Mozambique - Southern Africa Regional Gas Project

Document of International Bank for Reconstruction and Development and International Finance Corporation FOROFFICIAL USEONLY ReportNo: 26757-MOZ PROJECTAPPRAISAL DOCUMENT ONTWO PROPOSED INTERNATIONAL BANK FORRECONSTRUCTIONAND DEVELOPMENT PARTIAL RISK GUARANTEES INTHE AGGREGATEAMOUNT OF UPTO US$30MILLION FOR SYNDICATED COMMERCIAL BANK LOANS AND ON PROPOSED INTERNATIONAL FINANCE CORPORATION EQUITY INVESTMENT OF UPTO US$18.5 MILLION FORTHE SOUTHERNAFRICA REGIONAL GAS PROJECT BETWEENTHE REPUBLICOF MOZAMBIQUE AND THE REPUBLICOF SOUTHAFRICA October 22,2003 Energy Team, InfrastructureGroup, Africa RegionalOffice Oil and Gas Division, InternationalFinanceCorporation This document has a restricteddistribution andmay be usedby recipientsonly inthe performanceo ftheir official duties. Its contents may not otherwise be disclosedwithout World Bank authorization.  CURRENCY EQUIVALENTS (Exchange Rate Effective October 20,2003) Currency Unit = Meticais SDR 1.O = US$1.42782 (October 20,2003) US$l.O = 23,348 Meticais US$l.O = 7.5 Rand FISCAL YEAR January 1 -- December 31 ABBREVIATIONS AND ACRONYMS AfDF African Development Fund AFD Agence Franqaisede DCveloppement APL Adaptable ProgramLoan ASME American Society of Mechanical Engineers CAS Country Assistance Strategy CEF Central Energy Fund, wholly owned by the RSA Government CMG Companhia Mocambicana de Gasoduto (Mozambique Gas Company) CMH Companhia Mocambicana de Hidrocarbonetos (Mozambique Hydrocarbons Company) CPF Central ProcessingFacility DBSA Development Bank of Southern Africa DEG German Investment Company DNCH Direqgo Nacional de Carvgo e Hidrocarbonetos (National Directorate for Coal and Hydrocarbons) DNE Direqgo Nacional de Energia (National Directorate for Energy) DRC Democratic Republic of the Congo ECAs Export Credit Agencies ECIC Export InsuranceCorporation of South Africa EdM Electricidade de Moqambique (Mozambique Electricity Company) EFIC Export Finance InsuranceCorporation of Australia EIA Environmental Impact Assessment EIB EuropeanInvestment Bank EMP Environmental ManagementPlan ENH EmpresaNacional de Hidrocarbonetos de Moqambique (Mozambique National Oil Corporation) EPC Engineering, Procurementand Construction Contract EPCm Engineering, Procurementand Construction Management Contractor ERAP Energy Reform and Access Project ERR Economic Rate of Return FMO Netherlands FinanceCompany FRR Financial Rate of Return GDP Gross Domestic Product This document has a restricted distribution and may be used by recipients only inthe performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  FOROFFICIAL USEONLY f GLMC Grinaker LTA McConnell Dowelland ConsolidatedContractors International Company GoM Governmentof Mozambique GoSA Governmentof South Africa GSA Gas Sales Agreement GTA Gas TransportationAgreement HIPC Heavily IndebtedPoor Countries IBRD InternationalBank for Reconstructionand Development IDA InternationalDevelopmentAssociation IFC InternationalFinance Corporation JOA Joint OperatingAgreement LDP Letter of DevelopmentProgram LIBOR London InterbankOfferedRate MGJ Million gigajoules MGJ/a Million gigajoulesper annum MICOA Ministerio paraa Coordenaqiio da Acqao Ambiental (Ministry for Coordinationof EnvironmentalAffairs) . MIGA Multilateral InvestmentGuarantee Agency MIREME Ministry of Mineral Resourcesand Energy of the Republic ofMozambique MW Megawatt Natref National PetroleumRefineriesof South Africa NORAD Norwegian Agency for Development OED OperationEvaluationDepartment PA PipelineAgreement PPA PetroleumProductionAgreement PRG PartialRiskGuarantee PRI Political Risk Insurance RESA RegionalEnvironmentaland SocialAssessment ROMPCO Republic of MozambiquePipelineInvestmentsCompany (Proprietary) Limited RPIP Resettlement Planningand ImplementationProgram RSA Republic of South Africa SADC Southern Africa DevelopmentCommunity SCMB Standard Corporate and MerchantBank SPI Sasol PetroleumInternational SPT Sasol PetroleumTemane Limitada TA Technical Assistance TCF Trillion Cubic feet UJV UnincorporatedJoint Venture WBG World Bank Group Vice President, IBRD: Callisto Madavo Country Director, IBRD: DariusMans Country Director, IFC: HaydeeCelaya Sector Director, IBRD: Michel Wormser Director, IFC: Rashad-RudolfKaldany Team Leaders, IBRD: JoelMawenilMarie-Ange Saraka-Yao Team Leader, IFC: Gulrez Hoda Program Assistant, IBRD: Lily Wong ProgramAssistant, IFC: ElizabethHickman This document hasa restricted distributionandmay beused by recipients only in the performance of their official duties. I t s contents m a y not be otherwise disclosed lwithout World Bank authorization. I   MOZAMBIQUE SOUTHERN AFRICA REGIONAL GAS PROJECT CONTENTS A. ProjectDevelopmentObjective Page 1. Projectdevelopmentobjective 1 2. Key performance indicators 1 B. Strategic Context Sector-related Country Assistance Strategy (CAS) goal supported by the project Main sector issuesand GoM strategy Sector issuesto be addressedby the Projectand Strategic Choices World Bank Group Assistance Strategy C. ProjectDescriptionSummary ProjectDescription 7 ProjectCosts and FinancingPlan 9 Political RiskMitigation Strategy 12 The Proposed PartialRisk Guarantees 13 IBRDEnclave Guarantee 15 RisksAssociated with IBRDGuarantee 17 ProposedIFC Investment 17 The ProposedEquity Investment 18 RisksAssociatedwith IFC Equity Investment 19 Key Policy and InstitutionalReforms Supported