Power StrategyManaging growth and reform

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As Vietnam becomes richer it faces challenges in adapting its infrastructurepolicies and institutions. While the old challenges of providing basicservices to all remain, new challenges are emerging, such as accessing newsources of finance, refining planning processes, preparing for rapidurbanization, improving the efficiency of infrastructure service providers,developing stronger institutions to encourage private finance ofinfrastructure or direct private provision of infrastructure, and developingmore targeted approaches to poverty alleviation.

This report on Power Strategy - Managing Growth and Reform is one ofsix volumes dealing with Vietnam's Infrastructure Challenge. Other volumesdeal with Infrastructure Cross Sectoral Issues, Water and Sanitation,Transport, Telecommunications, and Urban Development.

The work for these reports was carried out between 2004 and 2006 byWorld Bank staff and consultants. The reports have been revised to takeaccount of comments made by the Government in workshops during May15-17, 2006. The comments of numerous colleagues from the World Bank,the United Kingdom's Department for International Development Bank, theAsian Development Bank, and the Japan Bank for International Cooperationare gratefully acknowledged.

Vietnam’s infrastructure challenge

Table of contents

Excutive summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3

The Twin Challenges of Growth and Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3

Optimizing Power Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4

Financing Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

Power Industry Restructuring, Equitization and Development of a Power Market . . . . . . . . . . . .6

Developing the Electricity Regulatory Authority of Vietnam . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

Recommendations for Follow-up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

Section one: Current status of Vietnam’s power sector . . . . . . . . . . . . . . . . . . . . . . . . . . .9

Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9

Policy and institutional framwork . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12

Power sector structure and ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

Investment needs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15

Sector performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

Section two: Main Power Sector issues and Study Recommendations . . . . . . . . . . . .21

Optimizing power sector investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

Financing investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32

Securing Investment Independent from EVN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33

Sector restructuring, equitization and the development of a power market . . . . . . . . . . . . . . . . .37

Economic regulation of the power sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44

Summary of recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46

Short-term Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46

1

Vietnam’s electric power industry isfacing tremendous challenges. Withannual growth in electricity demand of

15% 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 createdfor the reformed and restructured powerindustry will best serve long-term needs,combine together to create probably the mostcritical juncture of the country’s powerindustry.

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 of

Vietnam’s power sector, intended primarily forthose 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 Vietnam’s power system todeliver power to consumers needs to double injust five year, to meet demand growthprojected at 16% per year during 2006-2010.Demand is being driven especially byindustrial load growth, but also heavyincreases in residential power use as incomesare rising. During 2011-2015, demand growthis expected to remain very strong, projected at11% 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 main

3

Executive Summary

solution to the inadequate reserve margins andgap in meeting demand lies in efficientimplementation of a large-scale medium-termpower system capacity expansion program.

Vietnam’s 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 Minister’s approval in early 2006 of aRoad Map for the reform. The country’s 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 early2006, the Plan was under final Governmentreview. The basic institutional arrangements,analytical capacity and analytical tools beingused are fundamentally sound. The effort isbeing coordinated with similar planningexercises for the coal and petroleum industries,

for the first time all under Ministry of Industry(MOI) purview.

The new Plan emphasizes growth in allthree major power generation subsectors—hydropower, coal-fired power, and powerfueled by offshore natural gas. As hydropowerprojects identified in Vietnam generallyprovide lower cost alternatives than theaverage costs of new thermal power throughmuch of the load curve, a strong focus ondevelopment of the country’s hydropowerresources is retained. However, expansionprograms for thermal capacity, using domesticcoal and eventually imported coal, and largequantities of new natural gas, are alsonecessarily aggressive, providing the biggestcapacity additions. Demand-side managementefforts—including both improvements inenergy efficiency as well as loadmanagement—should play a more significantrole than in the past. Finally, imports fromChina and other neighbors are expected toincrease sharply and make a larger relativecontribution 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 supplygaps that emerge. Following basic analysis ofthe sensitivity of the relative economics ofthese options, two broad conclusions emerge:(a) Aggressive promotion of exploration andfirming up of natural gas resources, andcontinued gas field development, is a keypriority for the country’s power development,to ensure least-cost generation, and (b) farmore than in the past, updated review of bothemerging overall fuel supply availability and

4

the 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.

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. GivenEVN’s 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.

Major progress has been achieved in recentyears, including in policy development andfinancial commitment to resettlement work.The challenge is in the details ofimplementation to achieve the best long-termresults.

● Vietnam’s demand-side managementprograms need to be sharply expanded, as astrategic 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 EVN’s 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 increased

5

costs stemming in part from power shortages in2005, and the sharp increases in investmentrequirements, however, self-financing ratioswill plummet unless EVN’s 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 amajor injection of equity, which is unlikely).Overextension of borrowings aboveinternationally recognized rations would behighly imprudent, as maintenance of EVN’screditworthiness 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.

EVN’s 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 costs

than negotiated deals. The Phu My 2.2 successin competitive bidding provides a platform ofprior experience in Vietnam. Support is neededfor MOI’s 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 fora 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 Vietnam’s power sectorreform are to maximize efficiency throughcompetition in the power industry and toexpand mobilization of investment andmanagerial resources from outside of thecurrent state-operated system, in order tominimize costs and provide reliable, highquality service to consumers. As described inthe recently approved Road Map, the reformprocess is expected to span twenty years, andproceed through (a) a preparatory phase andinitial “trial” 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 as

6

a holding company for the state’s 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 powergenerators 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 for thereform. Use of an internal, “trial” market thatemulates the future power market, andcareful advance preparations are 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 of

directions 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 bebest 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 Government’sequitization 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)

7

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 protectVietnam‘s 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, emphasismay 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) ERAV’sability to establish itself as an objectiveinstitution, charged with implementation of thecountry’s laws, with a mandate recognized byall parties, and operating as an agency separate

from MOI’s regular business and departments,and (b) establishment of clear technicalcompetence in addressing the complex issuessurrounding regulation of the sector. Some areasfor ERAV’s attention during its first year include:(a) establishment of itself with a distinct identity;(b) definition and publication of a clear workprogram, (c) staff training and development, (d)agreement with power industry participants onclear arrangements for information collectionand monitoring, (e) definition of ERAV’senforcement powers, and (f) definition ofmechanisms for resolution of disputes.

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.

8

Overview

Introduction to Vietnam's Energy Sector

Vietnam is a net energy exporter, and is expectedto remain such for the foreseeable future. Thecountry is endowed with offshore oil and gasresources in the south, coal in the north, andhydroelectric power resources in the mountainsrunning from north to south along the country'swestern regions. The country is not exceptionallywell endowed in any of these resources, however,so Vietnam's exploitation of its energy resourceswill continue to be primarily for its own use.

Vietnam produced about 20 million tons ofcrude oil in 2004, up from 16 million tons in 2000.Almost all was exported, earning some $5.7 billionin foreign exchange revenues, and accounting forabout 21% of the country's total export earnings.However, Vietnam imported some 11 million tonsof petroleum products in the same year, at a costof $3.6 billion, so that net petroleum exportstotaled just $2.1 billion. Vietnam is currentlyconstructing petroleum refining capacity, so thatan increasing portion of its domestic petroleumproduct demand will be met by processing itsown crude oil. Crude oil production is expectedto increase in the future, but not dramatically:average production rates of 25-40 million tons peryear are expected through to 2020.

Vietnam has substantial offshore natural gasresources, both associated, and non-associated

gas. All natural gas is planned for domestic usefor the foreseeable future-the industry will do wellto meet planned domestic needs, especially for thepower sector, but also for fertilizer production andseveral other large industries. In 2005, about 6.6billion cubic meters of natural gas were broughton shore. Production is expected to increase tosome 15-20 billion cubic meters by 2015.

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.

Less than one quarter of Vietnam's estimatedeconomically exploitable hydropower resourceshad been developed by 2004. With the notableexception of the Da River in northern Vietnam,the country's hydro potential is not amenable tomassive single development projects, but ratherto medium and small-scale hydro plantconstruction. Except for the Hoa Binh, Son Laand Lai Chau sites on the Da, all other hydrosites in Vietnam are earmarked for hydro plantdevelopment well under 1000 MW.

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Section one:

Current status of Vietnam’s power sector

Introduction to Vietnam's Electric PowerSector

Vietnam's Power System. Vietnam's electricpower system caters to the country's resourceendowment and geographic configuration. Withhydro resources available in all three of thecountry's main regions (see Figure 1),hydroelectric power was the dominant source ofpower generation from the late 1980s until veryrecently. Thermal generation from coal addsbase load capacity in the north. Thermalgeneration from new offshore natural gas hasbeen developed in the south since the late 1990s,adding to small amounts of oil-fired thermalcapacity. Total generating capacity on the

system by the end of 2004 was almost 11,200 MW(see Table 1). A 500 KV backbone transmissionline connects the regions and generation sources,enhancing the optimal use of resources duringdifferent seasons and as the generation mix anddemand evolve. This basic configuration of thesystem is expected to continue over the longterm as the overall system expands. Althoughthe mix will continue to vary from year to year,as new large plants are added, hydro and gasare each expected to contribute about 40% ofpower generation, and coal about 20%, overmedium term.

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 2423 kmin 2004 to 3533 km in 2005. At the end of 2004,220 KV lines totaled 4798 km and 110 KV linestotaled 9339 km. Power transfers withneighboring China, Cambodia and Laos weresmall in 2004, but will grow significantly in the

future.Vietnam's power industry has

struggled 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 Table2). Electricity production during thesame period grew by 13.6% per year,growing somewhat slower due topower system efficiency gains.

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Table 1.

Vietnam’s Power Generating Capacity (MW)

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

Source: EVN.

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.

Total power production amounted to 46.2TWh in 2004 (Table 3).1 Power generation fromoil and gas surpassed hydropower generationfor the first time in many years, as a number ofunits in the natural-gas based Phu My complexcame on line. Power purchases fromindependent entities rose to about 6.3 TWH(14% of total generation) in 2004. In 2005, theshare of independent power production will besubstantially higher, as capacity additionsduring the course of 2004 brought the IPP share

in total capacity to 22% by the end of the year. Sources of Demand Growth. Electricity use

in Vietnam is growing from a very low base fora country of its size. In 1995, total power salesof 11,185 GWh amounted to only 156 kWh perperson per year. Even after growth of morethan threefold in electricity use during 1996-2004, total end-use consumption amounted toonly 484 KWh per capita per year, compared toan average of 1265 kWh per capita per year inlow and middle income countries worldwide.

Industrial and residential electricity use eachaccounted for about 45% of total sales in 2004(See Table 4). Although the service sector hasplayed a role, industry and household use havebeen primarily responsible for the total growthin electricity demand, and this trend is expectedto continue. The share of agriculture inelectricity demand, which is not an electricity-intensive sector, has fallen sharply.

