Document o f The World Bank

Report No.: 29379

BANGLADESH

PROJECT PERFORMANCE REASSESSMENT REPORT

ENERGY SECTOR ADJUSTMENT CREDIT

(CREDIT 1999-BD)

June 21,2004

Sector and Thematic Evaluation Group Operations Evaluation Department

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Currency Equivalents (annual averages) Currency Unit = Taka Tk)

1987 US$1 .oo Tk 30.8 1992 US$l.OO Tk 39.0 1997 US$l.OO Tk 43.9 2002 US$l.OO Tk 57.9

Abbreviations and Acronyms

BPDB CNG DESA DESCO ESAC GIDP GOB GTCL IOC LPG MCF MEMR MTR oc PB REB PPAR PSC SGDP TA TCF

Bangladesh Power Development Board Compressed natural gas Dhaka Electricity Supply Authority Dhaka Electricity Supply Company Energy Sector Adjustment Credit Gas Infrastructure development Project Government o f Bangladesh Gas Transmission Company Limited International Oil Company Liquified Petroleum Gas Thousand cubic feet Ministry o f Energy and Mineral Resources Mid-term review Operating Companies Petrobangla Rural Electrification Board Project Performance Assessment Report Production Sharing Contract Second Gas development Project Technical Assistance Trillion Cubic Feet.

Fiscal Year

Government: July 1-June 30

Director-General, Operations Evaluation : Mr. Gregory K. Ingram Director, Operations Evaluation Department : Mr. Ajay Chhibber Manager, Sector and Thematic Evaluation : Mr. Alain Barbu Task Manager : Mr. Fernando Manibog

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OED Mission: Enhancing development effectiveness through excellence and independence in evaluation.

About this Report The Operations Evaluation Department assesses the programs and activities of the World Bank for two

purposes: first, to ensure the integrity of the Bank's self-evaluation process and to verify that the Banks work is producing the expected results, and second, to help develop improved directions, policies, and procedures through the dissemination of lessons drawn from experience. As part of this work, OED annually assesses about 25 percent of the Bank's lending operations. In selecting operations for assessment, preference is given to those that are innovative, large, or complex; those that are relevant to upcoming studies or country evaluations; those for which Executive Directors or Bank management have requested assessments; and those that are likely to generate important lessons. The projects, topics, and analytical approaches selected for assessment support larger evaluation studies.

A Project Performance Assessment Report (PPAR) is based on a review of the Implementation Completion Report (a self-evaluation by the responsible Bank department) and fieldwork conducted by OED. To prepare PPARs, OED staff examine project files and other documents, interview operational staff, and in most cases visit the borrowing country for onsite discussions with project staff and beneficiaries. The PPAR thereby seeks to validate and augment the information provided in the ICR, as well as examine issues of special interest to broader OED studies.

Each PPAR is subject to a peer review process and OED management approval. Once cleared internally, the PPAR is reviewed by the responsible Bank department and amended as necessary. The completed PPAR is then sent to the borrower for review; the borrowers' comments are attached to the document that is sent to the Bank's Board of Executive Directors. After an assessment report has been sent to the Board, it is disclosed to the public.

About the OED Rating System The time-tested evaluation methods used by OED are suited to the broad range of the World Bank's work.

The methods offer both rigor and a necessary level of flexibility to adapt to lending instrument, project design, or sectoral approach. OED evaluators all apply the same basic method to arrive at their project ratings. Following is the definition and rating scale used for each evaluation criterion (more information is available on the OED website: http://worldbank.org/oed/eta-mainpage. html).

Relevance ofobjecfives: The extent to which the project's objectives are consistent with the country's current development priorities and with current Bank country and sectoral assistance strategies and corporate goals (expressed in Poverty Reduction Strategy Papers, Country Assistance Strategies, Sector Strategy Papers, Operational Policies). Possible ratings: High, Substantial, Modest, Negligible.

Efficacy: The extent to which the project's objectives were achieved, or expected to be achieved, taking into account their relative importance. Possible ratings: High, Substantial, Modest, Negligible.

Efficiency: The extent to which the project achieved, or is expected to achieve, a return higher than the opportunity cost of capital and benefits at least cost compared to alternatives. Possible ratings: High, Substantial, Modest, Negligible. This rating is not generally applied to adjustment operations.

Unlikely, Highly Unlikely, Not Evaluable.

to make more efficient, equitable and sustainable use of its human, financial, and natural resources through: (a) better definition, stability, transparency, enforceability, and predictability of institutional arrangements andlor (b) better alignment of the mission and capacity of an organization with its mandate, which derives from these institutional arrangements. Institutional Development Impact includes both intended and unintended effects of a project. Possible ratings: High, Substantial, Modest, Negligible.

achieved, efficiently. Possible ratings: Highly Satisfactory, Satisfactory, Moderately Satisfactory, Moderately Unsatisfactory, Unsatisfactory, Highly Unsatisfactory.

Bank Performance: The extent to which services provided by the Bank ensured quality at entry and supported implementation through appropriate supervision (including ensuring adequate transition arrangements for regular operation of the project). Possible ratings: Highly Satisfactory, Satisfactory, Unsatisfactory, Highly Unsatisfactory.

quality of preparation and implementation, and complied with covenants and agreements, towards the achievement of development objectives and sustainability. Possible ratings: Highly Satisfactory, Satisfactory, Unsatisfactory, Highly Unsatisfactory.

Susfainability: The resilience to risk of net benefits flows over time. Possible ratings: Highly Likely, Likely,

lnstifufional Development Impact: The extent to which a project improves the ability of a country or region

Outcome: The extent to which the project's major relevant objectives were achieved, or are expected to be

Borrower Performance: The extent to which the borrower assumed ownership and responsibility to ensure

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Contents

Principal Ratings ............................................................................................................... v

Preface ..............................................................................................................................vu

Summary ........................................................................................................................... ix

..

1 .

2 . 3 .

Introduction and Background .................................................................................... 1

Sector Issues and Institutional Structure Before the ESAC ..................................... 1 Previous and Subsequent Bank Lendingfor Energy ............................................... 2 Objectives and Design of the ESAC ........................................................................ 3

Implementation and Performance through 1992 ..................................................... 5

Performance since 1992 ............................................................................................... 7

Private Sector Participation in Energy ................................................................... 7 Private Sector Investment in Gas ............................................................................ 8 Investment Planning and Resource Development ................................................... 9

Energy Pricing ....................................................................................................... 10 Gas Pricing and Finances .......................................................................... 11 Electricity Pricing and Financial Performance .......................................... 12

Institutional Performance ............................................................................................... 13

Institutional Issues in the Gas Sector .................................................................... 13 Institutional Issues in the Power Sector ................................................................ 14

4 . Outcome and Assessment .......................................................................................... 15

Outcome. ................................................................................................................ 15

Sustainability ......................................................................................................... 16

Institutional Development Impact ......................................................................... 16

Bank Performance ................................................................................................. 17

Borrower Performance .......................................................................................... 17

Conclusions ....................................................................................................................... 17

5 . Lessons Learned ........................................................................................................ 18

This report was prepared by Sunil Mathrani (Consultant). under the supervision o f Fernando Manibog (Task Manager) . The report was edited by William B . Hurlbut . Rose Gachina provided administrative support .

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Annex A . Basic Data Sheets ............................................................................................ 19

Annex B . Borrower Comments ...................................................................................... 21

Annex C . Key Indicators ................................................................................................. 35

Annex D . Electricity Tariffs (Bangladesh Power Devt Boardmhaka Electric Supply Authority) ................................................................................................................... 37

Annex E . Bangladesh . IDA lending for energy. 1980-1995 ........................................ 39

Tables

Table 1 : Bangladesh Average Gas Prices .......................................................................... 11 Table 2: Comparative Performance Ratings ...................................................................... 17

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Principal Ratings ICR* PPAR Re-assessment

Outcome Satisfactory Barely Satisfactory Unsatisfactory Sustain a bi I ity Institutional Partial Partial Negligible Development Impact Bank Not rated Not rated Unsatisfactory Performance Borrower Not rated Not rated Unsatisfactory Performance

Uncertain U n ce rta i n U n li kely

~~ ~~~ ~ ___ * The Implementation Completion Report (ICR) is a self-evaluation by the responsible operational division of the Bank.

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Preface

This i s a Project Performance Reassessment Report for the Bangladesh Energy Sector Adjustment Credit (Cr. 1999). The project was approved by the Board for a credit o f SDR 137 mil l ion on April 11, 1989, and closed, fully disbursed, in July 1990.

A Project Completion Report (Report no. 10700) was produced by the South Asia Region in June 1992 and the Operations Evaluation Department (OED) prepared a Project Performance Audit Report (Report no. 12 1 13) on this operation in June 1993. The current reassessment i s part o f a series o f pilot studies being undertaken by OED to test whether such reassessments provide sufficient new insights to justify making them a routine part o f OED’s work.

The specific purpose o f this PPRR i s to evaluate energy sector performance in policy areas covered by the adjustment credit during the past decade, and thus to gauge the durability o f reforms undertaken as part o f the operation. The reassessment also seeks to validate the performance ratings established by the previous performance assessment report.

This report i s based on the previous PPAR as well as on the President’s Report (Report no. P-4549), dated March 22,1989, project files, and discussions with Bank staff. An OED mission visited Bangladesh in December 2003 to discuss the effectiveness o f the Bank’s assistance with the government and the energy sector enterprises. The collaboration and assistance o f all their officials are gratefully acknowledged.

The mission also carried out a Project Performance Assessment o f two gas projects, which will be issued concurrently as a separate report, containing complementary information on the performance o f the Bangladeshi gas sector.

Following standard OED procedures, the draft o f this report was sent to the borrower for comments before finalization. The comments received are included as Annex B to this report.

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Summary

The Energy Sector Adjustment Credit (ESAC) was the first and only quick- disbursing SECAL in the Bangladesh energy sector. The objective o f the ESAC was to assist the government in extending and refining its energy policy and to strengthen energy sector institutions. The major outcomes from the ESAC were expected to be (i) more rational patterns o f energy demand; (ii) improved investment planning; (iii) improved financial viability for energy sector entities; (iv) mobilization o f additional resources for the budget; and (v) removal o f institutional constraints.

The ESAC sought to bring about policy improvements in the areas o f investment planning, energy pricing and institutional performance of the main energy sector entities. The ESAC conditionalities were grouped around these three subjects, which are the focus o f this reassessment report. These topics have remained highly relevant throughout the past 15 years since the ESAC was approved in 1989.

The 1993 PPAR concluded that investment planning saw only modest improvement as a result o f the ESAC, but that there was good progress in energy pricing. On the other hand, institutional reforms were only very partially in place when the second tranche was released.

This reassessment o f the long-term outcome o f the ESAC found that there has not been a significant improvement in energy sector planning over the decade since the end o f ESAC. The Bangladesh energy sector has numerous examples o f shortcomings in planning, which have been compounded by insufficient or uncoordinated and delayed investments by the major public sector energy producers, leading to a suboptimal and wasteful use o f scarce resources.

Improvements in the real level o f gas prices during the ESAC period were not sustained. The almost five-year freeze in gas prices from early 1994 to late 1998 eroded their real value by a quarter. However, prices have climbed sharply since, to wipe out the declines o f the mid- 1990s. N o action was taken during the ESAC or subsequently to alter relative gas prices in order to reduce the extent o f subsidies to the power and fertilizer sectors or to domestic users o f gas.

