Tunisia - Energy Conservation Demonstration Project

The World Bank FOR OFFICIAL USE ONLY Report No. P-4351-TUN REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$4 MILLION TO THE REPUBLIC OF TUNISIA FOR AN ENERGY CONSERVATION DEMONSTRATION PROJECT June 6, 1986 rThis document has a restricted distribution and may be used by recipients only in the performarice l of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit - Tunisian Dinar (TD) CY 1985 March 1986 US$1 = TD 0.757 TD 0.740 TD1 = US$1.321 US$1.351 The rate used in the President's Report is: US$1 = TD 0.73 Fiscal Year = Calendar Year ACRONYMS AND ABBREVIATIONS AME - Agence de Maitrise de l'Energie (Agency for Energy Conservation) API - Agence de Promotion des Investissements Industriels (Agency for Industrial Investments Promotion) ETAP - Entreprise Tunisienne d'Activites Petrolieres (Tunisian Petroleum Company) FHME - Fonds des Hydrocarbures et de Maitrise de 1'Energie (Funds for Hydrocarbons and Energy Conservation) MEM - Ministere de l'Energie et des Mines (Ministry of Energy and Mining) SME - Societe de Maitrise de l'Energie (Center for Energy Conservation) STEG - Societe Tunisienne d'Electricite et de Gaz (Tunisian Electricity and Gas Company) LPG - Liquified Petroleum Gas Toe - Ton of Oil Equivalent  FOR OMCUAL USE ONLY TUNISIA ENERGY CONSMSATION DEMONSTRATION PROJECT Loan and Project Summary Borrower: Government of Tunisia. Amount: US$4.0 million equivalent. Terms: Repayable in 17 years, including 4 years of grace, at the standard variable interest rate. Project Description: The project would: (i) help the Agency for Energy Conservation (AME) develop an effective institutional and policy framework for a national energy conservation program; (ii) strengthen AME's abilities to promote and monitor the national action program, and the local consulting capabilities for carrying out energy audits, and implementing energy efficiency actions at users' level; and (iii) finance the development and implementation of specific, short-term actions (technical assistance and basic equipment) for 28 selected enterprises to demonstrate the benefits of energy conservation to other users in the same sectors. Benefits and Risks: The proposed demonstration project would yield an average total energy saving estimated at some US$3.4 million per year (at crude oil prices of US$15 per barrel). The technical, financial and commercial risks associated with the project are minimal. Energy conservation measures would be based on proven technologies and practices, and the financing requirements are modest compared to expected returns. Also, by rationalizing energy use, the project would have a long-term beneficial impact on the preservation of Tunisia's natural resources and environment. The principal risk relates to the fact that the expected secondary or demonstration effects on other users in the selected sectors may be slow to materialize, due to the promotional difficulties common to demonstration undertakings. This risk is reduced through the special technical assistance given to AME for promotion and extension activities, and through the system of obligatory periodic audits established under the Energy Conservation Law. This document hs a strctod distribution and may be used by recipients only in the performance oftheir officidutieL its contents may not otherwise be disclosed without World Dank authoxition.  - ii - Estimated Costs: Local Foreign Total - (US$ million) - I. Assistance to AME Consulting Services * 0.32 0.32 Equipment/Materials 0.08 0.08 - 0.40 0.40 II. Energy Conservation - Industry Consulting Services 0.33 0.63 0.96 Equipment/Materials 0.77 0.74 1.51 1.10 1.37 2.47 III. Energy Conservation - Transport Consulting Services 0.03 0.28 0.31 Equipment/Materials 0.03 0.26 0.29 0.06 0.54 0.60 IV. Energy Conservation - Hotels/Buildings Consulting Services 0.13 0.12 0.25 Equipment/Materials 0.48 0.77 1.25 0.61 0.89 1.50 Total Base Costs Consulting Services 0.49 1.35 1.84 Equipment/Mater-ials 1.28 1.85 3.13 1.77 3.20 4.97 Physical Contingencies 0.35 0.60 0.95 Price Contingencies 0.13 0.20 0.33 Total Costs (exempt 2.25 4.00 6.2.5 from taxes & duties) = - Financing Plan: IBRD - 4.00 4.00 Government/Users 2.25 - 2.25 2.25 4.00 6.25 Disbursement Estimates: Bank FY: 1987 1988 1989 1990 (US$ million)- Annual 1.0 1.2 1.0 0.8 Cumulative 1.0 2.2 3.2 4.0 Rate of Return: Not applicable. Staff Appraisal Report: None. * Negligible amount for local subsistence expenditures only.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF TUNISIA FOR AN ENERGY CONSERVATION DEMONSTRATION PROJECT 1. I submit the following report and recommendation on a proposed loan for the equivalent of US$4 mill!'p to the Republic of Tunisia to help finance an Energy Conservation Demonstration Project. The loan would have a term of 17 years, including 4 years of grace, at the standard variable interest rate. PART I - THE ECONOMY 2. An economic report entitled "Tunisia - Country Economic Memorandum: Midterm Review of the Sixth Development Plan (1982-86)", in two volumes (No. 5328-TUN), was distributed to the Executive Directors in October 1985. An economic mission to review the macro-economic framework of the Seventh Plan (1987-1991) visited Tunisia in January 1986; its findings are reflected in this part and the country data sheets attached in Annex I. 3. Tunisia is a medium-size, middle-income country with a population of 7.5 million and a per capita income of about $1100 1/. Much of Tunisia is arid or semi-arid. Only three percent of arable land is irrigated, and areas where rainfed agriculture is possible are subject to severe year-to-year fluctuations in rainfall. Nevertheless, agriculture still occupies nearly one out of every three Tunisians in the labor force. Tunisia's most important raw materials are phosphates, petroleum and natural gas. Known exploitable reserves of oil and gas are approaching depletion, and new hydrocarbon reserves are limited and require costly off-shore drilling; priority is now given to slowing down the growth of domestic energy consumption through conservation and pricing measures. The low quality of phosphate deposits constrains the expansion of the highly efficient Tunisian phosphate processing industry. The country has also a considerable tourism potential; after a period of stagnation due to high prices and unsatisfactory quality standards, tourism resumed rapid growth in 1985. 4. Tunisia has undertaken a massive effort to develop its human resources, paying special attention to family welfare, education, and technical and vocational training. As a result, between the early 1960s and the early 1980s, the infant mortality rate declined from almost 160 to 83, life expectancy at birth rose from 48 to 62 years, the adult literacy rate increased from about 15 to about 62 percent, and average caloric intake per capita increased from 95 to lll percent of minimum standard requirements. An active family planning policy pursued by the Government led to a decrease in 1/ 1985 figure at current prices and actual exchange rates.  fertility and birth rates. Even though mortality rates also decreased, the gross reproduction rate decreased markedly from 3.5 to 2.4 percent over the same period. However, since net emigration of Tunisians abroad was sharply reduced by restrictive measures taken in the European Economic Community countries and Libya, the growth rate of the labor force accelerated, a main reason for the rapidly growing, serious unemployment problem. Open unemployment reached 14 percent in 1983 and underemployment is extensive. These problems are particularly serious among the young. 5. Recent Economic Developments. During the 1970s, the Tunisian economy did well. Rapid growth in the range of 7-8 percent was accompanied by substantial structural transformation as manufacturing and tourism became more diversified and their share in total exports increased. Economic performance benefitted from substantial terms of trade gains due to the rapid price increase of oil, allowing both consumption and domestic savings to increase and investment to remain high (over 30 percent of GDP). It also benefitted from improved economic management with a cautious shift toward a more liberal, market-oriented economy. Price inflation was relatively modest, averaging 6.4 percent during this period. The balance of payments current account deficit, averaging 5 to 6 percent of GDP over the period, was easily financed, much of it by direct foreign investment. The debt service ratio was 10 percent at the end of the decade. The only major problem was a persistently high rate of unemployment/underemployment. 6. The Sixth Plan (1982-86) proposed a number of policy reforms to face the consequences of rising unemployment and the progressive decline in net energy exports. Its main objectives were employment generation, export promotion, regional development and public sector efficiency. Investment priority was given to agriculture, engineering industries and tourism. The overall rate of investment was projected to decline during the Plan period. To minimize the effects on economic growth and employment, measures were proposed to increase the efficiency of existing investments, and encourage a shift to labor-intensive activities. These measures were to be accompanied by a substantially tightened income policy, particularly in cautious wage and salary policies, and a considerable slowdown in the growth of recurrent budget expenditures. 