Report and Recommendation of the President to the Board of Directors

011111111111111111110ri Lanka Project Number: 43937 November 2010

Proposed Loan Zorlu Enerji Power Project (Pakistan)

In accordance with ADB's public communications policy (PCP, 2005) this abbreviated version of the RRP excludes confidential information and ADB's assessment of project or transaction risk as well as other information referred to in paragraph 126 of the PCP.

CURRENCY EQUIVALENTS as of 15 September 2010

Currency Unit – Pakistan rupee/s (PRe/PRs)

PRe1.00 = $0.0117 $1.00 = PRs85.60

ABBREVIATIONS

ADB – Asian Development Bank AEDB – Alternate Energy Development Board CER – certified emission reduction CO2 – carbon dioxide CPPA – Central Power and Purchasing Authority CPS – country partnership strategy EBRD – European Bank for Reconstruction and Development EIRR – economic internal rate of return EPA – energy purchase agreement EPC – engineering, procurement, and civil works FIRR – financial internal rate of return IA – implementation agreement IFC – International Finance Corporation IMF – International Monetary Fund IPP – independent power producer LIBOR – London interbank offered rate MTDF – medium-term development framework NEPRA – National Electric Power Regulatory Authority NTDC – National Transmission and Dispatch Company O&M – operation and maintenance WACC – weighted average cost of capital ZEPL – Zorlu Enerji Pakistan Limited Zorlu Enerji – Zorlu Enerji Elektrik Uretim

WEIGHTS AND MEASURES GWh (gigawatt-hour) – 1,000,000 kilowatt-hours km (kilometer) – 1,000 meters kV (kilovolt) – 1,000 volts kWh (kilowatt-hour) – 1,000 watt-hours MW (megawatt) – 1,000,000 watts tCO2 – tons of carbon dioxide

NOTES

(i) In this report, “$” refers to US dollars.

Vice-President L. Venkatachalam, Private Sector and Cofinancing Operations Director General P. Erquiaga, Private Sector Operations Department (PSOD) Director M. Barrow, Infrastructure Finance Division 1, PSOD Team leaders S. Shah, Senior Investment Specialist, PSOD M. Hashimi, Investment Officer, Central and West Asia Department Team members M. Greenhow, Counsel, Office of the General Counsel M. Manabat, Senior Investment Officer, PSOD J. Munsayac, Social Safeguard Specialist, PSOD M. Pascua, Environment Officer, PSOD S. Tu, Senior Environmental Specialist, PSOD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS Page

PROJECT SUMMARY i

I. THE PROPOSAL 1

II. BACKGROUND AND RATIONALE 1

A. Project Identification and Selection 1 B. Sector Background 1 C. Alignment with ADB Strategy and Operations 3

III. THE PROJECT 4

A. Project Description 4 B. Development Impact 5 C. Environment and Social Dimensions 7 D. Implementation Arrangements 8

IV. THE PROPOSED ADB ASSISTANCE 10

A. The Assistance 10 B. Justification for ADB Assistance 10 C. Assurances 11

V. RECOMMENDATION 11

APPENDIXES

1. Design and Monitoring Framework 12 2. Summary Poverty Reduction and Social Strategy 13 3. Economic Evaluation 16

PROJECT SUMMARY

Borrower Zorlu Enerji Pakistan Limited (ZEPL) Classification

Targeting classification: General Intervention Sector (subsector): Energy (renewable energy) Themes (subthemes): Economic growth (widening access to

markets and economic opportunities, promoting macroeconomic stability); environmental sustainability (eco-efficiency, global and regional transboundary environmental concerns); private sector development (private sector investment, public–private partnerships)

Climate change: Mitigation Location impact: National (high) Partnership(s): ECO Trade and Development Bank, IFC, Habib

Bank Limited Environmental and Social Safeguards Classification

Environment: Category B Involuntary resettlement: Category C Indigenous peoples: Category C

Project Description The project involves the construction, erection, and operation of a

56.4 megawatt (MW) wind power farm in southern Sindh, about 100 kilometers (km) northeast of Karachi—Pakistan’s commercial and industrial hub. Once completed, the project will be Pakistan’s first privately financed wind power project constructed under the Renewable Energy Policy, 2006. The project will supply power to the national grid under a 20-year take-or-pay energy purchase agreement under a tariff approved by the National Electric Power Regulatory Authority, Pakistan’s power sector regulator.

Impact, Outcome, and Benefits

The project will contribute to (i) developing Pakistan’s first private wind farm, thereby setting the precedent and framework for other wind projects to follow; (ii) addressing Pakistan’s growing energy deficit by adding 56.4 MW of power generation capacity to the national grid; (iii) encouraging the use of wind resources for low-carbon power generation; (iv) decreasing the reliance of Pakistan on imported oil and diesel fuel for power generation, thereby relieving pressure on the country’s dwindling foreign exchange reserves; (v) easing of serious infrastructure constraints in Pakistan’s energy sector (one of the core focal areas under the Pakistan country partnership strategy) for sustainable economic growth; and (vi) complementing and supporting the Asian Development Bank’s (ADB’s) extensive public sector support for renewable energy development in Pakistan.

ii

Borrower/ Project Sponsor/

ZEPL, the borrower, is owned by the sponsor, Zorlu Enerji Electrik Uretim (Zorlu Enerji), a company listed in the Istanbul Stock Exchange, principally engaged in energy production and distribution. Zorlu Enerji owns five gas-fired power generation assets in Turkey with a total installed capacity of 460 MW, which generates 3,754 gigawatt-hours (GWh) of power per annum. Zorlu Enerji also owns and operates Turkey’s largest wind farm—the 135 MW Osmaniye Rotor plant, which was financed by the International Finance Corporation (IFC) and the European Bank for Reconstruction and Development (EBRD) and reached commercial operation in mid-2010. Zorlu Holding A.S. (Zorlu Holding), the guarantor, directly and indirectly owns 68% of Zorlu Enerji. Zorlu Holding is one of the largest conglomerates in Turkey with investments in home textiles and/or polyester yarn, energy, construction, power plant operation and maintenance (O&M), information technology, real estate, and tourism.