Rapid increases in industrial electricity useare 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, increasedfrom 22.6% in 1995 to 30.8% in 2004, while theshare of agriculture fell from 26.2% to 20.3%.

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Table 2.

Total Electricity Production and Sales (1995-2004)

1995 2000 2001 2002 2003 2004

Total 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 EVN’s 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(2002-2004)

2002 2003 2004Hydro 18.2 19.0 18.1Coal 4.9 7.2 7.2Oil and gas 12.7 14.6 20.9Total 35.8 40.8 46.2EVN generated 33.7 34.8 40.1Purchased by EVN 2.1 6.0 6.1

Source: EVN.

Moreover, the types of light industry which aregrowing fast in Vietnam-food and beverageprocessing, textiles, light chemicals, and lightconsumer durable goods-often tend to increasepower use per unit value added as developmentproceeds, due to increasing automation,packaging and (for food, beverages and textiles)increased use of cooling. Industrial electricitydemand growth increased especially fastduring the last few years (e.g., 18.5% p.a. during2001-2004), and is expected to continue to be akey demand driver.

The sharp, steady increases in residentialelectricity demand follow both an increase inhousehold access and addition of loads otherthan the basic lighting load. With bothincreases in the urban population and thesuccess in rural electrification about 30 millionnew people were added as power users from1995 to 2004, representing some 37% of the totalpopulation. Probably even more influential ondemand growth, however, given the lowconsumption levels of new householdcustomers, has been growth in householdappliance ownership, as disposable incomeshave grown from very little in the mid-1990s.Even so, the current average consumption ofabout 20 kWh/month per person amongresidential electricity users is low, and certain toincrease, as power use grows from nascentlevels in the countryside and as heavy appliance

use, especially air conditioners, begins to takehold among middle-income groups.

Policy and institutional framework

In conformity with Vietnam's socialist marketeconomy, public ownership dominates the energysector, but increasingly, market forces are beingbrought to bear and private sector participation isexpanding. Since 1995, energy sector operationshave been organized into three GeneralCompanies, which are among the largestcompanies in Vietnam: PetroVietnam, Vinacomin(formerly Vinacoal) and Electricity of Vietnam.

Key legislation on the energy sectorincludes the Petroleum Law (1993) and itsImplementing Decree (1996); and the newElectricity Law (2004), followed by 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 inlater 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.

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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 9.0Total 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

Government Policy and RegulationResponsibilities

The Ministry of Industry (MOI) has first-linepolicy and supervisory responsibilities for theenergy sector, both as the 'line ministry' and asthe ministry with oversight responsibility forstate-owned companies. MOI is responsible forsupervising implementation of governmentpolicy, and recommending and drafting majorpolicy reforms for government adoption. MOIis responsible for review and submission forPrime Minister approval of master investmentplans for the sector and all major investmentprojects. Although these often require reviewand approval from other agencies as well,including the Ministry of Planning andInvestment (MPI) and the Prime Minister'soffice, MOI is the government window for theenergy companies. MOI reviews andrecommends retail price adjustments forapproval by the Prime Minister. Of the majorenergy subsectors, MOI has been particularlyinvolved in the oversight of the electric powersubsector.

In addition to the Government Office of thePrime Minister, other key government agenciesfor the power sector include:

The Ministry of Planning and Investment(MPI), which is responsible for the preparationof the country's overall economic developmentplans, and review and provision ofrecommendations to the Prime Minister for allprojects using public funds or other resources;

The Ministry of Finance (MoF), which, inaddition to its broad role overseeing financialmatters for the Government and the budget,arranges Government guarantees for exportcredits, and provides, through its DevelopmentAssistance Fund (DAF), public sector loans toqualified users;

The Ministry of Natural Resources andEnvironment (MONRE), which is responsible

for environmental regulation;The State Bank of Vietnam (SBV), which is

responsible for allocation of foreign exchange,and, as such, is the counterpart for internationaldonor lending, and a key agency forimplementing guarantees for foreign exchangeconvertibility; and

Provincial Peoples' Committees (PPCs),which have integrated government oversightresponsibility for local government, includingall government functions delegated by thecentral government.

Power sector structure and ownership

EVN is the vertically integrated power utilitycharged with development, management andoperation of the state's electric power industryassets. With the passage of Vietnam's ElectricityLaw, however, the country is just nowembarking on a long-term program torestructure the power industry, which willfundamentally alter EVN, the legal, ownership,and management structure of the industry, andhow the industry is regulated by Government.The sections below describe the situation as of2005, whereas the strategy for the future, and anumber of key trade-offs and choices, aredescribed later.

EVN is organized as a General Company,with a series of wholly owned subsidiaries.EVN owns and operates state-owned powerplants built to date, and is takingshareholding stakes in a number ofindependent power plants (IPPs). Keysubsidiaries include seven regional PowerCompanies (PCs), which are in charge ofpower transmission and distribution from 110KV downwards. The three largest PCs arePC1 (northern Vietnam), PC2 (southernVietnam), and PC3 (central Vietnam), whilethe remaining four manage the powerdistribution systems in Hanoi, Ho Chi Minh

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City, Hai Phong and Dong Nai. The PCseach maintain their own financial accounts,although these are also consolidated in EVN'soverall accounts. Other key entities under theEVN umbrella include four PowerTransmission Companies, four PowerEngineering Consulting Companies, theNational Load Dispatch Center, and a numberof equipment manufacturing companies.

Especially compared to many other state-owned companies in Vietnam, EVN has beensuccessful in establishing a corporateculture and commercial orientation,particularly in recent years. EVN's financialaccounts are strictly separate from theGovernment budget, and EVN receives noGovernment budget subsidy support forinvestment or its operations, with theexception of certain grants for a fewmultipurpose hydropower projects'resettlement. The company is now facingonly commercial terms for borrowings,except for (i) concessional loans for ruralelectrification (e.g., from IDA), and (ii) DAFloans for resettlement costs and locallymanufactured equipment, carrying interestrates 2-3% lower than commercial rates.EVN was able to steadily maintainprofitability through 2004, covering all of itscosts, including depreciation and financingcosts, from internally generated revenues.

EVN's generation and network developmentplans, and all major investment projects, must beapproved by the Government. MOI also iscurrently responsible for executing bidding andcontracting procedures for large IPPs. The retailelectricity tariff is also tightly regulated by theGovernment, with adjustments recommended byMOI requiring approval by the Prime Minister.Vietnam maintains a unified national tariff.

State policy has increasingly encourageddevelopment of independent power generationby investors outside the EVN system. Whereas

IPP capacity totaled some 620 MW in 2002,accounting for just 7% of installed capacityconnected to the system, this has grown sharplyto over 2400 MW in 2004 with thecommissioning of the gas-based Phu My 2.2 andPhu My 3 units, accounting for almost 22% ofsystem capacity. IPPs may be wholly owned byforeign, private firms, by domestic firms, or invarious joint-venture arrangements, includingwith EVN. Vinacomin and PetroVietnam aredeveloping several IPPs, both wholly owned oras joint ventures with EVN. Small hydro plantsalso are being developed by local firms, forconnection with the main grid and sale ofelectricity through power purchase agreementsto EVN.

In the countryside, local communities ownand operate the low-voltage electricitydistribution systems in most areas. The basicapproach adopted for rural electrification inVietnam has been for EVN's PCs to develop themedium-voltage network, and for localcommunities to develop the low-voltage system(although EVN has undertaken this role forabout one-fifth of Vietnam's communes).Provincial People's Committees have oversightfor rural electrification in their provinces, andprovide substantial financial support for thelocal share of investment. Until 2004, localpower distribution was handled by informalCommune Electricity Groups or other informalentities in about two-thirds of Vietnam'selectrified 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 asdistrict-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

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Investment needs

With electricity demand increasing unabatedly,Vietnam is facing sharp increases in powersector investment requirements. WhereasVietnam's original Fifth Power MasterDevelopment Plan foresaw an increase inpower generation averaging 13.4% per yearduring 2001-2010, to power a continuedeconomic growth rate of around 7.5% per year,power generation actually grew by 14.9% p.a.during 2001-2004, as demand grew faster thanexpected. EVN revised its development plansupwards in 2003, foreseeing shortfalls incapacity, but even so, the country still founditself seriously short of capacity in 2005, withneeds for large scale, involuntary loadshedding.

In the new Sixth Power Master DevelopmentPlan, covering 2005-2015, with a view towards2020, it is forecast that sector development andinvestment requirements through the balance ofthe decade will be substantially higher thanoriginally projected (see Table 5). The new Planremains under preparation, and drafts will be

reviewed at all Government levels the end of2005. Demand from projections preparedduring the summer of 2005, however, suggest abase case growth in power generation to 113TWh in 2010, up from 46.2 TWh in 2004-agrowth rate of 16% per year, compared to the12.4% per year originally planned. This growthrate implies a further continuation of a powerdemand/GDP growth elasticity of about 2.0.Industrial load growth is expected to beparticularly strong. During 2011-2015, recentbase-case forecasts point to a slow down inpower demand growth to 11% per year,followed by 9.1% per year during 2015-2020.

Total power sector investment requirementsto meet demand will exceed US$3 billion peryear during the latter half of this decade;representing levels which are triple those at theoutset of the decade, and an immense challengefor the country. As shown in Table 6, EVN'ssubstantial investments in generation, all of thecountry's transmission development, urbandistribution and a portion of rural low-voltagedistribution, will total $2.4-2.5 billion per year(in constant terms), just to meet original Fifth

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2. IDA’s 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.

Power Master Plan load estimates, which arenow clearly unrealistically low. Transmissioninvestments will continue to be substantial in2006, as EVN seeks to complete the backbone ofthe system, before tapering off some towardsthe end of the decade. EVN's distributioninvestments are expected to increase justmodestly (although rural investments outsideEVN are likely to increase substantially).Particularly critical, however, EVN'sinvestment forecast foresees a tapering off ininvestment in generation, despite heavygrowth, with a dramatic shift to greater relianceon power purchased from IPPs (see Table 7).Whereas purchased power accounted for just13.6% of total power production in 2004,Vietnam aims to increase purchases from IPPsto account for about a third of powerproduction on the system by 2010. EVN's seeksto focus its generation investment primarily in

hydropower, and rely much more on IPPdevelopment of thermal power. As a result, it ishoped that IPPs will account for over one-halfof total incremental power production during2005-2010.

Issues relating to financing of EVN'sinvestments, and the fostering of greater IPPinvestment, are discussed in further detailbelow.

Sector performance

Performance of Vietnam's power industry,managed primarily by EVN, has been quitegood during recent years. The industrybasically kept pace during the last decade withextraordinary increases in demand, maintainingbasic service for its customers most of the time.EVN has maintained strong financial viabilitywhile keeping costs to consumers at quite low

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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).

levels 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.