7. However, economic performance deteriorated during the Plan period. In 1982, a prolonged drought depressed agricultural output and agro-industrial production, technical problems plagued the phosphate and cement industries, and tourism and exports of manufactured goods were adversely affected by the recession in Europe and high domestic prices. Also, o-l production stagnated during the Plan period. The economy recovered in 1983 and 1984 due to buoyant growth in manufacturing output, stimulated by rapidly expanding local demand. Growth was further stimulated in 1985 by an exceptionally good agricultural crop and resumed growth in tourism, bringing the average annual GDP growth in the first four years of the Plan to 3.7 percent, compared to 6.3 percent targeted. This performance was nonetheless favorable in view of the world recession, and as compared with other countries. 8. The Government was slow in adjusting domestic demand to the decelerated economic growth. In contrast to the Plan's macro-economic objectives, the investment rate remained high rather than declined, mainly due to high public enterprise investments in energy and transportation, while domestic consumption expanded rapidly, fuelled by sharp increases in wages and  -3- salaries in 1982 and early 1983. This strong demand pressure, facilitated by rather liberal credit policies, was reflected in rising inflation which averaged nearly 10.5 percent in 1982-84, compared to 7.5 percent over 1977-81. It also contributed substantially towards the marked worsening of the current account deficit of the balance of payments, which reached 11 percent of GDP in 1984. The Government's overall budget deficit also increased from 5.3 to over 7 percent of GDP between 1982 and 1984. This reflected increases in recurrent expenditures due to wage and salary increases, higher subsidy payments to households and public enterprises, higher public investments and growing dollar-denominated debt service payments (caused by a 57 percent dollar appreciation vis-s-vis the Tunisian dinar between 1981 and 1984). 9. While the situation had not reached crisis proportions, the trend observed during 1981-84 clearly could not be sustained. Faced with this deterioration, the Government started to implement a package of policy measures aimed at stabilizing the economy. The minimum wage has not increased since January 1983. As a result, average nominal salaries increased by less than 3 percent per annum over the last three years, resulting in a cumulative decline of real salaries by over 15 percent by mid-1986. In April 1985, general interest rates were raised by 1-2 points and, later during the year, low special interest rates were raised by 3-4 points; with inflation declining to about 7 percent in 1985, most rates are now positive in real terms. In mid-1985 the authorities adopted a more flexible exchange rate policy resulting in a gradual downward adjustment of the dinar vis-a-vis European currencies. Finally, credit expansion was kept in line with GDP growth in 1985. 10. As a result of these measures, and of the imposition of drastic foreign exchange and import restrictions, the balance of payments current account deficit was brought back to 7 percent of GDP in 1985, despite reduced exports of oil and phosphates. While this improved the immediate situation, the underlying disequilibrium has not been resolved, and problems usually associated with controls, such as growing shortages of raw materials, semi-finished products and spare parts, have appeared. Meanwhile, the budget deficit rose to about 9 percent of GDP in 1985 because of a slowdown in revenues, despite a slight decline of capital expenditures in real terms. The authorities prepared a restrictive budget for 1986, designed to reduce this deficit to about 7 percent of GDP through a number of measures including a 15 percent reduction in real terms of subsidies to households and public enterprises. The decline in overall public expenditures of over 2 percent in real terms will make it possible to increase urgently needed imports of raw materials and spare parts for the country's productive sectors without exceeding last year's balance of payments deficit. 11. Medium-term prospects depend on two main factors: future developments in the hydrocarbon sector, and the speed with which the Government implements the far-reaching macro-economic policy changes discussed below. Oil and gas exploration programs since the mid-1970s have not been encouraging. Barring large new oil or gas discoveries, and given the rise in domestic energy demand, Tunisia is generally expected to turn into a net oil importer in the early 1990s. 12. Preparation of the Seventh Plan (1987-1991) is currently underway. Preliminary indications are that the Government will give high priority to a  - 4 - rapid improvement of the balance of payments and to more employment creation. To attain these objectives, it intends to pursue a strategy based on stimulation of non-oil exports, more efficient utilization of domestic economic resources, especially of human capital, and better savings mobilization through more restrictive demand management. Preliminary projections indicate that a GDP growth of 3.5-4 percent per annum, and a reduction in the current account deficit can be achieved without a systematic recourse to quantitative restrictions and other protection measures, and without excessive external borrowing. This growth scenario would only be possible, however, if additional substantive adjustment measures are taken over and above the ones already implemented. 13. The Tunisian authorities, in consultation with the Bank, have prepared a program of structural reforms emphasizing policy action in eight different fields: wages and salaries, exchange rate, budgetary policies, interest rates, monetary and credit policies, price and investment liberalization, and import protection. In the first five of these fields, the Government has, over the last few years, made considerable and successful efforts, and all indications are that it will continue to do so. Restrictive wage and salary policies are likely to continue; an austere budget is in place for 1986, and guidelines for the coming years include a nearly 10 percent annual reduction in subsidies in real terms. Most interest rates are now positive. On the exchange rate, the Government recognizes that a flexible policy has to be followed to improve Tunisia's competitiveness in agricultural and manufactured products, as well as in tourism, in order to achieve its ambitious export targets. 14. While substantial progress has been made since the early 1980s on these important issues, progress has been more limited in the remaining areas, i.e., on price and investment liberalization and import protection. Over the Iast years, the Government has focused with some success on administrative type measures. Concerned with immediate economic and social problems, it resorted to short-term measures and direct, quantitative controls such as mandatory price reductions and import restrictions. The price liberalization process has moved slowly, with some reductions in price subsidies (particularly for transportation and energy), increasing liberalization of agricultural producer prices and some liberalization in the price regimes for manufactured goods. While investment incentives were modified to stimulate exports and promote regional development, strict investment licensing was still maintained. The program of structural reforms to be implemented over the coming 2-3 years includes a number of concrete policy changes aimed at dealing with these issues, so as to achieve a gradual but systematic decontrol of the economy. 15. Social Issues. Since independence, the country has gone a long way tcwards meeting the basic needs of its population. Over 16 percent of GDP is now devoted to social programs, and the number of absolute poor declined from 17 percent of total population in 1975 to 10 percent in 1984. This improvement was largely concentrated, however, in urban areas. Since 1981, social issues have faced a different context than in the 1970s, when an easy financial situation seemed to allow a relatively unconstrained expansion of social services. On one hand, the Tunisian population has become increasingly aware of, and sensitive to income distribution issues, and to the Government's responsibility for redistribution. Furthermore, the beneficial effects of past rapid expansion in social services, reflected in the improvement of the  country social data (see Annex I), have created a demand for improved standards in social services delivery. On the other hand, the provision of adequate social services - education, health, urban infrastructure, housing - is being increasingly hampered by budgetary constraints. To reduce the financial burden of social services, the administration is reviewing the cost structure of the various types of social services, including free or below-cost delivery, and the possible introduction of some user fees. Special efforts are needed to improve social infrastructure management, in particular as regards hospitals. Also, decentralization of social facilities to deprived zones will have to be assessed carefully because costs for servicing and maintaining them could become prohibitive. 