Romania - Riul Mare - Retreat Hydropower Project

FILE C OPY Report No. 1103-RO Appraisal of the Riul Mare-Retezat Hydropower Project Romania March 17, 1976 Projects Department Europe, Middle East and North Africa Regional Office FOR OFFICIAL USE ONLY Document of the World Bank 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 (As of March 1976) Currency unit = leu(s), lei (pl) lei 20 = US$1.00 lei 1 = US$0.05 lei 1,000,000 = US$50,000 US$1 = lei valuta 4.97 in convertible currency terms = lei valuta 6.67 in Comecon currency terms WEIGHTS AND MEASURES m = meter = 3.28 feet km = kilometer = 0.62 mile ha = hectare = 2/47 acres i3 cubic meter = 1.31 cubic yards kWh = kilowatt hour = 3,414 British thermal units GWh = Gigawatt hour = 1 million kWh kW = kilowatt 1 thousand watts MW = Megawatt = 1 thousand kW kV = kilovolt = 1 thousand volts t = metric ton (tonne) = 1.1 US tons = 2,204.6 pounds 1 = liter cm = centimeter atm = atmosphere min = minute of time k/cm2 = kilogram per square centimeter mt/s cubic meter per second hr = hour GLOSSARY OF ABBREVIATIONS I.B. = Banca de Investitii (Investment Bank). CIEET = Centrala Industriala a Energiei Electrice Si Termice (Industrial Central for Electric Power and Heat). MEE = Minislaubii Energiei Electrice (Ministry of Electrical Energy). ISPH = Institutul de Studii si Proiectari Hidroelectrice (Institute of Hydroelectric Studies and Designs). tSCM = Santier Constructu Montaj (Distribution Construction Department). ISPE = Institutul de Studii si Proiectari Energetice (Institute of Power Studies and Designs). Government of Romania Fiscal Year January 1 to December 31  FOR OFmFCIAL USE ONLY APPRAISAL OF THE RIUL MARE-RETEZAT HYDROPOWER PROJECT ROMANIA Table of Contents Page No. STARY ...... ......... .. i-ii I . INTRDDUCTION ....................................... ......... 1 II. THE POWER AND ENERGY SECTOR . .. .. ...... 2 A. Power and Energy Resources . ................. 2 B. Power and Energy Sector ..................... 4 C. The Development Program ..................... 8 III. THE PROJECT ...................................... 9 A. Objectives ................................ . 9 B. Description ....... .......................... 9 C. Status of Engineering ..... .................. 10 D. Cost Estimate ....... ........................ 11 E. Financing ..12 F. Implementation ............... .. ............. 13 G. Environmental Impact . ...................... . 15 IV. THE PROJECT ENTITY ............................... 16 V. FINANCE ... ....................................... 16 A. Past Performance and Present Position of the Sector ........ ................. . 16 B. Financing Plan .............................. 18 C. Future Performance ........... ............... 20 D. Accounts and Audit . ........................ . 21 VI. BEMEFITS AND JUSTIFICATION .... .................. 21 VII. AGREEMENTS REACaED AND RECOMENDATI(O ............ 23 This report was prepared by Messrs. J.N.M. Green (Engineer), P.A. Cordukes (Financial Analyst) and R. Bloor (Consultant). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. 1I contents may not otherwise be disclosed without World Bank authorization.  Table of Contents (cont'd) ANNEXES 1. Council of Ministers of the Socialist Republic of Romania - Decision 2. Energy Generation, Sales History and Forecast 3. Electric power tariffs 4. Electric Power System Capability and Maximum demand 5. Electric Power Sector Planting History and Forecast 6. Civil Engineering Design Aspects of the Project 7. Capital Estimate as of December, 1975 8. Statement concerning tConvention" regulating riparian interests 9. Program of Execution 10. Estimated Schedule of Disbursement 11. An Extract from the Ecological Report on the Impact of the Project 12. Income Statements for the Years 1973-1985 13. Balance Sheets for the Years 1973-1985 14. Sources and Applications of Funds 1973-1985 15. Notes and Assumptions for Financial Forecasts 16. Justification 17. Comparison with Alternatives MAPS Electricity System (IBRD 11790) Riul Mare-Retezat Hydropower Project (IBRD 11791)  APPRAISAL OF THE RIUL MARE-RETEZAT HYDROPOWER PROJECT ROMANIA Summary i. This report appraises a hydroelectric power Project for the Govern- ment of Romania. The Project comprises a clay-cored rock-fill dam 173 meters high to be constructed on the Riul Mare river. It includes a 335-MW tnder- ground power station, Retezat, with two generating units and a smaller 14-MW power station at Clopotiva. Retezat is in the Transylvanian mountain region of Central-West Romania. ii. The total cost of the Project is estimated to be US$250.1 million equivalent having a foreign exchange content of US$54 million towards which a loan of US$50 million is proposed. This amount would represent about 20% of the estimated cost of the Project and about 93% of the foreign exchange costs. The remainder of the finance will come from internal sources of the Industrial Central and the State Budget. iii. The Project is a part of the 1976-80 5-Year Plan of the Industrial Central for Electric Power and Heat (CIEET) which collates and coordinates the power sector production and investment plans for the Ministry of Electrical Energy (MEE). Execution of the Project will be the responsibility of the Hatzeg generating enterprise which has been established specifically for carry- ing out the Project and associated future power developments. As in the case of the first power loan 1028-RO, the Turceni Thermal Power Project, the Minis- try's design institutes and construction trusts will design and construct the Project works, and the loan will be made to the Investment Bank (IB). Construc- tion started in the last quarter of 1974 with the upgrading of access roads. The generating units are expected to be installed by the end of 1981 and the dam construction to be completed in 1903. A detailed study of the impact of the Project on the ecology of the area has been made. The Bank will seek the Government's agreement to reduce to a minimum the adverse impact of the Project on the environment. The proposed arrangements for the organization and imple- mentation of the Project are acceptable. iv. Demand for power is expected to have increased 10% in 1975, about 7% p.a. in 1976-80 and 6% thereafter to 1985. The objective of the Project is to supply a part of the peaking power needs of the system. The plant will contribute directly and indirectly 469 MW and 739 GWh p.a. to the system in an average water year. In 1985, the system primary peaking demand will be of the order of 3,200 MW towards which the main hydro peaking stations in- cluding the timely Riul Mare-Retezat Project would contribute 1,800 MW.  - ii - v. The Romanians have proposed a suitable list for the selection of contracts covering goods to the full value of the loan, suitable for interna- tional competitive bidding under the Bank's guidelines. It is expected that Romanian suppliers would compete successfully such that local currency ex- penditures totalling about US$39 million will be covered under the loan. vi. The CIEET's financial performance in 1973 and 1974 was not as good as expected. The rates of return on average net fixed assets and working capital declined from 4.6% in 1973 to 2.9% in 1974 compared with rates of about 5-6% expected at the time of the Turceni Appraisal. However, if taxes are treated as a debt service item and not as an operating expense, these rates of return improve to about 9%. Despite difficulties in meeting planned tar- gets over the last 2 years these results still reflect satisfactory financial performance. The CIEET investment plans for the Project construction period 1975-81 will require about IJS$4.4 billion. Internal sources are expected to finance 33%, the State Budget 64% and IBRD loans including the proposed loan about 3%. The forecasts for 1975-85 show the average contribution to invest- ment from internal sources would be 31%. This level of performance would be satisfactory in the Romanian context. As the power sector plans are inte- grated with those of the rest of the economy, changes in the demand for funds in the power sector are absorbed by the State budget. Tariffs and prices are reviewed as part of the long-term planning process and any changes are reflected in the forecasts for the economy as a whole thus preventing distortion during plan implementation. Therefore, the Bank expects that the Government will re- view electricity tariffs at 5-year plan intervals. The Government has described its current policy and plans for the financing of the power sector and has agreed in a supplemental letter to continue to furnish financial and economic information to enable the Bank to evaluate benefits of the Project. vii. Though the Romanians used a mathematical model in 1972 to simulate the power sector development which pointed to the need and appropriateness of the Riul Mare-Retezat Project to meet system primary peaking demands, the mission was not able to verify the result. The Borrower has agreed to provide to the Bank an analysis of the future electric power sector development com- plete with data and methodology used, before requesting it to consider fi- nancing a further power project in Romania. A comparison with alternative gas turbine and pumped storage projects showed the proposed Project to be attractive. The economic rate of return is estimated to be 6-1/2%. viii. A statement by Romania quoting from an existing relevant agreement with Hungary declares that the Project does not infringe on the riparian rights of Hungary. ix. In the circumstances of the agreements reached, the Project is suit- able for a Bank loan of US$50 million to the Investment Bank with the guarantee of the Government of Romania. A term for the loan of 20 years including 5 years of grace is proposed.  