Djibouti - Geothermal Development Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 7762-DJI STAFF APPRAISAL REPORT DJIBOUTI GEOTHERMAL DEVELOPMENT PROJECT JUNE 8, 1989 Industry and Energy Operations Division South Central and Indian Ocean Department Africa Region This document has a restricted distibution and may be used by recipients only In the performauce of  CURRENCY EQUIVALENTS Currency Unit = DF US$1.00 = DF 177.72 WEIGHTS AND MEASURES 1 cm - centimeter = 0.39 inches 1 m - meter = 3.28 feet 1 m3 - cubic meter = 264 US gallons 1 1 - liter = 0.26 US gal'ons 1 bbl - barrel = 42 US gallons 1 kg - kilogram - 2.2 pounds 1 km - kilometer = 0.62 miles 1 km2 _ square kilometer = 0.39 square miles 1 t - ton - 2,205 pounds 1 kW - kilowatt = 1,000 watts 1 MW - megawatt = 1,000 kilowatts 1 kWh - kilowatthour = 2,000 watthours 1 GWh - gigawatthour 1 million kilowatthours FISCAL YEAR January 1 - December 31 ABBREVIATIONS BAD - Banque Africaine de Developpement (African Development Bank) BRGM - Bureau de Recherches Geologiques et Minibres CCCE - Caisse Centrale de Cooperation Economique CFP - Professional Training Center EdD - Electricite de Djibouti EdF - Electricite de France ENEL - Italian National Power Board EPH - Etablissement Public des Hydrocarbures FADES - Arab Economic and Social Development Fund KF - Kuwait Fund ISERST - Institut Superieur d'Etudes et de Recherches Scientifiques et Techniques MMB - Million barrels OPEC - Organization of Petroleum Exporting Countries TIC - Internal Consumption Tax TOE - Tons of Oil Equivalent in Heating Value UNDP - United Nations Development Program USAID - United States Agency for International Development  FOR OFFICIAL USE ONLY DJIBOUTI GEOTHERMAL DEVELOPMENT PROJECT STAFF APPRAISAL REPORT TABLE OF CONTENTS Page No. Credit and Project Summary . . . . . . . . . . . . . . . . . . . .(i)-(iii) Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Part I. THE SECTORAL ENVIRONMENT . . . . . . . . . . . . . . . . 1 The Economic Setting . . . . . . . . . . . . . . . . . 1 Overview . . . . . . . . . . . . . . . . . . . . . . 1 Recent Developments . . . . . . . . . . . . . ... . 2 The Energy Sector . . . . . . . . . . . . . ... . . . 3 Overview . . . . . . . . . . . . . . . . . . . . . . 3 Domestic Energy Resources . . . . . . . . . . . . . . 4 Energy Sector Institutions . . . . . . . . . . . . . 5 Energy Sector Objectives, Issues and Strategy . . . . 6 Petroleum Prices . . . . . . . . . . . . . . . . . . . 7 The Power Sector . . . . . . . . . . . . . . . . . . . 8 Oijerview . . . . . . . . . ... . . . . . . . . . . . a Power Sector Investment Program . . . . . . . . . . . 9 Tariffs . . . . . . . . . . . . . . . . . . . . . . . 10 Part II. BANK GROUP LENDING STRATEGY . . .11 Part III. BENEFICIARY ..................... . 12 Electricite de Djibouti . . . . . . . . . . . . . . . 12 Organization, Management and Staff . . . . . . . . . 12 Training . . . ..3...... 13 Operations, Maintenance and Losses . . . . . . . . . 13 Financial Planning and Budgeting . . . . . . . . . . 14 Accounting System ...14 Commercial System . ........ ... 14 EdD's Financial Position and Past Operatirng Results . 15 Audi.t .......... . 19 Taxes . . . . . . . . . . . . . . . . . . . . . . 19 Insurance and Asset Valuation . . . . . . . . . . . . 19 Transfer of Government Financed Assets . . . . . . . . 19 Future Financial Position and Operations of EdD . . . 20 This report is based on the findings of an appraisal mission to Djibouti in June/July 1988. Mission members included Christian Schmidt (AF3IE), Miguel Montes (EMTIE), Jack Warren (AFTIE), Peter Beard and James Koenig (consultants). A post-appraisal update on EdD was carried out by Ms. Mersman (consultant) in March 1989. 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.  Part IV. THE PROJECT .... . . . . . . . . . . . . . . . . . . . 22 Background .... . . . . . . . . . . . . . . . . . . . 22 Project Objectives and IDA's Role . . . . . . . . . . . . 23 Project Description . . . . . . . . . . . . . . . . . . . 23 Scaling Study .... . . . . . . . . . . . . . . . . 24 Nomad Settlement Impact Study . . . . . . . . . . . . . 24 Drilling Operation .... . . . . . . . . . . . . . . 24 Consumables . . . . . . , . . . . . . . . . . . . . 24 Purchase of existing wells . . . . . . . . . . . . . . 24 Drilling Supervision .... . . . . . . . . . . . . . 24 Studies ..... . . . . . . . . . . . . . . . . . . . 24 Installation of Generating Equipment and Surface Facilities . . . . . . . . . . . . . . . Z5 Installation of a 1MW Well-head Generator . . . . . . . 25 Installation of a Single Circuit Transmission Line . . 25 Overall Project Management and Training for EdD Personnel .... . . . . . ...... . . . . 25 Project Costs .... . . . . . . . ...... . . . . . 25 Financing Plan . . . . . . . . . . . . . . . . . . . . . 26 Project Implementation and Schedule . . . . . . . . . . . 27 Procurement ..28 Disbursements ..29 Monitoring and Reporting . . . . ... . . . . . . . . . 29 Environment ..29 Part V. PROJECT JUSTIFICATION AND RISKS . . . . . . . . . . . . . 31 Economic Rate of Return .31 Background . . . . . . . . . . . . . . . . . . . . . . 31 Methodology . . . . . . . . . . . . . . . . . . . . . 32 Plant Characteristics & Fuel Costs . . . . . . . . . . 32 Geothermal Plant .32 Results of the Analysis . . . . . . . . . . . . . . . . 33 Economic Rate of Return .33 Benefits .34 Risks. . . . . . . . . 34 Part VI. AC4REEMENTS .34 Agreements Reached .34 Conditions of Effectiveness. 36 Dated Covenants .35  ANNEXES 1. Power Sector 1.01 Electricity Supply Statistics for the Djibouti Network 1971-1987 1.02 Electricity Consumption and Losses in the Djibouti Network 1971-1987 1.03 Basic Indicators for Load Forecast Scenarios 1.04 Load F.recast 1988-2000 A: Reference Forecast (Djibouti City Network) B: Growth Forecast (Djibouti City Network) 1.05 Capability of Existing Generating Plant on Djibouti Network 1.06 Performance Characteristics of Diesel Generating !ant 1.07 Energy in the Economy 1.08 Power Histograms (1987) 1.09 Load Duration Curves (1987) 1.10 Composition of EdD Fuel Price 2. EdD 2.01 Organization Chart ?.02 Asset Valuation Study - Terms of Reference 2.03 Geothermal Training Program (including ISERST assistance) 2.04 Staffing Profile of Geothermal Division 2.05 Consultancy Services for the Geothermal Division 3. Present EdD Tariff Structure 4. Ed' - Past and Proiected Financial Statements 4.01 Profit and Loss Statement (1986-1988) 4.02 Balance Sheet (1986-1988) 4.03 Investment Program 4.04 Assumptions for Projections 4.05 Projected Profit and Loss Statement 4.06 Projected Balance Sheets 4.07 Cash-Flow Projection and Ratios 5. Draft Cooperation Agreement EdD-ENEL 6. Implementation Schedule 7. Schedule of Disbursements  Annexes (continued) 8. Economic Analysis 8.01 Estimated Phasing of Capital Expenditure 8.02 Net Present Value of: (1) Base Case (10 NW G-eothermal by 1993) with projected fuel prices (2) Base Case (all Diesel Option) (3) Base Case (10 MW Geothermal by 1993) with constant fuel prices (4) Base Case (all Diesel Option) with constant fuel prices (5) Sensitivity of No. (1): 20% capital cost increase (6! Sensitivity of No. (1): early reservoir depletion (geothermal maintenance cost + 20% and replacement wells in 1999, 2005 and 2011) (7) Sensitivity of No. (1): 1 year implementation delay (8) Growth Case Scenario of No. (1) (9) Growth Case Scenario of No. (2) 8.03 (1) Economic Rate of Return Analysis (2) Assumptions on Calculation of Internal Economic Rate of Return (3) Economic Rate of Return 8.04 Findings of Previous Studies on Geothermal Energy 8.05 Geothermal/Diesel Comparison (Reference Forecast; Growth Forecast) 9. List of Documents in the Prolect File  DJIBOUTI GEOTHERMAL DEVELOPMENT PROJECT CREDIT AND PROJECT SUMMARY Borrower: The Republic of Djibouti Beneficiary: Electricite de Djibouti (EdD) Amount: SDR 7.1 million (US$ 9.2 million equivalent) out of a total project cost of US$ 38.04 million. Terms: Standard IDA terms (40 years) On-Lending Terms: Fifty percent of credit proceeds are onlent from Government to EdD at 8.5Z (IBRD rate at negotiation plus IOZ thereof), repayment over 20 years including a grace period of five years. EdD carries the foreign exchange risk. The remaining fifty percent is an equity contribution of Government to EdD. Cofinancing: Italian Government with a grant of US$22.0 million, and a joint OPEC/UNDP grant of US$1.4 million. Project Description: Objectives: The project's principal objective is to assist Djibouti in the necessary replacement and expansion of its electric generating capacity at least cost through utilization of indigenous geothermal energy resources. Components: The project consists of the components below, of which the IDA credit would finance items (a), (b), (c) and (g)(i), the remainder being covered under Italian and OPEC/UNDP grant financing: (a) Scaling studies to insure that generating equipment, well tubes and steam gathering system are designed in a way which takes full account of the specific nature of the corrosion effects linked to the salinity of the brine; (b) Nomad Settlement Impact Study to spell out issues which