Report and Recommendation of the President to the Board of Directors

Project Number: 50240-001 September 2019

Proposed Loan and Grant Solomon Islands: Tina River Hydropower Project

Distribution of this document is restricted until it has been approved by the Board of Directors. Following such approval, ADB will disclose the document to the public in accordance with ADB’s Access to Information Policy.

CURRENCY EQUIVALENTS (as of 1 July 2019)

Currency unit – Solomon Islands dollar (SI$)

SI$1.00 = $0.13 $1.00 = SI$7.69

ABBREVIATIONS

ADB – Asian Development Bank CO2 – carbon dioxide EIRR

EOCC – –

economic internal rate of return economic opportunity cost of capital

EPC – engineering, procurement, and construction GGA – government guarantee agreement ha

HEC – –

hectare Hyundai Engineering Corporation Limited

IFC – International Finance Corporation kV – kilovolts kWh – kilowatt-hour K-Water – Korea Water Resources Corporation MW – megawatt O&M – operation and maintenance PAM

PPA – –

project administration manual power purchase agreement

SPC – special project company tCO2e – tons carbon dioxide equivalent TRHPO

WACC – –

Tina River Hydropower Project Office weighted average cost of capital

NOTE

In this report, “$” refers to United States dollars.

Vice-President Ahmed M. Saeed, Operations 2 Director General Ma. Carmela D. Locsin, Pacific Department (PARD) Director Olly Norojono, Energy Division, PARD Team leader Anthony Maxwell, Principal Energy Specialist, PARD Team members Flordeliza Asistin, Senior Operations and Institutional Coordination

Officer, PARD Ninebeth Carandang, Senior Social Development Specialist, PARD Eric Gagnon, Principal Procurement Specialist, Procurement, Portfolio and Financial Management Department Teresita Leono, Associate Project Officer, PARD Rommel Rabanal, Public Sector Economist, PARD Asghar Ali Syed, Principal Counsel, Office of the General Counsel Jean Williams, Senior Environment Specialist, PARD

Peer reviewer J-K. Han, Energy Specialist, Central and West Asia Department

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

PROJECT AT A GLANCE

MAP

I. THE PROPOSAL 1

II. THE PROJECT 1

A. Rationale 1

B. Impact and Outcome 3

C. Outputs 3

D. Summary Cost Estimates and Financing Plan 3

E. Implementation Arrangements 5

III. DUE DILIGENCE 7

A. Technical 7

B. Economic and Financial 7

C. Governance 7

D. Poverty, Social, and Gender 8

E. Safeguards 8

F. Summary of Risk Assessment and Management Plan 9

IV. ASSURANCES AND CONDITIONS 9

V. RECOMMENDATION 10

APPENDIXES

1. Design and Monitoring Framework 11

2. List of Linked Documents 13

Project Classification Information Status: Complete

PROJECT AT A GLANCE

Source: Asian Development BankThis document must only be generated in eOps. 23082019154220780816 Generated Date: 03-Sep-2019 15:39:46 PM

1. Basic Data Project Number: 50240-001Project Name Tina River Hydropower Project Department

/DivisionPARD/PAEN

Country Solomon Islands Executing Agency Ministry of Finance and TreasuryBorrower Government of Solomon Islands

2. Sector Subsector(s) ADB Financing ($ million)Energy Large hydropower generation 30.00

Total 30.00

3. Strategic Agenda Subcomponents Climate Change Information1

Inclusive economic growth (IEG)

Pillar 2: Access to economic opportunities, including jobs, made more inclusive

Environmentally sustainable growth (ESG)

Global and regional transboundary environmental concerns

CO2 reduction (tons per annum) 49,500Climate Change impact on the Project

Medium

ADB Financing

Adaptation ($ million) 6.00

Mitigation ($ million) 24.00

4. Drivers of Change Components Gender Equity and MainstreamingGovernance and capacity development (GCD)

Client relations, network, and partnership development to partnership driver of change

Knowledge solutions (KNS) Knowledge sharing activities

Partnerships (PAR) Official cofinancingPrivate Sector

Private sector development (PSD)

Promotion of private sector investment

Effective gender mainstreaming (EGM)

5. Poverty and SDG Targeting Location ImpactGeographic TargetingHousehold TargetingGeneral Intervention on PovertySDG Targeting

YesNoNo

Yes

Rural LowUrban High

SDG Goals SDG7, SDG13

6. Risk Categorization: Complex.

7. Safeguard Categorization Environment: A Involuntary Resettlement: A Indigenous Peoples: C.

8. Financing

Modality and Sources Amount ($ million)

