Documentof The World Bank FOROFFICIAL USEONLY ReportNo: 35747-TU PROJECTAPPRAISAL DOCUMENT ONA PROPOSEDLOAN INTHEAMOUNT OFEUR280MILLION (USS3 36 MILLIONEQUIVALENT) TO ELEKTHKW T I MA.8. (EUAS) WITH THE GUARANTEEOF THE REPUBLIC OFTURKEY FORTHE ELECTRICITY GENERATIONREHABILITATIONAND RESTRUCTURINGPROJECT May 5,2006 InfrastructureDepartment Europeand CentralAsia Region This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. Its contents may not otherwise be disclosed without World Bankauthorization. CURRENCY EQUIVALENTS (ExchangeRateEffectiveMarch31,2006) Currency Unit = New TurkishLira (YTL) YTL1.35 = US$1 US$1.20 = 1 FISCAL YEAR January 1 - December31 ABBREVIATIONS AND ACRONYMS Afyin GENCO Portfolio generating company (to be created from the restructuring o fEUAS) containing the Afgin- Elbistanpower stations APL Adaptable Program Loan BOOS BuildOwnandOperatePowerPlants BOTAS BORUHATLARIILEPETROL TASIMA A.S. (TurkishPipelineandPetroleumTransmission Company) BOTS BuildOperate andTransfer Power Plants CAS Country Assistance Strategy CFAA Country FinancialAccountability Assessment DISCO(s) Distributioncompany(ies) formed byrestructuring TEDAS DSI Devlet SuIgleri(State Hydraulic Works) EA EnvironmentalAssessment EC EuropeanCommission ECSEE Energy Community ofSouthEastern Europe EL4 Environmental Impact Assessment EML Energy Market Law, No. 4628,2001 EMP Environmental Management Plan EMRA Energy Market Regulatory Authority EPDK EnerjiPiyasasiDiizenlemeKurumu(EMRA inTurkish) ERP Enterprise Resource Planningprogram ESP Electrostatic Precipitator EU EuropeanUnion EUAS Elektrik UretimA,$. (Electricity Generation Corporation, Turkey) FGD FlueGasDesulphurizationUnit FMR FinancialMonitoringReports - Interimun-audited financial statements GENCO(s) Portfoliogenerating companies to be created from the restructuring ofEUAS IBRD International Bankfor Reconstructionand Development IDA InternationalDevelopment Association IFC InternationalFinance Corporation LNG LiquefiedNaturalGas MENR MinistryofEnergyandNaturalResources MOEF MinistryofEnvironment &Forestry MOF Ministryo fFinance PA Privatization Administration PPA Power PurchaseAgreement PPIAF Public-Private Mastructure Advisory Facility RWE RWEPower International SEE State Economic Enterprise SIL Specific Investment Loan SPO StatePlanning Organization TEAS TiirkiyeElektrik A$. (Turkish Electricity Corporation, Predecessoro fEUASandTEhS) TEDAS Tiirkiye Elektrik Dagitlm A.S. (Turkish Electricity DistributionCorporation) TEK Tiirkiye Elektrik Kurumu (TurkishElectricity Corporation, Predecessoro f existing Corporations) TEhS Tiirkiye Elektrik IletimA.S. (TurkishElectricity Transmission Corporation) UCTE Union for the Coordination o f TransmissionofElectricityinEurope Vice President: Shigeo Katsu Country ManagerDirector: Andrew N.Vorkink Sector Director: Peter D.Thomson Task Team Leader: Ranjit J. Lamech TURKEY ELECTRICITY GENERATIONREHABILITATIONAND RESTRUCTURING CONTENTS Page A. STRATEGICCONTEXT AND RATIONALE ................................................................. 1 1. Country andsector issues.................................................................................................... 1 2. Rationale for Bankinvolvement......................................................................................... 4 3. Higher level objectives to which the project contributes.................................................... 5 B. PROJECTDESCRIPTION ................................................................................................. 6 1 . Lendinginstrument ............................................................................................................. 6 2 . Project development objective and key indicators.............................................................. 6 3. Project components ............................................................................................................. 6 4. Lessons learned andreflectedinthe project design............................................................ 8 5. Alternatives Considered and Reasons for Rejection........................................................... 9 C IMPLEMENTATION . .......................................................................................................... 9 1. Partnership arrangements (ifapplicable) ............................................................................ 9 2 . Institutional andimplementation arrangements................................................................ 10 3. Monitoring and evaluationof outcomeshesults................................................................ 10 4. Sustainability..................................................................................................................... . . . 10 5. Critical risks andpossible controversial aspects............................................................... 11 6 . Loadcredit conditions and covenants............................................................................... 13 D APPRAISAL SUMMARY . ................................................................................................. 14 1. Economic andfinancial analyses...................................................................................... 14 2. Technical........................................................................................................................... 17 3. Fiduciary ........................................................................................................................... 18 4. Social................................................................................................................................. 19 5 . Environment...................................................................................................................... 19 6 . Safeguard policies............................................................................................................. 20 7. Policy Exceptions andReadiness...................................................................................... 21 This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. Its contents may not otherwise be disclosed without World Bankauthorization. Annex 1:Country andSector or ProgramBackground ......................................................... 22 Annex 2: Major RelatedProjectsFinancedbythe Bankand/or OtherAgencies ................27 Annex 3: ResultsFrameworkandMonitoring ........................................................................ 29 Annex 4: DetailedProjectDescription ...................................................................................... 31 Annex 5: ProjectCosts............................................................................................................... 40 Annex 6: ImplementationArrangements ................................................................................. 41 Annex 7: FinancialManagementandDisbursementArrangements ..................................... 42 Annex 8: ProcurementArrangements ...................................................................................... 49 Annex 9: Economic andFinancialAnalysis ............................................................................. 53 Annex 10: SafeguardPolicyIssues ............................................................................................ 72 Annex 11:ProjectPreparationandSupervision ..................................................................... 78 Annex 12: Documentsinthe ProjectFile ................................................................................. 79 Annex 13: StatementofLoansandCredits .............................................................................. 80 Annex 14: Countryat a Glance ................................................................................................. 83 Annex 15: Map IBRD34704 ...................................................................................................... 85 TURKEY ELECTRICITY GENERATIONREHABILITATION AND RESTRUCTURINGPROJECT PROJECT APPRAISAL DOCUMENT EUROPE AND CENTRAL ASIA INFRASTRUCTUREDEPARTMENT Date: May 5, 2006 Team Leader: RanjitJ. Lamech Country Director: Andrew N.Vorkink Sectors: Power (100%) Sector Managermirector: Peter D. Thomson Themes: Infrastructure services for private sector development (P);Debt managementand fiscal substainability (S) Project ID: PO85561 Environmental screening category: Full Assessment Lending Instrument: Specific Investment Loan Safeguardscreening category: Project Financing Data [XI Loan [ ] Credit[ ] Grant [ ] Guarantee [ ] Other: For Loans/Credits/Others: Total Bank financing (EURO million.): 280.00 I BORROWER 22.34 122.58 144.92 INTERNATIONAL BANK FOR RECONSTRUCTION AND I I I DEVELOPMENT 122.53 213.47 336.00 Total: 144.88 336.05 480.92 Borrower: ElektrikUretimA.$.(EUAS) Gene1Mudurliigii InoniiBulvariNo. 27 Bahgelievler Ankara, Turkey Tel: 90-312-212-69-00 Fax: 90-312-213-88-73 muzaffer.basaran@euas.gov.tr www.euas.gov.tr ResponsibleAgency: EUAS Annual 33.60 134.40 112.00 56.00 0.00 0.00 0.00 0.00 0.00 Cumulative 33.60 168.00 280.00 336.00 0.00 0.00 0.00 0.00 0.00 D o e s the project depart from the CAS incontent or other significant respects? Re$ PAD A.3 [ ]Yes [XINO Does the project require any exceptions from Bank policies? Re$ PAD D.7 [ ]Yes [XINO Have these been approved by Bank management? [ ]Yes [XINO I s approval for any policy exception sought from the Board? [ ]Yes [XINO Does the project include any critical risks rated "substantial" or "high"? Re$ PAD C.5 [XIYes [ ]No Does the project meet the Regional criteria for readiness for implementation? Re$ PADD.7 [XIYes [ ]No Project development objective Re$ PAD B.2, Technical Annex 3 To improve supply security during the reform transition and restructure the state- owned generation business into corporatized entities. Project description [one-sentence summary of each component] Re$ PAD B.3.a, Technical Annex 4 Component 1 - Afsin-Elbistan A Rehabilitation: The main component o f this project i s the rehabilitation o f Afsin-Elbistan A Power Plant. This component will focus on: (a) the repair, replacement and upgrade o f power plant systems to restore reliability, availability and power output, and improve plant efficiency; (b) the upgrade of environmental protection systems and environmental monitoring; (c) the improvement o f operational and maintenance practices - particularly maintenance monitoring systems, predictive maintenance based on historical data analysis, and maintenance planning/scheduling; and (d) investments to meet UCTE standards for primary and secondary frequency control requiredto integrate with the South East Europeanmarket. Component 2 -Support for restructuring o f the generation business: This component will focus on supporting EUAS in restructuring its generation business into financially and operationally viable portfolio companies and a hydro corporation. Which safeguard policies are triggered, if any? Re$ PAD D.6, Technical Annex 10 Environmental Assessment (OP/BP/GP 4.01) Significant, non-standard conditions, if any, for: Re$ PAD C.7 Boardpresentation: None Conditionsfor Loan Effectiveness: Publicationinthe Official Gazette o f the Amendment to the Regulation on the Control o f Air Pollution from Industrial Sources to allow a transition period for existing thermal plants, including Afsin-Elbistan A Power Plant, to install flue gas desulhrization controls to meet sulfur dioxide emission standards. Covenantsapplicableto projectimplementation: Covenantsinthe LoanAgreement The following covenants are included in the loan agreement, in addition to the standard covenants relatingto audits, accounts, procurement plans, mid-termreviews etc. I. AssignmentofObligation;DispositionofAssets (a) The Borrower shall consult with the Bank prior to the finalization o f any strategy related to the sale, lease, transfer, assignment or disposal o f the Afsin-Elbistan power sector assets, comprising power plant A, power plant B and the mining assets in the Afsin Elbistan area owned by the Borrower. 11. FinancialCovenants (a) EUAS will maintain a debt service coverage ratio o f not less than 1.2 every year starting on 2006. (b) EUAS will achieve a self financingratio (funds from internal resources as a proportion o f the three-year average capital expenditure) o f not less than 25% inevery year starting on 2006. 111. FinancialManagementCovenants (a) EUAS will maintain a financial management system acceptable to the Bank. (b) EUAS will install and make functional the enterprise resource planning program (ERP) by December 31,2007. I A. STRATEGICCONTEXTAND RATIONALE 1. Country and sector issues Country Economic Overview . The Turkish economy has rebounded from the 2001 crisis which had serious economic and social impacts. By the end of 2001, the currency had devalued by 50 percent, nominal interest rates were about 100 percent, and the banking system had virtually collapsed. GNP growth has been strong since 2001 - 8 percent in 2002, 6 percent in 2003, 10 . percent in2004 and about 7.6 percent last year. Inflation i s under control reaching single digits(7.7 percent) in2005, the lowest inTurkey for 35 years. Several factors contributed to the improved macroeconomic performance - key amongst them are: strong fiscal discipline which has allowed the maintenance o f a large . primary surplus on the order o f 6.5 percent o f GNP; on-going structural reform; and political stability since 2002. The EU's decision to open accessionnegotiations with Turkey in October 2005 -has been an important signal to financial markets and has created a firm anchor for the country's development and structural reforms inthe years ahead. Impetus for Electricity Sector Reforms The economic crisis o f 2001 led to the crystallization and recognition o f several structural and planning deficiencies inthe electricity sector, the most important o f which were: A build-up o f public contingent liabilities as a result of the Government guaranteeing debt for a substantial amount o f privately financed generation capacity. These generation projects have imposed a heavy take-or-pay burden on the electricity system and have . complicated the transition to a structure where the commercial risk can be shifted to private investors. A rising quasi-fiscal burden on the budget stemming from growing consumer non- payment and electricity theft problems at the distribution level. The non-payments worsened as a consequence o f the economic crises. Although an attempt was made at offering private sector concessions for the distribution sector in the period 1999-2001, most o f these concessions involved guaranteed distribution margins with the supply risk . borne by the Government. This approach was abandoned due to legal challenges to the approach and the nature o frisk sharing. Political influence on operating, planning and pricing decisions that made operational decision making more difficult. Reform Direction-Electricity Market Law and the EUMarket Integration Process . The Government has embarked upon a comprehensive reform and restructuring program o f the electricity sector to create a liberalized, efficient and economic sector. This was initiated by the Electricity Market Law (Law No. 4628) promulgated in February 2001. The principles and goals o f the reform program defined by this Law are substantially in . line with EC Directives (1996/92/EC and 2003/54/EC) concerning rules for the internal market for electricity. Turkey i s a signatory o f the Athens Memorandao f 2002 and 2003 that the EC initiated to develop the regional electricity market in South East Europe and eventually integrate it with the internal electricity market o f the European Union. The 2002 Athens Memoranduminitiated the regional market development process commonly referred to as the "Athens process". A more detailed version o f the memorandum was signed in 2003, 1 which i s referred to as the Athens Memorandum 2003, and supersedes the 2002 document. While other regional members signed the Treaty on October 25,2005, Turkey did not, owing to reservations on some o f the Treaty provisions (Annex 1). With the EU decision o f October 3, 2005 to begin negotiations for full accession, some reservations on the Treaty now become intertwined with the negotiations on the Energy Chapter o f the Acguis Communautaive. Turkey however remains committed to, and continues to implement the provisions o f the 2003 Athens Memorandum. Reform Implementation Functional and corporate restructuring of the sector - The electricity sector has been restructured into a generating corporation EUAS, a trading corporation TETAS, a transmission corporation TEIAS, a distribution corporation TEDAS and regional distribution companies (DISCOS). The regional distribution companies are being prepared for privatization. See Figure A.1 below on the currently planned transitional sector structure. Regulatory Authority - Turkey has set up an independent regulatory authority, the Energy Market Regulatory Authority (EMRA) withjurisdiction over electricity, gas and petroleum. EMRAhas powers over licensing, tariff setting and customer service issues. Retail Competition in Electricity - Consumers whose annual consumption exceeds 6.0 GWh can choose their own supplier-this represents more than 30% of the total Turkish electricity market. Competitive Market Structure - Market simulations are in progress to introduce a competitive bilateral contract market with a balancing and settlement system. TEIAS, the transmission company i s the independent system operator, and will also be the market operator. The market i s expected to provide the necessary price signals for potential new generation. Figure A.1: Transitional Electricity Sector Structure 2 K e y Medium-Term Sector Issues The key medium term sector issues include: (a) Ensuring supply security - Electricity demand has been growing at about 6 percent per annum between 2002 and 2005 and the Government anticipates that it will accelerate over the next decade closer to the long term average o f about 8%. (The Government i s also considering a low growth case where demand growth remains about 6%) In any case, capacity increases on the order of 1,500-2,000 MW per annum are required from around 2009-2010 onwards. The issue o f concern i s that although licenses have been issued for about 6,000 MW o f new capacity (of which 4,000 MW i s for small hydro and wind), presently very little new construction has been started. These problems are largely linked to the on-going market implementation which has not yet led to the formation of creditworthy private distributors who can contract for new capacity andor electricity offtake. In order to strengthen supply security, the implementation o f the market and privatization o f distribution are vital. The Bank team i s working with the Government on a policy note on addressing supply security in parallel - this study focuses on the near term solutions as well as more systemic solutions for the medium term. (b) Accumulated arrears in the electricity utilities -Operating revenues at all the publicly- owned electricity and gas sector companies inTurkey are inadequate to meet their longer term level o f operating costs and expenditures. The problem i s mainly inthe distribution business managed by TEDAS. As o f 2004, the theft and loss percentage i s 18.5% o f purchases by TEDAS. Due to these problems there i s a 25-27% shortfall inpayments for purchased electricity by TEDAS which in turn cascades as revenue shortfalls to all the upstreamelectricity and gas businesses. The Government i s studying various alternatives to deal with the problem o f accumulated arrears (See Annex 9). (c) Reconciling independent economic sector regulation with the Government's economic stabilization controls -Presently, the Government exercises certain economic controls and constraints on pricing o f energy services/outputs and investment decisions, in order to maintain fiscal prudence, achieve a healthy primary surplus, and restrain inflationary pressures. There remains a fine line between economic stabilization controls and other forms o f economic controls that prevent the development o f institutions essential to a functioning market economy. To mitigate regulatory risk for private investment it will be important that the economic stabilization restraints are relaxed to allow timely pass-through o f costs to consumers - specifically: (i) wholesale gas prices should be adjusted to reflect the market terms in the underlying contracts; (ii) electricity prices are adjusted to reflect operating cost changes at the distribution level; (iii) electricity produced by state-owned hydro power plants which i s sold into the market,is priced at levels that send appropriate signals o f scarcity and water value so as not to distort wholesale market price signals. In addition, the regulator should approve investment programs consistent with establishedperformance targets. (d) Transition to compliance with European internal market and environmental standards - Turkey is committed to the principles o f the Athens memorandum, even though it did not sign the Treaty in October 2005. Although Turkey has begun implementing fundamental structural reforms in its power sector, some o f which are far more advanced than required from the EU's perspective, there are several areas, such as the timeframe for complete retail market opening that Turkey has reservations on, for good reasons. Turkey has already allowed significant retail market opening with eligibility for consumers whose annual consumption exceeds 6.0 GWh (this i s more than 3 30% o f the total Turkish market). Turkey i s perhaps second only to Romania in the degree o f market opening amongst all SEE countries. The results have been positive from the point o f view o f attracting new capacity and ensuring better supply quality for these consumers. However, in order to free up all the existing consumers, several fundamental changes are required in the sector, most critical among these being the improvement in distribution system losses and payment discipline. The Government i s currently preparing for the privatization o f distribution, which i s seen as an important solution for these improvements. Privatization, however, has been delayed for several reasons, chief among them being the delays increation o f the electricity market, and the finalization o f a privatization mechanism that i s consistent with the market structure and operation, as well as legally permissible. A key area where Turkey has reservationsis with regard to compliance with the timetable in the Treaty to meet EU environmental standards. In July 2005 EU consultants produced a report on Turkey's investment needs in order for it to be in compliance with the EU Large Combustion Plant Directive which limits emissions by these plants (Directive 2001/80/EC). Almost all o f the plants covered by the Directive are thermal power plants and the estimated cost o f bringing them into compliance with the EU Directive i s 1.5- 1.9 Billion Euro (US$ 1.8-2.3 Billion). This is a large investment requirement for Turkey, and, in the absence of concessional financing, will require a number of years to implement, given the lack o f adequate fiscal space for incremental investment. 2. Rationale for Bank involvement Th World Bank's support under the proposed Electricity Generation Rehabilitation and Restructuring Project i s predicated on four elements o f critical importance to the economy and the . sector. These are to: ...Achieve security o f supply over the medium-term (specifically energy shortages in the 2009-20 10period). Prevent further deterioration and enhance value of an important state asset. Improve environmental quality and environmental compliance. Advance the implementation o f reforms in the electricity generation sector in a manner consistent with the overall reform program. Achievingsecurityof supplyover the mediumterm As noted above and discussed indetail in the economic analysis inAnnex 9, Turkey is likely to face growing shortages of energy in the 2009-2010 period depending on the pace of growth in demand. Large scale private sector investments innew generation capacity are not occurring at the required pace largely because the competitive market system i s still in trial stage and the distribution sector i s still in the process o f being restructured for subsequent privatization. Furthermore, the Government has constraints on the provision o f guaranteed long-term off-take agreements. The rehabilitation o f existing generation capacity by EUAS i s therefore, considered the fastest alternative for increasing necessary energy supplies. The economic and financial analyses demonstrate that the rehabilitation o f Af9in-Elbistan A power plant i s the least cost alternative for incremental generation and can be completed in about 2.5-3 years. Through engaging inthis rehabilitationproject therefore, the Bank would support one o f the most critical investments in the sector at this stage. Inparallel the World Bank i s supporting the Government indevisingprivate-public options to bringinginnew capacity over the medium term ina manner consistent with the market structure. 