World Bank Report Vietnam

Power StrategyManaging growth and reform

The World Bank in Vietnam2006

V I E T N A M ' S I N F R A S T R U C T U R E C H A L L E N G EWorkshop Edition

VIETNAM'S INFRASTRUCTURE CHALLENGE

As Vietnam becomes richer it faces challenges in adapting its infrastructure policies and institutions. While the old challenges of providing basic services to all remain, new challenges are emerging, such as accessing new sources of finance, refining planning processes, preparing for rapid urbanization, improving the efficiency of infrastructure serviceproviders, developing stronger institutions to encourage private finance of infrastructure or direct private provision ofinfrastructure, and developing more targeted approaches to poverty alleviation.

This report on Power Strategy Managing Growth and Reform is one of six volumes dealing with Vietnams Infrastructure Challenge. Other volumes deal with Infrastructure Cross Sectoral Issues, Water and Sanitation, Transport, Telecommunications, and Urban Development. The work for these volumes was carried out between 2004 and 2006 by World Bank staff and consultants.

This workshop edition of the report has been prepared as a means of inviting feedback on its contents from the Government and other stakeholders, prior to final publication.

Vietnams electric power industry isfacing tremendous challenges. Withannual growth in electricity demand of15% or more expected to continue as theeconomy grows further, a massive expansion ofthe power system is required over the nextdecade. Funds for investment must bemobilized from all sources, including greaterself-financing from the domestic powerindustry itself and large-scale development ofindependent power production (IPPs). At thesame time, the country is embarking on a majorpower sector reform program, designed toestablish new institutional arrangements,restructure the dominant utility and graduallydevelop a competitive power market. Thepressure to meet soaring power loads, urgentlymobilize investment for new capacityconstruction, and ensure that the new corporateconfigurations and institutions being created forthe reformed and restructured power industrywill best serve long-term needs, combinetogether to create probably the most criticaljuncture of the countrys power industry.

In an environment where the dominantpower utility, Electricity of Vietnam (EVN), andsupervising and regulating government entitiesare facing major decisions on a weekly basis,this report seeks to provide an integrated,medium-term perspective on the intertwinedissues, and some independent suggestions forconsideration. The bulk of the report wasprepared by World Bank staff in consultationwith Vietnamese counterparts during mid andlate 2005. Section One provides an overview ofVietnams power sector, intended primarily for

those new to the sector. Section Two outlinesthe main current issues facing the sector, andprovides analysis of potential solutions andrecommendations.

The Twin Challenges of Growth andReform

The capacity of Vietnams power system todeliver power to consumers needs to double injust five year, to meet demand growth projectedat 16% per year during 2006-2010. Demand isbeing driven especially by industrial loadgrowth, but also heavy increases in residentialpower use as incomes are rising. During 2011-2015, demand growth is expected to remainvery strong, projected at 11% per year.

During the last five years, performance ofthe power industry has been good overall, withsound financial performance, declines in systemlosses, and improved reports on service quality.A particularly noteworthy achievement hasbeen an increase in rural access to electricity to88% of households in 2004. Beginning in 2005,however, shortages became apparent, and areexpected during the dry seasons in 2006 and2007, with difficulties to add capacity to thesystem fast enough to meet demands. Short-run options to mitigate shortages includeaddition of gas turbine capacity to meet peakloads, aggressive demand-side management,and increases in imports from neighboringcountries. While demand-side managementmust be pushed as hard as possible, the mainsolution to the inadequate reserve margins andgap in meeting demand lies in efficient

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Executive Summary

implementation of a large-scale medium-termpower system capacity expansion program.

Vietnams far-reaching power sector reformprogram has been launched with passage of theforward-looking Electricity Law in late 2004, theestablishment of the new Electricity RegulatoryAuthority of Vietnam (ERAV) under theoversight of the Minister of Industry, and thePrime Ministers approval in early 2006 of aRoad Map for the reform. The countrys effortsto restructure the power industry and develop acompetitive power market are a long termproposition. Yet, there are key immediatedecisions and actions which will have majorimplications for the success of the reform overthe longer term. It is important to ensure thatdecisions on the restructuring and equitizationof various entities now under EVN and onagreements for new IPP developments providethe proper building blocks for the future. Thecapacity, credibility and effectiveness of ERAVneed to be established to put a regulatoryframework in place that ensures predictabilityfor investors. Subsequently, over a period ofseveral years, careful design work andconsensus building are required as preparationto roll out the new market.

Optimizing Power Investments

Vietnam has laid a good planning frameworkfor the coming massive capacity expansionprogram through the completion of the SixthPower Master Development Plan, covering2006-2015, with a view to 2025. As of early 2006,the Plan was under final Government review.The basic institutional arrangements, analyticalcapacity and analytical tools being used arefundamentally sound. The effort is beingcoordinated with similar planning exercises forthe coal and petroleum industries, for the firsttime all under Ministry of Industry (MOI)purview.

The new Plan emphasizes growth in all three

major power generation subsectorshydropower, coal-fired power, and powerfueled by offshore natural gas. As hydropowerprojects identified in Vietnam generally providelower cost alternatives than the average costs ofnew thermal power through much of the loadcurve, a strong focus on development of thecountrys hydropower resources is retained.However, expansion programs for thermalcapacity, using domestic coal and eventuallyimported coal, and large quantities of newnatural gas, are also necessarily aggressive,providing the biggest capacity additions.Demand-side management effortsincludingboth improvements in energy efficiency as wellas load managementshould play a moresignificant role than in the past. Finally,imports from China and other neighbors areexpected to increase sharply and make a largerrelative contribution in the future.

While both coal-fired and gas-fired powerare critical for Vietnam, the optimal balancebetween these two and specific projectscheduling priorities are highly sensitive tofuture relative fuel prices and specific fuelsupply arrangements. Ultimate supply levelsof domestic coal and natural gas are limited,and use of imported coal for power generationis planned to meet primary energy supply gapsthat emerge. Following basic analysis of thesensitivity of the relative economics of theseoptions, two broad conclusions emerge: (a)Aggressive promotion of exploration andfirming up of natural gas resources, andcontinued gas field development, is a keypriority for the countrys power development,to ensure least-cost generation, and (b) farmore than in the past, updated review of bothemerging overall fuel supply availability andthe latest relative economic costs of coal andgas supply should be carefully reviewedbefore sanctioning major specific powerinvestment projects, even if they are alreadylisted in the Plan.

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Discussed in further detail in pages 13-20,several conclusions concerning specificinvestment options include:

In reviewing coal-fired generation, it isimportant to evaluate investments usingeconomic values for coal inputs as opposed toactual prices,. In lieu of development of atruly competitive coal market, theGovernment needs to review domestic coalpricing strategies. Environmental impacts arealso a major issue, requiring strict attentionwhen considering the scale of development,siting and choice of technology.

More active efforts are required tocoordinate the actors and interests involvedin new gas field-pipeline-power plantdevelopment, given needs for new projectsto proceed as quickly as possible. Toachieve competitive power pricing at theend of the chain, firm, large-scale andsufficiently long-term commitments from anumber of parties are required. GivenEVNs financing and borrowing constraints,IPP investment is critical. However, lack ofcompetition is a major disadvantage inarrangements where IPP projects arenegotiated solely with fuel suppliers, andwhere this is undertaken, separate reviewand close monitoring of fuel supply andpower supply cost accounting is important.

Further work n the hydropower subsector isespecially important to improve detailedplanning and implementation of reservoirresettlement programs, and alignment ofenvironmental assessment to better informproject designs and focus on key issues. Majorprogress has been achieved in recent years,including in policy development and financialcommitment to resettlement work. Thechallenge is in the details of implementationto achieve the best long-term results.

Vietnams demand-side managementprograms need to be sharply expanded, as a

strategic measure to help bridge the powersupply and demand gap. The main issue isdevelopment of the institutional capacity todeliver effective programs, both in EVN andMOI.

In addition to short-term measures toincrease imports, increasing interconnectionwith Thailand, China, Laos and Cambodiathrough development of the GreaterMekong System, can bring larger and longterm benefits to Vietnam in the comingyears.

Financing Investments

Annual power sector investment requirementsto meet power demand during 2005-2010 areexpected to be over $3 billion. The countryseeks to mobilize investment through a varietyof vehicles, from both domestic and foreignsources, to meet this challenge. The two basiccategories include EVNs contribution toinvestment, from its own resources anddifferent types of borrowing, and independentinvestment, primarily by independent powerproducers. Both are critically needed.

Financing of new investment through thecurrent EVN system, including sub-entities, isessential for key parts of the construction effort,including the network, most of the hydropowerprogram, and selected elements in the thermalpower program. EVN exhibited strong financialperformance during 2002, 2003 and 2004,allowing substantial self-financing contributionto the investment program. With increasedcosts stemming in part from power shortages in2005, and the sharp increases in investmentrequirements, however, self-financing ratioswill plummet unless EVNs unit sales revenueincreases substantially. The corporation isproceeding to borrow from a wide variety ofsources, including issuance of bonds. However,EVN will reach borrowing limits very quickly,unless revenues are increased (or there is a

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major injection of equity, which is unlikely).Overextension of borrowings aboveinternationally recognized rations would behighly imprudent, as maintenance of EVNscreditworthiness is essential for any sustainableinvestment mobilization effort.