Proposed ADB Assistance

ADB will provide a loan of $36.8 million from its ordinary capital resources.

Implementation Arrangements

Once commissioned, the 56.4 MW project will supply power to the national grid under a 20-year take-or-pay energy purchase agreement to be entered into between ZEPL and the National Transmission and Dispatch Company (NTDC) through the Central Power Purchasing Authority (CPPA). The payment obligations of the NTDC will be counter-guaranteed by the Government of Pakistan under a guarantee to be issued pursuant to an implementation agreement to be entered into between the government and ZEPL. These power purchase arrangements have a long history in Pakistan and have been used for almost all of the current private power projects in the country, including many financed by ADB.

Justification/ADB Value-Added

The project merits strong ADB support as it (i) sets the precedent and provides a template for future wind

projects in Pakistan; (ii) provides financing to a critical power sector asset, a sector that

currently does not readily have access to long-term funding; ADB presence also provides political risk mitigation, which is highly valued by the sponsor; and

(iii) is fully consistent with ADB’s Energy Policy, 2009, under which support to renewable energy generation has been identified as a key priority. The project will help meet ADB’s commitment of clean energy investments of $2 billion per year from 2013.

NSO Rating 11

I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on a proposed loan to Zorlu Enerji Pakistan Limited (ZEPL) for the Zorlu Enerji Power Project in Pakistan.

II. BACKGROUND AND RATIONALE

A. Project Identification and Selection

2. Pakistan’s energy generation is highly dependent on imported fossil fuels. The country imports some $10.5 billion worth of oil each year, the bulk of which is for electricity generation. This is equivalent to about 34% of total imports, imposing a significant burden on the Government of Pakistan’s scarce foreign exchange reserves and making the country extremely vulnerable to energy supply disruptions and global price fluctuations.1 The situation will worsen as Pakistan’s main Sui gas reservoir will fully deplete in 2012, causing over half of all thermal power plants at that time to switch to imported oil-based fuel for base load generation. At the same time, Pakistan is endowed with abundant renewable energy resources—wind, mini-hydro (less than 50 MW), solar, and biomass. Accordingly, tapping the vast potential of renewable energy, especially wind, is of critical urgency to diversify the skewed fuel mix, hence ensuring energy security, saving precious foreign exchange, and enhancing macroeconomic stability by helping to protect against global price fluctuations. 3. The Asian Development Bank (ADB), building on strong Central and West Asia Department support to the Alternative Energy Development Board (AEDB), has been working closely with this institution to identify potential wind independent power producers (IPPs) that match ADB’s priorities for renewable energy power development in Pakistan. ADB has been actively engaged with several sponsors who are trying to develop viable wind projects in Pakistan, including the project sponsors, for more than 2 years. The project’s concept review was approved by the ADB Investment Committee in August 2009, and due diligence missions were fielded in November 2009 and in February and August 2010. The project is expected to achieve financial close by the end of December 2010. B. Sector Background

1. Electricity: Demand and Supply Gap

4. Pakistan’s power sector faces a major supply deficit, constraining the country’s already fragile economic growth. Peak demand was 18,926 MW in mid-2010, but the country had only 14,723 MW in firm supplies, resulting in a shortfall of 4,203 MW (or 22.2% of the country’s peak electricity demand).2 As of June 2010, the country’s installed power generation capacity was 20,375 MW, of which about 55% was owned and operated by government entities and 45% by IPPs and/or majority private sector led operators. Thermal power plants, with almost 52% based on imported fuel oil and the balance on gas, account for 68% of installed capacity; hydro plants account for 30%, and nuclear plants provide the remaining 2%.

1 Government of Pakistan, Federal Bureau of Statistics. http://www.statpak.gov.pk; State Bank of Pakistan.

http://www.sbp.org.pk/stats. 2 National Power Control Center daily log report dated 30 June 2010 and Karachi Electric Supply Company load

dispatch center report date 30 June 2010.

2

5. While electricity sales and demand have risen by over 40% during the last 5 years, investment in new generation capacity has lagged. The resultant power shortage has led to increasing incidents of brownouts and blackouts in all major urban centers. Measures to ration consumption are being taken, such as forcing—often through law enforcement agencies—shops and industries to close early. Left unattended, the country’s power deficit will worsen and affect Pakistan’s economy even more adversely. Given the acute current power shortage, even a likely slowdown in economic growth during the next few years will not change the imperative for more power generation. Hence, the addition of domestic resource-based power generation capacity is a matter of utmost national urgency (details on Pakistan’s power sector are in Supplementary Appendix B). 2. Government of Pakistan Response 6. To address the energy shortage and growing power crisis, the government has decided to implement a number of energy expansion initiatives. These include new or expanded generation by thermal and hydro IPPs under the 2002 Power Policy, procuring power from rental power plants under short-term agreements, securing electricity and gas imports from regional projects, as well as tapping the huge potential renewable energy sources. The government is also exploring the possibility of utilizing its domestic coal reserves—one of the largest (albeit low quality and remotely located) in the world—for power generation. However, the time horizon for domestic coal-fired power generation is long-term. In the short to medium term, it is expected that conventional (i.e., thermal), hydro, and wind energy will be mainstays of Pakistan’s electricity supply. The medium-term development framework (MTDF)—the government’s core planning document for 2005–2010—states that renewable energy should constitute 6% (or 9,700 MW) of the country’s energy mix by 2030. During the same period, it forecasts that the private sector will own and operate the majority of this renewable-energy-based generation capacity. 3. Private Sector Investment in Pakistan 7. Pakistan has undertaken wide-ranging reforms in the power sector with the assistance of ADB and the World Bank since the mid-1990s. This work is not yet completed and various challenges remain. During the past 2 years, nine IPPs representing almost 2,000 MW of installed capacity have achieved financial close under the 2002 Power Policy. Most have been commissioned and all are expected to begin commercial operation by the end of 2010 or early 2011. ADB has taken a lead in supporting the government’s initiative to attract private capital into the power sector and has been instrumental in many pioneering transactions. ADB financed the first private sector run-of-river hydro project, the New Bong Escape Hydropower Project.3 This transaction has set the precedent for many follow-up private hydro projects, several of which ADB is currently engaged in. ADB has also invested (equity and a partial commercial guarantee) in a gas-fired combined cycle power, the Daharki Power Company Limited, using domestic gas.4 ADB is processing proposed financial assistance for a 400 MW expansion of a similar gas-fired combined cycle power plant. To encourage investment in the power sector, the government has undertaken steps to privatize state-owned power entities—both generation plants and power utilities. ADB assisted the government in privatizing the Karachi Electric

3 ADB. 2005. Report and Recommendation of the President to the Board of Directors: Proposed Loan to Laraib

Energy Limited for the New Bong Escape Hydropower Project in the Islamic Republic of Pakistan. Manila. 4 ADB. 2007. Report and Recommendation of the President to the Board of Directors: Proposed Equity Investment

and Guarantee for Daharki Power Project in the Islamic Republic of Pakistan. Manila.