4 Prevent further deterioration and enhance value of an important state asset Af$in-Elbistan A power plant requires urgent rehabilitation. It has deteriorated significantly and pre-maturely owing to a lack o f maintenance management and investment which was exacerbated due to operational responsibility uncertainties from 1998-2001 '. The rehabilitation project will stem further deterioration by putting in improved operating and maintenance practices, and will extend the life o f the plant significantly. Improve environmentalquality and compliance The project will include investments which will substantially reduce dust and particulate emissions, a significant problem in the area. These investments will bring the plant into compliance with Turkish and most international standards. In addition, through its dialog with the Government, the Bank has helped accelerate a review o f SO2pollution controls on existing thermal plants, which has led to the Government to provide a reasonable transition period to implement flue gas desulphurization units (FGDs), provided that such plants continue to meet air quality standards. Advance the implementationof reforms inthe generation sector The reform components o f the project will support the Government in restructuring the generation sector in a manner consistent with the overall reformprogram. The project can focus on several aspects o f financial, accounting, operational and organizational restructuring which will have to be completed to establish the generation companies (Gencos) and prepare them for privatization. Based on the conclusions of the supply security work being carried out inparallel, the Bank will also provide assistance to explore options for bringing in additional generation consistent with the evolving competitive market over the medium term. Synergies with the World Bank Energy Programin Turkey From the perspective o f the World Bank's energy program in Turkey, the proposed Electricity Generation Rehabilitation and Restructuring Project i s an important part o f the Bank's ongoing lending and advisory support to the Turhsh energy sector (See Annex 2). The overall assistance o f the Bank supports the implementationo f structural reforms, bridges gaps in electricity and gas service delivery needs during the transition, and assists in meeting EU integration challenges. This loan inparticular will support reforms inthe generation sector. 3. Higher level objectives to which the project contributes The electricity reform strategy o f the TurkishGovernment, which is formalized inthe Electricity Market Law o f February 2001 and the Strategy Paper o f March 2004, envisages the restructuring of the electricity sector and the eventual privatization o f the distribution and generation businesses over the medium term. The privatization o f distribution, and the restructuring o f the generation business into separate companies, has been delayed. This in turn i s affecting the implementation o f the competitive market. Through the project, the Bank will assist in the restructuring o f the generation sector, thus supporting ultimately the successful transition to a competitive market. The Project is consistent with the Country Assistance Strategy (CAS) for Turkey, and i s listed in the Progress Report for the CAS for Turkey for the period FY 2004-07 (Report No. 33995-TU, dated November 8,2005). 'This was the period when a Concession contract for the plant was signed with a private operator but not implemented owing to inability to reach agreement on commercial and operational parameters. 5 B. PROJECTDESCRIPTION 1. Lending instrument This project will use a Specific Investment Loan (SIL). The loan will be borrowed directly by EUAS, under a sovereign guarantee fiom the Republic o f Turkey. The loan will be a variable spread loan (VSL) with level repayments o f principal, and a 15-year maturity including a grace - period o f 5-years. 2. Project development objective and key indicators Project development objective: To improve supply security during the reform transition and restructure the state- owned generationbusinessinto corporatizedentities. Achievement of these objectives will be monitored through the following indicators: (a) Progress inrehabilitationo f Afyin-Elbistan A Power Plant; (b) Progress in creation of generation companies (Gencos) from EUAS and finalization o f transitional contracts with distributioncompanies; and (c) Improvement indust emission levels by the Afyin Elbistan A Plant. 3. Project components The Project has two components (Table B.1below shows summarized cost estimates): Component 1-Afyin-Elbistan-A Rehabilitation The main component o f this project i s the rehabilitation o f Afyin-Elbistan A Power Plant. The Afyin Elbistan generation complex which includes Afyin ElbistanA and the newly commissioned Afyin Elbistan B, is the largest thermal generation complex in Turkey. Afyin Elbistan A has a capacity o f 1,355 MW (3x340 MW + 1x335 MW) and its four unitswere commissioned between 1984 and 1987. Performance o f the Afyin Elbistan A unitsinterms o f efficiency and availability has deteriorated sharply because o f inadequate maintenance. Current available capacity i s about 85% o f its original installed name-plate capacity. This component will include: (a) Repair, replacement and upgrade of the power plant systems to restore reliability, availability, power output and improve plant efficiency. (b) Implementationof environmentalprotectionsystems and monitoring-new electrostatic precipitators (ESPs) will be installed to reduce and bring dust and particulate emissions within the Turkish Emission limits. Power plant dust emission from Afyin Elbistan A is the most significant environmental problem from the complex. In addition, continuous environmental monitoring and data logging equipment will be provided and implemented. Environmental monitoringpractices will be revised and training will be provided. (c) Improvementsin plant operation and maintenance practicesthat are critical to keep the plant in good operating condition with high availability after rehabilitation. These will include procedures and systems for: equipment monitoring; historical data analysis for predictive maintenance; and maintenance scheduling. In addition, staff training programs to enhance operational and maintenance practices will be implemented. 6 (d) Implementationof control systems to meet UCTE standardsfor primaryand secondary frequency control - these systems would allow the power plant to meet the standards established by the Union for the Coordination o f Transmission o f Electricity in Europe (UCTE). Meeting these standards would help Turkey in being certified to operate synchronously with the South East European Electricitynetwork. This component will also include support services for project implementation. This will be in additionto the project management services that will be provided by RWEInternational. Component 2 - Support for Financial and Operational Restructuring of the Generation Business This component will focus on supporting EUAS in restructuring its generation business into financially and operationally viable portfolio generation companies and a hydro corporation. This work will create the basis for undertaking the future privatization o f these generation entities. The PHRD grant for the preparation o f this Project has been utilized to begin this work. Consultants have analyzed different portfolio configurations based on criteria such as fuel mix, load following capabilities and financial viability, and have also prepared draft transition contracts between GENCOs and TETAS/ distribution companies. Based on this work, the Government has decided on 6 portfolio companies, and these have been earmarked as separate units within EUAS, in addition to the residual EUAS Hydro. The Project proposes to assist in completing this work, focusing on aspects o f financial and operational restructuring o f the companies to create them as viable business units. The Project will also provide support, if necessary, to EUAS and the Government to implement mechanisms to address generation supply security needs in the period beyond 2008. The initial work on assessing options and strategies i s being funded through separate grant funds. FinancingPlan The proposedBank loan will finance the main rehabilitation contract. This contract will cover all the major critical aspects o f the rehabilitation included in Component 1 such as the rehabilitation o f the boiler and firing system, the electrostatic precipitators (ESPs), the main cooling water and condensate water system (covered under the Balance o f Plant Mechanical), control and instrumentation, and ash and coal handling. The remaining portions o f Component 1will be financed from EUAS' operating and maintenance budget since these elements are either currently ongoing or are logically covered by the annual maintenance budget. The most important sub-component covered by EUAS is the ongoing rehabilitation o f the steam turbines and generators. EUAS' maintenance budget will also cover elements such as the switchgear, transformers and other general instrument supplies (Balance o f Plant Electrical), cooling tower coating and reinforcement, and environment monitoring. The bidding documents for the main contract will contain suitable provisions to reflect the fact that some works are ongoing, and that EUAS will provide some components from its own resources. The operational and maintenance practice improvement services, and specialized project management services will be funded through the Bank loan. Under component 2 the Bank loan will be used for services to facilitate the financial and operational restructuring o f EUAS in to multiple generation companies. In addition, provision will be made under component 2 to utilize the earmarked resources to implement mechanisms to address generation supply security needs inthe medium-term. 7 Table B.1: Project Costs ( million) Project Cost By Component andlor Activity Local Foreign Total Emillion Emillion million Component 1 -Afsin Elbistan A Rehabilitation 99.9 228.3 328.2 1. Rehabilitation of A$in ElbistanA 92.1 160.4 252.5 2. Rehabof Turbine and Generators (funded from EUAS Maintenance Budget) 33.0 33.0 3. On-going MaintenanceWorks (funded from EUAS Maintenance Budget) 7.8 31.3 39.2 4. Environmental Monitoring Systems (fundedfrom EUAS Maintenance 0.9 0.9 Budget) 5. Operational and Maintenance PracticeImprovementServices 1.7 1.7 6. Project ManagementServices 1.o 1.o Component 2 Financial and Operational Restructuring of - 3.0 3.0 Generation Total Baseline Cost 99.9 231.3 331.2 Physical contingencies 10.0 23.1 33.1 Pricecontingencies 5.0 11.6 16.6 Total Project Costs 114.9 266.0 380.9 Interestduring construction 5.8 13.3 19.2 Front-endFee 0.8 0.8 Total Financing Required 120.7 280.2 400.9 4. Lessons learned and reflected in the project design Project design and preparation have benefited from the extensive experience that the Bank has in developing large infrastructure investment operations, and specifically in rehabilitation o f generating plants. These include: (a) Comprehensive feasibility and technical review The scope o f the rehabilitation component has been developed based on a comprehensive feasibility study and technical review. The initial pre-feasibility study was done by Chubu Electric from Japan in 2004. This study established the broad scope o f the rehabilitation needed based on a technical and economic assessment. This work clearly established the economic benefits o f the rehabilitation. The Bank's power engineers reviewed the pre-feasibility report and assisted EUAS in defining the terms of reference for the detailed engineering study. The detailed engineering study was undertaken by RWE Consulting Engineers, Germany. This consulting engineering firm i s an affiliate o f one o f the largest electric utilities inEurope, which operates a number o f lignite fired power plants and mines, and also has significant experience in lignite plant rehabilitation. The detailed engineering study provided a full assessment o f the power plant systems which require rehabilitation. The detailed feasibility study was reviewed by the Bank's power engineering team. This review provided important inputs to the decisions on what i s required and what i s optional, and enabled EUAS to finalize the scope and cost estimates for rehabilitation. (b) Focus on addressing environmentalissues systemically The EIA for this project analyzed the current and forecast (modeled) performance o f the plant withregardto sulfur dioxide and dust emissions, and their impact on ambient air quality, and the requirement for an FGD. Largely as a result o f this analysis, the Government has carried out a review o f existing thermal power plants and evaluated the alternative o f installing FGDs on them. The 8 Government has processed a regulation which will provide each thermal plant with a transition period for implementingthe FGD. As a result, Afvin A will have a transition o f 5 years for installing the FGD (This i s considered as the next phase o f the project). The rehabilitation o f the plant will improve the plant's environmental compliance especially inthe area o f dust emission, which has been identified, during public consultations, as the most significant environmental problemfrom the power station inthe vicinity. (c) Flexibility in policy dialogue and recognition of macroeconomic priorities The project has chosen flexibility in carrying out the policy dialogue on reforms in the Turkish electricity sector, as opposed to the use o f hard policy conditionality within the loan. Ongoing loans carry conditionality, and in recognition o f the fact that Turkey, as an EU candidate country, i s in the midst o f adopting the EU Acquis on Energy, separate Bank conditionality in this loan was not considered critical. The project is therefore designed to support the Bank's overall dialogue on the reform program which i s consistent with the EU Acquis and being carried out inparallel (supported by ongoing loans and grants). (d) Adaptation of procurement arrangements to suit specific circumstances EUAS and the Bank team evaluated the option of carrying out the rehabilitation using a number o f procurement packages, covering respectively, the firing system, piping, balance o f plant mechanical, balance o f plant electrical, electrostatic precipitator, control and instrumentation, ash and coal handling, civil works, and plant chemistry. This option was deemed unsuitable and EUAS and the Bank team chose to adopt a single supply and installation contract for the entire rehabilitation (except the turbines which are being rehabilitated separately by the original manufacturer of the turbines under a continuing service agreement), because this gives better control over implementation progress, and it reduces problems due to weaknesses, or delays, inintegration across different packages. 5. Alternatives ConsideredandReasonsfor Rejection The following alternatives to the rehabilitationo f Afvin-Elbistan A were considered: (a) The construction o f a new gas fired combined cycle power plant. Such a plant could be built rapidly but still not as rapidly as the rehabilitation o f Afgin Elbistan A, and hence again would not respond to the immediate supply security situation. Generation from this plant was also expected to be more expensive than from a rehabilitated Afvin-Elbistan A (see Annex 9). (b) Another alternative that was consideredinvolved the construction o fa new lignite-fired plant at Af9in-Elbistan. The economic analysis for the project (Annex 9) however, showed that such a plant would be more expensive than the rehabilitation project, and would take a much longer time for commissioning. The Government therefore gave priority to the rehabilitation of Afgin ElbistanA, and accordingly requestedthe Bank for support. C. IMPLEMENTATION 1. Partnershiparrangements(ifapplicable) Duringproject preparation the Japanese Government provided a PHRD grant for US$ 600,000 which was used for the initial feasibility study and for preparation o f the EIA for the project. The Government o f Japan has also provided funds for the construction o f Afvin-Elbistan B power plant, adjacent to Afvin-Elbistan A. This former plant shares some o f the same infrastructure as Afvin Elbistan A. In addition, PPIAF grants and the Spanish Trust Fund are being used for 9 supporting the overall reform program, which also includes support for the initial work on restructuring of generation, and preparation o f transition contracts between the generation and trading businesses. 2. Institutional and implementation arrangements The project will be implemented by EUAS and a special Project Management Team (PMT) has been established to oversee the implementation. Further, for Component 2, there i s likely to be significant oversight from the Ministry o f Energy and Natural Resources. The rehabilitationwill be carried out by one contractor who will be overseen by the PMT aided by EUAS' consultants, RWE, who will report to the PMT and EUAS top management. In addition, there will be considerable focus given to the monitoring o f the environmental impacts o f the project and the plant in general, either as part o f the implementation consultant contract, or as a separate contract. Because o f the importance o f this project to EUAS and to Turkey, EUAS management will follow its progress closely. It is likely that duringproject implementation, EUASwill be restructured into separate portfolio GENCOs. Inthis case, AfSin-Elbistan A will be transferred to the portfolio company which will contain the Afgin-Elbistan generation complex, hereinafter referred to as Afgin GENCO. The responsibility for rehabilitation and supervision will be transferred to this GENCO. The PMT, with adequate staff in Afgin GENCO, will be suitably enhanced to ensure that implementation does not suffer. The Bank loan will remain with the successor company o f EUAS, EUAS Hydro, with aback-to-back loan fromEUASHydroto Afgin GENCO. There i s also a possibility that while the rehabilitation i s ongoing, the operations o f the Afgin- Elbistan A power plant may be transferred to a private company, under an existing concession contract that i s however disputed at this time (See Section C.5 on Critical risks later for more details on this issue). In this eventuality, the Government will ensure that the rehabilitation i s completed as planned, and that the new operator will ensure the continued operation and maintenance o f the plant. 3. Monitoring and evaluation of outcomesh-esults The PMT, with the assistance o f the implementation consultant, will monitor progress against the agreed performance indicators specified in Annex 3. The PMT will provide, on a quarterly basis, 45 days after the end o f each quarter, consolidated reports on project implementation progress in the Bank's FMR format. The Bank will conduct regular supervision missions about once a quarter for the first several years while the project is under implementation. The PMT will prepare a detailed mid-term report to serve as the basis for a project mid-term review. The PMT will also help prepare the Borrower's contribution to an Implementation Completion Report (ICR), so that the Bank could complete the ICR within six months o fthe closing date o fthe Loan. The ICR would involve a complete assessment o f project costs and benefits, project execution and performanceso f the parties involved. 4. Sustainability The project i s considered sustainable for the following reasons: (a) Long-TermCompetitiveness- the rehabilitation extend the plant's economic life by at least 20 years and result in AfSin-Elbistan A being one o f the least cost sources o f base load power in Turkey. Apart from being an important facility to provide incremental capacity and energy to mitigate anticipated supply shortfalls in the next few years, this 10 plant will be preferentially dispatched over the long-term, since it will have low incremental costs and therefore will rank very highinthe merit order. (b) Experienced Project Manager to Supervise Implementation -During implementation, EUAS will be assisted by RWE in supervision o f the works. RWEis amongst the most experienced consulting engineers on lignite plant maintenance and rehabilitation and this i s expected to speed decision making on technical issues and choices that arise duringthe rehabilitationprocess, thereby reducing delays and maintainthe project on schedule. (c) Focus on O&M Practice Improvement - The project also includes in its scope, improvement in O&M practices in the plant, which will ensure that the plant i s well- maintained after rehabilitation. (d) Adequacy of Fuel Reserves - The lignite reserves at AfSin-Elbistan are approximately 2.6 billion tons and both the AfSin-Elbistan A and B power plants together, operating at full capacity, are projected to use around 37 million tons per year. Thus, the reserves at AfSin-Elbistan will be more than adequate for the two existing plants and also accommodate further capacity expansion. (e) Completion of Rehabilitation by EUAq - the Government and EUAS will ensure that the rehabilitationi s completed by EUAS by 2009 to ensure that the needed incremental energy i s available to meet potential supply shortfalls. 5. Critical risks and possible controversial aspects Risk Risk rating Mitigation Measure A.l Disruption/ N The restructuring of EUAS into portfolio generation companies (Gencos) Delay in may carry the risk of causing delays in the implementationof the project. implementation The scope of the portfolio gencos has already been defined and they are owingto on-going gradually expected to become operationally more independent from the restructuringof EUAg holding company. The Project ManagementTeam, with adequate EUASinto staff in Afsin GENCO, will be suitably enhanced to ensure that portfolio Gencos. implementationdoes not suffer. Further, since the timely completion of rehabilitationis very critical due to security of supply considerations, the Governmentwill monitorimplementationclosely. A.2 Delay due to N As the timely rehabilitationof Afsin ElbistanA is a strategic priority of the ongoing litigation. Government to address medium-term supply security concerns, the Government has been actively discussing the resolution of the on-going dispute with the private concessionaire. The efforts by both parties to achieve successful resolution without impacting the rehabilitation, indicates that the risk of the on-going dispute impacting project implementationis moderate. ~ A.3 Delayowing N The scope of rehabilitation may increase owing to the condition of the to increased boiler, in particular, being worse than currently assessed. This is not a scopeof major risk. While some scope change is likely the risk of delay is not rehabilitation deemed very large. The contract will have adequate flexibility to accommodate scope change and the conservative cost estimates will cover such increases. Most importantly,these changes will be identified early in the process, allowing additional equipment to be ordered, delivered and installed to meet the rehabilitation schedule. The procurement process will result in a highly-qualified contractor being selected, and EUAS will use RWE to ensure that contract progress is routinely monitored. A.4 Financingof M The FGD is an expensive investment,estimated at US$ 250 million, and the FGD may not be justified on economic parameters alone, given the remaining plant life even after rehabilitation. MoEF has prepared a regulation providing derogation from implementing an FGD to the Afqin-Elbistan A plant for 5 years, among all other thermal plants. The FGD will thus be installed at the end of the derogation period, in the absence of a further 11 Risk Risk rating Mitigation Measure extension of time, and financing will have to be arranged for this investment. The team will assist the Government in finding grants or subsidized financina for this eauipment. in order to help reduce the costs. ~~~~~~ 4.5 Inadequate M The project includes a significant level of support for improving operations maintenance and maintenance of the plant after rehabilitation. It is expected that this will assist in ensuring that the plant continues to operate efficiently. This risk therefore, is moderate. A.6 Constraint on N Based on a study by RWE on mine extension for Afgin-Elbistan B which mine capacity currently uses the mine for the A plant, EUAS has decided to extend the existing mine over the next 2-3 years. Potential constraints on mine capacity are possible, but this is not a big risk, since significant investments in developing and extending the mine are already underway, and the lignite seam has significant reserves. 