It is very clear that average retail power pricelevels must be increased quickly to covergreater costs but also, especially, to expandrevenues for financing of the massive powersector expansion. Ultimately, consumers mustcontribute to the financing of the new capacityto meet their needs. Power prices in Vietnamare relatively low by international standards,including industrial tariffs, but especially in theresidential sector.

EVNs purchase of power from sourcescurrently independent from EVN, includingmostly IPPs but also imports, is expected toaccount for more than one-half of new powerproduction during 1995-2010. A number of IPPprojects will be developed by other domesticstate-owned companies, or by those companiesin joint venture with EVN. However new IPPswholly owned by foreign or private firms areexpected to provide several thousands of newmegawatts of build-own-transfer (BOT) IPPcapacity.

Use of competitive bidding is stronglyrecommended as the standard method forawarding new IPP power purchase agreements.In country after country, and project afterproject, prices and terms awarded throughcompetitive bidding have provided lower coststhan negotiated deals. The Phu My 2.2 successin competitive bidding provides a platform ofprior experience in Vietnam. Support is neededfor MOIs efforts to (a) develop a governmentguarantee strategy which can meet the needs ofinvestors today but also provide a pathway forlimiting government exposure in favor ofincreasing reliance on Vietnamese corporateassurances and creditworthiness; (b) develop astandard framework for competitive bidding for

a full new patch of IPP projects; and (c) resolveoutstanding gas field/transmission/powergeneration development issues hinderingdevelopment of gas-based IPP projects.

Power Industry Restructuring,Equitization and Development of aPower Market

The objectives of Vietnams power sector reformare to maximize efficiency through competitionin the power industry and to expandmobilization of investment and managerialresources from outside of the current state-operated system, in order to minimize costs andprovide reliable, high quality service toconsumers. As described in the recentlyapproved Road Map, the reform process isexpected to span twenty years, and proceedthrough (a) a preparatory phase and initialtrial market, followed by operation of acompetitive market for supply from generatorsto a Single Buyer; (ii) a second phaseintroducing a wholesale competitive market forbulk supply to distribution companies and largeusers, and (iii) a final phase introducingcompetition at the retail level.

The implications of the approved reformpath need to be clearly understood by allparties. Four points worthy of special emphasisinclude:

EVN will need to be broken up into trulyseparate corporations. The model of EVN asa holding company for the states assets ingeneration, transmission and distributioncannot be retained if true competition is tobe achieved and a level playing field createdto facilitate private investment.

Reductions in costs to consumers should notbe expected soon. The main efficiency gainsof competition will only be realized whenlarge consumers and distribution companiesare able to contract directly with power

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generators in a competitive environment.These benefits are not expected during thenext five years. The most important factorsaffecting costs of supply to consumers overthe medium term will be the degree ofsuccess in using competitive bidding for IPPcontracts, changes in fuel prices, the degreeof success in maintaining developmentaccording to the least-cost investment plan,and the degree of success in loadmanagement and achieving systemoperation efficiency gains.

Prospective power shortages and tightreserves provide additional challenges forthe reform. Use of an internal, trialmarket that emulates the future powermarket, and careful advance preparationsare crucial.

Greater predictability and flexibility in retailelectricity pricing will need to be introducedover time. If a power market is desired,market forces must be brought to play, andhence flexibility in setting the retail tariff isessential, through mechanisms which allowchanges in costs to be passed through toconsumers, and for consumers to respond.

The current Road Map outlines a solid set ofdirections and steps for the reform. However,serious consideration should be given to allowdirect contracting between generators and largeconsumers and/or distribution companies forspecial conditions (e.g. financing newinvestment) during the single buyer phase. Thisway the main efficiency benefits of the reformcan begin to be realized earlier. In addition,experience elsewhere strongly suggests thatvested interests and pricing imbalances may becreated by giving a legal monopoly to a SingleBuyer, which can create difficult barriers tofurther reform and limit the benefits ofcompetition. Suitable time and care is requiredduring the preparatory phase of the reform.However, once preparation is in place, it may be

best to roll out the reforms towards directcontracting as quickly as possible.

Decisions made now and in the next fewyears on how to restructure the power sector,especially as part of the Governmentsequitization program, will have far-reachingimplications for the industry in the future andthe extent to which Vietnam can achieve thepower reform goals set forth in the ElectricityLaw. The size, structure and operational scopeof newly formed shareholding companies needto be conducive for the future power market.Companies need to be strong enough to beactive market participants, but should not wieldexcessive control. Distribution companies, inparticular, need to have sufficient financialstrength and managerial capacity to beperceived as credible and make long-termcontracts with generating companies. For this,and other reasons, it is strongly recommendedthat the Government review the results ofcurrent pilot projects to equitize distribution atthe provincial level before further rolling outthis particular equitization strategy. Theconcern is that such small provincialdistribution companies cannot become thereliable revenue collectors and powerpurchasing agents upon which the rest of thepower industry must depend, unless theGovernment continues financial backing ofmany of them indefinitely.

With the introduction of the power marketon the horizon, another current issue concernsthe balancing of new IPP investors needs forbankable power purchase agreements (PPAs)with the need to move steadily and smoothlytowards the power market. Clearly, PPAs mustprovide investors with sufficient medium-termsecurity of cash flow for them to obtain projectfinancing. It also is important to protectVietnams security of power supply and toensure adequate reserve margins in the system.The key here is to design the power market tomitigate these concerns. For example, emphasis

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may be given in the market design to cover loadprimarily with contracts, and limit spot tradingto non-contracted surpluses and to clearingdifferences.

Developing the ElectricityRegulatory Authority of Vietnam

Two important factors which will define thedegree of success of ERAV in its important andvery necessary position as the new regulatoryagency for the power sector include: (a) ERAVsability to establish itself as an objectiveinstitution, charged with implementation of thecountrys laws, with a mandate recognized byall parties, and operating as an agency separatefrom MOIs regular business and departments,and (b) establishment of clear technicalcompetence in addressing the complex issuessurrounding regulation of the sector. Someareas for ERAVs attention during its first year

include: (a) establishment of itself with adistinct identity; (b) definition and publicationof a clear work program, (c) staff training anddevelopment, (d) agreement with powerindustry participants on clear arrangements forinformation collection and monitoring, (e)definition of ERAVs enforcement powers, and(f) definition of mechanisms for resolution ofdisputes.

Recommendations for Follow-up

Recommendations in this report are summarizedin the final pages (pp. 34-36). Follow-up actionson many of these recommendations are alreadyunderway. Given the challenges which Vietnamfaces in development of its power sector over thenext five years, in particular, internationalassistance will be important, both in financingand as a source of ideas and lessons fromexperience elsewhere.

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Introduction to Vietnams EnergySector

1. Vietnam is a net energy exporter, and isexpected to remain such for the foreseeablefuture. The country is endowed with offshoreoil and gas resources in the south, coal in thenorth, and hydroelectric power resources in themountains running from north to south alongthe countrys western regions. The country isnot exceptionally well endowed in any of theseresources, however, so Vietnams exploitationof its energy resources will continue to beprimarily for its own use.

2. Vietnam produced about 20 milliontons of crude oil in 2004, up from 16 million tonsin 2000. Almost all was exported, earning some$5.7 billion in foreign exchange revenues, andaccounting for about 21% of the countrys totalexport earnings. However, Vietnam importedsome 11 million tons of petroleum products inthe same year, at a cost of $3.6 billion, so that netpetroleum exports totaled just $2.1 billion.Vietnam is currently constructing petroleumrefining capacity, so that an increasing portionof its domestic petroleum product demand willbe met by processing its own crude oil. Crudeoil production is expected to increase in thefuture, but not dramatically: averageproduction rates of 25-40 million tons per yearare expected through to 2020.

3. Vietnam has substantial offshorenatural gas resources, including associated gas,

but also major reserves of non-associated gas.All natural gas is planned for domestic use forthe foreseeable futurethe industry will dowell to meet planned domestic needs, especiallyfor the power sector, but also for fertilizerproduction and several other large industries.In 2005, about 6.6 billion cubic meters of naturalgas were brought on shore. Production isexpected to increase to some 15-20 billion cubicmeters by 2015.

4. Currently exploitable coal resources inVietnam are sufficient for an increase inproduction from the current 20 million tons peryear to about 45 million tons per year.Predominantly anthracite, the highest qualitycoals are exported as metallurgical coal, andlower quality coal is used domestically,primarily in the power and cement industries.Coal production has increased sharply over thelast few years, rising from some 11 million tonsin 2000. With the rise in international energyprices, export earnings from the 7.5 million tonsexported in 2004 totaled $355 million.

5. Less than one quarter of Vietnamsestimated economically exploitablehydropower resources had been developed by2004. With the notable exception of the DaRiver in northern Vietnam, the countrys hydropotential is not amenable to massive singledevelopment projects, but rather to mediumand small-scale hydro plant construction.Except for the Hoa Binh, Son La and Lai Chau

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Section one:

Current status of Vietnams power sector

Overview

sites on the Da, all other hydro sites in Vietnamare earmarked for hydro plant developmentwell under 1000 MW.

