Extended Annual Review Report

Project Number: 34912 Investment/Loan/Guarantee Numbers: 7167- LN/GU1815 December 2011

Loans and Partial Risk Guarantee AES Kelanitissa Power Project (Sri Lanka) In accordance with ADB’s public communication policy (PCP, 2005), this extended annual review report excludes information referred to in paragraph 126 of the PCP.

CURRENCY EQUIVALENTS

Currency Unit – Sri Lanka rupee/s (SLRe/SLRs) At Appraisal At Project Completion 30 October 2000 10 October 2003 SLRe1.00 – $0.0126 SLRe1.00 – $0.0106 $1.00 – SLRs79.35 $1.00 – SLRs94.42

ABBREVIATIONS

ADB – Asian Development Bank AES – AES Corporation AKL – AES Kelanitissa (Private) CEA – Ceylon Environmental Authority CEB – Ceylon Electricity Board CPC – Ceylon Petroleum Corporation DSCR – debt service coverage ratio EHS – environmental, social, health, and safety EIA – environmental impact assessment EIRR – economic internal rate of return EPC – engineering, procurement, and construction FBU – functional business unit FIRR – financial internal rate of return ISO – International Organization for Standardization LIBOR – London interbank offered rate NEPS – National Energy Policy and Strategy O&M – operation and maintenance PPA – power purchase agreement PRG – partial risk guarantee PRI – partial risk insurance PUCSL – Public Utilities Commission of Sri Lanka RRP – report and recommendation of the President SEA – Sustainable Energy Authority WACC – weighted average cost of capital XARR – extended annual review report

WEIGHTS AND MEASURES

GWh (gigawatt-hour) kWh (kilowatt-hour) kV (kilovolt) MW (megawatt) MWh (megawatt-hour)

1,000,000 kilowatt-hour 1,000 watt-hour 1,000 volt 1,000,000 watt 1,000,000 watt-hour

NOTES

(i) The fiscal year (FY) of the government ends on 31 December. The fiscal year of AKL ends

on 31 December. (ii) In this report, "$ refers to US dollars.

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgements as to the legal or other status of any territory or area.

Vice-President

L. Venkatachalam, Private Sector and Cofinancing Operations

Director General P. Erquiaga, Private Sector Operations Department (PSOD)

Director M. Barrow, Infrastructure Finance Division 1, PSOD

Team leader M. E. T. Raz, Senior Investment Officer, PSOD

Team member S. G. Suarez-Yabut, Associate Investment Officer, PSOD

CONTENTS

Page

BASIC DATA i EXECUTIVE SUMMARY i

I. THE PROJECT 1

A. Project Background 1 B. Key Project Features 1 C. Progress Highlights 2

II. EVALUATION 2

A. Project Rationale and Objectives 2 B. Development Impact 3 C. ADB Investment Profitability 6 D. ADB Work Quality 6 E. ADB Additionality 6 F. Overall Evaluation 7

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS 8

APPENDIXES 1. Basic Data: Investment Summary 11 2. Private Sector Development Indicators and Ratings: Infrastructure 13 3. Environmental, Social, Health, and Safety Performance 16

BASIC DATA

AES Kelanitissa Power Project

(Loan Nos. 7167, GU1815 - Sri Lanka)

Key Dates Expected Actual

Concept Clearance Approval June 2000 Board Approval December 2000 Loan Agreement 15 June 2001 Loan Effectiveness 15 June 2001 First Disbursement 1 October 2001 Physical Completion Date 31 August 2003 Commercial Operations Date 10 October 2003 Months (effectiveness to commercial operation date)

28 months

Project Administration and Monitoring No. of Missions No. of Person-Days

Fact-Finding (15-17 August 2000/24-27 July 2000) 2 18 Appraisal (30 October to 1 November 2000) 1 15 Project Administration (25-26/08;4/6-7/11/05/30-31/08/05) 3 10

Extended Annual Review Mission (19-25 Jun 08) 1 6

EXECUTIVE SUMMARY

On 19 December 2000, the Board of Directors of the Asian Development Bank (ADB) approved (i) a direct loan of $25.93 million, and (ii) a partial risk guarantee (PRG) of $52.00 million. Under a counter-guarantee agreement between the Government of Sri Lanka, ADB, and the ANZ Banking Group to AES Kelanitissa Private Limited (AKL), the guarantee facility was further broken down into a PRG of $31 million and partial risk insurance (PRI) of $21 million. The financing was for the construction and operation of a 163 megawatt (MW) diesel-fed combined-cycle power generating plant under a build-own-operate-transfer scheme that is covered by a 20-year power purchase agreement (PPA) with the Ceylon Electricity Board (CEB). The availability of fuel for the project is guaranteed by the Ceylon Petroleum Corporation under a 20-year fuel supply agreement. The government guarantees the payment obligations of the CEB under the PPA and the Ceylon Petroleum Corporation under the fuel supply agreement in accordance with the implementation agreement. This extended annual review report (XARR) assesses ADB’s support and overall performance in developing the project. ADB initiated the extended annual review by sending out its standard questionnaire to AKL. Its first evaluation of the project was based on information gathered from legal and ADB Board documents, progress reports, audited financial statements, annual monitoring reports, and related operations and business reports. On 19–25 June 2008, ADB fielded a mission to broaden the review and gather information from key management staff of AKL. The evaluation criteria used for the project are based on Project Administration Instructions 6.07b on Extended Annual Review Reports for Nonsovereign Operations issued in July 2008. The project was evaluated using four criteria: (i) development impacts and outcomes, (ii) ADB investment profitability, (iii) ADB work quality, and (iv) ADB additionality. The results of this analysis are then aggregated to derive an overall rating for the project. The development impact of the project was further evaluated using four criteria: (i) private sector development; (ii) business success; (iii) economic sustainability; and (iv) environment, social, health, and safety performance. The project’s contribution to private sector development is rated excellent. When the project was being developed in 2001, Sri Lanka had a shortfall in generating capacity of about 160 MW, resulting in rotating power interruptions. The project provided a timely addition to generating capacity while contributing towards meeting the 7%–8% projected growth in power demand. In 2001, only 61% of Sri Lanka’s population had access to electricity, with per capita consumption of 290 kilowatt-hours (kWh), among the lowest in Asia. Partly, as a result of the project and its positive demonstration effects, the electrification rate increased to 82% in 2008 and per capita electricity consumption increased to 492 kWh, which compared favorably with other Southeast Asian countries. In 2000, only 5% (133 MW) of Sri Lanka’s generating capacity was accounted for by the private sector. By 2008, the private sector’s investment in the power sector had increased to 27% (705 MW). Finally, the project helped the government change its generation mix and diversify away from hydropower, which had proven to be unreliable, especially in periods of severe droughts. The economic sustainability of AKL is rated satisfactory. The investment profitability of AKL is rated satisfactory since the company has been making interest and principal payments on time from the start of commercial operations.