Access to Electricity Service

Access to electricity in rural areas has increaseddramatically during 1996-2004, marking one ofthe most successful recent rural electrificationprograms in the world. As shown in Figure 2,the number of rural households with access toelectricity has increased from 50.7% in 1996 to88.0% in 2004. Rural household access rates areexpected to further increase during the nextseveral years, although achievement of accessamong the final 5% of rural households will notbe easy. The success of Vietnam's program liesespecially with the commitment of theGovernment to rural electrification, and thedefinition and systematic implementation ofnational plans as a matter of priority, with

public investment support to match localcommunity funds

Quality of Electricity Service

Widespread anecdotal evidence points tosubstantial improvements in the quality ofelectricity service over the last ten years, withbasic service for most customers in urban orperi-urban areas becoming noticeably morereliable. However, there is a basic lack ofsystematic statistical monitoring of serviceinterruptions and voltage drops, by service areaand customer voltage level. This shortcomingneeds to be rectified, to develop benchmarks,comparative performance indices betweenservice areas and categories, and monitorableprograms for improvement. The newElectricity Regulatory Authority of Vietnam(ERAV) will need to monitor such data as abasic regulatory tool. While there may havebeen general improvement in recent years, italso is clear further improvement is needed. Inthe World Bank's recent Investment ClimateSurvey for Vietnam, 19% of all manufacturingfirms surveyed, although connected to theelectricity grid, still described electricity supplyas a major or severe constraint for their

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business. This was due in many cases tocomplaints about the electricity pricescharged. However, in almost half of the firmslisting electricity supply as a constraint, a corereason listed was insufficiently reliableservice from the grid. Surveyed firmsreported an average of 12 power outages orsurges per year, and, in the case of small andmedium-sized firms, sales losses of 2-3% dueto outages. This points to a need for a majorand systematic effort to properly monitorservice quality, and for improvement inservice provision.

System Efficiency

As shown in Table 2 previously, transmissionand distribution losses in EVN's system havefallen steadily over the last decade to 12.2% in2004. This is not an unreasonable level for asystem such as Vietnam's at its current stage ofdevelopment, especially given the heavy role oflow-voltage residential consumers, but there isroom for further improvement. In the future,the ERAV must also monitor these efficiencyindicators carefully against variousbenchmarks.3

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.

Fuel efficiency in thermal power generationis highly plant specific. New, large-scalecombined-cycle natural gas based power plantsincorporate world-class technology and providehigh fuel efficiency. With the exception of thePha Lai 2 plant, however, existing coal-firedpower plant efficiencies are poor, as the

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

Retail Power Price Levels

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.

Vietnam's power tariff is sophisticated instructure, with rates varying by voltage leveland consumer type, and offering time-of-dayrates for 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 residentialrates are modestly

cross-subsidized by higher rates forindustry, commerce, and foreignestablishments.

Concern is often expressed in Vietnam thatelectricity rates for industrial production arehigh, compared to rates in other countries,undermining competitiveness. In reality,however, the current average industrial rates of

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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.

US 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 7-10

cents/kWh, with recent increases in Chinesedomestic coal prices, and even reach more thanUS 12 cents/kWh in some export-orientedregions

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Optimizing power sector investments

Overcoming Shortages

Meeting the rapidly growing demand forelectric power is the paramount challenge forVietnam's power industry. Key drivers of thecountry's economic growth-especiallymanufacturing and commercial and serviceindustries-are 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, andan essential part of increasing standards ofliving. Costs to the economy of insufficientpower supply from the grid are estimated to besome $0.50/kWh where small-scale auto-generation is an option, and are well over thatwhere production is actually lost due to lack ofpower.

The power shortages experienced in May-July of 2005 clearly reinforced a priority focuson meeting demand throughout Vietnam'spower industry, with highly visible nationalattention. The capacity shortfall was estimatedat some 800-1300 MW during peak load. Theshortage was caused by coincidence of severedrought conditions, reducing hydropowerproduction, with a paper-thin reserve margin inthe overall system, due to an inability todevelop new capacity over a short time to meetthe higher-than-expected surges in power

demand. During the dry season, top prioritymust be assigned to ensuring sufficient watersupply for basic livelihood and agriculture atthe 1920 MW Hoa Binh Hydropower station. In2005, with exceptionally low water levels in thereservoir due to drought, water flows for powerproduction had to be halted. With insufficientoptions to pick up the slack, rolling loadshedding was required in northern Vietnam forweeks, including in Hanoi.

Power shortages are likely to continue in2006 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 ofdemand-side management (DSM) measures.Imports of electricity from China also arelikely to be increased substantially over thenext few years. Current plans call for additionof four oil-fired 37 MW gas turbine units innorthern Vietnam, and larger additions of gasturbines in the south, which can utilize eitheroil or natural gas. In the north, the new gasturbines will remain expensive to run, oncenew, larger capacity gas, coal or hydroresources is finally brought on stream, andwill most likely be used for emergency peakload service. In southern Vietnam, it isimportant to integrate the new gas turbineseventually into the future combined cyclenatural-gas-based power complexes, to gainoptimal efficiency over the long run. On theDSM side, there is potential to reduce system

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Section Two

Main Power Sector issuesand Study Recommendations

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requirements by some 600-800MW over thenext few years, through energy efficiency andload management measures, but this willrequire aggressive efforts to put theinstitutional and program capacity in place.Aside from these measures, however, the keyis to develop new capacity, through efficientdevelopment of new generating plant,construction of transmission lines forimported power, and steady investments inthe power network to deliver power toconsumers.

Vietnam's Power Sector Expansion Program

During the latter part of 2005, Vietnam has beenengaged in a major power sector expansionplanning exercise. The draft Sixth PowerMaster Development Plan (2006-2015, with aview to 2025) is now under review by theGovernment. The effort is being coordinatedwith similar master planning exercises for thecoal and petroleum industries, for the first timeall under the purview of the Ministry ofIndustry. Based on the increased base-casedemand forecasts developed over the year,projecting electricity demand growth of 16%p.a. during 2006-2010, 11% p.a. during 2011-2015 and 9.1% p.a. during 2016-2020, the powerindustry 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.

On the planning side, the basic institutionalarrangements, analytical capacity and analyticaltools being used are fundamentally sound. Inits review of the major work being undertaken,the Bank team has recommended (a) astrengthening of the economic and sensitivityanalysis in the planning exercise, especiallyrelating to assessment of the balance betweencoal-fired and gas-fired thermal powergeneration, and (b) increased explicit attentionto demand-side management (DSM)investments and benefits.4 In addition it alsowould be useful to explore more sophisticatedmodeling options appropriate for hydropowerprojects.

Vietnam is facing a need of massive power systemexpansion

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

On the network side, a basic, strongertransmission backbone for Vietnam's system,planned under the Fifth Master Plan will becompleted during the next few years, includingthe 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%.

More than two-thirds of the investment forsystem expansion will be needed for expansionof power generation. The previous Master Plancalled for development with a blend of roughly40% hydropower, 40% gas-fired thermal power,and 20% coal-fired thermal power. In the morerapid growth anticipated under the Sixth PowerMaster Plan, the focus on strong developmentof the country's hydropower resources will beretained. However, the share of coal-firedpower generation may increase to take up alarge portion of the accelerated growth,although this is always subject to the extent ofnew discoveries and development of offshoregas. Although the economic viability ofhydropower projects are highly site-specific, thehydro projects under consideration in Vietnamgenerally provide lower cost power than theaverage costs of new thermal power throughmuch of the load curve. Thus, the country'soverall strategy is to develop existinghydropower resources relatively quickly.Assessment of best balances between coal andgas-fired power, however, is a key long-term

planning 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 country's coal export and gasexploration policies. The main parameters ofthis balancing issue include the following:● Both exploitable domestic coal supplies and

offshore 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 14 billion cubic meters(bcm) per year are to be provided for powergeneration.

● 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 at

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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.

capacity factors exceeding 50-60%.However, in economic terms, consideredfrom 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 Ineconomic terms, then, combined-cyclepower generation from offshore gas atrecently contracted gas prices is quitecompetitive with generation from domesticcoal. The most cost effective option dependslargely upon the evolving fuel costs (ineconomic terms) relevant for specificprojects. Hence, the Bank team'srecommendation to pursue carefuleconomic and sensitivity analysis in theplanning exercise.While conclusions on the best specific

scheduling of investment projects must awaitcompletion of the Master Plan, two broadconclusions concerning the coal and gas-fueledgeneration balance can be drawn from theparameters above: (a) Aggressive furtherpromotion of exploration and firming up ofnatural gas resources, and continued gas fielddevelopment, is a key priority for the country'spower development, to ensure least-costgeneration, and (b) 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.

The Bank team also has recommended thatsensitivity analysis also be conducted withdifferent demand growth assumptions,especially on the lower side. Assessment of

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

The basic framework and main issues foreach of the generating subsectors are outlinedbelow.

Coal-Fired Power Generation

Thermal power plants fueled with domesticallyproduced anthracite will continue to provide akey base-load power source for northernVietnam. Coal is currently supplied exclusivelyby Vinacomin, the general corporation holdingall of the state's assets in the coal industry. Coalsold for power generation totaled about 4.3million tons in 2004, accounting for some 22% ofVinacomin's 20 million tons of sales, whileVinacomin's exports totaled 7.5 million tonsand other domestic users purchased 8.2 milliontons. Production can increase strongly incurrent coal fields, and a major new coal miningoperation is planned at Mong Duong.Production in 2010 is expected to reach 35-40million tons. Further increases in productionbeyond 2010 are expected to be moderate,unless viable methods can be developed toexploit coal under the Red River Basin.Average production costs are expected to rise.

The highest quality anthracite produced isbeneficiated, 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-

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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)

5500 kcal/kg range. Similar to "white coals"produced in central and southwestern China,the high-ash anthracite used domestically maybe difficult to ignite, but it is acceptable forpower generation if boiler adjustments aremade and, often, starter fuel is used.

With the country's coal resources limited,the Government's strategy is to cap exportlevels strictly, in favor of expanding domesticsupply-essentially to postpone the expectedeventual need for coal imports. The highquality anthracite fetches a premium price onthe 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.

Issues confronting the coal-fired thermalpower subsector include coal pricing, powerplant siting, and environmental concerns.