Introduction to Vietnams ElectricPower Sector

6. Vietnams Power System. Vietnamselectric power system caters to the countrysresource endowment and geographicconfiguration. With hydro resources availablein all three of the countrys main regions (seeFigure 1), hydroelectric power was thedominant source of power generation from thelate 1980s until very recently. Thermalgeneration from coal adds base load capacityin the north. Thermal generation from new

offshore natural gas has been developed in thesouth since the late 1990s, adding to smallamounts of oil-fired thermal capacity. Totalgenerating capacity on the system by the endof 2004 was almost 11,200 MW (see Table 1). A500 KV backbone transmission line connectsthe regions and generation sources, enhancingthe optimal use of resources during differentseasons and as the generation mix anddemand evolve. This basic configuration ofthe system is expected to continue over thelong term as the overall system expands.Although the mix will continue to vary fromyear to year, as new large plants are added,hydro and gas are each expected to contributeabout 40% of power generation, and coalabout 20%, over medium term.

7. Electricity of Vietnam (EVN) is nowcompleting a parallel, second north-south 500KV line, and strengthening power transfercapabilities. With additional 500 KV lines forpower evacuation from new major generationcomplexes and work beginning on high-voltagerings around Hanoi and Ho Chi Minh City, thetotal 500 KV network will increase from 2423km in 2004 to 3533 km in 2005. At the end of2004, 220 KV lines totaled 4798 km and 110 KV

lines totaled 9339 km. Powertransfers with neighboring China,Cambodia and Laos were small in2004, but will grow significantly inthe future.

8. Vietnams power industry hasstruggled over the last decade toexpand the system to meet rapidlygrowing demand, and has beengenerally successful, althoughserious shortages did appear duringthe summer of 2005, when droughtconditions coincided with tightcapacity constraints. From 1995 to2004, electricity sales grew by 15.1%per year, at almost double the 7.1%p.a. rate of GDP growth (see Table 2).

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Table 1.Vietnams Power Generating Capacity (MW)

2002 2003 2004Hydro 4187 4154 4227Coal 1245 1245 1495Oil and gas 3428 4496 5475Total 8860 9895 11197

Source: EVN.

Electricity production during the same periodgrew by 13.6% per year, growing somewhatslower due to power system efficiency gains.Transmission and distribution losses, forexample, fell sharply during the period from anunfortunate 21.4% of power production in 1995to a reasonable level of 12.2% in 2004.

9. Total power production amounted to46.2 TWh in 2004 (Table 3).1 Power generationfrom oil and gas surpassed hydropowergeneration for the first time in many years, as anumber of units in the natural-gas based PhuMy complex came on line. Power purchasesfrom independent entities rose to about 6.3TWH (14% of total generation) in 2004. In 2005,the share of independent power production will

be substantially higher, as capacity additionsduring the course of 2004 brought the IPP sharein total capacity to 22% by the end of the year.

10. Sources of Demand Growth.Electricity use in Vietnam is growing from avery low base for a country its size. In 1995,total power sales of 11,185 GWh amounted toonly 156 KWh per person per year. Even aftergrowth of more than threefold in electricity useduring 1996-2004, total end-use consumptionamounted to only 484 KWh per capita per year,compared to an average of 1265 per capita peryear in low and middle income countriesworldwide.

11. Industrial and residential electricity useeach accounted for about 45% of total sales in2004 (See Table 4). Although the service sectorhas played a role, industry and household usehave been primarily responsible for the totalgrowth in electricity demand, and this trend isexpected to continue. The share of agriculturein electricity demand, which is not anelectricity-intensive sector, has fallen sharply.

12. Rapid increases in industrial electricityuse are following rapid growth in themanufacturing sector. Industrial value addedgrew by about 11% per year during 1996-2004.The share of GDP of industry, which is arelatively electricity-intensive sector, increased

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Table 2.Total Electricity Production and Sales (1995-2004)

1995 2000 2001 2002 2003 2004Total production (TWh) 14.6 26.6 30.6 35.8 40.8 46.2Total Sales (TWh) 11.2 22.4 25.8 30.3 34.9 39.7Own Usea/ (%) 9.3 4.1 4.2 4.9 4.8 4.3Transmission & Distribution Loss (%) 21.4 14.5 14.2 13.4 12.2 12.2

a/ Unidentified consumption inaddition to internal use may be included.

Source: EVN Staff calculations.

1. All figures in this chapter are from EVNs statistical series including only production and sale from capacity onthe network. Other sources of power generation totaled some 0.6 TWh in 2004.

Table 3.Electricity Production by Generation Type

2002 2003 2004Hydro 18.2 19.0 18.1Coal 4.9 7.2 7.2Oil and gas 12.7 14.6 20.9

Total 25.8 40.8 46.2

EVN generated 33.7 34.8 40.1Purchased by EVN 2.1 6.0 6.1

Source: EVN.

from 22.6% in 1995 to 30.8% in 2004, while theshare of agriculture fell from 26.2% to 20.3%.Moreover, the types of light industry which aregrowing fast in Vietnamfood and beverageprocessing, textiles, light chemicals, and lightconsumer durable goodsoften tend toincrease power use per unit value added asdevelopment proceeds, due to increasingautomation, packaging and (for food, beveragesand textiles) increased use of cooling. Industrialelectricity demand growth increased especiallyfast during the last few years (e.g., 18.5% p.a.during 2001-2004), and is expected to continueto be a key demand driver.

13. The sharp, steady increases inresidential electricity demand follow both anincrease in household access and addition ofloads other than the basic lighting load. Withboth increases in the urban population and thesuccess in rural electrification (see para. 29)about 30 million new people were added aspower users from 1995 to 2004, representingsome 37% of the total population. Probablyeven more influential on demand growth,however, given the low consumption levels ofnew household customers, has been growth inhousehold appliance ownership, as disposableincomes have grown from very little in the mid-1990s. Even so, the current averageconsumption of about 20 kWh/month perperson among residential electricity users is

low, and certain to increase, as power use growsfrom nascent levels in the countryside and asheavy appliance use, especially use of airconditioners, begins to take hold amongmiddle-income groups.

Policy and Institutional Framework

14. In conformity with Vietnams socialistmarket economy, public ownership dominatesthe energy sector, but increasingly, marketforces are being brought to bear and privatesector participation is expanding. Since 1995,energy sector operations have been organizedinto three General Companies, which areamong the largest companies in Vietnam:PetroVietnam, Vinacoal and Electricity ofVietnam.

15. Key legislation on the energy sectorincludes the Petroleum Law (1993) and itsImplementing Decree (1996); and the newElectricity Law (2004), followed Decrees 105and 106 (2005), which have to do withimplementation of the Electricity Law. Keygovernment decrees include Decree 55 (2003,establishing the functions, tasks, powers andorganizational structure of the Ministry ofIndustry), Decree 45 (2001, on electricityoperations and use), Decree 48 (2000, definingthe policy and regulatory framework for theupstream oil and gas sectors) As discussed in

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Table 4.Electricity Sales Growth by Type of User (1995-2004

Terawatt Hours Percentage of Total1995 2000 2004 1995 2000 2004

Industry & Construction 4.6 9.1 17.9 41.0 41.0 45.0Agriculturea/ 0.6 0.4 0.6 6.0 2.0 1.0Residences 4.9 11.0 17.7 44.0 49.0 45.0Commerce/other 1.1 1.9 3.5 9.0 8.0 9.0

Total 11.2 22.4 39.7 100.0 100.0 100.0

a/ Methods for collecting and calculating statistics for agriculture appear to have changed during the period.Source: EVN

later parts of this chapter, the new ElectricityLaw aims at development of a new frameworkfor the regulation and operation of the powersector in the coming years.

Government Policy and RegulationResponsibilities

16. The Ministry of Industry (MOI) hasfirst-line policy and supervisory responsibilitiesfor the energy sector, both as the line ministryand as the ministry with oversightresponsibility for state-owned companies. MOIis responsible for supervising implementationof government policy, and recommending anddrafting major policy reforms for governmentadoption. MOI is responsible for review andsubmission for Prime Minister approval ofmaster investment plans for the sector and allmajor investment projects. Although theseoften require review and approval from otheragencies as well, including the Ministry ofPlanning and Investment (MPI) and the PrimeMinisters office, MOI is the governmentwindow for the energy companies. MOIreviews and recommends retail priceadjustments for approval by the Prime Minister.Of the major energy subsectors, MOI has beenparticularly involved in the oversight of theelectric power subsector.

17. In addition to the Government Office ofthe Prime Minister, other key governmentagencies for the power sector include:

The Ministry of Planning and Investment(MPI), which is responsible for thepreparation of the countrys overalleconomic development plans, and reviewand provision of recommendations to thePrime Minister for all projects using publicfunds or other resources;

The Ministry of Finance (MoF), which, inaddition to its broad role overseeingfinancial matters for the Government and the

budget, arranges Government guaranteesfor export credits, and provides, through itsDevelopment Assistance Fund (DAF), publicsector loans to qualified users;

The Ministry of Natural Resources andEnvironment (MONRE), which isresponsible for environmental regulation;

The State Bank of Vietnam (SBV), which isresponsible for allocation of foreignexchange, and, as such, is the counterpart forinternational donor lending, and a keyagency for implementing guarantees forforeign exchange convertibility; and

Provincial Peoples Committees (PPCs),which have integrated government oversightresponsibility for local government,including all government functionsdelegated by the central government.