4.7 Procurement H EUAS does not have experience of using the Bank's procurement guidelines and procedures. The main contract under the project is also expected to be a very large and complex contract. EUAS therefore, will use the two-stage bidding process, and the Bank's procurement staff have been providing training and significant guidance on the bid documentation. EUAS is also being assisted by RWE in the preparation of the specifications and the bid document. B. Financial and market-related issues B.l Impact of N Given the high debt burden carried by the Afgin GENCO (due largely to competition the debt acquired in the construction of Afgin-Elbistan B), it is possible that prior to rehabilitation, the costs of Afgin GENCO will be uncompetitive. This may in turn imply that Afgin GENCO will be at risk in the market. This risk is being mitigated by ensuring reasonable transition contracts. Further, once the rehabilitation is complete, Afgin GENCO is likely to be at an advantage vis-a-vis the competition, because its costs, and hence, the required tariff, will reduce significantly (See Annex 9 for the financial forecasts for the company). B.2 Impact of M As mentioned above, Afgin GENCO carries about US$ 1.4 billion of debt significant associated with the Afgin B plant. The rehabilitation will require additional outstanding debt debt. Afgin GENCO is thus likely to require a higher initial tariff than other GENCOs. However, as discussed above, after rehabilitation, the tariff reauired will be reduced, and this risk is therefore likelv to be low. ~~ B.3 Financial H EUAS had about US$ 2 billion of outstanding receivables in 2004. WhG constraints on these have not hampered its ability to invest largely because the account of investment program has been severely curtailed, this is still a serious continued non- problem afflicting the entire sector. While it is difficult for this project to payment of EUAS mitigate this risk entirely, the Government is working towards improving bills, inadequate payments by Government departments, which are the main defaulters, tariffs. etc. through various measures including legislative means. Treasury is also working with MENR and the utilities to resolve the issue going forward. The present regulatory regime is considered robust and ELSA$' tariffs cover operating and debt servicing costs. Upon the restructuring of EUAS, the existing market arrangements will be replaced by transition contracts with the distribution companies and TETAS, with tariffs set so as to allow continued recovery of costs. Upon the establishment of the balancing market, EUAS companies are expected to be competitive, given their cost profiles and given that demand is expected to continue growing at a fast pace (See Annex 9). Overall Project S Based on risks discussed above, the overall project risk is assessed to be Risk "Substantial". H = High; S = Substantial; M = Modest; N = Negligibleor Low 12 World Bank Financingof the AfSin-ElbistanA Power Plant-The Government entered into a concession contract with a private company in December 1999 for the Afvin-Elbistan A Thermal Power Plant, pursuant to a 1994 Council o f Ministers Decree. The scope o f the concession includedrehabilitationo f the existing four units, construction o f two new units at the site, and the operation o f the plant for 20 years. However, the concession contract could not be made operational as the principal implementation agreements (i.e. the energy sales agreement and the transfer contract) could not be finalized. Owing to the inability o f the two parties to finalize the agreements, the private company filed a lawsuit with the Council o f State against the successors o f TEAS (ie. EUAS and TETAS respectively responsible for the transfer contract and energy sales agreement), stating an implicit denial from EUASand TETAS to sign the contracts. The Council o f State upheldthe statement o f the private company in February 2004. Both TETAS and EUAS (as successors o f TEAS) have appealed this judgment and the judicial process i s still inprogress. The Government considers the rehabilitation to be o f paramount importance given the supply security issues and given the requirement to improve the plant's environmental compliance. It i s therefore a priority investment included in the Government's investment plan for 2006, and the Government aims to ensure that EUAS completes the planned rehabilitation to mitigate supply problems that are forecast in2009/10. 6. Loadcredit conditions and covenants There are no conditions for presentationto the Board. Conditionfor Effectiveness Inaddition to standard procedural requirements, the following condition will apply for Effectiveness: - The amendment to the Regulation on the Control o f Air Pollution from Industrial Sources to allow a transition period for existing thermal plants, including AfSin- Elbistan A Power Plant, to install flue gas desulphurization controls to meet sulfur dioxide emission standards, have become effective upon publication in the official gazette. Covenantsinthe LoanAgreement The following covenants are included in the loan agreement, in addition to the standard covenants relating to audits, accounts, procurement plans, mid-term reviews etc. I. AssignmentofObligation;DispositionofAssets (a) The Borrower shall consult with the Bank prior to the finalization o f any strategy related to the sale, lease, transfer, assignment or disposal o f the AfSin-Elbistan power sector assets, comprising power plant A, power plant B and the mining assets in the AfginElbistanarea owned bythe Borrower. 11. FinancialCovenants (a) EUA$ will maintain a debt service coverage ratio o f not less than 1.2 every year starting on 2006. (b) EUAS will achieve a self financing ratio (funds from internal resources as a proportion o f the three-year average capital expenditure) o f not less than 25% in every year starting on 2006. 13 111. Financial Management Covenants (a) EUAS will maintaina financial management system acceptable to the Bank. (b) EUAS will install and make functional the enterprise resource planning program (ERP) byDecember 31,2007. D. APPRAISAL SUMMARY 1. Economic and financial analyses (a) Economic Analysis Supply and Demand Projections Electricity consumption inTurkey grew over 8% per year in each o f the decades from 1970-2000. However, it has slowed during the past five years in spite o f continuing rapid growth in GDP. Since the deep recession o f 2001 electricity consumption has grown 5.9 % per year (still a fairly highrate by international standards) while GDP has increased 7.2% per year. Two demand forecasts have been prepared by the Government. The official forecast, which i s based on a 5.5% GDP growth, projects an 8.3% per year average growth in electricity consumption. This forecast is based on a standard electricity forecasting model (MAED) which uses GDP growth to estimate electricity consumption growth and is consistent with the past three decades. An alternative but unofficial government forecast calls for about 6.3% per year average growth in electricity consumption using the same GDP growth rates but altering the MAED model to better reflect a shift o f Turkish manufacturing towards less energy intensive industries. Table D.1below shows these demand forecasts. While Turkey currently has adequate generating capacity, very little new capacity is due on line after the end o f this year. Capacity i s currently expected to rise less than 1%per year from 2005 to 2010. Moreover, while additional major new plants could be announced in the future, no such plants are anticipated and given the long lead times for large coal, lignite or hydro plants, construction needs to start immediately for completion in 2010. In addition, given the large role o f hydro plants (35% o f total capacity) the Turhsh electricity supply situation depends very heavily on whether it i s a dry or wet year. In dry years, hydro power generation can be 40% below normal hydropoweryears due to the lack o frainfall. As a result o f the continuing growth in electricity demand and the slow growth in generating capacity, Turkey i s expected to face supply shortages between 2008 and 2011 depending on the assumptions made. Under the official Government forecast and assuming a dry year, Turkey would have an electricity shortage in2008. Under the low demand case and dry conditions or the official case and normal hydro conditions, the shortage would occur in2009 while under the low demand case and normal hydro conditions the shortage occurs in 2011. The rehabilitation o f AfSin Elbistandelays these shortages by around a year. 14 Table D.l: ElectricityDemandand SupplyForecasts (TWh) 2006 2007 2008 2009 2010 2011 DEMAND OfficialGovernment Case 176.4 190.7 206.4 223.5 242 262 Low Case 169.5 180.2 191.7 203.8 216.7 230.4 SUPPLY Dry Conditions 192.2 199.3 199.4 199.4 198.9 198.1 Normal Hydro Conditions 213.4 222 222.4 223.2 223.7 222.9 Normal Hydro with Af$n A Rehabilitation 213.4 222 224.9 228.3 228.8 229 Scenario 1:Official case and dry conditions Shortage in 2008 Scenario 2: Low caseand dry conditions Shortagein 2009 Scenario 3: Official caseand normal Shortage in 2009 Scenario 4: Low case and Normal Hydro Shortage in 2011 Least-cost generationoption The economic analysis shows that the least-cost and fastest ways to provide additional electricity in time to avert shortages i s for EUAS to rehabilitate the Af9in ElbistanA power plant. Giventhe poor condition o fthe plant, rehabilitation would initially provide about 5.1 TWh o f incremental generation rising to around 8 TWh. This i s based on the assumption that the plant would not be able to continue operating for very long without rehabilitation. The cost o f electricity from the rehabilitatedAf9in- Elbistan A Plant is estimated at about 3.8 U S centskWh on a levelized basis including the FGD. These costs are in economic terms, and the levelized tariff i s discounted at a conservative 10%. Electricity from a new gas fired combined cycle power plant i s estimated at about 4.4 U S cents/ kwhon a levelized basis and importswould currently cost around 4.6 US cents/ kwhalthoughthey may not be available inadequate amounts inthe longer term. The rehabilitation i s expected to be completed in a little over 2-3 years after contract award, implying that the rehabilitated plant can be back online by 2009 - it is unlikely that any other option can result inthis quick a turnaround. Inaddition to these significantbenefits, the rehabilitationof the plant will also have significant environmental and social benefits. Once the rehabilitation is complete, it i s expected that the extremely high level of dust produced by the plant when it is operating at capacity would be reducedto well below the current emission limits. The smaller particles wouldbe reducedwhich would mitigate any adverse health impacts on the local population. Also the rehabilitation will reduce the emission o f large dust particles which, while they are less o f a health hazard, the local population says are damaging their crops. These benefits however, have not been quantified in determining the ERR o f the project. 15 The ERR for the project depends on the value assigned to the additional electricity produced as a result o f the rehabilitation o f AfSin-Elbistan A. Ifthe electricity generation from the rehabilitated Afgin A is valued at the cost of unserved energy (electricity), usually taken to be between 40 U S cents per kWh and US$ 1.00 per kWh in Europe, then the ERR i s very high and the payback period i s about 4 months, which is however, a notional calculation. More realistically, if the value o f the electricity i s taken to be the estimated level o f wholesale prices in Turkey after a functioning market i s established, which i s about 5.O U S centskWh, the ERR from rehabilitating the plant is 25%. The ERRwill be evenhigher ifthe value o fthe electricity is taken to be the cost o f electricity generation from single cycle gas turbines (around 5.9 U S centskwh) which would be the alternative for many industries, or diesel generators (around 8-8.5 U S centskwh). (Refer to Annex 9 for more details) (b) FinancialAnalysis The Government has decided to create 7 companies from EUAS (including the successor company o f EUAS, EUAS Hydro, which will operate the large hydros). One o f these companies - Afgin GENCO will contain the Afgin-Elbistan A and B plants. AfSin GENCO also includes - the Hopa (Fuel Oil) and Altinkaya, Derbent, and Karkamis (Hydro) plants, with the total installed capacity o f 3,548 MW before rehabilitation, and 3,788 MW after rehabilitation. Annex 9 contains a detailed discussion o f the historical and forecast financial condition o f EUAS, as well as the estimated future financial condition o f AfSin GENCO. The timeline for the creation o f Afgin GENCO has not been finalized, but the accounts o f the company have been separated and these are usedto forecast the financial condition. Historical financial performance of EUAS EUAS'Sprofitability has been reasonable through the period since its creation in 2001. The large increase inrevenue (and average sales per unit) from year to year i s primarily because o f the impact o f favorable changes in the generation mix, and not because o f an increase in tariffs. EUAS' cash flow, due to its receivables being at a significant level and increasing somewhat, i s a concern for the future (see discussion on arrears in Annex 9). Inthe past, EUAS has managed primarily due to its non-payment to suppliers and due to the low level o f investments that have been permitted by the Government. Receivables and Payables Outstanding trade receivables have accumulated to about 9 months' o f sales by endo f 2004 (although EUASbooks also show an amount o f about US$900 million as Other Receivables, which are dues from TEAS carried over from the time o f its restructuring and includes dues for electricity sales). EUAS has financed these large receivables with payables, which have accumulated to over a year o f fuel purchases. Again, the payables are with public economic enterprises that supply fuel, such as TKI, TTK and BOTAS. Currently the longer payable period allows EUAS to generate sufficient cash flow, but also is a risk factor inthe future cash flow and financial projections as these entities work to collect their receivables. The single-largest financial concern for EUAS i s its poor collection efficiency, almost entirely due to the collection problems at TEDAS. For TEDAS the main defaulters are government agencies such as municipalities, although there are cases o f private consumers who have large accounts outstanding as well. The Government i s evaluating several options for addressing the problem o f arrears including: legislative measures to enable utilities to enforce collections against municipalities and government agencies, and settlement o f cross-dues among government agencies. The outcome of these attempts however, i s difficult to quantify at this stage, but the Bank will remain indialog with the Government on this issue. Forecast financial performance of EUAS The impacts from the rehabilitation project are factored in (these impacts are discussed separately, while discussing the finances o f Afgin 16 GENCO). The forecasts are based on conservative assumptions regardingcommercial efficiency improvements such as collections. N o significant gains from privatization o f distribution or generation are factored in. The forecasts also assume that EUAS will no longer be able to defer its fuel and other purchases, and that payables will reduce significantly over time. Due to the forecast electricity shortage in 2009, EUAS will have to ramp up generation from its high-cost plants which will raise variable costs. EUASwill as a result need to manage its cash flow due to the conservative assumptions, as well as its debt service requirements. The forecasts show that EUAS i s able to maintain reasonable financial health, and i s able to service its workmg capital and debt servicing requirements. Investments The investment requirement for EUAS is large in the medium term, with most o f the investments in rehabilitation and maintenance. The investment needs in the next five years amount to more than US$2 billion, adding further to the existing debt service burden. Forecast FinancialPerformance of Afyin GENCO Afqin GENCO includes Af$n ElbistanA and B, Hopa (Fuel Oil), AltinkayalDerbentiKarkamis (Hydro) plants, with a total effective capacity o f about 3,400 MW. After rehabilitation, the effective installedcapacity will increase to 3,788 MW, as the effective installed capacity o f Afvin Elbistan A will increase from 1,000 MW to 1,360 MW. The forecasts for Af$n GENCO are prepared on the basis o f the same assumptions as inthe case o f EUAS forecasts. The main risk that Af9in GENCO faces i s its large debt service liability and required investment amount inthe near future. The large liability i s due to the construction o f Af$n ElbistanB lignite plant (commissioned in 2005), which was financed through a JBIC syndicated loan o f JPY 5.85 billion (approximately US$494 million), and other funds. Additionally, it i s expected that a large amount o f other investments will be required by Afvin GENCO in the near future. Major investments are the lignite mine expansion (EUR 424 million) and FGD installation in Af$in Elbistan A (EUR 181 million). As a result, the debt servicing obligation (interest and principal repayment) i s expected to increase fromUS$ 121million in2005 to US$293 million in2015. Debt service requirements and assumptions on trade receivable and payable (average annual cash outflow o f US$33 million) poses a significant burden for AfSin GENCO. However, its cash flow is expected to remain reasonably comfortable due to the high depreciation and increase in generation output as result o f the rehabilitation. The Debt Service Coverage Ratio i s expected to be at 2.6 in 2008, but will settle down at 1.3 from 2013 onwards, owing to the increased debt repayments. The leveraging i s also at a conservative 0.6 in 2006 but increases to 0.7 in 2009, as result o fthe investments above and their financing. The rehabilitationi s expectedto increase the effective installedcapacity of Af$n Elbistan A plant from 1,000 MW to 1,360 MW. It is also expected to not only improve the efficiency o f the plant, but also to improve the consistency o f the lignite fuel through improvements inthe lignite feeder system. 2. Technical EUAS has carried out a pre-feasibility study which done by Chubu Electric, and this was followed up by a detailed engineering study which was undertaken by RWE International, Germany. This consulting engineering firm i s an affiliate o f one o f the largest electric utilities in Europe, which operates a number o f lignite fired power plants and mines, and also has significant experience in lignite plant rehabilitation. The project i s therefore, based on very sound 17 engineering work, and has been reviewed and supported by Bank power engineers. The project i s considered satisfactorily prepared from a technical standpoint. Each rehabilitation sub-component was selected based on an economic and technical assessment o f options ranging from doing no rehabilitation, to repairinghenewing the system or replacingthe system entirely. The finally selected scope was defined based on an overall least-cost solution that would achieve a guaranteed power plant performance that the engineering contractors could be held accountable to. The scopes o f the environmental pollution control systems were defined based on regulatoryrequirements. The rehabilitationwork i s expected to improve the plant performance as follows: rn Plant output o f each unit will be increased from about 260 MW net to 300 MW net; rn Capacity factor will be increased from 40% or below to 75%; and rn Net plant efficiency will be increased from 27% to 31% (30.6% with the FGD). Performance parameters such as availability, steam output, boiler efficiency and auxiliary power consumption will be guaranteed by the rehabilitationcontractor. EUAS has considerable experience in thermal, and specifically lignite plants, and their rehabilitation. EUAS has continuously carried out and supervised rehabilitations in their plants over the past few years. The rehabilitation in this case will be carried out by an experienced contractor selected under Bank procedures. The work will be overseen by the EUAS Project Management Team aided by RWE. In addition, there will be considerable focus given to the monitoring o f the environmental impacts o f the project and the plant in general, either as part o f the implementation consultant contract, or as a separate contract. Project costs are summarized in Annex 5. Cost estimates have been derived from the feasibility study. The cost estimates are considered conservative, which is appropriate for a facility o f this magnitude, and accordingly, include reasonable price as well as physical contingencies. 3. Fiduciary The Bank's standard fiduciary requirements apply to this project. Procurement for the proposed project would be carried out in accordance with the World Bank's "Guidelines: Procurement under IBRD Loans and IDA Credits" dated M a y 2004; and "Guidelines: Selection and Employment o f Consultants by World Bank Borrowers" dated May 2004, and the provisions stipulated inthe Legal Agreement. An assessment o f the financial management arrangements for the project was undertaken in October 2005. The assessment determined that EUAS has financial management arrangements acceptable to the Bank and these systems will be relied upon for project financial management purposes. However the main system will be supplemented by excel sheets for project reporting and monitoring on a foreign currency basis. There will be a designated account for the project to assist disbursements from the World Bank loan. This account will be in Euro and will be located in a government-owned commercial bank. The commercial bank will be selected by EUAS. Payments to the contractors, suppliers and consultants for the project will be made from this account (except direct payments). See Annex 7 for further details on financial management aspects. EUAS will finance part o f the equipment for Component 1, taxes (except the withholding tax on consulting services), interest during construction, land and contingencies. The Bank loan will 18 finance about 73% o f the total project cost since EUA$ will finance the taxes, VAT, interest during construction, and other local expenses such as land (See Annex 4 and 5 for detailed Project Costs). 