ADB 30.00

Sovereign Project grant: Asian Development Fund 12.00

Sovereign Project (Concessional Loan): Ordinary capital resources 18.00

Cofinancing 175.50

Abu Dhabi Fund - Project loan (Not ADB Administered) 15.00

Government of Australia - Project grant (Not ADB Administered) 11.70

Green Climate Fund - Project grant (Not ADB Administered) 16.00

Green Climate Fund - Project loan (Not ADB Administered) 70.00

Korea Exim Bank - Project loan (Not ADB Administered) 31.60

World Bank - Project grant (Not ADB Administered) 9.70

World Bank - Project loan (Not ADB Administered) 21.50

Counterpart 17.07

Government 17.07

Total 222.57

Currency of ADB Financing: USD

1 The project reduces greenhouse gas emissions. However, it does not fall under the eligibility criteria for climate mitigation finance as defined by thejoint multilateral development bank methodology on tracking climate finance, which notes that not all activities that reduce greenhouse gases in the short

Project Classification Information Status: Complete

PROJECT AT A GLANCE

Source: Asian Development BankThis document must only be generated in eOps. 23082019154220780816 Generated Date: 03-Sep-2019 15:39:46 PM

term are eligible to be counted towards climate mitigation finance. Accordingly, greenfield fossil fuel projects are excluded, and climate mitigation financeis considered zero.

S O U T H P A C I F I C O C E A N

S o l o m o n S e a

Manning Strait

Indispensable Strait

Blanche Channel

ShortlandIslands

Rendova

Hauratarata

Liwe

Avu Avu

Sikaiana

Nendo

Anuta

Fataka

Tikopia

Papara

Noro

Munda

Vangunu

Kia

Sepi

Aola

Malu'u

Oteotea

Luaniua

Roncador Reef

Ke Loma

Yandina

Tinggoa

Peou

Susubona

Maravar

Taro

Gizo

Buala

Tulaghi

Auki

HONIARA

Kira Kira

Lata

S a n t a C r u z I s l a n d s

ONTONG JAVA(Lord Howe Atoll)

Vaghena

Kolombangara

Ranongga

Simbo

Florida

SavoRussell Islands

Ulawa

Reef

Duff

Utupua

Vanikolo

Vella Lavella

Rennell Island

Bellona Island

GUADALCANALPROVINCE

RENNELL AND BELLONAPROVINCE

MAKIRA-ULAWAPROVINCE

TEMOTUPROVINCE

MALAITAPROVINCE

CENTRALPROVINCE

ISABELPROVINCE

CHOISEULPROVINCE

WESTERNPROVINCE

National Capital

Provincial Capital

Town

International Boundary

Boundaries are not necessarily authoritative.

SOLOMON ISLANDS

TINA RIVER HYDROPOWER PROJECT

0 100 200

Kilometers

N

17

-22

17 1

7S

OL A

BV

'Eo

'Eo

'Eo

'Eo

'So

'So

'So

'So

This map was produced by the cartography unit of the Asian Development Bank. The boundaries, colors, denominations, and any other information shown on this map do not imply, on the part of the Asian Development Bank, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries, colors, denominations, or information.

NEWCALEDONIA

HAWAII

FRENCH POLYNESIA

GUAM

NORTHERNMARIANA ISLANDS

I N D O N E S I A

A U S T R A L I A

N E W Z E A L A N D

REPUBLIC OF PALAU

FEDERATED STATES OF MICRONESIA

K I R I B A T IPAPUANEW GUINEA

NAURU

MARSHALL ISLANDS

VANUATU

TUVALU

TONGA

COOK ISLANDS

SAMOATIMOR-LESTE

FIJI

SOLOMON

ISLANDS

S O U T H P A C I F I C O C E A N

N O R T H P A C I F I C O C E A N

TINA RIVER HYDROPOWER PLANTTINA RIVER HYDROPOWER PLANT

I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on (i) a proposed loan, and (ii) a proposed grant, both to Solomon Islands for the Tina River Hydropower Project.1 2. The project will support the development of renewable energy to supply electricity to Honiara, the capital of Solomon Islands. The project will reduce the cost of power supply generation by replacing diesel power with hydropower, and reduce greenhouse gas emissions. It is estimated that, following the project, hydropower will generate 68% of Honiara’s electricity. Transaction technical assistance was used in project preparation.2

II. THE PROJECT

A. Rationale 3. Solomon Islands has the fourth-largest economy among ADB’s 15 Pacific developing member countries, with a gross domestic product of just over $1 billion in 2016. However, annual per capita income is less than $1,800. Having withstood the impacts of the global financial and economic crises, the economy grew by an average of 6.6% in 2008–2011, driven by expansions in logging output and mineral extraction. Growth has since dropped to an average of just 2.6%, and is expected to remain low in the near term. The country’s longer term prospects depend on the development of more sustainable drivers of growth, including tourism and commercial services. This will need to be underpinned by a stable and reliable energy supply. 4. High tariffs from over-reliance on diesel power generation. Grid-connected electricity in Solomon Islands is generated and supplied by Solomon Power, a state-owned electricity utility company. Solomon Power provides electricity to the capital Honiara and eight isolated provincial centers on separate islands.3 Solomon Islands has a total population of 616,000, more than 10% of whom live in Honiara.4 Honiara has an installed electricity generation capacity of 34 megawatts (MW). Peak load on the Honiara grid is growing, having increased from 9.3 MW in 2003 to 15.8 MW in 2018. Solomon Power’s electricity supply relies almost entirely on diesel generation. The cost to Solomon Power of generating power from diesel decreased from $0.36 per kilowatt-hour (kWh) in 2014 to $0.26/kWh in 2018, mainly due to a decline in diesel prices. Similarly, retail tariffs paid by the consumer fell from $0.93/kWh in 2014 to $0.65/kWh in 2016, due in part to declining diesel prices and tariff reform.5 The high cost of electricity generation is negatively impacting economic growth, particularly in the commercial and tourism sectors. 5. Low access. Electricity access in Solomon Islands is low. Approximately 9% of the country’s population have access to grid-connected electricity, and another 2% rely on self-generated power. The access rate is 64% in urban Honiara, and 3% in rural areas. About one-third of all households have small solar home systems. To improve access rates, Solomon Power is (i) extending the grid within Honiara, with financing support from the World Bank;6 (ii) converting

