi VaiRiver itself Heated water will discharged on a once through basis further downstream to the Thi VaiRiver proper through a multiple outlet submerged diffuser system to assure rapid effective convective

'° The Safeguard committee has provided a conditional clearance for the project on June 11, 2002 subject toprovision of additional information from the developer prior to financial close

mixing and heat dispersal Temperature rise across the condenser is expected to be about 7 °C, and at the

edge of the mixing zone the temperature rise is expected to be about 1-2° C The cumulative impact on

ambient water temperature, particularly in the area of the mangrove swamp, from both the current project

as well as the other power stations currently under construction and/or operation, and the future powerstations planned for the PMPGC area were studied as part of the revised EA and found to beinsignificant The Project Sponsor utilized a sophisticated mathematical model that has been used forthermal power stations under similar conditions in Indonesia, Mexico, and the Philippines The WorldBank project is expected to discharge about 17 M3/sec of heated water, whereas with overall development

of power in the area will result in a discharge of about 90 M3/sec of heated water.

Noise: Combined cycle power stations are typically noisy However, noise attenuation technologies are

quite commonly used in this application and will be utilized here as well The plant will meet standards ofthe Government of Vietnam and World Bank environmental guidelines at the closest receptors

5-2 Main features of the EMP:

The EMP was provided by the Project Sponsor to the World Bank in January, 2002 and consists of fivebasic sections: (a) mitigation plan (including, as appropriate: measures, costs, and responsible parties), (b)monitoring plan (including, as appropriate: methods, locations, measurement frequencies, costs, andresponsible parties), (c) technical assistance requirements (training, monitoring equipment needs,consultant services etc.), (d) implementation schedule, and (e) a description of institutional arrangementsfor environmental management The monitoring program will pay particular attention to both theconditions of the mangroves in the protected area as well as water temperatures in this same area Shouldany stresses on the ecosystem be indicated appropriate mitigating actions will be taken as identified in themitigation plan (Details are provided in Annex 14)

5-3 Timeline and status of EA:

An EA was approved by the DOSTE on May 25, 2001, and sent to the Bank shortly thereafter.Environmental specialists in the Bank reviewed the document, and felt some extensions and revisions tothe EA document and EMP would be required to meet World Bank policies and procedures The ProjectSponsors, and their EA consultants: (a) revised the EA - primarily addressing the cumulative impactsanalyses for NO and heated water discharges, (b) prepared an EMP (as described under para 5.2 above),and (c) conducted a public consultation in accordance with Bank procedures and requirements, inDecember 2001

5-4 Stakeholders consultation:

A public consultation process in accordance with the Government of Vietnams' policies and procedureswas conducted in July 2001 Participants included Project Sponsors, preparers of the EA, 25representatives of the local authorities (Provincial Environment Department, District Peoples Committee),environmental faculty of the University of Technology of Ho Chi Minh City, and reporters from TanThanh Radio Station However, the consultation process did not include NGOs and/or representatives ofaffected groups An additional consultation process, fully satisfactory to the Bank, was conducted onDecember 20, 2001

In compliance with World Bank requirements, disclosure of the EA report was discussed and agreed uponwith the relevant local govemment environmental authorities

5-5 Monitoring and evaluation of the impact:

The EMP incorporates a monitoring program that will track the key environmental issues identified in themitigation plan of the EMP Key issues are primarily during operation and consist of heated waterdischarges and their potential impacts on aquatic ecology (primarily the protected mangrove swamps andfish/shrimp populations) and ambient levels of NO, Should the monitoring program indicate potentialstress, the Project Sponsors agree to take the actions indicated in the mitigation section of the EMP Itmust be noted and emphasized, that potential impacts identified for the proposed Project, namely Phu My2-2, have been carefully analyzed in the EA and determined to meet all Government and World Bankenvironmental standards/guidelines and are not likely to have any significant impacts in itself.Additionally, when taken in total with all other power generation facilities either currently in constructionand/or operation, as well as those additional facilities planned, the cumulative impacts from operation ofall these facilities, were also studied in the revised EA,and demonstrated to be minor Nonetheless, themonitoring program incorporated into the EMP will focus on these issues to provide even furtherdiligence in assuring that appropriate mitigation can be engaged sufficiently far in advance should adversechanges be detected

6 Social:

6-1 Key Social Issues / Participatory Approach:

The Project is an expansion of the Phase 1 of Phu My 2 power project financed by IDA under the Power Development Project (Cr.2820 of February 1996), for which an Environmental and Social Impact

Assessment (EA) was previously prepared by IDA in compliance with Bank policies and guidelines ThePhu My 2-2 power station does not require any land expropriation or resettlement EVN confirmed to theIDA that the EVN 500kV interconnection line from the Phu My 2-2 facility to the Phu My 500kVswitchyard, which is to be constructed by MECO and then turned over to EVN, remains routed inside thePhu My Complex as per the signed agreements as of August 21, 2002

In case of any changes in the future which require additional acquisition of land outside the Phu MyComplex, EVN would be required to comply with all relevant Bank policies on EA and ResettlementAction Plan (RAP) in accordance with the Policy Framework provided to the developer ThisResettlement Policy Framework has been revised to indicate eligibility of people whose land or livelihoodmay be affected during project implementation In addition, a grievance mechanism for these people hasbeen agreed upon with the project Sponsor (Details are in Annex 14)

6-2 Participatory Approach:

The area was acquired 5 years ago as part of PMPGC work and all work and consultation was as per Bankguidelines and policies at that time No additional land acquisition has been planned for this project