APPRAISAL OF THE RIUL MARE-RETEZAT HYDROPOWER PROJECT ROMANIA I. INTRODUCTION 1.01 The Government of Romania has requested a loan from the Bank to finance the Riul Mare-Retezat Hydroelectric Project (the Project). Forming part of the development plan of the electric power sector, the Project is to be executed by the Hatzeg Enterprise which itself is an organ of the Indus- trial Central for Electric Power and Heat (CIEET) under the control of the Ministry of Electrical Energy (NEE). The Investment Bank (IB) will be the Borrower. 1.02 The Project comprises a clay-cored, rock-fill dam across the Riul Mare river with supplementary diversions of neighboring streams discharging through a headrace tunnel to an underground power station with 335 MW of plant delivering 605 GWh p.a. which in turn discharges in direct cascade to an above ground power station having 14 MW of installed plant delivering 25 GWh p.a. Cascade power generating schemes on the Riul Mare downstream to its confluence with the Strei river and thence along the Strei to its confluence with the Mures river (Map IBRD 11791) can be enhanced by 141 MW of power and 111 GWh p.a. of energy output as a consequence of the water stored and re- gulated by the Project dam. Connections will be made with the main 220-kV transmission network. 1.03 The Project is estimated to cost US$250.1 million equivalent. The foreign cost is estimated to be US$54 million towards which a loan of US$50 million is proposed. 1.04 Finance for the Project was assured at the time the Council of Min- isters approved the principal techno-economic indicators (para. 3.07) relating to the investment. This approval was granted on December 20, 1974 by a "Deci- sion" signed by the President of the Council of Ministers. The document details the main parameters of the Project: physical, financial and opera- tional as well as delegating certain powers and discretions to facilitate its execution (Annex 1). However, the Government has requested Bank assistance in meeting the foreign cost component. 1.05 The Bank has made one loan for the development of the Romanian power sector; Loan 1028-RO of US$60 million in 1974, for a 1320-MWf steam power plant burning lignite, including transmission lines at 400 kV and 110 kV some 600 km in length, and an associated switching station. Apart from disburse- ment delays related to unfamiliarity with international competitive bidding procedures, the project is progressing satisfactorily.  - 2 - 1.06 This report is based on a technical and economic study prepared by the Institute of Hydroelectrical Studies and Desizns (ISPH) of the MEE entitled "Riul Mare-Retezat UHE - Technical Economical Synthesis Studv" dated March 1975, and the findings of a Bank mission consisting of Yessrs. 2. GrCe1. . C&ordukes and R. Bloor (Consultant) which visited Romania from June 4 to 24, 19715. 1.07 Whereas the appraisal of the first power loan was carried out through the MEE, this appraisal was undertaken largely with the assistance of the Investment Bank. The arrangement restricted the mission's access to informa- tion and staff of the MEE who were better acquainted with the Bank's require- ments for power sector loans, following the experience with the first loan. The appraisal reflects the best judgments of the mission on the basis of the information obtained. II. THE POWER AND ENERGY SECTOR A. Power and Energy Resources 2.01 Romania is nearly self-sufficient in energy resources which are principally crude oil, natural gas, coal, lignite, and hydroelectricity; some of this last is on international borders and shared with riparians. In addi- tion, bituminous shale and geothermal resources are being investigated and may prove to be exploitable. Crude Oil 2.02 Crude oil production is approximately 14.5 million tons p.a. and imports have risen gradually, standing at about 6 million tons in 1974. Ex- ports of refined petroleum products have risen in parallel with imports and were 4.6 million tons in 1974. Whilst the known indigenous reserves of oil are expected to last only through this decade at the present rate of extrac- tion, oil exploration including off-shore drilling in the Black Sea is in hand, but prospects are uncertain. Natural Gas 2.03 Natural gas reserves are estimated to last a further 30-50 years at the present 30 billion m3 p.a. extraction rate. In recognition of the dwindling reserves of oil and gas, the cost of oil in foreign exchange and the value of gas as a chemical feed stock, the Government has placed an embargo on their use for heating purposes in new plants including power sta- tions. W4here possible, plants using oil or gas for heating are required to be converted to an alternative fuel.  -3- Fossil Fuels 2.04 Th- fossil fuel reserves are 90% lignite; 3,000 million tons are estimated to be exploitable with present techniques, that is about one third of the total deposits. Nearly all the lignite is found in Oltenia where by 1985 the ultimate capacity of the field is likely to be developed at 54 mil- lion tons p.a. Of this output only 10.6 million tons p.a. is uncommitted and available for use in plants to be commissioned in the period 1980-85. The use of bituminous shales to the extent of 1.4 million tons p.a. is proposed although the technology for its successful application is still not adequately developed. Hydro 2.05 The hydro resources of Romania are assessed at 12,300 MW capable of providing 37,000 GWh p.a. from some 630 sites. Of this, 2,400 MW and 12,300 GWh p.a. is Romania's share of five installations on the river Danube. By 1975, 2,622 MW (22%) of the hydro resources had been developed and become operational, and the Iron Gates I station on the Danube contributes 40% of this. A further 1,800 MW (15%) of the resources is either under construction or com- mitted. Of the uncommitted balance (7,878 MW), 17% is located in four sites on the Danube and the remainder would need to be exploited in some 580 sites having an average capacity of 11 MW and only a few of these will individually contribute appreciably to the system capacity whilst most are at present too expensive to justify development. The Riul Mare Project is the largest of the remaining sites which can be exploited at an acceptable cost. Geothermal 2.06 A new impetus has been given to the search for geothermal resources in commercial quantities, but no information on this subject was made avail- able. Existing Facilities 2.07 By 1974, the total installed plant capacity of Romania of which 96% is interconnected, was 10,676 MW delivering 46,301 GWh p.a. and meeting a system demand of 7,470 MW during the December peak period. The apparently large plant margin is a result of the restrictions introduced in November 1973 to cope with the oil crisis resulting in a reduced growth of demand. Details of generation and sales 1970 to 1974 are given in Annex 2. The largest unit sizes now being connected to the system are of 330-MW rating. Hydro plant contributed 2,383 MW (22%) of system capacity and 8,399 GWh (18%) of the energy. The interconnected system is shown on Map IBRD 11790 annexed hereto.  - 4- International Power Connections 2.08 International power connections exist with Hungary at 400 kV, with Czechoslovakia at 400 kV through USSR, with Bulgaria at 220 kV and a second link with Yugoslavia is in preparation but not yet connected. At present, exports of electric energy to Czechoslovakia, in payment for plant supplied, are the main international transfers. Under this contract 2,000 GWh p.a. are being exported to Czechoslovakia until 1980. Imports of energy and ca- pacity are small and no reliance is placed on them. B. The Power and Energy Sector Organization of the Power Sector 2.09 The Ministry of Electrical Energy (MEE) administers the sector through a board comprising the minister, three deputy ministers and the various direc- tors of subordinated organizational units. The NEE presently employs in ex- cess of 100,000 personnel and is responsible overall for the research, plan- ning, design, construction and operation of all public power supply installa- tions in Romania. 