4. Social There are no major adverse social issues involved with the project. The project entails the rehabilitation o f an existing plant, and no land acquisition i s required. The rehabilitation will have a positive social impact since it will lower dust emissions by the plant very substantially compared to what they would be if it were to operate at capacity without rehabilitating the ESPs. This will help the localpopulation. Firstitwill reduce any potentialhealth impact. Second, it will remove the problem o f large dust particles settling on crops which the local population has been complaining about. Further, in the absence o f rehabilitation, the plant would gradually cease operating, which would have an adverse impact in terms o f loss o f jobs and requirements for ancillary services inthe area. 5. Environment The Environmental Impact Assessment (EIA): EUA$ used a PHRD grant for the environmental impact assessment (EM), which was carriedout by a consortium comprising Cinar and KEMA. Though TurkishEL4 regulations did not require an EIA for this project, the EIA was carried out per Turkish and World Bank guidelines. The Ministry of Environment and Forestry (MOEF)reviewed and approved the EIA on September 9,2005 (EMPositive Certificate Issued). The EIA concluded that: The rehabilitation o f the ESPs on the main stack gas and the Bruden stacks i s essential to address the dust and particulate emission problems. The Af9in-Elbistan A Power Plant operating at full load after rehabilitatiodupgrade will meetboththe long-term and short-term Turkishair quality standards for SO2. The Af8in-Elbistan A Power Plant operating at full load will however, not meet Turkish SO2 emission standards. In the evaluation of the EIA by MoEF, it was recognized that plant performance does not affect compliance with Turhsh air quality standards for SO2in the plant vicinity. Since the plant exceeds emission standards for SOz,the Government has evaluated the option o f installing an FGD on AfSin ElbistanA, along with all the other existing thermal plants. MoEF has decided to provide each thermal plant with a transition period (derogation) for complying with air pollution limits, and has prepared an amendment to the Regulation for the Control o f Air Pollution Caused by Industrial Facilities. This amendment provides an extension o f time by 5 years for installing the FGD in order to comply with SO2emission requirements. Providing transition periods for FGD installations i s not unusual because o f the substantial investment costs. The EU has granted such transition periods to candidate members such as Romania(for 8 to 10years) as well as newlyjoined members, such as Poland (for 5-12 years). Duringpublic consultations as part o f the EIA process, dust emissions were cited by the local populace as the most significant environmental impact inthe vicinity o f the plant. The project therefore, includes rehabilitation o f the electrostatic precipitators (ESPs) which will reduce dust emissions from current levels o f 400-6000 mg/Nm3to 100 mg/Nm3in accordance with Turhsh regulations. The Turkish standard i s the same as the relevant EU standard as well as the World Bank guidelines for dust emission for a plant with the size and fuel type such as that o f Af$n Elbistan A - the ESPs are therefore designed to meet EU and World Bank standards on dust emission. 19 The Af5in-Elbistan A plant uses local lignite, which has very high sulfur content. Currently, the plant operations meet Turlush ambient air quality standards for SO2 in the area. Air quality modeling results carried out as part o f the environmental assessment (EA) show that after rehabilitation, AfSin Elbistan area airshed will continue to comply with Turlush short term and long term limits. The Af$n Elbistan area airshed will also comply with EU standards and will also be consistent with the World Bank indicators for good air quality (annual average concentration above 80 pg/Nm3 i s considered as moderately degraded air quality; average concentration above 100 pg/Nm3is considered as poor air quality)' in the impact area o f the project. While over the project impact area, air quality i s within international standards and guidelines, modeling indicates that at two locations out o f 12 villages inthe project impact area, air quality falls outside the levels provided in the Bank guidelines, and that at an additional three villages the air quality may not comply with the stricter WHO guidelines ( 5 0 ~ g / N m ~ )When the ~ . FGD unit is installed at the end o f the transition period all international standards for ambient levels o f sulfur dioxide will be in compliance. The current power station emissions of sulfw dioxide (SO,) however, exceed Turkish regulations which specify an emission limit o f 1000 pgmm3. Lignite mine extension The Af$n Elbistan A plant i s supplied by an existing mine at Kislakoy near the plant. This mine currently has a capacity o f 18 Million tons per year - it is currently primarily supplyingthe B Power Plant because the A Plant i s operating at a very low level. The mine i s an open pit mine which was built using World Bank funds in the 1970s. It has an operational license from MENRand i s inspected periodically by various government agencies. (a) MENR inspects the mine to see whether it i s conforming with the Mining Law (which prescribes overburden and waste disposal guidelines); (b) The MinistryofLabor (MOL)carries out inspections for worker safety issues; and (c) MoEF inspections focus on adherence with environmental safeguards. Overburden from the mine and the ash from the power plant are used as backfill inthe mine and covered over with soil. Over 400,000 trees have been planted on the backfill area which i s now wooded as a result. After rehabilitation o f AfSin A, the existing mine will revert to supplyingthe A plant and EUAS will expand the mine inorder to continue supplyinglignite to Af5inB. 6. Safeguard policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP/GP 4.01) [XI [I NaturalHabitats (OP/BP 4.04) [I [XI Pest Management (OP 4.09) [I [XI Cultural Property (OPN 11.03, being revised as OP 4.11) [I [XI Involuntary Resettlement (OP/BP 4.12) [I [XI IndigenousPeoples(OD 4.20, being revised as OP 4.10) [I [XI Forests (OP/BP 4.36) [I [XI Safetyo fDams (OP/BP 4.37) [I [XI ProjectsinDisputed Areas (OP/BP/GP 7.60) [I 1x1 Projects on International Waterways (OP/BP/GP 7.50) [I [XI PollutionPreventionand Abatement Handbook, 1998 These are indicative statistics, and do not represent a non-compliance, since the guidelines and standards referred to here apply over a wide geographic area and not specifically to a particular point of measurement. 20 Project construction activities will present minor potential environmental issues associated with the movement o f men, equipment and materials. Typical issues are dust, exhaust gases from combustion engines, noise, disposal o f materials (hazardous and non-hazardous), etc. All o f these issues are of limited duration, confined to the plant boundaries, andor are readily managed with standard good engineering and construction practices. During operation, environmental issues are largely beneficial, particularly the benefits accrued with more efficient particulate removal. When the FGD system i s installed, disposal o f gypsum may be an issue if markets in the construction materials sector do not develop to the extent o f utilizing all the generated waste. Depending on the FGD technology selected, water consumption and wastewater discharge are potential environmental issues requiring effective mitigation. However, the gypsum is non- hazardous and in fact, its alkaline matrix will effectively inhibitmobilization o f most trace metals preventing their migration into the environment. 7. Policy Exceptions and Readiness N o policy exceptions are sought for the project, 21 Annex 1: Country and Sector o r Program Background TURKEY: ELECTRICITYGENERATIONREHABILITATIONAND R E S T R U C T U R I N G Country Economic Overview The Turkish economy has rebounded from the 2001 crisis which had serious economic and social impacts. By the end o f 2001, the currency had devalued by 50 percent, nominal interest rates were about 100 percent, and the banking system had virtually collapsed. GNP growth has been strong since 2001 - 8 percent in 2002, 6 percent in 2003, 10 percent in2004 and about 7.6 percent in2005. Inflation i s under control reaching single digits (7.7 percent) in2005, the lowest inTurkey for 35 years. Net public debt has decreased significantly - at the end o f 2004 it reached 64 percent o f GNP compared to 79% percent in2001. Several factors contributed to the improved macroeconomic performance - key amongst them are: strong fiscal discipline which has allowed the maintenance o f a large primary surplus on the order o f 6.5 percent o f GNP; on-going structural reform; and political stability since 2002. The EU's decision to open accession negotiations with Turkey in October 2005 -has been an important signal to financial markets and has created a firm anchor for the country's development and structural reforms inthe years ahead. Impetus for Electricity Sector Reforms . The economic crisis o f 2001 led to the crystallization and recognition o f several structural and planning deficiencies inthe electricity sector, the most important o f which were: A build-up of public contingent liabilities as a result o f the Government guaranteeing debt for a substantial amount of privately financed generation capacity. These generation projects have imposed a heavy take-or-pay burden on the electricity system and have . complicated the transition to a structure where the commercial risk can be shifted to private investors. A rising quasi-fiscal burden on the budget stemming from growing consumer non- payment and electricity theft problems at the distribution level. The non-payments worsened as a consequence o f the economic crises. Although an attempt was made at offering private sector concessions for the distribution sector in the period 1999-2001, most o f these concessions involved guaranteed distribution margins with the supply risk borne by the Government. This approach was abandoned due to legal challenges to the approach and the nature o frisk sharing. Political influence on operating, planning and pricing decisions that made operational decision making more difficult. ReformDirection-Electricity Market Law and the EUMarket Integration Process . The Government has embarked upon a comprehensive reform and restructuring program o f the electricity sector to create a liberalized, efficient and economic sector.This was initiated by the Electricity Market Law (Law No. 4628) promulgated in February 2001 and this path reflected in the Strategy Paper accepted by the High Planning Council in March 2004, accelerated the reform process. The principles and goals of the reform program defined by this Law are substantially in line with EC Directives (1996/92/EC and 2003/54/EC) concerningrules for the internal market for electricity. m Turkey is a signatory o fthe Athens Memoranda o f2002 and 2003 that the EC initiatedto develop the regional electricity market in South East Europe and eventually integrate it 22 with the internal electricity market o f the European Union. The 2002 Athens Memorandum initiated the regional market development process commonly referredto as the "Athens process". With the inclusion o f natural gas, a more detailed version o f the memorandum was signed, which i s referred to as the Athens Memorandum 2003, and supersedes the 2002 document. While other regional members signed the Treaty on October 25, 2005, Turkey did not, owing to reservations on some o f the Treaty provisions. With the EU decision o f October 3, 2005 to begin negotiations for full accession, some reservations on the Treaty now become intertwinedwith the negotiations on the Energy Chapter of the Acquis Communautaire. Turkey however remains committed to, and continues to implement the provisions o f the 2003 Athens Memorandum. Reform Implementation . Functional and corporate restructuring of the sector - Pursuant to the law TEAS, the former integrated generation and transmission corporation, was restructured into a generating corporation EUAS, a trading corporation TETAS and a transmission corporation TEIAS. TEDAS, the Government-owned distribution corporation had been earlier separated from TEAS' predecessor, TEK. In 2004, TEDAS was restructured into separate companies (DISCOS) in preparation for their privatization. The generation sector i s also in the process of being restructured into six separate portfolios o f generation assets that will be later formed into companies (portfolio companies) that would be privatized once distribution i s substantially privatized. EUAS however, will continue to own the large multipurpose hydroelectric projects amounting to about 7,000 MW. See Figure 1.1below on the currently plannedtransitional sector structure. Independent Regulatory Framework - Turkey has set up an independent regulatory authority, the Energy Market Regulatory Authority (EMRA) with jurisdiction over electricity, gas and petroleum. EMRA has powers over licensing, tariff setting and customer service issues. EMRA is currently involved in setting multi-year tariff principles for the distribution business, and a tariff equalization mechanism across regions in order to enable national uniform retail tariffs. The Law will be amended to allow uniform national tariffs and to enable an equalization mechanism. EMRA has also . conducted the privatization o f gas distribution reasonably successfully over the last few years. Privatization of Distribution and Generation - Turkey's plan i s to privatize its distribution companies inphases over the next two years. The regional companies have been created in preparation for privatization, which is expected to commence in mid- 2006. This process i s delayed from the original timeline since Turkey i s keen to avoid a repeat o f earlier difficulties inprivatization4. At present, the privatization o f distribution i s delayed as key preparatory tasks such as medium-term (i.e. 5-year) regulated tariff profiles and performance benchmarks, and the tariff equalization mechanism have not been completed. In addition, there are delays in market implementation. Turkey i s preparing the implementation o f the balancing and settlement system prior to privatization, in order to enable private investors to understand the market in its entirety before they bid. Turkey also plans to privatize its existing generating assets, once a substantial part o f the distribution business i s privatized. The configuration of the generation portfolio companies has been decided, and EUAS will be restructured into 7 companies, one o f which will retainthe large hydroelectricprojects and is not expected to be privatizedinthe medium term. Turkey attempted to privatize distribution in the 1998-2000, but the process was challenged in Court and the transactions resulted in beingcancelled. 23 . Retail Competition in Electricity- Consumers whose annual consumption exceeds 6.0 GWh can choose their own supplier -this represents more than 30% of the total Turkish electricity market. Competitive Market Structure - Market simulations are in progress to introduce a competitive bilateral contract market with a balancing and settlement system. TEIAS, the transmission corporation i s the independent system operator, and will also be the market . operator. The market i s expected to provide the necessary price signals for potential new generation. Turkey's Regional Interconnection Efforts - Turkey first applied for UCTE(Union for the Coordination o f Transmission o f Electricity in Europe) membership in March 21, 2001. Since then several studies financed by the European Commission within the framework o f the TEN (Trans-European Networks) Program, have assessed different scenarios for connecting the Turkish power system to the UCTE power system through Bulgaria and Greece. On September 28, 2005, a technical study was initiated by UCTE to complete transmission assessments including static and stability analyses to determine the technical conditions under which the Turhshpower systemwill be synchronized with the power system o f the UCTE. Turkey already has two lines to Bulgaria, and will complete its section o f the linkage to Greece [The Greek section has been delayed but i s expectedto be completed in20071. Figure 1.1 Transitional Electricity Sector Structure Key Medium-TermSector Issues (a) Delays in implementation of the competitive market in electricity -Turkey has begun implementation, on a trial basis, o f a competitive bilateral contract market with a balancing system for energy, as laid out inthe Government strategy paper o fMarch 2004. This process however, is delayed significantly largely for the following reasons: - Unwillingness o f existing market participants, the distribution companies primarily, to participate inthe market on a cash basis. - Delay in finalization o f transitional contracts for existing generation between - EUAS, TETAS and distribution companies. Delay in finalization o f the equalization mechanism for retail tariffs to enable - uniform tariffs inthe country. Delay inapproval o f market regulations and related amendment o f legislation. 24 The challenge facing Turkey i s to achieve coordinated and timely implementation o f the multiple activities integral to the creation o f the market, and generally, to the overall reform process. Most implementation activities are very closely linked - for example, the output by one implementing agency (e.g. tariff profiles prepared by TEDAS) needs approvals (from EMU) and also serves as inputsto the preparation o f vesting contracts (by TETAS and MENR). Effective coordination is therefore critical. The risk to the Government with implementation delays resulting from inadequate coordination i s the increasing levels o f direct and contingent liabilities owing to: (i)anon-functioning market mechanism with impacts on supply security (see point (b) below); (ii) continued cash-flow shortfalls at the distribution level (see point (c) below); and (iii) negative signals and perceptions created in the private investor community o f the Government's commitment and ability to implement the reform agenda. The Bank has been providing support to the Government in the design, preparation and implementation of electricity reforms, through ongoing lending operations, as well as through grant-funded panels o f international advisors. (b) Ensuring supply security - Electricity demand has been growing at about 6 percent per annum between 2002 and 2005 and the Government anticipates it will accelerate over the next decade closer to the long term average of about 8%. The Government has also prepared a low growth case where demand growth remains about 6%. In any case, capacity increases on the order o f 1,500-2,000 MW per annum are required from around 2009-2010 onwards. The issue o f concern i s that there although licenses have been issued for about 6,000 MW o f new capacity (of which 4,000 MW i s for small hydro and wind), presently very little new construction has been started. The problems are largely linked to the on-going market implementationwhich has not yet led to the formation o f credit-worthy private distributors who can contract for new capacity and/or electricity offtake. The Bank i s collaboratingwith the Government on a policy note addressing the problem o f supply security. This study aims to evaluate bothnear term as well as mediumto long term solutions for supply security. Upon its finalization, the Government may seek further support from the project to assist in implementing the recommendations o f the study. (c) Accumulated arrears in the electricity utilities -Operating revenues at all the publicly- owned electricity and gas sector companies inTurkey are inadequate to meet their longer term level o f operating costs and expenditures. The problem is mainly inthe distribution business managed by TEDAS. As o f 2004, the theft and loss percentage i s 18.5% o f purchases by TEDAS. Bill collection i s about 90%. Due to these problems there is a 25- 27% shortfall in payments for purchased electricity by TEDAS which in turn cascades into revenue shortfalls to all the upstream electricity and gas businesses (Refer to Annex 9 for a detailed discussion on the current situation o f bill collection and accumulated arrears). (d) Reconciling independent economic sector regulation with the Government's economic stabilization controls -Presently, the Government exercises certain economic controls and constraints on pricing o f energy services/outputs and investment decisions, in order to maintain fiscal prudence, achieve a healthy primary surplus, and restrain inflationary pressures. There remains a fine line between economic stabilizationcontrols and other forms o f economic controls that prevent the development o f institutions 25 essential to a functioning market economy. To mitigate regulatory risk for private investment it will be important that the economic stabilization restraints are relaxed to allow timely pass-through o f costs to consumers - specifically: - wholesale gas prices should be adjusted to reflect the market terms in the - underlying contracts; retail electricity prices should be adjusted to reflect operating cost changes at the distribution level as well as changes inwholesale prices; and - electricity produced by state-owned hydro power plants which i s sold into the market i s priced at levels that send appropriate signals o f scarcity and water value so as not to distort wholesale market price signals. Inaddition, the regulator shouldapprove investmentprograms consistent with established performance targets. (e) Transition to compliance with European internal market and environmental standards - Turkey is committed to the principles of the Athens memorandum, even though it did not sign the Treaty in October 2005. Although Turkey has begun implementing fundamental structural reforms in its power sector, some o f which are far more advanced than required fkom the EU's perspective, there are several areas, such as the timeframe for complete retail market opening that Turkey has reservations on, for good reasons. Turkey has already allowed significant retail market opening, and the results have been positive from the point o f view o f attracting new capacity and ensuring better supply quality for these consumers. However, in order to provide choice o f supplier to all the existing consumers, several fundamental changes are required in the sector, most critical among these being the improvement in distribution system losses and payment discipline. The Government i s currently preparing for the privatization o f distribution, which i s seen as an important solution for these.improvements. Privatization however, has been delayed for several reasons, chief among them being the delays in creation o f the electricity market, and the finalization o f the strategy for privatization. A key areawhere Turkey has reservations iswith regardto compliancewith the timetable in the Treaty to meet EU environmental standards. In July 2005 EU consultants produced a report on Turkey's investment needs inorder for it to be in compliance with the EU Large Combustion Plant Directive which limits emissions by these plants (Directive 2001/80/EC). Almost all o f the plants covered by the Directive are thermal power plants and the estimated cost o f bringing them into compliance with the EU Directive i s 1.5- 1.9 Billion Euro (US$ 1.8-2.3 Billion). This is a large investment requirement for Turkey, and, in the absence of concessional financing, will require a number o f years to implement, given the lack o f adequate fiscal space for incremental investment. 