Ukraine - Hydropower Rehabilitation and System Control Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No: 24947 IMPLEMENTATION COMPLETION REPORT (CPL-38650; TF-20272) ONA LOAN IN THE AMOUNT OF US$ 114 MILLION TO UKRAINE FOR A HYDROPOWER REHABILITATION AND SYSTEM CONTROL PROJECT 12/24/2002 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (Exchange Rate Effective as of November 1, 2002) Currency Unit = 1 Hrivnya = 100 kopeks UAH 1 = US$ 0.19 US$ 1 = 5.33 UAH FISCAL YEAR January 1 December 31 ABBREVIATIONS AND ACRONYMS CAS Country Assistance Strategy CFP Coal-Fired Plant CHF Swiss Franc CIDA Canadian Agency for International Development DHE Dniprohydroenergo EBRD European Bank for Reconstruction and Development EIRR Economic Internal Rate of Return EU European Union FSU Former Soviet Union GDP Gross Domestic Product GEF Global Environment Facility GoU Government of Ukraine GWh Gigawatt hour HPP Hydropower Plant IAS Intemational Accounting Standards ICR Implementation Completion Report IDC Interest During Construction kWh Kilowatt hour MW Megawatt (I0^6 W) MUV Manufacturing Unit Value NDC National Dispatch Center NERC National Electricity Regulatory Commission NPP Nuclear Power Plant NPV Net Present Value O&M Operations and Maintenance PPI Producer Price Index PSP Pump Storage Plant SAR Staff Appraisal Report SCADA Supervisory Control and Data System TA Technical Assistance TWh Terawatt hour (1012 Wh) UAH Ukrainian Hrivnya (1 Hrivnya = 100 kopeks) UE Ukrenergo UPS Ukrainian Power System VAT Value-Added Tax Vice President: Johannes F. Linn Country Manager/Director: Luca Barbone Sector Manager/Director: Hossein Razavi Task Team Leader/Task Manager: Nikolay Nikolov  UKRAINE HYDROPOWER REHAB CONTENTS Page No. 1. Project Data 1 2. Principal Performance Ratings 1 3. Assessment of Development Objective and Design, and of Quality at Entry 2 4. Achievement of Objective and Outputs 9 5. Major Factors Affecting Implementation and Outcome 16 6. Sustainability 19 7. Bank and Borrower Performance 20 8. Lessons Learned 24 9. Partner Comments 26 10. Additional Information 40 Annex 1. Key Performance Indicators/Log Frame Matrix 56 Annex 2. Project Costs and Financing 58 Annex 3. Economic Costs and Benefits 60 Annex 4. Bank Inputs 111 Annex 5. Ratings for Achievement of Objectives/Outputs of Components 113 Annex 6. Ratings of Bank and Borrower Performance 114 Annex 7. List of Supporting Documents 115 Annex 8. Summaries of project completion reports from the DHE and UE 116 Map IBRD 32185   Project ID: P038820 Project Name: HYDROPOWER REHAB AND SYSTEM CONTROL Team Leader: Nikolay Nikolov TL Unit: ECSIE ICR Type: Core ICR Report Date: December 24, 2002 1. Project Data Name: HYDROPOWER REHAB AND SYSTEM L/C/TF Nzmber: CPL-38650; TF-20272 CONTROL Country/Department: UKRAINE Region. Europe and Central Asia Region Sector/subsector: Power (100%) KEY DATES Original Revised/Actual PCD. 06/24/1994 Effective: 12/27/1995 05/24/1996 Appraisal: 09/14/1994 MTR: 09/30/1997 11/11/1997 Approval: 04/11/1995 Closing: 12/31/2000 06/30/2002 Borrower/Inmplementing Agency: GOVT OF UKRAINE/DNIPROHYDROENERGO & NATL. DISPATCH CTR. Other Partners: Governments of Canada, Norway, Switzerland STAFF Current At Appraisal Vice President: Johanes Linn Wilfried Thalwitz Country Manager: Luca Barbone Basil Kavalsky Sector Manager: Hossein Razavi Dominique Lallement Team Leader at ICR Nikolay Nikolov Laszlo Lovei ICR Primary Author: Nikolay Nikolov with contributions from Dennis Creamer - consultant (economic analysis); Simos Kamchis - consultant (financial analysis); Yun Miroshnichenko; Yolanda L. Gedse; Maria Koreniako 2. Principal Performance Ratings (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible) Outcome: S Sustarnabilety. L Institutional Development Impact: M Bank Performance: S Borrower Performance: S QAG (if available) ICR Quality at Entry: Project at Risk at Any Time: Yes  3. Assessment of Development Objective and Design, and of Quality at Entry 3.1 Original Objective: Background The Ukrainian Power System (UPS) was developed and operated as a part of the integrated power system of the FSU. The efficient performance of the system was severely affected by (i) a vertical state-owned monopoly structure; (ii) high energy intensity; (iii) limited domestic energy endowments, and (iv) a deep economic and institutional crisis which followed the disintegration of the FSU in 1991. The separation of the Ukrainian Power System from the Russian power system revealed serious structural and functional weaknesses which affected the overall system operation, security, reliability and quality of power supply. These weaknesses concemed the insufficient amount of load-following generation capacity, capable of maintaining flexible production schedule and providing frequency regulation, i.e., the lack of plants which operate in the mid and peak sections of the load duration curve. This critical function was provided by the hydropower plants on the Dnieper and Dniester rivers. Most of the Ukraine's thermal plants were base load, especially the coal-fired ones. Some larger gas units were more flexible, but were suffering from difficulties in fuel supply as the Ukrainian power sector had difficulties paying for gas imports. To address these issues, the GoU adopted a two-pronged strategy of institutional reforms and investments in priority areas. The development of the Government's energy strategy was supported by the Bank since 1992 through technical assistance and an Energy Sector Review (Report No. 11646-UA). During this process, the Bank reached an agreement with the Government and other international donors to enhance support to power generation and gas transmission and distribution as sectors in which the Bank could make a significant difference in Ukraine. In this context, the Government, assisted by the Bank and other donors, started the preparation of the Hydropower Rehabilitation and System Control Project. A comprehensive feasibility study outlined the overall rehabilitation needs of the Dnieper cascade. In view of the large scope of identified rehabilitation works, the project was designed to include as a first phase a portion of the needed overall hydropower plants rehabilitation. The remaining rehabilitation works at the Dnieper cascade were to be pursued in the context of the outcome of the first rehabilitation phase, the further advancement of the Governments priorities in the power sector and the continuation of a project enabling framework. The project aimed at addressing some of the important priorities in the Ukrainian power system: rehabilitation of hydropower plants meant maintaining the most flexible generation plants at their maximum productive levels. The project also provided a moderate leverage for implementation of broader sector reforms, especially in its preparatory stage. The early stage of the project's implementation was affected by a severe economic and financial crisis which caused a precipitous decline of electricity payments. Nevertheless, through sustained efforts of the Bank, the GoU, the project beneficiaries Dniprohydroenergo and Ukrenergo, and with support from the governments of Canada, Norway and Switzerland, the project was successfully implemented, within an unbundled power sector with much improved financial discipline, advancing privatization of electricity companies and a developed regulatory framework. Obiectives The project had the following objectives: (i) improve the efficiency, reliability, safety and environmental performance of hydropower plants - this objective included enhancement of the dam safety monitoring system, improvement of the water quality of the Dnieper River through reduction of oil leakages into the - 2-  river to minimal level due to installation of new ecologically safe turbines, and improvement of the management of the multi-purpose Dnieper reservoirs, (ii) increase hydropower generation capacity, which implied increasing peak capacity and power generation in peak time zone; (iii) improve the quality of electricity supply by upgrading load and frequency control; and (iv) reduce fuel costs by facilitating the economic dispatch of generating units. The objectives of the project were clear and important for sector development. They were responsive to the priorities of the least cost investment plan for the power sector which included the rehabilitation of the hydropower plants. The project objectives were also supportive of the Bank's overall strategy to facilitate Ukraine's effort to carry out structural reforms and to promote efficiency investments in high priority sectors such as energy in order to complete the transition to a market economy and to accelerate economic growth. The project was designed to respond to the needs of the power sector in a critical period of Ukraine's history, shortly after the country gained independence and suffered a deep economic crisis at the same time. The project was quite demanding on the two implementing agencies (Dniprohydroenergo and National Dispatch Center/Ukrenergo) because of its broad institutional, geographical and technical scope, the related complexity and risks, and the beneficiaries' limited experience in dealing with projects financed by international institutions. In this context, the good technical expertise of the implementing agencies was considered an important counterbalancing factor. Complex institutional and organizational aspects The rehabilitation of the hydropower plants (one of the two main investment components of the project), carried out by Dniprohydroenergo, required coordination of the work of eight large power plants on the reservoirs of the Dnieper cascade with a total capacity of 3,799 MW, 18 design institutes, more than 100 equipment manufacturers, over 30 installation and commissioning companies, and about 100 other contractors. The upgrade of the system control and dispatch (the other investment component of the project) was carried out by an entity - National Dispatch Center (NDC) - which, during the project implementation period, was subject to more institutional changes than any other entity in the electricity sector. NDC has endured a series of major reorganizations, starting up just as a dispatch center, then being a part of the company providing transmission, dispatch and market operation services, and ending up as a part of the Ukraine's unified transmission and dispatch company (Ukrenergo). Broad geographical scope The dams of the Dnieper cascade are some of the world's longest, located in six of the most industrialized and heavily populated regions of Ukraine along the basin of the third largest river in Europe. The upgrade of the system control and dispatch encompassed works throughout the country. Complex technical aspects. Rehabilitation on such a large scale was not carried out before in Ulraine. In view of the importance of the Dnieper cascade for the power system load and frequency regulation, the turbines and generators had to be rehabilitated without discontinuing the operation of the remaining equipment at the power plants. Maintaining normal operational parameters of the power plants even during rehabilitation of individual generation units was a pioneering approach in Ukraine. - 3-  Risks Low cash collections in the electricity sector represented huge financial risk to the project. The need to rehabilitate turbines and generators while continuing to generate posed difficult scheduling requirements and continuously risked delaying the project. The requirement to operate as many units as possible during the spring flood seasons put significant pressure on the rehabilitation works as well. 3.2 Revised Objective: The objectives of the project were not revised. 