Power Sector Structure andOwnership

18. Electricity of Vietnam (EVN) is thevertically integrated power utility charged withdevelopment, management and operation of thestates electric power industry assets. With thepassage of Vietnams Electricity Law, however,the country is just now embarking on a long-term program to restructure the powerindustry, which will fundamentally alter EVN,the legal, ownership, and managementstructure of the industry, and how the industryis regulated by Government. The sectionsbelow describe the situation as of 2005, whereasthe strategy for the future, and a number of key trade-offs and choices, are described later.

19. EVN is organized as a GeneralCompany, with a series of wholly ownedsubsidiaries. EVN owns and operates state-owned power plants built to date, and is takingshareholding stakes in a number ofindependent power plants (IPPs). Keysubsidiaries include seven regional Power

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Companies (PCs), which are in charge of powertransmission and distribution from 110 KVdownwards. The three largest PCs are PC1(northern Vietnam), PC2 (southern Vietnam),and PC3 (central Vietnam), while the remainingfour manage the power distribution systems inHanoi, Ho Chi Minh City, Hai Phong and DongNai. The PCs each maintain their own financialaccounts, although these are also consolidatedin EVNs overall accounts. Other key entitiesunder the EVN umbrella include four PowerTransmission Companies, four PowerEngineering Consulting Companies, theNational Load Dispatch Center, and a numberof equipment manufacturing companies.

20. Especially compared to many otherstate-owned companies in Vietnam, EVN hasbeen successful in establishing a corporateculture and commercial orientation, particularlyin recent years. EVNs financial accounts arestrictly separate from the Government budget,and EVN receives no Government budgetsubsidy support for investment or itsoperations, with the exception of certain grantsfor a few multipurpose hydropower projectsresettlement. The company is now facing onlycommercial terms for borrowings, except for (i)concessional loans for rural electrification (e.g.,from IDA), and (ii) DAF loans for resettlementcosts and locally manufactured equipment,carrying interests rates 2-3% lower thancommercial rates. EVN was able to steadilymaintain profitability through 2004, coveringall of its costs, including depreciation andfinancing costs, from internally generatedrevenues.

21. EVNs generation and networkdevelopment plans, and all major investmentprojects, must be approved by the Government.MOI also is currently responsible for executingbidding and contracting procedures for largeIPPs. The retail electricity tariff is also tightlyregulated by the Government, with adjustmentsrecommended by MOI requiring approval by

the Prime Minister. Vietnam maintains aunified national tariff, across the country.

22. State policy has increasinglyencouraged development of independentpower generation by investors outside of theEVN system. Whereas IPP capacity totaledsome 620 MW in 2002, accounting for just 7% ofinstalled capacity connected to the system, thishas grown sharply to over 2400 MW in 2004with the commissioning of the gas-based PhuMy 2.2 and Phu My 3 units, accounting foralmost 22% of system capacity. IPPs may bewholly owned by foreign, private firms, bydomestic firms, or in various joint-venturearrangements, including with EVN. Vinacoaland PetroVietnam are developing several IPPs,both wholly owned or as joint ventures withEVN. Small hydro plants also are beingdeveloped by local firms, for connection withthe main grid and sale of electricity throughpower purchase agreements to EVN.

23. In the countryside, local communitiesown and operate the low-voltage electricitydistribution systems in most areas. The basicapproach adopted for rural electrification inVietnam has been for EVNs PCs to develop themedium-voltage network, and for localcommunities to develop the low-voltage system (although EVN hasundertaken this role for about one-fifth ofVietnams communes). Provincial PeoplesCommittees have oversight for ruralelectrification in their provinces, and providesubstantial financial support for the local shareof investment. Until 2004, local powerdistribution was handled by informalCommune Electricity Groups or other informalentities in about two-thirds of Vietnamselectrified communes. According toGovernment regulations, however, all of theseentities are now required to convert to formallegal entities, such as cooperatives or joint-stockcompanies. Developed initially at cooperativeor commune levels in most cases, but also as

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district-level joint stock companies in somecases even at this stage, these companies need toconsolidate and expand, in order to developover time into important commercial actors inthe overall power system.2

Investment Needs

24. With electricity demand increasingunabatedly, Vietnam is facing sharp increases inpower sector investment requirements.Whereas Vietnams original Fifth Power MasterDevelopment Plan foresaw an increase in powergeneration averaging 13.4% per year during2001-2010, to power a continued economicgrowth rate of around 7.5% per year, powergeneration actually grew by 14.9% p.a. during2001-2004, as demand grew faster than expected.EVN revised its development plans upwards in2003, foreseeing shortfalls in capacity, but evenso, the country still found itself seriously short ofcapacity in 2005, with needs for large scale,involuntary load shedding.

25. In the new Sixth Power MasterDevelopment Plan, covering 2005-2015, with a

view towards 2020, forecasted sectordevelopment and investment requirementsthrough the balance of the decade will besubstantially higher than originally projected(see Table 5). The new Plan remains underpreparation, and drafts will be reviewed at allGovernment levels at the end of 2005. Demandprojections prepared during the summer of2005, however, suggest a base case growth inpower generation to 113 TWh in 2010, up from46.2 TWh in 2004a growth rate of 16% peryear, compared to the 12.4% per year originallyplanned. This growth rate implies a furthercontinuation of a power demand/GDP growthelasticity of about 2.0. Industrial load growth isexpected to be particularly strong. During2011-2015, recent base-case forecasts point to aslow down in power demand growth to 11%per year, followed by 9.1% per year during2015-2020.

26. Total power sector investmentrequirements to meet demand will exceed US$3billion per year during the latter half of thisdecade; representing levels which are triple thoseat the outset of the decade, and an immense

9

2. IDAs Second Rural Energy Project provides a major program of support for the development of new LocalDistribution Utilities in the countryside.

Table 5.Power Sector Demand Growth (2004-2020)

2004 2010 2015 2020 2004-2010Growth Rate

(% p.a)Fifth Power Master Plan

Total Sales (TWh) 39.7 81.2 113.8 12.7Generation Requirement (TWh) 46.2 98.0 129.8 12.4Capacity Requirement (MW) 11,197 20,636 30,892 10.7

Updated EVN Estimates (2004)Generation Requirement (TWh) 46.2 98.0 228.0 13.4Capacity Requirement (MW) 11,197 24,447 42,000 13,9

Source: Fifth Power Master Development Plan (2000-2010); EVN Estimates.

challenge for the country. As shown in Table 6,EVNs substantial investments in generation, allof the countrys transmission development,urban distribution and a portion of rural low-voltage distribution, will total $2.4-2.5 billion peryear (in constant terms), just to meet originalFifth Power Master Plan load estimates, whichare now clearly unrealistically low.Transmission investments will continue to besubstantial in 2005 and 2006, as EVN seeks tocomplete the backbone of the system, beforetapering off some towards the end of the decade.EVNs distribution investments are expected toincrease just modestly (although ruralinvestments outside of EVN are likely to increasesubstantially). Particularly critical, however,EVNs investment forecast foresees a tapering offin investment in generation, despite heavygrowth, with a dramatic shift to greater relianceon power purchased from IPPs (see Table 7).Whereas purchased power accounted for just

13.6% of total power production in 2004,Vietnam aims to increase purchases from IPPs toaccount for about a third of power production onthe system by 2010. EVNs seeks to focus itsgeneration investment primarily in hydropower,and rely much more on IPP development ofthermal power. As a result, it is hoped that IPPswill account for over one-half of totalincremental power production during 2005-2010.

27. Issues relating to financing of EVNsinvestments, and the fostering of greater IPPinvestment, are discussed in further details inparas. 73-87.

Sector Performance

28. Performance of Vietnams powerindustry, managed primarily by EVN, has beenquite good during recent years. The industrybasically kept pace during the last decade withextraordinary increases in demand, maintaining

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Table 6.EVN Investment Requirements (2004-2010)a/

2004 2005 2006 2007 2008 2009 2010Generation 711 1229 1544 1961 1869 1818 1917Transmission 275 306 239 161 104 113 121Distribution 381 331 402 412 421 397 398

Total b/ 1367 1866 2185 2534 2394 2328 2436

a/ Based on Fifth Power Master Development Plan requirements, which are not clearly insufficient.IPP investment requirements are excluded.b/ Numbers may not add due to rounding.Source: EVN and World Bank estimates (2005 IAS model).

Table 7.Planned Increasing Role of Purchased Electricity (TWh) 2004-2010

2004 2005 2006 2007 2008 2009 2010Power Purchased EVN 6.3 11.9 14.2 18.4 23.2 25.3 30.3EVN 39.9 41.5 45.5 48.3 51.3 57.9 62.7

Total b/ 46.2 53.4 59.7 66.7 74.5 83.2 93.0

Source: EVN estimates (2005 IAS model).

basic service for its customers most of the time.EVN has maintained strong financial viabilitywhile keeping costs to consumers at quite lowlevels by international standards. Dramaticincreases in rural access and steady reductionsin transmission and distribution losses havebeen particularly notable achievements. Thechallenge for the future is clearly to meet therapidly expanding demands of the economyand population, with minimum disruption,hopefully with further improvements in servicequality and without unreasonable increases incosts to consumers.