by the Project 19 BenefitsandTarget Population 19 ProjectImplementationand InstitutionalArrangements 20 Summary of ContractualArrangements 22 D. ProjectRationale Major ProjectsFinancedby the Bank and/or other DevelopmentAgencies 25 Lessons Learnedand Reflectedin the ProjectDesign 25 Indicationsof Government Commitment/BorrowerOwnership 27 Value of World Bank Group in this Project 27  E. SummaryProjectAnalysis 1. Economic 28 2. Financial 28 3. Technical 31 4. Procurement 32 5, Financial Management 32 6. Environmental and Social 33 Executive Summary andUpdate 33 Public Disclosureand Consultation 35 Environmental Impact Assessments 35 ResettlementPlanningand Implementation Program(RPIP) 37 Regional Environmentaland Social Assessment (RESA) 38 Monitoring and Auditing Provisions 39 7. SafeguardPolicies 40 F. Sustainabilityand Risks Sustainability 40 Critical risks 40 G. EffectivenessCondition IBRDPartial RiskGuarantees 43 IFC 43 H. Readinessfor Implementation 43 I.CompliancewithWorldBankGroupPolicies 44  Annexes Annex 1: Project Design Summary 45 Annex 2: Detailed Project Description 49 Annex 3(a): Estimated Project Costs 57 Annex 3(b): Project FinancingPlan 58 Annex 4: Economic Analysis 59 Annex 4: Attachment 1: Economic Analysis 65 Annex 5: Project Sponsors and Financial Analysis 66 Annex 6: Project FinancialPerformance of IFC Equity Investment 74 Annex 7: Project ProcessingTimetable 76 Annex 8: Mozambique at a Glance 78 Annex 9(a): Indicative Terms and Conditions of the IBRDGuarantees: 80 A. SPT IBRD-Supported Facility Terms 80 B. ProposedSPT IBRDGuarantee Terms 83 Annex 9(b): Indicative Terms and Conditions ofthe IBRDGuarantees: 88 A. ROMPCO IBRD-Supported Facility Terms 88 B. Proposed ROMPCO IBRD Guarantee Terms 91 Annex lO(a): Summary of Material Obligations to be covered by the SPT Partial Risk 96 Guarantee Annex 10(b): Summary of Material Obligations to be covered by the ROMPCO Partial Risk 98 Guarantee Annex 1: Statement of Loans and Credits -IBRD, IFC, IFC & MIGA 100 Annex 2: Environment and Social Assessment Management Plans and Monitoring 103 Annex 2: Attachment 1: Overview of Suite of Technical Reports for the Southern 118 Africa Regional Gas Project Annex 2: Attachment 2: Summary of Actions for Implementationof the RESA 122 MAP IBRD32737   Mozambique Southern Africa Regional Gas Project ProjectAppraisalDocument Africa RegionalOffice / IFC Oil and Gas Division Date: October 22, 2003 Team Leaders,IBRD: Joel Maweni, Marie-Ange Saraka-Yao Team Leader,IFC: GulrezHoda CountryDirectors: DariusMans, Haydee Celaya Oil and Gas Director: Rashad-RudolfKaldany Manager: Somit Varma, IFC Sector Director: MichelWormser Sector Manager: Yusupha Crookes, IBRD Sector: Energyand Private Sector Development LendingInstruments: IBRDEnclave PartialRisk PovertyTargetedIntervention:[ ] Yes [ x] No Guarantee I [XI Equity IFC [ ] Credit [ ] Grant [XI IBRDGuarantee [ ] Other [Specify] CommercialLoan Facility 229.00 IBRDSPT PRG 20.00 IBRDROMPCO PRG 10.00 MIGA 72.00 Export Credit Agencies 127.00 Other Debt Facility 220.00 Sasol Equity 206.00 CMH Equity 56.00 IFC Equity 10.00* * Total 721.00 IFC investmentcould be up to US$18.5 million. In addition to the US$lO million shown as direct contribution to the project, it will pay US$6 millionto CMH, asubsidiaryof the Mozambican national oil company for past costs incurred in bringingthe Project to this state and anotherUS$2.5 millionto Final maturity: 14years from financial closing. Amortizationprofile: Repaymentinstallmentsstructuredto meetthe Project profile. Financingavailable without IBRD guarantee: No. Ifyes, estimatedcost or maturitywith guarantee: NotApplicable. ImplementationPeriod: April 2002 to December2004. EffectivenessDate: November30,2003. ClosingDate: December 31.2017. 1 Excludescapitalized finance charges and pre-investmentfees for advisors.   A. Project Development Objective Project Development Objective: (see Annex 1) 1. The proposed Project's main objective is to initiatethe development and export o fMozambique's substantial natural gas resources in an environmentally sustainable manner, thereby contributingtowards economic growth and poverty reduction. The proposed World Bank Group instruments (IBRDpartial risk and MIGA guarantees' and IFC equity investment)will facilitate the mobilization o f critical private capital as well as commercial debt financing required for implementation o f the Project. Inaddition, IFC i s helping the Government o f Mozambique (GoM) on broadening the participationo f local investors and inraising financing to cover the shortfall inMozambicanparticipationinthe Project. As this would be the first large scale privately-financed energy export project in the gas sub-sector, it would also provide a framework for other future private sector projects and facilitate further investments in gas exploration and other gas-related industries. Key Performance Indicators: (see Annex 1) 2. The project's key performance indicators are as follows: (a) Gas Exports: Export o f about 72 million gigajoules (MGJ) o f gas inyear 2004 ramping up to a plateau rate o f 120 million gigajoules per annum (MGJ/a) inyear 2009 and remaining at that level for the duration o f the Project. (b) Fiscal Benefits2: As a host country, Mozambique will derive revenues inthe form o f gas royalties and taxes amountingto about US$498 million or US$l05 million in net present value terms