3.3 Original Components. The achievement of the project objectives was ensured by the adequate design of the original project components, listed below: (i) Rehabilitation of hydropower plants on the Dnieper cascade; (ii) Installation of a dam safety monitoring system at the main reservoirs on the Dnieper river; (iii) Upgrade of communications, dispatch, and system control; (iv) Technical assistance. The first two components, implemented by Dniprohydroenergo, supported the first two project objectives of improving the efficiency, reliability, safety and environmental performance of hydropower plants; and increasing hydropower generation capacity. The third component, implemented by NDC/Ukrenergo, supported the other two project objectives (improving the quality of electricity supply by upgrading load and frequency control; and reducing fuel costs by facilitating economic dispatch of generating units). Although demanding, the project design capitalized on the beneficiaries' good technical and engineering capabilities. Key aspects of the project components are presented below: (a) Rehabilitation of hydropower plants on the Dnieper cascade. Cost: US$ 84.2 million. This component included rehabilitation of the eight HPPs on the Dnieper River. (See attached map). The rehabilitation of the system control and monitoring at HPPs on the Dnieper cascade was also included. The component addressed critical performance aspects of aging HPPs such as derating of the units, low efficiency and availability. The oldest HPP, Dnieper-l (Dniproges-l) was built in 1932 and reconstructed in 1947, five of the plants were more than 30 years old and the other two were more than 20 years old. -4-  (b) Installation of a dam safety monitoring system at the main reservoirs of the Dnieper River (Kiev, Kanev, Kremenchug, Dniprodzerzhinsk, Dnieper, Kakhovka). Cost: US$ 2.5 million. This component aimed at rehabilitating the existing dam monitoring system in order to improve the safety of about 100 km of dams and dykes for the multipurpose reservoirs on the Dnieper river. The reservoir dams have low heads and long embankmnents with dykes protecting the surrounding land from floods. (c) Upgrade of communication, dispatch, and system control. Cost: US$ 55.2 million. This component included an upgrade of the following key elements of the UPS: (i) communications systems; (ii) frequency regulation, dispatch and control systems; (iii) relay protection devices of the main transmission network. The rehabilitation of the system control and monitoring at the Dniester HPP was also included. This component aimed at overcoming the deficiencies across the UPS that compromised the reliability, quality and security of electricity supply. The poor frequency regulation represented an increased risk for operation of the nuclear power plants, since their protection system would trip them off if the system frequency were to go beyond certain range. (d) Technical assistance. Cost: US$ 5.0 million. Building on a lesson learned from an earlier World Bank - financed Institution Building Project in Ukraine (Loan 3614-UA), a technical assistance (TA) component was included in the project to compensate for the beneficiaries' inexperience in implementing projects with donor financing and international procurement. This was to be done through supporting technical services for preliminary engineering design, preparation of technical specifications and tender documents, conducting international tendering, contract negotiations and administration, and helping in project monitoring and reporting. Training by equipment suppliers was envisaged in the tender documents. Training in management and procurement was also provided by Bank staff. In addition, in view of the importance of the multi-purpose use of the reservoirs on the Dnieper river, the technical assistance component included a review of the procedures in managing the river basin's reservoirs. 3.4 Revised Components: The number and the type of the components were not revised, but the schedules and physical quantities of some of the components were modified. The main revisions concemed the number of turbines and generators subject to rehabilitation which was financed from Dniprohydroenergo's revenues rather than from the IBRD loan. - 5-  The schedule for the installation of dam safety monitoring system experienced major delays as a result of the desire by DHE to have this system delivered by a local contractor and financed from internal funds. However, it turned out that the local contractor at the end was not able to deliver the system with satisfactory technical performance. Consequently, DHE then decided to procure the system internationally and finance it from the IBRD loan, but much time had been lost in the meantime. As a result, dam safety monitoring equipment was installed only at the most critical and longest Kiev dam of the cascade. The length of the fiber optic conmmunications lines was slightly increased together with the scope of equipment for hydro generators to better respond to the evolving system needs. The scope of system control and monitoring equipment was significantly increased and installed on two additional plants to fully accommodate the needs of the entire Dnieper cascade. Such equipment was additionally installed at Kremenchug and Dneprodzerzhinsk HPPs in view of their importance for regulating operations of the plants in the cascade. A component for installing thermal power plants (TPPs) governors (technical devices which regulate the output of the TPPs) was replaced by a relevant study to respond to the reduced incentives in the power market for installing such governors. The scope and timing of the TA were adjusted to the overall changes in scope and timing of the project works. Turbine and Generator Rehabilitation (a) The original project scope foresaw the rehabilitation of 23 turbines and 37 generators. Upon beginning of the project works, larger than expected wear and tear of the generating units called for a greater level of local works per each unit. Consequently, the number of turbines to be rehabilitated was reduced from 23 to 22 in the early stage of the project (b) In addition, the deterioration of electricity payments continued from 1998 to early 2000 and affected local project financing. It was therefore agreed to further scale down the turbine/generator rehabilitation works, which critically depended on local funds. Thus, the number of turbines and generators to be rehabilitated was reduced from 22 turbines and 37 generators to 13 and 15 respectively. At the end of the project, DHE had managed to exceed this target, rehabilitating 16 pairs of turbines and generators. Dam Safety Monitoring System (c) In the beginning of the project, locally financed national manufacturers could not ensure the required specifications of the dam monitoring equipment. It was then decided to launch an international competitive tender for a pilot contract for supply and installation of such equipment for only the Kiev HPP. The experience gained from this pilot contract was supposed to be used in procuring monitoring equipment for the other dams of the cascade. The unexpected replacement of the local supplier with an intemational one delayed the implementation schedule of the dam safety component. Consequently, the scope of installing monitoring equipment was reduced from 100 km along all HPPs to 50 km at Kiev HPP, which is most critically located at the beginning of the cascade. The experience from preparing tender documents for Kiev HPP was used for the design and technical specifications of the dam safety upgrade at the remaining plants. Control and Monitoring System (d) During the installation of the system control and monitoring equipment at Dnieper HPPs, additional possibilities were identified for a better adaptation of the equipment to the needs of the cascade. Therefore, the original scope of equipment was significantly expanded with modified software, electrical protection -6-  systems, metering equipment and spare parts, and included two more plants -- Kremenchug and Dneprodzerzhinsk - in view of the importance of their regulatory capacity for the entire cascade. At the same time, system controls at Kiev PSP and Dnieper HPP-2 were rehabilitated partially in response to the specific needs at these plants. (e) One hundred and sixty km of fiber optic communications line were laid in addition to the original scope of 1,000 km in order to connect the Central and Western communications networks of the UPS. Auxiliary Equipment (f) The quantity of the equipment for hydro generators was also slightly increased. (g) The Ukrenergo's component for upgrade of frequency regulation, dispatch and system control included originally a sub-component for upgrading the governors of the generation units of the thermal power plants. This activity was designed to improve the capability of the power system to regulate frequency. However, this sub-component was canceled due to (i) lack of financial incentives for the thermal plants to participate in load frequency regulation, since payments for this service were not recognized by the electricity market; (ii) the requirement for the plants to finance local costs associated with insta1ling new governors, while the plants lacked such funds due to non-payments in the electricity market; (iii) the status of the plants as independent legal entities, which hampered the management of this project sub-component outside the structure of the implementing agency Ukrenergo; (iv) the unique water technology of the governors, not supported by mranufacturers outside the former Soviet Union; (v) physical ware-and-tear of the thermal generators and the auxiliary TPP equipment together with outdated boiler automation called for much larger investments than expected. (h) The Bank proposed instead, that a study on the automatic frequency regulation by the thermal power plants be carried out in order to partially compensate for the cancellation of the sub-component for installing governors at these plants. The findings were used by the Ministry of Fuel and Energy as a basis for preparing official guidelines for providing economic incentives to the thermal power plants involved in automatic frequency regulation. Audits and Technical Assistance (i) The scope and timing of the technical assistance were modified to follow the changes in the actual scope and timing of the project work. In addition, in view of the insufficient local funds, the project beneficiaries, with the Bank's agreement, chose to use more than half of the technical assistance funds from the Bank to cover the cost of. annual audits under the project. Technical assistance from the Canadian and Swiss governments compensated for the reduction of the Bank's TA funds as a result of the audit funding arrangements. 