26 Annex 2: MajorRelatedProjectsFinancedby theBank and/or OtherAgencies TURKEY: ELECTRICITY GENERATIONREHABILITATIONAND RESTRUCTURING An Overview of the WorldBankPrograminthe EnergySector Advisory Support The Bank has a strong advisory support program to help the Government and the utilities in the gas and electricitv sector. The Bank supported the government in structuring and establishing the Energy Market Regulatory Authority in 2001 and indefining the detailed electricity market design. A Bank technical assistance loan supports specific implementation tasks, such as distribution sector unbundling, definition o f tariff review rules, and preparation o f initial vesting contracts to prepare for privatization. An independent expert panel o f leading international specialists in market implementation, regulation and privatization provides the government guidance on challenging implementation trade-offs and choices. Inthe gas sector a comprehensive gas development strategy was completed in2004 to set a framework and process for introducingcompetition inwholesale supply. The Bank i s also beginning its support to key energy utilities inachieving a credit quality and rating that will enable them to access capital markets without sovereign guarantees. Presently, financial advisors financed by PPIAF (Public Private Infrastructure Advisory Facility) are working with BOTAS inpreparing for a credit review by a rating agency. Inadditiontothe continuingwork onreformimplementation, theBankwill continueitsadvisory work focusing on issues o f energy supply security, EU market integration and helping the institutionaldevelopment o fvarious utilities inthe energy sector. ProjectLending The current program o f lending inthe energy sector aims to: (a) bridge gaps in gas and electricity service delivery needs during the reform transition; (b) meet EU integration challenges; and (c) ensure that essential infrastructure that can affect energy supply reliability is implemented. The projects include: (a) NationalTransmission Grid Project (NTGP): This project loan o f US$270 million was approved in 1998 to the then integrated transmission and generation corporation, TEAS. Project objectives are to: (i) develop adequate transmission grid capacity in a timely and environmentally sustainable manner; (ii)continue the reform o f the power sector by establishing the independent operation o f the transmission gnd system; and (iii) maintain the financial viability of the state institution responsible for the grid development and operation. The project was restructured in 2002, after TEAS was restructured into three corporations - TEIAS (transmission), EUAS (generation) and TETAS (trading and contracting). TEIAS is the successor and has taken on the obligations under NTGP, but US$ 20 Million o f the loan was assigned to the Government for helping fund the implementation o f the reform process. The project i s rated satisfactory both on a Development Objectives (DO) and Implementation Progress (IP) basis. While construction o f transmission lines has been slower than anticipated, capacity shortages have. been avoided, TEIAS has been designated the independent operator o f the transmission grid and TEIAS itself remains financially viable. In addition, the loan supports the creation o f an electricity market and ongoing efforts to 27 privatize distribution and generation, and capacity development within the independent regulatory agency. (b) Renewable Energy Project: The project loan o f US$ 202.3 million was approved inMay 2004. The objective o f the project i s to increase privately owned and operated power generation from renewable sources without the need for government guarantees, and within the market-based framework o f the Electricity Market Law. The Treasury has on-lent the funds to the TurkishDevelopment Bank (TKB)andthe TurkishIndustrialDevelopment Bank (TSKB). The two development banks in turn are on-lending the funds to private developers o f renewable electricity generation projects. The PHRD grant was used to support the government inthe preparation o f the renewable energy law approved inJune 2005. (c) ECSEE APLZ: As Turkey gets closer to its negotiations with the EU for accession, it i s in the process o fintegrating its energy markets with those o fEurope. Under the Athens Process, Turkey i s liberalizing its electricity market and linkingits market to the electricity markets of other countries in South East Europe. The World Bank established a regional adaptable program loan in FY05 to support the eight non-EU members in meeting their technical and institutional obligations. This regional program provides Bank investment support by using the adaptable program lending (APL) instrument. This loan o f EUR 50.6 million i s the first loan to Turkey under this program. The specific objectives o f APL2 are to: (i) with the assist creation o f a market management system for the electricity market; (ii)strengthen the SCADA system to enable TEIAS to operate more efficiently; and (iii)strengthen the transmission grid. This loan became effective inSeptember 2005. (d) The Gas Sector Development Project: This project loan o fUS$325 million to TurkishGas Pipeline Corporation (BOTAS) finances a gas storage facility for Turkey as well as part o f its transmission system expansion. Inaddition, the project will support the restructuring of BOTAS and help it achieve access to capital market financing in the future. This project results from the Gas Distribution Strategy and the Gas Sector Strategy Note completed by the Bank for the TurkishGovernment in July and September 2004. These studies indicated inter alia that peak demand for gas would increase rapidly with the expansion o f gas distribution and therefore storage i s increasingly needed. This storage would make gas supplies more reliable, thereby improving the investment climate for gas using companies. The system expansion and the storage would also assist with Turkey's increasing role as a gas transit country. The loan agreement was signed on February 2,2006. (e) ECSEE-APL3: This loan i s the second regional adaptable program loan to Turkey. Its objectives are to increase the safety, reliability, efficiency and capacity o f the bulk power transmission system in Turkey and to improve market access for consumers and suppliers o f electricity. The project will support the strengthening and expansion o f the transmission network to reliably meet the growing electricity demand. It will also help upgrade the transmission network in dense urban areas to minimize the risk to public safety posed by urbanencroachment on existingoverhead lines. Proposed Electricity Distribution Rehabilitation Project: In addition to the above projects, the Bank i s also currently preparing a distribution rehabilitation project with TEDAS. The distribution sector in Turkey has not completed essential investments in system upgrades and rehabilitation for several years, for two reasons. First, from 1997-2002 the sector went through an unsuccessful attempt at privatization. Second, the Government faced budget pressures during repeated fiscal crises and curtailed investments in the distribution sector. The proposed project will finance system rehabilitationand upgrading investments to improve reliability. The project is expected to be presented for Board consideration incalendar 2006. 28 Annex 3: ResultsFrameworkandMonitoring TURKEY: ELECTRICITYGENERATIONREHABILITATIONAND RESTRUCTURING ResultsFramework PDO Project Outcome Indicators Use of Project Outcome Information To improve supply security during (1) Rehabilitationof Afsin-Elbistan (1) Turkey would have a more the reform transition and A Power plant occurs so that its reliable and efficient generation restructure the state-owned generation capacity, its efficiency plant, which would help mitigate generation business into and its ability to reliably generate the supply security concern, and corporatizedentities. electricity are enhanced to which would operate more provide up to 5 TWh of efficiently and in an incrementalenergy. environmentallyfriendly manner. (2) EUAS Portfolio Generation (2) Turkey has multiplegenerating Groups are established and entities which can subsequently operating as separate generation be privatized and which provide entities. some degree of competition in the emergingelectricity market. Intermediate Outcomes Intermediate Outcome Use of IntermediateOutcome ~ Indicators Monitoring Component One Rehabilitation of the Af9in- EUAS and Contractors make Progress towards completion of Elbistan A Power Plant is regular progress in rehabilitating rehabilitation is assessed and completed. the plant. (Schedule will be remedial measures if necessary monitored based on the agreed identified. plan presented in Annex 4). New operational and maintenance As rehabilitated units are put into management practices are service, capacity and generation implemented. from plantwill rise. Component Two ~~ EUAS Portfolio generation Portfolio generation companies Will enhance the financial and companies (GENCOs) are (GENCOs) are functioning as operational capacity of the operated as viable business units separate entities in the power GENCOS to operate in the powermarket. market. independently in the market, and will assist with competition in the market. 29 - B a, Q E,0 zmnE I I I I I n C P n B E5 -s 3 Annex 4: DetailedProjectDescription TURKEY: ELECTRICITY GENERATIONREHABILITATIONAND RESTRUCTURING Component 1: AfSin-Elbistan A Rehabilitation (Estimated Cost EUR328.2. million) The main component o f this project is the rehabilitation of AfSin-Elbistan A Power Plant. This component will focus on: (a) the repair, replacement and upgrade o f power plant systems to restore reliability, availability and power output, and improve plant efficiency; (b) upgrade o f environmental protection systems and environmental monitoring; (c) improvement o f operational and maintenance practices - particularly maintenance monitoring systems, predictive maintenance based on historical data analysis, and maintenance planningkcheduling; and (c) environmental regulations; and (d) meeting UCTE standards for primary and secondary frequency control required to integrate with the South East European market. Component 2: Support for Financial and Operational Restructuring of the Generation Business (Estimated cost EUR3.0 million) This component will focus on supporting EUA$ in restructuring its generation business into financially and operationally viable portfolio companies and a hydro corporation. This work will create the basis for undertaking the future privatization o f these generation entities. The PHRD grant for the preparation o f this Project has been utilized to begin this work. Consultants have analyzed different portfolio configurations based on criteria such as fuel mix, load following capabilities and financial viability, and have also prepared draft transition contracts between GENCOs and TETA$/ distribution companies. Based on this work, the Government has decided on 6 portfolio companies, and these have been earmarked as separate units within EUAS, in addition to the residual EUA$ Hydropower company. The Project proposes to assist in completing this work, focusing on aspects o f financial and operational restructuringo fthe companies to create them as viable business units. The Project will also provide support, if necessary, to EUAS and the Government to implement mechanisms to address generation supply security needs in the period beyond 2008. The initial work on assessing options and strategies is being funded through separate grant funds. Financing Plan The proposed Bank loan will finance the main rehabilitation contract. This contract will cover all the major critical aspects o f the rehabilitation included in Component 1 such as the rehabilitation o f the boiler and firing system, the electrostatic precipitators (ESPs), the main cooling water and condensate water system (covered under the Balance of Plant Mechanical), control and instrumentation, and ash and coal handling. The remaining portions o f Component 1 will be financed from EUA$' operating and maintenance budget since these elements are either currently ongoing or are logically covered by the annual maintenance budget. The most important sub-component covered by EUAS is the ongoing rehabilitation o f the steam turbines and generators. EUAS' maintenance budget will also cover elements such as the switchgear, transformers and other general instrument supplies (Balance o f Plant Electrical), cooling tower coating and reinforcement, and environment monitoring. The bidding documents for the main contract will contain suitable provisions to reflect the fact that some works are ongoing, and that EUAS will provide some components from its own resources. The operational and maintenance practice improvement services, and specialized project management services will be funded through the Bank loan. Undercomponent 2 the Bank loan will be usedfor services to facilitate the financial and operational restructuring of EUAS in to multiple generation companies. In addition, provision will be made under component 2 to utilize the earmarked resourcesto implement mechanisms to address generation supply security needs inthe medium-term. 31 Component 1- Afqin Elbistan A Rehabilitation Af7in-Elbistan i s Turkey's largest thermal power generation complex. The complex uses domestic lignite which i s mined adjacent to the two generation stations: Af9in-Elbistan A with a nominal capacity o f 1,355 MW (3x340 + 1x335). The four units were commissioned between 1984 and 1987; and Afvin ElbistanB, with a capacity of 1,440 MW (4x360). Two unitswere commissioned in2005 and the remaining two unitswill be commissioned in2006. . The output and performance o f AfSin-Elbistan A has deteriorated significantly over in the last 20 years and the plant i s inneed o f major rehabilitation. Capacity Derating Available capacity i s currently about 1,000 MW o f the original name-plate - capacity of 1,355 MW - or about 74% o f the design capacity. a Availability has declined from 85% to below 40%. - a Plant efficiency -has declined fi-om 36.6% to about 27%. Several factors have contributed to this pre-mature decline inperformance inaddition to general wear and tear. (a) Variation in Lignite Quality from Design Specification (1987-1994) - the boiler was designed for lower lignite quality than was initially made available to the plant by the miningcompany (which was then separate). The lignite fiom the mine has a low calorific value, typically 1000-1,500 kcalkg. With dryer and higher calorific value lignite, the control systems in the bruden system were not able to maintain the necessary re-circulation o f combustible particles to the burners, which led to boiler combustion temperatures not being stabilized at the design level. This in turn led to excessive slagging and fouling o f tube surfaces and led to severe damage to boiler pressure parts. The ownership o f the mine was transferred to the power company in 1994, which improved coordination and quality control o f the lignite supplied. However, irreversible damage to the boiler had already been done. (b) MaintenancePractices- The power station maintenancepractices have not been upto the required standards owing to the shortcomings in: Planned and predictive maintenance - Plant maintenance was generally carried out inresponse to operating problems and equipment failures, with inadequate attention to systematic monitoring at each maintenance event followed by historical data analysis. Scheduling o f periodic maintenance . inspections and work was not done as it should have been, partly owing to the budget restrictions on maintenance. Budget provision for spare parts - Budget allocation practices led to phases when essential spare parts and maintenance materials could not be procured. Equipment wear increased substantially duringthese phases. Departures o f experienced and qualified staff - Over 200 trained staff who left the station for postings within the company or for alternative employment were not replaced. Plant Performanceafter Rehabilitation . The rehabilitation work is expected to improve the plant performance as follows: Plant output o f each unit will be increased from about 260 MW net to 300 MW net Capacity factor will be increasedfrom below 40% to 75% Plant efficiency will be increased fiom 27% to 31% (30.6% with the FGD) 32 Performance parameters such as: availability, steam output, boiler efficiency and auxiliary power consumption) will be guaranteed by the rehabilitationcontractor. RehabilitationScope EUAShas finalized the feasibility report prepared by RWEInternational, and has approved the scope of work after a comprehensive reviewjointly with the Bank's power engineers. The key sub-components o f the rehabilitation scope and cost estimates are summarized below. Each rehabilitation sub-component was selected based on an economic and technical assessment o f options ranging from doing no rehabilitation, to repairinghenewing the system or replacing the system entirely. The finally selected scope was defined based on an overall least-cost solution that would achieve a guaranteed power plant performance that engineering contractors could be held accountable for. The scope o f the environmental pollution control systems were definedbased onregulatory requirements. Table 4.1: Rehabilitationscope and cost estimates (E million) Rehabilitation Sub-component ____~ Boiler The interiorand exterior of the boilerwill be cleaned. Detailedinspectionand repair work of the boilerwaterwall, superheater, reheater and economizer tubes, headers and other pressure parts. The waterwall bottom section of the boiler (hopper) and the lower economizerwill be replaced. Damagedparts, the superheater, and reheater tubes will be repaired to the extent possible or otherwise replaced. A new boiler cleaning system and soot blowing system will be installed. This will improve the boiler efficiency as well as preventing slugging which causes tube failures. Steam Turbine Rehabilitation The high pressure (HP), intermediate pressure (IP) and low pressure (LP) inner casing and blades will be overhauled and replaced in selected units in order to achieve efficiency improvements and plant output increases. The turbine governors will be replaced for better frequency control. The boiler feed water pump turbinewill be overhauledto preventunexpectedfailures and unplannedoutages, thus increasingthe availability and reliability of the plant. The steam turbine system is funded by EUAS separately (and not financed by the Bank) because the turbine overhaul has already been scheduled under the periodic maintenance agreement negotiatedwith Alstom: the originalequipmentsupplier (OEM). High Pressure Piping Damaged pipe hangers will be replaced and repaired. Boiler pressure parts and major piping including main steam, cold and hot reheat, and feed water pipes will be inspected and non-destructivetesting (NDT) will be carriedout to maintainsafe operation of the plant. Balance of Plant Mechanical This includesinspection,overhaul, repair and replacementwork of the following main systems: ' the maincooling water system, 1 circulatingwater system, condensatewater system (LPfeed water heater replacement), 1 ' glandsteamsystem, fire suppression system, condenserair extractionsystem, 8 condenserre-tubing, 9 other system pumps. Balance of Plant Electrical This includes inspection, overhaul, repair and replacement work on the following; transformers, large motors, general instrument supplies, 6kV switchgear, 380V switch gear, generator protection and control system, automatic voltage regulator, high voltage system, medium and low voltage systems, uninterruptible power supplies,emergency generators and DC systems, power meteringand fire protection. 33 RehabilitationSub-Component Precipitator An additional compartment will be added to the main boiler flue gas and the bruden vapor Electrostatic Precipitators (ESPs) to achieve the required particulate emission level (100 mglNm3). This is necessary to comply with the Turkish environmental regulations for Afsin (150 mglNm3) and the Bank's environmental guidelinesfor rehabilitatedexisting plants. Control and Instrumentation The complete boiler and turbine control system will be upgraded to the modern Distributed Control System (DCS). The existing control panels in the control room will be replaced by computer display panels which will allow the operator to access plant control, monitoring and alarm systems. All the boiler and turbine measurementtransmitterswill interfacewith the new DCS and all the actuators requiredfor the new DCS will be overhauled, modified or added. Continuouswater quality monitoring and emissions monitoringsystems will be added. These measures will enable more flexible operation of the plant, record keeping, and thus helping improvementof operationand maintenancepractice, and improve efficiency, availability and reliability. After the rehabilitation, the plant will be able to participate in the primary and secondary frequency control systems requiredby UCTE. Ash and Coal Handling A dry bottom ash handling system (the Magaldi system) will replace the existing system which has had severe problems in the past, causing plant outages, high water requirements and pollution around the power plant. There is experience with dry bottom ash handling systems in Turkish imported coal plant, and at lignite fired plants in Portugal, Italy,and Macedonia.Analysis conductedby RWE during the feasibility study has shown that the dry bottom ash handling system will be suitable for Afsin-Elbistan A. The fly ash handling system will be changed to a pneumatic transport system, and new filters for the pneumatic system will be installed. These measures will improve availability and reliability of the plant, as well as environmental problems caused by the current ash disposal system. Enhancement of the coal handling system including covering tops of conveyers and lightingsystems,will improve availabilityof the plant. Civil Works The reinforcedconcrete, steel structure for the boiler,turbine and balance of plant will be repaired and replaced The civil works also includeexterior and interior painting, earthquake safety (additionalwalls) repair of damaged clear covers, and exposedreinforcement,protectivecoatingsand new foundationsfor concretestructure. Plant Water Chemistry Systemsfor new Condensatepolishing,demineralization,decarburization,ammonia and oxygen injection,water steamcircuit,coolingwater treatment and sewagetreatmentwill be installed andlor renewed. Environmental Monitoring Environmental monitoringsystems will be installedto monitorthe environmental quality near the power plant so that the emission and ambientlevels are within the limitof the regulations and guidelines. Operation and Maintenance Practice Improvement Operationand maintenance practices are critical to keep the plant in a good operating conditionand to ensure availability after rehabilitation. Priority will be given to improving performance and maintenance monitoring, as well as maintenance planning. A comprehensive program of improved operation and maintenance practice including systematic monitoring, historical data analysis, regular overhaul, predictive maintenance and non destructive testing (NDT) of materials will be introduced. A plan for rationalizationof the O&M budget and staff numbers etc will be developedfor both the power plant and lignite mine. Training on the blending system at the mine side will also be includedin the TA. Project Management Services 34 _z_ 0 Lo !I j; iaure 4.2: ScoPe Boundarv of Rehabilitation Work and FGD Installation - -.- = Boundary of imtial Rehabi1i:ation and FlueGas Desulphurization(FGD) The flue gas desulphurization (FGD) unit i s not included in the initial phase o f the rehabilitation project given the five year transition period granted by the Ministry o f Environment and Forests (MOEF). In accordance with this transition period granted by MOEF, EUAS will need to install the FGD by the end o f 2010. The FGD retrofit project i s estimated to cost US$ 250 million and will be funded separately by EUAS and the Government. A wet limestone FGD system will be used. The basic design for the system has recommended that the treated flue gas be emitted from the cooling tower instead o f the chimney. This design requires polymer coating and reinforcement of the cooling tower. There is adequate space for the FGD and connection ducts (See Figure4.3 below). The scope o f work will include: - construction and installation o fthe FGD, Bruden flue gas ducts to connect to the FGD, replacement of the ID fans - new IDfans with approximately twice the capacity o f existing fans are necessary as the Bruden flue gas will need to be directed into the FGD unit inaddition to the main flue gas from the boilers, ducts connecting to cooling towers, facilities for limestone preparation, gypsumtreatment and storage. 36 :igure4.3: Site Plan IndicatingLocationof FGD and Connectionto Cooling Towers 7 he FCD{r...j,huutd be located after the stacks (S.. 1which will be kept fo: t?