Future domestic coal pricing is uncertain,and additional clarity on how coal prices willmove is important for the power industry, asthe optimal role of coal-fired plant is quitesensitive to fuel prices. Vinacomin sold coal toEVN in 2004 at the Government regulated priceof $22/ton, which is well under internationalprices, adjusted for quality. AlthoughVinacomin reports that this price is belowaverage production costs, the price appearsquite high as a cost-based price to the Bankstudy team, given the role of several large openpit mines and prices and costs for similar coal inChina. However, reasonable production costsare very difficult to assess, as (a) there are widedisparities in unit costs between collieries, suchthat efficient producers provide heavy crosssubsidies to high-cost, inefficient producers,and (b) there is little incentive for efficiency, asindividual collieries are not operated withtransparent, independent accounts, with

Vinacomin undertaking all sales at standardprices, and then transferring funds to collieriesto cover costs. To improve efficiency, andensure that prices are aligned with reasonablecosts, major reforms will be required to allowgreater autonomy and proper market incentivesto bear at the mine level. Inevitably yieldingwinners and losers, such a reform is not asimple undertaking, but necessary over themedium term if the coal industry is to meet itsperformance potential. Barring such reform,the Government can undertake more in-depthreview of actual production costs, in an attemptto at least provide greater clarity to the domesticcoal pricing issue.

Vinacomin 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 country's 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 Vinacominis developed and agreed, and (c) clearagreement is reached in the Government as tohow such rents will be collected and used.

Concerning power plant siting, the bulk ofthe new coal-fired power plants will continue tobe 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 review

25

these plans, and other potential plans for coal-based power outside of the north, from theperspective of the integrated powertransmission and generation system.

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

Development of large-scale power generationusing Vietnam's offshore natural gas resourcesrequires alignment of the interests of a series ofinstitutional actors, and both major upfrontfinancing and long-term commitments.PetroVietnam Gas Corporation (PVGC),PetroVietnam's subsidiary charged withnatural gas operations, is a central entity,holding the Government's shares in fieldproduction facilities, retaining the sole rightsin most cases to buy offshore gas and sell gasto end-users, and charged with gastransmission system development, althoughthis may be in cooperation with internationalcompanies. Upstream, gas exploration anddevelopment is undertaken in joint venture orproduction sharing arrangements betweenPVGC and international petroleum companies,including concessions held with BritishPetroleum (BP) and KNOC in the Nam ConSon field, and with Chevron (formerly Unocal)in the Malay Basin. On the power generation

side, development of IPPs with investorsindependent of EVN is essential for a largeportion of the power generation capacity, dueto EVN's limited financing capacity. IPPinvestors may include the gas developers, butother investors are needed as well. EVNrepresents the purchaser of the final electricityproduct. Finally, the Government (aside fromits ownership position of PetroVietnam andEVN), must play key roles, both sanctioningthe specific development arrangements, butalso providing some type of partial riskcoverage on the electricity sale arrangementsto outside investors.

Vietnam's offshore gas is earmarked at thispoint 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 NhonTrach 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 ofseparate satisfactory arrangements for a fullfield development, pipeline transmission andpower generation facility chain.

Gas supply prospects are summarized inTable 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 southeast

of Vietnam's coast, petroleum production inthis basin began in 1995. Associated gasfrom Vietnam's main current oil fields inthis basin, is supplied onshore through the

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Bach 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,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 Vietnam's 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 Vietnam and Malaysia, and blocks with

Chevron. Whereas Vietnam's 50% share ofthe 2.8 bcm of associated gas in PM3 iscurrently sold to Malaysia, PV is nowdeveloping a 300 km pipeline to bring that1.4 bcm onshore at Ca Mau for use inVietnam, to be completed by December2006. Use of gas from the Chevron blockswill require construction of a new 400 kmpipeline. Supply potential from currentlyproven reserves in the Chevron blocks isassessed at some 4 bcm per year, sufficientfor the full O Mon power generationcomplexThe gas utilization complexes under

development or on the medium-term horizoninclude:

Phu My and neighboring areas. This areaincludes the Ba Ria and Tra Noc powerfacilities, totaling 484 MW owned by EVN, andwith 0.78 billion cubic meters (bcm) of annualgas demand from Cuu Long associated gasreserves. It also includes the large new Phu Mycomplex, totaling 3893 MW at the end of 2005,with an annual power generation gas demandfrom Nam Con Son of about 4.3 bcm. The PhuMy complex includes Phu My 1 (1107 MWowned by EVN), Phu My 2.1 (896 MW owned

by EVN), Phu My 2.2 (720 MWowned by EdF), Phu My 3 (720 MWowned by BP), and Phu My 4 (450MW, owned by EVN). A urea plantsupplied with Cuu Long gas is alsolocated at Phu My. Internationaldonor finance played an importantrole in development of EVN's plants.Closer to Ho Chi Minh City, 447 MWof new thermal capacity is alsoplanned by EVN at Hiep Phuoc andVe Den, eventually to use gas.

Ca Mau. 720 MW of combined-cycle independent power plantcapacity is under development byPetroVietnam to become operational

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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.

in 2006-2007, together with fertilizer productionfacilities, as part of this new industrial area. Asecond power plant is also planned. Gas willcome from the SW Basin.

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 1 isin advanced development stages as a 600 MWsteam unit being developed by EVN with JBICfinancing, which can burn oil until gas isavailable. Unocal (now Chevron) hadexpressed interest in partnering with EVN foranother of the plants. Financing for the balanceis being sought. Original plans were tocommission the first unit in 2007. However,without firmer commitments for the fulldevelopment, to offset the upfront field andpipeline development costs, Unocal had notbeen able to offer attractive prices andcontractual terms for the gas. In mid 2005, thegas development remained on hold, pending asolution which could satisfy all of the keyparties.

Nhon Trach. Located about 60 km from thePhu My complex, initial plans for this facilityincluded four power plants, for commissioningduring 2010-2015, totaling 2640 MW andrequiring some 3.3 bcm of gas per year. Gassupply has been planned from Nam Con Son,via a pipeline extension from Phu My.However, gas supplies are now less certain, anddevelopment of the full complex wouldcertainly require new offshore pipeline capacityabove current 7 bcm level.

The cases of O Mon and Nhon 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:

● 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 ofoff-take commitments. Hence,development of firm, large-scale andsufficiently long-term commitments wouldseem to be required to achieve competitivegas-based electricity prices.

● Participation of EVN in most of the powerplant ownership is not feasible, even withborrowed resources, due to EVN's financingconstraints. Outside IPP investment, inaddition to investment from gas developers,is likely to be required in each major complex.The PM3-Ca Mau development, involving

development of the required pipeline and twopower plants solely by PetroVietnam, needs tobe supervised closely by the Government toensure efficiency and lowest possible costs.Assignment of the full-chain development toPV may have some organizational advantages,given the urgent need for new powergeneration capacity, but also carries potentialserious disadvantages due to absence ofcompetition. The Bank team recommends thatthe Government monitor all aspects of thisproject closely, including (a) separate review ofeach cost center in the integrated project-including well-head gas supply cost andinternal pricing, pipeline development andoperation costs and internal pricing, and powerplant development and operation costs andinternal pricing; and (b) ensuring thatprocurement for all contracts proceeds in a fullytransparent manner, using competition to themaximum extent. Such close, transparentsupervision is also important to provide somecomfort for other, needed investors that theGovernment seeks to maintain a level playingfield for gas-based power generationdevelopments in Vietnam.

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On the gas exploration and developmentside, it is critical for the longer term for Vietnamto maintain an attractive framework forinternational companies to continue explorationand firming up reserves, as much potentialremains unexplored. In the current high-oilprice environment, international companieshave a variety of investment options to choosefrom. Areas for the Government to reviewinclude (a) simplification of fiscal terms andsharpening of their competitiveness, includingfor deep water areas, (b) continuing efforts toexpand and clarify gas marketingopportunities, and (c) development of a clearregulatory framework for pipeline investmentand operation.

Hydropower Development

Vietnam is embarking on an ambitious plan todevelop the bulk of its high-potentialhydropower resources over the next decade.Hydro capacity in 2004 stood at 4227 MW,with Hoa Binh (1920 MW) and Yali (720 MW)accounting for 60% of the total. Future planscall for two additional large plants on the Da

River, upstream from Hoa Binh, includingSon La (2400 MW) and Lai Chau (1100 MW).Once completed, this cascade of three largeplants on the Da River will total over 5400MW. Aside from this integrateddevelopment, the balance of Vietnam'shydropower program focuses on 30 medium-sized projects (generally 100-350 MW each),and scores of small hydro (under 30 MW).These projects are dispersed over nine majorriver basins in northern, central and southernVietnam. Fourteen new medium-sized plantswere listed as under construction in early2005 (with construction of all but one initiatedin 2003 and 2004), totaling 3170 MW. Plansare being drawn up for an additional 16medium-sized plants, totaling a further 2775MW, for which EVN would like to beginconstruction as soon as possible.

Son La is a key national project, for whichpreliminary construction work hascommenced. Power generating units areexpected to come on line during 2012-2015.The project 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 hasset high standards and a solid,modern policy framework forthe resettlement program, andcommitted over $650 millionfor the 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 attentionto livelihood development, effective planningand design at local levels, and strongermanagement both centrally and locally.

With goals to provide almost 6000 MW overthe medium term, Vietnam's 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 implementation-to 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, asVietnam's hydropower development programaccelerates.

One area for strengthening in Vietnam'shydropower 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.

An especially important area for additionalwork is to further improve detailed planningand implementation of reservoir resettlementprograms, and alignment of environmentalassessment work to better inform projectdesign and to sharpen focus on key issues andtheir mitigation. Vietnam has madesubstantial progress during the last five yearsin upgrading its reservoir resettlement andenvironmental assessment practices. Currentpolicies provide a reasonably well structuredset of legal and regulatory requirements.Financial commitments for resettlement workin new projects are now substantial. Theprimary issue concerns needs to strengthenimplementation to achieve the best results.Analysis, planning, organization, executionand, especially, follow-up often lack depth ascapacities for this specialized work are thin,especially at local levels. Staff and localexperts often lack experience andunderstanding of best practices. The mostdifficult issues-including restoration oflivelihoods for ethnic minorities which may beaffected by reservoir development, forexample-are 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.

With costs almost completely consisting ofupfront capital, and relatively long projectgestation periods, EVN's plan to concentrate itsown financing and borrowings particularly onthe hydro sector makes sense, leaving moresubstantial portions of the thermal powerinvestment requirement to potential IPPinvestors. Once operational, however, there ispotential to sell off hydro capacity to investors,as EVN has been pursuing for some older plant.

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Opportunities also exist for independent powerproduction in small hydro facilities, and, overtime, to explore innovative approaches to blendindependent financing sources into projectpackages.

Other Means to Meet CapacityRequirements

Vietnam's renewable energy developmentprogram is growing, and can provide anincreasing 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 may also providea small contribution.

Vietnam plans to develop nuclear energycapacity over the long term.

Interconnections with neighboring countriesare expected to become increasingly important.Discussions with power companies in southernChina during 2005 seek to result in increases inpower imports from China to some 400 MWover the near term. Vietnam is also investing inhydro facilities in Laos, with arrangements tobuy back the bulk of the power produced.Vietnam has undertaken to sell some 200 MW ofpower to Cambodia. Especially over themedium term, potential exists to substantiallyincrease the beneficial role of suchinterconnections, through development of aGreater Mekong System (GMS), which couldinvolve large-scale transfers between Vietnam,Thailand, China, Laos and Cambodia.