1 The design and monitoring framework is in Appendix 1. 2 ADB. 2016. Technical Assistance to Solomon Islands for Tina River Hydropower Project. Manila (TA 9305-SOL). 3 The current tariff setting mechanism allows Solomon Power to operate at full cost recovery without subsidies. 4 Government of Solomon Islands, Ministry of Finance and Treasury. 2015. Solomon Islands 2012/13 Household

Income and Expenditure Survey National Analytical Report. Volume 1. Honiara. 5 In 2016, the World Bank funded the development of a new tariff regulation that came into effect in January 2017. 6 Solomon Islands Sustainable Energy Project. The increased power supply from the Tina River Hydropower Plant will

expand residential access to the Honiara grid in the medium term.

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provincial grids to renewable energy with support from the Asian Development Bank (ADB);7 and (iii) establishing renewable energy mini-grids in larger villages, partially supported by the World Bank and Government of New Zealand.

6. Least-cost development and tariff reduction. Solomon Power’s least-cost power expansion plan recommends the construction of the Tina River Hydropower Plant supported by the expansion of solar power generation. 8 This will drive tariffs down by replacing diesel generation with least-cost renewable energy. Tariff reductions will boost Honiara’s economic development and lower power costs for households. The plan estimates that, with the construction of the plant, retail tariffs paid by consumers will decline to $0.33/kWh by 2023, compared to $0.51/kWh without the project. The plant will also provide suitable baseload power to facilitate the increased penetration of intermittent solar power in the Honiara grid. With the commissioning of the plant and proposed solar investments, the extent of renewable energy integration is expected to grow from 1% in 2016 to 85% in 2022 (68% from the plant and 17% from solar). The reduced use of diesel will significantly reduce Solomon Islands’ greenhouse gas emissions.

7. Public–private partnership. The project has been developed under a public–private partnership.9 A special project company (SPC) will be established to design, build, own, operate, and manage the plant. The SPC will undertake the construction of the hydropower facility through a build–operate–own–transfer scheme, and it will be capitalized with equity investment from the consortium of the Korea Water Resources Corporation (K-Water) and Hyundai Engineering Corporation Limited (HEC). The SPC will enter into a 34-year power purchase agreement (PPA) with state-owned Solomon Power, which will purchase power on a net availability basis under a 34-year implementation agreement with the government. Through the government guarantee agreement (GGA), the government will guarantee Solomon Power’s payment obligations to the SPC. To maintain the project’s financial viability and lower the tariff, the government is securing concessional financing from multilateral and bilateral development partners that will be onlent to the SPC.10

8. Project readiness. The project’s technical design is complete and has been reviewed by an independent panel of technical experts. Extensive topographic, geotechnical, geological, environmental, social, and hydrological site surveys have been undertaken. The land required for the project was under customary ownership, and the clear land title has been secured following considerable consultation and negotiation. The PPA was signed on 6 December 2018 and will become effective once conditions precedent are met.11 Financial close is currently targeting 5 December 2019. 9. Alignment with development plans. The project supports the operational priorities of ADB’s Strategy 2030 by (i) addressing remaining poverty and reducing inequalities; (ii) accelerating progress in gender equality; and (iii) tackling climate change, building climate and disaster resilience, and enhancing environmental sustainability.12

It will contribute to Sustainable

7 ADB. 2016. Report and Recommendation of the President to Board of Directors: Proposed Grant to Solomon Islands

for Solar Power Development Project. 8 Marsden Jacob Associates. 2016. Least Cost Modelling of Future Generation Expansion for the Honiara Electricity

System. 19 December. This report includes demand projections for the Honiara grid, including a sensitivity analysis. 9 The government and International Finance Corporation (IFC) explored alternative PPP models, particularly given the

government’s large commitment to secure concessional financing, and the proposed model was considered optimal. 10 Financial modeling indicates that the project would not be financially viable at commercial lending rates. 11 The following documents are currently being finalized: (i) the implementation agreement; (ii) the engineering,

procurement, and construction (EPC) contract; (iii) the operation and maintenance (O&M) contract; and (iv) the GGA. 12 ADB. 2018. Strategy 2030: Achieving a Prosperous, Inclusive, Resilient, and Sustainable Asia and the Pacific.

