Idea Transcript
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Report No: 32428-UA
PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN INTHE AMOUNT OF US$106 MILLION TO UKRAINE
FOR A HYDROPOWER REHABILITATION PROJECT
Public Disclosure Authorized
IN SUPPORT OF THE ENERGY SECTOR REFORM AND DEVELOPMENT P R O G W
May 24,2005
Infrastructure and Energy Sector Unit Europe and Central Asia Region This document has restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not otherwise be disclosed without World Bank authorization.
CURRENCY EQUIVALENTS (Exchange Rate Effective March 3 1,2005) Currency Unit = Ukraine (UAH) UAHl = US$0.19 US$1 = U A H 5 . 2 8
FISCAL YEAR
January 1
-
December 31
ABBREVIATIONS AND ACRONYMS APL BCM CAS CEE CF CIDA
co2 ccu DPL
EBRD EC ECU ERR EMP EU FIRR G7 GDP GHG GWh HPP IMF JI KfW KP MFE MIS MW NERC NOx NPV OP PAL PHRD PrU PPIAF
Adaptable Program Loan B i l l i o n Cubic Meters Country Assistance Strategy Central and Eastem Europe Carbon Financing Canadian Agency for Intemational Development Carbon Dioxide Coal Company o f Ukraine Development Policy Loan European Bank for Reconstruction and Development European Commission Energy Company o f Ukraine Economic Intemal Rate o f Retum Environmental Management Plan European Union Financial Internal Rate o f Retum Group o f Seven Gross Domestic Product Greenhouse Gas Gigawatt-hour Hydropower Plant International Monetary Fund Joint Implementation Bank for Reconstruction (Germany) Kyoto Protocol Ministry o f Fuel and Energy Management Information System Megawatt National Electricity Regulatory Commission Nitrogen Oxide N e t Present Value Operational Policy Programmatic Adjustment Loan Japanese Aid Agency Project Implementation Unit Public-Private Infrastructure Advisory Facility
FOR OFFICIAL USE ONLY
PWG SCADA Sida SIL
so2
TACIS TEN-E TPP TSO UCTE UHE USAID WEM WTO
Permanent Working Group Supervisory Control and Data Acquisition Swedish Agency for Intemational Development Specific Investment Loan Sulphur Dioxide European Commission’s Agency for Technical Assistance to the CIS Countries Trans-European Electricity Networks Thermal Power Plant Transmission System Operator Union for the Coordination o f Transmission o f Electricity in Europe UkrHydroEnergo United States Agency for Intemational Development Wholesale Electricity Market World Trade Organization
Vice President: Country Director: Sector Manager: Task Team Leader:
Shigeo Katsu Paul Bermingham Peter Thomson Dejan Ostojic
This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.
EUROPE AND CENTRAL ASIA Hydropower Rehabilitation Project in Support of the Energy Sector Reform and Development Program CONTENTS Page A
.
STRATEGIC CONTEXT AND RATIONALE
1
1.
Country and sector issues ....................................................................................................
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2.
Rationale for Bank involvement .........................................................................................
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3.
Higher level objectives to which the project contributes ....................................................
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.
PROJECT DESCRIPTION
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1.
Lending instrument ............................................................................................................. 5
2.
Program objective and phases .............................................................................................
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3.
Project development objective and key indicators ..............................................................
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Project components .............................................................................................................
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5.
Lessons leamed and reflected in the project design ............................................................
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Alternatives considered and reasons for rejection ............................................................
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4.
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. 1.
IMPLEMENTATION
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Partnership arrangements ..................................................................................................
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2.
Institutional and implementation arrangements ................................................................
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3.
Monitoring and evaluation o f outcomeshesults ................................................................
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4.
. . . Sustainability.....................................................................................................................
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Critical risks and possible controversial aspects ...............................................................
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6.
Loan conditions and covenants .........................................................................................
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D
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APPRAISAL SUMMARY
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Economic and financial analyses ......................................................................................
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Technical ...........................................................................................................................
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3.
Fiduciary ...........................................................................................................................
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4.
Social.................................................................................................................................
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5.
Environment ......................................................................................................................
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6.
Safeguard policies .............................................................................................................
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7.
Policy Exceptions and Readiness ......................................................................................
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............................................................. Annex 2: Major Related Projects Financed by the Bank and other Agencies ........... Annex 3: Results Framework and Monitoring ........................................................................ Annex 4: Detailed Project Description...................................................................................... Annex 5: Project Costs ............................................................................................................... Annex 6: Implementation Arrangements ................................................................................. Annex 7: Financial Management and Disbursement Arrangements ..................................... Annex 8: Procurement Arrangements...................................................................................... Annex 9: Economic and FinancialAnalysis ............................................................................. Annex 10: Safeguard Policy Issues............................................................................................ Annex 12: Documents in the Project Files .............................................................................. Annex 13: Statement of Loans and Credits ............................................................................ Annex 14: Country at a Glance........................................................................
Annex 1: Country. Sector and Program Background
Map IBRD 34052
25 39 43 45
51 53 59 65 72 93 102 103 105
UKRAINE HYDROPOWER REHABILITATION PROJECT IN SUPPORT OF THE ENERGY SECTOR REFORM AND DEVELOPMENT PROGRAM PROJECT APPRAISAL DOCUMENT EUROPE AND CENTRAL ASIA ECSIE Date: M a y 25,2005 Country Director: Paul Bermingham Sector ManagerDirector: Peter Thomson
Team Leader: Dejan R. Ostojic Sectors: Power (100%) Themes: Regional integration (P);Regulation and competition policy (P) Project ID: PO83702 Environmental screening category: Partial Assessment Lending Instrument: Specific Investment Loan Safeguard screening category: Limited impact
[XI Loan
[ ]Credit
Project Financing Data [ ]Grant [ ]Guarantee [ ]Other:
W
'
'
For Loans/Credits/Others: Total Bank financing (US$m.): 106.00 Pronosed terms: VSL
RECONSTRUCTION AND DEVELOPMENT Total:
261.80
112.70
Borrower: Ukraine Responsible Agency: UkrHydroEnergo 07300 Vyshhorod Kyiv Region Ukraine
Annual 0.0 7.0 27.0 32.0 17.0 12.0 7.0 4.0 Cumulative 0.0 7.0 34.0 66.0 83.0 95.0 102.0 106.0 Project implementation period: Start: October 1,2005 End: December 3 1,201 1 Expected effectiveness date: September 30,2005
374.50
Expected closing date: June 30,2012 Does the project depart from the CAS in content or other significant respects? Re$ PAD A.3 Does the project require any exceptions from Bank policies? Re$ PAD D. 7 Have these been approved by Bank management? I s approval for any policy exception sought from the Board? Does the project include any critical risks rated “substantial” or “high”? Re$ PAD C.5 Does the project meet the Regional criteria for readiness for implementation? Ref: PAD D. 7 Project development objective Ref: PAD B.2, TechnicalAnnex 3
[ ]Yes [ XI N o [XIYes [ ] N o [XIYes [ ] N o [ ]Yes [XINO
[XIYes [ ] N o [XIYes [ ] N o
and, therefore, facilitate unimpeded operation o f the energy market, both domestically and internationally. The main objective o f the Hydropower Rehabilitation Project i s to improve operational stability and reliability o f power supply by increasing regulating capacity, efficiency and safety o f hydroelectric plants, and, therefore, facilitate unimpeded operation and opening up o f the electricity market. Additional objective i s to support the Ministry o f Fuel and Energy and NERC in preparing and implementing the Energy Sector Reform and Development Program, including the Wholesale Electricity Market concept. l Project description [one-sentence summary of each component] Re$ PAD B.3.a, Technical Annex 4 The Hydropower RehabilitationProject comprises five components: Component A: Rehabilitationof hydroelectric plants. This component includes rehrbishment o f 46 hydroelectric units and associated plant equipment at nine hydroelectric plants. Component B: Dam Safety. This component includes rehabilitation and upgrade o f the existing, as well as installation o f new dam safety monitoring systems and rehabilitation o f drainage facilities and spillway gates on six dams. Component C: UHE Institutional Development. This component includes establishment o f a corporate-wide Management Information System in UHE. This component also includes provision o f technical assistance to UHE in improving financial management, enhancing dam safety, and project management. Component D: MFE Institutional Development. This component includes provision of technical assistance to the MFE in developing and implementing: (i) an action plan for legal and technical harmonization o f the Borrower’s energy market with the European Union Intemal Energy Market; and (ii) a program o f priority investments and technical assistance in the energy sector. Component E: Implementation of the WEM Concept. This component includes provision of technical assistance to NERC in implementing the wholesale electricity market (WEM) concept. Which safeguard policies are triggered, if any? Re$ PAD D. 6, Technical Annex 10 The Hydropower Rehabilitation Project triggers the safeguard policy o n environmental assessment. It also triggers policies on the safety o f dams and projects on international waterways.
Significant, non-standard conditions, if any, for: Re$ PAD C. 7 Board presentation: N o t applicable.
Loadcredit effectiveness: - UHE to select an intemational project management consultant under Terms o f Reference and with qualifications acceptable to the Bank. Covenants applicable to project implementation: - the Borrower to ensure that from Fiscal Year 2006 and onwards NERC would establish and maintain tariffs for UHE sufficient to cover project co-financing needs in a timely manner.
- the Borrower to ensure that NERC introduces a two-tier tariff for UHE by December 31,2005.
- UHE to maintain the following financial covenants: (i)debt service coverage ratio o f at least
current ratio o f at least 1.2 during the project period; and (iiito ) 1.5 during the project period; (ii) carry out revaluation o f i t s assets in accordance with terms o f reference and consultants satisfactory to the Bank by December 3 1, 2007.
- UHE to complete the design proposals satisfactory to the Bank for (i)rehabilitation of: (A)
drainage facilities; (B) design profiles (rehabilitation o f subsidence); (C) slope protections; (D) concrete spillways and other reinforced concrete works at Kyiv, Kaniv, Dniprovska and protection against higher phreatic lines (high piezometric Dneprodzerzhinsk dams; and (ii) levels) in the dam embankments at Kaniv, Kremenchug, Dniprodzherzhinsk and Kakhovka dams by December 3 1,2005.
- UHE to establish an adequately staffed Dam Safety Center under terms o f reference acceptable to the Bank by December 3 1, 2005.
A. STRATEGIC CONTEXT AND RATIONALE
1. Country and sector issues After a decade o f economic decline, which halved the country’s economic output and raised the poverty rate to almost a third o f population, GDP has rebounded by over 40% since 2000, and indications are that the poverty rates are beginning to decrease. The recent economic growth in Ukraine has been a mixture o f revival o f o l d and emergence o f new activities, both supported by access to inexpensive energy supplied from aging, inefficient and often environmentally polluting sources through extensive electricity, gas and o i l networks inherited from the former Soviet Union. Furthermore, the l o w priced domestic coal (and electricity) i s one o f k e y resources helping the revival o f the steel industry which accounted for 37% o f the total exports of Ukraine in 2003. Ukraine now faces the difficult task o f ensuring the sustainability o f the economic growth and the consolidation o f market reforms which are critical if the country i s to fulfill its stated aspirations with regard to increasing integration with the European U n i o n (EU) and with the W o r l d Trade Organization (WTO). Developments in the energy sector closely mirror the aforementioned changes in the economy. After a sharp decline in the 1990s, the production o f electricity in the last three years stabilized at about two thirds o f the production in 1990, while the primary energy production (coal, gas and oil) bottomed out at about 40% o f the 1990 level. W h i l e significant spare capacities freed by declining demand enabled unconstrained energy supplies in 1990s, albeit o f l o w quality and poor reliability, the recent economic revival i s exposing a significant loss o f available capacity and deterioration o f energy infrastructure. The system faces serious challenges in maintaining the lack o f investments and deferred security, reliability and quality o f energy supply due to (i) maintenance in aging infrastructure; (ii) the poor financial condition o f energy enterprises; and (iii) delays in sector reforms. These are far more than sectoral problems, because they threaten the sustainability o f economic growth, reduce competitiveness o f the country’s products and services, degrade the environment and increase the cost o f social services. Furthermore, attracting investments, creating jobs and increasing productivity - k e y drivers o f sustainable economic growth - can not be effectively stimulated without improvements in the security, reliability and quality o f energy supply. Ukraine has made considerable progress in energy sector reform which started with the restructuring and corporatization in the oil, gas, and power sectors in 1994. A s a result o f its reform effort, Ukraine unbundled its power industry’, introduced elements o f competition on the wholesale electricity market (WEM) and the coal market, and liberalized the o i l market. In dealing with the aftermaths o f the 1999 financial crises, the Government has been reasonably successful in reducing non-payments and in moving tariffs towards cost recovery levels. I t has established the National Electricity Regulatory Commission (NERC) which i s steadily building As a result o f restructuring, the power industry i s organized in five thermal power generating companies, one hydropower company, one nuclear power company, one power transmission company and 27 regional power distribution companies. One thermal power company and 13 power distribution companies are owned by private (Ukrainian and foreign) investors, while other power companies are (majority) state-owned.
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i t s capacity and has opened the energy sector to private investors. Annex 1 provides an overview o f main issues that constrain further improvements in sector performance and key reform measures needed in the power, coal and gas sub-sectors. The common problems affecting a l l three sub-sectors are outlined below.
The most difficult legacy o f the 1990s is the large historical debt which is the m a i n obstacle for achieving sector creditworthiness and continuing its ownership transformation. The main cause o f the large debt in the energy sector (about UAH 42 billion in January 2003)2 was a sharp decline in financial discipline and rapid accumulation o f payment arrears in late 1990s. For example, in 1999, cash collection in the electricity sector was only 8% and total collections (including barter) were about 80%. Despite significant improvement o f financial discipline (cash collections for gas and electricity reached 95% in 2004) due to l o w tariffs and less than full payment performance, the total sector debt i s growing, albeit at a slower rate. Recently, the Government prepared a comprehensive action plan which would bring fuel and energy companies to financial solvency and eliminate further accumulation o f arrears o f tax and other payment obligations. A key step in this action plan is adoption o f a law o n debt restructuring in the energy sector. This law would create a legal framework enabling and obliging sector entities to separate historical debts from the current financial operation and requiring the Government t o help establish a mechanism for the settlement o f historical debts. Energy demand in Ukraine i s characterized by high energy intensity (about three times higher than in the EU) and the high share o f industry in final energy consumption. Inefficient use o f energy is supported by l o w tariffs which are tailored more to the ability o f consumers to pay than to cost and value o f services provided. Distorted prices o f electricity, coal and gas, less than full payment performance and non-technical losses, result in a large energy-related quasi-fiscal deficit (estimated at about 7% o f GDP in 2003) which is financed through the decapitalization o f the asset base and the accumulation o f debt. The Government action plan for financial stabilization o f the energy sector recognizes the importance o f adjusting the level and the structure o f energy tariffs to fully cover supply costs and to provide price incentives for energy savings and investments in energy efficiency. At the same time, the Government needs to improve the design and implementation o f social assistance programs to help protect vulnerable groups from the impact o f inevitable price adjustments in the energy sector. Electricity sector restructuring, privatization and market liberalization, which started in the mid1990s, slowed down after 2001 when financial discipline in the “single buyer” electricity market was strengthened by increasing NERC’s control over its financial flows. W h i l e this measure helped reduce the non-payment problem, i t could not compensate for the l o w tariffs and the lack o f market competition in fuel (coal and gas) supply which stifle competition among thermal power producers and further undermine their poor financial viability. A failure o f the state management to address increasing financial strains in the power sector prompted the Government’s decision to merge the remaining state-owned power generation and distribution assets (except the nuclear power company) into a single holding - Energy Company o f Ukraine (ECU) in June 2004. E C U in many ways resembles the state owned, vertically integrated gas company, Naftogaz, but unlike Naftogaz which has a monopoly in the gas market, E C U does not ~~
This includes tax arrears to the state and local budgets, but does not include about UAH 11 billion o w e d to Russia and Turkmenistan for gas supplies.
2
control the whole power market and most importantly it does not control the high voltage transmission network and power dispatch. A similar increase in market concentration occurred in the coal sector after the Government merged all state-owned coal mines into a national holding company - Coal Company o f Ukraine (CCU) in October 2004. The separation between political and economic functions through the creation o f national holding companies in the energy sector i s expected to help commercialize state-owned enterprises, reduce costs and improve financial discipline. The Government action plan recognizes that meeting these objectives requires the improvement in corporate governance o f state-owned energy enterprises and the strengthening o f NERC’s independence and capacity in order to mitigate risks o f monopoly abuses which arise from the growing market concentration. Furthermore, the Government i s committed to develop a strategic action plan for continuing ownership transformation and attracting private sector investments in the energy sector.
2. Rationale for B a n k involvement The Bank has supported Ukraine in its efforts to reform and restructure its energy sector through policy dialogue, technical assistance and financing o f adjustment and investment projects since the early 1990s. The Bank prepared several energy sector policy notes3 in the last two years, which reviewed the results o f the first decade o f transition and mapped a way forward for a more strategic sector-wide approach. This deep country and sector knowledge puts the Bank in a strong position to provide policy advice, lending and technical assistance to further support energy sector reform and sustainable development. Through the proposed Energy Sector Reform and Development Program (the Energy Program) - based o n the Government action plan for financial stabilization o f the energy sector - the Bank would provide sector-wide support for sustainable energy development which, in Ukraine, requires coordinating and adapting financial support, policy advice and technical assistance to a rapidly changing and growing economy. The consolidation o f energy sector reforms is a cornerstone o f the Bank’s CAS. Energy reform cuts through the main themes o f the CAS: (i) fostering financial discipline, including reduction of tax arrears to the budget and improvement in payment discipline in the electricity and gas improvement o f the business environment, including strengthening o f the financial sectors; (ii) and administrative independence o f the energy regulator; and (iii) improvement o f industrial competitiveness and export performance through the transparent privatization o f industrial and energy companies. Therefore, the proposed Energy Program is a k e y component o f the Bank’s assistance strategy and working partnership with Ukraine. Cooperation in the energy sector i s high o n the agenda o f several donors, notably the European Commission (TACIS), and Governments of Japan (PHRD) and Sweden (Sida), although the overall donors support t o the sector declined in the last few years after U S A I D and C I D A reduced its assistance and focused o n the Chernobyl sarcophagus project and the nuclear safety. The Bank, through the multi-donor agency PPIAF, i s also providing support for the further development o f WEM. The enhanced cooperation in the energy sector i s an important element o f the EU-Ukraine Action Plan which was signed in February 2005. This Action Plan outlines a number o f concrete steps required to harmonize the structure, regulatory framework and operation o f the Ukraine energy market with the EU Internal Energy Market. Two recently In 2003 and 2004, the Bank energy team prepared sector notes o n coal, gas, energy regulation, and electricity.
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approved T A C I S projects will support Ukraine’s progressive participation in the trans-European gas and electricity networks. The proposed Energy Program would help implement priority reforms and investments identified in these technical assistance projects, and, thus, i t would facilitate the implementation o f the EU-Ukraine Action Plan. Furthermore, the proposed Energy Program would help establish a framework for sector-wide cooperation and partnership among the Bank, EBRD and bilateral donors in assisting Ukraine to reform and to further develop its large and strategically important energy sector. Ukraine i s the 11th largest emitter o f Greenhouse Gases (GHGs) in the world4 and has one o f the largest “surpluses” o f emission reductions (estimated at about 1.8 billion tons o f C 0 2 equivalent) compared to the 1990 baseline emissions under the Kyoto Protocol (KP). GHG emissions in the energy sector o f Ukraine account for about 75% o f all GHG emissions in the country. The energy sector offers ample opportunities for cost-effective reduction o f GHG emissions which could be used to attract significant financial support through the KP mechanisms to meet growing investment needs in the sector. Unfortunately, institutional capacity, which is necessary to implement KP mechanisms, is l o w in Ukraine and the country i s poorly prepared to capitalize o n this opportunity, which, at the same time, would help other countries (Le. developed countries) meet their obligations under the KP. Through its unique Carbon Financing (CF) experience and the pivotal position in the Carbon Market, the World Bank can help Ukraine build its institutional capacity in this area and mobilize C F support for Joint Implementation (JI) projects in the energy sector, which would also provide a valuable learning experience for further use o f KP mechanisms.
3. Higher level objectives to which the project contributes Reform and sustainable development o f the energy sector i s one o f the highest priorities in restoring Ukraine’ macroeconomic fundamentals, improving the investment climate and integrating the county into the global economy. Addressing emerging fiscal imbalances and inflationary pressures in Ukraine requires hardening budget constraints, including strengthening financial discipline in the energy sector and timely payment o f energy bills and taxes to the budget. The proposed Energy Program would help bring energy companies t o financial solvency and eliminate further accumulation o f tax and other payment obligations to the budget. I t will also help reduce quasi-fiscal deficit in the energy sector through gradual elimination o f price distortions, reduction o f technical and commercial losses, and increase in cash collections. Advancing energy sector reform and ensuring sustainable provision o f reliable, affordable and environmentally acceptable energy services i s crucial for improving the investment climate in Ukraine, which has a high concentration o f production and exports in energy intensive industries. From this point o f view, k e y aspects o f the proposed Energy Program are: (i) resolution o f large reduction and ultimate elimination o f subsidies in the debts accumulated in the energy sector; (ii) improvement o f financial sector both explicit (for coal) and implicit (for gas and electricity); (iii) This assessment i s based o n the study “Modeling and Analysis o f Greenhouse Gases Emissions in Ukraine” conducted by the Pacific Northwest National Laboratory (USA) and Agency for Rational Energy U s e and Ecology (Ukraine) in 200 1.
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solvency and corporate governance o f state-owned energy enterprises; (iv) strengthening the independence o f NERC; (v) improvement o f security, reliability and quality o f the energy supply; and (vi) capacity building in the Ministry o f Fuel and Energy (MFE) and NERC. Ukraine’s location o n the main comdor for energy trade between Russia and the EU5 and the country’s large energy resources and infrastructure make energy sector reform and sustainable development essential for integrating Ukraine into the global economy, including i t s membership in WTO. The proposed Energy Program would support Ukraine’s aspirations with regard to legal and technical harmonization and increasing integration o f its energy market with the EU Internal Energy Market. Strengthening energy interconnections and opening access to the EU electricity market will improve energy security and the reliability o f energy supply in the whole region and result in significant economic benefits for all market participants. Furthermore, the proposed Energy Program would help Ukraine benefit from i t s large surplus o f GHG emission reductions under the Kyoto Protocol. This would also help other countries (i.e. developed countries) meet their obligations under the Protocol and jointly mitigate the impacts o f the growing energy demand o n the global climate.
B. PROJECT DESCRIPTION 1. Lending instrument Bank support to the proposed sector-wide multi-phase long-term Energy Program would initially be provided by use o f a series o f specific investment loans (SILs). The S I L instrument would enable the Bank to provide support in a selective manner by focusing o n priority investments which have a strong ownership o n the Government’s part and a clear commitment to technical and governance excellence o n part o f implementing agency. The series o f SILs i s well suited to support sector wide programs and long-term investment projects - all o f which develop in phases. However, other lending instruments (e.g. development policy loan and adaptive programmatic loan) may also be used within the proposed Energy Program in order to adjust the Bank support to specific objectives and requirements o f each phase o f the sector reform and development. Each lending instrument within the program will build o n the previous one and together will help fund a long-term program based o n agreed program objectives, program milestones and performance indicators. The sector-wide programmatic approach would enable the Bank to provide support to each energy sub-sector (e.g. power, gas, coal) when an individual sub-sector has demonstrated commitment to broader sector reforms and when individual projects are ready to receive Bank support. All sub-sectors might not actually borrow under the Energy Program. However, all sector entities would know up-front that the Bank would support them in achieving reform and development objectives if specific criteria are met and if Bank support i s needed. The use of sector-wide programmatic approach, and the regular monitoring and benchmarking that will take place under the Energy Program, w o u l d provide greater awareness, as w e l l as peer pressure and
’In 200 1, about 20% o f total net E U o i l imports (16% o f EU total consumption) and over 40% o f EU gas imports
(19% o f EU total consumption) came from Russia with between 80% to 90% o f Russian gas exports moving over Ukrainian territory.
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incentives for sector entities to improve performance so as to avoid falling behind other program participants.
The first S I L of US$106 m i l l i o n i s allocated for the Hydropower Rehabilitation Project. 2. Program objective and phases The overall program objective i s to improve the security, reliability and quality o f energy supply, and, therefore, facilitate unimpeded operation o f the energy market, both domestically and internationally. Also, the proposed Energy Program would support Ukraine’s aspirations with regard to legal, institutional, regulatory and technical harmonization and increasing energy trade with the EU Internal Energy Market.
If successful, the Energy Program would support sustainable economic growth through the consolidation o f energy sector reforms, improved security, reliability and quality o f energy supply and growing energy trade in the domestic and international energy markets.
The key policy and institutional elements o f the proposed Energy Program have been defined and established by the Govemment o f Ukraine in partnership with the Bank and in close cooperation with the European Commission and other donors. Specifically, the proposed Energy Program i s based o n the Comprehensive Action Plan for Financial Recovery o f the Fuel and Energy Sector6 prepared by the Government in March 2005 and the EU-Ukraine Action Plan signed o n February 2 1, 2005. The Energy Program comprises two partially overlapping phases (2005-201 1) and (2007-2012). The first phase aims to improve financial and operational stability o f the energy sector. The most salient activities included in the first phase are: (i)the separation o f historical debts from the current financial operation o f energy enterprises; (ii) the establishment and the implementation of a mechanism for the settlement o f historical debts in the energy sector; (iii) the elimination o f cross-subsidies through gradual adjustment o f the level and the structure o f energy tariffs; (iv) opening up the power market by replacing the existing single-buyer WEM with a bilateral contracting market and a balancing mechanism; and (v) the improvement o f power system operational stability and the strengthening o f its balancing mechanism through rehabilitation and upgrading o f hydroelectric plants. The second phase will focus o n the implementation o f a strategic action plan for harmonization of energy policies, regulatory framework and operating practices o f the Ukraine energy market with the main principles o f the EU Internal Energy Market. The action plan will be developed early o n in the first phase o f the proposed Energy Program and would include measures to: (i) further improve financial viability o f energy enterprises; (ii) improve corporate governance and foster commercialization o f majority-state owned energy companies; (iii) strengthen financial and administrative independence o f NERC; and (iv) foster competition in coal and electricity supply through further market opening and gradual liberalization o f wholesale electricity trade.
The Action Plan has been prepared by the Ministry of Fuel and Energy with a support from the Bank. The Action Plan i s expected to be adopted by the Cabinet o f Ministers by May 30,2005 as a condition of the DPL1.
