Zambia - Petroleum Exploration Promotion Project

Document of FILE CC2Y The World Bank F1OR OFFICIAL USE ONLY Report No. P-3206-9A REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF ZAMBIA FOR A PETROLEUM EXPLORATION PROMOTION PROJECT April 22, 1982 Thb document has a resticted distributin nd may be used by recm Ints only In the pefomAne of their officld dutis. Its eontents may not othertwise be dbslosed withot W rd Eank authoratimn.  Currency Equivalents Currency Unit = Kwacha (K) K 1.00 = US$1.20 US$1.0 = K 0.83 Fiscal Year January 1 - December 31 Abbreviations and Acronyms AGIP = Agencia Generale Italiana Petroli (Italy) EFF = Extended Fund Facility GDP = Gross Domestic Product GRZ = Government of the Republic of Zambia GS = Geological Survey Department MOA = Ministry of Agriculture MOM = Ministry of Mines MPTC = Ministry of Power, Transportation & Communications NEC = National Energy Commission PPF = Project Preparation Facility TNDP = Third National Development Plan UDI = Unilateral Declaration of Independence ZESCO = Zambia Electricity Service Corporation ZIMCO = Zambia Industrial and Mining Corporation Limited ZNEL = Zambia National Energy Limited Weights and Measures MW = Megawatt = 1000 kilowatt GWR = Gigawatt hour = 1 million kilowatt hour toe = ton of oil equivalent tpy = tons per year  FOR OFFICIAL USE ONLY ZAMBIA PETROLEUM EXPLORATION PROMOTION PROJECT LOAN AND PROJECT SUMMARY Borrower: Republic of Zambia Beneficiary: Ministry of Mines Amount: US$6.6 million, including a capitalized front-end fee. Terms: 20 years, including 5 years of grace, with interest at 11.6% per annum. Project Objective: The Project would support the Government's efforts to attract oil companies to explore for hydrocarbons by providing information on the country's sedimentary basins through geophysical surveys and geological interpretation. Project The Project would consist of the following Description: geophysical surveys and related work: (a) Airmag survey totaling about 90,000 line-km of the prospective sedimentary areas; (b) Gravity survey to cover selected traverses in areas identified in the airmag survey; (c) Reprocessing of mineral airmag data totaling about 50,000 line-km; and (d) Supervision and quality control (15 man-months) of the airmag survey. The Project would also provide the following technical assistance: (a) Exploration consultants (30 man-months) to help establish the Petroleum Unit, coordinate the various project components, produce a strategy and a promotion report on Zambia's geological prospects, and provide training to Zambian geologists; (b) Legal consultants (9 man-months), to draft petroleum legislation, prepare model exploration/production agreements, and assist the Government in negotiating with oil companies; (c) Training of Zambian staff in petroleum geology | This document has a restricted distribution and may be used by recipients only in the performance of | their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - and interpretation of geophysical surveys; and (d) Equipment including vehicles, lab and office equipment. Project Benefits: The Project would assist Zambia in attracting oil companies to take exploration permits in an area where they have not shown much interest. If the search for hydrocarbons is successful, the Project would contribute to meeting part of Zambia's petroleum needs from domestic sources. Project Risks: The major risk is that the geological data collected would be insufficiently attractive to generate industry interest in applying for exploration permits. Given present indications, this risk is acceptable.  - iii - Estimated Cost Local Foreign Total (US$ 000) Airmag Survey 400 2,450 2,850 Gravity Survey 270 1,000 1,270 Mineral Airmag Data Reprocessing 10 350 360 Airmag Supervision and Quality Control 30 250 280 Exploration Consultants and Project Administration 240 700 940 Legal Assistance 60 150 210 Training 50 150 200 Equipment 70 250 320 Base Cost Estimate 1,130 5,300 6,430 Physical Contingencies 113 530 643 Price Contingencies 209 670 879 Total Project Cost 1,452 6,500 7,952 IBRD Front-end Fee - 100 100 Total Financing Required 1,452 6,600 8,052 Financing Plan: Government 1,452 - 1,452 IBRD - 6,600 6,600 Total 1,452 6,600 8,052 Estimated Disbursement: 1/ IBRD FY 1982 1983 1984 1985 1986 (US$ 000) Annual 460 3,910 1,230 950 50 Cumulative 460 4,370 5,600 6,550 6,600 Rate of Return: N.A. Staff Appraisal Report: None Map: IBRD 16275 1/ By Quarter in Annex V.   INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF ZAMBIA FOR A PETROLEUM EXPLORATION PROMOTION PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Zambia for the equivalent of US$6.6 million, including a capitalized front-end fee of 1.5%, to help finance the Petroleum Exploration Promotion Project. The loan would be for 20 years, including 5 years of grace, with interest at 11.6%. PART I - THE ECONOMY 2. A Country Economic Memorandum on Zambia (Report No. 3007-ZA) was distributed to the Executive Directors on March 17, 1981. This part is based on the report's findings and on those of more recent economic missions to Zambia. Country data sheets are attached as Annex I. 3. With its mineral resources and plentiful land area suitable for crops and livestock, Zambia, though landlocked, has the potential for rapid and sustained development. Economic and social goals since independence in 1964 have been security of transport routes to the sea, reduction of dependency on copper exports through agricultural and industrial development, more equitable distribution of income, and expanded educational and training opportunities. Progress toward achieving these goals has been below potential due to structural imbalances in the economy, prolonged turmoil within the region and since 1975, a severe economic depression. Increased educational opportunities and construction of the TAZARA Railway through Tanzania to Dar-es-Salaam are the main areas in which substantial progress has been made. 4. The economy is heavily dependent on external trade and on government activity. Imports and exports range between 40 and 45% of GDP. Government expenditures have amounted to about 35% of GDP in recent years and the Government owns a majority share of mining and most manufacturing enterprises. Much economic activity is dependent on expatriate technical, managerial and administrative skills. Despite high rates of savings and investment, real growth has been disappointing, averaging only about 2.8% a year before the onset of the economic depression in 1975.  