The modest real increases in electricity tariffs and improvements in the tariff structure during the ESAC period were effectively reversed because tariff levels remained frozen for five years. Financial covenants with IDA were not met. Despite rapid annual sales growth, the two main government-owned power utilities operated at a loss through the 1990s. However, since 2000 there are signs o f improvement in commercial performance: total power sector energy losses have been brought down in the last three years from 35 percent o f generation to about 30 percent today.

Reorganization o f the gas sector as envisaged under ESAC (as well in preceding and subsequent IDA gas projects), has never been fully implemented. Local vested interests prevented the merger o f the two gas producing companies into one. A transmission company was set up in 1993, but still does not own al l the high-pressure gas

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pipelines in Bangladesh. The only departure from an entirely state-run gas sector, albeit an important exception, has been the involvement o f international companies in exploration and gas production. The Bank’s gas projects have had l i t t le impact on the institutional development o f the state-owned sector entities in Bangladesh.

As part o f the ESAC institutional reforms for the power sector, the Bangladesh Power Development Board (BPDB) was split and the Dhaka Electricity Supply Authority (DESA) was set up. This was in no sense a solution to the deep-seated problem o f poor corporate governance and weak management in the power distribution business. In essence, part o f the commercial and operational problems that had afflicted BPDB prior to the creation o f DESA had simply been hived o f f to the new entity, which had not been given the authority, the incentives or the means o f solving them. The high level o f illegal connections and unrecorded consumption, combined with poor revenue collection were (and s t i l l are) the achilles heel o f the entire power sector.

This reassessment report concludes that the expected benefits from the ESAC did not materialize to any significant extent in the post-ESAC period. The ESAC’s overall outcome i s rated as unsatisfactory. Overall, ESAC’s institutional development impact i s rated as negligible and sustainability i s assessed to be unlikely. Both Bank and Borrower performance are rated as unsatisfactory. Compared to the 1993 PPAR, all these ratings are downgrades.

Even though private sector development was not a theme o f the ESAC, it i s important to record the economic benefits to the country from the big expansion in gas and power production by private enterprises. The Bank played both a catalytic as well as direct enabling role in bringing this impressive inflow o f foreign direct investment (US$ 1.5-2 billion) to the Bangladeshi energy sector, which, taken as a whole, i s in much better shape than a decade ago, despite major unresolved problems in i t s parastatal entities. Shortages have been greatly reduced, access to electricity has increased substantially in rural areas and the private sector plays an important and growing role in both gas and electricity production.

The main lessons that can be drawn from this reassessment o f the ESAC are:

SECALs are a poor choice o f lending instrument for long-gestation institutional reforms in the energy sector because o f the budgetaryhalance o f payments imperatives to disburse funds quickly and the difficulty o f obtaining ownership by implementing agencies o f reforms in the absence o f any targeted funding to them;

0 Creating new entities i s not a solution to the deep-seated problems o f corporate governance and managerial weakness that plague the energy sector; and

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0 The Bank should not push for the creation o f new entities unless it i s willing to commit to assisting such bodies as are born out o f Bank-financed reforms.

Gregory K. Ingram Director-General Operations Evaluation

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1. Introduction and Background

1. The Energy Sector Adjustment Credit (ESAC) was one o f three fast-disbursing operations in IDA’S lending program for Bangladesh during the late 1980s, and was the f i rs t and only SECAL the Bank financed for the country’s energy sector. Each o f these three operations was conceived to provide a comprehensive, long-term framework for policy actions - a sectoral “umbrella” under which specific investment projects would be identified and financed. The proceeds o f these operations were expected to be used primarily for general imports and not be allocated to particular sector entities because in the late 1980s Bangladesh was still in need o f substantial annual balance o f payments support in the form o f non-project aid’. However, the SECAL instrument proved to be unpopular with the government, which was accustomed to receiving balance o f payments support without having to meet difficult conditions.

2. The ESAC was approved by the Board for a credit o f SDR 137 mil l ion in April 1989 and fully disbursed and closed by July 1990. The South Asia Region issued a project completion report in June 1992 and an OED performance audit mission visited Bangladesh shortly thereafter. The performance audit report was published in June 1993. The decade that has elapsed since then provides a long interval to (i) reassess the contribution o f the ESAC to energy sector development, (ii) evaluate performance in ESAC policy areas since 1993, and (iii) gauge the validity o f the performance ratings established by the 1993 OED performance audit.

Sector Issues and Institutional Structure Before the ESAC

3. At the time o f the ESAC identification (1 986), overall investment programs o f the various energy parastatals were neither optimal nor integrated into sectoral investment programs that could be implemented with available resources. Progress in having energy prices reflect economic costs o f supply had been slow and uneven. Severe institutional weaknesses remained and further improvement in the performance o f sector entities was critical for the sector’s efficient development and operation.

4. Prior to 1991 , the Bangladesh Power Development Board (BPDB) was responsible for electricity generation, transmission and distribution throughout Bangladesh, except in those rural areas under the Rural Electrification Board (REB)’. From 1992 onwards, responsibility for electricity distribution in the Greater Dhaka area was transferred to a new entity, the Dhaka Electricity Supply Authority (DESA), as part o f the ESAC program (para. 21). Further steps in the unbundling o f the sector took place in the late 1 9 9 0 ~ ~ with the creation o f the Power Grid Corporation o f Bangladesh to

1. Between 1972, when Bangladesh became a member o f the Bank, and 1989, when the ESAC was approved, a third o f total lending (in dollar terms) had been in the form o f support for general imports.

2. In 1990 REB served about 30% o f all electricity consumers in Bangladesh, but accounted for only about 10% o f total electricity sales nationwide.

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operate the transmission system, and splitting o f distribution operations in the Dhaka area by the setting up o f the Dhaka Electricity Supply Company3.

5. The major causes o f poor performance by the BPDB in the midlate 1980s were the unclear definition o f responsibilities o f the chairman and board members, who were also BPDB’s top management, an excessive centralization o f responsibilities, particularly in the distribution function, and government interference in day-to-day matters. Other causes were instability in top management, the lack o f an appropriate incentive system for staff, and considerable overstaffing, particularly in distribution.

6. Petrobangla (PB) i s responsible for the exploration and development o f Bangladesh’s oil, gas and mineral resources. It has been a statutory body o f the government since 1985, operating under the purview o f the Ministry o f Energy and Mineral Resources. It holds the shares o f all the state-owned companies dealing in oil, gas and mineral exploration and development (now nine in number for gas, plus two for solid minerals) on the Government’s behalf. Prior to the ESAC, the PB Group consisted o f three production companies4, (one o f which also transmitted and distributed gas) and two transmission and distribution companiess. An exploration company and natural gas liquids company were set up in the late 1980s and a gas transmission company in the early 1990s.

7. The fragmented and overlapping structure o f the Petrobangla operating companies and their unsatisfactory collective performance called for a realignment o f the various entities involved in the sector, the streamlining o f their responsibilities, and consolidation and strengthening o f available expertise in planning and operations. A sweeping institutional reform o f the sector had initially been agreed in the course o f appraising the Second Gas Project in 1984 and was then incorporated in the conditionality for the ESAC.

Previous and Subsequent Bank Lending for Energy

8. Before the ESAC, IDA had provided 10 credits for energy projects amounting to about US$600 mill ion (see Annex E ). These projects represented 19 percent o f IDA resources committed to Bangladesh in the period 1979-88. Lending in the energy sectors had been designed to expand the use o f natural gas as a substitute for imported oil, rationalize the country’s supply o f petroleum products, promote conservation and more efficient energy use, and encourage gas and o i l exploration. IDA also had financed projects to expand the country’s power generation, transmission, and distribution capabilities and rural electrification systems. In the late 1980s, IDA’S energy project portfolio was substantial, with eight projects at various stages o f implementation. These

3. At present, DESCO i s s t i l l a wholly-owned subsidiary o f DESA. However there are a number o f crucial differences between the two: DESCO was set up under the Companies Act, i t s staff are contractual and are not paid per civil service scales. Most o f i t s operational services are carried out by private subcontractors.

4. Bangladesh Gas Fields Co., Bakhrabad Gas Systems Ltd., Sylhet Gas Fields Ltd.

5. Titas Gas Transmission & Distribution Co., Jalalabad Gas Transmission & Distribution Co.

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were evenly divided between gas development (production, processing and transportation), and electricity.

9. Lending by the Bank for the energy sector shrank dramatically during the 1990s. Only three new operations have been approved in the last decade, one for gas in 1995, a partial risk guarantee for power generation in 2000, and a rural electrification project in 2002. After a long hiatus, a new operation in support o f power sector reforms i s currently being prepared.

10. institutional reforms) had featured under prior SILs, but with limited progress. The Second Gas Development Project had already obtained government agreement to the principle o f the gas companies self-financing a reasonable proportion o f their future investment requirements, but very modest results had been achieved. BPDB's reorganization had been addressed for years by IDA and ADB through past project lending, but much remained to be done at the time o f the ESAC. Progress in improving the electricity sector's commercial and financial performance had also been disappointing. The reform o f the gas sector's institutional framework had been agreed with GOB in the mid- 1 9 8 0 ~ ~ but had not been implemented.

The main issues addressed by the ESAC (investment planning, pricing and

Objectives and Design of the ESAC

1 1. 1987 and negotiated in July 1987. However, presentation to the Board was delayed until April 1989 because the government had difficulty meeting the required conditions. According to OED's 1993 PPAR, this was basically due to a lack o f government commitment and an underestimation by Bank staff during project preparation o f the difficulty o f rapidly solving the policy and institutional problems that the sector had been facing for some time.

Formal preparation o f the ESAC began in May 1986; it was appraised in March

12. policy and to strengthen energy sector institutions. Under the Third Five-Year Plan (1986-1990) the government's objectives for the energy sector were to: (a) accelerate the development o f domestic natural gas resources to reduce the country's dependence on imported oil; (b) adjust energy prices to promote the efficient and economic use o f energy, taking into account social objectives; (c) meet the demand for energy at least cost to the economy; (d) improve power supply reliability and quality, and reduce system losses; (e) improve energy sector entit ies' financial performance and mobilize the resources required to meet the country's development goals; and (0 encourage private sector participation in the energy sector's development, particularly in o i l and gas exploration.

The objective o f the ESAC was to assist GOB in extending and refining i t s energy

13. The major outcomes from the ESAC were expected to be:

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0 improved investment planning; 0

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more rational patterns o f energy demand;

improved financial viability for energy sector entities; mobilization o f additional resources for the budget; and

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0 removal o f institutional constraints.