3

Supply Company, and processed a loan in 2007 for expansion of the privatized entity’s generation, transmission, and distribution infrastructure.5 4. Wind Sector: Key Players and Policy Framework 8. Noting international and regional (especially India’s) experience, the government established the AEDB in 2003 with the support of ADB to encourage development of renewable energy in the country .6 Pakistan has substantial wind resources—an estimated 50,000 MW is available in southern Pakistan alone.7 In 2004, the AEDB invited private investors to set up wind farms and several letters of intent were issued to eligible potential investors, most of them local. However, the projects were not able to move forward because of lack of required experience among this initial investor group and the perceived higher risk in this new sector. The government realized that, if it was to encourage participation in the new sector by both foreign and local private sector investors, it needed to pass policies targeted at the renewable energy sector. In 2006, the government released a formal policy for renewable energy power generation, covering wind power as well as other renewable technologies such as solar and small scale hydro. In line with other policies, such as those for thermal and larger-scale hydro, the Renewable Energy Policy lays down incentives to attract domestic and foreign capital into renewable energy power generation. These include exemptions from customs duty or sales tax for machinery imports, exemption from income taxes and withholding tax on imports, guaranteed rate of return of 17% in US dollar terms on equity (rather than the 15% allowed for thermal power projects), repatriation of equity along with dividends without incurring any additional penalties, and flexibility in the mode and currency of financing. C. Alignment with ADB Strategy and Operations

1. Consistency with Strategy 2020

9. The project is consistent with ADB’s Strategy 2020,8 which emphasizes ADB’s support for environmentally sustainable infrastructure projects and private sector development. The strategy seeks to meet the region’s growing energy demand by helping ADB members to develop their economies using environmentally friendly technologies, specifically addressing energy efficiency and expanding the use of clean energy sources. The strategy also aims to promote a larger role for the private sector in financing infrastructure by supporting public–private partnerships.

2. Consistency with the Country Strategy

10. ADB’s support for the project is in line with Pakistan’s country partnership strategy (CPS), 2009–20139 and the government’s strategic emphasis on energy sector development. “ADB views itself as one of Pakistan’s strategic development partners for infrastructure development,” with power as one of the main areas of support, and “the emphasis on lending for economic infrastructure will be continued, which is consistent with the high priority attached to it

5 ADB. 2007. Report and Recommendation of the President to the Board of Directors: Proposed Loan for Karachi

Electric Supply Corporation Post-Privatization Rehabilitation, Upgrade and Expansion. Manila. 6 ADB. 2004. Technical Assistance to the Islamic Republic of Pakistan for Capacity Building of the Alternate Energy

Development Board. Manila. 7 AEDB. 2010. CEO AEDB’s Presentation at the Quantum Leap in Wind Power in Asia Workshop. Manila. 21 June. 8 ADB. 2008. Strategy 2020: The Long-Term Strategic Framework of the Asian Development Bank, 2009–2020.

Manila. 9 ADB. 2009. Country Partnership Strategy: Pakistan, 2009–2013. Manila.

4

in the Government’s MTDF.”10 The proposed project also conforms to the crosscutting theme of sustainable environmental management as reflected in the CPS. Lastly, the CPS mandates ADB to develop greater complimentarity between its public and private sector operations. It places specific emphasis on the role of the private sector as a driver of investment, growth, and employment. Among the focus sectors of ADB’s private sector operations, power and energy infrastructure feature prominently.

3. Consistency with the Energy Sector Strategy

11. ADB’s Energy Policy identifies renewable energy generation as a key priority and requires ADB to place greater focus on meeting energy security and a transition to a low-carbon economy. 11ADB also seeks to help its members provide reliable, sufficient, and affordable energy supplies for inclusive growth in a socially, economically, and environmentally sustainable way. ADB applies three pillars for policy implementation: (i) promoting energy efficiency and renewable energy; (ii) maximizing access to energy for all; and (iii) promoting energy sector reform, capacity building, and governance. The project (as a precedent setter) will generate renewable-energy-based power in an economically and environmentally sustainable manner. The project also promotes energy efficiency with advanced and cleaner technologies, and will help ADB to meet its commitment under the policy to undertake clean energy investments of $2 billion per year from 2013 ($1 billion per annum until then).

III. THE PROJECT

A. Project Description

1. The Borrower/Sponsor

12. The project is being developed by ZEPL (the borrower), a special purpose company incorporated under the laws of Pakistan with 100% shareholding from Zorlu Enerji Elektrik Üretim. (Zorlu Enerji, the sponsor)—a Turkish joint stock company established in 1993 to meet the electricity and steam needs of the Zorlu group (one of the largest industrial conglomerates in Turkey). Zorlu Enerji has almost 460 MW of generation currently under operation (making it one of the largest private sector generation companies in Turkey). Zorlu Enerji also has expertise in the development and operation of wind power projects, having developed Turkey’s largest wind farm—the 135 MW Osmaniye Rotor plant, which was financed by the International Finance Corporation (IFC) and the European Bank for Reconstruction and Development (EBRD) and started commercial operations in mid-2010. 13. Zorlu Holding, Zorlu Enerji’s parent company, was established in the 1990s and is one of the largest private sector conglomerates in Turkey. Zorlu Holding’s activities are divided into various subgroups: (i) textiles, with interests in production and marketing of yarn and home textiles; (ii) energy, with interests primarily in power and energy, power project construction, and power project operation and maintenance (O&M); and (iii) various companies covering aviation, insurance, information technology, real estate, and tourism.

