Turkey - Issues and options in the energy sector

Report No. 3877-TU Turkey: Issues and Options in the Energy Sector March 1983 Report of the Joint UNDP/World Bank Energy Sector Assessrnent Program This document has a restricted distribution. Its contents may not be disclosed without authorization from the Government, the UNDP or the World Bank.  JOINT UNDP/WORLD BANK ENERGY SECTOR ASSESSMENT PROGRAM REPORTS ALREADY ISSUED COUNTRY DATE NO. Indonesia November 1981 3543-IND Mauritius December 1981 3510-MAS Kenya May 1982 3800-KE Sri Lanka May 1982 3794-CE Zimbabwe June 1982 3765-ZIM Haiti June 1982 3672-HA Papua New Guinea June 1982 3882-PNG Burundi June 1982 3778-BU Rwanda June 1982 3779-RW Malawi August 1982 3903-MAI Bangladesh October 1982 3873-BD Zambia January 1983 4110-ZA  Currency Equivalent September 1981: $rL.00 Ti 120 Abbreviations and Acr.onyms toe tons oil equivalent mmtoe million tons oil equivalent typ tons per year LRMC long run marginal cost gWh Gigawatt hours MWh Megawatt hours mW Megawatt DSI General Directorate of State Hydraulic Works EIEI Electric Resources Study Institute MOAF Ministry of Agriculture and Forestry MENR Ministry of Energy and Natural Resources MTA Geological Research and Survey Organization OGM General Directorate of Forests SEEs State Economic Enterprises SPO State Planning Organization TEK Turkish Electricity Authority TKI Turkish Coal Mining Authority TPAO Turkish Petroleum Company TSKB Industrial Development Bank of Turkey This report is based on the findings of an energy assessment mission t-hat visited Turkey in September-October 1981. Some updating was done on the basis of new data made available in August 1982. The mission assignments were: Bernard Chadenet (cons), Mission Leader; Richard Berney, Deputy Mission Leader; Jack Baranson (cons), Industry; Seok Hyun Hong, Macro Economics and Energy Balances; Walter Kaufmann (cons), Lignite and Coal Mining; Andres Liebenthal, Energy Conservation; Bernard Russell (cons), Electric Power; Paul Ryan (cons), Fuelwood; Peter Smith (cons), Transportation; John Strongman, Lignite and Coal; C.H Thompson (cons), Energy Demand; Cynthia Tobias (cons), Household Demand Management. Richard Berney was the principle author of the report. The report was discussed with the Government in November, 1982.   FOR OFFICIAL USE ONLY Report No. 3877-TU TURKEY ISSUES AND OPTIONS IN THE ENERGY SECTOR March 1983 This is one of a series of reports of the Joint UNDP/World Bank Energy Sector Assessment Program. Finance for this work has been provided, in part, by the UNDP Energy Account, and the work has been carried out by the World Bank. This report has a restricted distribution. Its contents may not be disclosed without authorization from the Government, the UNDP or the World Bank.   Table of Contents Page No. EXECUTIVE SUMMARY AND CONCLUSIONS ..... ..................... i Overview ............................................. Demand and Supply Projections . . ii Increasing the Production of Energy .................... iii Lignite . ........................................... iv Coal ............................................... v Electricity ... . ........... . v Fuelwood ... vi Geothermal ... vi Private Sector Initiatives . . . vi Efficiency in Energy Usage . . . vii Pricing ............................................ viii Institutional Changes .............................. ix Planning ... x I. ENERGY BALANCES ......................................... 1 Overview ............................................1.. Demand Projections ....... .......................... 4 Supply Projections ..................................... 7 Lignite and Electric Power .... o ....................... 8 Hard Coal, Asphalite and Shale .................... .... 10 Petroleum Production ...... ............................ 11 Fuelwood Production ...... ............................. 11 Petroleum Imports ..................................... 12 Energy Balances 1985 and 1990 ..................O. ...... 13 II. EXPANDING SUPPLY ..................................... 16 Role of the Institutions ..... ........................ 16 Remedies to Institutional Problems ................... . 17 Prospects for Expanding Resource Production ........... 19 Lignite ...o ...................................... 19 Coal .............................................. 24 Electricity ...................................... 25 Petroleum ........................................ 27 Fuelwood ......................................... 27 Better Use of Forest Residues . . . 29 Rehabilitation of Oak Coppice ... 29 Energy Plantations . . . 30 Village Woodlots . ... 30 Incremental Fuelwood Production . . . 30 Geothermal Energy ...... ......................... 31 Solar Energy ..... o...... 32 Role of the Private Sector ..... ....................... 32 Lignite Development . ......................... 32 Petroleum Exploration and Development .... ..... 33 Power Concessions ................................ 36  Page No. III. EFFICIENCY IN ENERGY USAGE ..... ...................... 38 Energy Consumption .. ....................... ...... .. . 38 Pricing ............................................... 39 Petroleum Product Prices ............ 41 Coal and Lignite Pricing ..... ................... .. 43 Power Costs and Tariffs ........................... 44 Fuelwood Pricing . .*......... 45 Increased Energy Efficiency ............................. 46 Government Regulations and Incentives ................. 47 Efficiencies in Power Production and Distribution . 47 Industrial Efficiency .. 49 Household Energy Usage . . 51 Transport Efficiency ............................... 52 Railways ....................................... 52 Automobiles ........... . 52 Road Maintenance ................. 53 Rail Tariffs and Road User Charges ............. 53 A Comprehensive Energy Efficiency Program ......... 54 Planning ........................................... 56  TABLES Page No. 1.1 Energy Balance 1980 . . .. 3 1.2 Demand for Energy Products . . . 7 1.3 Electric Power Supply Projection . . . 12 1.4 Summary Energy Balance .. ................ . . 14 2.1 TKI Lignite Mines Under Construction . . . 21 2.2 Potential Fuelwood Supply Schedule ............... . 31 3.1 1979 Commercial Energy Consumption . .. 39 3.2 Effective Tax on Petroleum Products in Turkey .......... 42 ANNEXES I. Details of Demand Projections . . 58 II. Macro Economic Trade Balance Projections ........... 62 III. Electricity Supply Projections ..................... 63 IV. Lignite Production Projections for 1980-1990 ....... 75 V. Energy Balances 1985 and 1990 ...................... 79 MAPS IBRD 16406 IBRD 2277R3   EXECUTIVE SUMMARY & CONCLUSIONS Overview 1. The high level of dependence on imported petroleum is the domi- nant factor in Turkey's pattern of energy consumption. The share of petroleum in consumption of commercial primary energy rose from 20% in 1960 to 60% in 1980. The oil import bill grew rapidly, surpassing total export earnings in 1980, and became a major contributing factor to the 1979 economic difficulties. In order to reduce Turkey's dependence on imported oil, the Government launched a massive program in the late 1970s to increase the domestic production of electricity and lignite. This program has stretched the implementation capabilities of the State energy agencies to their limit and beyond. Resources were spread too thin, over too many projects, with resulting long delays in completion schedules. 2. Improvement in the performance of Turkey's major State energy institutions is fundamental to the success of the energy development program and the elimination of the continuing energy deficit that Turkey faces. These institutions have particularly acute problems because, un- like other industrial State Economic Enterprises (SEEs), they will be called upon to increase their efficiency while growing at rates greater than ten per cent per year for the next several decades. However, even in the best of circumstances, Turkey will remain heavily dependent on im- ported fuels, primarily petroleum. A policy goal of reducing this depen- dence is important in that it could increase the Government's ability to take a more flexible approach in handling other important economic issues. It is to this goal of reducing import dependence, therefore, that this report is directed. The principle recommendations have been underlined in the main body of the report for easy reference. 3. The Government has concentrated most of its efforts to reduce dependence on imported oil by expanding lignite and power output. There is, however, a limit to what the State lignite and power development agencies can be expected to accomplish, even if all the proposed insti- tutional reforms are carried out quickly and effectively. It is, there- fore, quite possible that lignite and hydro power production may grow too slowly to meet the full requirements of a dynamically growing economy. If this happens, recourse would habe to be mafe to an even greater expan- sion in energy imports than is currently envisaged. In order to reduce Turkey's dependence on imported energy sources, the Government should put a higher priority on a complementary approach to the development and efficient use of its energy resources in the future than it has in the past. 4. One of the most important elements of such an approach is the expansion of efforts to develop other known primary energy resources, particularly through the expansion of programs to increase the recovery of oil from proven reservoirs, the exploitation of identified geothermal fields, and the more extensive use of forestry resources and wood planta- tions for fuelwood. Such developments would require an expansion of the financial and technical resources currently committed to these fields.  - ii - 5. A second important element is the expanded enlistment of the skills and resources of the private sector, both domestic and foreign. The local private sector could develop the smaller projects that the State enterprises are unable to consider because of a shortage of staff. The foreign private sector should be encouraged particularly in such fields as petroleum and geothermal where their expertise is needed to speed up the exploration for development of these resources. 6. The third element of the proposed approach is the encouragement of greater efficiency in the use of existing energy resources. This includes instituting pricing and other policies that encourage greater efforts to reduce energy consumption, establishing institutions that can provide technical assistance to industry in energy savings and by requir- ing state enterprises to institute energy saving programs. While none of these approaches alone will solve the problem of the high dependence on imported energy resources, together they will be able to make a substan- tial impact on the problem. I. Demand and Supply Projections 7. The demand and supply projections for major energy products were prepared by the various concerned ministries were reviewed in October 1981. The resulting demand projections used in this report and, based on the assumption of a moderate level of economic growth averaging 4.5% to 1985 and 5.0% thereafter, show electricity growing by 200% between 1980 and 1990, to 60,000 gWh; lignite demand from industries and households growing by 160%, to 27 million tons; lignite demand by thermal power plants growing by almost tenfold to about 50 million tons; fuelwood and biomass demand growing by 14% to 36 million tons; and petroleum demand growing by 110% to 30 million tons. If some products (such as fuelwood or lignite) are not available, demand may spill over into other energy substitutes. Demand would, of course, grow substantially faster in response to a more rapid rate of growth of GNP (para 1.11-1.16). 8. To resolve its energy difficulties, Turkey has concentrated its efforts on the expansion of its domestic energy production through the development of its hydro and lignite resources, while attempting to re- strain the growth in petroleum consumption. The implementation schedules for the major power and lignite projects were,therefore, also reviewed. The results indicate that even if the Government's proposals for reform- ing its energy institutions can be implemented, an optimistic estimate of net available electricity in 1985 and 1990 would be 37,300 and 60,500 gWh respectively, and 31.7 and 70.7 million tons lignite, respectively; these were used as the base case supply estimates for the energy balance pro- jections (para 1.17-1.32). 9. The energy balance based on the above demand and supply projec- tions shows that sufficient power could be produced and to eliminate im- ports in 1990. However, there would be shortfalls in lignite production of about 9 million tons in 1985 and 7 million tons in 1990, shortfalls that presumably would have to be made up with additional fuel oil im- ports. Energy import levels needed to balance demand requirements would  - iii - range from 28.4 million tons of oil equivalent (toe) in 1990, under the most favorable scenario, to 32.9 million toe in a less favorable, but quite possible scenario of a 20% slippage in the lignite and power in- vestment program and a low availability of hydro electric power due to substantially lower than average rainfall. A higher level of economic growth would, of course, lead to substantially higher levels of demand. An increase of an extra 1% in GDP growth per year until 1990, would, even with a low elasticity of demand of 1.2, increase total annual energy consumption by about 5 million tons oil equivalent, all of which, presum- ably, would have to come from imports (para 1.33-1.38). 10. The need for such a high level of energy imports would put a severe strain on Turkey's overall ability to import sufficient goods to keep the economy growing smoothly. This would have serious implications for economic growth that will not be analyzed in this report. The issue, therefore, is whether the most severe effects of the possible higher levels of demand for energy imports would cause energy supply shortfalls and imposition of emergency measures that could disrupt the growth of the economy, or whether the constraints on the economy could be reduced through long term strategies and tactics that could minimize energy im- port requirements and maximize the Government's freedom of action on non- energy related policies. This report focuses on a review of the policy issues that could form the core of an appropriate framework for an energy strategy and associated tactics to improve the potential for future sus- tained dynamic growth by minimizing the requirements for expanded energy imports. II. Increasing the Production of Energy 11. The above estimates of the levels of energy output of the State energy agencies are contingent upon rapid improvement in the mobilization and distribution of investment resources for priority projects and on the improvement of the capabilities of the energy SEEs to implement the proj- ects. The problems of the energy SEEs are particularly pressing, since these institutions will be called upon to increase their operating effi- ciency while increasing production at better than 10% per year over at least the next decade. The implementation of an effective reform program for the energy SEEs, therefore, should be seen as one of the Government's top priorities. Without action on this front, little or no progress can be made in resolving the country's energy difficulties (para 2.01-2.07). 12. The Government is currently revising the basic laws under which all SEEs operate, with the aim of removing the constraints on improving their efficiency. In addition to changing these laws it is recommended that: (i) in order to create a stable professional management, senior managers should be appointed for fixed terms; (ii) to assure adequate delegation of authority to management along with full accountability, the appointment contracts should be accompanied by annual "State Economic Enterprise Program Contracts" between the Ministries of Energy and Fi- nance on the one hand and the management of the SEEs on the other; and, (iii) to stop the losses of professional staff, the salary structure of management and engineering staff should be disassociated from that of the  - iv - civil service and aligned closer to that of the private sector (para. 2.01-2.11). In addition to implementing these reforms, however, a series of measures, the most important of which are discussed below, will be needed to improve the performance of specific energy subsectors (para 2.08-2.11). Lignite 13. Almost all of the planned new thermal plants would be lignite fired. This places a heavy burden on the Turkish Coal Authority (TKI), the Government owned coal and lignite mining enterprise to expand its lignite production facilities, and TKI has embarked upon an extremely ambitious program to meet this growing demand for lignite. From the 15 million tons produced in 1980, production in 1990 is planned to rise to 70 million tons, a more than four-fold increase, to be accomplished through the development of eleven large open pit mines and two large mechanized underground mines. However, TKI is understaffed and, there- fore, is technically not capable of undertaking the preparation, imple- mentation and monitoring activities that are required for such a large expansion program. Thus, TKI is faced with the prospect of having to follow through on many projects with insufficient technical staff and inadequate financial resources to complete them. To resolve its short term staffing problems while building up its own internal capabilities, TKI will have to rely heavily on outside assistance for project prepa- ration and project implementation and management. To supplement its limited in-house capabilities to develop its lignite resources rapidly, TKI could use foreign contractors to develop some of its proposed proj- ects on a turnkey basis, if sufficient foreign exchange were made avail- able. Otherwise it will have to scale down its program to a more manage- able level commensurate with its available staffing and financing re- sources, or face continued unforseen technical problems, unprogrammed project delays, and cost overruns (para. 2.12-2.16). 14. What TKI lacks is a coordinated program for maximizing the effi- cient use of its limited managerial and financial resources. In order to develop a realistic program, it is recommended that revised estimates be made of construction and operating costs of the various lignite mines and thermal power plants for all mine mouth power complexes that are in the early stages of development. A ranking should then be made of the econo- mics of the different units. This work should be done with the aid of outside financial assistance. Based on this ranking, explicit priorities should be set for completing the construction of those projects in an advanced stage and for starting construction on only those projects for which financing and staffing and implementation capacity can reasonably be assured (para. 2.17-2.19). 15. The potentially high cost of some lignite-based power projects raises questions about whether their development for power is economi- cally justifiable and competitive with other power development options. This is particularly true for the development of Elbistan B, C, and D. A detailed cost comparison between the alternatives of additional develop- ments at Elbistan and a shift to imported coal for power needs in the  v l990s and beyond should be made to determine the least cost approach (para 2.22-2.25). Coal 16. Coal prospects and problems are substantially different from those of lignite and should be treated separately. Production can be in- creased only marginally, even under the best of circumstances. Large scale mechanization is impractical at most under-ground mine faces. The industry is plagued by excessive employment and deteriorating capital equipment, and costs are above the alternative cost of importing. Efforts should, therefore, be directed at reducing costs through improving opera- tional efficiency. A comprehensive study is needed to determine the best way to accomplish this. Until this study is completed TKI should concen- trate its energies on lignite production since this is where the major expansion in output will come from. One way of ensuring this might be to have TKI's hard coal operations could be segregated to a totally separate profit centre with its own fully independent management. If need be, to accomplish this, hard coal and lignite operations should be split up and separated. into fully independent institutions (para 2.26-2.28). Electricity 17. The Government's planned power development program calls for a trip- ling of installed generating capacity in the decade of the 1980's, reach- ing 15,000 mW by 1990. About half would be in hydro and half in thermal. This program will require the Turkish Electric Authority, (TKI) the Gov- ernment owned power utility, to bring on stream three times more capacity in the 1980's than it brought on in the 1970's. A revised investment program is urgently needed for the power sector. It will need to be based on a more realistic demand forecast. It should also take into account the manpower constraints in the subsector, so that the available scarce human and financial resources can be focused effectively upon a smaller number of projects. Investment in upgrading and expanding of distribution and transmission facilities and particularly in repair of major urban facilities should be given high priority. They have both high returns and can increase available electricity supplies quickly (para. 2.29-2.39). 18. The process by which new projects are chosen for inclusion in the country's long term power development program needs to be revised before new projects are included in the next five year plan. One problem is that in calculating the economic costs and benefits of power, DIS, TKI, and TEK use different parameters for costing hydro power, lignite, thermal power and transmission investments. Different discount rates, investment costs, inflation rate and base case comparators are used for each economic feasibility study. These inconsistencies can often lead to suboptimal choices in the priorities among competing projects. It is recommended that this least cost power development planning model be revised and updated (para 2.31-2.32).  - vi - Fuelwood 19. The ministries concerned with fuelwood production have been slow in recognizing the potential ecological and economic consequences of fu- ture shortages of forest resources and fuelwood. For example, the Gen- eral Directorate of Forests (OGM), has put priority on the development of industrial wood resources almost to the total exclusion of fuelwood con- siderations. Its current plan calls for a decline of 25% in the volume of fuelwood supply coming from existing official sources over the next 15 years, and proposes to substitute lignite, coal and LPG as alternative energy resources for cooking and heating. It is clear, however, that under the present circumstances such a policy would go against the tide of new energy realities. For the development of fuelwood resources, a comprehensive plan for reducing production shortfalls should be prepared as soon as possible and appropriate funds allocated towards achieving reasonable production targets. Projects in the area of coppice rehabi- litation, energy plantations and village woodlot development should be given a high priority within the overall energy investment program (para. 2.34-2.45). Geothermal 20. Geothermal resources can be used for both power and space heat- ing. In spite of promising geological conditions the development of these resources has been given an extremely low priority; as a result, little has been accomplished to demonstrate the importance of their potential. Although the basic research work has been completed for some time, at present there is no organization dedicated to the development of this resource. As part of a realistic development program to develop these resources, consideration should be given to allowing the private sector, either local or foreign, to obtain concessions to develop some of the known reserves. The discussions currently in progress with Union Oil on a possible exploration agreement are an encouraging step in this di- rection (para. 2.46-2.47). Private Sector Initiatives 21. Even after taking into account the increase in energy supplies that can reasonably be expected to be provided by improved, more effi- cient energy SEEs, there will still be a need for more energy production. One important way that the Government can help increase production is by encouraging the participation of private enterprise, both local and foreign, in the development of Turkey's energy resources. The private sector could make important contributions in the expansion of lignite production and the exploration and development of petroleum resources. It could also make a smaller, but still important, contribution to power generation, geothermal development and fuelwood production. The follow- ing is a summary of the principal recommendations for encouraging private sector participation. (i) In the lignite subsector, the Government should return smaller mines to the private sector as quickly as possible  - vii - to increase the supply of lignite to the household and industrial sectors. It should also consider granting concessions or long term production contracts to private firms for the larger mines for which TKI has no current development plans. Since TKI is unlikely to be able to develop all nine major projects that it is planning during the 1980s, consideration should be given to opening the development of one of these projects to foreign competi- tive bidding. If successful, this could bring additional foreign capital as well as foreign expertise and training to the Turkish lignite industry. For the lignite mines owned and operated by TKI, the government should encourage the expansion of competitively bid, long term contracts for the removal of overburden by the private sector, con- sistent with TKI's firm financial program for purchasing its own equipment. This would give the private sector the incentive to purchase the heavy equipment required to do the work more efficiently (para. 2.50-2.52). (ii) Foreign participation in petroleum exploration is poten- tially of enormous significance to Turkey, with its pros- pect for early foreign exchange savings through expanded production and the transfer of skills and technology. Encouraging progress has already been made in this area. The promotion of exploration activities by foreign com- panies should focus on: (a) clarification of the policy framework within which foreign companies must operate, through the passage of the new Petroleum law; (b) the opening of prospective acreage where TPAO is not currently active; (c) revision of the legal, contractual and admin- istrative framework, with particular focus on key areas such as the remittance of capital and profit, pricing and fiscal arrangements; and (d) development of the skills needed to actively promote and negotiate new exploration contracts (para. 2.53-2.62). III. Efficiency in Energy Usage 22. With the supply of energy resources severely limited and the in- vestment cost of expanding these resources high, it is imperative that action be taken to influence the users of energy. Clearly, increased efficiency in the use of energy must play an important role in reducing the pressure on existing resources. There are three ways that the Government can promote energy efficiency. The first is through appropri- ate energy pricing policies. The second is through requiring high energy consuming industries within the state sector to implement programs to reduce energy consumption. The third is through exhortation, information and incentives for the private sector and through creating a climate under which energy efficiency will be considered by every energy user.  - viii - Pricing 23. The Government's pricing policy has been based on two major principles. First, that energy producing and distributing enterprises should recover their costs; and second, that relative energy prices should be set to encourage the substitution of domestic fuels for im- ported. To these a third principle should be added: the principle that energy pricing should provide a signal for the efficient allocation of resources in consumption, production and investment decisions. Under this principle, prices should reflect opportunity costs, that is, the real cost of producing or importing additional amounts of energy in the future. Therefore, for as long as there is going to be a shortage of foreign exchange for importing the required amount of energy and inter- national accounts are balanced by a system of import duties, import restrictions and export subsidies, the opportunity cost of imported energy will be higher than current cif prices, and the price of imported fuels should be raised accordingly. The application of these basic principles leads to the following conclusions: (i) The prices of petroleum products should be raised in order to keep the growth of oil import demand to economically sustainable levels. To reduce the strain on the balance of payments, the tariff on oil and oil products should be raised at least sufficiently to eliminate this bias impli- cit in the import system. Retail price increases of 25%- 30% would appear reasonable on the basis of existing in- formation. If the price increases that are required are impractical in the immediate future, the Government could achieve the goal by announcing a policy of gradually in- creasing prices in real terms over a period of three to five years. If strictly carried out, this announced pol- icy could influence present investment planning decisions, since these decisions are generally made on the basis of expectations about future prices (para. 3.04-3.10). (ii) Lignite prices should be raised to reflect reasonable pro- duction costs (including a reasonable return on invest- ment). At present, lignite prices do not cover production costs for most mines. While the Government may wish to subsidize household consumers on income distribution equity grounds, it should have no similar basis for subsi- dizing power and industrial users. These consumers should be charged the full economic cost. If the Government subsidizes household consumers, it should reimburse TKI for the price differential. This does not mean that prices should be automatically set on a cost-plus basis. Many of the new mines may be only marginally economic compared with other energy sources, and a guarantee of cost plus returns may lead to cost ineffectiveness in TKI. Therefore, prices for each mine should be agreed upon in advance, based on a reasonable target for operat- ing efficiency, with appropriate escalation clauses and  - ix - contingencies. The ability of each mining project (parti- cularly new ones) to contract for its output on the basis of price comparisons with domestic and imported alterna- tives would provide an important indication of the econo- mic viability of the project (para. 3.11-3.15). (iii) Electricity prices are substantially below opportunity costs, which, for this resource, are indicated by the long run marginal cost (LMRC) of supply. The present bulk and retail tariffs should be restructured to reflect the LRMC, including a reasonable return on investments valued at re- placement cost. Energy intensive industrial users, such as aluminum and ferro-chrome producers, that now get pre- ferential rates, should be charged the same rates as other bulk consumers; TEK should not be forced to subsidize them. TEK should also be allowed to increase its tariffs in a timely manner to reflect inflation and increases in fuel costs (para. 3.16-3.19). (iv) Fuel wood prices at forest village depots appear to be lower than necessary to encourage optimum production and distribution. Higher prices could provide the funds re- quired to expand investment in forestry projects (para. 3.20). Institutional Changes 24. In addition to establishing realistic prices to allow the market to work more effectively to bring about conservation in the private sec- tor, the GOT can also encourage the more efficient use of energy through the provision of the necessary technical information and assistance to energy users. This should be accompanied by a promotion and education campaign, and the formulation of an accompanying regulatory framework, such as building codes, traffic regulations, environmental controls, etc. For the majority of energy users, who cannot be expected to acquire their own in-house capability, the GOT should establish vigorous energy effi- ciency programs, to be coordinated by an organization exclusively devoted to this work. One possible way of achieving this would be to upgrade and expand the existing energy efficiency unit within the EIEI of the Minis- try of Energy. The proposed organization should develop a comprehensive program of promotion, energy surveys of individual plants and buildings, setting of efficiency targets, training, monitoring, and reporting to the Government on progress made on an annual basis. As an initial goal, this organization should be given the resources to perform an energy survey of the largest 100 energy users within three years (para. 3.47-3.50). 25. While the proposed organization will constitute the backbone of the energy efficiency program and would be responsible for monitoring its progress, the implementation of specific measures would still be the responsibility of the individual energy producing and consuming units. Thus, in the power subsector, TEK should set up a special unit to revise and implement its load management program, with a view of reaching the  - x - target of balancing supply and demand and of providing the industrial sector with the quality of electricity that it requires to operate effi- ciently. In addition, TEK should review its operation, maintenance and spare parts stocking procedures to ensure that short term demand consid- erations do not adversely affect long term operating capabilities. Energy audits should be carried out at all thermal stations. Further- more, investment in rehabilitation of transmission and distribution faci- lities should be substantially increased with the objective of reducing power losses (para. 3.25-3.30). 26. In the public industrial subsector (including refineries), the management of most SEEs tend to be relatively unresponsive to enegy price increases in their day to day operating decisions; they have failed, for the most part, to place stong emphasis on programs designed to find ways to reduce energy consumption in operations. To increase energy conser- vation consciousness, General Managers should have improvement in the efficiency of energy use as one of their operational targets. Each SEE should be required to set up a special department to measure, monitor, and make improvements in energy use. New investment proposals should in- clude an analysis of the energy consumption implications and the expected energy efficiency coefficients. Given the possibility of continuing energy shortages and the high cost of power from fuel oil fired power plants, there should be no new investments in energy intensive industries such as aluminum and ferro-steel unless such investments can be justified when evaluated with energy costs based on the real opportunity cost of the energy consumed (para. 3.31-3.38).- Planning 27. To be useful for policy makers, the planning process needs to be institutionalized and the staffing strengthened, possible within the Min- istry of Energy and Natural Resources, so that energy sector plans can be revised annually. The revisions would use updated estimates of critical parameters, including those of project completion dates for added produc- tive capacity, those of energy import capacity, and those of growth in demand by major consuming sectors. First priority should also be given to reevaluating all major new energy projects, particularly for lignite development. Attention should also be given to consumption priorities and the appropriate distribution of the limited lignite supplies avail- able among power, industry and household consumers, instead of allowing the implementation of such critical policies to go by default to TKI and TEK. Most importantly, however, is that a strengthened Energy Planning Secretariat would be able to review the full range of options available to the Government to meet the energy needs of each consuming sector (para. 3.51-3.53). 28. Clearly, Turkey's energy problems will be long lived. They must be tackled on many fronts simultaneously, as no one set of actions will I/ The aluminum expansion project investment has just recently been suspended.  - xi - be adequate to resolve them. Energy pricing and efficiency in energy use at all levels of private and public sector activity will be important in reducing the growth rate of demand. However, in the long run, the most critical requirement for resolving these problems is that the efficiency of the energy producing institutions be improved so that they may operate at maximum efficiency and expand output at the rates required.   CHAPTER I ENERGY BALANCES Overview 1.01 Turkey has substantial untapped lignite and hydropower resources, as well as more limited, but still important, oil, gas and coal resources and significant geothermal potential. Proven and probable lignite reserves are about 7.5 billion tons, but about half of this is of extremely low quality. Production in 1980 was about 15 million tons, equivalent in energy terms to about 3 million tons of oil (3 mmtoe). Hydropower with potential economic viability is estimated at over 70,000 gWh per year (19 mmtoe); in 1980 production was about 11,000 gWh (3 mmtoe). Oil production has been declining over the last decade, as few discoveries have been made in recent years; in 1980 production was about 2.3 million tons, about 15% of total consumption. Proven recoverable reserves are about 16 million tons. However, potential reserves that may become economically recoverable, using enhanced oil recovery techniques currently being tested, could be as high as 30 million tons. With the implementation of these enhanced recovery techniques production is expected to increase towards the end of the decade. Proven recoverable gas reserves are about 450 billion standard cubic feet (about 10 mmtoe). This gas is expected to be brought to major consumers by 1985. Production in 1980 was insignificant. Coal production has also been declining as operations move to deeper, less accessable seams; in 1980 production was 3.6 million tons (2.4 mmtoe). Proven reserves of economically recoverable and usable asphaltite and shale oil are insignificant. Asphaltite proven reserves are only 5 million tons. Unproven possible and probable reserves are about 10 times this amount but will require underground mining. While the possible geological reserves of shale oil are quite large (5 billion tons) minable reserves are less than 300 million tons. Furthermore, the low and variable quality of the shale make it unlikely that this resource can be economically exploited. While there is substantial potential for geothermal development for both power and space heating, no long term development program has been organized to exploit it. 1.02 The energy balance for 1980 (Table 1.1) shows that total energy consumption was about 30 million toe. Petroleum was of great importance, accounting for 60% of total commercial energy consumption. Electric power, 5% of which was imported from Eastern Europe, accounted for 23% of all commercial energy used, of which 75% was consumed in the industrial sector. Lignite consumption was less important, accounting for only 16% of commercial energy consumed, over a third of which went for power production. Non-commercial energy production, (primarily fuelwood, but also other biomass) was an important energy source, accounting for 37% of total energy production. While it represented only one quarter of the total energy consumed in the economy as a whole, it was the primary energy source for the household sector, accounting for almost 60% of total consumption.  -2- 1.03 The high level of dependence on imported petroleum is the dominant factor in Turkey's pattern of energy consumption. The share of petroleum in consumption of commercial primary energy rose from 20% in 1960 to 60% in 1980. As production fell from 3.5 million tons in 1970 (46% of consumption) to 2.3 million tons in 1980, (18% of consumption) the oil import bill grew rapidly, surpassing total export earnings in 1980, and -became a major contributing factor to the 1979 economic difficulties. Furthermore, because Turkey could no longer turn to such technically easy solutions to solve its electric power production requirements as increased oil dependence, the late 1970's and beginning of the 1980's became a period of increasing power shortages that have had serious repercussions in the operation of the economy. 1.04 Even in the best of circumstances, Turkey will remain heavily dependent on imported fuels, primarily petroleum. A policy goal of reducing this dependence would, therefore, appear reasonable and desirable since it would increase the Government's ability to take a more flexible approach to handling other important economic issues. It is to this goal of reducing import dependence that this report is directed. 1.05 In order to reduce dependence on imported oil, the Government launched a massive program in the late 1970s to increase the domestic production of electricity and lignite. It increased its investment in energy projects in constant 1980 prices, from TL 57 billion in 1973 to 154 TL billion in 1980, an increase from 1.9% to 3.8% of GNP, the bulk of which was concentrated on hydroelectric projects and on lignite mining for thermal power stations. This represents an increase in the share of total fixed investment from 9.3% to 17.9%. This program has stretched the implementation capabilities of the State energy agencies to their limit and beyond. Resources were spread too thin, over too many projects, with resulting long delays in completion schedules.l/ 1.06 The improvement in the performance of Turkey's major State energy institutions is fundamental to the success of the energy development program, and to the elimination of the continuing energy deficit that Turkey faces. The problems of all State enterprises are being addressed through proposals to change the laws governing their operations. However, because of the central and critical nature of the energy institutions, it is imperative for additional specialized attention to be focused on resolving the specific managerial and financial problems of these institutions, problems that are magnified manyfold by the need to improve efficiency while carrying out extensive expansion programs. Without these reforms lignite and power production throughout the 1980's will be substantially below the levels projected by the Government. 1/ See: Turkey: Public Sector Investment Review, World Bank, 1981, Report No. 3472 TU. This condition has been greatly improved in the past two years.  - 3 - Table 1.1 A: Erergy Balarce 1980 (In Original Units) Petrolem Crude Oil Products Coal Tlgnite Electricity Fueloda Biczas (- -illions of to_ s-- (gWh x 1000) (mnllions of tns ) FINAL EEMAND Irnlustry - 4.1 3.4 4.0 15.3 - - Transport - 5.0 0.2 0.1 - - - osehold - 2.2 0.2 6.3 5.5 15.8 10.9 Agricalture - 0.7 - - - - - TOtAL IEMAND - 12.0 3.8 10.4 20.8 15.8 10.9 SJPFLY Prlnry Produc- tion 2.3 - 3.6 15.5 11.3 15.8 10.9 Imports 10.6 2.8 0.9 - 1.3 - - Exportse-) - -0.2 - - Refineries -12.9 12.0 - - - lhemial Power Gen. - -1.6 -0.7 -5.1 11.9 Otler tran fonnationt/ - -1.0 - - -3.7 - - NET AVAfABIE S[P1LY - 12.0 3.8 10.4 20.8 15.8 10.9 B: ENERGY BALAN(E 1980 (In Milhions of ToTs Oil Equivalent) Petrolean Total Crude Oil Products Coal Lignite Electricity Fuelwood Bianas Enemy YIML lEKAD Industry - 4.3 2.1 1.5 4.0 - - 11.9 Transport - 5.2 0.1 - - - - 5.3 Husehold - 2.3 - 1.8 1.2 4.7 2.5 12.5 Agriculture - 0.7 - - - - - 0.7 TWL 1EmND - 12.5 2.2 3.3 5.2 4.7 2.5 30.4 SUPPLY Primary Prodxuc- tion 2.3 - 2.2 4.7 2.8 4.7 2.5 19.2 Imports 10.6 2.9 0.3 - 0.3 - - 14.1 Exports (-) - -0.2 - - - - - -0.2 Refineries -12.8 12.5 - - - - - -0.4 Themla Pawr Gen. - -1.7 -0.3 -1.4 3.0 - - -0.4 Other trans- fonnation a/ - -1.0 - - -0.9 - - -1.9 NET AVAILABIE S]PPLY - 12.5 2.2 3.3 5.2 4.7 2.5 30.4 SaLwoe: MM ard Mission Estimates; N2vember 1981.  - 4 - 1.07 There is, however, a limit to what the State lignite and power development agencies can be expected to accomplish, even if the proposed reforms were to be carried out quickly and effectively. In order to reduce its dependence on imported energy sources, the Government should put a higher priority on a complementary approach to the development and efficient use of its other energy resources in the future, than it has in the past. 1.08 One of the most important elements of such an approach would be the expansion of efforts to develop other known primary energy resources, particularly through increasing the recovery of oil from proven reservoirs, the exploitation of identified geothermal fields, and the more extensive use of forestry and wood lot resources for fuelwood. Such developments would require a substantial expansion of the financial and technical resources currently committed to these fields. However, the total volume of resources required is small relative to those being used for large scale lignite and hydro projects now under consideration. Furthermore, the institutions that would implement these projects could be strengthened without competing for technical skills from the lignite and hydro power subsectors. Fuelwood and, possibly, geothermal projects are of particular importance for the household sector, which consumes a substantial share of the country's energy resources to keep warm during the winter, a problem that few other developing countries have to face. 1.09 A second important element is the enlistment of the skills and resources of the private sector, both domestic and foreign. The local private sector could undertake small projects that the State enterprises are unable to consider because of a shortage of staff; this is particularly so in lignite mining where the private sector could undertake to provide a much larger share of the industrial and household market, and in hydro power, where smaller projects would be developed by independent engineering firms. The foreign private sector should be encouraged in such fields as petroleum and geothermal where their expertise is needed to speed up exploitation of these resources. It could also undertake mine development and operation in the lignite sector. 1.10 The third element of the proposed approach is the encouragement of greater efficiency in the use of existing energy resources. In addition to the market incentives of higher energy prices, the government should set up energy institutions to make available advice on and assistance with energy saving measures and technologies for both private and public enterprises. It should also encourage direct conservation action by public sector institutions. While none of these approaches alone will solve the problem of the high dependence on imported energy resources, together they will be able to make a substantial impact on the problem. Demand Projections 1.11 A detailed review and analysis was undertaken of the preliminary sector by sector demand projections that were being made by the Ministry  - 5 - of Energy and Natural Resources (MENR) for the Energy Master Plan, and the more aggregate demand projections that had been prepared by the Electricity Authority (TEK), and the Central Planning Organization (SPO). On the basis of the data available from these sources, the Bank's projections on economic growth rates (based on 1981 data), and its own estimate of the probable effect of price changes on demand within each sector, the mission put together its own tentative estimates of demand by subsector for each of the major energy sources. 1.12 The most important elements in the growth of demand for energy resources will be the growth rate of the energy intensive industrial sector and the growth rate of the economy as a whole and the efficiency with which the consuming sectors utilize energy in the future. The projections are based on the Bank's assumption that the economy would grow by 4.5% per year from 1981 to 1985, and by 5% per year from 1985 to 1990, and that the industrial sector would grow slightly faster, at about 7% per year during the decade. These estimates were made in January 1982. 1/ 1.13 The demand for electric power was estimated using the TEK's aggregate projections. They imply a growth rate of 12% for the first half of the decade and 9% for the second half. In view of the importance of a realistic forecast it is recommended that a detailed and comprehensive power market survey be carried out as soon as possible to improve the data base for future projections. 1.14 The demand for lignite is projected to increase rapidly by about 13% per year in industry and household use, and about 25% in power generation. Total demand would increase from 13 million tons in 1980 to 77 million tons in 1990, an average increase of almost 20% per year. Whatever portion of this demand that is not satisfied would spill over primarily into an increased demand for imported petroleum products, or imported coal if new investments in appropriate infrastructure were made. 1.15 The demand for petroleum products for energy by final consumption sectors (i.e. exclusive of power generation and non-energy uses) would increase from 12.0 million tons in 1980 to 24 million tons in 1990, an average increase of about 7.2% per year. For the largest consumer, the transportation sector, demand would increase from 5 million tons in 1980 to 8.3 million in 1990, if the Government maintains its strict controls over automobile supply and demand and maintains fuel prices at about their current real levels. This represents an average increase of about 5.1% per year, which is slightly above the projected 1/ More recent Bank estimates show a GDP growth of 1 to 2 percent higher. This will substantially increase energy demand. However energy demand estimates have not been revised at this time. It is recommended that the government revise these estimates as part of its preparatory work for its 1984-1988 five year plan.  -6- growth of GNP. In industry, the second most important petroleum using sector, demand would increase from 4.1 million tons in 1980 to 6.3 million tons in 1985 and to 7.9 million tons in 1990, a growth rate of 9% per year for the first half of the decade and 4.5% per year for the second half. The slowdown in the growth of demand in the second period reflects the assumption that a program of substituting lignite for fuel oil will be successfully implemented. It is expected that demand by the power generation sector will also grow as more of the gas turbines used for peak demand are repaired and brought back into operation; no new oil- fired plants are projected. 1.16 The Government hopes to keep household and commercial oil consumption from growing rapidly, by restricting licences for oil-based house heating. Nevertheless, the projections have shown substantial increases in domestic (and commercial) petroleum consumption, from 2.2 million tons in 1980 to 5.6 million tons in 1990, an average growth of almost 10% per year. This has been a result of the physical limitations on the availability of other heating resources, including biomass and fuelwood for the rural population and lignite for the urban population. It reflects a growth of only 1.2% per year in per capita household demand for energy. The demand for wood for fuel purposes will grow apace with the growth of population in forest and near forest villages. To a larger extent than with most other energy resources, demand will be a function of the availability of alternative energy resources for household consumption, since there is a high degree of substitutability. The issue of alternative energy sources for household heating and cooking needs will be of growing importance to Turkey as the growing population put pressure on forest resources and the growth of larger urban centers increase the demand for non-biomass heating resources. It is recommended that a study of the alternative ways of meeting this demand and dealing with air pollution be undertaken to determine what the optimum mix of energy sources should be for each major population center. The detailed, sector-by-sector analysis can be found in Annex I. Table 1.2 summarizes these demand projections.  - 7 - Table 1.2 Demand For Energy Products (Millions of Original Units) House- Industry holds Powera/ Transport Agric. Petroleum (tons) 1980 4.1 2.2 1.6 5.0 0.7 1985 6.3 3.1 2.1 6.7 1.6 1990 7.9 5.6 1.9 8.3 2.1 Lignite (tons)1980 4.0 6.3 5.1 0.1 - 1985 8.7 9.2 25.0 - - 1990 14.0 13.0 51.0 - - Electricity (MWh) 1980 15.3 5.5 - - - 1985 28.3 10.5 - - - 1990 42.7 17.8 - - - Coal (tons) 1980 3.0 - 1.2 - - 1985 4.9 - 1.2 - - 1990 6.0 - 1.4 - - Biomass (tons) 1980 - 10.9 - - - 1985 - 11.9 - - - 1990 - 12.6 - - - Fuelwood 1980 - 15.8 - - - 1985 - 17.1 - - - 1990 - 18.2 - - - a/ Based case estimates. Source: MENR and Bank estimates. Supply Projections 1.17 The resources needed to meet this growth in demand will come primarily from expansions in lignite, electricity, and fuelwood production and increases in the foreign exchange available for importing the additional energy requirements, particularly petroleum. As will be seen from the discussion that follows, there are severe limitations on the ability of the economy and its institutions to expand energy production rapidly. As a result, the supply of energy products will be one of the critical constraints to sustaining a high level of economic growth.  -8- Lignite and Electric Power 1.18 The government's strategy for meeting the projected growth of electricity demand is based on accelerating the development of Turkey's large unexploited lignite and hydropower resources. Only 10% of the estimated hydropower potential suitable for development (29,500 MW producing an annual average of 100,000 gWh) has been developed. Likewise, only a small fraction of the proven lignite reserves of 4.1 billion tons (including the 1.9 billion tons of very low-grade deposits at Elbistan) has been developed. The strategy also includes plans to construct the nation's first nuclear power station, although plans for this plant are still in the preliminary stage. 1.19 The base case projections were constructed using the following optimistic assumptions: first, that all the funds required for implementing the projects will be forthcoming at the times they are needed; second, that the government will successfully and speedily implement the institutional reforms recommended in this report to resolve the present institutional constraints (para. 2.02); and third, that the institutions will respond quickly to the new environment and recruit and train the necessary management and operating staff required. The resulting schedule of project completion dates is given in Annex 3. These completion dates are consistent with those projected by the Government State Planning Organization (SPO) with one major exception, the anticipated completion date for Elbistan, where the Bank believes further delays will most probably be encountered (see para 1.22). 1.20 The Government's power development program calls for nearly a tripling of the installed electrical generation capacity in the decade of the 1980's, from about 5000 MW in 1980 to about 14,600 MW by 1990, with an output capability (assuming average water flows) of 67,400 gWh (see Annex 3) compared with actual production of under 25,000 gWh in 1980. The 9,900 MW increase in installed capacity would be composed of 5,600 MW of hydropower (compared with the 1980 total hydro capacity of 2,100 MW) and 4,300 MW of thermal power (compared with 3,000 MW in 1980). All but 150 MW of the new thermal power would be lignite fired. 1.21 This program will require TEK to bring on stream three times more the installed capacity than it brought on stream in the 1970's. Furthermore, almost all of the new TEK thermal plants would be lignite- fired. This implies a tripling of lignite requirements for power to over 24 million tons in 1985 and then doubling again to over 50 million tons in 1990. The projection does not include any nuclear contribution, since it is unlikely that the one proposed nuclear power station will be in operation before 1995 at the earliest, considering the delays experienced in other countries in bringing a first station into operation and the fact that finance for the project still has to be secured. 1.22 Almost all of the new thermal plants would be lignite fired. This places a heavy burden on TKI to expand its lignite production facilities, and TKI has embarked upon an extremely ambitious program to meet this growing demand for lignite. Besides the 18 million tons per  - 9 - year (mmtpy) Elbistan project presently under construction, the lignite development program calls for TKI to finance and implement ten new projects costing an estimated US$960 million (1980 prices) with a rated production capacity of 25 (mmtpy) by 1990. Even if TKI were able to overcome its institutional limitations, strenghten its project implementation capabilities, attract new staff and obtain the required financing within the coming year (1983), given the construction and training periods required, TKI's maximum possible production, excluding Elbistan, would be 26.6 mmtpy in 1985 and 52.7 mmtpy in 1990. Elbistan production is estimated at 3.5 mmtpy in 1985 and 18 mmtpy in 1990. A detailed project by project projection is found in Annex 4. 1.23 At present, however, it appears unlikely that the Government will rapidly and fully implement the steps necessary to carry out this program. For example, as of January 1982, the Government had yet to give sufficiently high priority to the energy projects that were under implementation to enable TKI to earmark all the funds necessary to finance them; nor has it decided how to attract the calibre of staff that the institutions must have to implement the projects. Furthermore, even after the decisions are made regarding measures to improve the staffing structures at the energy SEE's, unless a large number of fully experienced staff can be induced to join these institutions, it will take several years to recruit and fully train the number of personnel necessary to do the job. 1.24 What then are the implications for the future supply of energy? Many alternative scenarios are possible. For example, a "highly pessimistic" case could be developed by assuming that the inadequate management and implementation capabilities of the energy SEEs will continue without abatement. However, this appears to be an unlikely possibility. It is more likely that the institutional problems of management and personnel will not (and indeed cannot) be resolved as quickly as desired, that insufficient priority will be given to resolving planning and coordination problems, and that some of the financing required will be unavailable at critical times. Further project delays can, therefore, be expected. 1.25 For this reason a second projection for lignite and power supplies that is less optimistic than the Base Case has been provided. This projection also assumes that the Government will take the required actions on institutional reforms soon and that the foreign and domestic funds will be made available for all of the projects. However, it assumes that the institutions will be able to respond only gradually to the new improved operating environment, and that, particularly in the case of TKI, the recruitment and training of new staff will take considerable time to fully implement. For the purpose of illustrating what the impact of this gradual response might be, the less optimistic scenario assumes a minimal, 20% slippage in project completion schedules of the base case. 1.26 However, these lower levels of production will also require a rapid resolution of the most pressing institutional, management,  - 10 - recruiting and project preparation and financial constraints (see para 2.16). In fact, given the staffing expansion and training programs required, and the apparent lack of action on the part of TKI to resolve these problems, it is unlikely that the less optimistic case may in fact, represent the upper limit of production that one can expect from TKI through 1990. In this scenario, TKI's lignite production, excluding Elbistan, would reach 21 mmtpy in 1985, and 37 mmtpy by 1990. Elbistan lignite production would not be significant in 1985 and would reach 9 mmtpy in 1990. A detailed project by project projection is in Annex 6. 1.27 The outcome of this less optimistic scenario illustrates the danger Turkey faces if it delays resolving the problems of the power subsector. Such a slippage would lead to a 16% reduction in electricity production in 1985 and a 5% reduction in 1990, which is enough to necessitate continued substantial net electricity imports well into the 1990's. It would also lead to large deficits in lignite availability. If production slipped from 70.7 million tons to 52.5 million tons, as the 20% slippage case suggests might happen, the lignite deficit for power generation, domestic heating and industry would rise from 1.9 million tons oil equivalent to 3.6 million tons oil equivalent. 1.28 The lignite deficits would most likely have to be made up by increased imports of fuel oil. In the power sector, in order to maintain electricity output at acceptable levels, TEK would be forced to continue to use its oil based power plants and to use fuel oil in its lignite based plants until the dedicated lignite mines reached planned production targets. In the industry sector many planned plant conversions to lignite will be postponed, while new plants will continue to rely on fuel oil. And in the domestic sector, Government will be required to supply fuel oil if lignite is not available in sufficient quantities to meet minimum demand requirements. An increase in petroleum imports of about 3.7 million tons (2.0 for power directly and 1.7 to make up for the higher lignite deficit) would cost about $800 million in 1982 prices (and almost $1.7 billion in 1990 prices). This would put an additional heavy strain on Turkey's capacity to import adequate levels of non-energy products required to maintain a rapid growth rate. Table 1.3 summarizes the implications of the two projections for power production. Hard Coal, Asphaltite and Shale 1.29 Present estimates of economically recoverable hard coal reserves would allow for production of about 5 million tons per year at least until the end of the century. Production can not be substantially increased because geological conditions make the use of mechanized technology impracticable. Proven reserves of asphaltite are about 5 million tons; possible and probable reserves are about ten times this amount, but substantial additional drilling will be required to move these reserves into the proven category. Reserves minable by surface methods are almost exhausted, so production is likely to fall from its present level of about 550,000 tpy in the near future, unless major investments in underground mining facilities are implemented. Shale oil quality variations have made production and use of this resource for  - 11 - power generation extremely difficult in practice. In most areas where shale has been considered, TEK has found it more efficient to continue to rely exclusively on lignite. It is unlikely that this situation will change during the 1980's. Where shale oil projects are under consideration, the economic merits should be carefully evaluated. Petroleum Production 1.30 Annual crude oil production, which fell from 3.5 million tons in 1970 to 2.3 million tons in 1980, is expected to rise again over the coming decade to between 4 and 6 million tons by 1990, depending on how successful Turkey is with its expanded exploration and enhanced recovery programs and in encouraging foreign companies to renew exploration activities. The projections use a conservative assumption of 4 million tons for 1990. For a detailed discussion of petroleum issues see para. 2.51-2.57. Fuelwood Production 1.31 Until recently, the development of forest resources for fuelwood has had a relatively low priority for Government planners. In fact, the present program calls for a shift to industrial wood production and a subsequent reduction in official fuelwood production from the current 8.6 million tons to 6.3 million tons by the end of the decade. However, a new awareness of the importance of fuelwood appears to be growing. The base case projections about the growth of fuelwood supply made here are, therefore, based on the assumption that a policy of emphasizing the importance of expanding the supply of fuelwood be adopted and vigorously pursued. Total production (including illegal cuttings) could increase from the 1980 level of 16 million tons to 17.1 million tons in 1985 and 18.2 million in 1990. Issues related to increasing fuelwood production are discussed in detail in para. 2.34-2.47.  - 12 - Table 1.3 Electric Power Supply Projection a/ 1980 1985 1985 1990 1990 BASE 20% BASE 20% ACTUAL CASE SLIPPAGE CASE SLIPPAGE Generating capacity (in MW) Hydro 2,131 4,045 3,805 7,772 7,279 Thermal 2,988 4,609 3,584 7,249 6,789 Total 5,119 8,744 7,389 14,711 14,068 Imports, '000 gWh firm 1.3 2.0 2.0 2.0 2.0 average 2.0 2.0 0.0 2.0 Electricity Production ('000 gWh) Hydro: Actual 11.3 -- -- -- -- Firmb/ -- 11.8 10.0 19.9 18.8 Averagec/ -- 17.0 14.5 28.3 26.1 Thermal 11.9 24.5 19.9 39.0 37.9 Available Supplyd/ ('000 gWh) Actual 20.8 -- -- Firmb/ -- 33.7 28.1 54.8 52.8 Averagec/ -- 38.3 32.2 60.5 59.4 Demand ('00Uo gWh) -- 38.8 38.8 60.5 60.5 Shortfall ('000 gWh) Firm -- 5.1 10.7 5.7 7.7 Average -- 0.5 6.6 0.0 1.1 a/ Details can be found in Annex 3. b/ Firm capacity is the amount that on the basis of historical water flow data could be produced in nine out of ten years. c/ based on power generated if rainfall and water flow equals historical average. d/ After transmission losses. Source: TEK and mission estimates. Petroleum Imports 1.32 The remainder of the energy supplies must come from imports. The bank's most recent balance of payments projects for Turkey, made in November 1982, indicate that after full account is taken of export potential, workers remittances, foreign capital flows, and loan repayment  - 13 - schedules, in 1990 the total resources available for commodity imports may be on the order of $33 billion ($20 billion in 1982 prices).1/ If 50% of these resources were to be used for energy imports about 35 million tons of petroleum could be imported. Coal imports, however, cost about half as much as oil imports on an energy equivalent basis, so that a move to coal would decrease the balance of payments impact of energy imports. Gas might also be imported to help fill this gap. Energy Balances 1985 & 1990 1.33 The energy balance estimates presented here are based on a large number of simplifying assumptions about growth and direction of the industrial sector, improvements in energy efficiency in response to higher prices, speed of development of both hydro and lignite resources, continued excellent export performance, and the ability of the economy to increase energy imports. Their purpose is to be illustrative: to show orders of magnitude of energy requirements and limitations. Table 1.4 summarizes the results, which are detailed in full in Annex 5. 1.34 The base case estimates show that if the appropriate policies are followed, Turkey will be able to meet its electric power demand requirements, and will, in addition, by 1990, be able to eliminate the need to rely on power imports, as long as hydrological conditions allow for an average availability of power from hydroelectric dams. However, the estimates also show that even in the best of circumstances there will be substantial shortfalls in lignite production, and that these shortfalls will have to be made up by imports of fuel oil, gas, or coal, if the economy is to continue to be free from energy supply constraints. 1.35 The shortage of electricity will be almost eliminated by 1985 under the base case scenario if imports are maintained at about 200 gWh per year, and electricity imports can be eliminated by 1990 if plants presently under construction come on stream as planned. Full details can be found in the tables of Annex 5. In 1990, under the least favorable conditions of a 20% slippage and poor rainfall that only provides for firm power, the deficit could reach about 7,700 gWh (about 12.5% of demand). Continuation of electricity imports would somewhat reduce the shortage. The Bank therefore recommends that the government continue to make provisions for electricity imports for the next five to ten years, as it is most likely that power shortages will continue through most, if not all, of the 1980s. 1/ For details of these projections see Annex 2.  - 14 - Table 1.4 Summary Energy Balance (In Millions of Tons Oil Equivalent) Oil Coal Lignite Electricity 1985 1990 1985 1990 1985 1990 1985 1990 Base Case Demand 22.9 28.9 3.6 5.0 9.7 17.0 9.7 15.1 Domestic Supply 3.0 4.0 2.6 3.4 6.9 15.1 9.1 15.1 Import Requirements 19.9 24.9 1.0 1.6 2.8 1.9 0.6 0 20% Slippage Demand 23.4 30.9 3.5 5.0 7.5 14.8 9.7 15.1 Domestic Supply 3.0 4.0 2.3 3.4 5.0 11.2 8.1 14.3 Import Requirements 20.4 26.9 1.2 1.6 2.5 3.6 1.6 0.8 Source: See energy balance tables in Annex V. 1.36 Lignite is expected to be the fastest growing commercial energy source in Turkey over the next ten years. However, lignite available for industry and household consumption will be determined by how the thermal power plant completion dates can be coordinated with the lignite mine development schedules. This will have a strong effect on the nature and impact of the demand-supply gap. It is assumed here that power plants would get first priority and that households and industry would have to make do with what was left. Under the base case scenario the supply shortfall would be about 50% of household plus industrial demand (on a toe basis) in 1985, and about 25% in 1990. Shortages of this magnitude clearly imply that there would be a large spillover effect, as consumers who could not get lignite would shift to other energy sources (possibly fuelwood and oil or imported coal) and others never undertake the proposed shift from fuel oil to lignite. Alternatively, there could be a substantial shortfall of household fuel. Unless the balance of payments situation permits the fairly free substitution of imported oil or coal, the distribution of lignite will continue to be subject to rationing that could, possibly, disrupt the growth of industry. Under these conditions of tight lignite supplies, planning for their distribution will be essential to maintain orderly markets. This planning should be undertaken by a joint ministerial body rather than by TKI. Furthermore, to the extent that imported coal could substitute for oil, particularly in industrial uses, the total cost of energy imports could be reduced, since on an energy equivalent basis imported coal costs about 50 to 70% of imported fuel oil. 1.37 In the base case energy balance estimates, energy imports need to grow from 14.1 million toe (of which 13.4 million was petroleum crude  - 15 - and product imports) in 1980 to a needed 28.4 million toe imports in 1990, of which 24.9 million tons are crude oil. This represents annual import growth of about 8%. If, however, the less optimistic, 20% slippage scenario prevails, required imports would have to increase by about 16% to 32.9 million toe, with average annual growth of about 9%. If rainfall levels are below average, more thermal power production using fuel oil will be required, and energy import requirements could rise further. For instance, if 1990 had as low rainfall as one year in ten, import requirements would be about one million toe higher. 1.38 It should be noted, however, that these energy balance estimates are based on the assumption of annual GNP growth rates of 4.5 to 5%. The Government is aiming at substantially higher growth rates, which will, in turn, induce substantially higher levels of energy consumption unless strong measures are taken in the field of energy conservation. For example, an average one percentage higher annual growth rate between 1982 and 1990 would increase GNP by about 8% in 1990, which, assuming a low elasticity of demand for energy of 1.2, would increase energy demand from 61 million toe to 66.0 million toe. To meet this new demand, energy imports would have to be increased by about 5 million toe, or about 20% of the base case import estimate, at a foreign exchange cost of almost $1.5 billion. Clearly such an increase, even if sustainable, would have serious repercussions on Turkey's balance of payments position. For this reason it would appear that further efforts to improve energy efficiency and shift the economy away from high energy intensive activities would be desirable. 1.39 The need for such a high level of energy imports could put a severe strain on Turkey's overall ability to import sufficient goods to keep the economy growing smoothly at the rate desired by the Government. At a minimum, would greatly restrict the freedom of the Government to pursue an active expansionary policy to maximize the rate of growth of the economy. The issue, then, is how Turkey will deal with these constraints: through the imposition of ad hoc measures at the time of crisis that may disrupt the growth of the economy, or through a set of long term strategies and tactics that could minimize disruption and maximize the Government's ability to use its foreign exchange for implementing an aggressive, rapid growth development strategy. Clearly the latter course is the desirable one. However, it will require concentrated action on strengthening the energy Sees, encouraging the private sector to take a larger role, increasing direct and indirect incentives to increase energy use efficiency and strengthening the planning of energy related activities. Chapter two and three discuss ways to accomplish these goals.  - 16 - CHAPTER II EXPANDING SUPPLY ROLE OF THE INSTITUTIONS 2.01 The single most important factor in the reduction of the looming energy deficit will be the ability of the institutions involved to implement the domestic energy development program. The problem of these institutions is of particularly acute dimensions because they will be called upon to increase their efficiency while growing at rates well above ten percent per year for the next one or two decades. Thus, what might be good enough for a reform of the average SEE with only limited growth prospects, may be insufficient to accomplish the task for the energy SEEs. The more important energy institutions and their problems are described in the following paragraphs. 2.02 TEK, the Turkish Electric Authority, and DSI, the General Directorate of State Hydroulic Works 1/ construction company, have both had to function with management teams that had short and uncertain terms of office, little autonomy even in day to day decisions, and no real accountability. Each of these organizations have suffered shortages of experienced professional staff, especially engineers in key operating and planning departments. Both TEK and DSI have been losing experienced staff at an increasing rate because their salaries are low, typically in late 1981 about one third of those in the private sector. TEK's net loss of engineers with six years or more experience rose from 6 in 1977 to 54 in 1980. Within DSI the number of engineers in the key Dam Design and Construction Department has declined in recent years from over 100 to 55, despite a large expansion in the dam construction program, which currently includes about 50 projects, one third of them with a power plant component. The government should look for ways to encourage experienced personnel to return to these organizations. 2.03 TKI, the Turkish Coal Mining Authority, suffers from many of the difficulties that face the other SEEs. Senior positions require Governmental approval and this can lead to delays in implementing appointments. TKI also faces difficulties in attracting and keeping professional staff. Estimates made earlier this year (1981) indicate that nearly 30 senior power management and engineering positions at TKI's lignite mining companies are unfilled. Furthermore, in the past 12 months there was little increase in the management staff at Elbistan, even though the project plan calls for an additional 100 managers and engineers to have been recruited. Part of this is due to the strict limit on SEE recruitment decreed by the Ministry of Finance; the major cause, however, is TKI's relatively unattractive salary structure and 1/ DSI is the central authority responsible for water supply, wastewater disposal, irrigation, and all major hydro power projects in Turkey.  - 17 - inadequate compensation packages especially for remote areas in Central and Eastern Turkey. 2.04 TKI's local management teams have very little authority over hiring, investment, production and planning. The situation is most difficult for the new projects. For example, at Elbistan, the site of one of the largest and most complex lignite projects in the world, the TKI local manager can (with the exception of one or two special items) only authorize expenditures of up to US$150,000 (TL 200 million). Most matters must be referred to Ankara, thereby lengthening the time required for decisions to be made and limiting the scope for on site response to project implementation problems. Furthermore, since TKI presently has fourteen operating subsidiaries and ten major projects under development, the present system concentrates a very large workload on a small number of headquarters staff whose time has to be allocated to a large number of issues of minor importance, as well as to the many matters of substance. Decentralization of decision making must, therefore, be a critical part of the reform of this institution. This may require a splitting up of the institution into two or more entities. 2.05 TPAO, the Turkish Petroleum Company, is generally considered to be a SEE, even though it was organized under the commercial code and is, therefore, legally able to pay its technical staff substantially higher salaries than those paid to civil servants under Law 657. Nevertheless, the opportunities for earning even higher salaries are greater in the local private sector and abroad. The result has been that many of the best and most qualified senior staff in the most critical sectors of exploration and drilling were leaving at an alarming rate in 1980 and 1981. The situation has stabilized in 1982, as salaries were increased and international demand for petroleum experts decreased. The Government should now try to find a way to take advantage of these new conditions by encouraging experienced staff to return to TPAO. 2.06 MTA, the Geological Research and Survey Organization, is organized to undertake research and exploratory work for the development of mineral resources. It has been able to identify and delineate lignite reserves and undertake the preliminary identification of prospective geothermal locations. However, since MTA salaries are insufficient to hold drilling technicians for more than a few years, drilling crews are young and inexperienced. They could not, for example, undertake a serious program of geothermal exploration drilling beyond the drilling of heat sink bore holes of a few hundred meters. Full development of a geothermal field would be beyond MTA's institutional and technical capabilities, as would the task of developing a lignite or copper mine. Remedies to Institutional Problems 2.07 Ephemeral managements, net losses of professional staff and lack of delegated authority and accountability are problems of such seriousness that they must be solved urgently, even before dealing with other institutional problems such as weak organization, poor finances or over-staffing. This is all the more essential as the fast growth of  - 18 - energy demand would require TKI and TEK to become by the end of the decade among the largest producers of coal and electricity in the world. Attaining such goals is impossible with the present weaknesses. 