5. Diversification efforts have lagged; mining still prov H es over 90% of foreign exchange earnings and 30% of gross value added. - Agriculture accounts for about 10 to 12% of GDP, compared with 14% at independence. Manufacturing grew quickly through 1975, but has since stagnated, due to foreign exchange scarcity and a heavy dependence on imported inputs. Services also grew quickly, to about 35% of GDP, due to Zambia's success in expanding education and to increased government activity. However, income is concentrated in urban areas as a result of high wages throughout the modern sector and a progressive deterioration in the rural-urban terms of trade. These factors have caused major rural-to-urban migration (about 40% of the population is urban) and unemployment in urban areas. The Current Economic Crisis 6. Zambia continues to experience an economic and financial crisis initiated by a 40% decline in copper prices in 1975. Unremunerative producer policies, difficulties in transporting goods to and from the sea and a recent decline in copper production have exacerbated the situation. Real GDP stagnated between 1974 and 1978, and declined by 8% in 1979, with mining down 19% and agriculture down 10%. There was little, if any, growth during the past two years, although agriculture has recovered following two years of poor weather. Real GNP per capita (US$556 in 1980) is 25% below that in 1974. 7. The balance of payments has been in chronic disequilibrium since 1975, with current account deficits averaging 8 to 10% of GDP. In spite of heavy external borrowing, a build-up in arrears on import payments and a draw down on reserves, foreign exchange has been insufficient to maintain the real value of imports, currently about one half its levels in 1975. As a result, there persists an economy-wide problem of underutilization of capacity. This has seriously affected production and investment especially in the crucial mining sector which has accumulated a large backlog of maintenance and rehabilitation requirements contributing directly to recent declines in copper production and exports. 8. The decline in copper prices severely affected Zambia's fiscal and monetary positions. Historically, mineral taxes provided a large share of government revenue, but they have been negligible since 1976. This contributed to large fiscal deficits, which required domestic bank borrowing averaging 13% of GDP in 1975-77 and 5% in 1978-80. At first, the shortfall in mineral revenue was perceived to be temporary and expenditures grew rapidly, in part carried by the momentum of large 1/ In constant prices. In current prices, however, the contribution of mining has fallen to about 18 percent in GDP in recent years, due to low copper prices.  capital projects already underway. Subsequently, a successful effort was made to raise non-mineral revenues, but these efforts were offset by large increases in expenditure on defense and subsidies, mostly for maize imports resulting from poor harvests in 1979 and 1980. Deficit financing has absorbed 88% of net domestic credit creation between 1975 and 1980, and contributed to a sharp rise in domestic prices, averaging 18% per annum during 1976-78 and 11% per annum in 1979-80. 9. In April, 1978 the Government signed a two-year Standby Agreement of SDR 250 million with the International Monetary Fund (IMF). In the event, the Government's recurrent account was balanced in * 1978, and the balance of payments recorded a small surplus on current account in 1979. However, once the Standby Agreement expired, the accounts returned to their previous imbalances with increased severity, partly as a result of pent-up demand for imports and postponed expenditures. A three-year Extended Fund Facility (EFF) of SDR 800 million was approved in May 1981. It aims at a more gradual but longer- lasting adjustment process and at balancing the government and external accounts by 1983. Under the EFF, the Government is committed to eliminate the maize subsidy and reduce the fertilizer subsidy by the end of 1983; to increase sorely needed recurrent expenditures for operations and maintenance in the productive sectors; to implement economic pricing for products subject to price control; to raise agricultural producer prices towards world price equivalents; to provide a larger share of domestic credit to the private sector; and to allocate sufficient foreign exchange to repay most of the external arrears. Implementation of the EFF has been difficult; drawings were delayed in 1981 and a program for 1982 has yet to be agreed. 10. Although Zambia's financial circumstances will remain tight for the immediate future, due to the continued low price of copper, its long-term development prospects have recently improved. A significant and long-overdue change in government policy towards agriculture appears to have occurred. Producer prices have steadily increased over the past few years, and special tax incentives have been approved, including a radical reduction in the tax rate on agricultural income. Recent capital budgets have allocated a higher percentage of expenditure to agriculture and includes a number of projects aimed at increasing smallholder productivity. These measures represent a necessary beginning towards exploitation of Zambia's considerable agricultural potential; constant attention to maintaining and improving these incentives will be required, however, to bring about sustained agricultural growth. In particular, a long-term strategy for the development of agricultural and agro-based industrial exports needs to be drawn up.  -4- Creditworthiness 11. Zambia's creditworthiness is inextrica'bly linked to the production and price of copper. Estimates of economically recoverable ore reserves indicate that copper production can be maintained at present levels through the mid-1990s, but that depletion of reserves is expected to cause production to fall off sharply thereafter. Thus, Zambia's long-term creditworthiness requires strong measures to develop avaiable source of non-mineral exports. The reczent policy measures in agriculture represent an important initial step towards increasing production and investment in this sector and should improve Zambia's creditworthiness to the extent that the export potential is developed. 12. Prior to 1975, Zambia's external public debt was relatively small, and the debt service ratio was less than 10% of exports. Since then, outstanding debt has risen sharply, to an estimated US$1,970 million by end of 1981, and the debt service ratio to about 22% of exports. In addition, external payments arrears on non-public debt stood at about US$490 million at the end of 1981, and net drawings from the IMF at about US$720 million. The IBRD and the People's Republic of China are Zambia's largest official creditors, each with 17% of contractual debt outstanding and disbursed. 