at a discount rate o f 10%. Inaddition, Mozambique will receive returns on its equity participation in the Project's upstream component (gas field development and central processing facility) and the pipeline over the Project's 25 year period. B. Strategic Context Sector-related Country Assistance Strategy (CAS) Goal Supported by the Project: (see Annex 1) Document number: 20521-MOZ Date of latest CAS discussion: June 1,2000 3. The latest CAS discussion for the period FY2001-FY2003 was held on June 1,2000. A new CAS covering the period FY2004-FY2007 will be discussed at the same time as the proposed Project. Under the new CAS, the World Bank Group's overall approach is to help Mozambique improve its investment climate, expand service delivery and build the capacity and accountability o f its institutions. To support the achievement o f Mozambique's long-term development priorities o f economic growth and poverty reduction, the CAS calls for the selective deployment o f the whole range o f World Bank Group instruments (IDA credits, guarantees, IFC instruments and MIGA guarantees) to leverage private resources for infrastructure development, including energy. The proposed Project would be the first 1 A separate Board Paper on a proposedModification of Prior Concurrenceto the Equity guarantee approved by the MIGA Board on December 11,2002 (MIGAR2002-0076) is being circulated separatelyand will be discussedat the same time as the proposedIBRD/IFC financing. 2 These represent staff estimates based on assumptionsregarding critical variables such as the prices o f crude oil, inflation rates in Mozambique and SouthAfrica as applied to data provided by the EmpresaNacional de Hidrocarbonetos(ENH) and its advisers. 1  operation under the new World Bank Group CAS to help Mozambique improve its investment climate in the gas sector by deployingIBRD's PartialRiskGuarantee, IFCequity investment andMIGA's guarantee. It would also contributetowards an improvedinvestment climateby providinga framework for development o f infrastructureprojects inthe future. Inaddition,the gas transportationinfrastructure to be providedunder the Project is likely to attract additional investments in gas exploration, industrial and commercialgas applications, small scale gas-to-electricityschemes, and to promote the substitution of importedpetroleumproducts with natural gas. Althoughthe extent is yet to be determined, the substitutionof gas for importedpetroleumproducts would help Mozambiquereducethe foreignexchange costs of imports while at the same time providingthe populationwith a cleaner form o f energy. 4. The award of contracts to Mozambicanlocal contractors, about 205 to date, for a total of approximatelyUS$68million andthe use of local inputs, (in excess ofthe agreed localcontent target of 15% for the Project, excludingimportedmaterials) is helpingto spur economic activity andthe creation ofjobs, particularly inthe provinceof Inhambane, one of the priority regions for the GoM efforts to promote balanced regionaldevelopment. Interms of direct financialbenefits, the estimatedrevenuesto the GoM of about US498 million innominalterms to be generatedby the Projectover its 25-year life, will help promote growth. As stated inthe Government's Letter of DevelopmentProgramfor the Energy Reformand Access Project, approved by IDA'SExecutiveDirectorson August 19,2003, the revenues generatedby the Projectwill be integrated intothe budget througha line itemandwill be spent ina manner consistent with the GoM's medium-termexpenditure framework which emphasizespoverty reduction. Main Sector Issues and GoM Strategy 5. The CAS objectiveof improvingthe investmentclimate is an essential ingredientofthe GoM's energy sector strategy for addressingthe following key sector issues: (i)a substantial, but largely untappedenergy resource base due to lack of investment anda limited domestic market; (ii)low access to modern energy, for bothelectricity and petroleum products; (iii)low operationalefficiency and weak financial situationofthe sector; (iv) limited institutional and human resources capacity; and(v) adverse environmental, livelihood, and health impacts of energy productionand use. With the helpofthe Bank andother donors, in recent years, the GoM has taken significant steps towards adoptinga legislativeand policy frameworkto reformthe energy sector to addressthese issues. Substantial, but LargelyUntapped. Enern ResourceBase 6. Southern Africa3is endowedwith diverse commercialenergy resources including hydroelectricity,coal, petroleumand naturalgas. However, due to the region's relatively smallurban population(approximately25.4%), access to commercialenergy resources is limited. The Republicof SouthAfrica (RSA), the dominant economy of the regionaccounts for about 85% of energy consumption and 77% of energy production. Mozambiquewith a rich endowment o fmodernenergy resources is increasinglyplayinga key role in the provisionof hydroelectricity,coal andnaturalgas. Ithasthe second largest hydropowerpotential(about 14,000 MW) inthe region, but only about 2,500 MW has so far been developed. Its internaldemand is only about 200 MW, hence the entire output of its largest power plant, the Cahora Bassa hydroelectricscheme on the Zambezi River with an installedgenerating capacity of 2,075 MW, is exportedto the RSA and Zimbabwe, the two biggest regionalenergy consumers. A further hydropower development is beingconsideredby the privatesector at MepandaUncua(2,400 MW), largely for export. 