Document of

The World Bank

FOR OFICIAL USE ONLY

Report No. 13889-IND

INPLEMENTATION COHPLETION REPORT

INDONESIA

GAS DISTRIBUTION PROJECT(LOAN NO.2690-IND)

JANUARY 20, 1995

Industry & Energy Operations DivisionCountry Department IIIEast Asia & Pacific Region

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit = Indonesian Rupiah (Rp)US$1.00 = Rp 2,200Rp 1,000 = US$0.45

WEIGHTS AND MEASURES

1 Standard cubic foot (cf) = 0.028 cu.m.1 British Themal Unit (btu) = 0.252 kilocalories (Kc)mcf = thousand standard cubic feetmmcfd = million standard cubic feet per daymcm = thousand standard cubic metersmumcm = million standard cubic meterstcf - trillion standard cubic feetm3 = standard cubic meter

FISCAL YEAR OF BORROWER

April 1 - March 31

ABBREVIATIONS AND ACRONYMS

MM MillionERR Economic Rate of RetumFIRR Financial Internal Rate of ReturnNPV Net Present ValueGOI Government of IndonesiaLNG Liquefied Natural GasLPG Liquefied Petroleum GasMIGAS Directorate General of Oil and Natural Gas,

Ministry of Mines and EnergyPERTAMINA National Oil and Gas CompanyPGN Perusahaan Umum Gas Negara

(State Gas Corporation)

FOR OFFICIAL USE ONLY

Table of Contents

Currency Equivalents, Weight and Measures, Abbreviations and Acronyms ............ ............. iiTable of Contents .................................................... iiPreface .................................................... iv

Evaluation Summary ..................................................... 1Project Review ........................................................................... 3

A. Statement/Evaluation of Objectives .3B. Achievement of Objectives .6C. Major Factors Affecting the Project .7D. Project Sustainability .9E. Bank Perforance .10F. Borrower Performance .10

G. Assessment of Outcome .10H. Future Operations .12I. Key Lessons Leamed .12

Statistical Tables

Table 1: Surmmary of Assessments .14Table 2: Related Bank Loans/Credits .15Table 3: Project Timetable .15Table 4: Loan Disbursements .16Table 5: Key Indicators for Project Implementation .16Table 6: Key Indicators for Project Operation .17Table 7: Studies included in the Project .17Table 8A: Project Costs .18Table 8B: Project Financing .19Table 9A: Economic Costs & Benefits .20Table 9B: Financial Intemal Rate of Retur .20Table 10: Status of Legal Covenants .21Table 11: Bank Resources: Staff Inputs .23Table 12: Bank Resources: Missions .24Table 13: Formal Training Places Filled .25

Appendices

A. Mission's Aide MemoirB. Borrower's ContributionC. Maps

This document has a restricted distribution and may be used by recipients only in the perfornance of theirofficial duties. Its contents may not otherwise be disclosed without World Bank authorization.

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IMPLEMENTATION COMPLETION REPORT

INDONESIA

GAS DISTRIBUTION PROJECT(Loan No. 2690-IND)

PREFACE

This is the Implementation Completion Report (ICR) for the Gas Distribution Project in Indonesia, forwhich Loan No. 2690-IND, in the arnount of US$ 34.0 million equivalent was approved on May 6, 86 andmade effective on December 23, 1986.

The loan was closed two years late on July 31, 1994 (the scheduled closing date was July 31, 1992).It was not fully disbursed (US$2,385,769.49 canceled) and the last disbursement was on December 20, 1994.Cofinancing for the project was provided by the Overseas Development Administration (ODA) of the UKgovernment.

The ICR was prepared by S. Khwaja, Senior Gas Specialist, IENOG and D. Vernilya, FinancialAnalyst, EA3E, and reviewed by Peter R. Scherer, Chief, EA3IE, and Richard A. Calkins, OperationsAdviser, EA3DR.

Preparation of this ICR was begun during the Bank's mission to Indonesia from September 26 toOctober 7, 1994. It is based on material in the project file. The borrower's contribution is attached asappendix B.

INDONESIAGAS DISTRIBUTION PROJECT

[Loan 2690-IND]

EVALUATION SUMMARY

A. INTRODUCTION

1. In 1981, the Bank's Energy Assessment Report confirmed that Indonesia's alternative energy sourcescould be developed economically to substitute oil in domestic consumption and recommended such substitutionin order to maintain potential oil exports. Subsequently (in 1984 and 1985), Bank initiated and supervisedthree studies for the gas sector: (a) a gas utilization study to assess, in a long-term perspective, the expandeduse of natural gas in domestic consumption; (b) a gas distribution study to assess the potential for expandedgas distribution to small and medium industries, commercial entities and households in urban areas; and (c) anLPG feasibility study to evaluate the economic viability of LPG distribution more widely for household use.These studies helped formulate: (a) the strategy of developing large-scale domestic markets for natural gas, asa substitute for oil, particularly for power generation, industrial and commercial users; and (b) the GasDistribution Project (Bank's first lending operation in the gas subsector) to support this strategy throughrehabilitation and extension of gas distribution systems in Jakarta, Bogor (West Java) and Medan (NorthSumatra), institution building of PGN (the gas utility responsible for this development) and Energy PricingPolicy Study. The Loan Agreement for this Project was signed on June 5, 1986, and it was made effective onDecember 23, 1986. The loan closing date was July 31, 1994.

B. PROJECT OBJECTIVES

2. The broad sector objectives to be advanced by the Project were:* to bring about institutional changes and policy modifications to facilitate the penetration of natural gas in

the domestic economy;* to support GOI's efforts to improve its energy pricing policy; and,* to accelerate the utilization of natural gas in high-value uses in the domestic market.

3. The specific obiectives to be achieved during the implementation phase of the Project were:* to encourage the use of natural gas by small and medium-sized industries, thus ensuring the utilization of

gas in a high-value market, by constructing new gas distribution facilities;* to replace and/or rehabilitate portions of PGN's existing gas distribution networks, which were unsafe and

subject to substantial leakage;* to build up the managerial and technical capabilities of PGN to plan and implement system expansion and

operate its networks efficiently and cost effectively;* to establish duplicable technological standards on which to base future expansions of existing gas

distribution networks, or the creation of new ones, as natural gas becomes more widely available; and,* to support GOI's efforts in the review and modification of sector policies, particularly with regard to

energy pricing.

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C. IMPLEMENTATION EXPERIENCE AND RESULTS

4. Overall, the Project implementation results have been highly satisfactory. The sales target has beensurpassed by 50%, the rates of return on revalued net fixed assets in operation of about 18%, 22% and 23%for FYs 91, 92 and 93 are well in excess of the 10% ROR covenanted under the Project loan (LN 2690-DND)and the amended 4% for FYs 91-93 covenanted under the follow-up Project' loan (LN 3209-IND). Thenumber of staff (1156) is well below the agreed ceiling (1440) and gas losses have been reduced from 30% to2%. PGN has now achieved unqualified financial audits for five consecutive years. Except for about a sixmonth delay in Project startup, poor customer response in the initial year and a half of project implementation,and restriction on gas supply (for about 9 months) in 1989/90, there were no mnajor implementation problems.The poor customer response issue was fully redressed by 1988 with skillful and aggressive marketingtechniques, leamed by PGN during the course of project implementation. In the end, the late project startupand restriction on gas supply resulted in a one and a half year delay in project implementation.

D. SUMMARY OF FINDINGS, FUTURE OPERATIONS, AND KEY LESSONS LEARNED

5. The Project achieved or exceeded all its specific objectives, and initiated a policy dialog. Overall, theproject has achieved substantial development results during the implementation phase. It's limited scope andleverage to effectively pursue broad sector issues and especially cross-sector issues notwithstanding, theProject has:

e demonstrated that a significant demand exists for natural gas in domestic industry;demonstrated that natural gas is a financially viable alternative to exportable petroleum productsin domestic energy consumption; and,

* provided an important entry point for broad sector policy discussions with GOI.

6. PGN with Bank's support commenced the second gas project, the Gas Utilization Project (Loan 3209-ND) in 1990 which is scheduled for completion in 1996. Beyond the existing projects, PGN is now seekingsupport from the Asian Development Bank for a natural gas transmission pipeline to deliver gas from Asamneraoperated gas fields (in South Sumatra) to Caltex's enhanced oil recovery operations at Duri oil fields (inCentral Sumatra), with a spur line to Batam island (near the coast of Sumatra). PGN is also seeking Bank'ssupport for a natural gas transmission pipeline between South Sumatra and West Java to bring additionalsupplies to West Java markets. In addition, PGN is slated to become a Persero2 (joint-stock company) duringthe first quarter of 1995 which will enable it to attract private sector participation in its expansion projects.

The on-going Gas Utilization Project (LN3209-IND).

Under GOI regulation No. 37, signed by the President on December 6, 1994, PGN has been permitted to become a Persero.

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7. The key lessons learned were: (a) the importance of using a twinning arrangement for institutionbuilding in parallel with project implementation, and careful selection of the twinning partner; (b) the key toPGN's rapid sales growth was the introduction of market development techniques; (c) gas sales contractsshould be in place before construction of the gas pipeline conmnences, otherwise the consumer has a significantadvantage over the distribution company; (d) sequencing of distribution network construction should be gearedtowards maximizing economic gains early on; (e) a component shouldn't be included in the Project withoutsufficient Borrower commitment and preparation, as was the case with the customer conversion component; (f)an appropriate legal and regulatory framework is needed (and still is needed) to enforce delivery of contractedgas supplies; (g) avoid hiring consultants about whom there are considerable technical reservations, as was thesituation during the Energy Pricing Policy Study.

PROJECT REVIEW

A. Statement/Evaluation of Objectives

8. TThe broad sector objectives to be advanced through the Gas Distribution Project were:

9. To bring about institutional changes and policy modifications to facilitate the penetration ofnatural gas in the domestic economy: This objective was relevant to Indonesia's natural gas sectordevelopment strategy because it focused on substitution of exportable liquid petroleum products with non-exportable natural gas which would increase Indonesia's foreign exchange earnings. The main operationalfocus of the Project was to strengthen PGN by linking it through a twinning arrangement to an experiencedforeign gas utility capable of providing assistance in key areas of gas utility management such as, marketing,procurement, system design, financial analysis and corporate planning. British Gas was selected as thetwinning partner. The policy modifications which the Project proposed to address were primarily concemedwith revising the producer and consumer energy pricing policies towards the domestic prices of fuels and totheir efficiency levels to encourage increased natural gas production and efficient use of these resources.

10. Since the Project was the first gas distribution project, it was focussed narrowly and primarily ongaining a market for gas in Indonesia. Beyond that, the development of gas distribution networks in Jakarta,Bogor and Medan and the Energy Pricing Policy Study provided a venue for initial discussions with theGovernment on wider policy issues and on institutional changes.

11. To support GOI's efforts to improve its energy pricing policy: This objective was to beaccomplished by conducting an Energy Pricing Policy Study (EPPS). The intent of the EPPS was to raiseawareness with GOI that there is a need to revise its energy pricing policy. The EPPS was an important partof the project, as it extended the project's influence beyond the hardware and institutional components into thepolicy arena. It provided an essential vehicle for pursuing and informing the Bank's dialogue on energy priceswith the GOI, and contributed towards the rationalization of liquid petroleum products prices, which exceptfor kerosene, are now at or above import parity prices.

12. While the study would have had the potential to affect pricing policy in the natural gas sector, it wouldhave had little potential to create fundamnental pricing policy changes with regards to other fuels such as dieselkerosene, and fuel oil. The implementation of the results of such a study, which would involve coordinationamong several government ministries, would be difficult given that the Project was largely focused on PGN,and to a lesser extent on MIGAS.

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13. Accelerate the utilization of natural gas in high-value uses in the domestic market: This objectivewas to be realized by developing the infrastructure needed to distribute gas to industrial and commercialconsumers currently using liquid fuels as a source of energy, and by building up the institutional capability ofPGN to actively market and distribute gas. Support would also be provided to facilitate the conversion ofindustrial consumers from liquid fuels to natural gas, and to assist GOI in setting appropriate fuel prices so asto encourage optimal utilization of gas.

14. This objective was achievable as PGN had the capability and commitment to develop its distributionnetwork design, construction, management and gas marketing abilities, with the assistance of an experiencedtwinning partner, to make a significant increase in natural gas usage in high-valued industries.

