Document o f The World Bank FOROFFICIALUSEONLY Report No: 36474-MG PROJECTAPPRAISAL DOCUMENT ON' A PROPOSEDCREDIT INTHEAMOUNT OFSDR6.8 MILLION (US$lO MILLIONEQUIVALENT) TO THE REPUBLIC OF MADAGASCAR FORA POWEWWATERSECTORS RECOVERYAND RESTRUCTURINGPROJECT INSUPPORT OF THEFIRSTPHASEOF THE POWEWWATERSECTORS RECOVERYAND RESTRUCTURINGPROGRAM June 14,2006 Energy Team InfrastructureGroup Africa Region This document has a restricteddistribution and may be used byrecipients only inthe performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS (Exchange Rate Effective June 7,2006) Currency Unit = Malagasy Ariary 2169.00 = US$1 FISCALYEAR January 1 - December31 ABBREVIATIONS AND ACRONYMS ACCT Agence Comptable Centrale du Tresor (Central Accounting Agency o f the Treasury) ADER Agence de Developpement de 1'Electrification Rurale (Agency for Rural Electrification) AFD Agence Franqaise de Dtveloppement (French Development Agency) AfDB African Development Bank APL Adaptable Program Loan BADEA Banque arabe pour le developpement tconomique de 1'Afrique (Arab Bank for Economic Development inAfrica) CAS Country Assistance Strategy CFAA Country FinancialAccountability Assessment CPAR Country Procurement Assessment Report CELCO Cellule de Coordination DEEL Direction de 1'Equipement Electricit6 (Department o f Electricity Equipment and Installations) DFB Directorate of Finance and Budget EBITDA Earning Before Interests, Taxes, Depreciation and Amortization EIB European Investment Bank EIRR Economic Internal Rate o f Return ESMF Environmental and Social Impact Management Framework ESIA Environmental and Social ImpactAssessment EMP EnvironmentManagement Plan FDI Foreign Direct Investment FIDEF FCdCrationInternationale des Experts Comptables Francophones (International Federation o f Francophone Accountants) FMRs FinancialMonitoring Reports GDP Gross Domestic Product G O M Government of Madagascar HFO Heavy Fuel Oil IFC International Finance Corporation IG2P IntegratedGrowth Poles Project IHP Independent Hydropower Projects INTEC Institut National des Techniques Economiques et Comptables (National Institute o f Economy and Accounting) IPP Independent Power Producer ISR ImplementationStatusReport JlRAMA Jiro Sy Ran0 Malagasy LSDP Letter of Sector Development Policy MEM Ministryof Energy and Mines NCB National Competitive Bidding OP Operational Policy ORE Electricity sector regulator PCB Polychlorinated Biphenyl POP Persistent Organic Pollutants PRG Partial Risk Guarantee PRGF PartialRisk Guarantee Facility PRSP Poverty Reduction Strategy Paper RAP Resettlement Action Plan ROSC Reports on the Observance of Standards and Codes SOEs Statement of Expenses UGMP Unite de Gestiondes Marches Publics (Unitfor Public Procurement) UNEP UnitedNations Environment Programme Vice President: Gobind Nankani Country Director: James Bond Sector Manager: S. Vijay Iyer Task Team Leader: Stephan Gamier - ProgramAssistant: Lily Wong MADAGASCAR MGPower/WaterSectors Recovery andRestructuringProject CONTENTS Page A. STRATEGIC CONTEXT AND RATIONALE ................................................................. 1 1. Country and Sector Issues................................................................................................... 1 2. Rationale for Bank Involvement......................................................................................... 5 3. Higher Level Objectives to which the Project Contributes ................................................ 7 B . PROJECT DESCRIPTION ................................................................................................. 7 1. LendingInstrument............................................................................................................. 7 2. Program Development Objectives ...................................................................................... 7 3. Project Components............................................................................................................ 9 4. Lessons Learned and Reflectedinthe Project Design...................................................... 11 5. Alternatives Considered and Reasons for Rejection......................................................... 12 C. IMPLEMENTATION ........................................................................................................ 13 1. PartnershipArrangements (ifapplicable) ......................................................................... 13 2. Institutional and ImplementationArrangements .............................................................. 14 3. Monitoring and Evaluation o f OutcomesResults............................................................. 15 4. Sustainability..................................................................................................................... . . . 15 5. Critical RisksandPossible Controversial Aspects ........................................................... 17 6. Credit Conditions and Covenants ..................................................................................... 18 D. APPRAISAL SUMMARY ................................................................................................. 20 1. Economic and Financial Analyses .................................................................................... 20 2. Technical........................................................................................................................... 23 3. Fiduciary ........................................................................................................................... 24 4. Environmental and Social................................................................................................. 25 5. Safeguard Policies............................................................................................................. 26 6. Policy Exceptions and Readiness...................................................................................... 27 Annex 1: ElectricitySector andProgramBackground .......................................................... 28 Annex 2: Major RelatedProjectsFinancedby the Bank and/or other Agencies .................36 Annex 3: Results Framework and Monitoring ........................................................................ 37 Annex 4: Detailed Project Description ...................................................................................... 43 Annex 5: Project Costs .............................................................................................................. 56 Annex 6: Implementation Arrangements ................................................................................. 57 Annex 7: Financial Management and DisbursementArrangements .................................... 59 Annex 8: Procurement Arrangements ...................................................................................... 66 Annex 9: Economic and FinancialAnalysis ............................................................................. 72 Annex 10: Safeguard Policy Issues ............................................................................................ 92 Annex 11: Letter of Electricity Sector Development Policy (Abstract) ................................. 97 Annex 12: Project Preparation and Supervision ..................................................................... 98 Annex 13: Documents in the Project File .............................................................................. 100 Annex 14: Statement of Loans and Credits ............................................................................ 101 Annex 15: Country at a Glance ............................................................................................... 102 Annex 16: M a p IBRD34815 .................................................................................................... 104 MADAGASCAR POWEWATERSECTORSRECOVERY AND RESTRUCTURING PROJECT PROJECTAPPRAISAL DOCUMENT AFRICA AFTEG Date: June 14,2006 Team Leader: StephanClaude Frederic G Country Director: James P. Bond Sectors: Power (100%) Sector Manager: S. Vijay Iyer Themes: Infrastructure services for private sector development (P) Project ID: PO95240 Environmental screening category: Partial Assessment Lending Instrument: Adaptable Program Lending ProjectFinancingData [ ] Loan [XI Credit [ ] Grant [ ] Guarantee [ ] Other: For Loans/Credits/Others: Total Bank financing (US$m.): 10.00 ASSOCIATION Total: 0.84 9.16 10.00 Borrower: Governmentof Madagascar ResponsibleAgency: Ministryof EnergyandMining andJIFUMA I Cumulative1 4.0 I 9.0 I 10.0 I 10.0 I Project implementation period: Start: September 1, 2006 End: December 31,2008 Expectedeffectiveness date: September 1, 2006 Expected closing date: April 30, 2009 Does the project depart from the CAS incontent or other significant respects? [ ]Yes [XINo Does the project require any exceptions from Bank policies? 1 Re$ PAD D.7 [ ]Yes [XINO Have these been approved by Bank management? [ ]Yes [ IN0 [s approval for any policy exception sought from the Board? [ ]Yes [ IN0 Does the project include any critical risks rated "substantial" or "high"? Re$ PAD C.5 [XIYes [ ] N o Does the project meet the Regional criteria for readiness for implementation? Re$ PAD D.7 [XIYes [ ] N o Project development objective Re$ PAD B.2, TechnicalAnnex 3 The aim o f the program i s to restore an adequate public utility service for electricity and water in urban areas o f Madagascar and to create the foundation for a sustainable expansion o f a commercially-oriented service inthe most cost-efficient way. Project description [one-sentence summary of each component] Re$ PAD B.3.a, Technical Annex 4 Component A: Investments for: (Al) Power generation reinforcement (rehabilitation); (A2) Reduction o f transmission and distributiontechnical losses; and(A3) Revenue management and Modernization o f Information Systems and IT equipment. Component B: Fundingand technical assistance for: (Bl) close cooperation with the IFC transaction advisor's team inthe process o f selecting and contracting a new private operator and communication; (B2) prolongation o fthe current management contract; (B3) preparation o f future generationprojects incoordination with IFC's (second) IPP mandate; (B4) strengthening of the Ministry of Energy and Mining; (B5) feasibility and environmental studies for APL-2 investments; (B6) monitoring and evaluation; and (B7) project implementation. Which safeguard policies are triggered, ifany? Re$ PAD 0.6, Technical Annex 10 OP 4.01 Environmental Assessment OP 4.37Safety of dams Significant, non-standard conditions, if any, for: Re$ PAD C.7 Board presentation: July 13, 2006 Loadcredit effectiveness: (a) The Subsidiary Agreement between GOM and JIRAMA has been duly authorized or ratified. (b) MEMhas adopted the ProjectManualandJIRAMA has adopted JIRAMA's Project Manual all inform and substance satisfactory to the Association. (c) For the purpose of Part B o f the Project, MEMhas elaborated its accounting manual o f procedures and upgraded its accounting and financial management and monitoring and evaluation system (capable o f producing FMRs) ina manner satisfactory to the Association; and has appointed an accountant specialist and a procurement officer within the MEMacceptable to the Association. (d) For the purpose of Part A o f the Project, JIRAMA (DEEL) has upgraded its accounting andfinancial management andmonitoring and evaluation system (capable o fproducing FMRs) inamanner satisfactory to the Association. (e) Two special accounts have been opened (for DEEL and MEM)inthe Central Bank under conditions acceptable to the Association. (f) Auditors satisfactory to the Association have been recruited for the purpose of Component A and Component B ofthe Project Covenants applicable to project implementation: Credit Covenants are likely to be: Dated covenants regarding tariffs (a) N o later than November 30,2006, GOM shall have adopted the Electricity Tariff Indexation Formula. (b) N o later than April 1,2007, GOM shall have publicly disclosed the Electricity Tariff Indexation Formula and adjusted electricity tariffs inaccordance with said formula, and shall subsequently adjust said tariffs inaccordance with the Electricity Tariff Indexation Formula every 6 months. Dated covenants (Milestones) regarding the process o frecruiting the long-term private partner for JIRAMA (c) N o later than December 31,2006, GOM shall have established terms and conditions to be used inthe contracting of JIRAMA's private partner satisfactory to the Association and have launchedthe prequalification process. (d) N o later than April 1,2007, GOM shall have launched the biddingprocess for the recruitment o f a new private operator for the management o fJIRAMA's operations. Financial covenants (a) Beginning with the first quarter o f C Y 2007, JIRAMA to produce a quarterly management report (including relevant technical, commercial and financial parameters for the monitoring o f the company andto communicate this reporting to the Bank less than 60 days after the end o f the quarter. (b) Accounts receivable not to exceed 3 months billings by the beginning o f FY 2008 and onwards. (c) GOM shall define inagreement with the Association, no later than September 30 o feach year duringProject implementation amounts to be injected as need be into JIRAMA during the following calendar year so as to allow normal operations o f the company. Specific condition of disbursements would be: (a) Credit disbursement for Component B would be permitted only after recruitment by MEMofatechnical advisor acceptable to the Association. (b) Credit disbursement for the rehabilitation o f the civil works o f the Vatomandry hydroelectric plant (to satisfy the requirements o f the safeguard policy OP 4.37 on Dam Safety) would bepermitted only after JIRAMA has submitteda report satisfactory to the Association on the condition o f the Vatomandry dam and the proposed safety measures to be implemented. A. STRATEGIC CONTEXT AND RATIONALE 1. Country and Sector Issues Sector Issues 1.1 Madagascar has a population o f over 17 million, a third o f which is urbanized. Average per capita income i s about US$290. In2004, 72.1% o f the population was deemed to be at or below the poverty line. The primary sector o f the economy accounts for a third of GDP but 80% of employment. Despite some macroeconomic instability in2003-2004, characterized byhigh inflation and a rapidlydepreciating currency, the real economy grew by over 5.3% in2004 and by4.6% in2005. The overall macroeconomic situationhas stabilized andinthe medium-term, real GDP growth is expected to average 5%. This implies robust growth inthe demand for electricity. Unfortunately, power shortages have become a bottleneck to growth as the demand for electricity recovered strongly in2003-2004, without any accompanying increase insupply capacity. The majority o f enterprises inthe Export Processing Zones, which employ over 100,000 workers (mainly ingarment manufacturing) were not equippedwith standby generators, so the adverse impact on output was acutely felt when power cuts began inmid-2005. Load shedding is estimated to have cut 0.5% o f f last year's economic growth rate. These shortages also adversely affect the overall investment climate and discourage Foreign Direct Investments (FDI). Power is anessential inputto the success o fthe Government o fMadagascar (GOM) economic growth agenda. Electricity Sector 1.2 At present, with the exception o fa handful o fprivate power producers, electricity supply and distribution i s entirely inthe hands o f JIRAMA, the state-owned power and water utility company. JIRAMA, with 6,500 staff, supplies about 400,000 electricity consumers in 112 urban centers and 125,000 water consumers across 65 urbancenters. Access to electricity outside the capital i s low (about 15% nationwide, but far less inrural areas). There i s no interconnected national electricity grid and JIRAMA operates small grids inand around three major urban centers, while the rest o f the country i s served by stand-alone systems, mostly supplied by high- cost diesel generators. Madagascar has a very large hydroelectric resource potential, about 6,000 MW, whichhas barelybegunto be tapped. 1.3 The presently installed capacity o f the grid serving Antananarivo (140 MW) i s inadequate andload shedding of at least 10 MW occurs at times o fpeak demand. This gridsupplies 70% of Madagascar's electricity consumption. An additional 40 MW o f fuel-oil fired generation capacity i s expected to enter service inmid-2007, which will ease the supply constraints inthe Antananarivo grid. 1.4 JTRAMA's total installed generating capacity is about 300 MW, over 35% o f which i s hydroelectric. Electricity sales in2005 were 754 GWh. Sales have increasedat an annual average rate of almost 7% since 1996, somewhat above the average increase inGDP over the same period. Hydroelectricity accounted for 65% o f production in2005. Total energy losses in 2005 were about 24%. 1 1.5 A new agency for rural electrification(ADER) operatingoutside the areas coveredby JIRAMA's concessionwas set up inlate 2002, along with a national electrificationfund. ADER began operating inmid 2004 and has as its mandate the objective of electrifying all 7,300 villages with more than 400 inhabitants over the next 15 years. It has an annual target o f 30,000 new rural connections over the next five years, but has yet to raise the necessary financing. 1.6 Legislation creating an electricity sector regulator (ORE) was passed in2001, but for practical purposes it only began operating inmid 2004. It i s still inthe early stages o f establishing itself as a full-fledged institution capable o f exercising its legal mandate. More details about the electricity sector are given inAnnex 1. Water Sector 1.7 Access to public water supply inthose areas served by JIRAMA i s about 50%, but i s only about 20% nationwide. In2005 JIRAMA produced about 95 millioncubic meters of treated water, over 50% of which was inthe capital. Unaccounted for water represents a third o f total production. JIRAMA has uniform water charges nationwide. In2006 the average revenue from water sales i s expected to be about USc30 per cu.m. Legislation setting up a water and sewage regulatory agency has beenpassed, but not yet implemented. Financial Issues .1.8 JIRAMA has beenunder severe financial stress for the past two years. Tariffs remained frozen from 2001 to mid-2005, even though this was a period o f highinflation, sharp devaluation of the local currency and risingworld oil prices. Furthermore, electricity production costs also rose because all additional demand inthe past few years has hadto be met by using expensive diesel-powered plants. The inaction on the part o f the GOM, due to political reluctance to raise tariffs, directly contributed to the financial insolvency o f JIRAMA. The latter was forced to buildup large arrears to its fuel suppliers and was incapableof servicing its debts. The inability even to pay for fuel to runits power plants and the resulting power cuts brought matters to a head inmid-2005. GOMwas obligedto interveneandbailout JIRAMAwitha cashinjectiontopay for fuel, to help ease the power shortages, which lasted from May-September 2005. 1.9 These shortages badly hurt the manufacturing and export-oriented industries such as garments, seafood processingetc. which were unpreparedto deal with load shedding due to a lack o f standby generators. This crisis brought an end to the complacency and neglect o f the power sector on the part of the authorities, as it was a sharp warning o f the vulnerability o f the entire economic recovery and growth program to disruptions arising from a lack o f electricity. 1.10 Very limitednew investment has takenplace inrecent years to increase power supply, while demandhas increased substantially as the economy recovered from the political crisis o f 2002. Most ofJIRAMA's power plants are now inadequate to meet demand intheir service areas. Over 6,000 requests for new connections inthe capital (backed by down payments) are currently frozen, due to the lack o f materials to connect them and the capacity to supply them. Additional generation capacity has been added on an ad hoc basis inthe past few years through expensive quasi-IPP/leasing contracts awarded on a non-competitive basis. JIRAMA's operationalperformance is unsatisfactory, with highlosses and poor maintenance. Thermal 2 plants are generally ina very poor condition. Billing, metering and revenue collectionpractices are weak. Unpaid arrears o f large consumers, bothpublic (like universities) andprivate (numerous manufacturing enterprises), exceeded three months' billings at end-2005. Recent Reforms 1.11 After an extended stalemate on institutional reforms o fthe sector in2003, the new government decided against privatization o f JIRAMA's assets. A diagnostic study and management audit o f JIRAMA carried out at that time revealed the severity o f the problems facing JIRAMA. This study led to GOM's decision to opt for a two-year management contract as a first step towards raising JIRAMA's performance to a level where it can carry out its mandate of providing satisfactory service to electricity andwater consumers. Giventhe changed international investment climate inthe early years o f this decade and the lessons from privatizations o f other developing country utilities, the Bank concurred with this approach. As a result, JIRAMA has been under private management since April 2005 (paras. 1.16-1.17) and GOMhas decided that the present short-term management contract will be succeeded by a longer-term solution based on a public-private partnership. 1.12 Two belated but large electricity tariff increases were introduced in2005, amounting to a cumulative rise of 75%. A further 10% rise intariffs took place inApril 2006, consistent with the GOM sector reform program. Average revenue this year should therefore be about UScl3/kWh. Average water tariffs were also raised by a third in2005 and by 20% inApril 2006. JIRAMA does not have a policy o f pan-territorial pricing for electricity, andtariffs charged inareas supplied entirely by thermal energy are substantially more than inthose with access to hydroelectricity. Time o f day pricing i s applied to medium and highvoltage customers. GovernmentObjectives,Policies,and Commitment Linkages to Macroeconomic Policies 1.13 The GOM's Poverty Reduction Strategy Paper (PRSP) states the overall objective o fthe government as the reduction o fpoverty by half inten years. The three key priorities set out by the PRSP are: (i) improving governance; (ii) promoting broadbased growth; and (iii) providing human and material security. Achieving rapid economic growth requires improved infrastructure, particularly improved transport links and the availability o f a reliable electricity supply. The absenceo fthe latter is bothan additional cost to existing businesses as well as an impedimentto attracting inflows ofnew foreign investment. The provision o fpotablewater is also a key element inachieving the goal o fproviding human andmaterial security. 