14. expanding private sector participation in energy supply outside o f o i l and gas exploration. Even for the latter, it was assumed that adequate action had been taken under the Petroleum Exploration Promotion project,6 in the form o f promotional packages aimed at international o i l companies. The possible involvement o f the private sector in gas production and transport or in the electricity sector i s not even mentioned in the ESAC program, even though it featured in GOB’S Third Five-Year Plan. Yet within a few years o f the end o f ESAC, these came to figure prominently in the Bank’s policy dialog on energy with GOB. Even before the ESAC was fully disbursed, the Bank had undertaken a review’ o f prospects for private participation in energy, which identified opportunities to attract private capital and which urged the government to issue a policy statement welcoming private investment in power generations8

The ESAC was a product o f the 1980s and therefore did not address the issue o f

15. The ESAC was both ill-suited for delivering timely BOP assistance to GOB (due to delays in meeting i t s sectoral conditionalities for tranche release) and unpopular with sectoral agencies, who were expected to deliver reforms, but received no direct financial support in return. The latter was a common design flaw o f energy SECALs, as noted by PARS o f similar operations in Turkey, Philippines and Cote d’Ivoire.

ESAC Conditionalities

16. The conditionalities were grouped under three subjects: investment planning, energy pricing, and institutional performance o f the main energy sector entities. These subjects are the focus o f this re-assessment report. These topics have remained highly relevant throughout the past 15 years since the ESAC was approved in 1989.

17. least-cost basis prior to the ESAC, the various agencies’ overall investment program had not been optimal or integrated into a sectoral investment program that could be implemented with the available financial resources. To address this weakness in investment planning, the ESAC the required preparation o f three-year, rolling Priority Investment program^,^ which were designed to take into account the availability o f financial resources as well as rank projects by rates o f return.

Investment planning: While individual projects may have been selected on a

18. aimed at obtaining the government’s agreement to increases in energy price levels and to improvements in tariff structures. As under the Second Gas Development project (1 985) before it, GOB agreed to price natural gas to achieve better economic efficiency, equity, and resource mobilization. Economic pricing would also help gas companies achieve

Energy pricing: In order to correct prevailing pricing distortions, the ESAC

6. Cr. 1402-BD o f 1983.

7. Report # 7879, dated March 9, 1990.

8. I t took six more years before GOB published i ts policy on private power generation.

9. The 3-year rolling plans have recently become the basis for overall national economic planning, since the 5-year planning cycle was dropped at the end o f the 5th national plan.

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their financial targets, so the ESAC was designed to put additional pressure on gas companies to increase self-financing o f investments. The margins on gas prices received by the gas companies were to be set at such levels as to allow each o f them to cover their costs, including depreciation, and to cover a rising proportion o f their annual investment programs from internally generated funds to reach 40 percent in FY93 and thereafter.

19. minimum rate o f return (of 2 percent in FY89 rising to 8 percent in FY93) on assets. The rural electrification Cooperatives'O, were required to raise tariffs to cover operating expenses and interest and an adequate proportion o f investment as a condition o f ESAC second tranche release.

Financial covenants were set in the ESAC to ensure that BPDB would earn a

20. SGDP conditionalities related to the reorganization o f the Petrobangla Group which had not been implemented would be included in the ESAC. Further implementation o f major gas sector reforms, including legal establishment o f new operating companies and appointment o f key staff, became conditions o f the ESAC second tranche release.

Institutional performance: I t was agreed during the ESAC negotiations that

21. o f BPDB led to a reorganization study that recommended that BPDB's distribution operations should be decentralized to strengthen the interface between BPDB and i t s consumers and to better control system losses and accounts receivable. Other recommendations pertained to organizational changes and restructuring within BPDB and to strengthening i t s operations, particularly in the areas o f planning, finance, management information, and personnel systems. These recommendations were agreed in principle by the government, BPDB, and IDA in 1988, leading to government approval for the reorganization o f BPDB, including the establishment o f the Dhaka Electricity Supply Authority (DESA) as a separate entity by July 1 , 1990.

In 1987, the prospects o f using the ESAC to make progress on the reorganization

2. Implementation and Performance through 1992 22. The ESAC was to be disbursed in two tranches, the f i rst at Credit effectiveness, and the second about a year later. Many actions were taken in the period prior to Board presentation, which was considerably delayed to permit GOB to meet them. For release o f the second tranche, the government had to meet eleven conditions, relating mainly to tariff increases and compliance with existing financial covenants o f previous loans designed to reduce system losses and accounts receivable. There were also nine dated covenants to be met. Despite only partial compliance with the tranche release conditions, Bangladesh's critical foreign exchange situation was used to justify a Board waiver on gas price increases and tranche release went ahead on schedule in June 1990. In addition, the data on power system losses and BPDB's accounts receivable submitted to the Bank by GOB for 2"d tranche release indicated a higher level o f compliance than later turned out to be the case, and the completion report'' concluded that the tranche should not have

10. Supplied with electricity by BPDB via the Rural Electrification Board.

1 1. Report # 10700.

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been released. The ESAC ‘experiment’ was not repeated in Bangladesh and instead subsequent S I L s were once again tied to policy reforms.

23. Priority Investment Program (PIP) process had l i t t le impact because o f major annual deviations between the actual outcome and the PIP, both in terms o f the volume o f spending as well as i t s composition. The PIP process helped to reduce the extent to which lower- priority projects received funding, but the PAR concluded that overall, investment planning saw only modest improvement as a result o f the ESAC policy conditionality.

Investment planning: The 1993 PPAR on the ESAC found that in practice, the

24. Energy pricing: During the ESAC period from FY87 to FY90, weighted average gas prices were increased by 43 percent in nominal terms and by 15 percent in real terms. As shown in Table 1, between FY87 and FY92, significant increases took place in real gas prices. A calculation o f the economic price o f gas at that time showed that the required level was Tk.45 per thousand cubic feet with a 12 percent discount rate. Thus, the increases achieved in 1987-90 under the ESAC, which raised the average gas price to Tk.44 per thousand cubic feet in 1990, were sufficient to reach at least the minimum estimate o f the economic resource cost.

25. During the ESAC negotiations in 1987 and before Board presentation in 1989, some restructuring o f

Table 1: Bangladesh Real Gas Price Increases, FY87-92

BPDB’s tariffs was carried out. Further restructuring was agreed as a condition o f second tranche release (July 1990). BPDB’s average tariff was also raised by 15 percent as a condition o f negotiations, so a large part o f the ESAC power tariff reforms were in fact carried out in 1987-88, before Board Presentation.

Sector Increase % Power 53 Fertiliser 33 Commercial 53 Industrial 22 Domestic 24 Weighted average price 45.5 in FY92 (TWMCF)

26. Institutional performance: Implementation o f key steps in a dated action plan for BPDB’s reorganization and the start o f commercial operations by DESA were to be conditions o f second tranche release, but waivers had to be granted regarding DESA, because o f major delays that stemmed from a lack o f commitment by BPDB’s management and heavy resistance by the unions to the creation o f DESA. Many months elapsed before GOB and BPDB were able to take the necessary actions to enable DESA to commence commercial operations in late 199 1.

27. The opposition o f the unions to the reorganization o f BPDB was underestimated both by the consultants and by IDA staff. The consultants had proposed the creation o f five distribution companies. But the unions were afraid that this would lead to BPDB’s dismantling and to privatization, and a decline in their influence. Despite the reluctance o f BPDB’s management (which was aware o f union opposition), GOB agreed with IDA to the establishment o f DESA as a starting point. It was only much later that the unions agreed to DESA’s formation under the condition that DESA would not be privatized. As pointed out by the PPAR, IDA staff and consultants should have been much more

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realistic about the difficulty o f setting up five distribution companies and the prospects o f enacting such fundamental structural reforms under the quick-disbursing ESAC,

28. losses down to 35 percent for Board presentation and to 32 percent for release o f the second tranche. While the Board condition was met, losses rose again and reached 41 percent in fiscal years 1991 and 1992. However, the second tranche had been released on the basis o f incorrect (unaudited) data provided to IDA that indicated a level o f losses below the covenanted 32 percent.

As part o f the ESAC program, the government agreed to bring BPDB’s energy

29. Under SGDP, agreement was reached with GOB to create gas operating companies with functional rather than geographical responsibilities. Petrobangla would be divested o f al l operational activities and become a holding company, with the government’s equity in the operating companies, and be responsible for investment planning and monitoring as well as sector policy formulation. The operating companies placed under Petrobangla’s control were to include a national exploration and drilling company, a single national gas production company, a national transmission company, initially three regional distribution companies, a compressed natural gas company and a solid minerals company. The boards o f directors o f the operating companies would include Petrobangla representatives but no government representatives; the government’s control would be exercised through i t s representation on Petrobanglas’s own board.

30. It was agreed during the ESAC negotiations that SGDP conditionalities related to the reorganization o f the PB Group which had not been implemented would be included in the ESAC. Further implementation o f major gas sector reforms, including legal establishment o f new OCs and appointment o f key staff, became conditions o f the ESAC second tranche release, but these institutional measures were only very partially in place when tranche release took place.

3. Performance since 1992

Private Sector Participation in Energy

3 1. Private gas and power production i s a major success story in an energy sector that has shown disappointing progress in virtually al l other respects. The past decade, and especially the past five years, has witnessed unprecedented foreign private investment in both gas and electricity production in Bangladesh. These investments have transformed the energy sector: today, over a fifth o f gas production and a third o f electricity generation i s by the private sector and these shares are likely to grow further. Meanwhile, in parallel, the performance o f energy parastatals continues to be unsatisfactory. This may appear paradoxal, but experience elsewhere’’ has also shown that substantial private investment can occur in unreformed energy sectors, depending upon specific country conditions.

12. “Power for Development - A review o f the World Bank Group’s experience with private participation in the electricity sector” OED/OEG/OEU, December 2003.

8

32. by the private sector eased the energy supply bottleneck (at least at the production end - there were s t i l l localized shortages due to insufficient transmission capacity) in Bangladesh for the f irst time in 20 years. This was a major benefit to the whole economy as power cuts (with all their attendant disruption and extra costs to manufacturers) were greatly diminished.

For a brief period (which i s now coming to an end) the gas and power produced

33. Even though private sector development was not a theme o f the ESAC, it was a priority o f the government under the Third Five-Year Plan. Therefore, this reassessment cannot ignore it, given i t s crucial importance, the economic benefits to the country from the b ig expansion in gas and power production, and the fact that the Bank played both a catalytic as well as direct enabling role in bringing this impressive inf low o f foreign direct investment (US$1.5-2 billion) to the Bangladeshi energy sector.

34. The Bank was instrumental in setting up and financing the Power Cell o f the Ministry o f Energy and Mineral Resources in 1995. The Power Cell played a key role in drawing up the government statement o f policy on private power generation in 1996, which in turn opened the door to potential investors. The Power Cell then successfully piloted the independent power production program, with assistance from a PHRD grant. I t also was a major participant in the analytical workI3 and in internal debate on power sector institutional reforms. By using a competitive selection process for IPPs, Bangladesh avoided the error committed by Pakistan in i t s 1994 private power generation policy o f offering a fixed tariff to all comers, as well as that o f Indonesia, which opted for negotiated and non-transparent deals with private project developers.

35. The Haripur (360 MW) and Meghnaghat (450 MW) independent power producers are important successes. The process through which they were selected was transparent and highly competitive, leading to Bangladesh obtaining the best prices on record for any developing country independent power producer. The energy from these plants i s cheaper than from BPDB’s own generation, which it has scaled back somewhat to be able to absorb this large chunk o f low-cost power. The Bank deserves credit for i t s support o f these projects via a Partial Risk Guarantee for Haripur and the on-lending o f IDA funds for Meghnaghat via a financial intermediary.