15. All of the specific project objectives to be accomplished during the implementation period of the GasDistribution Project were clearly stated and each directly supported the broad objectives of the Project. Thespecific objectives were:

16. To encourage the use of natural gas by small and medium-sized industries, thus ensuring theutilization of gas in a high-value market, by constructing new gas distribution facilities: PGN, with thesupport of an experienced twinning partner, could acquire the expertise to efficiently design, build and operatethe distribution facilities which would encourage and accelerate the use of gas by small and medium sizeindustries. However, there were risks associated with achieving this objective such as, insufficient gassupplies from Pertamina, a price devaluation which would make gas prices to consumers unattractive, and gassupply delays.

17. To replace and/or rehabilitate portions of PGN's existing gas distribution networks, which wereunsafe and subject to substantial leakage: This objective was integral to improving gas distribution safetyand efficiency -- by reducing gas losses from 30% to more acceptable levels (below 2%). This objective waseasily achievable by PGN, with a twinning partner, within the implementation period of the project. No majorrisks, other than material supply delays, would have prevented attainment of this objective.

18. To build up the managerial and technical capabilities of PGN to plan and implement systemexpansion and operate its networks efficiently and cost effectively: To bring this about, a long-termtechnical collaboration (called "twinning") with an experienced foreign gas utility was designed which wouldprovide the required broad based package of technical assistance to build PGN's mnanagement and operatingcapabilities in parallel with project implementation. The twinning arrangement and the choice of a twinningpartner which would work in conjunction with PGN, share the sane responsibilities as PGN, and train PGNmanagement and staff in specialized functions, formed the comerstone of this objective and of the wholeproject. The twinning arrangement, as opposed to discrete technical assistance packages to deal with differentdisciplines and hiring consultants to assist in their implementation, was preferable because it would: (a)provide integration of know-how transfer on site in the course of project irnplementation; (b) keep the workprogram flexible over time; and (c) expose PGN to an experienced operating organization (i.e. a role model)with the possibility of a long-term cooperative relationship. There were, however, risks associated with thetwinning arrangement: (a) the twinning team might not have been of high quality, (b) its members might nothave worked well with PGN staff, and (c) the twinning team might not have aligned itself with PGN's goals.

19. To establish duplicable technological standards on which to base future expansions of existinggas distribution networks, or the creation of new ones, as natural gas becomes more widely available:The objective is clearly linked to the promotion and efficient expansion of natural gas utilization in Indonesia.

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20. To support GOI's efforts in the review and modification of sector policies, particularly withregard to energy pricing: This specific objective clearly supports the broad objective to bring about policymodifications to-facilitate the penetration of natural gas in the domestic economy. It is, however, not clearfrom the Staff Appraisal Report (SAR), which sector policies the project intended to address and in whatmanner they would be addressed, other than changing the energy pricing policy for producer and consumerprices, which was to be addressed in the Energy Pricing Policy Study. The SAR didn't discuss how therecommendations of the Energy Pricing Policy Study would then be implemented. The objective, as stated,was vague and therefore difficult to implement.

21. None of the broad or specific objectives were changed during the project, however, gas supply delaysand funds reallocation (paras 3 8 & 41) affected the implementation of the project components listed below.

22. Project components designed to achieve the Project objectives:

1. Gas Distribution and Technical Assistance Component. This component involved:a) laying of about 218 km of high-pressure transmission pipelines and 535 km. of

medium-pressure polyethylene distribution pipelines;b) construction of 10 pressure reducing stations;c) construction of service lines and meter stations for a core group of about 350

industrial, 800 commercial and 12,700 domestic consumers;d) provision of a meter maintenance workshop, telecommunication and pressure/flow

monitoring systems, computer and other office equipment;e) twinning with an established gas utility to strengthen PGN's capability in the areas of

demand forecasting, system planning and design, construction management, systemoperation and maintenance, customer conversion, accounting and managementinformation systems; and,

f) training of PGN staff in management, finance, accounting and engineering.

2. Customer Conversion Component, involving the installation of intemal piping and conversionto natural gas of customers' appliances and equipment.

3. Studies, including:a) an Energy Pricing Policy Study (EPPS) to be carried out by the Ministry of Mines &

Energy, andb) LPG Feasibility Study (financing only).

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B. Achievement of Objectives

23. Bring about institutional changes and policy modifications to facilitate the penetration of naturalgas in the domestic economy: While substantial institutional improvements have occurred at PGN in gasutility management, marketing, procurement, system design, financial analysis and corporate planning,resulting in actual sales exceeding the target by 50%, sector policy modifications under this Project have beennegligible. However, the dialog initiated under this Project led to changes in the consumer energy pricingpolicy and PGN's corporatization, and paved the way for major sector policy and regulatory changes to beundertaken through the proposed Gas Development Project. The role of Pertamina vis-a-vis PGN in gas sectortransmission has been partially clarified through a government decree which gives PGN the right to transmitnatural gas. However, an adequate legal and regulatory framework is still not in place to assure that sufficientgas supplies will be available for future growth.

24. Support GOI's efforts to improve its energy pricing policy: This objective has partially beenachieved. Although the Bank commissioned the Energy Pricing Policy Study, there is little evidence that thestudy was used to change energy pricing in the gas sector or other energy sectors and no Energy Pricing Unitwas established to assist the Governnent with energy pricing. Following the EPPS, however, an internal Bankstudy, the Energy Pricing Review, was conducted which resulted in GOI taking into account the import priceof substitute fuels in setting natural gas prices.

25. Accelerate the utilization of natural gas in high-value uses in the domestic market: This objectivewas fully achieved. At the end of the project, actual sales exceeded the SAR target by about 50% with fewerconnections and a higher customer density than stipulated in the SAR, due to skillful identification andattachment of higher yield consumers. The fuels replaced in most cases were diesel oil and kerosene, whichare high-valued fuels.

26. The assessment of specific project objectives is given as follows:

27. To encourage the use of natural gas by small and medium-sized industries, thus ensuring theutilization of gas in a high-value market, by constructing new gas distribution facilities: This objectivewas fully met as total sales volume surpassed expectations in the SAR by 50%.

28. To replace and/or rehabilitate portions of PGN's existing gas distribution networks, which areunsafe and subject to substantial leakage: This objective was fully met. Apart from enhancing pipelinesafety, the rehabilitation process contributed to the reduction of gas losses from about 30% in 1986 tointernationally acceptable levels of less than 2% by 1993.

29. To build up the managerial and technical capabilities of PGN to plan and implement systemexpansion and operate its networks efficiently and cost effectively: This objective was substantiallyachieved. The twinning arrangement has been highly successful in upgrading PGN's skill to efficientlydevelop gas markets, as well as plan, build and operate distribution networks.

30. To establish duplicable technological standards on which to base future expansions of existinggas distribution networks, or the creation of new ones, as natural gas becomes more widely available:This objective has substantiallv been achieved. The distribution systems built in Jakarta, Bogor and Medanfollow internationally acceptable standards for system design, materials and safety.

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31. To support GOI's efforts in the review and modification of sector policies, particularly withregard to energy pricing: This objective has partially been achieved. While the Energy Pricing Policy Studv(EPPS) was not instrumental in changing energy pricing policy, the exchange of views based on the Bank'sfollow-up study, an Energy Pricing Review, prompted GOI to adopt a policy of pricing fuels based on realeconomic costs. GOI has been adjusting prices accordingly, by reducing various distortions in coal, gas andpetroleum product prices. In addition, the junior local consultants who benefited from the training provided aspart of the EPPS continue to be used by Pertamina for the analysis and setting of petroleum product prices.

C. Major Factors Affecting the Project

Factors not generally subject to government control

32. The price of crude oil on international markets, and therefore, the value of substitute fuels and thealternative cost of gas under the project, is a factor not subject to control by the Indonesians. The averagecrude oil price during project implementation was close to $16/bbl., similar to SAR estimates; future crude oilprojections steadily raise the cost per barrel to $30/bbl. within 15 years.

Factors generally subject to government control

33. Macroeconomic policies, like the timing and the magnitude of currency fluctuations, are subject togovernment control. In 1986, a 45% devaluation of the Rupiah to the dollar occurred. The SAR had warnedthat dollar-denominated, but Rupiah-payable gas supply contracts were a risk factor for the Project because allforeign exchange risk would be borne by PGN. Although most of the gas supply contracts were laterrenegotiated to give PGN just a 15% foreign exchange loss, as a result of the 1986 devaluation (and high gaslosses) PGN was unable to achieve its targeted 10% ROR until 1991.

34. The first major gas purchase price revision occurred at the outset of the Project. The 45% devaluationof the Rupiah to the dollar resulted in substantial and inmmediate losses for PGN. Another price changeoccurred in October 1991, the selling price of natural gas rose by 20% locally due to similar increases in theprice of competing fuels. This response to market conditions demonstrates that PGN has been responsive tothe messages of the Energy Pricing Policy Study and the Energy Pricing Review - to price at or above the gasefficiency price.

35. Lack of an adequate regulatory and legal framework to enforce supply contracts, resulted in gassupply delays.

36. PGN's ability to expeditiously process the procurement of goods and services was impaired, to someextent, by GOI's procurement procedures, particularly the regulations under Kepres 29, which required thataward of contracts valued above Rupiah 3 billion should be approved by the Ministry of Finance. This levelhas now been raised to Rupiah 10 billion.

37. Simultaneous retirement of three directors (out of a total of four) in 1993 disrupted the work resultingin procurement and disbursement delays.

Factors generally subject to implementing agency control

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38. Funds for the customer conversion component of the project (Category 1(b) and Category (2) ofSchedule 1 of the Loan Agreement), largely unutilized as customers had access to more attractive funds, werereallocated to augment the supply mains for Jakarta/Bogor to market additional 24 mmcfd of gas supply overand above the quantity contracted under the Project. US$ 9 million, of the original amount of $9.5 million wasthus transferred to the goods category for this purpose.3

39. PGN's twinning arrangement with British Gas was initially funded with a 2.5 million pounds sterlinggrant from Overseas Development Administration (ODA) of the UK Government covering 282 man-months.Following an evaluation by the British Gas twinning team during 1987/88 it was determined that additionalsupport (184 man-months) would be required in a number of key areas (distribution, finance and planning) forwhich ODA provided a further 1.7 million pounds sterling.

40. Following a review in 1993, PGN reorganized its procurement operations. A new division fullydedicated to procurement was established resulting in a marked improvement in the tendering process andcontract administration. The average time taken from the preparation of tender documents until the award ofthe contract was reduced from 40 weeks to 28 weeks.

Implementation delays

41. The loan closing date was extended twice. The first extension moved the closing date from July 31,1992 to July 31, 1993; the second extension moved the closing date to July 31, 1994. The first one-yearextension was granted for the following reasons:

a) there was about a 6 month delay in project startup due to delays in the finalization of twinningarrangements, which was a condition of loan effectiveness; and

b) there was about a 9 months delay in FYs 89/90 and 90/91 in implementation of expansionplans due to restricted supply of gas, by Pertamina, contrary to the supply agreement.

42. The second one-year extension was granted in order to provide additional time of about one-year toutilize funds reallocated from the customer conversion category to the goods category for theexpansion of gas supply infrastructure of Jakarta/Bogor area to accept additional gas supplies (inexcess of contracted quantities under the project) negotiated with Pertamina.

43. The implementation of the EPPS was delayed by about one year, because GOI's negotiations wsith thebest evaluated bidder broke down on the consultant fee issue, i.e., the fees expected and normally charged bythe consultants were higher than the "guidelines for international consultants" of the Ministry of Finance. Thesecond ranked bidder was then selected although the Bank had considerable reservations on its technicalabilities. In the end, the technical weaknesses of the consultant were compounded by poor management of thestudy.

3 Of which about S6.6 million has been utilized and $2.4 million has been cancelled.

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D. Project Sustainability

44. With the institutional strengthening received under the Project, PGN is capable of managing itsbusiness at the current pace of development. PGN now has a core staff of 190 professionals (engineers,accountants, sales executives, economists) and 260 technicians. Of the 1585 training course places (Table13) attended during the project, about 30% were taken by technicians and 70% by the professionals of which14 professionals obtained master's degrees from UK universities. Additionally, about 700 technicians ofindustrial customers and 200 technicians belonging to the contractors have been trained.