3 Fourteencountries makeupthe Southern Africa DevelopmentCommunity (SADC):Angola, Botswana, DemocraticRepublicofCongo (DRC), Lesotho,Malawi,Mauritius, Mozambique,Namibia, Seychelles, South Africa, Swaziland, Tanzania, Zambia andZimbabwe. 2  7. Coal resources are also abundant in Mozambique. The commercial development o fthe Moatize coal mines, whose reserves are estimated between 2 billion and 5 billion (bn) tons in Tete province, is being contemplated by South African investment companies and international miningcompanies. 8. There are significant natural gas reserves in Southern Africa, primarily inMozambique, Namibia and Angola. Although natural gas consumption is insignificant inthe region, several projects for expansion o f its use are underway, includingthe proposed Project. Gas was first discovered in Mozambique in the Temane fields in 1956, followed by the discovery o fthe Pande field in 1961. While the combined Temane and Pande probable reserves are estimated to be at least 2.78 Tcf` (of which 2 Tcf are proven), given the limited scope o f exploration in Mozambique thus far, the full extent o f natural gas reserves is far from being established. 9. Mozambique's abundant and diverse energy resource base therefore places it inan excellent position to use energy to leverage its economic growth. Exports o f primary and secondary energy products and o f energy intensive manufactured products could provide a substantial source o frevenues if adequate investment, estimated at about US$10 billion over a five-year period, could be mobilized to exploit the country's full energy potential, including mining. The GoM's national energy strategy, completed in October 2000, gave explicit recognitionto the two key imperatives for an enabling investment climate for the energy sector. First, the strategy recognized the importance of a supportive policy and regulatory framework to optimize the potentialfor private sector-led development o f the sector. Second, given Mozambique's limited institutional and human skills base, the strategy included a G o M decision to utilize external technical assistance for structuring and negotiatinglarge energy export projects, while simultaneously developingdomestic capacity. 10. Even prior to finalization o f the energy strategy, the G o M had enacted a series o f laws to signal the introduction of competition inthe sector, the shifto fthe Government's role from that o fan investodmanager to that o f a policy maker and a business facilitator. The reforms resulted in: (i) the conversion o f major parastatals, Electricidade de Mocambique (EdM) in the electricity sector, Empresa Nacional de Hidrocarbonetos de Mocambique (ENH) in the hydrocarbons sector, and Petromoc inthe petroleum sector, into corporate entities operating under commercial law; (ii)creation o fregulatory/quasi- regulatory bodies in charge o f overseeing the sector; and (iii) a legal framework for unbundlingo f the vertically integrated power utility into several business units and for future privatization o f some o f the business unitsthus created. 11. Subsequently, in 2001 significant changes were introduced inthe petroleum sector with the enactment o f Petroleum Law 3/2001 whose primary objectives were: (i) improve the institutional set- to up and policy framework, inparticular for the upstream development; and (ii) actively encourage private participation and investments in upstream development, particularly the gas sub-sector. Onthe institutional side, the law has prompted the clarification o f responsibilities o fthe key sector entities inthe sector. Inthe Ministry o f Mineral Resources and Energy (MIREME),the National Directorate for Coal and Hydrocarbons (DNCH) was empowered with the oversight o fthe exploration activities. The National Directorate for Energy (DNE) was entrusted with the supervision o f the distribution activities inthe local gas market. 12. Despitethese significant strides in reforming the sector's policy and regulatory framework, Mozambique has yet to implement the enabling regulations, adequately strengthen its sector institutions and establish a track record as an attractive destination for large private sector capital flows. Hence the 4 The reserve estimate is based on a report prepared by independent consultants,DeGolyer and MacNaughton (D & M)of the U.S.A. Sasol's estimate o f probable reserves is 3.2 Tcf. 3  need for: (i)technical assistance to support implementation of the detailed program laid out inthe Letter o f Development Program (LDP) submitted to the Bank in support of the Energy Reform and Access Project (ERAP); and (ii)the proposed IBRDand MIGA guarantees to cover the lenders against political risks inthe transition period while the policy, regulatory and institutionalframework improvements are implemented. The technical assistance (TA) to be provided under ERAP includes support for: (i)negotiationofexploration andproductionagreements,hydrocarbonresourcedatamanagement, and resource assessment, currently being handled by DNCH; (ii)development of a framework for growth of domestic gas markets, including concessioning arrangements, tariff setting, etc. through DNE; and (iii) provision of technical, legal and financial expertise for the Companhia Mozambicana de Hidrocarbonetos (CMH) and the Companhia Mozambicana de Gasoduto (CMG) --- ENHsubsidiaries --- to enable them to participate in the management of thejoint venture for the gas field development and manage the GoM's investment inthe pipeline operations respectively; and (iv) support for building the GoM capacity for management of environmental and impact assessments as well as for monitoring implementation of environmental management plans. This TA will build on the earlier support providedto the GoM under the Gas Engineering Credit (Credit 2629-MOZ) which supportedthe delineation ofthe Pande gas fields, the identification o f private investors and the negotiation of agreements for the commercialization of both the Pande and Temane gas reserves as well as for development of hydropower resources. The earlier efforts have resulted in recent agreementsbetween the GoM and Sasol for the development of the Pande and Temane gas fields and export of the gas to the RSA through an 865 km long pipeline. Exploration for additional gas resourcescontinues with the participation of Sasol and other private investors, in partnership with ENH, the national oil company. 13. Regional Context. While a minimum policy and regulatory framework is a necessary condition for the Project, it would not have been adequate for the realization of this Project inthe absence of a framework for regional cooperation and integration betweenMozambique and South Africa inparticular and in the SADC region generally. Mozambique's ratification of the SADC Protocol in 1999 and increasedtrade relations with South Africa have given impetus to regional integrationinitiatives, particularly in energy, transport and water resourcesmanagement. Foreign direct investment in infrastructure (N4 toll road linking Maputo to Gauteng province in South Africa, railways, power transmission concession) is concentratedaround the Maputo, Nampula and Beira corridors and includes significant participation of regional financial institutions and the private sector. Low Access to Modern Enerm 14. Only about 6 percent of Mozambican householdshave access to electricity, and over halfof these are in Maputo, the capital, and its surrounding areas. O fthe 120 or so "district capitals" more than 50 are without any form of public electricity supply, or have sporadic supplies from small diesel-fueled gensets to a handful of customers via old and poorly maintained small grids. Inthe supplied areas, supply reliability is low. Access to petroleum products by households(liquefied petroleum gas and kerosene), which could help to reduce the dependency on woodfuel, is also very low due to inadequatepurchasing power, high import transportation and storage costs. 15. The GoM's strategy for increasing access to modern energy forms involves: (i) for electricity, the supplementation of the traditional grid extension approach with a package o f technical and institutional changes to lower costs of service, enhance affordability, and bring in competitive private sector participation; and (ii)for petroleum products, the recent liberalization of the market and the ongoing restructuring of Petromoc, the national downstream company, to improve efficiency and reduce products' costs. The ERAP will initiate a program for addressingthis problem more comprehensively over a number of years. Inthe case of natural gas, it is expectedthat demand by households will be negligible (given the climate, and affordability considerations); on the other hand, domestic gas resources could be 4  used primarily for power generation, to complement hydroelectric and coal-based power plants, wherever the economics sojustify. Mozambique already has some experience with the development and operation o f gas-to-electricity mini-gridswhich were developed under the IDA-assisted UrbanHouseholdEnergy Project inthe Inhambane province. Limited Institutional and Human Resources Capacitv 16. While Mozambique has made significant progress inreforming the energy sector, the limited institutional and human resource capacity remains a major constraint to the design and implementation o f projects and programs necessary for achieving results on the ground. Thus, DNCH, DNEand ENH continue to require substantial technical assistance inputs to execute their functions. This situation is likely to persist for some time to come, given the scarcity o f graduates with adequate skills. 17. The GoM intends to support implementation o f its energy strategy with strengthening its key sector institutions --- the technical regulatory agencies and ENHsubsidiaries (in the transition to privatization) --- and training o f their staff. The strategy also includes better selection and coordinationo f donor technical assistance support, more focused training to address the priorities at hand, and increased reliance on the private sector. Adverse Environmental. Livelihood, and Health Impacts o fEnergy Production and Use 18. Most o f Mozambique's primary energy demand is met by traditional biofuels (wood, charcoal, and agro/animal wastes). Heavy reliance on biofuels imposes significant environmental costs. The growing demand for charcoal and fuelwood, combinedwith inefficient charcoal production practices, has led to significant depletion o f forest stocks. Inaddition, traditional combustion technologies and practices cause indoor pollution, with adverse health consequences, particularly for women and children. Use o f modern cooking fuels is limited, even in urban areas, by their highcost inrelation to incomes. 