1.14 GOMhas decidedto stimulate private sector led economic growth inthree distinct geographical poles, Nosy B e (for tourism) inthe north, Antsirabe-Antananarivo (for export processing) inthe center and Taolagnaro, formerly Fort Dauphin, (for minerals) inthe south. It i s indispensable for the success o f the growth poles strategy that the recent electricity supply problems do not recur. 3 Sectoral Policies 1.15 Restoring and improving electricity supply to acceptable levels necessarily requires both substantial new investment and major reforms to the power sector. The first major step in reforming the power sector took place in 1999, with the passageo f a law abolishing JIRAMA's monopoly and creating a regulatory body. This opened the door to private investment in generation for sale to JIRAMA, as well as to the creation o f new generation and distribution enterprises outside JIRAMA's current operating areas. New legislation was also passed for the water sector. 1.16 JIRAMA's top management was replaced inearly 2005 and the utility is currently being rununderatwo-year, IDA-funded management contract, which has already brought positive results. Better generation plant dispatching, optimization o fplant operations, enhanced revenue collection and cost control measures, have all contributed to improved cash flow and reduced financial losses. Financial recovery from a situation ofnear-bankruptcy is now under way. JIRAMA's balance sheet has also been restructuredthrough a mix o fwrite-offs and debt-equity conversions (Annex 9). 1.17 JIRAMA's recovery process is fully supported by GOM, as shown by the measures already taken, andbyhigh-level commitments publicly made to the donor community at a round table conference onthe sector held inJanuary 2006. A task force with wide representationfrom outside GOM was set up in2005 to study and advise on the best long-term structure for the power and water sectors. Its work i s close to completion and GOMhas indicated that it will follow the Task Force's proposal that JIRAMA be retained as a combined power and water utilityunder state ownership butwith operations delegated to aprivate firm. JIRAMA will be offered to the private sector to manage on a long-term basis under `affermage'- type' contractual terms that are inthe process o fbeing defined. It is expected that recruitment o f the long-term partner would be finalized inmid2007. IFC has already been retainedby GOM to act as its transaction adviser to guide and manage the selection and contractual process. Figure 1 illustrates the ongoing sector reform process. ' GOM would remain the owner o fthe assets and be financially responsible for all major asset renewals or system expansion. The operator would have a long-termoperating contract and pay an annual `rental' fee to GOM for the use of the assets. I t s remuneration would not be guaranteed, but would have to be generated from the cashflow o f JIRAMA. 4 Figure I:JIRAMA's ReformProgram 1.18 The Government's letter o f sector policy (Annex 11)reflects the progress made inthe reform agenda and the future role o f the energy and water sector as engines o f growth. The government's strategy articulates inter alia, the main goals o f the reformprogram, GOM's commitment to the public-private partnership model and the implementation o f cost-reflective tariffs. 2. Rationale for Bank Involvement 2.1 The Bank has been engaged inthe power sector inMadagascar for several decades, with mixedresults. However, after years o f resistance to fundamental sector reforms, the Bank was able to convince the government to consider far-reaching reforms, going beyond the interim step o f a management contract, and viewed as the only way to resolve the utility's poor and declining performance. The Bank has established a constant dialogue with the Government o f Madagascar over the last three years, and i s therefore considered as the lead donor inthe sector. 2.2 Donor assistance would continue to be needed to finance long-term sector investments, even when JIRAMA i s under private management. Inreality, given prevailingconditions inthe internationalutilitybusiness, combined with Madagascar's handicaps o f small market size, remote location, political history, lack o f a convertible currency, etc., a firm and explicit donor commitment to participate in financing long-term investments appears to be a precondition for attracting any private sector interest inoperating JIRAMA. 5 2.3 The Bank's close involvement with GOM's `rescue' o f JIRAMA in2005 and the design o f its financial andoperational recovery program over the past year is showing signs o f success. Inorder to maintainthe momentumofsector reforms, it is essential that the Bank remains fully engaged. Bank support of the recovery program was clearly an important signal to other donors at the recent roundtable conference to back GOM's reform efforts. They now expect the Bank to continue to lead external assistance to the sector reforms. 2.4 As clearly identified inthe World Bank's Africa Action Plan, better power supply is vital to promote growth and it i s an essential input for the success o f other Bank-supported projects. While the IDA supported Integrated GrowthPoles Project (IG2P) will address the most immediate barriers to accelerated growth inthree keyregions, the allocation inthe IG2P project for electricity is necessarily limited. The importance of a reliable power supply cannot be understated, particularly at a time when Malgache garment exports to the U S A and EUare facing severe competition from Chinese suppliers. IG2P does not have the means to tackle the very large needs o fupgrading JIRAMA's main grid. 2.5 The proposed operation is a logical follow-on to the Energy Sector Development Project (ESDP) that closed on December 31,2005, but which left a large agenda o f unfinished business that still needs to be tackled, particularly the short-term recovery program for JIRAMA and the transition to a sustainable long-term arrangement for managing the utility. With the GOM decision to put JIRAMA under an operations & maintenance (0& M) contract (uffeermage), it is clear that there will continue to be a need for public funds for investment insystem rehabilitation and expansion. N o international private operator ready to runJIRAMA will, however, be willing to commit substantialrisk capital on a long-term basis to the utility. GOM will therefore necessarily turn to the donor community to help finance JIRAMA's capital investment program. Further external support i s also needed to reduce the degree o f risk faced by foreign private investors considering generation IPPs inMadagascar and/or taking over JIRAMA's operations. Instrument o f credit enhancements such as IDA PRG, IFC A & B loans or MIGA guarantees could be employed as necessary. 2.6 The primary objective of providingIDA guarantee support would be to help make JIRAMA's O&M contract appealing to prospective operators by mitigating those critical sovereign andpolitical risks which have kept private operators and investors away from the power sector inMadagascar. 2.7 The attractiveness of JIRAMA's O&M contract and o f small private hydropower generation investment program will be greatly enhanced by the PRGbackingo f government commitments under the project. A fraction o f the PRGF amount would be used to issue a partial risk guarantee covering selected GOMobligations towards the O&M contractor. Tentatively, the mainrisks that could be covered by an IDA guarantee would be: (i) the regulatory risk i.e., the risk that the G O M and/or JIRAMA do not abide by the country's regulatory framework; (ii) the risk that GOM and/or JIRAMA breach their contractual obligations under agreements signed with the private operator; and (iii) inlaw, political force majeure, or currency change convertibility risks. 6 3. Higher Level Objectives to which the ProjectContributes 3.1 The GOM is currently preparing its "second-generation" PRSP called the Madagascar Action Plan (MAP)that sets out the "roadmap" aiming to produce a quantum leap inthe country's development process. The Bank i s currently preparingits new CAS inparallel which will support the implementation o fthe MAP. The CAS will reflect the GOM's focus on infrastructure provision to underpingrowth and private sector development. The proposed project i s thus a core element inthe Bank's support to the MAP because it addresses a critical gap ininfrastructure and a key constraint for private sector development inthe Madagascar economy. Growth andjob creation inthe modem sectors are vulnerable to inadequacies inthe public electricity supply system. B. PROJECTDESCRIPTION 1. LendingInstrument 1.1 The proposed lendinginstrument for this operation would be a two-phase, six year APL (mid-CY 2006 - mid-CY 2012). Only Phase 1(mid-CY 2006 to mid C Y 2008) o f the proposed APLispresented here. IDAfundingofUS$10millionvia APL-1is described indepthinthis report. An adjustable program loan provides the GOM with the necessary flexibility o f content and timing it needs to reform the sector and facilitate an orderly commercial transition o f JIRAMA. The GOM intends to commercialize JIRAMA through private operations. The search and recruitment o f a new private operator to runJIRAMA has yet to commence, and the terms of the PPP under which G O M and its donors would fund long-term investments for the `new' JIRAMA,have yet to be defined. These actions are expected to be undertakenwith APL 1. 1.2 This operation (APL-1) aims to assist the Government to prepare JlRAMA for enhanced operations and private participation. The content o f APL-2 has yet to be defined indetail, but components will be selected from a well-defined Government investment program to be presented at the next donors' round table, planned for September 2006. The two phases APL provides the Bank the possibility to introduce appropriate triggers that would be linkedwith satisfactory progress on the agreed recovery of JIRAMA and its future sustainable operation. 2. ProgramDevelopmentObjectives 2.1 The aim ofthe program is to restore an adequate public utility service for electricity and water inurbanareas o f Madagascar and to create the foundation for a sustainable expansion o f a commercially-oriented service inthe most cost-efficient way. 2.2 A successful outcome for the initialphase o fthe program wouldbe for a financially solvent JIRAMA to be inthe hands o f private managers on a long-term basis. (See figure 2). This outcome appears to offer the best prospects for efficiency and sustainability and is a necessary precondition for addressing the huge unmet needs for electricity andwater outside the mainurbancentres of Madagascar. It is also the considered andagreed choice o fthe Task Force appointed to advise GOM on its options for the long-term future o f JIRAMA. 7 Figure2: JlRAMKs FinancialRestructuring 2.3 At the conclusion o fAPL-2, the expectationis that JIRAMA would havebecome an efficient, profit-making and creditworthy enterprise, providing good-quality services, to an expanded customer base, and be able to finance a reasonable portion of new sector investments. 8 3. Project Components 3.1 To address immediate technical shortcomings inthe utility, JIRAMA has identified a short-term investment plan estimated to cost approximately US$100 million for electricity and US$100 million for water, to lower the cost and improvethe performance o f its generation plants, cut technical losses and improve commercialperformance. The Bank, incoordination with other donors, would finance some o fthe most pressing and high-priority investments o fthis recovery plan. This is the centerpiece of APL-1. Specifically, the program would assist with: (a) reduction ofgeneration costs: rehabilitation o f existing hydroelectric and thermal units, as well as conversion o f some diesel generators to heavy fuel oil; (b) reduction of technical losses in transmission and distribution: upgrading o fkey sections of MV lines, replacement o f overloaded transformers and undersized distribution lines and cables; (c) improvements to metering, billing and revenue collection: meter verification and replacement, high-value customer management, updatingof customer records, introduction o f prepayment meters and spot meteringtechniques inselected clusters; (d) modernization of JIRAMA's information systems and IT equipment: installation o f a company-wide computer network and associated hardware and software. 3.2 Only the most pressingneeds ofthe electricity sector would be covered by APL-1, which is entirely focused on restoring JlRAMA to a minimum acceptable level o f operational and financial performance, an essential precondition to attracting a private firm. The specific investmentsto be financed have been selected on the basis o ftheir short payback periods and highimpact onJIRAMA's earnings. 3.3 APL-1 would also support the long-term objectives o f improving the electricity and water sectors' performance by assisting Madagascar inproviding funds: (a) for complementary actions and communication activities needed to accompany the transaction advisor (IFC) inthe process of selecting and contracting a new private operator to take over JTRAMA; (b) for prolongation of the current management contract to avoid any hiatus before the takeover by the selected strategic partner; (c) TA for preparation o f future generation projects incoordination with IFC's IPP mandate; (d) TA to the Ministry o f Energy (MEM) to steer the above process to a successful outcome and for capacity buildingwithin MEMincluding environmental and social safeguards issues; and (e) the technical and safeguard studies required for APL-2 as well as the due diligence requirements for private hydro generation investments. 9 Table 1: ProjectCosts by Component(in US$ 000s) IDA AFD JIRAYA Sehcoinpotienr A1.w Puwei yeiieialioii reiiifoiceiiiiil(lelial~iiitalioiil 2 000 4 155 1700 Sulvxwipoiieiit A1.b' Retlailctive tinaiiciiig 1 000 500 Siihcoiiipoiieiir A2: Reduclioii of lraiisiiiissloiialld dinrltiiilioii tecliiiicai lanes 1,300 tbd tbd Sulicoiiipoiieiit PJ: Reveiirie i~i.iildgeliIeil1dlld iiiodeiiiIzd11oii of Iiiloiiiiatioii Systeiii aiid IT eqiiiliinent 2,300 400 U~uffocared 400 Total Component A 7.000 tbd tbd ~ nand PrOlBctlmDlement;ltlOn IDA I AFD JIRAMA Subcampoiieiit B1: Tecliiilcdl OsdStaiiCe 8nil colliliillliicatioii -Coiilianiiig irrlvale npeiarnrs to lake over JIRAMA 250 tbd Sirhcoiripoiieiit 82: Prnioiigarloii oftlie ciiireiit inaiiageineiit CoiitracI 900 tbd Subcoinpoiicnt 83: Preparstloii Of hilllie gelierallnii projects hi coordiiiatioii with IFC IPP iiimihle 600 Siilicoiiipoiient BI: Stieiigtlieiiiiig oftlie lvlinisliy of Energy aiid Irlliiliiy 400 Sribcoiiipoiieiit 05: Piepararloii of APL2 and eiiviioiiiiieiifd stridles for APL2 ilivestiiieiin 150 Siihcoinpoiieiil BG: Moi~iroiililjai111evalllaliuii 150 Sulicoiiipoiieiit 87: Pioject iiiipletiieiitatioii 150 Umfloc.?recl 400 Total Coimonent B 3 000 tbd tbd Total APL.11 10.000 1 tbd I tbd I ______ I PhaseI1(or APL-2) of the Program 3.4 The fundingneeds for APL-2 (FY 2009 - FY 2012) from IDAwould tentatively be about US$30 million, covering investments ingeneration, transmission and distribution system expansion, as well as capacity buildingand consulting services for implementation o f the institutional reform of the sector. A significant part o f APL-2 funding could be allocated to a credit enhancement facility (such as partial risk guarantee facility) to attract foreign investors. The second phase would be conditioned on satisfactory progress towards financial recovery o f JIRAMA and a signedPPP agreement for the long-term management o fthe utilityby a private firm. 3.5 The content o f APL-2 has yet to be defined indetail, but components will be selected from a well-defined Government investment program to be presented at the next donors' round table, planned for September 2006. Additional funding i s expected to be secured from AfDB, bilateral donors and the private sector. 3.6 Furtherdetails on APL-2 canbe found inthe table inAttachment 4.2 o fAnnex 4. FinancingRequirementsand FinancingPlan 3.7 The GOM's energy/water sector recovery plan estimates a need for US$lOO milliono f short-term investment financing for the years 2006-2009 for the Electricity and Water sectors respectively. These estimates do not include the developments o f Hydro Generation facilities that, although offered for private sector financing as PPs, are likely to require significant public sector support. 10 3.8 APL 1& APL-2 wouldtogether cover approximately 25% ofJIRAMA's priority investments duringthe period 2006 - 2011. US$125 million o f donor support (including the combined US$40 million from IDA) are already committed. Further financing for long-term investments are expected to be pledged at a second donor's conference to be held inSeptember 2006. 4. LessonsLearnedand Reflectedinthe ProjectDesign 4.1 The recently-closed Energy Sector Development Project (ESDP, Cr. 2844), implemented between 1996 - 2005, was over-ambitious, too complex andtoo broad inits scope. Within a single project it simultaneously attempted to improve service to existing consumers, extend access to electricity inrural and urban areas, undertake fundamental sector reforms to facilitate private sector entry, promote energy efficiency and conservation and improve management o f woodfuel supply and usage. The lesson learnt from ESDP and applied here is that the proposed project i s much more narrowly focused and does not attempt to address broader issues inthe energy sector. 4.2 ESDP didnot adequately address weak corporate governance inJIRAMA, including non- transparent and non-competitive contracting, abuse of privileges by staff, lax management and poor customer service. These problemshave now been sufficiently exposed to public scrutiny and the transfer o f JlRAMA to a private operator will serve to keep a check on costs, improve revenue collection and inculcate higher standards o f service. Transparency and accountability are also expected to be enhanced. 4.3 The early years o f ESDP (pre-2003) were also characterizedby an excessively dogmatic approach to institutional reformby the Bank, which led to stalemate. The proposed project has avoided repeating this error by its consultative andparticipatory approach to reforms, as illustratedby the importance attached to the role and recommendations o f the Task Force on reforms. Muchmore attention has been given to keeping the labour unions fully abreast o f all matters affecting JIRAMA staff, and regular press briefings have also been given to inform public opinion. 4.4 The experience under ESDP also shows that there i s a need to be more vigilant with respect to tariffs during inflationary times. The failure by GOM to address the erosion o f tariffs caused by devaluation and risingworld oil prices, contributed to the financial insolvency o f JIRAMA. The conditionality o f the proposed project reflects this lessonby front-loading actions expected o f GoM. 4.5 Experience and the lessons learned from similar projects elsewhere shows that attracting private operators to runAfrican utilities is fraughtwith difficulties. Recent cases also illustrate that even ininstances where long-term contracts were entered into private firms are ready to revoke them ifthe operating environment turns unfavourable. The proposed project will therefore seek to minimize such risks by ensuring that the ground rules and contractual arrangements are drawn up as clearly as possible, byproviding GOMwith suitably experienced international financial and legal advisers. 11 5. Alternatives Considered and Reasons for Rejection 5.1 A number o fstrong argumentsfavor an APLrather than a SIL. Inthe current context o f a utility emerging from near-bankruptcy, ina period o f transition involving changes to its corporate culture and business practices, some flexibility o f actions and their timing are felt to be needed and these are more easily accommodated in an APL structure than ina SIL. 5.2 Itwouldhave beenpossible to continue with the existing JIRAMA management contract on an open ended basis period, however this would have not incentivized the operator to improve performance. It would also be expensive, and require donor or GOM financing, since JIRAMA's own internal resources would be insufficient to cover its cost. 5.3 The option o f separating o f water from electricity activities was examined indetail by the consultants hired to assist GOM indeciding on JIRAMA's long-tern structure. The consultant recommended that a separation was inappropriate for a company o f relatively modest size. Vertical and horizontal unbundlingo f JIRAMA's electricity operations was also studied by the same consultants and advised against for the same reason. 5.4 The most extreme option could be called the `do-nothing' scenario, i.e. allow the current management contract to lapse andthen leave J R A M A to struggle on as best as it could. This would have been a recipe for rapid collapse, widespread damage to the modem export-oriented sector o f the economy and a repeat o fthe expensive 2005 G O M bailout for the sector. 12 C. IMPLEMENTATION 1. Partnership Arrangements(ifapplicable) 1.1 All donors involved inthe sector are closely coordinating their interventions for maximum effectiveness. This has been clearly expressed inthejoint aide memoire o f the January 2006 Paris donors' round table. The aide mCmoire set forth a common set o f conditionalities requested by the donors to commit financing to support GOM's recovery plan for JIRAMA, as well as for the sector's medium-termexpansion requirements. (See figure 3). Figure3: MediumTerm Power Generation& Investment Plan ....................... ....................... ................. ..................... 