45. The distribution networks are well planned and built, and have the capability to support continuedgrow-th, at the current level, over the next 5 to 7 years. The market development has been highly successful.PGN has successfully raised the awareness of the advantages of natural gas as a fuel in the main industrialand commercial centers. PGN alreadv has an inventory of potential industrial customers which if attachedcould provide additional 60 mmcfd sale without anv extension of the system and another 150 mmcfd salewith small extensions, provided additional gas supplies are available. According to PGN's projections, inthe medium term (7 years) the consumption of gas, in West Java, by general industry alone could rise to 450mmcfd. To maintain the momentum of this development, PGN would have to expeditiously secureadditional gas supplies for West Java, which is the basis of the Operational Plan outlined in the followingsection.

46. The demand for gas during the project period increased substantially more than the forecast. Themarketing of gas will, therefore, not present any problems for the long-term sustainability of the project.However, the securing of long-term supply commitments are likely to present impediment to PGN's futuregrowth. An eventual new gas project should, therefore, address the lack of an appropriate producer pricingpolicy and regulatory and legal framework to encourage additional gas supply.

Operational Plan

47. PGN has prepared an Operational Plan for the Project areas (Jakarta, Bogor and Medan) to sustainthe Project objectives during its operation phase (1994-2008). The premise of the Operational Plan is thatthe momentum of this development process should be maintained so as to maximize the use of natural gas indomestic energy consumption. While in Medan area the gas supply and distribution networks would beadequate due to expansion under the ongoing Gas Utilization Project (Loan 3209-IND), Jakarta and Bogorwould need additional gas supply which could be achieved through a follow-up project to bring 250 mmcfdgas supply from South Sumatra to West Java. The Operational Plan, therefore, assumes that a natural gastransmission pipeline will be built from South Sumatra to West Java under the proposed Gas DevelopmentProject. A financial analysis of the Operational Plan shows that a scenario which incorporates theincremental costs and benefits of such a gas transmission pipeline generates a sustainable FIRR of 28%.

48. PGN has sufficiently trained staff for its current operations and plans to train additional staff tohandle expanded distribution operations. However, as PGN enters into major gas transmission, includingpipeline construction and operations, it would need an experienced gas utility as equity or joint-venturepartner.

49. PGN has agreed with the Bank that it would monitor the following indicators over the operationalphase of the project: (a) ROR on re-valued net fixed assets in operation; (b) gas losses; and (c) staffemployed (see table 6).

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E. Bank Performance

50. Overall, the Bank's performance was satisfactory. During the project identification and appraisalstages potential risks to the project were flagged and steps were taken to mitigate these risks in the projectdesign phase and during project implementation. The Project was simple in design and well focused except forthe customer conversion component which proved superfluous, as customers had access to more attractivefunds. A key aspect of the Bank's role in the project is its contribution to the design and implementation of thetwinning arrangement for PGN. Project supervision was highly satisfactory. Appropriate skill mix andcontinuity of the supervision team was an important factor in the satisfactory outcome of the projectsupervision. The likely problem areas and remedial measures were flagged well in advance. The Bank wasflexible in extending the loan closing date twice, based on Borrower's cogent reasons. The Bank did not insistthat PGN should proceed with its construction program before it had adequate gas supplies and customercommitments to purchase gas.

F. Borrower Performance

51. The Government, as Borrower, generally performed well. All commitments made during negotiationsand covenanted under the loans were fulfilled with the exception of auditing of PGN's accounts by BPPKwhich was generally late; also the audit of EPPS was delayed. It is, however, noteworthy that prompt actionwas taken to fulfill the commitrnents with regards to reorganization of PGN, enhancement of staffremunerations, recruitment policy, size of PGN's establishment, and availability of counterpart funds. TheGovernment also assisted, though not very promptly, in restoration of contracted gas supply from Pertaminaand also allowed PGN to partially make up its loss on this account through a reduction in purchase price overa fixed period. The Government's policy of enforcing retirement of PGN's staff promptly upon reaching theretirement age, particularly in the case of senior management (i.e. Directors and President Director), has beentemporarily disruptive and could have been avoided by better succession planning. All in all, the Governmenthas been supportive in project implementation.

52. PGN's performance, as Beneficiary, was satisfactory or highly satisfactory on most counts. Theperformance covenants under the project were exceeded in all cases, primarily because of PGN's effective useof the twinning arrangement. Together with the twinning partner, PGN grew its sales substantially due toeffective market development and distribution expansion strategies. By targeting high volume, high returnindustries for connection, PGN was able to exceed anticipated sales by 50% with fewer than the originallyestimated number of customers. Moreover, PGN improved the safety of gas operations on its customer'spremises by providing in-house training to its customer's staff on the safe use of gas.

G. Assessment of Outcome

53. The project results are highly satisfactory because the project achieved or exceeded all of its specificobjectives and has achieved or is highly likely to achieve substantial development results, without majorshortcomings. In spite of the Project's limited leverage to effectively pursue broad sector issues and especiallycross-sector issues, such as energy pricing, the Project has:

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* provided a venue to enter into broad policy discussions with GOI;* demonstrated that a significant demand exists for natural gas in domestic industry;* demonstrated that natural gas is a financially viable alternative to exportable petroleum products

in domestic energy consumption.

54. The Energy Pricing Policy Study and follow-on Energy Pricing Review, which recommendedefficiency pricing of fuels to achieve the best allocation and most efficient utilization of energy resource,played a role in increasing gas prices by 20% in November 1990 following similar price increases insubstitute fuels. The EPPS, however, did not achieve the objective of creating an Energy Pricing Unit torecommend to GOI economic energy prices and monitor energy price movements.

55. Beyond the anticipated results, the financial success of the Gas Distribution project has alsopaved the way for private sector participation in the development of gas sector - PGN has beenpermitted by GOI to convert to Persero (joint-stock company), it is expecting to issue bonds on localcapital markets by mid 1995, and it is anticipating a joint-venture partnership with an experiencedgas utilitv during the coming year. A Bank sponsored study looked at private sector financingarrangements for PGN. Findings of the study reveal a significant level of interest by several largeinternational gas utilities in forming joint-ventures with PGN or taking an equity position in thecompany.

56. The Project has substantially achieved the economic rate of return target. The re-estimated ERR of38% and an NPV of $83.2 Mi\IM surpassed the original estimates of 31% and $69 MM, respectively. Theproject implementation delays had little impact on the ERR since project benefits were delayed at about thesame rate as project costs. Likewise, the value of gas replaced and the cost of gas were both proportionatelylower due to lower actual crude oil prices. The higher actual ERR is primarily the result of about a 50%increase over SAR estimates in gas sales volume (88 mmcfd achieved versus 54 mmcfd planned) by the lastyear of project implementation.

57. The financial internal rate of return objectives were substantially met. The re-estimated FIRR withtaxes was 27.1%, slightly lower than 29% predicte- in the S,\R; :he re-estimated FIRR without taxes, 63%,wvas also slightly lower than the original estimate, 65.3%. The considerable project implementation delays(totaling 15 months) effectively neutralized the substantially larger price margins attained under the project(a price margin of 70 Rp/m3 predicted, but actual margins ranged from 96.6 to 150 Rp/m3). The investmentin infrastructure was increased by about S6 NM through the reallocation of customer conversioncomponent funds to the goods category, however these funds were used to provide additional gas supplyand raise the sales volume higher that originally predicted.

58. The rate of return on revalued net fixed assets in operation achieved was originally lower thanexpected due to (a) devaluation of the rupiah, which increased the cost of gas, (b) an initially weakmarketing effort and (c) project startup delays. As a result the covenanted ROR target was lowered sincethe commencement (March 12, 1991) of the follow-on Gas Utilization Project (Loan 2690-rND). However,substantial improvement in gas marketing, gas price increases in November 1990, a substantial reduction isgas losses, reduced gas cost, and an increase in the volume of gas sold, raised the ROR to levels exceedingthe revised covenants. Since 1991, actual RORs have substantially exceeded the 10% ROR target. It shouldalso be noted that most of PGN's cash generation went to GOI in the form of income tax, DPS contribution,and social funds. PGN has, thus, contributed more fiscal benefits to GOI than it has received in the form ofGOI equity contributions.

12

59. Gas losses were reduced from 30% of gas sales to less than 2% within the implementation period ofthe project. Enhancement of maintenance and operational procedures, staff skills, and rehabilitation ofportions of existing distribution networks resulted in this steep decline and increased system safety.

H. Future Operations

60. PGN uith Bank's support commenced the second gas project, the Gas Utilization Project (Loan 3209-IND) in 1990 which is scheduled for completion in 1996. This project builds upon the first by expanding thegas distribution network in Medan and introducing natural gas service to East Java. ODA extended thetwinning arrangement to cover this project as well.

61. PGN is seeking the support of the Asian Development Bank for a natural gas transmission pipelinewhich would deliver about 250 mrncfd from the Asamera gas fields in South Sumnatra to Caltex's enhanced oilrecovery operation at Dun' oil fields in Central Sumatra. This project would include a spur transmission lineto Batam Island for a demand (PGN estimates) of about 250 mmcfd by the year 2005. PGN is also seekingWorld Bank support for its proposed Gas Development Project to build a natural gas transmission pipelinebetween South Sumatra and West Java to bring additional gas supplies to meet the existing West Javademand. Both the Asamera-Duri-Batam and South Sumatra-West Java projects are likely segments of anational transmission grid. These are large projects and for their implementation and operation PGN wouldrequire management and technical support which would be best obtained through equity partnership with anexperienced gas utility in the private sector.

62. PGN plans to convert to Persero in the first quarter of 1995, to enable it to attract potential investorsto help finance the aforementioned projects and provide the necessary management and technical expertise.PGN is also scheduled to conduct its first bond issue by mid 1995 in the amount of $275 MM to providefinancing for the Asamera-Duri-Batarn project.

63. A corporate plan indicating a likely development scenario for the company is under preparation.

I. Key Lessons Learned

64. There are several key lessons to be learned from this project, some which had a major influence on theproject's success and others which were detrimental to the project.

65. Twinning Arrangement: the long-termn technical collaboration with an experienced gas utility for on-site managerial, technical, and financial expertise and training to PGN was highly successful as it providedprompt conmnunication and advice on issues, technology transfer and hands on training through theimplementation of the project.

66. Focus on Gas Marketing: the key to PGN's rapid sales growth after 1988/89 was the introduction ofappropriate market development techrliques by the twinning tearn who studied the operations of the consumersand devised a marketing strategy to target and attract high-value added, high-volume industry and then to"sell" the financial, operational and environmental benefits of gas to each customer in its own terms.

67. Gas Sales to Lead Construction: PGN, in 1991, insisted that no distribution network constructionwould continue until such time as agreed gas volumes from Pertamina could be obtained for sale to customers.

13

Although this decision resulted in a one-year Project extension, the alternative would have likely significantlyreduced PGN's bargaining position, cut its profit margins and threatened the project's viability.

68. Sequence Distribution Network Construction to Maximize Economic Gains: by constructing andrehabilitating distribution networks linked to high-valued consumers first, PGN was able to use its resources togreater efficiency. As a result, greater economic gains were attained with fewer customers.

69. Don't Include a Component into the Project without Sufficient Commitment and Preparation:the funds allocated for customer conversion were largely unutilized because the customers had access to moreattractive funds. This indicates insufficient research into alternative sources of financing available to thecustomers.

70. Appropriate Regulatory/Legal Framework: should be in place to ensure that the agreementsbetween various "players" are adhered to. It should be noted that PGN did not receive the contracted suppliesfor about nine months and had little recourse to redress it.

71. Avoid Hiring consultants About Whom There Are Considerable Technical Reservations: theEPPS took considerably longer to implement, involved intensive efforts on the part of the Bank to superviseand in the end the study was not useful for pricing policy recommendations.