may arise from a potential settlement of Nomads in the area of the drilling activities; (c) geothermal drilling in the Lake Assal area of four deep production and replacement wells (about 2,000m deep) including necessary consumables; (d) complementary surface exploration works in the Lake Assal area, including gravity and electrical resistivity surveys and related studies;  - ii - (e) (i) installation of 2x5 MW power plants (including wellfield equipment) and (ii) a 1 MW well head unit and desalination plant; (f) installation of an electrical transmission line from the Lake Assal area to Djibouti City; (g) technical assistance to EdD including: (i) consulting services for further project preparation (PPF-financed); (ii) services of project management and supervision for three years; (iii) engineering services for the supervision of the deep drilling operations and the carrying out of related specialized services (logging, testing, etc.); (iv) training; and (v) equipment and vehicles. Benefits: The immediate expected benefit from the project is the production of electricity derived from commercial geothermal resources in the Lake Assal area. Exploitation of these reserves would contribute to reducing t'Le country's current total reliance on imported fuels to satisfy its energy needs and would thus contribute sub.tantially to foreign exchange savings. Another benefit from the project would be to assist EdD to further strengthen its role in geothermal development and production. Risks: The main risk associated with the project is that future reserves have characteristics (in terms of temperature or chemical composition) that could prevent additional development and production on an economical basis; however, based on the current data on the Lake Assal area, it is expected that this risk is small and is outweighed by the potential tenefits associated with the commercial exploitation.  - iii - Estimated Proiect Costs: US$ million Local Foreign Total 1. Bidding Documents & TORs 0.10 0.10 2. Special Studies 0.95 0.95 3. Purchase and Work-over of Assal Wells 4.83 0.12 4.95 Sub-total 4.93 1.07 6.00 4. Drilling (4 wells) & consumables 1.28 6.12 7.40 5. Wellfield Eqiiipment 0.45 2.55 3.00 6. Power Plant (2 x 5 MW) 0.70 6.30 7.00 7. Power Plant (1 x 1 MW) 1/ 0.13 1.17 1.30 i 8. Electrical transmission 0.67 3.80 4.47 9. Housing/Control Building 0.50 - 0.50 10. Drilling Supervision 0.12 0.50 0.62 11. Project Management 0.29 0.'i-A 0.72 12. Technical Assistance to EdD - Training/Initial Operation 0.48 0.72 1.20 - Project Engineering 0.18 0.43 0.61 Total Base Cost 9.73 23.09 32.82 Physical Contingencies 10% 0.48 2.32 21CO (except for #3) Price Contingencies 1.03 1.39 2.42 Total Prolect Cost 2/ 11.24 26.80 38.04 1J Including Desalination Plant. 2/ Net of Taxes and Duties Financing Plan: USS million Local Foreign Total IDA - 9.52 9.52 Government/EdD 5.30 .10 5.40 Italy 5.94 16.10 22.04 OPEC/PNUD - 1.40 1.40 TOTAL 11.24 26.80 38.04 Estimated Disbursements 3/ (US$ million) IDA FY ----FY90--------- --------FY91---- FY92-- 1st sem. 2nd Sem. 1st Sem. 2nd. Sem. 1st Sem. Annual 1.5 2.3 3.0 1.8 0.6 Cumulative 1.5 3.8 6.8 8.6 9.2 3/ The estimated disbursement schedule deviates from the standard profile as IDA's financial contribution will be mainly for drilling and related consumables, which, based on experience under IDA's previous Geothermal Exploration Project, is expected to be completed in a relatively short period. Rate of Return: 12.0% Map: IBRD No. 21648  DJIBOUTI GEOTHERMAL DEVELOPMENT PROJECT Introduction The proposed project represents a logical continuation of IDA's initial involvement in Djibouti's energy sector which dates back to 1985, when the Geothermal Exploration Project (Credit 1488-DJI) led to the discovery of Africa's most powerful geothermal source found so far. The findings under that exploration project confirmed that the steam sources are sufficient to generate electrical power on an economical basis, and the development phase now proposed will cover the actual implementation of a ,iirst phase of geothermal based power generation. The project will render unnecessary the expansion of diesel-based gen ration capacity, which was scheduled for 1992 in line with the power demand growth forecast, and will reduce the country's dependence on fuel oil imports for its energy requirements, which have increasingly absorbed scarce forei3n exchange resources. PART I. THE SECTORAL ENVIRONMENT THE ECONOMIC SETTING Overview 1.01 The Republic of Djibouti is a small country of 23,000 km2 with several social and economic difficulties that hinder its development efforts. Located at the mouth of the Red Se&. Djibouti is bordered on the North, West and South-West by Ethiopia and on the South-East by Somalia. Djibouti became independent in 1977 and joined the World Bank in 1980. Djibouti is classified by the United Nations in the Least Developed Countries group. 1.02 The country is characterized by a rugged topography, with elevations ranging from 150m below sea level to 2000m above. Its climate is very hot, and in the absence of any perennial rivers, the lack of fresh water is a major physical constraint. An estimated one million heads of livestock are herded by the nomad population, who comprise roughly 20 percent of the total population. Only about 600 hectares of land are cultivated, although some 6,000 hectares are deemed to be potentially cultivable. The country's fishing potential is just beginning to be exploited. Apart from the geothermal steam reservoirs, there are few proven natural resources except for salt, limestone, gypsum and other raw materials used in construction. The manufacturing sector is limited to a number of small-scale establishments producing for the domestic market. 1.03. The population is estimated at between 400,000 and 450,000 in mid- 1986, including about 40,000 refugees from neighboring countries. About two-thirds of the population live in Djibouti City. The rate of population  - 2 - growth is estimated at about 3 percent. Nearly 40 percent of the population is below 14 years of age. The age structure of the population, its rapid increase, and the influx of refugees, have resulted in acute employment problems. 1.04 In spite of its unfavorable climate and limited resources, Djibouti has been able to benefit from its strategic location and its historical and regional ties to build upon the service-oriented economy inherited at independence. While both the primary and secondary sectors are underdeveloped, accounting for less than 20 percent of GDP, there is a relatively important tertiary sector based mostly on the official and unofficial trade with neighboring countries, and the presence of a large number of French military and civilian personnel. Other services center around the port of Djibouti, shipyards, the railw-y to Ethiopia, the international airport, and a private banking system. Therefore, economic activities are vulnerable as they depend highly on the fluctuation of external demand for services. 1.05 The economy is highly open, notable for a complete absence of trade barriers and exchange restrictions, and there is a free trade zone at the port. Merchandise exports of local origin are insignificant, and the country depends heavily on imports of food and other consumer goods. Recent Developments 1.06 Real GDP declined on average by about 2 percent per annum during the period 1984-1988, as compared to an average growth of 3 percent between 1978 and 1982. This was due mostly to the sharp drop in service and construction activities. In 1989, the economic situation is likely to suffer a further setback due to the recent to!:rentisl rains which caused heavy floods and affected about 50 percent of the population of Djibouti City. 1.07 The external current account deficit improved substantially from 17 percent of GDP in 1984 to an estimated 4 percent in 1987 owing to a reduction in imports and a sizeable increase in unrequited transfers. On the fiscal front, Lhe budgetary deficit has remained worrisome. However, due to some remedial measures taken recently with support from France, the overall deficit, including grants, declined from 6.4 percent of GDP in 1984 to around 5 percent in 1988. Capital expenditures have been reduced in conjunction with a more cautious approach to borrowing and external debt management. 1.08 Djibouti is highly dependent on foreign assistance. External aid finances more than 40 percent of Government expenditures and represents nearly 25 percent of GDP. About two thirds of the total foreign assistance are in the form of grants and one third in the form of external borrowing mostly on concessionary terms. External debt outstanding at the end of 1987 amounted to US$152 million or 40 percent of GDP. Due to heavy borrowing in the early 1980s to finance infrastructure projects, debt service payments increased rapidly from US$3 million in 1982 to US$13 million in 1987. As a result, debt service payments reached 7 percent of total exports including re-exports.  - 3 - THE ENERGY SECTOR Overview 1.09 Due to the lack of any developed domestic energy resources, Djibouti currently relies exclusively on petroleum imports to meet its commercial energy requirements. The country's total internal energy consumption reached about 99,000 TOE in 1985 (essentially petroleum products). Per capita energy consumption was 230 kg of oil equivalent, relatively high by African standards, due to Djibouti's important expatriate community. 1.10 The significance of imported energy for Djibouti is shown in Annex 1.07. The figures therein contained suggest opportunities for the Government to reduce its commercial deficit by curtailing these imports. The figtures also spell out the real expenses incurred bv the Djiboutian economy (i.e. excluding taxes, salaries, adjustments etc.) for petroleum products consumed by the country. Expenditures on energy were over DF 6.2 billion (US$9.5 million) in 1982 representing 2.5 percent of GDP and 31.6 percent of net imports. In the past, the cost of the net imports noticeably increased when the price of oil rose. Since 1986, the substantial fall in the international price of oil has produced a significant positive effect on the balance of payments. Such an impact of the importation of petroleum products on the balance of payments, be it positive or negative, will continue to remain important for Djibouti until the substitution of geothermal energy and the simultaneous adoption of energy conservation measures enable the country to reduce these imports. 1.11 Consumption of electricity rose by 8 percent p.a. from 1980 to 1985, 3.38 percent from 1985 to 1986 and 6.26 percent from 1986 to 1987 and reached 143 GWh in 1987. Annual growth over the next ten years is forecast at about 4 to 6 percent p.a. Djibouti's long-term power development plan shows requirements for increments in capacity of 15-20MW every 3-4 years (taking into account the retirement of old electricity generation equipment). There are about 21,000 -ower customers in the country, and it is estimated that less than 45 percent of the population has access to elect-icity. 1.12 The production of primary energy is limited to wood, corresponding to 13,135 TOE (tons oil equivalent) in 1985, the year of the latest data available. With respect to the intermediate or secondary forms of energy, apart from a small quantity of imported charcoal (50 TOE), the principal import was 240,000 TOE of hydrocarbons, of which 155,000 TOE (65 percent) were re-exported, the remainder being used for the internal market supply. Of this remaining quantity, 36,460 TOE was used to generate electricity, 2,960 TOE was used in the production of charcoal, and the remainder went directly towards providing final energy for the end-user sectors. Electricity, which represents 16.6 percent of final energy, is consumed in decreasing order by the residential sector: 47.2 percent; services: 31.7 percent; the French Army: 16.8 percenti industry: 3.6 percent; and agriculture and fishing: 0.7 percent. Apart from the still minimal contribution of solar and wind energy, only 13.1 percent of the  -4- energy consumed in Djibouti in 1985 was provided by indigenous energy resources: wood; 86.9 percent of the energy consumed was imported. Domestic Enerzy Resources 1.13 Djibouti's energy sector is marked by its overwhelming (87 percent) dependence on imported fuel oils to meet its energy balance. Geothermal, wind and solar energy are Djibouti's only s2.^aificant potential energy resources and, so sar, remain essentially untapped. The previous IDA Geothermal Exploration Project (Cr. 1438-DJI of 1984, closed June 30, 1938) indicated a sizeable resource of geothermal energy in the Assal area. At the present time, two wells drilled into the high-temperature reservoir are capable of producing steam and hot water (paras. 4.03/4.05). Hydropower potential in the county is nil due to the absence of permanent rivers. Furthermore, the country's geology is not particularly favorable to significant hydrocarbon accumulation. Minor interest has been shown by international oil companies in exploring for petroleum in Djibouti, possibly on acreage offsetting that held in neighboring countries. 1.14 While no Reothermal energy is yet on production in Djibouti, the exploration for this resource started back in 1971 in the Assal region by BRGM, a French Government company, followed later in other areas by Aquater and Geotermica Italiana, Government and private Italian companies, respectively. This led to the drilling of eight deep wells, (five of which were financed under the IDA Exploration project, (see para. 4.03)), two in Hanle and six in the Assal area. Of these, Assal No. 1, which tested high enthalpy fluids in 1980, is now non-productive due to plugging. However, Assal No. 3 and Assal No. 6 are capable of producing geothermal energy. The other wells failed to produce, either for lack of temperature, or due to a lack of permeability in the rocks drilled, or because of mechanical problems. 1.15 Apart from the geothermal energy potential, some renewable energy resource potential exists in the form of wind and solar power and might have a significant impact on Djibouti's future energy supply. In addition, the possibility exists to utilize the difference in elevation between the Gulf of Ghoubet and Lac Assal to generate hydro energy. 1, 1.16 The wind regimes in Djibouti have not been measured on a regular basis until recently. Data published in the National Energy Plan indicate that windmills for water pumping are a viable option in many parts of the I/ Lac Assal is a salt lake located in the Danakil Depression some 14 km inland and 155 m below the level of the Gulf of Ghoubet. The area between the gulf and the lake is volcanically active; the rift is moving apart with movement of 6 cm per year having been measured.  - 5 - country, but that sites with average wind speeds in excess of the 6m/s limit, at which wind power is likely to be competitive with diesel, have not yet been identified. Wind power on a significant scale is unlikely, therefore, to be a viable alternative for Djibouti within the timescale being considered for the Geothermal Project. 1.17 Djibouti is favored with both high average levels and a high reliability in insolation (7800 mega joules/m2 per year). The country receives solar energy each year equivalent to 40 thousand times its present needs. However the present use of solar energy, apart from natural water heating is limited to photovoltaic systems with a total installed capacity of about 12 kW peak. While photovoltaic systems are already economic for certain low power applications, particularly .n remote parts of the country, their high capital cost makes this technology uneconomic for large scale electricity production. (A number of thermal solar power plants are operating in industrial countries and the latest plant constructed in California, with a capacity of 30MW is reported to have cost US$3100/kW peak). However, to provide a firm supply, these plants require some form of storage which is not cost effective at present. In spite of its present limitations, this technology is nonetheless sufficiently close to being cost effective in areas such as Djibouti as to warrant regular monitoring. Energy Sector Institutions 1.18 There are four institutions in Djibouti related to the energy sector. They are Institut Superieur des Etudes et Recherches Scientifiques et Techniques (ISERST), Electricite de Djibouti (EdD), the Etabliesement Public des Hydrocarbures (EPH), and the Ministry of Industry and Industrial Development, which has also responsibility for the energy portfolio. ISERST is the Government entity responsible for all aspects of energy related research, including geothermal exploration. An autonomous agency created in 1979, it reports directly to the Presidency. ISERST's full-time staff for geothermal exploration includes 6 local geologists, all of whom gained considerable experience in geothermal exploration during the implementation of IDA's First Geothermal Project for which ISERST was implementing agency. During that period, ISERST's director also has been able to call upon a group of French and Italian geothermal experts who formed ISERST's International Scientific Council. This council has been convened on various occasions (the last time in mid-1988) to advise ISERST on matters relating to geothermal exploration. In addition, ISERST's director has attended technical conferences and toured geothermal power installations abroad. 