16. To reduce socio-economic differences, in particular between rural and urban areas, and between workers in the modern sector and those precariously employed in informal activities, the Government is channelling more resources into regional development and youth employment. Integrated rural programs are being developed to stimulate productive job creation and grassroots participation. Subsidies and credit facilities are granted for young technicians to create their own enterprises, and for entrepreneurs to create new projects in underdeveloped regions. More efforts are needed, however, to strengthen the coordination of vocational and on-the-job training with market demand. 17. External Assistance and Foreign Debt. During the second half of the 1970s, foreign borrowing was modest and a large share of foreign funds was provided by public sources at relatively soft terms. At the end of 1979, debt outstanding and disbursed was estimated at $3 billion, or 42 percent of GDP; debt service was 10 percent of export revenues. For reasons mentioned earlier (para. 8), the balance of payments deficit has increased substantially since then, as has foreign indebtedness. According to preliminary estimates, total public foreign debt outstanding and disbursed reached nearly $4.1 billion (50 percent of GDP) at the end of 1985. The debt service ratio rose to about 22 percent in 1985. However, the Tunisian authoritied have followed cautious debt management policies; while the share of short-term borrowings has increased slightly since 1980, Tunisia's overall foreign debt remains predominantly long and medium-term, and debt service requirements are projected to increase only slowly. During 1980-84, 60 percent of foreign loan commitments were from official sources, and nearly 35 percent on concessional terms. Over 70 percent of official commitments came from bilateral sources (mainly Arab oil-producing countries, France, Japan and the Federal Republic of Germany), about 20 percent from the Bank Group and 10 percent from other multilateral sources. Overall borrowing terms were favorable, averaging 8 percent interest and 15.2 years maturity. 18. In the medium-term, external capital requirements should remain easily manageable. In the longer-term, much will depend on the policy changes to be initiated during the next few years. The Government's medium-term objective is to maintain the present level of indebtedness; this prospect strongly depends on a timely implementation of policy measures to accelerate exports, reduce public investments, slow down growth of domestic demand, and liberalize the economy by easing regulations and controls. On this basis, the current account deficit is projected to average about $540 million in 1988 and 1989, but decline thereafter. During 1986-91 new loan commitments from abroad could be kept at a little over $1 billion per year on average (in current prices), while net foreign borrowing might increase from about $360 to $400 million during the same period; this could result in a debt service ratio peaking at about 25 percent in 1990.  19. To conclude, Tunisia, after a decade of good performance, is facing a major challenge in having to adapt its economic structure to the post- hydrocarbon era at a time of external and internal financial constraints. A strategy of demand restraint and export promotion combined with more liberal economic policies is called for to improve efficiency and preserve the country's financial stability and creditworthiness. The Goverment has already taken several measures to implement such a strategy. Considering its long record of prudent external debt management, there are good grounds to assume that Tunisia will implement the necessary policy changes, and remain creditworthy for a continued high volume of Bank lending. PART II - BANK GROUP OPERATIONS IN TUNISIA 20. Since 1962, the Bank has committed to Tunisia sixty-nine loans and ten IDA credits amounting respectively to $1,481 million and $75.2 million (net of cancellations) of which forty-four loans and credits have been fully disbursed. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of March 31, 1986. Project implementation is generally satisfactory. As of March 31, 1986, overall disbursements amounted to 52.5 percent of appraisal estimates, which is in line with experience in other countries in the region. Disbursement performance for irrigation, energy, industrial finance and port projects has generally been above the country average, while longer than average disbursement delays have been experienced for agricultural credit, education, highways, urban and fisheries projects, due to project-specific problems that are being addressed through supervision missions and sector discussions. In a number of sectors, important institutional improvements have been achieved, and autonomous agencies have been created or strengthened to ensure the efficient management of the related sectors or subsectors. 21. The Bank's lending strategy in Tunisia aims at supporting the country's transition from a situation of reliance on petroleum exports to a sectorally-balanced post-hydrocarbon era through appropriate changes in economic policies and programs. This adjustment process will require further diversification of exports, greater savings efforts, reduction in consumer subsidies, gradual liberalization of all sectors of the economy, and stronger incentives to the private sector particularly in agriculture and industry, while taking measures to increase employment and target development to low-income groups. In support of the above, the overall objective of Bank lending is to emphasize projects which have a direct and rapid impact on production, employment and exports (or import savings) and which minimize Government net contributions. The focus of lending for agriculture and industry meets this objective. In addition to the above, proposed Bank lending would focus on improvement of public enterprise performance, conservation and development of energy resources, and continued support to the social sectors and operations targeted to low-income groups. For the latter, attention would be given to increased efficiency and cost-effectiveness of institutions and investments, and to linkages with directly productive sectors (e.g., education reforms stressing vocational training). We envisage only marginal lending for basic economic infrastructure, focussed in areas where Bank guidance would still be useful, such as rural water supply and highways maintenance. 22. Past Bank lending emphasized support for long-term investments in infrastructure and social development, each of which accounted for about one-third of Bank/IDA commitments since 1971. The rest of the commitments  7- were almost equally distributed between agriculture and industrial financing. In addition, the Banc has made two loans for technical assistance. Within the broad framework noted in para. 21, we expect a significant shift in our lending, with well over half going to agriculture and industry. In addition to the proposed Energy Conservation Demonstration Project, programmed lending in the next couple of years would include projects for urban development, highways maintenance, grain storage, credit lines for small-scale industries and agriculture, and sector loans for agriculture and industry. 23. The Bank's economic and sector work will address the increasing complexity of the macro-economic and sector problems that Tunisia will face in the medium term, and continue to focus on strengthening the macro-economic and sector base for our lending program. However, while in the past it was mainly devoted to the study of major structural problems, it is now focussed on implementing the policy recommendations of these studies through sector lending in agriculture, manufactured exports, public enterprises and transport; it will therefore concentrate on the following main tasks: (a) preparation of the macro-economic framework of the Seventh Plan, which will provide the policy base of sector lending; (b) review of public expenditures under the Plan to provide guidance for the necessary reductions in budget outlays; (c) assessment of public enterprise reforms prepared by the Government to reduce their drain on the State budget; and (d) monitoring of the agreed macro-economic and sector policy changes. The program also includes studies on education administration and finance, municipal finance and development, energy pricing, and the impact of the adjustment program on various income groups. 24. The Bank and IDA accounted for about 27.8 percent of total commitments from official sources to Tunisia during 1982-1984. Their share in total debt outstanding and disbursed at the end of 1984 (including loans from private sources) was an estimated 14.8 percent, and their share in debt service during 1984 was 11.7 percent. The share of the Bank and IDA in Tunisia's disbursed external debt is expected to increase to about 18.7 percent and their share in the debt service to about 17.3 percent in 1986. 