2I 1.2 The European Investment Bank (EIB) i s very active inwater supply and ..as alreac .y approved a project o f 47 million inmid-2006. The Dutch government is contributing grant funds towards the construction o f a 40 MW fuel-oil power plant (expected inservice inmid- 2007) that will help relieve the current supply shortages as well as substitute for higher-cost diesel generation. Agence Franqaise de DCveloppement (AFD) has indicated that it will support implementation of the JIRAMA recovery program with a contribution in2006 o f about US$lO - 12million. A third 30 MW generator at the existing Andekaleka hydro plant is about to begin, with financing from the Banque Arabe pour le DCveloppementEconomique de 1'Afrique (BADEA). The African Development Bank (AfDB) has indicated its potential sector financial support in2008. Since the financing plan for APL-2 is still to be completed, the involvement o f other donors will be needed and firm pledges obtained early enough to be included inthe information and guidance to potential private partners for JIRAMA. 1.3 Within the WBG, there is close cooperation between IFC andthe Bank. IFChas already beenhired by GOM to act as a transaction adviser for a series o f hydro generation projects that are to be offered to private investors to develop as PPs. Inresponse to the difficult climate for 13 attracting FDIto the power sector inMadagascar, an IDA-supported PRGis also beingprepared to complement IFC's efforts to attract potential investors andto attempt to lower the risk premium (and hence the cost) ina bulk supply contract to JIRAMA. 1.4 Inaddition, IFCwill also bethe GOM's investmentadviser and leadthe process o fhiring a private partner to manage JIRAMA. Inorder for IFC to successfully carry out its two mandates it requires the close collaboration o fthe Bank and other donors to provide financing for the preparatory work such as feasibility and environmental impact studies for the generation IPPS. 2. Institutionaland ImplementationArrangements 2.1 The project would havetwo distinct implementation entities. One would be an integral part o f JIRAMA's DEEL (Direction de 1'Equipement Electricitk), and would deal with hardware, procurement and physical implementationby JIRAMA o f its rehabilitation sub-proj ects. The other would be a small coordination and advisory group responsible for the policy and institutional reform components as well as for monitoring and evaluation o f the project inits entirety that would be attached to the office o f the Minister o f Energy and Mining. 2.2 The physical rehabilitation works do not present any significant technical difficulty for JIRAMA, and the implementation cell would predominantly deal with procurement-related matters. Adequate expertise for this exists within JIRAMA, backed up by local consultants on a short-term basis as required. 2.3 MEM,however, has aserious problemoflack ofadequate capacityto leadthe process of selecting a new private operator and carry through sector reforms. Despite GOM's decision to recruit IFC as its investment adviser to manage the selection process from start to finish, the MEMinterfacewithIFCwill needto be strengthened, andfor thispurposeit isenvisaged that the project will finance the services o f a resident expatriate adviser inMEMfor about two years. The adviser would also be responsible for managing the small coordination and advisory group (Cellule de coordination-CELCO) attached to the office o f the MEM(see above). 2.4 MEMandthe DEEL(JIRAMA)will maintain separate accounts for alltransactions related to each component for which they have overall implementation responsibility and will produce their individual annual financial statements inaccordance with internationally accepted accounting principles. The consolidation o fproject accounts ifnecessary, the production o f quarterly Financial MonitoringReports (FMRs) incompliance with international accounting standards and IDA requirements and the monitoring of the project progress will be assured by MEM. 2.5 While the capacity of JIRAMADEEL is deemed adequate, the capacity o f M E M K E L C O to deal with financial and accounting matters will need to be strengthened by: (i) improvingthe fiduciary system inplace to ensure timely delivery o f data on project activities; and(ii) recruiting a qualified and experienced accountant to assist the MEMaccounting staff in 14 performing financial management tasks including budgeting, accounting, financial reporting, and disbursement operations. 3. MonitoringandEvaluationof Outcomes/Results 3.1 The implementation o fthe project will be monitored through quarterly progress reports that the Project coordinators (both at JIRAMA andMEM)will prepare and submit to IDA. This will provide a way o ftracking actual project execution against implementationmilestones established at the time o f the project launch. These are the keyperformance indicators and project outcomes that are detailed inAnnex 3. 3.2 Further, inorder to assess impacts that the project i s expected to have on the quantity and quality o f electricity andwater supplied, it is envisaged that several surveys will be carried out at different points on JIRAMA's network. Monitoringo frevenue enhancement measures will be facilitated by the ring-fencing of clusters where these are to be introduced. Baseline data will be collected inthese clusters prior to introductiono f the new customer management techniques. 3.3 Other indicators of JIRAMA's overall performance, their baseline values and targets have been agreed duringnegotiations. These indicators are given inAnnex 3. 4. Sustainability Thefollowing topics are relevant to long-term sustainability: 4.1 Policyframework: The 1999 sector legislation is basically sound but will probably need to be revised to reflect Government's decision regarding JIRAMA's institutional reform. Some topics also need to be defined with greater clarity andprecisionandthese will be addressed under IFC's mandate as transaction adviser, which includes the provision o f legal support. The electricity sector regulator (ORE) i s operational and has established some initial credibility inthe recent round o f tariff increases. The Letter o f Sector Development Policy (LSDP) clearly spells out GOM's vision of the sector for the next 5 - 10 years andpresents a good basis for both private and donor participation in sector development. 4.2 Technical: It is expected that the future private operator o f JIRAMA will ensure that maintenance i s carried out according to good operational practice. The remuneration o f the future operator will depend on maximizing revenue andplant availability, which inturncreates a strong incentive for sound 0 & Mpractices. It i s also expected that JIRAMA under a private management would better assist the government inmaking strategic future electricity generation choices by providing a more reliable long-term planning and data on expected load growth. 4.3 Financial: The 1999 law makes a provision for indexation o f tariffs, but this was ignored. No cast-iron assurance canbe obtained that history will not repeat itselfinfuture, but the lessons appear to have been learnt from the economic damage to the country and the financial cost to the budgetof bailing out J W A in2005. The GOM has agreed to introduce a Credit 15 covenant under the proposedproject that will permit JIRAMA to apply tariffs that ensure full cost recovery (para. 6 - Credit conditions and covenants). Inaddition, the introduction of private management inJIRAMA will provide the necessary stimulus to improve revenue collection particularly from large industrial users, cut down on electricity and fuel theft and inject greater all-round cost consciousness within JIRAMA. 4.4 Fiscal: The GOM's budgetary support to JIRAMA in2006 i s expected to exceed AR 70 billion (roughly US$30 million), inorder for it to continue operating and to help it meet payment obligations, predominantly to fuel suppliers (over AR 180billion). Depending upon the evolution of world oil prices, further budgetary support will be needed from G o M in2007, although on a greatly reduced scale. The project seeks to ensure that from 2008, JIRAMA will no longer need to rely on budgetary support for its operating expenditures. However, it must be recognized that this turnaround i s vulnerable to further rises inworld oil prices andor unforeseen major delays incommissioning o f the 40 MW fuel oil power plant inmid-2007. It i s thus proposed as a trigger for the second phase o f the APL that JIRAMA should break even interms of EBITDA (Earning Before Interests, Taxes, Depreciation and Amortization) in2007. Such a target might not seem very demanding for a power andwater utility with a majority o f its generation derived from hydroelectric units. However, it would represent a major improvement compared to the situation that prevailed in2004 and 2005. Also given, the projected efficiency improvements that will begin to have a full year effect only in2008, andprovided an adequate tariff indexing formula i s effectively applied, JIRAMA's profitability should significantly improve in2008 and 2009. By the end o f the decade, JIRAMA should be expected to generate enough cash-flow from internal sources to fund the investments required to adequately maintain its assets. Inthese respects, the project will have a positive fiscal impact. Nevertheless, it has to be recognizedthat public funds through internationalloans or grants will still be requiredto fund the bulk of JIRAMA's long-term-investments required to increase significantly the rates o f access to electricity and water inMadagascar, but these will not have any budgetary impact. 16 5. Critical Risks and Possible Controversial Aspects Main Risks Mitigation Measures I RiskRating Macro-economic Proposed Guaranteefacility will protect private operator S problems: highinflation, against tariff erosion and ensurecurrency convertibility. currency devaluation, Bank and IMFmacro-economic programs with GOM; rising oil prices. but some risk will remain, especially ifoil pricesremain high. Uncertain whether GOM Datedcovenants, APL-2 triggers and Guarantee facility M i s able to stay the course provide some assuranceof coverage of political and on reform process. regulatory risks. Reforms stalled due to APL-1 investments to be committed prior to elections. M forthcoming elections. APL-2 will proceed only after selection o fprivate operator (post-elections). Political opposition to GOM will commit to preservingreal level of tariffs by S higher tariffs. indexation (FA covenant), but some element of riskwill remain. Unions participate inTask Force on long-term future o f M ~~~ Labor unionresistance to ~ internal JIRAMA reforms. JIRAMA. Will be kept informed inselection process for private operator. Weak institutional and TA to assistMinistryof Energyto implement sector M implementation capacity reforms, but some slippage riskwill remain. Insufficient interest by IFC's appointed as transaction adviser to GOMto guide M foreign utilities intaking over JIRAMA. be inplace end-2006 to mitigate risks. Project transactions may Recruitment of a qualified accountant inconformity with M not be properly accounted Bank procedures, to assist the MEMaccounting staff in byMEM,and financial performing FMtasks. reportsnot timely Elaboration and implementation of an accounting manual produced. o f procedures. Adjustment of the accounting software acquiredwithin the context of the Energy Sector Development Project and users training. The quality of the audit Recruitment of an international auditing firm acceptable M may not be acceptable and to IDA to carry out the annual audit of the project the report not deliveredin financial statementso f the Project. time due to weak capacity o f the accounting profession. The overall risk of the program has been assessed as moderate. 17 6. Credit ConditionsandCovenants 6.1 Effectiveness conditions would be: The SubsidiaryAgreementbetweenGOM andJIRAMA hasbeenduly authorized or ratified. MEMhas adoptedtheProject ManualandJIRAMA has adoptedJIRAMA's Project Manual all inform and substance satisfactory to the Association. Forthe purposeofPart B ofthe Project, MEMhas elaboratedits accounting manualof proceduresand upgradedits accounting and financial management and monitoring and evaluation system(capable o fproducing FMRs) inamanner satisfactory to the Association; andhas appointed an accountant specialist and a procurementofficer within the MEMacceptableto the Association. For the purpose o fPart A of the Project, JIRAMA (DEEL)has upgraded its accounting andfinancial management andmonitoring and evaluation system (capable o fproducing FMRs) inamanner satisfactory to the Association. Two special accountshavebeenopened(for DEELandMEM)inthe Central Bank under conditions acceptableto the Association. Auditors satisfactory to the Association have beenrecruited for the purpose of Component A and Component B of the Project. 6.2 Themain Credit Covenants are likely to be: Dated covenantsregardingtariffs - (a) No later than November 30,2006, GOM shall have adopted the Electricity Tariff Indexation Formula. (b) No later than April 1,2007, GOM shall have publicly disclosed the Electricity Tariff Indexation Formulaandadjusted electricity tariffs inaccordancewith said formula, and shall subsequentlyadjust said tariffs inaccordancewith the Electricity Tariff IndexationFormula every 6 months. Datedcovenants (Milestones) regardingthe process o frecruiting the long-termprivate - partner for JIRAMA (c) No later than December 31,2006, GOM shall have established terms and conditions to be usedinthe contracting o f JIRAMA's private partner satisfactory to the Association andhave launched the prequalification process. 18 (d) No later thanApril 1,2007, GOMshall have launchedthe biddingprocess for the recruitment o f a new private operator for the management o f JIRAMA's operations. Financial covenants (b) Beginningwith the first quarter o f C Y 2007, JIRAMA to produce a quarterly management report (including relevant technical, commercial and financial parameters for the monitoringo fthe company and to communicate this reporting to the Bank less than 60 days after the end of the quarter. (c) Accounts receivable not to exceed 3 months billings by the beginning o f FY 2008 and onwards. (d) GOMshall define inagreement with the Association, no later than September 30 of each year duringProject implementation amounts to be injected as needbe into JIRAMA duringthe followingcalendar year so as to allow normal operations ofthe company. Other covenants (Financial managementand audits) (a) DEEL/MEMshall maintainrecords andaccounts inaccordance with sound accountingpractices. (b) DEEL/MEMshall prepare andfinish to the Association not later than45 days after the end o f each calendar semester, interimun-audited financial reports for the Project covering the semester, inform and substance satisfactory to the Association. (c) DEEL/MEMshall have itsFinancial Statements audited inaccordance with the provisions of Section 4.09 (b) o f the General Conditions. Each audit o f the Financial Statements shall cover the period o f one fiscal year o f the Recipient. The audited Financial Statements for each such period shall be furnished to the Association not later than six months after the end o f such period. 6.3 Specific condition of disbursements would be: (a) Credit disbursement for Component B would be permitted only after recruitment byMEMof a technical advisor acceptable to the Association. (b) Credit disbursementfor the rehabilitation o f the civil works o f the Vatomandry hydroelectric plant (to satisfy the requirements of the safeguard policy OP 4.37 on Dam Safety) would bepermitted only after JIRAMA has submitted a report satisfactory to the Association on the condition o f the Vatomandry dam and the proposed safety measures to be implemented. 19 6.4 Triggersfor Initiating APL-2 In order to proceedwith APL-2, GOMwouldneedto demonstrate: (a) Satisfactory implementation o f APL-1investments; (b) Sufficient progress on the J M A financial restructuring as per the agreed financial covenants o f the FA for APL-1; (c) Regulatory agencies (water and electricity) fully operational with clearly defined and implemented tariffs indexation formulas; and (d) Completion of the recruitment of the long-term private partner for JIRAMA up to contract signature. D. APPRAISAL SUMMARY 1. Economicand FinancialAnalyses Economic Analysis 1.1 System expansionplan: The recent oil price hikes have turned JIRAMA's stop-gap and suboptimal choice o f diesel generators into a severe financial burden for its consumers and also for GOM. The success o fthe proposedrecovery program for JIRAMA is predicated upon a rapid move away from diesel generation, initially to Heavy Fuel Oil (HFO) and then inthe medium- to long-term to hydroelectricity. Unfortunately, inthe short- to medium-term, despite Madagascar's evident hydroelectric resource potential, the scope for rapidly developing new hydro power sources i s rather limited. Work on the addition o f a third 30 MW generator at the existing Andekaleka hydro plant i s about to begin, with financing from BADEA. Under normal hydrological conditions it will produce 200 GWhper year, representinga massive cost saving to JIRAMA.Two minor sites (Sahanivotry and Lily) are at a sufficiently advanced stage o f preparation byprivate developers to contribute a further 80 GWho fhydro power by 2009 - 2010. Due to a lack o f preparatory studies, other small to mediumterm hydro prospects are unlikely to be commissioned before 2010 - 2011. 1.2 Inthe near term, major fuel savings cantherefore onlybe achievedthrough substitution of heavy fuel oil burningplants inplace o f diesel generators (financed under APL-1). Implementation o f a 40 MW HFOplant (with financing from Dutch Government) to be sited in the capital has begunand it i s expected to be inservice inmid-2007. This plant will permit JIRAMA to greatly reduce its use o f diesel, since the plant is capable o fproducing 200-250 GWhannually. All of the above new generationprojects have beendelayedby several years and should already have been inservice. They produce substantial economic benefits and delays in completing them would be very costly to JIRAMA. 20 1.3 Economic Rate o f Return: Giventhe diverse nature o fthe physical investments envisaged under the recovery program and its nature as a two-part APL, the economic analysis i s based on a 5-year time-slice (2006-2010) o f the electricity sector's total investmentprogram, which has beenreviewed and found to be least-cost innature. Details are contained inAnnex 9. Assigning specific benefits to particular project components would have been botharbitrary and nearly impossible. The base case estimate o f the EIRR is 14.4%. 1.4 The physical benefits from these investments that have been quantified here are twofold: first, (and most important) the incremental electricity supplied to consumers; second, the reduction inhigh-cost diesel fuel consumption arising from the replacement of diesel generators bymore economical ones usingheavyfuel oil (HFO). 1.5 The incremental demand that can be met as a result o f investmentsmade possible by the program is based on the variant o f the load forecast prepared by JIRAMA's consultants, HQI. For the purposes of the economic analysis, only five years (2007 - 2011) o f cumulative load growth have been considered as benefits directly attributable to the 2006 - 2010 investment program. Total electricity demandis projected to increase at an annual average rate o f 7.6%. However, demand growth in2006-2007 is severely constrained to only 2% - 4%, due to a deliberate attempt by JIRAMA to restrain consumptionprior to the entry inservice o f a large, new HFOplant. 1.6 The minimumvalue o f the incremental sales has been taken to be the average tariff across all customer categories charged by JIRAMA in2006, i.e. UScl3/kWh. This does not represent the full value o f benefits to users from this electricity, but inthe absence o f an estimate of the `consumer surplus' it i s a minimummeasure o fbenefits that has been used as a proxy. It i s well below the JIRAMA tariff charged to LV consumers inZone 3 (isolated centers served entirely by diesel), o f USc19-20/kWh. Fuel savings to JIRAMA have been estimated at the difference between the cost o f generation using HFO inthe new HFOpower plant and diesel fuel that it would otherwise have to use inits existing generators, about USclO/kWh at current oil prices. 1.7 Fulldetails of the analysis andthe parameters usedinestimatingthe ERR are given in Annex 9. The EIRRi s particularly sensitive to variations inoil prices, the size and timingo f the investment program, delays incompleting more efficient plants, and to assumptions about demand growth. As can be seen inAnnex 9, depending on the combination of negative factors assumed, the EIRRvaries from 10.3% to 13.7%. Financial Financial Analysis of JIRAMA 1.8 The following conclusions canbe drawn from the financial forecasts presented inAnnex 9: (a) Inspite o fthe large funds injected inthe company bythe government anddonors, the ongoingconversion o f debt into company equity, and the successive tariff increases for electricity andwater, JIRAMA remains ina precarious financial situation. 21 (b) With most o fits debts cancelled or rescheduled, JIRAMAhas beengiven a fresh start financially; however its most immediate problem remains an insufficient generation of funds from internal sources: cash-flow from current operations i s likely to remain negative in2006 and 2007. This i s the result o f JIRAMA's unfavorable generation mix, with too muchdiesel fired capacity, andthe ever-rising world price o f oil. (c) Electricity tariffs have been raised bynearly 100%over the past year, bringingthe expected average revenue this year to UScl3 per kilowatt-hour, a level that i s similar to its value in2002 and 2003. However, oil prices are much higher today than they were then, and the current level o f tariffremains below what would be adequate to achieve cost-recovery. Further hikes duringthe next 12 months are politically and socially difficult to envisage. As a result, JIRAMA cash position is bound to deteriorate again over the period to 2008, especially ifthe company reduces its payment arrears to its suppliers, as envisioned inthe January 2006 `plan de redressement'. Therefore, a new injection of liquidity from GOMwill probably be needed inmid-2007. (d) The financial forecast presented inAnnex 9 assumes several internal efficiency improvements, but the biggest source o fpotential savings is the reduction o f generation costs, which will occur from mid-2007 onwards. (e) Tariff discipline i s essential ifJIRAMA i s to become financially viable on a sustainable basis. An updated tariff indexation formula needs to be defined and scrupulously followed. A FA covenant that would impose the consistent application o f a tariff indexing procedure from April 2007 onwards is thus proposed. Inaddition to this procedural aspect, the level o f the tariff should be set adequately (it is thus proposedto retain it as a trigger for the second phase o f the APL that JIRAMA should break even in terms o f EBITDA in2007). Situation of JIRAMA at the Beginning of the Management Contract 1.09 A diagnostic study o fJIRAMA's operations carried out in2003 revealed the severity of the problems the company had to face. The management contract, which has beeninplace since April 2005, shed further lighton the true extent o fJIRAMA's financial difficulties. Insummary, the situation inmid-2005 can be described as follows: 1.10 Extreme financial unsustainabilitv o f current operations: duringthe first semester o f 2005, the variable costs associated with thermal generation alone (fuel expenses and energy purchase costs) were superior to the total revenues of the company leaving no source o f funds to pay for other current expenses (maintenance, personnel etc), let alone new investments or debt repayment. 