1.19 EdD, the country's public electric utility, will take the leading role in establishing the country's future policy for geothermal develop- ment, as it will have direct responsibility for the production and supply of electricity from the geothermal field to be exploited under the project. EdD reports to the Ministry of Industry, which also approves EdD's tariffs (para. 1.33). Finally, the Public Hydrocarbons Establishment (EPH) is the public agency in charge of regulating the importation and distribution of hydrocarbon products, currently handled by three foreign oil companies (para. 1.25). Established in 1980, and dealing in only 4 types of fuels (super and regular gasoline, gas-oil and kerosene), EPH has the following  -6- responsibilities: (i) supply hydrocarbons to meet national demand in the most effective manner and (ii) regulate prices with the aim of stabilizing the market. Energy Sector Objectives, Issues and Strategy 1.20 The Government's major objective in the energy sector is to reduce the country's dependence on imported fuel. In light of the favorable conditions for the development of commercial geothermal resources in Djibouti, the Government gives a high priority to this program. However, as part of its national energy plan, the Government has also adopted conservation measures. As a result, the country is about to embark on a major energy conservation program promoting bioclimatic and energy efficient building design with thermal insulation as well as thermal insulation of refrigerators and fitting of low power street lighting fixtures. ISERST is also promoting widespread dissemination of information on the potential savings from improved building insulation. These programs should have a significant impact on the future demand for electricity, in particular during the hot summer season when the demand is dominated by air conditioning load. The impact of these programs should be carefully monitored and incorporated in future electricity demand forecasts. In anticipating some of the expected slow-down effects on demand, the project is built on a conservative growth scenario (para. 5.02) of 4 percent p.a.. 1.21 In devising its strategy for future exploration and development, the Government recognizes that the small size and concentration of the domestic power market represents a major constraint to be taken into account, sinr.e the production of electricity represents for the time-being the only economically viable option for the use of geothermal energy in Djibouti, although industrial use on a minor scale may prove feasible in the longer term. Therefore, the Government has established a strategy not to carry out more than one expensive deep drilling program in the country at the same time, primarily for budgetary reasons but also because two simultaneous discoveries could result in proving reserves far in excess of what is needed to meet the forecast increment in domestic power demand (about 30MW over the next decade) whereas an average (by international standards) geothermal field is capable of sustaining about 5OMW when fully developed. Hence, there is no immediate need for additional geothermal field development elsewhere in the country as was once contemplated in view of salinity and scaling problems existing in the Assal area. There is, however, the possibility that small geothermal exploration and development may be considered in the future near isolated population centers where such centers lie close to developable geothermal resources. 1.22 An additional potential source of electricity for Djibouti would be an interconnection with Ethiopia. This potential option of power exchanges is currently under review by EdD. Preliminary studies have been carried out by international consultants and focused on possible routes and technical design parameters for both internal connections of towns to the Djibouti city grid and interconnection with Ethiopia. However, no complete economic analysis has been ur.dertaken to date to establish the feasibility of a future interconnection with Ethiopia. The current characteristics of the power systems in tha two countries though rule out an economically  viable sale of energy from Ethiopia to Djibouti as both grids are at this stage nowhere close enough to be easily connected. Therefore, an additional power line of some 300 km of length would have to be built, with an estimated cost of US$15.0 million. As a result, the border price for Ethiopian electricity would not be competitive compared to geothermal based electricity. In a more medium term scenario, however, energy interchanges could become attractive as the Ethiopian system is expected to have surplus hydro energy, at least during the sunmmer 'wet' season when electricity demand within the country is relatively low and the demand in Djibouti is high. Demand on the Ethiopian system is highest in the cool season when rivers do not flow, and therefore the availability of hydro energy is low. There could then be scope for export of surplus geothermal energy from Djibouti, once fully developed. However, there will be no possibility for significant expor-. of geothermal energy until at least 20MW of geothermal plant is installed on the system. 1.23 Should an interconnection prove desirable in the future, Djibouti would be relying on potential Ethiopian sources only for contingency purposes or for meeting peak load, for two main reasons: a long, unprotected power line through Ethiopian territory of 300 km length is highly erposed to risk. A second concern pertains to the possibility of droughts which could cause the Ethiopian hydro system to be of limited value in terms of reliability. Therefore, an 'nterconnection could not be considered as a potential substitute for the geothermal project, but only as an addition and this only in the medium term, when electricity could be sold or purchased, depending on the season. 1.24 Petroleum Prices. As mentiozed in para. 1.19, EPH sets prices for the 4 fuels at specific levels for economic andlor social reasons. The prices of diesel fuel and kerosene, for example, are kept at a relatively low level, but all prices are well above import parity prices and incorporate a high level of taxation. Domestic retail prices and CIF import prices for petroleum products are as follows; Unit Prices (US$/gal) as of July 1988 Retail CIF Diibouti Gasoline (premium) 2.91 0.37 Gasoline (regular) 2.59 0.34 Kerosene 1.25 0.58 Diesel Oil 1.47 0.55 Fuel Oil (EdD) 0.76 0.48 1.25 Three oil companies, Mobil Oil, Total and Shell share the market, Mobil holding about 50 percent of the market and the other two 25 percent each. The system of supply is well matched to the demand in that up to the present time, there has been no shortage of the products on the market.  -8- The Power Sector 1.26 Overview. Public electricity supply in the Republic of Djibouti is under the control of EdD, a wholly-owned Government company. EdD's supply covers only the main urban centers of the country but represents around 95 percent of total electricity consumption, most of which is concentrated in the Djibouti-Arta area. Outside the Djibouti-Arta area, EdD also supplies the towns of Ali Sabieh, Dikhil, Obock and Tadjourah. Ali Sabieh and Dikhil were recently interconnected and there are plans to connect Obock to Tadjourah in the near future. Total electricity supplied by EdD in 1987 wias 181 Gwh or 400 kwh per capita. Taking into account other non-EdD production, total production was about 420 kwh per capita. 1.27 The total installed capacity of EdD's main Djibouti network and isolated rural systems is 88.2MW of which 84.7MW, or 96 percent is located in Djibouti City. The whole of EdD's capacity consists of diesel generators fueled by imported oil: the units at the main Boulaos power station burn a blend of medium fuel oil (600 sec Redwood) and gas oil. All other units burn gas oil. A number of the units at Boulaos are nearing the end of their useful lives and will need to be replaced over the next few years (Annex 1.05). Two large 15MW diesels were commissioned at Boulaos in 1985 and a further two 5MW in 1988. The total installed capacity on the Djibouti main system of 84.7MW corresponds to an effective capacity of 70.4MW after taking account of recent plant retirements at the old Marabout power station and derating of the Boulaos units for age and local operating conditions; this represents a plant margin of 34.4MW (96 percent) over the current maximum demand of 36MW (June 1988). Major problems have been experienced with the two 15MW diesels. The cylinder blocks on both engines had to be replaced and, as a resulc, the availability of the units was only about 60 percent during 1986 and 1987. Repairs to the units have been effected but a connecting rod failure has resulted in a further major outage to one of the units during the 1988 peak load season. As a result, the units have not been moire productive in 1988 than in 1987 and have experienced more outages than expected. 1.28 Electricity consumption is categorized by size of consumer rather than end use and is almost equally divided between small low voltage consumers and large and medium sized consumers with a declared demand greater than 36 kVA. Losses have increased gradually over the past ten years and are currently about 17.5 percent of total energy production. The electricity consumption by industrial consumers is low in Djibouti, comprising only 5 percent of total consumption. An analysis of the larger consumers carried out for the National Energy Plan showed that administration and public service accounted for 31 percent; commerce and hotels, 14 percent; French army, 36 percent; water pumping, 7 percent; agriculture and fishing, 2 percent; and public lighting, 3 percent. 