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The second phase o f the proposed Energy Program would support priority projects to be identified by the Commission for Energy Sector Reforms and Development7. The proposed Energy Program has a strong country commitment and a well established coordination mechanism. At the political level (Cabinet o f Ministers) program coordination i s performed by the Commission for Energy Sector Reform and Development. The Commission has two main tasks: (i)to review, approve and update an action plan for legal and technical harmonization o f the Ukraine energy market with the EU Internal Energy Market; and (ii) to coordinate and supervise implementation o f the action plan, including reviewing and approving changes in the legal and regulatory framework, and prioritizing reforms, investments and technical assistance to be supported by the Energy Program. Past experience has demonstrated that a critical success factor for Bank lending in Ukraine i s broad ownership o f the applicable project. Supporting a project that has a strong Government ownership i s more important in terms o f cementing the policy dialog than trying to press for a project that m a y more closely tie to the policy dialog per se. Therefore, the main thrust o f the Energy Program i s to allow the Government to propose projects that i t considers high priority with investment support o n the Bank’s part being linked to achievement o f k e y program milestones. The program milestones will be identified but will not be specifically tagged, i.e. the trigger for moving to the next component or loan in the program is achievement o f at least one o f key program milestones. A list o f key reform measures and program milestones i s provided in Annex 1. Program milestones are based o n the Comprehensive Action Plan for Financial Recovery o f the Fuel and Energy Sector prepared by MFE. The critical milestones to support the first investment operation within the proposed Energy Program were achieved with (i) the establishment o f the Commission for Energy Sector Reform and Development; (ii) the initial implementation o f WEM concept; (iii) the preparation o f the comprehensive action plan for financial recovery o f the fuel and energy sector; and (iv) the identification o f program milestones.
3. Project development objective and key indicators The main objective o f the Hydropower Rehabilitation Project is to improve operational stability and reliability o f power supply by increasing regulating capacity, efficiency and safety o f hydroelectric plants, and, therefore, facilitate unimpeded operation and opening up o f the electricity market. Additional objective is to support the Ministry o f Fuel and Energy and NERC in preparing and implementing the Energy Sector Reform and Development Program, including the Wholesale Electricity Market concept. The performance indicators that will be used to assess fulfillment o f the Energy Program and the proposed Hydropower Rehabilitation Project in terms o f results and outcomes are presented in Annex 3. K e y project performance indicators by the end o f the project and in comparison t o parameters in the year 2004, are:
’
The inter-agency Commission was established by the Cabinet o f Ministers order No.1091 on August 25, 2004. The Commission includes high-level representatives of the Ministry o f Finance, Ministry o f Economy, Ministry o f Fuel and Energy, Ministry of Foreign Affairs, State Tax Administration, NERC and the Power Market Operator.
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Increased production o f hydroelectric energy by 360 GWh; Increased (winter firm) hydropower capacity by 250 MW; Reduced O&M costs in rehabilitated hydropower plants by 20%; and Reduced emissions from thermal power plants, including emission reduction o f 1,300,000 tomes o f COz equivalent, due to the increased production o f hydroelectric energy.
4. Project components Eligible program components. Recent sector notes' prepared by the Bank concluded that significant investments in aging energy infrastructure are required for a well-functioning energy market. The following priority investments and technical assistance would be eligible for financing under the proposed Energy Program in order to help the Ukraine energy market to better meet increasing demand in a secure and reliable manner, while converging toward legal, regulatory and technical standards o f the EU Internal Energy Market.
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-
-
Investments to increase operational capacity and flexibility o f hydropower plants which play key role in providing load following, frequency control and other ancillary services in the Ukraine power grid, and, therefore, are critical for opening up the electricity market and meeting technical requirements o f the EU power grid (UCTE); Investments to upgrade the capabilities o f transmission system operator, UkrEnergo, so that i t can implement policy decisions to assure security and reliability o f power supply, including: (a) removing critical bottlenecks in transmission networks and sub-stations; (b) improving operational stability o f power grid; (c) upgrading load dispatch and system control capabilities; and (d) upgrading infrastructure and systems for electricity market administration; Investment to retrofit critical energy facilities and networks to help improve their environmental compliance and reduce losses; Investments in metering andor telecommunications programs designed to improve billing and collections and/or coordination and communications capabilities o f distribution utilities so that they can more effectively participate in the energy market; and A wide range o f technical assistance, for institutional development and p r o g r a d project preparation and implementation, to support implementation o f the WEM (as detailed in Annex 4); and to fund engineering/ environmental services for the preparation and implementation o f investment projects (including but not limited to projects financed by the Bank under the Energy Program) necessary for a functioning energy market.
Hydropower Rehabilitation Project comprises five components: Component A: Rehabilitation of hydroelectric plants. This component includes refurbishment o f 46 hydroelectric units and associated plant equipment at nine hydroelectric plants. I t also 8
Since September 2003, the Bank energy team has prepared separate sector notes o n coal, gas and electricity. These notes identify the k e y challenges facing the energy sector, including addressing the decapitalization o f the sector's asset base and inadequate investments in aging energy facilities and networks.
8
includes refurbishment o f high voltage equipment in nine switchyards connected to these hydroelectric plants.
Component B: Dam Safety. This component includes rehabilitation and upgrade o f the existing, as well as installation o f new dam safety monitoring systems and rehabilitation o f drainage facilities and spillway gates o n six dams o n the Dnipro river and one dam o n the Dnister river. Component C : UHE Institutional Development. This component includes establishment o f a corporate-wide Management Information System (MIS) in UHE. This component also includes provision o f technical assistance to UHE in improving financial management, enhancing dam safety, optimal scheduling o f the multi-purpose cascade o f hydropower plants, capacity building in procurement and project management and training for the UHE staff in dam safety. Component D: Implementation of the Energy Sector Reform and Development Program. This component includes provision to the MFE o f advisory services and consultant assistance in
developing and implementing: (i) an action plan for legal and technical harmonization o f the Ukraine’s energy market with the European U n i o n Internal Energy Market; and (ii) a program of priority investments and technical assistance in the energy sector.
Component E: Implementation o f the W E M Concept. This component includes provision o f clarifying technical assistance to N E R C in implementing the WEM concept, as required for (i) market design and main principles o f market operation; (ii) drafting o f main codes and rules; and (iii) specifying the supporting tools such as software, telecommunication systems and metering. Details o f the Hydropower Rehabilitation Project are presented in Annex 4 and the project costs are summarized in Annex 5.
5. Lessons learned and reflected in the project design Political commitment and adequate financial support are key ingredients o f successful reform programs. Based o n the experience o f the prior power sector investment and adjustment operations, an important lesson learned i s that assessment o f the Government’s long-term commitment and ability to carry out reforms is a key aspect o f assessing overall project sustainability. I t i s necessary to have a reform-oriented government not only during project preparation, but also throughout the entire project cycle. The experience in Ukraine has shown that a reversal o f the initially progressive course o f economic reforms adversely affected the implementation o f the Bank’s energy projects. The proposed Energy Program would mitigate the risk o f policy reversal by agreeing up-front with the Government o n a long-term comprehensive strategy for the energy sector reform and development and through aligning this strategy with the recently signed EU-Ukraine Action Plan. The proposed project would provide further support in the form o f technical assistance for these reforms. One o f key lessons from the past is that there is little merit in pursuing comprehensive energy sector reforms in a country in the midst o f a major economic crisis. W h e n an economy i s fundamentally barter-based, salaries and pensions are in arrears and the Government condones the culture o f non-payment, there is l i t t l e possibility to cause consumers to pay for electricity in
9
cash. In such an environment, the introduction o f an advanced model o f a competitive energy market is likely to fail. Ukraine has made major strides to overcome these past problems and to improve the functioning o f i t s economy, which has been growing significantly over the past four years. Therefore, the present time is judged more appropriate for implementing the proposed Energy Sector Reform and Development Program. Another important lesson learned i s that projects intended to benefit energy producers, such as UHE, ultimately depend upon the ability o f energy suppliers to collect revenues from consumers. This i s particularly critical for large scope investment operations which require significant local financing. The past experience in Ukraine has shown that initial government commitment to ensure the enabling financial environment through comprehensive reforms requires sustained support from IFIs and bilateral donors throughout the progrard project implementation. In this context, cross-sector adjustment operations have led to the most tangible results o n the ground. Therefore, the proposed Energy Program i s aligned with the Bank policy lending under which the Government has committed to further improve financial discipline in the energy sector, including reaching full payment performance, and adopted a comprehensive action plan for financial stabilization o f energy enterprises. Another factor that is critical for the success i s that the beneficiary requires very good technical skills, strong project ownership and commitment to results. UHE has already demonstrated that it has such ownership and commitment under the prior hydropower operation, which was implemented in an adverse reform environment when the power sector was operating mainly through barter and was not yet commercialized and thus required a downsizing o f the investment program. The financial viability o f the electricity market has greatly improved since that operation with payments to UHE at about 94% in the past two years, so that the problems with counterpart funding are less likely to arise again. In order to better ensure that UHE would be able to carry out the substantially larger investment program under this follow-on operation, the proposed project would ensure that proper project management arrangements are in place in a timely manner and supported by consultants and technical assistance as necessary.
6. Alternatives considered and reasons for rejection The Bank has supported Ukraine in its efforts to reform and revitalize its energy sector through adjustment and investment projects and technical assistance since the mid-1990s. Adjustment lending required that reforms be implemented or maintained during the course o f the lending operation, but when the reform targets were not met, the operation either had t o be restructured or cancelled. This was the case for the Coal Sector Adjustment Loan and the Electricity Market Development Project. Investment lending, o n the other hand, has had more positive results. The first investment project financed by the Bank in Ukraine was the Hydropower Rehabilitation and System Control Project which supported the first phase o f hydropower rehabilitation from 1996 to 2002. Despite the successful completion o f the first hydropower project (albeit o n a reduced scale as mentioned above) and subsequent positive results o f two on-going heating and energy efficiency projects’, the Bank concluded that responding to demand o f increasingly sophisticated clients and addressing sector wide issues call for a new lending approach. The proposed The Kyiv Public Building Energy Efficiency Project i s scheduled for completion in June 2005 and the Kyiv District Heating Improvement Project i s scheduled for completion by December 2006.
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programmatic approach would give the Bank the flexibility to match i t s commitments to the pace o f reforms implemented by i t s clients and adapt project design and financing over time to better meet i t s clients' needs. The rehabilitation o f hydropower plants is the highest priority investment project in the electricity sector due to the acute shortage o f regulating capacity in the Ukraine power grid". Increasing hydropower capacity and production o f peaking hydroelectric energy would help the development o f a functioning electricity market, and particularly its regulating/ balancing mechanism. By improving regulating capabilities o f the Ukraine power grid, the Hydropower Rehabilitation Project would help meet one o f the k e y requirements for technical harmonization with the EU electricity market and increasing interconnection with the U C T E power grid. Furthermore, UHE i s one o f the energy companies that is most committed to technical, commercial and governance excellence among all state-owned enterprises in the power subsector, which itself has the most developed reform agenda in the energy sector. C. IMPLEMENTATION
1. Partnership arrangements The proposed Energy Program is, in the first place, a framework for sector-wide cooperation and partnership between the Government o f Ukraine, energy sector entities, financial institutions and bilateral donors, including the World Bank. A s shown in Annex 2, the k e y IFIs and donors active in Ukraine's energy sector include the European Bank for Reconstruction and Development (EBRD), the E C and i t s aide agency TACIS, the United States Agency for International Development (US AID), Swedish Agency for International Development (Sida), the Canadian Agency for International Development (CIDA), and the Japanese aid agency PHRD.
A P H R D grant has been provided by the Government o f Japan for preparation o f the first phase o f the Energy Program. The $670,000 grant supports the Government and the Commission for Energy Sector Reform and Development in preparing a conceptual action plan for legal and technical harmonization o f the Ukraine's energy market with the EU Internal Energy Market. I t will also help assess overall investment needs and indicate priorities in meeting technical and environmental norms o f the EU electricity market. Finally, the PHRD grant provided initial funding for the Permanent Working Group (PWG) which has been established in MFE for preparation and implementation o f the Energy Program. The second phase o f the proposed Energy Program would use results o f technical assistance (TA) projects funded by TACIS in MFE and Naftogas. I t is expected that the recently approved TA projects in electricity and gas sectors (each about Euro 3 million) would help the Government develop: (i) an overall strategy in the electricity and gas sectors; (ii) a time bound action plan for further restructuring and alignment o f the Ukraine energy market with the EU directives and regulations for electricity and gas; and (ii)an investment strategy with a due emphasis on environmental issues.
loDue to the large share o f nuclear power production (about 50%) and poor maneuverability o f thermal power plants, Ukraine lacks regulating capacity for load following and frequency control in i t s power system.
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2. Institutional and implementationarrangements
A comprehensive coordination and implementation mechanism has been established for the preparation and implementation o f the proposed Energy Program. As shown in Annex 6, the mechanism covers and brings together political and administrative leadership, the energy regulator, energy enterprises, financial institutions and bilateral donors.
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A focal point o f the program coordination and implementation mechanism i s the Commission for Energy Sector Reform and Development which was established in August 2004. The Commission would prepare and present to the Cabinet o f Ministers strategic decisions related to energy sector reform and development, including changes in the legal and regulatory framework and prioritize investments to be supported by the Bank. In the process o f preparing these proposals, the Commission would review and approve (periodically update) the conceptual plan for legal and technical harmonization o f the Ukraine energy sector with the EU Internal Energy Market. During program implementation, the Commission would coordinate and supervise implementation o f the conceptual plan, including overall monitoring o f investment projects and technical assistance included in the Energy Program. The head o f the Commission would report to the Parliament annually o n Energy Program activities or o n an as-needed basis.
The Commission is supported by the Permanent Working Group (PWG) for Energy Program Preparation and Implementation. The PWG, headed by the Deputy Minister o f Fuel and Energy, would act as the Commission secretariat and would be in charge o f (i)preparing and updating a conceptual plan for legal and technical harmonization o f the Ukraine energy market with the EU Internal Energy Market; and (ii) developing a program o f priority investments and technical assistance in the energy sector. The PWG would also establish program communication and documentation procedures, manage technical consultants hired to assist in program and project preparation, and assist project implementation entities in meeting program requirements, including fiduciary requirements agreed with the Bank.
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Each beneficiary o f the Energy Program would establish a Project Implementation Unit (PIU). The PIU would be responsible for managing the technical aspects o f project implementation (preparation o f bidding documents, procurement, contracting, supervision o f contractors, construction management, payments and disbursement operations) related to each project component. The PIU would be an integral part o f the project implementing entity and would consist o f staff whose regular responsibilities include the implementation o f investment projects or technical assistance projects. Where necessary, the P I U would be assisted with international and domestic consultants for project management and procurement. The PIU for the Hydropower Rehabilitation Project has been established by an internal order o f the UHE.
Implementation of the Hydropower Rehabilitation Project will be the responsibility o f the project beneficiary, UHE. I t is the successor company o f DniproHydroEnergo (DHE), which has implemented the first stage o f hydropower rehabilitation under the Bank-supported Hydropower Rehabilitation and System Control Project (Loan 3865). UHE i s a fully state-owned open joint
12
stock company formed in February 2004 through a merger o f the state-owned companies DHE (operating a cascade o f hydropower plants o n the Dnipro river) and DnisterHydroEnergo (operating a hydropower plant o n the Dnister river). UHE operates nine hydropower plants (including the Kyiv pumped storage plant) with the total installed capacity o f about 4,600 MW. The overall organization o f UHE and the implementation arrangements for the proposed Hydropower Rehabilitation Project are described in detail in Annex 6.
3. Monitoring and evaluation o f outcomes/results At the national level, the Energy Program will be monitored and evaluated by the Commission for Energy Sector Reform and Development which will report to the Cabinet o f Ministers. The
above described coordination and implementation mechanism, comprising the Commission for Energy Sector Reform and Development, the Permanent Working Group in MFE, and each beneficiary PIU, will monitor and evaluate individual projects included in each phase o f the Energy Program. Hierarchical monitoring and evaluation o f each program component supported by the Energy Program would result in the collection o f all relevant program indicators through appropriate data and information processing starting from the level o f sector entities (individual project sites) and moving up to the level o f policy makers in the Cabinet o f Ministers. The Bank will participate in the monitoring and evaluation process through i t s continuing dialogue with the Government and through direct supervision o f the individual investment and technical assistance projects.
4. Sustainability The current situation and the outlook for the sustainable development o f energy market can be briefly outlined as follows:
M a r k e t participants. Despite some recent concentration o f market power in holding companies in the electricity and coal sectors, these sectors are s t i l l dominated by relatively independent public and private market players (see Annex 1) which are engaged in electricity and coal trading. The gas sector is dominated by Naftogaz, a vertically integrated state-owned holding company which acts as the “single buyer” o f all gas supplied in the country or transported through Ukraine. W h i l e unbundling in the gas sector does not appear very likely in the near-term, the electricity and coal sectors are in need o f further market liberalization which would help improve sector performance and attract investments in aging power plants, distribution networks and coal mines.
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M a r k e t sophistication. The most advanced market mechanism is in the power sector which i s based o n the power pool (single-buyer) model established in mid-1990s. The next step in its development will be the introduction o f a bilateral contracting market and a balancing mechanism which w i l l be implemented over the next 4 to 5 years (see Annex 4). Subject to the rationalization o f state subsidies and mitigation o f social and environmental impacts o f coal sector restructuring, the coal market i s also ripe for further opening which would h r t h e r stimulate competition among power producers.
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-
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M a r k e t regulation. The power and gas industry is regulated by the N E R C while the coal prices are set by the Government. The Government still exerts a considerable amount o f influence o n regulatory decisions across the energy sector, which partially explains why energy tariffs are below the cost and value o f services provided (see Annex 1). T o sustain its strong economic growth, Ukraine needs to restore macroeconomic fundamentals including the improvement o f financial discipline and the gradual elimination o f price distortions in the energy sector. The growing economy and falling poverty rate will also created a more favorable environment for further price adjustments, which will be best implemented through strengthening the independence of N E R C and better targeting o f fiscally affordable and socially adequate subsidies t o the sector and/or to consumers. Harmonization with the EU Internal Energy M a r k e t . The EU and Russia are the major trading partners o f Ukraine and energy is one o f the main dimensions o f this trade (see Annex 1). By virtue o f i t s location, Ukraine has been able to secure significant volumes o f o i l and gas transport through i t s pipelines and competitive prices for the o i l and gas imports. Gradual convergence towards the principles governing the regulation and operation o f the EU Internal Energy Market (gas and electricity) would strengthen Ukraine’s position as the preferred route for future increases in Russian gas deliveries to Europe. Furthermore, i t will open new opportunities for increasing access to the EU electricity market and expand electricity trade. Finally and most importantly, by introducing best practices tested in the EU energy market, consumers in Ukraine would benefit from improved security, reliability and quality o f energy supply.
5. Critical risks and possible controversial aspects Risks
Risk Mitigation Measures
Risk Rating
The proposed programmatic lending will help strengthen Government’s ownership o f the reform process and build up long-term partnership with the Government, IFIs and donors.
S
with Mitigation
To project development objective The political commitment to reform vanishes during the first years o f the program when the benefits are not yet fully visible.
Reform objectives and milestones aligned with the EU-Ukraine Action Plan. The energy sector reform remains one o f key elements o f the Bank C A S and policy lending.
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P
Risks
Risk Mitigation Measures
Risk Rating with Mitigation
Slow or no improvement in financial viability o f energy enterprises due to (a combination of) l o w tariffs, inadequate collections, commercial losses and delays in debt restructuring.
Financial discipline in the energy sector continues to be one o f pillars o f Bank policy lending in Ukraine.
S
Monopoly abuses and distortions arising from market concentration and political interference in NERC’s staffing and decision making.
Government’s commitment to improve transparency and corporate governance in state-owned energy enterprises.
T o component results Changes in MFE, N E R C and UHE’s management slow down program implementation and raise possible controversies about sector priorities.
Project implementation delays due to lack o f local financing and poor project management.
A robust program o f technical assistance to MFE and N E R C included in the proposed loan and complemented by donors.
S
Strengthening administrative and financial independence o f NERC. Selection o f program and project components on a strict priority basis using results o f donor funded studies.
M
Maintain regular intra-Government and intra-sector coordination through the Commission for Energy Sector Reform and Development. NERC’s approval o f tariff adjustments to meet local financing requirements and assure full payment from energy market (Energorinok) to UHE.
S
Technical assistance for project management and procurement during implementation. Close monitoring and supervision o f implementation o f investment projects. Overall risk rating
S
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6. Loan conditions and covenants Conditions for Loan Effectiveness the Subsidiary Loan Agreement between the Ministry o f Finance (on behalf o f the (a) Borrower) and UHE to be signed and duly authorized by Ukraine and UHE.
(b)
the Project Agreement to be duly authorized by UHE and i s legally binding upon UHE.
UHE to select an international project management consultant under Terms o f Reference (c) and with qualifications acceptable to the Bank. Legal Covenants the Borrower to ensure that from Fiscal Year 2006 and onwords N E R C would establish (a) and maintain tariffs for UHE sufficient to cover project co-financing needs in a timely manner. the Borrower to ensure that N E R C would distribute funds due f r o m Energomarket to (b) UHE in a timely manner according to the algorithm in place. the Borrower to ensure that N E R C introduces a two-tier tariff for UHE by December 3 1, (c) 2005. the Borrower to ensure that N E R C introduces a system service charge to be paid to UHE (d) in parallel with the development o f the WEM balancing mechanism. (e) the Borrower to open and maintain three separate Special Accounts in U S dollars for UHE, MFE and N E R C in a commercial bank acceptable to the Bank, under terms and conditions acceptable to the Bank.
the Borrower to maintain throughout the project implementation the Commission for (0 Energy Sector Reform and Development under terms o f reference satisfactory to the Bank.
(8) the Borrower, through the MFE and the UHE, to maintain the PWG and the PIU until the completion the project, under terms o f reference and with a composition satisfactory to the Bank. the Borrower, through the MFE, to provide the Bank o n an annual basis a progress report in accordance with the MFE Monitoring and Evaluation Indicators.
(h)
the Borrower, through MFE, and UHE to prepare a consolidated mid-term report and submit to the Bank by September 30,2008, and review such report with the Bank by December 3 1, 2008.
(i)
the Borrower and UHE to maintain a financial management system and to furnish to the 6) Bank Financial Monitoring Reports for each quarter.
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(k)
the Borrower, through MFE, NERC and UHE, to ensure that the project records, including the Special Accounts and UHE’s financial statements, are audited annually by independent auditors acceptable to the Bank, in accordance with Intemational Standards o n Auditing. (1) UHE to maintain the following financial covenants (see Annex 9 for details): (i) debt service coverage ratio o f at least 1.5 during the project period; (ii) current ratio o f at least 1.2 during the project period; and (iii) to carry out revaluation o f i t s assets in accordance with terms o f reference and consultants satisfactory to the Bank by December 31,2007. (m) UHE to prepare a report annually o n or about March 31, beginning in FY06, for each year during project implementation containing financial projections and projections o f UHE Monitoring and Evaluation Indicators for the upcoming year to be reviewed by the Bank.
UHE to complete the design proposals satisfactory to the Bank for (i) rehabilitation of: (A) drainage facilities; (B) design profiles (rehabilitation o f subsidence); (C) slope protections; (D) concrete spillways and other reinforced concrete works at Kyiv, Kaniv, Dniprovska and Dneprodzerzhinsk dams; and (ii)protection against higher phreatic lines (high piezometric (n)
levels) in the dam embankments at Kaniv, Kremenchug, Dniprodzherzhinsk and Kakhovka dams by December 3 1,2005.
UHE to establish an adequately staffed D a m Safety Center under terms o f reference acceptable to the Bank by December 3 1,2005. (0)
(p) UHE to ensure that a detailed plan for construction supervision and quality assurance, an instrumentation plan, an operation and maintenance plan, and an emergency preparedness plan are prepared and implemented, all in a manner satisfactory to the Bank.
UHE to ensure that all work under Part B o f the project i s designed and supervised by competent professionals.
(4) (r)
UHE to continue periodic dam safety inspections by personnel o f the D a m Safety Center.
(s)
UHE to implement the requirements o f the Environmental Management Plan.
D. APPRAISAL SUMMARY 1. Economic and financial analyses Economic analysis. The economic evaluation o f the proposed Hydropower Rehabilitation Project was carried out by comparison o f Net Present Value (NPV) and Economic Internal Rates of Retum (EIRTX) for “with rehabilitation” and “without rehabilitation’’ scenarios. The “without rehabilitation” scenario assumes the continued operation o f the hydropower units at a progressively deteriorating level o f efficiency. The main plant parameters and other assumptions
17
are presented in Annex 9. The main quantified benefits are: (i)an increase in hydroelectric production of about 360 GWh per year (by 2012) due to the improved efficiency o f the an increase in (winter generating equipment and improved plant management and control; (ii) firm) peaking hydropower capacity o f about 250 M W (by 2012) due to the increased capacity o f rehabilitated units and improved reliability and availability o f units and plant; (iii) power system dynamic benefits due to the enhanced ability o f hydropower plants to provide load following and frequency control; (iv) reduced O&M costs due to the introduction o f modern technologies and standards in operation and maintenance; and (v) environmental benefits due to the reduced emissions from thermal power plants by increasing production o f renewable hydroelectric energy. A s shown in Table 1, plant-by-plant ERRS range from 10.5% to 79.5% indicating that the proposed rehabilitation i s economically viable for each plant. Economic returns are very robust relative to variation in key project parameters. A switching value for the investment cost (to yield an ERR o f 10% for the whole project) i s an increase o f 85% which shows that cost overruns do not pose a significant risk. Variations in other key economic parameters (such as fuel price in thermal power plants) have even less impact o n the project economics.
Table 1. Summary Results o f Economic Analysis Plant Name Kyiv Kyiv PSP ~
Kaniv
I I
EIRR ( O h )
NPV US$ m i l l i o n
B/C Ratio
10.5
1
1.03
17.2 11.5
I I
5 3
I I
1.51 1.10
Kremenchug
21.1
14
1.71
Dniprodzerzinsk
18.5
13
1.59
Dniprovska HPP 1
42.6
19
2.95
Dniprovska HPP2 Kahovka Dnister
TOTAL UHE
I I
79.5 26.6
I I
63 8
I 1
4.39 1.95
13.1
1
1.15
23.2
126
1.85
I I 1 I
The above-quantified benefits are regarded as a minimum measure o f the true economic benefits conferred by the proposed Hydropower Rehabilitation Project. Additional, non-quantified benefits o f the hydropower rehabilitation include: (i)l i f e extension o f the plants (thereby deferring replacement); (ii)improved water quality as a result o f reduction o f leakage o f lubricating-oil fiom old turbine equipment; (iii)enhanced dam safety and reduced risk o f flooding; and (iv) improved plant safety resulting from the upgraded instrumentation and control systems.