ii

ADB’s additionality is rated excellent. ADB’s participation in the project by way of a direct loan, PRG, and PRI was crucial in attracting international financing which made the project possible even in the context of difficult country conditions. ADB’s involvement allowed the project to obtain financing on more acceptable terms.

I. THE PROJECT

A. Project Background

1. In December 2002, the Board of Directors of the Asian Development Bank (ADB) approved a direct loan of $25.93 million and a partial risk guarantee (PRG)1 of $52.00 million. Under a counter-guarantee agreement between the Government of Sri Lanka, ADB, and the ANZ Banking Group to AES Kelanitissa Private Limited (AKL), the guarantee facility was further broken down into a PRG of $31 million and partial risk insurance (PRI) of $21 million. The PRG covers scheduled principal and interest payments, due to a syndicate of commercial banks. which lent $31 million to AKL. The funds were used to finance the construction of a 163 megawatt (MW) diesel-fed combined-cycle electric power generation facility in the northern part of Colombo, Sri Lanka. 2. At the time of project processing in 2000, Sri Lanka’s supply of electricity was both insufficient and unreliable. In 2000, the electrification ratio in Sri Lanka was estimated to be only 61%. Sri Lanka’s power generation was heavily dependent on hydropower, which accounted for 60% of the country's installed capacity. The supply of reliable power was therefore vulnerable to rainfall fluctuations and severe droughts. Some of the thermal plants were old, poorly maintained, and inefficient. In 2000, about 95% of the generating capacity of Sri Lanka was publicly owned. The government turned to the private sector to help the power sector diversify from its reliance on hydropower and to address the country’s critical power supply shortfall in a cost-effective manner. 3. Following an international competitive bidding process, the project was awarded to AKL on 17 December 1998. AKL shareholders are (i) AES Corporation (90%), a leading independent power producer based in the United States; and (ii) Hayley’s (10%), a diversified Sri Lankan conglomerate. The financiers of the project are ADB and the ANZ Banking Group. 4. The project was the largest private sector power project in Sri Lanka in 2000, and ADB’s first private sector power project in Sri Lanka and its second PRG. The project was implemented under Sri Lanka’s new power policy and framework and was part of Sri Lanka’s least-cost power generation expansion plan. 5. The project is being undertaken under a build–own–operate–transfer arrangement over a 20-year concession period, which ends in 2023 when it will be transferred to the government. 6. Commercial operation date occurred on 10 October 2003. The plant was shut down for a period of time in 2004–2005 due to a fire and the required restoration. The plant has been running in combined-cycle mode since September 2005. B. Key Project Features

7. The AES Kelanitissa Power Project entailed the construction, commissioning, and operation of a 163 MW diesel-fed combined-cycle generation plant. The facility has a 1x1x1

1 ADB’s PRG operations are governed by the policy provisions contained in the Review of Bank’s Guarantee

Operations (the 1995 guarantee policy). ADB is allowed to offer PRGs. The PRG provides coverage (i) for loan payment default by AKL on scheduled debt service payments of principal and interest during a temporary interruption of the ADB guarantee loan, and (ii) as a result of the government’s failure to meet payment obligations under the implementation agreement and its duties under the Sri Lanka Board of Investment agreement.

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configuration consisting of (i) one model PG9171E combustion turbine provided by Bharat Heavy Electricals with a nominal output of 115 MW; (ii) one Cockerill Mechanical Industries certified, Larsen and Toubro designed, heat recovery steam generator; and (iii) one BHEL steam turbine with a nominal output of 55 MW. The plant was built within the Ceylon Electricity Board’s (CEB's) existing Kelanitissa power station premises on the south bank of the Kelani River, about 2 kilometers north of the Colombo city center. The project was implemented under a performance-based, fixed-price, turnkey engineering, procurement, and construction (EPC) contract with Larsen and Toubro. Larsen and Toubro is among the top five corporations in India and is India’s largest construction firm, with a successful track record in executing EPC contracts for combined cycle and cogeneration plants. 8. Pursuant to a power purchase agreement (PPA) dated 5 June 2000, the CEB is committed to purchase all electricity generated by the project for 20 years on a take-or-pay basis. Power generated by the plant is delivered by way of a 220 kilovolt (kV), 500-meter-long underground cable, which terminates at the interconnection bay of the 220 kV substation of the CEB. The Ceylon Petroleum Corporation (CPC) supplies low sulfur diesel fuel for the project over the concession period pursuant to a fuel supply agreement dated 5 June 2000. Fuel supply will utilize an existing 30-meter pipeline from the site boundary. The government has guaranteed the obligations of the CEB under the PPA and the CPC under the fuel supply agreement, based on the implementation agreement signed between the government and AKL on 5 June 2000. 9. On 5 November 1999, the Sri Lanka Board of Investments awarded AKL “flagship company” status, which entitles it to special concessions including income tax exemptions for the entire 20-year concession period. C. Progress Highlights

10. The government issued a note to proceed to the EPC contractor to begin preliminary works on 15 June 2000. The plant’s open-cycle operation date was declared on 7 February 2003 and physical completion date was achieved on 31 August 2003. The project began commercial operations on 10 October 2003.

