* * * DISCUSSION DRAFT * * *

NT2 Knowledge Exchange Series (No. 1)

Lessons from a New Business Approach to NT2

The US$1.45billion Nam Theun2 Hydroelectric Project (“NT2”) in Lao PDRsignifies the World Bank’s return to bigprivate hydro business– but this was not“business as usual.” This note describes how the Bank implemented a new business approach to project preparation, driven by externalforces and internal dynamics.A Decision Framework, underpinned by a risk identification and mitigation matrix, steered project due diligence in tandem with a comprehensive program for country policy and institutional reform.This not only made NT2 ready for the country, but also the country ready for the project, and gained the support of global players. But, the NT2 preparation experiencesuggests that, to be aneffective partner,the Bank mustimprove further on this new business approach.

Background

Lao PDR is a small, sparsely populated, landlocked country with extensive natural resources.It covers an area of 236,800 square km and shares borders with Thailand, Vietnam, China, Cambodia, and Myanmar– situating it in the center of the dynamic Mekong region. Its population, estimated at 5.7 million in 2004, is growing at a relatively rapid rate of 2.3 percent annually. While Lao PDR has made significant progress in reducingpoverty over the past decade,large geographical disparities remain; poverty incidence is high among ethnic minority communities; and some of the country’s Millennium Development Indicators are dismal. Its economy has been moving gradually toward a market-oriented system but development challenges include limited capacity in the central and provincialgovernments, a fledgling private sector, lack ofinfrastructure, and the absence of stakeholderparticipation in the development debate. Although infrastructure (including roads, telecom, water and electricity) is underdeveloped, the country has rich natural resources of water (used for hydroelectricity generation), tropical forests (covering 47 percent of land area) and minerals (e.g., coal, tin, copper, gold, gemstones, and gypsum).

To overcome poverty, Lao PDR will need 7 percent growth per year until2020.In partnership with the International Monetary Fund and the Asian Development Bank, IDA supported a country-owned poverty reduction strategy through macroeconomic measures and structural reforms. IDA support came largely through two Poverty Reduction Support Operations, while a third one is now under preparation. The US$1.45 billion Nam Theun 2 Hydroelectric Project (NT2) complements these interventions. It reinforces the government’s reform program and helps maintain Lao PDR on a sustainable development path by raising revenues through environmentally and socially sustainable hydroelectric exports to neighboring Thailand that can be applied to finance poverty reduction interventions. NT2 Revenue management arrangements are being implemented to ensure that Government revenues from the project flow through an improving public financial management system to pre-identified activities and programs,with appropriate accountability and impact assessment modalities.

NT2 Preparation: the Early Years (1994- 2001)

During the early phaseof NT2 preparation (1994-97), the World Bank was under intense scrutiny.The Bank’s past association with large dams generated heated debate and the Bank retreated from the controversial Indian Narmada project and also abruptly withdrew from the Arun III project in Nepal. The internal Bank managerial environment responded to the hostile external situation by becoming considerably risk averse towards large hydro projects, including NT2. Despite this backdrop, NT2 preparation proceeded to an advanced stagein the traditional Bank project mode – albeit with added emphasis given to environmental, social and poverty aspects, but with no assurance that the project would eventually fructify.Over this period, rebuilding bridges with international civil society had also become a priority.

The next phase,covering the Asian economic crisis (1997-2001),was a period of hiatus and change.The Electricity Generating Authority of Thailand (EGAT), the prospective purchaser of NT2’s electricity, shelved the project because of a sharp drop in Thailand’s demand projections and two of the three Thai partners (Jasmine International and Phatra Thanakit) in NT2’s private-sector development consortium withdrew.There was an impasse until 2001,when a changein government in Thailand triggered fresh contacts with Lao PDR on the NT2 project.

Meanwhile, this hiatus also coincided with a dramatic transformation within the Bank. A fundamental reorganization, built around country units and sector and thematic networks, took place and decentralization of staff and management actually happened. Poverty reduction took center stage as the Bank’s mandate and the state-of-the-art took rapid strides in this area, including invention of the Poverty Reduction Strategy Paper (PRSP) process. Remarkable progress was made in codifying and designing safeguard policies, and internal capacity on social and environmental issues as well as external relations rose rapidly. The external context had also changed to a more constructive and receptive one, thanks to the dialogue promoted by the Bank’s new Water Resources Strategy and the debate generated by the World Commission on Dams. The Bank had also decided to return to big infrastructure business.It was to this transformed World Bank that GOL and the developers, led by EdF (France) and supported by Ital-Thai Development (Thailand) and EGAT, turned for assistance on NT2 in 2001.