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 to

strengthen and accelerate these efforts. Loadmanagement programs and energy efficiencypromotion and investment programs areproven 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.

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 thecountry's 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 aplan for a dramatic scale-up in EVN's 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 thecommercial building sector, but also inindustry. In addition, ongoing load surveysand analysis, coupled with expansion in time-of-use metering, can provide the foundationfor improved load management efforts basedon time-of-use pricing. Using the loadresearch strategically, time-of-day sensitivepricing regimes and continued meteringinvestments can provide a framework forcustomers to respond to pricing signals on thecosts of service, and adjust consumptionaccordingly.

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Financing investments

As discussed above, annual power sectorinvestment requirements during 2006-2010 areover $3 billion per year. In developingstrategies to mobilize this level of finance, twobasic starting points are clear:● EVN cannot even come close to meeting this

requirement from its own resources ormassive borrowings, especially withoutfurther increases in unit sales revenues.EVN has maintained profitability each yearsince its inception in 1995, and has retaineda sound financial position, at least until theshortages of summer 2005. However, thesize of the sector investment requirement isno match for the company's borrowingcapacity.

● The Government is neither willing nor ableto pick up the bill. Having basicallyeliminated subsidies to the sector, theGovernment would like to reduce itsliability exposure in the sector, not increaseit. One way or another, directly orindirectly, consumers will need to pay thecost of the power system expansion. Thetask of the Government and power industryis to implement the expansion program asefficiently as possible, to keep the costs asreasonable and affordable as possible forconsumers.Chinese state-owned power companies

faced 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.

Vietnam's case has distinct differences, butthe same two basic categories of solution arerequired: (1) IPPs must carry a large portion ofthe investment requirement (albeit with greateruse of foreign capital than in the case of China,where almost all IPP investors were domestic),and (2) average electricity prices must beincreased, to directly raise more capital fromconsumers for investment in the aggressivecapacity expansion. These are discussed inmore detail below.

EVN's Contributions to Investment

With net profitability, self-financing ratios of 50-60%, debt-service coverage ratios of 3-5, anddebt:equity ratios of 1.0-1.4 in the three financialyears of 2002, 2003 and 2004, EVN might seemwell positioned within its current financialframework to shoulder most of the cominginvestment program. Unfortunately, nothingcould be further from the truth - the company'srevenue stream is no match for the sharpescalation in investment needed now to putcapacity on the system for the future.

Financial projections completed by the Bankand EVN in early 2005 include major increasesin investments by EVN compared to 2002-2004,rising to $2.4-2.5 billion during 2007-2010 (seeTable 6 shown previously). EVN's investmentsare financed with EVN's own resources plusheavy borrowing, through ODA and exportcredit facilities, and various commercialsources. Even so, these investment levels areconservative, in that they are built aroundearlier demand forecasts, and assumed thatover one-half of the new, incremental electricityto be generated during 2005-2010 will be

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purchased from outside of EVN. The forecastsalso assume that some $600 million will beraised by EVN through sale of existing powersystem assets to other investors through itsequitization program. The forecasts are alsooverly conservative in that the increases in costscaused by the shortages-including powerpurchases and power generation with high fuelcosts in lieu of hydro from plants with basicallyno operating costs-are not yet included.

Even without allowing for certain increasesin costs, EVN's basic position becomesuntenable very quickly, unless additionalrevenue is obtained. Key ratios depictinginvestment and borrowing capacity plummet.The self financing ratio falls to 20% in 2007, andthen steadily to just 5% in 2010. EVN's debt:equity ratio climbs steadily to 2.4 in 2007, andreaches 3.9 by 2010. As shown in Figure 3, debtservice costs from mounting debt quicklyabsorb EVN's cash for self-financing; even withincreasing sales, cash for investment financingfalls precipitously in absolute terms. Equallyalarming, the heavy borrowing for investmentbrings debt: equity ratios to levels which wouldrate the company as clearly not creditworthy inany independent financial assessment.

Although funds from its equitizationprogram can defray a small portion of theborrowing requirement, EVN is gearing up forbig increases in its borrowing from all sourcesto meet its portion of the sector's investmentrequirement, including increased officialdevelopment assistance (ODA) borrowings,export-credit financing, and expanded use oflocal commercial bank finance (if local bankscan arrange more capital for the long-term loansrequired). Borrowings from the DAF have beenlimited to resettlement and local equipmentexpenditures, but EVN is seeking to expandDAF borrowings beyond this scope. EVNsuccessfully issued about $13 million indomestic bonds in 2004, and plans are being

made to follow PetroVietnam with issuance ofinternational bonds. Ultimately, however,borrowing is borrowing, regardless of thesource, and EVN will reach its limits veryquickly unless revenue is increased sharply (orthere is a major injection of equity, which isunlikely). It is also critical to consider that ifEVN's financial ratios fall below the generallyrecognized prudent limits, it will beincreasingly expensive, if not impossible, toborrow funds from independent sources.

Forecasts completed by the Bank and EVNin early 2005 concluded that prices would needto increase by a minimum of some 11% in 2007and 10% in 2010, on average, for EVN to meetthe now conservative investment requirementsdepicted in the Fifth Power Master Plan. WithEVN subsequently reporting substantial lossesdue to the summer power shortages and theexpectation of increases in operating costsfrom efforts to stem further expectedshortages, price increases are now required assoon as possible, and clearly at higher levels.Following revisions in forecasts to reflecthigher growth in demand, higher generatingcosts due to needs to add more expensivesources of power to meet load, andconsequential updates in analysis of EVN'sborrowing capacity, a tariff increase must beimplemented before the situation worsens.Preparations and reviews in the Governmentfor a substantial tariff increase were under wayin early 2006. Clearly, substantial retail priceincreases will need to be implemented as soonas possible, as a basic and key measure toensure that future power demand is met.

Securing Investment Independentfrom EVN

Clearly, dramatic increases in power sectorinvestment from outside EVN will berequired to meet overall sector investment

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requirements. As depicted in Table 7, EVNwill need to purchase more than one-half ofthe incremental power required during 2005-2010 from independent sources, mainlyindependent power plants. The mostimportant source of independent investmentis through development of various types ofIPPs. In addition, however, independentinvestment could play a substantial role in thedistribution sector, if divestiture of EVN'sassets in distribution were strategicallyplanned to provide conditions under whichshareholders would be interested in investingin distribution system expansion andupgrading.

Independent Power Producers (IPPs).Vietnam is pursuing a full range of IPParrangements, in its efforts to meet the huge andrapid increases in power demand. IPParrangements for new power plants include (a)BOT or BOO ventures wholly owned by otherpublic-owned Vietnamese entities, (b) joint-venture BOT/BOO arrangements, involvingEVN investment with other parties (local publicor foreign), and (c) BOT arrangements whollyowned by foreign parties, either public orprivate. In addition, new joint-stock companyIPPs are being created from EVN's partialdivestiture of existing power plants under itsequitization program. This aggressive IPPdevelopment runs in parallel with theGovernment's effort to gradually restructureand unbundle the power industry, as dictatedin the new Electricity Law. In general, theGovernment seeks to pursue all manner of IPPs,as quickly as possible, in its efforts to get newplant quickly on the system.

Investment of other domestic public entitiesin new IPPs, either as sole investors or in joint

ventures, proved to be an effective means todevelop power generation quickly andreasonably efficiently in China during the late1980s and 1990s. However, the Chinese casehas been marked by large numbers of differenttypes of public investing entities, with quitevaried sources of capital and often supervisedby Government entities well removed fromGovernment entities supervising thepurchasing public power utilities (e.g. localgovernments as opposed to centralgovernment). Many public investorsrepresented major power users, either directlyor indirectly.

In the case of Vietnam, public entities withresources and interest for major powergeneration investments are few, and are, for themost part, limited to the state-owned fuelsupply companies or large constructioncompanies. While IPP development by suchcompanies may succeed in putting new planton the system quickly, the built-in potential forinsufficient transparency and inefficiency mayresult in unfairly high costs to consumers,unless rigorous attention is given by theGovernment and new ERAV to seek to resolvepotential issues. Key issues include (a)potential, actual or perceived unfaircompetition of power plants involvingPetroVietnam and Vinacomin, as the country'sfuel supply companies, with other independentpower plants, in terms of fuel supply costs andpriority, and, potentially, in terms of dispatchpriority assigned by another public entity whichmay be under pressure to favor large publicentities; (b) inefficiencies and potentially highcosts associated from direct negotiation, asopposed to competition, for award of powerpurchase agreements, and (c) expansion of

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8 . MOI has requested assistance from the World Bank for these efforts, in part with support from PPIAF. The Bankhas planned a substantial assistance program for this in 2006.

these companies away from their core business,into areas where they have little priorexperience.

EVN's involvement in large joint ventureIPPs may help project development now insome cases. However, it must also berecognized that management of these new

assets will need at some point in the future to beheld by entities not involved in any way inpower transmission or distribution, to avoidconflicts of interest when the power marketeventually begins operation.

New IPPs wholly owned by foreign orprivate firms are expected to be the biggest

area of development over the mediumterm, amounting to several thousandsof new megawatts of BOT IPPcapacity. The process of competitivebidding and closure of BOT IPParrangements for the Phu My complexprovides a platform of priorexperience. Yet, progress in closingnew BOT IPP deals with foreign firmshas been stymied since the successfularrangements for Phu My wereconcluded. Prominent issues haveincluded coordination of gas field,pipeline and gas-fueled power plantdevelopment, and desires by many inthe Government to avoid or morestrictly constrain the scope of

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The signing ceremony of development credit for Vietnam

Notes:1) An updated picture of post-2005-shortage investments, revenues and costs, and tariff requirements (available when EVN 2005

financial statements are completed and fully reviewed) will show different quantities, but yield the same conclusion, most likely evenmore strikingly.

2) All scenarios assume VND 9.2 billion is raised by EVN through equitizations during 2005-2009.3) 2007 and 2010 assumed weighted average tariff increases are 11% in current terms in each year.

Government guarantees. By the end of 2005,however, the urgency of unblocking theseconstraints was clear to the Government,which wishes to proceed aggressively. What isrequired is an agreed framework throughwhich a series of new IPPs can be brought online to meet burgeoning demand. MOI seeksto (a) review approaches to provision ofguarantees, to provide concrete solutionswhich can be acceptable to investors in thecompetitive international market of today, butalso provide a pathway for limitingGovernment exposure in favor of increasingreliance on Vietnamese corporate assurancesand credit-worthiness; (b) develop a standardframework of competitive bidding for a fullnew batch of IPP projects, using Phu My 2.2documentation as a foundation, developingseveral initial transactions using theframework, and then hopefully rolling out theframework for a series of additionaltransactions, and (c) move to coordination gasfield/transmission/power generationdevelopment issues, especially for the O Monfield, but also for others as well. In addition, italso is important to review details in proposed

power purchase agreements, withconsideration of the planned eventualdevelopment of a power market, to enableflexibility for integration into the market,where possible.