Private Sector Investment in Gas

36. The Bank’.s advice to the government to improve the incentive and contractual terms for o i l and gas exploration led to the publication o f a new petroleum policy in mid- 1993. This was followed by an investment promotion roundtable conference hosted by Petrobangla in late 1993 targeted at international o i l companies. It was highly successful and gave a major impetus to the opening o f the gas sector to foreign private capital for exploration activities. It was organized by specialized consultants and funded by the PHRD Trust Fund. Four production sharing contracts were signed in 1994-95 directly as a result o f this promotional effort and two more followed in 1997.

13. Various consultant studies on institutional reforms were funded by the Bank (using PHRD resources channeled through the Power Cell).

9

37. 1997 was also a significant form o f assistance from the World Bank Group via the PHRD Trust Fund. I t yielded 37 bids from 21 international o i l companies for the exploration blocks offered. Consulting assistance was also provided for bid evaluation from GIDP as the trust fund had been fully used. But the process was derailed, became politicized and subject to outside pressures. Ultimately, only four production sharing contracts were signed in 2000-01 after a lengthy delay. Only some seismic work has been undertaken for one o f the four blocks so far, partly because o i l company enthusiasm for investing in Bangladesh has since slackenedt4. In 2003, two major o i l companies divested their interests in Bangladesh, leaving only two foreign gas producing companies present in the country.

The second petroleum investment promotion roundtable conference held in early

Investment Planning and Resource Development

38. This reassessment found that there has not been a significant improvement in energy sector planning over the past decade since the end o f ESAC. The Bangladesh energy sector has numerous examples o f shortcomings in planning, often compounded by the absence o f decisions to implement plans, as illustrated in the ensuing paragraphs.

39. There i s l i t t le evidence that the Priority Investment Program (PIP) approach led to better coordination between power and gas investment programs. Preparation o f PIPS was continued under the Bank’s last lending operation for gas,” in which it was agreed that an annual review o f the sector’s PIPi6 would be undertaken with IDA, but this practice does not appear to have become routine.

40. The 1990s were characterized by shortages o f both gas and power that forced the private sector to invest in standby generators run on imported diesel. At times gas supply in some areas was adequate but pipeline bottlenecks prevented gas from being transported to defici t areas. Electricity supply was similarly unbalanced; some areas experienced a power surplus while others were experiencing load shedding. Expensive, barge-mounted oil-fired “emergency” power plants were brought in to ease the shortages, while a third o f BPDB’s generation capacity was unavailable due to lack o f maintenance.

41, There had long been a major imbalance in gas supply between the East and West Zones o f Bangladesh” and bringing gas supply to the latter was an economic priority for the government. Once the main gas pipeline over the Jamuna was commissioned in the late 1990s, a major push for increasing gas and power availability to the West Zone would have been the best way to reap the benefits from new pipeline. But the complementary investment in gas distribution was slow to materialize, despite the gfh National Five Year Plan (1 997-2002) objective to build a national gas grid. Nor has there

14. I n part due to the mishandling o f the 2”d round bidding process by GOB and poor management o f the existing PSCs.

15. GIDP, approved in 1995.

16. Then estimated to be about US$ 600m (in 1994 prices) for the 1995-2000 period.

17. Which were divided by the Jamuna River.

10

been a big push for electrification in the West Zone. Power plants in Khulna s t i l l depend on expensive liquid fuels because o f delays in extending the gas grid in the West Zone.

42. The gas sector has also continued to have problems with planning and prioritization, this was most evident in the failure to build the Ashuganj NGL fractionation plant. The first attempt to fund the project was through the Second Gas Development Project (SGDP), then through a proposed restructuring o f the LPG Transport and distribution project18 in the mid/late 1990s. Since the abortive attempts to fund the plant with IDA resources, there has been a debate on seeking a private investor to build and run the plant and/or the government financing it from i t s own resources. But to date, this supposedly “high-priority” project has never got o f f the drawing board; nor are there any current plans to build it. High-value petroleum products like propane and butane are thus being disposed o f for low prices instead o f being separated and sold as premium products like bottled LPG gas for domestic use.

43. developed by international o i l companies. Hence, the new independent power producers were not handicapped by insufficient gas supply and their production in turn helped reduce load shedding. However, there i s now a risk that power shortages will re-emerge in near term. The program for soliciting new bids for independent power producer capacity has run into delays, while demand continues to grow robustly. Near-term prospects for gas supply seem to be satisfactory, with new fields expected on stream shortly. However, gas transmission bottlenecks are already apparent.

Gas shortages eased around 2000, as a result o f production from new fields

44. principles. Investment in coal development in Bangladesh has continued since a 1994 agreement with a Chinese consortium to develop an underground mine to produce a mil l ion tons o f coal per year, despite Western donor objections on grounds o f high cost and misallocation o f resources. But coal production and power generation from it i s s t i l l several years away. This project i s expected to cost over half a bil l ion dollars to produce a fuel that will be used to generate electricity at twice the cost o f gas-based generation.

The coal sector illustrates the consequences o f ignoring least-cost planning

45. All these examples are indicative o f planning shortcomings during the post-ESAC period in Bangladesh, which have been compounded by insufficient or uncoordinated and delayed investments by the major public sector energy producers, leading to a suboptimal and wasteful use o f scarce resources.

Energy Pricing

46. both the gas and electric power sectors during the past decade. For a substantial period in the 199Os, energy prices actually declined in real terms.

This reassessment found that there was limited progress with pricing issues in

18. Cr. 2263, approved in 1991, depended entirely for LPG supply on the Ashugang NGL plant being built.

11

Gas Pricing and Finances

47. Improvements in the real level o f gas prices in the early 1990s (see para. 24) were not sustained, because o f the infrequency o f price increases, as can be seen from Table 2. The near five-year freeze in gas prices from early 1994 to late 1998 eroded their real value by a quarter.” However, prices have climbed sharply since 2000 in both real (Taka) and U.S. dollar terms to wipe out the declines o f the mid-1990s. Since 1990, the Bangladesh CPI has risen by about 70 percent in total, while average gas prices are now about 90 percent above their nominal 1990 level.

Table 2: Bangladesh Average Gas Prices 48. ESAC (or subsequently), to alter relative

N o action was taken during the

gas prices in order to reduce the extent o f Date ofprice adjustment - - subsidies to the power and fertilizer sectors or to domestic users o f gas. Only 4 percent o f households have access to domestic gas supply and benefit from a subsidy estimated at nearly Tk.3 bil l ion (over US$50 million) annually. The vast maiority, who use kerosene or LPG for

FY 90 May 1992 March 1994 December 1998 September 2000

Taka/ MCF

(nominal) 44 50 55 63 73

US$ /MCF *

1.36 1.28 1.37 1.29 1.37

” - cooking, receive no subsidy at all. January 2002 78 I .37 September 2002 86 1.48 * Using the exchange rate prevailing at the time of the price change. MCF = thousand cubic feet

49. A phased transition to a new gas pricing system was agreed with the government in early 2003 as part o f the reform program supported by the single-tranche Development Support Credit disbursed upon effectiveness in June 2003. It i s potentially a major breakthrough in that it l i n k s the wellhead price o f Petrobangla’s own gas to the international o i l price and i s designed to allow the operating companies to retain a higher proportion o f gross revenues. However, at the time o f the reassessment mission for the ESAC in December 2003, the government had fallen behind in the agreed timetable for i t s introduction*’. It i s too early to gauge if this reform i s likely to succeed after almost 20 years o f unsuccessful attempts to rationalize gas pricing in Bangladesh.

50. The only step to reduce the government share o f gross gas revenues and to increase the operating margins o f the gas companies was in 1994, when excise duties on gas were cut f iom 62 percent to 55 percent. Even though the government had agreed with IDA to annually review the operating margins o f the gas companies (as part o f the conditions o f the GIDP loan in 1985), no further action was taken to increase them. The total fiscal take from the gas sector at the end o f the 1990s was an excessively high 65 percent o f gross revenues. It has not yet been reduced. All Bank efforts to convince the government that permitting greater resources to remain in the sector will allow for better maintenance and new investment have been ineffective. The government continues to

19. The CPI rose by 24 percent during that period.

20. Petrobangla pointed out that the pricing formula has been gazetted by GOB and a proposal for a new price i s under active consideration by GOB.

12

treat the gas sector as a ‘cash cow’ which can be milked with l i t t le concern for the future development or sustainability o f the industry.

Electricity Pricing and Fin an cia1 Performance

5 1. Electricity tariffs saw a modest increase over the FY87-92 period that was examined by the original OED performance assessment. Significant progress was also achieved in reforming the structure o f tariffs. The number o f u n i t s o f power available to residential consumers at heavily subsidized rates was reduced, (with the exception o f the rural electrification cooperatives), and incentives to reduce consumption during peak hours (e.g., time-of-day tariffs) were introduced for BPDB’s major non-residential consumers. However, the progress was partially reversed because the structure o f the residential tariff blocks was altered in a regressive manner. In 1996, the f i rs t (subsidized) block was increased from 200 k W h to 300 kWh/month, contrary to economic logic, which would have led to a reduction in the size o f the initial block (see Annex table D).

52. In reality, after the ESAC performance assessment was written, the tariff structure was adversely modified, tariffs remained frozen for five years and financial covenants with IDA were not met. So, in terms o f power sector finances, the post-ESAC period saw reversals rather than progress. Electricity tariffs charged by BPDB and DESA” remained unchanged from 1991 to 1996, even though their 199 1 level was substantially below cost recovery. There have been small annual increases since 1997, so the increase in average revenue per unit for BPDB from Tk. 1.90/kWh in FY 92-93 to Tk. 2.5 in FY02-03 i s about 30 percent in total. However, during the same period, the Bangladesh consumer price index rose by over 50 percent, clearly indicating that real electricity prices have fallen substantially. In U.S. dollar terms, BPDB i s earning only about 4.5 cents/kWh on average, which i s less revenue per unit than 10 or 15 years ago when it was averaging 5.5-6.5 cents/kWh. Fortunately, BPDB’s operations and maintenance costs have also fallen as a result o f the rising proportion o f low-cost generation from independent power producers in BPDB’s generation mix.

53. Taka terms during the past decade. I t was Tk.2.4/kWh in FY92-93 and had only risen to Tk. 2.5/kWh in FY02-03. At this level, it cannot even cover i t s average supply costs o f about Tk. 3/kWh.

DESA has fared even worse: i ts average revenue barely increased in nominal

54. and commercial consumers continue to be overcharged in comparison to their long-run marginal supply cost (see tariff schedule in Annex D). The size o f the f i rs t residential tariff block has recently been reduced from 300 kWh/month to 100kWh, which i s a positive step, but the next tariff block (1 00-400 kWh) continues to be subsidized”. The bulk tariff to the Rural Electrification Board from BPDB and DESA also contains a

Major subsidies to household consumers are s t i l l prevalent today, while industrial

21. They have the same tariff schedule and charge the same rates to consumers. REB has different schedules and tariff rates that are somewhat higher.

22. The current tariff schedule has merged residential tariff blocks, with the result that the unit price for consumption between 300-400 kWh/month has been reduced and i s now only as much as it was in 1997.

13

subsidy, even though retail tariffs in rural areas are about 30 percent higher than in urban areas.