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Development Goal 7: ensuring access to affordable, reliable, sustainable, and modern energy for all. The project is in line with the objectives of ADB’s 2009 Energy Policy to promote renewable energy.13 The project is included in ADB’s country operations business plan for Solomon Islands, 2019-2021.14 The project supports the Solomon Islands National Development Strategy, 2016–2035 to promote private sector and renewable energy.15

B. Impact and Outcome

10. The impact will be improved economic conditions for Honiara in line with the Solomon Islands National Development Strategy, 2016–2035. The outcome will be the increased generation of renewable energy on the Honiara grid.

C. Outputs

11. The project’s output will be the Tina River Hydropower Plant constructed. The SPC will develop, design, finance, construct, operate, maintain, and transfer a 15 MW hydropower plant on the Tina River.

D. Summary Cost Estimates and Financing Plan

12. The project is estimated to cost $233.37 million (Table 1).16 Detailed cost estimates by expenditure category and financier are included in the project administration manual (PAM).

Table 1: Summary Cost Estimates ($ million)

Item Amounta A. Base Costb 1. Hydropower Plant (engineering, procurement, and construction) 140.25 2. Access road 26.00 3. Transmission line 22.82 4. Project development, advisory, and management costs 20.68 Subtotal (A) 209.75 B. Contingenciesc 19.30 C. Financial charges during implementationd 4.32 Total (A+B+C) 233.37 a Includes taxes and duties of $15.7 million to be financed from government resources through exemptions.

Such amount does not represent an excessive share of the project cost. b In mid-2018 prices. Base cost has not increased as it was negotiated as part of the PPA, and is set until

December 2019. c Physical contingencies computed at 7.5% for civil works and goods. Price contingencies estimated based on

foreign and local inflation factors. d Includes interest and commitment charges for loans from different financiers. Interest on the Asian

Development Bank loan has been computed at 1% of disbursed amounts during the construction period. Sources: Asian Development Bank and Government of Solomon Islands estimates.

Manila. 13 ADB. 2009. Energy Policy. Manila. 14 ADB. 2018. Country Operations Business Plan: 11 Small Pacific Island Countries, 2019–2021. Manila. 15 Government of Solomon Islands, Ministry of Development Planning and Aid Coordination. 2016. National

Development Strategy 2016–2035. Honiara. 16 Although the project costs are high by international standards, they are considered reasonable considering the

project design (optimal for available site conditions) and construction costs in Solomon Islands. An independent cost estimator engaged by Solomon Power verified the proposed bill of quantities and EPC price breakdown, which was found to be adequate given the reasonable level of profit.

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13. The government has requested a concessional loan of $18 million from ADB’s ordinary capital resources to help finance the project. The loan will have a 32-year term, including a grace period of 8 years, an interest rate of 1.0% per year during the grace period and 1.5% per year thereafter; and such other terms and conditions as set forth in the draft loan and project agreements. The government has also requested a grant not exceeding $12 million from ADB’s Special Funds resources (the Asian Development Fund) to help finance the project. Concessional financing is also being provided by the Government of Australia ($11.70 million), Green Climate Fund ($86.00 million), Abu Dhabi Development Fund ($15 million), Export-Import Bank of Korea ($31.60 million), and the World Bank ($31.20 million). The World Bank will administer funding from the Green Climate Fund and Government of Australia. Funding from Abu Dhabi Development Fund, ADB, Export-Import Bank of Korea and World Bank (including administered funds) will be provided directly to the government as parallel financing.17 ADB will not administer any cofinancing. The government will finance the remainder of the total project cost ($17.07 million), for the construction of transmission lines. K-Water and HEC will provide equity of $10.80 million, and will enter into the GGA, whereby the government will guarantee payment obligations under the PPA between the SPC and Solomon Power.18

14. Concessional loan financing from various sources will be onlent to the SPC, through a subsidiary lending agreement, on the same terms and conditions as provided by the various financiers to the government, with a 0.1% add-on to the onlending rate. Grants will be passed through as grants to the SPC. The summary financing plan is in Table 2.

Table 2: Summary Financing Plan

Source Amount ($ million)

Share of Total (%)

Asian Development Bank Ordinary capital resources (concessional loan) 18.00 7.7 Special Funds resources (Asian Development Fund grant) 12.00 5.1 Green Climate Fund Loan A 35.00 15.0 Loan B 35.00 15.0 Grant 16.00 6.9 World Bank IDA loan 21.50 9.2 IDA grant 9.70 4.2 ADFD (Abu Dhabi Development Fund) Loan 15.00 6.4 Government of Australia grant 11.70 5.0 Export-Import Bank of Korea Economic Development Cooperation Fund loan 31.60 13.5 Government of Solomon Islandsa 17.07 7.3 K-Water and HEC equity 10.80 4.6 TOTAL 233.37 100.0 HEC = Hyundai Engineering Corporation Limited, IDA = International Development Association, K-Water = Korea Water Resources Corporation. Note: Percentages may not total 100% because of rounding. a Includes transmission line

Source: Asian Development Bank.