The World Bank strongly recommends thatcompetition be used wherever possible inawarding IPP power purchase agreements.In country after country, and project afterproject, prices and terms awarded throughcompetitive bidding have been shown toprovide lower costs than negotiated deals. Asin Vietnam, power utilities, public officials,and especially potential power providersoften argue that there is insufficient time toproceed with competitive bidding. Often,however, this is due to lack of planningand/or lack of proper incentives to minimizecosts. Vietnam's power consumers will be theones to suffer from higher than justifiablecosts, unless competitive bidding is stronglyfavored over negotiated contracting. In caseswhere negotiated contracts proceed, clearand transparent information should beprovided to the public on costs and contractdetails. If power providers are public

entities, detailed and accuratereporting of all aspects ofequipment contracting,construction contracting, andpower plant operation affectingcosts should be openly reported toall relevant government agencies,and made public where possible.If power providers are also fuelsuppliers, the ERAV and othergovernment supervisingauthorities should insist on clear,separate and transparentaccounting of fuel supply costs(and how that relates to other fuelssupply cost arrangements), as wellas electricity generation costs.

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Phu My 2.2 - one successful example of IPP development inVietnam

Sector restructuring, equitization andthe development of a power maket

With the passage of the new Electricity Law,Vietnam has embarked on an ambitious long-term program to completely restructure itspower sector by discarding its currentvertically-integrated electrical utility systemin favor of a competitive power market. Theobjective of the reform is both to improveefficiency through competition in the powerindustry, to minimize costs to consumers,and to expand the mobilization of investmentand managerial resources from outside of thecurrent, state-operated system. As spelledout in the initial 2005 Road Map for thereform, the full process may span 20 yearsfrom beginning to end. However, criticalstrategic choices will need to be made overthe next 1-2 years, and major restructuringwill need to be completed before 2009, toadhere to the plan.

The passage of the Electricity Law representsa key milestone for Vietnam's power industry,built through national consensus, and creating alegal foundation for development of acommercial, market-oriented sector (see Box 1).It is important to move steadily on thecomprehensive and far-sweeping agenda, orelse the benefits will be postponed too far intothe future. However, the current pressure onthe power industry of increasing demand andlooming further shortages provides anespecially challenging environment for suchreforms, and dictates caution in approachingfast radical restructuring of a system which iscurrently functioning decently. The transitionto a new structure needs to be undertakensmoothly to avoid disturbances or inefficienciesin the effort to attract much needed newinvestment. The tension between these twoconcerns shapes current debate and reformplanning.

Current Plans for Equitization in the PowerSector

"Equitization" in the Vietnamese context meansto transform a wholly state-owned enterpriseinto a shareholding company. The basicobjective, as being pursued in Vietnam, is torestructure state-owned monopolies such asEVN into shareholding companies, or a series ofshareholding companies, including additionalinvestors, to create more market-orientedcompanies which are more separate fromgovernment. In a sense, the enterprise reformgoals of this effort are common to many"corporatization" reforms pursued in othercountries. The objective is not "privatization"per se - those holding shares may be publicinvestors as well as private ones. In the powersector, the equitization program involvessplitting various subsidiary entities from EVN,to form new shareholding companies. Currentgovernment policy requires EVN to maintain atleast 51% of the shares of the new "equitized"companies. The prevailing model is to offer aminority block of shares in a subsidiarycompany of EVN undergoing equitization tocommon investors, usually in many smallshares.

EVN is under strong pressure from theGovernment to accelerate equitization asquickly as possible. By the summer of 2005,pilots had been undertaken in both generationand distribution. Two hydropower plants(Song Hinh with 70 MW and Vinh Son with 66MW) formerly wholly owned by EVN wereequitized into one company. Also in March2005, one provincial-level power distributionsubsidiary of EVN - the Khanh Hoa Company -was equitized. In late 2005, shares in the PhaLai thermal power plant were offered for sale tothe public, including foreign investors. Plansexist to equitize all of the existing power plantsof EVN, except for the large, multi-purpose

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hydro plants, during the next three years. Inaddition, there are plans to proceed further withequitization in power distribution, throughfurther equitization of Vietnam's 64 provincial-level power distribution subsidiaries.

The process of equitization is a useful reformfor the country, especially as a step to developmore commercially-oriented companies.However, the process of equitization in thepower sector carries major long-termconsequences in terms of the structure of theindustry, which need to be carefully consideredin the light of needs for mobilizing independentinvestment and the overall power sector reformas dictated in the Electricity Law. The size, stateshare, and characteristics of the shareholdingcompanies to be formed are especiallyimportant:● Financial goals for equitization should

include both creation of companies withclear conditions for financial viability overthe short and long term, and maximizationof the proceeds of divestiture to the state.In addition, most divestiture programs inthe power industry in other countries havesought strategic shareholders which arestrong enough to shoulder newinvestments in system upgrading andexpansion and introduce modernmanagement and efficiencyimprovements. Maximizing divestitureproceeds, and especially attraction ofquality investors with incentives andcapacity to undertake major investmentswill require revisiting policies on majoritystate ownership. Attraction of activeinvestors usually requires sale of majorityshare ownership.

● The goal of reducing governmentguarantees and liabilities in contracting fornew generation can best be achieved if thepayment capability of the equitizeddistribution companies (the financial

strength and their efficiency as distributionoperators and retailers) is perceived byprivate investors as sound and sustainable.The scale (e.g., market share) and consumermix of each equitized distribution companyneeds to be sufficient for strong financialviability and sufficient scale economy. Anadditional issue, given the long duration ofPPAs, is to create conditions that givepredictability to distribution revenues (retailtariffs and recovery of generation / bulkpurchase costs) to ensure investors that thepayment chain includes a pass-through ofPPA costs outside their control.

● The size, structure and operational scope ofnewly formed shareholding companies needto be most conducive for the development ofthe power market under the plannedreform. Companies need to be strongenough to be active market participants,able to compete with others, but should notwield excessive control over the market. Asthe sector and market structure changes,distribution companies will be the drivers inattracting new generation investment andthus protecting end consumers reliability ofsupply. To be able to contract in a marketframework, companies must not only befinancially viable, but also have substantialfinancial strength, scale (market share) andoperational and commercial capacity tomake long-term contracting credible andgeneration companies willing to sell atreasonable prices. A distribution companyperceived to have financial problems wouldprobably face a premium in the prices atwhich generation is willing to sell.Given the long-term implications and

importance for the country, Governmentauthorities are undertaking a review of theexperience of the pilot equitization efforts ofEVN to date, and optimal strategies for furtherproceeding with equitization reform developed,

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given realities on the ground and experienceachieved. The purpose of pilot efforts is toallow experience to be gained in a limited scopeand evaluated, to then design a best informedbroader implementation strategy and minimizethe risk of failure or undesired outcomes.Particular attention needs to be given toequitization strategies in the power distributionsector. It is clear that many of Vietnam's powercompanies with predominantly rural loads arein a poor position to maintain financial strengthif made independent from more profitable loadcenters. For the planned power industry reformto succeed, distribution companies must bestrong and creditworthy to contract successfullywith large power generators.

2005 Electricity Market Road Map

The Electricity Law calls for development of theelectricity market through implementation ofthree phases - the first phase focusing oncompetition in generation, the second phaseadding competition for bulk supplies includingsupply to big customers, and the final phaseinvolving competition at the retail level. TheLaw leaves the timing, and design of the phasedapproach to the Government. In July 2005, MOIcompleted an initial, detailed road map on howto proceed. Figure 4 provides a schematic of thebasic plan.

Phase I in the current Road Map involvesestablishment and operation of a competitivemarket for power supply from existing and newpower generators, to be purchased in bulk byone Single Buyer. The Single Buyer will thenprovide power to the distribution companiesand large-scale end-users. The generationmarket is planned to begin in 2009, withoperation under the Single Buyer model forabout five years. The basic Single Buyer modelenvisaged is similar to the model implementedin China beginning in 2002. As designed in

Vietnam, operation of the competitive marketfor generation will involve: (i) powergeneration companies, selling into the system,largely through contracts, but also into a spotmarket; (ii) development of one transmissioncompany, integrating the current four; (iii)development of the National Load DispatchSystem into the System Operator; (iv)assignment of responsibilities to undertake theSingle Buyer function, involving contractingwith all bulk suppliers and selling to all bulkpurchasers; and (v) development of a MarketOperator to administer and settle the marketspot transactions. The Road Map does not callfor distribution companies to be involved in themarket during Phase I, but the plan notes that itwill be important for them to increase theircommercial orientation, acquire trading andcontracting know how, and develop as propercompanies.

The first step for Phase 1, to commence assoon as possible, is the creation of an internal,"trial" market within the current EVN system.The internal market will involve currentgenerating plants owned by EVN, or joint-stockgenerating companies where EVN owns thedominant share. Key aspects include thetransparent legal and financial definition of thepower plants as separate entities, definition ofmarket design and rules, clarification of legaland regulatory issues, and gaining experienceamong the parties on market operationmechanics. Based on this experience, and withthe addition of the institutional reformsnecessary to allow real market operation,competition between these existing powerplants and other generators would commenceat the end of Phase 1

Development of wholesale competition isenvisaged in Phase 2 by moving from theSingle Buyer model to a market with multiplebulk buyers and sellers. Distributioncompanies and large consumers directly

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Vietnam's National Assembly passed the country'sfirst Electricity Law on December 3, 2004, following adrafting process of several years. The Law becameeffective on July 1, 2005. Its primary scope and keyprovisions are summarized below.

Listed tenets of state electricity development policyinclude: (i) to develop the power sector based onoptimal development of all sources to satisfyincreasing demand; (ii) to establish and develop apower market on the principle of transparency,fairness and healthy competition, while maintaining aState monopoly in power transmission, national loaddispatch, and construction and operation of certainlarge-scale power plants which have key socio-economic, defense and/or security roles; and (iii) toapply advanced technology and science, to improveefficiency in energy consumption, to protect theenvironment, and to promote new and renewableenergy resources.

National power development plans will continueto be formulated for each 10-year period, but alsoincluding a notional view towards the next 10 yearperiod. MOI will organize the formulation of thePlans, utilizing funds from the central budget, forPrime Minister approval. Power investment projectsmust be included in the Plans, unless specialexceptions are granted.