25. As of March 31, 1986, IFC's net commitments in Tunisia totalled about $7.5 million. IFC has supported the Economic Development Bank of Tunisia (BDET) to foster development projects, and the National Bank for Tourism Development (BNDT) to promote and invest in tourism projects. It has also assisted the Societe Touristique et Hoteliere (RYM), a large hotel development; the Industries Chimiques du Fluor (ICF), a producer of aluminum fluoride from local fluorspar for export; and the Societe d'Etudes et de Developpement de Sousse-Nord for an integrated tourism development project. In FY84, IFC approved two new equitv investments in Tunisia: (i) Fluobar, a project to privatize, rehabilitate and expand an existing fluorspar mine; and (ii) Tunisia Leasing Company, the first leasing company in Tunisia to provide financing to the industrial sector. IFC's approval in FY86 of an equity investment in Societe Industrielle de Textiles (SITEX) would help privatize an existing state-owned textile mill. PART III - THE ENERGY SECTOR 26. Energy Resources. Tunisia's energy base, balance and consumption patterns and trends are discussed in more detail in Annex rV-1. In brief, oil and gas are Tunisia's main energy resources. In addition, the country has a  -8- modest hydropower potential, some lignite deposits and geothermal resources as well as the possibility for using renewable energy, notably solar and wind energy. Proven reserves of oil and gas are estimated at 70 mil'lion tons and 66 million tons of oil equivalent, respectively. El Borma, in the southwestern desert area bordering Algeria, and Ashtart, offshore in the Gulf of Gabes, are the major oil fields, contributing about 85 percent to total oil production. Both fields are depleting rapidly and will cease production in the 1990s. Natural gas is produced at El Borma as associated gas, and from a small reservoir at Cap Bon. In addition, starting in 1984, Tunisia is receiving natural gas as royalty (in kind or cash) for the transit through its territory of the Algeria-Italy Transcontinental Pipeline, and purchases, under a three-year contract, additional gas from Algeria. Major untapped gas reserves exist offshore in the gulf of Gabes (Miskar and Jugurtha) and onshore at El Franig near the Chott El Djerid. Given the depletion of its oil resources, the Government expected that natural gas would play an increasingly important role in meeting Tunisia's medium-term energy requirements. The viability of this gas option still remains to be determined in view of the high investments required for production, distribution and conversion, and the current fall in oil prices. 27. Tunisia has also a small already exploited hydropower potential of about 65 MW which includes the recently commissioned Sidi Salem plant, part of a multi-purpose project in which the Bank is participating. Poor quality lignite deposits in two locations are prosently under study. Underground hot water resources exist at several locationi. The extent of this geothermal potential is being investigated in the context of the Bank-assisted Technical Assistance Project (No. 2197-TUN). Several experimental schemes are planned or are under way to determine the viability of exploiting Tunisia's renewable energy resources. Energy Balance 28. In 1984, the total commercial energy consumption in Tunisia was estimated at about 3.8 million toe. As seen in the following table, Tunisia is almost totally dependent on hydrocarbons for meeting its commercial Tunisia - Energy Balance in 1984 ('000 tons of oil equivalent) Supply Amount X Demand Amount Z Domestic Crude Oil 5,487 Crude Oil Exports 3,831 Domestic Production Domcstic Consumption Oil Products 1,538 41 Industry 1,043 28 Natural Gas 692 18 Transport 982 26 Hydro Power 16 1 Commerce 164 4 Subtotal 2,246 60 Others 469 12 Stocks & Losses 174 5 Subtotal 2,658 70 2,420 65 Imports Oil Products 1,145 30 Electricity 842 22 Natural Gas 120 3 Stocks and Conversion Coal & Coke 71 2 Losses 256 8 Subtotal 1,336 35 Total 3,756 100 Total 3,756 100 Sources: MEM and Bank staff estimates.  - 9 - energy requirements. In 1984, oil represented about 74 percent of the commercial energy consumed; natural and manufactured gas another 23 percent; the remaining 3 percent was met by hydro and imported hard coal and coke. During the period 1976-84, when the average real rate of GDP growth was about 5 percent per year, the growth of energy consumption averaged some 8 percent per year. This high growth consumption rate was primarily due to the accelerated growth of the industrial sector (especially of energy-intensive industries such as building materials, chemicals and refineries) encouraged by low domestic energy prices. 29. Crude oil and gas production increased from about 4.8 million toe in 1976 to 6.3 million toe in 1984. Tunisia has been a net exporter of crude oil (3.8 million tons in 1984) and the Government continues to depend on the foreign e.ichange provided by these exports to sustain the growth of the economy. However, because of the limited local refinery throughput (1.6 million tons per year) and the growth in demand, Tunisia has had to import a substantial volume of oil products (1.1 million tons in 1984). The 1984 domestic natural gas 2roduction estimated at 692,000 toe, includes some 314,500 toe of gas received as transit fee for the Algerian Transcontinental Pipeline to Italy. In addition, Tunisia purchased about 120,000 toe of gas from Algeria by tapping this pipeline. Electricity production (estimated in 1984 at 841,700 toe) has been mostly gas based (87 percent of total national gas consumption) with fuel oil accounting for 37 percent of total fuel oil consumption. 30. On the consumption side, induscry is the largest energy user in the country, accounting for about 28 percent of the total domestic consumption (42 percent including electricity), followed by transport (28 percent). Within the industrial sector, cement and other building materials account for almost 43 percent, phosphate mining 16 percent, steel and mechanical industries 15 percent, and chemicals 9 percent. The total industrial energy consumption (1.5 million toe in 1984 including electricity) comes from heavy and light fuel oil (45 percent), purchased electricity (28 percent), natural gas (11 percent), gasoil (9 percent) and other sources (7 percent). It is estimated that in 1984, 30 of the most energy-intensive plants, publicly owned in full or in part, accounted for about 60 percent of industrial energy consumption. Within the transport sector, road transport activities are the heaviest energy users (69 percent of the estimated total sectoral consumption in 1984), followed by air (15.5 percent), and maritime transport (12 percent). Broken down by energy types, this sector is found to rely heavily on gasoil (over 66 percent) and gasoline (almost 23 percent). Although there is little information available on fuel use by vehicle category, it has been estimated that public passenger and cargo transport activities account for some 13 percent of the road fuel consumption (or about 82,300 toe in 1984). The commercial sector consumed in 1984 about 401,000 toe, of which electricity was estimated to be 237,300 toe. Hotels are the most important energy users, accounting for some 60-70 percent of the total sectoral consumption. Data on the other users (essentially commercial and institutional buildings) are not available. Almost all of the energy used in this sector is for heating and cooling, coming from electricity (59 percent) and gasoil (29 percent). Most of the sectoral energy consumption is accounted for by a relatively small number of large hotels. Future Prospects 31. The Tunisian oil and gas sector is expected to be in a difficult  - 10 - position over the next 5-10 years. No major oil reserves have been discovered, and well results since 1984 have been disappointing. Production from the two existing major oil fields (El Borma and Ashtart) will continue to decline, with a parallel decline in the natural gas resources currently exploited in association with El Borma. As discussed previously, there are other proven potential gas fields (Miskar is the most important one), but the economic viability of their production is still uncertain. For the remainder of the decade, the terms of trade for Tunisia are not expected to be as favorable as in the 1970s and early 1980s due to the continuing softening of petroleum prices. These lower prices in turn make decisions on the large investments required to develop new domestic supply sources more difficult. In the absence of efforts to rationalize national energy consumption, to develop domestic reserves and other energy sources, Tunisia would become a aet energy importer by the early 1990s. fuisia - Enew Suwly and Desrd Permx-ims ('000 tons of oil equilent) Suply in 1990 DaofIK in 1990 Dead Alternatives: Base Z LoW Z EB 2 Lo Z ility of lstic Crude Oil 4,400 4,400 L-& Oil Ecolts 2,800 2,800 Dhestic Pmductiol DlXEstic (XmpIm Oil Prodhucs 1,600 30 1,600 34 TIq&tzy 1,540 29 1,292 27 icuul Chs 1,045 20 1,045 22 1hup,ort 1,348 25 1,34 24 HydZr POW: 19 1 19 1 Q==en 159 3 137 3 Subtotal 2,664 51 2,664 57 0tE#S _ 56 11 497 11 StbtotaL 3,612 68 3,060 65 Mworts Oil PoActs 2,508 47 1,916 41 Electricity (in- atuml (As - - cluIirg losses) 1,660 32 1,620 35 Cbal & Coke 100 2 100 2 Subtotal 2,608 49 2,016 43 Thtal 5,272 100 7,680 100 Total 5,272 10 4,680 00 Sau=ce: World Bmk staff Est'tes. 32. The above 1990 energy balance projections are based on a conservative GDP growth of about 3.7 percent per annum, and two alternative energy demand growth rates: 6 percent per annum in the base case, and 3.7 percent per annum in the low demand case, with the assumptions that: (i) the existing domestic refinery capacity would remain unchanged (because expansion investments may not be justified in the face of expected softening of international oil prices); and (ii) a substantial gas substitution rate would not be a viable option (due to the current oil price trends and the possible constraints with regard to distribution infrastructure and equipment conversion at user  - 11 - levels). The low demand case implies a decline in the elasticity of energy demand from over 1.5 in 1984 to about 1.0, which could be achieved by 1990 only if vigorous energy conservation and rationalization efforts are undertaken soon. It is important to note that, even in this low demand scenario, Tunisia's domestic energy balance would deteriorate with crude oil exports declining from almost 4 million toe in 1984/85 to only about 2.8 million toe by 1990. Energy Savings Potential 33. Energy efficiency surveys carried out during 1980-84 by the Government with assistance from the USA and France indicate that potential energy savings in the country for the period 1985-1990 can be summarized as follows: Tunisia - Potential Energy Savings Potential Annual Savings Share of Total With Contri- 1984 Energy a/ Investments bution Share Consumption Minor Maior to Total ('000 toe) (X) (X) (Z) (Z) Sector Industry 1,453 42 10 20 4-8 Transport 983 28 10 15 3-6 Commrcial/Residential 876 25 10 20 3-6 Agriculture 188 5 - - - Total 3,500 100 10-20 a/ These include electricity consumption, net of generation and distribution losses. 