17 All co-financing has been approved by the respective Boards. 18 The low debt:equity ratio of 94:6 has been requested by the Government to lower tariffs to the greatest extend

possible and maximize economic and social benefits. ADB has agreed with this approach.

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E. Implementation Arrangements

15. The Ministry of Finance and Treasury will be the executing agency and the Ministry of Mines, Energy, and Rural Electrification will be the implementing agency19 . The Tina River Hydropower Project Office (TRHPO) has been established under the Ministry of Mines, Energy, and Rural Electrification since 2010. The TRHPO will act as the project management unit. Funding support for the TRHPO has been provided to date through the Government of Australia and World Bank, who have allocated a further $7 million grant to support it.20 ADB has reviewed the proposed support and considers it adequate to supervise and monitor project implementation. No additional ADB support for the TRHPO is proposed at this stage. A project steering committee has been established to review project progress, coordinate inter-ministerial activities, and guide the TRHPO. Co-financiers will develop a memorandum of understanding setting out coordination requirements. A coordination mechanism will be established for reporting and sharing information between the government and development partner financiers. The implementation arrangements are summarized in Table 3 and described in detail in the PAM.21 ADB will be jointly financing the EPC contract with cofinancing sources. As a result, universal procurement will apply to the contract.22

Table 3: Implementation Arrangements

Aspects Arrangements Implementation period December 2019–June 2025 Estimated loan closing date 31 December 2025 Management

(i) Oversight body Tina River Hydropower Steering Committee (chair) MOFT, MMERE, MID, and MECDM (members)

(ii) Executing agency MOFT (iii) Key implementing agencies MMERE (iv) Implementation unit TRHPO and SPC

Disbursement The loan and grant proceeds will be disbursed following ADB's Loan Disbursement Handbook (2017, as amended from time to time) and detailed arrangements agreed between the Government of Solomon Islands and ADB.

ADB = Asian Development Bank; MMERE = Ministry of Mines, Energy, and Rural Electrification; MOFT = Ministry of Finance and Treasury; SPC = Special Purpose Company; TRHPO = Tina River Hydropower Project Office. Source: Asian Development Bank.

16. Implementation agreement and power purchase agreement. The SPC will enter into an implementation agreement with the government specifying the rights and obligations of the parties. The SPC has entered into a PPA with Solomon Power covering a 34-year period (including a 5-year construction period). At the end of the implementation agreement and PPA (in

19 ADB Office of Public Private Partnerships is providing capacity support to Ministry of Finance and Treasury to

manage co-financier fund flows and finalize conditions precedent. 20 Support will include consultants to (i) monitor overall project implementation; (ii) provide capacity building and

awareness training for various stakeholders; (iii) monitor environmental and social safeguards, and implement plans, including environmental and social impact assessments and land acquisition and livelihood restoration plans, as well as independent safeguard monitoring agents; (iv) monitor the implementation of the gender action plan; (v) maintain a dam safety advisory panel; and (vi) help communities utilize project benefits for community development. The $7 million grant is part of the Government of Australia’s overall commitment of $11.7 million that will be administered by the World Bank.

21 Project Administration Manual (accessible from the list of linked documents in Appendix 2). 22 ADB. 2013. Blanket Waiver of Member Country Procurement Eligibility Restrictions in Cases of Cofinancing for

Operations Financed from Asian Development Fund Resources. Manila.

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2054), the project ownership will be transferred to the government. The PPA includes provisions for the transfer of the plant in a specified condition at the PPA’s conclusion and for capacity building to enable the government to take over management effectively.23 The PPA tariff is based on plant availability, regardless of water availability, meaning that Solomon Power takes the hydrology risk.

17. Engineering, procurement, and construction (EPC) and operation and maintenance (O&M) contracts. The SPC will engage an EPC contractor (expected to be HEC) to construct the Tina River Hydropower Plant and access road under an EPC contract.24 SPC will engage an owners engineer to supervise the EPC contract,25 and the SPC will engage a contractor (expected to be K-Water) to operate and maintain the plant and access road. Solomon Power will be responsible for procuring contractors to construct the transmission line. Drafts of the EPC and O&M contracts have been negotiated, but have yet to be finalized. 18. Land lease agreement. The land for the plant has been acquired, and the land title is now with the lands commissioner on behalf of the government. The government is currently establishing the Tina Core Land Company and will allocate 50% of the company’s shares to the original landowners. The SPC will then enter into a land lease agreement with the company.26