3.5 Quality at Entry: Quality at entry is judged to be satisfactory because the project objectives were consistent with (i) the government priorities; (ii) the CAS, and (iii) the Bank's safeguard policies. In addition, the project components were designed to enable the achievement of the project objectives. The project was consistent with the Government's strategy of rationalizing energy use through rehabilitating hydro and thermal power plants, increasing reliance on renewable energy, and improving safety of the power system within the context of overall sector restructuring. -7-  Bank sector work was used in the project preparation. In addition, the project was also responsive to the Bank's strategy to promote efficiency improvements and adapt the energy utilities to the requirements of a market economy. The project objectives were clearly outlined, and although demanding, were achievable in the context of the counterparts' implementation capacity and commnitment for results. The project was designed to respond to the priorities of the power sector and the funding arrangements were commensurate with the project scope and needs. Project conditionality focused on ensuring proper structure and operations of the implementing agencies in terms of consolidation of the Dnieper HPPs into a single joint stock company, transfer of the ownership of the regional dispatch centers to the National Dispatch Center, establishment of Project Implementation Units, signing adequate agreements for electricity sales and contracts with strategic domestic turbine and generator manufacturers, observance of proper financial reporting and auditing standards. The Bank ensured that the Ministry of Energy and the implementing agencies were actively involved in the relevant sector work and feasibility studies. The technical, financial, economic and environmental aspects of the project were thoroughly assessed. Sensitivity of project sustainability to cost overruns, decline of economic value of electricity and fuel savings was assessed as well. Readiness for implementation was also analyzed in detail: the implementation capacity of the project beneficiaries was reviewed along with the manufacturing potential of the local suppliers, critical to the project. On the basis of this analysis, technical assistance was envisaged to provide support in the areas of engineering, procurement and project management. The engineering design was based on detailed feasibility studies. The project performance indicators were designed to ensure adequate monitoring of progress towards achieving project objectives in terms of increasing generating capacity, improving efficiency and frequency, reducing oil leakages and enhancing dam safety. Major risks related to pricing and non-payments were addressed through relevant loan conditions, political risk of reversal of reforms was also outlined. In compliance with the Bank's safeguard policies, an environmental analysis was carried out and no implications for intemational waterways were identified. Although the former Operational Manual Statement (OMS) 3.80 on dam safety safeguards was applicable only to the construction of new dams, and not to the already existing dams included in the project at the time of appraisal, relevant safeguard measures, required under the current more rigorous safeguard policies, were actually designed and implemented in an effort to bring more dam safety benefits to the project company Dniprohydroenergo. Most of the assumptions made during project preparation were reasonable with the notable exception of those related to the timely improvement of the payment collections in the sector and the subsequent improvement of the financial situation of the project implementing agencies. Non-payments persisted until early 2000 when the govemment initiated efficient measures to resolve this issue. These measures coincided with the actual beginning of the economic recovery, which was forecasted at appraisal to begin much earlier in 1997. In addition, the electricity demand forecast and the related least-cost development program were more optimistic at appraisal than their revaluation towards the project's end in 2001. Nevertheless, the final outcome was overall satisfactory. -8-  4. Achievement of Objective and Outputs 4.1 Outcome/achievement of objective* Summary assessment of outcome The overall outcome of the project is rated as satisfactory. As noted in the following sections, all envisioned objectives were achieved, although with delays, and on occasion, on a reduced scale. The project objectives are in line with the current CAS objectives to attain job-creating sustainable economic growth, solve enviromnental issues in the energy sector and move Ukraine closer to the European Union's standards, fostering environmentally sustainable development. The development impact has been also satisfactory since the two project components brought desired quality, efficiency, safety and environmental benefits to the entire power system, although within the smaller scope of turbine/generator rehabilitation works at commensurate lower total costs. The assessment was facilitated by the performance indicators in the Staff Appraisal Report (SAR). Achievement of objectives Achievement of objective (a) improve the efficiency, safety, and environmental performance of the hydropower plants: Efficiency of the hydropower plants: The nominal target efficiency parameters have been achieved for all rehabilitated units at the hydropower plants. (See Annex 1) Safety of the hydropower plants: The installation of a dam safety monitoring system at the Kiev reservoir dam, situated upstream at the head of the Dnieper cascade, has improved the safety and reliability of the Kiev reservoir and the downstream reservoirs, all situated along very densely populated and industrialized areas. In addition, the installation of electrical protection devices and microprocessor-based control systems for turbine/generators units and entire plants has contributed to improved the safety of equipment maintenance and operation. Environmental performance of the hydropower plants: Environmental improvements have been also enhanced by upgrading the dam safety instrumentation at Kiev HPP. Oil leaks into the Dnieper River have been eliminated by installing new environmentally safe turbines. Environmental risks have been further reduced by improving the water management of the Dnieper reservoirs as a result of the installation of modem control and monitoring system equipment and the follow up on the TA recommnendations of a water management study. Achievement of objective (b) increase of hydropower generation capacity: Additional total capacity of 88.1MW (2% increase of total capacity of the Dnieper cascade) was obtained within the reduced project scope vs. 130 MW (3% increase of total capacity of Dnieper cascade) expected under the initial full project scope. The lower capacity increase at project completion was commensurate with the overall reduction of the scope of rehabilitation works under the project. -9-  Achievement of objective (c) improving the quality of electricity supply by upgrading load and frequency control: Frequency, a key criterion of the quality of electricity supply, has improved. Deviations of maximum and minimum frequency from the 50 Hz target have been reduced to acceptable ranges. Also, the monthly maximum accumulated time error has been reduced from minutes to seconds. The number and the amount (MW) of load curtailments per year have been also reduced. These results have been achieved from the joint effect of (i) the parallel operations of the Ukrainian power system with the power system of Russia since August 20, 2001, where Russia regulates frequency based on exchange of power flows with Ukraine; (ii) relatively lower demand and consequently lower system load which allows easier maintenance of adequate frequency; (iii) the further upgrade of load and frequency regulation under the project which is expected to bring about a substantial improvement of the scheduled inter-state exchange of active power flows. Achievement of objective (d) reduction of fuel costs by facilitating the economic dispatch of generating units: The project sub-component of upgrading the regulation and management systems of the TPPs was cancelled mainly because of the lack of a friamework for pricing ancillary system services such as frequency regulation. At project completion, this has contributed to somewhat lower estimates of 0.4% savings of fuel consumption in the UPS, (except nuclear fuel), compared with the original estimates of 0.9% of such savings as a result of the upgrade of the communications, dispatch and system control. 4.2 Outputs by components: (a) Rehabilitation of hydropower plants on the Dnieper cascade; Cost: US$ 84.2 million at appraisal, US$ 74.3 million at completion. The rehabilitation of the hydropower plants on the Dnieper cascade was satisfactory although in reduced scope. Out of 23 turbines and 37 generators, originally planned for rehabilitation, a total of 16 turbines and generators were rehabilitated at project completion. Hydraulic auxiliary and electric equipment was replaced or rehabilitated at all eight HPPs on the Dnieper cascade. The rehabilitation works resulted in increased efficiency, capacity, reliability, and safety, improved environmental performance and extended life of the power plants equipment. Oil leaks into the Dnieper River were eliminated from the rehabilitated turbines. In addition, the installation of a new control monitoring and protection system on 5 of the HPPs (Kiev, Kremenchug, Dniprodzerzhinsk Dnieper-l and Kahovka) has optimized the HPPs' output and has further enhanced their availability and lifetime due to the system's pre-waming capability in case of abnornal operation parameters. The ongoing integration of the control, monitoring and protection systems -of the hydropower plants with the SCADA system of the National Dispatch Center will further optimize the performance of the hydropower plants and will also enhance their load and frequency regulating role in response to the needs of the entire power system. Improved frequency regulation also allows to operate the nuclear power plants (NPP) at the right frequency and thus enhances their safety. - 10-  (b) Installation of the dam safety monitoring system; Cost: US$ 2.5 million at appraisal, US$ 1.9 milhon at completion. The installation of a computer-aided safety monitoring system at Kiev dam has been rated satisfactory in view of the complexity and umqueness of the component This has been the first such type of equipment installed in Ukraine and the other CIS countries. The uniqueness of this pilot project has been further enhanced by the fact that the Kiev 50 km earth dyke is one of the longest in the world, critically situated upstream at the head of the Dnieper cascade. The upgrade of the control instruments, the automation of information processing, and the