1.29 In common with other electricity systems in many developing countries, Djibouti experienced rapid growth in electricity production duting the 1970s, averaging 11.3 percent per annum up to 1980. However, since 1980, growth has slowed significantly to 6.9 percent per annum, reflecting lower levels of economic growth experienced in the country, and influenced by the general world economic recession. The reference forecast  - 9 - adopted under the proposed project is based on 4 percent per annum growth in consumption for the main Djibouti system, coupled with a gradual reduction in losses from the present level of 17.5 percent of gro:- generation to 13 percent by 1995. The loss reduction should be achievable as a result of the measures now being taken by EdD to identify and reduce both technical and non-technical losses. An alternative growth forecast based on 5.5 percent per annum increase, with no loss reduction, has been used as a sensitivity in evaluating EdD's future development program. 1.30 Power Sector Investment Prozram. Following the commissioning of the four new diesel units at Boulaos in ;985 and 1988, EdD's Djibouti system has been transformed from a position of undercapacity to one of surplus. However, a number of the units at Boulaos are already twenty years old and will need replacing during the 1990s. A target life of 25 years is currently used by EdD in planning capacity additions, together with a minimum reserve plant margin equal to the sum of the largest and next largest unit sizes on the system. On this basis, new capacity is required in 1994 for the reference load forecast and 1992/93 for the growth forecast. However, if a twenty-year life is adopted for the existing plant, the reserve plant margin falls below the required minimum in 1991. 1.31 The earliest feasible date the geothermal project (2 x 5MW) could be brought into service is late 1992/early 1993 as shown in the Project Implementation Schedule (Annex 6). Although this is one year earlier than needed under the reference forecast for new generating capacity, there are two principal advantages in commissioning the geothermal plant as soon as possible: (i) two of the Boulaos diesels are already over 20 years old, which is generally considered to be a realistic life span for mediui.-speed engines particularly given the harsh climate conditions in Djibouti. EdD adopts a flexible policy on plant retirements--keeping diesels in service--provided they are reasonably reliable and their operation and maintenance costs are not excessive. Although a 25-year life is used by EdD for the planning of replacement plants, this is a maximum figure and does not allow for possible earlier retirement of plants in the event of a major mechanical breakdown where it may be considered uneconomic to repair an engine which has a remnant life of only a few years; and (ii) the load forecast for the Djibouti system is considered to be conservative and there is a significant probability it could be exceeded if economic activity increases or if the 4.5 percent reduction in system losses is not achieved. As noted earlier, the analysis carried out (Annex 8.02) using a slightly higher load forecast (5.5 percent per annum growth in consumption, rather than 4 percent for the reference forecast, and assuming no reduction in system losses), indicates that new capacity is needed in 1993 (provided a small deficit of 1.1MW forecast for 1992 can be accepted).  - 10 - 1.32 The main Djibouti system comprises a network of 20 kV primary distribution lines--some overhead and others underground--overlain by a single 63 kV, 4 km underground cable circuit connecting the Boulaos power station with a primary distribution substation at Marabout close to the commercial center of the city. The town of Arta, some 35 km from Djibouti City, is supplied by a single 132 kV overhead line. Studies have recently been carried out to examine the feasibility of interconnecting the various rural systems, either with each other or with the main Djibouti City system. It was concluded that it is economic to connect Obock to Tadjourah via a 20 kV overhead line to avoid installing additional diesel capacity at Obock. EdD also has plans for connecting both Tadjourah and Ali Sabieh to a new central substation (Ghoubet) to the south east of the Bay of Ghoubet. The dates at which these latter interconnections become viable depend on, inter alia, the construction of a 132 kV transmission line from Djibouti City to Lake Assal as part of the Geothermal Project, the adoption of heavy fuel operation at the Boulaos power station and the dates when reinforcement of the existing isolated diesel stations is required. Any future interconnection with Ethiepia would also have to be taken into account. No decisions have been taken yet by EdD to proceed with any of these projects. However, as the viability of these projects (with the exception of the Tadjourah-Obock interconnection) depends on the existence of the Djibouti-Lake Assal transmission, they have not been considered in the economic analysis of the Geothermal Project. 1.33 Tariffs. Electricity tariffs charged by EdD have been unchanged since February 1983, when they were set consistent with the then high level of world oil prices of about US$35/bbl, compared to the present level of US$16-17/bbl. The average tariff level in recent years has exceeded 20 c/kWh, with tariff categories ranging from about 14 c/kWh to 26 c/kWh. Details of the tariff structure are set out in Annex 3. 1.34 The domestic tariff incorporates a social or lifeline element in the lowest consumption category, i.e. up to lkVA, with energy charges between 20 percent and 30 percent lower than the 3kVA and higher power categories. This distinction has led to abuses from consumers on the lkVA tariff, consuming power in excess of their declared limit, and resulting in a significant loss of revenue to EdD. 1.35 In 1985; the total cost of electricity in the Djibouti city and Arta system was DF 33.57/kWh (19c/kWh) compared with an average sales price of DF 37.16/KWh (21c/kWh), giving a total surplus of DF 358m (US$2.0m), including the isolated centers. Since that time the price of oil has fallen substantially and EdD has recorded larger surpluses; the surplus in 1987 was DF 600 million (US$3.4m). The surpluses have been used to repay borrowings from the Government made during the period of high oil prices in the early 1980s. Another part of the surpluses has been set aside for an energy conservation project involving incandescent lamp replacement and insulation of refrigerators (para. 1.20). 1.36 Tariffs have been reviewed twice in recent years. The first study (1986), undertaken by a power consultant under the National Energy Pian, proposed the introduction of seasonal time-of-day tariffs (for large consumers) and the opportunity to contract for energy at preferential  - 11 - rates, but with a se'.ere ipenalty for exceeding the monthly contracted energy by more than 50 percent. These proposals were considered by EdD to be too complicated ard costly to administer. A second study (1988) adopted the earlier analysis but put forward a revised tariff structure which would be more easlly understood by the consumers and less costly to implement. The key features of this tariff proposal, which has been found adequate by the mission, and which would cover long-term marginal cost, are: (i) introduction of a high rate second block in the 1 kVA domestic tariff to prevent abuse by higher income consumers which has led to a substantial loss of income to EdD; (ii} introduction of a fuel cost adjustment mechanism; (iii) reduction in average revenue of 8 percent from 37.5 DF/kwh to 34.5 DFIkwh at current fuel prices; and (iv) reductions of up to 17 percent in tariffs to large commercial and industrial consumers. EdD is planning to introduce the new tariffs incorporated in this proposal but they have yet to be ratified by Government. Ratification of the proposal is a date covenant (Dec. 31, 1990). It was agreed at negotiations that this would be done at the latest by December 31, 1990. PART II. BANK GROUP LENDING STRATEGY 2.01 Djibouti joined the Bank Group on October 2, 1980. Five IDA credits have since been approved: Technical Assistance (1982), Highway Maintenance (1983), Geothermal Exploration (1984), Urban Development (1984), and Education (1985). The Bank Group assistance strategy is currently aimed at engaging in a macro-economic dialogue with the Government and at assisting the country to reinforce the development base of the country, i.e. human resources, urban development, and geothermal energy. The latter is one of Djibouti's few natural resources and is therefore an ideal sector for IDA involvement to help diversify the economy. It is also in line with the strategy objectives of improving the exploitation of Djibouti's main assets and helping the Government identify a viable long-term development strategy, within which IDA and other donors can provide assistance. 2.02 The current five-year lending program includes, apart from the propised geothermal development project, an operation for education and manpower training (FY9Os), urban development II (FY91), and two reserve projects (health and geothermal III) in the outer years.  - 12 - PART III. BENEFICIARY Electricite de Diibouti 3.01 EdD (Electricite de Djibouti) was established in 1960, by decree, as a non-stock public entity, taking over what had previously been the Service for Public Works of the then French Territory of the Afars and Issas. EdD's charter, to which modifications were made in 1977 following independence, establishes its mandate as the country's public power company responsible for the development, construction and operation of all electric power generation and transmission facilities throughout the country. Any private sector power generation (through independent generators) needs to be authorized by EdD including stand-by generators operated by commercial and service entities. 3.02 OrRanization, Management and Staff. EdD's corporate power is exercised by a ten-member Board of Directors which consists of three ministers, three representatives of the National Assembly, EdD's Director of Finance and a representative of the company's staff, selected by the union. Appointment of the National Assembly members is for one year, with possibility for re-election. The Minister of Industry is Chairman of the Board and the Ministry also serves as EdD's 'tutelle". The Board's duties include the approval of all larger contracts and purchases, budget decisions, proposal for the nomination of the managing director, and decisions concerning staff remuneration, except for those of the director and chief accountant, who are appointed by the Council of Ministers. 3.03 EdD's organization chart is presented in Annex 2.01. The organization is sub-divided into a technical and an administrative department. The technical divisions are responsible for production, transmission, general regional services, both for the northern and southern part of the country. Additional regional subdivisions will not be necessary in view of the minor importance of operations in the interior of the country. Admin-stration includes customer services, which underwent successful restructuring in 1987 following collection problems. The training facility, the Centre de Formation Professionnelle (CFP) has been inoperative since 1987, but it is supposed to start activities again in 1990. 3.04 In 1987, EdD had 700 employees, including 20 foreign experts provided by EdF (Electricite de France). This employment force is considered appropriate and EdD does not intend to raise it substantially during the coming years (the number of additional staff per year is not expected to exceed 15). By the end of 1988, the total staff had risen to 702 due to the reorganization of the service department. The foreign employees have two year contracts which are renewable. Each of them is assigned to work with and train one or two counterparts. EdD plans to replace several of the foreign staff by local staff over the next three years. These replacements have worked smoothly in the past, except for  - 13 - once, when the French administrative director's assistant departed. His position remained vacant between August 1988 and May 1989, causing some disruption in maintaining up-to-date financial projections. 3.05 From an organizational point of view, an area that deserves attention is the supervision of the recently restructured service department (para. 3.18). Although positive effects of this new section have already occurred as a result, (e.g. the amount of delinquent private clients had significantly decreased by the end of 1988) a thorough and continuous follow-up of this vital part of EdDts organization has not yet been fully achieved. However, EdD is conscious of this deficiency and is awaiting the results and recommendation of the 1988 audit (para. 3.30) to introduce further measures to improve efficiency. 3.06 Training, EdD covers its need for personnel with higher education through recruitment of locally educated graduates, most of whom have studied abroad a few years. Once employed and confirmed, promising staff are sent on additional training programs to French institutions such as CCCE (Caisse Centrale de Cooperation Economique), which has granted several loans to EdD, or to Electricite de France. 3.07 On the technician level, approximately 20 employees with basic technical education (Certificat d'aptitude professionnelle, CAP) were hired per year in the past. They are then further trained by EdD for two additional years. Two technicians per year are also sent to France to gain further experience. Hiring of technicians is expected to decline. 3.08 EdD's own training center (CFP) was closed in 1987, because it was unable to furnish the highly specialized skills needed, above all, to respond to the needs of the data processing department. A reoriented professional training center is planned to open in 1990, financed by the Arab Social and Economic Development Fund (FADES), Kuwait Fund (KF) and the CCCE. 3.09 Operations, Maintenance and Losses. In spite of EdD's apparent large reserve margin of generation capacity in the main Djibouti network, a substantial proportion of the plant is old and cannot be operated at its rated capacity. The problem is further exacerbated by the very high ambient temperatures and humidity which generally coincide with the peak load season. EdD has experienced major problems with the large new 15MW diesel generators which have resulted in prolonged outages. Because of these operating problems, which continued througnout 1988, EdD's consumption of gas-oil has increased by 74 percent compared with 1987. These difficulties call into question the wisdom of installing these large units which, at the time they were commissioned, each represented approximately 50 percent of EdD's system peak demand. Apart from these problems, EdD has operated and maintained its assets satisfactorily. 3.10 EdD's system losses, including both station use and distribution, were running at about 17.5 percent of energy generated in 1987 and rose slightly to 18.5 percent in 1988. About 6 percent is attributable to power station consumption and the balance to distribution and non-technical losses. EdD has recognized that the present level of losses is too high and is employing expatriate technical assistance in an attempt to reduce  - 14 - non-technical losses by improved meter reading, inspection and billing practices. It is estimated that this program, together with a recently introduced practice of transformer load monitoring and replacement, should allow EdD to reduce its losses to the forecast level of 13 percent of gross generation over the next few yeat4. 3.11 Firancial Planning and Budgeting. Although wholly-owned by the Government, EdD enjoys substantial financial autonomy. It manages its financial affairs and maintains its accounts in a satisfactory manner. Subject to Board and Government approvals, EdD is authorized to formulate its investment program, establish its tariffs, enter into contract with suppliers of goods and services, and borrow for its own account from foreign as well as domestic lenders. 3.12 EdD's budget is prepared by the chief accountant assisted by a member of his department. A budget is prepared at the end of every fiscal year, in December, for the following year, taking into account the results of the current year (up to August) received by the accounting department. Data for the remaining months are estimated. A comparison between budgeted and actual results is carried out. The budget contains figures provided by the technical departments, estimating the necessary equipment to be installed. A budget document is submitted to the Board for approval. A program to analyze the monthly deviation has been prepared by the Data Processing Department and will be put into operation during the 1989 accounting period. 3.13 Long-term financial planning had been initiated by the assistant to the director, who left EdD in mid-1988. His successor is to arrive only in May 1989 but will continue working on these programs. 3.14 Accounting System. EdD's accounting system is based on French power utility principles and procedures. The accounting is operated using a data processing system to which the operations in the interior of the country, including Tadjourah, are also connected. In late 1989, a new computer-based stock management program will start to operate, at which time obsolete material will be identified and depreciated. 3.15 Commercial System. EdD has approximately 21,000 customers. The number of new clients per year is estimated at about 1,000 to 1,500, and individual electricity consumption is rising. Receivables are not expected to rise, however, since collection procedures are becoming more effective due to an improved customer service. In the short term, total demand is not expected to lncrease above the estimated 4 percent, because no new major industrial development is expected in the near future. 3.16 Clients are dlvided into middle and low voltage customers and, further, into governmental agencies and private customers. The amount of industrial customers is limited. EdD's largest customers include the French Army, the Sheraton Hotel, and the Government. 