7 Safeguard Policies:

Projects in International Waters (OP 7.50, BP 7.50, GP 7.50) No

Projects in Disputed Areas (OP 7.60, BP 7.60, GP 7.60)* No

F Sustainability and Risks

1 Sustainability

The Project is the first internationally competitively bid power project in Vietnam, and pricedcompetitively to supply power to the grid at US cents 4.14/kWh on a levelized basis This comparesfavorably with Bank estimates of Long Run Marginal Cost (LRMC) for generation As the tariff structurefor the proposed Project is based on a diminishing capacity charge to reflect pay-down of debt, the tariff

in real terms will decline over the life of the Project, increasing the Project's competitiveness over time.Based on the latest power demand projections for Vietnam, the Project is required to meet the electricitydemand even under the low growth scenario Despite regional economic crisis, electricity demand inVietnam increased at an average rate of about 13% per annum over the past 3 years The Project is located

in the PMPGC near Ho Chi Minh City in an area where EVN estimates that electricity demand will grow

at approximately 16% annually

The Government has acknowledged the implied macroeconomic risks of an unconstrained program ofprivately owned generating capacity in the power sector with take or pay contracts, and intends toimplement foreign private participation progressively to account for up to 20 % of the total systemcapacity while weighing the country's debt exposure The proposed Project is one of the only two BOTProjects of major scale (with combined capacity of 1,430MW) which recently received the investmentlicense

The Government has committed itself to a program of increasing tariffs periodically in order to meet an

SFR of 30% and DSCR of 1.5, covenanted under on-going IDA power projects.

The proposed Project is crucial for the use of offshore gas which is expected to be available from this yearand which the government is committed to purchase as production levels increase Any delay in thecommissioning of this plant would lead the government paying the private owners of the gas fields for thegas available but not consumed

The sustainability of the proposed Project will be underpinned through a combination of the followingfactors: (a) economic benefits to the Government from the proposed Project with a competitive tariffwhich would help to address needs for increased power generation capacity to sustain economic growth;and (b) private sector operation backed by firm financing commitments and commercial and financialbenefits to the Sponsors

2 Critical risks

From Outps W 3 6O

Expected rapid increase in market demand M Historical rapid demand growth during

necessity to increase reserve margin to

adequate level

Government commitment to power sector S Parallel dialogue with the Government

jeopardizing the financial viability of the acknowledgement of the importance ofpower sector; inadequate increase of progressive tariff increases and its

11 roiRi (Com$uetift.5 .Ok#t . _. _._

Power plant construction delays and cost N EPC contract on a fixed-price tunkey, date

maintained in line with international liquidated damages; Private sponsors' track

placed at risk for construction delays,inadequate project management and plantoperational performance below the agreed

targets

Project; impact of currency devaluation on selection under transparent policy

PPA with strict contractual provisions;Financial and managerial action plans forimproving performance of EVN through a

series of IDA credits

Supply of fuel in adequate quantities in a S Long-term GSA; substantial Government

resources and secure long-term users

Foreign exchange inconvertibility and M Adequate foreign exchange reserves and

country; limited provision of Governmentguarantee covering foreign exchange

availability

Political force majeure and natural force N Stable political situation under the reformist

relative lack of major natural disasters in theregion; purchase of commercial insurance

where available

Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk)

G Main Effectiveness Conditions

1 Guarantee Effectiveness Conditions

The conditions precedent are the customary conditions for project financing of this type and include thefollowing:

* Firm commitment for sufficient financing to complete construction of the Project, including thecontribution of equity by the Sponsors;

* Execution of all project financing and security documentation as well as the IDA Guarantee

Agreement, the Indemnity Agreement and the Project Agreement,

* Delivery of an environmental management plan that meets IDA guidelines;

* Effectiveness of all required insurance (to include IDA as an additional insured on third-party liabilityinsurance);

* Provision of satisfactory legal opinions; and

* The payment of the first installment of the Guarantee Fee and the Initiation Fee

H Readiness for Implementation

The key Project documents, including the BOT Contract between MOI and MECO, PPA between EVN and MECO, GSA between PV and MECO, Government Guarantee between MPI and MECO, have been negotiated and the Project received the Investment License (IL) of the Government on September 18,

MECO has conducted bidding and selected commercial bank lead arrangers; and the lender have beenconducting due diligence, including the hiring of Independent Engineer The financing documentation isbeing negotiated and finalized

As is customary with limited-recourse projects, financing by all lenders and equity would be madeavailable after approval by the respective institutions

MECO expects and is obliged under the BOT Contract to reach financial closure within 12 months after

the issuance of IL by September 18, 2002; and commissioning of the facility within 24 months after the

construction start date The commissioning of the Facility is scheduled by September 2004

1 Compliance with Bank Policies

This project complies with all applicable Bank policies

Annex 1: Project Design Summary Vietnam Phu My 2 Phase 2 Power Project Key Performance

Evaluation Sector-related CAS Goal: Sector Indicators: Sector/ country (from Goal to Bank Mission)

reports:

Sustainable economic growth Progress on sector reforms CAS reports Reliable and cost effective power

and poverty alleviation,

private investmnent

(ii) Major private investments likeAdequate tariff are Economic and Sector the Project would free up publicmaintained to ensure sector reports budget resources to tackle social

Degree of private sector (iii) Major direct foreignparticipation in the sector investment like the Project would

encourage competitive investments

in other sectors

Project Development Outcome / Impact Project reports: (from Objective to Goal)

Stable and reliable power (i) Power station delivers (i) Project supervision, (i) EVN would be able to

supply at competitive pnces high availability progress reports, and effectively dispatch the Project and

to meet increasing power annual financial efficiently distribute the resulting

shortages ~statements, electricity