A ccess to Electricity Service

29. Access to electricity in rural areas hasincreased dramatically during 1996-2004,marking one of the most successful recent ruralelectrification programs in the world. Asshown in Figure 2, the number of ruralhouseholds with access to electricity hasincreased from 50.7% in 1996 to 88.0% in 2004.Rural household access rates are expected tofurther increase during the next several years,although achievement of access among the final5% of rural households will not be easy. Thesuccess of Vietnams program lies especiallywith the commitment of the Government torural electrification, and the definition and

systematic implementation of national plans asa matter of priority, with public investmentsupport to match local community funds.

Quality of Electricity Service

30. Widespread anecdotal evidence points tosubstantial increases in the quality of electricityservice over the last ten years, with basic servicefor most customers in urban or peri-urban areasbecoming noticeably more reliable. However,there is a basic lack of systematic statisticalmonitoring of service interruptions and voltagedrops, by service area and customer voltage level.This shortcoming needs to be rectified, to developbenchmarks, comparative performance indicesbetween service areas and categories, andmonitorable programs for improvement. Thenew Electricity Regulatory Agency will need tomonitor such data as a basic regulatory tool.While there may have been general improvementin recent years, it also is clear furtherimprovement is needed. In the World Banksrecent Investment Climate Survey for Vietnam,19% of all manufacturing firms surveyed,although connected to the electricity grid, stilldescribed electricity supply as a major or serverconstraint for their business. This was due inmany cases to complaints about the electricityprices charged. However, in almost half of the

11

firms listing electricity supply as a constraint, acore reason listed was insufficiently reliableservice from the grid. Surveyed firms reported anaverage of 12 power outages or surges per year,and, in the case of small and medium-sized firms,sales losses of 2-3% due to outages. This points toa need for a major and systematic effort toproperly monitor service quality, and forimprovement in service provision.

System Efficiency

31. As shown in Table 2 previously,transmission and distribution losses in EVNssystem have fallen steadily over the last decadeto 12.2% in 2004. This is not an unreasonablelevel for a system such as Vietnams at its currentstage of development, especially given the heavyrole of low-voltage residential consumers, butthere is room for further improvement. In thefuture, the Electricity Regulatory Agency mustalso monitor these efficiency indicators carefullyagainst various benchmarks.3

32. Management of consumer accountsreceivable has been exceptionally effective for adeveloping country, with accounts receivable in2003 equivalent to only about 17 days of sales. Non-technical losses, including theft, are lowcompared to many countries.

33. Fuel efficiency in thermal powergeneration is highly plant specific. New, large-scale combined-cycle natural gas based powerplants incorporate world-class technology andprovide high fuel efficiency. With the exceptionof the Ph Lai 2 plant, however, existing coal-fired power plant efficiencies are poor, as thefacilities and technology are relatively old, andunits are relatively small. In 2004, the averageheat rate for coal-fired units was 458 grams ofstandard coal equivalent per gross KWh (e.g.,with two plants in the 500-700 gmCE/kWhrange. Similar issues exist with some of the

older oil-fired plant. Plans have been made torenovate or retire older, inefficient units, oncereserve margins allow.

Retail Power Price Levels

34. Vietnam has a uniform retail powertariff which applies across the country.Excluding value-added tax, the averagerevenue from the tariff was VND800 per kWh in2004 (US5.1 cents/kWh). Including the 10%V.A.T., the weighted average retail price wasUS 5.6 cents per kWh. This is lower than theaverage retail price today in most countries.The financial position of EVN has remainedsound with this unit revenue level during thelast few years through 2004, covering all of itsdirect and indirect costs, but this level willprove insufficient for the future (paras. 73-80).

35. Vietnams power tariff is sophisticated instructure, with rates varying by voltage level andconsumer type, and offering time-of-day ratesfor major consumers (see Annex 1). Urbanresidential rates increase progressively withincreasing consumption. Rural rates are cross-subsidized by other consumers. Both averageurban residential rates and rural residential ratesare modestly cross-subsidized by higher rates forindustry, commerce, and foreign establishments.

36. Concern is often expressed in Vietnamthat electricity rates for industrial productionare high, compared to rates in other countries,undermining competitiveness. In reality,however, the current average industrial rates ofUS 5.4-6.2 cents/kWh, including V.A.T., are nothigh by general international standards. InChina, for example, electricity rates forindustries in coastal provinces are now US 7-10cents/kWh, with recent increases in Chinesedomestic coal prices, and even reach more thanUS 12 cents/kWh in some export-orientedregions.

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3. Particular care is needed to maintain consistency in defining the boundaries of the system to be monitored,including the statistical treatment of rural low-voltage systems.

Optimizing Power SectorInvestments

Overcoming Shortages

37. Meeting the rapidly growing demandfor electric power is the paramount challengefor Vietnams power industry. Key drivers ofthe countrys economic growthespeciallymanufacturing and commercial and serviceindustriesare highly dependent upon powersupply. Reliable electricity service is essentialfor light industries to remain competitive withsimilar industries in neighboring countries.Electricity has also become an expected, basicelement in the livelihood of most people, and anessential part of increasing standards of living.Costs to the economy of insufficient powersupply from the grid are estimated to be some$0.50/kWh where small-scale auto-generationis an option, and are well over that whereproduction is actually lost due to lack of power.

38. The power shortages experienced inMay-July of 2005 clearly reinforced a priorityfocus on meeting demand throughoutVietnams power industry, with highly visiblenational attention. The capacity shortfall wasestimated at some 800-1300 MW during peakload. The shortage was caused by coincidenceof severe drought conditions, reducinghydropower production, with a paper-thinreserve margin in the overall system, due to aninability to develop new capacity over a shorttime to meet the higher-than-expected surges inpower demand. During the dry season, top

priority must be assigned to ensuring sufficientwater supply for basic livelihood andagriculture at the 1920 MW Hoa BinhHydropower station, and with exceptionallylow water levels in the reservoir due to drought,water flows for power production had to behalted. With insufficient options to pick up theslack, rolling load shedding was required innorthern Vietnam for weeks, including inHanoi.

39. Power shortages are likely to continuein 2006 and 2007, especially in the dry season.Quick measures to help alleviate the probleminclude addition of gas turbine generatingcapacity, which can be constructed relativelyquickly, and aggressive promotion of demand-side management (DSM) measures. Imports ofelectricity from China also are likely to beincreased substantially over the next few years.Current plans call for addition of four oil-fired37 MW gas turbine units in northern Vietnam,and larger additions of gas turbines in thesouth, which can utilize either oil or natural gas.In the north, the new gas turbines will remainexpensive to run, once new, larger capacity gas,coal or hydro resources is finally brought onstream, and will most likely be used foremergency peak load service. In southernVietnam, it is important to integrate the new gasturbines eventually into the future combinedcycle natural-gas-based power complexes, togain optimal efficiency over the long run. Onthe DSM side, there is potential to reducesystem requirements by some 600-800MW over

13

Section Two

Main Power Sector issuesand Study Recommendations

14

the next few years, through energy efficiencyand load management measures, but this willrequire aggressive efforts to put the institutionaland program capacity in place (see paras.70-72).Aside from these measures, however, the key isto develop new capacity, through efficientdevelopment of new generating plant,construction of transmission lines for importedpower, and steady investments in the powernetwork to deliver power to consumers.

Vietnams Power Sector Expansion Program

40. During the latter part of 2005, Vietnamhas been engaged in a major power sector

expansion planning exercise. The draft SixthPower Master Development Plan (2005-2015,with a view to 2025) is scheduled for completionby the end of the year. The effort is beingcoordinated with similar master planningexercises for the coal and petroleum industries,for the first time all under the purview of theMinistry of Industry. Based on the increasedbase-case demand forecasts developed over theyear, projecting electricity demand growth of16% p.a. during 2006-2010, 11% p.a. during2011-2015 and 9.1% p.a. during 2016-2020, thepower industry expansion foreseen is a massivechallenge for the country. Power systemcapacity will need to double in only five years.During 2011-2020, system capacity will need toincrease by 2.5 times again. This hugeexpansion will test the planning, financing,organization and construction limits of thepower industry as never before.

41. On the planning side, the basicinstitutional arrangements, analytical capacityand analytical tools being used arefundamentally sound. In its review of the majorwork being undertaken, the Bank team hasrecommended (a) a strengthening of theeconomic and sensitivity analysis in theplanning exercise, especially relating toassessment of the balance between coal-firedand gas-fired thermal power generation, and (b)increased explicit attention to demand-sidemanagement (DSM) investments and benefits.4

In addition it also would be useful to exploremore sophisticated modeling options appropriatefor hydropower projects.

42. On the network side, a basic, strongertransmission backbone for Vietnams system,planned under the Fifth Master Plan will becompleted during the next few years, including

Vietnam is facing a need of massive powersystem expansion

4. Further details were provided in a note by the Banks Vietnam Energy Team to MOI, EVN and the Institute ofEnergy, Suggestions on Economic and Sensitivity Analysis for Preparation of Vietnams Sixth Power DevelopmentPlan (November 11, 2005).

the second north-south 500 KV line, and the two500-KV urban rings. With the size of theexpansion envisaged, however, basic planningmust now proceed for further transmissionexpansion over the longer term. On thedistribution side, steady investment is requiredto expand and upgrade systems to meetincreasing load and minimize losses byreplacing outdated, inefficient and overloadedsubstation equipment, lines and transformers.Losses in outdated and overloaded ruralsystems are often over 20%.