3.17 As a general practice, payments from delinquent clients are deducted from the most current bills overdue. Thus, past overdue accounts  - 15 - may never be cancelled in spite of some subsequent payments. No interest is charged for payments overdue or for accounts which have been restructured. 3.18 An action program, "gestion clientele", has been established in 1987 to improve the collection stem and the service department has been reorganized accordingly. The department includes two divisions, ordinary customers (low voltage) and important customers, the latter of which has a coordination section attached to it. Instead of individual staff performing only one task, e.g. meter reading, a group is now responsible for an entire section of the town. Group members are in charge of all operations, such as establishing the initial contact, concluding a new contract, reading the meter, controlling the billing, contacting customers in case of overdue payments, restructuring of small customer debts and, as the ultimate measure, cutting off electricity. Although this program affected the behavior of small customers resulting in a substantial decline of unpaid checks at the end of 1988, it did not change the attitude of several larger customers. Meter reading, and subsequent billings are prepared on a bi-monthly basis which is also the payment rhythm requested from customers. 3.19 New connections require advance payment of a month's projected electricity consumption. In addition, a fixed rate is included in each billing (DF 350 flat fee per month for consumption of up to 36 KVA and DF 38 for each additional unit of KVA, also per month). These additional charges contribute to the high price of electricity for small customers. Approximately 9,000 of EdD's customers are entitled to benefit from the social tariff, allowing a maximum consumption of lOlkwh per month, which does not provide for the use of an air conditioner. Negotiations to restructure small customers' debts have been quite successful. 3.20 EdD has one cashier's office per district in the country. Clients living in the interior have to pay in person if they don't use existing check payment facilities. EdD has 30 customers who use a pre-authorized payment method. A new building next to EdD's existing office complex is under construction, and is to house the service department with improved service and payment counters. EdD's Financial Position and Past Operatina Results 3.21 EdD's capital structure is healthy. One third of total liabilities consists of equity, which is comprised of Government capital, retained earnings and reserves, capitalized loans from foreign donors and clients' subsidies. 3.22 As many other public utilities in developing countries, EdD relies on loans from multinational or bilateral donors. The priority given to the power sector in view of its role in economic development is reflected in favorable loan agreements obtained by EdD resulting in long grace periods a.d interest rates below market rates. 3.23 However, a relatively steady inflow of revenues can be expected from a power utility, with the financial situation of the company primarily influenced by the appropriateness of the tariff system and the efficiency  - 16 - of revenue collection. During the period of high oil prices, both were weak points within EdD, resulting in operating losses until 1983. As a consequence, capital reserves had declined to DF 1,049 million in 1983 and positive operating results in 1984 and 1985 were still absorbed by losses carried forward. As a result, 1986 was the first year with i taxable income. 3.24 EdD's past and present financial performance for 1986-1968 is presented in Annex 4 and summarized in the table below: EdD - Audited 1986, 1987 and Provisional 1988 Balance Sheets (DF Millions) ASSETS 1986 1987 1988 Gross Fixed Assets 15,607 16,487 n.a. of which Acc. Depreciation (6,823) (7,910) (n.a.) Net Fixed Assets 8.784 8,577 9,409 Work in Progress 466 1,289 n.a. Other M/T Assets 725 1,568 1,776 Current Assets Cash 1,944 2,742 3,820 Accts. Receivable (net) 2,921 2,685 3,120 Inventory 870 505 892 Other 185 317 313 Subtotal 5,920 6,649 8,145 Total Assets 15.895 18,083 19.330 EQUITY AND LIABILITIES Capital 308 308 308 Retained Earnings 1,329 1,840 2,016 Clients' Subsidies a/ 1,769 1,519 2,086 Capitalized Loans 469 1,483 1,483 Other 512 219 1,147 Subtotal 4,387 5,369 7,040 Long Term Debt 9,441 9,158 8,433 Loss Provision 1,034 1,798 1,830 Current Liabilities Accounts Payable 397 517 858 Other 636 1,241 1,169 Total Equity and Liabilities 15,895 18,083 19,330 a/ Clients financial contribution in the form of advances to cover installation cost.  - 17 - 3.25 EdD's debtiequity ratio was still high in 1986 with a relation of 65 s 35. In 1987 several Government loans were repaid by cancelling Government's current debts thus improving the debt/equity ratio to 58 : 42, and in 1988 further to 50 : 50. This relation is continuing in the real terms projeccion for the relevant period until 1995. For a public utility, this ratio is considered to be acceptable and is confirmed by the effort undertaken by EdD to stabilize its revenue inflow through reorganization of the clients section, thus offering high security to the lenders to cover future debt service. The Government's equity contribution of US$4.6 million equivalent (50 percent of the total Credit amount) is in this context to be seen as a potential heoge towards unexpected technological problems as EdD will be generating part of its base load from geothermal based energy for the first time. EdD - Summary of Audited Income Statements 1986 and 1987 and Non-Audited Statement 1988 (DF Millions) 1986 1987 198d Units Sold (GWh) 134.5 142.9 n/a Average Revenue (DF/kWh) 37.16 37.16 37.16 Power Sales and Other Revenue 5771 6264 6843 Operating Subsidy 113 328 300 Total Revenue 5884 6592 7243 Operating Expenses Personnel 992 1078 1123 Maintenance, Fuel, Admin., Other Provs. 3080 3939 3451 Depreciation + Asset Renewal Provision 1064 1092 1250 Total Expenses 5136 6109 5824 Operating Income 748 483 1319 Interest 237 264 173 Net Income 511 219 1147 Return on Assets (percent) 3.2 0.8 5.9 Debt Service Coverage (times) 2.1 1.6 2.4 Contribution to Construction (percent) 12 15 21 3.26 As noted above, EdD has produced annual profits on a consistent basis since 1984. Minor losses in the years preceding 1984 were due to high fuel prices which were not passed on to consumers. (To decrease the impact of oil price fluctuations on EdD's financial performance, an automatic adjustment mechanism will be inc_.uded as part of EdD's overall tariff structure revision (dated covenant) by December 31, 1990, so as to pass on potential gains or losses more directly to EdD's customers). As a  - 18 - result of the profits since 1984, EdD has had positive returns on assets. The significance of EdD's rates :f return on assets as a performance indicator for the past ten years is, however, redaced due to the somewhat arbitrary asset values assigned to them (para. 3.34). An asset valuation has not been carried out during the last ten years but is being prepared, and the completion thereof by June 30, 1990 is a covenant of the proposed Credit. 3.27 EdD's cash situation is strong. Ever since 1984, the last year in which a mi4or loss occurred, EdD has built up a 3trong annual cash surplus, and used it for considerable short-term investments. As a result of this strong cash position, EdD progressively increased its contribution to construction and investments over the past years. The amount of the contribution almost doubled between 1986 and 1988 (from 12 percent to 21 percent) and is to grow further to about 25 percent in the coming years. 3.28 The situation of EdD's accounts receivables has recently worsened, and is above accentable levels 2/. The 1987 level was at a 7.3 months' consumption level, declined somewhat to 6.1 and increased again to 6.5 in 1988. As mentioned in para. 3.18, EdD has made some efforts to bring the level down further, but these efforts need to be strengthened. A portion of existing Government receivables (about equivalent to the entire government energy consumption of 1988) will - offset against an asset transfer of geothermal wells to EdD (para. ...35), and will result, starting in 1989, in a reduction of receivables by about one third, to 4.4 months' consumption level. (A list of the major delinquent customers is available in the project file). In addition, the remaining receivables covering all consumers are also high. It was therefore agreed during negotiations that (i) outstanding arrears of the Government and of enterprises receiving government subsidies be brought to a targeted 4 months' level by end 1991 (dated covenant) and that (ii) the level of receivables outstanding for 1 year or less from private customers would not exceed 2.5 months' of sales by the end of 1991 and 2 months' sales in 1992 and thereafter (dated covenant). 