2.10 Among the various units subordinated to the NEE are design and re- search institutes, training centers, construction trusts, foreign trade enter- prises and a national dispatch center. It is the design institutes and the construction trusts which are responsible to the MEE for the preparation, design, construction and supervision of major power projects in Romania, including the Riul Mare-Retezat Project. 2.11 Power generation, transmission and distribution facilities are op- erated by enterprises which report to the Industrial Central for Electric Power and Heat. (In addition to selling electric energy, some of the generat- ing enterprises also sell heat, in the form of steam, to industrial and agri- cultural undertakings.) The Central collates the 5-year and annual investment and production plans of the enterprises, which are then submitted to the MEE. Each enterprise prepares monthly production statements and balance sheets for the Industrial Central, which serves as the head office of the enterprises supervising their activities and reviewing their finances. The Industrial Central has a staff of about 160 and is directed by one of the deputy minis- ters of the NEE. 2.12 There are 16 generating enterprises employing about 17,000 staff and 17 distribution enterprises with about 28,000 staff. A generating enter- prise is a self accounting unit responsible for a single plant or a group of generating plants covering a manageable regional area and distinguished by its thermal and hydro character. The distribution enterprises are similar, but within each is a distribution construction unit (SCM). Distribution works up to 110 kV are designed by staff of the enterprises but the SCM units carry  - 5 - out the construction. The SCM units employ about 4,000 staff and are inde- pendent self-accounting departments of the distribution enterprises. There are also two manufacturing/repair enterprises (about 4,000 staff) which sup- ply and service the generation and distribution enterprises. Legislation 2.13 The organizational units of the MEE including the Industrial Central and its enterprises are basically subject to the same legislation 1/ as that which regulates and controls all economic units in the Romanian socialist sys- tem. Some of this legislation, which is implemented through Ministry of Fi- nance instructions, covers matters ranging from depreciation rates, classifica- tion of accounts, distribution and payment of benefits, to the preparation of financial reports for the Central. 2.14 The Ministry of Electrical Energy has its own statutes or regulations which prescribe the functions and use of electric energy. They incorporate the tariff rates, conditions of supply and instructions on the application of the regulations. Management and Management Systems 2.15 Each enterprise is headed by a General Assembly of the Working People which is represented by a Working Peoples Committee and an Operating Management Collective. The Assembly generally meets twice a year. Similarly, the manage- ment and direction of the Industrial Central and all other organizational units of the MEE is directed by representatives of the people. Executive responsi- bility is in the hands of the general manager, (who is appointed by the min- istry), assisted by an executive board. In the case of the NEE, the minister and the heads of the respective organizational units have executive authority. 2.16 The best evaluation of the competence and the adequacy of the man- agement and staff can be gauged from the performance of the sector. The min- ister and the deputy minister of the MEE are technical specialists who have been appointed from within the electric power sector, as is generally the practice in technical sectors. Despite the very rapid growth of the system over the last decade, staff of the enterprises appeared competent and knowl- edgeable, exercising delegated authority and responsibility. Performance trends per employee have been consistently upward in the past decade. Al- though this undoubtedly reflects the general growth in the sector (e.g. in- creasing sizes of generating units), the general impression gained is one of increasing efficiency combined with productivity gains. Management methods and decision-making processes, while following a procedural code and con- strained by the dictates of standardization, employ modern tools and methods for data collection and evaluation. The design institutes and the construc- tion trusts of the MEE have proven performance records and they seem to be largely independent of foreign consulting services. 1/ Law No. 11/71 - covers organization and management of the Centrals and Enterprises. Decree No. 76/73 - covers organization and management of the Ministries and other State Bodies.  6 Insurance 2.17 Insurance of normal business risks is not practiced in Romania. However, enterprises do set aside a small share of benefits (para. 2.20) to cover unforeseen events. This reserve is sufficient to meet minor loss or damage. The Government acts as its own insurer supporting enterprises which suffer major losses arising from events beyond their control. Where normal budget provisions are not adequate to meet the cost of replacement of a major asset, specific provision is made in the next State Budget. Tariffs 2.18 Tariffs are approved by the Council of Ministers and are uniform throughout the country. They have been virtually unchanged since 1963 ex- cept for some restructuring as from January 1974 which introduced additional differential tariffs for low, medium and high voltage consumers (Annex 3). These changes were expected to increase revenues by only about 1% in 1975 and provide an average revenue per unit sold of .321 lei or US1.6 cents equiva- lent. This restructuring has helped to better reflect the cost of supply in distribution tariffs. Over 95% of the 4.8 million consumers are domestic who use about 8% of energy generated and provide about the same proportion of revenues. On the other hand large industrial consumers use more than 70% of generation and provide about 66% of the revenues. In recent years tariffs have adequately covered operating and administration costs and provided about half of future investment needs. Little information was obtained on the ex- tent to which the tariff structure reflects the marginal costs of supply. It is clear that the Government broadly aims to keep power prices as low as possible to foster industrial growth. During the next 1976-80 plan period it is not proposed to increase tariffs; any increases in costs are expected to be absorbed. Therefore tariff yields are expected to decline in real terms up to 1980. After 1980 the proposed joint developments with neighbouring countries, Iron Gates II and Turnu Maguarele with Yugoslavia and Nicopole with Bulgaria are expected by the MEE to increase efficiency and reduce average costs of production. Financing of the Sector 2.19 Being part of a centrally planned economy, the power sector finan- cial plans are integrated with those of all other sectors to form the Socio- Economic Plan. This plan covers a 5-year period, currently 1976-80. Prior to the commencement of each year, the annual production and investment plans for each sector are collated and submitted by each Ministry to the State Planning Committee and the Ministry of Finance, which coordinate all financial needs into a Financial Plan. The main component of the Financial Plan is the State Budget but the Financial Plan also includes self-financing of enterprises, funds from depreciation, and foreign funds. The Socio-Economic Plan, the Fi- nancial Plan and the State Budget are submitted through the Council of Minis- ters for the approval of the National Assembly whereby they achieve the status  - 7 - of law. Finance required to meet the production plans is allocated from State Budget funds by the National Bank. Each enterprise is allowed a "minimum' normal working capital calculated according to a prescribed formula and any additional requirement can be obtained from the National Bank as a short term loan. These loans are subject to a nominal rate of interest (2 to 5%) and are available for periods of up to a maximum of 12 months. 2.20 The distribution of benefits or net income is planned when the an- nual production plan is prepared. The first priority is a minimum contribu- tion of 10% of net income, payable to the State Budget. The xworkers' share of benefits, if the planned level of benefits has been attained, is then also paid. This benefit normally amounts to 2% of the annual net wages bill and is increased or reduced proportionally to the degree to which planned benefits are exceeded or not met. Loans and working capital must be repaid and the Industrial Central then receives a portion of benefits, sometimes as much as 70-80%, towards its re-investment requirements. Between 1% and 4% is left to each Enterprise to improve social amenities and to cover capital revairs and other minor investments. There is also a reserve fund not exceeding 0.5% to meet expenditures on representation and unforeseen expenditures. Should there be any balance remaining after the first distribution of benefits, a second distribution is made but the amount allocated to the State Budget is shared equally with the local administration budget. If an enterprise is unable during the year to meet the planned distribution payments or other commitments, and it is required to borrow additional working capital, such funds are sub- ject to a penalty rate of interest of 12%. The determination of the level of planned benefits is thus a fundamental part of the total planning process, any decisions to vary earnings will have an impact not only on funds available for reinvestment in the sector, but also on the State Budget and the Financial Plan for the country, and most importantly on the workers. 