14

Table 1: Summary of Assessments

A. Achievement of objectives Substantial Parial Negligible Not applicableMacroeconomic policies O 0 O USector policies 01 0 *Financial objectives * 0 0 Institutional development * 0 03Physical objectives * 0 03Poverty reduction 0 0 0 UGender concerns 0 0 0 0Other social objectives 0 0 0 UEnvironmental objectives * 0 0 0Public sector management * 0 0 0Private sector development Cl * 0 0

B. Project sustainabilitv Likely Unlikel] UncertainU 0 03

C. Bank performance Hi2hlv satisfactory Satisfactory DeficientIdentification 0 0 UPreparation assistance 0 * 0Appraisal * 0 0Supervision * 0 0

D. Borrower performance Highlv satisfactory Satisfactory DeficientPreparation 0 0 UImplementation * 03Covenant compliance 0 0Operation * 03

E. Assessment of outcome Highly satisfactory Satisfactorv Deficient* 0 0

15

Table 2: Related Bank Loans/Credits

Loan/credit title Purpose Year of approval Status

Preceding Operations1. none

Following Operations1. Gas Utilization Project Accelerate substitution 1990 Under implementation

(Ln 3209-IND) of exportable petroleumproduct fuels in Scheduled fordomestic consumption completion in 9/96with non-exportablenatural gas

Table 3: Project Timetable

Date actual/Steps in project cycle Date planned latest estimate

Identification 5-27-1985 5-27-1985Preparation/Preappraisal 8-1-1985

Appraisal4 11-1-1985 8-1-1985

Negotiations 3-28-1986 3-28-1986

Letter of development policy (if applicable)

Board presentation 5-6-1986 5-6-1986

Signing 6-5-1986 6-5-1986

Effectiveness 9-5-1986 12-23-1986

First trance release (if applicable)

Midterm review (if applicable)

Second (and third) tranche release (if applicable)

Project completion 7-31-1992 7-31-1994

Loan closing 7-31-1992 7-31-1994

4 Preappraisal mission was converted to appraisal mission.

16

Table 4: Loan/Credit Disbursements: Cumulative Estimated and Actual(USS millions)

FYL/ '87 '88 '89 '90 '91 '92 '93 '94 '95

Appraisal estimate 4.8 14.3 23.1 28.9 32.3 34 - - -

Actual 0.17 1.6 9.8 12.0 19.9 21.8 22.13 27.54 31.6

Actual as %of estimate 28 69 52 69 68 65 81 94

Date of final disbursement Dec 20

2 Fiscal year ending June 30

Table 5: Key Indicators for Project Implementation

I. Key implementation indicators inSAR/President's Report Estimated Actual

1. none n/a n/a

II. Modified indicators (if applicable)

1. none n/a n/a

III. Other indicators (if applicable)

1. Gas losses < 2% < 2%

2. Rate of Return on revalued net > 10% 23%fixed assets in operation

3. Gas sales 54 mmcfd 88 mmcfd

4. Staff employed < 1440 1156

17

Table 6: Key Indicators for Project Operation

I. Key operating indicators inSAR/President's Report Estimated Actual

1. none n/a n/a

II. Modified indicators (if applicable)

1. none n/a n/a

III. Other indicators (if applicable)

1. Gas losses < 2%

2. Rate of Return on revalued net > 10%fixed assets in operation

.3. Staff employed"' < 1440

S Staff employed covers PGN's second expansion project (Gas Utilization Project, Ln 3209-lND); fiuther projects may requireadditional staff.

Table 7: Studies Included in Project

Study Purpose as defined at Status Impact of studyappraisal/redefined

1. Energy Pricing recommend a completed initiated pricing policyPolicy Study (EPPS) methodology for setting discussion with GOI

energy prices inIndonesia & derivespecific pricing policiesfor the short to mediun-terrn

2. LPG Feasibility finance the remaining $ 200,000 provided toStudy work on the on-going complete study

LPG study financing

3. Energy Pricing not identified in the SAR; completed (a) initiated pricing policyReview purpose was to follow-up discussion with GOI

on EPPS & review (b) GOI has subsequentlyenergy prices in raised some energy prices inIndonesia and line with border prices ofrecommend changes to substitute fuelsGOI pricing policies

18

Table 8A: Project Costs

Appraisal estimate Actualllatest estimate(US$ million) (US$ million)

Item Local Foreign Local Foreigncosts costs Total costs costs Total

I. Distribution SystemDistribution System" 16.42 15.68 32.10 27.54 25.76 53.30Technical Assistance &

Computer 0.00 4.50 4.50 0.00 6.50 6.50Taxes & Dutiesb' 7.41 0.00 7.41 0.37 0.00 0.37Base Cost 23.83 20.18 44.01 27.91 32.26 60.17Physical & Price Contin. 6.42 6.21 12.63 0.00 0.00 0.00Total Cost I 30.25 26.39 56.64 27.91 32.26 60.17

II. TrainingBase Cost 0.00 0.38 0.38 0.00 0.50 0.50Physical & Price Contin. 0.00 0.12 0.12 0.00 0.00 0.00Total Cost II 0.00 0.50 0.50 0.00 0.50 0.50

IH. Customer ConversionEquipment & Installation' 2.62 13.86 16.48 2.62 13.86 16.48Taxes & Duties 4.50 0.00 4.50 4.50 0.00 4.50Base Cost 7.12 13.86 20.98 7.12 4.86 20.98Physical & Price Contin. 1.99 4.44 6.43 1.99 4.44 6.43Total CostI 9.11 18.30 27.41 9.11 18.30 27.41

IV. StudiesLPG Feasibility & Energy

Pricing Policy Studies 0.00 1.20 1.20 0.00 1.09 1.09Physical & Price Contin. 0.00 0.25 0.25 0.00 0.00 0.00Total Cost IV 0.00 1.45 1.45 0.00 1.09 1.09

Total Project (I+II+III+IV) 39.36 46.64 86.00 37.02 52.15 89.17- a- - --

Actual foreign costs include about US $6.6 million transferred from the funds allocated under the loan for customer conversionto finance the expanded scope of this componentb' World Bank projects are exempt from paying import duties and local taxes, therefore actual was much lower than estimated.u As the funds allocated for customer conversion were not utilized, no exact information on customer conversion is available.Therefore the appraisal estimate has been used. PGN introduced discounts of its gas price to industrial customers converting fromother fuels to gas. The conversion cost was thus compensated by the lower gas price. This proved to be a more practical solutionthan financing through the funds allocated under the loan for customer conversion as originally envisaged. The conversion costs arethus implicitly reflected in PGN's gas prices.

19

Table 8B: Project Financing

Appraisal estimate Actual/atest estimate(US$ million) (US$ million)

Foreign ForeignSource Local costs Costs Total Local costs costs Total

IBRD 0.0 34.0 34.0 0.0 31.5 31.5

Bilateral Assistance' 0.0 3.8 3.8 0.0 6.5 6.5

PGN Internal Cash 6.5 0.0 6.5 1.4 0.0 1.4Generation'

GOI Equity 18.3 0.0 18.3 26.6 0.0 26.6Contributions2'

Commercial Loans 10.4 0.0 10.4 7.5 0.0 7.5

Consumers' 4.2 8.8 13.0 1.5 14.2 15.7

TOTAL 39.4 46.6 86.0 37.0 52.2 89.2

A Additional twinning support required following operational review (see para 39)v Most of PGN' s cash generation goes to GOI in the forn of income tax, DPS contribution, and social funds. PGN has, thus,contributed more fiscal benefits to GOI than it has received in the form of govemrnent equity contributions.3 Actual costs are estimates of consumer's expenditure.

20

Table 9A: Economic Costs and Benefits (ERR)

Appraisal Estimate (US$ million) Re-estimate (US$ million)Base Case ERR (%) 31 38

Base Case NPV(US$ mnillion) 69 83

Major Costs

1. Capital Costs 37.7 59.12. Conversion Costs 18.6 15.63. O&M Costs 1.6 1.94. Cost of Gas 34.6 (by end of project) 46.9 (by end of project)

Major Benefits

1. Value of fuel replaced 48.6 (by end of project) 74.2 (by end of project)2. Volume of gas sold 402.4 mmcm 558 mmcm3. Operator O&M savings 0.7 (by end of project) 0.9 (by end of project)

Table 9B: Financial Internal Rate of Return (FIRR)

Appraisal Estimate Re-estimateProject Component Before Taxes After Taxes Before Taxes After Taxes

Total Project 65 29 63 27

Table 10: Status of Legal Covenants

Agreement Section Type of Original Revised Description of Covenant Current CommentsCovenant Fulfillment Fulfillment Covenant

Date Date StatusDescription

Loan 3.02(a) 10 - Subsidiary loan agre. ment with In compliance Condition ofPGN. effectiveness

3.05 5 GOI shall cause PGN to maintain In compliancea salary structure at a level asremunerative as that of othersimilar public corporations.

4.01(b) 1 12/31/90 7/29/94 GOI shall furnish to Bank a In compliancecrtified copy of audit report onrecords and accounts of Part D(studies) of the project not laterthan nine months after end of eachFY.

6.01 10 A) Subsidiary loan agreement In compliance Condition ofexecuted. effectivenessB) Borrower has approved In compliance Condition ofreorganization of PGN satisfactory effectivenessto Bank.C) Agreement signed with In compliance Condition ofestablished gas utility to assist effectivenessPGN.D) PGN has signed long-term In compliance Condition ofcontracts for timely supply of effectivenessrequired quantity of natural gas.

Project 2.06. 5 4/1/87 6/30/87 A) PGN shall prepare a rolling In compliancefive year plan of gas requirementsby the end of each FY and discussthe plan with GOI, gas supplierand the Bank within 3 months.

1/1/87 B) By Jan. 1 of each calendar In complianceyear, PGN shall prepare aninvestment program and furnish itfor Bank's comments.

2.07. 10 9/30/86 4/15/87 PGN shall prepare and furnish for In complianceBank's approval, the detailedoperating procedures forimplementation of the customer

.________ . conversion program. ___ _

Agreement Section Type of Onrginal Revised Description of Covenant Current CommentsCovenant Fulfillment Fulfillment Covenant

Date Date StatusDescription

2.08 5 3/31/87 6/30/87 PGN shall prepare and furnish In compliancefor Bank's review/comment adetailed training program.

3.03(b) 5 6/30/87 6/30/88 PGN shall carry out a review of In complianceits existing insurance practicesand discuss the results withBank.

4.01(b) I PGN shall fumish to the Bank In compliance Previousaudited financial statements not since FY93 statementslater than nine months after the were delayedend of each FY. due to late

audit by gov'tauditor

4.02 5 7/31/88 12/15/88 PGN shall carry out a review of In complianceits gas tariffs, discuss the resultswith GOI and Bank andthereafter make any necessaryadjustments of gas tariffs.

4.03 2 4/1/89 1/1/91 Realize ROR not less than 10% In complianceon revalued net assets in

... _______ .__________.__________.___________ operation.

Full text of General Covenant Cassification

Class DescriptionI Accounts/audit2 Financial performancelgenerate revenue from beneficiaries3 Flow and utilization of Project funds4 Counterpart fundingS Management aspects of the Project or its executing agency6 Environmental covenants7 Involuntary resettlement8 Indigenous people9 Monitoring, review and reporting

1 0 ImplementationII Sectoral or cross-sectoral budgetary or other resource allocation12 Sectoral or cmss-sectoral regulatory/institutional action1 3 Other

23

Table 11: Bank Resources: Staff Inputs

Stage of project cycle Planned" Revised ActualWeeks US$ Weeks US$ Weeks US$

Through appraisal 68.5

Appraisal--Board 35.0

Board--effectiveness 10.0

Supervision 100.5

Completion 12.0

TOTAL 226.0

Data other than Actual is not provided by the MIS or Asia Files.

24

Table 12: Bank Resources: Missions

Specialized Implemen- Develop-Stage of Month/ Number of Days in staff skills tation ment Types ofproject cycle vear persons field represented status Impact problemsThrough May 85 1 7 Energy _

appraisal July 85 5 15 EconomistFin. AnalystGas Spec., Fin.Analyst

Appraisal Sept 85 1 3 Gas Spec. project

through Boar schedule &approval staff-ng

BoardapprovalthrougheffectivenessSupervision March 87 2 6 Gas Spec. m 1 market

Fin. Analyst identification,system design,procurement,firancialviability

Nov 87 2 8 Gas Spec. j marketEnergy development,Economist skills

March 88 2 12 Gas Spec. 1 1 financial,Fin. Analyst marketing,

institutional

Nov 88 2 12 Gas Spec. 1 1 operationalFin. Analyst planning,

systemoptimization,financialviability

May 89 2 10 Gas Spec. 1 1 insufficientFin. Analyst

June 90 . 2 10 Gas Spec. 1 1 insufficientFin. Analyst gas supply

May 91 2 8 Gas Spec. 1 1 systemFin. Analyst optimization,

long termplanning

Oct 91 2 5 Gas Spec. 1 1 procurementFin. Analyst processing

June 92 2 8 Gas Spec. 1 1 procurementFin. Analyst processing

Feb 93 2 7 Gas Spec. I 1I Fin. Analyst _____

25

Specialized Implemen- Develop-Stage of Month! Number of Days in staff skills tation ment Types ofproject cycle year persons field represented status Impact problems

May 94 3 5 GasSpec. 1 1Fin. AnalystEnergy

_ Economist _

Completion Oct 94 2 8 Gas Specialist _. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Fin. A nalyst

Table 13: Formal Training Places Filled

Technical (eg. planning and design, construction, operations and maintenance,instrumentation and metering, specialist technical courses) 745

Finance (eg. financial management, accounting, payroll management, budgeting and audit) 280

Specialist functional/management (eg. marketing, procurement, legal, admin. procedures) 110

General management/personnel (eg. senior management training, corporate strategy,management development, project management and appraisal, job evaluation and personnel 450management

Total 1585

AIDE IEMOIRE

1. A World Bank -isson consisng of Messrs S. Kawaja (vission LeaderlSr. Gas Specialist) andMs. Dawvn Vecmilya (Financial Analyst) visited Intdonea from Scptmber 26 to October 7, 1994 for thepreparalion of Implcminanon Compieion Report (ICR) of the Gas Distbution Project (Loan 2690-IND)and supnrvision of the Gas Urisation Project (Loan 3209-IND). The mission held discussions withoficials of TIhe Ministry of Mines and E=rty, MIGAS, BAPPENAS, LEMIGAS, PGN, the UnitedKingdom Overseas Develop Qent Association (UKODA) and British Gas. The mission ac3owledges withthanks the courtesies and co-operation extended by the Government cf Indonesia and its agences.