II. EVALUATION

A. Project Rationale and Objectives

11. AKL achieved the developmental impact objectives as set out in the report and recommendation of the President2 (RRP) as it has

(i) helped ease Sri Lanka’s critical power supply shortfall in a cost-effective manner and therefore has helped minimize the cost of load shedding;

(ii) supported the government’s strategy of diversifying from hydropower; (iii) made competitively priced power accessible to consumers within a relatively

short time frame; (iv) brought the CEB close to its goal of achieving an electrification ratio of 80% by

2005 (achieved in 2008); and

2 ADB. 2000. Report and Recommendation of the President to the Board of Directors: Proposed Loan to AES

Kelanitissa (Private) Limited and Proposed Partial Risk Guarantee for the Kelanitissa Power Project in the Democratic Socialist Republic of Sri Lanka. Manila.

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(v) contributed to increased private sector participation in Sri Lanka's power sector and increased the financial resources available for the sector’s expansion, consistent with ADB’s country assistance plan 1999–2001.3

B. Development Impact

1. Private Sector Development

12. In 2000, about 95% of the generating capacity of Sri Lanka was accounted for by the public sector; from the private sector, there were only three thermal independent power producers with a total capacity of 133.3 MW. By 2008, private sector investment in the power sector had increased to 705 MW, representing 27% of installed capacity, though most of the investments were in high-cost thermal power plants. The 163 MW of incremental generating capacity contributed by AKL’s project represented a significant private sector investment in the power sector and has had positive demonstration effects. 13. In 2001, Sri Lanka’s total installed generating capacity was 2,000 MW, of which 60% was provided by hydropower generating plants and the balance was from thermal power plants. Over 50% (660 MW) of the hydro generating capacity was accounted for by the Mahaweli system, a multipurpose system where the operation of the hydropower plants is governed by downstream irrigation and flood control requirements. The dependability of hydropower had been a cause for concern, particularly during periods of severe droughts such as in 2001. In addition, some of the existing thermal plants were very old, poorly maintained, and inefficient. It was estimated that there was already a shortfall of 162 MW in generating capacity in 2000. Sri Lanka’s power situation in 2001–2002 was, therefore, unstable and characterized by rotating power interruptions. Since most of the economically viable hydropower plants had already been developed, any shortfall in demand would have to be met by thermal power plants. AKL’s project helped address Sri Lanka’s existing power supply shortfall and contributed towards meeting the 7%–8% demand growth expected under the Long-Term Generation Expansion Plan. However, additional investment in power generation is required to meet incremental demand. In 2005, thermal power became the primary source of power for Sri Lanka, with 61% of installed capacity, while the contribution of hydropower fell to 39%. However, current economic prospects of Sri Lanka gears its way to narrow the power deficit which has been widespread over the last decades. The country had already achieved electrification in 2008 and as per the national energy policy, the government aims to raise electrification to 95% by 2015. 14. In 2001, only 61% of Sri Lanka’s population had access to electricity, with per capita consumption of 290 kilowatt-hour (kWh), among the lowest in Asia. Although the CEB’s goal of an electrification ratio of 80% by 2005 was not achieved, the project contributed to the significant improvement in this rate, with the electrification ratio increasing to 77% and per capita consumption increasing to 369 kWh by 2005. The CEB target was finally achieved in 2008 when the percentage of electrified households further increased to 82% and per capita consumption increased to 492 kWh. The electrification ratio that Sri Lanka attained in 2008 compares favorably with other South Asian countries. 15. In addition to a direct loan of $26 million, ADB provided a PRG4 of $31 million to a commercial lender. The PRG was the first that ADB had arranged in Sri Lanka and was

3 ADB. 1998. Country Assistance Plan: Sri Lanka, 1999–2001. Manila.

4 The ADB PRG covers the risk of failure by AKL to pay scheduled principal repayments and interest payments that

have fallen due and not paid, and if the CEB fails to honor its payment obligations under the PPA and the CPC

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instrumental in mobilizing long-term financing given difficult country conditions, the relatively large financing requirement for the project, and the weak creditworthiness of the Sri Lankan power sector. 16. During the construction period in 2001–2003, AKL created job opportunities for about 150 local people. As of June 2011, AKL had 50 employees. 17. The private sector development impact of AKL is considered excellent. Private sector development indicators and ratings are presented in Appendix 2.

2. Business Success 18. When the project was awarded to AKL, it offered the CEB a highly competitive tariff. The project’s levelized tariff of $0.0607/kWh (applying a discount rate of 12.5%) was competitive with independent power producer contracts that were existing at that time, which had average tariffs of $0.0720/kWh. The levelized tariff was also significantly lower than the cost of emergency power that the CEB contracted in 2000. The project is expected to remain competitive even in the unlikely event that the Sri Lanka electricity market becomes fully deregulated, with competitive dispatch of power, in the medium term. 19. Since the start of its operations, the plant has experienced mechanical issues which affected plant availability and capacity utilization.6 20. AKL is compliant with financial covenants. 21. [CONFIDENTIAL INFORMATION REGARDING BUSINESS SUCCESS HAS BEEN DELETED]

3. Economic Sustainability 22. The nominal economic internal rate of return suggests that the Project is satisfactory according to the guidelines. [CONFIDENTIAL INFORMATION REGARDING ECONOMIC PERFORMANCE HAS BEEN DELETED].

4. Environment, Social, Health, and Safety Performance 23. The AES Kelanitissa Power Project was classified environment category A, which required a full environmental impact assessment (EIA). Environmental Resources Management of the United Kingdom completed the EIA of the project in August 1999, in accordance with the requirement of the government. The EIA was subsequently expanded (and completed on 18 July 2000) to comply with the EIA guidelines8 of ADB and other international financiers. ADB reviewed the EIA and confirmed that, with the adoption of the appropriate mitigating measures identified in the EIA process, the overall environmental impact during construction and operation of the plant would not be significant.

under the fuel supply agreement. ADB’s risk exposure under the PRG is offset by a counterindemnity issued by Sri Lanka in favor of ADB.