10 ADB. 2005. Country Strategy and Program Update, Pakistan, 2006–2008. Manila. 11 ADB. 2009. Energy Policy. Manila.

5

2. Project Design

14. The project is located close to Jhimpir town in Thatta district in southern Sindh, about 100 kilometers (km) northeast of Karachi—Pakistan’s commercial and industrial hub. The project, which will be spread over about 5 square kilometers, encompasses engineering, design, procurement, construction, turbine erection, grid tie-in, commissioning, and O&M of a 56.4 MW wind power plant. The project’s civil works include turbine (tower) foundations, substation and transformer foundations, and related works. Power evacuation from the project to the national grid will be through a 132 kilovolt (kV) line, built and operated by the National Transmission and Dispatch Company (NTDC), the national grid operator. Power offtake arrangements include a 20-year take-or-pay energy purchase agreement (EPA) between the NTDC (through its Central Power Purchasing Authority [CPPA]) and ZEPL. The government will guarantee the NTDC’s obligations under the EPA as part of its obligations under the implementation agreement (IA) for a period of 20 years. The government will also bear the wind availability risk as stated in the Renewable Energy Policy .12

3. Project Outputs and Outcome

15. The project’s output will be a 56.4 MW privately owned and financed wind power project. The project will contribute to the creation of employment opportunities and stimulation of economic growth in southern Sindh, one of the poorest regions in Pakistan, and an area of particular development and poverty-alleviation concern to ADB.13 16. The project’s outcome will be the provision of competitively priced and low carbon power to Pakistan’s consumers, with adequate returns generated for the project’s investors. The project will also help reduce the country’s carbon footprint. The amount of carbon dioxide emissions reduced is one of the project indicators, in addition to the usual financial and operational indicators. The design and monitoring framework is in Appendix 1. B. Development Impact

1. Contribution to Economic Growth and Poverty Reduction

17. By providing much needed power to a country facing severe power shortage, which is adversely affecting economic growth, the project has direct and indirect benefits. The project will incrementally increase access to energy for households, business, and industry. It will alleviate poverty through skilled and unskilled job creation and other associated economic activities. Pakistan’s energy mix, which is highly dependent on imported oil (with its price uncertainty), will be diversified by the addition of incremental renewable energy capacity through the project, as well as through its anticipated replication. The project will also help realize the government’s target of 6% renewable energy in the country’s energy mix by 2030, as stated in the MTDF. The project by using renewable source of wind energy will diversify the fuel mix of the power sector in Pakistan away from its current heavy dependence on the fossil fuels. The fossil fuels have seen escalation and volatility in their prices in recent years, which has put pressure on the financial health of the power sector of Pakistan. The diversification of the fuel mix using indigenous and renewable source of power is an important element in helping address the long term financial health and the circular debt of the Pakistan power sector. 12 This is similar to the water availability risk that the government bears for hydropower projects under the Power

Policy, 2002. 13 ADB. 2006. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the Islamic

Republic of Pakistan for the Sindh Coastal Community Development Project. Manila.

6

2. Private Sector Development

18. The project, being the first privately owned and financed wind project in Pakistan, will catalyze private sector investment in Pakistan’s renewable energy sector as it provides a successful template for follow-on projects. The success of this project sends an important signal to the markets that Pakistan’s power sector, especially wind IPPs, is attractive for private sector investment and financing. A number of other proposed wind projects are closely watching the progress of the project and can be expected to follow the success of Zorlu (some of them with ADB support), which will open up the wind power sector in Pakistan. Considering the country’s substantial wind resources, wind power can address part of the long-term needs of the power sector in Pakistan. 19. ADB has been a major development partner in Pakistan’s energy sector. Although the reform process in the sector has been challenging, considerable progress has been made with ADB assistance in creating an enabling environment for future investments and promoting private sector participation. ADB is assisting the government in the implementation of reforms, sector analysis, capacity development, and project identification and development. Over the medium term, ADB is supporting large infrastructure projects in renewable energy, power transmission, distribution, and energy efficiency. 14 ADB has supported several power and energy sector projects in Pakistan through loans and investments since 1995: Fauji Kabirwala—151 MW gas-fired combined cycle power plant;15 Daharki Power—171 MW gas-fired combined cycle power plant (footnote 5); Karachi Electricity Supply Corporation’s Expansion Program—first utility deregulation (footnote 5); and the New Bong Escape—first hydro IPP, 84 MW run-of-the-river hydropower plant (footnote 3).

3. Economic Sustainability

20. The project’s economic benefits include the value of power as an input to economic activity and the environmental advantage of clean energy. The project will also help improve energy security by developing an indigenous and renewable energy source. Since Pakistan faces a power supply deficit, the electricity generated from the project is considered to meet unmet demand (i.e., not substituting power from existing generation capacity) and the entire plant’s output is considered incremental. The economic costs include capital, labor, and O&M costs. The calculated economic internal rate of return is 14.7%, higher than the social discount rate of 10%.16 The economic analysis is in Appendix 3.

14 ADB. 2006. Report and Recommendation of the President to the Board of Directors: Proposed Multitranche

Financing Facility and Technical Assistance Grant to the Islamic Republic of Pakistan for the Renewable Energy Development Sector Improvement Program. Manila; ADB 2006. Report and Recommendation of the President to the Board of Directors: Proposed Multitranche Financing Facility to the Islamic Republic of Pakistan for the Power Transmission Enhancement Program. Manila; and ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Multitranche Financing Facility to the Islamic Republic of Pakistan for the Energy Efficiency Investment Program. Manila.

15 ADB. 1995. Report and Recommendation of the President to the Board of Directors: Proposed Loans for an Equity Investment in Fauji Kabirwala Power Company Limited in the Islamic Republic of Pakistan. Manila.

16 The Evaluation Cooperation Group’s Good Practice Standards for Private Sector Investment Operations rates a project satisfactory if the economic internal rate of return is 10% or higher.