2. A list of people met during the mission visit is given in Annex 1. The findings of the mission aresummarised as follows.

L Gas Distriburion Projeca (Loan 3209-LND) - ICR Preparation

3. The mission received the necessary data and reviewed the project implemenmtion covering, interalia, the aspects of project design, impleentantion plnning, orpnisaron and cost; procurement of goodsand services; loan disbursements; economic benefits and susainability. Special attention was paid to: gasmarket development, design and constuction of nw gas distibution infims =ture and rehabilitation afold disriution networks; PGN's instimtional development and finaneial health MIGAS, PGN andUKODA were apprised of the preliminary findingp of this review which, in summary are:

* the project substantially achieved its main objtves of development of gas markets in Jaarta, Bogorand Medan and, institution building of PGN;

* aca-1 sales (88MMCFD) exced the target (54NICvD) by about 50% with fewer connections and ahigher customer denity at the pipelines than supilnaed at project appraisal, due to skllfilidenification and attachment of higher yield customes;

* the 'twinning' approach to PGN's insrrution building (involving long term technical collaborationwith British Gas) has been verv successful. Under a well designed sks upgraiing and technologytransfer pro gam involving on-the-job training in parallel with project implementation, as wel as1650 course places on discrete courses, within the county and ovrseas, PGN has acquired a corestaff of 190 professionals (engineers, accountants sae execuds, economists) and 260 techniciansPGON is now capable of aging its business at the current level of development without any ortechnical assismnce;

* based on the audited financial statements for FY's 91, 92 and 93 and unadi statements of FY 94PGN achievd a rare of return (ROR) on revalued net fixed at in operation of about 18%, 22%s23e/., and 14% (estmated for 1994) respecdvely, we1 in excss of the 10% ROR covenanted underthe Loan 2690-INJD and the amended 4% for FY's 91-93 covenanted inder the subsequa Lam3209-IND; the number of staff (1156) is well below the agreed ceiling (1440) and the gas le (30%in 1986) are less than 2%;

4. The mission's draf of the Implementation Completion Report, reflecting the above finding isexpeaced to be sent to GOL PGN and UKODA by end November 1994.

Ahocr

.,

Operamional Plan

5. A plan was agr=d with PGN for the operaional phase of the Gas Distnbu2ion Project (1994 to2008). The basic premisc of this plan was that PGhN ould need to incres its supply of namural gasbevond the current limits of 88I MMCFD in order to meet the main objectve of the Gas DistibuticnProject - which was to inces ase the uw of nanzral gas as a ue in the domestic ark:t. The most libklysourc: of additional gas sunplies ws assumed to be nantral gas sen via a South Sumarra to West Javatansmission pipeline. The pipeline was assumed to send 250 NMCFD to Jalakr/Bogor beginning in1998 (for a 20 year period) fcr use in general industry where netback values are the highesL Furthermorethe assumed cost of gas at the transmission pipeline inlet was SI.40/m1 Total investment for thetransmission and distribuon components of the project were estmated at S350 tM, assuming a 30Wdiameter, 330 mile length transmission pipeline (270 miL. onshore, 60 ml. fshore) with 700 psig at thetransmission pipe inlet and 335 psig at its outlet This Operational Plan scnario yielded a viablefinnnei-l internal rate of renn Cf 23% after tax (21% if the cost of gas was raised to S2.00/mcf) and is

considered a viable oprion for expanding PGN's gm supply in Jakart and Bogor.

IL GAS UTILIZATION PROJECT (I!N3209-JYD) - SIPERVI9IOION

Gas Supply

6. For gas suppiy to Jakaxta/Bogor PGN now has agreed contracts for 49 MMv D, 7 MM:CD and13 MM2CFD. Discussions are currently talcng place with Prtnamina regarding the supply of an additional10 MMCFD. At the Mura Karang and Tanjung Priock power stations in North Jakarta, ARCO ispresently supplying 195 MMCFD of a contracted daily quairty of 260 MMCD. In Medan preparationsare underway for the completion af the PGN pipeie reinforcement to the PLN power station at Blawanand the completion of the Prratmina pipeline from Wampu-Pangkalan Brandon. Upon completion ofthes works PGN would cary an additional 60 MMCFD, on behalf of Perramina to the power station,commencing in mid 1995.

farketing

7. PGN gas sales forecasr for the current calendar year indicates that total annual sales would reach21,312 MM1CF in Jakarta and 3,688 NMCF in Bogor. Current daily sales figures for the Jakarta/Bogorarea are peakng at about 80 hMMCFD with the average daily raue being 75 MMCFD. A large number ofrequests for new gas supplies are received every month in Jakarta area. Unless further supplies can becontracted from Pertamina sales growth in the indusmial sector in Jakarta and Bogor would reainconstrained.

8. InMedan the recovery of gas sales to 1992 levels is expected to continue. Sales are currentlyaveraging 7.6 MMCFD. The resumption of sales to a large glass factory possbly in mid 1995 shouldensure that this recovery is mrntaed and in addition a number of new factories are to be connectdduring the rcmainder of 1994.

9. In Surabaya a total number of 11 customers have been connecd to the network and are curetlyusing approximatdy 3-4 MMCFD. It is anncipased that sales by the end of the year wilI be in the region of6 MMCFD. Work is proceeding on the constction of the distribuion networks to the RIi int dStilarea and an aditional 9/10 consums will be connected to this nework following the completion ofconsuuction in late 1994. Metering/regulating stations have been de3vcred from Pietro Florentini in Itland will be islled during the next few months.

AM4OCr

Financial Performance

10. Based on the audited finannial statements for FY's 92 and 93 and PGNh finannial projectons for1994, PG;N's finannal performance ccrntnes to be healthy as measured by its ROR on revalued net fix:dassets in operaznon, which is expected to be about 14°% for thz 1994 calendar year. FY 94's ROR is lowerthan that of 1993, when ROR was 23%', due to the coxmpltion af the gi=a period for the Gas Distibutionloan (Loan 2690-IND) and subsequent commencement loan principle repayment In adition, theassumed average gas sales margin for 1994 is smaier than in 1993 due to increased sales volumes at ahigher gas sales cost Gas sales margns are expe=ed to increase to above 1993 levels in 1995 wh.average gas sales price increases by 10%.

11. Financi projections throueh 2004 assume that both the Asamera - Duri - Batam and SouthSumara - West Java pipeline projects are implemented, that PGN secares S275 million of convertblebonds in 1995, and that PGN scils 95 MMCD in Jakar=Bogor beginning in 1996. Under thencircumstances, PGN's finanmal performance drops below the ROR on revalued net ficed assets target af10% in 1998, 1999 and 2000 (ranging between 6.4% to 9.8%); in years 2001 to 2004 RORs are well inexcess of 10%. On a historical basis, ROR on net fLxed assets in operanon are 13.2% in 1997, 13.3% in1998, 14.4% in 1999, 7.8% in 2000, and above 16% thereafter (note: ROR on a historical cost basisshould be higher thanb on a rev alued basis because the underlying asset value is smaller). Annual netcashtLo%s are: negative in 1994 due to cantial investment of S 53 MM; are postive in 1995 whea a newloan from ADB commences, and PCN issues S275 million in convermbie bonds; negative in 1996 and1997 when candal investznent reaches a hizh of S 410 MMv and positive from there on out. The negadeannual net cash flows are covered by PGN's build up of cash reserves from pr.or years.

12. Of primarv concern is the ability of PGN to pia;c S275 million in converdvble bonds in 1995. IfPGN does not receive these convermtble bonds, which can be teated as temporary equity on PGN's balansheet, the debt to total caitai ratos would rise bevond accptable limits (80%) - to 81% in 1996, 86% ix.1997, 84% in 1998, 82% in 1999. Moreover, without this convertible bond purchase or an equivale=equity injecdon into PGN bv 1995 or early 1996, PGN would not have the financial resources to undertaboth the Asamera - Duri -Batan and South Sumatra - West Java projects simultaneously. A guarantee byinvestors showing their intent to purchase xaveruble bonds in the amount of S275 million should be onthe crtical path of any follow-on project (i.e. the Gas Development Project).

13. PGN has successuly carned out the Efficiency Improvement Propam established under the GasUtilisation Project (Loan 3290-IND). All the performance idicators covering gas sales, gas losses,nuimber of staff and rate of return have been achicied

Procurement and Disbursement

14. PGNs procurement plans (Aanexes 2 and 3) for the remaining project implementaion periodwere reviewed. A total of 4 consruction packages and 10 equipment procurement package are at variousstages of processing, a summary of these packages is given below.

AMZMOC

S tan4 No of Packazes Packaez dent:4=tcn

Bids R±:ccved 1 PGNIWB5/94/1C

Cont-at unri- preparation I PGN/WBIEDD11

Evaluation complete 2 PiN/WB/W/1

Awaiting NOL tender 1 PGNIWBJP/IdocumentAwaiting deliverv 2 PIN/WB/5/94/lA

PGN/WB/8/9411Tender documents in 7 1 works, 6 materialspreparanion

15. The procurement plan is ambitious but it is feasible, with the possible exception of the offlmetering package. For expeditious processing cf the meterig package (PGN/WBI8/94/4) PGN shouldensure that specifications and quantities are prepared as quickly as possible to enable the procuremetprocess to cormence. In adidition PGN needs to improve its matrials stock position aiming to procuremate-.als one Year ahead of construcion. Mhis would allow for unforeseen delavs in the procurementcycle. Adherencc to the anached timetable vill be essental if PON are to complete all of the existingplanned procurement before the loan closing date in September 1996.

16. Under the above plans, of the total USS 76 millio, allocatd to the project components to beimplemented by PGN, about USS 61 million is expected to be disbursed by September 1996; for theutihisaion of the remaining USS 15 million, PGN is reviewing a number of options in the project arcas ofEast Java and North Sumra and will send proposals to the Bank for comment.

17. As the Asamera-Duri project in South Sumata approaches the implementation stage PGN WMneed to direct considerable resoures to assist in the procurement of 'long lead items' such as pipe, valvand fittings and other items of equipment. To ensure that this does not have a nepaive impact on theprocurement activities related to the Gas Utilisation Project. PGN should review the operations of theprocurement division and the likely impact of the Asamera-Duri project and stengthen the division asappropriate.

18. Design of the four offlake metering station is expected to commence in late 1994. On completionof the design, tender documents will be prepared for procurement oa tunky basis under Bank guideline

Coostnuction Activities

19. During the period May-October 1994 a total of 9 km of new steel pipelines were consruted. Thesupply to PT. Asia Tile was completed, the factory will use gas for power generation and process, totalsupply will be about 10 MMCFD. Ia addition a number of sewvice lines and regulators wre insUlled toinduscial customers in advance of main pipeline construction.

Training

20. A number of technicians have commenced the second diploma course at the MIGAS trainingfacility in Cepu. The technicians from the first course are now undergoing on the job training.

21. The post graduate training in the UK is currendy being atrrded by four professionals from PGNN.Another group of training packages, featuring courses of shorter duration is planned for 1995.

22. Five professionals from PGN are currently at the ILO training centre in Turin attending a 4 weekcourse for Procurement of Works.