6 Availability factor is the amount of time that the power plant is able to produce electricity over a certain period,

divided by the amount of time in the period. 8 ADB. 2000. Asian Development Bank’s Environmental Assessment Guidelines. Manila.

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24. The plant is located in the existing fenced and secured Kelanitissa power plant complex (an industrial site), did not require any new land acquisition, and therefore did not have any direct and negative social impact. 25. The AKL facility is required to comply with the environmental requirements of ADB, the World Bank, and the government. AKL contracts with the Environmental Division of the National Building Research Organization of Sri Lanka to conduct quarterly environmental testing of stack emissions, ambient air quality, noise levels, and water quality. The monitoring results, environmental impacts, and mitigations are further discussed in Appendix 7. 26. Under the project, AKL has strengthened its in-house monitoring capability for its environmental management system. AKL received International Organization for Standardization (ISO) 14001 and OHSAS 18001 certifications in February 2007 from SGS Switzerland. Two ISO and/or OHSAS surveillance audits were successfully completed without any major findings. AKL has a set of standard operating procedures on safe operation of the plant, and this is being updated as often as possible. As part of the EPC contract, training for operation and maintenance (O&M) of the plant was provided by Larsen and Toubro and supplemented by additional training, which AKL contracted from TechComm Simulation, an Australian company with experience in combined-cycle operations training that provided classroom and on-the-job training. 27. Various enhancements to the environmental, social, health, and safety (EHS) procedures were implemented for the benefit of AKL staff. These included

(i) assigning a dedicated person to take charge of all EHS-related issues, reporting to the EHS and/or BOP team leader;

(ii) holding three EHS meetings per month to get maximum participation, including the shift workers, with a target attendance of 100%;

(iii) creating an EHS committee actively functioning and holding meetings every month;

(iv) conducting regular EHS walk downs (target of 10 per month) in different areas to improve best practices and environmental awareness; and

(v) providing training on safety audits, environmental procedure for plant staff prior to ISO certification, and first aid and trauma pack.

28. AKL promoted job creation during construction and operation. The company employed 150 workers at the peak of construction. In 2007, AKL engaged people from the local community as temporary semiskilled and unskilled laborers during its major maintenance outages. As of June 2011, AKL employed 50 staff (2 expatriates and 48 local staff, 4 of whom were female). AKL also hired 2 trainee engineers. Local people worked as O&M helpers and in other positions. English language training was provided, and people were hired for day-to-day O&M and other activities of the plant. AKL also hired local contractors and suppliers for various services and supplies. The participation of the local community in O&M of the power plant has directly and indirectly benefited the local economy. 29. As of 30 June 2011, AKL had completed 2,113 consecutive days of operation without a lost time accident. 30. The rating for environment, social, health, and safety performance of the project is satisfactory.

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C. ADB Investment Profitability

31. ADB’s investment profitability is rated satisfactory. [CONFIDENTIAL INFORMATION REGARDING TERMS AND CONDITIONS OF ADB’S INVESTMENT IN THE PROJECT HAS BEEN DELETED] D. ADB Work Quality

32. The quality of ADB’s work in the area of screening, appraisal, and structuring is rated partly satisfactory. [CONFIDENTIAL INFORMATION REGARDING APPRAISAL AND STRUCTURING HAS BEEN DELETED] 33. ADB’s role and contribution is rated excellent. As a direct lender and provider of the PRG, ADB played an important role in mobilizing commercial financing. Commercial banks had been hesitant to lend on an unrecovered basis because of the market conditions, political situation, and lack of track record for independent power producer projects in Sri Lanka at that time. ADB took the lead in the due diligence process that covered key project issues, including the competitiveness of the project tariff. 34. ADB’s performance in the area of monitoring and supervision and work quality is rated satisfactory. E. ADB Additionality

35. At the time the project was being developed in 2001, Sri Lanka’s power sector was characterized by widespread shortages as a result of increasing demand and unreliable hydropower generating capacity because of a severe drought. At that time, about 95% of the generating capacity in Sri Lanka was accounted for by the public sector through the CEB. The government sought to encourage private sector participation in the sector, not only to provide much-needed incremental generating capacity but also to promote good commercial practices in the industry. However, the private sector had been deterred by the perception that investing in Sri Lanka entailed high risk. This view was further aggravated by CEB’s weak performance. Thus, ADB’s participation in the project by way of its direct loan and PRG was crucial in drawing the international financing which made the project possible. ADB’s PRG and PRI were the first arranged in Sri Lanka under difficult country conditions, and were instrumental in enabling the project to obtain financing on more acceptable terms. 36. In 1998, ADB partnered with the World Bank to assist the government in implementing the restructure of the power sector. ADB provided technical assistance9 to assist the government in unbundling the CEB into financially independent and viable successor generation, transmission, and distribution companies, and to create an independent regulator for the sector. 37. The Sri Lanka Ministry of Power and Energy, Ministry of Finance and Planning, Board of Investment, and Public Enterprise Reform Commission considered the project to be an essential first step in restructuring the power sector. This project was implemented under the newly instituted power policy and framework, which sought to rely on greater dependence on market forces and private sector involvement in the sector. This was consistent with ADB’s country assistance plan for Sri Lanka for 1999–2001 (see footnote 3).