7

C. Environment and Social Dimensions

1. Environment

23. The environmental assessment was carried out in line with the national regulations and ADB and IFC safeguard policies. The project is classified category B for the environment under ADB’s Safeguard Policy Statement (2009) and an initial environmental examination was therefore required. The initial environmental examination has identified impacts that may arise, and mitigation measures have been identified. Short-term impacts—including soil erosion and contamination, air quality deterioration, noise, and safety hazards—are anticipated mostly during the construction period. Impacts during wind farm operation include aesthetics impacts and bird mortality. Considerations to minimize the net impact of the project development works have been incorporated throughout the life cycle of the project from design, commissioning, and operations. ZEPL designed an environmental management plan with organizational structure, roles and responsibilities, mitigation plan, monitoring plan, change management plan, communication and documentation, and environmental training defined to ensure that all the mitigation measures and guidelines recommended for the project in the initial environmental examination will be adhered to. An audit of the existing 6 MW has been carried out in accordance with ADB’s Safeguard Policy Statement (2009). Public consultations were made in and around the project area to ascertain opinions concerning wind farm in the area; attitudes to specific aspects of wind energy, including visual, environmental, social, and economic dimensions; and acceptance of wind farms at the local level. The overall results of the public consultations are encouraging, with stakeholders generally very positive toward the development of the wind farm in the area.

2. Social Dimensions

24. The proposed wind farm is on 4.65 km2 of flat, rocky, and barren land located close to Jhimpir town, Thatta district in Sindh province. The AEDB acquired the land for the project from the government of Sindh and it will be leased to ZEPL for the duration of the EPA. Since the site is close to the Arabian Sea, the area is hot and humid with very low precipitation and is therefore not suitable for cultivation. Since basic amenities are not available in the area, most of the local population resides in nearby villages (more than 3 km from the project site) where better educational, health, and commercial facilities are available. The land identified as the project site does not belong to any tribal group nor is it being claimed as ancestral domain. People residing in the nearby villages graze their cattle in the project area during summer when there is enough rain to allow for grazing of their animals. Since the boundary of the project area will not be fenced, the local population will continue to use the area as grazing ground for cattle. The project is classified category C for involuntary resettlement and indigenous peoples under the ADB Safeguard Policy Statement. 25. The project will offer some employment opportunities for local villagers, primarily during the construction phase. It will have a relatively short construction period, and will require some skilled and semi-skilled workers, including crane and heavy equipment operators, engineers, electricians, electronic technicians, mechanical technicians, concrete workers, and laborers. The balance-of-plant contractor will accommodate as much local labor as possible from the local area. A total of 437 workers are expected to be employed till project completion. The

8

balance-of-plant construction contractor will be required to comply with core labor standards.17 The summary poverty reduction and social strategy is in Appendix 2. D. Implementation Arrangements

26. The key project contracts include an EPA with the power purchaser, NTDC (through the CPPA); an IA with the government; a balance-of-plant contract; a turbine supply agreement; and an O&M agreement. Overall responsibility for day-to-day management is assigned to the Zorlu Enerji project development team.

1. Power Offtake and Evacuation

27. Power from the project will be sold to the NTDC (through the CPPA) under a 20-year EPA in accordance with the tariff to be approved by NEPRA. The NEPRA-approved tariff takes into account the plant factor, project cost, power curves, O&M arrangements, inflation, and targeted rate of return on equity as well as cost of borrowing (both US dollar and Pakistan rupee tranches). Power evacuation from the complex, which is the responsibility of the power purchaser, will be via a 132 kV transmission line that has already been built and is operated by the NTDC.

2. Plant Engineering, Procurement, and Construction

28. Engineering, procurement, and civil works (EPC) for the project is governed by three separate agreements: (i) the phase 1 EPC contract; (ii) the turbine supply agreement; and (iii) a balance-of-plant contract. All contracts will be verified by lenders’ technical and legal advisers to ensure economy, value for money, efficiency, and competitiveness in the implementation of the project.

3. Operation and Maintenance

29. ZEPL will enter into an O&M contract for 20 years. The lenders’ technical advisers will confirm that the cost of the executed O&M agreement is in line with the approved O&M tariff component and, together with lenders’ legal advisers, will confirm that the O&M contract will contain adequate plant availability guarantees so that economy, value for money, efficiency, and competitiveness is maintained in the contract.

4. Government Implementation Agreement and Guarantee

30. Upon execution of the EPA, ZEPL will sign an IA with the government. The implementation agreement provides assurance of support from the government for development of the project in a timely and efficient manner. It also sets out various government commitments to the project that are standard for IPPs (both thermal and hydro) in Pakistan under the various power policies. These include various tax and customs concessions; government support in obtaining all necessary approvals and consents; the right to open and operate bank accounts in Pakistan and abroad; guaranteed availability of foreign exchange for remittance of dividends,

17 The core labor standards are a set of four internationally recognized basic rights and principles at work: (i) freedom

of association and the effective recognition of the right to collective bargaining, (ii) elimination of all forms of forced or compulsory labor, (iii) effective abolition of child labor, and (iv) elimination of discrimination in respect of employment and occupation. Pakistan has ratified all International Labour Organization fundamental conventions covering the four core labor standards. These are embodied in the Constitution and the Industrial Relations Ordinance of 2002.

9

debt servicing, and other project activities; assurances against discriminatory government action, including prohibition on compulsory acquisition of assets and shares; special protection against risks of political force majeure and change in law; commitments by the government to pay compensation in the event of a transfer of the project following termination of the implementation agreement; and final resolution of disputes by means of arbitration under the rules of the International Chamber of Commerce. Under the implementation agreement, the government also agrees to enter into a separate guarantee of the payment obligations of the NTDC under the EPA. Since the wind availability risk is covered in the calculation of the tariff under the EPA (in accordance with the Renewable Energy Policy), this risk is effectively guaranteed by the government under the IA. The project therefore bears the plant availability risk18 and this risk will be further mitigated under the project contracts.