13. Increased debt service payments and low copper prices during 1981 acted to push Zambia's debt service ratio hligher than expected. Service on external public debt will remain high for the next few years as Zambia ays off earlier commercial borrowings, which it has been replacing with more concessional funds. In the medium-term, copper prices are projected to rise, and debt service could be kept under 20% of exports through 1990 with careful debt management. The Government is aware of the magnitude of the problem and is taking steps to improve its debt management systems. It has also made some progress in reducing external payment arrears by about US$60 million during 1981, the first year of the EFF arrangement. Given the Governm(ent's commitment to implement an EFF program and its actions to improve the incentives for agricultural production, Zambia continues to be creditworthy for IBRD lending. PART II - BANK GROUP OPERATIONS IN ZAMBIA 14. Since 1956, the Bank Group has made 27 loans and 5 credits to Zambia, totaling about US$609.1 million (net of cancellations). Twelve loans and two credits have financed power, transportation and communication projects. Four loans for education have helped expand Zambia's secondary and higher education systems, teacher training, and commercial, agricultural and technical education systems. Two program loans have helped Zambia maintain its development program in periods of severe economic dislocation. In agriculture and forestry, six loans and two credits have been for industrial forest plantations, livestock, commercial crops, integrated family farming, coffee production, and  smallholder dairy development. An agricultural project in the Eastern Provinces is assisting smallholder farmers. Other loans have assisted Zambia's urban development program and, through the Development Bank of Zambia, its manufacturing, agricultural and industrial sectors. A technical assistance credit is helping the Government improve its planning and project preparation. 15. The International Finance Corporation (IFC) has invested about US$70 million in eight projects in Zambia since 1972. Two investments were in shoe manufacturing, two in a packaging materials plant, and one each in the Development Bank of Zambia, cobalt production and textiles. The latest IFC investment was approved by the Executive Directors on December 3, 1981. This investment (US$30 million equivalent) is helping to finance a copper leaching project of the Nchanga Consolidated Copper Mines Limited (NCCM), a major company in the Zambian copper sector. The IFC has also appraised a project for the production of ethanol from biomass (for blending into gasoline). Summary statements of Bank Group loans, credits and investments and notes on the execution of ongoing projects are in Annex II. 16. Until recently, except in the agricultural sector, implementation of Bank-assisted projects in Zambia has proceeded reasonably well. Currently, however, serious delays are being experienced in the execution of a number of projects -- particularly in agriculture -- due to ineffective coordination among Government agencies, but more importantly because of the tight budgetary situation and the Government's limited ability to mobilize local resources for its contribution to project financing and for prefinancing local expenditures which are subsequently reimbursed by the Bank/IDA. 17. The deterioration in project implementation has, expectedly, substantially reduced the rate of disbursements on Bank Group loans and credits. During the first four of the last five years (FY77-81), the disbursement rate averaged slightly over 25% per annum, higher than the Bank-wide average of 21.2%, 21.5% for the Eastern Africa Region, 22.2% for Tanzania, 23.4% for Senegal and 20.2% for Bolivia. In FY81, however, the rate dropped to just over 16%, compared with 20% Bank-wide, 16.5% for Eastern Africa, 22.2% for Tanzania, 20.8% for Senegal and 21.2% for Bolivia. This problem is being addressed through provision of technical assistance in projects to strengthen implementing agencies; more frequent supervision missions; and increased use of the Resident Mission in monitoring project execution. In addition, consideration is being given to the establishment of special project accounts, such as is proposed for this project (para. 62), under ongoing projects which should substantially accelerate disbursements. 18. The Bank Group expects to continue supporting government programs to reduce dependence on copper, improve the efficiency of the copper sector, reduce the energy import bill, narrow the urban-rural income gap and develop local managerial and technical skills.  - 6 - Anticipated lending reflects the Government's emphasis on directly productive sectors, particularly agriculture-related activities, and reducing the burden of imported energy on the foreign exchange earnings. Continued assistance to education, transportation and industry is also contemplated. The proposed project is a significant step in assisting Zambia in determining whether parameters favorable to the accumulation of hydrocarbons exist in the c:ountry, and is the Bank's second operation, outside of electric power, in the energy sector. PART III - THE ENERGY AND PETROLEUM SECTORS A. The Energy Sector Energy Base 19. Zambia is well-endowed with diverse energy resources; however, detailed assessment of the full potential and a strategy for their development to meet the country's goals are yet to be carried out. The country's energy resource base consists of hydropower, coal, uranium and renewable energy such as fuelwood, bagasse, mo:Lasses, wind, solar and geothermal. 20. The potential for hydropower is substantial. Existing installed capacity is 1,652 MW, and there is known scope for considerable further development. Zambia has been a net exporter of power since the mid-1970's. Out of a total current power production of 8740 GwH about one third is exported. Hydropower in 1980 accounted for 93.7% of electric power generation capacity of 1763 MW, with the largest hydropower plants being Kafue (900 MW), Kariba North (600 MW), and Victoria Falls (108 MW). 21. Known coal reserves, estimated at about 70 million tons of fair quality, are located in the southeastern section of the country. Additional deposits in other parts of the country have been identified, but further exploration would be required to d,etermine their quantities and qualitites, and whether they can be mined commercially. There is one open-pit mine owned by the Government, and producing about 600,000 tpy of thermal coal. Coke and coking coal for use in the mining industry are imported from Zimbabwe. 22. Fuelwood supplies the cooking, heating and lighting needs of about 85% of the country's population. Fuelwood collection and marketing is still largely on an informal basis. Urban demand for charcoal is high and at the current rate of exploitation of woodlands, supplies are becoming critically low. 23. Bagasse produced by the Zambia Sugar Corporation (ZSC) is used by the latter as energy source for its sugar milling operations. The Bank, under the ongoing Technical Assistance Credit (Credit 873-ZA),  financed a feasibility study for a project designed to use ZSC's residual molasses to produce ethanol for blending into gasoline. The IFC has already appraised the project (para 15). 