9 ADB. 1998. Technical Assistance Completion Report: Energy Sector Strategy Study. Manila

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38. ADB’s involvement in and supervision of the project helped to ensure that the operations met international standards and complied with environmental and social safeguard requirements. Furthermore, the successful implementation by AKL provided lessons and technical expertise for the subsequent development of other independent power producer projects in Sri Lanka. 39. ADB’s support for the power sector through direct loans, PRGs, and technical assistance strengthened its relationship with the government. Through ADB’s dialogue with the government, CEB’s payment of its obligations to AKL, which were delayed several times in 2006, has significantly improved and the long-open issue of the letters of credit has been partially settled. 40. ADB’s additionality is considered excellent. F. Overall Evaluation

41. The project (i) demonstrated a positive developmental impact in terms of its contributions towards addressing Sri Lanka’s immediate power requirements in a cost-effective manner, (ii) provided a more stable source of power, (iii) helped Sri Lanka diversify from an overdependence on hydropower, and (iv) provided a greater number of consumers with access to electricity. ADB’s involvement in the project provided positive demonstration effects and ushered in greater private sector participation in the electricity sector in line with government objectives. The project achieved this while registering an acceptable performance in environmental, social, health, and safety dimensions.. 42. Overall, the project is rated partly satisfactory. Following the assessment in section II, the ratings are presented in the following table.

Table: Evaluation of the AES Kelanitissa Power Project

Indicator/Rating Excellent Satisfactory Partly

Satisfactory Unsatisfactory

Development Impacts X

Private Sector Development X

Beyond Company Impacts X

Company Impacts X

Economic Sustainability / Development X

Environmental, Social, Health, and Safety Performance

X

ADB Investment Profitability X

ADB Work Quality X

Screening, Appraisal, and Structuring X

ADB Role and Contribution X

Monitoring and Supervision X

ADB Additionality X

Overall Rating X

ADB = Asian Development Bank, AES = AES Corporation. Note: Ratings are defined in Appendix 2. Source: Infrastructure Finance Division 1, Private Sector Operations Department.

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III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS

43. The project underscores the importance of a transparent and commercially driven regulatory framework. The CEB has been adversely affected by political influence over decision making within the power sector. In particular, its inability to charge tariffs that reflect its costs has pushed it to insolvency and made it a weak offtaker. ADB and the World Bank have recognized that unbundling and deregulation of the power sector is necessary to entice further private sector participation and are providing the necessary assistance towards this objective. [CONFIDENTIAL INFORMATION REGARDING PROJECT RESULTS HAS BEEN DELETED]

Appendix 1 11

BASIC DATA Investment Summary

A. Investment Identification 1. Country Sri Lanka

2. Investment Number/Loan Number

Partial Risk Guarantee Number

7167/LN1815 7167/GU1815

3. Type of Business

Conventional Energy Generation and Operation

4. Project Title

AES Kelanitissa Power Project

5. Investee Company/Borrower AES Kelanitissa (Private) Limited

6. Sponsors AES Corporation, US (90%) Hayley’s Limited, Sri Lanka (10%)

7. Amount of Approved ADB Assistance - Direct Loan - Partial Risk Guarantee - Partial Risk Insurance

$25.93 million $31.00 million $21.00 million

8. Environment Category A. Summary of environmental impact assessment submitted to ADB Board 10 Aug 2000

12 Appendix 1

Ap

pe

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PRIVATE SECTOR DEVELOPMENT INDICATORS AND RATINGS: INFRASTRUCTURE

Impact of the Project

Rating: Impact to

Dateb

Potential Impact (Sustainability) and

Risk to Its Realization Impact

b Risk

c

Combined Rating

a Justification / Annotations

1. Beyond Intermediary and Investee Company Impacts

1.1 Private Sector Expansion Contribution by a pioneering or high-profile project that facilitates or paves the way for more private participation in the sector and economy

Excellent Satisfactory Low Excellent The project was the largest private sector power project in 2000 when only 5% of Sri Lanka's generating capacity (or 133.3 megawatts [MW]) was in the hands of the private sector. Following positive demonstration effects arising out of the project, by 2008 27% or 705 MW of the industry's generating capacity was accounted for by the private sector.

1.2. Competition. Contribution of new competition pressure on public and/or other sector players to raise efficiency, and improve access and service levels in the industry

Excellent Satisfactory Low Excellent The project was considered by the government as an essential first step in restructuring Sri Lanka's power sector with the aim of relying on market forces and greater private sector participation.

1.3. Innovation. Demonstration of efficient new products and services, including in areas such as marketing, distribution, tariffs, production, and technology, and in ways to cover or contain costs and manage demand

Satisfactory Satisfactory Low Satisfactory The project has benefited from AES in terms of (i) technical guidance, (ii) sharing of best practices from other AES power plants, (iii) AES training programs, and (iv) AES support in terms of global sourcing and procurement of parts and supplies. AKL also participates in the AES Performance Excellence (APEX) programs which provide common tools and methodologies to improve operational efficiencies.

1.4. Links. Relative to investments, contribution of the project of notable upstream or downstream links to business clients, consumers, suppliers, key industries, etc., in support of growth.

Satisfactory Satisfactory Low Satisfactory AES provided support to AKL, such as (i) technical guidance; (ii) interaction through communicating best technical practices from other AES plants; (iii) common training programs for all AES staff, such as emerging leader training; (iv) P2P reviews and reliability improvement programs; (v) arranging global risk consultants annual visit in order to minimize potential risks to the plant; (vi) communicating and promoting common safety and environmental best practices; (vii) global sourcing when AKL must purchase major items or spares; and (viii) communication of all AES company-wide development and standards requirements.

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pp

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2

Impact of the Project

Rating: Impact to

Dateb

Potential Impact (Sustainability) and

Risk to Its Realization Impact

b Risk

c

Combined Rating

a Justification / Annotations

1.5. Catalytic Element. Contribution by pioneering and/or catalytic financing, mobilizing, or inducing more local or foreign market financing and/or foreign direct investment in the sector

Excellent Satisfactory Low Excellent ADB’s lead role in the due diligence process and involvement in the transaction provided comfort and attracted private sector interest. In providing the PRG, ADB also helped catalyze commercial financing. The successful operation of AKL created positive demonstration and catalytic effects for more private sector participation. However, the government needs to establish a framework to encourage more private sector participation in this sector and to sustain the accomplishments of the project.