Support is provided for electricity savingsmeasures, including preferential tax treatment forrelevant products and investment, implementation ofdemand-side management programs, provisionsenabling implementation of efficiency standards forelectrical equipment, endorsement of time-of-usepricing, encouragement of power factor standards,and energy auditing provisions. Investment incentives,preferential pricing and preferential taxes will beprovided for development of new and renewableenergy resources, regulated by MoF.

The power market is to be established throughsequential development of three levels or phases: (i)a competitive power generation market; (ii) acompetitive market in bulk power; and (iii) acompetitive retail power market. The Law does notprovide details on these, but assigns responsibility tothe Prime Minister to set the road map fordevelopment, and the conditions and timing forproceeding through the phased program. The powermarket will eventually include: (i) power generationunits; (ii) power transmission units; (iii) powerdistribution units; (iv) bulk power selling units; (v)power retailing units; (vi) the national load dispatch

center; (vii) the power market's transactionadministrator; and (viii) electricity consumers. Therights and obligations of these different parties arespecified. Electricity may be bought and sold throughtime-bound contracts between purchasers and sellers,or through a spot market overseen by the powermarket administrator. The Law outlines the basicscope, payment framework, and meteringrequirements for the time-bound contracts, but spotmarket arrangements are left open for future scoping.

Electricity tariff policy provisions includeinstructions to gradually reduce and eliminate thecross-subsidy of residential prices by prices for(industrial) production, and provision for self-determination of electricity sale and purchase prices inthe power market within the electricity framework andtariff stipulated by the State. The retail electricity tariffshall be approved by the Prime Minister. The newElectricity Regulatory Agency will assist the Minister ofIndustry to propose the electricity retail tariff. Thepricing framework for the entities in the power marketwill be appraised by the Regulatory Agency, andapproved by the Minister of Industry.

Licensing for various activities in the sector remainthe responsibility of the Ministry of Industry, where thenational power system is involved, and theresponsibility of Provincial People's Committees forsmall-scale activities. The Law includes provisions forthe protection of electricity equipment and works, andfor safety. The Law stipulates that State support is tobe provided for rural power operators where powerinvestment and operation is considered financiallyunviable and for rural household connections wheresubsidies are needed to conform with social policies.

The Law provides for the establishment of the newElectricity Regulatory Agency, which will assist theMinister of Industry to undertake his assignedelectricity regulation functions. Key areas of Agencyfocus listed in the Law are to assist the Minister to: (i)establish regulations on the operation of a competitivepower market and guidelines for implementation; (ii)review and recommend solutions concerning overallsector supply and demand; (iii) oversee and approvelicenses; (iv) oversee connection and supplysuspension or interruption policies; (v) review andimplement electricity pricing frameworks and provideretail pricing proposals to the Government; (vi)supervise power system development in accordancewith approved plans; (vii) check execution ofapproved electricity tariff policies; and (viii) adjudicatecomplaints and appeals rising in the power market.

BOX 1: Vietnam’s New Electricity Law

connected and supplied from thetransmission system will becomeindependent players in the market,contracting with generating companies (andother bulk suppliers or regional imports asmay be allowed) for bulk power supply. Thecurrent plan is to move to this stage around2014, initially with a pilot effort, with limitedgeographic coverage.

Phase 3 will involve competition for retailcustomers, who will have access to differentsupply companies. This is tentativelyplanned to commence around 2022,beginning with a pilot effort in several

localities, and with a gradual approach. Athreshold will define the consumers that willhave the freedom to choose from whom andhow to buy electricity. Depending on resultsand development, the threshold willgradually be reduced until achieving fullretail competition.

Key Implications of the Reform

With the passage of the Electricity Law, anddiscussions on the Road Map, theimplications of the development of a truepower market for the sector as a whole are

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gradually becoming clear, but perhaps not yetto all parties. Four points are worthy ofspecial emphasis:● EVN will need to be broken up into truly

separate corporations. The existing modelof EVN as the holding company for all of thestate's assets in the power sector cannot beretained if true competition is to be achievedamong existing and new generators, andlater, in wholesale and retail supply. Themarket requires independence amongplayers, to avoid perceived conflicts ofinterest or potential collusion. Ifcommercial, independent generators areasked to compete with state-ownedgenerators, they must be convinced thatthose generators maintain no specialinterests with the buyers or they will nottrust the system.

● Reductions in costs to consumers shouldnot be expected soon. Internationalexperience shows that the main gains ofcompetition will only be realized whenlarge consumers and distributioncompanies are able to contract directly withpower generators in a competitiveenvironment. The big benefits fromcompetition come from the power ofconsumer choice. Although it would beuseful to consider introduction ofcompetition for bulk power supply todistribution companies and largeconsumers earlier than planned in the RoadMap (e.g. 2014), large amounts of carefulpreparation work need to be completedprior to introducing such a market. For thenear-term, therefore, costs to consumers canbe expected to increase modestly, and themost important factors influencing howmuch the cost of electricity supply will goup are likely to be (i) the degree of successin using competitive bidding for IPPcontracts, (ii) the extent of increases in fuel

prices; (iii) the degree of success inmaintaining development according toleast-cost plans, despite the pressure ofpower shortages; (iv) the degree of successin shifting demand for high-cost peakperiods to lower cost off-peak periods; and(v) the degree of success in realizingefficiency gains in the power network anddispatch systems, being retained for nowunder EVN.

● Current and prospective power shortagesprovide additional challenges for thereform. Introduction of competition duringtimes of shortage will tend to drive upprices, which may necessitate specificmeasures to minimize excessive rent-seeking behavior. With the current plan tofocus on an internal "trial" market in thenear-term, this may not be a major problemwhen it comes to introduction of the truemarket. In addition, if properly designed,the power of consumer choice can be anefficient means to allocate shortage and/orto overcome it. In China in the late 1980sand early 1990s, the willingness of largeconsumers to pay higher "second-track"prices or make other types of contributionsfor new power plant investments, inexchange for guaranteed power in time ofshortage, was the most important singlefactor in overcoming national powershortages.Other types of problems may arise if assets

which are uneconomic over the long-term aredeveloped as state-owned assets in the near-term to meet urgent needs for power in time ofshortage. When the shortage is overcome,headaches will arise as these new assets willhave trouble competing in the market.● Increased predictability and flexibility in

retail electricity pricing will need to beintroduced over time. With theintroduction of a true competitive market

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for generation, and even more so with thedevelopment of competition for bulksupplies, flexibility must be built into thesystem for setting the retail tariff. Whereprices for power supply coming into thesystem rise and fall following marketforces, but end-user prices are inflexiblyfixed, the utilities in the middle are in aposition where they may be eithersqueezed into bankruptcy or gain undueprofits. (International experience hasexamples of both.)

Some Suggestions and Key StrategicChoices

Serious consideration should be given toallowing contracting between generators andlarge consumers and/or distribution companiesearlier in the reform phasing than currentlyplanned. The basic goal of the reform is toimprove efficiency through market competition,and the driver of market competition isconsumer choice. The main benefits of thereform can be expected only when largeconsumers and distribution companies cancontract directly with power producers. Inaddition, there are shortcomings from use of aSingle Buyer system for a substantial period oftime alone. As shown in China's recentexperience, vested interests and pricingimbalances may be created in a Single Buyersystem which then become barriers to furtherreform. Introduction of at least some directlarge user-generator contracts during Phase Icould help ensure that the reform is kept ontrack, and that the ultimate, main benefits canbe kept in sight.

The preparatory phase for the reform,involving all of the activities currently includedin the Road Map, is essential for success, andwill require time. Implementation details mustbe worked out in advance of implementation,

and issues concerning the structure of thepower industry and roles of the different actorsare major and difficult issues which must beclarified so that key decisions can be made.Success may often also require large-scale andeffective communication program to helpconsumers and the general public tounderstand the objectives and process of thereform.

ERAV must be developed and itsrelationships with all other actors clarified: ifthe credibility of the Regulator is not wellestablished, it will be difficult for the reform toproceed effectively. Trying to cut cornersduring the preparation phase is dangerous, andrarely beneficial in the long run. However,eventually the point must come when a majorshift has to be made between existing commandand control approaches and reliance on themarket-ultimately the choice must be madeclearly for one or the other. Once preparation isin place, and the country is ready to proceedwith a power market, the Bank team suggeststhat the reform then be rolled out quickly,including allowances for direct contractingbetween producers and users.

Several key choices which are important toreview and debate in the near term, involvingstrategic consequences, include:● How should Vietnam's power distribution sector

be organized in the future? With the programto equitize companies in the country'sdistribution sector beginning, it is nowcritical to consider the best futureorganization of Vietnam's distributionsector for the medium and long term. Thisincludes the future roles of the PCs, theprovincial power service companies, andrural distribution companies. For thereform to succeed, including attraction ofgeneration investment with minimalGovernment guarantees, strong, financiallyviable distribution companies must be in

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place. This is an important topic to begin toaddress seriously in 2006.

● How should the state's assets in the sector beorganized? The main state-owned entitiesneeded for operation of the competitivemarket for generation include (a) entitiescharged with managing state assets ingeneration, (b) the transmission company,(c) the System Operator, (d) the MarketAdministrator, (e) the (temporary) SingleBuyer, and (f) the distribution companies.These may be structured and grouped in avariety of ways. However, in the Bankteam's opinion, entities charged withmanaging the state's assets in generationmust be completely divorced from the otherentities, to ensure a level playing field. Thesimplest alternative to visualize is toorganize the generation assets into anumber of state-owned GeneratingCompanies. As noted in the 2006 RoadMap, a good general principle is to ensurethat no single company holds more than25% of total generation assets, to enablecompetition. Concerning the other entities,a number of them may be merged together,but different configurations have differentadvantages and disadvantages over thelonger term, and should be studiedcarefully, and decided prior to equitization.

● How will IPP projects and contracts be procuredand managed over the medium term? Securingthousands of megawatts of new IPPcapacity, with outside capital, is ofparamount importance to the sector, andimplementation of the reform in the nearterm must facilitate this. It is important tomake it very clear exactly who will maintainresponsibility for contracting with IPPs, andhow these contracts will be managed, bothnow and in the future - uncertainty aboutfuture changes to undetermined entities isnot helpful.

It is essential to balance both the need toattract private investment for newgeneration capacity, and the need to movesteadily and smoothly towards the powermarket. IPP investors must have sufficientmedium term security of cash flow in orderto obtain project financing. New PPAsmust accommodate these concerns. Inaddition, it is important to protect thesecurity of Vietnam's power supply and toensure adequate reserve margins in asystem that is partly based on hydro plantand subject to risk of drought. Lessonsfrom international experience show that itis possible to mitigate the concerns of IPPinvestors and financiers, and ensuresufficient supply security, through carefulpower market design. For example,emphasis may be given initially to coveringload primarily with contracts, and limitingspot trading to a small share of the market.