reading of the safety meters all have contributed to improving the safety in the Kiev dam flood zone along with the safety of the downstream HPPs which are all located in densely populated and industrialized areas. As a part of the dam safety works and in compliance with the Bank's new safeguards on dams, (i) a local institute has assessed the discharge capacity of the entire Dnieper cascade; (ii) flood assessment information is regularly conveyed to DHE; (iii) inspections of the sediments in water storages in front of the HPPs have been carried out; (iv) drainage devices have been rehabilitated where needed; (v) the emergency action plans of the HPPs have been updated; (vi) new guidelines have been developed for the exploitation of the reservoirs of the Dnieper cascade; and (vii) the preparation of project designs for installing dam safety equipment on the remaining HPPs on the Dnieper River is underway. (c) Upgrade of communication, dispatch, and system control; Cost: US$55.2 million at appraisal, US$46.9 million at completion. These activities were also rated satisfactory since the initially envisaged equipment was installed. The introduction of automated load and frequency control and the enhanced protection of the high voltage (HV) transmission network will improve the quality of electricity supply which will then enhance the system's capacity to integrate with the neighboring power systems. System efficiency will be also enhanced by the reduced fuel consumption from improved dispatch. The installation of an uninterrupted power supply system, including batteries, charging appliances and diesel generators, enhanced the operations of the power system by counteracting the impact of the emergency outages. (i) The upgrade of the communications system of the UPS was successfully achieved by laying 1,160 km of new fiber optic comrnmunications lines and installing digital automatic telephone stations. The introduction of a modem digital communications system on the basis of fiber optic cable increased considerably the speed and volume of the transmitted information among the subdivisions of the unified power system of Ukraine. The installation of digital automatic telephone stations at the regional dispatch centers increased the reliability of the power dispatch communications. (ii) The upgrade of the frequency regulation, dispatch and system control has been implemented satisfactorily by installing: * an integrated package for automated load and frequency control which replaced outdated inefficient manual control functions; * a protection, management and control system at the Dniester HPP (702 MW) which enhanced maneuverability and life of the plant equipment and integrated its regulating ability into the load and frequency regulation of the entire power system of Ukraine; and -1 1-  * relay protection devices on the high voltage transmission lines of the UPS main network, including transmission lines connected with the nuclear power plants. These devices further enhanced the reliability of the system, including the reliability of operations of the nuclear power plants (NPPs). (d) Technical assistance. Cost: US$5 million at appraisal, US$7.0 million at completion. Although this component has been completed in an overall satisfactory manner, the level of success of separate TA components varied. The Swiss consulting company Stucky S.A. assisted in a satisfactory manner in the procurement of project switchgear equipment financed by the Swiss government with a grant to the Government of Ukraine, on-lent to DHE. (see note I at the end of this section) The Norwegian Government financed a study on improved water management and hydropower generation. The study's recomnmendations were taken into account for the development of a new version of the Dnieper cascade water reservoir exploitation rules. A study on the automatic frequency regulation of the thennal power plants, financed by local funds, was completed as well. The Ministry of Fuel and Energy of Ukraine used the findings of the study as a basis to prepare guidelines for providing economic incentives to the thermal power plants involved in automatic frequency regulation. The local research institute Ukrhydroproekt together with DHE participated in developing the dam safety concept and preparing technical specifications for the procurement of project equipment. The Canadian Agency for International Development (CIDA) financed technical assistance services for the first 3 years of the implementation of the project. The technical assistance services were provided by Hydro Quebec Intemational (HQ]) in the areas of engineering, procurement and project management. These services initially suffered some difficulties related to the extremely limited number of experienced specialists available to work in a Russian and Ukrainian languages environment. However, after solving progressively this major recruitment problem, the situation notably improved after mid-1996 when more experienced consultants joined the project and at the same time a better interaction was reached with the beneficiaries. The situation was completely normalized in 1998 when the beneficiaries hired HQI with funds from the World Bank loan to provide further TA services. DHE's needs for project management assistance declined during the second half of the project period as a result of the reduction of the physical scope of some project components. In this regard, and in view of the improved local financing, DHE opted for hiring local consultants with its own funds until the project's completion. Audits by PriceWaterhouse and KPMG were also financed with technical assistance funds. The project design was appropriate for achieving the project's objectives. a/ technical aspects: adequate rehabilitation works and modem equipment were included in the project scope to ensure the envisaged improvements in the power system. Project sites and specific turbine/generator units were selected for rehabilitation in view of ensuring maximum benefits from the - 12 -  project works. Technical assistance was expected to compensate for the implementing agencies' lack of previous experience with Bank-financed projects. b/ country needs and Bankpriorities: the project provided critical support to the power sector in line with the government's priorities and the Bank's CAS. cl sustainability: the project was designed under the enabling famework for sector reforms, envisaged by the govemment. The benefits from improving the financial discipline in the power sector under the reform process, although delayed, trickled down to the project level and restored the financial stability of the project implementing agencies beginning in 2000, which consequently ensured successful project completion. dl project monitoring and reporting: the project performance criteria and the loan covenants were designed to enable adequate measurement and reporting of project progress and to provide a leverage for corrective actions, when needed. The performance indicators for minimizing frequency deviations, increasing operating capacity and turbine/generator efficiency were reasonably quantified to enable the assessment of project achievements during supervision and at completion. The logical framework tool did not exist at project appraisal. Therefore project outcomes and outputs were outlined at completion on the basis of analysis of the actual project results. The loan covenants related to auditing requirements, debt ratio, and self financing ratio facilitated the monitoring of compliance with the Bank's fiduciary responsibilities and financial requirements for the project's agencies. The loan covenants related to compliance with the power purchase agreement between DHE and NDC, and the contracts between NDC and its downstream clients were deleted from the respective project agreements with the Bank. Instead, during each following supervision mission, requirements for specific allocations of funds from the newly established Energomarket (the wholesale electricity market) to DHE and NDC were agreed and closely monitored thereafter. This change took place as a result of introducing a new mechanism of allocating payments for electricity transactions directly through Energomarket to all participants in the power sector, including DHE and NDC, which made irrelevant the earlier bilateral payment arrangements between DHE and NDC, and NDC and its clients. Note 1: Under the conditions of a Grant Agreement between the Governments of Switzerland and Ukraine, the Swiss Government extended a CHF 13.7 rnillion grant to Ukraine. The Grant Agreement also stipulated that the Ministry of Finance of Ukraine should then extend the Swiss grant proceeds as a loan to DHE. DHE has already used this loan to finance the supply and installation of Swiss switchgear equipment under the project. DHE was supposed to repay the loan with interest to the Mimstry of Finance. The Mmistry of Finance was expected then to use DIE's loan repayments for setting up fiunds to support environmentally friendly initiatives in the energy sector. However, DHE has repaid so far only a mmor portion of the loan due to earlier difficulties in payment collections. On November 14, 2002, the parties agreed on revised loan repayment options. 4.3 Net Present Value/Economic rate of return: Economic returns upon project completion were sustainable, although lower than the ones at appraisal due in large part to the lower benefits as a result of reducing the project scope. The SAR showed an estimated economic intemal rate of return (EIRR) for the total project at 18.1%. The re-estimated EIRR for the total project at completion was 13.6%. A separate EIRR was estimated for the Hydropower Plants Rehabilitation component: 17% at appraisal and 13% at completion, and for the System Control and Communications Upgrade component: 22.7% at appraisal and 17.7% at completion. - 13 -  Hydropower Plants Rehabilitation Component The lower EIRR of the hydropower plants rehabilitation component at completion was mainly due to lower gains in capacity and energy as a result of the reduction of the project scope, the revised smaller impact of improved reliability and availability of the HPPs. The reduction of the number of the turbines and generators, which were rehabilitated under the project, resulted in lower net benefits from additional energy output under the project. The original scope envisaged the upgrade of 23 turbines and generators which represented some 33% of the total energy capability of the hydropower plants. Only 16 turbines and generators, were actually rehabilitated representing about 18% of the total energy capability. Had the original number of turbines and generators been rehabilitated, EIRR would have increased by about 1%. In addition, at completion, gains in capacity and energy from improved reliability and availability of the HPPs were lower than expected - at about 0.15 % per year. Had the larger appraisal estimate of 0.4% annual gains been materialized, EIRR would have increased by about 2%. System Control and Communications component The cancellation of the component for govemors of the thermal power plants led to reducing the benefit of fuel savings from improved frequency regulation to 0.4% of the thermal fuel cost of the UPS, compared with the estimated 0.9% of such fuel saving at appraisal. This reduction in fuel savings was the main reason for obtaining a lower EIRR at completion for the System Control and Communications Upgrade component, despite the effect of new benefits from fiber-optic-based communication services which were not identified at appraisal. Environmental benefits from reducing emissions from fossil fuels as a result of additional hydropower generation under the project were estimated at completion. This has led to higher EIRRs at completion as follows: Total project: 17.7%, Hydropower Plants Rehabilitation component: 16.2%, and System Control and Communications Upgrade component: 23.7%. The original and completion EIRR estimates were based on total project costs. The appraisal and completion analysis included the cost of the technical assistance and dam safety components without quantifying any relevant benefits. 