New Business Approach to NT2 (2001- 2005)

In 2001, the Bank adopted a new Business Approach to NT2. The goal was not only getting this large complex controversial project ready for the country, but getting the country ready for the project, while persuading influential global players to support the project. This was a formidable challenge, given that Lao PDR is one of the poorest countries in South East Asia with weak human capacity, governance, institutions and physical infrastructure. The range of project preparation initiatives taken, therefore,included establishing a comprehensive risk identification and mitigation strategy, where the Bank openly acknowledged risks. This provided the context for strengthening the focus and range of due diligence carried out to determine the viability of the project.Also,the technical features of the project were strengthened; all the ten safeguard policies of the Bank were addressed; and consultations and communications were upgraded to meet the demands of achallenging environment influenced by the Bank’s mixed experience with past large infrastructure projects.

NT2 preparation centered on a publicly-announced Decision Framework (DF) as the basis for an ‘up/down’ verdict on support for the project.Comprehensive risk identification and mitigation strategies underpinned the focus and coverage of ‘due diligence’ measures to assess the viability of the project. The DF was founded on three pillars: (a) the government implementing a development strategy and program characterized by concrete performance on poverty reduction and environmental protection; (b) the project developer and the government ensuring that the technical, financial and economic aspects of the project and the design and implementation of safeguard policies were of a standard acceptable to IDA; and (c) the government obtaining broad support from international donors and civil society for the country’s development strategy and the NT2 project itself.

As the new business approach was launched, internal capacity to deliver the NT2 project was also stepped up. Measures focused on improving team organization, enhancing communication activities and strengthening oversight functions. A strong project team was mobilized within the Bank and a Project Oversight Group was established at the Bank’s regional management level to guide the team. External independent expert oversight groups played an active role; these included the International Advisory Group (IAG), reporting to the Bank’s President, as well as the Environmental and Social Panel of Experts (POE) and the Dam Safety Review Panel (DSRP) advising GOL.

The project preparation process was complex and time-consuming. The regional dimensions of the project, the design of private-public partnerships, the management of safeguards, the challenge of enhancing the quality of public financial management and the importance of open consultations and communications all increased the complexity of the project preparation. Concerted and coordinated efforts were required to ensure high project quality, gain the confidence of a broad range of stakeholders, devise fair burden-sharing, and reach agreement (among a large number of entities involved in preparation and financing) on the overarching project goals. Private and public entities had to agree on harmonized targets and work together in a coordinated way, understanding and respecting each other’s strengths and constraints.

Project preparation was successfully completed within the time frame set by the Power Purchase Agreement.A strong partnership with the government on macroeconomic reform, poverty reduction, and sustainable growth, implemented through technical support for building domestic capacity, helped implement the first pillar. The second pillar involved traditional project-level ‘due diligence,’ carried out within an evolving framework that nurtured partnership and engagement with all stakeholders, underpinned by transparency and disclosure. The third pillar triggered an unprecedented level of open consultation with the international community and local participants. Independent external oversight groups were established, and extraordinary effort went into mobilizing official and commercial funds in support of the project.

The World Bank Group used a range of IDA instruments to address the cross-sectoral complexities of the project and to support the new business approach.Three project instruments provided direct funding. A US$20 million IDA grant–the Nam Theun 2 Social and Environment Project (NTSEP)–helped fund a portion of the government’s equity in the Nam Theun 2 Power Company (NTPC) and the management of the social and environment impacts and independent monitoring and evaluation of the NT2 project. An IDA partial risk guarantee of US$42 million covered a syndicated commercial loan to NTPC. MIGA guarantees of about US$90 million for a syndicated commercial loan as well as an equity investment in NTPC covered political risks in Thailand (the external buyer of NT2 electricity) and Lao PDR. In addition, both strategy level and technical staff dialogue on policies and institutional reform addressed the total package of outcomesexpected from this mega-project. This was reflected in the project’s legal framework.

World Bank Group support to NT2 consists of three components: (i) a hydropower facility with installed capacity of 1,070 megawatts (MW), providing 995 MW of power for export to Thailand and an additional 75MW for domestic use; (ii) management of the project’s environmental and social impacts on the Nakai Plateau, in the NT2 Watershed and in the downstream areas of the Nam Theun and Xe Bang Fai rivers; and (iii) monitoring and evaluation arrangements designed to meet sound engineering practices, fiduciary responsibilities, and the respective oversight requirements of the participating financial institutions in a timely and cost-effective manner.

The project was approved by the Bank’s Executive Director’s on March 31,2005. Implementation so far has been on schedule and progress is satisfactory.