2.08 The Government is fully aware of these problems and in 1981 was preparing draft legislation to submit to the Consultative Assembly that would: (i) establish these SEE's under the private sector law, thereby freeing them from the SEE Law (Law 440) and the Personnel Law (Law 657). (ii) allow general managers and representatives of the Board of Directors to be appointed for fixed terms of at least 3 to 5 years, thereby promoting continuity of management. (iii) eliminate the ministries direct control over the operation of the companies, instituting instead a review of the companies' operations at the annual general meeting, (iv) institute a Special Planning Council to develop guidelines on investment and personnel policy matters. (v) establish the goals of efficiency and profitability as the primary objectives of management. Due to the complexity of the situation and the interrelationships between the SEEs and the rest of the civil service aparatus, a comprehensive reform package has been difficult to prepare. In June 1982 the consultative Assembly gave the Government the power to enact as law any decrees passed on the reorganization and operation of Government agencies and SEEs. This authorization was for a limited period of 18 months. The government is now proposing that all decisions on SEE reform be taken by May 1983. However, as of November 1982 no concensus had been reached in the form that these reforms would take. 2.09 To have the needed impact on improving the performance of the energy institutions, however, the reforms must be accompanied by a firm commitment on the part of the Government to raise the salaries of management and technical personnel in the energy SEE's to the point where these salaries are competitive with those in the private sector. This does not require salaries to be fully equal to the best found in the private sector, but it does require that the difference, particularly at the technical level is not overly large. However, those people who elect to accept the substantially higher salaries might be required to give up the job security that has been associated until now with working for a SEE. Management could then be given the right to terminate the employment of these specialized staff if they do not meet the expected performance levels.  - 19 - 2.10 The above system implies that the company's full time management team would be given adequate authority to implement agreed upon objectives and would be made accountable for reaching these objectives. To accomplish this delegation of authority and accountability, management of each energy SEE and the ministries of Energy and Finance could enter into a "State Economic Enterprise Program Contract" that would place goals and objectives on a firm, well understood basis. This type of contract was introduced in France in 1970 for SEEs such as Electricite de France and Railroads, for reasons which would apply to Turkey's current situation, e.g. that "the heavy capital needs and deficits of these enterprises were requiring subsidies which weighed heavily on the government's budget and on financial markets". A French interministerial task force concluded that the primary role of the SEEs should be to produce at minimum cost and that their prices should fully cover their costs. Since use of the SEE's to provide services outside their defined production role led to income transfers whose destination, valuation and impact were uncertain, the task force recommended that the Government should require SEE's to provide such special services only when the benefits to the general economy were shown to be greater than the losses to the SEE's; in such cases the SEE's should be fully reimbursed. 2.11 In Turkey, Program Contracts could be negotiated for a five-year period. They could set out quantified objectives for production, productivity (including energy efficiency), investment and financing, while delegating full authority to the management of the SEE's to decide how to meet these objectives. Management performance could then be reviewed and evaluated annually on the basis of the objectives formally agreed upon. The accountability of TEK and TKI might be further increased by including on their boards a representative of a major consumer organization, such as from an industry association. Such a system could also be used to make the SEE's management more accountable for the energy efficiency of their operations. PROSPECTS FOR EXPANDING RESOURCE PRODUCTION Lignite 2.12 In 1978, TKI proposed a plan to increase its production to 95 million tpy by 1988 (from 11 million tpy). The plan proved untenable, and the present program calls for the development of 10 new projects to produce 45 million tpy by 1986. All will be linked to new thermal power plants, with a total generating capacity of 4,000 MW, although they will also produce some lignite for industrial and household consumption. However, at the end of 1981, none of the projects has been fully financed, and only one, Afsin Elbistan, was in an advanced stage of construction. The status of the other projects is shown on Table 2.1. Excluding Elbistan, the proposed projects will have an estimated total cost of about one billion dollars, and an average cost of $38 per ton (in 1981 prices). This is extremely low by world standards, where most new mines have a capital cost of between $50 and $100 per annual ton of production, plus a similar amount for off-site infrastructure  - 20 - investments. Actual costs in Turkey may, therefore, be as much as double the current (1981) estimated costs, even before post 1981 inflation is taken into account. 2.13 TKI possesses neither the technical manpower nor the financial resources to implement a program of this magnitude over the next five years. Nor could it possibly recruit and train the staff necessary to operate the projects once they are completed. In fact, it has experienced substantial delays with almost every major project that it has undertaken. Afsin Elbistan is a good example. In late 1981, on the technical side it had yet to resolve the problem of how to dewater and remove the clay-like layers that are between lignite beds. Elbistan is also faced with continuing financial problems even though it has the highest priority and is in the last stages of development. This has caused many delays, including a delay in ordering the conveyor system that will move the lignite from the mine to the plant site, a project component that is on the critical path for project startup. There are problems on the staffing side as well. Hiring is a year behind schedule, with only a handful of the hundred or so new engineers and managers that the project plan calls for training during 1981 have been recruited. 2.14 There is a wide range in the costs for different mines, taking into account the different heat values of the lignite and a high probability that the costs of some projects have been inadequately estimated. Feasibility studies have been prepared and issued for five projects (see Table 2.1). However these feasibility studies are not as technically comprehensive as international standards would require for investment planning purposes, and they need to be revised to take into account recent price changes. Based on the data provided by TKI in late 1981, production costs for new mines will range from $10 to $15 per ton, equivalent to $35 to $75 per ton of coal equivalent after adjusting for the energy content of the lignite produced. It is therefore recommended that a reappraisal of all the projects in the early stages of develoment should be undertaken on an urgent basis to enable TKI to reorder its priorities to maximize its productive capacity given its limited resources.  - 21 - Table 2.1 TKI Ligitte Mines Under Construction 1/ Capacity Status of Status Invest- Ccst $ tpy Feasi- of mgnt2/ per Saleable bility Foreign Required a& Mines Ligite Study Ecchange ($ millions) ton Substantial Predevelop- ment Work Ccnipleted Miugla Yatagan 3.5 issued partial 118 34 Beypazari 3.0 issued partial 164 55 Predevelopment Work Started Sana sikiar 2.5 orgoiig none 82 33 Scma Dnis 2.5 ongoing none 82 33 Bursa Orhaneli 1.6 issued none 82 51 Milas Sdckoy 4.2 ongoing none 127 30 Sivas Kargal 4.2 issued partial 136 33 Bursa Keles 1.8 issued none 86 47 No Predevelopnwmt Work Tinaz Bayaka 1.8 orgoirg none 74 48 Grand Total 25.1 964 38 1/ Excluding Elbistan 2/ In 1981 costs. Cost, as estimated by TKI may prove to be substantially underestimated: see para. 2.12. Source: TKI. 2.15 TKI's existing organization and manpower will be unable to carry out the project preparation, implementation and monitoring functions that are required for the proposed expansion program. TKI staff have little experience in the design and construction of large open pit mines, since, historically, most of its production has been in underground mining. The planning department, which is responsible for all phases of project work, has only 15 engineers, several of whom are recent university graduates with minimal mine operating or design experience. The number of reports completed and the work undertaken by this department represent a substantial accomplishment, given the size of the group. However, the staffing limitations and the need to produce a large number of reports quickly, have resulted in inadequate project preparation and insufficient feasibility work. 2.16 It is unlikely that any company in the world could quadruple its production (from 15 million tpy to 60 million) in a decade while relying  - 22 - on its own staff to prepare feasibility studies and preliminary and detailed engineering studies in addition to its project supervision work. TKI is no exception; if it is to develop its lignite resources as rapidly as proposed, it will have to rely heavily on outside assistance for much of its project preparation and at least part of its operations. Otherwise, it will have to scale down its program to a more manageable level or face the continued prospect of unprogrammed project delays and cost increases. Clearly, the present approach will not suffice to meet the government's objectives for the subsector. 2.17 In its macro planning TKI has at times proposed production targets that, while politically desirable, were technically unachievable. Lacking a coordinated program for husbanding its limited managerial and financial resources, its efforts have often been dissipated over more projects than it can implement and have often been misdirected. Often technical feasibility studies have yet to be completed, (the mine to supply the Suma B power plan being a case in point) making it impossible to design an appropriate mining implementation program. In some cases, financing has been accepted for parts of a project without preparing overall financial plans for the entire project. In other cases, such as Sivas, foreign funds have been obtained for a project that will not be implemented until 1985 at the earliest. 2.18 It is counterproductive to start projects just because financing for special equipment packages is available in each case. Resources would be better used if priorities were established and decisions made about which projects should proceed first and which ones should be delayed, since, with inadequate funds some projects must inevitably be delayed. In order to develop a realistic program it is recommeded that the estimated construction costs and operating costs of the various lignite projects be updated in current terms, together with the thermal power plant costs for all minemouth power complexes in the early stages of development. A ranking should then be made of the economics of the different units. Based on this ranking, explicit priorities should be set to complete those projects that are in an advanced stage of development, and to selectively initiate or proceed with other projects for which financing, staffing and implementation capabilities are reasonably secure. 2.19 Because TKI has as yet only limited experience in the technologies of fully mechanized underground mines and large-scale open- pit mines on which all of its new lignite projects are based, it is faced with the enormous task of training a large number of new technical and managerial staff. In order to reach its production targets, over 2000 technical and managerial staff will have to be recruited and trained along with 10,000 workers. However, there is only a limited pool of skilled mining professionals from which TKI can draw, and new recruits will need training periods of two or three years before they become fully operational. It is, therefore, recommended that more attention be given to developing a comprehensive program for recruiting and training new staff.  - 23 - 2.20 In order to promote more effective project construction and operation, there should be (i) the creation of adequately staffed Project Management Units for each project under preparation and construction, (ii) full delegation of authority and accountability to the Project Units and to the operating mines, and (iii) the use of available local and foreign project management, contracting and training assistance to avoid costly mistakes, delays and dissipation of scarce staff resources. Senior management at the headquarters should concentrate on important overall policy issues such as expanding and strengthening project planning, construction and monitoring capabilities and on matters associated with the proposed SEE reforms, such as the development of new recruitment and training plans consistent with the expected reforms in personnel policies rather than spending a large part of their time on day to day operating or construction decisions. 2.21 TKI must also contend with major constraints on the availability of capital resources for the purchase of foreign equipment. Consequently, in order to make even limited progress on many projects, it has turned to local contractors to undertake the initial overburden removal. It will continue using contractors at some sites where, even after procurement funds are found, two or three years will be required for the manufacture, delivery, erection and testing of heavy earthmoving equipment, especially draglines and large shovels. Longer term (3 to 5 year) commitments to contractors might allow the contractors to better organize their investments to increase their productivity (see para 2.52). TKI could also become more efficient if it were to concentrate its limited capital resources on a smaller number of projects and if it were allowed to use for its capital budgeting more of the free foreign exchange that the Government currently uses for importing of industrial raw materials and intermediate goods, instead of having to rely so heavily on 1Wied loan funds for these foreign exchange capital expenditures- 2.22 The potentially high cost of some lignite projects raises questions about whether their development for power is economically justifiable. This is particularly true for the development of Elbistan B, C, and D. The Government has decided that a review of the operating results from Elbistan A should be undertaken before new committments are made. Early in the 1970s, prior to the rapid rise in petroleum prices and capital costs, the Government committed itself to developing the first of the Afsin-Elbistan lignite deposits. At that time, the alternative was to build a thermal power plant near Istanbul, the major power consuming center, that would be fired with imported fuel oil. However, the increase in oil prices and the high price of lignite based electricity generation has made the economics of producing power with imported steam coal far more attractive than it was in the 1960s. 2.23 For example, a power plant using imported steam coal (with a 1/ The Bank has been informed that this policy is now beginning to be pursued as Turkey's foreign exchange constraints become more manageable.  - 24 - heat value of 6500 kcal/kg) would use one sixth the amount of coal as the lignite used by the Elbistan power plant. Thus, based on a production cost of $12 per ton of lignite, Elbistan lignite costs between $75 and $80 per ton on a steam coal equivalent basis. It is, therefore, only marginally less expensive than imported steam coal, which is estimated to cost between $80 and $90 per ton delivered, depending on the size of the ship that the port facilities can handle. 2.24 It is recommended that a detailed cost comparison of the alternatives should be made to determine which is the least cost solution: additional developments at Elbistan or a shift to imported coal for power needs in the 1990s and beyond. Factors favoring imported coal would include; i) a much lower capital cost for the boilers, scrubber and coal handling facilities, which account for about 40% of 'the total power plant investment costs, because of the far lower quantity of the material to be burned; ii) the elimination of the cost of long distance high voltage transmission lines required for a power plant in Afsin-Elbistan, with a consequent elimination of instability problems and transmission losses that consume 5% to 10% of the power output before it reaches the consumer; iii) the savings of the 8% to 10% of the energy output-used in mining the lignite, and iv) the greater ease and lower off-site investment required to construct a power plant at an accessible port rather than in the middle of the country. As a balancing factor, the cost of constructing harbor and unloading facilities must be included in the imported coal project, along with the important element of much higher, long term foreign exchange requirements for the imports. 2.25 While the conclusion of such a study may well be that the Elbistan lignite is still an appropriate least-cost solution to producing additional power, it is fairly evident that the study would show that the use of low grade lignite is, at best, an expensive solution to Turkey's energy needs and not a solution to its energy problems. However, the real advantage that lignite based projects such as Elbistan have over their imported coal alternative is their foreign exchange savings. In the case of lignite, about 50% of the capital costs and 80% of the operating costs could be 'met with local currency. For the largest, most capital intensive projects, foreign debt service and operating expenses might then account for 40% of total annual costs. The alternative of using imported coal for Turkey's thermal power plant expansion program would require additional coal imports of some $2 billion per year to replace half of the lignite production planned by 1990. Government planners would have to decide whether this large an increase in imports for energy would be feasible, given the greatly improved prospects for growth in export earnings. Coal 2.26 The prospects and problems of hard coal production are totally different from those of lignite. Hard coal is found only in the region of Zonguldak, near the Black Sea. Present estimates of economically recoverable reserves would allow for production of about five million tpy of saleable washed coal (the volume reached in 1975), for between 15 and  - 25 - 35 years. Extensive mechanization at the coal face is not possible, and production can expand only marginally above current levels. 2.27 The limits on growth and the long production history have created a set of problems that is totally different from those found in the rapidly expanding lignite industry, particularly with regard to excess employment and low levels of productivity. As the only large scale employer in the region, TKI has been forced to take on far more workers than it needs. Three quarters of the work force are above ground, an excessively high proportion for a non-mechanized mining operation. Furthermore, the level of productivity of the underground workers is low compared to similar operations elsewhere. There is also an excessively large technical and managerial staff, including about 40 engineers per million tpy production, about twice the average level found in underground mines in Europe. 2.28 Given the limits on increasing output, it is recommended that all future efforts be directed towards reducing costs through more efficient operations. Moreover, coal operations should not be allowed to interfere with the far more important TKI activities of expanding lignite production. Given the tendency to concentrate decision making power at the most senior levels of management, it would be advisable to separate the hard coal and lignite operations into two distinct enterprises with their own management and financial capabilities. This would also avoid the tendency to have one part of the operation subsidize the other. Such a proposal would, however, have to be carefully evaluated within the context of the proposals now being formulated for reform and operation of all SEE's, since considerable flexibility would be needed to transfer engineers from the stagnant coal operations to the growing lignite ones. A comprehensive study of the hard coal industry, addressing the engineering and geologic work practices, as well as the investment and training options available is needed to form the basis of Government decisions about the level of resources that should be devoted to the industry. Until such a study is completed, TKI should concentrate its energies on lignite, where the major growth will be taking place. Electricity 2.29 Individual power projects have been reviewed in considerable depth in the Bank's recent Public Sector Investment Review report, and in the power subsector paper. As recommended in these reports, a revised investment program for power generation updated demand forecast is urgently required. It should also take into account the manpower contraints in the subsector, so that scarce human and financial resources can be concentrated upon a reasonable number of projects. (In parallel with the reordering of priorities in the lignite mining sector, in the electrical power sector). Consideration should be given to deferring work on all new projects and those in the preliminary phases of construction, with the possible exception of those projects for which full financing has been secured and which also have relatively short construction periods e.g. the Somas B (3 and 4) lignite plants. In particular, a major undertaking for initiating construction of first  - 26 - nuclear station seems premature and should be deferred pending revision of the investment program, since it is sure to require scarce manpower and financial resources that are needed to speed up completion of other more advanced higher priority shorter term projects. A decision on the timing of a nuclear plant could then be made on the basis of an overall review of the least cost development program and the place of nuclear power in the program. The investment requirements for a nuclear plant are to large to be justified on the basis of training benefits. Training should be done in on site countries that have extensive experience in nuclear power plan construction and operation. By permitting TEK and DSI to complete ongoing projects on schedule, this strategy would have the advantage of reducing the risk of shortfalls in supply in the short term. These issues are reviewed in greater detail in a separate paper on the power subsector. 2.30 Investment in the upgrading and expansion of transmission and distribution facilities particularly in the repair of major urban facilities'should be a high priority in the TEK investment program. In the past, the issues of transmission and distribution losses and the maximization of generation and efficiency have received insufficient attention. As a result, the level of losses in some urban electricity networks is running as high as 30%. This reflects the generally poor condition of these networks because of inadequate repair and maintenance. The transfer of distribution responsibilities from the municipalities to TEK should eventually lead to rectifying this situation, since it centralizes the responsibility for the urgently needed rehabilitation of the urban networks within one organization. Investment in transmission and subtransmission was also too low, having fallen from 23% of power investment in 1970 to 13% in 1981. A higher level of investment as well as greater emphasis on repair and maintenance could most probably substantially reduce the current high level of transmission losses. Such investments would have high rates of return and rapid payback periods. It is one of the few investments that can increase available electricity almost immediately. In 1982 the Government substantially revised its policies, upgrading the priority for transmission and distribution investments and repairs. 2.31 In the past, official development plans and projections have overlooked many of the risks and uncertainties associated with the proposed massive program for developing the power and lignite subsectors. This is due, partly, to delays in updating the program because of serious staff shortages in TEK's, TKI's and DSI's planning departments. It is also partly a reflection of managements' almost total preoccupation with their overwhelming day-to-day problems, and the consequent low priority given to problems which may arise in 10 or 20 years. As a result, the completion schedules for the projects planned to meet the forecast demand have often been over optimistic. Even now they are unlikely to be achieved if institutional reforms remain unimplemented. 2.32 The process by which new projects are chosen for inclusion in the country's long term power development program needs to be revised  - 27 - before new projects are included in the next five year plan. One problem is that in calculating the economic costs and benefits of power, DIS, TKI and TEK use different parameters for costing hydro power, lignite, thermal power and transmission investments. Different discount rates, investment costs, inflation rate and base case comparators are used for each economic feasibility study. These inconsistencies can often lead to suboptimal choices in the priorities among competing projects. The optimum investment model used by TEK includes only power generation projects in its choice criteria; it neglects (i) investment and operating costs of lignite mining projects that are required for thermal projects (using an administratively determined price for lignite instead); (ii) the power distribution investments required for optimum operations; (iii) all repair and maintenance requirements needed to maintain existing plants in good operating condition; and (iv) other potentially viable alternatives such as thermal plants based on imported coal. It is recommended that this least cost power development planning model be revised and updated. Petroleum 2.33 TPAO is engaged in a continuing program of petroleum exploration and development. The severe foreign exchange constraints of the past several years has greatly limited its ability to carry out the fundamental seismic exploration work on which to base its exploration drilling activities. TPAO is also actively pursuing a program for increasing the production from known petroleum fields, especially for heavy oil that previously was uneconomical to produce. However, these enhanced recovery activities have been confined primarily to the Bati Raman oil field financed in part by the Bank. Other enhanced oil projects are feasible, and when compared in costs to major lignite and hydro projects would appear to be rather inexpensive. It is recommended therefore that the Government give a higher priority to financing an expanded program to increase production from existing producing oil fields. To implement such a program TPAO would need to strengthen the operational experience of its professional staff, in part by finding ways to recapture some of the best qualified experienced engineers who took temporary employment abroad. Fuelwood 2.34 The fuelwood problems of today could, if unattended to, take on crisis proportions in the 1990s. About 15.8 million tons of fuelwood were consumed in 1980, of which it is estimated that 40% came from illegal cuttings for consumption in forest villages. Even the present level of consumption may be above the level that can be sustained without a substantial expansion in forestry programs. Effective demand has been increasing steadily over the past two decades by more than 2 percent per year, and one can expect that it will continue to increase by at least one percent a year, even if there is substantial migration out of the forest villages. If the supplies are not available from official sources (that is Government controlled cutting programs), they will most probably come from unofficial sources (random cutting by individuals), which could  - 28 - lead to further and more rapid degradation of forest areas. Indiscriminate cutting combined with over grazing can result in serious erosion hazards as is currently occurring in the vicinity of Adiyaman and Elazig in Eastern Turkey. 