1.11 Rapidlyaccumulating arrears to suppliers: giventhe structural disconnect between current expenses and revenues, JIRAMA could not continue to operate without increasing its level o f debt and arrears to suppliers. This practice merely postponed the liquidity crisis facing JIRAMAuntilafter the management contract took effect. 22 1.12 Lack o f effective and reliable financial reDorting and internal controls: Illustrations o f these deficiencies are the absence o f reliable and audited annual accounts, the lack o f monitoring o f the cashposition of the company, incomplete and late reporting o f financial information from the many remote outlying JIRAMA centers. The management contractor is already addressing most of these issues. The Financial Recovety Process Supported by APL-1 1.13 Financial restructuring of JIRAMA: JIRAMA cannot realistically service the debt it has accumulated. The financial restructuring entails substantial debt cancellation by the GOM, as well as an injection o f cash. Overall, the plan entails significant budgetary costs inexcess o f AFt 75 billion for GOM in2006. It is likely that an additional injection o f liquidity inJIRAMA will be necessary again inmid-2007, depending upon the trend o f world oil prices. 1.14 Tariff increases: While further increases o f tariffs inreal terms might be necessary inthe future, ifoil prices do not decrease, the bulk o f the adjustment effort inthis respect has already been done, especially taking into account expected reduction ingeneration costs thanks to planned investments. It is, however, vital that the current level o f tariffs be at least preservedin real terms. The definition o f an indexing formula for electricity andwater tariffs and a streamlined decision-making process to apply the formula and implement the necessary tariff adjustment will provide protection against the volatility o f the currency and o f oil prices. 1.15 Additional Supportfrom GOM: Under the assumption laid out inTable 9 o f Annex 9, JIRAMA would start to generate a positive cash-flow in2008, due to a combination o f moderate tariff increases, a bettergeneration mix, and improved operational performance. JIRAMA will nevertheless remain ina difficult situation with insufficient liquidity up to the end of 2008 (current ratio below 1 and increase o f short-term financial debt) without fresh injections o f cash from GOMin2007. Provision for continuing cash injections to JIRAMA needs to be made in the GOMbudget for 2007. 2. Technical 2.1 The investments underthe APL-1 havebeen designed to meet Madagascar's near term electricity sector objectives and to enable a swift financial turnaround o f JIRAMA, viz.: ' . Convert costly diesel generation to HFO, resulting insavings ofUSclOkWh on every unitofelectricity produced; Assure a minimumlevelo f maintenanceo f key power plants to maintain existing ''' capacity and reduce the numberof power cuts; Reduce technical and non-technical losses; Improve revenue management and collections; and Encourage development o f cost effective generation sources, e.g. small hydro plants. 2.2 The investments were chosen among a list o f candidates totaling about US$lOO million identified by JIRAMA as necessary for the success o f its financial restructuringplanpresented to 23 the donors' round table meeting inJanuary 2006. The first phase o f the APL focuses on immediate critical generation needs and investments with highreturns to urgently mitigate the severe financial problems o f JIRAMA. For these investments the biddingdocuments are already well advanced. For some, advance procurement is already ongoing and JIRAMA plans to quicklyutilize the IDA fundingbymeans o fretroactivefinancing right after Credit effectiveness. 3. Fiduciary Financial Management 3.1 The financial management systems both at the DEELinJIRAMA andMEMneed to be strengthened to address some deficiencies and buildtheir capacity to produce quarterly Financial Monitoring Reports (FMRs).The mainmeasures to be taken are the following: 0 For MEM: (i) recruitment, under terms and conditions acceptable to IDA, o f a qualified and experienced accountant to assist the MEMaccounting staff inplace in performing FMtasks; (ii) elaboration of a chart o f accounts to ensure the availability o f all relevant information for financial reporting; (iii) elaboration and implementation o fwritten operating instructions to ensure proper record keeping and adequate safeguarding o f assets; (iv) design and implementation of an accounting system to ensure timely production o f financial information required for managing andmonitoring activities to beimplementedbythe MEM. 0. For DEEL: (i) of the DEELchart o f accounts to reflect components and review activities outlined inthe PAD to satisfy reporting requirements; (ii) update of the current accountingmanuals o fprocedures inorder to include all necessary changes requiredbythis new project, facilitate adequate recordkeeping and the maintenance of proper control over assets; (iii)review and adjustment o f the accounting software acquired within the context of the Energy Sector Development Project inorder to satisfy DEELrequirements and ensure timely production of financial statements and FMRsrequiredby IDA. All these recommendationsshould be implemented prior to credit effectiveness. The content and formats o f financial statements and FMRs have been determined during appraisal mission and agreed at negotiations. 3.2 Theproject financial statements (CELCO andDEEL) will be audited annually by independent and qualified auditors acceptable to IDA in accordance with International Standards of Auditing. The auditors shouldbe recruitedprior to credit effectiveness. The audit report will be submittedto IDAnot later than 6 months after the end of each fiscal year. Procurement 3.3 A new Malagasyprocurement code was enacted inJuly 2004 but, since then, the texts for their application have recently been approved but it will take some time before entering in effectiveness and thus the existing Procurement Code o f 1998 will continue to be used at least untilearly 2007. The Bank has ascertained that deficiencies identified inthe 1995CPAR have 24 beenproperly addressed. IDA standard biddingdocuments (SBDs) are widely used in Madagascar. However, an area o f concern i s the cumbersome and overly bureaucratic approval process for contract signingby GOM, which causes unnecessary delays. Inaddition, insufficient programming and procurement planning contribute to delays inproject implementation which result inslow disbursement. To mitigate risks o f delays for the proposed project, proper prerequisites for the use of Bank SBDs, includingevaluationreports for National Competitive Biddingprocedures (NCB) havebeenagreed uponwith Government duringnegotiations. The procedures manual will be updated as a part of the Project ImplementationPlan. 3.4 A Procurement Capacity Assessment o fJIRAMA was not conducted duringappraisal because it was agreed with JIRAMA's management that the same team will be maintained in place as the one which dealt with the recently-closedESDP. Onthe basis o f the experience acquired by the JIRAMA procurement team, an action plan was drafted to address areas where capacity needs to be strengthened. The action planincludes (i) a specific section on procurement inthe ProjectImplementationManualto befinalizedor updatedbefore Credit effectiveness; (ii)improvement o f record keeping o fprocurement-related documents; and (iii) refresher procurement training sessions for project staff. 3.5 A separate ProcurementCapacity Assessment was conducted for the MEMprocurement Unitduringappraisal. The assessmentreviewedthe organizationalstructure for theunit. The key issues and risks concerning procurement by MEMhave been identified. Corrective measures which have been agreed are: (i) recruitment, under terms and conditions acceptable to IDA, o fa qualified and experienced procurement expert; and (ii) close follow-up o fthe the agreedprocurement plan and activity scheduling. A procurement action plan will be fine-tuned quarterly and the main procurement planwill be updated accordingly. 4. Environmental and Social 4.1 APL-1will finance generationrehabilitation, disti-ibution reinforcement and rehabilitation o f the existing transmission lines and substations invarious towns inMadagascar. The investments are entirely aimed at upgrading existinginstallations. N o new greenfield sites will be developed or human resettlement undertaken. 4.2 JIRAMA has undertaken an Environmental and Social Impact Management Framework for phase 1o f the proposed APL. Phase 2 o f the APL will be the subject of a complete study (ESIA) duringthe executiono fphase 1. The JIRAMA subprojects envisagedinAPL Phase 1 comprise 3 distinct groups: - Group 1: Rehabilitation o f thermal power stations. -- Group 2: Rehabilitation o f hydroelectric power stations. Group 3: Rehabilitation o f transmission and distribution networks. 4.3 The rehabilitation o f thermal power stations inAmbohimanambola, Mahajanga, Toamasina, Toliary, Antsiranana includes the rehabilitation o f the existing Power Plants. The environmental examination o f the projects related to the rehabilitation o f the power stations 25 showed that the environmental impacts are generally neutral. However, the impacts of the investments alone cannot be considered independently from the totality o f the installations and the current environmental situation inthe site inwhich they are located. The main impacts are noise, the atmospheric emissions, pollution o f ground and water due to non efficient management o f effluents, and poor risk management including absence o f an emergency plan. The mainmitigationmeasures to address these issues along with the action plans are available in the Environmental and Social impact ManagementFramework for phase 1. 4.4 The rehabilitation o f the hydroelectric power stations o f Antelomita 1, Ankazobe, Tsiazompaniry, Vatomandry, Andekaleka and Volobe, consist o f replacement o f used turbine and alternator parts, turbine cooling equipment, general revision o fplant, and rehabilitation of the civil engineering works. The investments will not alter the current design o f the dam, existing water levels nor surpass the original capacity o f the turbines. The main environmental impact identified concern the safety o f the sites (e.g. the transformer Switchyards are not locked and the fire fighting equipment is outdated) andthe silting up o f the reservoirs because o f the soil erosion on the basin slopes. The review o f the environmental impact o f these subprojects concluded that they are non significant and reversible, with the exception o f the environmental impacts o f the civil engineering works planned for the hydroelectric station inVatomandry (192 KW). For this plant, JIRAMA must meet the requirements o f the Bank safeguard policy OP 4.37 on dam safety. This rehabilitation will not be implemented until a review o f the dam's safety, carried out by an independent expert, has beenjudged satisfactory by IDA. 4.5 The transmission and distribution rehabilitation subprojects present very minor environmental issues. Specific attention i s given to the rehabilitation o f transformers inwhich the PCB (Polychlorinated Biphenyl) represents an environmental risk. JIRAMA has agreed to comply with the actionplan for the elimination o f Persistent Organic Pollutants (POP), elaborated incollaboration with the Malagasy Environmental Administration, the coordination committee o f POP and supported byUNEP. JIRAMA will therefore ensure safe storage of the old transformers inaccordance with the recommendations o f the action plan. 5. Safeguard Policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OPBP 4.01) [XI [ I Natural Habitats (OP/BP 4.04) [ I [XI Pest Management (OP 4.09) [ I [XI Cultural Property (OPN 11.03, beingrevised as OP 4.11) [ I [XI Involuntary Resettlement (OPBP 4.12) [I [XI Indigenous Peoples (OP/BP4.10) [I [XI Forests (OP/BP 4.36) [ I [XI Safety o f Dams (OPBP 4.37) [XI [I Projects inDisputed Areas (OP/BP 7.60)* [ I [XI Projects on International Waterways (OP/BP 7.50) [ I [XI * By supporting theproposed project, the Bank does not intend toprejudice thefinal determination of theparties' claims on the disputed areas 26 5.1 The environmental classification o f APL-1 i s Category B. The approach to safeguards is presented below, and the results are summarized inAnnex 10. 5.2 OP 4.01 Environmental Assessment: JIRAMA has hired consultants to prepare an Environmental and Social Impact Management Framework (ESMF) that guides the screening, analysis o f the existing environmental conditions and the environmental liabilities and impacts o f the present operations inAPL phase 1. The consultants have elaborated guidelines with mitigationmeasures and action plans to reduce the existing negatives impacts. The Government will prepare relevant safeguard studies (ESIAs with EMPs andRAPs, as applicable) for Phase 2 and these will be conducted and submitted to ASPEN for review and clearance. 5.3 OP4.12 Involuntay Resettlement: It is unlikely that this Operational Policy(OP) will be triggered for phase 1, since land acquisition or displacement is not necessary for this stage. Only under APL Phase 2, this Operational Policymay be triggered. Inthat event, ESIAs with R A P s will be conducted and submitted to ASPEN for review and clearance. 5.4 OP 4.37Safely of Dams: For the civil engineeringworks planned for the hydroelectric power station inVatomandry, an expert review o f the safety o f the structure will be availablejust before the implementation o fthe project and submitted to ASPEN for review and clearance. 6. Policy Exceptions and Readiness N o exceptions to Bank policies are requested. 27 Annex 1: Electricity Sector and Program Background M A D A G A S C A R : Power/Water Sectors.Recovery and Restructuring Project Energy resources 1. Despite a substantial hydroelectric potential inexcess o f 7,000 MW, Madagascar has so far only developed under 100 MW o f generating capacity usingthis resource. Access to electricity is extremely low (less than 5% inrural areas) and the vast majority o f the population relies on petroleum products and wood fuel for cooking and lighting. Little has been done so far to develop alternative energy sources likebagasse, solar or wind power. Electricity consumption 2. One o fthe notable features o fMadagascar's electricity supply system is its fragmentation and the absence of a national high-voltage transmission grid. Because of the low levels of demand, andthe large distances separating load centres; local supply systems still represent the least-cost solution for supply inthe majority o f cases. There are only three urbaninterconnected networks inMadagascar, serving Antananarivo-Antsirabe, (representing 70% o f national electricity sales), Toamasina andFianarantsoa, which together account for 80% of total sales. For the remainder o fthe countryJIRAMA has 112 separate supply systems serving other small urban areas, not all o f which provide 24-hour service. Electricity productionby JIRAMA2was 988 GWhin2005, with total sales o f 754 GWh. JIRAMA's electricity losses were about 24% in 2005, o f which half are estimated to be technical. Existing generation facilities 3. Electricity production inMadagascar i s based on a mix o f hydro and thermal plants for base load. Currently production capacity i s 292 MW with 105 MW (or 36%) o f hydro capacity and 187 MW o f thermal capacity, which are capable o fproducing about 1,000 GWhper year. A further 40 MWbelongs to private auto producers. The largest hydro plant, Andekaleka (2 X 29 MW) was built with IDA assistance in 1982. Dueto recent modifications o fthe operating regime that was formerly extremely conservative, the plant is now capable o f delivering 10% additionalpower - i.e. 64 MW. 4. Ingeneral terms, Madagascar's generation facilities are very old. As a consequence, a large number o f the existing thermal units needto be retired before year 2010. While the hydro production facilities are inrelatively good shape, mainly due to donor support, some o f the power plants also need substantial maintenance o f their turbines inorder to continue to function at nameplate capacity. Including purchases o f 24 GWhfrom private producers. 28 5. The state of the thermal plants i s generally poor due to lack ofpreventive maintenance, spare parts and fimding for new generators, especially inthe areas served exclusively by thermal diesel plants. JIRAMA's recent financial crisis has accelerated the problem to a point where if considerable investment resources are not provided, regions could be completely deprived of supply for sustained periods of time. Poorly managed andmaintainedthermal power plantshave further ledto an increase indiesel consumption that on average i s 20% above benchmark values. Evolution of Demand 6. L o w voltage users accounted for 63% o f JIRAMA's electricity sales o f 754 GWhin2005. As shown inFigure 1, demand growth duringthe period 1995-2005 was 7% annually, markedly faster than the previous decade, when it barely averaged 3% p.a. The last three years since the end of the political crisis in2002 exhibited unprecedented double-digit growth o f 12%, albeit after a 9% decline indemand in2002. The strong demand growth can be attributed inpart to the sharp decline inthe real cost of electricity to consumers, resulting from a four-year tariff freeze (2001-2005) at a time of highinflation and depreciating exchange rate. Peak demand inthe Antananarivo network was 148 MW in2005, which does not reflect the true level of demand due to load shedding arising from a shortage o f generating capacity. 7. The number of consumers increased from about 190,000 in 1994 to 402,000 in2005, an average annual growth rate o f 7%. The distribution o f consumers i s highly concentrated: Only 30 JIRAMAsupply centres have over 1,000 clients, while there are under 10 sites with 5,000 or more consumers. Figure 1:Electricity demand growth in Madagascar, 1987-2004 GWh I Evolution de laconsommation 1987-20041 800 700 600 500 400 300 200 100 Source: Etude de marche etprkvision de la demande, HQIAug. 2005. 29 Tariff policy 8. Madagascar i s unusual in not having a pan-territorial pricing policy for electricity. To reflect differences incosts (particularly fuel), and infactors such as load density and load factor, JIRAMAhas classified its networksinthree "tariff zones", with prices being lowest for zone 1 and highest for zone 3. Zone 1comprises three o f the larger systems, where generation comes mainly from hydropower. Zone 2, including Mahajanga and Toliary, corresponds to larger thermal systems that use mainly heavy fuel oil. Zone 3 covers the rest of the systems, which generate power from plants usingonly diesel. The general low voltage residential tariff inzone 3 is presently 2.4 times than the one paid by consumers inzone 1. For high and medium-voltage consumers, rates are differentiated by time o f day (peak, day, and night). The peak price inzone 1is over five times the night rate, inan attempt to flatten JIRAMA's evening peak. 9. In1992, GOMpassedan importantdecree (No.7800-92) which introducedthe principle of automatic tariff adjustments, based on an indexation o f tariffs to the exchange rate, the price o f oil, and the local consumer price index. However inpractice this indexationpolicy has never been systematically applied. The current JIRAMA tariff schedule i s presented at the end o f Annex 9. Future demand for electricity 10. Demandfor electricity is projectedto increase at anaverage o f 6.5% to 7.5% annually, according to the load forecast undertaken as part o f the Least Cost Generation Master plan preparedin2005-2006 by Hydro Quebec International. The study forecasted electricity demand up to 2030. The increase isprimarily fuelledby an increase inthe number o f consumers and could be further accelerated if GDP per capita growth figures increase more than projected. As seen inthe chart below, the difference inthe forecasts between the highand low case scenarios is highlydependent on the construction o f a small number o f large industrial/mining projects. Figure 2: Scenarios o f future electricity demand 1 6000 , I 5000 4000 f 3000 (3 2000 1000 Source:Etude de marche etprevision de la demande, HQIAug.2005. Low case (GDPgrowth 3.5%, Population growth 2.0%, major industrial projects delayed),Base case (GDP growth 5.6 %, Popn.growth 2.3%), High Case(GDPgrowth 7.6 %, Popn.growth 2.5%, Major industrial/mining projects advanced). 30 11. Inthe short- to medium-term, however, itis expected that demand growth willbemuch lower (2% - 4%) over the period 2006-2007, due to supply constraints, but once these are eliminated, there will be a rapid `catch up' period (2008-2009) when demand is expected to increase by 8% - 10%p.a. 12. The Madagascar grid i s highly dispersedacross the country, with a large number o f small unconnectedgrid systems. Peak energy demand projections for investment purposes are therefore unsuitable on an aggregate basis for the country as a whole, since the type o f load and amount o f commercial use vary greatly between the regions and the various grids. It i s o f greater relevance to study the main growth centres such as the Antananarivo network, that represents 70% o f the electricity consumption and half o f the total medium and highvoltage loads inthe country. Peak demand here has been projected to rise from 147 MW to 594 MW, or over 300% inthe 25 years between 2005 and 2030. 