19. Selection of the concessionaire. The International Finance Corporation (IFC) acted as transaction advisor and helped the government select the concessionaire. ADB’s involvement in the project was requested following the completion of the concessionaire selection. The World Bank conducted a procurement due diligence and endorsed the concessionaire selection; and the World Bank Board of Directors approved project financing in June 2017. To accommodate the government’s request to finance the project in part, ADB conducted a detailed post-review of the concessionaire selection to ensure that procurement was undertaken in a manner consistent with the core procurement principles of economy, efficiency, transparency, and fairness as outlined in ADB’s Procurement Guidelines (2015 as amended from time to time). The review confirmed that this was the case. ADB’s Procurement Guidelines for a build–operate–own–transfer project stipulate that the concessionaire should be selected in a transparent manner, preferably through competitive bidding procedures acceptable to ADB. Eligible bidders were provided with the same information and equal opportunity to compete in the bidding. There was adequate transparency in the multi-stage selection process, which commenced with a request for expressions of interest in 2011 and was republished in 2014, followed by a prequalification phase in 2014 during which two submissions were received. Following the withdrawal of one consortium, the government proceeded to develop the project on a single bidder process based on a modified request for proposal. The selected concessionaire is a joint venture comprising two firms from ADB member countries, and the arrangement does not place any restriction on the origin of goods to be supplied under the EPC contract. Neither the joint venture nor the firms constituting it are subject to ADB sanctions. The government and World Bank confirmed that no representation or complaint was received about the concessionaire selection.

23 The PPA was prepared with inputs from the IFC’s technical and legal advisors and was signed on 5 December 2018,

with PPA close scheduled within 12 months of signing. The execution of implementation agreement, land lease agreement, EPC contract, and GGA are conditions precedent to closing under the PPA.

24 The EPC contract will be a fixed price contract, with the EPC contractor taking construction-related geological risk. 25 The owners engineer will verify construction progress to support withdrawal applications to ADB against milestone

payments in the EPC contract. 26 The government will not commence the establishment of the Tina Core Land Company until all landowners have

accepted the negotiated payment.

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III. DUE DILIGENCE

A. Technical

20. The technical design of the proposed hydropower plant has been reviewed and is considered technically viable27. Alternative sites for the plant within the catchment were assessed and the current site is considered optimal. The TRHPO prepared the feasibility study with technical support from the World Bank and Government of Australia. Based on the feasibility study, K-Water submitted a proposed design that was reviewed by the World Bank dam safety advisory panel and modified based on their comments. The advisory panel will continue to provide guidance during detailed design, construction, reservoir filling, and operation of the plant. IFC technical advisors supported the preparation of the minimum functional specifications (contained in the PPA) which ensure the plant will be constructed to international standards. The PPA also contains O&M requirements, including plant condition requirements during the transfer of the plant to the government.

B. Economic and Financial

21. Economic. The project is economically feasible with an economic internal rate of return (EIRR) estimated at 9.3%, slightly above the economic opportunity cost of capital (EOCC) of 9%. A sensitivity analysis was conducted to test the robustness of the project’s economic viability against (i) a 20% increase in capital costs, (ii) a 20% increase in O&M costs, (iii) a 20% decline in diesel prices, and (iv) a 1-year delay in operation. The project’s EIRR falls below the minimum required EIRR of 9% in 3 of the 4 scenarios considered. The largest potential reduction in economic viability occurs in a scenario with a substantial capital cost overrun. A 20% increase in capital costs reduces the Project’s EIRR to 7.8%. The switching value confirms that any capital cost overrun over 3.8% would cause the Project’s EIRR to fall below the EOCC. Further, a one-year delay in realizing Project benefits also reduces the EIRR to 8.8%. The results show that the project’s economic viability may be sensitive to adverse shocks. However, the project is considered economically viable given that risks are mitigated by robust project preparation and the conservative estimation of benefits, and substantial economic benefits remain unquantified. 22. Financial. The project’s financial viability was examined by comparing incremental costs and benefits in the with- and without-project scenarios. The real weighted average cost of capital (WACC) for the SPC is 2.06%. The financial internal rate of return based on the expected cashflows is 4.71%, which exceeds the WACC. Financially, the project is viable. The sensitivity analysis reveals that the financial internal rate of return remains above the WACC under such adverse scenarios as a 10% increase in operating costs, 10% increase in investment cost and 2-year implementation delay.

C. Governance

23. Financial management. A financial management assessment has not been completed on the SPC as it has yet to be fully established. Financial management systems will be established and operated by K-Water. A desk review of K-Water and HEC indicated that K-Water is a large progressive company with operations in several countries in partnership with various development partners, and that HEC has a robust corporate structure and solid financial performance. K-Water and HEC both have advanced financial management systems. Project development under a

27 The hydropower plant will include (i) a 72-meter (from foundation) roller compacted concrete dam, (ii) a 3.3-kilometer

headrace tunnel (3.3 meters in diameter), (iii) a surge shaft and steel penstock (3 meters in diameter), and (iv) a powerhouse with three 5 MW Francis turbines.

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public–private partnership model is a sustainable model due to the lack of capacity within Solomon Islands to own and operate the hydropower plant.

24. Anticorruption measures. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government. The specific policy requirements and supplementary measures are described in the PAM.