43. More than two-thirds of the investmentfor system expansion will be needed forexpansion of power generation. The previousMaster Plan called for development with ablend of roughly 40% hydropower, 40% gas-fired thermal power, and 20% coal-fired thermalpower. In the more rapid growth anticipatedunder the Sixth Power Master Plan, the focus onstrong development of the countryshydropower resources will be retained.However, the share of coal-fired powergeneration may increase to take up a largeportion of the accelerated growth, although thisis always subject to the extent of newdiscoveries and development of offshore gas.Although the economic viability of hydropowerprojects are highly site-specific, the hydroprojects under consideration in Vietnamgenerally provide lower cost power than theaverage costs of new thermal power throughmuch of the load curve. Thus, the countrysoverall strategy is to develop existinghydropower resources relatively quickly.Assessment of best balances between coal andgas-fired power, however, is a key long-termplanning issue, which is highly sensitive tofuture relative fuel price and supplyexpectations. During the next few years,

decisions on launching specific power plantconstruction projects are clear: all power plantswhich have available domestic coal or gassupply will be needed as soon as possible tomeet the pressure of rapid demand growthOver the longer term, however, definition ofoptimal balances requires careful attention, alsotied with the countrys coal export and gasexploration policies. The main parameters ofthis balancing issue include the following:

Both exploitable domestic coal supplies andoffshore gas supplies entail supplyconstraints. The availability of domesticcoal for the power industry is capped bydomestic resource limits, given currenttechnology, and export levels. Expansion ofgas supply requires not only field andpipeline development, but also furtherexploration and firming up of reserves ifsupplies of over some 14 billion cubicmeters (bcm) per year are to be provided forpower generation.

Thermal power generation using importedcoal is expected to be the most cost effectiveoption once the main options for generationfrom domestic coal and gas have beenexploited. However generation fromimported coal is expected to be significantlymore expensive, in both financial andeconomic terms, than the other options, atleast until strong diminishing returns beginto prevail in domestic coal mine operations.5

At current domestic coal prices, set with aview towards production costs, powergeneration from domestic coal issignificantly less expensive than combined-cycle gas-based power generation atcapacity factors exceeding 50-60%.However, in economic terms, considered

15

5. An exception may be if coal-fired power plants are developed in the south, in which case costs of imported coaland domestic coal (shipped from north to south) may be similar, in economic terms.

from the perspective of the country as awhole, the value of domestic coal used forpower generation is higher than its currentprice, as it can be exported for more money,which would accrue to Vietnam.6

In economic terms, then, combined-cyclepower generation from offshore gas at recentlycontracted gas prices is quite competitive withgeneration from domestic coal. The most costeffective option depends largely upon theevolving fuel costs (in economic terms) relevantfor specific projects. Hence, the Bank teamsrecommendation to pursue careful economicand sensitivity analysis in the planning exercise.

44. While conclusions on the best specificscheduling of investment projects must awaitcompletion of the Master Plan, two broadconclusions concerning the coal and gas-fueledgeneration balance can be drawn from theparameters above: (1) Aggressive furtherpromotion of exploration and firming up ofnatural gas resources, and continued gas fielddevelopment, is a key priority for the countryspower development, to ensure least-costgeneration, and (2) Far more than in the past,sanctioning of major specific power investmentprojects in the future must include updatedreview of both emerging overall fuel supplyavailability and the latest relative coal and gassupply costs (including opportunity costs ofexports foregone), as the optimal mix betweenthese two is very sensitive to these parameters.

45. The Bank team also has recommendedthat sensitivity analysis also be conducted withdifferent demand growth assumptions,especially on the lower side. Assessment ofelectric power demand is particularly hardduring periods of fast economic growth.Demand scenarios should be quite differentfrom each other (e.g. 3-4% p.a., in this case)the

purpose is not only to forecast the mostprobable scenarios, but also to understand howthe schedule of investment would change underfaster or slower growth.

46. The basic framework and main issuesfor each of the generating subsectors areoutlined below.

Coal-Fired Power Generation

47. Thermal power plants fueled withdomestically produced anthracite will continueto provide a key base-load power source fornorthern Vietnam. Coal is currently suppliedexclusively by Vinacoal, the general corporationholding all of the states assets in the coalindustry. Coal sold for power generationtotaled about 4.3 million tons in 2004,accounting for some 22% of Vinacoals 20million tons of sales, while Vinacoals exportstotaled 7.5 million tons and other domesticusers purchased 8.2 million tons. Productioncan increase strongly in current coal fields, anda major new coal mining operation is planned atMon Duoung. Production in 2010 is expected toreach 35-40 million tons. Further increases inproduction beyond 2010 are expected to bemoderate, unless viable methods can bedeveloped to exploit coal under the Red RiverBasin. Average production costs are expectedto rise.

48. The highest quality anthracite producedis beneficiated, achieving calorific values of 7200-8500 kilocalories per kilogram, and thenexported as metallurgical coal at high marketprices. Supply to the power industry is of farlower quality, with calorific values in the 3500-5500 kcal/kg range. Similar to white coalsproduced in central and southwestern China,the high-ash anthracite used domestically maybe difficult to ignite, but it is acceptable for

16

6. Over the short term, the government may wish to consider its regulatory position vis-a-vis the coal sector beforeundertaking any reforms to price coal at export parity levels (see paras. 51-52)

power generation if boiler adjustments aremade and, often, starter fuel is used.

49. With the countrys coal resourceslimited, the Governments strategy is to capexport levels strictly, in favor of expandingdomestic supplyessentially to postpone theexpected eventual need for coal imports. Thehigh quality anthracite fetches a premium priceon the international market. The low and mid-range quality anthracite, however, must be soldat a major discount. In mid-2005, Vietnameseanthracite of some 5000 kcal/kg was being soldat US$29-33/t, f.o.b. to Japanese and Chinesecustomers, compared to the US$50-53/t, f.o.b.paid for Australian coal of 6500 kcal/kg.

50. Issues confronting the coal-firedthermal power subsector include coal pricing,power plant siting, and environmentalconcerns.

51. Future domestic coal pricing isuncertain, and additional clarity on how coalprices will move is important for the powerindustry, as the optimal role of coal-fired plantis quite sensitive to fuel prices. Vinacoal soldcoal to EVN in 2004 at the Governmentregulated price of $22/ton, which is well underinternational prices, adjusted for quality.Although Vinacoal reports that this price isbelow average production costs, the priceappears quite high as a cost-based price to theBank study team, given the role of several largeopen pit mines and prices and costs for similarcoal in China. However, reasonable productioncosts are very difficult to assess, as (a) there arewide disparities in unit costs between collieries,such that efficient producers provide heavycross subsidies to high-cost, inefficientproducers, and (b) there is little incentive forefficiency, as individual collieries are notoperated with transparent, independentaccounts, with Vinacoal undertaking all sales atstandard prices, and then transferring funds tocollieries to cover costs. To improve efficiency,and ensure that prices are aligned with

reasonable costs, major reforms will berequired to allow greater autonomy and propermarket incentives to bear at the mine level.Inevitably yielding winners and losers, such areform is not a simple undertaking, butnecessary over the medium term if the coalindustry is to meet its performance potential.Baring such reform, the Government canundertake more in-depth review of actualproduction costs, in an attempt to at leastprovide greater clarity to the domestic coalpricing issue.

52. Vinacoal and others advocate a gradualincrease in the coal price charged domesticallyuntil prices reach CIF import parity levels,adjusted for quality. In the medium term, it isin the countrys best interest to allow coal pricesto move to import parity levels, which bestreflect economic costs. However, this is bestachieved through development of a truedomestic coal market, with competitionbetween a meaningful number of domesticsuppliers. If pricing policy remains one wherethe Government sets prices, it is not advisable tofix coal prices at import parity levels until (a) astrong, independent review of production costsand efficiency incentives is completed, (b) atransparent and clear way of estimating theeconomic rent which will accrue to Vinacoal isdeveloped and agreed, and (c) clear agreementis reached in the Government as to how suchrents will be collected and used.

53. Concerning power plant siting, the bulkof the new coal-fired power plants will continueto be in northern Vietnam. However, there areplans to develop a major coal-fired powerfacility in central Vietnam to provide base-loadpower there, using a blend of trans-shippeddomestic and imported coal. The ongoing least-cost expansion plan study will need to reviewthese plans, and other potential plans for coal-based power outside of the north, from theperspective of the integrated powertransmission and generation system.

17

54. Coal-fired power generation carries asubstantial disadvantage globally in terms ofgreenhouse gas emissions. In terms of localpollution, Vietnamese air pollution emissionstandards are now quite strict, such that newplants will be required to install sophisticatedpollution control equipment to meet them.Even so, the overall impact of large new powerplants on ambient air quality must be reviewedin some cases, as in the tourist areas of QuangNinh Province, because coal deposits and hencepower plant siting may be concentrated to suchan extent that ambient air quality still suffers,even if emissions standards are met.