13. This massive increase opens up the possibility o f interconnectionsbetweenthe three main load centres o f Antananarivo, Toamasina and Fianarantsoa, to make better use of untappedhydro resources and achieve economies of scale ingeneration expansion that would otherwise be difficult to justify ifintended solely for one o f these grids taken alone. The interconnections are expected to cost U S 7 5 million for the Antananarivo - Fianarantsoa interconnectionand US$47 million for the Antananarivo - Toamasina transmission line3and will enable JIRAMA to save about US$400 millionon fuel duringthe 2006-2029 period compared to the scenario o f having three independent, unconnected systems. These transmission links will also enable JIRAMA to connect the future hydro generation sites o fVolobe and Antetezambato with the main grid. according to HQIestimates in the 2005 master plan. 31 Medium- andLong-Termsupply options Medium Term Supply 2006-2010 14. The Supply/Demand Balance for the Antananarivo networ--(R Tana) over the next 5 years is largely dependent on an ambitious investment program and JIRAMA's ability to keep the old plants going long enough prior to the entry inservice o f new plants. (see Figure 3). Figure 3: AntananarivoGrid ElectricitySupply-Demand Balance RI TANA Demand/ Supply Balance 260 240 220 200 180 Peak Supply (MW) 160 140 120 100 2006 2007 2008 2009 2010 2011 15. As shown inTable 1, peak supplyis barely keepingupwith demand duringthe wet season. Load sheddingo f 10% o f the supply duringthe dry season occurs at present, since hydro output is reduced. Several ofthe old thermalplants are inapoor state or at the endoftheir estimated lifetime, causingbreakdowns and further interruptions insupply. This precarious situation is likely to persist untilthe commissioning of the first batch o f generation investments inmid/late 2007. 32 PeakDemand (MW) 147 153 168 182 196 212 Hydro 95 95 95 95 95 95 HFO 9 14 14 14 14 14 Diesel 27 27 27 27 27 15 IPP 18 18 18 18 18 18 Existing supply 149 154 154 154 154 142 New Generation 86 86 86 101 Peak Supply (MW) I 149 154 240 240 240 243 iource: JIRAMA. 16. Inorder to meet the increasingdemandandputanendto the current supplyshortages, the government has identifiedthe most urgent generation investments for the medium-term. These are geared towards increasing supply and loweringthe cost o fproduction o f existing plants, while investmentswill bemade innew HFOplants with quick returns on investment largely replacing more expensive diesel alternatives. These investments can be clustered as follows: 0 Rehabilitationand conversion Rehabilitation and conversion of the thermal power plants inAmbohimanambola, Antsirabe, Antsiranana, Mahajanga, Toliara. The investments o f about USSl.7 million would save around US$lmillion per year infuel costswhile improving reliability and increasing production by 27 GWh. e New Production o A new 40 M W HFOthermal power plant for the Antananarivo grid. This will be able to produce 200-250 GWh annually at base load. o The addition ofathirdturbine inAizdekaleka hydro plant to increaseproduction capacity by 30 MW and 200 GWWyear under normalhydrological conditions. o Construction ofsmall sizedhydro plants as IPPs, notablySahanivotry and Lily adding 12+4 M W of base load capacity and total average energyo f 80 GWh. o Leasingor IPPsfor anumberof smaller power plants for the regional centers of Antsiranana,Mahajanga, Toliary. 33 1 400 000 1200 000 .-- 1 000 0001 -- -.- ...-. 800 000 1 600000 - 400 000 -- 200000 0 ._ 19. The least cost Generation Master Plan identifies the following hydroelectric candidates for the main grid5for the long-term. Project Commissioning Capacity Guaranteed Approx. Cost Year in MW Energy US$m (GWh) Talaviana 2009 15 7 26 Lohavanana 2012 120 56 194 Volobe Amont Phase 1 2015 60 38 107 Phase 2 2018 30 23 Antetezambato Phase 1 2019 60 60 180 Phase 2 2020 60 90 26 Phase 3 2023 60 26 20. The ranking and sequencing o f the principal hydro investments shown inTable 3 are dependent on development o f various grid interconnectionprojects as well as the possibilities o f co financing with proximate large-scale miningoperations, as inthe case o f the Volobe Amont project. The Antananrivo and Taomasina grids would also be interconnected inparallel. 35 Annex 2: Major RelatedProjectsFinancedby the Bank and/or other Agencies MADAGASCAR: Power/WaterSectors RecoveryandRestructuringProject Ratings Sector Issue Project (Bank-financedprojectsonly) zompletedProjects ED Rating! Outcome Sustain- IDImpact ability Hydro-generation, Andekaleka Hydroelectric Development Project (Approved 1978), Credit 0817 Rehabilitation and Energy Project (approved S L su maintenance o f the power 1987), Credit 1787 system and institutional strengthening Increased generation Energy Sector Development ICR not ICR not ICR not capacity, rehabilitation o f Project (approved 1996), Credit completed completed completed the power system and 2844 (Rating institutional strengthening N/A) Improved Access to Water Rural Water Supply and S L su supplyand Sanitation Sanitation Pilot (approved services inRural areas 1997), Credit 30250 Improved Urban Urban InfrastructureProject S L su Infrastructure and Job [approved 1997), Credit 29680 creation LatestSupervii on Implementation Development ~OngoingProjects Progress(IP) Objective(DO) Transport Sector Transport Infrastructure S S Development Investment Project (approved 2003), Credit 38360 Stimulate Economic Integrated Growth growth and Job creation Poles (approved 2005), Credit 41010 Note: M S Marginally Satisfactory S Satisfactory U Unsatisfactory MU Marginally Unsatisfactory 36 W E .I L3 d .I c, 0 a 9 30 E m 3 i: .y m II 2E m .. 3 2 C d pa E h h .I z Y h 0 a E cd E 0 .I Y 0 s CL, d & cd II) II) a" Y 8 0 e 8 E 8 W W W 13 s3 0 0 tz L3 e, 2 2 h k 2 2h x rj 0 d d 3 d 3 Ns - 2 s%I 0 d nl hl m s3 0 0 t- d > 4: .-cd0 3 0 hl a .-c Annex 4: DetailedProjectDescription MADAGASCAR: Power/WaterSectors Recovery andRestructuringProject Introduction 1. The proposed lending instrument for this operation is a two-phase, five year Adaptable ProgramLending(APL). The APL programi s conceived as a 6 year effort (mid-CY2006/mid-CY 2012) to be implementedintwo phases. Only Phase 1o fthe proposed APL (mid-CY 2006 to mid-CY 2008) i s presented indetailed inthis annex with a detailed cost table presented inAttachment 1. A preliminary description of APL-2 is presented inAttachment 2 o f the present annex. IDA'Scontribution to the first phase (APL-1)is expected to beU S 1 0million and for the secondphase (APL-2) is expected to be about US$30 million and should provide resources to implement critical investments and guarantees for investmentsto be made by the private sector. 2. Through a programmatic approach, the proposedproject aims at supporting the most pressing needs o fthe electricity sector. Hence APL-1 i s entirely focused on restoring JIRAMA to a minimumacceptable level o f operational and financial performance. This restoration i s an essential precondition to attracting a private firm to operate JIRAMA under an `affermage' contract. APL-1would inter alia, provide funds for TA to GOM to facilitate close cooperation with the IFC transaction advisor's team in the process of selecting and contracting a newprivate operator to take over JIRAMA at the end o f the current management contract, as well as for prolongation o f the current management contract to avoid any hiatus before the takeover by the selected strategic partner. APL-1will also provide funds for some preparatory studies needed to buildup a pipeline o f APL-2 investments and Guarantees. 3. APL-1comprises two components: ComponentA: Investments for: (Ala) Power generation reinforcement (rehabilitation); (Alb) retroactive financing; (A2) Reduction of transmission and distribution technical losses; and (A3) Revenue management and Modernization of Information Systems and IT equipment. ComponentB: Fundingand technical assistance for: (Bl) close cooperation with the IFC transaction advisor's team inthe process o f selecting and contracting a new private operator and communication; (B2) prolongation o f the current management contract; (B3) preparationof future generation projects in coordination with IFC's (second) IPP mandate; (B4) strengthening o f the Ministry of Energyand Mining; (B5) feasibility and environmental studies for APL-2 investments; (B6) monitoringand evaluation; and (B7) project implementation. 43 ComponentA: Short-terminvestments(including;continpencies:IDA: US$7.0 million) 4. To address the immediate technical shortcomings o fthe utility, JIRAMA has drawn up a medium-term (2006 - 2010) investment plan estimated to cost US$200 million (for both electricity andwater), to improve the performance o f costly andpoorly performing generation plants, reduce hightechnical losses and introduce improvements inrevenue management. TheBank, incoordination withother donors, would finance some of the highestpriority and most urgent investments of this plan. This is the centerpieceof APL-1. This component will be executed byJIRAMA. Bidpackages for these projects are under preparation. SubcomponentAla: Power generation reinforcement (rehabilitation) (IDA: US$2million) 5. This subcomponent supports the project objective o frestoring and improving electricity supply and contributing to JIRAMA's financial recovery. It includes rehabilitation of existing hydroelectric and thermal units, and conversion o f generation units from diesel to heavy fuel oil (HFO). (a) Replacement o f hydro-refrigerants system for the ANDEKALEKA hydropower plant (2 x 32 MW): The project proposes to finance the replacement (6) and rehabilitation (7) of those hydro-refrigerants. (b) Rehabilitationo funitNo3 o fthe ANTELOMITA 1hydropower plant (0.8 MW): The current state o f Antelomita 1does not allow using its energy to full capacity. The project proposes to finance the acquisition o f components to rehabilitate the plant. The project will also finance some training insystem control and protection. (c) Renovation works inthe VOLOBE hydropower plant (6.7 MW) The present condition o f Volobe does not allow its energy potential to be fully used. The project proposes to finance acquisition o f components to rehabilitate and restore the plant. Generalrehabilitation o f some equipment (turbine wheels, alternators, etc.) o fthe plant will also be done under the proposedproject. (d) Rehabilitation of small hydropower plants o fANKAZOBE, TSIAZOMPANIRY, AMBODIRIANA and VATOMANDRY: The project proposes to finance the rehabilitation o f these small hydropower plants to reduce JIRAMA's dependence on thermal generation inits isolated system. (e) Rehabilitation o f mechanical auxiliaries o f the AMBOHIMANAMBOLA thermal power plant (3 x 6 MW): Most o f the mechanical auxiliaries are inpoor condition. The plant cannot be runon a permanent basis with HFO. A first tranche of rehabilitation is already ongoing, and this will be completed under the project by replacement o f some mechanical auxiliaries such as boilers, re-heaters and exchangers. 44 (0 Rehabilitation of thermalplantsinMAHAJANGA(Unit 1303), TOAMASINA (2 x 8 MW) and TOLIARY (Unit 1305) are expected to be financed by the Agence Franqaise de Dkveloppement (AFD). SubcomponentA1b: Retroactivefinancing (IDA: US$l rnillion) 6. Some of the urgent works needed to rehabilitate JIRAMA's thermal plants were to have been financed under the previous IDA Credit for ESDP that closed inDecember 2005. As these could not be finished prior to the closing date, JIRAMA has had to finance them from its own resources. Some o f these expenditures meet the requirements o f OP 12.10 on Retroactive Financing; inparticular because (i) they represent less than 10% o f the Credit amount; (ii)they have beenpaid for within 12 months o f Credit signing; and (iii) followed Bank's procurement processes. An amount o fup to they US$1 million would be eligible for retroactive financing under the proposedproject. The concerned contracts for the following works will be reviewedfor eligibility: (a) Rehabilitation of the Ambohimanambola thermal power plant (3 x 6 MW) (tranche 1): Contract C1190/ 911823/T0501A with SEMT PIELSTICK. (b) Rehabilitationof the Antsirabe thermalpower plant: Contract C1200/91824/T0502A with SEMT PIELSTICK. (c) Rehabilitation o fthe Mahaianga thermal power plant: Contract C1210/91825/T0503A with MANB & W Diesel. (d) Rehabilitation of theAmbohimanambola thermal power plant (3 x 6 MW) (tranche 2): Contract C1220/91826/T0504A with POLYRESINE. (e) Rehabilitation of the Ambohimanambola thermal power plant (3 x 6 MW) (tranche 3): Contrat C1240/91828/T0506A with SEMT PIELSTICK. 45 Detailed cost table for subcomponent A1 ConlaonenrA Power- .. . I . IDA AFD JIRAMA a Replacement of hydro-refrigerants system for the ANDEUALEUA hydropower plant 260 25 b Rehabilitation of unit N' 3 ofthe ANTELOMITA 1 hydropower plant 710 84 c Renovation works inthe VOLOBE hydropower plant 750 76 d Rehabilitation of small hydropower plants ofANK9ZOBE TSIAZOMPANIRY,AMBODIRIANA and VATOMANDRY 80 e Rehabllitatlon of mechanical auxillaries Olihe AMBOHIMANAMBOLAthermal power plant 200 20 Total IDA(Sub)omponentAl.aI 2,000 I 0 1 205 1 AFD Rehabilitation ofthermal plants in MAHAJANGA(Unit 1303) - 1,081 215 AFD. Rehabilitation ofthermal plants in TOAMASINA(2x8 M W 2,234 113 AFD- Rehabilitation ofthermal plants inTOLLARY (Unit 1305) 840 1167 Total AFD (ncwprojccts)/ 0 I 4.155 I 1.495 1 Recroactlve financing I 1,000 I Total retroactive financing A1.b 1.000 500 ~~ TOTAL Subcomponent AI 3.OOO 4,155 2.200 Subcomponent A2: Reduction of traizsmission and distribution technical losses (IDA: US$I.3million) 7. Reduction o f losses: rehabilitation o f transmission networks (APL-1:US$0.3 million): Reliability o f the transmission system is poor arising from a combination o f factors like old equipment, lack o f protection and control equipment and inaccurate metering. Highvoltage networks inMadagascar need to be strengthened and rehabilitated; this upgrade will result inincreased power reliability with a reduction o f significant outages inthe network to be rehabilitated. The project proposes to finance the rehabilitation o fthe AmbohimanambolaNandraka transmission line, which serves Antananarivo. 8. Reduction o f losses: rehabilitation o f distribution (APL-1:US$lmillion): Many of JIRAMA's distribution transformers and lines are already saturated, which leads to voltage drops, hightechnical losses, low reliability and load shedding. The project would finance the acquisition o f distribution materials and equipment to rehabilitate and reinforce networks inthe RITANA (peak demand o f 136 MWl698 GWhin2004) and in some other centers such as MORONDAVA (1.375 kWl5 MWh), MANAKARA (890 kWl3 MWh), ANTSIRANANA (7.083 kWl32 MWh),S A M B A V A (1.680 kWl7 MWh), ANTALAHA (1.3 15 kWl5 MWh), AMBANJA (735 kWl3 MWh)andTOAMASINA (13.250 kWl59 MWh). Specific subprojects are being finalized and would be financed in part by APL-1 and by AFD. 46 Detailed cost table for Subcomponent A2 2: Redtmion of Tra?sm&uona& . . IDA AFV JlRAlulA New projects a Rehabilitation ottransmlsslon networks j m / tbd 85 b Rehabilitation ofdlstrlbuti0n neiworks I 1 no0 I tbd 11 130 Total Subcomponent A2 1.300 tbd 215 Subcomponent A3 Revenue management and Modernization of Information Systems - and acquisition of IT equipment (IDA - US$2.3million) 9. Revenue management (APL-1:US$1.35 million and JIRAMA: US$0.385 million): While the overall revenue collection performance o f JIRAMA is reasonable, there is still considerable scope for improvement, particularly as regards industrial clients. The Project will support targeted investments that aim at improving the commercial side o f the distribution business as measuredby enhanced billingand increased revenues. The mainrationale o f these investments is to create value inthe Madagascar electricity business and demonstrate the returns on such investments so that they canbe replicatedon a larger scale. 10. Giventhe large investment requirements compared to the available IDA financing, the desired developmental impact would not be achieved ifinvestments are thinly spread and ifthey are not directed to achieve specific outcomes inidentified areas. Inorder to addressthis concern, itis proposedto adopt a"cluster" approach in implementation o f the Project. Investments would be implemented inthese clusters to create "islands o f excellence" to be replicated inthe Second Phase o f the APL or by the JIRAMA operational budget. The results would thus be improved revenues, reduced losses and reduced billing complaints. The choice o f clusters will be made inclose cooperation with JIRAMA following specific criteria. 11. The rationale behind such an approach is: (a) spreading activities thinly across JIRAMAmaynot demonstrate clear impact; (b) it is easy andpracticalto establish a baseline for key performance indicators at a cluster level, or for a specific type o f customer; and (iii) measurement o f impacts will be facilitated. 12. A set o factivities is proposedto be financed under APL-1, some ofwhich will be comprehensive, as for industrial customers, while others will be more on a trial basis that may be extended under APL-2, if good results are obtained. (a) OrganizatiodManagement: The revision andimplementationo f a standard flowchart for commercial teams will be carried out during the Management Contract, inorder to revise andimprove commercial procedures andto improve the circulation o f information. Tasks and responsibilities will bebetter assigned 47 andjob descriptions made more appropriate. This action does not require any financing, but i s part o f the accompanying actions inthe JIRAMA recovery program. (b) Improvement o finvoicing: Increasingthe ratio o fmeter readerdcustomers ando f the number and qualification of supervisors will reinforce internal controls and will improve billing. This action does not require any financing through APL-1. (c) Fight against fraud - adiustment o f the penalties: Another aspect of the reduction o f costs and the improvement o f efficiency i s the revision and the upward adjustment o f the penalties applied to fraudulent customers. This action does not require specific financing. (d) Meter and residentialcustomer records verification program: This program covers the following activities: (i) carrying out, in conjunction with local authorities, a technical and administrative check o f the meterdcustomers, by neighborhood (cluster level); (ii) identifyingand dealing with frauds and abnormalities and updatingthe meter/customer databases, both for electricity and water; (iii) creating and training anti-fraud units; (iv) carrying out technical and commercial adjustments such as replacement/normalization o f connections and meters; and (v) acquiring metering tools, IT equipment and GPS. The project proposes to finance an exhaustive verification program inpre-identified zones (clusters). IDA financing will be intended for the purchase o f metering tools and implementation o f the program. (e) Purchase and installation o fprepayment meters: Inorder to address problems o f payment recovery insome o f the more difficult service areas, Prepaid Systems (prepayment meters) ina predefined cluster area will be implemented. This trial at the level o f an entire zone will be spread to administrative customers and to some specific customers with highconsumption. The project proposes to finance the purchase and installation o f these prepayment meters. (f) InvestmentsinSpot MeteringEquipment and Systems: Better cash flow management and revenue control by introduction o f spot billing which involves hand-held terminals, printers, modems and associated accessories. Inthis method, bills are printed and delivered on the spot at the customers' premises whentheir meters are read, and the utility's customer database i s updated electronically. Customers have the additional advantage o f staggered payment due dates, thus reducing crowding at cash collection centers on or near the due date. Apart from improving customer service, this intervention also compresses the cash flow cycle, and introduces electronic data recording, facilitating diligence on this critical revenue generating part o f the business. It is proposed that 100Meter readers ina defined distribution cluster o f Antananarivo would be equipped with spot billing equipment. The project will also finance consultant support for training and capacity building of JIRAMAstaff inthe application o f spot metering and pre-payment metering techniques inthe selected clusters. The component will include on-the-job 48 training inuse o f spot billing equipment by meter readers so as to fully benefit from the new technology as well as training in software applications to use the customer data made available. The project will further assist inestablishing a suitable framework for pre-payment metering o f residential consumers.such as arrangements for card sales licensing, meter verification procedures, suitable client interface etc. (g) Systematic verification o f installations inPremises o f all 800 industrial customers: About 800 industrial subscribers represent more than 30% o f total electricity consumption; because o f lack o f resources, industrial installations are verified and checkedby specialized JIRAMA staff only every 5 years. The systematic verification o f these HV/MV installations is an absolute priority. The results of these verifications and the necessary corrective actions need to be implemented without delay, giventhe potential loss o f revenue to JIRAMA. The project proposes to contribute to the financing of the corrective actions. (h) Purchase andinstallationofelectronic meters for all 800industrial customers: In order to improve demand management, to have a better knowledge of HV and MV customers and for a better understandingand monitoring o ftheir consumption (daily load), it i s essential to replace the traditional mechanical and electro-mechanicalmeters by electronic meters. This action was started under the previous IDACredit and will be completedwith JIRAMA financing. 