>-passoperation. Emergency sto:age tanks (La) be indalkd in the same a m . shall f,imestonc storage and griqding as well asfhe process water systcrn and electricat system hase to be erected in thc:: m e hejogld the cuoiing towers. Thc aczi next 10 hirers is m t s\ailahle &e :O plans for fit:ure extension ofthe power pian1 Lignite M i n e Development To ensure adequate lignite for the new AfSin-Elbistan B Station and the rehabilitated Af$n Elbistan A, lignite production capacity has to be almost doubled in the mine. Based on the planned rehabilitation schedule (i.e. 3 units commissioned in 2008 and 1 unit in 2009), and FGD installation in 2010 lignite demand for Afqin ElbistanA and B power stations i s shown inthe table below: Table4.2: LigniteDemandfor Afsin ElbistanA and B Power Stations(Million tons) Af9in-Elbistan A Af9in Elbistan B Total 2006 7.2 14.6 21.8 2007 7.2 17.3 24.5 2008 8.4 17.3 25.7 2009 16.9 17.3 34.2 2010 16.9 17.3 34.2 2011 16.9 17.3 34.2 2012 18.6 17.3 35.9 37 To produce the required amount of lignite, two options were assessedby EUAS and RWE International - these options are shown inthe mine area map inFigure 4.4: Option 1:expansion o fthe existingKislakoy Mine and Option 2: development o f anew mine for Afvin ElbistanB (Collolar mine). Both options require around EUR424 million investment and extensive use o f contractors for overburden removal, estimated at 30 million tons per year at the Kislakoy mine. The second option requires additional boxcut overburden removal o f about 30 million tons annually at the Collolar mine. Ifthe new mine i s developed by a private entity as EUAS i s expected, significant amount o f upfront investment cost i s required for option 2. Further, given that the development o f a new mine would require 5-6 years to complete, inorder for bothplants to operate at full capacity in 3 years, the existing mine would have to be extended even in option 2. Thus, although the development o f a second mine will improve supply reliability and increase employment in the mine, the costs of this option i s not justified. A levelized lignite production cost in option 2 i s about EUR 0.5-1.5/ ton higher than that of option 1. Therefore, the available analysis shows that option 1 (i.e. extension o f the Kislakoy mine) i s the most economic option for increasing lignite production to meet the demand of rehabilitated Afvin A and plant B. Coal production and demand are shown inthe table below. 1 Reserve from Existing annual Increase in Total annual Afgin A + B previous year capacity annual capacity availabitity demand 2006 9.5 18.6 0 28.1 21.8 2007 6.3 18.6 7 31.9 24.5 2008 7.4 18.6 12 38.0 25.7 2009 12.3 18.6 12 42.9 34.2 2010 8.7 18.6 12 39.3 34.2 2011 5.1 18.6 12 35.7 34.2 2012 1.5 18.6 16 36.1 35.9 The production capability o f Kislakoy mine has to be increased from the present 18 million todyear to a maximum o f 34.6 million ton by 2012 by means o f contracts for overburden removal, a performance improvement program, 2 additional compact size bucket wheel excavators (2 x 10 million m3p.a.) and 2 additional medium size bucket wheel excavators (2 x 28 million m3p.a.) with a total investment of EUR 324 million. In addition, rehabilitation investment o f EUR 100 million has to be made to maintain the existing capacity o f excavators and other equipment. The capacity increase will be carried out more effectively and efficiently by a private entity as EUAS expected, considering the engineering and management capacity of EUAS at the existing mine. After the installation o f the FGDat Afvin Elbistan A plant due to the net efficiency reduction o f the power plant, the mine capacity needs to be further expanded to 36.0 million ton by 2011. To achieve this capacity increase, the following milestones have to be met: Contract with overburden removal contractor by the middle o f 2006; Engineering and procurement o fmine equipment and belt conveyors by the middle o f 2007; Manufacturing, delivery and start o ferection o f the first equipment inthe second half o f 2008; Commissioning o fthe first equipment inthe second half o f 2009; Last equipment to be commissioned inthe second halfo f 2011. The above milestones will be supervised duringProject implementation. 38 From the point o f view of the long-term strategic need to increase the electricity generation capacity, EUAS is continuing its technical and feasibility study for opening the new Collolar Mine along with its plans for a 3'd lignite fired power plant (Af9in Elbistan C). These studies will be shared and discussed with the Bank team duringimplementation. Ifconsideration is given to developing a new mine (Collolar) rather than expand production inKislakoy, EUAS will present a comprehensive economic case for such a choice. 39 Annex 5: ProjectCosts TURKEY: ELECTRICITY GENERATIONREHABILITATIONAND RESTRUCTURING Project Cost By Componentandlor Activity Local Foreign Total million million Emillion Component 1 -Afqin ElbistanA Rehabilitation 99.9 228.3 328.2 1. Rehabilitationof Af$n ElbistanA 92.1 160.4 252.5 '2. Rehabilitationof Turbineand Generators (fundedfrom EUAS 33.0 33.0 MaintenanceBudget) 3. On-going MaintenanceWorks (fundedfrom EUAS Maintenance 7.8 31.3 39.2 Budget) nvironmentalMonitoringSystems (fundedfrom EUAS Maintenance 0.9 0.9 Budget) 5. Operationaland MaintenancePractice Improvement(Consultant 1.7 1.7 ervices) roject Management(ConsultantServices) 1.o 1.o Component 2 - Financial and Operational Restructuring of 3.0 3.0 Generation Business Total Baseline Cost 99.9 231.3 331.2 Front-endFee 0.7 0.7 Total FinancingRequired 120.7 280.1 400.8 'Identifiabletaxes anddutiesare US$26 million(excludingVAT). FGD Project Project Cost By Component andlor Activity Local Foreign Total Cmillion Cmillion miIIion FGDequipment and installation Cost 36.3 144.9 181.2 Physicalcontingencies 3.6 14.5 18.1 Pricecontingencies 1.8 7.2 9.1 Total Project Costs 41.7 166.7 208.3 Extension of the existing mine Project Cost By Componentandlor Activity Local Foreign Total million million million Mine development cost 84.8 339.2 424.0 Physicalcontingencies 8.5 33.9 42.4 Pricecontingencies 4.2 17.0 21.2 Total Project Costs 97.5 390.1 487.6 40 Annex 6: ImplementationArrangements TURKEY: ELECTRICITY GENERATIONREHABILITATION AND RESTRUCTURING ImplementationAgency The project will be implemented by EUAS, the Government-owned generating company owning and operating about 24,000 MW o f thermal and hydro plants. A special Project ImplementationTeam (PMT) has been established to oversee the implementation o f the Project. The PMT i s managed by and staffed with engineers and other staff experienced in thermal plant operations and rehabilitation. The rehabilitation will be carried out by a contractor chosen based on ICB procedures o f the Bank. The contractor will be overseen by the PMT aided by RWE who will report to the PMT and EUAS top management. Inaddition, there will be considerable focus given to the monitoring o f the environmental impacts o f the project and the plant in general, either as part o f the implementation consultant contract, or as a separate contract. Because o f the importance o f this project to EUAS and to Turkey, EUAS management will follow its progress closely. It is likely that during project implementation, EUAS will be restructured into separate portfolio GENCOs. In this case, AfSin-Elbistan A will be transferred to the portfolio company containing the AfSin-Elbistan complex, hereinafter referredto as AfSin GENCO. The responsibility o f rehabilitationand supervision will be transferred to AfSin GENCO. The PMT, with adequate staff in Afgin GENCO, will be suitably enhanced to ensure that implementationdoes not suffer. The Bank loan will remain with EUAS' successor, EUAS Hydro. EUAS Hydro will enter into a back-to- back loan with AfSin GENCO. ImplementationSchedule The rehabilitationo f Afgin-Elbistan A i s expected to take about 33 months after contract award. The two- stage bidding process and contracting is likely to take about 11 months after preparation o f technical specifications, with contract signature estimated by end-March 2007. Thereafter, as shown in Figure 4.1 inAnnex 4 above, contract implementationwill start with the delivery ofmaterials, whichwill take about 14months, and rehabilitationwill be carried out for each unit sequentially. This i s an ambitious timeline, and will require very close and regular monitoring to be implemented. Based on this schedule, the first rehabilitated unit will be commissioned inmid-2008, and the entire plant will be re-commissioned inthe second half o f 2009. Under an alternative compressed schedule project duration i s estimated at 22 months, with the assumption that work will continue during winter months and that several units can be rehabilitated inparallel. This will have cost implications. 41 Annex 7: FinancialManagementand DisbursementArrangements TURKEY: ELECTRICITY GENERATIONREHABILITATIONAND RESTRUCTURING A. Summary of FinancialManagementArrangements An assessment o f the financial management arrangements for the project was undertaken duringOctober 20-3 1, 2005 and the assessment will be updated during appraisal and before Board. The current financial management arrangements for the project are marginally satisfactory to the Bank and an action plan i s developed to bringthe arrangements to a satisfactory level for the Bank. Detailed financial management questionnaire i s presented as an annex to this report. A summary o f the conclusions are as follows: RATING COMMENTS 1. Implementing Entity Satisfactory 2. Funds flow Satisfactory 3. Staffing Marginally Additional qualified staff will be assigned to the Satisfactory project by May 15, 2006. 4.Accounting Policies and procedures Marginally A draft financial management manual will be Satisfactory prepared and accounts relating to project transactions will be opened in the main accounting system by April 30,2006. No reliance will be placed on internal audit. The project will start in 2006. Therefore, the Satisfactory auditors for the project will be assigned by November 30, 2006. The Financial Affairs Department will prepare the TOR for the annual audit of project financial statements as well as for the audit of entity financial statements. 7. Reporting and Monitoring Satisfactory The format and the contents of the interim un- audited financial reports (or the Financial Monitoring Reports - FMRs) have been determined. 8. Information systems Marginally Satisfactory OVERALL FM RATING Marginally Satisfactory Country Issues State Economic Enterprises in Turkey are subject to basic accounting and auditing obligations which apply to companies in Turkey. These are laid down in the Commercial Code, which was last revised in 1956. More detailed requirements were introduced in the Tax Procedures Law o f 1950 (which has since been consolidated into the Tax Procedures Code). Under the powers granted to it by the Code, the Ministry o fFinance (MOF) introduced a Uniform Chart o fAccounts which became effective on January 1, 1994. This prescribes certain fundamental accounting concepts, a code o f accounts, and a format for the presentation o f financial statements. The mainpurpose o f these requirements i s to provide information to the taxation authorities, there i s no obligation to publishthe financial statements, nor are they subject to a mandatory financial statement audit. 42 RiskAnalysis A summary o fthe riskassessmentfor the project is as follows IRisk IComments Board 7. Reporting and Monitoring Moderate Draft FMRs will be prepared by EUAS prior to Board 8. Information Systems Moderate Overall Control Risk Moderate RiskMitigationStrategy Country financial management risk -the project will be implemented by EUAS, a state owned enterprise which has adequate financial management arrangements inplace. Control risk - an action plan is agreed with EUA$ to reduce the control risk to a negligible level before Board. ImplementingEntity The project implementation will be carried out by EUAS. There will be a Project Management Team (PMT) responsible for the daily implementation o f the project. Overall project coordination will be carried out by the deputy general manager responsible for power plants. The technical departments will be responsible for the procurement o f goods and services and the physical progress o f the project. The financial management functions will be performed by the Loans Directorate under the Financial Affairs Department o f EUA$. Currently there i s one manager and two assistant managers working in the Loans Directorate which requires the support o f an additional staff with the necessary qualifications. The related technical departments, together with a consultancy firm, will prepare the technical specifications or Terms o f References (TORs) for the goods, works, and services required. The evaluation committee will be made up o f representatives from EUAS power plants and other departments o f EUAS e.g. the finance department. The acceptance and oversight o f the related items procured will be the responsibility o f the technical department. The consultancy firm will supervise the implementation o f the project in line with the TORs. The Loans Directorate will make the payment fi-om the Designated Account following the approval o fthe technical departments. 43 The Loans Department will document the format and the contents o f the information required from technical departments to make payments following the project financial management manual. The risk associated with implementingentity i s negligible. EUAS i s a well established SOE. FundsFlow There will be one designated account for the project for disbursements. The Designated Account will be inEUROSand will be at an acceptable commercialbank. All payments to the contractors, suppliers and consultants will either be made directly from the loan account or from the Designated Account with the authorization o f the responsible personnel. EUAS obtained a budget allocation o f YTL 52 Million for the AfSin-Elbistan Plant Rehabilitation. The State Planning Organization approved the feasibility studies o f the project on March 27, 2006. Accordingly, the project funds can be utilized when they become available. The risk associated with funds flow i s considered as negligible. Staffing The Loans Directorate, which will be responsible for the financial management functions, i s currently staffed with a manager and two assistant managers. The department i s responsible for the financial management functions o f all foreign loans o f the company. Considering the additional work that will be introduced by the project it i s important that an additional staff with the necessary linguistic skills and computer literacy i s assigned to the Loans Directorate. The risk associated with staffing i s assessed as moderate. EUAS will assign an additional staff with satisfactory qualifications and experience to the Loans Department by May 15,2006. Accounting Policies and Procedures The project transactions will be entered into the main accounting system o f EUAS however the accounting system does not have the capability o f having detailed sub accounts or codes for transactions relating to the World Bank loan to facilitate project reporting. Therefore, EUAS will assign a specific ledger code for the project under the relevant accounts and at the same time it will make use o f supplemental Excel spreadsheets to account for transactions based on activities and disbursement categories. Those spreadsheetswill be reconciledwith the main accounting records on a regular basis. EUAS is a well-established SOE and the current accounting policies and procedures are acceptable to the Bank. The company uses the Uniform Chart o f Accounts and applies the accounting policies as required by the Ministry o f Finance. The financial management procedures relevant for the project will also be included in the financial management manual for the project. The financial management manual will cover (a) the financial and accounting policies and procedures for the project (b) organization of the financial management functions (staff responsibilities) (c) the financial management information system (d) disbursements (e) budgeting and financial forecasting and (f) project to be finalized. The draft project financial management manual will be prepared by M a y 30,2006. Currently, EUAS has a partially centralized accounting system. Thermal power-plants, hydraulic power- plants and other similar directorates have the responsibility for recording their own transactions into the accounting software. The accounting data i s then sent on a quarterly basis to the Financial Affairs Department inthe General Directorate, where the control and consolidation work i s done. EUASplans to replace the existing accounting system with a fully integrated ERP system, the tendering process for 44 which i s completed. EUAS expects that the project will be completed by the end o f 2007. The project financial management will than be fully integrated into EUAS system and therefore the successful implementationo f ERP will be a dated loan covenant. The risk associated with accounting policies and procedures i s considered as moderate. EUAS will generate the excel worksheets to facilitate accounting in foreign currency and project reporting by M a y 30,2006. InternalAudit There i s not an internal control department which undertakes regular audits o f the departments within EUAS andtherefore noreliance will beplacedon internal audit. EUASdoes not fall withinthe scope o fthe enacted Public FinancialManagement and ControlLaw which requires internal control departments to be established at Government institutions. However, since EUAS i s committed to modernize its financial management systems it i s important that the Organization considers the establishment o f a modern InternalAudit Department. ReportingandMonitoring The Loans Directorate will maintain records and will ensure appropriate accounting for the funds provided. Financial statements for the project will be prepared by the Loans Directorate. The interim un- audited financial reports - also expressed as Financial Monitoring Reports (FMR), will be prepared quarterly and will be submittedto the Bankno later than 45 days after the end o fthe quarterly period. The format and the contents o fthe FMRhave been discussed and agreed between the Bank and the Loans Directorate. The financial management manual o f the project will include a section on the FMR. The FMR will include financial reports, output monitoring reports and procurement reports. The responsible unitsfor the preparationo feachofthese reports have alsobeenagreed. The financial accounting software is not capable o f producing the financial reports. Excel based spreadsheets satisfactory to the Bank will be preparedby the Loans Directorate by May 30,2006. The risk associated with reporting and monitoring i s assessedas moderate. InformationSystems EUAS uses an in-house developed accounting software. The project transactions will be recorded using the current software and the Loans Directorate will prepare separate financial reports based on Excel spreadsheets. Currently, EUAS has a partially centralized accounting system. Thermal power-plants, hydraulic power-plants and other similar directorates have the responsibility for recording their own transactions into the accounting software. The accounting data is then sent on a quarterly basis to the Financial Affairs Department in the General Directorate, where the control and consolidation works are done. EUAS plans to replace the existing accounting system with a fully integrated ERP system, the tendering process for which is completed. (See above.) The risk associated with information systems i s assessed as moderate. EUAS will generate excel worksheets to support project and will successfully implementthe ERPby December 31,2007. StrengthsandWeaknesses The significant strengths that provide the basis for reliance on the project financial management system include (a) experience o f the staff in the Loans Directorate under the Financial Affairs Department in 45 World Bank projects, (b) preparation o f a financial management manual for the project satisfactory to the Bank before Board. A weakness inthe project's financial management system is the staffingissuewhich will be addressedby EUAS by assigning additional qualified staff with CVs satisfactory to the Bank to the Loans Directorate before Board Action Plan It is concluded that the financial management arrangements for the project marginally satisfy the Banks minimum requirements. The following action plan is proposed to develop the financial management system to a satisfactory level before the loan i s submitted to Board: ctorate for the financial management of the ended Decembe; 31,2006. I7. Financial Monitoring Reports integrated to the 1December31, 2007 ERPsystem SupervisionPlan Duringproject implementation, the Bankwill supervise the project's financialmanagement arrangements intwo mainways: (i) the project's quarterly financial managementreports as well as the project's review annual audited financial statements and auditor's management letter; and (ii)during the Bank's supervision missions, review the project's financial management and disbursement arrangements (including a review o f a sample of SOEs and movements on the Designated Accounts) to ensure compliance with the Bank's minimum requirements. As required, a Bank-accredited Financial Management Specialist will assist inthe supervision process. ExternalAudit EUAS was established in 2001. As there was no legal obligation for having its accounts audited by external auditors, the company didn't receive such services until 2005. Considering the fact that the external audit will be mandatory with the starting o f the project in2006, the company decided to have its accounts for the years ended 2002,2003,2004 and 2005 be audited prior to that date. Accordingly, EUAS has completed the tendering process for the audit services and assigned external auditors who will audit the company's financial statements for 2002, 2003, 2004 and 2005 in accordance with International Financial Reporting Standards (IFRS) and International Standards on Auditing.(ISA). The audit firm assigned by EUAS to carry out the audit o f the financial statements for the years ended 2002 to 2005 is a local firm however it i s included inthe Capital Market Boards list o f accepted audit companies. Once the loanbecomes effective the audit TOR will be revised for 2006 and onwards to include the audit o fproject financial statements. 46 State Owned enterprises in Turkey are subject to the audit o f Higher Audit Board (YDK). YDK was established in 1938 to audit State Owned Enterprises (SOEs) on behalf o f the Parliament. The YDK reports for the years 2003 and 2002 were reviewed. The main findings relating to financial management issues are that inventory and registration procedures relating to the fixed assets transfers from other government institutions to EUAS are not completed. The IFRS financial statements audited in accordance with ISA will be reviewed once they are received. If the results o f the audits reveal any weaknesses inthe financial management o f EUAS, an action plan will be agreed with the company to address the issues identified and progress will be monitored during supervision. The risk associated with external audit i s considered moderate. EUAS' IFRS and ISA financial statements are not available but the YDK report has been reviewed and no major internal control issues were identified. EUAS will assign the auditors acceptable to the Bank for the year ended December 31, 2006 byNovember 30,2006. B. DisbursementArrangements Designated account: EUAS will open and maintain a Designated Account (DA) in EURO at an acceptable commercial bank. The DA will be used following procedures to be agreed with the Bank, and will have an authorized allocation o f 20 million. Two signatures indicated in the list o f authorized signatures submittedby EUASwill be required on the withdrawal applications. The minimumapplication size for payments directly from the Loan Account for issuance o f Special Commitments i s 4.0 million. Applications for replenishment o f the DA will be submitted to the Bank on a monthly basis, or when the balance o f the DA is equal to about half o f the initial deposit or the authorized allocation, whichever comes first, and will include a reconciled bank statement as well as other appropriate supporting documents. Use of statements of expenditure (SOEs): Disbursements will be made against Statements o f Expenditures for: (a) goods costing less than 5 million equivalent per contract; (b) consulting contracts with firms, costing less than E 275,000 equivalent each; (c) consultingcontracts with individuals, costing less than E 75,000 equivalent each. Full documentation in support o f SOEs would be retained by EUAS for at least one year after the Bank has received the audit report for the fiscal year in which the last withdrawal from the Loan Account was made. This information will be made available for review during supervision by Bank staff and for annual audits which will be required to specifically comment on the propriety o f SOE disbursements and the quality o f the associated record-keeping. Utilization of Loan Proceeds: EUAS will finance the turbine rehabilitation expenditures, other elements such as the switchyard etc., taxes, interest during construction, and contingencies. The Bank loan will thus finance about 70% o fthe total project cost (excluding VAT). Retroactive Financing: Expenditures incurred for consulting services after April 30, 2006 may be financed, upto amaximum o fE 500,000. 