Gas-fired Power Generation

55. Development of large-scale powergeneration using Vietnams offshore natural gasresources requires alignment of the interests ofa series of institutional actors, and both majorupfront financing and long-term commitments.PetroVietnam Gas Corporation (PVGC),PetroVietnams subsidiary charged with naturalgas operations, is a central entity, holding theGovernments shares in field productionfacilities, retailing the sole rights in most casesto buy offshore gas and sell gas to end-users, and charged with gas transmissionsystem development, although this may be incooperation with international companies.Upstream, gas exploration and development isundertaken in joint venture or productionsharing arrangements between PVGC andinternational petroleum companies, includingconcessions held with British Petroleum (BP)and KNOC in the Nam Con Son field, and withUnocal in the Malay Basin. On the powergeneration side, development of IPPs withinvestors independent of EVN is essential for alarge portion of the power generation capacity,due to EVNs limited financing capacity. IPPinvestors may include the gas developers, butother investors are needed as well. EVN

represents the purchaser of the final electricityproduct. Finally, the Government (aside fromits ownership position of PetroVietnam andEVN), must play key roles, both sanctioning thespecific development arrangements, but alsoproviding some type of partial risk coverage onthe electricity sale arrangements to outsideinvestors.

56. Vietnams offshore gas is earmarked atthis point for a series of onshore, large-scale gasutilization complexes, which, aside from severalnitrogen fertilizer plants, are focused on powergeneration. Other, smaller-scale utilizationloads are not expected to materialize insufficient concentration over the medium termto warrant network development for such uses.With the exception of the plannedinterconnection of a new complex at NongTrach with the existing Phu My complex, thegas utilization complexes also are notinterconnected, with each basically relying ondifferent gas resources. Thus, the developmentof each complex requires negotiation of separatesatisfactory arrangements for a full fielddevelopment, pipeline transmission and powergeneration facility chain.

57. Gas supply prospects are summarizedin Table 8. Gas supplies are expected to growfrom some 6.6 billion cubic meters (bcm)expected in 2005 to 10-12 bcm in 2010 and atleast some 14 bcm in 2015. The main fieldsinclude the following:

Cuu Long Basin. Located to the southeastof Vietnams coast, petroleum production inthis basin began in 1995. Associated gasfrom Vietnams main current oil fields inthis basin, is supplied onshore through theBach Ho pipeline. Currently connectedassociated gas supplies are declining, butsome additional gas can be captured that iscurrently being flared. In addition there is amost promising discovery of non-associatedgas at Su Tu Trang in the Cuu Long Basin,

18

relatively close to shore, that is currentlybeing appraised. If reserves are sufficient(e.g. some 40 bcm or more), this gas may bebrought onshore to Binh Thuang Provincevia a new pipeline.

Nam Con Son Basin. Also located to thesoutheast of Vietnams coast, but furtheroffshore, Nam Con Son is the supply sourcefor the Phu My complex. Production fromfields contracted mainly with BP and KNOCis expected to rise steadily, until constrainedby the 7 bcm carrying capacity of theexisting pipeline. Although the capacity ofthe pipeline might be stretched somewhatthrough additional compression,development above 7-8 bcm per year willrequire new pipeline development.

SW Basin. This basin includes two majorproject developments: the PM3development in the Joint Development Areaof PetroVietnam and Malaysia, and blockswith Chevron (formerly Unocal). WhereasVietnams 50% share of the 2.8 bcm ofassociated gas in PM3 is currently sold toMalaysia, PV is now developing a 300 kmpipeline to bring that 1.4 bcm onshore at CaMau for use in Vietnam, to be completed by

December 2006. Use of gas from theChevron blocks will require construction ofa new 400 km pipeline. Supply potentialfrom currently proven reserves in theChevron blocks is assessed at some 4 bcmper year, sufficient for the full O Mon powergeneration complex.

58. The gas utilization complexesunderdevelopment or on the medium-termhorizon include:

Phu My and neighboring areas. This areaincludes the Ba Ria and Tra Noc powerfacilities, totaling 484 MW owned by EVN,and with 0.78 billion cubic meters (bcm) ofannual gas demand from Cuu Longassociated gas reserves. It also includes thelarge new Phu My complex, totaling 3893MW at the end of 2005, with an annualpower generation gas demand from NamCon Son of about 4.3 bcm. The Phu Mycomplex includes Phu My 1 (1107 MWowned by EVN), Phu My 2.1 (896 MWowned by EVN), Phu My 2.2 (720 MWowned by EdF), Phu My 3 (720 MW ownedby BP), and Phu My 4 (450 MW, owned byEVN). A urea plant supplied with Cu Long

gas is also located at Phu My.International donor finance playedan important role in development ofEVNs plants. Closer to Ho Chi MinhCity, 447 MW of new thermalcapacity is also planned by EVN atHiep Phuoc and Ve Den, eventuallyto use gas.Ca Mau. 720 MW of combined-cycleindependent power plant capacity isunder development by PetroVietnamto become operational in 2006-2007,together with fertilizer productionfacilities, as part of this newindustrial area. A second powerplant is also planned. Gas will comefrom the SW Basin.

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Table 8.Prospective Natural Gas Supply in Vietnam(billion cubic meters per year)

2010 2015Cuu Long

Bach Ho pipeline 1-2 2New pipeline 0-3

Nam Con SonExisting pipeline 7-8 7-8

SouthwestDM3 PV pipeline 1.4 1.4Pipeline for Chevron fields 0-3 2-4

Total 10-12 12-18Gas from other fields & new discoveries 5-10

Source: Bank team estimates based on various sources.

O Mon. The O Mon complex is planned fordevelopment with gas under contract withChevron in the SW Basin. Four power plantsare envisaged, totaling 2700 MW, with gasdemand of about 3.3 bcm per year. O Mon 1is in advanced development stages as a 600MW steam unit being developed by EVNwith JBIC financing, which can burn oil untilgas is available. Unocal (now Chevron) hadexpressed interest in partnering with EVNfor another of the plants. Financing for thebalance is being sought. Original plans wereto commission the first unit in 2007.However, without firmer commitments forthe full development, to offset the upfrontfield and pipeline development costs,Unocal had not been able to offer attractiveprices and contractual terms for the gas. Inmid 2005, the gas development remained onhold, pending a solution which could satisfyall of the key parties. Nhon Trach. Located about 60 km from thePhu My complex, initial plans for thisfacility included four power plants, forcommissioning during 2010-2015, totaling2640 MW and requiring some 3.3 bcm of gasper year. Gas supply has been plannedfrom Nam Con Son, via a pipeline extensionfrom Phu My. However, gas supplies arenow less certain, and development of thefull complex would certainly require newoffshore pipeline capacity above current 7bcm level.

59. The cases of O Mon and Nong Trachdemonstrate the challenge of aligning interestsand balancing risks to realize these technicallyand economically attractive developments.Solutions require both increasing clarity on thespecifics of the following issues, as well asresults-oriented dialogue between the parties:7

The optimal share of gas-based powergeneration relative to other options inVietnam is ultimately quite sensitive to thecontracted gas prices. Gas prices, in turn,are sensitive to the firmness and scale of off-take commitments. Hence, development offirm, large-scale and sufficiently long-termcommitments would seem to be required toachieve competitive gas-based electricityprices.

Participation of EVN in most of the powerplant ownership is not feasible, even withborrowed resources, due to EVNs financingconstraints (paras. 75-79). Outside IPPinvestment, in addition to investment fromgas developers, is likely to be required ineach major complex.

60. The PM3-Ca Mau development,involving development of the required pipelineand two power plants solely by PetroVietnam,needs to be supervised closely by theGovernment to ensure efficiency and lowestpossible costs. Assignment of the full-chaindevelopment to PV may have someorganizational advantages, given the urgentneed for new power generation capacity, butalso carries potential serious disadvantages dueto absence of competition. The Bank teamrecommends that the Government monitor allaspects of this project closely, including (a)separate review of each cost center in theintegrated projectincluding well-head gassupply cost and internal pricing, pipelinedevelopment and operation costs and internalpricing, and power plant development andoperation costs and internal pricing; and (b)ensuring that procurement for all contractsproceeds in a fully transparent manner, usingcompetition to the maximum extent. Suchclose, transparent supervision is also important

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7. A Bank mission in October 2005 reviewed these issues with the relevant parties, moving on from the constructdeveloped for the Phu My complex, and seeking to identify pathways forward.

to provide some comfort for other, neededinvestors that the Government seeks tomaintain a level playing field for gas-basedpower generation developments in Vietnam.

61. On the gas exploration anddevelopment side, it is critical for the longerterm for Vietnam to maintain an attractiveframework for international companies tocontinue exploration and firming up reserves,as much potential remains unexplored. In thecurrent high-oil price environment,international companies have a variety ofinvestment options to choose from. Areas forthe Government to review include (a)simplification of fiscal terms and sharpening oftheir competitiveness, including for deep waterareas, (b) continuing efforts to expand andclarify gas marketing opportunities, and (c)development of a clear regulatory frameworkfor pipeline investment and operation.