2.21 The investment plans are prepared separately from the production plans and are based on projects approved by the delegated authority; the enterprise, the Industrial Central, the MEE or the Council of Ministers. Projects estimated to cost in excess of 70 million lei (US$3.5 million equiv- alent) are approved by the Council of Ministers after careful vetting and analysis by the MEE, the Investment Bank and the State Planning Cornittee. Projects estimated to cost 30 million lei and up to 70 million lei are ap- proved by the MEE; projects estimated to cost 10 million lei and up to 30 million lei by the Industrial Central. Up to 10 million lei, projects can be approved by the enterprise. 2.22 Investment expenditure is financed firstly from internal sources, a predetermined portion of planned benefits, depreciation funds and other sources (largely the sale of scrap material and obsolete equipment). The remainder is provided by way of allocations from the State Budget or in the form of loans from the Investment Bank. The latter at the present time are  - 8 - not significant in amount. However, the Investment Bank does play a signi- ficant role in the allocation and expenditure of all investment funds in that it is responsible for authorizing all investment expenditures in accordance with the approved plans. It has staff in all districts who review the progress of investment projects, ensure that expenditures are properly au- thorized and finally arrange the transfer of funds effecting payment. 2.23 In practice the Industrial Central coordinates the sector finances. Each enterprise pays its depreciation, planned share of benefits and taxes twice monthly from its revenues. Depreciation funds, which are treated as real expense items, are paid to the Investment Bank for the credit of the Industrial Central, and other items to the National Bank for the credit of the State. C. The Development Program 2.24 The power sector development program is evolved by the MEE using its specialized agencies: the Institute of Power Studies and Designs (ISPE), and the Institute of Hydroelectric Studies and Designs (ISPH), which use data supplied by the various generating and distributing enterprises throughout the country. The power development plans are closely coordinated with the 5-year national development plans and are reviewed annually. The present cycle ends in 1975 to be followed by the 1976-1980 plan. Annex 4 shows the planned generation plant development and Annex 5 gives the make-up in greater detail. Since the oil crisis in 1973 there have been several revisions of the load forecasts, each successively more conservative; but the planting pro- gram has not yet been adjusted to reflect the lower requirements. This report has assumed annual sales increases of 7% for the years 1976-80 followed by increases of 6% to 1985, which are conservatively realistic and use as a starting point the forecasts for 1975. On this basis, the system firm plant capacity in 1976 will be greater than needed by about one year's demand growth. By 1983 some 4,900 M of installed plant would be in excess of the system needs (some 3 years too soon) if the rate of development does not exceed the assump- tions which are at the low end of the probability range. ISPE has mathematical models for the study of the economic development of the power system as well as for the analysis of plant reserve margins, system demand forecasting, etc., which are based on up to date techniques as used in other countries having systems of similar and greater complexity. Their methods have been presented at international conferences. The Bank has sought and obtained the Borrower's agreement to provide an analysis of the future electric power sector develop- ment. Such analysis, including the data and methodology used, is to be provided to the Bank before requesting it to consider financing a further power project in Romania. 2.25 The power development plan provides for maximum utilization of indigenous lignite and hydro resources. By 1980 some 3,930 M1 of lignite- fuelled plant will be consuming about 33 million tons p.a. Allowing that  - 9 - after 1980 the second stage of the Turceni project will be commissioned re- quiring 11 million tons p.a., the full potential of the Oltenia deposit, which contains nearly all the country's reserves, will have been absorbed unless the life of the lignite field is reduced from 70 years as now foreseen. 2.26 The development of hydro resources is geared, as one would expect, to the preferential exploitation of those giving the higher return on invest- ment and limited to those comparable with their appropriate thermal alterna- tives. With the exception of Danube river schemes (1350 H4), the remaining uncommitted hydro potential (7878 MW) is best suited for development to meet the system peaking demands. 2.27 The commissioning of 440 MW of nuclear plant in 1981/82, followed by 1,090 MW in 1983 and 650 MW in 1985, is planned. Negotiations are actively in hand for the supply of equipment, know-how and manufacturing licences. 2.28 The extension of supplies to the rural community has been actively pursued since 1960 and is now virtually complete excepting only such remote locations as are unlikely to be connected to the main system. For practical purposes electric power is available to all inhabitants of the country. IIT. THIE PROJECT A. Objectives 3.01 The Project is the key component of a cascade development on the Riul Mare and Strei rivers. It is designed to supply a part of the peaking power needs of the system and all cascade stations will serve the same pur- pose, except that at any stage of development, the lowest station will serve to reregulate the flow in the river downstream of the cascade and supply base load power. B. Description 3.02 The Project comprises the following works (see map IBRD 11791). (a) A reservoir called Gura Apelor to be formed by a clay-cored, rock-fill dam, Tomeasa, 173 m high across the valley of the Riul Mare in the neighborhood of Mount Retezat from which the Project takes its name. A high pressure tunnel 18.4-km long conveys the reservoir releases to the Retezat underground power plant of 335 MW having two units working with a gross head of 583 m. The tailrace of Retezat is also the headrace of the above-ground 14-MW powerhouse, Clopotiva, which uses a head of 25 m. There are 25 secondary intakes which collect  - 10 - water from adjacent streams and drop it into the pressure tunnel or convey it through a tunnel 34 km long to Gura Apelor reservoir. (b) Transmission lines at 110 kV will interconnect the Retezat- Clopotiva power stations and 220-kV lines will connect the Retezat power station with the existing system at Barul Mare. (c) Roadworks needed for the execution of the Project are in hand. These will later serve general communication and tourism pur- poses; but since the standard of construction will be no greater than required for the Project purposes, they are con- sidered a charge to the Project. 3.03 The first cascade power station downstream of Clopotiva power sta- tion is called Ostrovul-Mic. The headpond of this station will be completed before the commissioning of the Project works and will be able to reregulate, to an acceptable pattern, the short duration flows (about 5 hr per day) from the Project. The cost of this work is attributed to the development of the Ostrovul-Mic power station. Because reregulation is essential for the opera- tion of the Project, the Loan Agreement includes the Ostrovul-Mic works as part of the project description although they form part of a separate stage of the river development. C. Status of Engineering 3.04 The design institute, ISPH, has a long record of activity with some 39 hydroelectric schemes completed and commissioned by 1974. A further 18 schemes are actively under construction or have recently been commissioned. By way of illustration, Iron Gates I of 2,100 MW on the Danube was engineered in collaboration with Yugoslavia: the highest head developed by ISPH is in the Ciunget Lotru power station, where a discharge of 80 cubic meters per second under a head of 809 m through 3 pelton wheel turbines delivers 510 MW, and at the Arges power station 4 Francis turbines under a head of 324 m deliver 220 MW. The Project thus lies within the scope of experience of ISPH. The choice of Francis type turbines is appropriate for the size of the proposed units operating under a head of 583 m gross because there are difficulties dimensionally in providing an adequate number of nozzles around the periphery of a pelton wheel which is the alternative type suitable for the operating head. The selection of the type of dam and the choice of its height has been carefully made taking all the usual factors into consideration. Annex 6 gives a more detailed evaluation of civil engineering aspects. Engine- ering designs are as well developed as is usual at this stage of the Project. The Borrower has provided in the design of the dam for the inclusion of moni- toring instruments to observe stability throughout its life. The Borrower has undertaken to cause the hydroworks, including the dams, to be inspected regu- larly in accordance with appropriate engineering practice for the safety of the structures and their operation.  - 11 - D. Cost Estimate 3.05 - The estimated cost of the Project (Annex 7), excluding interest during construction, is US$250.1 million (lei 5,002 million) of which the esti- mated foreign exchange cost is US$53.8 million if it is assumed, as is likely, that Romanian suppliers will win all contracts under conditions of international competitive bidding (i.c.b.), in which they compete. A summary of the cost estimate is shown below: Lei millions US$ millions Project Project Element Local Foreign Total Local Foreign Total Cost A. Civil works & plant erection 2,855 801 3,656 142.7 40.1 182.8 73.1 B. Electrical & Mechanical equipment 236 29 265 11.8 1.5 13.3 5.3 C. Transmission lines & roads 140 5 145 7.0 0.2 7.2 2.9 D. Management, engi- neering and other costs 178 - 178 8.9 - 8.9 3.5 Sub-total 3,409 835 4,244 170.4 41.8 212.2 84.8 Contingency allowances: Physical/a 323 84 407 16.2 4.2 20.4 8.2 Price/b 194 157 351 9.7 7.8 17.5 7.0 Sub-total 517 241 758 25.9 12.0 37.9 15.2 Total Project Cost 3,926 1,076 5,002 196.3 53.8 250.1 100.0 Note: Figures in this Table have been rounded. /a 10% on Project elements A, B and C. /b 2% p.a. on Project elements A and C and 7-1/2% p.a. on direct foreign component of A and total of B.  - 12 - 3.06 The cost estimate is based on that of ISPH updated to December 1975, having been discussed with all the executing agencies, and is in conformity with the system of regulated prices that applies in Romania. Where scheduled rates are not determined, the Decision document of the Council of Ministers lays down the guidelines for costing purposes (Annex 1). Whereas the system of fixed prices tends to provide ample margins and physical contingencies up to 5% are allowed, this estimate has added price contingencies at the rate of 2% p.a. on local works and supplies. In the controlled situation in Romania, price escalation has hitherto been negligible, but 2% p.a. is considered prudent and adequate to reflect conditions in the execution period. For foreign goods directly imported as well as the electrical and mechanical equipment for the power stations, the estimate has assumed a price increase of 7-1/2% in the project execution period. The physical contingencies allowed in this estimate were assessed at 10% on the base costs of the construction works, i.e., civil works, electro-mechanical equipment of the power stations and transmission lines. E. Financing 3.07 The Project is an integral part of Romania's 5-Year Plan 1976-80 for the electric power sector and will be financed as part of the development program of the CIEET. It represents about 6% of the US$4.4 billion (equivalent) investment requirements of the CIEET during the construction period (1975-81). About 33% of the required funds will be derived from internal sources and most of the remainder will be provided from the State Budget. In addition to the CIEET investment, the HUNEDOARA Council, in whose county the Project will be located, will contribute 95 million lei for modernizing access roads and the MEE will provide 74 million lei for transmission links, substations and river regulation. The decision of the Council of Ministers No. 1612 dated December 20, 1974 which has approved the technical and economic indicators for the Project constitutes the Government authorization for project construction and the ex- penditures to be incurred. At the Bank's request an official copy of the Deci- sion was provided at negotiations. 3.08 The proposed Bank loan of US$50 million is expected to finance about 20% of the estimated cost of the project of US$250.1 million. It has been assumed that the Bank loan would be for a term of 20 years including a 5-year period of grace subject to interest at 8-1/2%. The loan would be made to the Investment Bank, which is responsible for authorization and control of investment expenditure in the power sector. It would be guaranteed by the Government of the Socialist Republic of Romania. As in the case of the first power loan for the Turceni Thermal Power Project, the Investment Bank would meet the debt service on the Bank loan and has agreed that the sum of the annual benefits and provision for depreciation of the Hatzeg Enterprise would, after the Project is completed in 1981, be sufficient to cover the debt service pay- ments on the Bank loan. Proposals for formal onlending of Bank loans to ben- eficiary enterprises are still being considered. After the Project is complete,  - 13 - the assets which are taken on charge will be valued, if imported and financed out of the proceeds of the loan, using a rate of exchange of US$1 = 20 lei. Duties on isprted iteus will be included. Where items are manufactured in Romania and financed under the loan, it is understood that they will be valued according to Rommnian foreign trade prices. 3.09 Since, under the Romanian system, any changes in prices are not applied to projects for which the Council of Ministers have approved the technical and economic indicators unless supplementary approval for the in- creased cost of imports has been obtained (although this is reportedly seldom done, but has happened in the case of the previous power loan), the need for financing of a possible cost overrun as a result of price increases should not arise. Prior to the approval of the indicators, firm contract prices have been established with the suppliers of plant and the construction trusts for the civil and electro mechanical works. However, should additional funds be required they would be provided in the first instance from resources of the CIEET or if they proved to be insufficient from the State Budget. F. Implementation 3.10 An enterprise responsible for the execution of the Project and centred at Hatzeg, has been established which will also be responsible for the further hydropower development of the Riul Mare and Strei rivers. This is suitable for the effective implementation and operation of the Project. Prior to the creation of the Hatzeg enterprise, the Project was the responsibility of the Cluj enterprise. 3.11 The Project will alter the pattern of flow of the Riul Mare which has a mean annual flow of 457 x 106m3 at the dam site. With exception of the period needed to fill the Gura Apelor reservoir, this volume of water will still join the Strei river annually. The Strei river flows into the Mures which enters Hungary near the town of Arad. In Hungary the Mures joins the Tisa and eventually reaches the Danube in Yugoslavia. A riparian interest can be said to exist. The mean annual flow of the Mures at the Hungarian border with Romania is 5200 x 106m3 which means that the Project influences the Mures conditions to a minor degree by reducing flows in flood seasons and increasing flows in the dry periods. Map IBRD 11790 illustrates the relevant catchment areas. The Romanian authorities have stated that the Project is not harmful to other riparians and the mission agrees with this view. Regarding Romania's association with Hungary, there is an agreement between them in respect of the Mures river which regulates the development in the river course extending 34.5 km upstream of the border. As the Project is beyond this limit, the Government has stated that no riparian problem arises. A written statement quoting from an existing "Convention" between Romania and Hungary dealing with riparian interests has been received (Annex 8) and is acceptable.  - 14 - 3.12 Land acquisition and wayleaves are within the competence of the Ministries to arrange, and mechanisms for the resolution of such matters exist and are part of the normal Project execution process once the invest- ment is decided and authorized. Compensation in accordance with published scales is paid to farmers, cooperatives and others whose productive capacity or facilities will be detrimentally affected, and some payments have already been made. The site of the Project is virtually uninhabited by man and human resettlement is not a problem. Construction 3.13 The construction of the Project started in the last quarter of 1974 with the upgrading of the access roads. Diversion of the Riul Mare is pro- posed in early 1977, and the first turbine delivery is scheduled for the third quarter of 1978 followed by its generator in early 1979. Commissioning of the first unit of the Retezat station should be complete by the end of 1980 followed by the second unit a year later. The Clopotiva units are to be commissioned in the first and second quarters of 1982. W4hereas the filling of the dam will have reached minimum operating level in 1980, dam construc- tion will continue through 1983 at which time the upper levels of the asphaltic membrane will be completed (Annex 9). This construction schedule is considered realistic. 3.14 The organizations that will execute the Project works are the following: (a) Trustul de Constructii Hidroenergetice (T.C.H.) which is the Hydropower Construction Trust. This organization was founded in 1950 and has completed more than 2,400 MW of installed hydro capacity. The scope of wrork undertaken covers the full range of civil engineering needs of such works- (b) Trustul Energo Montaj (T.EnM), which is the Electro-mechanical Construction Trust, performs the erection and commissioning of the electro-mechanical plant in the power stations. T.EnM can claim an even wider experience since it performs the erection services in both hydro and thermal power plants: (c) Trustul Electro Montaj (TEM) is the Transmission and Substation Construction Trust which in its own field is as experienced as its sister organizations; (d) Various other organizations concerned with roads, water supply, forestry, game and fisheries will take part.  - 15 - Procurement 3.15 The Decision of the Council of Ministers which provides approval for the Project presupposes that all works will be executed by the construction trusts of the MEE and that the plant will be manufactured in Romanian factories, and sets the limit on the amount of foreign currency which may be expended on the purchase of goods from foreign sources. In this case, lei valuta 0.688 million (US$103,000 equivalent) is authorized for expenditure in COMECON countries and lei valuta 3.41 million (US$686,000 equivalent) is authorized for expenditure in convertible currency areas. These sums provide for the direct foreign procurement needs of the executing enterprise, but exclude foreign procurement by other entities such as the civil construction con- tractor and plant manufacturing enterprises. There is no assumption made that Bank finance will become available. The limits set by the Decision No. 1612 may be exceeded should the cost of imported equipment prove to be higher than estimated and also in the event that foreign suppliers win contracts under i.c.b. that would otherwise have been supplied from Romania. It has been recorded in agreed minutes of negotiations that the Project will be implemented taking into account the needs of the Project and the conditions set out in the Loan Agreement specifying the eligibility of funds for disbursement. Thus, the terms of Decision 1612 are not to be construed as being limiting in this sense. 3.16 At negotiations, the Romanians represented a list of goods for se- lection to the full amount of the loan, suitable for i.c.b. under the Bank's guidelines, and this is recorded in a to the Loan Agreement. It is expected that Romanian supplie r ii esuE.essfully for all con- tracts for which they submit bids and a domestic preference of 15% would be applied or the applicable customs duty, whichever is the lesser. In this event local currency expenditures to the extent of about US$39 million would be covered under the loan. Disbursements 3.17 Disbursements from the proposed Bank loan would be made for 100% of the foreign exchange cost or ex-factory cost of equipment and supplies. Any funds remaining undisbursed after completion of the Project would be cancelled. The closing date for disbursements is expected to be December 31, 1981. The estimated quarterly disbursement schedule is given in Annex 10. G. Environmental Impact 3.18 The Project is in a mountainous area exceeding 900 m above sea level, beautifully scenic and richly endowed with flora and fauna. A national park, which includes a special scientific reserve, has been established for many years (Map IBRD 11791). The relevant authorities concerned with such  - 16 - matters have made a detailed study of the impact of the Project on the ecology of the area and have made certain recommendations regarding the design and management of the Project in this regard (Annex 11). As a direct result of the study, the main pressure tunnel from the Gura Apelor reservoir has been relocated from the right bank of the river to the left. The secondary intake tunnel which traverses the national park will be excavated so as to place the adits outside the scientific reserve, and road access will be arranged to cause a minimum of disturbance. Abstractions of water to the secondary in- takes have been restricted in accordance with the recommendations of the ecological study. No additional measures are considered necessary. The appraisal mission is satisfied that all those aspects, that are within the competence of the power authorities, will be respected. The Borrower has under- taken to cause the Project to be carried out in conformity with appropriate ecological and environmental practices and to report on these matters at regular intervals in accordance with the reporting requirements recorded in a Supplemental Letter to the Loan Agreement. IV. THE PROJECT ENTITY 4.01 The designated Project Entity is the Hatzeg Generating Enterprise which was set up in March 1976. 4.02 The organization and management of enterprises is according to well tried patterns and is effective. At the same time there are organizational research departments both in the MEE and the CIEET responsible for constant review and improvement of these matters. The impression gained by the mission is that the systems and structures are appropriate and comparable with ef- fective systems in other countries. 4.03 The staff employed, especially in the engineering fields, is well qualified and experienced according to the needs for the job. In the field of accountancy, there are indications that accounting is used principally as a means of recording historical data and is constrained by the rigid system of standardization of presentation. More analytical methods geared to modern decision-making practices would be beneficial; but whilst the rigid central planning system prevails it is doubtful whether there would be adequate scope for the application of such techniques. V. FINANCE A. Past Performance and Present Position of the Sector 5.01 In the appraisal report for the first power loan, the Turceni Thermal Power Project, a review was made of the financial performance of the enterprises in the Romanian power sector for the years 1970-72 inclusive.  - 17 - During these years the sector was co-ordinated by two centrals. However, from April 1, 1973 a single central (the Industrial Central for Electric Power and Heat - CIEET) was established. The financial performance of the sector for the years 1973-74 as recorded by the CIEET is presented in Annexes 12-14. 5.02 The Turceni appraisal was conducted at the time of the 1973 "energy crisis" which the Government of Romania responded to by enacting a decree aimed at rigid conservation of fuel and energy. In particular, the structure of electricity tariffs was revised and average revenue from electricity sales (1973 .313 lei per kWh) was expected to increase about 1.4% by 1975 as a result of the revised tariffs. Sales in GWh were expected to increase 11.3% in 1973, 15.3% in 1974 and 9.8% in 1975. In fact actual sales growth in these years was only 4.7% and 9.1% respectively and the forecast for 1975 was for an unrealistic 18% increase. 5.03 The operating results for 1973 and 1974 were not as good as forecast not only because of the reduction in sales but also because the average costs per unit sold of .268 lei or USO1.34 (1973) and .264 lei or USJ1.32 (1974) were 15-16% above the appraisal estimate prepared for the Turceni project. Substantial increases in fuel prices effective January 1974 were absorbed without any corresponding adjustment to tariffs. Despite the increased fuel prices, overall savings in fuel costs were achieved because of the reduction in thermal generation but they were more than offset by increased operation, maintenance and administrative expenses. Wage increases of the order of 8% were made during 1974 reflecting productivity gains during the 5-year plan period which commenced in 1971. In addition social security contributions were increased from 11% to 15% of gross wages as from January 1, 1974. 