4.4 Financial rate of rehirn: The financial intemal rate of return (FIRR) for DHE's hydropower plants rehabilitation component is currently estimated at 9.9% (in real terms) which is lower than the appraisal estimate of 13%. Nevertheless, the FIRR at completion still compares favorably with DHE's cost of capital, 8.5%, reflecting the cost of borrowing under the project (1.5% on-lending interest rate, plus 7.0% estimated World Bank rate). As in the case of the EIRR, the lower FIRR of the hydropower plants rehabilitation component at completion was also due to lower gains in capacity and energy which altogether resulted in a lower additional average annual electricity output at completion - 270 GWh/yr, compared with the expected 567 GWh/yr appraisal. - 14-  Key assumptions for the analysis at appraisal and completion do not differ. The same cost-recovery principle in tariff formation and the taxation rules relevant to enterprise income were followed at appraisal and completion. Savings from operation and maintenance costs did not differ significantly. The FIRR is sensitive to changes in project cost, level of electricity output, and rate of inflation. These changes can be absorbed under the present tariff mechanism based on cost recovery. Adding US$ 8.8 million equivalent of the Swiss Grant to the project cost (See footnote 3 in Section 4.2), which is 10% of total DHE's project cost) would require at least an additional average tariff increase of 0.4% per year during the project life in order to ensure the project's financial sustainability. The estimated level of project electricity output can be reduced by no more than 1.7% within financial sustainability limits. Any larger reductions will have to be compensated by commensurate tariff increases. Any changes in rate of inflation can be also absorbed by corresponding tariff increases. No FIRR was calculated for NDC (Ukrenergo) at appraisal since the quantified benefits from fuel savings as a result of more efficient economic dispatch did not accrue to the company, but to the entire power sector. Nevertheless, at completion, the financial viability of Ukrenergo was assessed on the basis of the corresponding framework for the company's operations, reflected in the assumptions on tariffs for UE's services, and the electricity transmitted through UE's high voltage lines. The assumptions regarding taxation, the expected inflation and exchange rate in subsequent years are the same as those used for DHE. The FIRR for UE was calculated at 15.9% on a current basis and 13.4% on a real basis which also compares favorably with UE's cost of capital, 8.5%, the same as the one for DHE. The UE's FIRR is critically sensitive to even very minor to changes in the tariff for UE's services, and less sensitive to changes in the amount of electricity transmitted through the UE's lines. (See section 10 for details on FIRR calculations and sensitivities). 4.5 Institutional development impact: Background As the first Bank investment operation in the energy sector of Ukraine, the project was successful. It complemented the Bank's Programmatic Adjustment Loan (PAL) and the IMF's Extended Fund Facility (EFF) mainly in the area of improving cash collections in the power sector. The original project design depended on progress of sector reforms, and coupled with the requirements for financial viability of the project implementing agencies, contributed to creating an initial basis for the pursuit of key elements of the current joint Bank/GoU strategy to improve institutions and governance through (i) design of a regulatory environment with a level playing field in the energy sector; (ii) creation and protection of property rights, and (iii) improvement of fiscal and financial discipline, public accountability and management of social and environmental risks. - 15 -  Sector level impact The project was designed and implemented in the context of the first steps to improve management of the electricity sector through restructuring of the hydropower plants into a joint stock company and consolidating the regional dispatch centers into a National Dispatch Center, followed by sector unbundling, establishment of a National Electricity Regulatory Commission and a Wholesale Electricity Market and privatization of electricity distribution companies to strategic investors. The improved quality of electricity supply and stability of the power system, achieved under the project, improved the safety of the NPPs and enhanced Ukraine's possibility for interconnection with neighboring power systems, thus moving the country closer to EU standards. Since 2000, efficient government measures to improve collections and restructure arrears in the power market, in addition to all of the above institutional improvements, further contributed to increasing private interest in the sector and enhanced the financial stability of the project companies, a key factor for successful project completion. Company level impact The project had a direct beneficial impact on improving corporate govemance of the implementing agencies by (i) involving them in intemational project management, accounting and procurement practices, (ii) ensuring transfer of advanced technologies and know-how, and (iii) enhancing national key scientific research and industrial capacity. In addition, the project covered important social and environmental aspects of the country's policy priorities by generating additional employrnent and reducing environmental hazards along the Dnieper basin. The project helped Dniprohydroenergo and Ukrenergo acquire experience in management and implementation of projects financed by international financial institutions. The companies' accounting improved by adopting standards closer to international practices. Project procurement experience contributed to incorporating sound procurement principles of economy and efficiency, international competition, transparency, equity and fairness in the national procurement legislation. Intemational competitive bidding enabled DHE and Ukrenergo to acquire at least cost equipment which was best suited to the project needs and resulted in transfer of most advanced technology. Transfer of project know-how was ensured by proper training of Ukrainian experts by suppliers. This enabled further transfer of knowledge. Inovative technological experience from the project was shared with the programs of two key engineering institutes in Ukraine which train high caliber experts for the hydropower industry. In support of the joint Bank/GoU strategy to ensure employment-generating growth, 10,000 new jobs were created in the course of project implementation. In addition, amid the economic crisis, project design works preserved the existence of research and design institutes. 5. Major Factors Affecting Implementation and Outcome 5. 1 Factors ou2tside the control of government or implementing agency Lengthy Parliamentary ratification procedures and an international economic crisis were the main factors outside the control of the Government, DHE and LJkrenergo which affected project implementation. -16 -  Inclement weather and spring floods additionally constrained project works on occasion. In this context, close flank supervision and intensive work of local contractors mitigated adverse impacts on the project and facilitated the completion of physical works under a tight schedule. Parliamentary ratification, and respectively the date of effectiveness of the project Loan Agreement, approved by the Board of the Bank in April 1995, were delayed by more than a year. This postponed accordingly the start of project implementation. Lengthy and repetitive internal government procedures also contributed to the delayed approval of the Loan Agreement by Parliament Economic instability: Intensified economic problems in East Asia and Russia in 1998 destabilized debt service dynamics in Ukraine by causing yields on Ukrainian T-bills, issued to foreign investors to finance a large budget deficit, to rise to unsustainable levels. In this regard, the effort to pay off or restructure the T-bills debt alnost depleted the country's foreign exchange reserves and triggered a severe financial crisis, which then, among other adverse impacts, brought to a halt payments in the power sector and led to an interruption of local project financing. Force-Majeure: On occasion, winter blizzards led to icing and damage of power transmission lines and related equipment. The unforeseen need to repair these damages imposed an additional strain on the scarce local project funds and related project works. Longer than usual spring flood periods, when as many turbine/generator units as possible have to operate, occasionally delayed project rehabilitation schedules 5 2 Factors generally subject to government control: The main factors subject to government control that critically affected the project were (i) overall inconsistent economic and reform policies, and (ii) poor payrnent discipline in the electricity sector. Project implementation was also negatively affected by additional factors subject to government control such as (i) varying profit tax and VAT regulations; (ii) burdensome customs and export-import rules; (iii) lack of clear regulations on contract liabilities; (iii) lack of national standards for new project equipmnent and (iv) the 1998 merger of the of the project implementing agency National Dispatch Center (NDC) together with the National Power Transmission Company into a new National Power Company Ukrenergo which also encompassed the establishment of the Wholesale Electricity Market within the new company. Economic policies and non-payments in the electricity sector: Adverse extemal economic developments only aggravated persisting domestic economic imbalances caused by a relaxed fiscal stance and weak financial discipline, particularly in the power sector, in the context of the overall reversal in the government's drive for economic reforms between 1996 and 2000. As non-paymnents, coupled with barter and promissory notes (veksels) transactions, continued during this period, scarce collections in Energomarket were re-allocated