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Financial analysis. A financial analysis was carried out for the Hydropower Rehabilitation Project in order t o determine the financial internal rate o f return (FIRR) o f the project. The analysis examined the incremental financial cash flows, defined as the difference between the “with” and “without” project situations both in current and constant 2004 U S dollars. Details o f the FIRR calculations are included in Annex 9, Attachment 9-3. The FIRR has been calculated to be about 7% in real terms and about 15% in nominal terms. This outcome compares favorably to UHE’s estimated cost o f capital o f about 5%, reflecting the estimated cost o f borrowing from the World Bank under the proposed project and the past project, and considering the interest-free loan from the Swiss Government under the past project. Therefore, i t i s judged in UHE’s financial interest t o undertake the proposed investments. Projections o f the likely financial performance o f UHE over the period 2005-2012 have been prepared and are presented in detail in Annex 9. The projections have been prepared to determine the average tariffs” necessary for UHE to undertake the project investment program, repay the proposed Bank loan and other prior loans, remain profitable and maintain satisfactory overall financial performance. The financial analysis shows that the project would require roughly a doubling o f UHE’s tariff by January 2007, t o a s t i l l relatively l o w level o f about U S cents 1.2/kWh12. This i s mainly due to the large share (about 72%) o f financing by UHE o f the project investment costs which are to be covered by current revenues. NERC’s methodology for establishing UHE’s tariffs allows for the recovery o f the costs o f UHE’s operations but not its future investment projects. On April 13, 2005, N E R C provided the letter o f support for the proposed investment project. Furthermore, at the negotiations, it has been agreed that the Borrower would ensure that N E R C would (i)from Fiscal Year 2006 and thereafter establish and maintain tariffs for UHE sufficient to cover project co-financing needs in a timely manner; (ii) distribute funds due from Energomarket to UHE in a timely manner; (iii) introduce a two-tier tariff for UHE by end-2005; and (iv) introduce a system service charge to be paid to UHE in parallel with the development o f the balancing mechanism in the wholesale electricity market. With the proposed adjustments, UHE would reach and maintain a sound and generally satisfactory financial position.
2. Technical UHE is the lowest-cost generator in the Ukraine power system. In addition, hydropower plants operated by UHE are practically the only significant generator o f peaking electricity and provider o f load following and frequency control services in the Ukraine power system, which currently imports the remaining requirements for peaking electricity and power system ancillary service^'^ from Russia. The rehabilitation o f hydropower plants would enhance their ability to provide ancillary services in the Ukraine power system and, therefore, help improve its operational stability and meet technical requirements o f the EU power grid (UCTE).
I’ The analysis was based o n the current singe-tier t a r i f f structure and did not consider potential revenues f r o m the proposed introduction o f capacity and system service charges. l2 For comparison, average hydropower tariff in Romania is about U S cents 21 kWh. l3 The ancillary services, including fast responding generation reserve, are critical for maintaining power system stability and ensuring reliable power supply.
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After more than three decades o f heavy duty operation, the plants’ electro-mechanical equipment i s overdue for extensive rehabilitation. Under the Hydropower Rehabilitation Project, UHE will continue to replace and/or refix-bish key electro-mechanical equipment in nine hydropower plants and associated plant switchyards. This will include (i) replacement o f turbine runners, turbine governors, and rehabilitation or upgrade o f other related equipment; (ii) replacement, rehabilitation o r upgrade o f generator stator and rotor windings, generator circuit breakers, excitation and cooling systems; and (iii) replacement o f high voltage circuit breakers, disconnect switches, surge arrestors and measurement transformers. UHE would also replace practically all plant control and protective relaying with modem Supervisory Control and Data Acquisition (SCADA), diagnostics and protective systems which will increase plant automation and help reduce operation and maintenance costs through better management o f the hydropower cascade and the introduction o f preventive maintenance o f hydropower equipment. Furthermore, the dam safety component will improve monitoring o f six large dams o n the Dnipro river and one dam o n the Dnister river which supply water to the project related hydropower plants and to more than 50 large urban areas with population o f about 30 million. Annex 4 provides a detailed description of the project components. The project costs are summaries in Annex 4. The cost estimates are based o n the feasibility study prepared by UkrHydroProject (UHP) in 2004. This study has updated results o f the hydropower rehabilitation study prepared by SGI Engineering Ltd (Switzerland) in 1994. Therefore, cost estimates reflect the price level o f similar equipment and installation services procured by UHE during the first phase o f hydropower rehabilitation.
3. Fiduciary Lending under the Energy Program will be through IBRD specific investment loans to Ukraine and Bank’s standard fiduciary requirements will apply to the projects and utilities supported. Procurement will be in accordance with the Bank Guidelines for Procurement and Bank Guidelines for the Use o f Consulting Services will apply. The financial management assessment o f the proposed Hydropower Rehabilitation Project covers three main implementing agencies: UkrHydroEnergo (thereafter -“Company”, UHE), Ministry of Fuel and Energy (MFE), and National Electricity Regulatory Commission (NERC). In UHE, the existing financial management system o f the entity would be used for this project. In the case o f MFE and N E R C the project would rely o n the country normal financial management arrangements (use of the agencies’ financial management staff with assistance from financial consultant in the PWG, and use o f the agencies’ accounting and reporting systems). These arrangements are acceptable to the Bank due to: (a) relative strengths o f the treasury system and MOF in ex ante and ex post control over project funds flow, expenditures and reports, (b) relatively l o w risk o f the components D and E (mostly TA), and (c) small size/value o f these components (around 2% o f the total project costs). Despite some minor weaknesses in the financial management arrangements in the three agencies, the financial management arrangements o f the project are acceptable to the Bank.
The Country Financial Accountability Assessment (CFAA) for Ukraine confirms that improvement i s required in the management o f public expenditures, especially for the strengthening o f internal and external audits. The C F A A also identified a lack o f adequate
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control over state owned enterprises, but appropriate steps have been taken recently to improve the control over these enterprises. The annual audited financial statements, which will include (a) entity financial statements for UHE (incorporating components managed by UHE), and (b) combined project financial statements for components D and E, will be provided to the Bank within six months o f the end o f each fiscal year and also at the closing o f the project. The project will produce a full set o f consolidated Financial Monitoring Reports (FMRs) every three months throughout the l i f e o f the project.
Annex 7 and Annex 8 present financial management and procurement arrangements under the proposed project.
4. Social The main objective o f the Energy Program i s to stimulate sustainable economic growth and improving the security, reliability and quality o f energy supply at investments in Ukraine by (i) supporting the country’s aspirations with regard to legal and technical reasonable cost; and (ii) harmonization and increasing integration o f its energy market with the EU Internal Energy Market. The overall social impact o f improving energy supply; mitigating environmental impacts o f the energy sector; supporting growth, investment and employment; and facilitating introduction o f EU norms and standards i s positive. Access to reliable electricity i s a key driver o f economic growth and a direct means o f reducing poverty by improving the productivity o f households and enhancing the delivery o f social services. Ukraine has virtually universal electricity service coverage and the tariff system includes a functioning mechanism to support low-income household^'^. The challenge is to maintain the funding and to improve the quality o f targeting o f this extensive service. The Government has concluded that as a part o f ongoing ambitious reform program, implementation o f the proposed Energy Program is essential to maintain such service. Ukraine, as well as many countries in the region, i s implementing reforms in its energy sector, which inter alia involve tariff adjustments towards full cost recovery and financial discipline including bill collection. This raises the issue o f social protection, to ensure that low-income households have access to adequate levels o f energy supplies. The Energy Program does not contain additional financial targets or conditions, but reinforces these ongoing national efforts. The Hydropower Rehabilitation Project will have n o negative social impact. No land acquisition or resettlement is required and no social assets will be affected. Hydropower accounts for only about 7% o f the total electricity generation in Ukraine, so an increase in hydropower cost, as the result o f the proposed rehabilitation project, would have negligible impact o n the wholesale electricity tariff.
l4 All communal services, including electricity, gas, heat and water, are covered by Ukraine’s social assistance program which provides funding for the costs o f these services that exceed 20% of monthly income for normative usage by eligible households.
21
The Hydropower Rehabilitation Project continues the work carried out under the earlier project, increasing the number o f sites and greatly increasing the number of units to be rehabilitated. Five sets o f stakeholders will benefit from the project: 0 The public - who will receive more reliable electricity supplies at little additional cost; will enjoy cleaner water in the Dnipro River and the Dniester River due t o rehabilitation o f hydro units that currently discharge oil; and decreased dependence o n thermal plants, which will reduce air pollution; 0 UHE management will benefit by having more dependable, efficient equipment that can be managed more effectively and ensure that they can meet their obligations; 0 UHE technical staff and workers will upgrade their skills to operate and maintain updated technologies; 0 Design institutions benefit from updated skills, as well; and 0 Contractors will also acquire new skills and competencies which they can market within and outside Ukraine. These benefits have already been realized through the earlier project, but the number o f affected stakeholders in each category will increase through the new project. The investments included in subsequent phases o f the proposed Energy Program will be assessed individually to ascertain their likely social impact and to identify ways to enhance social benefits and mitigate negative impacts, o f any.
5. Environment Environmental strategy. Ukraine has substantial incentives and opportunities to improve environmental performance in the energy sector. A s a signatory t o the K y o t o Protocol, Ukraine can attract investments in a wide range o f technologies that reduce GHG, as well as obtain carbon credits which in effect are a source o f capital. Fortuitously, most technologies that offer reductions in GHG which affect the global environment also provide reductions in traditional coal combustion pollutants such as dust and acid gases (SO2 and NO,) which impact local and regional air quality and thus are a serious influence o n public health. This i s particularly important in Ukraine where most o f environmental problems stemming from the energy sector are related to the use o f coal. There are other incentives as well. Harmonization o f environmental performance in the energy sector with the EU Directives will allow Ukraine to increase its access to the EU electricity market. Thus environmental improvement provides a significant economic incentive for the energy sector as well.
Air pollution problems and air quality impacts are not the only issue. In some regions, ash disposal has also created significant difficulties. For example, the highly inefficient anthracite
boilers at the Prednipro combined heat and power plant have created a huge waste disposal problem. The ash contains about 20 per cent unbumed carbon, making i t unsuitable as a building material. So, the ash continues to accumulate creating an eyesore and significant source o f water pollution. In this case, with proper combustion technology, this solid waste could be used as a fuel essentially free o f charge.
22
Ukraine n o w needs to develop an overall strategic framework for environmental improvement in the energy sector, and an objective o f the Energy Program i s to support Ukraine in this effort. In the first phase o f the Energy Program, the Bank would provide technical assistance to support the Government in developing this strategic framework. In subsequent program phases, the Energy Program would either directly support appropriate investments for environmental improvements in the energy sector or further assist the Government in developing expertise in utilizing various financing mechanisms such as the KP-based carbon financing (CF) for their investment strategy. Annex 2 provides a detailed description o f the overall approach used to mobilize CF support for the Hydropower Rehabilitation Project.
Hydropower Rehabilitation Project. In accordance with the World Bank Environmental Assessment, the rehabilitation o f hydropower plants is a Category B project. UHE (the project implementation agency) provided an English language version o f the EMP acceptable t o the World Bank o n March 9, 2005 and disclosed Ukrainian language versions o f the EMP at each o f the nine subproject sites from March 4 to 9, 2005. The W o r l d Bank provided the English language version to the Infoshop o n March 9, 2005. Prior to disclosure, public consultations were held at each o f the nine subproject sites. The EMP and supporting documentation for the public consultations are included in the project file. Project approval by the Ukrainian environmental authorities (State Ecological Expertise) i s also presented in the EMP. UHE’ capacity for implementing the requirements o f the EMP was reviewed by the Bank and found to be highly adequate, having benefited from the experience gained in the first hydropower project. Chief environmental issues are associated with project implementation, and these include: noise and engine exhausts from construction machinery, fumes from welding and painting, o i l y wastewaters from roofing and waterproofing operations and disposal o f scrap metal and building material (concrete, bricks, etc.) wastes. At four locations, disposal o f old batteries and battery acid i s an issue. Other than waste mineral oils, there are n o significant hazardous wastes, such as heavy metals, polychlorinated biphenyls (PCBs), o r asbestos. M i n o r environmental issues are associated with normal plant operation and routine maintenance operations. These include noise (turbines and compressors), paint fumes and metal dust in the machine shop, o i l leaks, and oily wastewater from r u n o f f at the o i l storage site.
All environmental issues for both the project implementation and operation phases are minor, of limited duration and extent and readily managed. 6. Safeguard policies Table 2. Safeguard Policies Safeguard Policies Triggered by the Project
Yes
No
[XI
El
Natural Habitats (OPIBP 4.04)
11
[XI
Pest Management (OP 4.09)
[I
[XI
Environmental Assessment (OPIBPIGP 4.01)
23
Cultural Property (OPN 11.03, being revised as OP 4.1 1)
[I
[XI
Involuntary Resettlement (OPIBP 4.12)
[I
[XI
Indigenous Peoples (OD 4.20, being revised as OP 4.10)
[I
[XI
Forests (OPIBP 4.36)
[I
[XI
Safety o f Dams (OPIBP 4.37)
[XI
[I
Projects in Disputed Areas (OPIBPIGP 7.60)
[I
[XI
Projects on International Waterways (OPIBPIGP 7.50)
[XI
[I
-
The Hydropower Rehabilitation Project is in full compliance with a l l environmental requirements o f the Government o f the Ukraine and the World Bank. In accordance with the World Bank Environmental Assessment safeguard policy and procedures (OP/BP/GP 4.0 1) the project has been assigned Category B and an EMP i s required. The proposed financing o f the rehabilitation o f hydropower plants triggers OP 4.37 o n D a m Safety. A detailed description o f the dam safety component o f the Hydropower Rehabilitation Project i s in Annex 10. The hydropower project also triggers OP 7.50 o n Projects in International Waterways. An exemption from the notification requirement under OP 7.50 has been approved by the Bank, as the Hydropower Rehabilitation Project does not involve works and activities that would exceed the original scheme, change its nature, or alter and expand i t s scope and extent t o make i t appear a new or different scheme, and will therefore not adversely affect the quality o r quantity o f water flows to the other riparian. The project will not involve land acquisition o r resettlement or cultural assets, thus neither OP 4.12 nor OPN 11.03, respectively, apply Annex 10).
7. Policy Exceptions and Readiness The Project Team has obtained from the Bank management an exception from the notification requirement under OP 7.50, Projects in International Waterways, as the project will not affect the quantity or quality o f water flows to other riparians, nor be adversely affected by their use. The project i s ready for financing.
24
Annex 1: Country, Sector and Program Background UKRAINE: Hydropower Rehabilitation Project in Support o f the Energy Sector Reform and Development Program
1999
PRODUCTION
IMPORT
Coal (Mt) Crude Oil (Mt) Natural Gas (Bcm) Petroleum Products (Mt) Electricitv (TWh) Total Import (mtoe)
I I
4.70 8.70 59.90 3.70 65.67
2001
2000
60.60 3.80 18.10 3.50 72.06 14.45 71.81
Washed Coal (Mt) Crude Oil & Condensate (Mt) Natural Gas (Bcm) Peat & Wood (Mt) Nuclear (TWh) Hydro (TWh) Total Production (mtoe)"
60.50 3.80 18.10 3.50 77.34 11.39 72.32
I I
''
6.00 5.60 58.60 4.10 62.51
2002
59.90 3.70 18.50 3.50 76.17 12.11 72.15
I 1
6.40 12.80 56.90 1.40 65.77
2003
57.76 3.74 18.60 3.50 77.99 9.66 71.04
I I
5.15 17.00 57.80 1.oo 0.23 69.76
57.60 3.96 19.46 3.50 8 1.40 9.30 72.68
I I
8.40 19.98 59.5 0.507 0.21 75.31
Ukraine has large coal resources and significant proven reserves of natural gas and crude oil. The coal reserves are estimated at 34 billion tons. The o i l reserves are 227 million tons. The natural gas reserves are 1,136 bcm.
25
* A ton o f o i l equivalent i s defined as 10 million kcal. In addition to significant fossil fuel imports for its o w n needs, Ukraine i s also transiting large volumes o f o i l and natural gas to the EU and the South East Europe. About 15% o f total EU o i l imports and over 30% o f EU gas imports are transported through Ukraine. Transit fees contributed about US$416 million to Ukraine’s budget in 2003, while the official economic activity o f Naftogaz and its subsidiaries made contribution o f 6.7%.to the gross economic output.
Energy demand in Ukraine i s characterized by high energy intensity in relation to industrial output and the high share o f industry in final energy consumption. This i s due to the high share of heavy industry (iron and steel) and the l o w efficiency o f energy conversion technologies. Energy consumption per capita is estimated at US$1040, while the energy intensity i s about 2.6 t.0.e. per US$lOOO o f GDP. Despite the economic restructuring and the closure o f some inefficient industrial enterprises during the last decade, Ukraine’s energy intensity is still about three times higher than in the EU. A close correlation between the electricity demand and the change in the country’s GDP suggests that relatively few improvements in energy efficiency were implemented during the 1990s (see Figure 1). This indicates that significant energy savings could be achieved through employing more efficient operating practices and using more modern technologies in energy intensive industries, a l l o f which require strong price incentives and continued reform in the energy sector.
3. Energy Pricing and Financial Viability Average energy prices have been rising in recent years because o f the gradual liberalization o f the energy market. Prices o f o i l and o i l products have been freed, but most o f other energy tariffs are still tailored more to the ability o f consumers to pay than to cost and value o f services provided. Electricity and gas tariffs effectively cross-subsidize from one group o f consumers to others (industry to household), and at the same time do not cover the full costs to suppliers. Table 4 shows that Ukraine must continue its program to raise energy prices to full recovery o f supply costs and to correct serious distortions in the pricing structures for coal, gas and electricity.
Table 4. Actual vs. Cost Recovery Price in the Energy Sector Sectors
Cost Recovery Price
Actual Price
Coal Sector
$3 l l t o n
$25lton
Gas Sector
$7211000m3 (based o n import parity price o f $6011000m3)
$4311000m3
Electricity Sector
U S 4.7 centslkWh
U S 2.87 centslkwh
26
Figure 1. Power consumption in Ukraine 1990-2004
mOther
100
a0
s 0 g
6" Losses and Own
m m r
-
nResidential
x'
0 Municipal Sector
Needs
0
60
Consumers
U
40
0 0
-
6" Transport
-
Q m
20
d
0Agricultural
consumers
0
Industrial consumers
1990 1992 1994 1996 1998 2000 2002 2004
-Real
Years
Figure 2. Gas Payments
90
GW, Index, 1990=100
i
Figure 3. Electricity Payments
4
85 95 ~80
I
75 70
I
'
I
65 2001
2002
Total
2003
2001
2004
Cash
2002
Total
2003
2004
Cash
The financial viability o f the energy sector i s further undermined by non-payments which were significantly reduced in recent years (see Figure 2 and Figure 3), but still remain below 100% and cause continued accumulation o f debts and payment arrears in the energy sector.
27
Furthermore, accumulation o f tax arrears in the energy sector (see Table 5) creates fiscal imbalances and threatens macroeconomic performance o f Ukraine. The poor financial performance limits the ability o f energy enterprises to maintain reliability and quality o f energy supply, which is becoming a major threat for sustainable economic development and more quickly so i f Ukraine’s economy continues to grow at i t s current pace. The financial recovery o f the energy sector, including (i) further strengthening o f financial resolution o f payment arrears, and (iii) elimination o f price distortions, i s one o f discipline; (ii) the main challenges facing the Government in fueling a sustainable economic growth. At the same time, the Government needs to improve the design and the implementation o f social assistance programs16 to help protect vulnerable groups from the impact o f inevitable price adjustments in the energy sector.
Table 5. T a x Arrears of the Energy Sector, UAH million
2001
2002
2003
2004
Electricity Sector
1755.6
2446.8
2515.5
2087.9
Coal Sector
1015.3
1832.7
241 1.1
2588.2
Naftogaz o f Ukraine
2925.6
4635
4562.6
4448.5
Total
5676.5
8914.5
9489.2
9124.6
Sectors
I
4. Energy Sector Reform The progress o f energy sector reform over the last decade was uneven and i t is characterized by different degrees o f restructuring and unequal levels o f market liberalization in three main subsectors (power, gas and coal). Further delays in sector reform may put at risk some special strategic advantages. By virtue o f its location as a crossroads to Europe, Ukraine has been able to secure significant volumes o f o i l and gas transport through i t s pipelines and competitive prices Ukraine needs to maximizing the value o f its pipeline o n the gas and o i l i t imports”. opportunities, the revenues from which already represent a significant share o f GDP. Furthermore, i t needs to invest in its nuclear reactors, hydro and thermal plants, other power facilities and thus secure the growing energy supply i t needs, while capturing power export opportunities arising from i t s increasing access to the EU electricity market. Notably, the upgrading o f the Ukraine energy infrastructure can be subsidized by selling K y o t o carbon credits o n the world market. And while preserving i t s imports o f cheap o i l and gas, the country needs to reserve a competitive place for its o w n production and sale o f oil, gas and coal resources.
l6 In M a y 1995, the Housing and Municipal Service Allowance program was launched. The original objective o f this program was to shield families from the impact o f rapidly rising fuel costs. While this program benefits from an effective administrative structure there are coNERCns about the effectiveness o f its targeting - i t suffers from problems o f both inclusion and exclusion. Consequently the timing o f the implementation o f tariff increases needs to take into account the timing o f reforms to the social safety net. ” Ukraine imports gas at $5OIMCM, which i s less than half the European parity price (in 2003), estimated at $108IMCM by the World Bank.
28
T o protect against its threats and make the most o f i t s opportunities in the energy sector, Ukraine can do the following: (a) further strengthen financial discipline in the energy sector, (b) eliminate price distortions o n a gradual, but firm schedule, (c) improve strategic and operational management o f energy sector assets (the power grid, the o i l and gas pipelines, state-owned energy companies), (d) improve energy regulation, and (e) attract financial resources for refbrbishing and expanding the sector. By doing this, Ukraine will be able to reap the benefits o f more efficient resource allocations and increased productivity across the economy, it will secure the most value out o f its strategic advantages in the sector, and i t will assure itself o f sufficient energy to meet its growing needs. The following provides an outline o f the current reform issues in each sub-sector (power, coal and gas), key areas that need attention and reform actions which will help improve the sector performance.
4.1 The Power Sector During the second h a l f o f 1990s, the power sector went through major structural reforms, including the unbundling o f generation, transmission and distribution, the establishment o f a “single buyer” electricity market and the privatization o f 15 (out o f 27) distribution companies and one thermal power generation company. The reforms produced mixed results in terms o f the sector performance and slowed down after 2001 when the non-payment problem in the “single buyer” electricity market was alleviated by increasing NERC’s control over its financial flows. In the context o f an overall economic revival and an increasing monetarization o f the national economy, the administratively managed electricity market shown impressive improvements by increasing the cash collections from 33% in 2000 to 95% in 2004. The tariffs, however, s t i l l remain below the economic cost and the residential consumers (about 20% o f the total electricity demand) continue to pay less than 55% o f the applicable tariff at the expense o f higher tariffs for non-residential consumers. The energy regulator (NERC) estimates that this cross-subsidy” amounts to about 2 billion UAH per year. The most difficult legacy o f the 1990s i s the large sector debt (an equivalent o f about US$3 billion)” which is the main obstacle for further reforms, including privatization. Furthermore, because o f l o w tariffs and less than full collections, the total sector debt is growing, albeit at a slower rate. The result is a lack o f funds for maintenance and investments in power facilities which are deteriorating at an increasing pace. The decapitalization i s particularly pronounced in thermal power companies which are facing lack o f working capital and in some cases (e.g. Dniproenergo - the largest state-owned thermal power company) are practically bankrupt. Without an urgent improvement in the management o f state-owned thermal power companies and an improvement o f their financial condition, Ukraine may face a crisis in meeting i t s increasing electricity demand2’ despite a large capacity margin2’ in i t s thermal power generation.
Since a l l consumers are paying less than full cost recovery prices, these “cross-subsides” are actually simple subsidies, but the tariff methodology developed by NERC recognizes them as “cross-subsidies”. Based o n this methodology and due t o pressures f r o m trade unions through the Government, tariffs for residential consumers did n o t change since April 1999 and currently cover about 53% o f supply costs. 19 The outstanding payment arrears represent about 85% o f the annual wholesale market revenue. 2o The electricity demand increased about 3% in 2004 and i t is expected t o growth at the same o r higher rate in 2005. Since the nuclear and the hydroelectric plants are fully utilized, most o f the incremental demand must be covered by thermal power plants, which requires higher production o f coal a n d o r imports o f natural gas.
29
A failure o f the state management to address increasing financial strains in the power sector by
using administrative measures prompted the Government’s decision to merge all state-owned assets in the power sector, except for the transmission and power dispatch company ( k e n e r g o ) , into a single holding - NAK Energy Company o f Ukraine (ECU) in 2004. The new company in many ways resembles vertically integrated gas company NAK Naftogaz, but unlike NAK Naftogaz which has a monopoly in the gas market, NEK E C U does not control the whole power market and most importantly i t does not control the high voltage transmission network and the power system dispatch. Through i t s holding o f majority stakes in four thermal power companies and one hydropower company, NAK E C U accounts for about 42% o f the electricity produced in Ukraine and for about 53% o f electricity sales to the wholesale power market2*. Also, the holding company has about 68% o f the distribution market. Therefore, ECU i s a “net buyer” o f about 36 TWh o n the wholesale electricity market. The main challenge for the management o f E C U stems from the poor financial condition o f (majority) state-owned companies included in the holding. F r o m the point o f view o f consolidated financial situation, the amounts owed by E C U exceed the amounts owed to the holding by about UAH 4.5 billion. As shown in the Table 6, practically all debt overhang o f E C U comes from the debt overhang o f distribution companies (Oblenergos) which were transferred to the holding. Furthermore, these Oblenergos account for about 90% o f the debt overhang o f all power distribution companies. The amounts owed by the WEM (Wholesale Electricity Market) to all thermal power companies reached UAH 7.8 b i l l i o n o n January 1, 2004, which includes UAH 7.5 billion owed to state-owned generators transferred t o ECU. The total payment arrears o f thermal power generators in E C U i s estimated at UAH 7.5 billion, about h a l f of which i s owed to fuel (gas and coal) suppliers.