5.04 At the beginning of 1974, taxes on the production of electric and thermal energy were repealed and a new tax (or interest) of 4% was introduced to be applied to invested funds, i.e. the value of net fixed assets at the beginning of the year and working capital funds. The new tax provided about 900 million lei in additional revenue to the State Budget in 1974 and repre- sented about 20% of total operating revenues, by comparison with the production tax which took up about 14% of operating revenues. 5.05 The net effect of the reduced sales, increased costs and the revised taxation provisions was to reduce net income in 1973 by about 0.4 billion lei or 16% and in 1974 by about 1.7 billion lei or 53%. The rate of return on average net fixed assets and working capital declined from 4.6% in 1973 to 2.9% in 1974 compared with expected rates of about 5-6%. However, if the tax on invested funds were to be treated as an interest charge which it is, and not as an operating expense, the rates of return for these years would improve to 8.7% and 8.8% respectively. For the purposes of this report and future financial analysis within the Romanian power sector, this tax will be treated as an interest charge.  - 18 - 5.06 No significant change in the financial position of the power sector is reflected in the 1973 and 1974 balance sheets of the CIEET which are included in Annex 13. There is no long-term debt and consequently no debt service commitment 1/ (except for commitment fees on the Turceni Thermal Power Project loan which was signed July 10, 1974). Although investment expenditures exceeded previously planned estimates by 1 billion lei (about 7%), gross fixed assets only increased in value by about 12.5% (1970-72, 14.5%) to 70.7 billion lei (about US$3.5 billion equivalent). The value of fixed assets continues to be based on recorded costs and the level of inflation remains insignificant although a comprehensive review of prices has been carried out under Law No. 19/1971 during the last 2-3 years. Slightly more than half of the CIEET invest- ment requirements in 1973 and 1974 came from internal sources. The remainder was provided from the State Budget. Because of reduction in net income, State Budget allocations were increased by 1.9 billion lei (32%) and the 10% min- imum contribution to the State Budget normally payable under the Benefits Law (No. 858 of 1973) was waived for 1974. 5.07 Despite the difficulties in meeting the planned targets over the years 1973 and 1974 the CIEET's accounts reflect satisfactory financial perfor- mance. However, they do reflect the need for more careful review of forecasts so that they realistically reflect the impact of changing circumstances e.g. impact of the energy Decree. Although the forecasts may not always be achieved, CIEET's financial viability will not be jeopardized because the plans of the Industrial Central are a part of the national Socio-Economic Plan which is financed from State sources. B. Financing Plan 5.08 The forecast sources and applications of funds of the CIEET for the period 1975-85 are given in Annex 14. A condensed version for the Project construction period 1975-81 is given below: 1/ Although "interest on invested funds" is shown under "debt service" in Annex 14, it is not strictly debt service since it is calculated on the volume of funds invested in fixed assets and working capital. However, "debt service" is considered the most appropriate heading under which to show it.  - 19 - 1975-1981 (Millions of Lei) _ Sources of Funds Internal Sources Benefits Reinvested 33,650 38 Depreciation Reinvested 26,425 30 Sales of Scrap etc. 584 1 Gross Internal Sources 60,659 69 Less: Debt Service (31,199) (36) Net Internal Sources 29,460 33 External Sources State Budget Allocations 55,763 64 Investment Bank Loans 292 - Existing IBRD Loan 1,200 2 Proposed IBRD Loan 1,000 1 Total External Sources 58,255 67 Total Sources of Funds 87,715 100 Construction Requirements Proposed Riul Mare-Retezat Hydropower Project (including interest during construction) 5,225 /1 6 Other Construction 82,490 94 Total Construction Requirements 87,715 100 /1 Total interest during construction on the Project is 223 million lei. 5.09 It can be seen from the above table that the CIEET investment program will require about 87.7 billion lei (USS4.4 billion equivalent). Internal sources are expected to finance 33%, the State Budget 64% and IBRD loans in- cluding the proposed loan about 3%. 5.10 At the time of the Turceni appraisal, it was decided in discussions with the MEE that for the purposes of the Bank's forecasts 70% of total benefits should be assumed to be available for reinvestment in the CIEET expansion program. This assumption has not been followed for the purposes of the present analysis since new principles are being considered for adoption from the start of the new 5-Year Plan period in 1976 to simplify the process of distribution of benefits in order to eliminate transfer from enterprises to the budget which are subsequently returned as budget allocations. Under the existing benefits law, a minimum contribution to the State budget of 10% is required. In 1974 the contributions to the budget were waived (para. 5.06) and only nominal amounts of 300 million lei in each of the years 1975-80 and 400 million lei in each of the years 1981-85 have been provided at the insti- gation of the MEE and the CIEET.  - 20 - 5.11 The 1975-81 investment program prepared by the CIEET has been pro- portionally reduced by the mission by about 7% to match its best estimate of the most probable growth in energy sales. One of the principal reasons for presenting a reduced program is that the CIEET is required to reflect nationally planned targets in the forecasts even though they appear unrealistic. This was confirmed during negotiations by the Romanians who informed the Bank that actual sales for 1975 fell short of the planned target by about 8%. The rea- son given for this shortfall was mainly the restrictions imposed by the Govern- ment on the use of energy as a result of the world energy crisis. As a result the figures, particularly those for sales of energy and the investment plan for the 1976-80 5-year plan, have been revised subject to approval by the Government expected in April 1976. The Bank expects that the decisions taken or to be taken by the Government which will be reflected in the approved 5 year plan for 1976-80 will confirm the assumptions in this report with respect to sales growth and the investment plans for the power sector. Following review of the 1976-80 5-year plan, the Government have undertaken in a supplemental letter to furnish the results of their review to the Bank. C. Future Performance 5.12 The financial forecasts 1975-85 prepared by the CIEET were based on an 18% increase in energy sales in 1975 and thereafter an annual average growth rate of about 7% to 1985. These sales growth rates produced rates of return on average net fixed assets in service and working capital (when calculated on the same basis as for the Turceni Report), ranging from a high of 3.3% in 1975 to a low of 0.5% in 1985 (Turceni 4-6% 1975-80). The reduced rates of-return can be attributed to two principal factors: firstly, operation, maintenance and administration costs which were previously expected to decline between 1975 and 1980 in terms of cost per unit sold by about 26% but are now expected to remain at about 1973 levels because of the restructuring of internal prices, and secondly the revised taxing mechanism. The projections also showed an average contribution to investment from internal sources of 38% by comparison with 46% for Turceni (1973-80). 5.13 In the light of recorded sales growth in 1973 of 4.7% and 1974 of 9.1% and after discussion with staff of the MEE and the CIEET, the sales fore- casts have been revised and the financial forecasts have been recalculated to reflect the revised estimates and are shown in Annexes 12-14. Details of assumptions used for these forecasts are given in Annex 15. Operating costs have been assumed to be constant. However, no increases in tariffs have been assumed. If the new tax on invested funds is treated as an interest rate, rates of return ranging from 8.4% in 1975 to 4.5% in 1985 are obtained. The forecasts for 1975-85 show the average contribution to investment from internal sources would be 31%. This level of performance would be satisfactory in the Romanian context and the decline in the forecast financial performance to 1985 is not viewed with concern because the Bank expects that the Government will  - 21 - review electricity tariffs before 1985 and very likely at the end of the 1976-80 5-year plan. Under the Romanian economic system, increasing costs or a higher level of investment than planned is not normally rectified by increasing prices in one particular sector. As the power sector plans are integrated with those of the rest of the economy, changes in the demand for funds in the power sector are absorbed by the State budget. Varying the level of taxes and contributions to the State budget can also be used to improve financial performance of the sector. Tariffs and prices are normally reviewed as part of the long-term planning process so as to ensure that any changes are reflected in the fore- casts prepared for the economy as a whole thus preventing distortion during plan implementation. They are not adjusted to reflect changing costs or supply and demand as in market economies. 