13. Modernization o f information systems and acquisition o f IT equipment: (APL-1- US$0.95 million) (a) Interconnexion of all JIRAMA premises: The objective o f this action is: (i) to open up the Inter-Regional's Services; (ii) to reduce time for data processing transfers, to accelerate the exchange o f local information; (iii) to reduce the various expenses (transport, computer supplies) linked to present non-networked exchanges o f information; (iv) to improve customer satisfaction (internal and external) by the reduction o f response times; (v) to facilitate monitoringo f connections reliability; and (vi) reduce telephone costs within JIRAMA. The project proposes to finance the introduction of an internal IT ((backbone)) for all JIRAMA's site. The progressive installationo f adequate communication support will allow more reliable data transfer and analysis andinreal time. (b) Acquisition o f IT equipment and training o fJIRAMA staffintheir use: JIRAMA is clearly under equipped regarding IT equipment. The project proposes to finance the acquisition o f equipment and software such as: computers, related software, and various office equipment such as printers, video-projectors, scanners. Due to limitedresources, only a part o f the needs will be financed throughAPL-1. The project also proposes to finance training programs o f users and I T staff. 49 Detailed cost table for SubcomponentA3 IDA AFD JIRAMA a OrganizationlManagement 0 b Improvemenlofthe invoice function 0 c Fight against the fraud- adjustmentofthe penalties 0 d Meter and resldentlal customer recordsverlflcatlon program 150 85 e Purchase and installation of prepayment meters 4m f Investments in Spot Metering Equipment and systems 500 g Systematicverification of installations in premises ofthe all 800 industrial customers 300 h Purchase and installation ofeletronic Meters for all 800 industrial customers mn Total -revenue Manaaemend 1350 I 0 1 385 1 Modernization of Information System and IT equipments a lnterconnexion ofall JlRAMApremises 400 I 7 b Acquisition of ITequipment and training ofJlRAMA staff intheir use I1 550 1I E Total Modernization of InformationSystem and IT equipmentsl 950 1 0 1 15 ~~ Total Subcomponent A3 2.300 0 400 Cost table for Component A IDA I AFD I JIRAMA Siihcoiiiponeiit A1.a: Powei yeiieiatioii ieiiifotceiriit (ieliaiiililaiioii) 2,000 4 155 1.700 Siilconipoiieiit A1.L: Retioactive fiiidiiciiig 1,000 500 Suhcninpoiieiit p2: Retliictioii of lidiisiiiissioii mid ilistiihtioii tecliiiicsl losses 1,300 tbd tbd Siibcoiiipoiieiit A 3 Reveiiiie iiimdgeiiieiit diid iiinileiiiiz.itioii of iiiloiiiidtioii Systeiii .iiiilIT eyiripiiieiit 2,300 400 Ufwllowted 400 Total ComponentA 7.000 tbd tbd 50 ComponentB: TechnicalAssistance andCapacityBuildinP(IDA US$3 million, includinecontingencies) Subcomponent Bl: Technical Assistance and Communication - Contracting aprivate operator to take over JIRAMA (IDA US$0.25million) 14. The project proposes to finance technical assistance to assist the Government and IFC inthe process o f selecting and contractirlg a new private operator to take over JTRAMAat the endo fthe current management contract. 15. Through this subcomponent, the project will intend to strengthen the transparency and the credibility o f the proposed reform agenda through consultation and information on the objectives o fthe reform. It is therefore essential for the MEMto formulate, adopt and implementa strategic communication plantargeting all interested groups and parties. To prepare and implement such plan, the MEMshould benefit from specialized technical assistance. Subcomponent B2: Extension of the current management contract (IDA US$0.9 million) 16. The project proposes to provide funds for the prolongation of the current management contract by 6 - 9 months to avoid any hiatus before the take over by the selected strategic partner. (see provisional timetable below). Subcomponent B3: Preparation of future generation projects in coordination with IFC'sIPP mandate (IDA: US$O.6 million) 17. The project proposes to finance some studies (pre-feasibility, environmental studies etc.) inorder to assist the Government and IFC to have sufficient project documentation available for a selection o f small to medium size hydroelectric generation projects to attract investor interest. 51 Subcomponent B4: Strengthening of the Ministry of Energy and Mining, (IDA: US$O.4million) 18. The Minister o f Energy and Mining(MEM) has requested the services o f an international consultant to advise himon activities linked to the reform process and the IPP program (mandates 1 & 2 o f IFC). The Consultant will report directly to the Minister of Energy and Mining. The Advisor will also have to ensure project coordination and will lead the miniproject implementationteam (CELCO) inMEM. The project proposes to finance the services o f an individual resident expatriate advisor for a period o f 12 - 24 months. 19. The project also proposes to finance a Technical Assistance to perform a capacity analysis and core competence strategy for the MEMfuture mission. This will include an assessment o f environmental and social safeguard capacity within the Ministry to handle future investments. Subcomponent B5: Preparation of APL-2 feasibility and environmental studiesfor APL-2 investments, (US$0.15 million) 20. Inorder to confirm the feasibility, carry out detailed engineering, secure the relevant financing (andor guarantee) and obtained the required approvals, the technical, environmental, social and commercial feasibility and the engineering o f Phase I1 investments will need to be assessed andthe relevant biddingdocuments prepared. The project will provide resources for JIRAMA and MEMto be able to hire the necessary consulting services to carry out some o f this preparatory work. Subcomponent B6: Program monitoring and evaluation (US$O.l5million) 21. The project will support monitoring and evaluationo f the APL program by providingresources to design a MonitoringandEvaluation System for the Ministry o f Energy andMiningand JIRAMA to be able to follow andreport progress, track performance inline with the indicators agreed at negotiations (Annex 3), and assess the impacts ofthe activities supported by the Project. CELCO/MEM will have overall responsibility for meeting Bank M & Ereporting requirements. Subcomponent B7: Assistance to MEMin project implementation (US$O.lSmillion) 22. Component B of the project will be implemented through a mini Coordination Cell (CELCO) to be located inthe MEM. The project proposes to finance the services of an accountant andprocurement officer for CELCO. This component will also finance project related external audits by auditors acceptable to IDA. 52 IDA I AFD 1 JIRAMA Siibcoiiipoiieiit 81: Teclinlcrl Assistaiice .1nd coiiiiiiiiiiic~itioii Contractiiig pibate operators to take ovei JlRAlrlA - 250 ibd Siilleomponent 82: Prnloiiyatioil of the ciirient inanageinelitcontian 900 tbd Siihcoiiipniient 83: Prepaiation of liltlire yeiieratioii piojecn in cooidilialion with IFC iPP iiianclate 600 Sulcoiayonent 81: Stieiigtlieiiiiiy oftlie hlinistiy of Eneigy aiitl Mining 400 Siihcoiiieoiieiit 85: Pievaiatioii of APL2 and enviioiiiiieiital studies foi APL.2 investiiieiits 150 (campleiiei?Iedby A tins; PPR Subcoiiipoiieiit 86: Yoiiitoiilig aiid evaluitioii 150 Siibcoiiipoiient 87: Ploject iiilyleineiitdtinii 150 Ulwllowad 400 Total Component B 3.000 tbd tbd 53 Attachment 4.1APL-1 -Cost table ConlDonenrA?Ai:Power- IDA AF[I JIRAMA a Replacement of hydro refrigerants systpm for the ANDEKALEKA hydropowerplant 260 25 b Rehabilitation ofunit N' 3 oftheANTELOMlTA1 hydropowerplant 710 84 c Renovationworks In the VOLOBE hydropowerPlant 750 76 d Rehabilitation of small hydropower plants ofANWOBE TSIAZOMPANIRYAMBODIRIANAand VATOMANDRY 80 e Rehabilitation of mechanical auxiliaries Ofthe AMBOHlMANAMBOL4thermal power plant 200 20 Total IDA (Sub)omponentA1.a 2.000 0 205 AFD- Rehabilitation ofthermal Plants in MAHPJANGA(Unit1303) 1 0 8 1 215 AFD Rehabilitation ofthermal plants in TOAMASINA(Zx8MW 2,234 113 AFD Rehabilitation ofthermal plants in TOLIARY (Unit 1305) E40 1167 Total AFD (new projects) 0 4,155 1,195 Retroactive financing 1 000 Total retroactive financing A1.bI 1.000 500 I 1 1 ~ TOTAL SubcomponentA I 3.000 4,155 2.200 of Tran- . . IDA AFD JIRAUA New projects a Rehabilitation oftransmissionnetworks 300 tbd 1 85 b Rehabilitation of distribution networks 1I 1000 11 tbd I 130 Total SubcomponentA2 1,300 tbd 215 Total Component A( 7.000 I tbd 2.815 ConlDonenrs & Fvoluau120and Pr- Inn I AFD 1 JlRAlrlA (complemented by a future PPF] Subcomponent86 Prooram monitoring and evaluation 150 SubcomponentB7 Assistance in MEM to project implementation 150 Unwllocated 400 Total Component B/ 3000 I tbd 0 Total APL-1 I 1~.000 1 tbd 2,215 I 54 Attachment 4.2: APL-2 - Description and Cost Table 23. The second phase o f the APL would be conditioned on satisfactory progress towards financial recovery of JIRAMA and a signed"affermage" contract for the long-term management o f the utility by a private firm. 24. APL-2 would seek to lay the foundation for a sustainable expansion of a commercially- oriented utility inthe most cost-efficient way by investing in strategically important areas such as: (i) HV interconnectionso fthemainload-centres; (ii) preparation o f the next large scale hydro facility; and (iii) investments and TA necessary to make JIRAMA raise its performance to developing world utility best practice. 25. APL-2 funding (mid-2008 - mid-2012) from IDA would tentatively be about US$30 million. A significant part ofAPL-2 fundingwill be allocated to apartial risk guarantee facility to attract private investors for large scale PPP hydro operation. Additional funding i s expected to be secured from AfDB, bilateral donors and the private sector. 26. Further definition o f the investment component will be funded by the TA component o f APL-1. The table below proposes indicative areas o f investments to be included inAPL-2. Tentative cost tab for APL-2 3 1Prep hture large scale hydroproject 3 2 Reform andStrengthemg o fMEM 3 3 Cotrunurucataoq Momtotonng andevaluataon 3 4 Projectunplementatlon TOTAL Undoeated 1 2 1 I I ~ APL-2 -TOTAL 10 20 114 70 204 APL-2 -TOTAL IDA (10+ 20) - 30 I 55 Annex 5: ProjectCosts MADAGASCAR: PowerWater Sectors RecoveryandRestructuringProject Project Cost By Component and/or Activity Local Foreign Total US$ million US$ million US$ million ComponentA Subcomponent A1 150 2,850 3,000 Subcomponent A2 65 1,235 1,300 Subcomponent A3 115 2,185 2,300 ComponentB Subcomponent B1 140 110 250 Subcomponent B2 900 900 Subcomponent B3 600 600 Subcomponent B4 400 400 Subcomponent B5 50 100 150 Subcomponent B6 100 50 150 Subcomponent B7 150 150 Total Baseline Cost 770 8,430 9,200 Physical Contingencies 35 365 400 Price Contingencies 35 365 400 TotalProjectCosts 840 9,160 10,000 Interest during construction Front-end Fee TotalFinancingRequired 840 9,160 10,000 56 Annex 6: ImplementationArrangements MADAGASCAR: Power/WaterSectors RecoveryandRestructuringProject 1. The proposed Power/Water Sectors Recovery and Restructuring Project would have two distinct implementation entities. One would be an integralpart o fJIRAMA's DEEL (Direction de 1'Equipement Electricitk), and would be responsible for implementation o f Component A, Equipmentand services related to JIRAMA. The other would be a small coordination and advisory group (Cellule de coordination-CELCO) responsible for the policy and institutional reform components, Component B, as well as for monitoring and evaluation o f the project inits entirety. CELCO would be attached to the office o f the Minister o f Energy and Mining. Implementingagencies 2. JIRAMA's DEEL: DEEL(Direction de 1'Equipement Electricitk) is a department within JlRAMA incharge o fproject Management activities for JIRAMA electricity sector investments. DEELwas within JIRAMA, incharge o fthe implementation o frelatedcomponents o fthe former energy project PDSE. Financial management andprocurement procedures and staffing expertise were found to be adequate. 3. MEM's CELCO: MEM's own assessmenthas demonstrated that there is a lack o f adequate capacity within the ministryand that therefore a small coordination and advisory group (Cellule de coordination-CELCO) attached to the ministrywould be responsible to implement Component B o f the project. The CELCO i s composed o f (i) a resident expatriate advisor who will manage the unit; (ii)qualified and experienced accountant to assist MEMaccounting staff a inperforming financial management tasks including budgeting, accounting, financial reporting, and disbursement operation; and (iii) a qualified and experienced procurement officer familiar with World Bank procurementprocedures to assist MEMinall procurement activities. Incremental costs of the unit will be supported by the project. ProjectReporting,Monitoringand Evaluation Project implementation manual 4. BothDEELand CELCO will prepare a Project ImplementationManual. The PlMswill set forth all operational andprocedural steps regarding activities evaluation, reviews and approval, flow o f information, procurement and financial management arrangements. Financial management 5. CELCO (MEM) and DEEL (JIRAMA) will maintain separate accounts for all transactions related to each component for which they have overall implementation responsibility and will produce their individual annual financial statements inaccordance with internationally accepted accounting principles. The consolidation o fproject accounts if necessary, the production of quarterly Financial Monitoring Reports (FMRs) incompliance with international accounting standards and IDA requirements andthe monitoring o f the project 57 progress will be assured by CELCO (MEM). They will also need to upgrade the fiduciary systems already inplace to ensure timely delivery o f data on project activities. Audits 6. CELCO andJIRAMA financial statements will be audited annually by an international private accounting firm acceptable to IDA inaccordance with International Standards o f Auditing and the FMPractices inWorld Bank-financedInvestment Operations issuedbythe FM Sector Boardon November 3,2005. The auditors will be required to: (i) an opinion on express the project financial statements; (ii)carry out a comprehensive review ofthe internal control procedures and provide a management report outlining any recommendations for their improvement. The audit reports will be submitted to IDAnot later than six months after the end o f each fiscal year. The auditors should be recruitedprior to credit effectiveness. The terms of reference o f the audit will be reviewed by the financial management specialist o f the Bank/IDA to ensure the adequacy o fthe audit scope, drawing special attention to particular risk areas identified during project preparation. Monitoring and evaluation 7. The implementation o fthe project will be monitoredthrough quarterly progress reports which the Project coordinators (both at JIRAMA and MEM)will prepare and submit to IDA. This will provide a way o ftracking actual project execution against implementation milestones established at the time o f the project launch. These are the key performance indicators and project outcomes that are contained inAnnex 3. 8. Further, inorder to assess impacts that the project i s expected to deliver on the quantity and quality o f electricity and water supplied, it i s envisaged that several surveys will be carried out at different points on JIRAMA's network. Monitoring o frevenue enhancement measures will be facilitatedbythe ring-fencing o fclusters where these are to be introduced. Baseline data will be collected inthese clusters prior to introduction ofthe new customer management techniques, 9. Other indicators o f JIRAMA's overall performance, their baseline values and targets have been agreed duringnegotiations. These indicators are given inAnnex 3. 58 Annex 7: FinancialManagementandDisbursementArrangements MADAGASCAR: PowerrWaterSectors Recovery andRestructuringProject Introduction 1. Inaccordance with Bank policyandprocedures, the financial management arrangements o fthe DEEL (Direction de I'Equipement Electricitk, a department o f JIRAMA) and the MEM (Ministryo fEnergy and Mines) respectively responsible for the implementation o fthe components A (Investments) and B (TA, studies etc.) o f the proposed Credit (Power/Water Sectors Recovery and RestructuringProject) have beenreviewed to determine whether they are acceptable to the Bank. 2. This review is rather an update for the DEEL (JIRAMA) since the FMsystems of this entity have already been assessedinthe context o f the previous Energy Sector Development Project closedinDecember 2005. The conclusions o f this review are given inSection D (Appraisal Summary) o f the main body of this P A D and not repeated here. 3. With regardto MEM,no FMassessmenthas beencarried out yet since the Coordination Unit(CELCO) incharge ofimplementationofcomponent Bis stillnotinplace. However, we have started to define with the MEMthe characteristics o f the FMsystem(s) to be implemented, and developed an agreed action plan to ensure that the ingredients for sound project financial management are inplace prior to Credit effectiveness. Countryissues 4. The World Bank's CFANCPAR, completed in2003, and some diagnostic works carried out over the last three years by the Bank and other donors, identified a range o f weaknesses and issues hampering the performance o fMadagascar's budget and expenditure management system. To address these issues, the Government has developed in2004 and 2005, inconjunction with all key development partners, a priority action plan for public finance reform. The main achievements encountered so far include: (i) adoption o f a new organic public finance law; (ii) introduction o fprogram budgets to improve the presentation o f the budget and its alignment with policy priorities of the government as specified inthe PRSP; (iii) reinforcement o f the Treasury internal control system by recruiting additional staff and improving the operational efficiency o f the "Brigade du Tresor"; (iv) simplification o fthe expenditure managementprocess by integrating the functions o f "sous- ordonnateurs" and credit managers; (v) creation o f an internal control mechanism (IGF: General Finance Inspection) at the level o f the Ministry o f Finance; (vi) review o fthe legal framework for the control institutions (IGF, Brigade du TrCsor, Auditor general) and implementation of capacity buildingmeasures to improve their efficiency; (vii) development and implementation o f a computerized integrated financial management systemin six maintreasuries, capturing the different phases ofthe expenditureprocess. The reinforcement of the Treasury internal control and the implementation o f the integrated financial management system (IFMS) insix treasuries have improved timeliness and quality o f financial information. 59 5. The Auditor General has also cleared the backlog o f accounts and completed the examination o f the draft budget execution laws for the years 1998 until 2003. The oversight function o f Parliament has been strengthened through capacity buildingand trainingo f the Public Finance Committee. 6. While overall implementationprogress o f the reform program i s encouraging, significant actions remain to be done, including the following: (i) improvement o fbudget execution rate in priority sectors; (ii)reinforcement o f the capacity o f the line ministries inpublic financial management, especially inthe implementationo f the new program budget structure; (iii) strengthening o f cash management; (iv) production o f the treasury accounts within the legal timeframe; and (v) reinforcement o f control over state owned companies andnational public institutions. The strategic coordinationo f the multiple reforms and the monitoring & evaluation system also need to be improved. To mitigate risks inpublic expenditure management, the World Bank, throughthe Governance and Institutional Development Program (PGDI), and a number o f donors continue to support Government's public finance reforms reflected inits annual priority action plan for 2006. 7. Regarding the accountingprofession, some positive developments have been noted over the last three years through assistance providedby the FIDEF (Fbdbration Internationale des Experts Comptables Francophones) and INTEC (Institut National des TechniquesEconomiques et Comptables). However, a number o f local accounting firms continue to operate below the international standards due to the lack o fproper auditing standards, clearly defined guidelines and procedures for systematic peer reviews, quality control mechanisms to harmonize methodology. To improve the capacity and the competitiveness o f local auditing firms, the following measures have been taken while auditing Bank/IDA financed projects: (i) obligation for local auditors to enter into partnership with international accounting firms; and (ii) effective participation of the international accounting firm inaudit fieldworks and submission o f audit reportjointly signed by the local and international audit firms. An accounting and auditing ROSC (Reports on the Observance o f Standards and Codes) would be certainly helpful to identify clearly both issues and actions to be taken to strengthen the capacity o f the accounting profession inMadagascar. Budgeting 8. Budgetingarrangements for the MEMandJIRAMA are clearly documented. The budgeting needs o f the project will be fulfilled by the DFB (MEM-Directorate o f Finance & Budget) regardingcomponent B and by the JIRAMA Directorate o f Finance regarding component A. The accounting software actually inplace (at the MEMand DEEL) can adequately cater for the budgeting arrangements o f the project. Accounting 9. The DEELaccounting system is incompliance with generally accepted accounting standards. It uses standard book accounts (journals, ledgers and trial balances) to enter and summarize transactions and operates on a double entry accrual principle. The accounting system to be usedby CELCO will present exactly the same characteristics. However, regarding budgetary executionprocedures, CELCO will apply the procedures actually used within the 60 MEM(Le, preparation ofexpense commitment formbythe DFB,verification ofthisrequestby the Expenditure Commitments Oversight Directorate, execution o f the transactions by the project, determination o fthe exact amount to be paidupon reception o f final bills, preparation o f payment order andpayment after appropriate verification o f the validity o f the transactions) and will provide the Budget Directorate o fthe Ministryo fFinance with monthly statement o f commitment and payment drawn under the project credit lines. 