34. At the 1984 consumption level for the industrial sector, the estimated sectoral savings would represent some $14-29 million per year, at $100 per toe (or $15 per barrel of crude oil). For the transport sector, potential savings have been estimated at about $10-15 million per year, and for commercial/residential sector to some $8-16 million per year. About 40-50 percent of these potential savings can be realized with modest investments through better housekeeping, and simple operational and maintenance procedures. Experience in developed and developing countries confirms that these simple measures represent an essential first phase in an energy conservation program. The proposed project would finance these first-phase measures. 35. Energy Conservation Policies. Significant improvements have been achieved by the Government in energy pricing. As a result of the successive price increases since 1980 (the most recent in December 1985), and in view of the current continuing softening of international oil prices, domestic prices of petroleum products are above international levels. The domestic retail to border price ratios as of May 1986 ranged between 4.7 for gasoline and 2.6 for gasoil, with almost 2.2 for heavy fuel oil. During negotiations, it was agreed: (i) that the Government and the Bank will hold annual consultations, not later than December 31 of each year during project implementation, to review energy conservation policies in the country, including the Government's  - 12 - energy pricing policy, with the objective of maintaining national energy prices for petroleum products at international levels and ensuring efficient implementation of energy conservation activities; and (ii) that the Government will take appropriate measures on the basis of this review. However, appropriate energy prices alone are not sufficient to generate interest in conservation, as the current price control system regulating the industrial sector allows producers to pass on all production cost increases to consumers. The Bank is discussing price liberalization reforms as part of its macro-economic policy dialogue with the Government, and this issue would be addressed specifically in the context of sector lending operations now under preparation. 36. Energy and its efficient use is being assigned top priority by the Government in its Seventh Development Plan (1987-91). In 1985, an Energy Conservation Law was passed, calling for: (i) the establishment of an Agency for Energy Conservation (Agence de Maitrise de l'Energie [AME]), an autonomous public institution under the supervision of the Ministry of Energy and Mining (MEM) to promote, implement and coordinate national energy conservation policies and action programs, including energy-related training, setting of standards and norms in energy efficiency for all major users in the country; (iii) obligatory periodic energy audits by auditors to be licensed by AME; (iv) provision of incentives to users to promote energy efficiency and the development of new/renewable energy sources; and (v) setting of "contract-programs" between AME and users/enterprises benefitting from the incentives provided under the Law, to implement and monitor the actions under (ii) through (iv) above. This legislation was prepared in close consultation with the Bank by the Societe de Maitrise de l'Energie (SME) created in 1984 to prepare the way for AME. The latter has already been created. Next in priority is the preparation of the implementation procedures of the Conservation Law. These include the decrees related to the obligatory periodic energy audits, and the role of AME in reviewing energy-intensive investment proposals in coordination with existing agencies (e.g., the Agency for Industrial Investment Promotion [API|), and the administrative circular regarding the procedures for granting and controlling energy conservation incentives, including the system of contract-programs. These decrees are being prepared by AME with the assistance of foreign advisors financed through French bilateral aid, and in close consultation with the Bank. It was agreed, during negotiat.ons, that the draft decrees, which will be ready by end-1986, will be reviewed by the Bank prior to their promulgation. 37. In light of the policy environment discussed above, the system of mandatory periodic audits would help ensure that, in the foreseeable future, the needed energy conservation measures will take place effectively and rapidly in the country. The audit periodicity is expected to be every 2-3 years, with the first audit being a real, full audit and subsequent ones being more of an update of the information already established within the enterprises. To allow sufficient time for energy users and local consultants to get ready, the energy consumption threshold value above which a periodic audit is required would be phased over 2-3 years from 1987, starting with the larger energy users and gradually incorporating smaller users in subsequent years; different threshold values will be applied depending on the characteristics of each sector. Thus it is estimated that about 100 industrial enterprises, 50 transport companies, and 50 hotel establishments would be covered by this periodic audit regulation between 1987 and 1989. With regard to incentives measures, the Law provides for small grants to help  - 13 - users with the costs of energy audits, staff training, and feasibility studies (50 percent of costs, subject to ceilings ranging between $2,500-25,000 equivalent depending on the type of activity), as well as duty exemptions on imported equipment not produced in the country. Users submitted to the periodic audit regulation and desiring to receive Government incentives would sign a contract-program with AME which spells out an agreed set of efficiency remedial actions and targets they are committed to implement and achieve over a specific time period. Approved investments would be eligible for credit that the local banking system would make available under terms and conditions defined by the Central Bank of Tunisia, as indicated in the Conservation Law. This package of incentives was reviewed by the Bank during appraisal and negotiations, and is considered appropriate. As indicated above (para. 36), detailed implementation procedures will be reviewed by the Bank to its satisfaction. 38. Institutional Framework for Energy Conservation. The institutional framework for implementing and enforcing the Energy Conservation Law consists of: (a) the General Directorate of Energy (DGE) located within the Ministry of Energy and Mining (MEM) responsible for national energy policies and planning, and overall management of energy-related activities in the country; (b) AME which has three functions: (i) to prepare the necessary studies/analyses for a rational and effective use of traditional and renewable energy resources in the country, and help formulate related policy measures and actions for Government decision; (ii) to implement these Government policies through the formulation, promotion, supervision and control of the related regulations and action programs, including the screening of the qualifications of Tunisian energy auditors and specialists, and approving them for use by energy consumers; and (iii) to undertake and coordinate training for the rational use of energy including the use of renewable energy resources; and (c) the local consulting firms to be hired by energy users to carry out in their plants/establishments energy audits and resulting recommended operations. 39. Organization of AME. The Government appointed in December 1985 a qualified president-director general for AME, who had worked previously in the Tunisian Petroleum Company (ETAP) as well as in the Ministry of Industry, and served as head of the State Agency for Industrial Investments Promotion (API) whose basic promotional, supervisory and assistance activities for industry are similar in nature to the activities of AME in energy conservation. AME, under the supervisory authority of MEM, will operate as an autonomous institution, with a board consisting of representatives from MEM and the Ministry of Coimerce and Indusl:ry (both the General Directorates of Energy and Industry), the Ministries of P'anning, Finance, Housing and Public Works, Transport, Agriculture, and Totrism and the Central Bank. AME's organization chart was established in consultation with the Bank (Annex IV-2). At full operation by 1987/88, AME will have a maximum total professional staff of 18 divided into 5 departments: Promotion (2), Studies/Planning (4), Technical Operations (8), Renewable Energy (1), and Finance/Administration (3). This staffing was assessed during appraisal, and is considered sufficient for AME's planned activities. The Studies/Planning Department is already fully operational with four staff transferred from SME, and the Technical Operations Department is in place with four newly recruited experienced engineers. They are to work closely with the four technicians currently in SME responsible for managing the on-going energy component under the Bank'& Technical Assistance Project.  - 14 - 40. The services of a foreign resident advisor and institutional/regu- latory specialist, provided to AME through bilateral aid, are expected to be continued for another 1-2 years. To assist AME's promotional and follow-up responsibilities, the services of specialized consultants would also be provided under the proposed project for the training of staff and the design of promotional activities as well as operational procedures required for efficient monitoring/control of the regulations/action programs. 41. Local Consulting Capabilities. The actual implementation of energy audits and conservation actions at users' level would be carried out by energy auditors and specialists to be approved by AME. According to the Law, to fulfill the periodic audit obligation, and be eligible for the Government's energy efficiency incentives, users can contract only consultants/experts licensed by AME and not affiliated with the user(s). The rules and procedures for qualifying these local consultants have been prepared by AME, reviewed by the Bank and found satisfactory. The local consulting industry is keenly interested in getting into this new field; a few consultant firms have already hired staff with appropriate backgrounds, and have associated themselves with foreign consultants to carry out the energy audits being financed under the Bank's ongoing Technical Assistance Project. It is expected that over the next three years, after some training and actual practice under the guidance of foreign specialists, there would be some 4-5 qualified firms. On-the-job training has already started under the Bank's Technical Assistance Project, and would be pursued under the proposed project, in close coordination with other ongoing and future bilateral/multilateral aid programs. As there is already some local experience in the building/hotel sector, it is envisaged that the existing local consulting firms would have a significant participation relatively early in this sector; in contrast, their qualification in the industrial sector would need further and more intense strengthening. 42. To ensure efficiency, AME will certify individual energy auditors and conservation specialists rather than consulting firms. An understanding was reached during negotiations that having fulfilled its mandate, SME will be dismantled after the completion of its current activities under the Technical Assistance Project, and that the public institutional framework for energy conservation will remain as light and flexible as possible, allowing the development of private initiatives and an effective competitive participation of local private consultants in the national conservation program. 43. Energy Conservation Activities. Since 1980, preliminary energy audits have been carried out with US and French assistance for some 15 large public enterprises in the most energy-intensive industries. These activities have not, however, led to tangible results because the quality of the audit reports has been quite uneven; the audits were carried out in a sporadic, uncoordinated manner, and, especially, without the active participation and commitment of the users; the enterprises audited have serious problems of basic viability or corporate restructuring which require further Government decisions and more complex remedial actions; more importantly, there was no consistent, well-coordinated institutional set-up for the needed follow-up and promotion work, a serious gap now filled by AME. Six industrial energy audits are being financed under the Bank's on-going Technical Assistance Project, together with some activities for studying/testing the possibilities for the use of renewable energy resources; they will be completed early in 1987 by SME  - 15 - under the supervision of AME. Also initiated by SME during 1985 are commendable promotional/sensitization activities such as conferences and seminars (e.g., for the transport and hotel sectors). While these were useful and appreciated (high users' attendance), participants have expressed an urgent need for more concrete, technical actions to demonstrate what methods and equipment/imaterials are required to resolve their specific energy inefficiency problems. The Government, AME and the Bank intend to address this crucial operational gap under the AME's planned activities for 1987-1989, of which an important part is supported by the proposed project. 44. AME's Work Program. In close consultation with the Bank, a preliminary AME activity program for the next three years has been formulated bearing in mind that: (i) a demonstration approach, using a selected number of users with representative problems, would be the most effective use of limited available resources; (ii) demonstration cases should include a complete range of actions, from audits to implementation of basic, short-term conservation measures; (iii) users should be selected on the basis of their willingness to participate in the actions (i.e., designation of an energy manager in the plant and financial contribution to the costs) as well as the extent of their potential savings and demonstration effect on other users; (iv) the proposed demonstration program should be focused on enterprises that are financially viable, and for whom the costs of energy conservation actions would have a pay-back period of three years maximum for the transport sector, four years for the industrial sector, and six years for the hotels/buildings sector; (v) operations should include an intensive and effective promotional program (to include users' training) as a crucial element to maximize the impact of demonstration cases; and (vi) participation of the existing local consulting firms in the demonstration and training/promotional programs is essential for an effective and expeditious strengthening of their capabilities. The preliminary AME 1987/1989 activity plan would consist of the management of two programs: (a) demonstration activities in three main energy-consuming sectors to take place under the proposed Bank project; and (b) activities related to the periodic obligatory audits, some of which would be carried out with bilateral aid funding. The total costs of this three-year activity plan are estimated at about $8 million, of which about $5 million in foreign exchange. This includes AME technical staff costs and the equipment/materials to be purchased under the Bank's project, but excludes studies and administrative costs. 45. AME has several funding sources, the most important being the petroleum tax fund (Fonds des Hydrocarbures et de Maitrise de l'Energie, [FHME]). In 1985 the Government allocated $3 million from FHME resources to energy conservation activities, of which 20 percent, or $600,000, would cover AME's annual administrative budget. An analysis of past and future availability and utilization of FHME during the period 1980-89 indicates that there would be sufficient resources to cover AME's 1987-1989 planned activities. Assurances were obtained during negotiations that sufficient funds will be made available by the Government for AME to carry out its activities under the proposed project. Experience with Past Lending 46. Starting in 1971, Bank lending to Tunisia for power and energy consisted of six operations amounting to $110.4 million of which  - 16 - $109.7 million to STEG. The first loan (No. 724-TUN of 1971 of $7.5 million) helped finance El-Borma pipeline in the South, and a second loan of $12 million (No. 814-TUN of 1972) financed combustion turbines and the expansion of the transmission and distribution systems. The Project Performance Audit Reports (Nos. 1078 of March 12, 1976 and 2521 of May 24, 1979) for both projects noted their catalytic effect, particularly on STEG's improved financial performance and technical capability, and concluded that the projects were successful (the audit rate of return, in both cases, was substantially higher than appraisal estimates) and effective in making STEG a well organized and efficient utility. No major problems were encountered during project implementation. A third loan of $14.5 million (No. 1355-TUN of 1977) helped finance additional combustion turbines. The Bank approved in 1980 a $37 million loan for a second gas operation to build the Tunisian on-shore section of the Algerian Transcontinental Pipeline and network distribution lines in the North in support of the Government's then long-term strategy of substituting gas for petroleum products. A fourth power loan of $38.7 million (No. 2455-TUN of 1984) will help rehabilitate STEG's transmission and distribution network in urban and rural areas. With the objective of identifying conservation/ renewable energy projects for inclusion in the Sixth Plan (1982-1986), a $700,000 energy component of a Technical Assistance loan of $4.5 million (No. 2197-TUN of 