Not only must these choices, and others, becarefully studied, but it also is clear thatdifferent stakeholders will have different viewson the best ways to manage the consequences ofthe choices. Care must be taken to ensure thatthe genuine interests of the consumers - forwhom reforms are planned - are not lost to thevested interests of powerful stakeholders.

Economic regulation of the powersector

The Electricity Law provides for theestablishment of ERAV which will assist theMinister of Industry to discharge all of theregulatory functions necessary for thefunctioning of the electricity industry andmarket. A working group developed the basicorganizational setup, staffing plans, and workscope during the first half of 2005, and ERAVwas subsequently established by a Decision ofthe Prime Minister later in 2005.

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As described in Box 1, the scope of workassigned by the Law to ERAV includes thestandard tasks expected of such a regulatoryagency. However, ERAV is not independentfrom the Government, in that the Minister ofIndustry presides over it. In addition,approval of retail tariffs remains theprerogative of the Prime Minister. With thesecaveats, which many argue are advisableunder current conditions in Vietnam, ERAVcan and should become a key player in thepower sector henceforward, and is wellpositioned to provide the objective, technicallyrobust guidance and oversight which will berequired. Two important factors which willdefine the degree of success of the new agencyinclude (i) its ability to establish itself as anobjective institution, charged withimplementation of the country's laws, with amandate recognized by all of the relevantparties, and operating as an agency separatefrom MOI's regular business and departments,and (ii) establishment of clear technicalcompetence in addressing the complex issuessurrounding regulation of the sector. Keepingthis in mind, the following arerecommendations for ERAV as it moves intoits first year of operation:● ERAV should be established as a distinct

identity separate from the executivedepartments of MOI. To discharge itsfunctions effectively, ERAV must berecognized by the various market players asthe sole agency responsible for theGovernment's regulatory oversight of theindustry and market. If ERAV developswithout a distinct identity and strongdegree of independence, market playerswill consider MOI as the regulatory agency,and ERAV as just one more MOIdepartment. It is therefore recommendedthat ERAV's funding should becomeseparate from that of MOI, and is best

provided through fees charged for issuinglicenses and in the dispatch of its regulatoryfunctions. It would be best if relevantlicenses and especially regulatory decisionscould be issued under the letterhead ofERAV, with an indication of ministerialapproval affixed somewhere in thedocument, to comply with legalrequirements. The necessary relationshipsbetween ERAV and various MOIdepartments should also be developed asarms-length relationships.

● Definition and publication of a clear workprogram. To signal the role of ERAV in thecoming months, and to set the priorities forregulatory attention, ERAV should publisha work program. The program shouldidentify the tasks, and particularly thelicenses and regulations to be issued, and anassociated timetable for perhaps the next 18months. Such a work program could beregularly updated.

● Staff training and development is a keyand high priority task. With experience inVietnam limited, ERAV is unlikely to be ableto recruit staff with operational regulatoryexperience. Training is therefore especiallyimportant, and needs to be well plannedfrom the outside. Technical excellence is anessential part of establishing a solidreputation with players in the industry.

● Clear arrangements for informationcollection and monitoring need to beagreed with power industry participants.Information from sector entities is a basicrequirement for the work of a regulator. ForERAV to implement the tasks required of itby the Law and the Prime Minister'sDecision, large amounts of timely andaccurate data must be sent regularly, inappropriate formats, by the various powersector entities in the country. ERAV needsto develop the basic requirements, templates

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and timetables, and these need to becoordinated with the entities for effectiveimplementation. Clear consequences forlack of provision of timely, complete,accurate and not misleading informationmust also be established.

● Powers of enforcement need to be defined.Current legal provisions are not clear as tohow enforcement of regulatory decisionswill be ensured. This issue needs to beaddressed as a matter of urgency, or ERAVmay not be taken seriously. Requirementsinclude needs for ERAV to be legallyauthorized to order operators in the sector tosubmit such information necessary for theexecution of its duties.

● Mechanisms for dispute resolution need tobe defined. Adjudication of disputes withinthe power sector is one of the functionsassigned to ERAV in the Law. Provisionsneed to be made for further action in theevent that ERAV is not able to solve somedisputes to the satisfaction of the bothparties, and regarding appeals of ERAVdecisions.

Sumary of recommendations

Recommendations to the Government andEVN for action are included in thediscussions above, and summarized brieflybelow for convenience. Paragraphreferences refer back to discussion in themain text. Recommendations pertaining toaction during 2006 and early 2007 are listedunder "short term recommendations."

Short-term Recommendations

i) As Vietnam's comprehensive Sixth PowerDevelopment Master Plan is finalized,analysis should include (a) analysisrelevant to the sensitivity of the mix

between coal and gas-fired generationplant, especially using fuel priceassumptions reflecting true costs to thecountry, (b) analysis on the implications ofslower demand growth for power plantconstruction scheduling, and (c) analysis ofthe role of DSM . This work was alreadyunder way in late 2005.

ii) Average retail power price levels must beincreased to cover increased costsresulting from generation capacityshortages and hydropower productionshortfalls, and, especially, needs toexpand revenues for power sectorinvestment. Increases would best beconcentrated especially on the residentialconsumption categories.

iii) A standard competitive biddingframework for a full new batch of BOT IPPprojects needs to be developed, andapplied to several pilot transactions.Following analysis and consensusbuilding, the framework should include anacceptable approach to provision ofgovernment guarantees, integration ofIPPs into the future power market, andPPA design. The Bank team attaches highpriority to this work, beginning in the firsthalf of 2006.

iv) Active efforts need to be made tocoordinate the actors and interests involvedin new gas field-pipeline-power plantdevelopment, including for O Mon, toallow the development of new gas-basedpower generation facilities to proceed asquickly as possible. The Governmentshould also closely monitor thermal powerprojects owned by fuel suppliers, insistingon separate fuel and power salesaccounting.

v) Government authorities should review theexperience of EVN's pilot equitizationefforts so far, and develop optimal

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strategies for further proceeding withequitization in the power industry,especially in the distribution sector. Thisshould take into consideration needs todevelop financially strong andcreditworthy new shareholding companies,and to provide the best building blocks forthe development of the future powermarket.

vi) As ERAV is beginning its first year ofoperation, major efforts must beundertaken to develop staff, operationalprocedures, the short and medium-termwork program, clarify the relationshipsbetween ERAV and other entities, anddevelop and agree on reporting andinformation systems. Internationalassistance is being organized.

vii) Efforts need to be launched to review andimprove the implementation ofhydroelectric power projects, especiallyconcerning resettlement and environmentalmanagement. International assistance isbeing organized.

viii)Vietnam's DSM efforts need to be greatlyexpanded, as a least-cost means to provideadditional power services through greaterefficiency, including a major effort toinclude operationally-oriented institutionalcapacity within EVN's system.

Longer Term Recommendations

i) Vietnam's plans to unbundle the powerindustry and develop a power market are amost worthwhile endeavor, aimed atimproving efficiency through competition.In reference to the current Road Map, directcontracting between generators and largeconsumers and/or distribution companiesmight best be considered earlier in thereform. Increased advanced planning andconsensus building are needed, concerning

the details of the restructuring of EVN'svarious holdings, to best accommodate thelong-term interests of the power industryand its reform. The development ofsuitable, synchronized power industrystructural reforms, implementation details,and clear understandings of proceduresand expectations between participants isessential during the preparatory phase,which requires suitable time and strongeffort. EVN and ERAV coordination andcooperation in Phase 1 is important,including in the establishment andoperation of the trial market.

ii) Vietnam's equitization program in thepower industry should be developed inharmony with plans for power sectorreform and development of the powermarket. Consideration should also be givento how to maximize returns to the statefrom divestiture and attract investorscapable of shouldering major newinvestments.

iii) Once a suitable framework for competitivebidding for BOT IPPs is developed, it iscritical for this framework to be rolled outfor a full series of new projects over themedium term.

iv) Once Vietnam's Sixth Power DevelopmentMaster Plan is finalized, it remainsimportant for the Government to re-reviewrelative costs and priorities, especiallybetween coal and gas-based plant, prior tosanctioning major new generationdevelopments, to ensure least-costdevelopment from the country'sperspective. Periodic reviews also mustconsider assessment of existing PPAcommitments, and their impact on thesystem and relationship with actual, ratherthan projected, evolving demand, to ensurethat new commitments are mostappropriate. It also would be worthwhile

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to develop more sophisticated modelingoptions appropriate for hydropowerprojects.

v) Electricity retail tariffs need to be reviewedregularly by the Government, and adjustedperiodically to ensure not only powersector financial viability, but also thatsufficient revenue can be mobilized for newinvestment. In addition, the Governmentneeds to consider greater flexibility insetting retail tariffs, allowing tariffs to varyin different localities based on the cost ofsupply, and, eventually, following marketforces, as required under a proper powermarket system, while also allowing forsocially sensitive power pricing wherejustified for low income households.

vi) Gas-based power generationdevelopment will require continuedcoordination between the variousindustrial actors and the Government tomeet the needs of the country. Inaddition, it is critical for Vietnam tomaintain, through revisions where

required, an attractive framework forinternational companies to continueexploration and firming up reserves.

vii) Strong Government support is required toensure that ERAV can develop its role andcredibility in the market, with a positiondistinct from the general MOI, with strongand capable staffing, with clear authority,and with sufficient budgetary resourcesthrough enforceable funding mechanisms.

viii)Options exist for increasing beneficial powerexchanges between Vietnam andneighboring countries through developmentof the Greater Mekong Subregion (GMS),which are in Vietnam's interest and deservestrategic attention and support.

ix) The Government needs to undertake acareful review of domestic coal pricingoptions, and, in lieu of a reform of thecoal industry to allow development ofcompetitive market between domesticcoal suppliers, develop a clear set of coalpricing regulations which are transparentand meet the country's interests.

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Annex 1Vietnam: Retail Electricity Tariff(effective from September 2002, excluding VAT)

VND/kWh a/

Main Categories b/ Peak Load Off Peak Bid Average Industry

> 110 kV 1325 425 78522 kV-110 kV 1370 445 8156 kV-22 kV 1430 480 860< 6 kV 1480 505 895

Commercial > 6 kV 2190 790 1350< 6 kV 2300 815 1410

Agriculture > 6 kV 950 240 600< 6 kV 1000 250 630

Urban Residential First 100 kWh/month 550Next 50 kWh/month 900Next 50 kWh/month 1210Next 100 kWh/month 1340Over 301 kWh/month 1400

Rural, excluding Agriculture Direct residential connection 390Other direct connection 730Collective meter for residences 570-580Collective meter for other 770

a/ June 2005 exchange rate = VND15,856 / US$1.00.b/ Addition categories include urban water & sewage, by voltage and time

of day; administration, by voltage; and foreign establishments by type,voltage and time of day.

Source: September 20, 2002 Government Decree.