AMocr

Instirutonal Strengthening

23. PGNs proposal and draft cOnn. docurent for the funding of 48 m=-months of British Gasexperts under Loan 3209-IND vas cleared by the Bank in April 1994. Conformed ccpies of the conradocument are now awaited .PGN should expedite the sigaing Cf the connact

24. The support to PGN under twinning arrangements with British Gas is now drawing to a clos: Atotal of 100 -n months under IJKODA gant remain available which are consid-red sufficien for PCGNsrquirements until Decembr l995, when UTKODA support would cs.

25. While PGN is capable of manging its ongoing business acnvirics, it would require frtherenhancment of its technicaL rnannagrial and financial c3npailities to hndle large scal e anprojecs now under consideranon. Conversion to Prsem and establishing a joint ventnre/eqityparmership with an cxperiencnd gas utaity would be an cci=n way of obtaining such experse and PGNis acsvel following this approach. It is, howver, not crmin that such a parmvhip can be bMicbefiore the C^try af the rwinning arrangement (ill December 195). PGN has therefore instmted a rcvifwof is ornisation, and current and planned acuvinetis to ascermin its technical assistanc requireme forthe interim penod and intends to send it to the Bank for comments by end January 1995.

TEIOGAS

26. TKOGAS staff now rcmprises 41 emplovess. A total of 24 staff (6 more than orignalyscheduled) have riered uainizg at the Institute of Gas Technology (IGT), Cbicago, USA sinceSeptember 1993. The taaing program has been accelesated to provide basic taining forthe staff tobecome acvivly involved in the TE2NOGAS projects. By the end of second contact year (endingSeptember 1995), 36 staff are scheduled to have completed taining ulnder the program.

27. The institutional development program has, in general. followed the schedule, however, tbehighest priority acvitry, development of codes and standards for Indonesian gas industry, has notprogressed at the rate anticipated and requires more attention from T=iOGAS and resident IGT st;fTEKNOGAS conducted two workshops in Semarang and Jakarta on pipeline riskl management andpipeline integrity. It is currently involved in monitoring of quality assurance of Pertnmina's Citrak-TeplGede (West Java) gas pipeline.

28. The mission advised that in accordance vith secuon 4.01 of the Loaa Agree=nt for Loan No.3209-ND Lemigas should provide the Bank with audited financial stareemnts fo TEKNOGAS withinnine months afrer the end of each financial year. As LEMIGAS's financial year ends March 3 1, thesestatements for FY 1993/94 should be sent to the Bank before December 31, 1994.

Compliance with Loan Covenants

29. PGN, hlIGAS and LEMIGAS are in compliance with all covenants under Loan No. 3209-IND.

Washington, D. C.November 3, 1994

AM"OCr

Aannx

LIST OF KEY PEOPLE NFET

Mfinistrv of NTines & Enezy

Dr. Umar Said Secretary General

MNIGAS

Ir. Suyitno Patmosuisisno Dire-tor GeneralDr. Rachmat Sudibvo Director, Excpioration & Production

BAPPENAS

Dr. Richard ClapforTh Chie4 Bureau of Mines & EnergyIr. Bemby UriptoMIr. Hann Nugroho

Drs. A. Qoyum President DirectorDrs. W.M.P. Simandjuntak Director FnanceIr. Rohali Sani Director En!neerinarr. Oemar Hasan Soewarno Director DevelopmentNirboyo SH Direcor Administon

LENTIGAS

Ir. Soebiyanto Di?ectorIr. Hendro Prawoto Head, TEKYOGAS

British Gas

Mr. Bernard Milne Resident Manager

Gas Distributon Project: Operational Plan (1994 to 2008)

The main objective of the Gas Distribution Project (Loan No. 2690-IND) was to facilitate thepenetration of natural gas as a fuel in the domestic market. To this end, the project helped creatnatural gas markets in Jakarta, Bogor and Medan areas during the implementation period (December1987 to July 1994). The premise of the Operational Plan for the Gas Distribution Project is that themomentum of this development process should be maintained during the remainder of the projectlife, 1994 to 2008 so as to maxinize the use of natural gas. While in the Medan area the gas supplyand distribution networks would be adequate due to expansion under the ongoing Gas UtilizationProject (Loan 3209-IND), Jakarta and Bogor would need an additional gas supply and additionaldistribution networks. This could be achieved through a follow-on project to bring additional 250mmcfd natural gas supplies from South Sumatra to West Java. The Operational Plan, therefore,assumes that a natral gas transmission pipeline will be constructed from South Sumatra to WestJava under the proposed Gas Development Project.

The current demand for natural gas in Jakarta and Bogor is about 200 mmcfd more than whatis currently being supplied (79 mmcfd), based on Perum Gas Negara's (PGN's) waiting list ofcustomers. The South Sumatra - West Java (SS-WJ) gas transmission pipeline could bring up to 350nmmcfd to Jakarta/Bogor if gas supply contracts were available in South Sumatra in this amount Inorder to realize this additional gas supply, a total investment of about USS 350 million would berequired to construct transmission and distribution networks, with the bulk of the investmentoccurring in 1998 and 1999 for construction of the transmission pipeline. Gas delivery via thetransmission pipeline would begin in 2000 at a volume of 50 mmcfd rising by 50 n,mcfd per year (theassumed absorptive capacity of Jakarta/Bogor) until it reached 250 nmucfd, leveling off thereaftr.For simplification of the Operational Plan, it was assumed that PGN would buy natural gas at theinlet price to the transmission pipeline at a price of Sl.40/mcf (this is the same price which is beingnegotiated under a similar gas transmission project in South Sumatra).

All additional 250 mmcfd gas supplies are assumed to be sold to general industry in Jakartaand Bogor as opposed to carrying the gas for a transmission fee to the combined cycle power plantin Cilegon because the netback values for natural gas are the higher in general industry (as concludedin the World Bank Report No. 10293-IND, Natural Gas Development Planning Study). Detailedassumptions underpinning the Operational Plan are provided in the attached summary. Per theattached assumptions, the FIRR of the Operational Plan (using cashflows from 1987 to 2008) is 23%after tax and 42%MO before taxes (and social fund).

PGN has sufficiently trained staff and has the ability to train more staff to manage itsdistribution operations. PGN would, however, require expertise in gas transmission (pplineconstruction, as well as operations) for which it plans to take an experienced gas utility as equity orjoint-venture partner.

PGN has agreed with the Bank that it would monitor and maintain the following indicatorsover the operational phase of the project: (a) a ROR on re-valued net fixed assets in operation of atleast 10%; (b) a debt to total capital employed ratio of under 80%.; and (c) a gas loss percet below2%.

GAS DISTRIBUTION PROJECT (LOAN 2=4ND)OPERATIONAL PLAN SU)ARY(1994- 2008)JAKARTAIBOGORJMEDAN/CIREBON

S. OPERATIONAL COSTSa. TrarwnimmanAiwd 2.5% annualy of umisdve fmnwm uwoneb. O' rib " eiwad 6% annu5% ay of mmjdv daWnA*on vuotnwe

6. EXCHANGE RATE USS 1 3 Rp. Z175hI 1994rmnui wurwVgd for the ywstur.fta

7. DOMESTIC INFQATION RATE 10% hI 1994, 6 w. I fterINTERNATIONAL INFLATION RATE 22% hI a y*11 per WB' May 194 Price Ca*ige S mic emo

8. FINANCING OF SS -WJ 75% finaSin by Waid Bar* ban; 25% by GOUPGN hfnds; no equity o conveWe bonds

9. OEPRECIATION RATE 20 year sfalt4I depracadn caluiwd 5% per yev of not fbcad asseW

10. INTEREST RATE 12% per yew of buAWxn loan bWv

11. TAX RATE 35% of nrt bincome -11.5(11 .S awntfor graduatad x ruts)

12. SOCIAL FUND 20% of prV s yewtr * x tnao

13. GAS RECUPERATED Imam reducon h g lsse * gsaes pri

14. SS - WJ PIPEUNE SPECIFICATIONSM. Diameter 30 hchb. Oflh IagU 60 ml.c. Ove,a 1ngUh 330 mi.d. Wkl pret,w 700 pug*. Ou*L prUaure 335 peag

15. SS-WJ CAPACrIYa. Trunasion Ciapety 350 imb. Capacky ulilon 64%

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Perusahaan Umum Gas Negara

IMPLEMENTATION COMPLETION REPORTWORLD BANK LOAN 2690

1. Background

1.1 Historically, Indonesia has been very dependent on oil and liquefied natural gas exports assources of foreign exchange, demands for which are fuelled by spiralling capital-intensivemanufacturing growth. GDP growth has averaged over 6% during the last decade, and thegovernment has targeted continuing growth at similar levels, underpinned by furtherindustrialisation.

1.2 The availability of oil for export has, however, been restricted in recent times by fallingproduction levels, and is expected to fall off further in the next few years, and so the Governmentis prompted to utilise its abundant indigenous reserves of natural gas more effectively.

1.3 A key element of its strategic response to the current scenario is to displace oil and petroleumproducts with non-exportable natural gas in domestic markets where possible, and there istremendous potential for doing so in general industrial markets. Furthermore proven reserve toconsumption ratios are significantly higher for natural gas (around 50 years as opposed to around20 for oil), and substantial proportions of proven reserves are suitable for development andutilisation domestically. The need to exploit natural gas more effectively is further underscoredby the country's increasingly acute deficiencies in power generation, for which gas is a primefuel. There are also, of course, substantial environmental benefits to be gained from the increaseddomestic utilisation of gas.

1.4 It has long been our view that as the state-owned distribution company Perusahaan UmumGas Negara (PGN) is the agency best placed to promote and implement a domestic gas utilisationpolicy. PGN was created in 1958 by the nationalisation of Dutch gas distribution operations invarious locations throughout Indonesia. The legacy of distribution networks in extremely poorstates of repair, coupled with the fundamental uncompetitiveness of gas manufacturing, left PGNfor many years with little prospect of profitability and anything other than providing a basicsocial amenity to a small core of predominantly household consumers.

1.5 The availability of natural gas in the late 1970's provided the opportunity to discontinuemanufacturing operations, although PGN was still unable to capitalise on the opportunities thispresented at that time due to a shortage of capital and a lack of technical and managementcapabilities.

1.6 This project and the subsequent Gas Utilisation Project (Loan 3209-IND) were designed torectify those shortfalls, to provide a platformn for the turnround of PGN, and to enable PGN to

I

make the beginnings of large scale inroads into the very large potential markets for natural gas inits existing supply areas, mainly in the industrial and commercial markets.

2. Project Objectives and Description

2.1 The main objectives of the project were to assist PGN to promote the high-value use ofnatural gas within its supply areas, by constructing additional distribution networks and replacingand rehabilitating unsafe and leakage-prone existing networks, and to develop PGN's technicaland managerial capabilities to plan and implement system expansion and to operate distributionnetworks efficiently and economically. The project also sought to support the review of sectorpolicies, specifically with regard to energy pricing.

2.2 To achieve these objectives, the project primarily involved a gas distribution and technicalassistance component, comprising:

(a) the installation of approximatelv 218 km of high pressure bulk transmission pipelines and 535km of medium pressure urban distribution mains

(b) the installation of 10 pressure control stations and associated facilities

(c) the construction/rehabilitation of individual service lines to supply approximately 350industrial, 800 commercial and 12700 household customers (and associated metering)

(d) the provision of a meter maintenance facility, telecommnunications and monitoring systems,information technology and other office equipment

(e) the establishment of a twinning relationship with an established and experienced overseas gasutility to strengthen PGN's technical and management capabilities

(f) the provision of technical, vocational and management training for PGN staff

2.3 In addition the project included a customer conversion component involving the installationof pipework within customer's premises and the conversion of their equipment and appliances tooperate on natural gas. It also supported a GOI' energy pricing policy study and provided aretrospective contribution to an LPG feasibility study initially funded by a World Bank TechnicalAssistance Credit.

2.4 The project targeted the expansion of gas distribution infrastructure into industrial andcommercial areas in Jakarta and Bogor in West Java, and in Medan in North Sumatera, alongwith the upgrading of PGN's existing assets wherever economically justified. Some provisionwas also included to enable PGN to improve the condition of its old networks in other locationswithin its area of operations.