primarily to ensure emergency purchase of fuel for the thermal power plants during the winter, to the detriment of the needs for local project financing. Consequently, the overall project implementation delay, relative to the initial schedule, rose to about 20 months in early 2000 and affected primarily turbine/generator rehabilitation and installation of already imported equipment, as these activities entirely depended on sufficient local financing. In 2000 the new reform-oriented government undertook active measures to irnprove electricity payments. The cash collections consequently rose from only 9% in April 2000 to 71% in May 2001 and 90% in May 2002. The concerted govemment's effort to improve electricity payments provided grounds for extending the loan closing date for another 18 months which allowed for overall achievement of project objectives, although with delay and reduced scope of rehabilitation works. - 17 -  Tax legislation: Introduction of an accruals form of accounting for tax calculations in 1997 resulted in much higher accounting profits and consequently higher profit tax obligations for the power sector enterprises. This measure was enforced without consideration of the actually low revenues of the power companies due to non-payments for their output and lack of tax exemptions for their mandatory contributions to various state funds, unrelated to the companies' activities. In addition, the availability of local project funds was further constrained by the temporary introduction of VAT (1998 and 2002) on imported equipment and electricity sales (1999) under the project. Customs and import-export regulations: Lengthy and complex procedures for customs clearance of project equipment compressed subsequent installation and commissioning schedules. Import-export regulations did not contain provisions for exporting earlier imported project equipment for repairs at the supplier's site. This limited the possibility for repairs of project equipment under suppliers' contract guarantees. Lack of clear stipulations in the national legislation regarding local liabilities of foreign contractors and suppliers, engaging in project activities in Ukraine, hampered preparation of tenders. Lack of national standards for project equipment which was new to the country required additional time for testing and acceptance procedures for such equipment. Restructuring of the National Dispatch Center and frequent changes of its management. The 1998 merger of the original project implementing agency (the National Dispatch Center) with the National Transmission Company and the Energomarket (the wholesale electricity market) into a new entity Ukrenergo seriously constrained the review of the financial performance of the resulting project entity. The situation improved since 2000 when Energomarket was separated from Ukrenergo. However, further re-organizations within the sector affected the project implementation schedule. Complex project equipment had to be contracted and delivered first to the project implementing agency Ukrenergo which then had to lease it for installation, commissioning and operation to other entities which have remained outside Ukrenergo's structure. In addition, throughout project implementation until 2000, changes of Ukrenergo's directors (there have been four directors of Ukrenergo during project implementation) and staff involved in project implementation adversely affected the project. 5 3 Factors generally subject to implementing agency control: Slow, burdensome and inaccurate intemal procurement review processes within both project agencies throughout the project, particularly at its beginning, along with seriously delayed project status reporting from UE during the first half of the project, compounded overall project implementation difficulties. In addition, some project works were constrained by UE's intemal difficulties to optimally schedule disconnections of transmission lines to install project equipment. Nevertheless, the strong ownership and drive for results of DHE's top management and staff at all power plants throughout the entire project period, along with improved project ownership at UE since 1999, upon the advent of the company's present management, have altogether compensated for the initial lack of knowledge of Bank procedures, have mitigated negative external impacts and have ensured overall successful completion of the project works. - 18-  5.4 Costs andfinancing: Total project costs, including interest during construction (Il)C), were about US$141.5 million equivalent, or 66% of the appraised estimate of US$215.1 million. The difference of US$73.6 million equivalent in project costs resulted from: (i) the reduction of the number of rehabilitated turbine/generator units; (ii) the cancellation of the TPP governors sub-component, (iii) and generally lower than estimated local costs of the System Control component. In addition, actual interest paid during construction was lower than estimated due to cancellation of unused Bank funds. The above reductions of costs have outweighed increases in the cost of installing dam safety equipment per km of dam, the cost of higher volume of local works related to a turbine/generator unit along with the increase in contract values because of additional project quantities of fiber-optic cable, switchgear, system control and monitoring equipment and extended technical assistance. The brunt of the project financing was based on a 17-year IBRD loan with a 5-year grace period and a level repayment pattern. Seventy two percent -US$ 82 million- of the original amount of US$ 114 million of the Bank loan was used. The Canadian Government more than doubled the funds for the project-related consulting services which were extended to cover additional needs for such services as a result of the almost one year delay in the start of project implementation due to late Parliamentary ratification of the Loan Agreement. The grant from the Swiss government in the amount of CBP13.7 million was used for the supply and installation of high voltage (HW) equipment at the hydropower plants. The US$ 0.6 million grant from the Norwegian government was used for a study on the management of the reservoirs on the Dnieper River. 6. Sustainability 6.1 Rationalefor sustainability rating: The benefits from the project are sustainable in view of the improvements in the power system's efficiency, stability and safety, the system's enhanced possibility for interconnections with the neighboring systems, achieved in the context of macro-economic improvements, coupled with positive trends in the overall business environment, sector privatization, improving cash collections, debt restructuring and GoU's continuing commitment to further sector reforms with active support from donors and international financial institutions. Continued adequate financial discipline in the sector remains a critical factor for ensuring project sustainability. Current competition among thermal generators, their expected privatization and the continued process of divesting electricity distribution companies are expected to enhance overall performance of the power sector through attracting new investments. 6.2 Transition arrangement to regular operations: DHE and UE will continue the work to (i) ensure proper financing of their operations; (ii) integrate completely the project equipment in their systems; (iii) draft internal regulations for equipment operations and maintenance and train relevant staff accordingly; (iv) ensure arrangements with suppliers for proper servicing of the project equipment beyond the contract guarantee period, and (v) monitor key physical and financial performance indicators. - 19 -  DHE and UE will also pursue improvements in their financial management and accounting practices based on the auditors' recommendations received during project implementation. Both companies will continue training staff to improve preparation of their consolidated financial statements based on National Accounting Standards (NAS) format, will work on introducing proper registry and software systems along with streamlining their tax records and tax payments forecasts. (See details on transition arrangements in Section 10, paragraph V) UE has estimated that the project impact on the entire power system will be fully felt in about 5-10 years in view of the large size of the system and the additional time needed to fully integrate the project equipment into overall system operations. The project rehabilitation improvements in terns of hydropower plants' efficiency, capacity and oil leakages have been already assessed, although it will take more time to completely materialize the benefits of better cascade operations as a result of improved system control and monitoring. Dniprohydroenergo and Ukrenergo are satisfied with the results achieved under the project, which in addition to responding to the needs for upgrading dispatch, communications, and system control, also covered about 20% of the rehabilitation needs of the Dnieper cascade equipment. Further support to the remaining rehabilitation works at the hydropower plants will enhance the benefits to the power system provided (i) the Government's overall reform efforts remain on track; (ii) proper financial discipline in the sector is consistently maintained, and (iii) completion of the hydropower plants rehabilitation, and further dam safety improvement remain a Government's prionty. 7. Bank and Borrower Performance Bank 7.1 Lending: Identification The Bank's performance in project identification was satisfactory. The project was identified in line with the Bank's country assistance strategy which responded to a far-reaching reform program advanced by the Govemment in 1994-1996. The Bank carried out an Energy Sector Review to assist the Govermment in crafting its strategy for the energy sector. The Bank also agreed with the Govemment and other international donors that power generation was an area in which the Bank's support could make a notable difference. In this context, the Hydropower Rehabilitation and System Control Project was proposed in consideration of the Bank's comparative advantage in the sector. An earlier Power Demand and Supply Options study of 1993 (report No.1 1561-UA) indicated that the rehabilitation of thermal and hydropower plants was likely to result in the most significant net benefits for the power system. The priority of reforming and upgrading the power sector was clearly outlined in the Government's strategy. The Bank provided critical investment to the power industry along with donors' co-financing in a crucial period of the country's transition from a centrally planned to a market economy. At the same time, the Bank also initiated the coordination of the donors' technical assistance to implement the Government's energy sector strategy, which was conducive to a proper enabling environment for this investment operation. -20-  Preparation assistance The Bank's performance in project preparation was satisfactory. The Ukrainian counterparts benefited from early Bank involvement in the preparation process soon after project identification. The Bank undertook