5. Insurance Arrangements

31. ZEPL will take out the necessary insurance to cover essential risks for (i) the supply and transportation of turbines and machinery; (ii) turbine erection and plant construction; and (iii) once commercial operations commence, business interruption. The insurance package will be designed to maximize cover for all possible insurable risks. Because of the size of the project and the limited capacity in the local insurance market, it is expected that a major portion of the insurance will be placed with reputable insurers in the international market.

6. Anticorruption Policy

32. ZEPL and Zorlu Enerji were advised of ADB’s Anticorruption Policy (1998, as amended to date) and the Policy on Combating Money Laundering and the Financing of Terrorism (2003). Consistent with its commitment to good governance, accountability, and transparency, ADB will require ZEPL to institute, maintain, and comply with internal procedures and controls following international best practice standards for the purpose of preventing corruption or money laundering activities or the financing of terrorism and covenant with ADB to refrain from engaging in such activities. The investment documentation between ADB and ZEPL will further allow ADB to investigate any violation or potential violation of these undertakings.

7. Project Performance Monitoring, Reporting, and Evaluation

33. ZEPL will be required to submit quarterly unaudited financial statements, quarterly operations reports (including contractor and construction reports before the project achieves its commercial operations date), annual business plans and budgets to ADB and other lenders, and must report any material changes. ZEPL will be required to hire an internationally reputable accounting firm (or its local affiliate) to audit its annual accounts in line with international financial reporting standards. ADB will monitor the project against its business plans and operational budgets, using information from its sources, lender’s advisers, and from government counterparts. The project will be evaluated on three levels: (i) project completion, successful commissioning, and its satisfactory operation; (ii) increase in Pakistan’s private power generation capacity and wind power generation capacity in particular; and (iii) reduction in carbon emissions. The performance indicators are included in the design and monitoring framework (Appendix 1). 18 The availability factor is the measurement of the reliability of a wind turbine or other power plant and refers to the

percentage of time that a plant is ready to generate (i.e., not out of service for maintenance or repairs). Modern wind turbines have an availability of more than 95%—higher than most other types of power plant. After 2 decades of constant engineering refinement, today’s wind machines are considered highly reliable.

10

IV. THE PROPOSED ADB ASSISTANCE

A. The Assistance

34. The sponsors and government authorities greatly value ADB’s support for this project and for the renewable energy and power sector in general. ADB has played a key role for this transaction in getting the financial consortium together and has been working closely with the sponsor for a long time. The sponsor appreciates that ADB’s presence enhanced the project’s ability to mobilize financing that might otherwise be unavailable for a project of this nature in Pakistan in today’s challenging market. The proposed loan of up to $36.8 million will be provided from ADB’s ordinary capital resources without government guarantee. B. Justification for ADB Assistance

35. The proposed loan merits ADB’s support for the following reasons: (i) The project, being the first privately financed wind project in Pakistan, sets an

important precedent and provides a bankable template for future wind projects in the country. It is estimated that three to five projects in the wind sector can be expected to achieve financial close and hence come online following ADB support to this project. This trend is consistent with the one observed after the ADB-supported New Bong Escape Project (Pakistan’s first hydro IPP) achieved its financial close in December 2009, wherein a number of hydro projects have regenerated developer interest and one is nearing financial close (with ADB support).

(ii) ADB is providing financing to a critical power sector asset, a sector that does not

readily have access to long-term funding. ADB’s assistance to the project will help increase the incremental supply of energy to reduce a growing power deficit, which has seriously constrained economic growth. It will also increase access to energy for households, business, and industry.

(iii) The presence of ADB reassures the sponsors that the government entities will

continue to support this project throughout its life. Given its track record in the country and in the sector, ADB was the first financial institution that the sponsors approached to finance the project. The sponsors value the risk mitigation and the financial catalyst role that ADB has played in supporting private sector projects in Pakistan; this affirms ADB’s status as the preferred partner of choice in undertaking any privately financed infrastructure project in the country.

(iv) The project makes efficient use of an energy resource that is domestic, idle, and

renewable; and reduces reliance on expensive oil imports, which have contributed to extreme stress on Pakistan’s foreign exchange reserves. It contributes directly to Pakistan’s energy security through diversification of the power mix and supports the government’s target of having 6% of power generation from renewable energy sources by 2030.

(v) The project helps improve the country’s environment by reducing greenhouse

gas emissions and pollutants such as sulfur dioxide and nitric acid, by lessening the need to construct or rent (imported) fossil-based power generation capacity to meet demand. The project will reduce greenhouse gas emissions by about

11

86,024 tons of carbon dioxide (CO2) per year and about 1.72 million tons of CO2 during the 20 years of operation.

(vi) As part of its public sector program, ADB has a strong energy focus in Pakistan.

Its work on the enabling environment, reform, and regulations has helped create the right conditions for further private and public sector investment. ADB is also the largest renewable energy sector assistance provider to the country under its Renewable Energy Development Sector Investment Program.19 Support to the project will directly build on and complement extensive work undertaken under the investment program in promoting renewable energy in Pakistan.

(vii) The project will contribute toward creating employment opportunities, stimulating

economic growth, and developing infrastructure in southern Sindh, considered one of the poorest regions in Pakistan and in particular need of development.

(viii) The project remains fully consistent with ADB’s Energy Policy, under which

support to renewable energy generation is identified as a key priority. The project will also help meet ADB’s commitment of clean energy investments of $2 billion per year from 2013 (and $1 billion per annum until that date). Furthermore, the project is fully consistent with both Strategy 2020 and the Pakistan CPS.

C. Assurances

36. Consistent with the Agreement Establishing the Asian Development Bank, the Government of Pakistan will be requested to confirm that it has no objection to the proposed assistance to Zorlu Enerji Pakistan Limited. No funding will be disbursed until ADB receives such confirmation. ADB will enter into suitable finance documentation, in form and substance satisfactory to ADB, following approval of the proposed assistance by the Board of Directors.

V. RECOMMENDATION

37. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the loan of up to $36,800,000 to Zorlu Enerji Pakistan Limited for the Zorlu Enerji Power Project from ADB’s ordinary capital resources, with interest to be determined based on the procedures applicable to ADB’s London interbank offered rate (LIBOR)-based loans for nonsovereign operations; and such other terms and conditions as are substantially in accordance with those set forth in this report, and as may be reported to the Board.

