Madagascar - Energy Sector Development Project

Document of The World Bank Report No. 15086-4AG STAFF APPRAISAL REPORT REPUBLIC OF MADAGASCAR ENERGY SECTOR DEVELOPMENT PROJECT MARCH 14, 1996 Industry and Energy Operations Division Central Africa and Indian Ocean Department Africa Region  CURRENCY EOUIVALENTS Currency Unit = Malagasy Franc (FMG) US$1 = FMG 4,602 (August 1995) WEIGHTS AND MEASURES kV = kilovolt (1,000 volts) kW = kilowatt (1,000 watts) MW = Megawatt kVA = kilovolt-ampere (1,000 volt-amperes) MVA = megavolt-ampere (1,000 kilovolt-amperes) kWh = kilowatt-hour (1,000 watt-hour) GWh = gigawatt-hour (I million kilowatt-hour) km = kilometer kgoe = kilogram of oil equivalent toe = tons of oil equivalent ABBREVIATIONS AND ACRONYMS ABEDA = Arab Bank for Economic Development of Africa CFD = French Development Agency DE = Directorate of Energy EIB = European Investment Bank EIRR = Economic Internal Rate of Retum FANALAMANGA = Parastatal owner of pine plantation near Antananarivo JIRAMA = Madagascar's Utility for Electricity and Water LPG = Liquified Petroleum Gas LRMC = Long-Run Marginal Cost MEM = Ministry of Energy and Mines PMU = Project Management Unit PPF = Project Preparation Facility SOE = Statement of Expenditure SOLIMA = National Petroleum Company UPED = Household Energy Planning Unit, within the DE WTP = Willingness To Pay FISCAL YEAR January I - December 31  MADAGASCAR ENERGY SECTOR DEVELOPMENT PROJECT TABLE OF CONTENTS Credit and Project Summary ....................................... i 1. PROJECT SETTING AND RATIONALE ......................... 1 The Project's Contribution to Poverty Reduction and Economic Growth . .. 1 The Energy Balance ...................................... 2 Lessons and Principles incorporated in Project Design ............... 3 II. INSTITUTIONAL ISSUES ................................... 4 Overview ............................................. 4 The Electric Power Subsector ............................... 4 JIRAMA's Present Structure and Operations ..................... 6 The Woodfuels Subsector .................................. 7 Energy Efficiency ....................................... 8 III. DEMAND AND SUPPLY. PRICING. AND ENERGY EFFICIENCY. 8 Overview. 8 The Electricity Subsector. 8 JIRAMA's Power Facilities: Present Situation and Needs .10 JIRAMA's Investment Program .12 The Need to Extend Electrification in the Country .12 The Woodfuels Subsector .13 Energy Efficiency .15 IV. THE PROJECT .......................................... 16 Project Objectives .16 Project Description .16 Project Preparation .17 Project Costs .......................................... 18 Financing Plan .18 Project Implementation .19 Disbursements .19 Procurement .21 Accounting, Financial Reporting and Auditing .22 Environmental Considerations .23 Project Monitoring and Supervision .23 V. FINANCIAL ANALYSIS OF JIRAMA .......................... 24 Introduction ........................................... 24 Overal Operations ...................................... 24 Electricity Section ....................................... 25 Restructuring Recommendations .............................. 27 Financing Plan ......................................... 28 Future Finances ........................................ 29  Table of Contents (Page 2) VI. BENEFITS. RISKS, ENVIRONMENTAL ASPECTS AND ECONOMIC ANALYSIS ............................................ 30 A. BENEFITS .. ....................................... 30 B. COST RECOVERY ................................... 31 C. COST-BENEFIT AND SENSITIVITY ANALYSIS ...... ......... 31 D. RISKS ............................................ 34 E. INSTITUTIONAL CAPACITY ANALYSIS .................... 34 F. POVERTY ANALYSIS ................................. 35 G. ENVIRONMENTAL IMPACT ........... .. ............... 35 H. PERFORMANCE INDICATORS .......... .. .............. 36 I. OVERALL ASSESSMENT ............................... 36 VII. AGREEMENTS AND RECOMMENDATION . . 36 Agreements Reached During Negotiations ......... .. ............. 36 Conditions of Effectiveness ............... .................. 37 Condition of Disbursement for the Electrification Program .... ........ 37 Recommendation ................... ..................... 37 This report is based on the findings of an appraisal mission to Madagascar in June/July 1993 which consisted of Messrs. Angel Baide (Task Manager), Power Engineer; Noureddine Bouzaher, Senior Economist; Richard Senou, Senior Financial Analyst; Robert Van der Plas, Domestic Energy Specialist; Ms. Rangaswamy Vedavalli, Principal Economist; Stephen Gaull, Financial Analyst; Mario Zenteno, Consultant for the institutional reform component; Georges Maestrini, Consultant for human resources management and training in JIRAMA; Edward Gaither, Geoffrey Smith and Marc Methe, Consultants for the electrification program. The financial analysis of JIRAMA was updated by Mr. John G. Davis, Financial Analyst (consultant) during a pre-negotiations mission in June 1994, and again by JIRAMA in August 1995. Ms. Lily Wong provided secretarial support in the preparation of the report. Mr. lain T. Christie and Mr. Andrew Rogerson are the managing Division Chief and the Department Director, respectively, for the operation.  Madagascar: Energy Sector Development Project ANNEXES TABLE OF CONTENTS ANNEX I Annex 1.1 Energy Balance, 1993 ............................. 38 Annex 1.2 Project Experience In Madagascar and Lessons Learned ... ..... 39 ANNEX II Annex 2.1 Statement of Sector Policy .40 ANNEX III Annex 3.1 JIRAMA's Sales and Number of Consumers .... ........... 44 Annex 3.2 JIRAMA's Demand Projections ...... ................. 46 Annex 3.3 Electricity Tariffs and Long Run Marginal cost .... .......... 48 Annex 3.4 JIRAMA's installed generating capacity ..... ............. 49 Annex 3.5 JIRAMA's investment program (1995-2000) .... ........... 51 ANNEX IV Annex 4.1 Project Description ........... .................... 52 Annex 4.2 Project Cost Tables . ............................... 57 Annex 4.3 Project Implementation Schedule ...... ................. 65 Annex 4.4 Disbursement Profile Comparison ...... ................ 71 Annex 4.5 Environmental Analysis of Transmission Components .... ...... 72 Annex 4.6 Indicators of Achievement of Project Objectives .... ......... 74 ANNEX V Annex 5.1 JIRAMA: Financial Statements ...... ................. 78 Annex 5.2 Assumptions for Projections of Financial Statements .... ....... 81 Annex 5.3 JIRAMA: Financial Indicators ....... ................. 84 ANNEX VI Annex 6.1 Economic Analysis of Electricity Components .... .......... 85 Annex 6.2 Economic Analysis of Woodfuels programs ............... 96   REPUBLIC OF MADAGASCAR ENERGY SECTOR DEVELOPMENT PROJECT Credit and Project Summary Borrower: Republic of Madagascar Implementing The state-owned utility, Jyro sy Rano Malagasy (JIRAMA) or Electricity and Water Agencies: of Madagascar and Ministry of Energy and Mines (MEM). Amount: SDR 31.8 million (US$46 million equivalent). Terms: Standard IDA terms, with 40 years maturity including 10 of grace. On-lendi rn Terns: The Government of Madagascar will on-lend a maximum of SDR 22 million (US$31.8 million equivalent) from the proceeds of the Credit to JIRAMA at an adjustable interest rate equal to the London Interbank Rate (LIBOR) plus 0.9 percentage point per annum for a period of 25 years (including a 5 year grace period). JIRAMA will bear the foreign exchange risk on these funds. Project Objectives: The project aims at: (a) improving Madagascar's prospects for sustainable growth by ensuring an adequate supply of electricity both for businesses and households, including increased access to the service of peri-urban and rural populations; (b) creating the institutional foundation in the power sub- sector to increase economic and management efficiency and attract private investment; and (c) promoting greater efficiency in the overall production and consumption of energy, thereby helping to mitigate the adverse environmental impact of woodfuel use. Project Description: The project consists of four major components. The first comprises most of JIRAMA's investment program, including: infrastructure (rehabilitation and extension of generation transmission and distribution facilities); tools and equipment for maintenance; a loss reduction program; improvements in management systems and personnel training; and feasibility studies for two small hydro projects. The second is an electrification program to increase selectively access to electricity, by applying low-cost design standards, with emphasis on increased use of existing infrastructure and the extension of networks with surplus generating capacity. The third consists of studies and capacity building to support a program of reforms in the power subsector, including the establishment of a new legal and regulatory framework that will allow private sector participation, as well as the restructuring of JIRAMA according to principles of commercial operations. The fourth is a country-wide program to promote energy efficiency, with emphasis on woodfuels, including an integrated pilot program to ensure a sustainable supply of woodfuels for the Mahajanga region, while improving the management of natural forest resources. Project Benefits: Support of JIRAMA's investment program would help ensure a reliable electricity service, and avoid or reduce outage costs, fuel costs and energy losses. Without the project, outage costs would increase as a result of shortfalls in generating capacity, as well as the increased incidence of faults in the existing systems. The project would lower fuel costs by: (a) rehabilitating hydro plants, thus reducing the need for thermal power; and (b) expanding the transmission system to substitute power from hydro plants for diesel generation. System losses will also be reduced, thereby achieving savings in both capacity investment and energy generated. The electrification program for peri-urban and dynamic rural areas will result in savings from the  - ii - substitution of electric power in end-uses which currently depend on kerosene, candles and batteries, and will make possible increased economic activity. Benefits from policy reforms to eliminate the state monopoly include: efficiency gains that will be shared with consumers through adequate tariff regulation, and will generate savings in public resources; and greater sustainability of electricity supply through mobilization of private capital for investment in the sector. The woodfuels component will: reduce the adverse impact of wasteful woodfuels production and consumption practices; and sustain the supply of woodfuels and, in areas with severe wood deficits, avoid increases in the use of kerosene, which is a more costly fuel. Risks: Because the infrastructure components consist mainly of rehabilitation, and of straightforward distribution works, they do not involve any unusual risks. The principal risks in implementing reforms in the power sub-sector are the possibility that the new Electricity law will be modified by the National Assembly during the debates preceding approval, and the possibility that the Government might be later reluctant to relinquish its domination of the subsector or be tempted to backtrack on pricing policy. These risks are counterbalanced, however, by the awareness that in the future the availability of financing for public investments in power will be sharply reduced, and the consequent need to establish the credibility of the new legal and regulatory environment in order to attract private capital to the subsector. Another risk is delay in implementing the investment program and in mobilizing the corresponding local financing requirements. The agreement on annual reviews of the investment program and the related financing plans, is designed to minimize this risk. The economic rates of return on the investment program as a whole and on components thereof are relatively high due to the rehabilitative nature of the work to be undertaken. However, rates of return on thermal plants and the distribution components show sensitivity to even moderate decreases in the expected demand for electricity. The risk associated with this has been minimized by estimating the demand conservatively. The technical complexity of the project poses no significant problem, since the implementing agencies, JIRAMA and MEM, have acquired considerable experience through the implementation of the Energy I Project (Cr. 1787-MAG). Estimated Costs: (FMG billion) (USS milLion) Local Foreign Total Local Foreign Total A. JIRAMA's Investment Program 1. Generation 33.2 106.8 140.0 9.5 30.5 40.0 2. Transmission 5.3 12.5 17.9 1.5 3.6 5.1 3. Distribution 39.9 118.5 158.3 11.4 33.8 45.2 4. Tools and Equipment for Maintenance 2.5 8.9 11.3 0.7 2.5 3.2 5. Other Programs a. Loss Reduction Program 0.5 1.3 1.9 0.2 0.4 0.5 b. H. R. Management and Training 0.4 9.8 10.2 0.1 2.8 2.9 c. Information Technology Program 2.1 7.1 9.2 0.6 2.0 2.6 d. Feasibility Studies for Hydro 0.5 3.5 4.0 0.2 1.0 1.2 Subtotal Other Programs 3.6 21.7 25.3 1.0 6.2 7.2 Su*btotat JIRAMA's Investment Program 84.4 268.4 352.8 24.1 76.7 100.8 B. Electrification Progra 3.8 19.9 23.7 1.1 5.7 6.8 C. Institutional Reform of the Power Subsector 1. Regulatory Framework 0.0 5.4 5.4 0.0 1.5 1.5 2. Corporatization of JIRAMA 0.2 4.3 4.5 0.1 1.2 1.3 SubtotaL Inst. Reform of the Power Subsector 0.2 9.7 9.9 0.1 2.8 2.8 D. Energy Efficiency Program 1. Energy Conservation Program 2.6 2.8 5.4 0.7 0.8 1.5 2. Mahajanga Woodfuels Program 2.2 3.8 6.0 0.6 1.1 1.7 Subtotal Program of Activities by the MEM 4.8 6.6 11.4 1.4 1.9 3.2 TOTAL BASELINE COSTS 93.2 304.6 397.8 26.6 87.0 113.7 Physical Contingencies 10.0 31.8 41.8 2.9 9.1 11.9 Price Contingencies 54.1 225.1 279.2 -0.7 7.6 6.9 TOTAL PROJECT COSTS 157.3 561.5 718.8 28.8 103.7 132.5  - iii - Finwcirm Plan: USS miLLion X of Total IDA 46.0 34.7 EIB 24.7 18.7 CFD 28.3 21.3 ABEDA 6.6 5.0 JIRAMA 26.7 20.1 GOVERNMENT 0.2 0.2 TOTAL 132.5 100.0 Estimated IDA disbursements (US$ million): IDA FY FY97 FY96 FY99 FY00 FY01 FY02 Annuat 1.7 8.5 16.7 12.7 4.4 2.0 CumuLative 1.7 10.2 26.9 39.6 44.0 46.0 Economic Rate of Return: 22 percent on JIRAMA's investment program as a whole; 57 percent on the rehabilitation of hydropower stations; 28.7 percent on the interconnection Namorona- Manakara-Mananjary; 23 percent on the rehabilitation and extension of thermal power plants; and 12 percent on the rehabilitation and extension of the distribution networks. These rates of return were calculated using existing tariffs as a proxy for benefits. The economic benefits are much higher when calculated using the willingness of consumers to pay for electricity. For the improved stove program and the Mahajanga pilot woodfuel program, the economic rates of return are 22 and 42 percent respectively. Environmental Categorv: The project is rated 'B'. New transmission corridors and sub-station sites do not traverse any environmentally-sensitive areas but do cross inhabited and agricultural areas. To mitigate any potential impact, the project will adopt good route planning and construction practices. Several of the project components will help enhance the quality of the environment. The rehabilitation of hydro plants, and the incorporation of several centers now served from diesel plants to systems with surplus hydro capacity will reduce CO2 emissions and environmental pollution. Improving energy efficiency will also lessen pollution. The woodfuels components will reduce deforestation. Povertv Categorv: Not applicable. Map: IBRD No. 25661. MIS Task Code: 1533.   REPUBLIC OF MADAGASCAR ENERGY SECTOR DEVELOPMENT PROJECT I. PROJECT SETTING AND RATIONALE The Project's Contribution to Poverty Reduction and Economic Growth 1.1 The proposed energy sector development project will contribute to implementing Madagascar's strategy for poverty reduction through provision of electricity infrastructure to support rapid economic growth; opening the power sub-sector to private investment, with the Government adopting a regulatory role; improvements in energy efficiency; and preservation of the environment through better natural resource management. The project -- which concerns mainly the power and woodfuels sub-sectors -- builds upon the recently completed Energy I Project (Cr. 1787 MAG) and complements the ongoing Petroleum Sector Reform Project (Cr. 2538 MAG). 1.2 As a result of an unsuccessful economic strategy that reserved the leading role for the State, Madagascar's per capita income plummeted by 45 percent between 1971 and 1994, and three quarters of the population now live below the poverty line. After a period of political turmoil and transition to democracy in 1991-1993, the central objective of the Government's economic strategy is to achieve a reduction in poverty levels. Poverty has become a problem of such magnitude, that only accelerated economic growth can begin to provide a permanent solution. The Government's goal, developed in dialogue with IDA, is to attain growth of six percent per annum by the end of the decade. The sectoral composition of growth underlying this projected economic growth rate indicates growth of 4 percent in agriculture, 10 percent in the industrial sector, and 6 percent in services, including tourism. The lack of adequate infrastructure, including electricity, transport and telecommunications, is a major constraint to achieving these goals. Without an adequate electricity supply, the expected development of labor- intensive industry and services, in particular, would be impossible. 1.3 Another important aspect of the Government's strategy is the refocussing of public expenditures, aiming to improve resource allocation to priority sectors. In the energy sector, the Government has begun implementing a strategy to move away from the present sector structure, dependent on public investment and entirely dominated by state-owned enterprises (SOLIMA for petroleum and JIRAMA for electricity), to a new sectoral environment designed to stimulate private sector investment, with the Government adopting the role of regulator and arbiter. This strategy also includes moving from a past situation of price distortions to one featuring efficient pricing policies, and promoting efficiency in energy production and use. These changes, which require technically complex reforms and the building up of regulatory capacity, are supported by the ongoing Petroleum Sector Reform Project for the petroleum sub-sector and will be supported by the proposed project for the electricity sub-sector. 1.4 The initial emphasis of power sub-sector reform will be on creating a transparent legal and regulatory framework, conducive to greater efficiency and capable of attracting private investment, and on preparing JIRAMA for operation in the new environment through corporatization and commercialization, rather than on outright privatization of the utility. Before substantial private investment can realistically be expected, a transition period of three to five years is needed to establish the credibility of the new legal and regulatory environment. For that reason, the proposed project will support public investment in power infrastructure up to the year 2001 to ensure that there are no bottlenecks that could constrain economic growth.  Madagascar: Energy Sector Development Project 2 1.5 Improving the efficiency of all energy processes has been a longstanding concern of the Ministry of Energy and Mines (MEM). Under the Energy I project MEM carried out a successful program for increasing the efficiency of charcoal production, and for disseminating improved charcoal stoves. The MEM, with support from consultants, also carried out a series of energy audits in industry. These initiatives will be continued and extended nationwide under the proposed project, with a main emphasis on woodfuels processes, particularly the production and use of charcoal, which currently involve high energy losses. 