1.6. Affected Laws, Frameworks, Regulation Contribution to (i) better laws and sector regulation for PPPs, concessions, joint ventures, and BOT and BOOT projects; and (ii) liberalization of markets as applicable for better sector efficiency

Satisfactory Satisfactory Medium Satisfactory The government decided to restructure the CEB separately from the regulatory reform. In addition, cabinet is presented with amended legislation that would allow the Public Utilities Commission to regulate tariffs and issue licenses to the CEB and other utilities, to ensure fair competition in the sector and encourage more private sector participation. The reform is expected to bring on stream much-needed base-load capacity by 2011–2012. Investments are required to increase generation capacity as well as to strengthen and expand the transmission system and distribution network.

2. Company Impact With Wider Potential

2.1. Skills Contribution. Contribution to new strategic, managerial, and operational skills with actual or potential wider replication in the sector and industry

Satisfactory

Satisfactory Low Satisfactory AKL hires five new engineers for on-the-job training each year. Most of the trainees are inducted after 1 year of extensive training. This training helps to recognize local talent and provides employment opportunities. A training committee is formed, primarily for arranging training not only for newcomers but also for the O&M team. It helps improve the skills and knowledge of the individuals as well as the team. The project provided socioeconomic benefits as it created about 48 regular local jobs and five local trainee engineer positions, and contributed to upgrading the skills of the local workforce through an apprentice system. Further opportunities for employment are not anticipated in the near future and will only be available to fill vacated positions. Turnover at AKL is not very high, though several skilled employees have found jobs abroad.

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a The combined rating should weigh impacts and risk to its sustainable realization.

b Excellent (4), satisfactory (3), party unsatisfactory (2), unsatisfactory (1).

c Risk: low (4), modest (3), medium (2), high (1).

Impact of the Project

Rating: Impact to

Dateb

Potential Impact (Sustainability) and

Risk to Its Realization Impact

b Risk

c

Combined Rating

a Justification / Annotations

2.2 Demonstration of New Standards. As seen in new ways to operate the business and compete, and in investee performance against relevant best industry benchmarks and standards

Satisfactory Satisfactory Low Satisfactory AKL introduced not only service standards but also a professional work ethic and corporate governance to the sector. Its human resource policies and programs are geared toward improving worker compensation and promoting strong worker relations.

2.3 Improved Governance. As evident in standards set in corporate governance; stakeholder relations; environmental, social, health, and safety fields; and/or in good energy conservation standards, etc.

Satisfactory Satisfactory Low Satisfactory AKL receives corporate technical support through APEX that provides a set of common tools and methodologies to improve operational efficiencies. There are five general APEX projects that seek to find process improvements, cost reductions, and revenue opportunities: (i) increase the start-up reliability of the plant to avoid unnecessary availability loss and delay start-up penalty; (ii) optimize auxiliary power consumption; (iii) improve water chemistry by optimizing chemical usage, maintain water Ph, proper control on scaling and internal corrosion; (iv) HP feed water line reliability to avoid the frequent failure of plant instrumentation (transmitters / transducers) on HP feed water line; and (v) identify and repair the steam and hot gas leaks to avoid wastage of plant-generated energy and hence improve plant heat rate.

3. Overall Private Sector Development Rating. The rating (excellent, satisfactory, partly satisfactory, or unsatisfactory) is not an arithmetic mean of the individual indicator ratings, and does not have fixed weights. Actual impact (positive or negative), potential future impact, and the risk to its realization need to be considered.

Excellent Satisfactory Medium Excellent AKL is the first large-scale BOOT power plant in Sri Lanka. It has increased the reliability of power supply and has helped diversify from an overdependence on hydropower. The project also serves as a successful model for the development of private power projects. AKL's operations have created positive demonstration and catalytic effects for future private sector participation in the power sector. AKL gives importance to environment, social, health, and safety as priorities; adopts best practices in these areas; and shares the knowledge with other counterparts in the sector. The overall rating of the project is assessed excellent.

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ENVIRONMENTAL, SOCIAL, HEALTH, AND SAFETY PERFORMANCE A. Project Facilities and Features

1. The AES Kelanitissa Power Project is a diesel-based combined-cycle power station with a design capacity of 168-megawatts (MW) constructed in the south bank of the Kelani River in the northern part of the city of Colombo, Sri Lanka. Larsen and Toubro Ceylinco provided installation, erection, and commissioning. The facility uses a 1x1x1 configuration with one model PG9171E combustion turbine provided by Bharat Heavy Electricals with a nominal output of 115 MW, one Cockerill Mechanical Industries certified LTC-designed heat recovery steam generator, and one BHEL steam turbine with a nominal output of 55 MW. The facility began commercial operation in combined-cycle mode on 10 October 2003. 2. Power generated by the project is sold to the Ceylon Electricity Board under a 20-year take-or-pay power purchase agreement. Power will be delivered via a 220 kilovolt (kV) underground cable which is 500 meters long and terminates at the interconnecting bay of the 220 kV gas-insulated substation located within the Kelanitissa power station complex.

3. The project will be powered with low-sulfur diesel fuel, supplied through an existing pipeline by the Ceylon Petroleum Corporation. Storage of at least 20,000 tons will be provided to allow the plant to operate at full capacity for 28 days. 4. The main design parameters for AES Kelanitissa (AKL) are presented in Table A7.1.