24. The potential for utilizing solar energy and wind in Zambia is good. Possible low-cost applications are in crop drying and water pumping. The potential for geothermal energy is still undetermined but there would seem to be potential for small scale applications using the energy from hot springs for refrigeration on farms. 25. Reasonably large uranium deposits have been found in several parts of the country, particularly around the Copper Belt region and in the Rift Zone in the south. Estimates of the deposits range between 10,000 to 100,000 metric tons. Several foreign firms have been carrying out detailed exploration of these deposits. Energy Production and Consumption 26. Zambia's total commercial energy production from domestic sources currently is about 1.8 million tons of oil equivalent (toe), of which 84% is hydropower and 16% coal. The share of hydropower increased steadily from about 77% in 1974 to about 82% in 1978 following the expansion of hydropower generation capacity during the 1970's, while the production of coal, the second most important domestic commercial energy source, has been stagnant. In addition, domestic fuelwood provides an estimated 1.4 million toe of energy for non-commercial uses. There also is some energy production from waste heat recovery in mineral processing, but its share of domestic energy production is not yet significant. 27. Commercial energy consumption in Zambia consists of domestic coal and hydropower and of imported petroleum and coke and for 1981 is estimated at about 2.58 million toe, as shown below: ZAMBIA: Estimated Commercial Energy Consumption in 1981 Quantity (in metric tons of Energy Source of oil equivalent) % Share Coal 274,000 10.6 Coke 68,000 2.6 Hydropower 1,485,000 57.7 Petroleum Fuel 748,000 29.1 Total 2,575,000 100.0 Source: INDENI refinery, ZNEL and NCDP  - 8 - Hydropower has become the dominant source for Zambia's commercial energy consumption. The second most important energy source is petroleum and, despite the Government's conservation efforts, its share has been increasing from around 26% in 1974 to about 29% in 1981. On the other hand, the relative contribution of coal has been declining from around 16% (1974) to only 10.6% in 1981. 28. The main consumer of commercial energy in Zambia has been the mining industry, with about 60% of all commercial energy consumed in the country, followed by commerce and households with about 24%. The share of manufacturing has been declining from around 17% in 1974 to about 12% at present, reflecting the prolonged recession affecting Zambia. Transport accounts for about 3% and agriculture for only about 1% of comercial energy consumption. Energy Pricing 29. In general, prices in Zambia for energy, including for petroleum products as a whole, reflect their economic values, although there are deviations for particular products. Wholesale prices for petroleum products are determined by the Government and for a number of products include subsidies borne by Government. Petroleum product prices in effect in December 1981 (wholesale) are shown below in comparison with international prices: Prices for Selected Petroleum Products End-1981 Zambia Wholesale Rotterdam Zambia as % Product US$/ton US$/ton of Rotterdam Premium gasoline 989 346-352 283 Regular gasoline 915 329-339 274 Kerosene 428 349-351 122 Diesel 428 319-325 133 Heavy Fuel Oil 145 166 87 Source : Government, Platts Oilgram Price Repcrt The comparison shows that Zambian ex-refinery prices for petroleum products were higher than spot prices quoted at Rotterdam in December 1981, with the notable exception of heavy fuel oil. Landlocked and without domestic petroleum resources, Zambia's petroleum prices may be expected to be high by international comparison, since sea freight, handling and pipeline transportation bring the c.i.f. cost per barrel of crude to about US$40. Moreover, the uneconomic configuration of the refinery adds another penalty charge on the likely economic cost of petroleum products in Zambia, although this has not yet been quantified. Under these conditions, the ex-refinery wholesale prices for kerosene and diesel may be close to their incurred economic cost. On the other hand, gasoline appears to be priced well above its economic  - 9 - cost, while heavy fuel oil is clearly subsidized. The subsidy on heavy fuel oil is due to the design of the refinery which results in a high percentage of heavy fuel oil for which a local market has to be found since export possibilities are uneconomic. At least part of these subsidies is covered by heavy surcharges on other products such as gasoline which in December 1981 was selling in Lusaka at about US$4/gallon (regular), among the highest prices anywhere in the world. This cross-subsidization permits Zambia National Energy Limited (ZENL) which is responsible for the procurement and shipment of spiked crude and for the sale of refined products ex-refinery, to fully recover the cost of petroleum fuels, including taxes, and earn profits. Development and Organization of the Energy Sector 30. Organization of Zambia's energy sector has evolved over the last decade and a half in response to the effects of the Unilateral Declaration of Independence (UDI) in 1965 in neighboring Zimbabwe, then Rhodesia. Prior to that period nearly all of Zambia's commercial energy supplies originated from or were imported through Zimbabwe. Petroleum products were shipped by rail from the Feruka Refinery near Umtali in Zimbabwe; coal for both industrial use and power generation came from the Wankie coalfields, also in Zimbabwe; hydropower was supplied by the Kariba South Power Station, which, although jointly owned by both countries, had its generating facilities and control centers located within Rhodesia. In early 1966, as a result of events subsequent to the UDI by Rhodesia, Zambia found itself unable to rely on Rhodesia to meet its commercial energy requirements; it therefore became necessary to set up institutions to develop domestic energy to reduce dependence on external energy supply sources. 31. One of the first institutions established was the Zambia Electricity Service Corporation (ZESCO) with responsibility for the development of hydropower. The Bank provided assistance in setting up ZESCO, and has since made two loans (Loans 701-ZA and 919-ZA) for the development of Kariba North and Kafue hydropower projects, the two main sources of hydropower in Zambia (para 18). Other institutions established for the development of other parts of the energy sector were Maamba Colliery for mining of domestic coal, the TAZAMA Pipelines for transfer of crude petroleum from Dar-es-Salaam, Tanzania to Ndola, Zambia, and the INDENI Petroleum Refinery for the refining of the imported crude. All these operating companies are subsidiaries of the state-owned holding company, the Zambia Industrial and Mining Corporation Limited (ZIMCO). 