1.6 Preservation of Madagascar's fragile and precious natural environment is crucial to sustainable growth and to fighting poverty. One of the contributing factors to the destruction of the country's rich, biodiverse environment has been the large scale consumption of woodfuels. In some regions, the main cause of current forest degradation is the production and consumption of firewood and charcoal. The decline in forest cover is serious not just because it threatens the availability of woodfuels to meet cooking needs, but also because it jeopardizes the existence of a unique natural heritage and hinders the country's potential for ecotourism, which could provide foreign exchange for development. The proposed project will support a pilot program to ensure a sustainable supply of woodfuels to the Mahajanga region, including better management of natural forests which are being exploited for fuel and are being seriously degraded by this activity. Under the project, approximately 30 villages will begin managing their forest resources and reaping a financial benefit from their sustainable exploitation. 1.7 The Government and IDA agreed that the proposed project meets the priority needs of the energy sector in support of the country's overall program of economic growth and poverty reduction. It is very much in line with the priorities of IDA's country assistance strategy which focuses on upgrading of infrastructure emphasizing rehabilitation over new investment; elimination of de jure monopolies and promotion of private sector participation; and improving natural resource management. The project also meets the general criteria for IDA lending in the power sector, and incorporates Government as well as Bank Group concerns for energy efficiency. The Energy Balance 1.8 Madagascar's energy balance (Annex 1.1) reflects the country's early stage of economic development. The economy's modern sector uses only a small portion of total net energy supply, while households consume 73 percent, mostly in the form of woodfuels for cooking. Total consumption is about 2.6 million tons of oil equivalent (toe) 1/. Firewood accounts for 74 percent of the total and charcoal for 9 percent. The consumption of energy other than woodfuels consists mostly of petroleum products (imported petroleum supplies 12 percent of net supply), and amounts to only about 30 kilograms of oil equivalent (kgoe) per capita, much lower than the 100 kgoe average for sub-Saharan Africa. The energy balance also reveals very large conversion losses in the production of charcoal, which amount to about 1.2 million toe annually. 1.9 The transport sector is the largest consumer of petroleum products (71 percent). Industry, commerce and agriculture account for 17 percent of petroleum product consumption, comprising mostlv fuel oil and diesel. Households consume the remaining 12 percent, mostly kerosene, with a very small amount of liquefied petroleum gas (LPG). Despite the low profile of petroleum products in the overall energy balance, they absorb a considerable amount of Madagascar's export earnings, about 26 percent in 1993. Electricity's share of net energy supply is only two percent of the total, but this source of 1/ These figures reflect 1993 data, which are the latest available.  Madagascar: Energy Sector Development Project 3 energy is crucial to running a modern productive sector. Industry, commerce and other services are the largest consumers of electricity, accounting for 76 percent of the total. Households consume the remaining 24 percent. 1.10 Vigorous economic growth will bring about not only an increase in overall energy demand, but also major changes in energy supply and consumption patterns. The evolution will be towards greater consumption of modern fuels and, at least initially, higher consumption of charcoal, wliich serves as a transition fuel between traditional and modem fuel use by households. The Government wants this transition to be accompanied by an increase in efficiency, through institutional reform and adequate energy pricing, and also that it be accomplished with due consideration for environmental protection. Lessons and Principles incorporated in Project Design 1.11 Longstanding Energy Sector Dialogue. The proposed project is an important next step in the dialogue between the Government and IDA on energy. It draws on the experience gained and the lessons learned in this process. IDA has been supporting the development of the energy sector in Madagascar since 1978, with one hydroelectric project (1978); three petroleum projects (1980, 1982 and 1993); an ESMAP energy assessment (1984); and the Energy I project (1987), which closed in December 1994. Annex 1.2 provides a brief description of these projects and a summary of the relevant lessons learned. The proposed project also takes account of lessons learned from other energy projects in the Africa region and elsewhere. The most important lessons that have been incorporated in the design of this project are: (a) that greater efficiency and financial viability of power subsector operations requires structural reform: opening the subsector to private participation, maintaining economically efficient pricing, and commercializing state-owned utilities; and (b) that electrification of new areas has to be done selectively, focusing on areas that can make productive use of electricity, trying to make more intensive use of existing infrastructure, and applying low-cost design standards. Also, on a more specific level, and based on the experience of the Energy I project, JIRAMA has sought to structure procurement packages to minimize the burden of supervision and coordination. 1.12 Bank Group Principles for Power Sector Restructuring. The proposed project satisfies the guiding principles for Bank Group support of power-sector restructuring programs. The Government is commnitted to reforming the legal and regulatory framework of the power sector. The new framework will include: a clear articulation of tariff policies; the establishment of an independent regulatory agency; and clear rules for entry and exit of private producers and distributors of electricity. The design of tariff regulation will seek to stimulate efficiency. A restructuring study for JIRAMA will explore the options for splitting certain support activities, such as information technology, construction, and engineering design, into wholly-owned subsidiaries which the Government could later privatize. Finally, JIRAMA will become a joint-stock company to allow potential private partners access to its capital. 1.13 Bank Group Policy for Energy Efficiency and Conservation. The proposed project has incorporated IDA's current policies for efficiency and energy conservation in developing countries through: its components for loss reduction in the power systems; improvements in the efficiency of charcoal production and use; studies on the potential for broad-scope energy efficiency programs; and agreements on energy pricing.  Madagascar: Energy Sector Development Project 4 II. INSTITUTIONAL ISSUES Overview 2.1 The Ministry of Energy and Mines (MEM) has five separate directorates corresponding to energy, mines, water, geology, and project coordination. MEM also has supervisory authority over the state electricity and water company, JIRAMA, and the state petroleum company, SOLIMA. Within MEM, the Directorate of Energy (DE) has direct responsibility for overall energy policy, planning, and oversight of agencies in the energy sector. For the woodfuels subsector, institutional responsibility is spread across the MEM, the Ministry of Agriculture, the National Office of the Environment, as well as regional and local authorities. The following sections describe the institutional aspects of the electricity and woodfuels subsectors, highlighting the key issues that relate to the design of the project. 2.2 Madagascar has embarked on a program of restructuring the energy sector, opening up for private sector participation activities that in the past have been the exclusive domain of the state. This restructuring has begun with the petroleum subsector, where the Government already has taken steps towards: abolishing the state monopoly on the import, refining, storage, and distribution of petroleum products; establishing rules for open access to common storage facilities; liberalizing the system of petroleum pricing; and designing a rational tax system. The Petroleum Sector Reform Project is covering this restructuring. 2.3 The proposed project will deal with institutional issues in the electric power subsector and the woodfuels subsector, and will also explore options for an institutional framework to promote energy efficiency nationwide. In the electric power subsector, the project will support restructuring, in line with Madagascar's policy of economic liberalization. For the woodfuels subsector, the project will test, on a pilot basis, arrangements giving more responsibility to local governments and promoting community ownership of selected forested areas to encourage exploitation of wood resources using techniques that will sustain the resource base. The Electric Power Subsector 2.4 The proposed project will support the Government's actions to change the power subsector's legal framework to allow private sector participation; to further efficient electricity pricing by establishing clear and independent pricing regulation; and to create an arms-length relationship between the Government and the utility. The project will also finance JIRAMA's financial restructuring and reorganization, and the utility's incorporation as a joint-stock company, subject to company law. Under the new legal environment the utility will be managed on a commercial basis. Indeed, after having achieved progress within the framework of Energy I in the fields of least-cost expansion planning and tariff policy, the Government is now ready to proceed with deeper reforms, in line with the change in the direction of economic policy. It has established in a letter of sector policy (Annex 2.1), the following objectives for the energy sector: (a) opening of the sector to private capital, and adoption of a normative and arbitration role by the state; (b) an efficient and adequate pricing policy; and (c) efficiency in energy production and use. 2.5 Presently, Madagascar's power subsector is characterized, at the institutional level, by state domination. The 1974 decree defining the subsector's current legal framework declares electric power to be an economic activity reserved for the state and spells out Government policies for the subsector. JIRAMA was created to implement those policies. During JIRAMA's early years, the Government pursued a strategy focussed on the creation of a power-supply base for industrialization, the promotion of rural electrification, and the maintenance of low electricity prices. This led to overinvestment, the  Madagascar: Energy Sector Development Project 5 creation of many small isolated systems which are making financial losses, and to a weak financial position for the utility. 2.6 The Current Legal Framnework. A 1974 Governmental ordinance (Ordonnance 74-002) establishes Madagascar's current legal framework for the power subsector. It declares both the water and electricity subsectors to be part of the domain of economic activities reserved for the state. The state has the exclusive right to carry out all operations for generation, transmission and distribution of electrical energy in the country, and all installations necessary for these operations are part of the public domain of the state. The law allows electricity operations for private use only on an exceptional basis. To facilitate policy implementation in the water and electricity subsectors, the law allows the state to vest part of its exclusive rights in a company which operates in the national interest. 2.7 The National Objectives for the Subsector. The above Ordinance also defines the elements of a national strategy for water and electricity: (a) the gradual extension to all of the territory of power and water infrastructure, in accordance with national policies for economic and social development; (b) exploration of all means to make water and electricity available to the national community as efficiently as possible; and (c) the progressive uniformity of operating conditions, particularly concerning tariffs. The ordinance also stipulates that water and electricity tariffs must cover all expenses, including depreciation and financial charges, and generate a reasonable surplus as a contribution to investment. It establishes the municipalities' authority to impose specific taxes destined to the payment of public consumption of water and electricity. 2.8 JIRAMA. The Government created JIRAMA in 1975, through Ordinance No. 75-024 to implement the national objectives for the water and electricity subsectors, as defined in Ordinance 74- 002. JIRAMA, according to Ordinance No. 75-024, is "a state enterprise governed by Company Law, except as limited by the particular provisions of the present statutes." JIRAMA did not become operational until 1977, upon dissolution of the following state-controlled entities that were responsible for electricity and water supply: Societ6 Malgache de l'Eau et de l'Electricite (SEE), Societe d'Energie de Madagascar (SEM), and Gerance Nationale de l'Eau (GNE). The Government transferred the assets and liabilities of these entities to JIRAMA. 2.9 After JIRAMA's creation, the Government began using the new company to pursue its socioeconomic objectives. For exanple, it directed the utility to create the power supply infrastructure that would support an industrialization program based on large state-owned industries. This program failed, leaving JIRAMA with excess generating capacity and a substantial amount of debt. Also, the Goverrnent ordered JIRAMA to electrify many remote centers, with low levels of economic activity on the assumption that electrification would induce regional development. Actually, in many of these centers, demand has barely increased from its initial level and high fuel costs create financial losses for JIRAMA. Also, the Government allowed tariffs to fall below costs. Furthermore, the Government caused the utility to invest in subsidiaries for manufacturing lightbulbs and home appliances for sale at Government-controlled prices, below cost. All of this shows that the social objectives ranked higher than the commercial performance requirements which Ordinance 74-002 had established. This fact, plus the Government's failure to demand of, and allow, management to run the utility on a commercial basis has led to a weak financial position, as described in chapter V. 2.10 In 1991, within the framework of the Energy I project, JIRAMA and the Government entered into an agreement formalized in a contract-plan defining their respective obligations. This plan has resulted in some important achievements, especially in tariff policy. It established the principles of least-cost expansion planning, marginal cost pricing, and indexation of electricity tariffs to the exchange rate, fuel prices, and the consumer price index (paras. 3.6 and 3.7). Energy I financed JIRAMA's acquisition of an expansion-planning model, training in its use, and the execution of an initial planning  Madagascar: Energy Sector Development Project 6 exercise. It also financed a tariff study based on Long Run Marginal Cost (LRMC). However, the contract-plan failed to clearly establish the principle that JIRAMA should operate on a commercial basis, honoring its financial obligations, and making a profit for its shareholder. It also failed to solve the problem of public sector arrears. 2.11 In the water subsector, a recently-completed Sectoral Strategy and Action Plan study recomnmends that the Government move towards separating JIRAMA's electricity and water sections, and privatizing water operations. A water project, which IDA will finance, current!y is under preparation and will take these recommendations into account. The energy and infrastructure project teams within the Bank are coordinating and will jointly monitor JIRAMA's restructuring. Concerning separation of water and electricity, one issue in particular that deserves attention is the fact that, in the small centers, JIRAMA's staff handle both water and electricity operations. Thus, any restructuring of the utility which separates the electricity and water operations should address the potential impact on staffing requirements and costs. 2.12 CFD and EIB, have also been involved in the discussions concerning the reform program for the power subsector. The Government, JIRAMA, and the Bank's project teams for the energy and the water projects are maintaining a continuous coordination with them for actions in this field. JIRAMA's Present Structure and ODerations 2.13 Organization and Management. An eight-member Board of Directors governs JIRAMA. Four members represent the Government, two are elected representatives of the staff, and two are chosen for their competence in specific areas. The Government must appoint all members formally. The Board is supposed to meet at least twice a year. This has not always been the case and, in practice, the Board has not played an active role in the management of the company. The Government nominates a Director General, the chief executive officer, who is responsible to the Board of Directors. The Director General has broad authority in the conduct of the company's daily management activities. 2.14 Personnel. Human Resources Management. and Training. As of mid-1993, JIRAMA had 6,140 employees. 5,050 were permanent staff and 1,090 had temporary status. Of these employees, 1,290 worked in the water subsector; 3,580 in the electricity sector; and 1,270 in ancillary services 2/. The productivity ratios, relating the number of customers and the electricity and water supplied to them to the number of employees in operations (production, transmission, distribution, and commercial functions), are: 47.7 customers per employee and 110 MWh sold per employee for electricity operations; and 58.9 customers per employee and 41 cubic meters sold per employee for water operations. The productivity ratios for electricity are about average for African utilities with a comparable number of clients and volume of energy sales, but low by international standards 3/. 2.15 JIRAMA's engineering staff is of high quality and the company has proven its technical capacity for design and construction of power facilities. The fact that very old installations are still functioning, despite budgetary and foreign exchange constraints to preventive maintenance, is a good 2/ This allocation is based on actual figures by activity, provided by JIRAMA, plus an estimated allocation of those employees who did not appear in the categorization by activity. 3/ For comparison, in 1988, the average figures for Latin American countries were 114 customers per employee and 558 MWh per employee.  Madagascar: Energy Sector Development Project 7 indication that JIRAMA's technicians are highly skilled. However, a major staffing problem is the regional imbalance of qualified personnel, with a high concentration in Antananarivo, due to the lack of sufficient incentives for relocation to the outer regions. The proposed project will upgrade the systems for human resource management, including a revision of the salary grid and the rules for promotion. The revision will improve compensation and benefits for perso.nel in remote areas, and thus help to attract and retain qualified personnel in these areas. 2.16 Personnel Training. JIRAMA has a large training center in Antananarivo which currently is under-utilized. The proposed project includes a systematic diagnosis of the need for training programs with an operational orientation to support ongoing efforts in the different centers to improve organization and methods for operation and maintenance. 2.17 Information Technology. JIRAMA is in the process of setting up a company-wide information system, integrating accounting, stock management, financial management, commercial operations, personnel management, and technical applications. The project follows a master plan which the utility developed in 1990, with the assistance of consultants financed by CFD. IDA and CFD also financed some data processing equipment under the Energy I project to implement the first phase of the plan, designed to test the system on a pilot basis. The proposed project will include the financing needed to complete the program. 2.18 Billing and Collection. Meter reading and billing of customers takes place once a month in all of JIRAMA's centers. Collection delays for private clients are within the 60 days established in the Contract-Plan, but public sector customers have in the past tended to accumulate large arrears (see para. 5.10). The utility is in the process of decentralizing its billing and collection procedures and there is an ongoing pilot decentralization exercise in the largest demand center outside of Antananarivo, the northwestern port of Mahajanga. The new system will introduce local processing of meter readings and billing, but the regional offices will continue to send all funds collected to Antananarivo. 