Table A7.1: Main Design Parameters for AES Kelanitissa Power Project

Item Data Plant Location South bank of Kelani River, northern part of Colombo, Sri Lanka

Power Generation 168 MW combined cycle

Annual Net Power Generation 791,461 MWh

Plant Concept

Technology Combined-cycle system

Stack heights 25 meters and 60 meters

Type of Fuel Diesel

Water Intake Kelani River

Waste Water Discharge Waste water treatment plants and then to Sebastian canal

Waste Oil Government authorized buyer to recycle waste oil

Emissions

NO2 Within World Bank and CEA Sri Lanka limit of 0.100

SO2 Within World Bank and CEA Sri Lanka limit of 0.080

SPM Slightly higher than World Bank limit in first and second quarters of 2007, within CEA Sri Lanka limit of 0.300

Noise Level

AKL complex boundary Daytime CEA limit 70 dB: exceeded the limit several times Night time CEA limit 60 dB: frequently exceeded the maximum permissible levels in 2007

AKL = AES Kelanitissa, CEA = Ceylon Environmental Authority, dB = decibel, MW = megawatt, MWh = megawatt-

hour, NO2 = nitrogen dioxide, SO2 = sulfur dioxide, SPM = suspended particulate matter. Source: AES Kelanitissa Private.

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B. Environmental Impact Assessment

5. The AES Kelanitissa Power Project was classified environment category A, which required a full environmental impact assessment (EIA). Environmental Resources Management of the United Kingdom completed the EIA of the project in August 1999 in accordance with the requirement of the Government of Sri Lanka. The EIA was subsequently expanded (and completed on 18 July 2000) to comply with the EIA guidelines of the Asian Development Bank (ADB) and other international financiers. The summary of the EIA was circulated to ADB's Board on 10 August 2000.

C. Environmental Performance

6. ADB reviewed the EIA and confirmed that, with the adoption of the appropriate mitigating measures identified in the EIA process, the overall environmental impact during construction and operation of the plant would not be significant. The environmental performance of the project during construction and operations is considered satisfactory.

1. During Construction

7. The project is located in the existing fenced and secured Kelanitissa power plant complex (an industrial site), did not require any new land acquisition, and therefore did not have any direct and negative social impacts.

2. During Operations

8. The key piece of environmental legislation in Sri Lanka is the National Environmental Act No. 47 of 1980, under which environmental guidelines were established. The act was amended in 1988 by act No. 56. The act also established the Central Environmental Authority (CEA) to enforce it.

9. The AKL facility is required to comply with the environmental requirements of ADB, the World Bank, and the Government of Sri Lanka. AKL has contracted the Environmental Division of the National Building Research Organization of Sri Lanka to conduct quarterly environmental testing of stack emissions, ambient air quality, noise levels, and water quality.

10. During operations, the key environmental issues from the power plant relate to the

following: (i) Exhaust gases, which will be emitted to the atmosphere from the main stack as a

result of diesel combustion. The main emissions are carbon dioxide and water; small quantities of oxides of nitrogen, sulphur, and carbon; and suspended particulate matter.

(ii) Liquid effluent, including process wastewater, which will be discharged with the cooling water into the Kelani River via the canal which runs along the western boundary of the site.

(iii) Solid wastes, which will be segregated, collected, recycled, or disposed of at licensed waste disposal sites.

11. Stack emission monitoring. The most significant source of air emissions is the combustion turbine exhaust emanating from the stack of the heat recovery steam generator. The World Bank guidelines for stack emissions and the permissible levels proposed by CEA of

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Sri Lanka are listed in Table A7.2, along with the quarterly results from the National Building Research Organization testing for financial year 2008. Measured stack emission levels were within the emission levels proposed by the CEA.

Table A7.2: Stack Emission Monitoring

Pollutant

Unit

Limits Quarter Results

World Bank

CEA of Sri Lanka

(FY2008)

1st 2nd 3rd 4th

SO2 g/Nm3 2.000 2.500 0.059 0.046 0.082 Not taken

NO2 g/Nm3 0.165 3.000 0.150 0.156 0.171 Not taken

SPM g/Nm3 0.050 0.300 0.051 0.042 0.053 Not taken

CEA = Central Environmental Authority, NO2 = Nitrogen dioxide, SO2 = sulphur dioxide, SPM = suspended particulate matter. Source: World Bank guidelines.

12. Sulfur dioxide and nitrogen dioxide levels were within World Bank and Sri Lanka standards for the first three quarters in 2008. Suspended particulate matter levels were slightly higher than World Bank limits in the first and third quarters of 2008, but were within the Sri Lankan limits during the first three quarters of 2008. Stack emission data were not collected for the fourth quarter of 2008, as the fourth quarter environmental monitoring was conducted during a plant shutdown in December 2008 in order to assess the background environmental conditions at the site.

13. Ambient air quality monitoring. The World Bank air quality guidelines and the permissible levels by the CEA of Sri Lanka are listed in Table A7.3, along with the quarterly results from the National Building Research Organization testing for 2008. Testing was conducted in three separate locations around the plant (L1, L2, and L3). All measured ambient air quality levels were within the standards stipulated by the CEA of Sri Lanka (Extraordinary Gazette No. 850/4, Dec. 20, 1994).

Table A7.3: Ambient Air Quality Monitoring

CEA = Central Environmental Authority, NO2 = Nitrogen dioxide, SO2 = sulphur dioxide, SPM = suspended particulate matter. Source: WB guidelines 14. Noise levels. Quarterly noise-level testing is conducted by the National Building Research Organization of Sri Lanka at nine locations around the plant. The level stipulated by the CEA is 63 decibels (dB) during the daytime and 50 dB at night. Night-time noise levels at the boundary locations frequently exceeded the maximum permissible limits in 2008, and daytime noise levels exceeded the limits several times. However, residual noise levels in the area are high due to vehicular traffic noise. To confirm the significant noise contributed by traffic, AKL

Pollu- tant Units

Limits 2008 Quarter Results

World Bank

CEA Sri

Lanka

1st 2nd 3rd 4th

L1 L2 L3 L1 L2 L3 L1 L2 L3 L1 L2 L3

SO2 g/Nm

3/

24 hrs 0.150 0.080 0.053 0.032 0.034 0.038 0.022 0.033 0.045 0.033 0.032 0.063 0.028 0.039

NO2 g/Nm

3/

24 hrs 0.150 0.100 0.063 0.041 0.033 0.12 0.042 0.021 0.088 0.023 0.028 0.073 0.054 0.048

SPM g/Nm

3/

24 hrs 0.150 0.300 0.135 0.048 0.061 0.131 0.106 0.038 0.144 0.111 0.085 0.082 0.068 0.050

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measured noise levels on Saturday 5 April 2008, during the daytime, when the plant was on reserve shutdown. The measurements indicated that the noise levels from traffic that Saturday, when the plant’s major noise-making machines were not operating, still exceeded Sri Lankan limits.