19. To mitigate the above adverse impacts, the GoM strategy includes: (i) expansion o f access to modern forms o f energy to partially substitute for biofuels; (ii)reforming the legal and regulatory framework for land use, wood extraction, and charcoal production and its transport; (iii)strengthening the resource management capabilities o f the rural communities and creating alternative means o f income generation, other than wood fuels exploitation; and (iv) employing more efficient and/or cleaner technologies. Studies to be undertaken by the G o M for the possible use o f gas inthe domestic market will include an economic feasibility study o f substitutingelectricity for biomass fuels, which could help to mitigate the adverse environmental impacts o f bio-fuels. Sector Issues to be Addressed by the Project and Strategic Choices 20. The World Bank Group support will facilitate financial closure for the Project, thereby helping Mozambique to attract investment to the sector and to begin to establish a track record for the sector as an attractive destination for significant private sector capital flows. World Bank Group assistance for expansion o f access to modern forms o f energy and for strengthening sector institutions and human resources will be provided under the Energy Reform and Access Project as indicated above. 21. The Project concept outlined here reflects several strategic choices by the Mozambican authorities. The alternative choices for maximizing the value o fthe Pande/Temane natural gas resources are: (i)gas distributionto households; (ii)fuel oil and some diesel oil substitution; (iii)gas use for 5  electricity generation; and (iv) the creation of new gas-based industries. Options (i)and (ii)--- distribution of gas for householduse and substitution of fuel and diesel oils, either separately or taken together, do not present a sufficiently large market to make exploitation of the gas reservescommercially feasible. For example, the consumption o f fuel oil in Mozambique is very small and dispersed(about 20,000 tons per annum) so that local gas grids will have little economic merit inthe short-term. The alternative of using gas to produce electricity for the domestic market is also not viable because Mozambiquehas substantial hydropower resourceswhich are more competitive than gas, although gas is a suitable option for small-scale complementary systems. At the same time exportinggas-based power is constrained by the current surplus inthe RSA, the largest potential market. The fourth option would be to create gas-based industries, but their viability would needto be establishedand this would take time. Still another alternative would be to convert the gas to LiquefiedNaturalGas for export markets --- but, the provenreserves, at 2 Tcf, are insufficient for this type of application. Thus, because of the limited opportunities for using gas resources internally, Mozambique has not beenable to exploit these reserves since they were discovered in the early 1960s. This leaves the alternative of gas exports to the RSA as the only viable option for Mozambican gas. Inthe short- to medium-term, Sasol is the only buyer with in- depth technical expertise, the financial wherewithal, knowledge of the gas market, and an existing adequate customer base to make the project viable5. 22. Mozambique also hadto makethe strategic choice regardingthe mode for developing the gas resources as a public sector project, private project or public-private partnership. Commercializationof the gas resources by public sector institutions was ruled out early on due to limited financial resources and lack of appropriate technical skills and access to markets and technology. At the same time local participation was seen as essential to allay the political risks associatedwith the exploitation of such a large resource-basedproject. However, there were no domestic private enterprises with the requisite human, financial and technical skills to partner with Sasol, hence the decision to include ENHas a public sector sponsor, The GoM long-term strategy, nevertheless remainsto include local private sector participation, once the project has become operational and qualified local parties are identified, a process that is being supported by IFC advisory services. World Bank GroupAssistance Strategy 23. The World Bank Group is supporting the GoM's strategy with the following ongoinghecently completed and proposedoperations. (a) Gas EngineeringProject (Cr, 2629-MOZ, closedJune 30,2003) --- providedsupport for: (i)Pandegasfielddelineationtoprovetheadequacyofreservesforcommercialization; (ii)negotiationofagreementsforcommercialization ofthePande/Temanegasfieldwith investors; and (iii)initiation of the process of strengthening Mozambique's gas sub-sector institutions to enable them to play a substantial role in future gas operations. (b) EnergyReformand Access Project (approvedby IDA'S ExecutiveDirectorson August 19, 2003) --- willhelp Mozambique to: (i)expand access to electricity ina commercially viable manner so as to support economic growth and the provision of social services; and (ii)strengthen key institutions inthe sector, including targeted support to: (a) the gas sub-sector institutions, DNCHand MICOA to enablethem to monitor implementation of contractual obligations under this project; (b) DNEto develop a framework for development ofthe domestic markets for gas; 5 Severalcompeting proposalsfor commercialization o f Mozambique's gas, includingthose of ARC0 and ENRONwere considered, but ultimatelyonly Sasol was able to providea viable scheme. 