2.19 Accounting and Auditing. JIRAMA's accounting practices follow African and Malagasy regulations (Plan Comptable Africain et Malgache) which francophone countries across Africa use. The utility has adequate software for accounting and finance, which a consultant helped install in 1982. The system integrates general and analytical accounting, as well as budget control, and is able to exchange information with the systems handling payroll, commercial operations, and stock management. However, the system needs updating to take account of recent changes in JIRAMA's operating environment: internal reorganization, reform of the payroll process, and the increasing importance of project management operations. 2.20 The local auditor that audits JIRAMA's financial statements regularly issues unqualified opinions on them, but has made certain observations about the accounts, particularly the need to complete the set-up of a system for the management of fixed assets, and the lack of a clear legal basis for JIRAMA's operation of power facilities that belong to the state. Indeed, the concessions under which JIRAMA's predecessors operated expired a long time ago. The proposed project's component for financial restructuring and institutional reform will address these issues. The Woodfuels Subsector 2.21 Under Energy I, the DE created a Domestic Energy Unit to implement the woodfuels component. This unit now has become part of DE's permanent structure, and will continue to be involved in woodfuels activities included in the proposed project. The woodfuels study (para. 3.22) makes three basic recommendations concerning woodfuels subsector actions: (a) implementing activities on a regional basis; (b) testing activities on a pilot scale before extending their scope throughout the  Madagascar: Energy Sector Development Project 8 country; and (c) involving the local population in woodfuels activities, giving responsibility to local authorities without central Government intervention. The proposed project's component for a pilot management plan in the Mahajanga region incorporates these guidelines. The pilot plan also will help establish a closer coordination at the local level with Forestry officials and community authorities. Enerur Efficiency 2.22 The MEM has long shown interest in promoting energy efficiency. The Energy I project financed a series of activities in this field. Now the MEM would like to study the feasibility of creating an institution dedicated to promoting energy efficiency through dissemination of information, demonstration projects, development of standards, promotion of private energy services companies, and intermediation to obtain financing. The proposed project will finance activities in this field, including an evaluation of whether or not the creation of such an institution makes sense for Madagascar. III. DEMAND AND SUPPLY. PRICING. AND ENERGY EFFICIENCY Overview 3.1 This chapter outlines the salient characteristics of the electric power and woodfuels subsectors 4/, and the status of efforts to improve energy efficiency across subsectors, since these are the focus of the proposed project. The chapter highlights the present needs, and the actions required to satisfy them. 3.2 The electric power subsector needs financing to rehabilitate and expand the existing supply system, as well as to facilitate the access of new areas and population groups to the service. In the woodfuels subsector, improvements are necessary in the production and use of woodfuels and the management of forest resources, in order to ensure the sustainability of woodfuels supply and preserve Madagascar's natural environment. Concerning energy efficiency, the Government seeks improvements in end-use sectors other than household use of woodfuels. One major element in this effort has been a move toward the economic pricing of energy. The Government also wants to explore options to promote energy efficiency in industry and transport. The Electripct Subsector 3.3 Fragmented Structure of the Supply System. The marking feature of Madagascar's electricity supply system is its great fragmentation. Because of the low levels of demand, and the vast distances separating load centers, local power networks still represent the least-cost solution for supply in the majority of cases. As a result, the supply system consists of 63 separate public networks plus a number of private, independent systems. Total installed generation capacity is about 250 MW, of which an estimated 34 MW belongs to autoproducers. 105 of JIRAMA's 216 MW of installed capacity are in hydro plants. Annual energy production from all sources was around 610 GWh in 1994, with an estimated 64 GWh generated by autoproducers. There are considerable differences between JIRAMA's 41 The petroleum subsector is the subject of a separate project, the Petroleum Sector Reform Project (Cr. 2538-MAG), declared effective on September 20, 1994.  Madagascar: Energy Sector Development Project 9 networks. Just seven of them account for 94 percent of JIRAMA's generation. The largest of these seven, the interconnected system serving the Antananarivo region, accounts for 64 percent of total sales and generation by the utility. Additionally, there are 56 small, isolated networks, nearly half of which provide only part-time service, which varies from four to nineteen hours per day. 3.4 Evolution of Demand. JIRAMA's electricity sales were 437 GWh in 1994, supplied from a gross generation of 546 GWh of which 71 percent came from hydro plants. Demand growth has been uneven along time, reflecting the vicissitudes of GDP growth. Demand grew at an average annual rate of 4.8 percent between 1986 and 1990, decreased 2 percent in 1991, the year when civil disorders swept the country, grew again at 5.6 percent from 1991 to 1993, and stagnated in 1994. The number of consumers increased from about 140,000 in 1986 to about 190,000 in 1994, at an average annual growth rate of 3.7 percent. Only about eight percent of the country's population has access to electricity 5/. Annex 3.1 provides further details on sales and number of cunsumers. 3.5 Future Demand Growth and System Expansion. Annex 3.2 details JIRAMA's demand projections for each of the larger systems and for the aggregate of the smaller systems up to the year 2000. These projections are an update of load forecasts done in 1989 by consultants (Hydro Quebec/Monenco) which IDA financed within the context of the Energy I project to define a least cost expansion plan. They are built up from projections by center and by consumer category. The projected overall growth rate of sales for the period 95-2000 is 4.8 percent. Because of the expected effect of the loss-reduction program included in the proposed project (para. 3.17), the corresponding projected growth rate of gross generation is only 4.1 percent. JIRAMA has also updated the least-cost expansion plan, which is the basis for its investment program (para. 3.18). 3.6 Electricity Pricing. Following the determination of the least-cost expansion plan for the electric power system, JIRAMA and its consultants designed in 1990 a new tariff system based on the long-run marginal cost of supply (LRMC). To reflect differences in costs (particularly fuel costs), and in factors such as load density and load factor 6/ which determine revenue per dollar invested, JIRAMA has classified its networks in three "tariff zones", with prices being lowest for zone I and highest for zone 3. Zone I comprises three of the larger systems, where generation comes mainly from hydropower. Zone 2, including Mahajanga and Toliary, corresponds to larger thermal systems that use mainly heavy fuel oil. Zone 3 covers the rest of the systems, which generate power from plants using diesel. For high and medium-voltage consumers, rates are differentiated by time of day (peak, day, and night). 3.7 At the time of the tariff study, the overall tariff level was too low, and JIRAMA had 438 different tariff categories, which the company had inherited from the multiple entities previously responsible for electricity supply. JIRAMA adopted the structure defined by the tariff study and set a target level which the company was to reach through successive adjustments to ensure financial 5/ This rate is based on: the number of domestic consumers in 1994, which was 188,000; an estimated population of 13.5 million; and an average of 5.9 persons per household (a UNDP figure). 6/ Load density is given by the product of the number of consumers connected per km of line and the average consumption per consumer. The load factor is the ratio between average power demand and peak power demand. Peak power demand determines required capacity investments while average demand determines revenue.  Madagascar: Energy Sector Development Project 10 equilibrium. To make the transition possible, the Government authorized significant tariff increases. During 1989-92, it raised tariffs by up to 30 percent annually, for a cumulated increase of 100 percent. By Ju.y 1993, tariff categories had declined to the current 30 and by July 1994, the average tariff had reached the target level (equivalent to US$0. 10/kWh). Annex 3.3 provides the details of the current tariff system. At the end of 1992, the Government issued an important decree (No. 7800-92) which introduced the principle of automatic adjustments, based on an indexation of tariffs to the exchange rate, the price of oil, and the local consumer price index. These actions, and similar measures taken by the Government conceming water tariffs, will ensure JIRAMA's financial equilibrium beginning in 1995. 3.8 The above tariff policy will remain in effect until the institutional reform of the power subsector takes place and the regulatory agency becomes operational. The LRMC will continue to be the basis of the tariff structure, and the level will be subject to automatic adjustments based on indexation formulas. But the new system for price regulation will add an efficiency incentive. Each tariff adjustment will reflect the changes of the economic indices but will be for less than the full amount, to encourage the utilities to make efficiency improvements in order to maintain profitability. In setting the initial tariff level, the regulatoiy authority will take into account the need to ensure a reasonable level of profitability for JIRAMA, considering its present situation and capabilities. JIRAMA's financial viability will improve in the short term as a result of measures that the Government has agreed to take (see para. 5. 11). Additionally, a restructuring of the utility, included in the project, will further strengthen the company's financial position (see para. 5.12). JIRAMA's Power Facilities: Present Situation and Needs 3.9 Generation capacity. JIRAMA's total installed capacity is 216 MW, of which hydro plants account for 105 MW. Annex 3.4 provides the details. By comparison, current aggregate peak demand is about 110 MW. Although the installed-capacity figure suggests excess capacity, most of Madagascar's power facilities are very old. As a consequence, a large number of the existing thermal units has to be retired before year 2000 (para. 3.10), while most of the hydro units need urgent rehabilitation to extend their lives. For example, four of the seven hydro power stations with installed capacities greater than I MW are more than 60 years old and one of the remaining three is 39 years old. These plants need rehabilitation. The most important rehabilitation works are in the Antananarivo system and concern the power stations of Antelomita I and 11 (4.1 MW each), Mandraka (24 MW), and Manandona (1.6 MW). Consultants prepared a detailed identification of needs and preliminary engineering for hydro rehabilitation under the Energy I project. These works are part of the system's least cost expansion plan. 3.10 A survey of thermal plants which JIRAMA and Hydro Quebec-MONENCO completed in 1990 indicated that of the 182 units existing at that time, 44 units, with an installed capacity of 11.5 MW, should be retired immediately, and 90 others with an installed capacity of 17.9 MW, would reach the end of their useful lives sometime during the 1990s. JIRAMA, however, still counts many of the units with no remaining useful life as part of its installed capacity, thus overstating the installed- capacity figure. The Energy I project financed 32 new diesel generating sets with individual capacities between 30 and 300 kW, and one larger unit of 1.6 MW, for a total capacity increment of about 6 MW. Additionally, JIRAMA, using its own funds, purchased 38 small units with a total capacity of 2.8 MW, and the Energy I project financed spares and technical assistance to repair 61 other units. 3.11 Despite these improvements, future load growth and the scheduled retirement of older units require investments in new diesel generating sets and plant rehabilitation. JIRAMA, with the assistance of consultants financed under the Energy I project, determined the needs on the basis of demand  Madagascar: Energy Sector Development Project 11 projections, scheduled retirement of units, and the reserve criteria adopted for planning. The works which the proposed project will finance are part of the least-cost expansion plan, and include rehabilitation of thermal plants, as well as the purchase of new diesel generating sets to replace retired sets and to expand generating capacity. 3.12 Transmission. There is little transmission infrastructure in Madagascar. Apart from the lines in the Antananarivo and Fianarantsoa interconnected systems, the only other transmission line is a 40-kin, 35-kV line connecting the hydro power station of Volobe to the city of Toamasina. With demand growth, some old medium-voltage lines have become overloaded and have to be rebuilt. Additionally, JIRAMA has to replace old wood structures in several lines. 3.13 JIRAMA's Directorate of Planning has investigated the feasibility of interconnecting some of the major power systems in the country, and has found that this is not economically justified at the present time, given the long distances involved and the low level of the power transfers that would take place. On a smaller scale, however, some interconnections are viable, and the proposed project will support their construction. The main one will incorporate the port cities of Manakara and Mananjary on the east coast into the Fianarantsoa interconnected system, which has surplus hydro generating capacity. Presently, Manakara and Mananjary get their power from diesel plants. Additionally, three small thermal systems to the west of Antananarivo will be linked to the capital, through an extension of medium-voltage lines. 3.14 Distribution Systems. Most of the distribution systems are old, and in some cases operate close to their capacity limits. JIRAMA has identified a series of needs in its distribution substations, where equipment that has reached the end of its useful life needs replacement. This equipment consists mainly of medium-voltage switchgear, protection systems, and control panels. Furthermore, an increase in transformer capacity is also necessary in some substations where the growing loads are approaching the level of existing capacity. Concerning the networks, numerous small rehabilitation and reinforcement operations are necessary to improve quality of service and reduce losses. The lack of sufficient materials currently is constraining the implementation of these operations. Difficulties in obtaining foreign exchange also have restricted the availability of materials for service connections and distribution network extensions, so that the distribution networks do not keep pace with urban growth. 3.15 The distribution network serving Antananarivo uses a medium-voltage level of 5 kV, which has become inadequate for the size of the city. A master plan for renovating Antananarivo's distribution network, which consultants prepared with French financing under the Energy I project, proposes the introduction of a medium-voltage level of 20 kV and a new structure for the medium- voltage network. Additionally, the same study identified urgent rehabilitation works for the existing facilities, which JIRAMA executed under Energy I. The proposed project will execute the second phase of the works, which consists of implementing the master plan. 3.16 Operation and Maintenance. The larger systems operate reasonably well but the smaller ones lack sufficiently-qualified personnel and work equipment for efficient operation. The project will finance tools and equipment for maintenance, including specialized trucks for transmission and distribution work, as well as training for operational personnel. 3.17 Energv Losses. Table 3.1 shows total energy losses, or the difference between net generation and sales, for the period 1989-94. The data seem to indicate growing commercial losses. Indeed, total losses have increased faster in recent years than can be explained by the increase of technical losses caused by demand growth. The proposed project's component for loss reduction will comprise two parallel sets of actions: one will attack commercial losses and the other will look at ways  Madagascar: Energy Sector Development Project 12 of reducing technical losses. The program will identify the magnitude and location of energy loss in the systems, so as to concentrate corrective actions in the areas of maximum impact. The reinforcement of the transmission and distribution systems which the proposed project will execute will have a major impact on loss reduction, especially in the Antananarivo system. Table 3.1: Evolution of Energy Losses 1989 1990 1991 1992 1993 1994 Net generation, GUh 429.9 460.1 454.4 488.9 518.1 531.2 Sales, GWh 377.8 401.0 393.0 410.0 438.2 436.9 Losses, GWh 52.1 59.1 61.4 78.9 79.9 94.3 Losses, X of net generation 12.1 12.8 13.5 16.1 15.4 17.8 Source: JIRANA. lRUtM's Investment Pron 3.18 On the basis of the least cost development plan, JIRAMA has prepared an investment progran for 1996-2001, which Table 3.2 summarizes. Annex 3.5 describes the investment program in more detail. JIRAMA updates this program periodically, responding to changes in demand growth, fuel availability and relative fuel prices. The total investment progrum amounts to UJS$130 million over the period 1996-2001. Its breakdown across various sub-categories is as follows: 49 percent in generation and transmission; 40 percent in distribution; 5 percent in general plant, including data processing equipment, and 6 percent for institutional strengthening and studies including improved human resources management, staff training and training materials, and feasibility studies for two small hydro projects. Tabte 3.2: JIRJA 's Investmnt Progr 1996-2001 (USS milLion) 1J Category LocaL Foreign TotaL Percentage Generation and Transmission 15.92 47.88 63.80 49 Hydropower rehabilitation 7.52 29.34 36.86 Thermal rehab. & Replacement 4.83 8.80 13.63 Transmission Lines 2.83 4.58 7.41 Substations 0.74 5.16 5.90 Distribution 14.94 37.12 52.06 40 General pLant 1.29 4.75 6.04 5 Institutional strengthening 1.80 6.22 8.02 6 Total 33.95 95.97 129.92 Percentage of totaL costs 26 74 100 100 j/ In constant 1993 doLlars. Including duties and physicaL contingencies. Source: JIRAMA. The Need to Extend Electriflcation in the Countrv 3.19 Because of Madagascar's low electrification rate, the Government is keen to promote the extension of electricity to new areas, and facilitate access of social groups that at present cannot  Madagascar: Energy Sector Development Project 13 afford service due to their lack of financial resources to cover up-front costs, mainly house-wiring costs, the connection fee, and the required contribution to the initial investment in cases where network extensions are required. The objective of expanding electrification is to support economic diversification and growth as well as improve the quality of life, in an economically rational way. The Government has learned important lessons from past experience with electrification in Madagascar. Many of the existing small isolated systems were created in the 1970s and 1980s, when one of the Government's objectives was to progressively extend electricity infrastructure to cover the entire country, in an effort to create regionally-balanced economic and social development. But because the emphasis was on social and political objectives, many of the centers electrified lacked the volume of economic activity that would have been necessary to make productive use of the electricity. 