Table 6. Chain o f Payment Arrears in the Power Sector, as o f January 1,2003 Consumers to Oblenergos
Item
WEM
(coal industry)
Total Arrears o f I
NAK E C U
I 10.3 (1.8) I 7.7’
I 12.2 I
I
I
* Estimated by the Bank
I 15.6 I 7.5
15.5
I
Generators to Creditors
WEM to Generators
Oblenergos to
I
I
(for coal)
I 13.4(1.3) I 7.5I
I
I I
The power sector cannot become financially viable without settlement o f accumulated payment arrears, which, first o f all, requires the adoption o f draft law o n resolution o f debts in the energy sector. The establishment o f proper legal framework and adequate institutional arrangements are necessary but not sufficient conditions for the resolution o f debts. The implementation o f the debt resolution scheme will critically depend o n the readiness and the ability o f sector entities to participate in this process, which may include write-offs, mutual settlements, debt restructuring, 2’ Installed generation capacity in the Ukraine Power System (UPS) i s about 53 GW, including 13.8 GW in nuclear power plants, 34.4 G W in thermal power plants, and 4.6 G W in hydropower plants. However, the total available generating capacity i s estimated at about 43 GW, due to the derating and l o w availability o f aging thermal power plants. 22 The largest producer o f electricity i s Energoatom - the state owned nuclear power company - which accounts for about 50% o f electricity production and 36% o f sales to the wholesale power market.
30
refinancing and partial payments. The above table shows that a significant portion o f debts in the power sector m a y be resolved within E C U as a number o f creditors to generators (e.g. coal companies) are also large debtors to distribution companies. The lack o f investments and differed maintenance in aging power infrastructure, particularly thermal power plants, continue to reduce reliability o f power supply and degrade environment in Ukraine. During the 1990s, the declining demand created a large capacity reserve which masked a rapid loss o f available capacity in thermal power plants and increasingly inefficient use o f power facilities, including large distribution losses (about 20% o f electricity supplied t o Oblenergos). The resumption o f growth in electricity demand after 2000, exposed the loss o f available capacity and highlighted the need for investments in the power sector o n the order o f US$1.5 b i l l i o n per year over the next 5 years. About 20% o f this amount i s needed for rehabilitation and re-powering o f the existing thermal power plants and at least the same amount ~. investments are also needed to help introduce for investments in power d i ~ t r i b u t i o n ~These technical and environmental standards which should enable Ukraine to meet conditions for increasing electricity exports24 to the Westem European Power Grid (UCTE). E C U could help uniformly implement technical and environmental standards across the thermal power sector and facilitate its harmonization with the EU directives. I t i s important to note that investments in assets managed by E C U (causing improvements in environmental performance o f thermal power plants and/ or reducing losses in distribution companies) could attract considerable financial support under the K y o t o Protocol. In the near to medium term, NAK E C U could solve many problems which the state management failed to address, including commercialization o f state-owned entities, reduction o f costs and improved payments between distribution companies and power plants. However, lack o f Government commitment to continued privatization and delays in sector reforms could increase risks of market concentration associated with the establishment o f NAK ECU, particularly the risk o f monopoly abuses and weakening o f the energy regulator (NERC). The main sector reforms, needed t o mitigate these risks and to help meet sector challenges in the near to medium term, include: (i) increasing and balancing electricity tariffs; (ii) improving corporate govemance strengthening the financial and administrative of the majority state owned power companies; (iii) independence o f the energy regulator (NERC); and (iv) continuing the process toward gradual market opening based o n replacement o f the single-buyer wholesale electricity market, with a bilateral contracting market and a balancing mechanism.
Even if successful in meeting the above challenges, E C U i s unlikely to solve the current contradictions in the energy sector and to achieve the potential performance which private initiative and competition could. The main such weakness in the energy sector i s lack o f market competition in fuel (gas and coal) supply which stifles competition among power producers. In fact, without market pricing for gas and coal, i t is difficult to clearly identify viable parts o f the thermal power sector and to target necessary reforms, including decommissioning o f non-viable The largest investment needs in the power sector (up to US$500 million per year) w i l l continue to be in improvement o f nuclear safety and other programs o f “Energoatom”. 24 In 1990, Ukraine exported 28 T W h to the nowadays EU member countries or EU-candidate countries in Central and South East Europe. Electricity exports practically disappeared in the mid 1990s but re-started in 1999 and reached 4.3 TWh in 2003. K e y conditions for increasing access to the EU electricity market include (i) harmonization o f technical standards; (ii)reciprocity in market opening; (iii)improvements in environmental protection; (iv) nuclear safety; and (v) pricing based o n full cost recovery. 23
31
power producers. I t i s important to note that the relative stability o f the price o f gas25points out to the coal sector as the main source o f market distortions and non-transparent subsidies which are passed through the power sector to final consumers.
4.2 The Coal Sector The coal i s the largest indigenous fuel source in Ukraine and, therefore, i t plays an important role in ensuring the security o f energy supply. The coal sector i s also the largest recipient o f Government subsidies in the energy sector due to complex and environmental issues associated with the coal production which is concentrated in the Donbas region. The unusually difficult geological conditions (thin, steeply inclined coal seams at great depth) in the central Donbas make the mining o f coal costly and labor intensive. The legacy o f decades o f mismanagement and unfinished reform agenda from 199Os, further increase the social and environmental costs o f the sector reform. The main reform issues in the coal industry and mining communities include: (i) governance in the coal sector, (ii) coal pricing, (iii) state support for the coal industry, and (iv) mitigation o f social and environment impacts o f sector restructuring. Deficiencies o f govemance permeate the Ukrainian coal sector and constitute the overarching problem that will require resolution if restructuring i s to succeed and the industry set firmly o n the path to recovery. The most important attributes o f the sector govemance problems are: murky ownership structure o f the industry, poor mine safety record2’, non-transparent pricing and marketing arrangements, and opacity in allocating subsidies. In order to address governance deficiencies there i s a need to restore Government authority, accountability o f mine operators, and to further involve the private sector through an outright privatization or other forms o f private sector participation through transparent and fair competition and establishing binding clear rights and obligations o f both the public and the private operators. The coal underpricing represents a core problem o f the industry with coal prices reflecting neither the cost o f production nor the cost o f alternative energy sources. While the coal prices have been growing during 2003 and 2004 they are s t i l l below production costs. The difference between the production cost ($30.7/ton) and market price ($25.2/ton) in 2003 was $5.5/ton resulting in annual revenue loss o f about $322 million. Achieving coal prices that fully cover the production cost o f viable mines and reflect economic alternatives to domestic coal could be done in two phases. First, i t is necessary t o identify viable mines having production cost below the 25
Following the settlement o f gas debts (US$1.4 billion) in August 2004, Ukraine and Russia signed two framework agreements on the transit o f o i l and gas through Ukraine for the next 15 and 25 years, respectively. According to the 2005-2030 gas transit agreement, Russia guarantees additional gas transits (raising from 5 b c m in 2005 to 19 b c m in 2010) above the previously agreed levels o f 122-127 bcm per year in 2002-2006. Furthermore, after 2007 Gazprom w i l l be a single source supplier o f gas to Ukraine as the company contracted practically all available gas production in Turkmenistan from 2007 to 2028. 26 In 2001, about 480,000 people were employed in the coal sector. While the labor productivity increased from about 25 tons per month in 2001 to 28 tons per month in 2004, it i s still significantly lower than the productivity in Poland (56) and Western Europe (140). Despite the increasing productivity, the cost o f producing a ton o f coal continues to grow due to non-competitive procurement o f mining equipment and materials, deteriorating quality o f coal and increasing environmental costs. 27 The number o f fatal accidents has decreased in the last few years to about 3 person per 1 million tons o f extracted coal, but i t i s s t i l l higher than in 1991 (2.2 persons) and much higher than in Russia (0.5) and U S A (0.03).
32
economic alternatives and to introduce (temporary) price regulation forbidding the sale o f coal at price below cost recovery levels. Second, the regulation o f coal prices should be phased out with the development o f fuel markets. Hopelessly loss-making mines with depleted economic coal reserves and those with unacceptable and economically unsolvable safety parameters should b e closed. The subsidies to viable core o f the industry are to be provided o n market and not cost basis with revised levels and forms o f support and improved administration. The coal industry has been receiving sizable subsidies for the State budget exceeding 3 UAH billions per year over last t w o years. However, the subsidies were not efficiently utilized through nontransparent ad hoc allocations and the sector performance has been deteriorating. There are two aspects pertaining to the subsidy subject that should be considered and addressed, namely the level and form o f support, and its administration. The level o f subsidies should go down with coal price realignment toward cost recovery and other forms o f subsidization, such as interest-free credits should be gradually introduced. W o r l d experience with administration o f subsidies shows that the most effective subsidy systems share two key attributes: (a) they are provided for clearly defined purposes under transparent rules; and (b) they are provided for a limited period o f time. Policy goals will be most effectively achieved when Governments make public their programs of subsidizing specific industries and unsure that they are diligently implemented. The sector downsizing and resulting social and environmental aftermath need t o be addressed in a more decisive and rational manner if restmcturing benefits are t o be fully realized. There are n o w more than 100 mines that have been shifted from the production to closure since the beginning o f the restructuring in 1996. However, none o f those mines has been completely closed and written o f f from the industry balance, because o f inflated design cost o f closure and inadequate budget resources to fully cover these costs. A s a result, there is growing displeasure o f both the profile ministry charged with the closure o f mines (MFE) and population living around ex-mining sites that i s suffering from poor environmental, healthy, and infrastructure conditions. In order to rectify the current unsatisfactory situation with the mine closure and mitigation o f social and environment impact i t i s necessary to undertake to following measures: - Rationalize the plans o f physical closure o f mines by excluding unrelated costs, optimizing the remainder expenses, and accelerate the completion o f the closure; Assistance in finding new employment and other forms o f social support should be focused on most vulnerable groups o f population i.e. women, elderly people and children. The priority should be given to l o w cost measures such as supporting the migration. Creation o f new jobs for miners from closed mines should be replaced with assistance to move to the regions where there i s shortage o f mine force (according to MFE, there are several tens o f thousands vacancies at operating mines); Environmental expenses are to be prioritized with clear delineation o f urgent works to be supported from the mine closure budgets and the other less burning measures to be excluded from the closure plans and financed in the context o f broader regional environmental management programs; - Revise cumbersome legal and regulatory framework for accelerating the transfer o f social assets from mines to municipalities. Provided continued migration from ex-mine settlements, rationalize the social assets and develop plans for restoration and financial viability o f remaining assets;
-
-
33
4.3 The Gas Sector The gas sector plays a major role in the economy o f Ukraine. Gas represents about 50% o f Ukraine’s primary fuel consumption, domestic gas production meets about 12% o f the country’s primary fuel needs and the transit gas pipeline system is a significant strategic asset generating annual revenues o f about $1.5 billion2*. The sector, however, provides implicit subsidies t o the economy o n the order o f 2% o f GDP and does so at the cost o f being unable to generate the funds needed for prudent reinvestment in the sector both to maintain existing assets and to expand operations with the objective o f more effectively exploiting Ukraine’s underlying hydrocarbon resource base and strategic location. These subsidies are effectively provided by NAK Naftogaz, which is a vertically integrated state-owned company and the “single buyer” o f all gas supplied in Ukraine and transported through the country. In providing these subsidies, Naftogaz and its subsidiaries have been forced to forego potential profits associated with domestic gas production and attributable to payments received in kind for the transit o f Russian gas. Naftogaz has also proved unable to meet its full tax obligations with the result that i t is n o w the largest tax debtor in the country with tax debts in excess o f UAH 4.6 billion (equivalent to $0.85 billion).
While collection problems, which have been substantially reduced over the last few years, contribute to the creation o f these implicit subsidies, by far the lar est component o f the subsidies results from gas being priced at below its true economic value2’. Continuing efforts t o improve collections and a focus o n reducing operating costs and commercial losses are needed and will contribute to an improvement in the financial outlook for the gas sector. However, until gas price tariffs are brought up to levels that cover the full economic cost o f the gas, the sector will remain financially susceptible and the country’s ability to achieve optimum exploitation o f its gas resources and infrastructure will be constrained. Ukraine is endowed with substantial gas reserves and has the potential t o increase production significantly. Naftogaz’s o w n assessment suggests that gas production could be increased by as much as 12 B C M per year or more. A production increase o f this magnitude will require investments o n the order o f $1.5 to $2 billion, w h i c h the country would be hard pressed to generate from internal sources. In addition, Ukraine has sizeable funding needs to maintain its existing infrastructure and would also require substantial capital if i t is to expand the gas transit line to take advantage o f a potential future increase in Russian gas exports to Europe. Consequently, Naftogaz already started raising resources o n the international bond market with its US$450 million Eurobond issue in 2004. In order to do that, Naftogaz organized an audit o f its consolidated financial statements by an international recognized auditing firm.30I t also worked with international advisors to enhance its o w n ability to develop strategic plans, and made progress on consolidating control over its o w n subsidiaries. In the future, current and 28 The transit tariff is currently paid largely in kind, in the f o r m o f gas. In 2002, the tariff consisted o f a cash payment o f about $141 m i l l i o n and a payment in the f o r m o f gas o f about 26 b i l l i o n cubic meters. This represented a total value o f almost $1.5 billion. 29 At present, the economic value o f all the gas consumed in Ukraine is equivalent t o import parity cost which i s approximately $60 per thousand cubic meters. 30 In particular, i t hired international firms t o conduct o i l and gas reserve evaluations, assessment o f the value o f its fixed capital, and the audit itself.
34
potential investors are going to demand continued improvements in operational performance o f Naftogaz, and more transparency o f the company. Thus, Naftogaz should take all necessary steps to embrace best practice transparency requirements for national o i l companies both at the holding company and at the subsidiary level.
If Ukraine i s to take maximum advantage o f the opportunity for future trade with the EU, it should plan to harmonize i t s o w n gas market structure with the structure o f the EU Internal Energy Market. From this point o f view, an unbundling o f gas operations both vertically (Le. by separating production, transmission, storage and distribution) and horizontally (i.e. by setting up a series o f competing production companies) would go a long w a y in meeting applicable EU
directives which provide common rules o n storage, transmission, supply and distribution o f natural gas. This would also eliminate potential conflict o f interest and w o u l d promote gas to gas competition in Ukraine. The unbundling does not require a break-up o f Naftogaz, as i t can be done through full separation o f subsidiary units into discrete operating companies with financial and managerial autonomy, with each company being expected t o function as an independent commercial enterprise, but with an obligation to report financial and operating results t o the holding company. This “internal unbundling” would have the added benefit o f separating specific investment components financed by bond or other instruments. This should help attract investment to the most viable projects, while narrowing and strengthening management accountability o f the use o f raised funds by project, without surrendering the ability o f Naftogaz itself to borrow o n behalf o f i t s subsidiaries. Ukraine’s high pressure gas transit line i s a major strategic asset. However, if Ukraine is t o extract the maximum benefit from this asset i t needs to convince Russia that it will behave as a “good transit country” for the indefinite future and that i t should be the preferred route for future increases in Russian gas deliveries to Europe. At the same time, Ukraine needs t o ensure that the State receives a fair share of the economic rent associated with gas transport. I t should also provide support to the development o f the domestic gas production sector by ensuring that some transmission capacity is available for exports o f Ukrainian gas.
Discussions have been underway about establishing a consortium involving Ukraine, Russia and, possibly, one or more European partners to manage the operation o f the transit pipeline system. Discussions have addressed both the existing transit system and a possible new transit pipeline. Such an arrangement, particularly for the existing transit system, should go a long w a y to achieving the goal o f convincing Russia that Ukraine will act as a “good transit country” in the future. If structured as a concession or outright privatization, i t should also address the question o f funding sources for needed capital investments in the system. With o r without a new arrangement for the management and operation o f the transit pipeline system, the transit tariff needs to be reviewed and the amount allocated t o the State budget3’ needs to be re-examined. Ukraine should also seek to have the payment o f tariffs converted from a predominantly in kind arrangement to a 100% cash arrangement.
3’
The transit arrangements calls for a tax payment by Naftogaz o f $0.29lMCM per 100 kilometers o f gas transited through the system. In 2002, this tax payment amounted to about $380 million which represented the total o f direct contributions to the State associated with the transit.
35
4.4 Key steps and program milestones In light of the issues outlined above, the following recommendations summarize k e y next steps that should be considered by the Government o f Ukraine. This effort can be supported by the Bank through b o t h technical assistance and financial resources under the Energy Sector Reform and Development Program.
The overall objective o f the Energy Program is to improve the security, reliability and quality o f energy supply and, therefore, facilitate unimpeded operation o f the energy market, b o t h domestically and internationally. Also, the Energy Program would support Ukraine’s aspirations with regard to legal, institutional, regulatory and technical harmonization and increasing energy trade with the EU Internal Energy Market through priority investment projects and technical assistance.
To achieve this overall objective, the Energy Program is designed to help with the following:
-
-
Adopt an action plan for harmonization o f energy policies with the main principles o f the EU Internal Energy Market, including EU Directives o n electricity (2003/54/EC) and gas (2003/55/EC); Converge toward market principles: > Improve financial viability o f energy enterprises through: (i) reducing payment increasing collections; (iii) reducing energy losses; and (iv) reducing arrears; (ii) price distortions;
> Improve corporate governance and commercialization o f majority state-owned energy enterprises through: (i) contracting o f performance targets with independent (from company management) and professionally qualified Supervisory Boards; and (ii)increasing transparency and compliance with reporting and disclosure requirements applicable t o publicly quoted private sector enterprises in the EU energy market; >
Strengthen the energy regulator (NERC) through: (i)adopting l o w o n the state regulation which will exempt NERC’s decisions from reviews by individual ministries and other Government agencies, enable N E R C t o set its own staffing and salary policies, and establish a source o f funding for N E R C separate from the state budget; and (ii) building institutional capacity o f NERC through provision o f necessary technical assistance;
>
Introduce E C regulations related to the third party access to electricity and gas networks, cross-border energy trade, public service standards (quality o f service) and environmental protection requirements;
> Open up the power market by replacing the single-buyer wholesale electricity market model with a bilateral contracting market and a balancing mechanism;
-
> Implement priority investment projects need to improve safety, security and reliability o f energy supply, reduce environmental pollution and meet technical requirements for increasing access to the EU Internal Energy Market. Adopt a strategic action plan for further restructuring, ownership transformation and private sector participation in the energy sector.
36
-
Adopt an action plan for increasing electricity interconnection o f the Ukraine power grid with the U C T E power grid.
5. Energy sector investments as affected b y the Kyoto Protocol Ukraine is one o f the countries with the most to gain from the entry into force o f the K y o t o Protocol (KP) o n Greenhouse gas (GHG) emissions in February 2005. By taking advantage o f financial mechanisms introduced under the KP, significant financial resources and foreign investment could be harnessed to meet growing investment needs in the energy sector. largest emitter o f GHGs in the world3* and has one o f the largest “surpluses” Ukraine is the 1lth o f carbon emission allowances33estimated at about 1.8 billion tons o f C 0 2 equivalent under the KP. This gives Ukraine the opportunity to eam billions o f dollars starting in 2008. This additional foreign exchange can be earned through two separate mechanisms: either by selling excess permits (AAUs) or by undertaking investments projects co-financed by O E C D countries which reduce emissions o f greenhouse gasses. Regarding the first mechanism, Ukraine can cash in these excess emission permits o n the international emission trading market. In order to do this it will need to meet UN eligibility requirements for (a) calculating i t s excess emissions units, and (b) managing transactions and reporting, by January 1, 2007. In addition, O E C D countries have indicated they will buy these excess emission permits provided the selling country, Ukraine for example, re-invests the corresponding proceeds in projects that reduce emissions, the so-called “green” investments. If Ukraine meets these requirements, i t will be able to start selling excess greenhouse gas units (Le., a ton o f carbon) at the market price34, starting o n January 1,2008. Using these proceeds to invest in “green” projects would enable Ukraine to reduce its emissions further and generate additional excess emission permits which can also be traded o n the international market. But Ukraine should be ready to enter the market o n January 1, 2008, and be aware that the price o f carbon credits will fall significantly in case Russia enters the market. This is because the excess emission permits by Ukraine and Russia combined far exceeds the shortage o f emission permits among OECD signature countries (which exclude the US). The second mechanism, and a more palpable approach at the moment, i s that Ukraine can cash in through investments co-financed by OECD countries that reduce GHG emissions.
GHG emissions in the energy sector o f Ukraine account for about 75% o f all GHG emissions in the country. The energy sector offers ample opportunities for cost-effective reduction o f GHG emissions35which could be used to attract significant financial support through the above KP mechanisms to meet growing investment needs in the sector. Unfortunately, institutional capacity, which is necessary to implement KP mechanisms, i s l o w in Ukraine and the country i s poorly prepared to capitalize o n this opportunity and at the same time to help other countries (i.e. This assessment i s based o n the study “Modeling and Analysis o f Greenhouse Gases Emissions in Ukraine” conducted by the Pacific Northwest National Laboratory (USA) and Agency for Rational Energy U s e and Ecology (Ukraine) in 2001. 33 Ukraine’s carbon emission allowances or Assigned Amount Units (AAUs) under the KP are well in excess o f what the country needs to meet its obligations in the f i r s t commitment period from 2008 to 2012. 34 The market price i s expected to vary from US$2 to U S $ l O per ton o f C02 equivalent. Therefore, proceeds from emissions permit trading may be $300-500 million per year or more between 2008 and 2012. 35 The National Strategy o f Ukraine for Joint Implementation and Emissions Trading estimated that Ukraine has an emission reduction potential o f about 565 million tons o f C 0 2 through the implementation o f energy savings measures from 2003 to 2012. 32
37
developed countries) meet their obligations under the Protocol. Through i t s unique Carbon Financing (CF) experience and the pivotal position in the Carbon Market, the World Bank can help Ukraine (i) build i t s institutional capacity in this area; (ii)mobilize C F support for Joint Implementation (JI) projects in the energy sector, which will also provide a valuable learning experience for further use o f KP mechanisms.
38
Annex 2: Major Related Projects Financed by the Bank and other Agencies
UKRAINE: Hydropower Rehabilitation Project in Support o f the Energy Sector Reform and Development Program The following i s a selective listing o f related projects and highlights o f those that are directly supporting le proposedEner y Program. Activities Donors
The W o r l d Bank
Hydropower Rehabilitation and System Control Project (completed). Total Project Cost: US$190 million World Bank Loan: US$114 million. Co-financing from the Swiss, Canadian and Norwegian governments. Board Date: April 11, 1995 Completed: June 30,2002 The objectives o f the Hydropower Rehabilitation and System Control Project were to: (a) improve the efficiency, reliability, safety and environmental performance o f hydropower plants; (b) increase hydropower generation capacity; (c) improve the quality o f electricity supply by upgrading load and frequency control; and (d) reduce fuel costs by facilitating the economic dispatch o f generating units. The project includes the following components: (1) partial rehabilitation o f the K i e v pump storage plant (PSP); Dnieper Iand 11, Kakhovka, Kiev, Kanev, Kremenchug and Dniprodzerzhinsk hydropower plants; (2) installation o f dam safety monitoring systems at the main dams o n the Dnieper river; (3) upgrade o f communications, dispatch, system control and protection, and generating unit control; and (4) technical assistance for project implementation, and optimization o f the use o f the reservoirs on the Dnieper river. Coal Sector Adjustment L o a n (Coal Secal) (completed) Total Project Cost: US$300 million World Bank Loan: US$300 million. Board Date: December 11, 1996 Completed: December 3 1, 1999 The objectives o f the Coal S E C K project were to : (a) to support balance o f payment and budget financing needs through 1996 - 2000, including the part o f the fiscal costs o f restructuring the coal sector; (b) to help transform the coal sector onto a self-sustained sector; and (c) to improve the productivity o f the coal sector. Coal Pilot Project (completed) Total Project Cost: US$28.5 million World Bank Loan: US$15.8 million Board Date: M a y 16, 1996 Completed: December 3 1,2000 The main objective o f the Coal Pilot Project was to mitigate the social and environmental consequences that have arisen from the government's decision to close uneconomic coal mines, as part o f govemment's overall restructuring program for the coal sector. The project also aimed to help: (a) test ways to implement the government's decision to close mines safely, with due regard to technical, environmental, economic, financial and social aspects at three pilot mines; (b) ensure
39
that mine workers were afforded opportunities to either transfer to other jobs in the sector or exit the industry with reasonable compensation and a choice o f assistance for seelung other employment; (c) transfer social assets to municipal management, support their rationalization and help ensure that adequate social protection measures are put in place to support the most vulnerable people; and (d) gain experience from the project for subsequent bank assistance operations in the sector. The project consisted o f the following five components which will serve as the basic framework for mitigation initiatives in subsequent sector operations requested by the govemment: (1) mitigation o f mine closure including physical closure and environmental mitigation; (2) social mitigation; (3) social infrastructure divestiture; (4) institutional strengthening and j o b counseling; and (5) technical assistance.
Kyiv District Heating Improvement Project (under implementation) Total Project Cost: US$250 million W o r l d Bank Loan: US$200 million, Finnish and U S Govemments provided project preparation funding. Board Date: M a y 2 1, 1998 The objectives o f the K i e v District Heating Improvement Project are: (a) to replace and increase heat production capacity to better meet existing and expected future demand and to improve the reliability and service levels in the K i e v District Heating (DH) system; (b) to extend the life of, increase the efficiency of, and enhance conservation o f the K i e v DH system, through rehabilitation and introduction o f modem technologies and materials; and (c) to promote sound cost recovery policies and practices and the commercialization an institutional strengthening o f project DH companies, to identify the most efficient corporate and institutional structure for provision o f DH in K i e v and ways to facilitate the eventual privatization o f the service, and to support project implementation. The components include: (1) heat production capacity improvement; (2) DH rehabilitation; and (3) institutional support.
Kyiv Public Building Energy Efficiency Project (under implementation) Total Project Cost: US$30 million World Bank Loan: US$ 18.29 million Board date: January 27,2000 The K i e v Public Buildings Energy Efficiency Project supports the Government's Comprehensive State Energy Conservation Program, which aims at achieving energy savings through targeted investments. The components include: (1) Energy efficiency improvements in public buildings, healthcare and educational buildings. The component supports installation o f heat meters, automate substations, radiator reflectors, ceiling fans, faucet f l o w restrictors, and hot water heat exchangers. (2) Technical audits, to yield engineering estimates o f the buildings' present energy consumption, and identify feasible retrofit actions for energy efficiency. Technical designs for retrofit measures will be required, as w e l l as technical specifications for competitive bidding. Substantial training will be provided. (3) Consulting services for project management, to include monitoring and evaluation, and, to develop training modules for energy efficiency measures. An awareness campaign will be developed, and training programs included. Consultants will review regulations for social assistance support, and strengthen communications, through computerizatior provision. (4) Financial audits, t o cover incremental audit costs.
40
European Bank for Reconstruction and Development (EBRD)
Balkan Gas Transit I1 Year signed: 2001 EBRD loan: Long-term loan o f up to U S $ 9 7 million (€1 12 million) to finance construction expenditure o f 70 km o f parallel gas pipelines. There are also potential co-financing opportunities to commercial banks. Total Project cost: $ US 118 million Project objectives: Project aims to reduce the bottleneck in the Ukrainian gas transportation system and increase supply, especially in winter periods, to Turkey, Bulgaria, Romania, FYR Macedonia and Greece.
