Malawi - Energy Project

Document of The World Bank FOR OFFICIAL USE ONLY c-t /49'q-<6, Report No. 7476-MAI STAFF APPRAISAL REPORT MALAWI ENERGY I PROJECT FEBRUARY 6, 1989 Southern Africa Department Industry and Energy Operations Division This document has a restricted distribution and may be used by recipients only in the performance of their oMcial duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit - Ma!awi Kwacha (MR) USS 1.00 - M'R t.53 MK 1.00 - US$ 0.40 MK 1.00 - 100 tambalas WEIGHTS AND MEASURES . meter (m) - 3.28 feet 1 square meter (m2) - 10.75 square feet 1 kilometer (km) - 0.621 miles 1 square kilometer (km2) - 0.386 square miles 1 cubic meter (m3) - 35.3 cubic feet 1 kilovolt (kV) - 1000 vo!tl 1 kilowatt hour (kWh) a 1000 watt hours 1 megawatt (MW) - 1000 kilowatts 1 gigawatt hour (GWh) - 1 mil'ton kilowatt hours 1 megavolt ampere (MVA) - 1000 kilovolt ampere mtpy - million tons per year MVAr - megavolt ampere-reactive pf - power factor toe tonnes of oil equivalent tpd ' tonnes per day WEIGTS S, VOLUMES AND MEASURES 1 m3 (solid) wood - 1.43 m3 (stacked) wood 1 m3 (stacked) wood * 0.70 m3 solid wood 1 m3 (solid) hard wood - 0.70 m3 ton of wood 1 m3 (stacked) hard wood - 0.49 ton of wood 1 ton of charcoal - 7 giga calories 1 ton of hard wood - 3 giga calories 1 meter (m) - 3.3 feet 1 cubic meter (m3) - 35.3 cubic feet 1 hectare (ha) - 2.47 acres 1 kilometer (km) - 0.62 miles 1 square kilometer (km2) a 0.39 square miles GLOSSARY AND ABBREVIATIONS ACU - Area Control Unit CDC - Commonwealth Development Corporation DSB - Department of Statutory Bodies EEC - Puropean Economic Community EIB - European Investment Bank EPD - Economic Planning and Development EPU - Energy Planning Unit ESCOM - Electricity Supply Commission of Malawi ESMAP - Energy Sector Management assistance Program PD - Forestry Department FG - Forest Guards FRIM - Forest Rssearch Institute of Malawi GDP - Gross Domestic Product ICS - Interconnected System KfW - Kreditanstadt far Wiederaufbau MAI - Mean Annual Increment MC? - Malawi College of Forestry M & E - Monitoring and Evaluation MFNR - Ministry of Forestry and Natural Resources MIDCOR - Mining Investment and Development Corporation MTIT - Ministry of Trade, Industry, and Tourism NM - Nurserymen NRDP - National Rural Development Program NORAD - Norwegian Aid Development OPC - Office of the President and Cabinet PCC - Petroleum Confrol Commission PM - Patrolmen PSIP - Power Subsector Investment Program RCP - Revenue Collection Posts SADCC - Southern African Development Coordination Conference SCADA - System Control and Data Acquisition TA - Technical Assistant TAMS - Tippets - Abbet - McCarthy - Stratton UNDP - United Nations Development Program WLPU - Watermeyer, Legge, Pieshold & Itrlmann FISCAL YEAR Government of Malawit April 1 - March 31 ESCOMt January 1 - December 31  FOR OMCAuL USE ONLI Z ~~~~~~~~~~MAIAWI ENERGY I PROJECT CREDIT AND PROJECT SUMMARY Borrower: The Republic of Malawi. Amount: SDR34.8 million (US$46.7 million equivalent). Baneficiaries: Electricity Supply Commission of Malawi; the Ministry of Forestry and Natural Resources (MFNR); and the Department of Economic Planning and Development (EPD). Terms. IDA standard terms. On-lending terms for the power component estimated at US$31.9 million will be at an interest rate of 7.65Z, repayment period of 20 years including grace period of 5 years, ESCOM taking the foreign exchange risk. The balance of the Credit will be passed on by Government to MFNR and EPD. Pro_ect Obiectives 1. The proposed Project would assist the Government to formulate and implement an integrated program to make the most eco.