3.20 The proposed Government program will select areas for electrification based on evidence that they can use the electricity productively. Given this basic premise, the program will focus on peri-urban and dynamic rural areas. A pilot electrification project, which JIRAMA built under Energy 1, is testing design standards, corresponding to the North-American type of distribution system, which reduce construction costs by about 30 percent. Low-cost construction and credit mechanisms can make possible more intensive utilization of existing medium-voltage lines. These lines often traverse villages and other populated areas without making a single connection, because the investments required using the traditional urban distribution technologies are too high and the expected number of initial new connections too low. This increased utilization of existing infrastructure would apply predominantly to systems with surplus hydro generation capacity. The Woodfuels Subsector 3.21 The Environmental Problem and the Need for Action. Madagascar's forested areas are dwindling rapidly. In some areas, wood off-take for fuel is the major cause of deforestation and the firewood and charcoal markets fail to account for the environmental costs of exploiting natural forests. To protect the environment, the Government will have to encourage improved process efficiency at all stages of woodfuels production and use, as well as better forest resource management. Furthermore, if the Government delegates responsibility for managing forestry resources to the local communities and establishes mechanisms to allow them to share the benefits, it will create an incentive base for sustainable resource exploitation. 3.22 Magnitude and Impact of Forest Degradation. IDA, with support from the Household Energy Planning Unit (UPED) within the MEM, has studied the environmental impact of woodfuels in Madagascar 7/. According to this study, total forest cover declined by 75 percent between 1927 and 1989. Estimates of annual wood offtake for all purposes range widely, from 30.1 million cubic meters to 55.3 million cubic meters, while annual wood production is 36.9 million cubic meters from all forests and plantations. The low figure indicates that supply is sustainable on a country-wide basis. However, the global data masks considerable differences in regional demand/supply balances. The high estimate indicates a serious problem on a national scale. 3.23 Both the low and high estimates of wood offtake show that forest exploitation for fuel, and for the destructive "slash and burn" agricultural method known in Madagascar as "tavy", account for 80 percent of all wood offtake. According to the low estimate, the annual wood offtake for fuel purposes and tavy are very close, 11.4 million cubic meters and 12.0 million cubic meters 7/ Environmental Impact of Woodfuels in Madaeascar, May 1994.  Madagascar: Energy Sector Development Project 14 respectively. The high estimate shows that tavy uses more than double the amount of wood used for fuel purposes. These figures are broadly indicative only, because there has been no complete forest inventory since 1960. In any case, the apparent rapid decline in Madagascar's forest cover is alarming and deserves priority attention from the Government. 3.24 The above-mentioned study evaluated the environmental problems of seven regions and found two, Mahajanga and Toliary, where the exploitation of forest resources for fuel was the main cause of environmental degradation, severely threatening the sustainability of wood supply and forest ecosystems. In these areas, annual wood offtake exceeds the annual rate of wood production from the natural forests. In the Mahajanga region, more than half of woodfuel supply comes from the natural forest, which is disappearing at an annual rate of 10 percent. The proposed project will include an integrated woodfuels program for Mahajanga, which will test, on a pilot basis, a mix of measures that the Government later could extend to the national level. 3.25 How the Woodfuels Market Operates. The main use of firewood and charcoal is for cooking, but, on a smaller scale, industry uses both fuels to fire boilers, fuel kilns, and provide the heat needed in drying processes. In rural areas, households cook mainly with firewood, while most urban households prefer to cook with charcoal. Much of the firewood that rural households use consists of dead wood that the local population gathers freely, but the production and distribution of charcoal is a significant commercial operation. The charcoal each urban center consumes comes from a catchment area around it, where entrepreneurs harvest wood from available forests or plantations, convert it to charcoal, and distribute it to many small retail outlets. The estimated value of the charcoal market is about 60 percent of the electricity market and 20 percent of the petroleum import bill. Furthermore, the industry creates a great number of jobs. For example, in the Antananarivo area alone there are 6,000 to 10,000 charcoalers. 3.26 Scope for Efficiency Improvements. Although it is technically possible to increase the efficiency of woodstoves, which is generally low, there are practical difficulties to implementing changes. One is the lack of a financial incentive, since the majority of households do not pay for the wvood they gather. Another difficulty is the multipurpose use of firewood by rural households. In the traditional rural Malagasy home, firewood stoves serve not only for cooking, but also for heating, and even for light in the evening. Households would lose these benefits with changes aimed at improving the fuel efficiency of the cooking process. In the industrial sector, however, energy audits under the Energy I project found that efficiency gains were possible in processes using firewood as fuel, by teaching boiler operators how to better control the combustion process, for example. The proposed project will pursue this possibility as part of a program for energy conservation in industry and transport. 3.27 The focus of the proposed project's energy efficiency component is on charcoal because the greatest scope for efficiency improvements in the woodfuels subsector is clearly in the charcoal network. Indeed, traditional methods for both, production and consumption of charcoal are inefficient, and there is considerable scope for improvements. Under the Energy I project, the MEM initiated actions in this field. It is for this purpose that the Directorate of Energy (DE) created the UPED. To test improvements in the carbonization process, UPED had a ready-made wood supply base -- a considerable amount of smallwood which FANALAMANGA, a state-owned pine plantation near Antananarivo, was looking to market. The partnership of UPED and FANALAMANGA led to the introduction of an improved kiln design which allows proper control of the carbonization process, improving efficiency by 40 to 50 percent. FANALAMANGA has trained about 500 charcoalers in this process.  Madagascar: Energy Sector Development Project 15 3.28 Also, during the Energy I project, UPED looked into potential savings on the demand side, by testing varieties of improved charcoal stoves used in various parts of the country. UPED found that the most efficient models improved efficiency by about 30 percent. It then trained stove manufacturers in the production of these stoves and mounted a promotional campaign in the area of the capital. The improved models now sell at a premium due to the demand which the promotional campaign created. The program overall has been successful. The proposed project's integrated woodfuels program for Mahajanga will include subcomponents for better carbonization and for improved stoves. Also, the program for promoting the production and use of improved charcoal stoves will expand to cover a group of 16 cities. 3.29 Scope for Imorovements in Resource Management. Charcoalers usually harvest trees before they have reached their optimum size and tend to exploit an area until its depletion, before moving on to a new one. To address these problems, integrated long-term plans for the use of wood resources are needed. These plans should include: (a) a system of permits, cutting fees, and pricing that reflects the cost of resource replenishment; (b) legislation to limit the over-exploitation of natural forests; and (c) programs that allow farmers private ownership of the areas they cultivate since experience shows that private land ownership promotes tree planting and long-term care of both the land and its wood resources. Because of the wide regional variation in environmental problems, it is important to develop such plans on a regional basis. 3.30 Using the pilot program for Mahajanga as a testing ground, the proposed project will develop a management plan for all wood resources in the area. The DE will take the leadership, but will work closely with local authorities and local officials of the Directorate of Water and Forests (Ministry of Agriculture). The program will include the promotion of local community responsibility for managing community resources and will investigate the feasibility of using alternative energy sources since wood plantations are not a cost-effective energy supply option for Mahajanga. Enemy Efficiency 3.31 Within the framework of the long-term policy dialogue with IDA, the MEM has consistently shown interest in energy efficiency issues. The design of the Energy I project reflected this interest through the inclusion of a woodfuels component aimed at improvinig both the efficiency of the carbonization process and of charcoal stoves, and a program of energy audits in industry which identified some scope for efficiency improvements. The Government also has made progress in the related areas of energy pricing and institutional reform, both for the electriciiy and petroleum subsectors. In the future, the Government wishes to continue and extend the woodfuels program, as already explained; begin implementing some of the recommnendations which resulted from the energy audits in industry, and evaluate whether it is worthwhile to develop a full-fledged program of incentives for industry; and explore the feasibility of setting up an institutional framework for promoting energy efficiency nation-wide. Furthermore, since the transport sector is by far the largest consumer of petroleum products, the Government also wishes to broaden the efficiency program to cover the potential for efficiency improvements in this sector as well. The proposed project will support these initiatives.  Madagascar: Energy Sector Development Project 16 IV. THE PROJECT Project Objectives 4.1 The proposed project aims at: (a) enhancing Madagascar's prospects for economic recovery and growth by ensuring an adequate supply of electricity in the medium-term, both for businesses and households, including an increased access of peri-urban and rural populations to the service; (b) increasing economic and management efficiency in the power sub-sector, and attracting private capital for investmnent, through institutional reform; and (c) promoting greater efficiency in the production and consumption of energy, which, in the case of woodfuels, will at the same time, help mitigate adverse environmental impacts. The proposed project will build on the Energy I project in some of these areas, and complement the Petroleum Sector Reform project. Proiect Description 4.2 The project components, which are briefly described below, fall under four major groups: first, the bulk of JIRAMA's investment program; second, a program under MEM responsibility to increase access of peri-urban and dynamic rural areas to the electricity service; third, actions in support of the institutional reform of the power sector; and fourth, a program for energy efficiency dealing mainly with the woodfuels subsector. Annex 4.1 provides a detailed description of these components. 4.3 The part of JIRAMA's investment grogram that the project will finance (US$118.1 million) includes the rehabilitation and extension of generation, transmission and distribution facilities, the provision of tools and equipment for maintenance, a loss reduction program, improvements in human resources management and personnel training, a program for information technology, and feasibility studies for two small hydroelectric projects. The project will rehabilitate the hydro power stations of Antelomita I and II (8 MW in total), Mandraka (24 MW), Manandona (1.6 MW) and Volobe (7 MW), and will provide 30 new diesel generating sets, 29 of them with unit capacities ranging between 40 and 300 kW, and one larger unit of I MW, for JIRAMA's thermal systems. The project will also finance the construction of transmission lines to link the ports of Manakara and Mananjary, on the east coast, to the hydro power station of Namorona in the Fianarantsoa interconnected system, as well as the rehabilitation of several existing transmission lines. Finally, the project will finance the renovation of Antananarivo's distribution system, and the rehabilitation and extension of distribution systems in Antsirabe, Toamasina, Antsiranana, Nosy Be, Mahajanga, Toliary, and Fianarantsoa. 4.4 The electrification pro,ram (US$7.8 million) will define a strategy to extend electricity services selectively, at low cost, including mechanisms to ease the financial barrier to connection, and focusing on areas that can make productive use of electricity. MEM, with the support of consultants financed by the project, will carry out a country survey and prepare a master plan, develop appropriate design standards, identify and screen candidate projects, and design and build those individual projects selected for construction. Disbursements for works and equipment for this comnponent will be conditioned to the establishment of the regulatory agency for the power subsector that is mentioned below.  Madagascar: Energy Sector Development Project 17 4.5 The project will finance consulting services, training, data-processing equipment and vehicles (US$3.2 million) to support the Government's program to reform Madagascar power subsector which includes putting in place a new legal and regulatory framework, setting np a regulatory agency, and restructuring and converting JIRAMA into a joint stock company subject to company law. 4.6 The energv efficiency program (US$3.4 million) will comprise two components: a program for energy conservation and a pilot program for sustainable supply of woodfuels to the Mahajanga region. The program for energy conservation will continue disseminating the improved techniques developed under Energy I for charcoal production and use, and will also pursue the implementation of selected reconmmendations from the program of energy audits in industry carried out under the Energy I project. Furthermore, the project will finance under this component consulting services to assist MEM in exploring options to promote energy efficiency in transport, as well as the feasibility of creating an entity to promote energy efficiency country-wide. The pilot program for the supply of woodfuels to the Mahajanga region will include the preparation of a master plan, dissemination of more efficient techniques in the production of charcoal and of improved charcoal stoves, an investigation of alternative energy sources, and the development and implementation of a plan to manage the region's forest resources. Prolect PreDarstion 4.7 As already mentioned, many of the components of the proposed project are based on studies carried out under the Energy I project, such as, for JIRAMA: the least-cost expansion plan for generation, the studies for the rehabilitation and extension of hydro and diesel power stations; the master plan for Antananarivo's distribution; and the master plan for information technology. Furthermore, an advance for project preparation from the Project Preparation Facility (PPF) has financed or is financing the following services: preparation of a master plan for the expansion of distribution networks in the country's largest cities other than Antananarivo; technical assistance for JIRAMA to set up its organization and systems for project management; and the final engineering and preparation of bidding documents for hydro rehabilitation. JIRAMA's own staff is doing the engineering and preparing bidding documents for diesel power stations, transmission lines, new service connections, loss reduction, and tools and equipment for maintenance. 4.8 For the institutional reform component, the Directorate of Energy prepared a first draft of an Electricity law with the assistance of a consultant, and will finalize the drafting of all legal texts necessary with the assistance of consultants financed from the PPF. MEM is also in the process of recruiting consultants to define a restructuring program for JIRAMA. The woodfuels component is based on the studies and experience of Energy I, and much preparatory work was done under that project. Additionally, the PPF financed consulting services for the preparation of the pilot woodfuels program for Mahajanga. For the electrification program, MEM and IDA have agreed on the terms of reference for the survey and preparation of the master plan.  Madagascar: Energy Sector Development Project 18 Table 4.1: Project Cost 9ummory (FMG billion) (USS million) Local Foreign Total Local Foreign Total A. JIRANA's Investment Progrm 1. Generation 33.2 106.8 140.0 9.5 30.5 40.0 2. Transmission 5.3 12.5 17.9 1.5 3.6 5.1 3. Distribution 39.9 118.5 158.3 11.4 33.8 45.2 4. TooLs and Equipment for Maintenance 2.5 8.9 11.3 0.7 2.5 3.2 5. Other Programs a. Loss Reduction Program 0.5 1.3 1.9 0.2 0.4 0.5 b. Capacity Buitding for Management and Training 0.4 9.8 10.2 0.1 2.8 2.9 c. Information Technology Program 2.1 7.1 9.2 0.6 2.0 2.6 d. Feasibitity Studies for Hydro 0.5 3.5 4.0 0.2 1.0 1.2 Subtotal Other Programs 3.6 21.7 25.3 1.0 6.2 7.2 Subtotal JIRANA's Investment Progrm 84.4 268.4 352.8 24.1 76.7 100.8 B. Electrification Progrm 3.8 19.9 23.7 1.1 5.7 6.8 C. Institutional Reforu of the Power Sibsector 1. Legal and Regulatory Framework 0.0 5.4 5.4 0.0 1.5 1.5 2. Corporatization of JIRAMA 0.2 4.3 4.5 0.1 1.2 1.3 Subtotal Institutional Reform of the Power Subsector 0.2 9.7 9.9 0.1 2.8 2.8 D. Energy Efficiency Progra 1. Program for Energy Conservation 2.6 2.8 5.4 0.7 0.8 1.5 2. Mahajanga Woodfuels Pilot Program 2.2 3.8 6.0 0.6 1.1 1.7 Subtotal Energy Efficiency Progrm 4.8 6.6 11.4 1.4 1.9 3.2 TOTAL BASELINE COSTS 93.2 304.6 397.8 26.6 87.0 113.7 PhysicaL Contingencies 10.0 31.8 41.8 2.9 9.1 11.9 Price Contingencies 54.1 225.1 279.2 -0.7 7.6 6.9 TOTAL PROJECT COSTS 157.3 561.5 718.8 28.8 103.7 132.5 Proiect Costs 4.9 Table 4.1 summarizes project costs and Annex 4.2 provides additional cost details. MEM and JIRAMA prepared the cost estimates -- which were found reasonable by IDA -- with the assistance of consultants for some of the components. The estimated total cost, including contingencies, is US$132.5 million, of which US$103.7 million (or 78 percent) correspond to foreign exchange expenditures, and US$17.0 million to import duties that JIRAMA will pay. Physical contingencies of 10 percent has been adopted across the board, except for hydro rehabilitations, which have a 15 percent contingency. The analysis derives price escalation from World Bank estimates of local and international inflation for the six years of the implementation period (1996-2001). Financing Plan 4.10 Table 4.2 presents the proposed financing plan. The proposed project will receive financing from IDA (US$46.0 million), EIB (US$24.7 million), CFD (US$28.3 million), ABEDA (US$6.6 million), the Government (US$0.2 million) and JIRAMA (US$26.7 million). EIB has already appraised the project, and CFD will appraise during the first half of 199o. The conditions for ABEDA financing are still under discussion. All cofinancing is parallel, so that any deiays will iiot affect the implementation of the IDA-financed portion. The Government of Madagascar will on-lend an amount equivalent to US$31.8 million of IDA Credit proceeds to JIRAMA, with a 25-year repayment period including a 5-year grace period at an adjustable interest rate equal to the London Interbank Rate (LIBOR) plus 0.9 percentage point percent per annum. JIRAMA will bear the foreign exchange risk on that portion of the Credit. The execution of a subsidiary loan agreement between the Government and JIRAMA will be a condition of effectiveness. The Government will retain the balance of US$14.2 million for the electrification program, the institutional reforn of the power subsector, and the energy efficiency program which MEM will implement.  