K2R4 Safety Upgrade In July 2004 the EBRD Board o f Directors approved a $42 million loan to modemise and improve safety for two nuclear reactors in Ukraine: unit 2 at Khmelnitsky (K2) and unit 4 at Rime (R4). The 1,000-megawatt reactors are being built by Energoatom, Ukraine’s state-owned nuclear power-generating company. As Ukraine completed construction o f these reactors, it has requested that the EBRD and the European Community help finance post start-up safety and modemisation measures. In addition to the EBRD’s $42 million, the EC plans to lend a further $83 million.
Canadian International Development Agency (CIDA) European Union (TACIS)
USAID
Ukraine Energy Service Company Year signed: 1998 EBRD loan: U S $30m Project objectives: UkrEsco identified and implemented energy-saving investments in SMEs and public sector institutions. Currently the second energy efficiency project i s being considered by the Bank. Energy and Nuclear Safety 3 projects from C A D $3,900,000 up to C A D $32,200,000 for the period o f 1997/122007/12) The Project on Creation of the Gas Metrology Centre at Boyarka (split up into t contracts for the design, supply o f equipment and certification o f the Centre) An overall amount - Euro 7,9 million: Financing small scale investments in o i l and gas RAP INOGATE 1999 Inogate metrological station eastern Europe - TA: RAP INOGATE 1999 Validation and certification RAP INOGATE 2002 Gas Meter Test and Calibration Equipment for the East European Regional centre for Metrology o f Natural Gas in Boyarka, Ukraine.
AP 2000 Technical Assistance Support to NERC in strengthening the energy market reform and assessment o f the energy sector sustainability (Euro 3 million). USAID programs in the energy sector produced substantial results and were instrumental in achieving current threshold for infrastructure reforms. The key programs that contributed to this result include: (a) Legal, Regulatory and Market Development Reform; (b) Support to Privatization in the Energy Sector; (c) Education o f Energy Managers; (d) Partnership o f Utilities. USAID programs produced following results: Electricity Market has been created, including generation, transport, distribution companies set up, Market Agreement signed, energy regulator
41
(NERC) established; Successful transparent privatization occurred in 6 power distribution companies; Tariff policy developed and approved for power distribution utilities; Financial stability restored due to cash collection improvements. While USAID’s assistance has directly led to the creation o f power market and privatization o f some energy assets, further liberalization o f the energy sector was not supported by the previous Government o f Ukraine. There three areas o f U S A I D investments in energy sector:
District Heating and Energy Efficiency Total amount: US$ 11.7 million Projects: Installation and Monitoring o f Energy Efficiency. Equipment for ESCO Alexandrina; Municipal Energy Efficiency (Alliance to Save Energy); Energy Efficiency - Kharkiv; Industrial Energy Efficiency; Energy Efficiency Center; Demand Side Management. Energy Subsector Restructuring - Privatization and Restructuring Total amount: US$ 5 1,8 m i l l i o n Projects: Power Sector Restructuring GeneratiodRegulatory Reform; Distribution Companies Restructuring; Coal Safety and Restructuring; Coal M i n e Safety; Coal B e d Methane; Coal Marketing; Alternative Fuels Center; Utility Partnerships; Oil and Gas; Power Sector Privatization; Debt Restructuring; Ukraine Regulatory Association; Coal - U S Dept o f Interior; Energy Market Development. Nuclear Safety Total amount: US$45,00 million Projects: Chemobyl Initiative; Nuclear Safety; Nuclear Safety-Chomobyl; Energy Efficiencv-Chomobvl
42
Annex 3: Results Framework and Monitoring
UKRAINE: Hydropower Rehabilitation Project in Support o f the Energy Sector Reform and Development Program Table 7. Results Framework
PDO The Energy Sector Reform and Development Program would (1) help the Ukraine energy market t o better meet increasing demand in a secure and reliable manner, while converging toward legal, regulatory and technical standards of the EU Internal Energy Market; and (2) provide priority investment support for rehabilitation and upgrading o f hydropower plants.
Intermediate Results One Der ComDonent
Component A: M a i n contracts for rehabilitation o f hydropower units are awarded by November 30,2005.
Component B: Design proposals for dam safety strengthening measures completed by December 3 1,2005 Component C: UHE hires an international project management and procurement consultant by September 30, 2005. Component D: Permanent Working Group in MFE prepares an indicative l i s t o f priority investments in energy infrastructure by M a r c h 3 1, 2006. Component E: NERC hires consultants for development o f market rules by M a r c h 3 1, 2006.
Outcome Indicators
Use o f Outcome Information
(1) Progress in energy market reforms in accordance with the program milestones agreed under the Energy Program.
A n increasing number o f eligible electricity consumers are free t o choose their electricity supplier.
(2) M o r e than 70% o f hydroelectric units in UHE are refbbished and the balancing mechanism o f liberalized power market operates with a help o f ancillary services provided by UHE.
Ukraine i s better prepared to meet UCTE requirements related to the load following, frequency control and stability o f its power grid.
Results Indicators for Each ComDonent
Use o f Results Monitoring
Component A: Rehabilitation is completed and ancillary services are available f r o m 8 units in 2007; 8 units in 2008; 9 units in 2009; 9 units in 2010; 7 units in 201 1; and 5 units in 2012.
Component A: Transmission system operator (TSO) uses the ancillary services made available by UHE.
Component B: Computer-aided dam safety monitoring systems i s installed and operational at Dniprovska, Dniprodzerzhinsk, K a n i v and Dnister dams.
Component B: D a m Safety Center uses monitoring systems for immediate analysis and interpretation o f a l l relevant dam safety data
Component C: A m o d e m Management Information System (MIS) i s established in UHE. ComponentsD: A conceptual plan for legal and technical harmonization o f the Ukraine’s energy sector with the EU directives and norms i s established and periodically updated. Component E: Balancing mechanism i s established based o n market rules approved by NERC.
I
43
UHE participates in the balancing mechanism and provides key ancillary services..
Component C: UHE uses M I S for financial management, including sales, billing and collections fimctions. Components D: MFE harmonizes energy policies with the main principles o f the EU Internal Energy Market. Component E: Power producers and eligible wholesale buyers are using bilateral contracts for electricity trade.
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Annex 4: Detailed Project Description
UKRAINE: Hydropower Rehabilitation Project in Support of the Energy Sector Reform and Development Program Project Component A: Rehabilitation o f Hydroelectric Plants. This project component deals with the rehabilitation o f nine hydroelectric plants which account for practically all hydropower production in Ukraine and meet about 7% o f the total electricity demand in the country. The Table 9 summarizes main features o f these nine hydroelectric plants. Table 9. Main Parameters o f UHE’s Hydroelectric Plants Installed Capacity MW
Plant Name Kviv Kyiv PSP ~~
Kaniv
I I
408.5 235.5 444
Turbines
I
Type and Number Bulb(20)
I Frances(6) I Bulb(24)
Year o f Comwiaain,.
I
I I
1964-1968 1971-1972 1972-1975
I I ~
749.6 182.9 924.5
I 1
21 9 24
625
Kaplan ( 12)
1959-1960
1,496.6
27
Dniprodzerzinsk
356.4
Kaplan (8)
1963-1964
1,278.9
41
Dniprovska HPP 1
627 876.6
Frances (9)
1932-1950 1974-1980
3,85 1.4
29
Kremenchug
Dniprovska HPP2
Kaplan (2) Propeller (6)
Kahovka Dnister
TOTAL UHE
311.6
Kaplan (6)
1955-1956
1,439.2
53
702
Kaplan (6)
1981-1983
1,060.2
17
1932-1983
10,983.4
27
4,586.6
99 units
The proposed project will build on the previous Hydropower Rehabilitation and System Control Project (Loan 3865) which was successfully completed in 2002. Beneficiary o f the Loan 3865 DniproHydroEnergo (DHE) - completed rehabilitation o f 16 hydroelectric units between 1996 and 2002. After the Loan closing, DHE continued the rehabilitation and its successor company UHE3’ will complete refurbishment o f another 10 units by the end o f 2005. The proposed Hydro Power Rehabilitation Project will support the next phase o f hydropower rehabilitation (2006201 1) which includes refurbishment o f 46 hydroelectric units at nine hydropower plants. The experience gained during the first Bank project and sound financial condition o f UHE (due to improved financial discipline in the power sector) are main reasons for the increase in number o f units to be rehabilitated during the next 6 years in comparison to the first phase o f hydropower rehabilitation. 37 UHE is fully state owned Open Joint Stock Company (OJSC) which was established by merging OJSC DniproHydroEnergo and OJSC DnisterHydroEnergo in February 2004.
45
The rehabilitation o f hydroelectric plants involves: 0
0
0
Rehabilitation o f generating units, including replacement o f turbine runners, turbine governors, and replacement, refurbishment or upgrade o f other related equipment (guide vanes, servomotors, measuring and control devices). I t will also involve rehabilitation o f generators including replacement, refurbishment or upgrade o f stator and rotor windings, generator circuit breakers, excitation and voltage control systems, and unit transformers. Modernization o f plant monitoring and control systems, including introduction o f hierarchical Supervisory Control and Data Acquisition (SCADA) system, upgrade o f protective relaying, metering and telecommunication systems, and refurbishment o f plant auxiliary systems (e.g. l o w voltage substations and compressors). Rehabilitation o f plant switchyards, including replacement o f high voltage circuit breakers, disconnect switches, surge arresters, measuring transformers and protective relaying.
The total cost o f the above rehabilitation program (2006-201 1) is estimated at about $342.5 m i l l i o n equivalent, o f which $87.3 m i l l i o n (25%) represents the foreign exchange component. Annex 5 shows detailed cost estimates for each project component. The project base costs are in 2004 prices and are estimated based o n actual costs for rehabilitation completed so far by UHE and o n contract prices for on-going works. Physical contingencies are calculated for each project component separately and vary between 5% and 10% for locally supplied components and are about 10% for foreign supplied components. The price escalation for costs expressed in foreign exchange (US$) has been calculated in accordance with the anticipated intemational price escalation. The price escalation for costs expressed in local currency i s calculated according to the projected local inflation rates. Taxes and duties are estimated o n the basis o f current levels of VAT and custom duties in Ukraine. The breakdown o f the project costs into foreign and local components reflects UHE’s decision to procure most o f heavy electromechanical equipment in Ukraine, such as turbine runners (estimated cost about U S 6 4 million), generators (estimated cost about US$36 million) and power transformers (estimated cost about US$6 million). During the loan negotiations, the Bank confirmed that the share o f Bank financing could be enlarged to cover the cost o f the required electromechanical equipment subject to its I C B procurement in accordance with the Bank procurement guidelines. The preparation o f necessary bidding documents and the international competitive bidding for this equipment will take at least one year. Therefore, the equipment scheduled for replacement in 2006 will need to be procured through direct (non-competitive) contracting which is not eligible for the Bank financing. I t was agreed that the Bank will consider additional (supplemental) financing for the procurement o f equipment needed in 2007 and onwords subject to (i)GOU’s approval o f the international competitive bidding for the procurement o f this equipment; and (ii) UHE’s submission o f the applicable bidding documents satisfactory to the Bank by December 3 I,2005. Since the rehabilitation o f all hydroelectric units (64) has a long implementation period (12 years), a phased financing approach would avoid tying up financial resources that could be used 46
for other projects with more immediate needs under the Energy Program. Furthermore, such approach would help reduce financing costs for UHE. N o problem is envisaged for UHE in raising foreign exchange financing for the third phase o f hydropower rehabilitation (2012-201 7) at a later date. Therefore, i t was agreed that the proposed loan would be used to finance the second phase (2006-201 1) o f hydropower rehabilitation which includes 46 units and nine hydropower plants. This would not prevent Ukraine from seeking additional assistance from the Bank for the third phase o f the hydropower rehabilitation project.
Project Component B: Dam Safety. This project component includes measures to rehabilitate and upgrade the existing dam safety and monitoring systems which are described in detail in Annex 10. Project Component C: UHE Institutional Development. The Hydropower Rehabilitation Project will initiate the establishment o f a modem Management Information System (MIS), including financial management system (FMS) in UHE. The M I S will include systems and procedures to enable the company management to exercise better and timely control over critical matters, including its financial transactions. The strategy involves a phased approach to developing a corporate wide MIS, with the first phase under the Project aimed at F M S which would be designed and implemented first at headquarters o f UHE. This will assist UHE in automated information exchange and analyses o f critical data related to sales, billing and collections. A consultant will be recruited to design the M I S R M S , define the specifications and assist in procurement o f suitable I T systems, supervise the implementation o f the selected system and organize a training for the UHE staff.
The design phase o f the MIS is expected to span over a two-year period. Technical assistance estimated to cost about US$0.3 m i l l i o n will cover design, procurement and implementation o f MIS. The consultants will first design an appropriate M I S for UHE, prepare the specifications and tender documents and assist UHE in the procurement o f the necessary I T systems. The design scope includes both hardware and software and any required customization. Subsequently, the consultants will also assist UHE in supervision o f the implementation of the M I S and in training o f UHE staff. Institutional development in UHE would also include provision o f technical assistance in capacity building in procurement and project management, enhancing dam safety, optimal scheduling o f the multi-purpose cascade o f hydropower plants, revaluation o f UHE’s assets and auditing o f project and company financial statements.
Project Component D: Implementation o f the Energy Sector Reform and Development Program. One o f the main project objectives i s to help the Ministry o f Fuel and Energy in establishing longer-term development priorities and sector policies based o n sound technical, economic, social and environmental principles. The initial funding for preparing the Energy Program was provided by the Government o f Japan through the $670,000 P H R D Grant, which was signed in November 2004. The Grant provides funding for the PWG which includes (i) program coordinator; (ii) financial management specialist; (iii) power sector specialist; (iv) gas sector specialist; and (v) coal sector specialist. The core PWG team may be expanded, as needed, by international experts o n specific legal, economic, environmental and engineering
47
issues. The PWG, and other consultants which may assist the Government, will help MFE develop: (i) an action plan for legal and technical harmonization o f the Ukraine energy market w i t h the EU Internal Energy Market; and (ii)a program o f priority investments in energy infrastructure. Specific investment loans, such as the proposed Hydropower Rehabilitation Project, will continue to support institutional development o f MFE through funding o f PWG and other technical assistance needed in preparing and implementing the proposed Energy Program. Project Component E: Implementation o f the WEM Concept. N E R C is a lead member o f an Inter-Agency Commission (IAC) which i s implementing the new Wholesale Electricity Market (WEM) concept based o n an action plan approved by the Cabinet o f Ministers o n June 15,2004. The on-going technical support (funded by PPIAF and managed by the Bank) helped NERC, inter alia, define implementation stages o f the WEM concept in terms o f k e y steps; sequencing; organizational responsibility; and technical assistance needs. The Table 10 summarizes technical assistance needs related to the following three phases in implementing the WEM concept: (1) clarifying market design and main principles o f market operations; (2) drafting o f main codes and rules, and (3) specification and implementation o f supporting tools such as software, telecommunications systems and metering. Table 10. Key Steps, responsibilities and TA needs in implementing WEM
Task 1
I
Step Clarify industry structure
Comments Any changes in the ownership structure o r unbundling needs to be clarified; e.g. the dominant role o f NJSC i s a significant factor in market design
1
Agency MFE
1
TA
needs
i-I
Finalise the principles o f h o w the market will work, participants, market opening steps, interaction between the two markets
NERC
5
3
Eligibility analysis
If prices t o ECs in the administered market (pool) are below cost, the competitive market will n o t open. N e e d an analysis o f real costs o f supplying the large customers
NERC, MFE
2
4
Market rules
Define the detailed operation o f the market, e.g. pricing, settlement, information flows
NERC
4
Revisions t o primary legislation
Following development o f the market rules, changes m a y be necessary in electricity o r other primary legislation
MFE, NERC
3
Simulation model o f new market
Develop model for simulating n e w market trading arrangements, t o examine price impacts and t o assist with training participants
NERC, EM, TSO
2
7
1 Commercial code
(Balancing and settlement code)
" [ Grid code
Needs to be consistent with commercial code, includes scheduling code, dispatch
48
1 NERC TSO, NERC
I
I
6 7
I
code, metering code, communication standards
9
Distribution codes and access agreement
10
Distribution network pricing
Tariffs for ECs connected to the distribution network, or for embedded generators
11
Transmission pricing
Tariff regulation for use o f system
NERC
5
12
Revaluation o f assets o f power companies
Methodology for asset revaluation in power companies subject to NERC’s regulation
NERC. Obl, TSO, GenCos
10
13
Transmission access agreement
Draft contract for third party access
NERC. TSO
3
14
Connection agreements
Tariffs and rules for connecting to the networks (could b e part o f 9-13)
NERC
2
15
Ancillary services agreements
Tariffs and rules for procuring ancillary services, to b e consistent with 8
NERC, TSO
4
16
Standard bilateral contracts
Model or template contracts
EM
2
17
Supplier o f last resort rules
Specify who takes over supply if competitive supplierigenerator fails
NERC
1
18
Allocation o f initial contracts
Allocation o f generation capacity to each market
MFE
2
Credit rules
Credit guarantee r u l e s for the balancing market
EM
20
Consultation exercises
Communication and participation in consultation meetings with wider group o f stakeholders, and public
21
Specifications for software and hardware systems
Required systems by SO and EM
22
Hardware requirements for generators
Load Frequency Control and Automatic Generation Control
23
Hardware, software requirements for Discos
Systems required by Oblenergos
24
Market registration
Meter registration, contract registration, participant registration r u l e s
NERC, EM, TSO
25
Upgrade metering and telecoms
Ensure that all market participants have necessary commercial standard meters and telecommunications facilities to comply with market requirements
TSO, MFE
26
Trading system software
Develop the software to run the balancing market trading system
27
Financial settlement svstem software
Develophmplement the software for financial settlement o f imbalances
~
~
~~
~
NERC, Obl, TSO
4
NERC
3
~
~
~
~~
~
19 ~
~
Total staff-months
I
49
INERC
TSO, EM
I
I
Gencos, TSO,EM,
l4 I 2
l 2 3
I
90
T h e sequencing o f the above implementation steps i s shown in Figure 4. Figure 4. Sequencing of WEM implementationsteps
Clarify industry structure Market design Eligibility rules Detailed market rules l Revisions to primary legislation Simulation model of new market Commercial code Grid code Distribution codes Distribution network pricing Transmission pricing Transmission access agreement Connection agreements Ancillary services agreements Standard bilateral contracts Supplier of last resort rules Allocation of initial contracts Credit rules Consultation exercises Specifications for systems Hardware specs for gencos Hardware, software for discos Market registrartion systems Upgrade metering, telecoms Software for trading system Settlement systems, financial
Phases >
1
2
50
Annex 5: Project Costs
UKRAINE: Hydropower Rehabilitation Project in Support of the Energy Sector Reform and Development Program
Table 11. Cost Estimates for Hydropower Rehabilitation Project (2006 - 2011)
r------
Project Component
A.l Rehabilitation o f generating units Generator circuit breakers Unit controls and diagnostics Turbines Generators Power Transformers A.2 Modernization o f plant systems SCADA and protective relaying Telecommunications Plant auxiliaries A.3 Rehabilitation o f switchyards Circuit breakers Disconnect switches Surge arresters Measurement transformers B. Damsafety Monitoring system Hydro-mechanical equipment C. U H E Institutional development Management Information System Technical assistance D. MFE Institutional development E. Imdementation o f WEM conceut
Note: IDC includes commitment fee
Estimated Project Cost US$ million
Foreign as YOof Total cost
Local
Foreign
Total
137.8
28.6
166.4
17%
7.3
22.3
29.6
75%
2.5
9.1
11.6
78%
4.1
2.6
6.7
39%
0.5
6.6 2.6 4.0 1.5 2.0 72.7
7.1 2.6 4.5 2.5 3.0 226.9 17.2 52.9 64.8 361.8 12.2 0.5 374.5
93%
0.5 1.o 1.o 154.2 10.8 47.8 49.0 261.8 261.8
Detailed cost estimates are shown in Attachment 5-1.
51
6.4
5.1 15.8 100.0 12.2 0.5 112.7
60% 67%
32% 3 7%
10% 24% 28% 100% 100% 30%
I
I
I
I
I
I
I
I
Annex 6: Implementation Arrangements UKRAINE: Hydropower Rehabilitation Project in Support o f the Energy Sector Reform and Development Program Energy Sector Reform and Development Program The k e y policy and institutional elements o f the proposed Energy Program have been defined and established by the Government o f Ukraine in partnership with the World Bank and in close cooperation with the European Commission and other donors. The program has a strong country commitment and a well established coordination mechanism shown in Attachment 6-1. At the level o f Cabinet o f Ministers, the program coordination is performed by the Commission for Energy Sector Reform and Development3*. The Commission has two main tasks: (i) to review, approve and update conceptual plan for legal and technical harmonization o f the Ukraine energy sector with the EU Internal Energy Market; and (ii) to coordinate and supervise implementation o f the conceptual plan, including review and approval o f changes in the legal and regulatory framework, prioritization o f investments in energy infrastructure and identification o f priority programs of technical assistance. The Commission i s supported by the Permanent Working Group (PWG) for preparation and implementation o f the Energy Program. PWG i s established in the Ministry o f Fuel and Energy and acts as the secretariat o f the Commission for Energy Sector Reform and Development. Initially, PWG i s funded by the PHRD Grant39provided by the Government o f Japan, which will be rolled over to the technical assistance component o f the Hydropower Rehabilitation Project. The main tasks o f PWG include: (i)developing an action plan for legal and technical harmonization o f energy market in Ukraine with the EU Internal Energy Market, including regulatory requirements for electricity and gas markets, environmental requirements, regulation o f cross-border trade and monitoring and evaluation program; (ii)developing a program o f priority investments in energy infrastructure; (iii)identifying technical assistance needs and preparing proposals for donors support in the energy sector; and (iv) assisting the Ministry o f Fuel and Energy and other Government agencies in preparing and coordinating implementation of specific investment projects supported by the Bank, such as the Hydropower Rehabilitation Project.
Hydropower Rehabilitation Project The implementation of the Parts A, B and C o f the proposed Hydropower Rehabilitation Project will be responsibility o f UHE (the Loan Beneficiary) which was formed through a merger of OJSC DniproHydroEnergo (DHE - the beneficiary o f the Loan 3865) and OJSC DnisterHydroEnergo in February 2004. The merger did not significantly affect the structure and the staffing o f DHE because i t only increased the number o f hydropower plants operated by the company from eight to nine (the total number o f employees o f UHE i s about 2,500). The main The inter-agency commission was established by the Cabinet o f Ministers order No.1091 on August 25, 2004. Commission includes high-level representatives o f the Ministry o f Finance, Ministry of Economy, Ministry o f Fuel and Energy, Ministry of Foreign Affairs, State Tax Administration, NERC and Energorinok. 39 The PHRD Grant Agreement was signed by the Government of Ukraine and the World Bank on November 18, 2004. 38
53
new function assumed by UHE after the merger is that the company n o w has an overall responsibility for investment planning in the hydropower sub-sector. This function i s performed by the department for development and investments. The overall organization o f UHE and the responsibilities under the proposed hydropower rehabilitation project are shown in Attachment 6-2.
UHE has experience in all aspects o f hydropower development and operations. I t utilizes UkrHydroProekt, an engineering firm, for specialized support o n a regular basis, including the preparation o f the Hydropower Rehabilitation Project. The rehabilitation o f hydropower plants will be based o n the same engineering and procurement approach which UHE used during the first phase o f hydropower rehabilitation which was successfully completed in 2002. However, due to increasing scope o f rehabilitation activities included in the next phase, an experienced international consultant will be engaged to assist UHE in project management, scheduling, procurement and contract management. The process to select the consultants is currently underway. Due to i t s large size, the proposed project practically include the entire investment program o f UHE over the next 6 years. This requires a strong support from all parts o f the company and, as shown in Attachment 6-2, a project unit (section) has been established in each department t o provide necessary technical support in implementing the project. The department for reconstruction and hydropower production has been be reorganized and strengthened to lead all engineering activities. Furthermore i t will coordinate project implementation units which will be established at each plant. The overall management responsibility will be with the President o f UHE who will be assisted by (i)procurement unit; (ii) financial management unit; and (iii) project management consultants to be hired under the technical assistance component o f the proposed loan. The procurement unit (PU) will be responsible for procurement scheduling, preparation of bidding documents, contract management, reporting and other aspects o f project implementation which require technical coordination o f various project activities. The financial management unit (FMU) will be responsible for financial management and disbursement under the project. P U and FMU will be integral parts o f UHE and will consist o f staff whose regular responsibilities include the investment planning and financial management in the company. PU and FMU will be headed by Deputy Project Mangers (DPMs) who will report to the President o f UHE. The selection o f an international proiect management consultant under Terms o f Reference acceptable to the Bank i s a condition o f loan effectiveness.
UHE has prepared and will implement an Environmental Management Plan for the project. I t will also continue to carry out a dam safety program outlined in Annex 10.
PWG established in the Ministry o f Fuel and Energy (see Attachment 6-1) will provide an overall reporting o n all program activities, including the implementation o f the Hydropower Rehabilitation Project. Therefore, PWG will periodically collect and integrate implementation progress reports prepared by the project implementing agencies in accordance with reporting requirements to be established under the Loan Agreement and accompanying project documentation. Furthermore, PWG will be responsible for a l l implementation arrangements
54
under the Part D o f the Hydropower Rehabilitation Project. It i s expected that procurement and financial management specialists hired by MFE for the implementation o f the PHRD Grant will continue to provide these services for the implementation o f MFE institutional development component o f the Hydropower Rehabilitation Project. The implementation o f the WEM concept (Part E o f the Hydropower Rehabilitation Project) is the responsibility o f NERC. Since i t s establishment in 1994, N E R C has steadily built i t s capacity for implementation o f TA projects. I t regularly hires and manages local and international consultants funded by donors, IFIs and its own funds. Therefore, N E R C w i l l rely o n i t s existing organizational structure to implement the Part D o f the Hydropower Rehabilitation Project.