15. Water quality. The AKL facility consumed 248 million gallons of raw water in 2008. The source of the water is the Kelani River, which is about 0.5 kilometers from the plant. The facility discharged 41 million gallons of wastewater into the Sebastian canal in 2008. According to the testing conducted by the National Building Research Organization, parameters tested for wastewater quality were all within the standards recommended by the CEA. The facility also generated 40,000 gallons of waste oil in 2008. AKL has a contract with a government-authorized waste oil buyer to dispose of or recycle waste oil as per environmental regulations. 16. AKL has progressively strengthened its in-house monitoring capacity. The company received its certifications from the International Organization for Standardization 14001 in March 2007 for its safety measures and OHSAS 18001 for environmental measures in February 2007 from SGS Switzerland. Two ISO and/or OHSAS surveillance audits have been successfully completed without major findings. D. Social Impacts

17. The project provided socioeconomic benefits including (i) a more reliable and consistent energy supply to Colombo, (ii) enhanced economic activity and development, (iii) more local jobs, and (iv) upgrading the skills of the local workforce through an apprentice system. 18. Enhanced economic activity and development. In 2003, by donating much-needed books and school supplies, AKL supported about 1,000 school children of Marplergama Mixed School in the remote southern part of Sri Lanka affected by the heavy rains which resulted in large-scale flooding with most school buildings under water. AES people from all over the world have also made contributions to support the relief work for the tsunami-affected people of Sri Lanka; $20,000 was paid to individuals whose houses were damaged by the 2004 tsunami. In 2001, AKL also launched a program by using the students from the Art College in Colombo to design the AKL logo rather than using a designing firm. In January 2002, AKL appropriately rewarded the successful students and also gave an award to the college. AKL has been determined to spread knowledge in order to groom and sustain communities, particularly young Sri Lankans, and has organized Safety Day and World Environment Day activities. During Safety Day, school children were invited to the power plant where they were presented with home-related safety information regarding emergencies and accidents. World Environment Day was celebrated by giving lectures on the conservation of energy, proper water usage, and simple techniques to “kick the water habit.” 19. AKL promoted job creation during construction and operation and AKL employed workers at the peak of construction. In 2007, AKL engaged people from the local community as temporary semiskilled and unskilled laborers during its major maintenance outages. At the time of the review mission in 2008, AKL employed 52 staff (four expatriates and 48 local staff), three of whom were female. AKL also hired five trainee engineers. Local people worked as operation and maintenance (O&M) helpers and in other positions. English language training was provided, and people were hired for day-to-day O&M and other activities of the plant. AKL also hired local contractors and suppliers for various services and supplies. The participation of the local community in O&M of the power plant has directly and indirectly benefited the local economy. The following table presents staffing profile from 2003 – 2013.

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Table A7.4: AKL Staffing Profile, 2003–2013

AKL = AES Kelanitissa (Private), US = United States. Source: S&L 2007 Operations and Maintenance Review. April 2008.

20. AKL has also contributed to upgrading the skills of the local workforce through an apprenticeship system. The company has developed a professional training program for young graduate engineers and technicians that includes 1 year of extensive power plant fundamentals classroom sessions and practical hands-on training at the site. This gives a unique opportunity for young Sri Lankans to participate and gain knowledge of power plant operations and maintenance and also receive financial support in terms of monthly remuneration to cover expenses. E. Health and Safety Performance

21. AKL has developed a procedure to assess health and safety risks concerning workplace conditions and activities to ensure all control measures are in place, with accreditation to the OHSAS 18001 standard. As of December 2007, AKL had an excellent safety record of 836 consecutive days of operation without a lost time accident. In the near-miss incident report, a remarkable improvement was achieved from 2005 to the first half of 2008 (Table A7.5).

Table A7.5: Near-Miss Incident Report

Year No. of Near-Miss Incident

2005 17 2006 18 2007 276 First half of 2008 214

Source: AKL reports 2005 - 2008

22. AKL considers health and safety a high priority and allocates substantial budget for this purpose. Medical services and preventive medical treatment are provided for employees free of charge. In one very rare case, AKL extended its full support to one staff member in his fight against cancer by matching the amount contributed by AKL staff. 23. AKL employees are also encouraged to participate in various health and safety trainings. Trainings in 2007 included safety audit training and first-aid trauma pack training. F. Security

24. Sri Lanka continued to experience a high level of violence in 2008, and the Kelanitissa power plant was a potential target for attack. A nearby Ceylon Electricity Board plant was bombed in October 2008 and sustained damage. Although there was no impact on the AKL facility as a result of the bombing, security at the plant was increased, with more Sri Lankan army bunkers and personnel within the plant. Communications were also improved between the

Year 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Expat US 2 2 Expat Subcontinent 5 6 7 5 4 4 2 1 1 1 0 Local Plant Mgrs 2 2 2 2 3 2 2 3 3 3 4 Local Employees 36 37 39 39 38 35 34 33 33 33 32 Total 45 47 48 46 45 39 38 37 37 37 36

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Sri Lankan army command center at the Kelanitissa power complex and AKL by utilizing two-way radios. 25. The following are some security measures that AKL maintains:

(i) The road in front of the plant is closed to the public daily from 10 p.m. to 5 a.m. (ii) The area has been declared a high-security zone and, hence, remains under

high alert. (iii) Members of the Sri Lankan army are permanently stationed within the plant

premises. 26. The civil war in Sri Lanka was declared over in May 2009, which should lessen the chance of political unrest in the country.