Madagascar: Energy Sector Development Project 19 TabLe 4.2: Finrwcirg Plan USS mitLion Percent of TotaL IDA 46.0 34.7 EIB 24.7 18.7 CFD 28.3 21.3 ABEDA 6.6 5.0 J I RAMA 26.7 20.1 GOVERNMENT 0.2 0.2 TOTAL 132.5 100 Project Implementation 4.11 JIRAMA will implement Part A of the proposed project, while the Directorate of Energy will implement Parts B, C and D. The implementation of the proposed project will take advantage of the structures and arrangements in place and of the experience gained in the implementation of the Energy I project. However, both the Directorate of Energy and JIRAMA will revise the organizational arrangements for project management. As a condition of effectiveness, DE and JIRAMA shall have appointed key staff, whose qualifications shall be satisfactory to IDA, for the new project management units. The consulting firm that is assisting JIRAMA in improving its organization and procedures for project management has prepared a project implementation manual. JIRAMA's personnel will do most of the detailed engineering, construction of transmission and distribution facilities, and electromechanical erection works in power stations, with specialized assistance from manufacturers or contractors in certain areas, particularly for hydro power stations. 4.12 The Government will implement the reform program for the power subsector according to the following timetable: Legal and regulatory framework Submission of the draft Electricity Law to National Assembly June 3, 1996 Expected date of enactment of the law July 31, 1996 Issuance of complementary regulations September 1, 1996 Establishment of the Regulatory Commission September 30, 1996 Effectiveness of revised electricity tariffs October 1, 1997 Restructuring of JIRAMA Beginning of restructuring study June 3, 1996 Beginning of implementation of the results of the study January 1, 1997 Disbursements 4.13 The implementation of the proposed project will span a five-and-a-half year period, with December 31, 2001, as the closing date. Annex 4.3 presents the project's implementation schedule. Table 4.3 sets forth the categories of items which the IDA Credit will finance, the allocation of credit amounts, and the percentage of expenditures for items to be financed in each category. The credit  Madagascar: Energy Sector Development Project 20 will finance 100% of foreign exchange expenditures and up to 90% of local expenJitures for goods, works and training. Consulting services will be disbursed against 100% of tA.,ai expenditures. Annex 4.4 compares the disbursement profile expected for the proposed project with that corresponding to Bank-financed power projects in Africa. The disbursement profile for the Energy I project is also shown. The implementation of Energy I was much affected by the political transition the country went through in 1991-1993. Table 4.3: Disbursement Schedule (USS witlion) Description Percentage Financed by IDA Total A. JIRAMA (1) Goods: (a) Electromechanical Equipment 100% of foreign expenditures 18.4 (b) General Plant 100% of foreign expenditures and 90% of local expenditures 5.5 (2) Consulting Services: 100% 3.2 B. MINISTRY OF ENERGY (3) Works: 100% of foreign expenditures and 90% of Local expenditures 0.9 (4) Goods: (a) ELectromechanical Equipment 100% of foreign expenditures and 90% of locaL expenditures 4.7 (b) General PLant 100% of foreign expenditures and 90% of local expenditures 0.4 (5) Consulting Services: 100% 7.7 (6) Training: 100% of foreign expenditures and 90% of tocaL expenditures 0.4 C. OTHER (7) Refunding of the PPF: Amounts Due 1.5 (8) UnatLocated: 3.3 TOTAL 46.0 4.14 In order to expedite disbursements, two special accounts in US dollars, Fund-A (Ministry of Energy and Mines) and Fund-B (JIRAMA), will be opened in local commercial banks acceptable to IDA. The authorized allocations will be US$350,000 and US$600,000 respectively, and cover four months of eligible expenditures. Upon credit effectiveness, 50 percent of the authorized allocations will be deposited into the special accounts. The remaining balances will be made available as needed. All replenishment applications will be fully documented, except in the case of expenditures of less than US$50,000 for works, goods and services, which may be claimed on the basis of Statements of Expenditures (SOEs). All documents will be kept for review by Bank supervision missions and external auditors.  Madagascar: Energy Sector Development Project 21 Table 4.4: Su=ary of PraFposd Proctmcnt Arrgemaents (USS million) Procurement Method International Local Competitive Competitive Consulting Bidding Bidding Services Other N.B.F. TotaL A. Works 1. JIRAMA works - 8.7 8.7 2. MEM eLectrification works - 0.9 - - - 0.9 C0.8) (0.8) B. Equipsent 1. Power system equipment Hydro plant equipment 0.8 28.8 29.7 (0.7)pj (0.7) Diesel plant Equipment 8.5 - - 2.5 - 11.0 (7.1) (2. 1) (9.2) Transmission and Distribution Equipment 8.5 0.5 - 39.2 48.2 (7.8) (0.5) (8.3) Service connection equipment 9.9 - - - - 9.9 (8.2) (8.2) 2. General plant Cars; office and D. P. Equipment 2.3 0.2 - 0.5 0.2 3.3 (2.0) (0.2) -(0.5)J - (2.6) Equipment for 0 & M, and for training center 4.0 - - 0.2 - 4.3 (3.3) (0. 2)!gl (3.5) C. Services 1. Engineering and consultancies - - 9.4 0.3 3.8 13.5 (9.3) (0.3)S/ (9.6) 2. Training - - 1.1 0.4 - 1.5 (1.1) (0.4)f/ (1.5) D. Niscellanueus 1. Land and Rights of Way - - - - 0.1 0.1 2. PPF Refinancing - - 0.9 0.5 - 1.5 - - (0.9) (0.5) (1.5) Total 33.4 1.6 11.4 5.3 80.8 132.5 (28.5) (1.5) (11.3) (4.7) (46.0) Note: Figures in parentheses are the respective amounts financed by IDA. p/ Direct contracting for proprietary spares. b/ USS1.4 million direct contracting for proprietary spares, and USS0.7 million Limited international bidding for specialized equipment including fuel processing equipment. cJ From U.N. agencies. d/ International shopping for measuring instruments and software to be used in the loss reduction program. e/ Direct contracting to finalize feasibility study for the Ambodiroka hydro project. f/ Travel expenses, subsistence and tuition equivalent for training abroad. Procurement 4.15 Table 4.4 summarizes the project elements, their estimated costs and the proposed method of procurement. IDA will finance mainly goods (US$32.7 million) and consulting services (US$11.3 million). The goods contracts will be primarily for new diesel generating sets (US$5.7 million), electrical equipment for transmission and distribution (US$16.5 million), and general plant (US$6.1 million). The designation "general plant" includes: tools and equipment for maintenance; vehicles, including specialized trucks for transmission and distribution work; data processing equipment; other office equipment; and equipment for JIRAMA's training center. IDA will also finance purchases of proprietary spares, for an estimated US$2.1 million, from original suppliers. Consulting services will be needed mainly for institutional reform, capacity building for management, training, and research and extension activities related to the woodfuels programs.  Madagascar: Energy Sector Development Project 22 4.16 Of the total US$32.7 million in goods that IDA will finance, US$28.5 million will be subject to procurement through ICB. Other procurement methods will be used for the rest, as follows: proprietary spare parts for the rehabilitation of hydro and thermal power stations in lots of less than US$400,000, with an aggregate limit of US$2.1 million would be procured directly from original suppliers; special fuel and lubricant-oil-processing equipment (US$0.7 million), for which a limited number of manufacturers exist, will be procured through Limited International Bidding (LIB); measuring instruments and data-processing equipment for the loss reduction program (US$0.2 million) will be procured through international shopping; locally-produced materials for distribution lines, such as wood poles and cross-arms, as well as some vehicles, computers, and office equipment, in lots of US$250,000 or less, up to an aggregate amount of US$700,000, will be procured through local competitive bidding; and vehicles, computers, and other office equipment, in lots of US$300,000 or less, up to an aggregate amount of US$500,000 will be procured through UNDP's Inter-Agency Procurement Services (IAPSO). 4.17 The Directorate of Energy and JIRAMA staff handling the procurement and disbursement processes under the Energy I project will continue to be in charge of these tasks for the proposed project. In addition to the experience they have gained, this staff also participated in two procurement seminars organized by the World Bank in Antananarivo. JIRAMA will prepare bidding documents for electric power transmission and distribution equipment, a field where the utility has sufficient experience. Consultants will prepare bidding documents for electrical equipment needed for the electrification program under responsibility of the Directorate of Energy and for equipment for JIRAMA's training center. The Bank's standard bidding documents will be used. The submission by MEM and JIRAMA, for IDA review, of bidding documents corresponding to all contracts to be awarded during the first year of implementation of the project will be a condition of effectiveness. The procurement of works and goods which other agencies are co-financing will take place in accordance with those agencies' practices. 4.18 During project supervision, Bank-financed contracts for goods and works above a threshold of US$250,000 will be subject to the Bank's prior review procedures, covering about 95 percent of the total value of Bank-financed goods and works. The remainder will be subject to selective post-award review at the rate of one in four works contracts and one in eight goods contracts. Consulting services contracts will be subject to prior review when the contract value is US$100,000 or more in the case of consulting firms, and when the contract value is US$50,000 or more in the case of individual consultants. Accounting, Financial Reportin2 and Auditing 4.19 The Directorate of Energy will establish and maintain separate project accounts both at the central office and the various regional offices responsible for project execution. The consolidation at the central level will begin with project implementation. DE will maintain such accounts in accordance with sound accounting principles and practices satisfactory to the Bank. DE will provide interim and annual financial statements to reflect the financial performance of the project. JIRAMA will maintain its accounting system in accordance with sound and recognized accounting principles and practices acceptable to the Bank, to provide interim financial reports and annual financial statements that reflect the financial performance and position of the project and JIRAMA, from the commencement of project execution. Annual auditing of the project accounts will be performed by external auditors deemed satisfactory by the Bank. These audits will include the Special Accounts and the SOEs. The Bank will receive the report of the auditors within six months of the end of each fiscal year. Audits of the funds onlent and made available to JIRAMA will be done in the context of the overall audits of the company.  Madagascar: Energy Sector Development Project 23 The auditors' report will include a "management letter" and any other material that is relevant to the interpretation of the audit. The foregoing project accounting, financial reporting and auditing arrangements should provide adequate and timely information to the Bank for supervision of the project. 4.20 MENI and JIRAMA will collect and record information as follows: (a) prompt reporting of contract awards; and (b) comprehensive quarterly reports to IDA indicating: (i) revised cost estimates of individual contracts and for the total project, including best estimates for physical and price contingencies; (ii) revised timing of procurement actions, including advertising, bidding, contract award and completion time for indicated contracts; (iii) compliance with aggregate limits on specified methods of procurement; and (c) preparation of an implementation completion report wi.thin six months of the Credit Closing Date. Environmental Considerations 4.21 The proposed project falls into Environmental Category B. In March 1994, a consultant did an environmental analysis for transmission facilities which the proposed project will construct. The analysis, which was approved by IDA, confirmed that the transmission corridors and substation sites that JIRAMA has designated for the planned installations do not traverse any environmentally sensitive areas. The proposed systems do cross a variety of inhabited and agricultural areas, and the primary environmental issue is therefore the potential socio-cultural and anthropological impact. Environmental planning to mitigate any adverse effects will focus on good route planning and construction practices. Annex 4.5 provides a summary of the environmental analysis. Several of the project components will help enhance the quality of the environment. The rehabilitation of hydro plants, and the incorporation of several centers now served from diesel plants to systems that have surplus hydro generating capacity will help reduce CO2 emissions and environmental pollution. The substitution of hydro for thermal generation in Manakara and Mananjary, through the incorporation of those towns to the Fianarantsoa interconnected system, will reduce contamination of the surrounding lagoon systems with fuel and lubricant from the existing diesel plants. Improving energy efficiency will also lessen pollution. The woodfuels components will reduce deforestation. Project Monitoring and Supervision 4.22 MEM and JIRAMA have agreed with IDA on the records and reports necessary to monitor the progress of the project and the achievement of its objectives. During project implementation, there will be two supervision missions per year to monitor progress, as well as project costs and compliance with legal covenants. Annex 4.6 shows a series of indicators that will be used to monitor progress in the achievement of project objectives and in JIRAMA's performance. The Government and IDA have agreed that project supervision will include a joint annual review of the project with a mid-term review by December 1998, with the participation of JIRAMA and the cofinanciers. The purpose of the reviews is to: exchange views on all matters relating to the progress of the project, and agree on actions that may be necessary to keep implementation on schedule; and verify progress in implementing the institutional reform of the electricity subsector. Further discussion on reporting requirements will take place during project launching soon after Credit effectiveness.  Madagascar: Energy Sector Development Project 24 V. FINANCIAL ANALYSIS OF JIRAMA Introduction 5.1 This chapter discusses the principal problems affecting the finances and financial management of JIRAMA, especially those constraining the development of power operations. The chapter also proposes steps to establish a sound financial base for the future operations and development of both, the power and water subsectors. Finally, since JIRAMA's power section will be the main beneficiary of the proposed IDA credit, the chapter presents the financial outlook for that section through the year 2000, taking into account various corrective measures which JIRAMA is implementing in the short-term. Overall Operations 5 2 JIRAMA's overall finances are in an unsatisfactory condition and in need of restructuring. Several factors have led to the company's weak financial condition: the failure in the past to set adequate tariffs; investments in non-productive plant; Government directives for JIRAMA to provide service, without adequate compensation, in areas of low demand; high energy and water losses; the failure of the Government and other major public sector consumers to settle their bills; and some unsuitable accounting practices, particularly the failure to revalue fixed assets. Between Fiscal Years 1990 and 1992, JIRAMA's operations became increasingly unprofitable: net financial losses rose from FMG 2.2 billion to FMG 9.8 billion, after reaching FMG 13.2 billion in 1991. 5.3 The higher tariffs introduced since FY89 finally brought about a net profit in FY93, which amounted to FMG 10.8 billion. However, in 1994 there was again a deficit of FMG 19.8 billion, caused by a combination of stagnant sales and the effects of rapid devaluation on debt service. Tariff indexation is designed to compensate for the latter effect, but in 1994 the correction was insufficient because of the abruptness of devaluation and because of the time lag for the correction to take effect. Overall accumulated losses for power and water services as of December 31, 1994, were FMG 94.8 billion (US$24.5 million). The Government has allowed JIRAMA to delay its annual debt service payments, which are accumulated in a "State's current account", resulting in an excessive amount of outstanding debt and an unacceptable debt/equity ratio. Therefore, corrective measures are necessary if JIRAMA's proposed development programs are to be satisfactorily implemented. 5.4 Until recently, JIRAMA maintained an analytical accounting system which produced separate financial results for the power and water sections, but the company operated its cash and bank accounts on a joint basis for both sections. Under this arrangement, it was possible to determine the cash and bank balance of each section only at the end of the Fiscal Year, when the final accounts were prepared. In effect, there was no separate cash management for the individual sections. The audited balance sheets indicate that the water section had been drawing increasingly on the power section's funds for liquidity, and at the end of FY94, the water section owed the electricity section FMG 28.6 billion (US$7.4 million) on which it was charged interest at 12 percent per year. This arrangement could cause problems for program implementation for two sections which envisage to undertake significant development programs. JIRAMA has therefore implemented a separation of funds following an agreement reached at negotiations, and described in para. 5.11. Furthermore, a system of cash management was established for each section. Under these arrangements, both sections will be financially autonomous.  Madagascar: Energy Sector Development Project 25 5.5 Since the Govemment will on-lend two thirds of the proposed IDA credit to JIRAMA, and the utility's power section will be the principal beneficiary, the following paragraphs analyze the recent past and expected future financial performance of that section only. Annex 5.1 provides detailed income statements, balance sheets, and funds flow statements for the period FY94 to FY2001. The assumptions for the forecasts are in Annex 5.2, and Annex 5.3 provides projected financial ratios and other indicators. Electricity Section 5.6 Past Eamings Performance. The table below summarizes the section's eamings performance for the four-year period FY91 to FY94. Table 5.1: Perforwince of JIRMAR's Electricity Section FY91 FY92 FY93 FY94 Sales in MWh 393,043 409,965 438,164 436,940 FMG (millions) Operating Revenue 53,653.3 62,689.4 88,679.0 117,333.6 Operating Expenses 61.218.7 54443. 56.585.T 97.216.4 Operating Income (Loss) (7,586.4) 8,245.6 32,093.3 20,117.2 Interest Charged (10.993.3) (8.747.6) (13.587.8) (23.372.9) (18,579.7) (502) 18,505.5 (3,255.7) Interest Received 3.286.1 6.634.3 8.969.0 1 1.0 (15,293.6) 6,132.3 27,474.5 8,655.3 Exchange Adjustments 1,817.6 (14,584.8) (16,098.0) (28,566.0) Non-operating Income 99.6 110.4 72.6 Net Profit (Loss) (13.476.0) (8.352.9) 11.486.9 (19.838.1) 5.7 Electricity tariffs were increased by 30 percent in 1989, 10 percent in 1990, 18 percent in late 1991, and 10 percent in 1992. In December 1992, the Government approved four increases of five percent each, for application at six-month intervals beginning in January 1993, and indexed electricity tariffs to currency devaluation, changes in fuel cost, and cost of living. Up to 1992, the increases were insufficient to avoid significant net losses. Only in 1993, with higher energy sales, did JIRAMA have a net profit. However, in 1994, losses of FMG 19.8 billion were again recorded. As of end-FY94, the accumulated net losses of the electricity section were FMG 63.3 billion (US$16.4 million). 