D. Poverty, Social, and Gender

25. The project design includes pro-poor and poverty reduction measures, such as engaging low-income households (including landowners) for construction works. The project will place downward pressure on electricity tariffs which will improve affordability of electricity and reduce household expenditure on electricity. The project will comply with applicable national labor laws and core labor standards, including, but not limited to, equal work for equal pay regardless of gender, race, or ethnicity, and excluding child labor. The TRHPO will implement the poverty reduction measures.

26. The project is categorized as effective gender mainstreaming. A gender action plan has been developed based on a gender analysis and community consultations. The plan includes specific measures related to the construction of the hydropower plant and ensuring long term compensation benefits are directed to women. Measures include (i) women’s engagement in consultation activities, (ii) gender awareness training for target groups, (iii) increased women’s participation in project-related contracts, (iv) ensuring compensation is payed directly to women’s bank accounts, and (v) community development activities from ongoing lease payments which benefit women.

E. Safeguards

27. Environment. The project has been classified as category A for the environment following ADB’s Safeguard Policy Statement (2009).28 An environment and social impact assessment has been prepared and disclosed on ADB’s website. Aquatic and terrestrial flora and fauna and habitat surveys and impact assessments were conducted, and project-affected communities were consulted extensively. The main potential environmental impacts during construction are increased sedimentation, the inundation of 30.5 hectares (ha) of the reservoir, the removal of 115 ha of modified and natural habitat, and minor impacts on fauna. The main potential impacts during operation are induced impacts on terrestrial flora and fauna from increased human access to the upper catchment, and impacts on aquatic fauna due to reduced water flow in the bypassed river section. The SPC will prepare and implement a biodiversity management plan targeting no net loss of biodiversity for identified species, including an offset program to rehabilitate modified habitat. The project design includes an environmental flow of 1 cubic meter per second in the bypassed river section. The SPC will update the environmental and social impact assessment, environmental and social management plan, and other management plans as required in the environmental and social impact assessment. The TRHPO will monitor and supervise compliance with the approved environmental and social management plan during construction.29 A climate change risk evaluation was conducted and the findings considered in the project design. Adaptation measures include an increase in the spillway size to address anticipated increase flood severity, and improved catchment monitoring to predict flooding.

28 ADB. Safeguard Categories. https://www.adb.org/site/safeguards/safeguard-categories. 29 The TRHPO will have dedicated international and national environment staff to support monitoring and reporting.

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28. Involuntary resettlement and indigenous peoples. The project is classified as category A for resettlement and category C for indigenous peoples following ADB’s Safeguard Policy Statement. The government has acquired 428.8 ha of customary land for key project infrastructure. The project will have an economic impact on tribal landowner groups and users mainly due to a lack of access to commercial timber and non-timber resources, although there will be no physical displacement. ADB confirmed that the land acquisition processes for the core land meet the safeguard policy requirements of the government and ADB. The benefits package includes royalties and the establishment of a benefit-sharing mechanism. Approximately 32.6 ha of private land has yet to be acquired for a power transmission corridor. A land acquisition and livelihoods restoration plan will provide compensation and benefits to affected persons, and the plan has been disclosed on ADB’s website. Although the Policy on Indigenous Peoples has not been triggered, all necessary measures to minimize adverse impacts on tribal communities are consistent with ADB requirements. The SPC will implement a community development plan, overseen by TRHPO and supported by safeguard specialists.

F. Summary of Risk Assessment and Management Plan

29. Major risks and mitigating measures are summarized in Table 4 and described in detail in the risk assessment and management plan.30

Table 4: Summary of Risks and Mitigating Measures

Risks Mitigation Measures

Hydrological risk. As the PPA is established on a net available capacity basis, the hydrology risk lies with Solomon Power. During drought periods, Solomon Power will pass additional costs to consumers through higher tariffs.

Solomon Power will develop a cash reserve mechanism by accumulating savings during wet periods to cover additional costs and level out tariffs during dry periods.

Geological Risk. Geological survey indicated that there may be karstic formations in the catchment which may impact reservoir storage.

Surveys will be updated during site clearance and grouting undertaken as required.

Climate change risk. Climate change modeling indicates a 25%–30% increase in the intensity of peak storm events.

The dam design incorporates the projected increase in peak storm events.

Diesel prices experience a significant sustained fall. Project benefits are calculated using diesel price projections. A sustained low diesel price will reduce project benefits.

The projections are considered reasonable. Diesel prices will be monitored.

Finalization of negotiations on project documents. Negotiations are advanced on remaining project documents. If these negotiations are extended, this will create delay risks and project financing implications.

The targeted date for the signing of the EPC contract, implementation agreement, operation and maintenance contract, and government guarantee agreement is November 2019.

IPP engagement risk. K-Water have a relatively low equity investment.

K-Water equity has been partially front-loaded.

ADB = Asian Development Bank; EPC = engineering, procurement and construction; GGA = government guarantee agreement; PPA = power purchase agreement; SPC = special project company. Source: Asian Development Bank.

IV. ASSURANCES AND CONDITIONS

30. The government has assured ADB that implementation of the project shall conform to all applicable ADB policies, including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement as described in detail in the PAM and loan documents. The government has agreed with ADB on certain covenants for the project, which are set forth in the draft loan and grant agreements.