6  and (c) ENHsubsidiariesthrough provision o f technical, legal and financial services to help manage the GoM's interests inthe transition to privatization. Proposed Southern Africa RegionalGas Project --- for which: (i)two IBRDenclave partial risk guarantees will cover definedcommercial lenders against Mozambicanpolitical risks, thus enabling the sponsors to raise required commercial debt at reasonable prices and maturities and enable completion o f the Project; (ii)a MIGA guarantee for political risks for equity was approved by MIGA's Executive Directors inDecember 2002 and additionalpolitical risk coverage for debt is being proposed; and (iii)an IFC equity investment will be made in the Project's upstream component. IFC Support for Gas Distribution --- IFC is working with the Matola Gas Company, ajoint venture between Gigajoule Africa o f the RSA and ENH, which plans to distribute gas inthe Matola industrial area near Maputo. The Matola Gas Company will supply gas to industrial customers, including to Mozal for its second stage expansion, through a 75 km pipeline to be connected to the main pipeline at Ressano Garcia, one o fthe five gas take-off points in Mozambique. IFC is examinin the possible use o f carbon credits to improve the gas distribution project's commercial prospects . I!? Southern AfricanPower Market Project --- aregional project which aims to promote power trade amongthe pool members, will facilitate investment flows into Mozambique to develop its abundant energy resources, particularly hydro, for the regional market. The first phase o f this Adaptable Program Loan is scheduled to be discussed by the Board on November 11,2003. The second phase which includes construction o f a transmission line to link Mozambique to Malawi is scheduled to be discussed by the Board inthe first quarter o f FY2005. This transmission link will enable Mozambique to earn revenues from power sales to Malawi while the latter will be able to increase its power system security and to avoid higher power costs inthe long run. ProjectDescriptionSummary ProjectDescription(Annex 2) 24. The Project consists o f two key distinct but integrated components: (i)the upstream component (the gas fields development and central processing facility); and (ii)the transmission component comprising the gas pipeline from Mozambique to the Republic o f South Africa7. The Pande and Temane 6 Sasol is also consideringthe use of carboncredits in South Africa and has alreadycommencedregistration of the Project in this regard. 7 This is the project definition adopted for the purposes of project analyses (including safeguards issues), however, for the purposes ofthe use o fthe proceeds of the debt guaranteed by the Bank, the Project includesonly those components which are physically locatedinMozambique; i.e. the upstreamcomponent and the gas pipeline to the Mozambique-RSA border. Section4 (i)ofArticle 111ofthe IBRDArticles of Agreement provides that IBRD may guarantee, participate in, or make loans to a member, a political sub-division of a member or an enterprise in the territory of a member on the condition that, when the member in whose territories the project is locatedis not itself the borrower, the member or the central bank or some comparable agency o f the member which is acceptable to IBRD, fully guaranteesthe repayment ofthe principal and paymentof interestand other charges on the loan. As the proceeds of the loans guaranteed by IBRDwill only be used for the components o fthe Project locatedin Mozambique, IBRDwill only seek a counter-guaranteefrom Mozambique and not the Republic of SouthAfrica. This approach has been followed by IBRD in guarantees for other cross-border projects, including the Sea Launch Project and the Bolivia-Brazil Gas Pipeline Project. 7  gas fields reserves are estimated to be at least 2.78 trillion cubic feet (tcf), o f which 2.0 tcf are proven. The Project's upstream component includes two sponsors, Sasol, a leading South African petrochemical company with a market capitalization o f approximately US$8 billion, and ENH, the Mozambicannational oil company which, through its subsidiary, CMH, will hold the GoM's interests inthe upstream.*. The pipeline component o fthe Project includes three sponsors, Sasol, CMG, a subsidiary o f ENHand i-Gas, a subsidiary o f the South A h c a n Government's Central Energy Fund(CEF)'. Implementation o f the Project i s substantially completed with more than 80% o f the Mozambican and more than 60% o f the South African sections o f the pipeline already completed as o f June 2003 and more than 80% o fthe central processing facility also completed as o f the same date. (a) The UpstreamComponent. The fields are locatedinMozambique's Inhambane Province. An unincorporatedjoint venture (UJV)consisting o f Sasol PetroleumTemane Limitada (SPT), a wholly owned subsidiary o f Sasol, C M H and IFC will develop the gas fields and the associated processing facilities. Sasol has been designated as the operator o f the UJV. Itplans to make use o f the five previously