Government of Indonesia

2

2.5 At appraisal, the estimated project cost was US$ 86m with an foreign exchange component ofUS$ 46.6m. to be financed bv a World Bank loan of US$ 34m, bilaterat assistance of US$ 3.8mand customer expenditure of US$ 8.8m. The local component of US$ 39.4m was to be fundedfrom GOI equity contributions to PGN (US$ 18.3m), commercial loans (US$ 10.4m), PGN'sinternal funds (US$ 6.5m), and customer expenditure (US$ 4.2m). Project costs and financingarrangements are summarised in Tables I and 2.

2.6 The project objectives for PGN were unambiguous and achievable in practical terms althoughdemanding a significant degree of concurrent organisational, management and technicaldevelopment within the company. The physical objectives of the main components werestructured sufficiently flexibly to enable PGN to react to transient market opportunities andchanging priorities in their own development programme.

2.7 The principal focus of the project was on market development through the identification andattachment of high yield customers and the efficient planning, design and construction of gasdistribution systems and facilities: PGN was already familiar with the fundamentals involved,although the scale of the project (projecting a seven-fold increase in PGN's sales) introduced afurther degree of complexity in implementation.

2.8 Project risks were identified at appraisal in terms of security of supply, delays in marketdevelopment, adverse fuel price scenarios and shortfalls in institutional capabilities, although allwere assessed as marginal in comparison to the expected project benefits.Where necessaryhowever they were mitigated against in the project design.

3. Project design

3.1 PGN was assigned overall responsibility for project implementation, with the exception ofthe study elements. Technical assistance during implementation was provided by a twinningarrangement with an experienced overseas operator. Twinning agency staff assisted primarily ingas market development, distribution system design work, construction supervision and skillsupgrading and provided support and consultancy in project management.

3.2 The SAR recommended, and PGN actioned, a functional restructuring at Board level, and thedelegation of construction responsibility to specialist project managers at the local operatingunits. Contract administration and quality control functions were handled centrally.

3.3 It was envisaged that construction would be carried out by local contractors, and no problemswere envisaged (or encountered) with manpower availability or skill capabilities. Directsupervision by PGN was used, supplemented by the use of independent external QAIQCagencies where appropriate.

3.4 The responsibility for the planning and coordination of all customer conversion andinstallation activities was assigned to the Board member responsible for operations, with on-sitesupervision delegated to the local operating unit manager. The twinning agency providedtechnical and supervisory support.

3

3.5 With some functional reorganisation, the existing corporate structure within PGN wasconsidered adequate to deal with the development programme resulting from the implementationof the project, given the enhancement of capabilities through additional training and technicaland management support from the twinning agency.

3.6 Major items of procurement were sourced using international competitive bidding inaccordance with World Bank guidelines. Certain small value items were bought "off the shelf',again in accordance with Bank guidelines.

3.7 Implementation was envisaged in the initial design over a six year period. The SAR assessedthe impact of possible variations in the project timescale as relatively minor, in terms of bothcosts and rates of return.

3.8 No environmental problems were anticipated as a result of implementing the project, and thenet environmental effect was expected to be strongly positive. Natural gas is the most benign offossil fuels, once constructed infrastructure is buried and hence largely invisible and unobtrusive,and appropriate technical standards were specified and used for design and construction.Furthermore, the project was expected to significantly reduce environmental hazards and incidentrisks from gas leakage from existing systems.

3.9 PGN was tasked with providing quarterly progress reports to the Bank covering technicalissues, expenditure, management and operations, and conversion activities. These were as asupplement to standard supervision and monitoring mechanisms.

4. Achievement of objectives

Physical objectives

4.1 The main physical project objectives were to (a) expand distribution systems in the mainPGN supply areas, attach more customers to increase the use of natural gas in high value marketsand (b) undertake rehabilitation of leakage-prone parts of the existing networks, increasingoperating safety and reducing unacceptably high levels of gas losses.

4.2 These objectives were substantially achieved: a ten-fold increase in gas sales has beengenerated (from 77 mmcm in 1985 to a budgeted 841 mmcm in 1994), almost 11000 additionalcustomers have been connected, and over 600 km of new transmission and distribution pipelineshave been constructed. Detailed comparison of these parameters with the original SAR objectivesis provided in Table 3.

4.3 The success of the marketing effort enabled PGN to maximise the effectiveness of the projectinvestment by prioritising construction activity to service the larger industrial loads. As a resultPGN have achieved (and indeed exceeded) the primary sales target, but from a smallerinfrastructure and customer base than that originally thought necessary.

4

4.4 The customer conversion component of the project (ie. the installation of internal piping andthe installation of equipment and/or its conversion to natural gas operation) was undertakensuccessfully and concurrently with the expansion of the networks.

4.5 The rehabilitation of substantial portions of the existing networks has also been successfullycarried out. A total of around 200 km of old cast iron distribution mains have been replacedduring the life of the project, improving or restoring supplies to approximately 3000 customers inthe process. Gas losses as a percentage of sendout have been reduced from up to 30% at theinception of the project to 2% in 1994 (estimated outturn). This is comparable to levels ofunaccounted for gas achieved by utilities in developed countries.

4.6 A number of other technical infrastructure objectives in support of this core expansion andupgrading of supply systems were also specified in the SAR. Seven additional pressure controlstations and associated equipment have been installed along with a sophisticatedtelecommunications system, enabling PGN to remotely monitor and control the operation of thecity gate stations and facilities supplying major customers. A significant amount of ITequipment, software and other office equipment has also been purchased, and many systems arenow computerised throughout the organisation and linked to a corporate communicationsnetwork.

4.7 The planned replacement of a meter maintenance facility was deferred from the project infavour of a lower cost alternative of upgrading existing workshops to an acceptable standard,and surplus funds from this, together with reduced requirements for linepipe and pressure controlstations, were used for the procurement of other infrastructure items deemed more appropriate inthe light of PGN's changing requirements and development.

Institutional development objectives

4.8 The principal institutional objectives of the project were:

(a) to strengthen PGN's technical and management capabilities by twinning with an establishedgas utility,

(b) to provide local and overseas training for PGN staff in management, finance, accountancyand engineering, and to facilitate the transfer of technology, and

(c) to support GOI sector initiatives, nanely studies in energy pricing policy and LPG feasibility.

4.9 The twinning arrangement incorporated into the project design has proved to be a cornerstoneof the project's success, and has achieved a substantial degree of organisational developmentwithin PGN in line with the project objectives. It has been fundamental in supporting the rapidgrowth in sales and profitability, in achieving quantum increases in skill levels and the transfer oftechnology, and it has facilitated improved management and control resulting in more effectiveuse of resources.

5

4.10 The twinning design involved an experienced overseas operator seconding a teamn oftechnical and management experts to work alongside counterparts within PGN to provide skillstransfer, ongoing consultancy support and to act as a role model. The strength and compositionof the twinning team has been varied to suit changing project requirements.

4.11 A core element of the twinning effort has been the implemetation of appropriate technicalstandards and operating procedures within the company. Over the life of the project these haveprogressively covered the full range of PGN's operations, ie. gas marketing, system planning anddesign, pipeline construction, operating and maintenance procedures, utilisation engineering andspecialist operations.

4.12 At the outset of the project, technical capabilities within the company were very limited andbased on a few technical standards which had been procured from overseas on an ad hoc basis,with little regard for consistencv or implementation issues in the local environment. In contrast,PGN now has a relatively comprehensive suite of internal codes of practice reflecting leadingindustrv practice as appropriate. and modified where necessarv to take into account localoperating conditions.

4.13 The translation of the successes of the twinning effort into improvements in internalcapabilities has been underpinned by a wide-ranging and sustained formal training input,designed and initiated in the first instance by the twinning agency, with PGN assuming ultimateresponsibility for sustaining policy and implementing a continuing programrne.

4.14 World Bank funds have supported 65 staff undertaking advanced technical and managementtraining overseas, and within Indonesia over 500 PGN technical and professional staff, and 1000contractors and customers have been involved in training during the life of the project.

4. 15 Training in new technology has been supported by the implementation of certificationschemes for operatives, supervisors and inspectors where appropriate.

4.16 The institutional development in terms of technology transfer. training and the developmentof standards has however largely been internal within PGN. In many respects. PGN are thereforenow an industry leader in certain activities, particularly in distribution and marketing, utilisationpractices.

Financial aspects

4.17 Volumetric sales growth as a result of the project has surpassed expectations and at the sametime slightly higher margins have been achieved to those anticipated in the SAR. Staff numbershave been held down during the project (roughly in line with SAR assumptions), and operatingcosts have been further restrained by other efficiency measures and achievements (eg.computerisation, improved management/control, reductions in gas losses etc.). As a result, PGN'srate of return on net fixed assets (a key performance indicator identified in the SAR) hasconsistently exceeded target2 .

6

4.18 Details of sales turnover and ROR throughout the project, and in comparison to the originalSAR targets. are given in Table 4. The growth in post-tax profits is also shown.

4.19 Actual project costs and finance sources are shown against SAR estimates in Tables 1 and 2.

4.20 The Loan Agreement contained financial covenants regarding audit procedures andreporting requirements, all of which have been satisfied.

5. Implementation

Market development

5.1 PGN's overall achievement of the fundamnental objective of expanding its sales of natural gas(and the concomitant displacement of liquid fuels) has significantly exceeded expectations (seeTable 3). This has been achieved by targeting the larger industrial loads. primarily in theindustrial conurbations in the environs of the capital, Jakarta. The rates of penetration in eachsector have been governed by the relative marketing advantages which natural gas has vis a visthe existing fuel option(s), and the rate at which PGN has been able to manage networkexpansion and get gas to the potential customer.

5.2 In competition with LPG, and to a lesser extent diesel fuels, natural gas has enjoyed a clearprice advantage.In more marginal sectors, eg in competition with fuel oils, it is increasinglynecessary to exploit its other marketing advantages (eg. convenience of supply, the release ofcapital and production space, customer cash flow considerations, and in many cases enhancedproduct quality due to superior combustion characteristics).

5.3 PGN has well exploited this marketing environment, and clearly targeted the industrial andcommercial sectors in its approach throughout the project. This is reflected in the fact thatvolumetric sales have consistently led construction activity and the growth in customer numbers,when compared to the projections in the SAR. PGN has therefore achieved expected sales levelsfrom a somewhat smaller customer base than originally thought necessary.

5.4 However initial market response was poor, but the marketing effort gradually promotedinterest and awareness, to the extent that all operating units now have long lists of potentialcustomers, and can select and prioritise customer attachment. At the time of project completion,PGN had over 130 potential industrial customers (with an aggregate demand of over 60 mrmscfd)committed to a future supply by memoranda of understanding. This is a high priority group, alllocated in close proximity to the existing infrastructure, and there are an additional 550 (with afurther potential demand of 150 mmscfd) whose supply would require a degree of networkextension.

2 The SAR required PGN to achieve a rate of return on revalued net fixed assets in excessof 10% wef FY89, although this was revised to 4% in FY91-93, 8% in FY94 and 10%thereafter under the subsequent Loan 3209

7

5.5 Generally, PGN's development of the market has been governed by supply issues, and gasavailability has effectively constrained the potential extent of development. PGN is completelyreliant on gas allocation by Pertamina, the state oil company. The provision of adequate suppliesfor the implementation of the project and the achievement of its initial objectives was a conditionof loan effectiveness however, and underwritten by GOI. It was in the event achieved, althoughnot without some difficulties. In 1989, a reduction in the transfer price was negotiated in view ofPertamina's inability to meet contractual supply requirements, and more recently protractednegotiations on an additional 24 mmscfd of supplies to the Jakarta and Bogor areas (over andabove the quantities originallv contracted for the project) delayed final procurement andconstruction under the project.

5.6 Satisfactory resolution of the gas supply issue is critical to PGN's success in its futuredevelopment.

Distribution system design and development

5.7 Satisfying the anticipated load growth (primarily in the Jakarta/Bogor area) entailed thedesign of major extensions and developments of the distribution system in place at projectcommencement, which at that time supplied around 4.5 mmscfd. The nominal design capacity ofthe extended sytem was necessarily based initially on the increased supplies committed to PGNby the State Oil and Gas authority (Pertamina) as a condition of loan effectiveness, raising theplanned total availability to PGN in Jakarta/Bogor to 49 mmscfd by the time of loan completion.

5.8 The design of a gas distribution system is an iterative process however, and its capacity isdependent on many design variables and assumptions, and particularly on the magnitude andlocation of predicted demands with respect to the position of the system inputs. For example,generally, the closer that the loads on the system are to the inputs, then the higher the systemcapacity as there are less losses due to friction.