32. Authority for the development of the country's energy resources is fragmented among the above institutions, the Ministry of Power, Transport and Communications (MPTC), which is expected to coordinate government policy on energy, the Ministry of Mines (MOM), which has responsibility for geothermal and hydrocarbons development, and the Ministry of Agriculture (MOA), which oversees biomass energy resources. Coupled with the lack of an integrated strategy for the development of the energy resources is a paucity of reliable and systematic data on the sector's resource potential and lack of  - 10 - managerial and technical skills to initiate the required assessment for policy considerations. 33. As a first step in initiating a national plan on energy for the sector, the Government set up, in April, 1981 a National Energy Council (NEC) to function as an advisory body to the Government. Subsequently, the Bank in conjuction with NEC undertook the energy assessment of Zambia and the report is under preparation. The report is expected to provide important inputs on macro aspects of the energy sector (e.g., overall energy demand/supply perspectives, and desired pricing policies). Main Policy Objectives and Investment Priorities 34. The energy sector objectives as reflected in the Third National Development Plan of 1979-1983 (TNDP) are to (i) reduce domestic consumption and imports of petroleum products; (ii) promote a shift to the use of electricity and coal; and (iii) consolidate supplies of traditional fuels. 35. These priorities are reflected in the energy investment proposals included in the TNDP. The bulk of the K 145 million TNDP energy budget is earmarked for electric power, followed by petroleum and wood fuels. There are little or no allocations for coal, nuclear, and soft energies, such as wind and solar. 36. Electric Power. The Government plans rural electrification projects with a total cost of about K 26 million, an expansion of the Lusiwasi hydropower plant from 38 MW to 50 MW and some new transmission lines and substations. 37. Petroleum. The main project in this subsector is an engineering study to modify the refinery at Ndola (para 39). The Bank is proposing an engineering loan for this project. Other planned investments include an oil drum factory and a lubricating oil blending plant at a total cost of K 5 million, which would be a joint venture of ZNEL with Shell, British Petroleum (BP), Agencia Generale Italiana Petroli (AGIP) and other product distributors. The proposed Petroleum Exploration Promotion Project was not yet identified at the time of preparation of TNDP. However, following its identification, the Government added the proposed project to its investment program. 38. Fuelwood. The most important project in this sub-sector is a fuelwood plantations project, assisted by Commonwealth Development Corporation (CDC) and aimed at large scale charcoal production to serve the Lusaka urban market. 39. Energy Conservation and Substitution. The substitution of domestic energy sources for imported petroleum is being carried out by the mining and industrial sectors, and the TNDP includes a program of  - 11 - replacing petroleum with coal, hydropower and ethanol produced from surplus molasses. Zambia has been one of the first African countries to use coal instead of oil in the heavily energy-intensive cement industry. A study financed under the IBRD's Third Railway Project will also look into the feasibility of electrifying the rail system which currently uses diesel oil. Similar measures in other sectors include a rural electrification program that would reduce the use of kerosene by the rural population and of diesel oil at remote power plants. To provide a consistent approach to energy savings and substitution, a comprehensive study to review energy substitution measures, energy pricing and the institutional framework is being prepared as part of the proposed Bank financed, INDENI Refinery Modification Engineering Project. B. The Petroleum Sector Petroleum Sector Organization 40. There have been no petroleum exploration and production in Zambia and the consumption and distribution pattern is completely geared to imports. Activities related to imported petroleum are divided into five areas of operations: (a) procurement of crude and refined products; (b) pipeline transfer of petroleum; (c) petroleum refining; (d) storage and distribution and (e) retail marketing. Procurement of crude and refined products and the sale of refined products ex-refinery are handled by ZNEL, a wholly-owned subsidiary of ZIMCO. ZNEL procures crude petroleum from Middle East sources and refined products from international markets on a spot basis. The refined products - naptha, kerosene and diesel oil, known as spikes - are mixed with the crude petroleum before shipment to Dar-es-Salaam in order to minimize handling and shipping costs. About 44% of all the petroleum fuels purchased by Zambia are refined products. The refinery, given its existing process configuration, would produce large surpluses of products (fuel oils) not required by the country and not economically exportable while there would be correspondingly large deficits in products such as kerosene and diesel, the predominant petroleum products required by Zambia. To avoid this, the refinery input consists of about 49% crude and 51% of spikes, which leads to a product mix more suitable to the country's need. The proposed INDENI Refinery Modification Engineering project will seek means of reducing or eliminating spiking, which at high levels produces technical problems for the refinery process and is uneconomical. ZNEL's operations have been carried out reasonably efficiently with a small staff which includes experienced expatriate professional personnel. 41. The transfer of the crude feed from the port of Dar-es-Salaam to the INDENI Refinery at Ndola, Zambia, is the responsibility of TAZAMA Pipelines Limited, a joint venture company owned 67% by the Government of Zambia and 33% by the Government of Tanzania. The throughput charge per ton of US$23 covers debt service, maintenance, insurance, operating expenses and profit requirements. The INDENI Petroleum Refinery Company Limited, owned 50% by ZIMCO and 50% by AGIP, refines the imported  - 12 - petroleum. AGIP is in charge of operation and management of the refinery. 