drilled appraisal wells and develop the Temane gas reservoir first as it has higher pressure than the Pande reservoir. Gas will ultimately be gathered from 18 wells inthe Temane field and later on from 16 wells inthe Pande Field as the pressure equalizes, giving a total o f 34 wells, phasedinover the life o f the combined fields to maintain the sales plateau. The Central Processing Facility (CPF), which i s part o f the upstream component, will be constructed at Temane. The raw gas will be gatheredthrough a 177 kmnetwork and processed at the CPF where it will be dehydrated, the condensate will be extracted, and the gas compressed into the inlet flange o f the gas pipeline for transportation to downstream customers. The CPF consists o f gathering networks linkingthe wells, drying, compression and condensate removal facilities. The Project includes associated infrastructure, such as roads, utilities, workshops, accommodation unitsandoffices. (b) The GasPipelineComponent. The gas pipeline component consists o fan 865-km 26-inches diameter highpressure steel pipeline between the gas fields and Sasol's petrochemicalcomplex at Secunda in South Africa. The pipeline will be constructed by the Republic o f Mozambique Pipeline Investments Company (Pty) Limited (ROMPCO), currently a Sasol wholly-owned subsidiary and will be operatedby Sasol Gas Limited. It will be buried at a minimumo f one meter below the ground surface. Without initial intermediate compression, the pipeline will have a capacity o f 120 MGJ/a. Sufficient wall thickness has been allowed inthe gas pipeline design to enable the capacity o fthe pipeline to be doubled to 240 MGJIa with the addition o fmidpoint and quarterpoint compression, should market demand and availability o freserves justify this. The pipeline design includes five take-off points inMozambique (at Ressano Garcia/Maputo, Magude, Macarratane, ChigubdFunhalouro and Temane) to provide for possible domestic use o f gas. The 525-km Mozambican route portion will start at the Temane CPF to the immediate North West o fVilanculos, and proceed to the Mozambique-RSA border near the town o f Ressano 8 Under the PetroleumProduction Agreement (PPA), C M H has a 30% interest inthe gas fields and an option, under the Joint Operating Agreement to acquire a 30% interest inthe Central Processing Facility (CPF). While the C M H has not yet exercised its option for the CPF, C M H intends to do so. The Project i s preparedon the basis that CMH will exercise its optionfor a 30% interest inthe CPF andthat it will farm- out 5% o f its interest inboth the gas fields and the CPF to IFC. 9 The Governments o fMozambique and South Africa through C M G and i-Gas respectively have an option to acquire up to an aggregate o f 50% o f shares inROMPCO. 8  Garcia, from where the SouthAfrican portion thencontinuesto Secundawhere it will be tied into Sasol's gas distribution network. 25. To utilize the gas imports in South Africa, Sasol, the Project's private sponsor, will carry out the following activities which are outside the scope ofthe Project: (i)conversiono f its gas distribution network equipment andcustomer systems, from hydrogen-richgas to natural gas; (ii) conversion ofthe Sasol's Sasolburgchemicalcomplex from coal to gas as a feedstockfor chemicalproduction; and (iii)modificationofSasol'ssyntheticfuelplantinSecundatoaugmentcoal-basedgrowthinthe production of petroleum and petrochemicals. All ofthese components are beingundertakenby Sasol on an integratedproject management basis in order to ensure alignedcompletion. Over a periodof thirty years, Sasol Gas Limitedhas developeda pipeline network coveringmore than 1,500 km anddelivers gas to over 600 customers, mainly inthe industrial sector. A trainedteam will helpthe customersto convert in a phased approachafter the arrival of naturalgas in South Africa. Sasol believesthere could be a substantial increase in industrial consumptionof gas which is currently constrainedby inadequatesupply. Sasol Gas's captive market (SasolChemical IndustriesLimited, National PetroleumRefineries of South Africa Ltd. and Sasol Synfuels(Pty) Limited) and its third party customerswill form the base load required for the Projectat about 94 MGJ/a. One ofthe motivations o f Sasolto import gas is as an alternativeto the imminent needto develop a new coal mine given that the previous coal source had reachedthe end of its economic life. Sasol will still develop a smaller coal mine for generationof electricity. Project Costs and FinancingPlan 26. Financing is being organizedfor expendituresto be incurreduntilDecember 2004 (Initial Funding Period), after which cash generated by the Project as well as sponsors' equity contribution will finance further development. The Project cost on this basis is estimatedto be US$721million (excluding capitalized finance charges), but including anamount of US$96.7 million incurred by Sasolprior to the signatureofthe key PetroleumProductionAgreement (PPA) inOctober 2000 (Sunk Cost). The Project cost of ~ $ 7 2 million includesUS$317 million for the upstreamcomponentand US$404 million for the 1 pipeline component (Annex 3 (a)). 27. The financing ofthe Project is being structuredand implementedintwo separate financing and security packagesfor the upstreamandpipeline components. The gas fields andthe CPF will be financed jointly by SPT, CMH and IFC in the ratio 70:25:51