3.29 Accounts payable, contrary to the high receivables, will remain reasonable. They increased slightly from DF 517 million in 1987 to DF 658 2/ EdD has collection problems with several Government agencies and other clients related to the Government, including the airport. In 1987, outstanding Government debt to EdD which was set off against loans, totalled DF 608.0 million. In 1988, such an arrangement was not repeated. By March 1989, unpaid Government accounts amounted to DF 652.0 million, which represents more than 10 percent of all annual billings. Previously, in 1987, the airport's accumulated debt (DF320 million) had been converted into a long-term loan with monthly payments of DF 2.4 million. In 1988, the local airline's debt was also restructured, from an accumulated total of approximately DF 32.5 million to monthly installments of DF 0.5 million, without interest being charged. Payments on the restructured debts have been met regularly.  - 19 - million in 1988 and consisted mainly of payments to suppliers other than fuel supply. 3.30 Audit. Until 1987, EdD's external audits have been carried out by a local company, SOFRACOR, which is managed by French expatriates and which also audited ISERST during the implementation of IDA's Geothermal Exploration Project. Starting in 1988, EdD has chosen as its auditor a French firm specializing in audits and organizational analysis of public utilities. 3.31 The 1986 and 1987 audits were unqual4fied but the management letters listed recommendations on accounting procedures for clients' subsidies 3/ in 1986, and on the register of clients and the evaluation of stocks both in 1986 and in 1987. EdD has already acted on all of the auditors' recommendations. 3.32 Taxes. EdD is liable for income tax of 25 percent of annual profits. In addition, EdD pays sales taxes (TIC = Taxe interieure a la consommation), on all directly imported goods, at rates between 28 and 31 percent. However, EdD purchases most cf the goods required for production from local wholesalers. 3.33 Insurance and Asset Valuation. EdD self-insures part of its assets, namely equipment at the Boulaos station. Total insurance provisions in 1987 were DF 30.0 million, bringing it to an accumulated total of DF 283.0 million. All additional systems are insured for an annual premium of DF 55.1 million by a French insurance company, and include transformers, the entire transmission and distribution network, production break-down equipment, overcharge damages at clients' residence, production losses, conflagration, earthquakes and an insurance for the transport fleet. 3.34 An annual revaluation of assets is conducted for purposes of adjusting the insurance premium. As a result, an independent consultant has been retained to value the assets mainly based on a desk study that considers, inter alia, the replacement cost. This methodology could result in some overvaluation of EdD's fixed assets as it does not cover the regular items of a typical utility asset valuation. (The latter is being carried out under PPF financing). The insurance-based asset valuation shows a value of DF 8,561 million for the externally insured units and all other assets, excluding the self-insured Boulaos units. Following the completion of the full technical asset revaluation (terms of reference are in Annex 2.02), IDA plans to review, during supervision of the proposed project, EdD's methodology for asset revaluation, and seek the implementation of adjustments considered appropriate by both parties. 3.35 Transfer of Government Financed Assets. The Government has so far contracted all the IDA debt related to IDA's Geothermal Exploration 3/ Client 'subsidies" represent the client's financial contribution for the connect.ion to the system, essentially covering part of the installation cost.  - 20 - Project that led to the discovery of two productive wells. Under that project, the Government had agreed to legally transfer any productive assets to EdD which, in exchange, would assume the corresponding debt service. The estimate of the asset value has recently been prepared by a special commission comprising members of the Min. Fin., ISERST and EdD and the amount is about DF 1,000 million. However, these assets (essentially wells Assal 3 and Assal 6) will not be transferred on the basis of a credit agreement (Government/EdD) but instead by cancelling outstanding Government receivables, which in turn will reduce EdD's receivables by almost one third. 3.36 EdD's foreign exchange exposure is well covered by existing provisions for potential foreign exchange losses. All of EdD's long-term loans are contracted in foreign currencies, whether made to the Government (and passed on to EdD) or directly lent to EdD. An exchange gain has contributed substantially to the high 1983 profits, as the US dollar, to which the Djibouti franc is pegged, strengthened against the French franc (as many of EdD's loans originate from the CCCE). In 1987, on the other hand, EdD had increased its foreign exchange loss provision by DF 736 milllon, exceeding more than half of the amount spent for fuel purchases during that year. 3.37 Over the past two years, EdD's foreign exchange exposure has decreased as a result of debt service and debt/equity conversions, the latter of which was particularly due to conversions agreed upon by the Arab Development Fund (FADES). Debt service will start having a stronger impact again after 1989, when grace periods for EIB and CCCE loans will be terminated. 3.38 EdD has in the past benefited substantially by low interest charges on foreign loans. This explains why EdD displays a preference to contracting those rather than using its own cash surplus to finance its investment program. If EdD's foreign lenders were to charge the appropriate market based (relending) rates reflecting actual cost of capital, EdD's debt would be reduced (and along with it its forex exposure). Its belf-financed contribution (in percent) of new investments would go up and its financial results would more adequately reflect a realistic situation, based on which future tariff reviews could be based. 3.39 Future Financial Position and Operations of EdD. The projected financial statements of EdD for the years 1987 through 1995 together with notes and assumptions used in these statements are given in Annex 4. Selected financial performance indicators are shown in the table below:  - 21 - EdD Financial Performance 1987-1994 - Selected Indicators"/ 1987 1988 1989 1990 1991 1992 1998 1994 Electricity Sales (DF millions) 5,380 5,740 5,721 6,729 5,995 6,263 6,584 6,842 Contribution to Construction percent 15 21 23 26 30 30 so s0 Debt Service Coverage (times) 1.6 2.4 2.6 2.0 1.8 1.9 2.1 2.1 Current Ratio 10.9 9.0 13.1 18.9 14.9 16.1 18.3 20.4 Debt/Equity Ratio 1.1 0.8 0.9 1.0 1.1 1.2 1.1 1.0 Rate of Return (percent) 2.9 10.6 8.3 6.3 5.8 7.9 7.0 7.2 Receivables (months) b/ 6.5 6.6 6.6 5.6 4.5 8.6 2.6 2.0 Payables (months) 1.6 2.2 2.3 2.2 2.1 2.0 2.3 2.3 !/ In constant prices and on the basis of tariff rates based on the adoption of the new proposal (para. 1.35). k/ Based on the Implementation of measures proposed by IDA. 3.40 For the above analysis, power tariffs rates would achieve the main financial objectives, namely that internal generation of funds will result in a 30 percent contribution to construction and cover debt service 1.5 times. The rate of return on assets shows a return of over 10 percent for 1988 as a result of high tariffs in effect and declining operating costs. In the projections, where a tariff reduction is scheduled in 1990, the rate of return correspondingly drops to about 6 to 7 percent. Taking into consideration opportunity cost of capital and in view of the interest rates of loans received by EdD, this rate of return is considered apptopriate. It also confirms that the average tariff after reduction is in line with the cost-recovery principle (an average tariff in real terms of 34 DF is calculated for the period 1989 to 1995 on the basis of total cost and energy sold). 4/ 3.41 Based on the new rate structure, the adoption of which is proposed under the project, the debt service coverage remains well above the target, averaging 2.0. The slight reduction in 1991/1992 is due to expiration of grace periods under EIB and CCCE loans, as noted earlier (para. 3.37). The debt/equity ratio is favorable (roughly 50:50) in view 4/ Long term marginal cost calculation at different discount rates. Discount Rate 6.0% 8.0% 10.0% PV of Cost 44,141 41,207 38,604 PV of Sales 1,257 1,171 1,094 Marg. Cost Tariff 35.10 35.20 35.29 (For period 1987-1995) PV of Cost 36,764 34,857 33,125 PV of Sales 1,081 1,024 973 Marg. Cost Tariff 34.00 34.02 34.05 (For period 1989-1995)  - 22 - of recent conversions of debt into equity by FADES and in view of the fant that over two thirds of the proposed project financing are being extended to EdD as a grant. The projected current ratio, almost doubling from 10 to 20 is a result of the reduction of receivables to targeted levels, despite EdD's increase of contribution to construction. PART IV. THE PROJECT Background 4.01 Geothermal exploration was started in 1971 by the Bureau de Recherches Geologiques et Mini;res (BRGM) in the Lake Assal area, at a time when Djibouti was still a French territory. Work in this area culminated in 1975 with the drilling of two deep wells, Assal 1 and 2 (about 1,000m depth), which encountered high temperatures (230-260