Haruhiko Kuroda President

24 November 2010

19 ADB. 2006. Report and Recommendation of the President to the Board of Directors: Proposed Multitranche

Financing Facility and Technical Assistance Grant to the Islamic Republic of Pakistan for the Renewable Energy Development Sector Investment Program. Manila.

Appendix 1

12

DESIGN AND MONITORING FRAMEWORK

Design Summary Performance Targets/Indicators Data Sources and/or

Reporting Mechanisms Impact Diversification of energy mix by addition of replicable wind projects in the country

150 MW–175 MW of wind energy projects reach financial close in Pakistan by 2012

Government and ADB statistics

Domestic and international commercial investors demonstrate greater appetite for private power generation projects in Pakistan

Private power generation in Pakistan increases from 32% in 2010 to 40% by 2012

Government and ADB statistics

Outcome Pakistan’s power consumers receive increased low carbon power

Project dispatches with an estimated minimum annual production of 158.8 GWh

Annual greenhouse gas emission savings of 86,024 tons of CO2

Project reports

Government and ADB statistics

Output Installation and operation of wind power plant, the first privately financed plant in Pakistan

Pakistan’s electricity generation capacity increases by 56.4 MW on commissioning by 2012

300 workers will be employed during the construction period and 30 annually during operations period

CPPA/NTDC reporting

Project reports

ADB = Asian Development Bank, CO2 = Carbon dioxide, CPPA = Central Power Purchasing Authority, GWh = gigawatt hours, MW = megawatt, NTDC = National Transmission and Dispatch Company. Source: Asian Development Bank.

Appendix 2

13

SUMMARY POVERTY REDUCTION AND SOCIAL STRATEGY

Country/Project Title: Pakistan: Zorlu Enerji Power Project

Lending/Financing Modality:

Direct loan Department/ Division:

Private Sector Operations Department Infrastructure Finance Division 1

I. POVERTY ANALYSIS AND STRATEGY

A. Linkages to the National Poverty Reduction Strategy and Country Partnership Strategy Expensive and unreliable energy sources are restricting investments and hampering sustainable economic growth in Pakistan. The Pakistan country partnership strategy (CPS)a focuses on supporting energy sector reforms; capacity development for key agencies in the energy sector; and investing in supply-side activities, including power generation, transmission, and distribution and system enhancement. The CPS also identifies clean energy as one of the key drivers of the strategy and the private sector as playing a key role in expanding private sector operations in the renewable energy sector. The project will involve the construction, erection, and operation of a wind farm that is in line with the CPS targets to support power generation using clean energy sources. The project will help to ease reliance on imported fuel for power generation, resulting in foreign exchange savings for the country. Availability of reliable power from renewable sources is expected to increase investments in businesses, which will generate more jobs and other income-earning opportunities for the local population. B. Poverty Analysis Targeting Classification: General intervention 1. Key issues. During the construction stage, the project is expected to generate employment opportunities that can be tapped by qualified local laborers. During operations, the project will provide additional supply of clean energy source to the national grid. The local people, commerce, and industry will benefit from this additional power source—significantly increasing productivity. The enhanced economic activities will have a direct impact on Pakistan’s poverty reduction initiatives. 2. Design features. The project entails the construction and operation of a wind farm, an additional power source to support the country’s energy demand. Being clean and renewable and not dependent on burning fossil fuel, it is expected to contribute in abating the impact of climate change, which often disproportionately affects the poor and vulnerable.

II. SOCIAL ANALYSIS AND STRATEGY

A. Findings of Social Analysis Land acquisition and resettlement. The wind towers will be constructed on 4.65 km2 of flat, rocky, and barren land. Because of its very low precipitation and its location close to the Arabian Sea, the land is unsuitable for agriculture. The nearest community or village where basic amenities are present can be found 3 kilometers (km) from the project site. The Alternative Energy Development Board acquired the land from the government of Sindh on a long-term lease that has been re-leased to the project for its duration. The project is classified involuntary resettlement category C under the ADB Safeguard Policy Statement (2009). Indigenous peoples. No people or groups in the project area will be affected by the project construction and operation. The project is classified indigenous peoples category C under the ADB Safeguard Policy Statement. Labor. The project will offer limited employment opportunities. During the preconstruction phase (phase 1), 137 were employed (including 22 locals hired directly). During project construction (phase 2), 300 persons will be employed.

Appendix 2

14

B. Consultation and Participation

1. Provide a summary of the consultation and participation process during the project preparation. The consultation and participation process for the project involved the following stakeholders: host communities (about 16 villages located 3 km–6 km from the project site); elected representatives of the area; nongovernment organizations (national and international) working in the area; environmental protection agency officials; other nearby communities; suppliers, traders, and service providers in the project area; among others. The process adopted an interactive and participatory approach, ensuring that each participant expressed their opinions openly on the proposed wind farm in the project area. A total of 112 consultations and meetings were held and data collected from all these were analyzed. Extra efforts were made to maximize women’s participation during the process. Separate consultations with women were undertaken by a dedicated female consultant. In general, the communities consulted expressed support for the project as they thought that the establishment of the wind farm would develop the area and give them access to better civic amenities. They also expressed apprehension about an influx of migrant workers and that were concerned that these workers would replace them over time. Details of the discussions on issues, expectations, apprehensions, and possible outcomes from the proposed wind farm are incorporated in the EIA report. A grievance redress system will be implemented, under which the project will maintain a social complaint register at the site to document all complaints received from the local communities. The information recorded in the register will include the date of the complaint, particulars of the complainant, a description of the grievance, actions to be taken, the person responsible for taking action, follow-up requirements, and the target date for implementation of the mitigation measure. The register will also record the actual measures taken to mitigate these concerns.

2. What level of consultation and participation (C&P) is envisaged during the project implementation and monitoring?

Information sharing Consultation Collaborative decision making Empowerment 3. Was a C&P plan prepared? Yes No Consultation and participation activities are integrated into the environment and social documentation, including the environmental impact assessment report.