Hydropower Development

62. Vietnam is embarking on an ambitiousplan to develop the bulk of its high-potentialhydropower resources over the next decade.Hydro capacity in 2004 stood at 4227 MW, withHoa Binh (1920 MW) and Yali (720 MW)

accounting for 60% of the total. Future planscall for two additional large plants on the DaRiver, upstream from Hoa Binh, including SonLa (2400 MW) and Lai Chau (1100 MW). Oncecompleted, this cascade of three large plants onthe Da River will total over 5400 MW. Asidefrom this integrated development, the balanceof Vietnams hydropower program focuses on30 medium-sized projects (generally 100-350MW each), and scores of small hydro (under 30MW). These projects are dispersed over ninemajor river basins in northern, central andsouthern Vietnam. Fourteen new medium-sized plants were listed as under construction inearly 2005 (with construction of all but oneinitiated in 2003 and 2004), totaling 3170 MW.Plans are being drawn up for an additional 16medium-sized plants, totaling a further 2775MW, for which EVN would like to beginconstruction as soon as possible.

63. Son La is a key national project, forwhich preliminary construction work hascommenced. Power generating units areexpected to come on line during 2012-2015. Theproject is intended as a key new source ofeconomic electricity, and will also benefitoperations at Hoa Binh. However, there are

also substantial risks, as for anyconstruction project of thismagnitude. A particularly bigchallenge is the effectiveresettlement of some 70,000people. The Government has sethigh standards and a solid,modern policy framework forthe resettlement program, andcommitted over $650 million forthe program, which is quitehigh compared to budgets perresettler in other large projectsin the region. Nevertheless, toensure that the fundingachieves sustainable positiveresults for the affected people,

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Vietnam is embarking on an ambitious plan to develop high-potentialhydropower resources to meet power demand

implementation will require greater attention tolivelihood development, effective planning anddesign at local levels, and stronger managementboth centrally and locally.

64. With goals to provide almost 6000 MWover the medium term, Vietnams program todevelop its many medium-sized hydro sites willprovide a core contribution to the overall powerdevelopment program in each of the threegeographic regions. Particular advantagesinclude development of a source of domesticrenewable energy divorced from internationalenergy price and security risks, and benefitsfrom associated water control in many cases.Although economics vary by site, costs aregenerally quite competitive with the thermalpower options in Vietnam. The challenge willbe in effective implementationto maintainquality project development under the pressurefor speed to meet every-climbing load growth.International assistance is needed in thissubsector of the power industry more than anyother, to enable Vietnam to benefit frominternational experience. As internationalagencies have been reticent to support majorhydropower developments in recent years,practitioners in Vietnam have been relativelyisolated, and now need gain from the rich recentdevelopment experience elsewhere, asVietnams hydropower development programaccelerates.

65. One area for strengthening in Vietnamshydropower development program includeshydro subsector planning, plant siting anddesign, and reservoir and power plantoperating practices. Planning and operationalimprovements could be made to best optimizebetween complex choices and trade-offs to: (a)maximize multiple water control benefits; (b)minimize adverse impacts, including negativesocial impacts and negative downstreamimpacts; and (c) maximize the value of electricpower within the overall power system.

66. An especially important are for

additional work is to further improve detailedplanning and implementation of reservoirresettlement programs, and alignment ofenvironmental assessment work to betterinform project design and to sharpen focus onkey issues and their mitigation. Vietnam hasmade substantial progress during the last fiveyears in upgrading its reservoir resettlementand environmental assessment practices.Current policies provide a reasonably wellstructured set of legal and regulatoryrequirements. Financial commitments forresettlement work in new projects are nowsubstantial. The primary issue concerns needsto strengthen implementation to achieve thebest results. Analysis, planning, organization,execution and, especially, follow-up often lackdepth as capacities for this specialized work arethin, especially at local levels. Staff and localexperts often lack experience andunderstanding of best practices. The mostdifficult issuesincluding restoration oflivelihoods for ethnic minorities which may beaffected by reservoir development, forexampleare complex in every country, andrequire concerted efforts in consultation withlocal people throughout implementation.Given plans to develop many projects over themedium-term, strong efforts are necessary tointegrate knowledge from elsewhere and tobuild local capacities to achieve results whichare sustainable over the long term.

67. With costs comprised almostcompletely of upfront capitals costs, andrelatively long project gestation periods, EVNsplan to concentrate its own financing andborrowings particularly on the hydro sectormakes sense, leaving more substantial portionsof the thermal power investment requirement topotential IPP investors. Once operational,however, there is potential to sell off hydrocapacity to investors, as EVN has been pursuingfor some older plant. Opportunities also existfor independent power production in small

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hydro facilities, and, over time, to exploreinnovative approaches to blend independentfinancing sources into project packages

Other Means to Meet CapacityRequirements

68. Vietnams renewable energydevelopment program is growing, and canprovide an increasing contribution in the future.Development has focused especially on off-gridpower supply, in isolated areas, but small hydrofacilities, in particular, can also provide animportant source of renewable energy to thegrid. Wind power generation also can providea small contribution.

69. Vietnam plans to develop nuclearenergy capacity over the long term.

70. Interconnections with neighboringcountries are expected to become increasinglyimportant. Discussions with power companiesin southern China during 2005 seek to result inincreases in power imports from China to some400 MW over the near term. Vietnam also isinvesting in hydro facilities in Laos, witharrangements to buy back the bulk of the powerproduced. Vietnam has undertaken to sell some200 MW of power to Cambodia. Especially overthe medium term, potential exists tosubstantially increase the beneficial role of suchinterconnections, through development of aGreater Mekong System (GMS), which couldinvolve large-scale transfers between Vietnam,Thailand, China, Laos and Cambodia.

71. Both MOI and EVN have developeddemand-side management (DSM) and energyefficiency programs in recent years, in partthrough Bank and GEF support. With thesevere shortages experienced in 2005, andcontinued pressure for more electricity service,the Government and EVN are moving tostrengthen and accelerate these efforts. Loadmanagement programs and energy efficiencypromotion and investment programs are

proven means to address capacity constraintswhich are far less expensive than new capacity.Such efforts also can yield results relativelyquickly in some cases, but do requiresophisticated institutional development whichhas proved challenging in most countries.

72. As discussed with MOI and EVN in late2005, the Bank team recommends that the DSMeffort be strengthened through: (a)development of a DSM chapter in the SixthPower Development Master Plan, to assess andestablish the role of DSM in helping to meet thecountrys future power service needs, (b) theestablishment of a formal DSM Center withinEVN, to provide an expanded institutional andhuman resource base to mobilizeimplementation of a scaled-up DSM program, (c) development and implementation of a planfor a dramatic scale-up in EVNs energy-efficient lighting programs, includingsubstitution of compact fluorescent lamps forincandescent lamps, and popularization ofmore efficient fluorescent tube lamps, and (d)continued, and yet stronger efforts by MOI tocatalyze a new energy efficiency businessindustry in Vietnam, which can play asubstantial role in achieving energy efficiencygains in the future, especially in the commercialbuilding sector, but also in industry. Inaddition, ongoing load surveys and analysis,coupled with expansion in time-of-usemetering, can provide the foundation forimproved load management efforts based ontime-of-use pricing. Using the load researchstrategically, time-of-day sensitive pricingregimes and continued metering investmentscan provide a framework for customers torespond to pricing signals on the costs ofservice, and adjust consumption accordingly.

Financing Investments

73. As discussed in para. 26, annual powersector investment requirements during 2005-

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2010 are over $3 billion per year. In developingstrategies to mobilize this level of finance, twobasic starting points are clear:

EVN cannot even come close to meetingthis requirement from its own resources ormassive borrowings, especially withoutfurther increases in unit sales revenues.EVN has maintained profitability eachyear since its inception in 1995, and hasretained a sound financial position, at leastuntil the shortages of summer 2005.However, the size of the sector investmentrequirement is no match for the companysborrowing capacity.

The Government is neither willing nor able topick up the bill. Having basically eliminatedsubsidies to the sector, the Governmentwould like to reduce its liability exposure inthe sector, not increase it. One way oranother, directly or indirectly, consumerswill need to pay the cost of the power systemexpansion. The task of the Government andpower industry is to implement theexpansion program as efficiently as possible,to keep the costs as reasonable and affordableas possible for consumers.

74. Chinese state-owned power companiesfaced a similar situation in the latter half of the1980s and into much of the 1990s. Demand wasrising so fast that the power industry hadtrouble to keep up, and even though thefinancial position of the power companies wasfundamentally sound, the investment needs farsurpassed their capacity. The problem wassolved in two basic ways: (1) the power-starvedindustrial consumers, and the local governmententities supporting them, pooled resourcestogether to construct large numbers of new,joint-venture IPP power plants, and (2) variouspower investment surcharges were added ontoretail electricity tariffs, directly raising morefunds from consumers specifically for newpower capacity.

75. Vietnams case has distinct differences,but the same two basic categories of solutionsare required: (1) IPPs must carry a large portionof the investment requirement (albeit withgreater use of foreign capital than in the case ofChina, where almost all IPP investors weredomestic), and (2) average electricity pricesmust be increased, to directly raise more capitalfrom consumers for investment in theaggressive capacity expansion. These arediscussed in more detail below.

EVNs Contributions to Investment

76. With net profitability, self-financingratios of 50-60%, debt-service coverage ratios of3-5, and debt:equity ratios of 1.0-1.4 in the threefinancial years of 2002, 2003 and 2004, EVNmight seem