UHE will monitor and evaluate o n an ongoing basis the carrying out o f the Parts A, B and C o f the project and the achievement o f the objectives, and will submit to the Bank, at the end o f each calendar year, annual progress reports. UHE will also prepare and furnish t o the Bank, by September 30, 2008, a mid-term review report integrating the results o f the monitoring and evaluation activities. UHE will review the mid-term report with the Bank, by December 31, 2008, and will take all measures required to ensure the efficient completion o f the Project, based o n the conclusions and recommendations o f the mid-term review. MFE and N E R C will monitor and evaluate o n an on-going basis the implementation o f the Parts D and E o f the project, respectively. MFE and N E R C will submit to the Bank annual progress reports (at the end o f each calendar year) o n the achievement o f the objectives o f the Energy Program, including the implementation o f the WEM concept. MFE and N E R C will also prepare and furnish to the Bank, by September 30, 2008, a mid-term review report integrating the results o f the monitoring and evaluation activities. MFE and N E R C will review the mid-term report with the Bank, by December 31, 2008, and will take all measures required to ensure the efficient completion o f the Project, based o n the conclusions and recommendations o f the mid-term review. Implementation schedule. According to the draft implementation plan (see Attachement 6-l), the project will be implemented over a period o f 6 years and i s expected to be completed by December 31, 2011. The replacement o f turbine runners and governors and refurbishment of generators is o n the critical path o f the project implementation. The installation o f new monitoring and control equipment (at three hierarchical levels - unit, plant and the cascade) i s also a challenging task which will require close coordination with other project components. Rehabilitation o f plant switchyards and expansion o f dam safety monitoring system is expected to proceed without difficulties since i t is not critically related to other project components.
55
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Annex 7: Financial Management and Disbursement Arrangements UKRAINE: Hydropower Rehabilitation Project in Support o f the Energy Sector Reform and Development Program
1.
Financial Management Assessment Summary
Country Financial Management Issues The 2001 Country Financial Accountability Assessment (CFAA) for Ukraine confirms that improvement i s required in the management o f public expenditures, especially for the strengthening o f internal and external audits. Accordingly, the audits o f the entity and project financial statements would be conducted by acceptable private sector auditors acceptable to the Bank. The CFAA also identified a lack o f adequate control over state owned enterprises, but appropriate steps have been taken recently to improve the control over these enterprises. UHE would be subject to regular internal and external Government and energy sector regulatory control, and i t has been involved in the successful implementation o f previous Bank’s financed project.
Implementingentities
A focal point o f the program coordination and implementation mechanism i s the Commission for Energy Sector Reform and Development, which is supported by the Permanent Working Group (PWG). I t is expected that the PWG would provide centralized project implementation monitoring and will prepare consolidated FMRs for the project. The projects would be implemented by the implementing entities: UHE, MFE, and NERC, which will implement their respective project components independently. UHE has established Project Implementation Unit (PIU) through a reorganization and creation o f project implementation sections in all main departments, as shown in Attachment 6-2. MFE and N E R C will function as PIUs for Parts D and E, respectively, by using their existing organizational model and staff whose regular responsibilities include the implementation o f technical assistance projects.
In UHE, the existing financial management system o f the entity would be used for this project. MFE and N E R C would rely o n the country normal financial management arrangements for project implementation. MFE and N E R C will prepare financial reports with the support o f the financial consultant from the PWG. Strength and weaknesses The strengths o f UHE that provide a basis o f reliance o n its financial management system include: (i) the experience o f UHE and i t s finance staff in implementing Bank-financed project; and (ii) the assessed strengths o f the financial management system o f the UHE. Although MFE and N E R C are familiar with the project and energy sector, they have not finalized their implementation arrangements for the projects. B o t h agencies have n o prior experiences with Bank’s financed projects. B o t h MFE and N E R C would b e relying o n the
59
country normal financial management arrangements. It is expected both agencies would need some capacity building and support in financial management, especially with regards to W o r l d Bank’s policies and procedures. However both agencies will receive support from the procurement and financial management consultants in the Permanent Working Group (P WG) within the MFE.
Funds flow The MOF, as the borrower, will control all loan funds. Because there are three implementing entities, there will be three separate special accounts.
UHE will open a special account in a commercial bank acceptable to the World Bank. This account will be used for loan funds processing and will be under control o f the MOF and the UHE’s management. Nevertheless, i t i s expected that major part o f the project money would be disbursed through the direct payments as most o f the contracts under the Components A, ByC are high value and are using I C B tendering procedures. I t i s expected that fund f l o w scheme under the Component D (MFE) and Component E (NECR) will use two separate Special Accounts, which are to be opened in the commercial banks acceptable to the Bank. These accounts will be used for loan funds processing and will be under control o f the MOF and the management o f the two implementing agencies.
There are two sources o f counterpart financing under the project: the financing from UHE’s o w n sources and state budget financing from the MFE and NERC. There will b e n o separate accounts for counterpart financing.
Staffing Components A, B and C o f the project will be implemented by the employees o f the UHE. Formally, UHE assigned responsible employees to deal with project financial management issues (including disbursement and reporting), and all accounting, budgeting and reporting for UHE’s needs will be managed within the existing financial system. The UHE’s financial management structure and financial management staff are adequate for the project implementation. Additional training o n project financial management and disbursement arrangements would be necessary. Both MFE and N E R C appointed regular financial staff from their entities to work o n financial management matters o f this project. These staff would need support and additional training. They will be supported by the PWG, which will have procurement and financial consultants. MFE has hired a financial consultant in the PWG who will provide technical support to MFE and N E R C on financial management matters, including support in disbursement arrangements, preparation o f consolidated FMRs for all components, and responsibility for audit arrangements for components D and E. The financial consultant will be financed by PHRD grant initially, and will be financed by the project subsequently.
Accounting Policies and Procedures There will be no centralized accounting for the project. Accounting functions would be performed by each implementing agencies separately, in accordance with the accounting standards applied in those entities.
60
UHE uses the current national accounting standards as the basis for its accounting policies and for the establishment o f accounting procedures for main type o f transactions. Loan funds will b e accounted both under local accounting standards and under IFRS. IFRS statements based o n IAS, will be prepared annually for the I S A audit. UHE will prepare regular Financial Monitoring Reports (FMRs) for the components which are implemented by the Company. The UHE’s F M R s will be combined with reports for other components in consolidated FMRs for the project, t o be done by the PWG. The PWG will prepare a financial manual to be used by the project.
MFE and NERC will rely o n the accounting policies, procedures, regulations and controls o f the State Treasury. Reporting for the components under this project will also follow the Cabinet of Ministers regulations and State Treasury regulations which cover accounting and reporting formats in case o f donors’ funds receipt. B o t h entities will also prepare FMRs, with the assistance from the PWG, in the simple format to reflect funds inflow and outflow. Based o n the separate FMRs, the PWG will prepare consolidated quarterly F M R s for all components. Planning and budgeting
UHE has a budget unit within the “Financial and Economic” department. This group i s responsible for preparation o f the Company budget, its monitoring and analysis as well as the budget for the components under the project. Company Budget system allows keeping budgets in physical and monetary units. The budging function i s one o f the most important functions in the Company. I t i s considered that such budgets are sufficient in content and in format for project cost planning and monitoring. MFE and N E R C run their planning and budgeting functions according to the State Budget regulations. Cash management and cash planning follow the regulations o f the State Treasury, which require monthly projections forecast. MFE and N E R C would be required to include project funds in the State Budget and would provide supporting documentation, projections and procurement plans. I t i s planned that the PWG would support both entities in expenditure planning under the project, based o n the procurement plans. MFE and N E R C will provide monthly financial reports, including cash forecast statement, to the MOF. Reporting and monitoring The accounting for the project i s cash basis with additional information provided for commitments o n signed contracts. The project, through the PWG, will prepare quarterly consolidated financial monitoring reports (FMRs) for the Bank throughout the l i f e o f the project. All three entities will provide separate FMRs, for their respective components, to the PWG for consolidation. Sample FMR formats have been prepared and will be agreed upon during negotiations. The FMRs will include the following areas: (a) Financial Reports (b) Project Progress Reports; and (c) Procurement Management Reports. These financial reports will be submitted to the Bank within 45 days o f the end o f each quarter. The first quarterly F M R s will be submitted at the end o f the first quarter in which disbursements commence.
61
Information system I t is not planned to have separate accounting systems for the project needs. Accounting and reporting will be provided within the existing accounting and reporting programs in the UHE, MFE and NERC.
All implementing entities are capable to provide proper accounting within their financial information system, keeping track records and audit evidences. Those systems allow retrieval o f
necessary information which would allow preparation o f the F M R s for the project needs.
UHE has financial information (accounting) system, which i s based o n 1-C accounting system.
The system i s fully sufficient for the project accounting needs as w e l l as it allows tracking information for the project F M R s needs. It i s considered that UHE may require more advanced and integrated Financial Management Information System (FMIS) in order t o run integrated budgeting, online accounting, cash management and other functions, which are not supported by current system.
MFE and N E R C will rely o n the Treasury system for the payments, accounting and reporting.
Because both entities would only need to report o n one component and one disbursement category, the treasury system would be able to generate appropriate financial reports.
Impact o f procurement arrangements The overall procurement r i s k and capacity assessment indicates that the project has been rated as high-risk. Initial review o f project design suggests that project will have a lot o f large value contracts. These contracts will be most probably paid by direct payments, which simplify funds flow controlling and monitoring but requires more attention to the control over counterpart funding in case if taxes to be financed by borrower. Control should also be provided over the assets safeguards, which to be procured and installed at the stations. The perceived risk associated with the project’s financial management arrangements will be mitigated by an increased level o f Bank supervision.
Supervision Plan The project will be part o f the r i s k based supervision model, which i s based o n the project risk assessment. I t i s considered that minimum number o f FM supervisions i s to be at least once per annum. During project implementation, the Bank will supervise the project’s financial management arrangements in two main ways: (i)review the project’s quarterly financial management reports as well as UHE’s and the project’s annual audited financial statements and auditor’s management letter; and (ii)during the Bank’s supervision missions, review the project’s financial management and disbursement arrangements for all three agencies to ensure compliance with the Bank’s minimum requirements. A Bank-accredited Financial Management Specialist will assist in the supervision process.
2.
Audit Arrangements
Internal audit
62
Although UHE has an internal controlling and revision department, and the head o f the department is reporting to the Chairman o f the Board o f Directors. The project will not rely o n the internal audit as there i s inadequate capacity.
External audit There will be two audits under this project, including: (a) the audit o f UHE’s financial statements which include adequate disclosure o f the information related to the project funds for component A, B and C ; and (b) the audit o f the consolidated project financial statements for component D and E. The UHE’s entity financial statements would be prepared using IFRS and audited according to ISA. The project financial statements, using cash accounting, for Components D and E would be audited separately. I t was confirmed that the UHE’s entity financial statements will incorporate information o f the components A, B and C by including additional footnotes o n these components, which were agreed with the Borrower during the negotiations. The UHE’s entity audited financial statements will continue to be acceptable only if the following conditions continue to be met: o the entity financial statements are prepared in accordance with IFRS; o the entity has an acceptable independent auditor in place; and o the entity audits are conducted in accordance w i t h International Standards o n Auditing. Terms o f reference for both audits have been agreed during the negotiation. B o t h audits will be conducted by the independent private auditors, accepted by the Bank, according to the acceptable terms o f reference. The annual audited financial statements will be provided to the Bank within six months after the end o f each fiscal year. The contract for the audit awarded during the first year o f project implementation and thereafter extended from year-to-year with the same auditor, subject to satisfactory performance. The cost o f the audits m a y be financed from the proceeds o f the loan.
3. Disbursement Arrangements Allocation of loan proceeds i s shown in the Table 12:
Table 12. Allocation o f Loan Proceeds Expenditure Category
Amount in US$ million
1. Goods (including installation)
90.00
2. TA: Consulting Services
10.00 5.47
3. Unallocated Amount
Total Project Costs with Bank Financing Front-end fee
105.47 0.53
63
Financing Percentage 100% o f foreign expenditures, 100% o f local expenditures (exfactory cost) and 80% o f local expenditures for other items procured locally. 100%
Use o f Statements of Expenditure (SOEs):
Bank funds would be disbursed under the Bank’s transactional procedures including SOEs and
direct payments. Supporting documentation for SOEs including completion reports and certificates w o u l d be retained by the Borrower and made available to the Bank during project supervision. Disbursements for expenditures above the SOE thresholds would be made o n the basis o f the presentation o f full documentation relating to those expenditures. All disbursements would be made o n the basis o f full documentation for (a) contracts for goods costing more than the equivalent o f US$200,000 each; and (c) services under contracts o f more than the equivalent o f US$200,000 for each consulting firm and more than the equivalent o f US$lOO,OOO each for individual consultants. Disbursements below these thresholds, and all contracts for training and study tours, w o u l d be made according to certified Statement o f Expenditure (SOEs). This documentation would be retained by the MFE, N E R C and UHE for at least one year after receipt by the World Bank o f the audit report for the year in which the last disbursement was made. Disbursements for expenditures above the SOE thresholds would be made against presentation o f full documentation relating to those expenditures.
Special Account: For the purposes o f the project, three Special Accounts (SAs) would be opened and managed in commercial banks acceptable to the World Bank, including appropriate protection against setoff, seizure and attachment, in the case o f a commercial bank. The f i r s t signatures would be delegated to the Deputy Minister o f the MFE, representative o f the MOF, and second signatures would be delegated to the Chief Accountant o f the MFE and N E R C and CEO/CFO o f the UHE. Replenishment for the SA would follow IBRD procedures. The MFE, N E R C and UHE would submit a replenishment application monthly, or sooner if desired, but quarterly at the latest. A bank statement and reconciliation o f the S A against World Bank records would support the replenishment applications. The minimum amount for applying for direct payment and for special commitment would be 20 percent o f the authorized allocation to the SA.
MFE. The initial allocation to this S A for the Component D would be limited to US$ 500,000. The Authorized Allocation shall be limited to an amount equivalent t o US$ 250,000 until the aggregated amount o f withdrawals from the Account plus the total amount o f all outstanding special commitments are equal to or exceed the equivalent o f US$ 1.O million. NERC. The initial allocation to this S A for the Component E would be limited to US$ 500,000. The Authorized Allocation shall be limited to an amount equivalent to US$ 250,000 until the aggregated amount o f withdrawals from the Account plus the total amount o f all outstanding special commitments are equal to or exceed the equivalent o f U S $ 1.O million. Ukhydroenegro Company (UHE). The initial allocation to this S A for the Component A, B and C would be limited to US$ 1.0 million. The Authorized Allocation shall be limited to an amount equivalent to US$ 0.5 million until the aggregated amount o f withdrawals from the Account plus the total amount o f all outstanding special commitments are equal to or exceed the equivalent o f US$3.0 million.
64
Annex 8: Procurement Arrangements UKRAINE: Hydropower Rehabilitation Project in Support of the Energy Sector Reform and Development Program General Procurement for the proposed project would be camed out in accordance with the W o r l d Bank's "Guidelines: Procurement under IBRD Loans and IBRD Loans" dated M a y 2004; and "Guidelines: Selection and Employment o f Consultants by World Bank Borrowers" dated M a y 2004, and the provisions stipulated in the Legal Agreement. For each contract to be financed by the Loan, the different procurement methods or consultant selection methods, the need for prequalification, and time fi-ame are agreed between the Borrower and the Bank project team in the Procurement Plan in Table 13. The Procurement Plan would be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. Other procurement information, including IBRD's review process etc. i s presented in Table 14.
1. Procurement of Goods and Technical Services Procurement of Goods: Goods procured under this project would include: electrical and mechanical equipment for use in power generating stations. Information and control technology and dam safety equipment.
-
-
-
International Competitive Bidding (ICB) procedures would be used for contracts above US$200,000 equivalent. In the comparison o f bids for goods procured through ICB, a domestic preference would apply in accordance with the provisions o f the Procurement Guidelines. Bid documentation for I C B would be prepared in accordance with the latest applicable Bank Standard Bidding Document (SBD) for the Procurement o f Goods or Supply and Installation o f Plant and Equipment (S&I), single o r two stage as appropriate. Prequalification shall be undertaken where justified for large S&I contracts using the latest applicable Bank Standard Prequalification document and procedures. National Competitive Bidding (NCB). Contracts for the procurement o f goods that are estimated to cost less than US$200,000 equivalent per package may be procured in accordance with N C B procedures subject to the prior agreement o f the Bank. The E C A regional Standard Bidding Documents (SBD) for N C B Goods would be used and the conditions applicable for conducting N C B procurement as agreed with the Bank would be followed. Shopping procedure would be used for off-the-shelf goods estimated t o cost less than US$lOO,OOO per contract. Shopping, which requires to obtain three quotations, is used here because more competitive methods are not justified o n the basis o f cost or efficiency. The E C A Regional sample format for shopping "Invitation to Quote" would be used.
65
-
Direct Contracting (DC): would be used to finance the procurement o f proprietary equipment and software after prior consultation and agreement with IBRD.
2. Procurement of Works Procurement o f c i v i l works will be undertaken by the Borrower using local procurement procedures. Such procurement will not be financed by the Bank.
3. Selection of Consulting Services and Training Consulting services are required for project management, procurement and auditing assignments.
The procurement will be carried out using the latest published version o f Bank’s RFP for all QCBS and for other procurement methods such procedures and documents as are agreed with the
Bank.
Contracts shall be packaged for consulting and training services required from firms and individuals. Short lists o f consultants for services estimated to cost less than $200,000 equivalent per contract may be composed entirely o f national consultants in accordance with the provisions o f paragraph 2.7 o f the Consultant Guidelines. The following methods o f procurement would be followed:
-
-
-
5.
Quality and Cost-based Selection (QCBS) procedures would be used for contracting consultant services for contracts estimated to cost over US$200,000. As an alternative, Fixed Budget Selection and Quality Based selection may also be used where this is included in the Procurement Plan. Consultant Qualification (CQ) procedures would be used for contracting consulting and training services with the most qualified firms from a shortlist o f firms expressing interests for contracts estimated under US$200,000. Least Cost Selection (LCS) procedures may be used for contracting the financial audit services. The shortlist shall consist o f f i r m s acceptable for Bank financed projects. Individual Consultants (IC) would be hired in accordance with Section V o f the Guidelines. Individual consultants would be hired for small assignments o f short-term duration for consulting services to meet the requirements o f the proposed IBRD Loan. Single Source (for firms)/sole source (for IC) procedures would be used for contracting the consulting and training services following the procurement plan after prior consultation and agreement with IBRD. Expenses for the study tours and training related t o the project would be disbursed based o n SOE. Training and seminars will be procured directly from the service provider subject to the Bank’s agreement to the course content; list o f participants and budget.
Notification of Business Opportunities
66
A General Procurement Notice (GPN) would be published in the UN "Development Business" on -line (UNDBonline) and in the Development Gateway's dgMarket at the tiem o f appraisal. For I C B goods contracts and large-value consultants contracts (more than US$200,000), Specific Procurement Notice would be advertised in the Development Business on-line (UNDBonline) and in the Development Gateway's dgMarket and national press, and in the case o f NCB, in a major local newspaper (in the national language). 6. Review by the IBRD o f Procurement Plan The Borrower has developed a Procurement Plan for project implementation. The plan provided by the Borrower is shown in Table A. Procurement o f goods, works and services for the project would be carried out in accordance with the agreed procurement plan, which would be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs and improvements in institutional capacity.
7. Prior Review The following contracts will be subject to the Bank's prior review and no objection prior to signature:
-
Goods: Prior review o f bidding documents, including review o f evaluation, recommendation o f award and contract would be conducted for all contracts over US$200,000, all I C B and D C and first N C B and first shopping contracts, if used. Consulting Services and training: Requests for Proposal (RFP), short lists, terms o f condition o f contracts as well as evaluation reports and recommendation for award would be prior reviewed by IBRD for contracts for individual consultants above USD100,OOO and for f i r m s above USD200,OOO. All documents and recommendations involving single source selection would be subject to IBRD prior review. Terms o f reference for consulting assignments and training may be reviewed and cleared by the Task Team Leader.
After award o f contracts, should any material modifications or waiver o f terms and conditions of a contract resulting in an increase or decrease above 15 percent o f the original amount, IBRD would undertake a prior review o f such modifications (including modifications to contracts for consulting services).
8. Borrower's procurement The project envisages several contracts that would be placed directly by the UHE using its o w n budget funds and in accordance with its o w n rules and procedures (see section 9 below). This includes single source contracting for refurbishment and replacement o f components essential for the project from its existing long-standing local sources, for standardization purposes. These include the following contracts:
67
Turbines: Turboatom Generators: Elektrotezhmash Transformers: Zaporizhe Transformatorski Zavod
UHE will provide details o f previous supply contracts for these items, with contract prices, to the
Bank for its review in order to determine that the pricing structures are reasonable, considering that the contracts include refurbishment o f existing units. Contracts for single source contracts should as a minimum include detail o n contract terms including payment, inspection, delivery, force majeure, contract language, liquidated damages, responsibilities o f the parties, arbitration and guarantee period.
9. Assessment of the agency’s capacity to implement procurement Procurement activities will be carried out by the Borrower, UkrHydroEnergo (WE), which will be staffed by a sufficient number o f skilled personnel to satisfactorily implement the project. A Project Management and Procurement Consultant will be appointed to provide advice and training o n working with Bank’s procedures. A Procurement Manual will be prepared which will include, in addition to the procurement procedures, reference to the SBDs to be used for each procurement method. The project will provide for procurement training.
An assessment o f the capacity o f the Implementing Agency to implement procurement actions for the project has been carried out. The assessment reviewed the organizational structure for implementing the project and the experience o f UHE in similar contracts.
The first stage o f Hydropower Rehabilitation and System Control Project (IBRD 3865-UA) was implemented during September 1995- June 2002. I t was one o f the first investment loans to Ukraine. At that time, the Public Procurement System was not in place and the company had n o A Canadian firm (Hydro Quebec experience in competitive procurement procedures. International) provided project management and procurement services. Only the two last ICBs were managed solely by the company staff. Currently the company has a tender committee and procurement i s undertaken according to Order #1455 dated December 25, 2002 o f the National Commission for Regulation o f Electric Energy in Ukraine. The provisions o f this order are mainly based o n the provisions o f the Public Procurement Law. The company undertakes about 10 open tenders (equivalent o f N C B ) per year and a number o f procurement according to request for quotations, mainly for works (equivalent to M i n o r Works). T w o departments will be involved in the process o f bidding documents preparation and project implementation. The technical part will be handled by the Department o f Reconstruction and Production and the commercial/financial part by the Department o f Finance and Economy. Different ‘sectors’ (groups o f 2-6 employees) within the Departments will be responsible for different contracts, depending upon the specialization. None o f the UHE staff can work in English and relies upon 3 professional translators. They will translate bidding documents and correspondence the company intends to hire more translators, as needed. UHE were encouraged to seek some experienced English speaking staff that would be able to directly assist with bid document preparation, interface w i t h contractors and importantly check the translations before 68
issue. I t was made clear to UHE that the Bank cannot accept sub-standard English language documents and that this was a potential source o f project delays. The tender documents will b e also reviewed by an Expert Group consisting o f the Heads o f Departments and extemal experts (about 8 people). The Expert Group comes under the control o f the Managing Director. After this, the documents will be submitted for Bank's no-objection and the comments, if any, will be taken into account according to Departments' recommendations. The Country Procurement Assessment Report (CPAR) completed in 2001 indicates that projects should be rated "High" risk based o n the then assessment o f the country's national procurement system. The staff o f UHE has little experience o f carrying out procurement under international tenders, most o f their larger contracts being sole source with monopolist Ukrainian producers. Based o n assessment o f the capacity for procurement administration o f the Project, the following Action Plan to strengthen the procurement administration capacity o f the UHE i s recommended:
-
-
UHE procurement staff would be given the opportunity to attend intensive procurement training in Russian language, such as the one offered by ILO in Turin.
Consulting services o f an individual consultant to assist with tender document preparation should be provided under the separate PHRD Grant. Consulting Services o f a Project Management and Procurement Consultant (firm) to assist with the implementation and management o f the project i s included in the Loan. Initiating a Project Launch Workshop before the loan effectiveness, as part o f the project implementatiodcapacity building initiatives, especially in procurement. This to be supplemented by further training for management and members o f the Tender Committee o f the UHE in Bank procurement procedures. The project would be subject to supervision by the Bank and support from the Kyiv Office. During each o f the first two years o f project implementation, there would be at least two supervisions.
10. Re-assessment o f agency's procurement capacity and use of country systems.
A revised CPAR will be prepared in 2005. This will focus o n assessment o f the Public Procurement L a w (PPL), regulations, procedures and practices w i t h a view to eventual certification for use o f country systems under W o r l d Bank financed projects. This i s not expected to have an impact o n this project due to the large value o f the proposed contracts and the fact that all equipment covered by the Loan is in any case imported. Currently, use o f country systems i s not recommended for World Bank financed projects due t o the following fundamental issues:
-
-
-
Lack o f in-country training capacity and therefore capacity o f procurement staff lack o f standard bidding documents for any f o r m o f procurement lack o f recognition o f consultancy services in the PPL lack o f clear written procedures for tendering, evaluation and contracting lack o f standard contract forms
69
-
-
overuse o f restrictions, exemptions and exceptions in the PPL restricting openness o f tendering procedure unrestricted use o f merit points with no pre-defined allocation leads to ineffective, untransparent and costly procurement Lack o f status o f the Public Procurement Department
The Government o f Ukraine is addressing most o f these issues with the assistance o f the Bank and i s in the process o f preparation o f a development strategy to be agreed with the Bank.
Overall Procurement Risk Assessment: High Table 13. Procurement arrangement involving Internationalcompetitive bidding
P-Q
Domestic Preference
Review by Bank
Expected Bid Opening
4
5
6
7
8
12 8
ICB
NO
NO
PRIOR
15-Jul-05
Speed Governors
8.1
ICB
NO
NO
PRIOR
16-Jul-05
3
Static Excitation Systems
20 0
ICB
NO
NO
PRIOR
17-Jul-05
4
Diagnostics
87
S& 1
YES
NO
PRIOR
30-Sep-05
5
SCADAIEMS,
20.4
S& 1
YES
NO
PRIOR
15-NOV-06
Ref. No.
Contract (Description)
1
2
1
Estimate
Procurement Method
3
Generator Circuit Breakers
2
(US$m)
70
NO
NO
PRIOR
20-Oct-05
2.5
ICB
NO
NO
PRIOR
25-Oct-05
3.6
ICB
NO
NO
PRIOR
30-Oct-05
8.2
S& 1
YES
NO
PRIOR
30-Sep-05
S& 1
YES
NO
PRIOR
6 -Dec-05
0.7
14
H i g h Voltage Disconnect and Earthing Switches
15
H i g h Voltage Current and Voltage Measuring Transformers D a m Safety equipment Management Information System
16 17
2 Consul1
I
I
ICB
High Voltage Surge Arresters
4.1
I
119.3
TOTAL
(a) List of Consulting Assignments with short-lists including internationalfirms.