C. Gender and Development

Key issues. The public consultation undertaken by the project noted that women in the vicinity are engaged in livestock rearing and a small number also work as laborers. No adverse social impacts from project activities are foreseen for the following reasons: (i) locals will be employed, especially for semi-skilled and unskilled labor, to avoid causing social stress—particularly to women and children; (ii) the project is located in vacant and barren land with no evidence of sustained farming activities and therefore no impacts on livelihoods; (iii) the wind farm will not be fenced, so livestock herding will not be materially affected; and (iv) the nearest village is about 3km away and noise and dust generated during construction and operation is not expected to be a major issue. Once the wind farm is operational and has started generating electricity, some indirect gender benefits are expected. Expected indirect benefits include increased productive working hours because of the availability of electricity in the evening, improved education for children who can continue studying in the evening, better health outcomes for women and children, and reduced time devoted by women to domestic chores and caring for sick family members—thereby increasing women’s time for income generation and/or leisure activities. On providing employment to qualified women during the construction and operation of the project, the project company and the construction contractors will have to comply with core labor standards to ensure that women are not discriminated against in employment opportunities, salaries, and benefits packages. Key actions. Measures included in the design to promote gender equality and women’s empowerment—access to and use of relevant services, resources, assets, or opportunities and participation in decision-making process:

Gender plan Other actions/measures No action/measure

The loan agreements will include specific provisions to ensure that the project company and the construction contractors will comply with core labor standards to ensure that women are not discriminated against in employment opportunities, salaries, and benefits packages.

Appendix 2

15

III. SOCIAL SAFEGUARD ISSUES AND OTHER SOCIAL RISKS

Issue Significant/Limited/

No Impact Strategy to Address Issue

Plan or Other Measures Included

in Design Involuntary Resettlement

No impact. The Alternative Energy Development Board has acquired the land from the government of Sindh on a lease that has been re-leased to the company for life of the project.

None Resettlement Plan

Short Plan Resettlement

Framework No Action

Indigenous Peoples

No impact. The land available for the project is not owned, used and/or claimed by any indigenous group. The project operation will not entail any impact to such groups.

None Plan Other Action Indigenous

Peoples Framework

No Action Labor

Employment opportunities Labor retrenchment Core labor

standards

Limited. Employment opportunities to be created during the construction and operation phases will be limited.

Recruitment of qualified local people for the project and by the contractors will follow the established core labor standards.

Plan Other Action No Action

Affordability No impact None Action No Action

Other Risks and/or Vulnerabilities

HIV/AIDS Human trafficking Others

None None Plan Other Action No Action

IV. MONITORING AND EVALUATION

Are social indicators included in the design and monitoring framework to facilitate monitoring of social development activities and/or social impacts during project implementation? Yes No

a ADB. 2009. Country Partnership Strategy: 2009 – 2013 Pakistan, Manila. Source: Asian Development Bank and Zorlu Enerji Pakistan Limited.

Appendix 3

16

ECONOMIC EVALUATION

A. Introduction 1. The project is the first private wind farm in Pakistan. It is a 56.4 megawatt (MW) wind power plant close to Jhimpir town in Thatta district, southern Sindh, about 100 kilometers (km) northeast of Karachi. 2. As of mid-2010, Pakistan had a shortfall of 22% (4,200 MW) of the country’s peak demand. While electricity sales and demand have risen by over 40% since 2005, investment in new generation has lagged. The extent of power outages all over the country, including major urban areas, has become a significant bottleneck to growth. Energy security is further compromised by a 50% dependence on imported oil. Global price fluctuations threaten the already scarce energy supply. 3. The Government of Pakistan implemented initiatives to expand energy supply and encourage renewable energy. In 2004, the Alternative Energy Development Board (AEDB) invited private investors to set up wind farms but the sector has not developed for a variety of reasons. The government has since established other incentives for investors in renewable energy. The success of this project is expected to provide lessons for other investors who are considering investing in Pakistan’s renewable energy sector. B. Valuation of Economic Benefits and Costs 4. The economic analysis for the project was conducted in accordance with the Guidelines for the Economic Analysis of Projects of the Asian Development Bank (ADB).20 The values in the economic analysis reflect 2010 price levels, and the exchange rate assumed is PRs85.6 per $1. This economic analysis is carried out using the domestic price numeraire. The economic internal rate of return (EIRR) is calculated from the year of construction to the expected end of the project life (2010–2032). Assumptions on macroeconomic variables and operations are consistent with the financial evaluation.

1. Economic Benefits

5. The two quantifiable benefits from this project are the value of power as an input to economic activity, and the environmental advantage of clean energy. 6. With Pakistan’s energy supply deficit, the power produced by the plant is not expected to substitute the existing generation capacity, thus the entire output of the plant is considered incremental. The price of incremental power is in the tariff set by the regulator. This represents the value of power as an input to economic activity. 7. The environmental advantage of clean energy is valued using an estimate of the traded price of certified emission reduction (CER) of the Clean Development Mechanism. The CER price represents society’s willingness to pay for cleaner energy, and is quoted per ton of carbon dioxide (tCO2) avoided. This price is assumed at €10 (PRs1, 155) per tCO2. 8. As this project is pioneering wind power in Pakistan, its successful implementation will result in lessons that will help facilitate subsequent renewable energy investments in the country. However,

20 ADB. 1997. Guidelines for the Economic Analysis of Projects. Manila.

Appendix 3

17

the benefit of producing such lessons, and the indigenous and renewable nature of the source of power, are not quantified.

2. Economic Costs

9. Capital and operating costs exclude interest during construction, fees and taxes, and financing costs. The tradable component of the capital and operating costs are adjusted for a shadow exchange rate factor of 1.1. The capital cost includes the present value of the cost of the 6 MW of wind power that is already installed. C. Calculation of Economic Internal Rate of Return

10. The real EIRR of 14.7% exceeds the social discount rate of 10% (Table A4.1).21

21 Multilateral Development Banks, Evaluation Cooperation Group. 2006. MDB-ECG Good-Practice Standards for

Evaluation of Private Sector Investment Operations, 3rd Edition. Manila. The Evaluation Cooperation Group’s Good Practice Standards for Private Sector Investment Operations rates a project satisfactory if the EIRR is 10% or higher.