1982) is financing energy audits and efficiency studies to assess and test new and renewable energy potential. This component suffered, until the recent creation of SME and AME, implementation delays resulting essentially from the absence of an effective project interlocutor within the Government. Under the management of SME, this component and, in particular, the ongoing audits of six industrial enterprises is now progressing satisfactorily, and is expected to be completed in early 1987. Follow-up feasibility studies, as required, and recommended viable energy conservation actions in these six enterprises would be implemented under the proposed project. Rationale for Bank Involvement 47. The Bank has assisted the Government in developing an opera- tional/institutional framework for energy conservation activities. Under the proposed project, the Bank will pursue its active advisory role to promote better energy planning and management, and ensure consistency of these policies with the broader issues in the industrial sector which are part of the ongoing macro-economic dialogue between the Bank and Government. Finally, the proposed project would assist the Government and energy users in their drive for energy conservation, an effort which is made inevitable by the projected energy balance of the country, in spite of the currently low international oil prices. PART IV - THE PROJECT Background 48. At the request of the Government of Tunisia, the proposed project was identified by a Bank mission in April 1985 and appraised in January 1986. Negotiations were held in Washington from May 27 to May 30, 1986. The Tunisian Delegation was led by Mr. Sadok Rabah, Director General of Energy of the Ministry of Energy and Mining, and included representatives from the  - 17 - Ministry of Planning and from AME. A Loan and Project Summary is given at the beginning of this report, and a Supplementary Project Data Sheet appears as Annex III. Prolect Obiectives and Description 49. The objectives of the proposed project are to: (i) help AME establish an institutional and policy framework to promote and monitor effectively the implementation of energy conservation activities; (ii) strengthen the local capabilities in energy auditing, and in implementing energy conservation actions at the user's level; and (iii) finance specific short-term demonstration actions for 28 selected users in three energy intensive sectors. More specifically, the project includes the following: (a) Strengthening local technical capabilities: technical assistance to AME to design, follow up and control the implementation of energy conservation and related promotional activities over the first two years of its operation; training for AME staff in basic energy auditing and conservation methods (including some training overseas as needed) as well as for the participating users and selected technicians (e.g., teaching staff at the local engineering schools); and purchase for AME of basic working instrumentation, tools and equipment (e.g., for measurement, control, basic training of users, promotional campaign, etc.). (b) Industrial sector demonstration component: energy audits, feasibility studies and implementation of recommended short-term energy-saving actions for 12 manufacturing enterprises selected for demonstration (to include specific shop-floor technical assistance/on-the-job training), and basic energy-saving tools and equipment. (c) Transport sector demonstration component: energy audits and implementation of recommended actions for 8 transport companies and large vehicle parks, to include driver training, technical assistance in energy conservation management, and instrumentation for fuel-efficient driving and preventive maintenance. (d) Hotel/building demonstration component: energy audits and implementation of recommended conservation actions, including application of renewable energies (e.g., solar heating), technical assistance for energy conservation management and related equipment for 8 buildings (7 of which are hotels). Project Implementation 50. All project preparatory work has now been completed. AME would be responsible for overall project implementation and management, including coordination and supervision of the work carried out by foreign consultants in association with local consultants. It would: (i) select with participating user-enterprises the consultants for the execution of energy audits, feasibility studies and conservation actions, and help them with procurement procedures; (ii) supervise and coordinate the work of consultants; (iii) control the quality, costs and schedules of services and goods; (iv) organize  - 18 - training and promotional campaigns under the project; (v) process disbursement requests from the Bank loan for payment of incurred expenditures; maintain the necessary project records; monitor progress, and prepare periodic status reports for review by the Bank; and (vi) collect on behalf of the Government the users' contributions to the costs of energy audits, equipment and conservation actions, and deposit them every three months in an account located in the Treasury Department according to Government rules and procedures. AME will receive expert assistance: (a) to help in the design and supervision of the audit/conservation work at the users' level, and in campaigns to promote the demonstration cases; and (b) to train their own staff and participating technicians. Draft bidding documents and terms of reference for these activities have been reviewed by the Bank and found satisfactory. 51. The energy audit/feasibility study, detailed planning and implementation of recommended conservation measures for each demonstration case will be carried out by teams of foreign consultants. As under the energy audit component of the ongoing Technical Assistance loan, these consultants will be encouraged to enter into long-term association with one or several Tunisian consulting firm(s) of their choice to ensure proper transfer of expertise, and strengthen local capabilities. In the hotels/buildings sector, where local experience is already well developed, local consulting firms would have meaningful inputs, at least for simple demonstration cases. Selection Criteria 52. The 28 demonstration cases have been selected by AME and Bank staff in accordance with the following basic criteria: (i) they do not have serious restructuring problems and have energy conservation needs representative of their respective sectors; (ii) they are assessed to have good potential energy savings, and are prepared to serve as demonstration cases for other users in their sectors; (iii) they agree to designate an energy manager in the plant, and contribute to the costs of the audits/studies and the recommended energy saving actions as spelled out in para. 53 below; and (iv) the costs of energy conservation actions would have a pay-back period of three years maximum for the transport sector, four years maximum for the industry sector and six years maximum for the hotels/buildings sector. The chosen 12 industrial enterprises account together for some 16 percent of the total industrial sector energy consumption in 1984; the transport and hotel establishments account for some 3 percent of their respective sectoral total consumption. The selected demonstration cases in each of the three sectors are listed in Annex IV-4. Adjustments in these lists (cases dropped and new ones added) as well as in the preliminary cost estimates may be necessary during project implementation depending on audit results; they will be made in agreement with AME, the concerned users and the Bank in accordance with the above mentioned criteria. Agreement was reached during negotiations that AME will provide to the Bank for its approval the final list of selected participant enterprises not later than December 31, 1986. About half of the 12 industrial demonstration cases would be the enterprises being currently audited under the ongoing Technical Assistance Project; for these cases, the proposed project would only provide for feasibility studies and recommended operations. Cost Recovery 53. The users participating in the demonstration program are expected to  - 19 - contribute at least 35 percent of the total costs of the energy audits and studies, and 100 percent of the total expenditures incurred for implementing recommended energy-saving actions. The users' commitment to serve as demonstration cases and their payment of the incurred costs will be recorded in a signed agreement with AME. The following terms and conditions for cost recovery were agreed during negotiations: (a) with regard to audits, feasibility studies, and training activities, 20 percent of the amount will be due at the signature of the agreement with AME, 20 percent at the start of activities, and the balance in a maximum of 3 installments, the last of which is to be made at completion of the activities, with the total payment period not exceeding three years from the start of each activity; and (b) for the energy saving actions, payment will be made according to a fixed amortization schedule, based on a period of seven years, including one year of grace, and at the same interest rate fixed by the Central Bank of Tunisia (currently 6.5 percent per year) for credits financing renewable energy investments. Local agents attending AME's technical training programs will also be charged a participation fee. These arrangements were agreed with AME during negotiations. 