30 Risk Assessment and Management Plan (accessible from the list of linked documents in Appendix 2).

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31. The following conditions of effectiveness have been included in the loan and grant agreements: the implementation agreement, government guarantee agreement, shareholders’ agreement, and power purchase agreement, each in form and substance acceptable to ADB, have been duly executed and delivered by, and have become fully effective and legally binding on, the parties thereto in accordance with their terms. 32. The following conditions of disbursement have been included in the loan and grant agreements: (i) the SPC has established financial management procedures acceptable to ADB; (ii) all parallel cofinancing agreements for the project have been signed and all conditions to its effectiveness have been fulfilled or arrangements satisfactory to ADB have been made for fulfillment thereof within a time-period satisfactory to ADB; (iii) the Tina Core Land Company has been established and its shares have been allocated to affected peoples in accordance with the RP; and (iv) the land lease agreement has been signed and all conditions to its effectiveness have been fulfilled or arrangements satisfactory to ADB have been made for fulfillment thereof within a time-period satisfactory to ADB.

V. RECOMMENDATION

33. I am satisfied that the proposed loan and grant would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve

(i) the loan of $18,000,000 to Solomon Islands for the Tina River Hydropower Project from ADB’s ordinary capital resources, in concessional terms, with an interest charge at the rate of 1% per year during the grace period and 1.5% per year thereafter; for a term of 32 years, including a grace period of 8 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft loan and project agreements presented to the Board; and

(ii) the grant not exceeding $12,000,000 to Solomon Islands, from ADB’s Special Funds resources (the Asian Development Fund) for the Tina River Hydropower Project, on terms and conditions that are substantially in accordance with those set forth in the draft grant and project agreements presented to the Board.

Takehiko Nakao President

3 September 2019

Appendix 1 11

DESIGN AND MONITORING FRAMEWORK

Impact the Project is Aligned with

Improved economic conditions of Honiara’s population (Solomon Islands National Development Strategy, 2016–2035)a

Results Chain Performance Indicators

with Targets and Baselines Data Sources and

Reporting Risks Outcome

By 2025:

Generation of renewable energy on the Honiara grid increased

a. Renewable energy generation as a percentage of Honiara’s power generation increased to 68% (2018 baseline: 1%)

a. Solomon Power annual corporate report

Diesel prices experience a significant sustained fall.

b. CO2 emissions reduced by 49,500 tCO2e per year

b. SPC annual corporate report

Outputs

By 2025:

Tina River Hydropower Plant constructed

a. The SPC commissions a 15 MW hydropower plant (2018 baseline: not commissioned) b. A 20 km access road constructed (2018 baseline: not constructed) c. A 23 km 33 KV transmission line erected (2018 baseline: not constructed) d. At least 80% of livelihood training participants (at least 30% of whom are women) report improved skills

a–d. SPC annual corporate report

Unresolved land owner disputes prevent the full operation of the plant.

Key Activities with Milestones

1. Tina River Hydropower Plant constructed 1.1 Development permits, including environmental permits, approved by September 2020 1.2 Access road constructed by December 2020 1.3 Transmission line completed by September 2023 1.4 Dam constructed by April 2024 1.5 Tunnel completed by July 2023 1.6 Plant constructed by July 2024 1.7 SPC commissions the plant by December 2024

12 Appendix 1

Inputs

Source Amount ($ million)

Asian Development Bank Ordinary capital resources (concessional loan) 18.00 Special Funds resources (Asian Development Fund grant) 12.00 Green Climate Fund Loan A 35.00 Loan B 35.00 Grant 16.00 World Bank IDA loan 21.50 IDA grant 9.70 ADFD (Abu Dhabi Development Fund) Loan 15.00 Government of Australia grant 11.70 Export-Import Bank of Korea Economic Development Cooperation Fund loan 31.60 Government of Solomon Islandsa 17.07 K-Water and HEC equity 10.80 TOTAL 233.37

ADB = Asian Development Bank, CO2 = carbon dioxide, km = kilometer, kV = kilovolt, MW= megawatt, OCR = ordinary capital resources, SPC = special project company, tCO2e = total CO2 equivalents, a Government of Solomon Islands, Ministry of Development Planning and Aid Coordination. 2016. National

Development Strategy, 2016–2035, Honiara. Source: Asian Development Bank.

Appendix 2 13

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=50240-001-3

1. Loan Agreement

2. Grant Agreement

3. Project Agreement

4. Sector Assessment (Summary): Energy

5. Project Administration Manual

6. Contribution to the ADB Results Framework

7. Development Coordination

8. Climate Change Assessment

9. Financial Analysis

10. Economic Analysis

11. Country Economic Indicators

12. Summary Poverty Reduction and Social Strategy

13. Gender Action Plan

14. Environmental and Social Impact Assessment

15. Resettlement Plan: Land Acquisition and Livelihood Restoration Plan

16. Community Development Plan

17. Risk Assessment and Management Plan