55. were modified in 1 99323 to emphasize revenue collection and energy loss reduction rather than an unattainable 8 percent return on revalued assets. Despite rapid annual sales growth o f about 10 percent, BPDB and DESA operated at a loss through the 1990s, essentially due to inadequate tariffs and high system losses. In FY02 their combined net losses were U S $ l l O million.24

BPDB has almost never met i t s financial covenants with IDA, even though these

56. decade. Combined (BPDB+DESAz5) energy losses have fallen by about 1 percent annually. More noteworthy i s the significant progress achieved o f late: total power sector losses (BPDB+DESA+Rural Electrification Board) have been brought down in the past three years from 35 percent o f generation to about 30 percent today.

Performance in reducing power system losses has improved slowly over the past

INSTITUTIONAL PERFORMANCE

Institutional Issues in the Gas Sector26

57. then ESAC (paras 29-30) has never been fully implemented. Local vested interests prevented the merger o f the two gas producing companies into one. The transmission company GTCL, was set up in 1993, but s t i l l does not own all the high-pressure gas pipelines in Bangladesh, due to resistance to the pipeline transfers from the staff o f the other operating companies.

Reorganization o f the gas sector along the l ines first envisaged under SGDP and

58. operating companies until 2003 and decisions relating to pricing, operating and development budgets, organizational setup, award of contracts, and even staffing and training have been subject to government as well as Petrobangla approval. All matters o f any importance are s t i l l ultimately decided by the government. The long-standing problem o f insufficient autonomy for operating companies has not eased to any significant extent during the past decade. Unsurprisingly, neither Petrobangla nor the government have been keen to reduce their tight control over these entit ies and pressure from donors in this direction has been to no avail. A Petrobangla-appointed local consultant i s expected to report sometime in 2004 on the institutional relationships between the operating companies, Petrobangla, and the Ministry o f Energy and Mineral Resources.

The government continued to be directly represented on the boards o f the

23. Under the subsequent Power Distribution (16 Towns) project, which closed in 1998.

24. On the other hand, REB recorded a profit o f about US$12 million.

25. I t did not exist at the time o f ESAC.

26. More detailed discussion can be found in the PPAR for SGDP and GIDP, prepared concurrently with this report.

14

59. the performance o f their o i l and gas sectors, especially through opening the sectors to increased competition (including from foreign companies), stronger regulatory authorities operating separately from any state ownership interests, abolition o f state monopolies, and the privatization o f state companies, often accompanied by (or preceded by) upstream and downstream restructuring.

Over the past 15 years, many developing countries have taken steps to improve

60. the involvement o f international companies in upstream activities (exploration and related development and production). The Bank’s gas projects have had l i t t l e impact on the institutional development o f the state-owned sector entities in Bangladesh. There has been l i t t le systemic reform since the time the SGDP was appraised 20 years ago and Bangladesh does not yet have modern and well-run gas enterprises in the public sector that can contribute to the eff icient utilization o f i t s resources.

In Bangladesh, the only departure from an entirely state-run gas sector has been

Institutional Issues in the Power Sector

61. under the 16 Towns Power Distribution Project in September 199 1 (which included a covenant to the effect that DESA would start commercial operations in mid- 1990). It eventually took three years (from late 1988 to February 1992) between the time the government approved the creation o f DESA and the time DESA’s organizational structure was sanctioned and redeployment and recruitment o f staff started.

Because o f the repeated delays in DESA’s start-up, IDA suspended disbursements

62. Disbursements under the 16 Towns Power Distribution Project remained suspended for 17 months ”, Thereafter the project was restructured and the financial covenants altered. But no component for the newly created DESA was included in the project, presumably because it was fe l t that DESA’s needs were being met by the Asian Development Bank and U.K. bilateral assistance.

63. However, DESA started l i f e with several major handicaps. I t s management came from the same pool as BPDB since new senior staff were not hired from outside. It also inherited the same labor problems that had plagued BPDB. The fact that it was set up as an “authority’’ rather than as a company meant that it was saddled with the same bureaucratic constraints as BPDB and inherited strong, politicized unions and a poorly performing workforce that could not easily be dismissed.

64. Furthermore, the creation o f DESA was in no sense a solution to the deep-seated problem o f poor corporate governance and weak management in the power distribution business. The high level o f illegal connections and unrecorded consumption, combined with poor revenue collection were (and s t i l l are) the Achilles’ heel o f the entire power sector. There i s no indication in the Bank documents for the ESAC as to how this was to be tackled.

27. New lending for power by IDA and the major donors had also been suspended because of BPDB’s financial problems. Although IDA has considered a new lending operation for BPDBDESA at various times in the post ESAC period, this has never materialized.

15

65. The Bank’s major role in the decision to create DESA as part o f the ESAC conditionality behooved it to assist in building the new institution. Yet in the past decade, the Bank has consciously stayed away from involvement with DESA and has not provided it with any institutional or capacity building assistance. However, it should have been clear that there could be no comprehensive improvements in sector performance by ignoring such a large segment o f the market - DESA accounted for a third o f total system peak demand in 1992. A decade later the DESA’’ share had risen to 42 percent o f peak demand and net energy sales. In the absence o f the Bank, DESA has relied mainly on funding and advice from the Asian Development Bank. N o twinning arrangement with a foreign utility was put in place2’ for capacity building. Non-technical losses remained unacceptably high throughout the post-ESAC decade.

66. DESA has also suffered from inadequate management leadership, having had about 10 chairmen since it started operations in 1992, almost one a year. Today, DESA i s burdened with surplus staff at a time when i t s own franchise area i s shrinking. When DESCO was created in 1998, (as part o f policy reforms pursued by the ADB) and took over distribution zones from DESA, it did not take any o f the former DESA staff, but hired afresh. I n essence, part of the commercial and operational problems that had afflicted BPDB before the creation of DESA had simply been shifted to a new entity, which had not been given the authority, the incentives, or the means of solving them.

4. Outcome and Assessment

Outcome

67. significant extent in the aftermath o f the ESAC, as indicated below:

This reassessment concludes that the expected benefits did not materialize to any

More rationalpatterns of energy demand: Modest progress was recorded in introducing some time-of-day pricing but distortions in both gas and electricity tariff structures and excessive cross subsidies o f residential consumers were not eliminated. Improved investmentplanning: Planning fe l l out o f favor during the 1990s in many countries and Bangladesh was no exception. There are no recent long-term investment plans for power or gas development, but even if there were, better planning could not have made up for the shortcomings in public sector management, decision-making and project implementation in the energy sector as a whole. Improvedjnancial viability for energy sector entities: For gas, ESAC price increases were not sustained in real terms during most o f the 1990s, although they have risen sharply in the last 2-3 years. Operating company margins are s t i l l much too low and the finances o f the Petrobangla group o f companies remain weak. Initial ESAC gains in electricity pricing have been eroded by inflation and they

0

0

28. Including DESCO.

29. Akin to the assistance given to the Rural Electrification Board by the U.S. National Rural Electric Cooperative Association.

16

are now lower in real terms than a decade ago. BPDBDESA consistently made large financial losses during the 1990s. However, there are now indications o f real progress in improved revenue collections and energy loss reduction since 2000. Mobilization of additional resources for the budget: L o w tariffs, high losses, and poor revenue collection in the power sector mean that it i s a burden, not a net contributor to the national budget. Unpaid debt service to the government by BPDB on foreign loans amounts to US$1 billion (Tk.56 billion) and the combined sectoral operating loss in FY02 was nearly Tk. 8 billion. The gas sector has always been a substantial contributor to government revenues, but cannot generate more resources in relative te rms since the government already takes about 65 percent o f gross gas sector revenues. However, expanding sales and a higher share o f “equity” gas from production sharing contracts will lead to higher revenues for the government in absolute terms. Removal of institutional constraints: As described in paras 57-60, above, institutional reforms envisaged as part o f the ESAC were either undertaken only partially (the Petrobangla reorganization), or failed to lead to better performance (the creation o f DESA).

68. Table 3 compares the key performance ratings o f the PAR with those o f this Reassessment Report.

For the above reasons, the ESAC’s overall outcome i s rated as unsatisfactory.

Sustainability

69. pricing (paras 52-53), overall sustainability i s assessed to be unlikely.

Given the modest benefits from the ESAC and the backsliding on electricity

Institutional Development Impact

70. under GIDP. However, they are s t i l l incomplete (paras 58-60). ESAC’s contribution to institutional development in the gas sector was modest at best.

Gas sector reforms were initiated under SGDP, reiterated in ESAC and continued

71. In electricity, the creation o f DESA did not solve any o f the sector’s institutional weaknesses. In some respects it was a retrograde step and it could be argued that overall commercial performance o f the sector in the 1990s might have improved more had it remained part o f BPDB all along. While this cannot be proved, it i s clear that creating a new entity gave r ise to additional costs, (such as in the form o f overheads), with no discernible benefits to consumers or to the government through better performance. This reassessment therefore concludes that ESAC’s institutional development impact in the power sector was negative.

72. taken together i s therefore rated as negligible.

Overall, ESAC’s institutional development impact on the gas and power sector

17

Bank Performance

73. SECALs are an inappropriate lending instrument for wide-ranging and difficult energy sector reforms, particularly o f an institutional nature. While this may not have been apparent at the time the ESAC was appraised, the program’s over-ambitious scope, complexity and unrealistic timeframe should have been taken into consideration. Insufficient attention was paid to the low-level o f ownership by the borrower. The Bank’s advice to create DESA was probably erroneous. Finally, as recognized by the completion report for the project, the second tranche conditions were not thoroughly scrutinized for compliance and the tranche was released prematurely. For these reasons, Bank performance i s rated as unsatisfactory.

With similar experience from other countries, it has become apparent that

Borrower Performance

74. Commitment to the goals o f the ESAC on the part o f the government and the energy sector entities was low. The government did not meet a significant number o f ESAC second tranche conditions. Data submitted to the Bank showing reductions in BPDB’s accounts receivable and system losses necessary for the latter turned out to be erroneous and the real figures were significantly worse. Reversal o f progress on energy pricing in the post-ESAC period by a five-year freeze on tariff increases, aggravated the already poor finances o f the sector. For these reasons, borrower performance i s assessed as unsatisfactory.

CONCLUSIONS Table 3: Comparative Performance Ratings

Indicator PAR (1993) Reassessment (2004) 75. It i s significant as well as sobering to note that Overall Outcome Barely satisfactory Unsatisfactory the bulk o f the energy sector Rehance Not rated High issues, problems and policy Sustainability Uncertain Unlikely recommendations from the I D Impact Partial Negligible 1980s recurred in the 1990s Bank Performance Not rated Unsatisfactory and are s t i l l high on the Borrower Performance Not rated Unsatisfactory agenda today. The l i s t o f unfinished reforms i s lengthy and judging by the slow progress o f the past two decades, they are likely to take another decade or two to implement.

76. extend access to gas and electricity nationwide (but most particularly in the western half o f Bangladesh) i s a regrettable omission in Bangladesh’s developmental goals. I t s absence has also hindered progress toward accelerated access to modern energy for Bangladeshis by allowing attention to be diverted to the option o f gas exports to India, despite the political difficulties involved.