appropriate coordination with donors and Ukrainian counterparts. Feasibility studies were carried out to prioritize the Government's hydropower rehabilitation programs and analyze the rehabilitation needs of system-wide control and dispatch facilities. The studies were carried out by consultants financed by trust funds of the governments of the Netherlands and Switzerland under the supervision of the Ministry of Energy. The project investment activities were linked with specific policy measures regarding tariffs and arrears in connection with the project entities. Appraisal The Bank's performance at appraisal was satisfactory. The Bank's appraisal team included experts with a comprehensive skill mix. The Government's and implementing agencies' commitment to the project was analyzed. Major risks related to pricing and non-payments were addressed through relevant conditions of effectiveness and loan covenants. The political risk of reversing sector reforms was also outlined. Capitalizing on the lesson learned from the first Bank project in Ukraine about the importance of technical assistance (TA), technical assistance from the Govemments of Canada, Norway and Switzerland was incorporated in the project scope to complement rehabilitation and water management activities and compensate for the Borrower's insufficient experience with procurement and project management. All relevant safeguard policies were reviewed and discussed within the Bank and with the Government. Continuity from identification through appraisal was good. Important project benefits were outlined and the goal of achieving and preserving them served as a key incentive for the implementing agencies and the Government to pursue project sustainability. The loan amount was commensurate with the project scope. The performance indicators were designed to ensure adequate monitoring and reporting of project implementation progress. The institutional and commercial conditions of installing governors at the TPPs could have been assessed in greater detail in order to ensure that the system is ready for such investmnent and avoid cancellation of this sub-component. On the other hand, the project was brealing new grounds as the first Bank investment operation in Ukraine. 7.2 Supervision. The Bank's performance during supervision was satisfactory in terms of (i) ensuring regularity of supervision missions and adequate skill-mix of Bank staff; (ii) providing timely responses to project issues and involving management when called for by the complexity of the project matters; (iv) actively involving the field office in maintaining close working contacts with the local project counterparts; (v) applying realistic project performance ratings. -21 -  The skill-mix and frequency of missions was aligned with the needs of implementation and responsiveness to the issues as they emerged. Close supervision and interaction with the Ukrainian counterparts facilitated constructive agreements on amending contracts, loan covenants and project scope in response to evolving company needs, changes in sector structure and adverse external impacts. This approach prevented project cancellation, and later allowed the extension of the loan closing date by 18 months to ultimately achieve project objectives, although with delay and reduced physical scope of some components. In addition, close and regular supervision enabled the Bank to take a pro-active stance and follow up on cases of serious noncompliance with Bank requirements, and even issue a threat to suspend the UE's component when the company continuously failed to present a mid-term progress report and an updated implementation plan. The Bank's proactivity continued throughout the project through regularly following up on key agreements on project financing, audits and completing project works under a realistic time schedule. Performance ratings were realistic and when required, "unsatisfactory" and "high risk" flags alerted sector and country management about critical problems with project implementation and facilitated constructive discussion to find solutions. The Bank went to great lengths to ensure high quality advice to the Borrower. A world class dam safety expert assisted DHE in implementing current Bank safeguards on dam safety and solving difficult and unique dam safety issues related to some of the major and the longest dams in the world along the Dnieper cascade. The Bank developed a very good working relationship with the management and staff of the implementing agencies during supervision missions, site visits, and regular follow-up communications. A good interaction was also developed with the National Electricity Regulatory Commission, Energomarket administration and the Ministry of Finance to ensure proper project financing. The Bank also maintained close contacts on project-related issues with the Ministry of Fuel and Energy despite frequent changes in the Ministry's leadership. The Bank should have been more proactive in guiding DHE about formally closing the process of selection of project management consultants. Although the changes in project scope and the uncertainties surrounding the closing date of the project during the second half of 2000 may have made the intended TA inappropriate and unnecessary after the selection was initiated, the process could have been terminated earlier. 7.3 Ot'erall Bankperformance: In view of the above assessments, overall Bank performance was satisfactory throughout the project cycle. Borrower 7.4 Preparation: The Borrower's performance during project preparation is assessed as satisfactory. The Borrower demonstrated a high level of commitment and responsibility during project preparation since the Government assigned high priority to improving electricity supply as a main prerequisite for modemizing the country's industry. Rehabilitation of the HPPs on Dnieper cascade was considered a key factor for improving electricity supply in view of the important role of the HPPs in regulating frequency of the power system. In this context, there was close cooperation during preparation between the Government and the - 22 -  Bank. The earlier work on preparing a comprehensive Government strategy for the energy sector ensured that the project was appropriate to Ukraine's needs. 7.5 Government implementation performance: The Government's implementation performance is assessed as satisfactory since the project objectives were ultimately achieved with critical Government support, despite the deep financial crisis suffered during project implementation. The low level of payment collections in the power sector -the key constraint to project implementation-- was overcome as a result of the Government's decisive measures aimed at financial recovery through elimination of barter and promissory note transactions, enforcing disconnections of delinquent electricity consumers along with other measures conducive to improving cash payments in the sector. In addition, the Government and the National Electricity Regulatory Commission adopted specific measures to ensure sufficient allocation of local funds to the project companies through Energomarket's funds distribution mechanism. The Government's effort to enhance economic growth and continue energy reforms within a broad program to improve institutions and govemance in the economy, with support from the Bank and donors, provided a framework which facilitated satisfactory completion of the project works. 7.6 Implementing Agency: The performance of the implementing agencies is rated as satisfactory because they managed to complete the revised scope of project works agreed with the Bank within the extended loan closing date. Both DBE and UE suffered the adverse influence of a deep financial crisis in the sector which paralyzed implementation of the DHE's component for more than six months and delayed for more than 20 months the installation of some equipment under UE's component. Despite the extemal difficulties, DHE demonstrated strong commitment and ownership with respect to the project throughout the entire preparation and implementation periods. The company did its best to ensure that all possible actions within the scope of its capacity and authority were undertaken to enable project completion, including provision of adequate management and staffing. Interaction with Bank and Government counterparts on project issues was active and contributed to finding solutions to problems. Project reporting and audit compliance were adequate except for delays at the initial stage due to lack of knowledge of Bank procedures. NDC/UE's audits suffered delays due to irreconcilable discrepancies of accounts caused by the temporary inclusion of Energomarket in the structure of the project agency. . UE's management was less persistent at the early stage of the project in exploring all possible means to mitigate the impact of the external financial crisis on project implementation. UE's project staff had the necessary skills and experience which contributed to the final successful project completion. - 23 -  DHE and UE managed to comply with the agreed self financing ratio only after 2000 as a result of the improved cash collections and local financing for the project. The companies did not incur any other major debts except for the borrowing from the World Bank. This ensured compliance with the relevant project covenant not to incur debt unless a reasonable forecast of the beneficiaries' revenues and expenditures indicates an agreed debt service ratio throughout the term of the debt. Both companies, and especially Dniprohydroenergo, had certain problems in conducting procurement efficiently throughout the project, particularly during the early stages of project implementation. In a number of cases there were significant delays in concluding procurement due to protracted or improper evaluation of bids, vagueness in technical specifications, etc. Subsequently, these deficiencies were corrected -- with significant involvement of Bank staff, - and did not result in violation of procurement policies and procedures, except the case of not properly closing the consultant selection process at DHE. These deficiencies did adversely impact on the project schedule. Despite this setback, DHE management and current UE management did not spare efforts to coordinate the complex project works in a largely successful manner. 7.7 Overall Borrowerperformance: In view of the above assessments, overall performance of the Borrower was satisfactory. 