5.14 Since the Bank's conventional financial covenants have been found to be incompatible with the Romanian economic system, as in the case of the first power project, no financial covenants have been sought. Instead, the Govern- ment has described its current policy and plans for the financing of the power sector. The Borrower has agreed in a supplemental letter to continue to fur- nish financial and economic information to enable the Bank to evaluate the benefits of the Project to the Romanian economy and the position of the Hatzeg Enterprise in the Romanian power sector. There will continue to be reasonable opportunity for representatives of the power sector and the Bank to discuss this information. D. Accounts and Audit 5.15 The Investment Bank will continue the auditing arrangements agreed for the Turceni power loan i.e. that it will furnish to the Bank independent audit reports on its financial statements and those of the Industrial Central and the Project enterprise (Hatzeg). The reports will be prepared by the Ministry of Finance and submitted to the Bank within three months of the end of each fiscal year except in the case of Investment Bank itself for which an audit report will be submitted within four months of the end of each fiscal year. VI. BENEFITS AND JUSTIFICATION 6.01 The power system would be improved to the extent of the value of the peak load capacity of the Project. As described in greater detail in Annex 16 the plant will contribute directly and indirectly 469 MW and 739 GWh p.a. in an average water year or less than 2% of the system needs in 1989 when this benefit will mature in full. 6.02 In 1985, the system primary peaking demand i.e. in excess of base load and secondary peaking requirements, will be of the order of 3,200 MW towards which the main hydro peaking stations including Riul Mare-Retezat would  - 22 - contribute 1,800 MW. The 1,400 MW of peaking demand remaining would be con- tributed by other base and secondary peak load plants such as the Danube schemes. Very short duration peaks can also be met by the use of gas turbines of which there are presently 109 MW. Despite the fall off of system demand growth in 1973/74, the Project is timely. Return on Investment 6.03 The Romanians used a mathematical model in 1972 to simulate the power sector development which under the conditons then applicable indicated that, by 1985, the development options still open to choice pointed to the need and appropriateness of the Riul Mare-Retezat Project to meet system primary peaking demands. Annex 16 gives a brief summary of the assumptions used and the outcome of the analysis. The results indicate that under any of the assumed conditions of fuel importation, fuel cost, and specific investment cost for nuclear plant, there is a place in 1985 for hydro peaking capacity to the extent of 400 MW, and the Riul Mare Project with its associated downstream cascade development fills this need being the cheapest of the hydro schemes from which a choice could be made. It has not been possible to examine the 1972 calculations nor in other ways to verify the result. However, it is evident from discussions that the exercise was not undertaken for purely academic reasons and that it is likely to have played a part in the development of the program now being followed. The conclusions regarding the development of other types of generation, particularly of base load plant, have undoubted- ly been altered to comply with the Government embargo on the further use of oil or gas for industrial heating processes of which power generation is con- sidered to be one. 6.04 A comparison with a gas-turbine and a pumped storage type of alter- native made by the ISPH (Annex 17) shows that the equalizing discount rate is not less than 10% and that higher rates would apply if the cost of fuel were set at US$100 per ton as opposed to the US$66 per ton used in the comparison. As noted in para. 3.06, by virtue of the fixed pricing systems used for goods and services in Romania, costs can be estimated reliably and economic com- parisons are not sensitive to this reliability factor. 6.05 Aside from the output of electric power, other benefits are associ- ated with the Project. River regulation will provide a perennially secure flow in the Riul Mare and Strei rivers, the Gura Apelor reservoir recreational benefits and road works which by extension beyond the Project area will serve to improve communications. Such benefits are judged to be relatively small and would not materially influence the Project's justification. 6.06 The internal rate of return on the Project is estimated to be 6-1/2% (Annex 16) if benefits are measured by incremental revenue attribut- able to the Project and financial costs are adjusted for taxes and other internal transfers. The return of 6-1/2% is not susceptible to the inter- pretation that could be placed upon it in a market economy, in which it could be compared with the opportunity cost of capital and therefore provide an indication of the extent to which consumers' willingness to pay is being  - 23 - used to signal Project justification, and is thus not an appropriate indicator. The Romanian power tariffs which have been used to gauge the least level of benefits attributable to the Project have, in the past, been adequate to gen- erate a 40-50% cash contribution to investments in the sector, and as such have been at satisfactory levels (para 2.18). It is likely that increasing real costs of power sector development will lead to higher real tariffs (para 5.13). In this case, the rate of return would be commensurately higher. VII. AGREEMENTS REACHED AND RECOMMENDATION 7.01 During negotiations, agreement was reached on the following principal issues: (a) the Investment Bank has agreed to provide to the Bank an analysis of the future electric power sector development complete with data and methodology used, before requesting it to consider financing a further power project in Romania (para 2.24); (b) the Investment Bank has undertaken to cause the hydroworks, including the dams, to be inspected regularly in accordance with appropriate engineering practice (para 3.04); (c) the Investment Bank would meet the debt service payments on the Bank loan, as proposals for formal onlending of Bank loans to beneficiary enterprises are still being considered in Romania (para 3.08); (d) the Investment Bank gave assurances recorded in agreed minutes of negotiations that goods needed for the Project and to be financed out of the proceeds of the loan will be procured in accordance with the provisions of the Loan Agreement and will not be subject to the limitations contained in Decision No. 1612 (para 3.15); (e) a list of goods for selection to the full amount of the loan, suitable for i.c.b. under the Bank's guidelines, has been agreed between the Investment Bank and the Bank (para 3.16); (f) the Investment Bank has agreed to cause the Project to be carried out in conformity with appropriate ecological and environmental practices and to report on this subject regularly (para 3.18); (g) the Government agreed to furnish to the Bank the results of their review of the 1976-1980, 5-year plan (para 5.11);  - 24 - (h) the Investment Bank has agreed to continue to furnish financial and economic information to enable the Bank to evaluate the benefits of the Project to the Romania economy and the position of the Hatzeg Enterprise in the Romanian power sector (para 5.14); (j) the Investment Bank will continue the auditing arrangements agreed for the Turceni power loan except that the audit report on its own accounts will be submitted within 4 months (previously 3 months) of the end of each fiscal year (para 5.15). 7.02 In the foregoing circumstances, the Project is suitable for a Bank loan of US$50 million to the Investment Bank with the guarantee of the Socialist Republic of Romania. An appropriate term for the loan is 20 years, including 5 years of grace. March 17, 1976  ANNEX 1 Page 1 of 3 APPRAISAL OF THE RIUL MARE-RETEZAT HYDROPOWER PROJECT ROMANIA Council of Ministers of the Socialist Republic of Romania Decision No. 1612 concerning the approval of the main techno-economic parameters of the investment "Hydropower Plant - Riul Mare-Retezat" and some provisions for the implementation of this Project. The Council of Ministers of the Socialist Republic of Romania decides: Article 1 The principal techno-economic parameters for the investment "Hydropower Plant - Riul Mare-Retezat" are approved as follows: Total amount of the investment 4,100 million lei of which - amount for civil construction and plant installation, of which 3.,440 million lei - civil construction 3,387 million lei Total installed capacity 34