42. Except for fuel oil and bitumen which are lifted directly from the refinery by the main users, storage of refined products (gasoline, diesel, kerosene and aviation fuel) is handled by the Ndola Oil Storage Company (NOSCO), a joint-venture operation of the retail distributors (50%) and ZIMCO (50%). Distribution and retail operations are handled by Shell, BP, AGIP, Mobil, Caltex and Total. ZIMCO owns 50% of AGIP's, Shell's and BP's retail operations. The remaining distributors are locally-incorporated wholly-owned subsidiaries of their multinational parents. Distribution of petroleum products is working well and the government pricing policies permit the distributors and retailers to make reasonable profits. Petroleum Consumption 43. In volume terms, Zambia's recent oil consumption has varied between 650,000 and 850,000 tons annually. However, reflecting the increase in crude oil prices, Zambia's oil import bill more than quadrupled in value terms between 1973 and 1978.. Petroleum consumption for 1981 is estimated at about 748,000 tons, which is considerably higher than the 1980 level of 683,000 tons. For 1981, petroleum imports are estimated to have totalled US$240 million or about 23% of Zambia's export earnings. There have been occasional small exports of petroleum products to neighboring countries of less than 50,000 tpy. 44. Zambia's petroleum consumption profile, like most other developing countries', is dominated by the middle distillates (kerosene and diesel oil) which account for about 54% of total petroleum fuels consumption. The light ends (liquefied petroleum gas (LPG) and premium and regular gasoline) used for cooking and transportation respectively, constitute about 17.6%; while the heavy ends (fuel oil and bitumen) make up 28.2% of the consumption. 45. As the claims of imported fuel on the declining export earnings increased, the Government, starting in 1976, began using administrative (rationing) and pricing measures which, along with the general decline in economic activity, resulted in an average annual decline of 4.4% of overall consumption from 1976 to 1980. During this period, consumption of LPG dropped by 26.6% p.a., premium gasoline by 30.0% p.a. and diesel by 7.1% p.a., while consumption of regular gasoline (2.1% p.a.), kerosene (5.4% p.a.) and fuel oil (1.3% p.a.) increased slightly. Potential for further reductions through rationing and pricing measures without seriously affecting vital services appears to be very limited. Recognition of the limitations of this method of reducing consumption has led to the initiation of programs designed to reduce petroleum demand by substitution with domestically-produced energy supplies para 38).  - 13 - Petroleum Legislation 46. Petroleum Legislation in Zambia is non-existent, because oil exploration/production has not been considered at all. The existence of attractive and fair legislation would be a precondition for attracting oil companies to exploration and production. Such draft legislation would be prepared by legal consultants financed under the proposed Bank loan and the Bank would be consulted on the legal framework and incentives to be implemented (Section 3.03 (b) of draft Loan Agreement) upon determination that the country's potential so justifies. Petroleum Geology and Status of Exploration 47. Zambia's sedimentary areas total around 300,000 km2 out of a total of 720,000 km2 or about 42%. About 50% of these areas, or roughly 150,000 km2, are deemed modestly prospective for hydrocarbons. No systematic oil exploration, as such, has taken place so far, although there have been attempts in recent years to present Zambia's geology from a petroleum rather than a mining viewpoint. Zambia is the second copper exporter of the world (most of the copper is extracted from sedimentary formations), and intensive prospecting for copper, cobalt, uranium, etc. has been carried out for over 70 years in both sedimentary and basement rocks. All of these investigations and geological surveys resulted in numerous geological maps and publications of high quality, which were not petroleum oriented, although old sedimentary rocks giving off strong bituminous smell have often been reported even in the Gopperbelt. An Annex on Zambia's geology is attached as Annex VII. 48. A review of the geology indicates that the hydrocarbon potential is modest, but deserving of further consideration. Karroo sediments (sandstones, shales, minor limestones) contain potential source rocks, reservoirs and caprocks which, if properly buried, may have generated hydrocarbons. Older sediments such as the thick Katanga Series also made up of sandstones, shales and limestones may have generated gaseous hydrocarbons that could be trapped in the same series or else in the overlying Karroo rocks. These rocks occur in grabens or rifts whose depths are not known. In order to attract oil companies, it is necessary to establish the distribution of the structural elements of the country as well as the thicknesses of the sedimentary setting in known grabens. 49. The Western Zambia basin is one of the largest sedimentary basins in the world that remain to be explored for hydrocarbons. To date, no petroleum exploration, neither seismic nor drilling, has been undertaken there by oil companies. Although the Government has recently made efforts to attract oil companies to explore for hydrocarbons in Zambia, this has not yet been successful. The proposed project is intended to provide information that might make the geology of Zambia more attractive for exploration. Because of their size (over 200,000 km2) Zambia's main basins deserve exploration to establish their hydrocarbon potential.  - 14 - The Sectoral Institution: Ministry of Mines (MOM) 50. Because petroleum exploration and production are considered as part of the mining sector, the Ministry of Mines (MOM) is in charge of the petroleum sector, as far as exploration is concerned, while refining and distribution are being handled by the existing ZIMCO companies under the supervision of the Ministry of Industry. MOM is responsible for the formulation of policies on mines and minerals. MOM includes three technical departments: Mines Safety, Mines Development and Geological Survey. MOM supervises a number of mining and minerals marketing companies whose shares are held by ZIMCO. 51. The Geological Survey Department (GS), an MOM department established in 1951, monitors mining operations, gathers geological data for resource evaluation and is in charge of petroleum exploration. Staffed with 40 professionals, including a number of expatriates, it is an efficient institution. Its staff is well-trained and dedicated, but its experience in petroleum exploration is limited. 