Estimated S$m
IC
PRIOR
0.4
QCBS
PRIOR
0.3
QCBS
PRIOR
assistance for dam safety component Technical assistance for M I S
revaluation
LCS
Audit o f project and company accounts in UHE assistance to MFE 3.0
Technical assistance to
I
TOTAL
4 QCBS
Project Management Consultant
I
Expected
Selection Method
I
IC/ CQ
PRIOR
IC/ CQ
PRIOR
PRIOR
10.00
71
I
I
Annex 9 : Economic and Financial Analysis
UKRAINE: Hydropower Rehabilitation Project in Support of the Energy Sector Reform and Development Program A. Economic analysis The economic evaluation o f the proposed Hydropower Rehabilitation Project was carried out by comparison o f ‘with and without rehabilitation’ scenarios. The economic investment cost i s estimated at a total o f $219.5 m i l l i o n disbursed over 2006-201 1. The economic investment cost does not include the cost o f dam safety, institutional development (MIS) and technical assistance for which n o direct economic benefit can be assigned. The economic investment cost includes physical contingencies but does not include price contingencies, taxes and duties. The project economic benefits have been assessed under the following five categories:
-
Increase in hydroelectric production o f about 360 GWh per year (by 2012) due to: Improved efficiency o f the generating eauipment. This i s primarily the result o f the replacement o f turbine runners, refurbishment o f generators, replacement o f unit control systems and the main unit transformers which are all o f more modem design. The replacements also provide as-new performance in contrast to the significantly poorer performance from the o l d units (typically the units replaced are over 40 years old). As a result, with the same water flow, energy production is increased on average by about 2 to 8%, and > Improved plant management and control. The application o f upgraded plant controls and modem management systems (including the optimization o f water flow through units, plants and reservoirs) together with related personnel training is expected to increase the amount o f energy produced and also to enhance its timing and value relative to power system demands.
>
-
Increase in (winter firm) peaking hydropower capacity o f about 250 M W (by 2012) due to:
> Increased capacity o f rehabilitated units. The rehabilitated turbines and upgraded generators are expected to increase the installed (maximum) capacity by 10 to 30%. > Improved reliability and availability o f units and plant. This is largely attributable to the as-new physical condition o f the replacement equipment - not only the turbines and generators but also transformers, circuit breakers, switchgear and protection equipment.
-
Power Svstem dvnamic benefits. The value o f these benefits i s difficult to establish without a comprehensive production costing and system dispatch study, covering both the current and the future power system operation. Research within the industry o n the dynamic benefits attributable to hydropower plants has yielded a wide range o f values, o f the order o f $ 1 to $20/kW/year. The variation i s
72
due to the characteristics o f the power system as a whole and to those o f the hydropower plant itself. Given the difficulties already evident within the Ukraine system in providing adequate load-following and frequency control a relatively high value o f system dynamic benefits could be justified. However, in view o f the lack o f detailed modeling and system studies, a conservative estimate o f $SlkWlyear was adopted.
-
Reduced Operation and Maintenance (O&M) Costs. Recent O&M costs were provided by UHE. In total they amount to over $10 million. By international standards these costs are o n the l o w side, probably due to the relatively l o w cost o f labor. The introduction o f both new equipment and improved operating systems will lead t o a substantial reduction in O&M costs. Staffing levels can be gradually reduced, particularly if the plants ultimately revert to fully automated remote control o f hydroelectric units. The improved instrumentation and monitoring will reduce the number and frequency o f outages and the scope of repairs. By introducing modem diagnostic tools in monitoring and on-line evaluation o f unit condition, UHE can implement preventive maintenance techniques which can further reduce maintenance costs. Finally, the as-new major equipment components (turbines, generators, transformers etc.) will reduce the need for and frequency o f major overhauls. The cost reduction i s estimated to amount to 50% o f the normal i.e. current cost.
-
Environmental Benefits. These are derived from the reduction in polluting emissions attributable to the reduction in electricity generation from thermal power plants replaced by the increased hydroelectric production under the project. Three harmful pollutants have been considered: Sulphur Dioxide (S02), Nitrous Oxide (NOX) and Carbon Dioxide (C02). Data from thermal plants in Ukraine has established representative amounts o f these emissions. The benefits associated with reducing SO2 and NOX emissions have been valued at the corresponding mitigation costs, based o n the results in the (Global Environmental Facility) GEF Klaipeda Geothermal Demonstration Project, Report N o . 14614 LT. The benefit o f reducing C 0 2 emissions was based o n estimates provided by the Prototype Carbon Fund (PCF). Ukraine is eligible to participate in carbon emissions trade and therefore the Hydropower Rehabilitation Project can directly benefit from reductions in (C02) emissions.
Table 14. Summary Results of Economic Analysis
Plant Name
Discounted Investment cost
US$ million
Total Benefits US$ million
EIRR (Yo)
NPV US$ m i l l i o n
B/C Ratio
Kyiv
25
26
10.5
1
1.03
K y i v PSP
9
14
17.2
5
1.51
Kaniv
32
35
11.5
3
1.10
Kremenchug
19
33
21.1
14
1.71
Dniprodzerzinsk
22
35
18.5
13
1.59
73
Dniprovska HPP 1
10
29
42.6
19
2.95
Dniprovska HPP2
18
81
79.5
63
4.39
Kahovka
9
17
26.6
8
1.95
Dnister
5
6
13.1
1
1.15
149
275
23.2
126
1.85
TOTAL UHE
The economic analysis was performed in a series o f spreadsheets (base case analysis is shown in Attachments 9-1) for each power plant. The investment costs and benefits were discounted over the expected project l i f e (30 years). Table 14 summarizes the project economic viability in terms of its Net Present Value (NPV) in U S $ as discounted to 2004 at the 10% discount rate, the Economic Internal Rate o f Return (EIRR) and the Benefit to Cost (B/C) ratio for each plant and for the whole project.
The above results confirm that the proposed hydropower rehabilitation project has excellent economic characteristics. I t i s important to note that i t s energy and capacity benefits ($166 m i l l i o n out o f the total discounted benefits o f $275 million) alone exceed the economic investment cost. Also, the project i s economically robust, as illustrated by the sensitivity analysis which shows that an increase in the investment cost o f 20% would reduce EIRR to 18%. Furthermore, the switching value for the investment cost (to yield an ERR o f 10%) is an increase o f 85%. Variations in other key economic parameters (such as fuel price in thermal power plants, discount rate etc.) have even less impact o n the project economics. B. Financial Analysis Background. UkrHydroEnergo (UHE) State Joint Stock Company was established by Order o f the Ministry o f Fuel and Energy dated December 3 1, 2003 by merger o f DniproHydroEnergo State Joint Stock Company and DnisterHydroEnergo State Joint Stock Company. The State, in the person o f the Ministry o f Fuel and Energy, i s a Founder and single shareholder o f the company.
The company operates 8 hydroelectric plants located along the Dnipro River and 1 hydroelectric plant located o n the Dnister River, together with an available capacity o f 4,600 M W at design head. Production volumes o f the hydropower plants are coordinated by UkrEnergo and the electricity generated i s sold to the Energomarket. Tariffs are regulated by N E R C and are set o n a monthly basis in consultation with UHE’s management. The company is governed by (a) the Superior Body; (b) the Supervisory Board; (c) the Board o f Directors; and (d) the Auditing Committee. The Superior B o d y is the State, represented by the Ministry o f Fuel and Energy, and, as a body, i s authorized t o govern various activities primarily related to changes to the company’s statute, approval o f annual business results and audit findings, profit distribution procedure, establishment o f subsidiaries, branches and representative offices, and liquidation. The Supervisory Board performs control over the Board o f Directors with regard to staffing and corporate management, among other things, and consists o f 7 members. The Board o f Directors, which consists o f 11 persons, is an executive body o f the 74
company that manages its current operations. The Auditing Committee o f 5 members submits audit information to the Superior Body and the Supervisory Board. On June 22, 2004, by Regulation o f the Cabinet o f Ministers, a National Joint Stock Company “Energy Company o f Ukraine” (ECU) was established, and 100% o f the state shares in UHE were transferred into the statutory fund o f ECU.
Past and Current Financial Performance. The past financial performance o f DniproHydroEnergo and DnisterHydroEnergo for the years 2002-2003, when operating as separate companies, and for UkrHydroEnergo for 200440i s shown at the end o f this Annex and the financial highlights are shown below in Table 15 and Table 16. The financial highlights show that electricity sales vary considerably from year to year depending on the weather conditions and water inflows into the Dnipro and Dnister Rivers, with electricity sales between 8.85-1 1.09 TWh during 2002-2004. As a result, the average tariff for electricity sold to the Energomarket varies considerably from year to year, with higher average tariffs in years o f lower electricity sales (e.g., 3.53 kopekslkWh in 2003) and lower average tariffs in years o f higher electricity sales (e.g., 2.97 kopeks/kWh in 2004). Table 15. Summary Income Statements4’ for DniproHydroEnergo and DnisterHydroEnergo, Separate and Combined Operations, and for UkrHydroEnergo for Years Ending December 31,2002-2004 (UAH million)
Actual performance for 9 months and estimated performance for the remaining 3 months o f 2004. The 2002 and 2003 income statements have been adjusted to exclude revenues from the surcharge for investments in the Dnister Pump Storage Plant and for taxes o n the surcharge, which were managed by (former) Dniprohydroenergo on behalf o f the Dnister Pump Storage Plant, a separate enterprise. 40
4’
75
Item Current Assets Investmentshongterm Receivable Fixed Assets Current Long-term Liabilities Equity Current Ratio Long-term Debt as % of Equity
2002
DniproHydroEnergo 301.2
I
DnisterHydroEnergo 56.6
Combined Operations
54.5
69.0
184.0 8.5
1,100.4 125.8
19.0
221.5
912.3 2.6
267.6 6.7
1,179.9 2.8
22.2
7.1
18.8
14.5
I
916.4 117.3
I
202.5
1
2003
DniproHydroEnergo 335.3
357.8
I
Combined Operations
UkrHydroEnergo
393.7
410.7
54.5
69.0
69.0
174.7 3.7
1,055.9 79.0
1,04 1.6 57.7
16.5
198.4
180.8
973.8 4.5
267.4 15.8
1,241.2 5.0
1,282.8 7.1
18.7
6.2
16.0
14.1
14.5
I
88 1.2 75.3
1
2004
DnisterHydroEnergo 58.4
181.9
I
The financial statements show that the combined hydropower company h a d increasing revenues, with revenues in 2004 o f UAH 329.6 m i l l i o n (about $ 62 million) and profits on operations, averaging about 30% o f revenues during the three-year period. Except for 2002 when DniproHydroEnergo took an extraordinary expense for the foreign exchange losses o n the first W o r l d Bank loan which had accumulated over the prior five years, the combined hydropower company eamed profits after taxes. Beginning in 2003, the company has paid dividends to the state on its shareholdings. Apart from water inflows and tariffs received for electricity sold to the Energomarket, the financial performance o f UHE is affected by the payment performance o f the Energomarket. The payment performance o f the Energomarket was highly problematic in the past, with payment levels as l o w as 30-45% during 1995 and 1996. As o f June 2000, cash payments o f electricity bills were required to be paid into bank accounts managed by an authorized bank and distributed to market participants according to an algorithm established by NERC. As a result, payment performance has greatly improved during the period 2001-2004, with average payment ratios to UHE o f 94.8% in 2003 and 94% in 2004, reflecting the general improvement in the economy and electricity market conditions, but s t i l l less than full payment performance. The past poor payment performance o f the Energomarket has resulted in a significant level o f debts for electricity sold by UHE. The level o f trade accounts receivables estimated as o f end2004 is UAH 357 million or about US$ 67 m i l l i o n (somewhat more than 1 year o f revenues). W h i l e debts are continuing to build up as long as payments from the Energomarket are less than loo%, the amount o f annual debt build-up currently i s relatively small. Resolution o f these past debts will require resolution o f the whole chain o f debts starting f r o m the consumers to oblenergos and oblenergos to the Energomarket, which would in tum allow the Energomarket to repay UHE, as well as other generators and fuel suppliers.
76
The Government, together with the Parliament, are working o n a comprehensive debt resolution plan for the energy sector, for settling debts between the various parties. The plan creates greater transparency conceming the size and structure o f the debts and debt overhang, clarifies h o w much debt i s to b e written o f f and mutually offset, identifies the mechanisms for debt write-off and mutual offsets, and allows for debt restructuring and payment through the tariffs for the residual debt obligations. In order for the plan to be fulfilled, a law i s needed, particularly given the magnitude o f the debts to be resolved. A comprehensive law o n debt resolution was submitted to the Parliament (for the second reading) o n M a y 19, 2005, which, when passed, i s expected to f o r m the legal basis for carrying out debt resolution schemes. Passage o f such legislation is an expected outcome under the World Bank-financed Development Policy Loan (DPL1). Despite the significant level o f debts from the Energomarket to UHE, the company has relatively smaller debts to its suppliers and contractors, with trade accounts and other payables estimated at about UAH 41.8 million (about US$ 7.86 million) at end-2004. Taxes payable to the state budget are estimated at about UAH 11.4 m i l l i o n (US$ 2.1 million) at the same time. UHE also has two significant prior borrowings for capital investments - one loan f r o m the World Bank in the amount o f U S $ 35.2 m i l l i o n and a loan from the Swiss Government in the amount o f UAH 59.0 m i l l i o n equivalent. Another factor affecting the financial performance o f UHE i s the value o f net fixed assets in operation, which i s judged to be substantially below the current replacement value o f the assets4*. N e t fixed assets are estimated at only about U A H 1 b i l l i o n (about U S $ 188 million) according to Ukrainian accounting standards at end-2004 and about UAH 1.25 b i l l i o n (about U S $ 235 million) according to IAS at end-2003. As a result, the proposed project investments appear large because o f the l o w value o f net fixed assets. The l o w fixed asset values result in too l o w depreciation charges, thereby limiting UHE’s ability to finance needed capital investments. Therefore, i t has been agreed during negotiations that UHE will carry out a proper revaluation of i t s assets not later than December 31, 2007 in accordance with terms o f reference and with the assistance o f consultants satisfactow to the Bank. It was also agreed that the revaluation o f UHE’s assets will help establish a consistent methodology and a practical approach for the revaluation o f assets o f other power companies regulated by NERC. Based o n today’s tax laws, an increase in the value o f fixed assets through a revaluation i s treated as a realized capital gain43 and is thus subject to a tax liability o f 30% o n the increase in value. Thus the present tax laws act as a disincentive to companies to revalue their fixed assets as the basis for the depreciation charge. I t is therefore recommended that the tax legislation be reviewed to encourage depreciation charges to be based o n the replacement costs o f fixed assets. The proposed asset revaluation consultancy should review the tax implications o f its proposals for revaluing UHE’s fixed assets.
Conservative estimates place the value o f net fixed assets at about 10 times the value in UHE’s accounting records. 43 Countries utilizing international accounting standards typically treat a revaluation o f fixed assets as an unrealized gain in value.
42
77
UHE's tariff structure. UHE currently has a one-tier tariff which varies according to electricity generation. However, UHE's hydroelectric generation i s characterized by large variations in the production volumes per month due to changing weather conditions, with peak periods during the periods February-April and October-December and l o w production levels in the summer months, as shown in Figure 5 below. In addition, unlike other generators, its cost o f production does not have a fuel component and thus the variable items in its cost structure are small, with most costs items considered to be fixed costs. This rigid dependence o n the weather for electricity generation and the high level o f fixed costs results in frequent revisions o f the tariff by NERC during the year (as many as 9 times during 2002), as shown in Figure 6 below and with wide variations in the tariffs from month to month, as shown in Figure 7 below for 2003. This tariff policy makes it difficult for UHE to operate with stable revenues throughout the year to cover costs which are also largely stable and unrelated to production levels.
Figure 5 Dynamics of DniproHydroEnergo Electricity Sales in 2002-2003
91 6,636
0 0 0 0-
: o
i o ,
496,428
+2002
-w-
78
2003
Figure 6. Dynamics o f DniproHydroEnergo Tariffs in 1999-2004 5.00
4.00
f
3.00
P
2.00
1.00
0.00
Figure 7. Actual Sales o f Electricity and Tariffs for DniproHydroEnergo in 2003
1000000
__
4.4
800000
5 c
m m v1
5
5.00
4.00
600000
E
- 903;313----
3.00 I
400000 200000
2.00 418,181
le9 1.9
1.oo
0
0.00
79
5e
a
0 % .
In order to overcome these difficulties, UHE initiated a study, with the approval o f NERC, t o establish a methodology for introducing two-tier tariffs for the company. The proposed new tariff structure w o u l d include a capacity charge to cover UHE’s fixed costs o f operation and a variable charge for its variable costs. The new tariff structure i s expected to even out the revenue flows o n a monthly basis to better ensure the efficient operation o f the company and its ability to make its required operational payments in a timely manner. I t has been agreed with NERC that the new tariff structure would be introduced o n an experimental basis f r o m January 2005 and, if judged satisfactory, would be introduced in 2005. During negotiations, i t was am-eed that the Government w o u l d ensure that N E R C introduces a two-tier tariff for UHE by end-2005.
As UHE provides an essential service for maintaining frequency and tie-line flows in the electricity system, i t is important for it to receive proper compensation for providing those services. The necessary compensation for such services i s a topic currently being examined by consultants working with N E R C o n implementation o f the WEM Concept reform, specifically regarding the establishment o f a bilateral and ancillary services market. I t i s anticipated that a separate system service charge for UHE would be established in the future in connection with the establishment o f the balancing mechanism. During negotiations, i t was agreed that the Government would ensure that N E R C introduces a system service charge to be paid to UHE in parallel with the development o f the balancing mechanism in the Wholesale Electricity Market. Future financial performance of UHE. Projections o f the likely financial performance o f UHE over the period 2005-20 12 have been prepared and are presented in summary form in Table 1720 and in detail in Annex 1. The financial projections include a forecast o f UHE’s income statements, sources and applications o f funds statements and balance sheets along with financial performance indicators. The analysis has been based o n UHE’s statutory accounts which are prepared in accordance with Ukrainian accounting standards44 as these accounts closely correspond to the accounts which are considered by N E R C when establishing tariffs. The projections have been prepared to determine the average tariffs45necessary for UHE to undertake the project investment program, repay the proposed W o r l d Bank loan and other prior loans, remain profitable and maintain satisfactory overall financial performance. The projections have been prepared o n a conservative basis assuming that:
(a)
the electricity generation forecast includes the benefits o f increased efficiency o f hydropower production from the project investments;
(b)
the general rate o f domestic inflation in Ukraine would be 9.8% in 2005, 6.5% in 2006, 5.9% in 2007,5.6% in 2008, 5.3% in 2009, and 5% thereafter;
(c)
the UAH/US$ exchange rate would be 5.30 in 2005, 5.36 in 2006, 5.47 in 2007, 5.58 in 2008, 5.69 in 2009, 5.80 in 2010 and 5.85 thereafter;
Ukrainian Accounting Standards are not substantially different f r o m Intemational Accounting Standards (IAS) but some significant differences arise f r o m the restatement of the value o f net fixed assets and depreciation charges when I A S i s used. 45 The analysis has not yet considered potential revenues f r o m introduction o f system service charges for UHE. 44
80
the majority o f UHE's expenses would increase annually with the estimated rate o f domestic inflation, with the exception o f charges for water use which would reduce per unit o f electricity generated due to the efficiency gains o f the project investments; other project benefits from reduced O&M costs have also been included in the financial forecast; payment performance o f the Energomarket to UHE for i t s electricity sales would gradually increase from 95% in 2005 by 1% per year to full payment performance by 2010;
UHE would undertake a capital investment program, including technical assistance, o f about US$356.2 m i l l i o n over the period 2006-2011, o f which the World Bank would finance about $ 100 m i l l i o n or about 28%; UHE would finance the balance o f the capital investment program, including all taxes and import duties, out o f current revenues which would b e supported by sufficient tariffs; the World Bank loan would be at an interest rate o f about 5%, with a maturity o f 18 years, including a 6-year grace period; UkrHydrogEnergo would pay interest during construction annually and not capitalize these charges into the World Bank loan amount (as under the prior World Bank loan); and the proposed payments from carbon trading have been included at an estimated annual amount o f about U S $ 1.04 m i l l i o n during 2009-2013.
Expenses
251.4
261.9
275.6
296.8
317.7
337.5
357.1
375.2
Net Operating Income
36.1
137.2
350.8
278.3
369.5
224.0
206.9
200.5
Net Income
14.2
72.3
195.2
149.0
201.2
113.3
102.4
98.8
Operating Income as % o f Revenues
~
12.6%
34.4%
56.0%
81
48.4%
53.8%
39.9%
36.7%
34.8 %
Net Income as '70of Revenues Return on Equity
5.8% 1.3%
21.3% 6.2 %
36.7% 14.7%
30.5% 10.2 9'0
34.4% 12.3%
23.7% 6.5%
21.4% 5.6%
20.2% 5.2 Yo
Table 18 Summary Forecast Balance Sheets for UkrHydroEnergo as of December 31,2005-2012 (UAH million)
Table 19 Summary Forecast Sources and Applications of Funds Statements for UkrHydroEnergo for Years Ending December 31,2005-2012 (UAH million)
Construction Projects
10.0
331.9
397.2
313.4
394.1
283.7
250.7
250.0
Technical Assistance Taxes and Dividends
21.6
2.7 59.8
5.5 143.8
5.6 112.9
5.7 148.8
2.9 89.4
2.9 82.5
80.4
Working Capital
26.3
12.2
11.0
14.4
3.5
5.5
0.6
0.2
82
Increase (Decrease) Debt Service Equipment Lease
Total Applications
33.0
36.4
43.3
48.3
39.8
42.0
42.9
81.2
1.1
1.1
1.1
1.1
1.1
1.1
1.1
1.1
92.0
444.1
601.9
495.6
593.1
424.5
406.4
391.8
The forecast shows that the project investments, which would bring about electricity generation efficiency improvements and increased electricity sales, would require significant increases in the average electricity tariff, due primarily to the large share (about 72%) o f financing by UHE o f the project investment costs which are to be covered by current revenues. The schedule o f proposed increases in the average electricity tariff based o n the above assumptions are as shown in the Table 2 1.
T a b l e 20. Schedule o f UHE’s average electricity tariff
As Ukrhydrogenergo’s share o f total electricity generation in Ukraine i s relatively small (around 6-8%), the above tariff increases would not, however, be expected to have a major impact o n the average wholesale electricity market price.
NERC’s methodology for establishing UHE’s tariffs allows for the recovery o f the costs of UHE’s operations but not its future investment programs. In accordance with current regulatory requirements, N E R C must approve investment programs prior to any tariff increases. N E R C has provided its approval in the form o f a letter o f support o n April 13, 2005 for the proposed investment project to be undertaken by UHE.
During i t s meeting o f December 29, 2004, the Cabinet of Ministers decided to start preparation o f the proposed investment operation w i t h the W o r l d Bank and requested N E R C to consider including project costs in UHE’s tariff. With the proposed increases in average tariffs during the project period, UHE would be able to generate the counterpart contribution to the project investment costs and maintain satisfactory financial perfonnance, with a satisfactory operating ratio46(averaging 57% over the project period), adequate working capital4’ (current ratio above 46
Ratio i s calculated as operating expenses divided by operating revenues.
83
1.2) and debt service coverage48 (well above the minimum advisable ratio o f 1.5). In order t o protect UHE’s financial position. i t was agreed that the company will maintain a debt service coverage ratio o f at least 1.5 during the proiect period. Also, in order to ensure adequate liquidity. i t was agreed that UHE maintain a current ratio o f at least 1.2 during the proiect period. T o properly monitor financial performance, UHE will prepare a report annually o n o r about March 3 1. beginning in FY06. for each year during proiect implementation, containing financial proiections for the upcoming year to be reviewed by the Bank.
As mentioned previously, the financial performance o f UHE i s affected by the payment performance o f the Energomarket. As the economy continues to improve, it is anticipated that payment performance would also continue to improve, gradually increasing to full payment performance, assumed by 2010. I t was agreed during negotiations that the Government will cause N E R C to ensure the distribution o f funds due from Energomarket to UHE in a timely manner according to the algorithm in place. The financial forecast incorporates the estimated savings in water charges as a result o f the improvements in the efficiency o f electricity generation brought about by the project investments. The forecast also incorporates potential savings in staffing and operations and maintenance costs from the project investments. In addition, the forecast has included the revenue from the sale o f greenhouse gas Emission Reduction Units (ERUS)~~ created through the increase o f hydroelectric production under the Hydropower Rehabilitation Project. Based on a preliminary analysis o f the expected amount and the price o f ERUs, i t is estimated that UHE would earn about U S $ 1.04 million per year starting in 2009 for five years.
Ratio i s calculated as current assets divided by current liabilities; a ratio greater than 1.0 i s required to ensure company solvency. Defined as the ability o f UkrHydroEnergo to cover i t s interest and principal payments o n loan obligations out of internally generated funds. 49 In parallel with the preparation o f the Hydropower Rehabilitation Project, the Bank assisted UHE in preparing a carbon financing operation based on the “Second Track Joint Implementation’ arrangements under the Kyoto Protocol. 47
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Annex 10: Safeguard Policy Issues
UKRAINE: Hydropower Rehabilitation Project in Support of the Energy Sector Reform and Development Program Most o f the investment projects supported under the Energy Program are expected to be Bcategory projects. Hydropower Rehabilitation Project i s a B-category project. However, future investment projects included in the later phases o f the Energy Program m a y contain components that would be rated as belonging to other categories. Therefore, compliance with the Bank safeguard policies will be evaluated separately for each phase o f the Energy Program.
Hydropower Rehabilitation Project triggers OP 4.37 on D a m Safety: The existing Cascade System o f DamsResewoirs on the Dnipro River in Ukraine, is one o f the largest system in dam engineering in the world (see Table 21). While many other cascade systems o f dams/resewoirs could be identified as equally important in many other countries, these systems are mainly founded o n solid rock foundations. A majority o f the damsh-eservoirs o f the Dnipro Cascade system, however happen to be founded o n sandy foundations and built o f sandy soils, thus, necessitating continuous protection against dam safety hazards, and greater emphasis o n regular dam safety inspections and dam safety monitoring. The Dnipro HPPl built as the first dam structure o f the system, is the only one structure built o n solid rock foundations. When its gigantic horseshoe dam was built in 1934, i t was considered as one o f the most important projects in dam engineering in the world. Currently, UHE has overall responsibility for the safe operation and maintenance o f the Dnipro Cascade system o f dams/reservoirs and the Dnister damheservoir.
Table 21. The Dnipro and Dnister System of Dams
Note: ED = earth dam; CD = concrete d a m
93
The Dnipro river i s the third largest river o f Europe, with a catchment area o f about 505,000 km2. M o r e than 30 m i l l i o n people use the Dnipro river water. For Ukraine, the Dnipro river is often considered as its life line, where more than 50 large cities, over 10,000 industrial enterprises, over 2,000 rural, more than 1,000 public utilities, and over 50,000 irrigation systems are provided with Dnipro water. The reservoirs o f Dnipro Cascade system are for multi purpose and the water resources are used for: supply o f urban, rural and industrial water, - hydroelectric generation, irrigation, - fisheries, - navigation (water transportation), and - recreation.