8. Lessons Learned Assessment of the Government's long term commitment and ability to carry out reforms is a key aspect of analyzing overall project sustainability. It is important to have a reform-oriented government not only during project preparation, but throughout the entire project cycle as well. The experience in Ukraine has shown that a reversal of the initially progressive course of economic reforns has adversely affected the implementation of the Bank's investment project Ensuring the enabling environment for a large scope investment operation is a critical success factorfor the operation: The experience in Ukraine has shown that initial government commitment to provide such an environment through comprehensive reforms requires sustained support from the international financial institutions and bilateral donors throughout the entire reform process. In this context, cross-sector adjustment operations have led to most tangible results on the ground. Although during project preparation the Government indicated that improving financial discipline in the energy sector was a priority of its reform program, and the project itself generated specific pressure on the Government to deliver in this regard, cash collections reached their highest levels only when included as specific targets in the IMF's Extended Fund Facility Program and the Bank's Programmatic Adjustment Loan. Donor coordination and "distribution of labor" in project finance has allowed to exploit the comparative advantages of each of the donors' contributions. Thus, the Bank's experience in power sector rehabilitation has been complemented by Canada's support with technical assistance in project management, Norway's support in reservoir management and Switzerland's supply and installation of switchgear equipment The governments of the Netherlands and Switzerland have generously contributed to the preparation of the project feasibility studies. The donors' working group on energy sector reforrns has provided valuable assistance to the Government's sector reform efforts. -24-  Very good technical skills, strong project ownership and commitment to results on the side of the project beneficiaries have been critical success factors. Such ownership and commitment have partially mitigated the adverse impacts of the financial crisis, the initial lack of experience with the Bank's project cycle, and have provided the Bank with grounds for extending the closing date to ensure successful project completion. Flexibility and adaptation to changes in the project environment helped the Bank and the Borrower overcome adverse external impacts and achieve the project development objectives. The Bank's flexible approach to the Borrower's request to reasonably reduce the physical scope of some project components, adjust loan covenants, amend contracts and extend the loan closing date in response to changes in the power sector and the entire economy have ultimately preserved the project benefits and ensured achievement of the development objectives. Conclusions: (i) The first phase of the rehabilitation of the hydropower plants of the Dnieper cascade and the upgrade of the system control of the UPS have been successfully completed. (ii) The installation of a computerized dam monitoring system at Kiev HPP, at the head of the Dnieper cascade, enhanced the safety of the entire cascade which is situated along densely populated and industrialized areas. The installation of new ecologically safe turbines with adjustable blades eliminated leakages of lubricating oil from these turbines into the Dnieper River, thus contributing to overall improvement of the quality of the river water shared for multiple purposes by numerous household, urban, industrial and agricultural users along the Dnieper basin. (iii) The turbine/generator rehabilitation led to improved efficiency and increased capacity of the hydropower plants. This, coupled with the installation of system control and monitoring equipment and specialized TA, improved hydropower plants maneuverability, management of the Dnieper reservoirs and overall power system regulation. (iv) Improved load and frequency control enhanced the quality of electricity supply. This improved the UPS capacity for interconnections with neighboring power systems and brought the UPS performnance closer to relevant EU standards. (v) Important social issues were addressed by opening new job opportunities during project implementation. Know-how was transferred from foreign suppliers to project beneficiaries. Local research and development capacity was enhanced during project preparation and implementation. (vi) The overall project and its two main components, hydropower rehabilitation and system control upgrade, are sustainable. In addition, benefits from improved safety and environmental performance of the power system significantly enhance project sustainability. (vii) Completion of the remaining hydropower rehabilitation works will bring further benefits to the power system provided the Government's overall reform efforts remain on track and adequate financial discipline is maintained in the power sector. - 25 -  9. Partner Comments (a) Borrower/implementing agency: Comments from the Borrower, implementing agencies and donors were as follows: MINISTRY OF ECONOMY AND EUROPEAN INTEGRATION OF UIKRAINE 12/2 M. Hrushevskyi St, Kyiv 01008 Ukraine Tel: 293-93-94, fax: 226-31-81; www.me.gov.ua E-mail: meconomy@me.gov.ua Mr. Luca Barbone December 5, 2002 Country Director Ukraine, Belarus and Moldova Europe and Central Asia Region The World Bank Dear Mr. Barbone: The Ministry of Economy and European Integration of Ukraine has examined the Implementation Completion Report (ICR) for the Hydropower Rehabilitation and System Control Project prepared by the World Bank and approves it in the whole. As evidenced by the materials presented in the report, the result of project implementation is assessed as satisfactory. The goals envisaged by the project have been achieved, although with some delays and reduced physical volume under some components. Under conditions of the reduced amnount of work, an additional total capacity of 88.1 MW was achieved under the project as compared to 130 MW, which was planned with the initial full amount of work. On completion of the project, the economic gains proved to be stable, although smaller than planned at the appraisal stage due to reduced gains as a result of the decreased project volume. Based on the results of project implementation, the lower than calculated rate of return under the hydropower station rehabilitation component is explained by the lesser volumes of increased capacities and additionally generated electricity due to reduced amounts of work under the project, lesser gains from the increased reliability and available capacities of hydropower stations, and by the revision of the system load forecast. As a result of project implementation, the efficiency of the rehabilitated turbines of the Kyiv, Kakhovka and DniproHES-1 hydropower stations has increased by 4.3%, 4.1% and 4.2% and constitutes 91.8%, 83% and 92.2%, respectively. The total expenditures under the project, including the percentage paid during the construction period, amounted to nearly $141.5 million (or 66% of the calculated sum that constituted $215.1 million). The difference totaling $73.6 million was the result of: - 26 -  a) reduced number of rehabilitated turbines/generators; b) cancellation of the subcomponent of installing governors on thermal power plants, and c) lower than planned local expenditures. In addition, the actual percentage paid during the construction period was lower than planned due to the withdrawal of undisbursed funds of the Bank. As regards financing, 72% of the initial sum of the World Bank loan was used and $82 million was disbursed out of $114 million. The report further notes that the proper financial discipline to be maintained in the future continues to be an extremely important factor in ensuring the viability of the project results. The existing competition among the thermal power enterprises, their expected privatization, and continued privatization of oblenergos are to facilitate the general improvement of the power sector performance by attracting additional investments to it. The financial rate of return and internal economic rate of return in rehabilitating the Dniprohidroenergo hydropower station (up to 2031) and the financial rate of return of Ukrenergo (up to 2020) are deternined in the annexes to the report. In summing up the material presented in the report, it should be noted that at the appraisal stage, the matunty of the project loan was 17 years, including the 1995 to 2002 period during which the project was implemented, with the loan and interest on it to be repaid from 2000 to 2012. Therefore, it would be appropriate to supplement the report with a mechanism of loan and interest repayment to the World Bank providing for more precise terms and schedules of loan redemption. In doing so, the actual fulfillment of the schedule of loan and interest repayment should be shown as of December 1, 2002, as well as the expected loan redemption for 2003. Problems should also be outlined that arise, as the World Bank sees them, in connection with the loan repayment. In our view, concrete reasons for the general decrease in the amount of project works should also be noted in the report. In addition, we would like to stress that given the results achieved and taking into account the shortcomings that occurred during the carrying out of the above-referenced project, the implementation of the second phase of the project associated with the rehabilitation of hydropower stations will bring further benefits to Ukraine's power system. Sincerely, (signature) L. Musina Translated by V Ivchenko Deputy State Secretary Response to the recommendations from the Ministry of Economy and European Integration of Ukraine: Comment 1: Supplement the report with a mechanism of loan and interest repayment to the World Bank providing for more precise terms and schedules of loan redemption. In doing so, the actual fulfillment of the schedule of loan and interest repayment should be shown as of December 1, 2002, as well as the expected loan redemption for 2003. Attached below are Amortization Schedule and Statement of Account for Loan 38650 UA for the Hydropower Rehabilitation and System Control Project. The interest rate is applied to the principal - 27-  amount outstanding. For more details on this matter please refer to the World Bank Debt Servicing Handbook for Borrowers which can be made available to the Ministry through the World Bank Country Office in Kiev. In addition, Mr. Oliver Rajakaruna, Loan Accounting Officer, can be reached for consultations on issues related to loan repayment at 202473-4326, e-mail address: Orajakaruna@worldbank.org INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Run Date 11-DEC-2002 AMORTIATION SCHEDULE Report Id: RDM900 Rtun Tinle 12 50:16 PM (AmLounts in USC } Page: Country UKRAINE Loan Number IBRD 38650 Borrower MINISTRY OF FINANCE Original Amount 1114,000,000.00 First Matunty 1-AUG-2000 Cancellatlions 31,494.629.79 Last Malurity 1-FEB-2012 Maturity Original Cancellations/ Prepayments Revised Date Maturity Tmsfers Maturity 1-AUG-2000 4,750,000.00 0.00 0.00 4,750,00.C 1-FEB-2001 4,750,000.00 0.00 0.00 4,750,000.C 1-AUG-2001 4,750.000.00 (643,700.00) 0.00 4,106.300.C 1-FEB-2002 4,750,000.00 (643,700 00) 0.00 4,1061300 ( 1-AUG-2002 4,750,000.00 (1,395,500.00) 0.00 3,354,500.( 1-FES-2003 4,750,000.00 (1,516,60000) 0.00 3,233,4W.C I-AUG-2003 4,750,000.00 (1,516,600.00) 0.00 3,233,400.( 1-FEB-2004 4,750,000.00 (1,516,600.001 0.00 3,233,400.( 1-AUG-2004 4,750,000.00 (1,516,60000) 0 00 3,233,400 ( 1-FEB-2005 4,750,000 00 (1,516,600.00) 0 00 3,233,400.( 1-AUG-2005 4,750,000