52. MOM's strategy for petroleum exploration is in line with the country's potential. It includes a succession of logical steps designed to lead to increasingly accurate information. The exploration efforts could be stopped after each step without incurring unnecessary expenses should a continuation of exploration appear unjustified. The first step would be the airmag survey which would explore the depth of Zambia's sedimentary basins. Should the survey provide positive results, i.e. identify thick sedimentary basins, structural trends, etc. the next step would be a gravity survey in the most prospective areas. This would be followed by seismic exploration and finally by the most capital- intensive step, drilling. The Bank's role would be to finance the first two steps in order to obtain information that might attract oil companies to carry out the following more costly and more risky steps of exploration. PART IV - THE PROJECT Introduction 53. The proposed Project was identified in August 1981 following preliminary discussions between the Government and the Bank earlier in the year. The project was appraised in December, 1981. Negotiations were held in Washington on April 8-10, 1982. The Zambian delegation was headed by Mr. Austen S. Mweemba, Acting Permanent Secretary, Ministry of Mines. A Loan and Project Summary is given at the beginning of this Report and a Supplementary Project Data Sheet in Annex III. No staff appraisal report has been prepared.  - 15 - Project Objectives and Description 54. The Project would support the Government's efforts to gather geological and geophysical information to promote hydrocarbon exploration by attracting foreign companies with the technology and capital to conduct expensive seismic surveys and high risk exploratory drilling. The Project would include the following components: (a) Geophysical Surveys (i) Airmag Survey: an airmag survey would be flown over the prospective sedimentary Karroo areas (estimated at about 90,000 line-km) to establish their structural setting, the thickness of the sediments above the basement and the magnitude of possible volcanic intrusions in order to appraise the prospectiveness of these areas and generate interest in further petroleum exploration. The work program and the specifications, which are satisfactory to the Bank, have already been prepared. (ii) Gravity Survey: a broad reconnaissance gravity survey of about 1,500 stations would cover traverses to check the airmag interpretations. The gravity survey would help tie-in the airmag results to make them more readily usable and confirm structural trends in the basins. Together they form the basis for the decision to do seismic exploration. The work program and the specifications would be prepared by GS consultants in a manner satisfactory to the Bank. The gravity survey would be performed only if the airmag survey yielded results that would make further exploration appear worthwhile. A condition for disbursing the funds related to the gravity survey would be for MOM and the Bank to agree that the proposed program is justified in view of the results of the airmag survey. (Schedule 1 Section 4(c) of the draft Loan Agreement). (iii) Airmag Supervision and Quality Control: the Project would provide about 15 man-months of consultants' services for supervision and quality control and interpretation of the results of the airmag survey. (iv) Reprocessing of Available Mineral Airmag Surveys: the Project would include funds to reprocess and reinterpret relevant data collected under 5 previous mineral airmag surveys covering about 50,000 line-km over part of the Katanga Group sediment areas.  - 16 - (b) Technical Assistance (i) Exploration Consultants: GS would retain a consulting firm which would dispatch a geologist and a geophysicist (together 24 men-months), assisted by a photogeologist for about six months. The consultants would (a) review all the geological information on sedimentary areas; (b) select rock samples for paleontologic and maturation analysis; (c) monitor the various geophysical surveys, including the reprocessing of existing mineral oriented airmag data, and also the laboratory analysis; (d) prepare a photogeologic map of Zambia's sedimentary areas from conventional air pholtographs and Landsat imagery; (e) interpret the resuLts of the surveys, reprocessed data and laboratory analyses and integrate them with the new geologic information in a final promotion report for sale to interested companies; (f) prepare a strategy report for exploration blocks offering, administer the bidding, negotiate the contracts; (g) assist the legal consultants (see below) in the preparation of model agreements; (h) help establish the Petroleum Unit, (i) coordinate the various project components, in particular the airmag and gravity surveys, and (j) provide training for Zambians in the Petroleum Unit. Besides the provision of 30 man-months of consultant services, this component would cover the cost of the strategy report and of a promotional report (items (e) and (f) above) special services or studies (such as lab tests) that may become necessary during project implementation. (ii) Legal Consulting: the Project would provide about nine man-months of legal consultant services by an experienced law firm to draft petroleum exploration legislation, prepare model exploration/production contracts which would be both attractive to potential investors and protect Zambia's interests, and assist the Government in negotiating with oil companies. (iii) Training: the project would include funds for overseas training of two GS geologists and two GS geophysicists and the attendance of specialized short-term courses abroad by senior GS staff. (iv) Equipment: including vehicles to be used in the field as well as some office, lab, camping and training equipment.  - 17 - Project Cost and Financing 55. The total cost of the Project, net of duties and taxes, (from which the project would be exempt) is estimated at about US$8.1 million equivalent. The cost of one man month of consulting services has been estimated at US$16,500 on the average including travel, subsistence and overhead. This amount is reasonable, taking into account the high level of expertise required and salaries prevailing in the petroleum industry. The estimated cost of the airmag survey (US$27/line km) is based on recent actual airmag cost data for petroleum exploration in neighboring African countries. The cost of airmag reprocessing at US$7/km, of the gravity survey at US$700 per station and the remaining cost estimates are based on data obtained from recent similar projects. The cost of the strategy and promotion reports is estimated to total US$150,000 and of the special services US$50,000. The cost estimates include 10% physical contingencies. Price contingencies have been calculated on the basis of inflation rates of 8.5% for 1982 and 7.5% p.a. thereafter for foreign exchange and of 12% p.a. for expenditures in local currency. 