2.35 The concerned ministries have been slow in recognizing the potential seriousness of the problem. For example, the General Directorate of Forests (OGM), has put priority on the development of industrial wood resources, almost to the total exclusion of fuelwood considerations. Its current plan calls for a decline of 25% in the volume of fuelwood supply coming from existing official sources over the next 15 years; industrial wood consumption from small roundwood would increase from 30% in 1980 to 50% in 1995. 2.36 In order to reduce village wood consumption, the OGM has attempted to increase the consumption of lignite, coal and liquid petroleum gas as alternative energy resources for cooking and heating. It is clear, however, that the continuation of such a policy under the present circumstances would go against the tide of new energy realities. What is needed, instead, is a set of policies that could (i) increase the availability of fuelwood, and (ii) reduce the per capita fuelwood requirements through the introduction of conservation programs in the forest villages, particularly more efficient cook stoves and house insulation techniques. 2.37 This is not to say that industrial wood production should not also be increased. However, in order to ensure the minimization of pressures for illegal gathering and cutting the projects that are designed primarily for increasing industrial production should take into consideration the local needs for fuelwood. Similarly, projects designed primarily for fuelwood production should be expected to yield 15 to 20% industrial-quality wood. For instance, in Eastern Turkey, where the rapid growth of underbrush has led to difficulties in spruce tree replanting programs for industrial wood production, the planting of alder trees for fuelwood could choke off underbrush growth and allow subsequent interspacing with spruce trees. Such programs should be a part of a conscious effort to increase the supply of fuelwood and should be incorporated into the forestry development program. An increase in the price of fuelwood at the supply depot would help to dramatize the priority set on producing more fuelwood. It could also be a way of raising funds for future replanting and development programs, and might also have some impact on enhancing conservation efforts. 2.38 It is important that the role and value of fuelwood be recognized by the responsible agencies. It is, therefore, recommended the OGM prepare comprehensive plans for closing the demand-supply gap as soon as possible and that appropriate funds be allocated towards achieving reasonable production targets. In designing projects to meet fuelwood production requirements, the OGM must take into account local and regional differences in climatic conditions, soil suitability, demand patterns, and social customs and institutions. The following paragraphs describe the basic elements of such a program.  - 29 - 2.39 The most rapidly available and least cost fuelwood resources come from better access to existing forests, increased thinnings, and bette use of existing residues within the context of improved management of industrial roundwood production programs. Such programs are being implemented in the current Bank-assisted Northern Forest Project. Other potential areas for increasing fuelwood supplies include: (i) the rehabiliation of oak coppice areas, (ii) the development of energy plantations and (iii) the expansion of private woodlots. It is recommended that projects in all of these areas be given high priority within the overall energy investment program, particularly since only a small percentage of the costs of such projects would entail foreign exchange expenditures. Better use of Forest Residues 2.40 Currently, much of the bark and branches from logging remain in the forest in areas some distance from the villages. Development of cost effective collection and transport systems could add an additional 0.5 million tons of fuelwood annually, based on present industrial production. The OGM's proposal for tripling industrial wood production by expanding its forest resources development program would add an additional 3 million tons of fuelwood, However, because of the distance from consuming villages half of this would not be collected using the present practices. Studies are needed to determine efficient ways to collect and transport these residues. While there are possibilities for using mobile chippers and pellitizing plants, careful consideration should also be given to the reintroduction of charcoal manufacturing in the forest using new, more efficient conversion processes in order to reduce transport costs. Rehabilitation of Oak Coppice 2.41 The OGM has a program to rehabilitate between 1.5 and 2.0 million ha of oak coppice over the next twenty years. This could produce 2.0 to 2.5 million tons of fuelwood a year in addition to substantial quantities of industrial wood. In addition, there are more than seven million ha of degraded coppice in Turkey, of which it would be possible to rehabilitate a further two million ha over 20 years. This could result in production of an additional 2.5 million tons of fuelwood per year, bringing the total increase from coppice rehabilitation to between 4 and 5 million additional tons per year. Field research to determine empirically the best tree species for increasing fuelwood yields is also required for a successful coppice rehabilitation program. It is recommended that this research be started as soon as possible. 2.42 Further development of degraded coppice forest will require the resolution of land usage conflicts with the residents of the regions whose livelihood is dependent, to a large extent, on the livestock who graze on this land. One possible solution to the conflicting interests problem would be to encourage the villagers to take a personal stake in the resources that are to be developed. To do this, the Government could assign land to the villages, and the Forestry Department would have to  - 30 - assist in the rehabilitation of the land through the provision of tree stock and technical assistance. Such a program could lead to a more effective integration between agricultural and forestry activities, thereby improving forest village incomes and quality of life. Providing a financial stake in the outcome would be a far more effective means of protecting the area from indiscriminate cutting and grazing than would the posting of guards. Energy Plantations 2.43 The establishment of energy plantations is the most expensive way to increase fuelwood production. However, it is likely that such plantations will be needed in the central and eastern Anatolian regions where other household energy resources are not readily available. If 250,000 ha were planted over 20 years, as suggested by a recent Bank pre- identification mission, fuelwood production of about 1 million tons per year could be expected. On the coastal belt a realistic target of a further 250,000 ha could yield another 1.5 million tons of fuelwood annually. Village Woodlots 2.44 Village and individual woodlots, if accepted by non-forest villagers, could provide a further source of fuelwood and could become a potential source of increased income through the sale of fuelwood and, where markets exist, the sale of industrial wood mainly for poles and posts. A realistic starting target might be 30,000 ha over 20 years yielding about 100,000 tons of fuelwood and industrial wood annually. Bank experience with village woodlots in South Asia shows that the incentive of a cash crop, rather than a purely subsistence one, greatly increases the interest among villagers to set up such woodlots. These woodlots would probably be placed on river flats or ridges outside existing cultivated areas. However, the legal issue of villagers growing wood for sale on public land would need to be resolved, as it would with Government-owned degraded coppice forest areas. Incremental Fuelwood Production 2.45 It is, therefore, possible to close the projected demand-supply gap for fuelwood by the year 2000. Table 2.2 indicates a potential scheduling of incremental fuelwood volumes from all these projects.  - 31 - Table 2.2 Potential Fuelwood Supply Schedule (million tons) 1980 1985 1990 1995 2000 2005 2010 Projected Supply from existing sources 8.60 7.40 6.80 6.30 6.30 6.30 6.30 Incremental Supplies Thinnings - 1.30 2.10 2.60 3.00 3.00 3.00 Residues - 1.60 2.50 3.00 3.50 3.50 3.50 Coppice Rehabilitation - - 0.30 1.00 1.20 4.20 5.20 Energy Plantations - - 0.30 0.70 1.40 2.30 2.30 Woodlots - - - 0.10 0.10 0.10 0.10 Total Potential Control Supply 8.60 10.30 12.20 13.70 15.50 19.40 20.40 Illegal cutting 7.20 6.80 6.00 - - - - Demand 15.80 17.10 18.20 - - - - Source: Mission estimates. Geothermal Energy 2.46 Turkey is one of the few developing countries that has substantial high geothermal potential and where both high temperature and low temperature energy sources can be used effectively. High temperature sources can be used for generating electricity. Based on its geochemical investigations and shallow bore drillings, MTA estimates that from the ten areas investigated to date the reserves may be adequate to produce as much as 4000 MW of power, equal to Turkey's total current power production. Low temperature sources can be used for space heating homes and greenhouses, as well as for low grade heat processing of agricultural products. MTA estimates of probable reserves from the same ten areas indicate a heating potential of up to 40 times the high temperature potential. However, to date, geothermal energy has only been used on a demonstration scale. 2.47 To exploit this resource in a more systematic manner a new organization might be created with the sole purpose of developing geothermal resources. It should be endowed with sufficient funds to have one or two drilling rigs exclusively for geothermal activities. Such an organization would have to be able to pay salaries that could attract and hold qualified technical and professional staff who could learn how to effectively develop geothermal energy fields. Clearly, the current  - 32 - drilling engineer teams at MTA, with their high turnover rates and limited experience, primarily from drilling lignite boreholes, would be inadequate for such a program. It is recommended that the Government study the possibility of allowing private local groups to develop some of the fields and pay royalty to the Government, particularly for low temperature resource development. Another alternative would be for the Government to offer to farm out its geothermal fields to foreign contractors, much the same way that petroleum exploration acreage is farmed out. This last system is being tried in Indonesia and the Philippines. The foreign companies have the money, the experience and the interest that are presently lacking in local institutions. The foreign company could, therefore, provide the initial capital investment funds, while Turkey would pay for the energy only when it was produced. Solar Energy 2.48 The potential for solar energy appears to be favorable for applications such as water heating, space heating, greenhouses and crop drying in the central and southern parts of Turkey. Although about 40 private shops are currently manufacturing solar flat plate collectors for domestic water heating, they appear to have quality control problems that have inhibited wider acceptance of the technology. It is recommended that the GOT show its commitment to the development of solar energy by establishing quality standards for solar equipment, by providing technical assistance to the manufacturers, and by undertaking a demonstration program for solar space heating and water heating in new government financed buildings. While the overall impact of such a program will clearly be limited, it should not be neglected. ROLE OF THE PRIVATE SECTOR 2.49 It is imperative for the government to encourage the participation of all sectors of the economy in the development of energyif the objectives of its investment plan are to be achieved. The private sector should especially be encouraged to play its part. However, changes in the legal relationship between the Government and private enterprise, coupled with changes in attitudes towards the desirability of allowing private participation, will be required if there is to be action in this field. While the potential role may be much greater in developing petroleum and to a lesser extent lignite, the potential for important contributions on a regional level are also available in the development of power, fuelwood, and non-conventional energy resources such as solar and geothermal. Lignite Development 2.50 In 1978, prior to nationalization, the private sector produced over 6 million tons of lignite compared with 8 million by TKI. In 1979, all of the major private sector mines and deposits were nationalized, and private sector production today accounts for around I million tons from a number of very small mines. The Government has recently decided to hand back some of the smaller mines for development by the private sector, but  - 33 - that it does not intend to give back any of the large deposits that can be developed for use in power plants. It is recommended that the proposals for developing each field should be subject to a technical review by the Mining Department of the Ministry of Energy and Natural Resources, which would also supervise and regulate the mining developments. This could help to provide a larger supply of lignite for household and industrial consumption -- without further straining TKI's limited managerial and financial resources. 2.51 Given the development constraints facing TKI, greater involvement by the private sector could also help accelerate the growth of lignite production for power plant consumption. It is recommended that TKI investigate using foreign private participation for the development and operation of some of its proposed lignite mines, as a way of overcoming the immediate bottlenecks of lack of technical and managerial staff. Such foreign private participation could take the form of either (i) a joint venture between TKI and a foreign private firm that would provide some of the investment capital or (ii) contract mining whereby the foreign firm would undertake mine operation and staff training on TKI's behalf for an agreed upon period and cost. Private sector production would be an addition to production levels projected in this paper. 2.52 In addition to the ownership and development of lignite mines, the domestic private sector also has a potentially important role as contractor for overburden removal and lignite production for TKI mines. Presently, 60 percent of the overburden removal at TKI mines is done by the private sector. However, because each contract covers a small volume and a short work period, the private contractors, uncertain about future work, are unwilling to invest in large-scale equipment. The result has been that contractors use whatever equipment they have on hand, even if it may be poorly designed for the task. This has resulted in low levels of efficiency and high costs to TKI. It is recommended that consideration be given to allowing the contractors to bid on contracts of several years duration so that some of the of cost savings associated with purchases of large-scale equipment would be passed through to TKI in lower contract prices. Petroleum Exploration and Development 2.53 Since the introduction of the Petroleum Law in 1954,1/ over 500 exploration wells were drilled in Turkey through 1978, about 40T% of them by foreign companies. The latter part of the 1950s saw the greatest activity as the companies made their initial evaluation of Turkey's prospects. Interest gradually decreased during the 1960's as few discoveries were made. By the late 1960's only two important foreign companies, Shell and Mobil, continued to explore for and produce oil. Restrictions on well head prices between 1974 and 1980 further reduced 1/ This law regulates all petroleum activities by both foreign and domestic companies in Turkey.  -34 - incentives for private companies to undertake new exploration activity. TPAO was expected to fill this gap, but it too was restricted by the lack of available resources and the loss of experienced staff as salaries and moral fell during the inflation of the late 1970's and opportunities to work abroad expanded. This process was reversed early in 1980, when the Government issued a series of decrees offering foreign oil companies international prices for new production and the right to export 35% of the oil produced. Taken in combination with existing favourable fiscal terms, these decrees represent a major step towards the revival of foreign investor interest in petroleum exploration. The Government intends to incorporate the new decrees along with other promised reforms into a new Petroleum Law, expected to become law in the early part of 1983. 2.54 About 75% of Turkey's licensed acreage is in TPAO's hands and most of the acreage with attractive oil potential is included in these holdings. However, this portfolio is well beyond the capacity of TPAO to effectively explore: qualified staff are extremely limited, and even a modest exploration program on a single license area could exhaust a large percentage of TPAO's current annual exploration budget. Under these circumstances, TPAO's holding of exclusive control over prospective acreage can delay discovery and production of new petroleum resources at a high cost to the Turkish economy. Furthermore, when TPAO is overstretched it cannot undertake an exploration program with the comparable efficiency of experienced private company operators. Therefore, given its considerable technical and financial constraints, TPAO needs to push forward with a program to seek out private investor participation in its exploration licences; it is, in fact, actively pursuing this goal. 2.55 Since 1980, TPAO has been indicating to all interested investors that most concession areas presently under its jurisdiction are available for joint venture partnerships on mutually agreable terms; one offshore joint venture program to drill two wells in the Bay of Iskanderun has been signed, and in late 1981 drilling was in progress. Discussions on onshore joint venture agreements with Shell and with other foreign oil companies are currently in progress, and some letters of intent have already been signed. 2.56 It is a matter of public record that the Turkish Government wishes to have foreign and domestic private investors take a major role in the development of the petroleum sector. Turkey's basic petroleum exploration fiscal framework is generous by current industry standards. The 12.5% royalty and a maximum income tax of 55% result in an average Government share in profits in the 55 to 65% range. Furthermore, reasonable cost recovery provisions, taken together with the moderate royalty and tax terms, promise a relatively rapid recovery of investment. At present, it is entirely appropriate that Turkey's fiscal policy toward petroleum emphasize generous incentives for the promotion of new interest by the industry. However, in exchange for these generous conditions it is recommended that the Government require specific work committments of exploration seismic work for each block awarded. The  - 35 - Government should also give serious consideration to the removal or amendment of other fiscal rules that partially offset the incentive offered by the basic terms, such as the withholding tax on subcontractors' payments and taxes on imported capital equipment that is either consumed or re-exported after it has performed its function, and the five year limit for carrying forward exploration losses. The fiscal provisions of the law should also be elaborated as concisely as possible with a view to improving their clarity, especially where it relates to the treatment of allowable costs for tax purposes. To accomplish this, it is recommended that a subsidiary document be prepared that would indicate with specific numerical examples how the provisions of the Petroleum Law would be applied. 2.57 At the same time, care should be taken that Turkey's, longer term interests are not compromised in pursuit of immediate goals. Turkey should plan now to avoid a repeat of the serious difficulties and eventual suspension of investor interest occasioned by the introduction of Decree No. 20. The dual concerns of creating broad investor interest in new exploration, while at the same time safeguarding Turkey's longer term interests would be addressed in a number of ways. One way is to be selective in the type and amount of acreage released, by making available only a portion of the uncommitted acreage at any one time. Turkey could reserve the option to release subsequent acreage on such different terms as may be more appropriate in the light of discoveries in the first round of acreage awards or changes in the economic environment (e.g., substantial price increases). This kind of decision can and should be taken prior to major acreage promotion programs. 2.58 Since most of the exploratory acreage of interest to private investors is currently in the hands of TPAO, TPAO does, de facto, become an important licensing authority for negotiating deals with foreign investors. Under typical contractual terms, TPAO will also assume administrative and oversight functions with respect to private company activities on this acreage. This approach has an additional advantage because licensing through TPAO permits the negotiation of work commitments and financial benefits beyond those specified in the Petroleum Law. 2.59 The exploration promotion program requires a clear and continuing Government commitment. New petroleum legislation has been delayed for over two years. Differing ministerial objectives have apparently played a major role in this delay. Action should not be delayed any further now that the draft decree is in the final stage of preparation, since many foreign companies will be willing to consider any possible committment only after they see proof of the Government's intentions in the form of a revised Petroleum Law. Steps should then be taken, in consultation with a foreign investment advisor, to advertise the opportunities that exist in Turkey today. This is an essential step for Turkey to succeed in inducing more oil companies to commit themselves to active exploration programs.  - 36 - 2.60 Present practices at the policy implementation level also need a careful reappraisal. The major responsibility for policy implementation, according to the present Petroleum Law, lies with the General Directorate of Petroleum Affairs (GDPA) which is within the Ministry of Energy and Natural Resources (MENR). To date, the GDPA has experienced difficulty in executing its assigned task of providing up to date easily accessible technical materials relating to available acreage. Reportedly, approval of licence applications may take up to a year. Nevertheless, some exploration agreements have been arrived at on satisfactory terms, including an important exploration agreement with HUFFCO covering two large exploration blocks in southeast Turkey. A weakness in the present assignment of acreage is that screening of prospective investors is inadequate and is giving rise to agreements with either weak work obligations or without adequate financial backing. 2.61 Other GDPA responsibilities include certain administrative and price control functions related to the referring industry and oversight functions relating to the conduct of exploration operations once a licence has been obtained. It is recommended that the responsibilities for all activities unrelated to petroleum exploration and production be handed over to another department of the MENR along with the staff thus employed. At the same time, GDPA's administrative and technical capabilities of providing information and assistance for exploration activi'ties ~should be strengthened. 2.62 Alternatively, consideration should be given to the possibility of shifting some GDPA functions to TPAO, where Turkey's scarce petroleum expertise is concentrated and must remain if there is to be an effective national oil company, and where the institutional problems of salary, incentives, etc., are more easily handled. For these same reasons, developing countries elsewhere (e.g., Indonesia, Brazil, India, Argentina, and Egypt) have almost universally assigned the responsibility for policy implementation to their national oil companies. As described in paragraph 2.54, TPAO is already playing a complementary role to GDPA in promoting and discussing joint venture agreements with foreign oil companies on acreage under its jurisdiction. Power Concessions 2.63 The role of private enterprise in the power subsector has declined in relative importance since the establishment of TEK in 1970. In particular, the two private power companies have not been permitted to build any new generating plants, but have had to purchase their additional power requirements from TEK. A new proposal is being considered to permit these companies to resume construction. The proposed law would also permit private industry to develop smaller hydro projects and co-generation schemes, subject to Government approval, and sell surplus electricity to the TEK system. The Bank endorses the goals of these laws. However, great care must be taken to ensure that all the necessary safety precautions in both design and construction are adhered to if necessary a special commission to supervise these matters should be set up. The possibility of poaching of key DSI and TEK technical and  - 37 - managerial staff by the private companies would be only a limited danger to DSI and TEK if they themselves are able to pay reasonable salaries and are involved in a dynamic and effective expansion program. However, if salary conditions are not improved, private sector hiring of experienced staff could cripple the public sector investment program.  - 38 - CHAPTER III EFFICIENCY IN ENERGY USAGE Energy Consumption 3.01 Turkey's energy consumption of 0.40 tons oil equivalent per $1,000 GNP in 1979 was lower than that of most temperate zone middle in- come developing countries, but slightly higher than that of most of the higher income OECD countries (see Table 3.1). Its per capita energy consumption was, of course, substantially below that of the comparator countries. This reflects its relatively lower per capita income, per- capita number of motor vehicles and level of industrialization. Per capita energy consumption is likely to rise rapidly in parallel with rising percapita income. The big question facing energy planners in Turkey is whether through an appropriate choice of industrial policies they can mdintain their relative ranking among energy consumers as the industrialization process speeds up over the next two decades, or whether they will lose further ground with their EEC trading partners in their efforts to create an efficient competitive industrial economic base for their economy. 3.02 Turkey's development strategy must recognize that Turkey is likely to remain an energy deficit country throughout the remainder of this century. As such, one of the major constraints on the growth of its economy will be the finite limits on the economy to produce and import energy, particularly electrical power and petroleum. In this sense, it will be an energy constrained economy that must learn to conserve on its use of energy in order to maximize its growth rate. In addition, as long as Turkey must rely on fuel-oil fired thermal plants and diesel-fired gas turbine generators for its baseload power requirements, its energy costs will be greater than they potentially could be, with implications for the future cost competiveness of Turkish industry. This implies that Turkey's comparative advantage would then have to depend more on develop- ing relatively low energy intensive industries. In this regard, Turkey is in a favorable position: it is still in the early stages of its indus- trialization process and is not yet heavily committed to the many high energy intensive technological options. As a result, it can take the new energy cost realities into account in planning its development strategy. Indeed, such an approach will be necessary for a healthy, long term growth prospect based on an open trade economy. 3.03 In order to accomplish the above, Turkey should attempt to keep the elasticity of energy consumption to around 1.0. This should be pos- sible if Turkey emulates the OECD countries emphasis on improving the efficiency of energy use through pricing policies and technical assis- tance in improving energy efficiency. The scope for action is large and the payoff can be high. For example between 1973 and 1980, industrial output in the OECD grew by an average of 2% per year whereas energy consumption in industry actually decreased slightly. Pricing clearly  - 39 - played an important role in this process, the impact of which should not be underestimated in a market economy; it may be imperceptible in the short run, but like the movement of a glacier it will be irresistible in the long run. Table 3.1 1979 Commercial Energy Consumption a! (Tons Oil Equivalent) Per Capita Energy Consumption Energy Per Capita Country Per $1000 GNP Consumption Income in $ Japan 0.323 2.840 8,810 Denmark 0.335 3.985 11,900 France 0.349 3.330 9,550 Germany 0.377 4.418 11,730 Switzerland 0.390 3.425 13,920 Austria 0.402 3.471 8,630 Turkey 0.404 0.538 1,330 Belgium 0.412 4.497 10,920 Spain 0.429 1.881 4,380 Italy 0.437 2.292 5,250 Portugal 0.455 0.997 2,180 Chile 0.470 0.795 1,690 Greece 0.478 1.894 3,960 U.K. 0.595 3.750 6,320 Ireland 0.605 2.546 4,210 Argentina 0.609 1.359 2,230 Hungary 0.705 2.715 3,850 Bulgaria 0.975 3.602 3,690 a/ Countries chosen were those in temporate zones that had higher levels of per capita income than Turkey. Source: World Development Report, 1981. Pricing 3.04 The Government's pricing policy has been founded on two basic principles. First, price should be high enough to allow energy producing and distributing enterprises to recover their costs, including replace- ment of plant and equipment (i.e. depreciation) and a reasonable return on investment; and second, relative energy prices should be set to en- courage the substitution of domestic energy resources for petroleum  - 40 - products. However, in the past year the imposition of other government objectives, including reducing the level of inflation and social equity targets has resulted in a delay in reaching these expressed goals. Even while pursuing these important priority goals the Government has been able to increase petroleum product prices substantially in lira terms and has kept them constant at international levels or above in dollar terms. However, lignite prices in 1980 covered only 77% of TKI's costs, even with depreciation calculated on book value of assets, and power tariffs, while considerably higher than they were even a year ago in lira terms, are still far below the level required to generate a reasonable level of cash flow relative to the cost of new investment. 3.05 A third basic principle for energy pricing should be to provide a market signal for the efficient allocation of resources ih consumption, production and investment decisions. To do so, energy prices in the longer term should reflect the opportunity cost to the country of import- ing energy (e.g., petroleum or coal) or of producing the next increment of the non-tradable energy (e.g. power or fuelwood). To calculate the opportunity cost for traded energy, it is important that the appropriate opportunity cost of foreign exchange be used. Since the country's balance of payments is currently equilibrated through a regime of tariffs and restrictions on imports and subsidies to exports, it is inappropriate to use the official exchange rate to compare the foreign currency cost of imports to domestic currency prices. Instead, a shadow exchange rate should be estimated based on the net effect of the set of trade restric- tions now in place. 3.06 Estimates of implicit tariffs for Turkey should be available in a few months within the framework of the protection study being carried out jointly by Turkish authorities and the Bank. In the meantime, based on existing information, 1/ a shadow exchange rate of about 30-35% above the official rate appears to be a reasonable approximation. 3.07 While they are helpful to industry and household consumers in the shortrun, low energy prices can create substantial long-term problems for the economy. If energy prices are too low (as they have been in the past), industrial and consumer investments in high energy using techno- logies and products will be made that will require high levels of energy consumption to sustain them. These high levels of consumption may re- quire a level of imports that could, in turn, create severe strains on the balance of payments, which might necessitate a devaluation to bring back equilibrium. This, in fact, appears to be part of the explanation for what has happened in Turkey over the past decade. However, prices cannot always be changed quickly. Rapidly changing circumstances may create short-run conditions in which the equilibrium energy prices (i.e. short-run opportunity cost or market clearing price) may be so high as to 1/ See the recently completed, TURKEY: Industrialization and Trade Strategy; Report No. 364-TU.  - 41 - be potentially destabilizing for the economy. Under these conditions non-price market clearing mechanisms (i.e. rationing in its various forms) are called for. Petroleum Product Prices 3.08 As noted in para. 3.05, domestic petroleum prices should prob- ably be about 30%-35% above cif costs of imports (plus local distribution costs and road user taxes) to properly reflect their border value. While prices for all major petroleum products are currently above the cif cost of imports, the import tariff portion of this price is substantially below the 30-35% level recommended. If one were to take an average dis- tribution and retailing margin of 18% for Turkey, 1/ the effective tax on regular gas would be 65%, on diesel fuel 16%, on kerosene 10% and on fuel oil only 1%. (See table 3.2 for details). Furthermore, transport fuels (diesel and gasoline) should, in addition, be taxed to pay for road user costs. It would appear, therefore, that an average price increase of 25- 30% might be reasonable for products other than gasoline (and increased gasoline taxes might also be justified on grounds of discouraging luxury consumption). Given the long run consumption implications of the cost of oil on the growth rate in energy imports, such large price increases appear to be justified. However, a more detailed study of the implica- tions of such price increases would be desirable before they are imple- mented. Therefore, it is recommended that a review of the relative prices of petroleum products with similar uses should be undertaken in conjunction with an indepth study of refinery capacity expansion planning and optimum product mix. In this study particular attention should be paid to the choices between investment in additional primary refining capacity and investments in needed secondary refining capacity (crack- ing), as it is probable that recent (and expected future) changes in demand patterns and in the types of crude oil available may require a revision in investment policies promulgated during the 1970s. 1/ On average, in countries where data are available, the margin between wholesale refinery prices (or cif product prices) and retail prices net of taxes is between 15% and 20%.  - 42 - Table 3.2 Effective Tax On Petroleum Products in Turkey ($ per ton) Cif Delivered Retail Eff. EEC Avg. Price b/ Price c/ Price f/ tax (%) Price a/ Gasoline (Reg.) 409 483 799 65 990 Kerosene 395 466 514 10 421 Diesel Oil 354 418 483 16 646 Fuel Oil d/ 232 274 277 1 353 Composit Bbls e/ 306 361 437 21 550 a/ Average of UK, France, Italy and Germany, July 1981 F/ July-Sept. 1981 - Bank staff estimates C/ cif price plus 18% to represent distribution and retail mark-up. d/ Fuel Oil is a composite of heavy industrial and lighter home heating oils. e/ The Turkish composite barrel is 17% gasoline, 5% kerosene, 29% diesel oil and 49% fuel oil. f/ August 1981. Source: TPAO. 3.09 It should be noted, however, that it might not be necessary to increase prices immediately to these levels, if an alternative could be found to convince investors that prices will reach these levels gradually over the next few years. If energy consumers are convinced that a policy of real price increases will be implemented, they will take into account the higher prices in their investment decisions, choosing less energy in- tensive production processes and lifestyles. The advantage of such a po- licy of announced, scheduled real price increases is that it would spread the inflationary impact of the higher prices over a longer time horizon. Higher announced petroleum product prices would also improve the pros- pects for a more rapid introduction of investment that would allow the economy to shift towards substituting lignite for imported liquid fuels. 3.10 Currently, the prices of petroleum products are insufficiently high to encourage replacement by domestically produced resources. For example, on a calorific equivalent basis the price of fuel oil in Istanbul is about 40% higher than that of coal and high grade lignite, but the differential between fuel oil and low-grade lignite, the only commodity for which the domestic supply is likely to be expanded substan- tially, is only about 17%. If lignite prices are raised to cover costs this differential will become even smaller. In most developed countries  - 43 - a differential of about 35% is generally considered necessary to compen- sate for the additional difficulties and costs of using high quality coal. This would imply that in Turkey the differential is inadequate to encourage the substitution of low grade lignite for fuel oil. For low grade lignite the differential probably needs to be in the 40 to 50 percent range. Coal and Lignite Pricing 3.11 Prices for coal and lignite continue to be regulated and are set by the Council of Ministers based on recommendations from the Ministry of Energy and Natural Resources (MENR). Government policy is to set lignite prices for households in relation to the perceived ability of people to pay for the fuel. The Government also regulates prices to TEK so that electricity tariffs are not increased above "reasonable" levels; it sets coal/lignite prices for industry to encourage the substitution of lignite for fuel oil. There are no set intervals for coal/lignite price reviews; new prices have been issued annually since 1977. On the latest schedule, minehead hard coal prices are US$75 to US$90 per ton. Minehead lignite prices vary from US$5 to US$25 for households, from US$15 to US$35 for industry, and from US$10 to US$20 for power, depending on lump size, heating value and whether the lignite is washed or run of mine. Because of the generally poor quality of the lignite, average prices for lignite are towards the lower end of the above ranges. Prices for Elbistan lignite have not yet been set. 3.12 The Government's pricing policy, combined with TKI's inability to meet its production and cost targets, resulted in the need for subsi- dies to TKI to cover losses of 12 billion TL (about US$150 million) in 1980 (on gross receipts of 20 billion TL). For 1981, a subsidy of 15 billion TL (about US$125 million) is projected by TKI, based on a produc- tion of 18.5 million tons of saleable lignite. In actuality, lignite production will probably be only 15-16 million tons and losses and sub- sidies will be accordingly higher (by $25 to $40 million). As long as the Government follows a policy of deliberately underpricing lignite to household customers and power plants, and TKI fails to meet its operating targets, TKI will continue to incur substantial losses, which, together with the capital requirements for new projects, will create a growing burden for the Government's budget. At a production level of 50 million tons in 1990, the subsidy required could rise to over $500 million, clearly an unsustainable level. 3.13 What is needed, therefore, is a pricing system that allows TKI to cover its production costs, including a reasonable return on its capi- tal, in parallel with implementing the institutional reforms discussed earlier to enable it to achieve a reasonable level of operating effi- ciency. This does not mean that prices should be automatically set on a cost plus basis. Prices for each mine should be agreed upon in advance with appropriate escalation clauses and contingencies. In order to discourage the promotion of marginal or submarginal projects, these prices should be compared to the cost of importing coal on a long term contract, taking into account the shadow pricing criteria discussed in para 3.04.  - 44 - 3.14 It is recommended that the pricing structure for the various grades of lignite should also be revised to reflect their relative scar- city and value to the consumer. Since high calorific lignite is both preferable to use and more difficult to find and mine, it should command a higher price per kilocalorie than lower grades of lignite. This is not currently the case; for industrial use low quality 1000 kcal/kg lignite costs 50% more per kilocalarie than higher quality 4000 kcal/kg lignite. Furthermore, if the Government wishes to subsidize domestic lignite con- sumers for social welfare purposes, it should do so explicitly by identi- fying the differential between the industrial and domestic price and then paying TKI this differential separately from any other possible required subsidy. Industrial consumers should not be subsidized. 3.15 Coal prices are about 20% above cif prices. In view of the foreign exchange shortage, this may be a reasonable premium for the eco- nomy to pay for domestic production. However, the supply price for coal should be no greater than its border price, when the border price is the cif price taken at the appropriate shadow exchange rate. If this is insufficient to allow TKI to operate profitably, then the difference between these prices and average costs should be provided as a direct predetermined government payment per ton of coal produced. The size of this subsidy would serve as a measure of the need to improve producti- vity, while profits or losses after the subsidy payment would be some measure of the management's ability to maintain an expected level of efficiency. Power Costs and Tariffs 3.16 The present electricity prices, both bulk and retail, are sub- stantially below the long-run marginal costs of supply. They are also too low to provide a satisfactory contribution towards the financing of the large expansion program in the power subsector. The TEK bulk supply tariff, effective April 1, 1981, would yield a contribution of only 9% to the cost of the 1981 expansion program, compared with a more reasonable level of 20%. It would need to be increased by 60% from the present level (October, 1981) to meet this requirement. The Government is cur- rently preparing study of economic costs and appropriate economic prices. 3.17 The policy of subsidizing some energy consumers needs careful review. The highly energy-intensive aluminum and ferrochrome industries are heavily subsidized, since they pay only half the standard energy charge under the existing two-part tariff, representing a subsidy of TL 1.875/kWh, which is nearly double the subsidy of TL 1.0 per kWh that was applicable before October 1981. Although the electricity will come from a nearby low cost hydro dam, this dam will be connected to the national grid. As long as low-cost electric power sources cannot produce enough electricity to meet total base load demand, the real cost of this energy will be the marginal cost of generating power in diesel sets and gas turbines and the oil fired thermal plants that are supplying energy to the national grid. If the energy intensive industrial projects are not economically viable using the real opportunity cost for electric power, they should not be encouraged to use more power through lower prices.  - 45 - Rural consumers supplied under TEK's village electrification program are also subsidized, paying only 70% of the price charged to urban consumers. Complete elimination of the subsidy to rural consumers would require them to pay more than urban consumers, but it would seem reasonable for the subsidy to be limited to a level at which both groups pay the same basic price. 3.18 It is recommended that the present bulk and retail tariffs for electricity be restructured to reflect the long-run marginal cost (LRMC) of supply including a reasonable real rate of return to assets valued at replacement cost. This would allow prices to signal the real cost of energy, so that users can make efficient (optimal) decisions regarding energy-related investments. The difference between LRMC pricing and the cost recovery policy used by the Government is significant because the major primary sources of electricity, hydro and lignite, are both charac- terized by rising LRMCs. In other words, the cost of producting addi- tional output is substantially higher than the production costs of exist- ing units. Thus, the current prices (in principle based on the cost recovery or average costs) appear to be considerably lower than the LRMCs, and do not signal to the consumer the true absolute or relative cost of the elecricity that is consumed. 3.19 The lack of appropriate signals on the cost of energy has con- tributed to incorrect decision-making for energy-related investments, as is evidenced by the comparatively low levels of energy efficiency in most sectors. It is therefore, recommended, that the 1977 tariff study be up- dated to provide the basis for setting power tariffs following the prin- ciple of LRMC. The scope of the study should be expanded to cover an analysis of the actual marginal economic costs of all inputs. It is important to use the real investment and operating costs for producing lignite to represent the cost of lignite to power plants; accounting transfer prices or prices approved by the Government as proxies for real costs are likely to produce inaccurate results. This would consititute the first step toward the adoption of LRMC as the guiding principle for energy pricing as well as provide a clear signal on the future price levels for power and lignite. It is also recommended that TEK consider regular, possibly quarterly, reviews of tariffs so that any increase necessary may be introduced in a timely manner and that the present fuel adjustment clause in the TEK tariff be amended to permit TEK to pass on increased fuel costs automatically without the prior approval of the MENR. Fuelwood Pricing 3.20 Wholesale fuelwood prices at forest depots and retail prices are controlled by the Government. The current differential between the price that the OGM depots charge for fuelwood and the price that the retail distributors pay in the major urban centers is TL 2,000 to TL 3,000 greater than the average transportation costs, (this is about a third of the total retail price). This tends to indicate that consumption could be substantially increased if more wood were available, as the margin is  - 46 - sufficient to allow for extending the range of distribution by an addi- Pional 100 to 150 km. Given the short and medium term restrictions on the growth of supply, the Government should consider greatly increasing the depot markup, (which is currently 200 to 300 TL per ton) to provide additional funds for expanding investment in the sector. Increased Energy Efficiency 3.21 The changes in the prices of energy relative to other resources has clearly been the single most important factor in bringing about a new strong emphasis on improving energy use efficiency in the OECD countries. The EEC, for instance, is expected to invest more than $9 billion on energy conservation related plant improvements, during the first half of the 1980's. However, other government policies including persuasion, legislation, and subsidization can play an important part in speeding up the process. For instance, Sweden has given away half a million thermo- meters to encourge people to keep their homes and officess down to 20 degrees in the winter; the U.S. has passed legislation requiring automo- tive manufacturers to improve the efficiency of new cars; and the U.K. has provided financial assistance for firms wishing to carry out energy audits. 3.22 The need for better energy demand management became painfully obvious in Turkey during the second half of 1979 when an acute petroleum products shortage combined with a chronic electricity shortage to cause severe disruption to the economy and hardship to its people. In response to these shortages, the Office of the Prime Minister prepared a framework for a national energy conservation program and issued as a series of directives covering the major energy using sectors: industry, transport commerce, public buildings and residences. The circulars prescribe extensive measures for providing industry with the necessary technical information, for training energy users and appointing energy managers, for improving energy efficiency in buildings, industry and transport, and for preventing the wasteful use of electricity. Instructions were also issued for the increased use of domestic energy resources, primarily lignite, as well as for bituminous shale, biogas, geothermal and solar energy. Higher energy prices have, of course, gone a long way towards increasing the awareness of the need for energy conservation in the private sector. However, programs of technical training and education, along with appropriate incentive policies, are still required to imple- ment these measures. 3.23 An energy efficiency unit has been recently organized in compli- ance with one of the conditions of the second SAL loan. However, it has been placed within the Electricity Studies Administration (EIEI), a spe- cialized agency of the MENR that has been traditionally oriented toward  - 47 - hydrological and geotechnical studies. 1/ The first year work plan of the energy efficiency unit is limited to assisting foreign experts in the performance of energy audits at 12 industrial plants (11 of which are in the public sector) under a Bank-financed project. At this rate it would take many years for the unit to perform energy audits of the major energy using plants in the public sector, to say nothing of the private sector industries. Given the low level of energy efficiency in Turkey, as docu- mented in a recent TSKB report (see para. 3.31), a much more active ef- fort is needed to restore the competitiveness of Turkish industry, and limit energy imports. Thus, the current inadequate energy efficiency unit needs to be substantially upgraded and expanded so that it can con- duct the vigorous campaign that has been recommended. Para. 3.447 de- scribes a specific program such as would be required for Turkey. It is, therefore, recommended that energy conservation be given a much higher priority than at present, that a more vigorous energy efficiency program be initiated, and that it be coordinated by an organization exclusively devoted to such work. Government Regulations and Incentives 3.24 Beginning in January 1981, the GOT's industrial incentive pro- gram, now administered by the SPO, included investments in the following categories: (i) energy production from non-traditional sources, (ii) en- ergy distribution and (iii) the rational use of energy. The incentives made available for these types of investments include exemption from cus- tom duties on imported capital goods, accelerated depreciation for tax purposes, and availability of medium term credit at favorable interest rates. However, little use has as yet been made of them because of the depressed state of the economy and the low overall rate of investment; as of October 1981 only two applications amounting to less than US$1 million had been filed. Another reason for the low usage may be that the incen- tives fail to cover engineering services at the preinvestment stage. Al- though such activities (energy audits, hydrologic or geothermal surveys, pilot tests and feasibility studies) constitute only a small percentage of the total investment costs, they are often not undertaken because their potential value is usually underestimated. The encouragement of such preinvestment steps could presumably lead to a greater number of energy saving and producing investments, as well as to changes in proce- dures which cost very little but save a lot. The financial incentive package includes financial assistance for technical services related to the rationalization of energy use. Efficiencies in Power Production and Distribution 3.25 A return to rapid growth in the industrial sector of the economy and the subsequent growth in demand for power could, in the near future, 1/ The newly created department of the EIEI has also been given respon- sibility for studies of the development of renewable and geothermal resources, although it has has no previous experience in these areas.  - 48 - lead to a return to the need for persistent power cuts to reduce consump- tion. In order to reduce the need for such power cuts, effective meas- ures are needed for encouraging greater efficiency in the use of electri- city and discouraging waste. Turkey urgently needs an action program that will attack the problem from both the demand and supply sides. 3.26 On the demand side, the first imperative is to set prices for electricity that convey the correct message to consumers about its real cost and scarcity value (para. 3.10-3.12). Secondly, these prices need to be accompanied by a series of other measures to keep demand for elec- tricity within the limits set by available supplies. A study of energy conservation by MENR suggested a list of such measures for adoption, but there has been no serious attempt to implement them. 3.27 The power shortages of 1980 and 1981 were handled by TEK through a two-part load management program: (i) a cut-off program (currently running at 3-5 hours per day) designed to reduce energy demand by about 5%; and (ii) a peak shaving program designed to reduce peak demand by about 8%. The cut-off program tries to balance the electric energy shortage, and the peak shaving program addresses the shortage of gen- eration capacity. As implemented, however, the load management program was insufficient to balance supply with demand, and led to a substantial reduction in the quality of electricity (low and fluctuating voltage levels). Peak shaving procedures required TEK's direct industrial cus- tomers and municipal distribution systems to reduce their load by about 50% between 7 PM and 11 PM. The municipal systems did this through a system of rotating power cuts. However, numerous exceptions were granted to coal and lignite mines, oil refineries and other continuous process industries, and the municipalities frequently failed to reduce their loads by the required amounts. 3.28 The low and fluctuating voltage that resulted caused extensive damage to electrical motors and home appliances and lowered the quality of output (e.g. the proportion of defective goods in the output of a tex- tile mill rose from 10% to 20%). In view of the high cost of voltage drops and the fact that it is very difficult for electricity users to prepare for or protect themselves from its effects, it is recommended that if the need arises again, TEK should revise its load management program with a view to reach, without voltage reduction, the target of balancing supply and demand, and to provide the industrial sector with the quality of electricity that it requires to operate efficiently. This may prove to be an easier task now that TEK has taken over full responsi- bility for municipal power distribution facilities. 3.29 In addition to increasing scheduled power cuts, the GOT should also examine the merits of closing down certain large and possibly un- economic users of power at least for the duration of any future power shortages. An example is the aluminum plant which consumes about 3% of TEK'S electricity production. The Turkish price for aluminum in late 1981 was about US$ 3500/ton, as compared to the import price of about US$ 1400/ton. The fuel cost of the electric power required to produce  - 49 - one ton of aluminum is about US$ 1200 (assuming that fuel oil is the marginal fuel). The temporary closure of this plant at a time of criti- cal electricity shortages would help to reduce these shortages. Further- more, given the questionable viability of this plant in the light of current fuel costs, the impact of this measure on the overall economy would probably be less harmful than that of the past power cuts. 3.30 Unsatisfactory plant operating and maintenance procedures, coupled with inadequate investment in spare parts and materials, resulted in frequent plant breakdowns and long delays in restoring them to ser- vice; about 9% of TEK's installed capacity was out of service in 1981 for this reason. The problem was aggravated by the power shortages which caused the Government to press for the operation of plants (e.g. gas tur- bines) beyond their design limits. One result has been the neglect of regular maintenance for the sake of keeping plants in operation in the short term and to keep power cuts to a minimum. It is recommended that this policy be revised as soon as possible and that plant operation and maintenance procedures, including spare parts policy, be reviewed and purchase of essential spares be given priority in the allocation of investment. Energy audits should be carried out at each of TEK's major generating stations, particularly the thermal stations, to identify ways of reducing power station electricity consumption, which accounts for around 5% of the total electricity generated. Available data on some thermal stations indicate relatively high levels of fuel consumption, suggesting that there is considerable scope for such savings. Many of these policies are now being implemented, and SP0 now has a special con- tingency fund for required spare parts. However, a more systematic approach could still provide important dividends for medium term power generation facilities. Industrial Efficiency 3.31 The research department of the Industrial Development Bank of Turkey (TSKB), has recently completed review of the potential for more efficient energy use in seven of the most energy intensive industries in Turkey. These industries are iron and steel, cement, glass, brick, alu- minum, copper smelting, and pulp and paper, and they account for about 40% of total industrial energy demand. 1/ The study demonstrates that energy consumption in these industries in Turkey was, on average, about 30 to 40 percent higher than that found under the best practices in OECD countries. On the basis of plant visits, the study further suggests that up to half of the excess energy consumed could be saved in the next five years if energy efficiency programs were instituted. Saving by 1986 could be over one million toe, or about $250 million per year at current international prices. Furthermore, if similar energy efficiency measures were taken in other industrial sectors, the total savings could be 1/ See Metin S. Ar, Energy Conservation in Industry, Industrial Development Bank of Turkey, January 1981.  - 50 - doubled. The net effect would be an energy savings equivalent to about 4% of all the energy consumed in Turkey While reasonable as a five-year target these savings appear to be on the conservative side for a ten year horizon, given the experience of the OECD countries. Experience in other countries would also suggest that transport and household/commercial together could produce the same volume of savings if appropriate policies were implemented. 3.32 The SEEs present the greatest opportunity for improving the ef- ficiency of energy use in Turkey. While it is true that their management is generally rather insensitive to the price of inputs such as energy, it should be possible to increase their responsiveness through Program Con- tracts. A Program Contract could make management responsible for meeting a number of well specified targets of economic efficiency in addition to targets of financial profitability. One such target could be a reduction in the ratio of energy consumption to a convenient unit of output. This system would have the advantage that management, in its day to day opera- tions, would be encouraged to become aware of the energy aspects of its business and to take appropriate action to improve its performance. 3.33 As a second step in increasing the awareness of energy factors in production, it is recommended that each SEE set up a special depart- ment just to measure energy usage and to make recommendations on changes in operational procedures and new investments that would lead to better energy efficiency usage. In fact, a number of private industrial groups in Turkey have already set up their own energy audit groups to accomplish this end. Energy savings possibilities are being evaluated in the refin- ery sub-sector by the individual refineries in the TPAO group. A report which will recommend specific short term investment needs for energy sav- ing over the next five years is expected before the end of 1982. Such studies should be required of all SEE's. 3.34 In addition to putting more emphasis on improving the efficiency of existing plants, it is important for the GOT to focus more attention on the energy implications of new investments within the industrial sec- tor. In the past, emphasis on import substitution as a basic industrial- ization strategy, along with associated protectionist policies, resulted in the development of a number of internationally inefficient industries. This appears to be particularly true in the energy-intensive state run industries such as steel and aluminum. The recent decision to halt the expansion of the aluminum smelting industry is an important indication of the change in Government policy. 3.35 In planning the growth of its industrial sector, Turkey needs to highten the awareness of the energy implications of its investment pro- gram. As far as possible, it should direct its industrial growth towards less energy intensive secondary industries and away from high energy in- tensive primary industries unless it can be demonstrated that the engy intensive industries are internationally competitive. To do this, the Government should require each public sector investment proposal to have an energy impact statement presenting energy implications of alternative technologies, including (i) the energy efficiency of the proposed plant  - 51 - relative to those in the most efficient countries, (ii) the energy in- tensity of the product (energy costs as a percentage of operating costs and physical energy consumption per unit of output), and (iii) the energy used per job created. As with the energy departments recommended above, the attempt here is to increase the awareness of the consequences of in- vestments on the country's energy balance and, by doing so, to encourage the required shift in industrial structure. 3.36 It is especially important that the Government avoids justifying investments in particularly energy intensive industries by allowing them to be profitable through special concessionary energy prices. In fact, the need for (or request for) concessionary energy prices, such as those being given to the aluminum and the ferro steel industries, should be prima-facie evidence that these industries are inefficient, internation- ally uncompetitive and, therefore, have very low priority in the coun- try's development plans. It is particularly important that these high energy intensive industries, like aluminum smelting, are not expanded in the face of limited power supplies. Household Energy Usage 3.37 National supply and demand projections indicate that there will most probably be a shortage of lignite for the domestic sector throughout the 1980's. Unless private lignite mines are able to substantially in- crease their output, the shortfall could reach three million tons (i.e. about one-third of household demand) by 1985 before the planned lignite mines come on stream in the latter half of the decade. As there are likely to be severe constraints on the ability to increase petroleum imports to cover this gap, the most likely alternative for domestic heating would appear to be a growth in the fuelwood supply combined with extended conservation measures. As an alternative to fuel oil, coal could be imported at roughly half the cost per calorie for consumption in coastal areas. 3.38 Consumer preference studies indicate that fuelwood, when avail- able, is preferred over lignite by most middle income urban households. It would appear, therefore, that the major question is the extent to which fuelwood supplies can be increased and can be stretched to serve a wider market. The best way to stretch existing supplies would be to in- crease the efficiency of their use. Here, the scope appears to be sub- stantial, for firewood used under normal uncontrolled draft conditions burns so rapidly that 80 to 90 percent of its heat energy goes up with the smoke. The development and distribution of more efficient stoves for urban and rural heating requirements should be an important government priority. While the Government might take the lead in developing such stoves, the private sector could most probably produce and distribute them. However, since the Goverment cannot charge an economic price for locally-consumed wood in forest villages, it may have to subsidize the cost of these stoves to make them attractive to villagers. The proposed study on alternative household energy supply options (para 1.16) would evaluate an appropriate rural strategy taking into account non market and environmental aspects of the problem.  - 52 - Transport Efficiency 3.39 The transport sector is expected to consume about 10 million tons of petroleum products per year by 1990, almost 90% of which will be used in road transport. Energy savings can be achieved by (i) improving rail handling capacity for bulk commodities, (ii) discouraging the use of private automobiles, (iii) improving the condition of the road system, (iv) ensuring that both road and rail users pay the full cost of supply- ing these transport services, and (v) increasing petroleum prices. Many of these recommmendations are in the process of being implemented. Railways 3.40 The Turkish State Railways (TCDD) forecast of an average annual growth of 13.8% for intercity passengers and 16.7% for freight during the decade of the 1980's appears to be overly optimistic. The.railway has experienced difficulty in its freight operations. Traffic has actually been declining over the past several years, as the system had to turn cargo away, to the extent that a significant amount of iron ore is now moving up to 400 km by road. A recent review of the system suggests that with improvement in operational procedures and administration they could carry all the traffic that is presently being offered. Clearly, opera- tional and organizational reforms will be necessary before any major in- creases in activity take place. Such reforms are still in the prelimin- ary, identification and discussion phase. More rapid action is required. Additional investments will also be required to upgrade the system, in- cluding on a priority basis lines that are expected to handle substantial increases in traffic such as those transporting iron ore and coal. Fail- ure to improve the system and to coordinate its operations with the grow- ing demand from industry and commercial export oriented agriculture could result in further untenable burdens being placed on the road system. 3.41 The mission's alternative projections call for a growth in freight traffic of about 8.5% per year from 1980 to about 8.7% per year from 1980 to 1985, increasing to 10% per year thereafter following opera- tional improvements and a shift in orientation towards high volume long distance bulk movements. Intercity passenger-km will grow by only 3% per year during the first half of the decade as prices are rationalized to cover real costs. In the second half of the decade they will grow by 9% per year in response to improved handling capabilities. It is, there- fore, recommended that the railway refocus its investment programs to- wards rehabilitation and upgrading of rail lines that would otherwise reach saturation in bulk freight handling capacity in the 1980's and leave investments for moving passenger traffic to the more flexible and less capital intensive bus system. Electrification of existing lines, particularly passenger lines, could be delayed. Automobiles 3.42 Turkey has the lowest per capita passenger car ownership of all OECD member countries (about 14 cars per thousand inhabitants), well below that expected by international comparison for a country of its per  - 53 - capita income level. Given this low level of car ownership, Turkey can expect that during the next decade strong market pressures will develop for a rapid increase in the vehicle fleet. On the basis of international comparisons, the elasticity of demand could be as high as 3.0. So far, Turkey has restrainted demand through the imposition of a 100% import duty, and in the past has rationed foreign exchange for parts for car assembly plants and for imported cars. In order to avoid the burden of having to supply the petroleum requirements of a large private vehicle fleet, it is recommended that the Government continue to restrain demand as much as possible. Even with the continuation of the restrictive policy one can expect the elasticity of demand to be about 2.0, with GDP expected to grow by 60% in the decade and the resulting vehicle fleet to more than double its current size by 1990. Unrestricted growth, which would bring the car fleet to three times its current size coupled with no increase in petroleum price levels could lead to the need to import at least one million tons more of gasoline than would otherwise be needed by 1990. Road Maintenance 3.43 A program to rehabilitate a large part of the national main road network would offer a substantial reduction in vehicle operating costs, including savings in fuel. Much of the national road network is in poor condition as a result of age and heavy traffic, much of which consists of overloaded heavy vehicles. As a general rule, improving a paved road from an extremely poor condition to good or excellent condition would result in overall vehicle operating cost savings of up to 80 percent. Road improvements allowing average speed increases from 30 km/hr. to 45 km/hr. would result in a reduction in fuel consumption over these im- proved stretches of about 35% in the case of a two axle truck and about 20 percent in the case of passenger cars. If the rehabilitation program has an impact on 20% of non-urban traffic fuel savings are likely to be about 20,000 TOE in 1985 and 350,000 TOE in 1990. It may be possible to select rehabilitation programs that have an even greater impact. More exact calculations will be possible when details of the Bank's forth- coming program for rehabilitation are finalized. If the roads are not improved the situation could deteriorate further. This could have severe repercussions on energy demand, since transport over roads in poor condi- tion can increase fuel consumption by as much as one third. The impact on the total cost of transport, and on the ability of the existing truck fleet to handle all the country's transport needs would have further high economic costs. Rail Tariffs and Road User Charges 3.44 In 1981 tariffs for rail freight covered less than 45% of total freight cost, while tariffs for rail passenger service covered less than 15%. For road service, the cost/tariff ratio is less clearly defined. While gasoline passenger cars are taxed heavily on the original purchase price and on the gasoline consumed and probably pay their share of road costs, diesel powered trucks and buses probably do not. While it is important that taxes and tariffs reflect real costs for commercial  - 54 - traffic, a detailed study of the impact of transportation and the share of road costs applicable to each type of vehicle would be necessary before specific policies can be recommended. Road use taxes and diesel taxes should be made high enough to provide for full cost recovery of maintaining and improving the road system. A price increase for diesel fuel could, also, have an important impact on the overall efficiency of the sector. Increases in the price of gasoline would have an important impact on the use of automobiles; it is estimated that a 10% increase in gasoline prices would reduce fuel consumption by about 100,000 tons per year by 1990 or about a $25 million dollars annual foreign exchange sav- ing in 1981 prices. Rail tariffs should be raised to reflect real costs thereby ensuring that the most economic use was made of the limited availability of rail services. 3.45 One result of inadequate rail and road tariff and taxing poli- cies has been that the highway department has been unable to get suffi- cient funds to rehabilitate roads for modern traffic conditions the most heavily used roads and the railway has been unable to obtain sufficient funds to maintain railbeds and keep diesel engines in operation, let alone obtain enough money to invest in upgrading the system. It would also provide the funds required for the railway authority to improve its performance. 3.46 The gradual increase in the percentage of diesel automobiles due to the wide spread between diesel and gasoline prices is a trend that may have to be discouraged in the future. The long term world trend has been for diesel fuel to become progressively in greater demand in interna- tional markets or in some markets diesel fuel has become more expensive than gasoline. This may become particularly true for Turkey, where because gasoline is exported and diesel fuel imported to balance product markets, the shift from gasoline to diesel would be counter-productive from the viewpoint of the national economy. A Comprehensive Energy Efficiency Program 3.47 As mentioned above, the energy efficiency program that has been recommended could be located within an upgraded and expanded energy office within the EIEI or established independently. This office would have the following functions: (i) promote increased energy efficiency by gathering and dis- seminating information on energy saving maintenance and operating practices, ways to improve process efficiency and economic fuel substitution opportunities; (ii) provide an energy audit service to all sectors of the eco- nomy including industry, commerce, transport, government and residences; (iii) on the basis of the above audits, ensure that energy con- servation targets are set for the audited plants and build- ings and monitor progress in their achievement;  - 55 - (iv) provide technical and economic appraisals of energy conser- vation opportunities to see if they qualify under the in- vestment incentives program; (v) provide technical support for the formulation of a national demand management strategy, including a contingency plan for periods of electricity shortage, building codes, traf- fic regulations, environmental controls, etc.; (vi) cooperate with technical training institutes in the provi- sion of energy efficiency courses and workshops, including the training of plant specific energy managers. 3.48 The proposed office will constitute the backbone of the program and, in conjunction with proper pricing incentives, would create a cli- mate under which energy efficiency will be within the reach of every energy user, but the implementation of specific measures would still depend on the participation of the individual energy producing and con- suming companies. Thus, TEK would be responsible for reduction of trans- mission/distribution losses and its own consumption as well as the more effective implementation of the load shedding program. Fuel efficiency in the oil refineries would be the responsibility of the refining com- panies. Fuel efficiency in the SEE's as well as private companies would be the responsibility of their own management. The energy efficiency office would mainly inform, provide certain specialized services, and monitor the transition of the Turkish economy from its current energy imbalance to a more energy efficient state. 3.49 To accelerate the implementation of the overall program, it is recommended that the proposed energy efficiency office establish a target of performing an energy survey of the largest 100 energy users (estimated to consume about 50% to 60% of industrial energy use) within three years. These surveys could be performed by two six-member technical teams at the rate of one plant every three weeks. The expected benefits of this effort would be a 15% savings in energy use at those plants, equivalent to a 2% savings in Turkey's commercial energy use. Based on the 1978 consumption level this would amount to 0.4 million toe per year or about US$120 million per year. The investment requirements associated with energy efficiency are difficult to estimate. A recent Bank-financed ana- lysis of a comparable country suggests that about 40% of the savings will result from maintenance and operational procedures and 60% from invest- ments to improve the efficiency of energy use (investments that would modify the process were not considered). The cost of the investment- related energy savings average US$300/annual toe saved. Applying the same ratios to the case of Turkey suggests that about $50 million worth of fuel could be saved every year as a result of improved maintenance and operational procedures and about $70 million could be saved each year as a result of investments of the order of US$70 million. 3.50 The above comparison of the costs of conservation investments with the expected fuel savings indicates that energy efficiency is an attractive option to pursue and that it deserves the full backing of the  - 56 - GOT. Energy efficiency constitutes, however, only one aspect of a gen- eral program to ameliorate the energy problem. The first priority be- longs to the implementation of an effective reform for the energy SEE's, as discussed in Chapter 2. Without action on this front little or no progress can be made. The second major aspect is that energy prices have to reflect opportunity costs. With prices set at opportunity costs in- vestors will have to consider the true economic cost of fuel, and the economy will begin a transition towards the more efficient use of energy, both as it relates to the energy intensity of production as well as the choice of fuel. The proposed energy efficiency program will assist the economy in accelerating this transition. Planning 3.51 Planning for the energy sector in Turkey is an extremely diffi- cult exercise. The uncertainties require that the plans be continually revised as the situation unfolds and as more information becomes avail- able. The major uncertainties involve the completion dates for almost all of the major lignite projects, thermal projects based on lignite, and hydroelectric projects. For instance, there is still substantial doubt that the Elbistan project will start producing lignite (and therefore electricity) in 1983, or even in 1984 as planned. On the other hand, previous energy demand projections are of dubious value, since they were based on quite optimistic projections for the economic growth rates for the economy. Finally, the growth of exports over the coming years, which will determine the economy's ability to import oil and coal and to reduce the energy constraints is also open to conjecture. Export growth rates in 1981 and 1982 have been impressive; however, a continuation of such rapid growth will depend to a large extent on the world economy and Turkey's ability to continue to expand its exports rapidly during a prolonged period of slow world economic growth. 