5.8 Past Financing Performance. Table 5.2 below summarizes the section's reliance on internal vs. external sources to meet its financing needs during the four-year period FY91-FY94.  Madagascar: Energy Sector Development Project 26 Table 5.2: Sources of Fuids, Electricity Section FY91 FY92 FY93 FY94 FMG (millions) Net Revenues 24,141.2 24,176.0 53,182.5 70,887.9 Debt Service (29,073.8) (25,694.6) (34,016.5) (54,516.9) Variation in Working Capital (excLuding cash) (6.759.4) (960.4) (13.922.8) (1.823.1) Available for Self Financing (11.692.0) 558.2 5.243.2 14.547.8 Investment 29.926.3 41.095.4 38.930.8 528740.7 Financing Requirement 41.618.3 41.653.6 33.687.6 38.192.9 Sources State's Current Account 22,190.6 22,735.5 16,146.3 37,877.7 Borrowings 12,241.5 27,579.8 29,506.6 19,218.6 Grants and Contributions 6,199.0 7,032.2 32,514.1 9,638.2 Consumer's deposits 92.3 21.4 17.2 7.6 40.723.4 57.368.9 78.184.2 66.742.1 Cash Increase (Decrease) (894.9) 15.715.3 44.496.6 28.549.2 The available self-financing of the section was negative in 1991, and negligible in 1992, while the debt service coverage was unsatisfactory for both years. Following increased tariffs, the funds available for self-financing were equivalent to about 14 and 28 percent of investment in 1993 and 1994 respectively. Debt service coverage also improved significantly. 5.9 Financial Position. The financial position of the electricity section as of December 31, 1994, was as follows: Table 5.3 FMG (millions) Percent Share Fixed Assets Net physical assets 220,846.8 Capitalized Exchange Losses (net) 257,916.3 Miscellaneous investments 1.041.0 479,804.1 Current Assets Cash and Bank 105,684.8 Water Section Loan 28,594.8 Receivables Public Sector Clients 18,641.8 Other 36,005.9 Stock (net) 27,855.7 Payments in advance 4,178.3 JIRAMA's subsidiaries 2 702.1 223,663.4 Less: Total Current Liabilities 123.88.9 99.774.5 Total Net Assets 579.578.6 Financed by: Capital and Provisions 59,579.0 10 Long Term Debt 363,949.8 State's Current Account 155,208.0 Consumers Deposits 841.8 519.999.6 90 579.578.6 100  Madagascar: Energy Sector Development Project 27 The debt/equity ratio of 90/10 is unsatisfactory. It should gradually improve to an acceptable level in the near future, however, with a revaluation of fixed assets, the conversion of EIB debt (see para. 5.11(d)), the reduction of the State's current account (considered by JIRAMA to be long-term debt), and improved earnings. With the proposed write-off of the debit balances for both the water division and JIRAMA's subsidiaries in the electricity section's FY95 balance sheet against the State's current account (para. 5.11(e)), the current ratio is expected to normalize at about 2. 5.10 As of December 31, 1994, current assets included arrears in payments due from the Government and its agencies, amounting to FMG 11.0 billion (US$2.8 million). These arrears have since been settled through a compensation against amounts due to the Government by JIRAMA. The Government and JIRAMA will settle the arrears remaining at the end of 1995 not later than May 31, 1996. Furthermore, from January 1, 1996 onward, the Government and JIRAMA have put into effect simplified payment procedures, to ensure the settlement of electricity bills of the Govermnent and its agencies within three months after bill receipt. Regarding the settlement by autonomous municipalities of bills for public electricity consumption in their localities, it has been agreed that, in consultation with the Government and the municipalities, and not later than December 31, 1996, JIRAMA will establish a mechanism designed to ensure full recovery of the costs incurred in providing public lighting and the use of electricity in public buildings within the confines of such municipalities, taking into account the statutory powers of the municipalities concemed to impose a surcharge on electricity bills. Restructuring Reconunendations 5.11 During negotiations, JIRAMA and the Government agreed to the following measures: (The deadlines indicated have been adjusted to reflect delays in credit processing). Separation and Improvement of Cash Management for the Electricity and Water Sections (a) JIRAMA would maintain separate bank accounts and cash management for its power and water sections. As of January 1, 1996, all receipts and payments for those services will be paid into or from their respective accounts. (Actual). (b) On January 2, 1995, JIRAMA would deposit, in the bank account of the water section, an amount of FMG 15 billion, as liquid working capital, and a provision would be made in the power section's FY95 accounts for such an amount. (Actual). (c) Effective January 2, 1996, JIRAMA would ensure that any surplus funds from the power section will not be made available for any other purpose (including payment of dividends) unless the financial requirements for the section's operations, debt service, additional working capital, and investment have been fully met. (Actual). Improvement of JIRAMA's Capital Structure (d) As provided for in the EIB Credit Agreement No. 70660, the Government would convert an amount of debt in the power section's accounts, presently estimated at FMG 32.4 billion, into equity. (Actual).  Madagascar: Energy Sector Development Project 28 (e) The debit balances for the water section and JIRAMA's subsidiaries in the power section's FY94 balance sheet would be written off against the State's current account. (Actual). These amounts are the following: FMG (millions) Water section 43,594.8 JIRAMA's Subsidiaries 2,702.1 Total 46.296.9 Additionally, the Government and JIRAMA would negotiate a settlement for the balance of the State's current account of FMG 155.2 billion. This will ensure that JIRAMA attains a debt/equity ratio not exceeding 70/30 as of December 31, 1996. As of January 1, 1996, the State's current account will be closed. (Negotiations are ongoing). (f) Effective FY96, JIRAMA will maintain its debt service to the Government on a current basis. 5.12 Additionally, the consultants commissioned by MEM for JIRAMA's restructuring will: (a) Revalue the power section's fixed assets. JIRAMA will incorporate the revised values in its books of accounts as of January 1, 1997. (b) Review the adequacy of present methods of allocating expenses common to the power and water sections. MEM will provide IDA with the results of the study and make JIRAMA introduce any agreed improvements into its allocation practices by January 1, 1997. (c) Define possible measures to alleviate the financial losses incurred by the poweer section as a consequence of investments executed by JIRAMA, at the Government's request, which subsequently proved not to be financially viable or economically justifiablc. The scheduled completion date for this part of the study is December 1, 1996, following which the Government, JIRAMA and IDA will agree on the specific actions necessary. Furthermore, not later than January 30, 1997, the Government shall submit to IDA its proposals for the reorganization, recapitalization and transformation of JIRAMA into a joint stock company, and subject to the approval of IDA, proceed thereafter to implement such proposals. Financine Plan 5.13 The estimated financing requirements of the Electricity Section for the six-year period FY1996-2001, and the sources of financing, are as follows:  Madagascar: Energy Sector Development Project 29 TabLe 5.4: Estimted Firnacing Requireients and Sources of Funds, Electricity Section FMG (millions) USS miLLion Percent share Reauirements 1996-2001 Investment 867.652.3 159.8 Sources Net Revenue 1,130,477.0 Less Debt Service 516,460.9 Less Increase in Working Capital 313,685.3 Less Dividends 10.,000.0 290.330. 53.5 33.5 Borrowing (net increase) 540,937.2 99.6 62.3 Grants, Contributions, Deposits 36 384.3 6.7 4.2 - 867.652.3 159.8 100.0 The capital expenditure in the financing plan includes the investment for the proposed project during the period FY96-2001. The plan takes into account: the conversion of EIB debt into equity, the closing of the State's current account after the write-off of amounts owed to the power section by the water section and JIRAMA subsidiaries and conversion of the balance to equity; and the provision for modest dividend payments to the Government. For Energy I, the Government agreed, as a contribution to that project, to exonerate JIRAMA from customs duties. For the proposed project, the power section's forecasts indicate that internal cash generation would be sufficient to pernit JIRAMA to pay the customs duties, estimated at FMG 92.3 billion (US$17 million). Accordingly, JIRAMA has agreed that beginning January 1, 1996, it will take all measures necessary to ensure that its power section's annual internal cash generation will be not less than 30 percent of the annual average capital expenditure incurred or expected to be incurred during the previous, current, and succeeding fiscal years. 5.14 JIRAMA increased its electricity tariffs by an average of 8 percent effective April 1994, and 35 percent effective August 1, 1994, corresponding to the last of the four half-yearly 5 percent increases which the Government had decreed at the end of 1992, plus the application of the indexation formula. During negotiations, the Government confirmed that JIRAMA would continue to make any further adjustments of its electricity tariffs required in accordance with the rules for the revision of electricity tariffs provided in Decree No. 7800-92. After negotiations, tariffs have been raised three times, for a total increase of 63 percent, as a result of indexation. 5.15 As a protection for the financing plan, JIRAMA has agreed to submit, for IDA 's approval, a financing plan for any capital expenditure additional to the agreed investment program which exceeds US$2 million equivalent. Furthermore, JIRAMA agreed not to incur debt for its power section without IDA 's approval unless a reasonable forecast of revenues and expenditures showed that the estimated net revenues of the power section for each fiscal year during the term of the debt to be incurred was at least 1.5 times the estimated debt service requirements of the power section, in each year, on all the section's debt, including the debt to be incurred. Future Finances 5.16 The table below gives the salient features of the power section's financial forecasts for the period FY95 through FY2001:  Madagascar: Energy Sector Development Project 30 TibLe 5.5: FinanciaL Forecsts, Etectricity Section FY95 FY96 FY97 FY98 FY99 FY00 FY01 Sates GWh 444 462 482 504 529 563 599 FMG (millions) Total Operating Revenue 199,663 250,834 275,054 297,636 322,765 346,555 416,329 Total Operating Expenses 1/ 128.233 145.215 156.978 165.406 199.643 218. 253.662 Operating Income 71,430 105,619 118,076 132,230 123,122 127,669 162,667 Interest Charged (30,577) (32,599) (31,989) (30,059) (26,596) (23,231) (17,634) Interest Received 12,085 10,129 15,992 18,371 19,268 20,305 27,209 Other Income 250 250 250 250 250 250 250 Exchange losses (44.512) (55.271) (58.767) (54.749) (37.690) (39.199) (40.511) Net Profit 8.676 28.128 43.562 66.043 78.354 85.794 131.981 Current Ratio 1.8 2.0 2.2 2.5 2.7 3.0 3.2 Debt/Equity Ratio 68/32 67/33 64/36 62/38 61/39 58/42 52/48 Debt Service Coverage Ratio 1.4 1.5 1.6 1.9 2.6 2.8 3.3 1/ Includes amortization of deferred charges for debt revaluation. The financial projections do not include the effect of JIRAMA'S financial restructuring, which will be defined by the restructuring study, nor of the revised system of electricity tariffs to be introduced as part of legal and regulatory reform. These changes, which aim to improve efficiency, should not negatively affect JIRAMA's finances. As JIRAMA becomes more commnercially oriented, dividends should increase, and tariffs might go down in real terms to transfer some of the efficiency gains to consumers. In view of the economic uncertainties, JIRAMA has prepared these forecasts on a conservative basis. Nevertheless, they do indicate a significant improving trend after FY95 in all the basic financial parameters. The indicated growth of sales is 4 percent, increasing to 6 percent by the end of the decade. Electricity pricing is assumed to evolve in line with the indexation formulas currently in effect. The debt/equity ratio, which is presently a source of concern, should improve significantly after the proposed corrective measures are in place, and will improve further with the settlement of the large State's current account balance (para. 5.1 1(e)). As economic conditions improve, there is reason to believe that actual results will be even better. VI. BENEFITS. RISKS. ENVIRONMENTAL ASPECTS AND ECONOMIC ANALYSIS A. BENEFITS 6.1 The project will: (a) provide about 45,000 new connections to households and industries, one third of which will be in peri-urban and dynamic rural areas; (b) serve an additional demnand of about 240 million kWh/year; (c) increase the reliability of supply and reduce losses from 18 to 12 percent of net generation; (d) substitute hydro-electricity for more expensive thermal generation by extending the life of existing hydroelectric plants, and by connecting several centers (about 1,000 kW), now served by diesel plants to systems that have surplus hydroelectric capacity; (e) reduce fuelwood consumption by 100,000 tons/year through efficiency improvements in the production and use of fuelwood and charcoal in some 16 cities; (f) train about 450 artisans in the production of improved stoves and about 300 charcoalers, each producing 20-30 bags per month and using 40% less wood; and (g) lower, through the use of improved stoves and cooking practices, the relative share of  Madagascar: Energy Sector Development Project 31 energy expenditures in household budgets by about 20%. Furthermore, the reform component is laying the ground for private sector participation in the electricity subsector and empowering communities and consumers to decide the type and speed of the country's electrification. B. COST RECOVERY 6.2 In electricity, an adequate tariff system as well as acceptable and improving collection efficiency ensure that the costs of supply are recovered from beneficiaries. Presently, there are no Government subsidies. The structure of JIRAMA's tariff system is based on the LRMC and its level is automatically adjusted in response to changes in the economic environment ensuring the utility's financial equilibrium (paras. 3.6 to 3.8). There is a small cross subsidy from the larger hydroelectric systems to the thermal systems -- tariffs in the former are about three percent higher than they should be -- but this subsidy is gradually being eliminated. There is also a social tariff which will be maintained. Power sector reform will introduce a revised pricing system based on the same principles but including a mechanism to gradually elicit from the utilities efficiency gains that will be shared with consumers. With the exception of a large industrial client in Mahajanga, with whom JIRAMA is negotiating a solution, collection delays from private clients are within 60 days. Public sector clients, on the other hand, have in the past tended to accumulate large arrears which were periodically settled through cross-debt compensations. The Government and JIRAMA have taken measures to ensure timely payment in the future (para. 5.10). C. COST-BENEFIT AND SENSITIVITY ANALYSIS JIRAMA's Investment Proeram 6.3 Analysis of Alternatives. The proposed project includes the bulk of JIRAMA's investments in generation, transmission and distribution rehabilitation and extension for the period 1996-2001. For generation, the program emphasizes rehabilitating existing hydroelectric plants, and is the result of a least-cost expansion planning study carried out with the assistance of consultants financed by IDA under Energy I. The alternative of increasing diesel-based generation was more costly. For the majority of the small isolated centers, however, the only alternative availablc is the addition of small diesel generating sets (40 to 300 kW). In transmission, an extension will incorporate several centers now served from diesel plants to systems that have surplus hydioelectric capacity. Higher fuel costs make the alternative of letting the systems develop separately more expensive. In distribution, the project will finance rehabilitation, expansion and renovdtion of networks in the country's eight largest urban centers. Expansion will be done following a master plan prepared by consultants that IDA financed, which considered different alternative voltage levels and timing of network additions. In Antananarivo, where the capacity of the exist'ng 5-kilovolt distribution system has become insufficient for the city, the network will be renovated using a 20-kY voltage level, following a master plan prepared within the framework of the Energy I project by consultants with French financing. The study considered several alternative voltage levels and network structures which the technico-economic analysis found less adequate. 6.4 Cost-Benefit Analysis. The cost-benefit analysis was carried out for the investment program as a whole and for each of the individual components to ensure that they are justified. The capital costs of the investment program, together with incremental fuel costs, and incremental operation and maintenance costs associated with the investment program, are shown in Annex 6.1. All costs are expressed in terms of their equivalent border values. The incremental demand served,  Madagascar: Energy Sector Development Project 32 was determined through simulations of the operation of JIRAMA's systems with and without the investment program. On this basis, the economic internal rate of return (EIRR) would be 22 percent. 6.5 However, the EIRR calculated as described above, better measures the adequacy of tariffs than the true economic merit of the investment program. A superior measure is the consumers' willingness to pay (WTP) for the incremental electricity sales. Using WTP as a proxy for benefits to domestic consumers and the respective average tariffs as benefit proxies for incremental non-domestic consumers' consumption, the EIRR would be 31 percent. Annex 6.1 shows the derivation of the WTP. 6.6 The analysis tested the sensitivity of the EIRR to less favorable scenarios, including: (a) a 15 percent increase in investment costs; (b) a 40 percent increase in fuel costs; and (c) a 20 percent drop in expected benefits, or a drop of one percentage point in expected demand. This analysis indicates that the investment program is most sensitive to a drop in benefits. Even in this case, however, the EIRR would be 15 percent. Table 6.1: Sensitivity Analysis Case Rate of Return (percent) Using Tariffs Using WTP Base Case 22 31 (a) 15% increase in investment costs 19 26 (b) 40% increase in fuel prices 21 28 (c) 20% drop in expected benefits (or one percentage point lower rate of growth in expected demand) 15 22 6.7 EIRRs on Subcomponents of JIRAMA's Investment Program. The EIRRs on the various subcomponents of the rehabilitation work under the proposed project range from 12 percent to 57 percent. The following sections briefly review the salient features of the calculations for the investment program's subcomponents. Annex 6.1 outlines the details of this analysis. 6.8 Hydroplant Rehabilitation. The rehabilitation of the Mandraka, Antelomitas, and Manandona hydropower stations will help meet the demand in the Antananarivo Interconnected System at least cost. The estimated EIRR of the rehabilitation of these power stations is 57 percent. This rate is high but quite usual for this type of rehabilitation. Even under highly unfavorable circumstances (a 25 percent increase in investment costs combined with a 25 percent drop in expected benefits), the estimated EIRR would be 31 percent. 