47 Category Allocation Loan I % of Expenditureto be financed 1. Goods (including supply and installation) 273,600,000 100%of foreign expenditures, 100%of local expenditures (ex-factorycost) and 85% of other items procured locally 2. Consultingservices 5,700,000 100% 3. Front-endFee' 7oo,ooo Amount due under Section 2.04 of the Loan Agreement in accordancewith Section 2.07 (b) of the General Conditions Total 280,000,000 Front-endFee calculatedon the basis of 0.25% ofloan amount. This will be applicable ifthe loan is approved by the Bank Board by June 30,2006. 48 Annex 8: ProcurementArrangements TURKEY: ELECTRICITY GENERATIONREHABILITATIONAND RESTRUCTURING A. General Procurement for the proposed project would be carried out in accordance with the World Bank's "Guidelines: Procurement Under IBRD Loans and IDA Credits" dated May 2004; and "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" dated May 2004, and the provisions stipulated in the Legal Agreement. The general descriptions o f various items under different expenditure categories are described below. For each contract to be financed by the Loan, the different procurement methods or consultant selection methods, the need for two-stage bidding, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank project team and listed in the Procurement Plan. The Procurement Plan will be updated regularly to reflect the actual project implementationneeds and improvements in institutionalcapacity. Procurement of Works: No Works contracts are foreseen inthe Project. Procurement of Goods/Supply and Installation: Goods procured under this project would include: Rehabilitationo f AfSin-Elbistan Lignite fired power plant including all equipment supply and installation. Because o f the size and complexity o f the rehabilitation works, two-stage bidding will be conducted in accordance with the provisions o f paragraph 2.6 o f the Procurement Guidelines. The Bank financed part of the rehabilitation works will include the rehabilitation o f boilers, firing system, piping, balance of plant, electrostatic precipitators, instrumentation and controls, ash and coal handling, civil works, chemistry plant. Turbine and generator rehabilitation will be done by EUAS'S own sources. The environmental monitoring will be financed by EUAS'Sown sources under a separate contract including equipment supply. Basically, there will be one large Goods/Supply Installation contract in this Project and it will be conducted through two-stage International Competitive Bidding (ICB) procedures. The cost estimate for this bigcontract was done by German firm RWEwhich has been employedby EUASunder the scope of feasibility study. The cost estimate has been reviewed by the Bank's technical experts and found conservative in order to allow for unforeseen situations during the rehabilitation works. It has been estimated that overall uncertainty does not exceed 15% o f the base cost. The procurement will be conducted usingthe Bank's latest Standard BiddingDocuments for Supply and Installationo f Plant and Equipment. The Goods/Supply and Installation Contract will be subject to prior review by the Bank. Procurement of non-consulting services: No non-consulting services are foreseen inthe Project. Selection of Consultants: Consulting firms would be required for Financial and Operational restructuring o f EUAS, improvement o f O&M practices of EUAS, and assistance to EUAS Project Management Team duringthe implementationo fthe project regarding the specialized subjects. Short lists of consultants for services estimated to cost less than 160,000 equivalent per contract may be composed entirely o f national consultants in accordance with the provisions o f paragraph 2.7 o f the Consultant Guidelines. Individual consultants may also be required for highly specialized subjects and for support to the Project Management Team. 49 The envisaged procurement methods for the Selection o f Consultants inthis project are: - Quality and Cost Based Selection (QCBS); - Selection Based on the Consultants Qualifications (CQS) for the services estimated to cost less than 160,000; - Individual Consultants. Consultancy services estimated to cost above 275,000 per contract and Individual Consultants estimated to cost above 75,000 per contract will be subject to prior review by the Bank. Regardless o f the estimated cost, the first two contracts for each selection method and the Terms o f References o f all individual consultancy contracts will be subject to prior review by the Bank. OperationalCosts: The project will not finance any operational cost. B. Assessment of the agency's capacityto implementprocurement Procurement activities will be carried out by EUAS. Assessments o f the capacity o f the Implementing Agency to implement procurement actions for the project has been carried out by the Bank team between September 2004 and October 2005, and updated in February 2006. The assessments reviewed the organizational structure and procedures for implementing the project. EUAS has established a Project Management Team (PMT) under the coordination of Deputy General Manager responsible from Department o f Thermal Power Plants and Mining Areas. The PMT composition i s as follows: the Department Head, Deputy Department Heads, one Mechanical Engineer, one Environmental Engineer. The PMT will be supported by the procurement staff experienced inpublic procurement and other international procurement procedures during the procurement process. EUAS' existing consulting firm, RWE, which prepared the feasibility study and basic design, will help EUAS in preparingthe biddingdocuments for the main supply and installation contract. This firmwill also conduct the site supervision o f the rehabilitation works and will be continued to be financed by EUAS' own sources. EUAS as an institution has experience in the procurement and implementation o f large international contracts. However, EUAS does not have experience under the Bank's procurement Guidelines (except the selection o f consultants under PHRDTrust Fund). Considering that the EUAS staff has little experience inthe Bank's procurement procedures the following action plan for reducingprocurement riskwas agreed: 1. During the project preparation stage between September 2004 and February 2006, the Project Management team staff was informed about the Bank's procurement Guidelines, Standard Biddingdocuments andthe procedures. 2. The Project Management Team Staff participated in the procurement training given on June 24, 2005 by the Bank's procurement specialist inthe Bank's Ankara office. 3. Since EUAS intends to initiate the procurements before the Loan negotiations, in the preparation o f the bidding documents EUAS' staff and the Bank's procurement specialist agreed to work closely. 4. EUAS staff will participate in regular monthly procurement meetings arranged by the Bank's procurement specialist. The overall project risk for the procurement i s high. 50 C. ProcurementPlan The Borrower has developed a Procurement Plan (Attachment 1 to this Annex) for project implementation which provides the basis for the procurement methods. This plan has been agreed between the Borrower and the Project Team on April 26,2006 and is available at the Project Management Team's office in EUAS. It will also be available in the Project's database and in the Bank's external website. The Procurement Plan will be updated annually inagreement with the Project Team to reflect the actual project implementationneeds and improvements ininstitutional capacity. D. FrequencyofProcurementSupervision Inadditionto the prior review supervisionto be carriedout from Bankoffices, the capacity assessmentof the Implementing Agency has recommended semi-annual supervision missions to visit the field to cany out post review o fprocurement actions. The Project Management Team in EUAS will keep a complete and up-to-date record o f all procurement documentation and relevant correspondence in its files which will be reviewed by the Bank staff during supervision missions. Monitoring reports and on procurement progress inthe form o f completed-ongoing-planned procurements will be submitted semi-annually as an integral part o f the Financial Monitoring Report on Project implementation. E. Other EUASmay initiate procurement o f consulting services scheduled in2006 (or before the Loan effectiveness date) in accordance with the Bank's Consultant Guidelines [Refer to paragraph 1.12 o f the Consultant Guidelines]. The contracts which will have beenreviewed by the Bank may retroactively be financed by the Bankas described inthe Loan Agreement. 51 z 8 L IC 0 L 2 ; W 0 Annex 9: Economicand FinancialAnalysis TURKEY: ELECTRICITY GENERATIONREHABILITATIONAND RESTRUCTURING Summarv a The hovernment forecasts electricity demand growing by about 8.3% per annum till 2010 (and gradually slowing thereafter) whereas supply from existing plants and those under construction i s expectedto grow only marginally after 2005. a Supply shortages are expected to start in the period 2008 to 2010, depending on the actual growth indemand inthe interveningperiod. It i s prudent to prepare for a shortage starting in 2008-09. a Rehabilitating Af9in-Elbistan A is the fastest response that the Government can provide for mitigating the risks to supply security. Rehabilitation can be completed in 2-3 years, and about 8 TWh of energy can be generated once the plant is re-commissioned. The increased generation from Af$n A will defer the shortages by around a year, giving the Government more time to arrangefor the construction of new plants to meet the shortage. a A rehabilitated Af9in-Elbistan A power plant is also the least cost option for additional generation in this time frame. After rehabilitation, the plant can generate at a discounted price of about 3.8 U.S.cents/kWh with an FGD. The next lowest cost option is a combined cycle gas plant using imported natural gas which will cost about 4.4 U.S.cents/ kWh (discounted). a The rehabilitation will reduce the dust emissions significantly - dust emissions have been reported by the local population as beingtheir most important concern with the plant. While this benefit is not quantified in the economic analysis, the health benefits are clearly significant. I. ECONOMICANALYSIS Maineconomicbenefitsofthe rehabilitation The rehabilitation of Af9in-Elbistan A has been analyzed from two broad aspects - one, from the point of view of its importance for ensuring supply security, and second, from the point of view of whether the rehabilitation is the least cost generation option for Turkey. The main benefits from the rehabilitation of Af9in Elbistan A are summarized here, and discussed in detail thereafter: Security of supply -The rehabilitation of Af9in-ElbistanA can be completed very quickly, in 2-3 years, just in time to meet the shortages anticipated in 2009-10. The incremental generation from Af$n A will defer the shortages by around a year, giving the Government critical time to arrange for additional capacity. Least cost source of generation-At alevelizedprice of about 3.8 centskWhwith the FGD, the rehabilitated Af9in-Elbistan A i s the least cost option for additional generation. A combined cycle gas plant using imported natural gas will cost about U S cents 4.4/ kWh (levelized). Reduction in dust emissions- Dust emission has been reported by the local population as being their most important concern with the plant, and rehabilitation will reduce dust significantly. 53 A. Security of supply The analysis o f demand and supply forecasts shown below indicate that Turkey may beginfacing growing shortages starting in 2008-2009 under the scenario o f high demand growth with or without dry conditions, and 2009 under a more conservative scenario o f dry conditions and low demand growth. The rehabilitationo f AfSin Elbistan A i s critical to meetingthe shortages. Electricity demand and supply inTurkey Table 9.1 below shows the growth rates o f GNP and electricity consumption for the past two decades Inthe 1980s and 1990s, electricity demand grew at a rapid average rate o f 8.6 % but varying from 4% to 13% per year. The impliedelectricity demand to income/GDP elasticity in these two decades ranged from an average o f 1.00 to a high o f 5.56 but averaged 2.0. In the current decade, demand growth has slowed owing to the economic crisis o f 2001. However, demand has since then grown at 5.9% per year which - although representing a healthy rate o f growth - implies an electricity demand to income/GDP elasticity averaging about 0.83. Table 9.1: GNP and Electricity Consumption Growth Rates (1980-2005) 1 Percentage I1980-85 I 1985-90 I 1990-95 I 1995-`00 1 2001 I 2002 12003 I 2004 I2005 1 IGNPGrowth I 4.7 I 5.7 1 3.2 1 3.8 1-9.6 I 8 1 5.8 1 9.9 I 7.6 I ElectricityGrowth 8.1 9.4 8.5 8.4 -0.8 4.7 6.9 6.2 6.9 Demand forecasts The Government has prepared two forecasts for growth o f electricity . demand. These are based on economic growth scenarios prepared by SPO and the forecasting i s done usingthe MAEDmodel (Model for Analysis of Energy Demand) that i s runby MENR. High Case: Electricity demand growth o f 8.6% per year - based on a GDP growth o f 5.5% per year. This implies electricity demand to income/GDP elasticity o f slightly over 1.5. Low Case: Electricity growth rate in demand o f about 6.3% per year. This i s based on the same forecast o f GDP growth but makes different assumptions in the MAED model about the composition o f manufacturing. It assumes that Turkish manufacturing moves towards less energy intensive industries compared to the high case. This implies an income elasticity of about 1.0. These forecasts are inTable 9.3 as the "high case" and the "low case" respectively. Energy Intensity The Bank reviewedthe energy intensity o fthe Turkisheconomy as part o fthe Energy and Environment Review work. Turkey has been below the OECD average energy intensity measured as total primary energy supplied divided by GDP measured on a purchasing power parity basis. Ifinstead o f usingpurchasing power parity, GDP were measured based on an exchange rate basis, Turkey would be at or a little above the OECD average intensity although considerably lower than some developed OECD countries. While this leaves considerable room for growth in energy demand, unlike most o f Eastern Europe Turkey has not had subsidized energy and therefore has not developed the highdegree o f energy intensity so common inEastern Europe. There were some negative elasticities also when electricity demand continued to grow duringrecessions. 54 The Government i s endeavoring to improve energy efficiency over time through various demand side means as well as supply side efforts such as improvement o f power plant operations. However, electricity demand is likely to witness an offsetting factor in the rapid growth o f urbanization (and especially the rapid growth o f air conditioning loads especially along the Aegean and Mediterranean coastal areas). The high growth anticipated in demand forecasts discussed above therefore, seem consistent with comparable energy intensity across countries. ExistingCapacity and Addition Projections As o f end 2004 Turkey had 36,822 MW o f installed generating capacity, o f which about 60% i s owned and operated by EUA$ and its affiliates, with the remaining under private operation. The last 4 years (2000-2004), have seen a steady increase in generating capacity, a compounded average growth o f 8% per annum. Almost this entire increase in capacity (99%) came from the private sector, and EUAS' share of total capacity declined from 80% in2000 to about 59% in2004. Generating capacity i s adequate to meet the current level o f demand and there i s adequate reserves capacity to meet the anticipated increase in demand over the next few years. A significant amount o f capacity (2,573 MW) has been completed in 2005 (mostly lignite fired power plants' and hydro power plants being built by EUAS) taking the total capacity to about 39,000 MW. However, after that there are few additions to capacity anticipated, and compounded average annual growth from 2005 to 2010 i s expected to be only 1% (the growth in energy availability i s even lower). Table 9.2 below shows the growth in existing installed capacity, and the forecast 2010 capacity. Table 9.2: Growth in Installed Capacity in Turkey (2000-2010) 2010 Capacity based on existing plants and those under construction (Capacity in MW) 2000 2005 2010 EUAS and Affiliates 21,682 24,276 26,346 (% of total) 80% 59% 64% Hydro 10,587 11,721 13,791 Lignite 6,090 7,461 7,461 - Natural Gas and others 5,005 5,094 5,094 Private 5,582 15,032 15,110 (% of total) 20% 41% 36% Hydro 587 1,621 1,658 Lignite 829 1,204 1,204 - Natural Gas and others 4,166 12,207 12,248 Total 27,264 39,308 41,456 Capacity ReserveMargin* 57% 6% ExpectedCapacity Need (High Demand) 17,0001 CAGR' (2000 to 2005,2005 to 2010) 7.6% 1% Energyoutput sensitivityto hydro conditions The Turkish electricity system i s very dependent on hydropower output. The present share o f hydropower capacity is about 34% and this is expected to increase to 37% by 2010. Ina normal rainfall year, hydro energy contributes 'Primarilythe Afsin- ElbistanB lignite plant with 1440 MW ofpower, the Can lignite power plant with 320 M W and two hydropowerplants, Borcka(306 MW) and Muratli (117MW). No other lignite fired plants are under construction buthydropowerplantswill still be cominginto operation including Deriner (670 MW) in2007. (InstalledCapacityMW- Peak DemandMW)/Peak Capacity M W Compounded annualgrowthrate 55 around 30% o f total energy availability. In dry periods therefore, which occur very regularly in Turkey, hydropower production drops sharply and can reduce the ability o f the country to produce hydro electricityby as muchas 40%. Supply Forecasts This analysis has used three forecasts o f supply growth (shown inTable 9.3 ... below). These forecasts are based on estimates by the TEIAS Planning Group o f the expected generation ability o f existingplants and plants under construction: Dry conditionssupply forecast assumes lower than average rainfall in each year in the future and that Af$n ElbistanA i s not rehabilitated, Normal hydro conditions forecast assumes average rainfall in the future also without rehabilitation o f Afgin ElbistanA, and The last forecast assumes normal hydro and rehabilitation of Afyin-Elbistan A as planned. Because o f the continuing growth o f demand and the slower growth innew capacity after 2005, Turkey i s expected to begin experiencing shortages of energy in the latter part o f this decade unless additional capacity, which i s not currently planned, i s provided. Inthe scenario with "dry conditions", Turkey would start to run short o f electricity in 2008 inthe "high demand case", and in 2009 in the "low demand case". Under a scenario with "normal hydro conditions", the shortfall occurs in2009 inthe "high demand case", and in2011inthe "low demand case". These results are shown in Table 9.3 below. While it i s more realistic to anticipate shortages in 2009- 10, it i s prudent to be conservative and to prepare for a shortage starting in2008-09. Peaking shortage Inaddition to the energy shortages shown inthe table below, Turkey will also face peaking shortages in the future under current demand and supply forecasts. Additional capacity to meet peak demand i s thus also required, but this requirement i s less urgent than that for base load generating capacity to meet energy requirements. For example, in the "high case", additional peaking capacity i s not required until 2010 compared with the requirement for additional energy in 2008. This delay in the requirement for peaking capacity relative to the requirement for energy occurs because Turkey has a lot o f hydropower which can provide peak load intimes of peak requirements but provides much less annual generation since water supplies for generation are limited. Table 9.3: Forecastsupply and demand balancefor Turkey (2006-2011) 2006 2007 2008 2009 2010 2011 DEMAND Official GovernmentCase 176.4 190.7 206.4 223.5 242 262 Low Case 169.5 180.2 191.7 203.8 216.7 230.4 SUPPLY Dry Conditions 192.2 199.3 199.4 199.4 198.9 198.1 - Lignite 63.5 68.3 68.0 68.2 68.0 68.0 - Natural Gas 88.9 88.9 88.9 88.9 88.9 88.9 -Hydro 28.6 30.9 31.3 31.1 31.2 31.2 - Other (oil, wind, etc.) 11.2 11.2 11.2 11.2 10.8 10. NormalHydro Conditions 213.4 222 222.4 223.2 223.7 222.9 - Lignite 63.5 68.3 68.0 68.2 68.0 68.0 - Natural Gas 88.9 88.9 88.9 88.9 88.9 88.9 56 2006 2007 2008 2009 2010 2011 - Hydro 49.8 53.6 54.3 54.9 56.0 56.0 - Other 11.2 11.2 11.2 11.2 10.8 10 Normal Hydro with A$in A Rehabilitation 213.4 222 224.9 228.3 226.8 229 - Coal/ignite 63.5 68.3 70.5 73.3 73.1 73.1 - Natural Gas 88.9 88.9 88.9 88.9 88.9 88.9 -Hydro 49.8 53.6 54.3 54.9 56 56 - Other 11.2 11.2 11.2 11.2 10.8 10.8 Scenario 1: Official case and dry conditions Shortage in 2008 Scenario 2: Low case and dry conditions Shortagein 2009 Scenario 3: Official case and normal Shortagein 2009 Scenario 4 Low case and NormalHydro Shortage in 2011 The main benefit from the rehabilitation o f Afqin-Elbistan A i s that the plant will be able to supply substantial additional electricity to meet the potential supply shortages shown above. Currently, the plant generates around 2.6 TWh-3.0 TWh at a capacity factor o f about 30% (based on the net effective capacity o f 1,040 MW). Further, it i s a strong possibility that in the absence of major overhaul, the plant's capacity will deteriorate, and its generation will decline over time until it cannot run anymore. After rehabilitation on the other hand, the capacity o f Afqin A is expected to go back to design conditions o f about 1360 MW gross and 1200 MW net. Generating at a capacity factor o f about 75%, Afyin A will thus be capable o f producing at least 8 TWh per year while being used as a base load plant. The rehabilitation will further extend the remaining economic life significantly, enabling this high level o f generation to continue for a much longer time than i s presently possible. The rehabilitation o f Afqin-Elbistan A provides the Government with the quickest source o f additional energy at a time to meet the impending shortages. On its own, the rehabilitation can prevent shortages for about a year. Thereafter, other sources o f generation will be required. Given however, that most types o f generating plant will take 3-5 years to construct, the rehabilitation o f Afyin Elbistan A gives very critical breathing space for additional capacity to be plannedand implemented. B. Least cost source of generation The rehabilitation o f Afyin-Elbistan A i s the least cost means o f providing additional electricity generation in Turkey. The Bank team's estimate o f the economic cost o f generation from a rehabilitated AfSin ElbistanA i s a levelized cost (discounted at 10%) o f 3.8 U S centskWh with an FGD. These calculations are based on a cost o f rehabilitation excluding VAT o f US$ 453 million and a cost for the FGD o f US$ 250 million. The rehabilitated plant i s expected to have a capacity factor of 75%. 