10. DEELwill maintainseparate financial records for all transactions under its responsibility and will send, o n a monthly basis, the balance sheet to CELCO for consolidation. CELCO will be incharge o f timely production o f monthly trial balances for the ACCT (Agence Comptable Centrale du TrCsor), and quarterly FMRs. 11. To ensure better understanding and proper application o f policies and procedures by the project staff (DEEL and JIRAMA), appropriate accounting manuals o f procedures will be prepared and implemented both at the MEMand JIRAMA. This manual will describe inter alia the outline of the project accounting system, the accounting policies to be followed, the formats of books and records, the Chart of accounts, the financial reporting, and relevant information to facilitate record keeping and maintenance o fproper control over assets. The consultant incharge of this implementation will also provide adequate training to project staff. 12. DEELandCELCO will use the integratedcomputerized system acquiredwithin the context o f the previous Energy Sector Development Project, which inparticular facilitates annual programming o f activities and project resources, record-keeping (general accounting and cost accounting), financial and budgetary management and preparation o f project financial statements. However, this software needs to be adjusted to meet DEEL andMEMrequirements, especially to allow for procurement management, fixed assets management, timely production o f quarterly FMRsrequired for managing and monitoring project activities, and follow-up on project implementation progress. The consultant incharge o f this update will also provide training for users to ensure efficient use o f all modules offered by the software. The TORSfor this consultant will be reviewed by the Bank Financial Management Specialist. The new computerized systemwill be fully functional before project implementation begins. InternalControl& InternalAuditing 13. DEEL's accounting staff i s qualified and has relevant experience to be fully successful in carrying out their functions. For CELCO, the recruitment o f a qualified and experienced accountant will be required to assist the MEMaccounting staff inplace inperforming FMtasks. The recruitment o f this accountant is a condition o f effectiveness. To ensure efficient use o f credit funds for the purposes intended and consistent application o f procedures on procurement, financial management, disbursement, the IGF/IGEinclose collaboration with the JIRAMA Internal Audit Department will play the role o f internal auditors. They will report directly to the Minister o f Finance, the Minister of Energy and Mines, and the JIRAMA Board o f Directors. All issues identifiedduringinternalaudit shouldbe addressed quickly to improve the project performance. 61 FundsFlow andDisbursementarrangements 14. The flow of funds from IDA and Government is presented as follows: Designated acct. A Designated acct. B 1 1 Contractors,suppliersof goods and services DisbursementfromIDA creditand Governmentcounterpartfunds 15. For the implementation o f the Power/Water Sector Recovery and Restructuring Project the followingbank accounts will be opened ina commercial bank under conditions satisfactory . to IDA: DesignatedAccount A to be managed by DEEL (JIRAMA): Denominated inU S dollars, disbursements from IDA credit will be deposited inthis account opened ina local commercial bank to finance project activities under component A, inaccordance with the . disbursement percentage indicated inthe FA; DesignatedAccount B to be managedby CELCO (MEM): Denominated inU S dollars, disbursements from IDA credit will be deposited on this account opened ina local commercial bank to (i) finance project activities under component B inaccordance with the disbursement percentage indicated inthe FA; 16. Fundsdeposited inthese accounts will be usedto ensure timely payments o fcontractors and suppliers o f goods and services. The project implementation and accounting manuals will describe indetails all procedural aspects regarding financial management and disbursements from the designated account(s), and project account (payments, replenishment, accounting, reporting and internal controls). 62 Methodof Disbursement 17. Duringthe first year o fproject implementation, DEELandCELCO would follow the transaction-based disbursementsprocedures (traditional mode) outlined inthe Bank's Disbursement Handbook. The use o freport-based disbursements could be possible ifrequested bythe borrower and ifthe following criteria are met: (i) FMrating (both at DEELand the CELCO) has been maintained at satisfactory level; and (ii) the submission of at least three quarterly satisfactory FMRs that could be relied upon for purposes o f disbursement. Detailed disbursement procedures will be described inthe project accounting manual o f procedures. MinimumApplication Size 18. The minimumapplication size for direct payments, and special commitments is 20% o f the amount advanced to the related special account. Use of Statementsof Expenses(SOEs) 19. Disbursementswould be made against Statement o f Expenses(SOEs) for contracts and . goods not requiring the Bank's prior review. Therefore disbursements for all contracts for: ... Contracts for equipments and goods in an amount inferior to US$200,000; Contracts for consulting services, training by firms o f less than US$lOO,OOO; Contracts for consulting services, training by individual of less than US$50,000; Training not subject to contract and all incremental operating expenses; would be made on the basis o f SOEs and certified by the DEELconcerning the component A, and CELCO with regard to component B. SOE statements would be audited semi annually byindependent auditors acceptable to the Bank. All SOEs supportingdocumentation would be kept therefore by the executing agencies and made available for review by donor supervision missions, and internal and external auditors. DesignatedAccounts 20. To ensure that finds will be available when needed, two designated accounts inUS$ will be established ina local commercial bank under conditions satisfactory to IDA. The designated account A will be opened inthe name o f DEELwhereas the designated account B will be inthe name o f the CELCO. The authorized allocation for the designated accounts A and B covering IDA's contribution would be respectively US$500,000 and US$350,000 covering IDA'sshare o f four (4) months o f estimated expenditures. CELCO and DEELwould be responsible for preparing disbursement requests for components under their responsibility. The designated accounts would finance all project eligible expenditures inferior to 20% o f the authorized allocation, and replenishment applications would,be submitted at least on a monthly basis. 21. The designated accounts would bereplenished on the basis o f documentary evidence o f payments required by IDA, made from the designated accounts, eligible for financing under IDA Credit. All SOEs supportingdocumentationwill be keptby the executing agencies andmade available for review by bank supervision missions and external auditors. 63 FinancialReporting 22. To monitor project implementation, JIRAMA and MEM will produce respectively the following reports incompliance with international accounting standards: . (a) JIRlMA. JIRAMA's audited annual financial statements . (b) DEEL: Projectfinancial statements related to componentA: (i) Summary o f Sources and Uses o f Funds (by components/activities/credit category and showing all sources o f funds); (ii) the Accounting Policies Adopted and . Explanatory Notes; and (iii) a Management Assertion. FMRs related to component under its responsibility: The FMRsto be prepared by DEELwill include financial reports, physical progress reports andprocurement reportsrelatedto component A. The FMRs should be submitted to the CELCO within 30 days of the endo f the reporting period (on a six monthbasis) for consolidation. (e) MEM (CELCO): Projectfinancial statements related to component B: (i) Summary o f Sources and Uses o f Funds(by components/activities/credit category and showing all sources o f funds); (ii) Project Balance Sheet; (iii) Accounting the Policies Adopted and Explanatory Notes; and (iv) a Management Assertion. Quarterly FMRs: The FMRs to bepreparedby CELCO will include financial reports, physical progress reports andprocurement reports related to all project components to facilitate project monitoring. The project FMRs should be submittedto IDAwithin 45 days o fthe end ofthe reportingperiod (on a six monthbasis). 23. The form and content o fFMRs and annual financial statements were determined during appraisal and agreed at negotiations. Models o f these reports will be presented inthe project accounting manual o f procedures. Auditing 24. Duringthe first phase o fthe project, CELCO andJlRAMA financial statements will be audited annually by an international private accounting firm acceptable to IDA inaccordance with International Standards ofAuditingandthe FMPractices inWorldBank-financed Investment Operations issued by the FMSector Boardon November 3, 2005. The auditors will be required to: (i) an opinion on the project financial statements; (ii) out a express carry 64 comprehensive review o f the internal control procedures andprovide a management report outlining any recommendations for their improvement. The audit reports will be submittedto IDAnot later than six months after the endo feach fiscal year. The auditors shouldbe recruited prior to credit effectiveness. The terms o f reference o f the audit will be reviewed bythe financial management specialist o f the Bank/IDA to ensure the adequacy o f the audit scope, drawing special attention to particular risk areas identified duringproject preparation. Audit Report DueDate 1. Continuing entity financial statements Within six months after the end of each (JR4MA) financial year. I 2. Project financial statements related to Within six months after the endof each component implemented by DEEL financial year. 3. Project financial statements relatedto Within six months after the end o f each component implemented by CELCO. Ifinancial year. SupervisionPlan 25. A supervisionmissionwill be conducted at least once every year based on the risk assessmento f the project. The mission's objectives will include that o f ensuring that strong financial management systems are maintained for the project throughout its life. A review will be carried out regularly to ensure that expenditures incurred by the project remain eligible for IDA funding. The Implementation Status Report (ISR) will include a financial management rating for the component. 65 Annex 8: ProcurementArrangements MADAGASCAR: Power/WaterSectors RecoveryandRestructuringProject A. General 1. Procurement for the proposedproject would be carried out inaccordance with World Bank's "Guidelines: Procurement Under IBRDLoans and IDA Credits" 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 inthe Legal Agreement. The general description o fvarious items under different expenditure category is described below. For each contract to be financed bythe Credit, the differentprocurement methods or consultant selectionmethods, the need for prequalification, estimated costs, prior review requirements, and time frame have been agreed between the Borrower and the Bank project team inthe Procurement Plan. The Procurement Planwill be updated at least annually or as required to reflect the actual project implementation needs and improvements ininstitutional capacity. 2. Advertisement: A General ProcurementNotice will bepublished inUNDevelopment Business and Development Gateway Market (dgMarket) and will show all International Competitive Bidding(ICB) for goods and works and major consulting service requirements. Specific Procurement Notices will be issued inDevelopment Business and dgMarket and at least one newspaper with nationwide circulation for I C B contracts and before preparation o f short lists with respect to consulting contracts above US$200,000, inaccordance with the Guidelines. 3. Procurementof Works: There will not be any specific procurement o fworks. Complementary works inrelation to goods contracts will be procured within those goods contracts. 4. Procurementof Goods: Goods procured under this project would include: spare parts for rehabilitation and maintenance o f generator units, equipment for rehabilitation o f distribution networks, pre-payment meters, spot meteringequipment, and computer hardware and software. The procurement will be done using Bank's SBD for all ICB and National SBD agreed with or satisfactory to the Bank. The project will also finance expenditures which meet the requirement of OP 12.10on retroactive financing. 5. DirectContractingfor goods maybeused inexceptional cases, such as for the extension o f an existing contract, standardization, proprietary items, spare parts for existing equipment, and urgent repairs and emergency situations, according to paragraphs 3.6 and 3.7 o f the Guidelines. The items to be procured through Direct Contracting would be agreed on inthe procurement plan. 6. Selectionof Consultants: The Project will finance the contracting o f consultancy services for improvement of the commercial aspects o f the electricity distribution business in terms of, improving inter-alia the billling system, financial management controls, fraud prevention, technical controls, modernization o f information systems and IT equipment, revenue management and project monitoring and evaluation. The project i s also expected to finance the 66 extension o f the existing management contract for JIRAMA incase o f a delay inthe process o f selecting the long-term strategic partner. The project is further expected to finance pre- feasibility anddetailed engineering studies including studies of environmental and social safeguard aspects with regard to future generation projects. As part o f Component B the project will finance technical assistance for MEMcovering the preparatorywork for APL-2 including advisory services duringthe reform process. Specialized advisory services would be procured through Individual Consultants Selection (ICs). 7. Operational Costs: These relate to the functioning o f C E L C O N E M and would be procured using MEM's administrative procedures, which were reviewed and foundacceptable to the Bank. The Project will finance some operating expenditures under component B. 8. Review by the Bank of Procurement Decisions. The thresholds for prior review by Bank are specified inthe procurement plan. Table A shows (a) the proposed thresholds for the different procurement methods; and (b) the proposed initially-agreed thresholds for prior review bythe Bank. The Bank will previewprocurement arrangements proposedbythe Borrower for the items specified inthe procurement plans for their conformity with the Financing Agreement and the applicable Guidelines. Any procurement item not specified for prior review may be subjected to a post-review o f the procurement process. Table A: Thresholds for Procurement Methods and Prior Review Expenditure Category 1Contract Value Procurement Contracts Subject to Threshold (US$) Method Prior Review (US$) Works No major specific works are expected Goods 200,000 or more ICB All 30,000 or more and NCB less than 200,000 Less than 30,000 Shopping Consultant Services - 100,000 or more QCBS All Firms CQS LCS sss Consultant Services - 50,000 or more ICs All Individuals 67 B. Assessmentof the agency's capacityto implementprocurement 9. Procurement activities will be carried out by JIRAMA for component A and by MEM through CELCO incollaborationwith the Unit for Public Procurement (UGMP) for component B. JIRAMA is properly staffedandits Procurement unitconsists ofproficient procurement officers and procurement assistants. MOEMAJGMP is staffed with a procurement officer who will be further supported by an initialprocurement officer to be recruitedby CELCO. 10. An assessmento fthe capacity o fJIRAMA to implement procurement actions for the project has not been carried out because its procedures and staffing were already found to be satisfactory duringthe implementation o fthe former Project PDSE and has since then not substantially changed. An assessment o f the capacity o f MOEMAJGMPwas carried duringthe appraisal mission o f May 2006. The assessment reviewed the organizational structure for implementing the project and the interaction between the project staff responsible for procurement and the Ministry's central unit for administration and finance. 11. Most o f the issues/risks concerningthe procurement component for implementation o f the project have been identified. Identified issues and corrective measures which have been agreed are described inthe table below. Considering the lack o f capacity within the MEM,the overall project risk for procurement is considered high. Table B: ProcurementRiskAssessment and Risk MitigationComponentB, Implemented by MEM ~ Designation Concerns Risk mitigation Duedate Planning and Lack o f budget - Capacity buildingon - At Project budgeting planning budgeting effectiveness - Recruitmento f an experienced - At Project Procurement officer to effectiveness CELCO Executionand Lack o f internal Audit Development o f cost - At Project monitoring and contract 1effectiveness management control Staffing Competent but -Recruitment o f an - At Project insufficient experienced effectiveness Procurement officer to CELCO Competition among Lack o f advertisement Use o f GPNat national - At Project private sector level effectiveness Use o f Bank procedure for advertising Project management Lack o f definition of Development of - At Project responsibilities project implementation effectiveness manual 68 C. Procurement Plan 12. The Project's detailed activities for the first 18 months o f implementation are detailed in the procurement planwhich was discussed and agreed between IDA and the borrower on June 2, 2006 and is available at MEMand JIRAMA Headquarters. It will also be available inthe Project's database and inthe Bank's external website. The Procurement Planwill be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs and improvements ininstitutional capacity. D. Frequency of Procurement Supervision 13. Inadditionto the prior review supervisionto becarriedout from Bank offices, the capacity assessment of the ImplementingAgency has recommendedbi-annual supervision missions to visit the field to carry out post review o f procurement actions. 69 a I E L 0 -3 .CI c, c, W a E 3 0 3M V 2 I I .% d Y E u 0 .3 c, - d e 0 28 W 7 Z E Y 4 E .I M e .I * I0 > c9 a Y E 2 P 2 2 .L B Y W M E 0 0 0 3E 8 80 0 0 8 3 P v, P co c Y sE a2 eE h p3 Qm 0 m m .CI , ; Y 3 4 I < 2 .. B c, 33 2 c, I , 9 10 3 9 1 0 0 3 3 0 ?a 3 0 0 N h l hl 5; 4 J 4 Z L 2 b 2 1, L 3 0 3 0 3, 0- 3 3 0 10 9 hl c0 0 E .-a .C U L R8 m a d - a Annex 9: Economicand FinancialAnalysis MADAGASCAR: Powerwater Sectors Recovery andRestructuringProject A. Economicanalysisof the Prowam Introduction 1. The proposedprogram offers the prospect o f higheconomic returns to the economy o f Madagascar, which i s clearly suffering from inadequate electricity supply. Lack o f power severely hurtthe modem, garment manufacturing sector in2005, with adverse consequences on output, lost orders andlower exports thanwould otherwise have beenpossible. GDP growth is estimated to have been lower by 0.5% simply as a result o f the load shedding imposed by JIRAMA on its clients. Evenbefore the 2005 financial crisis, the service renderedby JIRAMA was inadequate and declining due to insufficient investment and neglected maintenance. Finally, resource constraints meant that JIRAMA was not ina position to either extend service or to increase its generating capacity ina timely, least-cost manner. Many sizeable urban centers outside JIRAMA's main grids have long had daily power cuts and supply interruptions due to lack o f fuel and/or equipment breakdowns. These issues are all beingaddressed under the 5-year restructuring and recovery program for the power sector. 2. Inaddition, the program also putinplacethe necessary conditions and operating environment needed to attract private investors to the sector. The sector's large investment backlog is beyond the limitedbudgetary resources o f GoM. Puttinginplace a private operator to manage JIRAMA will provide bothpotential IPP investors as well as Madagascar's development partners with the assurance that JIRAMA will be professionally managed, internal efficiency will be raised and service quality to consumers improved. A solvent JIRAMA with a healthy cash flow and good payments record is an essential precondition to private participation indeveloping Madagascar's plentiful hydroelectric potential. Least-cost generation plan 3. JIRAMA's current mix o fgenerationplant reflects sub-optimal choices madeover the past decade. Poor management, delayed decision making and o f late, lack o f funds have led to an excessive reliance on diesel generators, even insites where hydroelectric or heavy-fuel generators would have produced cheaper electricity. For reasons o f expediency and rapidity several high-cost diesel generators have been acquired on a rental/leasing basis, without competitive tendering. The recent oil price hikes have turned the choice o f diesel generators into a severe financial burden for JIRAMA, its consumers and also for GoM. The success o f the proposedrecovery program for JIRAMA is predicated upon a rapid move away from diesel generation, initially to HFO and then inthe medium-to long-term to hydroelectricity. 72 4. Inthe short- to medium-term, despite Madagascar's evidenthydroelectric resource potential, the scope for rapidly developing new hydro power sources i s rather limited. Work on the addition o f a third 30 MW generator at the existing Andekaleka hydro plant i s about to begin, with financing from BADEA. Undernormalhydrological conditions it will produce 200 GWh per year, representinga massive cost saving to JIRAMA. Two minor sites (Sahnivotry and Lily) are at a sufficiently advanced stage o fpreparationby private developers to contribute a further 80 GWho f hydro power by 2009-2010. Due to a lack o fpreparatory studies, other small to medium-term hydroprospects are unlikely to be commissioned before 2010-2011. Nor has there been sufficient technical investigationor pre-feasibility work done on the larger hydro sites (Lohavanana, Volobe and Antetezambato) that have been identified as the least-cost options for 2012 onwards. 