The lack o f a clearly articulated energy sector development strategy to rapidly

77. Nevertheless, the Bangladeshi energy sector taken as a whole i s in much better shape than a decade ago, despite major unresolved problems in i t s parastatal entities. Shortages have been greatly reduced, access to electricity has increased substantially in

18

rural areas3’ and the private sector plays an important and growing role in the energy supply business. Bangladesh’s successful experience with independent power producers (para 35) deserves more international coverage, particularly among the Bank’s other clients. Contrary to expectations in the midlate 1990s, the participation o f the private sector in energy has neither acted as a catalyst for reforms among energy parastatals, nor led to an unsustainable financial crisis in the Bangladesh energy sector (which in turn could have triggered reforms). This finding i s fully consistent with the recent OED/OEG/OEU study3’ on private participation in electricity that concluded ‘good individual private sector project outcomes cannot alone ensure good sector-level outcomes’.

5. Lessons Learned

78. The main lessons that can be drawn from the Bangladesh ESAC and subsequent developments in the energy sector are given below. They are consistent with experience from energy sector operations in other countries.

0 SECALs are a poor choice o f lending instrument for long-gestation institutional reforms in the energy sector because o f the budgetarylbalance o f payments imperatives to disburse funds quickly and the difficulty o f obtaining ownership by implementing agencies o f reforms in the absence o f any targeted funding to them (paras 15 & 22);

0 Creating new entities such as DESA or GTCL i s not a solution to deep-seated problems o f corporate governance and managerial weakness that plague the energy sector (para 64); and

0 The Bank should not push for the creation o f new entit ies unless it i s wil l ing to commit to assisting such bodies as are born out o f Bank-financed reforms (para 65).

30. There are now over 4 mi l l ion rural households with access to electricity, considerably more than the total number o f electrified homes in urban areas, although the rural access rate i s s t i l l only 20 percent. I f the current annual rate o f 0.5 mi l l ion new connections can be sustained by REB, 30 percent electrification o f rural households i s achievable by 201 0.

3 1. “Power for Development - A review o f the WBG’s experience with private participation in the electricity sector” by Manibog, Dominguez & Wegner, December 2003.

19

Annex A. Basic Data Sheets

Annex A

ENERGY SECTOR ADJUSTMENT CREDIT (CREDIT 1 9 9 9 - ~ ~ )

Key Project Financing Data (amounts in US$ million)

Appraisal Actual or Actual as% of estimate Current estimate appraisal estimate

International Development Association 177.3 179.45 101

Cumulative Total Actual Disbursements FY89 FY90

Planned l a 0.00 117.30 Actual (US$M) 30.00 147.56

Project Dates Original Actual

Board approval 0411 1/89 0411 1/89 Effectiveness 06/27/89 06/05/89 Closing date 12/31 191 07/03/90

Staff Inputs (staff weeks) Staff Weeks

Preappraisal 190.5 Appraisallnegotiat ions 42.8 Supervision 32.0 ICR 10.8 Total 276.1

Mission Data Date No. of

(m on th/year) persons Specializations represented

Identification/ May 1986 12 _ _ Appraisal March 1987 I O -- Supervision July 1988 7

Preparation

__ _ _ December 7

1989 Completion

21 Annex B

Annex B. Borrower Comments

~ ~ ~ 2 F i e l , r M s l l o ~ q a o F i ~ ~ ( t ~ s p T c ) Bangladesh Oil, Gas & Mineral Corporation (Petrobangla)

No. 32.07.70 '1 8 6 Dated: 15 -06-2004.

Thc Secretary Eiurgy and Mineral Kosources Division Ministry o f Power, Energy and Minerd Resources Bangladesh Secretariate Dhaka-1000. 1

Initial : .l..l-.-...-.l... C--..-..-.--- 1 - - 4 E a I Tcam, WOO0

Attention : Benum Maksura Noor. Sr. Asstt. Secretam.

Sub: Comments o f Petrobangla on Draft Project Performance Assessment Report of Second Gas Development Project (Cr. No.l586BD), Gas Mastructure Development Project (Cr. No, 2720-BD) and Bangladesh-Energy Sector Adiustment Credit (Credit No. 1999-BD).

Dear Sir,

Kindly refer to the World Bank letter of 17 May, 2004 addressed to the Secretary, Economic Relations Division along with the copy of Draft Project Performance Assessment Report of Second Gas Development Project (Cr. No.l586BD), Gas Inhtructure Development Pmject (Cr. No. 2720-BD) and Draft Project Performance Re-assessment Report of Bangladesh- Energy Sector Adjustment Credit (Credit No. 1999-BD). As desired necessary comment conceming Petrobangla is attached herewith for kind perusal and fiuther necessary action.

Thanking yod,

Sincerely Yours,

/&$&$&\,, Major . Muqtadir Ali (Retd.)

Enclo : As stated above.

7 Mr. Alain Barby Manager, Sector and Thematic Evaluation Group. Operation Evaluation Department. World Bank Office, 3& Paribagh, Dhaka

' 2. Manager (Co-ordination). Chairman Section, Petrobangla, Dhaka.

.- PETROCENTRE, 3, Kewran 0erar CIA. Dhaka-1216, G.P.O. ~ O X No-&W. Cable : Petrob.nala Telephone : PABX-0121010-18, 9121095-41, Fax : 88-02-9120224 web slte : www.petrobnngla.org, E-mail : petchair@ petrobangle.org

22 Annex B

hrr 110.

1.

2.

3.

4.

5.

6.

Comments of Petrobangla On Project Performance Reassessment Report Of Energy Sector Adjustment Credit (Cr.1999-BD)

stment programs o f the into sectoral investnaent

continue at the rate

23 Annex B

7.

8.

9.

IO.

11.

12.

13.

The f n m t e d and overlopphg structure of the Peaobangla open- COrnpanieS md their unsatisfactory collective perfommce d e d for a realignment of tbe variouc entities involved in the sector, the streamlining of their responsibilities, and consolidation and strengthening of available expertise in p lanaing and Operations. A sweeping institutional reform o f t he sector had initially been a p e d in the course Of appraising the Second Gas Project in 1984 and was then incorporated in the conditionality for the ESAC. Previous and Submquent Bank Lending for Energy

Before the M A C , IDA had provided 10 credits for energy projects amounting to about USS600 million (see Annex E). Thew projects represented 19 percent of IDA resources committed to Bangladesh in the period 1979-88. Lending in the energy sectors had been designed to expand the use o f natural gas as a substitute for imported oil, rationalize the country's supply of petroleum products, promote conservation and more eficient energy use, and encourage gas and oil exploration. IDA also had !%wed projects to expand the country's power generation, transmission, and distriiution capabilities and rural electrification systems. In the late 19809, IDA'S energy project portfolio was substantial, with eight projects at various itages of implementation. These were evenly divided between gas development (production, processing and transportation), and electricity. Lending by the Bank for the energy sector shrank dramatically during the 1990s. only three new operations have been approved in the last decade, one for gas in 1995, a partial risk guarantee for power generation in 2000, and a rural electrification project in 2002. After a long hiatus, a new operation in support of power sector reforms is currently being prepared. The main issues addressed by the ESAC (investment planning, pricing and institutional reforms) had featured under prior SILs, but with limited progress. The Second Gas Development Project had already obtained government agreement to the pMciple of the gas companies self-financing a reasonable proportion of their fi~ture investment requirements, but very modest results had been achieved. BPDBIs reorganization had been addressed for years by IDA and ADB through past project lending, but much remained to be done at the lime of the ESAC. Progress in improvhg the electricity sector's commercial and financial performance had also been disappointing. The reform o f the gas sector's institutional framework had been agreed with GOB in the mid-1980% but had not been implemented. Objectiva and Deslgn of the ESAC Formal preparation of the ESAC began in May 1986; it was appraised in March 1987 and negotiated in July 1987. However, presentation to the Board was delayed until April 1989 because the government had difficulty meeting the required c o n d i t i ~ ~ . According to OED's 1993 PPAR, this was basically due to a lack o f government :o"itmnt and an underestimation by Bank staff during project preparation of the iiflhlty o f r apidly s olving the p olicy and i nstitutional p roblrms that t hc s ector had =en facing for some time. me objective o f the M A C was to assist GOB in extending and refining its energy )olicy and to strengthen energy sector institutions. Under the Third Five-Year Plan '1986-1990) the government's objectives for the energy sector were to: (a) accelerate he development of domestic natural gas resources to reduce the country's dependence )n imported oil; (b) adjust en-rgy prices to promote the efficient and economic use of mrgy, taking into account social objectives; (c) mcet the demand for energy at least :ost to the economy; (d) improve power supply reliability and quality, and reduce iystem losses; (e) improve energy sector entities' financial performaace and mobilize he resources required to meet the country's development goals; and (0 encourage )rivate sector participation in the encrgysccto~s development, particularly in oil and !as exploration. The major outcomes from the ESAC were expected to be:

more rational patterns o f energy demand; . @roved financial viability for energy sector entities; mobilization o f additional resources for the budget; and

improved investment planning; 0

0

0 removal of institutional constraints.

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24 Annex B

14.

I S .

16.

17.

18,

19.

20.

in energy price levels and to

before it, GOB agreed to price natural gas to achieve better economic efficiency, equity, and resource mobilization. Economic pricing would also help gas companies achieve their financial targets, so the ESAC was designed to put additional pressure on gas companies to increase self-financing o f investmnts. The margins on gas prices received by the gas companies were to be set at such levels as to allow each of them to cover their cos&, including depreciation, and to cover a rising proporlion o f their annual

programs Erom internally generated funds to reach 40 percent in FY93 and

cent in FY93) on assets.

3een implemented would be included in the ESAC. Further implementation of major

8

25 Annex B

In 1987, the prospects o f using the M A C to make progress on the reorganization of BPDB led to a reorganization study that recommended that BPDB's distribution operations should be decentralized to strengthen the interface between BPDB and its consumers and to better control system losses and accounts receivable. , O k recommendations pertained to organizational changes and restructuring within BPDB and to strengthening its operations, particularly in the a m s of planning, m, management information, and personnel systems. These recommendations w m agreed in principle by the government, BPDB, and IDA in 1988, leading to gov-t approval for the reorganizatian o f BPDB, including the establishment of the Dhaka Electricity Supp ly Authority (DES A) as a separate entity by July 1,1990. - 2. Implementation and Performance through 1992

The ESAC was to be disbursed in two tranches, the fmt at Credit effectiveness, and the second about a year later. Many actions wen taken in the period prior to Board presentation, which was considembly delayed to permit GOB to m e t them. For release of the second tranche, the government had to meet eleven conditions, relating mainly to tariff increases and compliance with existing financial covenants o f previous loans designed to reduce system losses and accounts receivable. There were also nine dated covenants to be met, Despite only partial compliance with the tranche release conditions, Bangladesh's critical foreign exchange situation was used to justify a Board waiver on gas price increases and tranche release went ahead on schedule m June 1990. In addition, the data on power system losses and BPDB's accounts receivable submitted to the Bank by GOB for 2nd tranche release indicated a higher level of compliance than later tumed out to be the case, and the completion report 1 J concluded that the tranche should not have been released. The ESAC 'experiment' was not repeated in Bangladesh and instead of subsequent SILs were once again tied to policy reforms. Investment planning: The 1993 PP AR on the ESAC found that in practice, the Priority Investment P rogram (PIF') process h ad 1 ittle impact b ecause o f major a unual deviations between the actual outcome and the PIP, both in terms o f the volume of spending as well as its composition. The PIP process helped to reduce the extent to which 1 ower- priority projects received funding, but the P AR c oncluded that overall, investment planning saw only modest improvement as a result of the ESAC policy conditionality. Energy pricing: During the ESAC period from FY87 to FY90, weighted average gss prices were increased by 43 percent in nominal terms and by 15 percent in real terms. As shown in Table I, between FY87 and FY92, significant increases took place in real gas prices. A calculation o f the economic price of gas at that time showed that the required level was Tk.45 per thousand cubic fcet with a 12 percent discount rate. Thus, the hcrcases achieved in 1987-90 under the ESAC, which raised the average gas price to Tk.44 per thousand cubic feet in 1990, wen sufficient to reach at least the mini" estimate of the economic resource cost.