57 The key factor in determining the cost o f generation from the rehabilitated plant i s the cost o f the lignite. Lignite costs from the Afgin Elbistanmine were US$ 5.9 per ton for the first 10months o f 2005. Currently the mine is operating at about 15 Million tons per year, compared to capacity o f 18 million tons, and it i s primarily supplyingthe Afgin Elbistan B Power Plant. For the past five years (1999-2004) costs have varied between US$ 3.27 per ton and US$ 11.46 per ton depending almost entirely on capacity utilization at the mine. Most o f the costs in the mine are fixed and when production is down, as for example in 2004 (6.1 million tons), then costs are high at US$ 11.46 per ton. When the mine is operating at close to full capacity, as in 1999(17.5 million tons), then the cost is low at US$3.27 per ton. Looking ahead the current mine will needto be upgraded at an estimated cost o f US$ 140million spread over 10 years. Also the mine will need to be expanded or a new mine built so that there will be adequate capacity to supply not only the Afgin Elbistan A Power Plant but also the Afgin Elbistan B Power Plant .The mine expansion or new mine will have to have capacity also of 18 million tons per year. Based on an RWE study on mine expansion options, it appears that the least cost approach may be to expand the existing mine, as opposed to developing a new mine. RWE has estimated that an expansion of the existing mine would cost about US$ 354 million. The team made a simulation o f the economic cost o f coal from an expanded and upgraded mine based on the estimated capital costs indicated above as well as current mining costs including labor, electricity, materials etc. Over a 20 year period the levelized economic cost o f the coal would be about US$ 5.80 in2006 dollars, and this was used for estimating the cost o f generation from the rehabilitated Afgin Elbistan A Power Plant. The heating value o f the coal from the Afgin Elbistan Mine i s quite low. The power plant was designed on the assumption that the heating value i s about 1050 kcalkg. However, the actual heating value has been somewhat higher with the mining staff claiming it is close to 1200 kcalkg. To be on the conservative side the Bank team assumed 1100 kcal/kg. If 1200 Kcalkg were usedit would reduce the levelizedcost o f generationby about 0.1 U S cents. Given that the rehabilitated plant will be the least cost option for Turkey under any scenario and have low incremental costs, it will rank very high in the merit order, and will begin dispatching from the moment it i s commissioned. Afgin ElbistanA is thus likely to displace some higher cost plants such as plants runon expensive fuel oil or natural gas that currently have to be dispatched to meet the energy demand. This will result in fuel cost savings for EUAS, but these benefits are not currently factored into the economic analysis. Other alternative sources of generation Table 9.4 below gives the respective discounted cost o f production for different new generating plants. The next least cost alternative would be a combined cycle gas generation plant using imported natural gas. The cost o f power from a new combined cycle is estimatedas 4.4 U S cents per kwh(levelized). This estimate assumes capacity utilization at SO%, construction costs o f $600kW excluding interest during construction (IDC) and a technical efficiency factor o f 55%. Currently, EUAS pays US$277 per thousand cubic meters for gas. Ifgas costs were to remain at this high level a new combined cycle plant would generate at a cost o f over 6 U S centskwh. However, natural gas prices paid by EUAS follow crude oil and product prices with a lag. They are in effect indexed to a moving average o f crude and product prices. The Bank's forecast of crude oil prices was used to forecast the sales price o f natural gas in Turkey to electricity generators. This price drops from US$277 per thousand cubic meters today to US$ 192 in 2015 after which it begins to rise slowly. Based on this forecast o f natural gas sales prices in Turkey the levelized cost o f generation froma combined cycle plant i s 4.4 U S cents/kwh. 58 A combinedcycle plant can also be builtquite rapidly. Most o fthe equipment is off-the-shelf and a new combined cycle plant could be available to operate in a few years. All o f the other alternative power plants discussed below would take longer because they have to be individually designed with most of the equipment specifically built for that particular plant. For the imported coal plants, capital cost i s assumed at US$978/kW, fuel cost o f US$ 60 per ton, coal with a calorific value o f 6000 Kcalkg, 38% efficiency, and a 75% capacity utilization factor. The resultant levelized cost o f production i s 4.9 U S centskwh. (Ifcoal prices were to fall to US$ 45 per ton then the cost o f generation would be reduced to around 4.3 cents.) In the unlikely scenario where an FGD i s required (the new importedcoal plant at Iskenderun has one although it i s not required to meet Turkish emission standards if low sulfur coal i s used) it raises the cost from 4.9 U S centsfkwh to 5.2 U S cents/ kwh. Another alternative would be to buildan entirely new plant at Afyin Elbistan (Afvin Elbistan C). This new plant would however, be substantially more expensive than the rehabilitation o f Afvin A. Based on information provided by the TEIAS planning group, RWE and the actual cost o f Afqin B, it is estimated that a new Afqin C with an FGDwould cost around $ 1.98 billion. Thus a new Afqin C would cost over twice as much as rehabilitation o f Afqin A. In addition the new plant would take longer to construct and would be unlikely to be available before 2011. Finally the levelized cost of production from this plant (assuming the same coal costs as for Afvin A and 37% efficiency) is about 4.9 U S centsfkwh - significantly above the cost o f production fiom a rehabilitated Afqin A (including an FGD)o f 3.8 U S centskwh. Table 9.4 below shows several other options. The first i s a fluidized bed plant, which does not need an FGD, and would cost around US$ 1416kW to build. The lignite cost is assumed to be US$21 per ton with a calorific value o f 2470 Kcalfkg., it i s assumed to have 38% efficiency and to operate at 75% capacity. At current coal prices it appears to have about the same cost as an imported coal plant. The estimated cost o f nuclear power o f 4.4 centsfkwh i s based on a cost o f construction o f US$ 1750kW. The wind power cost depends on the capacity utilization factor which in turn i s site-specific and cannot be generalized. The estimated wind energy cost of 7.1 US cents/ kwhis TEIAS' estimate for a new plant ina reasonable location. The table also shows an estimated cost for electricity imports fiom Bulgaria. This cost i s based on what Bulgaria's Balkan neighbors pay to import electricity since Turkey does not currently import any energy. Moreover, this source o f electricity is limited. The Balkans are becoming power short and Bulgarian exports may not be available in substantial amounts when the nuclear units, Kozloduy 3 and 4 are closed as i s currently planned. Table 9.4: Levelized Costs of generation (US cents/ kWh)for different plant types Capital Cost Fuel Cost Utilization PLANT TYPE COST (blkw) Centslkwh % UScentslkwh Af$n -Elbistan A Rehabilitationwith FGD 3.8 584 1.8 75 NewGas fired Combined Cycle 700 MW 4.4 600 3.4 80 ImportedCoal, 600 MW 4.9 978 2.3 75 ImDOrtedCoal 600 MW, FGD 5.2 1118 2.4 75 59 Capital Cost Fuel Cost Utilization PLANT TYPE COST ($lkW) Centslkwh % Lignite Fluidized Bed, 160 MW 5.1 1416 1.9 75 Af$n C 5.0 1350 1.1 75 Wind 7.1 1500 0 32 Nuclear, 1500MW 4.4 1750 1.o 80 ImportedPower (Bulgaria) 4.6 N.A. N.A. MA. Source: TEIAS Generation PlanningGroup, Bankstaff estimates C. Environmental benefits The plant dust emissions are far in excess o f Turkish emission standards, even at its current low level o f utilization, and this is a major problem for the population inthe immediate area. Most o f the complaints inthe area relate to the dust levels perceived to be caused by the plant. As part o f the project, the electrostatic precipitators (ESPs) at the plant will be rehabilitated and as a result dust emissions are expected to decline sharply. While dust emissions exceed Turkish standards, the current ambient dust conditions for the smaller dust particles (PM,,) around the plant as measured by the EIA consultants were within the permissible daily limits (a maximum o f 300 micrograms per cubic meter 95% o f the time). However, the plant i s operating at a low level. If the plant were to operate at a higher capacity (which would be needed after 2008) without improving the ESPs, the ambient dust conditions are expected to exceed the Turkish Standards more than 5% o f the time. Modeling shows that after rehabilitation o f the ESPs, ambient dust (PM,,) levels are reduced by almost 99% and under the conditions o f full capacity Turkish ambient dust standards would be met. The main benefit from this i s likely to be a lower incidence o f respiratory disease. In addition, the local population argues that settleable dust which should be trapped by the ESPs are settling on crops and reducingproductivity. This issue should also be minimized when the ESPs are rehabilitated. Neither o f these benefits, however, has been quantifiedinthe economic analysis. Economic Rate of Return (ERR)- The Project has an ERR of 25%. The economic value o f the incremental electricity from the plant is considerable whether it is valued based on the wholesale price o f electricity, or it is valued based on the cost o f unserved energy. Unserved energy i s energy which i s indemand but i s not supplied because o f a shortage o f supply or transmission constraints etc. Given that the rehabilitated Afyin A will enable the existing demand to be met, it i s possible to assign an economic value to this electricity based on the cost o f unserved energy. Estimates" o f the cost o f unserved energy are typically in the range o f US$ 0.50 to US$ 1.00 per kWh- this value derives from the cost that a shortage imposes on consumers such as industries and relates to the costs o f coping mechanisms or the costs o fceasing operations. Using a value o f 38.5 Euro cents/ kwh" for unserved energy, which was used by Bank consultants working in the Balkans, the additional electricity from the rehabilitated Afyin- Elbistan A would be worth about US$ 2 billion per year, providing the project with a payback period o f 4 months and producing an ERR o f more than 100%. A more realistic estimation of economic rate o f return i s however, based on the forecast level of wholesale prices inTurkey once a market i s fully functioning. This has been assumed to be about 5.0 U S centskWh. Using 5.0 US cents as the value o f the incremental electricity generated by the rehabilitation o f Afyin Elbistan A provides the rehabilitation project with an ERR o f 25% "EstimatedbyconsultantsRedElectrica(SpanishGridCompany) for S.E.Europe 60 including the FGD. The financial rate o f return which includes taxes that would be paid by the plant, but otherwise has the same assumptions as the economic analysis, i s 22.1%. Sensitivity Tests A number o f sensitivity tests were done on the project to ascertain the impact of variations invarious parameters as follows: Increase inlignite prices, Increase inrehabilitationcosts, Reduction inelectricity prices, Reduction inthe estimatedlife o f the plant after rehabilitation, and Reductioninthe output o f the plant. As can be seen from the table below, the rehabilitationproject is very robust to changes inthese parameters and remains quite attractive under different sensitivities. Table 9.5: SensitivityTests for Afsin ElbistanA Rehabilitation Base Case Assumptions ERR FRR" Base Case 25% 22.1% Lignite Prices US$5.90 per ton Sensitivity 1 + 20% 21% 18.5% Sensitivity 2 + 50% 17% 13.4% Rehabilitation Costs US$454 million Sensitivity 1 + 20% 22% 18.8% Sensitivity2 + 50% 18% 15.3% Electricity Price US cents 51 kWh Sensitivity 1 -- 20% 10% 19% 16.5% Sensitivity 2 14% 10.9% Life Of Rehabilitated Plant 20 years Sensitivity 1 20% (- 4 years) 24% 21.7% Sensitivity2 --50%(- 10 years) 16% 19.6% Output of Plant Average 8 TWhl year Sensitivity 1 -- 20% 10% 19% 16.5% Sensitivity 2 14% 10.9% 11. FINANCIAL ANALYSIS The Government has decided to create 7 companies from EUAS (including the successor company o f EUAS, EUAS Hydro, which will operate the large hydros). One o f these companies -Af9inGENCO-willcontaintheAfgin-ElbistanAandBplants. AfyinGENCOalsoincludes the Hopa (Fuel Oil) and Altinkaya, Derbent, and Karkamis (Hydro) plants, with the total effective installed capacity o f about 3,400 MW before rehabilitation, and 3,788 MW after rehabilitation. Annex 9 contains a detailed discussion o f the historical and forecast financial condition of EUAS, as well as the estimated future financial condition o f Af9in GENCO. The timeline for the creation o f AfSin GENCO has not been finalized, but the accounts o f the company have been separated and these are usedto forecast the financial condition. Includes impact oftaxes 61 Past andCurrent FinancialPerformance-EUAS Profitability and Cash Flow EUAS'Sprofitability has beenreasonable throughthe period (the abnormal changes shown below fiom year to year are due to adjustments in foreign exchange and in inflation). The inordinate increase in revenues and average sales per unit in some years i s primarily on account o f the impact o f favorable changes inthe generation mix, and not because o f increase in tariffs. EUAS' cash flow, with its debt service amount and its receivables beingat a significant level, i s a concern for the future, and inthe past, EUAS has managed primarily due to its non-payment to suppliers and due to the low level o f investments that have been permitted by the Government. Table 9.6 below shows a summary o f EUAS's historical financial performance (EUASwas created in2001 and the income statement for that year i s thus only for 3 months). In 2004, the Debt to Equity ratio improved from 0.7 to 0.4 with the increase in paid in capital from about US$ 800 million to US$ 5.2 billion. Equity capital was increased by conversion o f accumulated capital reserve to equity capital, and does not involve cash infusions. Improvement inDebt to Equityratio and Debt Service Coverage indicates that EUAShas room for additional financing. However, the vulnerability of the cash flow from debt service and receivables should be kept inmind. Table 9.6: Historical Financial Performance (2001 -2005) - EUAS Income Statement Summary Revenues 524 2,488 2,160 2,693 2,964 Cost of Sales 350 1,445 1,238 1,110 1,492 Gross Profit 174 1,043 922 1,583 1,472 OperatingCosts 28 143 217 242 325 OperatingIncome 115 711 536 1,100 901 Net Profit 134 227 301 911 410 Balance Sheet Summary CurrentAssets 1,012 1,913 2,550 3,112 3,619 _____.-------------------.--------.--____________________________________ FixedAssets 2,777 4,760 6,333 8,262 8,313 Total Assets 3,789 6,673 8,882 11,374 11,932 Capitaland Reserves 714 2,980 4,372 6,778 7,573 Debt 2,120 2,715 3,023 2,773 2,168 ____-------------------------..---.---...-------------------------------.--- Other Liabilities 955 978 1,488 1,822 2,192 Total Equity and Liabilities 3,789 6,673 8,882 11,374 11,932 Financial Ratios Net Profit Margin 25.5% 9.1% 13.9% 33.8% 13.8% Gross Profit Margin 33.3% 41.9% 42.7% 58.8% 49.7% Annual Generation(gwh) 16,323 77,051 58,881 61,890 66,312 Average Sales Price (US$/Kwh) 0.03 0.03 0.04 0.04 0.04 Ave. Sales PriceChange (Oh) NA 0.6% 13.6% 18.6% 2.7% Pre-Tax Returnon Assets 8.0% 8.6% 6.6% 15.3% 8.3% Returnon Equity 18.7% 7.6% 6.9% 13.4% 5.4% Return on Capital Employed 5.9% 4.3% 4.3% 9.9% 4.3% Self-FinancingRatio 11.6% 54.1% 53.2% 141.4% 77.5% Debt ServiceCoverage Ratio 0.6 1.2 1.3 2.4 2.0 62 Debt to Equity Ratio Collection Efficienc NIP. 723% 732% Arrears for Sale of Electricity At the end of 2005, EUAShad an estimatedUS$2.8 billionof outstanding trade receivables from TETAS, representing about 11months o f electricity sales. There was also an additional US$ 900 million o f Other Receivables carried over from the time of the restructuring o f TEAS, which includes receivables for sale o f electricity. The rate o f accumulation o f receivables has decreased significantly in the past two years on account o f improvement in collection efficiency from 484%% in 2002 to 36% in 2004 (see Table 9.7). In the past, EUAS has financed these large receivables by building up payables, which have accumulated to over a year o f fuel purchases, primarily to public economic enterprises that supply fuel such as TKI, TTK and BOTAS. Currently the longer payable period allows EUAS to generate sufficient cash flow, but also i s a risk factor in the future cash flow and financial projections as these entities work to collect their receivables. Table 9.7: Receivablesand Payables- EUAS EUAS' receivable accumulation is due to the collection shortfalls o f the Turkish Electricity Distribution Corporation, TEDAS. TEDAS receivables have been growing due to the following reasons: (a) TEDAS' collections, although improving over time, currently average only 90% o f sales revenue. (b) 50% o f the accumulated receivable i s from the public sector, which prevents aggressive enforcement o f collection. Municipalities are particularly notorious for not paying their bills-they alone account for about US$ 1.3 billiono fthe accumulated receivables. The burden o f receivables gets passed on from one company to the next (see Figure 9.1 below), resulting in cash shortfalls being financed by increasing payables to the next company in the chain. The issue i s complicated further by the fact that at the time o f the break-up o f TEAS in 2001, the receivables were not settled but carried over to the newly restructured companies. The accounting systems of the SOEs do not indicate readily the actual "age" o f these receivables, thus it i s difficult to calculate the loss inNPV terms. Ideally, these receivables would be provisioned, and thereafter written off, but this has not been the practice in the government-owned electricity utilities. 63 The issue o f receivables from Government agencies has two facets to it - first, the stock or "overhang", i.e., the accumulation o f receivables over the past, and second, the ongoing problems related with nonpayment o f current bills by public agencies. Receivables from the public sector including municipalities and street lighting make up about 47% o f the accumulated receivables as o f November 2005 - and these are receivables that TEDAS cannot pursue aggressively through the use o f disconnections and legal actions. Accumulated receivables inflate the balance sheet o f electricity utilities unrealistically, since there i s little prospect o f such dues being collected in their entirety. Addressing the stock of accumulated receivables from all government agencies EUAS and the Government are evaluating solutions for addressing the issue o f accumulated receivables. Among the options being considered i s the settlement o f cross-dues among government agencies. The legal and fiscal implicationso f such action are beingcarefully considered. Specific attention i s being given to avoiding the issue o f moral hazard which could result from a perverse incentive on the part o f the companies as well as consumers to not behave commercially. The Bank will remain engaged inthis discussion with the Government through its policy dialog. Specifically with regard to municipalities, which are the largest concern interms o f nonpayment, the Government has processed new legislation which aims to improve payment discipline. The Law on Municipality (Law No. 5393), ratified in July 2005, provides for the establishment o f a "Reconciliation Committee" under the Undersecretariat o f Treasury. The Committee i s expected to focus on the restructuring o f accumulated receivables and debts to public institutions and authorities by municipalities, affiliates and companies in which a municipality owns shares more than 50%. One gas utility has already undergone this process, and the payment schedule has been agreed among all parties. The process is an important step in strengthening financial responsibility o f the public sector, although the fact that the participation to the process i s voluntary leaves room for doubt on its enforceability. Addressing the problem of poor collections from government agencies Even ifthe overhang i s resolved through a combination o f means, the real problem o f cash flows will continue, since this will not address the ongoing nonpayment by municipalities and other government agencies. The Government i s considering several mechanisms, including legislative changes that would allow SOEs to enforce collections against public sector entities. Inaddition, there will also be a need for adequate budgeting, especially for municipalities, for electricity bill payment on an ongoing basis. 64 I Forecast Financial Performance of EUA$ Table 9.8 below shows the forecast financial performance o f EUAS. The impacts from the rehabilitation project are factored in (these impacts are discussed later, while discussing the finances o f AfSin GENCO). The forecasts are based on conservative assumptions regarding commercial efficiency improvements such as collections. No significant gains from privatization o f distribution or generation are factored in. The forecasts also assume that EUAS will no longer be able to defer its fuel and other purchases, and that gradually payables will reduce to approach normal commercial levels. Due to the forecast electricity shortage in 2009, EUAS will have to ramp up generation from its high-cost diesel and fuel oil plants, which will raise variable costs even after assuming that the diesel plant i s converted to LNG. The projections assume that the fuel oil plants will begin operating in 2008, and the resulting increase in cost will necessitate a marginal increase in tariffs -the current tariff regulations allow a pass through o f fuel costs. The diesel plant has not been factored insince there are plans to upgrade the plant to enable the use o f natural gas, and the timeframe for this investment i s not clear at this stage. Table 9.8: FinancialForecastSummary- EUAS Revenues Cost of Sales Gross Profit 1,553 1,447 1,365 1,309 1,344 1.361 1,411 1,444 1,483 1,440 OperatingCosts OperatingIncome Net Profit Current Assets 4,043 4,433 4,709 5,139 5,537 5,921 6,303 6,690 7,084 7,479 _FixedAssets_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _____-__________________________________------------- 19,429 19,152 19,136 19,063 18,842 18,473 18.118 17,786 17,475 17,184 Total Assets 23,472 23,584 23,846 24.203 24,378 24,393 24,421 24,476 24,559 24,663 Capital and Reserves 19,138 19,365 19,616 19,874 20,151 20,408 20,705 21,035 21,405 21,742 Debt 2,048 2.084 2,239 2,458 2,567 2,563 2,523 2,436 2,319 2,190 ____.._________________ Other Liabilities ._______________________________________-------------- 2,285 2,135 1,991 1,870 1,660 1,422 1,192 1,004 835 730 Total Equity and Liabilities Operations Net Cash Flow from Investments Net CashFlow from __________------._----. Financing Net Change inCashand __________..-.--_------ Cash Equivalents _BeginningBalance- _ - - - - - _ - - - _ _ _ _ _ _ _ _ - _ EndingBalance NetProfit Margin 11.0% 7.4% 8.3% 8.4% 8.7% 7.9% 8.9% 9.7% 10.6% 9.7% Gross Profit Margin 49.3% 47.5% 45.0% 42.4% 42.5% 42.0% 42.3% 42.4% 42.5% 41.3% Annual Generation (GWh) 68,975 72,562 77,767 81,323 81,323 82,307 82,307 82,307 82,307 82,307 66 (US$ million) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Per unit Revenue (USS KWh) 0.05 0.04 0.04 0.04 0.04 0 04 0.04 0.04 0 04 0.04 Increase in ave re\enue 2 P 0 -8.1'0 -7.1'0 -2 6"o 24". 13'0 2 8'0 22'0 2 4 ' 0 00". Pre-Tau Rerum on Assets 2.2O. 1.6'0 1 . 8 O o 19'0 1 9 % 1 . 8 O 0 2 On. 7 7 O o 2.3O0 ?.Zoo Retum on Equir). 1.80. 1 2 0 . 1 3 0 0 1.3'6 I.4"o 1.3O0 1.400 16'0 1 700 1.6O0 Return on Capital Employed I7% 1.10. 1 2 0 . 1.20b 1.200 I 10. 1300 1 .too 16O0 140" Self-Financing Ratio 730b 32"o 28'0 30
World Bank Group · Project Appraisal Document
Turkey - Electricity Generation Rehabilitation and Restructuring Project
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Organisation
World Bank Group
Document type
Project Appraisal Document
Country
Türkiye
Source
World Bank