6.9 Transmissicn Line Subcomponent. The ports of Manakara and Mananjary, now receiving electricity from diesel plants, will be connected by means of transmission lines to the hydro power station of Namorona in the Fianarantsoa Interconnected system. The economic analysis compared the present value of total system costs for two alternative expansion programs to meet the projected  Madagascar: Energy Sector Development Project 33 demand (1995-2000) for the systems of Fianarantsoa, Manakara and Mananjary. One of them assumed that the three systems would operate in isolation, as they are at present. The other assumed the interconnection of these systems. On the basis of the assumptions in Annex 6. ', the base case- equalizing discount rate is 16 percent, with the interconnection having the lowest value of system costs up to that rate. 6.10 A sensitivity analysis of this rate considered both a 20 percent drop in fuel costs and a 20 percent increase in line-investment costs. Given these two conditions, the equalizing discount rate would be 13 percent and 11.5 percent respectively. Using the average tariff for Zone 1 as a proxy for economic benefits, the estimated EIRR is 28.7 percent. Sensitivity tests show that this rate is most sensitive to a drop in expected sales. For example, a 25 percent decline in expected sales would lower the EIRR to 20.7 percent. 6.11 Rehabilitation and Extension of Diesel Plants. The least-cost solution for meeting the demand in secondary centers requires the rehabilitation and extension of diesel plants, most of which are small. Annex 6.1 provides the EIRR calculations for these centers. Using tariffs as a proxy for economic benefits, the estimated low case EIRR is 23 percent. Separate sensitivity tests for a 15 percent increase in investment costs, a 20 percent increase in fuel costs, and a 10 percent decrease ir. expected benefits indicated that the EIRR would decline to 19, 18 and 17 percent respectiveiy. 6.12 Rehabilitation and Extension of Distribution Networks. The rehabilitation, renovation and extension of the distribution networks in Antananarivo and other large urban centers will permit JIRAMA to meet demand growth, keeping pace with urban development, and to reduce the level of losses. The estimated EIRR on the distribution component is 12 percent. The sensitivity analysis shows that increases of 15 percent in investment costs, supply costs or expected demand would lower the EIRR to 10, 6 and 9.5 percent respectively. Annex 6.1 gives the details of the EIRR calculation. Electrification Pro2ram 6.13 The electrification program for suburban and dynamic rural areas will result in savings from the substitution of electric power in end-uses which currently depend on kerosene, candles and batteries. MEM, with the assistance of consultants financed by the project, will determine economic criteria for the electrification program. Only individual projects with expected rates of return exceeding ten percent would be undertaken. Institutional Reform of the Electric Power Subsector 6.14 Several benefits will result from policy reforms in the electric power sector to eliminate the monopoly of the state. These benefits include: (a) efficiency gains, which will be shared by consumers through adequate tariff regulation; (b) greater sustainability of electricity supply through mobilization of private capital for investment in the sector; and (c) savings in public resources, which the Government can reallocate to social programs. Program for Country-Wide EnerLv Efficiency Improvements 6.15 Annex 6.2 provides an analysis of the benefits of introducing improved charcoal stoves to a medium-sized city with a population of 12,700, which yield an EIRR of about 22 percent. Concerning the national program for energy conservation, quantitative estimates of benefits would be premature at the present time, since they will depend on data to be gathered during the  Madagascar: Energy Sector Development Project 34 implementation of the project. Annex 6.2 also provides details on the economic analysis of the Mahajanga pilot woodfuel program, which has an estimated EIRR of 42 percent. It is estimated that wood savings from this program would reach 40,000 tons/year after five years and stabilize at about 100,000 tons/year after 12 years. D. RISKS 6.16 The possible devclopments that may adversely affect the project can be divided into pre- and post-commissioning risks. The pre-commissioning risks relate to: (a) construction cost increase; and (b) delay in completion. The post-commissioning risks are related to: (a) the market risk; and (b) government policies and actions on market structure and regulation, and pricing policy. 6.17 The risk of construction-cost increase was minimized by taking into account cost data for similar works and setting aside contingencies in proportion to the perceived risks (15% for hydro- rehabilitation and 10% for other components); the risk of delays in completion have been reduced through: (a) advance preparation of bidding documents; (b) provision, as part of project preparation, of assistance to set up the organization and management systems for project implementation, and to prepare detailed implementation schedules for each component; and (c) experience gained by both JIRAMA and MEM with the implementation of the Energy I Project (Cr. 1787-MAG). The woodfuel component will be implemented by MEM through local consultants and NGOs which are closer to the conmmunities most affected by the woodfuel crisis. 6.18 Once the project is constructed, the market risk becomes predominant. The sensitivity analysis (para. 6.7) has evaluated the effect on the return to the project of a drop in sales, due, e.g., to an economic downturn. Due the rehabilitative nature of the majority of the work, the economics of the project remains sound. However, other policies and actions the Government could take may have a negative effect on the project. There is a risk that, for social and political reasons, the Government might renege on tariff policy, or try to create barriers to private sector participation. As has been shown by the sensitivity analysis on the program as a whole as well as components thereof, a reduction in benefits either through lower prices, lower quantities or both would significantly affect their rate of return. Reneging on commitments to open up the electricity subsector to private participation would have some serious medium to long-term effects as the Government cannot afford to pay for power expansion and rehabilitation. The system would not be able to satisfy demand and would deteriorate. Although this risk is present, great care has been taken to develop and strengthen local ownership of the process. The local authorities have had the leading role in the formulation of the reform program, which ensured that social and political constraints were given particular consideration. The authorities decided that the program's emphasis would be on creating an adequate legal and regulatory framework, and on putting JIRAMA on a commercial footing. With this approach, there will be a transitional period, estimated at three to five years, before substantial private investment in power infrastructure can realistically be expected. E. INSTITUTIONAL CAPACITY ANALYSIS 6.19 Both JIRAMA and MEM have had experience in the implementation ot projects of this magnitude and complexity (involving several donors), acquired primarily through the implementation of the Energy I Project (Cr. 1787-MAG). Both, but particularly JIRAMA, have well trained and motivated staff. All these factors have been taken into account in the design and implementation arrangements of the project. The key institutional risk is a drastic change in personnel such that all the training and experience accumulated are lost. If this were to happen, it would hamper the ability  Madagascar: Energy Sector Development Project 35 of the institutions involved in carrying out the project and for the benefits to materialize in a timely fashion. This has been taken into account in the sensitivity analysis, by lowering the level of expected benefits (see cost-benefit analysis above). F. POVERTY ANALYSIS 6.20 The inadequacy of the electric power infrastructure has been identified in the CAS as one of the constraints to development in Madagascar. This project would not only help removing that constraint but would also help the Government in moving away from public involvement in the energy sector and redirecting public expenditures to priority social sectors. The project has an indirect impact on poverty alleviation through its effect on the overall rate and pattern of economic growth by developing off-farm opportunities. No country has significantly reduced poverty without considerable and sustained growth. Setting the conditions of such growth is thus essential to reducing poverty in Madagascar. It has been observed 8/that a source of income within the household that is salaried has a strong inverse relationship to household poverty. In Madagascar, however, only 2.7% of the population are in non-agricultural, wage-earning jobs. In addition, to raising productivity and income to farmers, the development of off-farm productive opportunities, including salaried employment to absorb the expanding labor force, is essential. Madagascar's labor force is expected to grow by approximately 220,000 people each year between 1995 and year 2000, or more than half the total number of existing non-agricultural jobs. The Government needs to provide incentives for private sector investment to absorb much of this labor in labor-intensive works. Most investments in the Free Trade Zones (FTZ) are in labor-intensive sectors such as garment, food-processing, and jewelry industries, which require mostly unskilled labor and also employ a substantial number of women. Thus providing the necessary infrastructure to remove the constraints for the expansion of labor-intensive industries would increase the potential for job creation and the reduction of poverty. 6.21 The woodfuel component and the electrification component which would focus on peri- urban and dynamic rural areas, have an impact on poverty alleviation. It is expected that the implementation of the woodfuel component will reduce woodfuel and charcoal consumption and lessen the energy burden of the poor. The electrification program will target lower income groups, helping them to finance the up-front costs, such as house wiring and connection fees. In order for the program to benefit a maximum number of people, the average cost per connection will be minimized by more intensive utilization of existing infrastructure, and by applying low-cost design standards. For remote poorer areas, solutions based on photo-voltaics or wind will be tested. G. ENVIRONMENTAL IMPACT 6.22 The proposed project has been assigned environmental category B, mainly because of the new transmission facilities -- lines and substations - that JIRAMA will build. The rest of the infrastructure-related works are environment-neutral as they involve electromechanical work inside existing power-houses, or reinforcement/construction of distribution lines in existing rights-of-way, along streets in urban areas. A consultant financed by IDA carried out an environmental analysis for the transmission components (para. 4.21) and JIRAMA has been following, in the topography and engineering phases, the mitigation plan she recommended. The project will benefit the environment, as substitution of hydro for thermal generation will reduce CO2 emissions and environmental 8/ Madagascar: Poverty Assessment (World Bank, March 23, 1995).  Madagascar: Energy Sector Development Project 36 pollution, and the woodfuels components will reduce deforestation and will also lessen CO2 emissions (para 4.21). However, no attempt was made to quantify these environmental benefits in monetary terms, and they have not been included in rate-of-return calculations. H. PERFORMANCE INDICATORS 6.23 Selective performance indicators to be monitored during project implementation have been agreed during negotiations and were included in the minutes of negotiations. The indicators of achievement of project objectives are given in Annex 4.6. I. OVERALL ASSESSMENT 6.24 On balance, the project is expected to properly address the concerns of growth and alleviation of poverty, environmental protection and economic efficiency. VII. AGREEMENTS AND RECOMMENDATION Agreements Reached Durin2 Neaotiations 7.1 During negotiations, IDA reached agreements with the Government of Madagascar and with JIRAMA on: (a) onlending and cofinancing; (b) power subsector reform; (c) JIRAMA's financial performance; (d) electricity tariff policy; and (e) project management and supervision. 7.2 On-lending and Cofinancing. The Government will onlend to JIRAMA US$31.8 million of the credit's proceeds at an adjustable interest rate equal to the London Interbank Rate (LIBOR) plus 0.9 of one percentage point per annum, for a period of 25 years, including a five-year grace period, with JIRAMA bearing the foreign exchange risk. The Government will arrange cofinancing with EIB and ABEDA. JIRAMA will arrange cofinancing from CFD. 7.3 Power Subsector Reform. The Government will implement the power sector reform program, including setting up a regulatory agency not later than September 30, 1996, and launching an electricity tariffs' study not later than March 31, 1997, as well as restructuring JIRAMA and converting it into a joint stock company. The Government will submit to IDA for approval, not later than January 30, 1997, its proposal for the latter restructuring, and proceed thereafter to its implementation (para. 5.12). 7.4 JIRAMA's Financial Performance. JIRAMA agreed to implement the following measures with effect from January 1, 1996: (a) the separation of bank accounts and cash management functions of JIRAMA's power and water operations; (b) the provision of FMG 15 billion as liquid working capital for the water section; (c) a limitation on the use of surplus funds of the power section; and (d) the maintenance of its debt service to the Government on a current basis. (All these measures are actual). Furthermore the Government and JIRAMA agreed to an action plan designed to enable JIRAMA to attain a debt to equity ratio of not more than 70/30 by December 31, 1996 (para 5.11).  Madagascar: Energy Sector Development Project 37 7.5 JIRAMA also agreed to: (a) generate from internal sources, as from January 1, 1996, not less than 30 percent of the average annual capital expenditures incurred or expected to be incurred during the previous, current and succeeding fiscal years (para. 5.13); (b) submit for IDA's approval a financing plan for any capital expenditure additional to the agreed investment program which exceeds US$2 million equivalent; and (c) not incur any debt other than that agreed for the proposed program of investments unless a reasonable fcrecast of net revenues and expenditures shows that the projected internal cash generation is at least 1.5 times the estimated debt service requirement on all debt (para. 5.15). 7.6 Electricity Tariff Policy. The Government agreed to maintain the present tariff policy, defined in decree No 7800-92, until the new legal and regulatory framework is in place and the regulatory commission takes over the responsibility for setting tariffs. JIRAMA will therefore be able to continue adjusting electricity tariffs automatically, by applying indexation formulas (para. 5.14). A plan was agreed to give a permanent solution to the problem of public-sector arrears. The plan includes: (a) the estabiishment, from January 1, 1996, of new, simplified procedures for payment by the Government and its agencies of electricity bills (actual); and (b) the adoption of measures by JIRAMA to ensure that all municipalities impose surcharges to the electricity bills of all consumers to cover public consumption of electricity, as allowed by Ordinance 74-002, not later than December 31, 1996. 7.7 Proiect Management and Supervision. Both JIRAMA and the Directorate of Energy confirmed their existing arrangements for project implementation. Consultants will provide any additional support, if necessary (para. 4.1 1). Both DE and JIRAMA will have qualified, independent auditors, satisfactory to IDA, audit records and accounts for the proposed project, including: the Project Accounts; the Special Accounts, and the Statements of Expenditures. For each fiscal year, DE and JIRAMA will furnish IDA with a certified copy of the audit report within six months after the end of each successive fiscal year (para. 4.19). There will be a joint annual review of the project, including a mid-term review by December 1997, with the participation of the Directorate of Energy, JIRAMA, and the cofinanciers (para. 4.22). Conditions of Effectiveness 7.8 (a) Execution by the Government and JIRAMA of a subsidiary loan agreement (para. 4.10); (b) issuance by MEM of the request for proposals for the restructuring of JIRAMA (para. 4.8) (actual); (c) appointment of key implementation staff by DE and JIRAMA (para. 4.11); and (d) submission by MEM and JIRAMA, for IDA review, of bidding documents corresponding to all contracts to be awarded during the first year of implementation of the project (para. 4.17). Condition of Disbursement for the Electrification Promram 7.9 Disbursements for the electrification program's works and equipment shall take place only following the establishment of a regulatory agency for the power subsector (para. 4.4). Recommendation 7.10 Subject to the above agreements, the proposed project is suitable for an IDA credit of SDR 31.8 million (US$46 million equivalent) to the Republic of Madagascar on standard terms, with maturity of 40 years, including 10 years of grace.  REPUBLIC OF MADAGASCAR ENERGY SECTOR DEVELOPMENT PROJECT ENERGY BALANCE, YEAR 199 PrimaEry Er_Enwrgy Urle tatwW Primary Seco5 dary Convwslon Cruds oil Coal Hydro Woodfusls Bp TobIs Eltricty LPG Gasolirn Kerosne Ga Oil Fuel Oil Charcoal Totrs loss" Gro4s Supl _ Production 41.1 3,402.0 74.3 3,517.4 3,517.4 Imports 419.0 7.7 426.7 6.1 1.0 136.0 143.1 569.8 Exports 0.0 129.2 129.2 129.2 Stocl; IrOaeas_ 0.0 0.4 2.1 0.3 8.7 6.6 18.1 18.1 Total Gross Supply 419.0 7.7 41.1 3,402.0 74.3 3,944.1 0.0 -0.4 4.0 0.7 127.3 -135.8 0.0 -4.2 3,939.9 ConvemiQn Petroleum Refining 408.0 408.0 4.7 62.0 60.8 87.2 160.1 374.8 33.2 Power generabon, JIRAMA 41.0 41.0 41.7 -26.1 -10.2 5.4 35.6 Poaer generabon, autoproducers 0.1 10.8 10.9 5.6 -10.0 -4.4 15.3 Li Charcoal Producbon 1,442.7 1,442.7 248.8 248.8 1,193.9 c Conversion Totals 408.0 0.0 41.1 1,442.7 10,8 1,902.6 47.3 4.7 62.0 60.8 51.1 149.9 248.8 624.6 1,278.0 Own uscv Loss 10.8 10.8 6.2 6.2 17.0 Consumptofn by Setor Industry, Mining, Consbuction 7.7 231.6 63.5 302.8 21.8 0.2 4.1 32.7 12.2 6.0 77.0 379.8 Transport 0.0 86.0 20.8 140.9 1.9 729.6 229.6 Agricutture, Fishing 0.0 4.3 4.3 4.3 Households 1,685.4 1,685.4 9.8 3.6 36.6 192.8 242.8 1,928.2 Commerce & Othr Servmces 42.4 42.4 9.6 0.5 0.5 50.0 60.6 103.0 ToTal Consumpbon 0.0 7.7 0.0 1,959.4 63.5 2,030.6 41.2 4.3 66.0 61.5 178.4 14.1 248.8 614.3 2,644.9 Source: MEM 0* X-~  - 39 - Annex 1.2 Page 1 of 1 MADAGASCAR ENERGY SECTOR DEVELOPMENT PROJECT IDA ENERGY PROJECT EXPERIENCE IN MADAGASCAR AND LESSONS LEARNED Andekaleka Hydroelectric Project (Credit 817-MAG), approved in 1978 for a credit of US$43 million. The project included a dam, a 58-MW plant, and a 138-kV line to Antananarivo. Andekaleka was predicated on the need for electric power to supply an ambitious state industrialization program which subsequently failed, leaving the country with excess generation capacity. The main lesson learned is the need for a cautious approach to demand projections in the case of large, capital intensive, indivisible investments. Petroleum Exploration Project (Credit 1016-MAG), approved in 1980 for a credit of US$12.5 million, and the Tsmiroro Heavy Oil Exploration Project (Credit 1298-MAG), approved in 1982 for a credit of US$11.5 million. These two projects were supply re:sponses to the oil crises of the 1970s and focused on exploring domestic petroleum to reduce dependence on high-cost foreign oil. The Petroleum Exploration Project helped the Government establish the legal and fiscal framework for petroleum exploration promotion and assemble the requisite ge.1ogical data. As a result, four major oil companies (Agip, Amoco, Occidental and Mobil) signed exploration and production contracts, investing a total of US$300 million. The Tsmiroro Heavy Oil exploration project was terminated because the initial results indicated that the project was not ecorioinically attractive and the Government used the remaining funds for another exploration promotion campaign. Lesson learned: a relatively small investment can attract a considerable amount of risk capital from the international petroleum industry, which may help find commercial oil deposits, and provides the country with important geological information to help manage its exploration effort. Madagascar Energy Assessment, prepared by the UNDP/World Bank Joint Energy Sector Assistance Program (Report No. 5700-MAG, January 1987). The report of the Assessment identified the following major energy sector issues: (a) the increasing shortage of woodfuels ior cooking; (b) the need for rehabilitation of electricity generation, transmission and distribution systems; (c) need for improvements in energy policy planning and investment; and (d) the need for better evaluation of domestic energy resource potential. Energy I Project (Credit 1787-MAG), approved in 1987 for a credit of US$25 million. This project addressed needs across various energy subsectors in response to the issues identified in the Energy Assessment and financed priority investments for: detailed identification of power system rehabilitation needs and initial rehabilitation works; a least-cost master plan for the power sector; a tariff study; development of more efficient charcoal production techniques; energy audits in the industrial sector; and technical assistance and training to the Ministry of Energy for energy planning and household energy development. The project finished in December 1994. Petroleum Sector Reform Project (Credit No. 2538-MAG), approved in June 1993 for a credit of US$51.9 million. The objectives of the project are to: open the petroleum subsector to private participation and create an appropriate framework for a competitive environment; support investments in basic infrastructure (refinery operation and facilities for transport, handling and storage of products); and develop an institutional capacity for efficient regulation of the subsector. The credit was declared effective on September 20, 1994.  - 40 - Annex 2.1 Page 1 of 4 October 13, 1994 Mr. Francisco Aguirre-Sacasa Director Department 3, Africa Region World Bank Dear Sir: Subject: Sector Policy Statement The key objectives of the new electric power sector policy adopted by the Malagasy Government are: - Opening of the energy sector to private capital, with the Government taking the role of regulator and arbiter; - An efficient and adequate pricing policy; - Promotion of efficiency in energy production and utilization. To implement this strategy, the Government will execute the following measures: - Reform of the legal and regulatory framework of the electric power subsector; - The electrification program; - Reorganization of JIRAMA; - JIRAMA's investment program; - An energy efficiency program; - Mitigation of environmental impacts; - Resolution of the arrears problem; - Continuation, during the transition period, of the current tariff policy. It is my conviction that the energy sector reform program, as detailed in the attached Policy Statement, as well as the energy sector project we have proposed to you, will benefit from World Bank financial and technical support. Yours truly, Francisque Ravony Prime Minister  - 41 - Annex 2.1 Page 2 of 4 SECTOR POLICY STATEMENT 1. SITUATION AND KEY PROBLEMS OF THE SUBSECTORS a. Woodfuels subsector Since 1920, 75 percent of the country's forests has disappeared. Indeed, beyond the destruction caused by slash-and-bum agriculture and bush fires, wood and its derivatives are used by 80 percent of the Malagasy population for cooking. The inefficiency of the usual combustion methods, and of the conversion from wood to charcoal only widen the gap between woodfuels demand and supply. In certain regions, the scale on which wood is being consumed will have a significant impact unless immediate measures are taken to economize and conserve this energy source. b. Electric power subsector Activities in this subsector concem the generation, transmission and distribution of electricity. Demand for electric power is still relatively low, reflecting Madagascar's low population density and the physical characteristics of its territory. The current electrification rate is 6.6 percent. Energy is produced by power stations with a combined installed capacity of 219 MW, of which 48 percent corresponds to 12 hydro plants, and 52 percent to 54 thermal stations. Despite Madagascar's abundance of hydroelectric resources, only a minimum percentage is being exploited. Existing power facilities are old and no longer capable of meeting consumer requirements (quality of service, etc.). Moreover, there is no interconnection at the country level. Some regions possess surplus capacity while supply is insufficient in others. An additional, major problem in this subsector is the magnitude of the public sector's arrears with JIRAMA, the power company. This has significant consequences for the company's management performance. c. Energy losses High losses occur in many energy processes, industrial and other. Steps have already been taken, chiefly as part of the Energy I Project, to bring this situation under control and to improve it. High levels of losses have also been detected in the transmission and distribution of electricity. d. Institutional and legal framework For commercial energies, the institutional framework is characterized by almost total state-domination, both in the petroleum and electricity subsectors. Indeed, under the terms of Decree 74-002 of February 4, 1974, which establishes the basic policy orientations for the water and electricity subsectors in Madagascar, the state has the exclusive right to carry out all operations relating to generation, transmission and public distribution of electricity. All such activities are to be carried out under the direct supervision of the Government, exercised through the Ministry of Energy and Mines. The Government has delegated part of its exclusive rights in this field to JIRAMA, a company operating in the national interest.  - 42 - Annex 2.1 Page 3 of 4 e. Pricing policy Petroleum product prices were recently liberalized and are set according to international prices and the exchange rate. Electricity tariffs are based on marginal costs and are subject to automatic indexation under the terms of Decree No. 7800/92 of December 31, 1992. 2. KEY POLICY OBJECTIVE Given the strategic importance of energy, the Government's main policy objective in the sector is to satisfy domestic demand while promoting the sector's economic and management efficiency, and safeguarding the environment. This policy will be implemented by: - Opening the energy sector to private capital, with the Government taking the role of regulator and arbiter; - An efficient and adequate pricing policy; - Promotion of efficiency in energy production and utilization. 3. KEY MEDIUM-TERM MEASURES The measures the Government proposes to implement, within the context of a new economic policy oriented toward liberalization, aim to reform the legal and regulatory framework governing the electricity subsector; to reinforce and extend power infrastructjre throughout the country, facilitating at the same time the population's access to electricity; ;, modernize the public enterprise, JIRAMA; and to improve efficiency in the production and uti!hzation of energy, simultaneously protecting the environment. a. Reform of the legal and regulatory framework The Government will propose to the National Assembly an Electricity i-aw, that will govern activities in the subsector. This law will open the subsector to private acoromic agents, and will establish clear and transparent rules applicable to all enterprises operating ;r the subsector. The Government will see to it that the law is strictly observed. The law makes provision for the establishment of an independent regulatory agency that will be responsible for setting electricity tariffs in accordance with criteria also prescribed in the law. During the transitional period, the Government will continue applying its current policy on electricity prices. b. Electrification program and promotion of electricity use The electrification program will be designed in accordance with clearly defined and fuily justified socioeconomic criteria and methods. Its implementation will include: - the formulation of an electrification master plan; and, - the execution of the program set out in the master plan, applying low-cost distribution techniques. In the interest of promoting the rational use of the electricity produced, the project is to include measures to facilitate the financing of house wiring and connection costs.  - 43 - Annex 2.1 Page 4 of 4 c. JIRAMA and the new institutional arrangements JIRAMA will have to be reorganized to adapt it to the new rules that will govern the subsector, beginning with: - a redefinition of the functions and composition of its board of directors; - a financial rehabilitation and restructuring; - establishment of separate accounting systems for its power and water operations, and - a revision of JIRAMA's statute to convert it into a joint-stock company. d. Provisions affecting JIRAMA's investment program JIRAMA's investment program calls for the rehabilitation of various hydro and thermal power stations, the construction of the Namorona-Manakara-Mananjary transmission lines, the construction of phase 2 of the master plan for Antananarivo's distribution, reinforcement and extension of distribution networks in other urban centers, connection works, and loss reduction measures. JIRAMA will be provided with a legal and institutional framework enabling it to finance its investment program and to operate or to install facilities under satisfactory conditions, particularly giving it the capacity to contract loans and meet its debt service commitments. e. Energy efficiency program The following actions are proposed to implement this program: - Establishment of a national energy efficiency group; - Studies for, and drafting of, laws and regulations, and definition of supporting measures; - Creation and start-up of an operational entity in charge of energy efficiency. Its responsibilities will be: to serve as the national energy monitoring body; to develop means of rationalizing fuelwood consumption; to promote use of local energy resources, energy substitution. and rational energy use in all economic and social spheres (industrial, residential, service, transport, agricultural, etc.). f. Mitigation of environmental impact In order to reduce the ecological impacts of the utilization of energy resources, it will be necessary to expand the activities initiated under the Energy I Project, set up a pilot woodfuels supply program in the Mahajanga region, and continue with the work of the Domestic Energy Planning Unit - all in strict compliance with the environmental regulations in force. g. Resolution of arrears problems The Government will propose a schedule for the settlement of payment arrears. In addition, preventive measures are to be taken to ensure that government departments and agencies pay regularly and to avoid any reconstitution of arrears. c:\GRAY\ANNEX-2. 1\1 1/23/94\10\19\95  - 44 - MADAGASCAR Anaex 3.1 ENERGY SECTOR DEVELOPMENT PROJECT Page 1 oL 2 JIRAMA's SALES AND NUMBER OF CONSUMERS 1989-1994 A. SALES (MWh) 1989 1990 1991 1992 1993 1994 Total JIRAMA Medium Voltage 228846 238389 221 060 227691 242858 235 179 Industry& Comm. 176459 187 148 172 157 178468 191 296 188 139 Public Services 23 340 22 378 20 017 19915 22 287 21 270 Water Pumping 29 047 28 863 28 886 29 308 29 275 25 770 Low Voltage 148 979 162 570 171 983 182 273 195 306 201 761 Domestic 119506 129804 138245 145322 156787 162389 Public Lighting 5 892 6 771 6 668 7 343 6 975 6 633 Industry&Comm. 23581 25995 27070 29608 31 544 32739 Total Medium & Low Voltage 377 825 400 959 393 043 409 964 438 164 436 940 Antananarivo Interc. Network Medium Voltage 145779 154 122 142599 149067 162063 154767 Industry & Comm. 107 678 115 686 106 123 IH1 817 123 123 120 432 Public Services 16 318 16 295 14 148 14 355 16 295 15 534 Water Pumping 21 783 22 141 22 328 22 895 22 645 18 801 Low Voltage 92 035 100 880 107 184 112 776 122 371 126 132 Domestic 76 193 82910 88622 92578 101 315 105010 Public Lighting 2 952 3 605 3 841 4 330 3 881 3 874 Industry&Comm. 12890 14365 14721 15868 17 175 17248 Total Medium & Low Voltage 237 814 255 002 249 783 261 843 284 434 280 899 Other Center Medium Voltage 83 067 84 267 78 461 78 624 80 795 80 412 Industry & Comm. 68 781 71 462 66 034 66 651 68 173 67 707 Public Services 7 022 6 083 5 869 5 560 5 992 5 736 Water Pumping 7 264 6 722 6 558 6 413 6 630 6 969 Low Voltage 56 944 61 690 64 799 69 497 72 935 75 629 Domestic 43313 46894 49623 52744 55472 57381 Public Lighting 2 940 3 166 2 827 3 013 3 093 2 757 Industry & Comrn.. 10 691 11 630 12 349 13 740 14 370 15 491 Total Medium & Low 140 011 145 957 143 260 138 121 153 730 156 041 Source: JIRAMA  - 45 - MADAGASCAR Annex 3.1 ENERGY SECTOR DEVELOPMENT PROJECT Page 2 of 2 JIRAMA's SALES AND NUMBER OF CONSUMERS 1989-1994 B. NUMBER OF CONSUMERS 1989 1990 1991 1992 1993 1994 Total JIRAMA Medium Voltage 677 679 693 680 678 685 Industry & Comm. 459 472 487 482 481 494 Public Services 199 188 188 181 178 172 Water Pumping 19 19 18 17 19 19 LowVoltage 156384 159940 166127 170160 177939 187316 Domestic 150568 153921 160018 163943 171 541 180822 Public Lighting 665 682 673 685 693 693 Industry & Comm. 5 151 5 337 5 436 5 532 5 705 5 801 Total Medium & Low 157 061 160 619 166 820 170 840 178 617 188 001 Voltage Antananarivo Intercon. Network Medium Voltage 435 435 450 446 454 4h6 Industry&Comm. 311 319 335 334 343 353 Public Services 121 113 112 110 109 108 Water Pumping 3 3 3 2 2 2 Low Voltage 99 797 101 763 105 785 106 6000 10 '57 116 541 Domestic 96 337 98 225 102 227 103 089 107 011 112 943 Public Lighting 352 369 354 345 342 342 Industry & Comm. 3 108 3 169 3 204 3 1V.6 3 204 3 256 Total Medium & Low 100 232 102 198 106 235 107 04b 111 011 117 804 Voltage Other Cente Medium Voltage 242 244 243 234 224 222 Industry & Comm. 148 153 152 148 138 139 Public Services 78 75 76 71 69 66 Water Pumping 16 16 15 15 17 17 Low Voltage 56 587 58 177 60 342 63 560 67 382 70 775 Domestic 54 231 55 696 57 791 60 854 64 530 67 879 Public Lighting 313 313 319 340 351 351 Industry & Comm. 2 043 2 168 2 232 2 366 2 501 2 545 Total Medium & Low 56 829 58 421 60 585 63 794 67 606 70 S97 Voltage Source: IIRAMA  MADAGASCAR ENERGY SECTOR DEVELOPMENT PROJECT DEMAND FORECAST: 1995 -2000 (GWh) 1992 1993 1994 1995 1996 1997 1998 1999 2000 Growh Rate (%) Actual Actual Actual ANTANANARIVO Sales 261.8 284.4 280.9 282.1 294 305.3 319.1 335.7 359 4.94 Gross Generation 326.7 348.1 360.7 360 370.4 382.2 397 414.8 438.2 4.01 TOAMASINA Sales 22.3 24.2 24.4 25 25.8 27.1 28.5 30.5 32.8 5.5S Gross Generation 30.2 31.7 30.2 30.2 31.1 32.5 34.2 36 39.4 5.46 MAHAJANGA Sales 59.2 60.6 60.8 62.1 63.7 66.7 68 70.7 73 3.29 Gross Generation 69.2 69.3 69.5 70.2 71.7 73.6 75.9 78.5 80 2.65 FIANARANTSOA Sales 8.1 8.9 9.4 11.3 11.7 14.9 15.6 16.4 17.3 8.89 Gross Generation 10.9 12.1 12 12.9 13 16.5 17.7 18.8 20.7 9.92 NOSY BE Sales 9.8 10.2 8.9 9.9 10.5 11.2 11.9 12.2 12.6 4.94 GrossGeneration 11.1 11.8 10.1 10.9 11.5 12.2 12.9 13.2 13.7 4.68 ANTSIRANANA Sales 13.1 12.7 13.8 14.1 14.5 15 15.8 16.6 17.7 4.65 Gross Generation 15.2 15.2 16 16.9 16.6 17.2 18 18.9 20.1 3.53 TOLIARY Sales 8.8 9.9 9.6 10.1 10.4 10 11.3 11.6 12.5 4.36 GrossGeneration 10.6 10 11.1 11.7 12 12.4 13.9 13.5 14.9 4.95 SUBTOTAL Sales 383.1 410.9 407.8 414.6 430.6 450.2 470.2 493.7 524.9 4.83 Gross Generation 473.9 498.2 509.6 512.8 526.3 546.6 569.6 593.7 627 4.10 OTHER CENTERS Sales 26.9 28.3 29.3 29.6 31.4 31.8 33.5 35.3 37.8 5.01 Gross Generation 32.4 34.4 36.6 36.7 39.1 39.3 41.4 44 45.5 4.39 TOTAL JIRAMA o a Sales 410 439.2 437.1 444.2 462 482 503.7 529 562.7 4.84 ,_ X Gross Generation 506.3 532.6 546.2 549.5 565.4 585.9 611 637.7 672.5 4.12 o Source: JIRAMA  MADAGASCAR ENERGY SECTOR DEVELOPMENT PROJECT FIANARANTSOA INTERCONNECTED NETWORK DEMAND FORECAST 1995-2000 1993 1994 1995 1996 1997 1998 1999 2000 Growth Rate(%) FIANARANTSOA Actual Actual Sales (GWh) 8.9 9.4 11.3 11.7 14.9 15.6 16.4 17.3 S.89 Gross Generation (GWh) 12.1 12 12.9 13 16.5 17.7 18.8 20.7 9.92 Peak Demand (MW) 3.08 3.3 3.39 3.49 3.55 3.58 3.76 3.97 3.21 MANAKARA Sales (GWh) 1.51 1.52 1.6 1.73 1.81 1.93 2.16 2.24 6.96 GrossGeneration(GWh) 1.07 2.02 2.12 2.17 2.24 2.31 2.48 2.66 4.64 Peak Demand (MW) 0.44 0.48 0.51 0.52 0.53 0.55 0.59 0.63 4.32 MANANJARY Sales (GWh) 0.95 0.92 0.96 1.01 1.07 1.13 1.21 1.29 6.09 1 GmosGOeneration(GWh) 1.17 1.23 1.28 1.29 1.31 1.34 1.43 1.52 3.50 Peak Demand (MW) 0.35 0.35 0.37 0.38 0.38 0.39 0.42 0.44 3.53 1 TOTAL Sales (GWh) 11.36 11.84 13.86 14.44 17.78 18.66 19.77 20.83 8.49 Gross Generation (GWh) 14.34 15.25 16.3 16.46 20.05 21.35 22.71 24.88 8.83 PeakDemand((MW) 3.87 4.13 4.27 4.39 4.46 4.52 4.77 5.04 3.37 Source: JIRAMA e m 04 hN,  - 48 - Annex 3.3 Page 1 of I MADAGASCAR E~NERGY SEFCTOR DEVELOPMIENT PROJEFCT Electricity Tnarffs and ILong Run Mgrgwinal Costs. August 1995 Tariffs Compared with Long Run Marginal Costs % of Total LRMC Present Ratio Tariff to Consumption FMG/kWh Tariff LRMC (%) FMG/kWh Zone 1: 71.0 429 442 103 High Voltage 303 325 107.3 Medium Voltage 400 400 100 Low Voltage 473 500 105.7 Zone 2: 16.7 624 621 99.5 Medium Voltage 568 605 106.5 Low Voltage 819 677 82.7 Zone 3: 12.3 922 845 92 Medium Voltage 799 890 111.4 Low Voltage 969 828 85.4 Total JIRAMA 100.0 522 522 100.0 Source: JIRAMA. Movement towards LRMC in Zones 2 and 3 Tariff/LRMC (July 1993) (%) TarifflLRMC (August 1995) (%) Zone 2: 83.3 99.5 Medium Voltage 85.2 106.5 Low Voltage 83.7 82.7 Zone 3: 73.8 91.6 Medium Voltage 94.0 1 i 1.4 Low Voltage 67.1 35.4 Source; JIRAMA  MADAGASCAR ENERGY SECTOR DEVELOPMENT PROJECT JIRAMA'S INSTALLED GENERATING CAPACITY, 1994 1. Hydropower Plats No. of Unit Commissioning Installed Availability Dependable Firm Secondary Average plant Units Capacity date Capacity Capacity Energy Energy Energy (kW) (kW) (%) (kW) (GWh) (GWh) (GWb) 1. Hydropower plants A. Antananarivo Interconnected System Antelomits 6 1360 1930-53 8160 94 7670.4 33 16 49 1 640 1918 640 0 0 Mandraka 4 6000 1956-72 24000 94 22560 53 46 99 Manandona 2 480 1930 960 94 902.4 9.8 1.9 11.7 1 640 1960 640 94 601.6 Andekaleks 2 29000 1982 58000 94 54520 451 30 481 Subtotal 92400 86254.4 546.8 93.9 640.7 B. Toammuina Volobe 3 1520 1931-55 4560 94 4286.4 56.7 56.7 1 2200 1971 2200 94 2068 Vatomandry 1 90 1953 90 94 84.6 1.45 0.08 1.53 2 40 1953 80 50 40 Subtotal 6930 6479 58.15 0.08 58.23 C. Fimnarantson Namorona 2 2800 1980 5600 94 5264 38.5 6 44.5 Manandray 2 140 1932 280 94 263.2 2.5 0.9 3.4 1 170 193 170 94 159.8 Subtotal 6050 5687 41 6.9 47.9 D. Other Hydropower Plsnts Ankazobe 1 50 1959 50 94 47 0.42 0 0.42 Tsiazompaniry 1 50 1956 50 94 47 0.5 0 0.5 Ampefy 1 30 1987 30 94 28.2 0.28 0 0.28 Subtotal 130 122.2 1.2 0 1.2 Total Hydro 105510 98542.6 647.15 100.88 748.03 * _ _ _ _ _ _ _ _ _ _ _ _ _ _ ~~~~~~~~~~~~~~~~~~0~  MADAGASCAR ENERGY SECTOR DEVELOPMENT PROJECT JIRAMA'S INSTALLED GENERATING CAPACITY, 1994 2. Thermal Plants No of Unit Installed Dependable Plant Fuel Units Capacity Commission. Retirement Capacity Availability Capacity (kWh) Date Date (kW) (%) (kW) A. Antananarivo Interconnected System Ambohimanambola GO+F 3 6000 1972-81 2011 18000 80 14400 Antsirabe GO 2 1200 1964-67 1999 2400 80 1920 GO 1 1800 1968 2001 1800 0 0 GO+F 1 7000 1982 2007 7000 80 5600 Mandroseza GO 1 700 1949 - 700 80 560 GO 2 1160 1950-51 - 2320 80 1856 GO 1 960 1955 - 960 80 768 Subtotal 33180 25104 B. Mahajanga GO+F 1 8000 1979 2002 8000 80 6400 GO+F 1 5500 1973 - 5500 80 4400 GO+F 1 4000 1975 - 4000 80 3200 GO 3 1800 1969-70 - 5400 80 4320 GO 1 830 1960 - b30 0 0 GO 1 1400 1971 - 1400 80 1120 Ln' Subtotal 25130 19440 o C. Toamasina GO+F 2 8000 1983 2011 16000 80 12800 GO 1 1400 1973 2004 1400 80 1120 Subtotal 17400 13920 D. Toliary GO 1 500 1980 2004 500 80 400 GO 2 500 1970-79 2004 1000 80 800 GO+F 1 4500 1981 2001 4500 80 3600 GO+F 1 3300 1981 1999 3300 0 0 Subtotal 9300 4800 E.Antsiranana GO 2 1600 1971-74 2005 3200 80 2560 GO 1 500 1955 1994 500 0 0 GO 1 500 1955 1994 500 80 400 Subtotal 4200 2960 E. Nosy Be GO 1 500 1980 2004 500 80 400 GO 3 500 1958-92 1994-2007 !500 80 1200 GO I 500 1959 1994 500 0 0 GO I 150 1953 1992 150 0 0