3.52 It is therefore important to institutionalize and strengthen the planning process, (probably within the Ministry of Energy) so that plans can be updated on an annual basis. It is recommended that the major tasks of a strengthened and enlarged energy planning secretariat would be that of reviewing the full range of options open to the Government to meet the Country's energy needs. This would include (i) updating demand studies to determine what is needed in the future; (ii) reviewing all new energy investment projects with a view to assuring that projects are properly evaluated and to setting investment priorities among competing energy sectors and consumer groups, (i.e. rural and urban, households, industry, transport, etc.); and (iii) initiating new studies on such issues as potential long run alternatives for household energy consump- tion and on coal vs. lignite thermal power plants. 3.53 However, as a first priority energy planners should undertake a review of the lignite sector. To start with they should develop realis- tic estimates of how much lignite can actually be produced, what produc- tion costs will be, and what will be needed in terms of financial and manpower resources to produce it. Given the large role that lignite is to play in the future, it is also important for planners to determine  - 57 - what the priority uses of the lignite will be, rather than leave this decision entirely to TKI and TEK. A balance must be found between power, industry and household consumption if maximum benefits are to be ob- tained. To do this, an evaluation would have to be made on a regional and mine by mine basis, taking into account the lignite qualities, the important regional industrial consumers, and the alternatives available for heating homes in the winter. The results of this evaluation would allow industry to determine an appropriate conversion investment program, and would eliminate the potential problem of having industry invest too much in fuel substitution conversions that would end up inopereative because of the lack of a suitable lignite source or the alternative problem of industries refusing to invest because they are unsure of receiving supplies. It should also give the private sector more confi- dence in what will be available, thereby encouraging it to invest in conversion facilities when the lignite actually becomes available. This type of study would, of course, have to be updated annually to ensure its accuracy and usefulness.  - 58 - ANNEX 1 Page 1 of 4 DETAILS OF DEMAND PROJECTIONS 1. The mission made a sector by sector estimate of demand for each of the major energy sources. It relied on some of the preliminary data being prepared by the staff of the MENR for the Energy Master Plan. This data was reviewed, evaluated, and revised by the mission to create a consistent demand picture. Where necessary, the mission prepared its own estimates. The mission's two projections on the supply of power, led to two estimates of demand for lignite, coal and petroleum products to be burned in power stations. The high estimates apply in Scenario I for which more optimistic assumptions have been made about the project completion dates of power plants as well as lignite mines than those made in Scenario II for which the low estimates would apply. It must be noted that the mission could not incorporate the possible effects of major changes in relative prices into the demand projections as there was no statistical basis to make such estimates. Aggregate Demand for Electricity 2. In view of the importance of a realistic forecast, the mission recommends that a detailed and comprehensive power market survey be carried out as soon as possible to improve the data base. The areas covered would include end-uses of electricity and industry and appliance usage trends among residential consumers. This kind of data might make it possible to assess the impact of price changes on demand. Industry 3. Demand estimates for industry make use of the results of a survey of manufacturing industry made by the MENR. Although the survey was not complete, it provided a useful basis for estimating the demand for energy for major industrial subsectors. The mission assumed that industry would expand somewhat slowly in the 1980s at around 6-7 percent per annum compared with a growth rate of around 10 percent per annum in the first half of the last decade. 4. Industry demand for lignite is expected to increase rapidly as a result of firms switching from fuel oil to lignite in accordance with Government policy, especially for steam generators and the process industries such as the cement, fertilizer, sugar and textile industries in that order of importance. The MENR has made detailed factory by factory studies according to which lignite consumption by the cement industry alone would increase from 1.6 million tons in 1981 to 4.1 million tons in 1988. The same study shows that the fertilizer industry could quadruple its demand from 0.7 million tons in 1981 to 2.7 million tons in 1988. Total demand is thus estimated to rise from the 1980 consumption level of a mere 4 million tons to about 9 million tons *in 1985 and to 14 million tons in 1990.  - 59 - ANNEX 1 Page 2 of 4 5. It is straight forward to estimate the demand for coal since most of the coal is consumed by the iron and steel industry, with some used by power plants close to the mines. The iron and steel industry consumed more than 3 million tons in 1980 accounting for three quarters of total consumption, part of which was met through imports. With the planned expansion of its capacity from 2.5 million tons now to 4.0 million tons in 1990 the demand for coal would increase to 4.9 million tons in 1985 and to 6.0 million tons in 1990, assuming some increase in efficiency of the industry. 6. Industry is the second most important user of petroleum products next to transport. Demand for energy uses is expected to increase from 4.1 million tons in 1980 to 6.3 million tons in 1985. In the second half of the decade demand will increase more slowly to 7.9 million tons in 1990 as the Government's policy of substituting lignite for fuel oil gathers force. However, this projection assumes that sufficient lignite will be available for this shift to take place. Otherwise, the rate of growth could be much higher. 7. Industry demand for power is estimated to increase from 15,300 gWh in 1980 to 28,300 gWh in 1985 to 42,700 gWh in 1990. For this estimate, the aggregate demand for power was first determined (para 1.21), after which the consumption shares by sector as projected by TEK were employed. This method led to an 11 percent per year growth in demand for power in industry, or an elasticity of about 1.6 to 1.8. Transport 8. The transport sector will remain the largest consumer of petroleum products throughout the decade. In 1980 more than one- third of all of petroleum fuel distributed in Turkey was used by transport and 85 percent of that was used by road vehicles, mostly trucks and buses. Demand projections for the transport sector are based on the assumption that the automobile fleet, starting from a very low base for a middle income country, will to grow at twice the rate of GNP, even if the current restrictions on the growth of passenger cars are maintained. After some allowance is made for improving efficiency in the use of fuel, total vehicle fuel consumption is projected to increase from 5.0 million tons in 1980 to 6.7 million tons in 1985 to 8.3 million tons in 1990. These projections assume the continuation of the present pricing policies. However, increasing fuel prices by 10 percent in real terms could result in a savings of 70,000 tons in 1975 and 105,000 tons in 1990, assuming an international average of 0.3 price electricity. In addition, it must be noted that if the size of the automobile fleet is left completely uncontrolled, fuel consumption could increase by an additional 0.2 million tons in 1985 and by 0.9 million tons in 1990.  - 60 - ANNEX 1 Page 3 of 4 Agriculture 9. Petroleum products are the only significant energy source used in agriculture, although there is scope for having geothermal heat if it were to become available. Government projections of fuel needed for agriculture show that consumption by tractors, harvestors and pumps would rise from less than 1 million tons in 1980 to 2 million tons in 1990, implying an annual increase of 12 percent. While this appears large, it is consistent with a greater emphasis on agricultural production for the export market, where higher mechanization levels will be required. Household and Commerce 10. Household and commerce aggregate demand for non-electric energy sources, which include oil, lignite, coal, fuelwood and biomass, and non- conventional energy, is estimated using the MENR's method. The past rate of growth in per capita consumption has been extrapolated into the 1980's. Then, assuming population growth rates of 2.3 percent during 1981/85 and 2.2 percent thereafter, total demand is projected to be 13.6 million toe in 1985 and 17.4 million toe in 1990, implying a growth rate of about 3.5 percent per annum. Total energy demand, including electricity, from the household and commercial sector would be 16.2 million toe in 1985 and 21.8 million toe in 1990. 11. Household demand for lignite is estimated precisely the same way and is estimated to increase to 9.2 million tons in 1985 and to 13 million tons in 1990, a growth rate of about 8% per year. By contrast consumption of coal would stay the same as in 1980, at 0.2 million tons throughout the decade, since the high calorific coal will be allocated only to industry. 12. Fuelwood and biomass were the major fuel sources for the household sector, especially for those villagers who are classified as forest villagers and who by definition live within 10 km of forested areas, accounting for 50-60 percent of total consumption during the last decade. In 1980, it was estimated that about 16 million tons of fuelwood and 11 million tons of biomass were consumed in Turkey. While they will be less important in relative terms by 1990, meeting about 40 percent of household demand, it is estimated that 18 million tons of fuelwood and 13 million tons of biomass will still be required, the maximum quantities that are expected to be available. Additional demand will spill over to petroleum products. Although geothermal would be used if it were available, it is expected that the remainder of the household and commercial demand for non-power energy demand will fall on petroleum products. Thus, petroleum demand will increase from about 2.3 million toe in 1980 to 4.1 million toe in 1985 and 5.8 million toe in 1990.  - 61 - ANNEX 1 Page 4 of 4 13. Demand for power was estimated, given the aggregate demand based on the consumption share structure projected by TEK. Here, demand would increase from 5,500 gWh in 1980 to 10,500 gWh in 1985 to 17,800 gWh in 1990, implying average annual growth rates of 14% and 11% for the two periods respectively. It is expected that the remainder of the household and commercial demand for non-power energy demand will fall on petroleum products. Thus, petroleum demand will increase from about 2.3 million toe in 1980 to 4.1 million toe in 1985 and 5.8 million toe in 1990. 14. For electricity demand projections, the mission adopted a TEK demand forecast for 1981-85, which is based on a detailed analysis of consumption trends for each individual substation in the system. This method is best suited to projections up to 5 years because plans to bring new industries on stream and new housing developments cannot be effectively estimated beyond this time horizon. For the second half of the 1980's, the mission's demand projection is based on the historical elasticity of electricity demand with respect of GDP, which for the period of 1962-78 was about 1.85. Electricity demand is thus projected to be 45,800 gWh in 1985 and 71,200 gWh in 1990, implying average annual growth rates of about 12 percent for 1980-85 and 9 percentt for 1985- 90. The 1985 estimate is fairly close to the projections of TEK and the SPO of 46,500 gWh, but the 1990 estimate is well below their figure of 87,700 gWh. Power Sector's Derived Demand for Primary Energy Resources 15. Lignite will be the principal energy source to meet most of the incremental demand from power stations during the next decade. Government policy is to substitute lignite for imported oil to the extent possible in all major consuming sectors, especially in the power sector. Total demand for power generation is expected to rise from 5 million tons in 1980 to between 18 and 25 million tons in 1985 and to between 49 and 51 million tons in 1990. The high estimates apply under the optimistic power plant project implementation schedule (Scenario I), while the low estimates relate to the slightly less optimistic scenario of an additional 20 percent slippage there from in project completion dates (Scenario II). 16. The power sector's demand for petroleum products is also expected to rise rapidly over the next few years from 1.6 million tons in 1980 to 2.5-2.7 million tons in 1985, as existing oil fired plants currently out of service are repaired and brought up to full capacity operation to reduce power shortages. In the second half of the decade, demand should stabilize between 2-3 million tons depending on hydrological conditions (the higher demand in a dry year). 17. Demand for coal for power plants would increase only marginally in the 1980's from 0.7 million tons in 1980 to 1.2 million tons in 1985 to 1.4 million tons in 1990.  - 62 - ANNEX 2 Page 1 of 1 Trade Balances from Macroeconomic Projections 1. Exports are projected to grow in volume at an average annual rate of 17% from 1972 to 1985, and by 10.4% from 1985 to 1990. While this is well below the 33% increase expected in 1982 and the extraordinary 79% growth in 1981, it is well above the average growth rate for 1972 through 1978 of about 3% per year. Workers' remittances are seen to be relatively stagnant through 1983 and 1984 and then are projected to increase at the same rate as world inflation for 1985 through 1990. The assumptions underlying these projections are somewhat on the optimistic side but the goals are achievable if definite steps are taken to stabilize the economy and to promote exports. 2. It is assumed that foreign capital flows will be about $2.5 billion in 1985 and $4.4 billion in 1990, in current dollar terms. This would include $1.5 billion and $2.5 billion respectively for projected committments of loans from identified sources and another $1 billion and $3 billion in 1985 and 1990, respectively, in from as yet unidentified sources. These levels of foreign capital inflows would imply a gradual improvement in the debt service ration, from about 18% in 1985 to about 15% in 1990. Resources Available for Imports a/ (In billions of current dollars) Estimated Projected 1982 1985 1990 Exports 6.1 11.6 26.8 Net non-factor service income 0.9 1.4 2.7 Workers' remittances & other Factor service income 2.9 3.3 4.4 Total foreign exchange earnings 9.9 16.3 33.9 Debt service -2.4 -3.1 -5.4 Amortization (-1.2) (-1.8) (-3.9) Interest (-1.2) (-1.3) (-1.5) Gross capital inflows b/ 2.1 1.7 5.0 Total Imports 9.6 14.9 33.5 Imports in 1982 constant dollars 9.6 12.5 20.3 Debt service ratio 22.2 18.0 14.9 a/ Rough estimates for illustration b/ Excluding debt relief and including net IMF. Source: Bank estimates.  - 63 - ANNEX 3 Page 1 oT 12 Electricity Supply Projection 1. The mission has made separate supply projections, based upon its own assessment of the likely completion dates of each project in the light of field visits to major projects under construction, discussions with the project departments in TEK and DSI and the various delaying factors referred to in the main text. Two projections were made. The first, the base case, is identical to the recently revised TEK/SPO supply projection except with respect to the Elbistan A project for which Bank forecasts are at divergence with the TEK/SPO forecasts. The second Bank projection assumes an average 20% slippage in the project completion schedules. 1167P  Installed Capacity 1981-1990 - Base Case Projections MW 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 HYDRO PLANTS Existing TEK 1,872 1,872 1,872 1,872 1,872 1,872 1,872 1,872 1,872 1,872 Other 259 259 259 259 259 259 259 259 259 259 Total 2,131 2,131 2,131 2,131 2,131 2,131 2,131 2,131 2,131 2,131 New (all TEK) Dogankent B 40 40 40 40 40 40 40 40 40 40 Keban 5-8 - 360 720 720 720 720 720 720 720 720 Suat Ugurlu 1-2 - 46 46 46 46 46 46 46 46 46 Oymapinar 1-4 - - 135 405 540 540 540 540 540 540 Hasan Ugurlu 3-4 - - 250 250 250 250 250 250 250 250 Aslantas 1-3 - - 92 138 138 138 138 138 138 138 Karacaoren 1-2 - - - 30 30 30 30 30 30 30 Kokluce 1-2 - - - 90 90 90 90 90 90 90 Adiguzel 1-2 - - - - 60 60 60 60 60 60 Karakaya 1-6 - - _ - - 600 1,200 1,800 1,800 1,800 Kapulukaya 1-3 - - - _ _ 51 51 51 51 51 Kilickaya 1-2 - - _- - - 120 120 120 120 Altinkaya 1-4 - - - - - 175 700 700 700 700 Gezende 1-3 - _ - - - - 150 150 150 150 Derbent - - - - - - 56 56 56 Camligoze - - - - - - 16 16 16 Menzelet 1-4 - - - - - 120 120 120 120 S. Yenice - - - - _ - - 37 37 37 Tobma - - - - - - 14 14 Kandil - - - - - - - 261 Tercan - - - - - - _ 15 15 15 Kralkizi - _ - - - - - 90 Catalan - - - - - 155 155 155 Batman - - - - - - - - - 130 Total New 40 446 1,283 1,719 1,914 2,740 4,255 5,134 5,148 5,641 Total Hydro 2,171 2,577 3,414 3,850 4,045 4,871 6,386 7,265 7,279 7,772 Q July 1982 1 16 7P  Installed Capacity 1981-1990 - Base Projections (continued) MW 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 THERMAL PLANTS Existing TEK 2,118 2,118 2,118 2,118 2,118 2,118 2,118 2,118 2,118 2,118 Others 876 876 876 876 876 876 876 876 876 876 Total 2,994 2,994 2,994 2,994 2,994 2,994 2,994 994 2,994 2,994 New Thermal (TEK) Soma B 1-4 330 330 495 650 650 650 650 650 650 650 Yatagan 1-3 210 420 630 630 630 630 630 630 630 630 Cevrim C.T. - 60 60 60 60 60 60 60 60 60 Geothermal - 15 15 15 15 15 15 15 15 Elbistan A 1-4 - - - - 340 680 680 1,020 1,360 1,360 Seyitomer 4 - - - - 150 150 150 150 150 150 Yeni Catalagzi - - - - 150 150 150 150 150 150 Cayirhan 1-2 - - - - - 300 300 300 300 300 Kangal 1-2 - - - - - 150 300 300 300 300 , Orhaneli - - - - - 200 200 200 200 200 Yenikoy 1-2 - - - - 420 420 420 420 420 Keles - - - - - 200 200 200 200 Bingol Karliova - - - - - - - - 100 100 Cankiri Orta - - - - - - 100 100 100 Total TEK 540 825 1,200 1,355 1,995 3,405 3,755 4,195 4,635 4,635 Others Self-producers /1 140 140 140 140 140 140 140 140 Total New Less Retirements - - - 520 520 520 520 520 520 520 TOTAL THERMAL 3,534 3,819 4,334 3,969 4,609 6,169 6,369 6,809 7,249 7,249 TOTAL INSTALLED CAPACITY 5,705 6,396 7,748 7,819 8,654 11,040 12,755 14,074 14,528 15,041 /1 SPO/TEK estimates are at divergence with the Bank on the likely commissioning dates of Elbistan A-14. It is SPO/TEK's estimate that 3 x 340 MW will be on stream by 1984 and 4 x 340 by 1985. /2 PETKIM Source: TEK | July 1982  Average Hydropower Supply 1981-1990 - Base Case 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 Existing Stations TEK 9,420 9,420 8,670 8,670 8,670 8,670 8,670 8,670 8,670 8,670 Others 1,222 1,222 1,222 1,222 1,222 1,222 1,222 1,222 1,222 1,222 Total 10,642 10,642 9,892 9,892 9,892 9,892 9,892 9,892 9,892 9,892 New Stations Dogankent B 55 155 155 155 155 155 155 155 155 155 Suat Ugurlu 1-2 - 135 270 270 270 270 270 270 270 270 Keban 5-8 600 1,400 1,625 1,625 1,625 1,625 1,625 1,625 1,625 1,625 Aslantas 1-3 - - 325 540 570 570 570 570 570 570 Hasan Ugurlu 3-4 - - 210 300 300 300 300 300 300 300 Oymapinar 1-4 - - 1,000 1,500 1,600 1,600 1,600 1,600 1,600 1,600 Karacaoren 1-2 - - 50 100 140 140 140 140 140 140 Kokluce 1-2 - - - 300 580 580 580 580 580 580 Adiguzel 1-2 - - - 140 280 280 280 280 280 280 Karakaya 1-6 - - - - 1,600 4,550 6,329 7,275 7,400 7,400 Kapulukaya - - - - - 175 175 175 175 175 Kilickaya 1-2 - - - - - 225 235 235 235 235 C Altinkaya 1-4 - - - - - 1,296 1,632 1,632 1,632 1,632 Gezende 1-3 - - - - - - 429 525 525 525 Menzelet 1-4 - - - - - 267 334 334 334 Derbent - - - - - - - 257 257 257 Camligoze - - - - - - - 88 88 88 S. Yenice - - - - - - - 122 122 122 Tohma - - - - - - - - 67 67 Kandil - - - - - - - - - 911 Tercan - - - - - - - 24 24 30 Kralkizi - - - - - - - - - 145 Catalan - - - - - - - - - 484 Batman ---- --- - 495 Total New 655 1,690 3,635 4,930 7,120 11,766 14,587 16,187 16,379 18,420 TOTAL 11,297 12,332 13,527 14,822 17,012 21,658 24,479 26,079 26,271 28,312 July 1982 X 1167P 'O  Firm Hydropower Supply 1981-1990 - Base Case GWh 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 Existing Stations TEK 7,001 7,001 7,001 7,001 7,001 7,001 7,001 7,001 7,001 7,001 Others 898 898 898 898 898 898 898 898 898 898 Total 7,899 7,899 7,899 7,899 7,899 7,899 7,899 7,899 7,899 7,899 New Stations Dogankent B - - - - - - - - - _ Suat Ugurlu 1-2 - 117- 194 206 206 206 206 206 206 206 Keban 5-8 84 527 632 632 632 632 632 632 632 637 Aslantas 1-3 - - 22 344 360 360 360 360 360 360 Hasan Ugurlu 3-4 - - - - - - - - - - Oymapinar 1-4 - - 227 386 412 412 412 412 412 412 Karacaoren 1-2 - - 17 84 100 100 100 100 100 100 Kokluce 1-2 - - - 96 485 576 576 576 576 576 Adiguzel 1-2 - - - 105 146 150 150 150 150 150 Karakaya 1-6 - - - - 1,600 4,550 5,975 6,047 6,060 6,060 Kapulukaya - - - - - - 150 150 150 150 150 Kilickaya 1-2 - - - - - 236 236 236 236 Altinkaya 1-4 - - - - - 206 1,039 1,234 1,234 1,234 Gezende 1-3 - - - - - - 104 130 130 130 Menzelet 1-4 - - - - - - 154 192 192 192 Derbent - - - - - - - 201 201 201 Camligoze - - - 77 77 77 S. Yenice - - - - - - - 92 92 92 Tohma - - - - 34 34 Kandil - - - - - - -- - 590 Tercan - - - - - - - 14 14 18 Kralkizi - - - - - - - - - III Catalan - - - - - - - - - 271 Batsan - - - - - - - - - 201 Total New 84 644 1,092 1,853 3,941 7,342 9,823 10,809 10,967 12,033 TOTAL 7,983 8,543 8,991 9,752 11,840 15,241 17,722 18,708 18,866 19,932 OQ July 1982 w 1167P I-.  Thermal Power Supply 1981-1990 - Base Case GWh 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 Existing Stations TEK 10,700 11,300 11,300 9,845 9,845 9,845 9,845 9,845 9,845 9,845 Others 2,678 2,678 2,678 2,238 2,238 2,238 2,238 2,238 2,238 2,238 Total 13,378 13,978 13,978 12,083 12,083 12,083 12,083 12,083 12,083 12,083 New Stations Soma B 1-4 300 1,600 2,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 Yatagan 1-3 - 1,260 2,700 3,400 3,700 3,700 3,700 3,700 3,700 3,700 Cevrim C.T. - 70 180 180 180 180 180 180' 180 180 Geothermal - 30 90 90 90 90 90 90 90 90 Elbistan A 1-4 - - - - 1,140 2,850 3,800 5,700 7,600 7,600 Seyitomer 4 - - - - - 900 900 900 900 9.00 Cayirhan 1-2 - - - 1,800 1,800 1,800 1,800 1,800 1,800 Yeni Catalagzi - - - - 900 900 900 900 900 900 Yenikoy 1-2 - - - - - 2,500 2,500 2,500 2,500 2,500 Kangal 1-2 - - - - - 540 1,800 1,800 1,800 1,800 Orhaneli - - - - 720 1,200 1,200 1,200 1,200 1,200 Keles - - - - - - 1,200 1,200 1,200 1,200 Bingol Karliova - - - - - - - - 600 600 Cankiri Orta - - - - - - - 360 360 600 Total 300 2,960 4,970 6,670 11,530 17,600 21,070 23,330 25,830 26,070 Others Self Producers /1 - - 400 840 840 840 840 840 840 840 Tbtal New 300 2,960 5,370 7,510 12,270 18,500 21,910 24,170 26,,70 26,910 Total Thermal 13,678 16,938 19,348 19,593 24,453 30,583 33,993 36,253 38,753 38,993 /1 Bank estimates are at divergence with TEK on the likely commissioning dates of Elbistan A 1-4. See page 5 of Annex. /2 PETKIM Source: TEK July 1982 0 1167P I-.w  Installed Capacity 1981-1990 - Base Projection with 20% Slippage MW 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 HYDRO PLANTS Existing TEK 1,872 1,872 1,872 1,872 1,872 1,872 1,872 1,872 1,872 1,872 Other 259 259 259 259 259 259 259 259 259 259 Total 2,131 2,131 2,131 2,131 2,131 2,131 2,131 2,131 2,131 2,131 New Call TEK) Dogankent B 40 40 40 40 40 40 40 40 40 40 Keban 5-8 - 360 720 720 720 720 720 720 720 720 Suat Ugurlu 1-2 - 46 46 46 46 46 46. 46 46 46 Oymapinar 1-4 - - - 135 405 540 540 540 540 540 Hasan Ugurlu 3-4 - - 125 250 250 250 250 250 250 250 Aslantas 1-3 - - 46 92 138 138 138 138 138 138 Karacaoren 1-2 - - - 15 30 30 30 30 30 30 Kokluce 1-2 - - - - 45 90 90 90 90 90 Adiguzel 1-2 - - - - - 60 60 60 60 60 Karakaya 1-6 - - - - - - 600 1,200 1,500 1,800 Kapulukaya 1-3 - - - - - - 34 51 51 51 Kilickaya 1-2 - - - - - - - 120 120 120 Altinkaya 1-4 - - - - - - - 175 350 700 Gezende 1-3 - - - - - - - - 150 150 Derbent - - - - - - - - 56 56 Camligoze - - - - - - - - 16 16 Menzelet 1-4 - - - - - - - - 90 120 Catalan - - - - 155 155 S. Yenice - - - - - - - - 37 37 Tohma - - - - - - - - - 14 Tercan - - - - - - 15 Total New 40 446 977 1,298 1,674 1,914 2,548 3,460 4,4 39 5,148 Total Hydro 2,171 2,577 3,108 3,429 3,805 4,045 4,679 5,591 6,570 7,279 July 1982 1167P OQ m~ no.  Installed Capacity 1981-1990 - Base Projection with 20% Slippage MW 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 THERMAL PLANTS Existing TEK 2,118 2,118 2,118 2,118 2,118 2,118 2,118 2,118 2,118 2,118 Others 876 876 876 876 876 876 876 876 876 876 Total 2,994 2,994 2,994 2,994 2,994 2,994 2,994 2,994 2,994 2,994 New Thermal (TEK) Soma B 1-4 - 330 330 330 495 650 650 650 650 650 Yatagan 1-3 - 210 420 420 420 630 630 630 630 630 Cevrim GT - 60 60 60 60 60 60 60 60 60 Geothermal - - 15 15 15 15 15 15 15 15 Elbistan A 1-4 - - - - - 340 680 1,020 1,020 Seyitomer 4 - - - - - - 150 150 150 150 Yeni Catalagazi - - _ _ _ 150 150 150 150 150 Cayirhan 1-2 - - - - - 150 300 300 300 300 Kangal 1-2 - - - - -- 150 300 300 300 Orhaneli - - - - - - 200 200 200 200 Yenikoy 1-2 - - _ - _ _ 210 420 420 420 4 Keles - - - - - - - 200 200 200 Bingol Karliova - - _- - 100 100 Total TEK 600 825 825 990 1,655 2,850 3,755 4,195 4,195 Others Self-producers /1 - - 140 140 140 140 140 140 140 140 Total New 600 965 965 1,130 1,795 2,995 3,895 4,335 4,335 Less Retirements - - - 520 520 520 520 520 520 520 TOTAL THERMAL 2,994 3,594 3,959 3,439 3,604 4,269 5,619 6,369 6,809 6,809 TOTAL INSTALLED c CAPACITY 5,165 6,171 7,067 6,868 7,409 8,314 10,298 11,960 13,379 14,088