-
-
The various damdreservoirs o f the Dnipro Cascade System interrelated and continuous so that the lake levels o f the downstream reservoir more or less control the tail water level o f the hydropower station o f the upper reservoir. I t is important to note that five o f the damslreservoirs o f the Dnipro Cascade system are identified among the world’s major dams, t w o among the longest dams (Kyiv, Dniprodzerzhinsk) and two with very large reservoir volume (Kremenchug, Kahovka). Also, all these damslreservoirs are located in the most industrialized and heavily populated regions o f Ukraine. The dams safety thus, plays a greater role in Ukraine than many other countries, due to the likely tremendous hazard to population in future, in case o f any uncontrolled happenings. The Dnister dadreservoir i s located o n the Dnister river in the south westem part o f Ukraine, at a distance o f about 15 km upstream from the point where the river forms the border l i n e between Moldova and Ukraine (or a distance o f about 678 km from the Dnister mouth). The multi-purpose use o f the reservoir includes water supply, irrigation, navigation, hydropower generation, and flood control. The Dnister dam (Dnister river) i s also founded o n sound rock as the Dnipro HPPl (Dnipro river), but the lake length happens to be very long (194 km) necessitating continuous monitoring. The project team performed an overall assessment o f dam safety and found it very encouraging that UHE attaches great importance on the safety o f Dnipro Cascade system o f dams (Dnipro river) as well as on Dnister dam (Dnister river). The UHE has already taken several steps in this respect as required in accordance with the Bank Guidelines for Safety o f Dams (OMS 3.80, 1977 and the revised OPBP 4,37, 1996), specially in respect of: - The dam safety monitoring. - Annual dam safety inspections. - Emergency Preparedness Plan (including the Emergency Action Plan through the Emergency Ministry and other relevant organizations). Operation and Maintenance. D a m Safety Legislation (Draft).
-
The overall Dnipro cascade system o f dams/reservoirs appear to have been successfully monitored, operated and maintained by the UHE for periods varying from over 30 to 60 years without any major safety hazard so far. A team of 4 staff members i s understood t o be 94
maintained for each o f the six damsheservoirs o f the Dnipro Cascade system and for Dnister dam (Dnister river), for dam safety inspections, instrumentation observations and dam safety monitoring. The draft D a m Safety Legislation has been prepared by the UHE, the Hydropower Design Institute, and the Institute o f Environmental and Water Problems, and submitted to the Ministry o f Fuel and Energy in July 2004, for further processing through other Government agencies, and thereafter for final approval by the Government. The draft i s currently under review by the various committees and Ministries and UHE i s following up o n the required processing o f the draft law. Ukraine i s not yet a member o f the Intemational Commission o n Large Dams (ICOLD). With such an important Dnipro Cascade System o f damsheservoirs, and other substantial water resources and hydro potential in Ukraine, and so much commitment being given by the UHE to Dams Safety, i t i s essential and it is strongly recommended that the Ukrainian Government should consider joining the Intemational Community in the field o f Dams and Water Resources, and becoming a member o f the ICOLD. The project team reviewed the design o f some o f the more important dam embankments and appurtement structures o f the Dnipro Cascade system (Kyiv, Kaniv, Kremenchug, Dniprodzerzinsk, Dniprovska and Kakhovka) along with the engineering professionals and the design personnel from UHE and their consultants UkrHydroProject (UHP). The designs o f the relevant concrete structures and the dam embankments, in general, appear to have been w e l l designed, more or less meeting the international standards. Also, the quality o f construction o f works i s understood to appear to be excellent and w e l l controlled during construction. The existing condition o f the structural concrete and the dam abutments even after a period o f over 30 to 60 years, i s apparently an ample proof o f the well designed and constructed dam structures o f the Dnipro Cascade system. Due to the very long operating periods for these damshtructures, and the recent detailed dam safety inspections by the UHE and UHP professionals, some immediate dam safety strengthening measures have been identified comprising o f c i v i l works including (drainage channels, dam embankments, and concrete works), and rehabilitation or replacement o f the hydro-mechanical gates for some dams/spillways which need to be undertaken in the near term, i.e. within the scope o f the proposed hydropower rehabilitation project.
-
-
Geological: Only one dam (Dniprovska) o f the Dnipro Cascade system i s founded o n geologically good rock foundation. All other five dams are founded o n geologically pervious (sandy) foundations, and the dam embankments built o f sandy soils. Thus, the continuous dam safety monitoring for these dams o n pervious (sandy) foundations becomes most important for safety o f the Dnipro Cascade system. Hydrological: The hydrology o f the Dnipro i s characterized by pronounced seasonal regime, w i t h the highest floods during the spring, strongly influenced by the snowmelt. The Hydrological Forecasting Department o f the HydroMet Center in Kyiv i s responsible for preparation o f hydrological forecasts in the Dnipro Basin. The hydrological data (by
95
HydroMet) i s understood to be based on nearly 200 hydrological gauging stations located within Dnipro Basin (more than 80 o f these stations located in Belarus and Russia), and some 2 10 stations for snowmelt depth (including 118 in the territory o f Ukraine). Some hydrological instrumentation i s required to be upgraded and replaced for the HydroMet, for reliable measurements, assessments, and accurate flood forecasting. Most o f the dams/structures o f the Dnipro Cascade system have been provided for 10,000 year design floods (covering present international standards). However, the two structures ( Kyiv and Kaniv), which are the first structures on the Cascade system, are apparently designed for 1000 year flood, which could not be considered adequate from the presently adopted norms in d d s p i l l w a y designs.
-
Sedimentation: N o sedimentation surveys for any o f the reservoirs are understood to have been done so far, with apparently no knowledge o f the behavior o f the sediment deposits and/or the sediment delta movement in the reservoirs, for future planned actions, which is important specially for Kyiv reservoir (which is the first structure o f the Dnipro Cascade system), and the sediment deposits are understood to have been h r t h e r complicated due to the Chemobyl NPP accident in 1986 and the resulting radiated sediments.
Instrumentation, mainly comprising o f embankment piezometers, foundation piezometers, observation pipes, settlement devices, survey points, inclinometers, and the seepage discharge measurement devices are provided o n almost all the dam structures o f the cascade system to monitor the dams behavior. Some o f the instrumentation is understood to have been damaged and i s inoperative. The previous Bank project (Hydropower Rehabilitation and System Control Project, Loan 3865) provided the first successful step towards dam safety monitoring o f the Dnipro Cascade system, with provision and installation o f the needed instrumentatiordequipment and the computer-aided monitoring system for Kyiv dam and HPP (the uppermost structure o f the entire system), as a model, incorporating installation of: - new drill holes and piezometers; - water flow transducers; - jointmeters; - inclinometers; - data concentrators; concrete shelter boxes, and concrete towers; cables/trenches, and - computer hardware and software.
-
A site inspection by the project team, along with the UHE and UHP professionals, for the installed dam safety monitoring instrumentatiordequipmentand its computer-aided operation, for
Kyiv dam and HPP, indicated that provision and installation o f computer-aided dam safety monitoring system for Kyiv dam and HPP, has been very successful safety monitoring system, providing immediate monitoring control o f the collection and interpretation o f a l l the dam safety monitoring data (including the piezometer readings, the safe phreatic lines in the dam
embankments, the drainage channel water levels, the drainage discharges and variations with
96
reservoir levels, the concrete joint openings, the concrete block defections and inclinations, the water temperatures, and other relevant data, and an automatic alarm system for critical data observations), at the Monitoring Center at Kyiv HPP, and that the same need to be duplicated and provided to other needed dams o f the system, for an overall monitoring control o f the whole system. While the computer aided dam safety monitoring instrumentation provides an extremely useful tool for the overall reliable surveillance o f the dams safety, specially for long dams, i t i s necessary t o continue physical dam safety inspections, since every foot length o f dam could not be covered by instrumentation or for interpretation o f the readings from adjacent areas for reliable results. Based o n the experience gained o n the dam safety monitoring system for Kyiv dam, the UHE has also installed similar dam safety systems at: (i) Kremenchug dam and HPP (completed in September 2004); and (ii) Kakhovka dam and HPP (scheduled for completion in December 2005). Measures Required to Strengthen Dam Safety
The overall dam safety strengthening measures as presently needed for the Dnipro Cascade system and the Dnister dam and HPP (Dnister river), as per detailed proposals by the UHE and UHP (and reviewed by the project team), could be identified as: Computer aided dam safety monitoring system for Dniprovska, Dniprodzerzhinsk, K a n i v and Dnister dams and HPP. - The needed strengthening c i v i l works for Kyiv, Kaniv, Dniprovska, and Dniprodzerzhinsk dams, incorporating rehabilitation of: > drainage facilities; > design profiles (rehabilitation o f subsidence); > slope protections; > concrete spillways and other reinforced concrete works. - Protection against high phreatic lines (high piezometric levels) in the dam embankments at Kaniv, Kremenchug, Dniprodzherzhinsk and Kakhovka. The design proposals for above c i v i l works should be completed by December 31,2005. - Rehabilitation and/or replacement o f the needed hydro-mechanical gates for Dniprovska and Dniprodzerzhinsk damdspillways.
-
Provision for these identified dam strengthening measures has been made as a part o f the D a m Safety Component under the Project. Possible additional measures related t o rehabilitation and/or replacement o f any o f the spillway gates for Kremenchug and Kakhovka dams will be evaluated by UHE by December 3 1,2005.
With the modernization and automation o f the dam safety monitoring and telecontrol o f the dam surveillance for the overall Dnipro Cascade system o f damdreservoirs, i t i s essential that a D a m Safety Center (DSC) should be established, for immediate analysis and interpretation o f a l l the relevant data, specially the questionable (or alarming) data. During negotiations, i t was am-eed that UHE will establish and maintain an adequately staffed D S C under scope o f work acceptable to the Bank by December 31, 2005. The scope o f work would include, inter alia, to (A) inspect 97
and evaluate the safety status o f the existing - dams, i t s appurtenances, and i t s performance history; (B) review and evaluate UHE's operation and maintenance procedures; (C) provide a written report o f findings and recommendations for any remedial work o r safety-related measures necessary to upwade the existing dam to an acceptable standard o f safety; and (D) provide an immediate analysis and interpretation o f all relevant data, specially the questionable or alarming one, gathered from the operation o f the dams under the project. Furthermore, at the negotiations, i t would be aweed that UHE ensures that (i) a detailed plan for construction supervision, an instrumentation plan, an operation and maintenance plan, and an emergency preparedness plan would be prepared and implemented: (ii)all work under the dam safety component i s designed and supervised by competent professionals; and (iii)DSC performs periodic dam safetv inspections. The proposed project will also include the needed technical assistance related to the dam safety component : 1. Study for the Safe Design floods for Kyiv and Kaniv reservoirs (presently designed for only 1000 year flood), with safe and economical options including necessity or otherwise o f (emergency spillway, increased reservoir capacity, optimized reservoir regulations, and/or installations o f additional hydrological instrumentatiodequipment for accurate flood forecasting). 2. Upgradingheplacement o f hydrological instrumentation for the HydroMet, for more reliable measurements, assessments, and flood forecasting. 3. Study, Assessment and Analysis o f the Reservoir Sedimentation for Kyiv dam (sediment volume, sediment profile, and sediment characteristics) specially in view o f the fact that Kyiv reservoir i s the first reservoir o n the Dnipro Cascade system o f dams, and the reservoir sedimentation has been further complicated due to the Chernobyl NPP accident in 1986, and the resulting radiated sediments. 4. Training o f Professionals in dam safety management. 5. Eight local professionals, in 2 groups o f 4 engineers each, for 3 month training, w i l l be identified at an early stage o f the project, for specialized training in the fields o f - Computer aided monitoring system design. Monitoring, maintenance, and operation o f system. D a m safety inspections and safety monitoring. These trained professionals will later assist in implementation and monitoring o f the Project D a m Safety Component.
-
UHE will prepare criteria for selection o f candidates for training acceptable to the Bank by December 31, 2005. The criteria will meet various requirements as proposed by the UHE, including:
-
-
the relevant basic qualifications; working professionals at the dams and HPP, and the Design Institute; an arrangement with the professionals to stay with the U H E D e s i g n Institute for a minimum o f 3 years after training.
98
Rehabilitation of Hydropower Plants triggers OP 7.50 on Projects in International Waterways: Hydropower plants included in the proposed rehabilitation project are located o n the Dnipro and Dnister rivers, w h i c h both flow into the Black Sea. An exemption from the notification requirement under OP 7.50 has been granted to the project team because the Hydropower Rehabilitation Project does not involve works and activities that would exceed the original scheme, change i t s nature, or alter and expand its scope and extent to make it appear a new o r different scheme. Consequently, i t falls within the exception set forth in paragraph 7 (a) of OP7.50 as: (a) i t will not adversely affect the quality or quantity o f water flows to the other riparians; and (b) i t will not be adversely affected by other riparians’ water use. Ukraine is signatory of the Black Sea Convention and Agreements with the Republic o f Belarus (the Belarus Convention), Russia (the Russia Convention) and the Republic o f Moldova (the Moldova Convention) on the joint use and conservation o f boundary water bodies. The Bank’s project team reviewed the relevant provisions5’ o f these Conventions and concluded that any notification requirement under the applicable Conventions is triggered only in cases o f negative effects or consequences. The team also assessed that the works falling within the scope o f the Hydropower Rehabilitation Project will not cause any negative or detrimental effects (along the ones described in the applicable Conventions) and, therefore, no notification or information requirement under the applicable bilateral or multilateral agreements would be applicable. Rehabilitation o f Hydropower Plants does not trigger Social Safeguards. Rehabilitation o f the hydropower units will take place entirely within existing sites, thus n o land acquisition will be required and no resettlement will occur as the result o f the project. N o indigenous peoples will be affected by the project. Thus i t does not trigger either OP 4.12 Involuntary Resettlement pr OD 4.20 Indigenous Peoples. Likewise, it does not trigger 0P:N 11.03, Cultural Property for the same reasons.
50 Article 3, third paragraph o f the Belarus Convention; Article 3, second paragraph o f the Moldova Convention; Article 3, third paragraph o f the Russia Convention; and Article XV, paragraph 5 o f the Black Sea Convention.
99
Annex 11: Project Preparation and Supervision UKRAINE: Hydropower Rehabilitation Project in Support of the Energy Sector Reform and Development Program
Table 22. The Project cycle schedule Activity P C N review Initial P I D to PIC Initial ISDS to PIC Appraisal Negotiations Board/RVP approval Planned date o f effectiveness Planned date o f mid-term review Planned closing date
Planned
Actual
September 2004
September 22,2004 December 7.2004
March 2005 June 2005 September 2005 October 15, 2005 June 2008 September 201 1
March 2005 M a y 10-13,2005 June 16,2005
K e y institutions responsible for preparation o f the project:
-
-
-
ESRDP - The Government o f Ukraine, Ministry o f Fuel and Energy Hydropower Rehabilitation Project - UkrHydroEnergo (UHE) and its consultants including UkrHydroProekt Energy market and regulatory framework - N E R C and its consultants
Bank funds expended to date on project preparation: 1. Bank resources: $262,965.1 1 2. Trust funds: $ 3. Total: $ Estimated Approval and Supervision costs o f the Hydropower Rehabilitation Project: 1. Remaining costs to approval: $ 2. Estimated annual supervision cost: $100,000.00 Bank staff and consultants who worked o n the Energy Program and the Hydropower Rehabilitation Project included:
Table 23. The Bank staff and consultants involved Name
Dejan Ostojic
Claudia Pardinas Ocana Jonathan Pavluk Nikolay Chistakov Carolyn Gochenour Dennis Creamer Permanand Gupta Bernard Baratz
Title Sr. Energy Specialist - Program Team Leader Senior Counsel Senior Counsel Senior Finance Officer Consultant - Financial Analyst Consultant - Economist Consultant - D a m Safety Specialist Consultant - Environmental Specialist
100
Unit
ECSIE LEGEC LEGEC LOAG2
__ ----
L u d m i l a Butenko
Sr. Resource Management Officer
Varadaraian Atur
Sr F i n a n c i a l A n a l m t
101
I I
SFRRM ECSIE
Annex 12: Documents in the Project Files UKRAINE: Hydropower Rehabilitation Project in Support o f the Energy Sector Reform and Development Program
1. Country Assistance Strategy for Ukraine, 2003 2. Decision o f the Cabinet o f Ministers o f Ukraine on the establishment o f Commission for Energy Sector Refonn and Development, No.1091, August 25,2004.
3. Letter from Vice Prime Minister Andriy Kluyev to Country Director Paul Benningham requesting the Bank support in preparing and implementing the Energy APL, October 20,2004 4. Letter from Country Director Paul Benningham to Vice Prime Minister Kluyev on Energy APL Pre-Appraisal mission, and signing o f the PHRD Grant Agreement, November 10,2004
5. Signed Letter o f Agreement on Japanese Grant No. 053330, November 18,2004 6. Decision o f the Cabinet o f Ministers o f Ukraine on the preparation o f Hydropower Rehabilitation Project for possible financing under the Energy APL, December 29,2004. 7. Ukraine's Country Economic Memorandum, 2004 8. No Objection Letter from the Deputy Minister o f Environmental Protection Sviatoslav Kurulenko, March 10,2005 9. Decision Package Review Meeting, March 24, 2005
10. Minutes o f Decision Meeting, April 2, 2005 11. Letter from the National Energy Regulatory Commission o f Ukraine Acting Head Yuri Kyyashko with suggestions on the Project, April 13,2005 12. Invitation to Negotiate to the Government o f Ukraine addressed to Prime Minister Yulia Tymochenko signed by Country Director Paul Benningham, April 11,2005
102
Annex 13: Statement of Loans and Credits
UKRAINE: Hydropower Rehabilitation Project in Support of the Energy Sector Reform and Development Program
-
Table 24. Statement of loans and credits
I
I
Difference between expected and actual disbursements
Original Amount in US$ Millions Project ID PO74972
FY 2004
-
PO76338 2004 PO57815 2003 PO69857 PO35777 ~
2003 2003
Purpose
PAL 2 DEVSTAT ST T A X SERV M O D PROG (APL #I> TBiAIDS CNTRL
2003 2002 PO54966 2002 PO48790 2002
AZOV-BLK SEA CORR BIODIV
PO35 786 2001 PO55739 2000 PO44832 1998
K Y I V DISTRICT HEAT.
GEF 0.0 0.0 0.0
Cancel. 0.0
Undisb. 172.5
0.0 0.0
SF 0.0 0.0 0.0
0.0 0.0
32.0 38.4
0.0
0.0
0.0
0.0
59.1
0.0
I 0.0 I
0.0
IBRD 250.0
IDA 0.0
32.0 40.0 60.0
Rev’d
172.5 15.9
PO74885 PO69858
-
Total:
I
200.0
1904.9
103
I
I
0.0 IO.0
1
6.9
I
I
40.0
42.0
I
I
101.1
I
I
141.1
701.1 388.4
I
I
16.4
29.5
Table 25. Ukraine Statement o f IFC’s on Held Held and Disbursed Portfolio (In Millions o f U S Dollars) Committed
FY Approval
Disbursed
I 2000 1994196
Total portfolio:
13.50
0.00
10.13
0.00
3.50
10.13
FY
Approval
Loan ~
Equity
Quasi
Partic.
~~~
2004
First Lease
0.00
0.00
0.00
0.00
2004
MBU RI
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Total pending commitment:
104
0.00
0.00
0.00
Annex 14. Ukraine at a Glance
Ukraine
Europe 8 Central Asia
Lowermiddleincome
48.4 970 46.9
473 2,570 1,217
2,655 1,480 3,934
-0.8 -0.4
0.0 0.2
0.9 1.2
67 68 16 3 98 0 90 91 90
63 69 31 91 3 103 104 102
50 69 32 11 81 10 112 113 111
1993
2002
2003
GDP (US$ billions) Gross domestic investmenffGDP Exports of goods and services/GDP Gross domestic savingslGDP Gross national savingslGDP
65.6 36.3 25.9 36.0
42.4 18.7 55.1 23.0 26.1
49.5 19.3 52.9 24.0 25.2
Current account balancelGDP Interest paymentslGDP Total debffGDP Total debt servicelexports Present value of debffGDP Present value of debffexports
-1.3 0.1 5.9 1.3
7.5 1.3 32.0 13.7 29.8 53.4
6.2 1.2 23.1 10.6
POVERTY and SOCIAL
2003 Population,mid-year (millions) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)
Development diamond' Life expectancy
-
Average annual growth, 1997-03 Population(%) Labor force (%J
GNI per captta
Most recent estimate (latest year available, 1997-03) Poverty (% of population below nationalpoverly line) Urban population (% of total population) Life expectancy at birth (years) Infant mortality (per 7,000 live births) Child malnutrition (% of children under 5) Access to an improvedwater source I%of population) Illiteracy (% ofpopulation age 75+) Gross primary enrollment (% of school-age population) Male Female
Gross primary enrollment
-
Access to improved water source
-
Ukraine
Lower-middl~ncomeamuD
~
KEY ECONOMIC RATIOS and LONG-TERM TRENDS
1983
(average annual growth) GDP GDP per capita Exports of goods and services STRUCTURE of the ECONOMY (% of GDP) Agriculture Industry Manufacturing Services
(average annual growth) AQriCUltUre Industry Manufacturing Services
1993-03
2002
2003
200307
-5.6 -5.9
-1.6 -0.8 5.3
5.2 6.0 9.1
9.4 10.2 5.0
5.0 5.7 4.8
1983
1993
2002
2003
21.7 37.7 29.9 40.6
15.3 38.2 23.2 46.5
14.1 40.3 25.0 45.6
48.0 16.0 26.2
57.0 20.0 50.7
60.2 15.8 48.3
1993-03
2002
2003
-2.5 -0.3 1.0 -2.9
3.6 5.0 7.0 6.3
-8.0 14.0 16.0 18.2
Private consumption General government consumption Gross domestic investment Imports of goods and services
-0.8 -2.0 -5.1 3.6
5.1 -0.7 -22.3 3.7
-15.7 13.8 16.3 10.4
1983-93
Trade
__
Domestic savings
Investment
Indebtedness
1983-93
Private consumption General government consumption Imports of goods and services
Economic ratios'
-Ukraine Lower-middleincome arom
Growth of investment and GDP (%) 40 20
-
-
0
-20 -40
*GDP
-GDI
~~~~
~
Growth of exports and imports (%)
-30 -
-
Exports
-
*imports
Note: 2003 data are preliminary estimates. This table was produced from the DevelopmentEconomics central database. * The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete.
105
I
I
Ukraine PRICES and GOVERNMENT FINANCE Domestic prices (% change) Consumer prices Implicit GDP deflator
1983
Governmentfinance (% of GDP, includes current grants) Current revenue Current budget balance Overall sumlusldeficit TRADE (US$ millions) Total exports (fob) Ferrous and non-precious metals Mineral products Manufactures Total imports (cif) Food Fuel and energy Capital goods
1983
1993
2002
2003
10,125.0 3,334.8
0.8 5.1
1.1 6.9
42.8 -25.4 -28.1
35.3 3.3 0.5
34.2 1.5 -0.4
1993
2002
2003
12,796
18,669 7,126 2,389 3,508 17,959 1,114 6,940 3,785
21,225 8,745 2,558 3,540 20,029 1,225 7,289 4,714
99 114 87
107 115 93
1993
2002
2003
15,850 16,755 -905
23,351 21,494 1,857
26,240 23,922 2,318
-69
-606 1,922
-446 1,187
15,315 6,156
Export price index (7995=700) Import price index (7995=100) Terms of trade (1995=700)
BALANCE of PAYMENTS (US$ millions) Exports of goods and services imports of goods and services Resource balance
1983
Net income Net current transfers Current account balance
-854
3,173
3,059
Financing items (net) Changes in net reserves
817 37
-2.128 -1,045
-406 -2,653
2.26E-2
4,417 5.3
6,874 5.3
1993
2002
2003
3,855 0 0
13,555 2,233 0
11,448 2,121 0
Total debt service IBRD IDA
202 0 0
3,243 198 0
2,817 209 0
Composition of net resource flows Official grants Official creditors Private creditors Foreign direct investment Portfolio equity
117 307 441 200 0
120 -272 689 693 -1,958
27 0 0 0 0 0
82 45 121 -76 77 -153
Memo: Reserves including gold (US$ millions) Conversion rate (DEC, local/US$) EXTERNAL DEBT and RESOURCE FLOWS (US$ millions) Total debt outstandingand disbursed IBRD IDA
World Bank program Commitments Disbunements Principal repayments Net flows Interest payments Net transfers
1983
Note: This table was produced from the Development Economics central database
106
_ _ _ ~ -
I
Inflation ( O h )
W
99
gS
02
01
03
deflator +CPI
"-GDP
Export and import levels (US$ mill.) 2 5 m
-
97
98
99
Exports
w
M
01
M
w Imports
I
Current account balance to GDP (%) 10 -
,
-5 -
~-
Composition of 2003 debt (US$ mill.) 578
-265 -1.578
0 28 139 -111 70 -181
A - IBRD B - IDA C - IMF
D - Other mullilateral
E - Bilateral
F
- Pnvate
G - Short-term
9/29/04
MAP SECTION
IBRD 34052 20°
25°
30°
35°
40° This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries.
B E L A R U S
Prypy at
Des
h
20
Bu
°
North
P OLAN D
FEDERATION
Chernobyl
Rivne
Dobrotvirsk
RUSSIAN
na
Kiev PS/Kiev 50°
50°
KIEV
Zmiiv
West Ukraine Trypillia Khmelnytski
Burshtynsk
Kiev 6
North Ukraine
Kaniv
SLOVAK REPUBLIC
Vinnitsa
Kremenchuk
So
Dniester
HUNGARY Tis
Dniester
a
uth
Dniprovsk
Bu
Luhansk
Slaviansk
Dniprodzerzhinsk Pridniprovsk
Donbass
h
Ladyzhynsk
Uglegorsk Kurakhivsk
Dniprovsk
ROMANIA
Kryvyi Rih 25°
Starobesheve
South Ukraine
Pr
I
ut
et
HYDROPOWER REHABILITATION PROJECT
Sir
UKRAINE
MOLDOVA
Zuiv
Zaporizhia
u nh
le
ts
Zaporizhia
Zaporizhia South Donbass
Kakhivka
MAIN POWER STATIONS AND TRANSMISSION LINES
Sea of Azov
TRANSMISSION LINES: 750 kV
°
330-500 kV SUBSTATIONS
NUCLEAR POWER PLANTS
45°
Crimea (halted)
ube
THERMAL POWER PLANTS
45°
Dan
HYDROELECTRIC POWER PLANTS
40
RUSSIAN FEDERATION
NATIONAL CAPITAL
KILOMETERS
INTERNATIONAL BOUNDARIES
BLACK
RIVERS
BULGARIA
30°
0
SEA 35°
0
50
100
150
50
100
150
MILES MAY 2005