5.9 Furthermore, the complexity of these relationships increases greatly with the degree ofintegration of the system and with the number of inputs and demands. The Jakarta/Bogor systemwas originally designed with five inputs and several hundred individual loads, and thereforeaccurate assessment of its initial design capacity was very subjective, and dependent on manyassumptions, particularly regarding the possible patterns of load distribution around the network.

5.10 Nevertheless, on the information available at the time, the nominal design capacity wasestimated as sufficient to cater for the committed availability, ie. 49 mmscfd, with the potentialfor future uprating by the order of 25% (ie. to 61 mmscfd), if additional load growth wasfavourably located.

5.1 1 With any design, however, it is inevitable that subsequent system developments will deviatefrom plan as assumptions may become invalid, fuel prices may change or new markets emerge.The development must therefore be dynamic and react to changes in the marketing environment,and the design continually reassessed in the light of the size and location of the loads actuallysecured, and the ongoing revisions to estimates of further potential.

8

5.12 This process was fundamental in the development of the PGN JakartalBogor system, and

design capacity was subsequently increased even further in some instances by the inclusion of

strategic reinforcements of the network, with the effect of achieving substantial increases in

capacity at relatively low marginal costs. This continual review and improvement to design and

reaction to the marketing environment is particularly critical in developing networks from a

relativelv small base to supply markets with high growth potentials. It is imperative in these

situations that design capacity leads the marketing effort to enable attractive new loads to be

connected at minimal marginal capital costs and without unnecessary delay.

5.13 As a result of this dynamic design and development process, the PGN Jakarta/Bogor system

was already supplying peak flows of over 80 mmscfd at the time of loan closure, and had an

ultimate capacity at that time estimated in the region of 130 mmscfd. (The network

reinforcements necessary to achieve these increases in capacity were largely funded from an

agreed re-allocation of USS 9m from the customer conversion fund).

5.14 Additionally there is now the potential to increase system capacity by a further 100 mmscfd

by installing one additional input facility, upsizing another, and carrying out some relatively

minor pipeline reinforcements. The marginal capital cost of this work is estimated at US$ 2m.

5.15 The increases in system design capacity which have been achieved have been mainly as a

result of upsizing certain pipelines and/or operating them at higher pressures than proposed in the

original design, and by focusing on fewer but larger customer loads. The total cost of the

installed system has, however, been contained broadly in line with the original design estimates.

5.16 Rehabilitation of existing leakage prone systems has been undertaken in tandem, but only

where economically justified and the sections where rehabilitation or replacement was

inappropriate have been taken out of service and the customers are now being supplied with

LPG.

5.17 As a result of this selective approach to rehabilitation, and the successful marketing effort

enabling tight targeting of the larger potential customers (see para 4.3), total construction (in

installed kin) as a result of the project is therefore slightly below the original SAR estimate. Unit

costs are somewhat higher however, due to changes in project scope requiring additional high

pressure and/or larger diameter lines.

5.18 Development of the PGN distribution systems was carried out using sound planning and

design principles using standards applicable both in the USA and the United Kingdom, and

sophisticated network analysis techniques were introduced for system design.

5.19 Optimising design and the selection of new pipeline materials such as medium density

polyethylene has reduced the costs of urban distribution and enabled PGN to continue a policy of

expanding supplies to household markets.

9

Procurement

5.20 Procurement has been a key factor throughout the life of the project, and has to a largeextent dictated disbursement and overall project cash flow. Inevitable organisational andadministrative difficulties in PGN embracing relatively complex procurement procedures towhich it had no previous exposure were addressed early in the implementation phase, althoughprocurement throughout the life of the project has also generally been impeded by the additionaladministrative requirements of GOI, both per se, and those imposed on PGN.

5.21 Internal procurement processes have been significantly streamlined during the life of theproject however by a number of measures initiated by PGN and the twinning agency, principallythe establishment of a specialist functional division with a reporting mandate direct to Boardlevel. This was effected in FY94 following discussion with the Bank, with the followingobjectives:

(a) to allocate management responsibility for procurement to a specialist divisional head,reporting directly to the Director of Engineering

(b) to dedicate staff to the division and train them in procurement procedures and activities

(c) to establish internal procedures and guidelines, including timescales for the preparation andevaluation of tender documents

(d) to draw up and implement regular monitoring mechanisms to provide enhanced managementcontrol and quickly identify potential difficulties

5.22 Nevertheless a number of delays were experienced in the procurement process at varioustimes during the period of the Loan, as a result of:

(a) a delay in appointing the twinning agency at start-up. When this issue was finally resolvedmobilisation of agency staff proceeded promptly, and allowed urgent work to commence on thepreparation of tender documents and procurement procedures

(b) a reduction in the planned gas supplies from Pertamina during the later stages of the project,resulting in PGN adjusting their planning philosophy and only procuring materials andequipment as and when the additional supplies became available

(c) internal organisational problems during the latter stages of the project. These issues wereaddressed and resolved by the internal review of procurement activities referred to in para 5.21.

5.23 All equipment and materials procured under the project have now been received by PGNand final disbursement is currently in progress. It is predicted that US$ 2m will remainundisbursed from the Loan amount at closure at the end of November 1994.

10

Institutional development

5.24 As noted previously, project implementation has been well supported throughout by theconcurrent achievements in institutional development as a result of the technical assistance effortand training. In particular, the transfer of planning and design, construction and utilisation skillshave been well synchronised with the implementation programme.

5.25 In tandem with the technical assistance effort, PGN has made sustained progress in systemsand management development. The penetration of information technology/systems is nowprevalent in all functions/operating units, and PGN is now beginning to deploy it at morestrategic levels. As a result of this, together with specific training/skills transfer and otherdevelopment initiatives, management capabilities have improved significantly in all businessareas during the life of the project. In particular, project management and control capabilitieshave improved significantly and PGN is now well equipped to carry out feasibility studies andinvestment appraisal. Certain management structure changes recommended in the SAR weresuccessfully implemented at the start of the project, providing for a better distribution ofresponsibilities at Board level, a clearer definition of lines of control and placing emphasis onstrengthening the functional weaknesses which existed at that time.

Implementation delays

5.26 Loan closure was originally planned to take place in July 1992. Two further extensions havebeen granted due to unforeseen implementation delays, principally:

(a) a start-up delay of around six months in finalising the twinning arrangement, which was acondition of loan effectiveness

(b) a delay of around nine months in FY90 and FY91 in the implementation of expansion plansdue to gas supply restrictions by Pertamina

(c) delays in the negotiation of an additional 24 mmscfd of additional gas supplies over andabove the original contract quantities underwritten by Pertamina for the Jakarta and Bogor areas,(which triggered the re-allocation of US$ 9 million from the customer conversion element of theproject to the system construction element, as noted in para 5.13: the overall delay in theutilisation of these funds was in the order of twelve months).

5.27 As a result of these delays, closure was finally extended to July 1994.

5.28 Final disbursement is forecast at 95% of the SAR estimate, the principal reasons for theshortfall being the procurement of certain materials and equipment where physical installation orcommissioning has been deferred, and variations in exchange rates affecting the prices of itemsprocured late in the project.

11

6. Sustainability

6.1 The prospects for sustainability are generally excellent. As a result of the project, PGN hasbeen transformed into a financially sound, profitable business, consistently achieving rates ofreturn on revalued net assets in excess of 20%. This underpins further organic growth, and thereremains vast market potential within existing supply areas, presently estimated by PGN in theorder of 20000 rnmcmlyear3 , supplying general industry alone.

6.2 PGN distribution networks are now extensively integrated in the main supply centres, andhave the capacity to support continued growth into the medium termn. Growth will be maintainedand accelerated in the short term by the ongoing implementation of the Gas Utilisation Project(Loan 3209-IND).

6.3 Operating capabilities and management skills are now relatively well developed, and morethan adequate to support further progressive growth. which no longer demands particulartechnical imperatives/development.

6.4 The marketing environment has been significantly developed as a result of the project, andPGN have successfully raised the awareness of the advantages of natural gas as a fuel in the mainindustrial and commercial centres. Future market penetration issues will be related to strategyand priorities rather than to developing potential.

6.5 PGN now have wider development plans with a more strategic focus, and are activelylooking at a number of potential transmission projects. These will carry significantly higher risks,and so careful appraisal, design and implementation will be essential and further specificinstitutional strengthening will be required in kev areas. PGN is also planning to take the firststeps towards privatisation later this year, and this will also require careful management.

6.6 Supply issues and the securing of long-term commitments are likely to remain the mainimpediment to continued growth and the lack of statutory rights in this respect continues to be afundanental institutional obstacle for PGN. Despite a review of its operating charter in FY92,PGN still has to negotiate supplies from Pertamina, who retain the responsibility for managingexploration and production and for coordinating supply and demand for both domesticrequirements and LNG exports. This arrangement effectively creates a buffer between endusers/distributors (e.g. PGN) and the suppliers/producers (in the main production sharingcontractors to Pertarmina), and there is therefore little open dialogue across the supply chain.

6.7 In the Natural Gas Development Planning Study (Report 10293-IND, July 1992) the Bankrecommended that this issue be addressed by the establishment of a combined gas transrnissionand marketing entity within Indonesia, with complete responsibility for domestic transmission,distribution and marketing activities. The study concluded that PGN was the agency best placedto assume this role.

3 including greenfield potential, ie. yet undeveloped industrial zones

12

7. Future operations and development

7.1 PGN will consolidate the growth achieved as a result of the project and continue expansionas a direct result of the ongoing Gas Utilisation Project (Loan 3209-IND), and in other supplyareas generally as gas supplies become available and internal resources permit.

7.2 Expansion on a wider/more strategic scale is being planned following privatisation and by thedevelopment of major transmission projects.

7.3 Institutional development is ongoing as a component of the Utilisation Project, although thespecific achievements within this project are considered sustainable in their own right.

7.4 PGN are seeking to establish themselves as the principal domestic gas supply and marketingagency in Indonesia, and are taking appropriate steps to raise their corporate profile within theindustry structure and government departments.

7.5 Privatisation plans are well developed, and will increase growth capabilities by theintroduction of additional capital and improving access to development funding through moresophisticated financial instruments. Further institutional development can also be expected as aresult of equity being offered to private sector/overseas investors.

7.6 The above objectives are also reflected in PGN's medium-term corporate planning/strategy,and specifically in the following elements:

(a) to complete the successful implementation of the current Gas Utilisation Project by achievingthe target levels of gas sales within the specified financial parameters and satisfying all attachedcovenants

(b) to undertake the successful privatisation of the company

(c) to recruit suitable business partner(s), i.e. from experienced overseas utilities, for joint ventureor equity participation in new project developments and/or to support privatisation

(d) to develop options for an appropriate corporate structure in the light of future developmentplans, e.g. by:

-establishing subsidiary distribution and transmission companies

-establishing a subsidiary transmission company with the holding company retainingresponsibility for distribution

-retaining centralised operations and control within a single company structure, butexpanding the scope by recruiting equity/joint venture partners

13

(e) to identify and select appropriate development projects and prepare investment plans

(f) to maintain organic growth by continually developing and extending the existing distributionnetworks. as gas availability permits

(g) to maintain progress in human resource development

8. Conclusions

8.1 This project has initiated the first major steps towards the expansion of the role ofnon-exportable natural gas in domestic energy consumption within Indonesia. It has clearlydemonstrated that domestic gas markets can be effectively developed in parallel with theupgrading of indigenous expertise.

8.2 The project has been highly successful from PGN's perspective and has been a cornerstone inthe commercial turnround of the company, and the profitable growth which has been achievedduring its lifetime. This has provided a secure basis on which PGN can now confidently planfuture development and expansion. The project has also made a significant and lastingcontribution to the implementation of GOI energy strategy, and has had positive environmentalbenefits.

8.3 There is still tremendous potential for further increasing the domestic utilisation of naturalgas in Indonesia, and the achievements of this project provide a firm platform for newdevelopment initiatives. The implementation experience gained will be of value in the design andoperation of future projects and developments.

8.4 In particular, the Bank's Natural Gas Development Planning Study (Report 10293-[ND) hasformulated a medium-term (1992-2002) investment plan to promote a further four-fold increase(base case projections) in gas utilisation in domestic energy consumption. This is achievableprovided:

(a) an enabling environment is established promoting private sector investment, the developmentof a regulatory framework and energy pricing reforrn, and

(b) an organisation is created to spearhead this development. PGN is now well placed toundertake this role.

14

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