During the ESAC negotiations in1987 and befonBoard presentationin 1989,, some nstxuchaing of LBPDB's tariffi was c a n i d out. Further restructuring was agreed as a POWr 53 condition o f second tranche release Fmiliser 33 (July 1990). BPDB's average tariff was also raised by 15 percent as a Industrial 22 condition of negotiations, so 8 large Dolzlestic 24 part of the ESAC power tarif€reforms 5 were in fact carried Out m 1987-88), before Board Presentation.

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26

Under SGDP, agreement was reached with GOB to create gas operating compaaies with functional rather than geographical responsibilities. Petrobangla would be divested of all operational activities and become a holding company, with the government's equity in the operating companies, and be responsible for investment planning and monitoring as well as sector policy formulation. The operating companies placed under Petrobangla's control were to include a national exploration and drilling company, a single national gas production company, a national transmission company, initially three regional distriiution companies, a compressed natural gas company and a solid minerals company. The boards of directors of the operating companies would include Petrobangla representatives but no government representatives; the government's control would be exercised through its representation on Petrobanglads own board. I t was agreed during the ESAC negotiations that SGDP conditionalities related to the

reorganization of the PB Group which had not been implemented would be included in the ESAC. Further implementation of major gas sector refonns, including legal :stablishment o f new O C s and appointment of key staff, became conditions of the ESAC second tranche release, but these institutional measures were only very partially in place when tranche release took place. 3. Performance since 1992 Prlvate Seetor Participation in Energy Private gas and power production i s a major success story in an ener~y sector that has shown disappointing progress in virtually all other respects. The past decade, d especially the past five years, has witnessed unprecedented foreign private investment in both gas and electricity production in Bangladesh. These investments bave transformed the energy sector: today, over a fifth of gas production and a tlrird of clectricity generation is by the private sector and these shares arc likely to grow further. Meanwhile, in parallel, the performance of energy parastatals continues to 'bo unsatisfactory. This may appear paradoxal, but experience elsewherell has also shown hat substantial private investment can occur in unreformed energy secton. dcpendins *.m- *-;fir rniintrv rnnditinns.

Annex B

26.

27.

28.

29.

30.

31.

Inrtltutlood p erformnce: Implementation of key steps in a dated action plan for BPDBs reorganization and the start of commercial operations by DESA were to be conditions of second tranche release, but waivers had to be granted regarding DESA, because of major delays that stemmed h n a lack 'of commitment by BPDB's management and heavy resistance by the unions to the creation of DESA. Many months elapsed before GOB and BPDB were able to take the necessary actions to enable DESA to commence commercial operations in late 1991, The opposition of the unions to the reorganization of BPDB was underestimated both by the consultants and by IDA staR The consultants had proposed the creation of five distribution companies, But the unions were athid that tbis would lead to BPDB's dismantling and to privatization, and a decline in their influence, Despite the reluctance ofBPDB's management (which was aware of union opposition), GOB agreed with IDA to the establishment o f DESA as a starting point, I t was only much later that the unions agreed to DESA's formation under the condition that DESA would not be privatized. As pointed out by the PP AR, I D A staff and consultants should have been much more realistic about the difficulty of setting up five distribution companies and the prospects

As part of the ESAC program, the govenunent agreed to bring BPDB's energy losses down to 35 percent for Board presentation and to 32 percent for release o f the second tranche. While the Board condition was met, losses rose again and reached 41 percent in fiscal years 1991 and 1992. However, the second tranche bad been released on the basis of incorrect (unaudited) data provided to IDA that indicated a level of losses below the covenanted 32 percent.

o f enacting such fbda"td -tutal r e f o m under the quick-disbursing ESAC.

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27 Annex B

offering a fixed tariff to all

ewes credit for its

s h , leaving only two foreign gas

be undertaken with IDA, but this

28

gas transmission bottlenecks are already apparent. The coal sector illustrates the consequences of ignoring least-cost planning principles. 44.

Annex B

No com"t

shortages, while a third of BPDB's generation capacity was unavailable due to lack of

shedding. However, there i s now a risk that power shortages will reemerge in near term The program for soliciting new bids for independent power producer capacity has run into delays, while demand continues to grow robustly. Near-term prospects for &ps supply seem to be satisfactory, with new fields expected on stream shortly. However,

with a Chinese consortium-to develop anundcrground mine to produce a ndI& tons of coal per year, despite Western donor objections on grounds of high cost and misallocation of resources. But coal production and power generation b m it is still several years away. This project is expected to cost over half a billion dollars to produce e firel that will be used to generate electricity at twice the cost of gas-based generation. AU these examples iadicati~e o f plarming shortcomings during the poSt-ESAC period in Bangladesh, which have been compounded by insufficient or uncoordinated and delayed investments by the major public sector energy producers, leading to a suboptimal and wasteful use o f scarce resources. Energy Priclng This reassessment found that there was limited progress with pricing ksues in both the

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45.

46.

47.

gas and electric power sectors during the past decade. For a s u b s t d a l p~riod in the 199Os, energy prices actually declined in real tcrms. Gas Pricing and Finances Improvements in the real level of gas prices in the early 1990s (see para. 24) wcn not

sustained, because of the M q u e n c y of price increases, as can be seen from Table 2. The near five-year freeze in gas prices from early 1994 to late 1998 eroded their real value by a quarter. 19 However, prices have climbed sharply since 2000 in both real

Bangladesh CPI has risen by about 70 percent in total, while average gas prices arc now about 90 percent above their nominal 1990 level.

( T h ) and U.S. dollat terms to wipe Out the declines of the mid-1990S. Since 1990, the

No comment

29 Annex B

- 48.

- 49.

50.

S I .

No laion wu hken duriug the ESAC (or subaquently), to dta relative gas prices in order to reduce tbe extent of subsidiw to the power rad tsailizcr sectors) or to dormtic users of gas. Only 4 percent of howholds have access to domestic gas FY 90 44 1.36 supply and benefit from a subsidy May 1992 50 1.28 estimated at nearly Tk.3 billion (over March 1994 55 1.37 USSSO million) annually The vast majority, who use kcrosene or LPG for cooking, receive no subsidy at all. A phased transition to a new gas pricing system was agreed with the government in

Support Credit disbursed upon effectiveness in June 2003. It M potentially a major breakthrough in that it links the wellhead price of P m baagia's own gas to the international oil price and is designed to allow the operating companies to retain a higher proportion of gross ~VCLIUCS. However, at the tkae of the reassessment mission for the ESAC in December 2003, the government had fallen behind in the agreed timetable for its introduction. It is too early to gauge if this reform is likely to succeed after almost 20 yean of unsuccessful attempts to rationalize gas pricing in Bangladesh.

~ l y 2003 a~ part of the refom program supported by the single-tranche Development

The only step to reduce the government shan of gross gas revenues and to increase the operating margins of the gas companies was in 1994, when excise duties on gas wen cut from 62 percent to 55 percent. Even though the government had agreed with IDA to annually review the operating margins of the gas companies (as part of the conditions of the GIDP loan in 1985), no Wer action was taken to increase them. The total fiscal take fiom the gas sector at the end of the 1990s was an excessively high 65 percent of gross revenues. I t has not yet been reduced. All Bank efforts to convince the govenunent that permitting greater resources to remain in the sector will allow for better maintenance and new investment have been incffectivc. The govemment continues to treat the gas sector as a 'cash cow' which can be milked with little concern for the future development or sustainability of the industry.

Electric& M i n g and Finmclal Pcrforrnance Electricity tariffi saw a modest increase over the FY87 -92 period that was cxamined-by the original OED performance assessment. Siflcant progress was also achieved in reforming the structure of tariffs. The number of units of power available to residential consumers at heavily subsidized rates was reduced, (with the exception of the rural electrification cooperatives), and incentives to reduce consumption during peak h o w (e+, time-of-day tariffs) w n introduced for BPDB's major non-residential consu", However, the progress was padally revcrsed because the structure of the residential tariff blocks was altered in a regressive manner. In 1996, the f h t (subsidized) block was increased &om 200 kWh to 300 LWmonth, contrary to economic logic, which would have led to a reduction in the size of the initial block (see Annex table D).

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As per agreement ma& between WorId Bank and GOB formula for fixation o f gas price ha$ been approved by GOB. Accordingly a SRO/Gazzete Notification

been issued vide No. @( 9Tt-

have already

>)M3000 (we) /uoc 0m a-oh- aoooa; I AS stated in the pricing formula, a proposal for fixation of gas price is in the process of active consideration by GOB, Present 55% GOB margin on gas price consist of supplementary duty and VAT in the new system supplmtary duty on per unit o f gas is fixed and VAT will be on 15% As a m l t GOB margin will not be incruucd against increase volume of SalCS for WPl-tarY duty. This i s also in the process o f approval.