56. The proposed Bank loan would finance the foreign exchange component of US$6.6 million equivalent. The local cost component would be financed by the Government. Status of Project Preparation 57. The Project was prepared by GS who for some time has presented Zambia's geology from a petroleum viewpoint in an effort to promote hydrocarbon exploration. During the December 1981 appraisal, terms of reference for the airmag consultants were discussed and agreed with the Bank. The list of qualified firms was discussed and agreed subsequently. The firms to carry out the airmag and the airmag quality control are to be contracted by May 1982 and the exploration consultants by June 1982 so that the airmag can be flown as planned during the 1982 dry season. 58. In order to help finance the cost of the airmag services that would be incurred until the loan became effective, a Project Preparation Facility (PPF) of US$1 million was granted in February 1982. This was critical in order to avoid a postponement of the airmag survey until the 1983 dry season. Any expenditures financed under the PPF would be reimbursed by the proposed loan as soon as the loan becomes effective. Project Implementation 59. The Project would be implemented by GS. To implement the project, MOM has established under GS the Petroleum Unit (PU). The PU is headed by a Project Coordinator who shall be a senior professional of the Geological survey in the Ministry of Mines assisted by geologists, geophysicists, an accountant and an administrative officer whose qualification and experience shall be satisfactory to the Bank.  - 18 - The appointment of the Project Coordinator was confirmed at negotiations. The consultants would be employed by GS. Terms of reference for the consultants are to be made satisfactory to the Bank and all consultants would be selected and engaged on terms and conditions satisfactory to the Bank. The planned implementation schedule is presented in Annex IV. 60. GS is expected to sell some of the data collected during the project, in particular the results of the airmag survey, to interested oil companies. The proceeds of any such sales would be recorded in a special account and used for future hydrocarbon exploration (Section 3.06 draft Loan Agreement). The Project would be completed by June 30, 1986. Procurement and Disbursement 61. The contract for the airmag survey will be awarded following limited international tendering (LIT). The need to fly this survey before the rainy season begins in November precludes use of the more time-consuming international competitive bidding (ICB) and a delay of one year to permit ICB would be costly to Zambia. Moreover, there are only a limited number of firms qualified to carry out such surveys and proposals have already been solicited from all of these. The firms were chosen and the proposals solicited under procedures agreed to with the Bank. Bids opening is scheduled for mid-April. The firms are widely scattered geographically (UK, France, Germany, Canada and the US), providing a broad range of interregional competition. If for any reason the procurement of the airmag is delayed until after the 1982 dry season, the contractor to carry out the airmag would then be selected on the basis of ICB. The contract for the gravity survey would be awarded following ICB in line with Bank guidelines. Vehicles and materials (estimated to total less than US$250,000) would be procured following local procurement procedures which are acceptable to the Bank. Consultants would be hired in accordance with Bank guidelines. Disbursement for the gravity survey will be conditioned on agreement between the Bank and Government that the survey is justified in view of the results of the airmag survey (para. 54 a(ii). Disbursements would be made against 100% of foreign expenditures and 80% of locally purchased vehicles and equipment. The loan is expected to disburse quickly since the biggest project component - the airmag - would be carried out in mid-1982. Accounting, Auditing and Reporting 62. GS would keep separate project acounts. The Project's accounts would be audited by external auditors acceptable to MOM and the Bank. The audited reports would be submitted by GS to the Bank within five months of the closing of the fiscal year, beginning with 1982 (Section 4.02 of draft Loan Agreement). GS would submit quarterly and annual reports on the implementation of the project in a format acceptable to  - 19 - the Bank. After completion of the Project, GS would prepare a report on the execution of the project (Section 3.05 (d) of draft Loan Agreement). Project Benefits and Risks 63. The main benefits of the Project would be (a) to provide information to the Government on the depth and thickness of sedimentary rocks and on stratigraphic sequences of Zambia's sedimentary basins; (b) based on the results of the geophysical surveys, to attract oil companies to invest risk capital for exploration in the areas surveyed under the project; and in the case of successful exploration (c) to initiate hydrocarbon production domestically and thus replace expensive imports. 64. The main risk associated with the proposed Project is that the results of the surveys might be insufficiently attractive to spur widespread industry interest. However, the advantages of proceeding with the Project outweigh the costs involved. Even if the results do not induce strong interest of foreign oil companies in exploration, it would help Zambia's planners and policy-makers to better assess the resource limitations that the country has to face and thus eliminate illusions about possible resources that otherwise could lead to wrong policy decisions. In any event, the remainder of the Project would be terminated if the results of the airmag survey are negative. 65. A further risk of the Project is that the quality of the data obtained in the surveys might not be high enough to be attractive to oil companies. This risk is intended to be addressed through the project component providing for supervision and quality control by experienced consultants. PART V - LEGAL INSTRUMENTS AND AUTHORITY 66. The draft Loan Agreement between the Republic of Zambia and the Bank and the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank are being distributed to the Executive Directors separately. 67. The draft Loan Agreement conforms to the usual pattern of agreements on petroleum exploration promotion projects. Special conditions of the loan are listed in Section III of Annex III of this Report. 68. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank.  - 20 - PART VI - RECOMMENDATION 69. I recommend that the Executive Directors approve the proposed loan. A. W., Clausen President By: Ernest Stern Attachments Washington, D.C. April 22, 1982  - 21 - ANNEX I TABLE 3A Page 1 of 5 ZAMBIA - SUCIAL INDICATORS DATA SHEET ZAMBIA REFERENCE GROUPS (WEIGHTED AVE9AGES LAND AREA (THoUSAND bO. KM.) - MOST RECENT ESTIMATE)- TOuAL 752.o MOST RECENT MIDDLE INCOME MIDDLE INCOME AGRILULuRAL j50.6 1960 lb 1970 /b ETIMHAtE /b AFRICA SOUTII OF SAHARA LATIN AMERICA & CARIBBEAN GNP PEA CAPITA (US() 200.0 340.0 Soo.O 794.2 1616.2 ENERGY LONSUEPTION PER CAPIIA (KILOCRA