54. The project would be implemented over a 40-month period, and completed by December 31, 1989. By that time, it is expected that an adequate number of technicians in both AME and consulting firms wn ' hiave been trained to continue the basic energy conservation work without f a specialists, except for the cases involving more advanced retrofitting ..-/or enterprises with complex process technology. For these, it is expected that AME would draw upon the experience acquired through the design of this demonstration project, and formulate more complex operations in close collaboration with local consultant firms and users. 55. The total manpower required to implement the project is estimated at about 176 man-months of foreign and local consultants, and 137 man-months of AME staff time over the 1987-1989 period. The project has been designed as an integral part of the total overall assistance to be received by AME. It would represent about 85 percent of the cost of the envisaged AME work program for the same time period, and about 90 percent of the related total foreign exchange costs. The balance of this program is to be financed through funds from local sources (users) and foreign aid (e.g., France, the US and UNDP); the continuation of on-going foreign aid programs is expected to be negotiated by end-1986. Discussions with potential donors during project appraisal confirm their intention to coordinate closely with the Bank project for optimum use of resources and results. During negotiations, it was agreed that AME would provide a report to the Bank and the Government every six months on the progress made in its work program, including the activities to be financed by users and/or with other aid funds during 1987 through 1989, and introduce changes, as required, in order to ensure consistency and maximize impact. Agreement was also reached during negotiations that the Government and the Bank will hold annual reviews on the institutional and administrative framework and the Government's policies for energy conservation, taking into account: (i) the changes needed in Government industrial and energy pricing policies; (ii) the capability of local consultants to undertake energy conservation operations without supervision; and (iii) the progress and future prospects of energy savings in order to ensure the efficient implementation of energy conservation in the country.  - 20 - Proiect Cost and Financina Plan 56. The total cost of the project is estimated at $6.25 million equivalent, of which $4 million (64 percent) in foreign exchange. These estimates do not include customs duties and import taxes following the exemptions provided under existing regulations. Physical contingencies are estimated at about 19 percent of base cost, to cover possible adjustments in the list of demonstration cases, and the variations of costs that will result from audit and feasibility studies. Price contingencies are based on domestic and international inflation of 7 percent per annum for the 1986-1989 period. The proposed Bank loan of $4 million would be made to the Government for 17 years including 4 years of grace, at the Bank's standard variable interest rate; it would cover 64 percent of the total financing requirement, and 100 percent of the foreign exchange costs of the project. The Government would cover all project-related local costs. Procurement 57. Procurement arrangements are summarized in the following table: Procurement Method (US$ million) LIB/IS a/ Other b/ LCB c/ Total Cost Consulting/Engineering Services -- 1.69 0.63 2.32 = (1.69) () (1.69) Equipment & Materials 2.31 -- 1.62 3.93 (2.31) (2.31) Total 2.31 1.69 2.25 6.25 (2.31) (1.69) (-) (4.00) a/ Bank's guidelines for limited international bidding and international shopping. b/ Bank's guidelines for use of consultants. c/ Local competitive bidding. Note: Figures in parentheses are the amounts financed by the Bank. 56. As all goods to be acquired under the project will be in small quantities (standard instrumentation materials and simple energy-saving equipment), their procurement would be through the Bank's procedures for limited international bidding (LIB) on the basis of evaluation and comparison of bids from at least 3 suppliers eligible under the Bank's guidelines, and international shopping if the items involved cost less than $25,000, on the basis of comparison of price quotations solicited from at least 3 suppliers. In the case of LIB, the Bank will have prior reviews of procurement decisions. To the extent possible, identical or similar items will be grouped together for purposes of bidding and procurement. Contracts for consulting and engineering services would be procured according to Bank guidelines on the use of consultants. For local cost items (not financed under the Bank loan), local competitive bidding procedures would be followed.  - 21 - Disbursement 59. The proposed loan would be disbursed as follows: (a) 100 percent of foreign exchange costs of equipment/materials, and (b) 100 percent of foreign exchange costs for consulting, engineering, and training services. Although the loan disbursement profile for Tunisia is 9 years, the small loan size and project implementation arrangements justify a disbursement period of 46 months. All disbursements will be made under quarterly statements of expenditures (SOE) to be prepared by AME after verification of relevant documentation; these records would be kept by AME for subsequent review by the Bank. A Special Account to assist AME in making timely payments would be opened at the Central Bank with an initial deposit of $400,000. To assist an early start, retroactive financing of up to $300,000 is recommended to cover expenditures incurred after June 30, 1986. The Closing Date of the loan would be June 30, 1990. 60. The Government would make available the proceeds of the Bank loan to AME. The latter would be authorized to withdraw funds to pay foreign consultants and equipment suppliers for the costs of services and goods provided to project participants. Auditing and Reporting Requirements 61. Within six months of the end of each fiscal year, AME would submit to the Bank financial statements and reports and a report on the Special Account, audited by independent auditors acceptable to the Bank. AME would also maintain separate project accounts; an audit of these accounts (including SOEs) would be included in the audit of its financial statements. It would maintain records to monitor progress in project implementation, and submit status reports in a form acceptable to the Bank within 60 days after the end of each semester. Within six months after the Closing Date, it would submit a project completion report reviewing problems and achievements under the different project components, and assessing the demonstration impact and experience gained from the project. Benefits and Risks 62. Unlike past ineffective efforts in energy conservation in the country, this project would be a coordinated, comprehensive action program covering complete energy conservation cases from audit to implementation in three major energy-consuming sectors. While the viability of the energy-saving actions recommended for each demonstration case will be assessed by feasibility studies prior to implementation and investment decisions, the overall viability of the demonstration program can be analyzed based on preliminary costs and savings estimated from specific plant visits by energy conservation specialists during project appraisal. The short-term expenditures envisaged for participating users (e.g., housekeeping measures and simple retrofitting) are expected to yield some 14,000-27,000 toe per year of direct/primary savings (i.e. by the participating users only), representing on average about 8 percent of their total 1984 energy consumption. At a price of $100 per toe of fuel oil (or $15 per barrel of crude oil), these estimated primary savings are valued in the range of $1.4-2.7 million per year. If the expected demonstration or secondary effects on other users in the same sectors are  - 22 - included, a conservative estimate of total savings under the project would be in the range of $2.8-4.1 million per year. The participating enterprises may expect a pay-back period averaging 3.3 years. If the secondary demonstration effects on other energy consumers and the cost of the AME component are also included in this analysis, the pay-back period for the total project as a whole would average 2.2 years. As seen in the following table, the estimated pay-back results remain within acceptable ranges in spite of large variations in crude oil prices. Tunisia - Sensitivity Analyses of Pay-back Estimates Number of Pay-back Years for: Average Participating Total Project Enterprises Total At Crude Oil Price of: Direct Savings Only Savings a/ $20/barrel 2.5 1.7 $18/barrel 2.8 1.9 $15/barrel 3.3 2.2 $13/barrel 3.6 2.6 a/ Including potential savings expected from the demonstration or secondary ef- fects that participating users would have on other users in the same sectors. 63. The proposed project would have a long-term beneficial impact on Tunisia's environment; it jould contribute to the rationalization of energy use, conservation of energy, and the preservation of the country's natural resources. The project is expected to have a strong institutional impact on two fronts. One, it would provide training in energy audit and conservation for the technical staff not only of the participating enterprises, but also and more importantly, o