Results from the New Business Approach

NT2 project preparation led to several desirable outcomes.These include:

  • formulating an acceptable way in which natural resource rents could be extracted and applied transparently to poverty reduction in a country like Lao PDR, with limited capacity, inadequate infrastructure and serious governance problems, thereby avoiding the "natural resource curse" affecting similar countries;
  • designing the best way of forging a private-public partnership on large regional infrastructure projects in a country where the private sector has yet to emerge as a major development player;
  • fashioning constructive Donor engagement with government, regional partners, local populations, and other key stakeholders, including the international private sector and civilsociety, by building ownership, quality, participation, communications and consensus and achieving a high degree of transparency and disclosure, something that is unusual in a country not characterized by openness; and
  • strengthening management of the environmental and social impacts (all ten Bank safeguard policies were triggered by this project), an aspect that has plagued many of the past hydro projects, through enhanced design features relating to risk mitigation, financing, participation, monitoring and evaluation.

The new business approach has triggered fundamental changes in Lao PDR.For the first time, local populations have been given a voice in designing projects. It has promoted more transparency in government. GOL officials now discuss development issues more openly within the country and with foreign partners. Lao officials and interlocutors are now well positioned to negotiate other deals, including several regional hydropower deals now in the works, spurred by increased international confidence and trust in GOL resulting from the IDA NT2 experience. Indeed, Lao PDR is now more competitive, more attractive for investors and more transparent than before and this might not have happened without the strategic deployment of World Bank resources through the new business approach.

But is the new business approach replicable?

It was based on a business partnership driven by features that were unique to NT2, many of which were serendipitous. In response to strong pressures from a coalition of stakeholders wishing to re-enter into the ‘Big Dam’ business, the Bank was prepared to put an abnormal amount of budget and other resources into NT2 preparation. Butthe opportunity cost of doing another hydro using the new business approach employed in NT2 is prohibitive in terms of budgetary costs, management time, diversion of best quality staff, and the communication efforts involved. The range, depth and cost of due diligence carried out under NT2 is widely believed to be excessive. It reflected lack of prioritization by a highly risk-averse Bank management. To compound this burden, the Bank responded to changes in the state-of-the-art and the ups and downs in the global debate on dams and constantly made new demands and imposed further costs on the developers (including their taking on what would normally be implementation responsibilities of a government). The design and standards employed in safeguard mitigation measures are also considered by many private sector players as “gold plated.”

The combination of behaviors of NT2 partners is unlikely to happen again, except by accident. There were special reasons why the private sector partners remained patiently engaged for over ten years. Public sector ownership of EdF and EGCO played a part. The strong financials of the project, thanks to its technical features, provided space for the project company to take on the onerous financial obligations. The level of commitment to policy and institutional reform shown by the GOL,and their readiness to link progress in this area to IDA support for a hydro project, is also an unusual feature. This was driven by strong geopolitical reasons to diversify sources of financial and technical support for large hydro in Lao PDR. Again,the remarkable degree of regional cooperation displayed in this project is due to its timing coinciding with an unprecedented commitment of regional players to set aside past differences and work together on regional water issues.

Feedback from partners confirmsthat the replicability of NT2’s success is open to question. When interviewed for the Bank’s recently conducted NT2 Learning Activity, both governments and private partners applauded the Bank’s NT2 efforts and were of the view that NT2 would not have seen the light of day but for the Bank’s involvement. The high standards in NT2 were appreciated as was the successful introduction of Lao PDR to the private international markets, which opened the possibilities for private sponsors to seriously consider large infrastructure projects in other low income, weak creditworthiness countries in East Asia as well. In fact, preliminary proposals have already been made to EGAT in Thailand for a number of cross-border energy projects for supply of power to Thailand, without the involvement of multilateral institutions. However, both groups were less than enthusiastic about partnering with the Bank on future hydro projects -- unless business partnership arrangements recognized on-ground realities and were more responsive to the problems faced by private partners. The Bank is seen as a high cost, high hassle partner of last resort.

Lessons from the NT2 preparation experience

The key lessons that the Bank needs to draw from this experience is that there is a critical need to reduce the costs (monetary and “intangible”) that the private sector incurs in doing business with the Bank. The Bank needs to better understand the constraints under which the private sector (and the government) works, including seeking:

  • earlier signals to private partners on the Bank’s level of commitment to a project;
  • a better prioritized, more cost-effective, properly sequenced work program on due diligence;
  • more equitable burden sharing of project preparation costs among relevant shareholders; and
  • a more collaborative and less threatening relationship.

Improving the Bank’s business approach