No comment

30 Annex B

In reality, ifter the ESAC performance mseament waa written, the tariff Structure w8a advenety modified, tariffs remained for five y e u ~ and Anancid C O V ~ with IDA were not met, So, in tmns of power sector fiaances, the post-ESAC period reversals rather than progress. Electricity tarinrs charged by BPDB and DESAZO remained unchanged from 1991 to 1996, even though their 1991 level was substantially below cost recovery. There have becn small annual increases since 1997, so the increase in average revenue per Unit for BPDB fiom Tk 190kWh in FY 92-93 to Tk. 2.5 FY02-03 is about 30 percent in total, However, during thc same period, the Bangladesh consumer price bdex rose by over 50 percent, clearly indicating that red electn'.city prices have fallen substantially. In U.S. dollar tenas, BPDB is earniag only about 4.5 centa/kwh on average, which is less revenue per unit than 10 or I S years ago when it was averaging 5.5-6.5 cents/kwh Fortunately, BPDB's operations and maintenance costs have also fallen as a result of the rising proportion of low-cost generation from independent power producers in BPDB's generation mix. DESA has fared even worse: its average revenue barely increased in nominal Taka tams during the past decade. I t was Tk+2,4/kwh m FY92-93 and had only risen to Tk. 2.S/kWh in FYO2-03. At this level, it cannot even cover its average supply costs o f about Tk. 3/k Who Major subsidies to household consumers arc still prevalent today, while industrial and commercial consumers continue to be overcharged in comparison to their long-run marginal supply cost (see tariff schedule in Annex, D). The size of the first residential tariff block has recently been reduced from 300 kWmonth to IOOkWh, which is a positive step, but the next tariff block (100-400 kwh) continues to be subsidized!] The bulk t arB t o the Rural E lectrification B oard from B PDB and D ESA a Is0 c ontains a subsidy, even though retail tariffs in rural areas are about 30 percent higher than in urban areas. BPDB has almost never met its financial covenants with IDA, even though these were modified in 199322 to emphasize revenue collection and energy loss reduction rather than an unattainable 8 percent return on revalued assets. Despite rapid annual sales growth of about 10 percent, BPDB and DESA operated at a loss though the 1990~~ essentially due to inadequate taxiffs and high system losses. In FY02 their combined net losses were US$ 1 1 0 million.23 Performance in reducing power system losses has improved slowly over the past

decade. Combined (BPDB+DESA 24) energy losses have fallen by about I pcrcent mually. More noteworthy i s the significant progress achieved of late: total power sector losses IBPDB+DESA+Runrl Electrification Board) have bccn brought down in I the past three

I MSTITUTIONAL PERFORMANCE &om 35 percent of generation to about30 percent today.-

Institutional Issues in the GM Sector Reorganization o f the gas sector along the lines fmt envisaged unda SGDP and then ESAC (paras 29-30) has never been fully implemented. Local vested interests prevented the merger of the two gas producing companies into one. The transmission company GTCL, waa set up in 1993, but stil l docs not own all the high-pres~m gas .pipelines in Bangladesh, due to resistance to the pipeline transfers from the staff of the other operating companies. The g ovement c ontinucd to b e directly r epresented on the b oar& o f t he o pcrating companies until 2003 and decisions relating to pricing, operating and development budgets, organizational setup, award of Contracts, and even staffig and training have been subject to government as well as Petrobangla approval. All matten of any importance a re st ill ultimately d ecided b y the government. The f ong-standing pmblem of insufficient autonomy for operating companies has not eased to any significant extent during the past decade. Unsurprisingly, neither Petrobanglo nor the government have been kcen to reduce their tight control over these entities and pressUn from donors in this direction has been to no avail. A Petrobangla-sppoinad local consultant i s expected to report sometime in 2004 on the inStitUtiona1 relationships between ?he operating companies, Petrobarrgla, and the Ministry of Energy and M b e d Resources. *

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31 Annex B

- 59.

- 60.

- 61.

- 62.

66.

Ova the p u t 1 5 yean, many developiag c ouatries h ave taken steps t 0 improve the pcrfomnnca of their oil md gas sectors, especially though opening the secton to increased competition (including fiom foreign companies), stronger regulrtory authorities operating separately h m any state ownership inmts, abolition of state monopolies, and the privatization of state compauies, often accompanied by (or

preceded by) upstream and downstrum restructuring. In Bangladesh, the only departure from an entirely state-run gas sector has been the

involvement o f international companies in upstream activities (exploration and related development and production). The Bank's gas projects have had little @act on the institutional d evelopmcnt o f t he s tate-owned s ector e ntities i n B angladesh. There has been little systemic reform since the time the SGDP was appraised 20 years ago and Bangladesh does not yet have modern and well-run gas enterprises in the public sector that can contnitc to the efficient utilization of its resources. Inrtitutlosal Issues In the Power Sector Because of the repeated delays in DESA's start-up, IDA suspended disbursements

under the 16 Towns Power Distribution Project in September 1991 (which included a covenant to the effect that DESA would start commercial operations in mid-1990). I t eventually took three years (from late 1988 to February 1992) between the time the ~ovemnun! approved the creation of DES A and the timc DESA's organhtional - structure was &ctioned and redeployment and recruitment o f staff started Disbursements under the 16 Towns Powa Distribution Project m i n e d suspended for 17 months 26. Thereafter the project was restructured and the financial covenants altered. B ut no c omponent for the n ewly c reated D ESA was included in the project, presumably because it was felt that DESA's needs were being met by the Asian Development Bank and U.K. bilateral assistance. However, DESA started life with several major bmdicaps. I& management camc from the samc pool as BPDB since new senior staff w e n not hired fkom outside. I t also inherited b e same labor problems that had plagued BPDB. The fact that it was set up as an "authority" rather than as a company meant that it was saddled with the same bureaucratic constraints as BPDB and inherited strong, politicized unions and a poorly performing workforce that could not easily be dismissed. Fu~themon, the creation o f DES A was in no sense a solution to the deepseated

problem o f poor corporate governance and weak management in the power distribution business. The high level of illegal C O M C C ~ ~ O ~ S and' unrecorded consumption, combined with poor revenue colIcction were (and stil l arc) the Achilles' heel of the entire power sector. There is no indication in the Bank documents for the ESAC as to how this was to be tackled. The Bank's major role in the decision to create DESA as part o f the ESAC conditionality behooved it to assist m building the new institution. Yet in the past decade, the Bank has consciously stayed away from involvement with DESA and has not provided it with MY institutional or capacity building assistance. However, i t should have been clear that there could be no comprehensive improvements in sector performance b y ignoring such a large segment o f the market - DESA accounted for a third of total system peak demand in 1992. A decade later the DESA nshare had risen to 42 percent of peak demand and net energy sales, In the absence of the Bank, DESA has relied mainly on funding and advice fiom the Asian Development Bank NO twinning arrangement with a foreign utility waa put in place28 for capacity building. Non-technical losses remained unacceptably high throughout the post-ESAC decade. DESA has also suffered from inadequate management leadership, having had

about 10 chaixmcn since it started operations in 1992, almost one a year. Today, DESA i s burdened with su~plus staff at a time when its own franchise area is shrinking. When DESCO was created in 1998, (as part of policy reforms pursued by the ADB) and took over distribution zones from DESA, it did not take any of the former DESA staff, but hired afiesh. In essence, part of the commercial and operational problems thar had aflicted BP DB before the creation of DESA had simp& been shifted to a new mti@, which had not been given the authority, the incentives, or the meam of solving them.

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32 Annex B

67.

4. Outcome and Assessment OutCoIne This reassessment concludes that the expected benefits did not materialize to any significant extent in the aftermath o f the ESAC, as indicated below:

. More rational patterns of energy demand: Modest progress was recorded in introducing some time-of-day pricing but distortions in both gas and electricity tariff structures and excessive cross subsidies o f residential consumers were not elkninated. h m ~ v e d investment planning: Planning fell out of favor during the 1990s In many counbies and was no exception. Them am no m t kmg-tsrm Invcrsbnent plana for power or gas development but even If them ware, better phning could not haw made up for the ahtoomlngs In public s e&or management dedalon- making and pmject lmplementatlon In the enw sector as a whole. Improved financial viability for energy sector entities: For gas, ESAC price

increases were not sustained in real terms during most o f the 199Os, although they have risen sharply m the last 2-3 years. Operating company margins are stil l much too low and the finances of the Petrobangla group o f companies remain weak. Initial ESAC gains in electricity pricing have been eroded by inflation and they are now lower in real terms than a decade ago. BPDBlDESA consistently made large financial losses during the 1990s. However, there arc now indications of real progress in improved revenue collections and energy loss reduction since 2000. Mobilization of additional resources for the budget: Low tariffs, high losses, and poor revenue collection in the power sector mean that it is a burden, not a net contributor to the ~ t i 0 ~ 1 budget. Unpaid debt service to the government by BPDB on foreign loans amounts to USSl billion (Tk.56 billion) and the combined sectoral operating loss in F YO2 was nearly Tk. 8 billion. The gas sector has always been a substantial contributor to government revenues, but cannot generate more resources in relative terms since the government already takes about 65 percent of gross gas sector revenues. However, expanding sales and a higher share of "equity" gas fiom production sharing contracts will lead to higher revenues for the government in absolute terms. Removal of institutional constrain@: As described in paras 57-60, above, institutional reforms envisaged as part of the ESAC were either undertaken only partially (the Petrobangla reorganization), or failed to lead to better

the time the ESAC was appraised, the program's over-ambitious scope, complexity and unrealistic timeframe should have been taken into consideration. Insufficient attention I--- -..:A *n *I.- I n = ~ l w r l nf nwnershio by the borrower. The Bank's advice to create

I

33

~ _ ~ _ _ - I t is significant as well as sobering to note that the bulk of the energy sector issues, problems and policy nconnncndations &om the 1980s recurred in the 1990s andanstil l highonthe agenda today.Thelistofunfhishedreforrmislengthyand judging by the slow progress of the past two decades, they are likely to take another decade or two to implement. The lack of a clearly articulated energy sector development strategy to rapidly extend access to g as and e lectricity nationwide (but most p articularly in the western half o f Bangladesh) i s a regrettable omission in Bangladesh's developmental goals. Its absence has dso hindered progress toward accelerated access to modem energy for Bangladeshis by allowing amt ion to be diverted to the option of gas exports to India, despite the political difficulties involved Nevertheless, the Bangladeshi energy sector taken os a whole is in much better sbape than a decade ago, despite major unresolved problems in its parastad entities. Shortages have been greatly reduced, access to electricity has increased substantially in rural areas29 and the private sector plays an important and growing role in the energy ' supply business, Bangladesh's successll experience with independent power producers (para 35) deserves more i n t ~ r ~ ~ t i 0 ~ 1 coverage, parb',cuarly among the Bank's other clients. Contrary to expectations in the m i a t e 199Os, the participation of the private sector in energy has neither acted as a catalyst for r e f o m among energy parastatds, nor led to an unsustainable financial crisis in the Bangladesh energy sector (which in turn could have triggered reform). This finding i s fully consistent with the recent OED/OEG/OEU study on private participation in electricity that concluded 'good individual private sector project outcomes carmot alone ensure good sector-level outcoms'.

The main lessons that can be drawn fiom the Bangladesh ESAC and subsequent 1 developments in the energy scctor are given below. They are consistent with experience from energy sector operations in other countries.

SECALs (IIC a poor choice of lending instrument for long-gestation institutional reforms in the energy sector because of the budgetaryhalance of payments inrperatives to disburse funds quickly and the difficulty of obtaining ownership by implementing agencies of reforms in the absence of any targeted funding to them (paras 15 & 22); Creating new entities such as DESA or GTCL is not a solution to deep-seated problems o f corporate governance and managerial weakness that plague the energy sector (para 64); and The Bank should not push for the creation of new entities unless it i s willing to cormnit to assisting such bodies as arc born out of Bank-financed reforms (para

1 5. Lessons Learned

I

~

Annex B

DESA was probably erroneous. Fiually, u recognized by the completion nport for thc project, the second tranche C O Y ~ ~ ~ ~ O M were not thoroughly scrutinized for compliance and the tranche was released prematurely. For these WOM, Bank performance is rated as unsatisfactory. -

74.

- 75.

- 76.

77.

- 78.

Borrower Performance C o d t m e n t to the goals of the M A C on the part of the government and the energy sector entities was low, The government did not meet a significant number o f ESAC second tranche conditions. Data submitted to the Bank showing reductions in BPDB's accounts receivable and system losses necessary for the lattcr tuned out to be moncous and the real figures were significantly wone. Reversal of progress on energy pricing in the post-ESAC period by a fiveyear freeze on tariff increases, aggravated the already poor Gnances of the sector. For these reasons, borrower p c r f o m i s assessed as Unsat is fac tO~. CONCLUSIONS

qo COmmCnt

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- I 65).