5. Inthe nearterm, major fuelsavings can therefore onlybe achievedthrough substitution o f HFO plants for high-cost diesel generators. Implementation o f a 40 MW HFO plant to be sited inthe capital has begun and it is expected to be inservice inmid-2007. This plant will permit JIRAMA to greatly reduce its use o f diesel, since the plant is capable o f producing 200- 250 GWhannually. Andekalela 3, has been delayedby several years and should already have been inservice. It produces even greater economic benefits and delays incompleting these two projects would be very costly to JIRAMA. Economic Rate of Return 6. Given the diverse nature o f the physical investments envisaged as part o f the program, the economic analysis is based on a 5-year time-slice (2006-2010) of the electricity sector's total investment program, which has been reviewed and found to be least-cost innature (see table 3). Assigningspecific benefits to particular project components would havebeenboth arbitrary and nearly impossible. 7. The physicalbenefits from these investments that havebeen quantified are twofold: first, (and most important) the incremental electricity supplied to consumers; second, the reduction in high-cost diesel fuel consumption arising from the replacement o f diesel generators bymore economical ones usingheavy fuel oil (HFO). Benefits from reduced technical losses and improved reliability o f service have not been quantified inthe economic analysis presented here (Table 2). The base case estimate of the EIRRis 14.4%. 8. The incremental demand that can be met as a result o f the investment program is based on a variant o f the load forecast preparedby JIRAMA's consultants, HQI.For the purposes o f the economic analysis, only five years (2007-201 1) o f cumulative load growth have been considered as benefits directly attributable to the 2006-2010investment program. Total electricity demand is projected to increase from about 770 GWh in2006 to 1,110 GWhin2011, equivalent to an annual average increase of 7.6%. However, demand growthin2006-2007 is severely constrained to only 2% - 4%, due to a deliberate attempt by JIRAMA to restrain consumption prior to the entry inservice o f a large, new HFO plant. By way o f comparison, duringthe period 1995-2005, electricity demand rose at an average o f 7% annually, despite the minimal investment inthe sector to expand service. 73 9. The minimumvalue o f the incremental sales has been taken to be the average tariff across all customer categories charged by JIRAMA in2006, Le. USc13kWh. This does not represent the full value o f benefits to users from this electricity, but inthe absence o f an estimate o f the `consumer surplus' it i s a minimummeasure o f benefits that has beenused as a proxy. It is well below the JIRAMA tariff charged to LV consumers inZone 3 (isolated centers served entirely by diesel), o f UScl9-20/kWh. 10. Fuelsavings to JIRAMA havebeenestimated at the differencebetweenthe cost o f generation using HFO inthe new HFOpower plant due inservice inmid-2007 anddiesel fuel that it would otherwise have to use inits existing generators. This works out at about USclO/kWh at current oil prices6. 11. Fulldetails o fthe analysis andthe parameters usedinestimatingthe EIRRare given in the tables below. The EIRR i s particularly sensitive to variations inoil prices, the size and timingofthe investment program, delays incompletingmore efficient plants, and to assumptions about demand growth. As can be seen from Table 1, depending on the combination o f negative factors assumed, the EIRRvaries from 10.3% to 13.7%. Table 1: Resultsof EIRRSensitivityAnalysis Parameter EIRR(in %) Fuel costs 20% higher 13.7 1Year delav inAndekalela Unit 3 13.1 6 month deiay inHFOplant 12.7 Lower demand growth (5% p.a.) 11.7 Higher fuel costs+lower demand 11.8 Investment costs 20% higher 11.3 Higher fuel+lower D+HFOplant delay 10.3 InApril2006 spotprices FOB Singapore were US$52/barrelfor HFOandUS$SO/bbl for diesel. Inaddition, HFO engines consume less fuel per unitof electricity (220 gm vs, 250 gm/kWh). 74 Table 2: EIRR Analvsis-Base case Notes 0 8, M = 4 5 UScentsIkWhto cover G+T+D operating costs Fuel costs of2lcentslkWh for diesel and 12c/kWh for HFO = April 2006 CIF Anatananrivo price (excl taxes) equates to $80/bbl diesel and $52/bbl HFO Singapore FOB spot price+$30/ton sea freight+$l20/ton land transport to tana Prices assumed to decline per WB crude oil price fcast Sales assumed to rise by 2% in U6,4% in 07, 10% in 138 and 8% thereaffer No incremental fuel cost in 2008 due to Andekaleka3 hydro startup - supply greater than sales increase Fuel savings of 10c/kWh between diesel and HFO in 2007 on 80 GWh due to change in generation mix Due to start ofAndekalela3 in 2008, the fuel savings are 62GWh of diesel and 42 GWh of HFO production avoided Incremental sales valued at 13c/kWh, which is the current average revenue earned by Jirama in 2006 75 Table 3: Electricity Sector Investment Program I l v lADAGASGAR ELECTRIGIW SECT0R INVESTfvlENT PROGRAfvl Table 4: Sales and production forecast r SALES AND PRODN. FORECAST I JlRAfvlA TOTAL 2005 2006 2007 2008 2009 2010 2011 ELEC SALES (Gwh) 754 769 800 880 924 970 1019 Losses % 23 7 24 24 23 22 5 22 21 5 Prnriiirtinnfcwhl 988 1012 1052 1143 1192 1244 1297 of which Hydro 650 680 680 875 925 975- 1025 Thermal 338 332 372 268 267 269 272 296 202 112 50 60 60 70 Notes Load fcast 2% in 06,4% in 07,10% in 08,8% thereafter Andekalela 111-150 GWh in 2008,200 GWh thereafter Sahnivotry 60 GWh, Lily 20GWh ORET prodn rises from 100 GWh in 2007 to 200 GWh in 2011 New hvdo IPP exaected in setvice in 2009-10 with 100 GWhlvr arodn 76 B. FinancialInternal Rate of Return Analysis of the Project 12. The Project proposes a blendof investments intechnical facilities (rehabilitation o f hydro and HFO generation, transmissionnetwork rehabilitation and/or reinforcements, reinforcement of distribution facilities), as well as a support to commercial activities (loss reduction, IT...). 13. The following financial analysis o f the Project i s based on an aggregate cost-benefit analysis o f its maincomponents for the first phase o f the APL (including the costs that will be supported by the client). The scope o f this rate o f return analysis i s therefore much narrower than for the EIRRanalysis presented above which considers the whole investment program of JIRAMAo fwhich only a fraction is financedbythe Bank (for a financial analysis o fJIRAMA as a whole, see part C o f this annex). VdUe I BaseCase Lmvcase , Generation, TransmissioqI 51.O%lI 38.3% RevenueManagementand 24.8% 17.7% IT TotalBasecase 412% 46.1% I cost mSDS I 7 3 I 7.8 i 14. The project investments yield the following distinct benefits: reduction o f generation costs, additional revenue from incremental electricity supply, reduction of T & D technical losses, reduction o f commercial losses. Other economic benefits o fthe project such as an improved reliability o f supply are not considered because the main beneficiaries will be JIRAMA's customers rather thanthe company itself. 15. The Base Case and L o w case FIRR calculation are given inthe table below. The calculation is based on a total costs o f 7.3 MillionUSD for the components o f the project included inthe analysis (retroactive financing and technical assistance are not included, and 15% of contingency costs are added to Bank costs). 16. The Low Case scenario i s based on more pessimistic assumptions for the profitability o f the Project (Le., hels prices 20% lower, electricity tariffs 20% lower, contingency costs o f 25% instead o f 15%). The profitability o f the activities supported by the Project remains highunder the low case, reflecting past under-investment by JIRAMA. 17. The FIRR for technical investments i s based on technical parameters that are relatively straightforward. The forecasting for the revenue management activities is fraught with greater uncertainties (our assumptions are muchmore conservative than JIRAMA's). Beyond their direct impact, the revenue management activities have an experimental value. On the basis o f their results that will be carefully monitored, it should bepossibleto base future investment decisions on more reliable forecasts (regarding, for instance, the decision to invest inthe generalizationo fprepaid meters). 77 C. Financialanalvsis of JIRAMA Introduction 18. The Project strategy i s centered on: (a) Rescuingthe company from financial and technical collapse; (b) Implementing small but highly profitable investments to rehabilitate existing generation, transmission and distribution facilities, and increase revenues; (c) Creating the adequate organizational, institutional, technical and financial conditions that will allow inthe medium-term to pursue a more ambitious policy o f access expansionbased on larger investments notably in additional hydro generation capacity. (d) The Project will complement the restructuring planthat has been initiated, including activities Key actions to be accomplished: Recreating the basic process and procedures necessary to efficiently manage JIRAMA,restructuring o f JIRAMA balance sheet, (financial restructuring o f liabilities, re-capitalization o f the company). A financial restructuring exercise is currently underway andthis summary analysis incorporates the measures that have beendecided. 19. The present annex describes and analyzes succinctly (i) the recent financial history o f JIRAMA;(ii) situationo fthe company in2005 when the full extent o fits difficulties became the apparent with the beginningo fthe management contract; (iii) the restructuring plan o f the company that i s underway and the medium-term financial prospects o f the company. 20. Among the conclusions that can be drawn from this forecasting exercise, the following stand out: (a) Inspite o fthe large hnds injectedinthe companybythe government anddonors, the projected conversion o f debt into company equity, and the successive tariff increases on electricity and more recently on water, JIRAMA remains ina precarious financial situation. (b) With most o fits debts cancelled or rescheduled, JIRAMA has been given a fresh start financially, however its most immediate problem remains an insufficient generation o f funds from internal sources: cash-flow from current operations is likely to remain negative in2006 and 2007, given JIRAMA's unfavorable generation mix (new HFO and hydro plants not yet inoperation, Andekaleka will not be operating at full capacity during rehabilitation works). (c) As aresult, JIRAMA cash position is boundto deteriorate again over the next two years (especially ifthe company reduces its arrears towards suppliers as envisioned inthe "plan de redressement"), and will probably need a new injection o f liquiditybefore 2008. 78 (d) Our financial forecast assumes several efficiency improvements (reduced transmission and distributionlosses, improved revenue collections, better management o f personnel costs). The biggest source o fpotential savings is however the reduction o f generation costs. The Project includes several activities components precisely devoted to the rehabilitation o f hydroelectric installations. These activities have an extremely very ' highrate ofreturn. (e) However, once these "low-hanging fruits" are harvested (the small investments that should have beenmade years ago), a further reduction inaverage generation costs can only be achieved by following a disciplined investment planning approach, based on the least-cost expansion plan. Giventhe leadtime o f large hydroelectric projects, this approach will take several years before its benefits are felt interms o f increased supply and/or lower tariffs. (f) Tariff discipline i s essential ifJIRAMA i s to become financially viable again: an updated indexing formula should be defined and scrupulously followed. Our financial forecast assumes yearly tariff adjustments (the next one being scheduled for April 2007) slightly above the rate o f localinflation. The average tariff perkWhexpressed inUSDis currently similar to its value in2002 and 2003, and oil prices are much higher today than theywere then. (g) There is a trade-offbetweenthe expansiono f access and the affordability o ftariff for existing users that needs to be acknowledged. To be able to invest, with donor support, inaccess expansion, JIRAMA needs to generate a positive cash-flow from current operations. A way to address this issue is through the sequencing o f activities and investments. An ambitious policy to increase access to electricity can only be based on the availability o f new sources o f generation at an affordable price because as long as JIRAMA meets extra demand at the marginwith thermal generation, any effort to increase supply will directly deteriorate its cash position. (h) JIRAMA needs to betterprioritize its investment program: after years o f neglect and under-investment, all domains o f JIRAMA's operations (generation, transmission, distribution, commercial, administrative, IT...) seem to require significant investments. However, financing has yet to be found for a large portion o f the investment program that JIRAMA initially has presented for the years 2006 - 2009. This initial program seemed extremely over-ambitious financially, but probably also inoperational terms. The current project attempts to address this need for a more prioritized and better sequenced investing approach. Therefore, during the first phase o f the APL, the project targets the most profitable investments. Also, concerning revenue management activities, it will allow the experimentation o f several approaches inorder to facilitate future decisions regarding larger scale investments. For the next phase o f the APL, the use o f a PRGguarantee should bringan important leverage and allow the financing o f large scale expansion investments. 79 Recent Financial History of JIRAMA 21. From 2001 to 2005, the financial performance o f JIRAMA has severely deteriorated, primarily on account o fincreasingly inadequate electricity andwater tariffs. Tariffs have remainedunchanged in local currency from July 2001 to July 2005. Over this period, Madagascar has experienced political troubles in2002 and a significant domestic rate o f price inflation. This has been accompanied by a substantial depreciation o f the national currency against the U S dollar from 2003 onwards. 22. Throughout the period, for various reasons including the political instability, the lack o f financial resources, and a systematic preference by decision-makers for solutions yielding quick results, no rigorous planning process o f investments was followed. Given their short lead time and low investment costs, diesel generators were systematically preferred to hydroelectric generation or even to HFO-powered generators. Also, in2003 and 2004, JIRAMA entered into contracts with Independent Power Producers. Usually negotiated ina situation o f emergency given the risk o f disruption o f supply created by the lack o f advanced planning, the contracts with IPPwere usually costly because (i) were based onthermal generation; (ii) were they they not always tendered on a competitive basis; (iii) the independent producers rationally demanded a large risk premium on their investment given the uncertainties attached to JIRAMA's signature. 23. The choice o f thermal generation with diesel oil proved disastrous. The combination o f a depreciating national currency and o frising oil prices inU S D on international markets logically increased the cost o f thermal generation. In2001,fuel costs represented 48% o f the revenues derived by JIRAMA from electricity sales, an already highproportion given that thermal generation made up less than a third o f the generation mix o f JIRAMA at the time. From 2001 to 2005, the volume o f thermal generation rose by 35%, but the corresponding fuel costs increased by 280%. As aresult, in2005, fuel costs alone were significantly above the revenues derived from electricity sales. JIRAMA was infact selling each kWhlargely below its variable cost o f generation. 24. The decline inthe profitability of the company goes back to at least the year 2001, but became really acute in2004. In2002, the operations o f the company suffered from the consequences o f the political situation but J W A paradoxically benefited fi-om reduced demand that allowed a significant reduction inthe volume o f thermal generation. In2003, a further deterioration ofoperatingprofitability was maskedinthe annual accounts bya change in the accounting rules governing the depreciation o f assets. This accounting change, though without impact on cash-flow, allowed JIRAMA to show an operating profit in2003, inspite o f a barely positive EBITDA. 25. Over the course o f the FY2004, the price o f Diesel Oil inlocal currency more than doubled, provoking severe cash-outflows. The magnitude o f the operating losses should have prompted a large tariff increase, primarily inorder to prevent a bankruptcy o f JIRAMA, but also to recreate an adequate economic signal (due to non-reevaluated tariffs, electricity hadbecome extremely cheap compared to oil and natural gas). 80 26. Instead, JIRAMA's management didnot attempt to address the structural inadequacy o f revenues but chose to continue to operate as long as possible within the existing tariffs, by implementing short-term solutions. A positive step that was undertaken is the improvement o f revenue collection. The company managed to collect significant amounts of arrears from its customers (mainly from the government). However, the other measures taken aimed at saving cash inthe short-term went against the medium-term technical and financial viability o f the company. JIRAMA managed up to the endo f 2004 to maintain a quasi-normal electricity supply inmost ofthe country only byaccumulating largeamount ofdebts toward its suppliersandthe government (non payment o f taxes and nonrepayment o f financial debt). The lack o f funds also prompted the company to more or less halt muchneeded maintenance operations. Investments had already been severely restricted for several years. 27. The pronounced deterioration o f JIRAMA finances was entirely predictable given the increase inthe price o f oil and the absence o f tariff reevaluation. The need for an immediate and significant tariff increase should have been recognized much earlier. Indeed, the sector regulator hadrecommendedinthe fall o f 2004 to increase electricity tariffs by nearly 80% on average. It must be noted, however, that the (unaudited) financial accounts producedby JIRAMA did not adequately reflect the severity o f the situation. For instance, the accounts for 2003 presented a net positive result. Also, the management o f JIRAMA should have been clearer on the seriousness o f the liquidity crisis. The lack o f sincerity o f JIRAMA's accounts and o f financial transparency played a part inthe failure ofthe GOM to recognize earlier the absolute necessity of a large tariff increase. 28. The historical financial results o fJIRAMA that are summarized inthe table below must be taken with caution. They originate from the annual accounts that have been reviewed but not been certified by external auditors (the audit firm Mazars). Inparticular, there are reasons to thinkthat JlRAMAdidnot adequately depreciate its inventories andits customer receivables. 81 Table 5: JIRAMA SummaryIncomeStatement(FY 2001-2005) (in millions USD) Actual -Accounts not certified Prov. - - - 2001 2002 2003 2004 - 2005 Electricity Sales 66,8 64,9 79,l 62,5 69,2 Water Sales 17,7 16,7 19,3 14,3 14,5 Other operating Revenues 11,7 7,3 21,8 13,3 14,O Total Operating Revenues 96,l 89,O 120,2 90,l 97,7 Fuel 32,O 32,5 46,4 50,9 79,3 Power Purchase, excluding fuel 4,6 5,O 7,5 Other operating expenses 33,2 25,s 39,5 26,O 51,6 Personnel 17,O 17,3 21,s 15,4 18,5 EBITDA 13,8 13,4 7,s -7,2 -59,3 Depreciation 596 8,6 -2,l 3,5 935 OperatingIncome 8,2 4,8 10,O -10,7 -68,9 Net Interests -10,2 -8,6 -6,4 -1 1,l -,1 Company tax -95 -,4 -35 -34 - 31 NetIncome -2,4 -4,3 3,l -22,2 -69,l Working Ratio (cash opex / op rev) 86% 85% 93% 108% 161% Rate of return on assets 8% 5% 7% -10% -84% Average Electricity Tariff(Ar/kWh) 135 149 143 141 I78 Average Electricity Tariff (Usckwh) 10,4 11,l l l , 7 8,2 8,9 82 29. As the table above illustrates, JIRAMA operated in2001 with a relatively low level o f margin (interms of EBITDNsales) for an electricity andwater utility. This meant that the level o f cash flow fi-omcurrent operations was probably barely adequate to maintain andrenew existing assets, but not to service its long-term debt and/or fund an expansion o f service. However, the situation became really dramatic in2004, primarilydue to the increase inoil prices inlocal currency. (The abyssal deficit for 2005 isprobably somewhat overstated andthe deficit for 2004 underestimated due to lack o fproper provisions for inventories and receivables at end 2004). Table 6: JIRAMA Summary Balance Sheet (FY 2001-2005) (in millions USD) - - Actual -Accounts not certified Prov. 2001 2002 - - - 2003 2004 2005 Net Fixed Assets 102,7 99,7 141,O 103,2 81,6 Inoperation 116,8 118,8 157,4 119,6 118,9 Work in progress 875 654 18,8 22,2 275 Concession -22,6 -25,6 -35,l -38,5 -39,9 Current Assets 126,4 137,7 144,5 85,l 79,2 Accounts Receivables 105,O 112,7 122,3 61,3 70,8 o f which customers 62,8 76,l 78,4 27,a 21,8 o f which others 42,2 36,6 43,9 33,4 49,O Inventories 21,4 25,O 22,2 23,9 894 Cash 7,2 12,9 12,2 15,8 14,2 Total Assets 236,3 250,3 297,7 204,2 175,O Current Liabilities 47,s 58,7 66,s 106,3 168,2 Suppliers 18,l 21,7 34,2 48,l 94,2 Other 29,7 37,O 32,6 58,I 74,O Short Term Financial Debt 377 692 991 437 90 Long Term Debt 158,l 161,3 187,9 145,3 120,6 Total Liabilities 209.6 226.2 263.8 256.3 288,8 26,7 24,i 34,o -52,a -113,7 260% 232% 206% 91% 56% Financial Leverage 85% 87% 84% 163% NA 271 340 291 132 95 83 30. Facedwith a liquidity crisis, JlRAMA was able to continue to operate in2004 thanks to improved revenue collection and a very large accumulation o f short-term debt. Table 7: JIRAMA PerformanceIndicators(FY 2001-2005) Prow - 2002 2001 2003 2004 - 2005 Electricity Generated (GWh) 834 780 898,3 981,l 1015,5 % of Thermal Generation 32,4% 31,4% 31,9% 35,1% 36,0% Ofwhich Gas Oil 90% Ofwhich HFO 93,31 3;;';l T & Dlosses(inc. non technical) Water produced (millions m3) Losses (YO) 32,1%91,3 35,9%90,9 36,lYo93,7 34,0
Groupe de la Banque mondiale · Project Appraisal Document
Madagascar - Power/Water Sector Recovery and Restructuring (APL) Project
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Project Appraisal Document
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Madagascar
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Banque mondiale