- 'ic use of Malawi's energy resources through the implementation of (i) a least cost power development plan; (ii) a comprehensive strategy for the management of wood energy on a cost-effective and environmentally sustainable basis. Additionally, the Project would give support to strengthening the management information eystem of the power utility and of the forestry sector, and help strengthen energy pricing policy. Project Description 2. The Project's power component comprises: (i) increasing the hydro generation capacity by 50 MW and rehabilitating existing hydroelectric generating units; (ii) strengthening the in-house planning capability of the power utility through training and provision of hardware and software; (iii) undertaking studies related to tariffs, asset revaluation as well as transmission and distribution systems. The energy component of the Project comprises: (i) increasing on-going pilot charcoal production and marketing activities and encouraging commercialization; (ii) encouraging increased tree planting by the private sector through provision of seedlings, extension services and incentive payments; (iii) encouraging fuelwood conservation through the production of more efficient charcoal kilns and cooking stoves as well as through dissemination of research findings on fuel-efficient techniques in tobacco curing; (iv) improvements in wood prices and in the system for revenue collection and protection and management of indigenous forest; (v) strengthening the forestry institutions; and (vi) undertaking an energy pricing study covering liquid fuels, woodfuel and coal. This document has a restricted distribution and may be used recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - 3. The pilot charcoal production and wood energy components of the proposed Project are continuations of on-going activities. Charcoal production and marketing was initiated on a pilot basis in 1987 under the Wood Industries Restructuring Loan. The Project will assist in expediting the privatization of the sector. The wood energy component was initiated in December 1986 under Wood Energy II Loan which has been cancelled following the request of the Government. PPF bridge financing has been provided to support the continuation of essential activities pending effectiveness of the proposed Credit. Benefits arnd Risks 4. The Project would enhance the economic utilization of the indigenous energy resources by increasing hydro generation capability and by supporting a comprehensive program to (a) increase private wood production and conservation; (b) promote more efficient utilization of existing resources including conversion of industrial thinnings to chsrcoa'.; and (c) improve the system to protect and manage the natural forest. 'she Project would also benefit the institutional development of ESr.OM and the Forestry Department and would introduce reforms in wood energy pricing policy. The economic rate of return for the power component is estimated at about 11Z. The charcoal and wood production components have corresponding figures of 182 and 142 to 1.i respectively. 5. Because of the long gestation period of hydroelectric schemes, there is risk that new capacity will be brought on stream too early or too late if demand forecasts prove inaccurate. Both such eventualities can be costly. In the case of Malawi forecasting uncertainties have been increased by the situation in Southern Africa. Accordingly, the power development program is being designed to permit flexibility to respond to demand through phasing of generators and availability of standby capacity. The risk of energy deficits from probable consecutive dry years would be mitigated through the contingent plan of dredging the entry channel from Lake Malawi to the Shire River. The wood energy component involves simultaneous implementation of a wide array of policy measures and programs and will pose an implementation chal!enge for the Forestry Department. The risks would be minimized through strengthening of the Forestry Department and the Energy Planning Unit which will continuously review progress and, together with the Bank's supervision missions, provide timely advice on corrective measures.  - iii - PROJECT COST ESTIMATE Local ForeiLn Total (US$ million) Power Component ________________ A. Tedzani III Main civil works 8.49 15.22 23.71 Electromechanical 1.04 17.65 18.69 Substations 1.99 9.94 11.93 Engineering 0.74 4.66 5.40 Subtotal Tedzani III 12.26 47T.47 59.73 B. Generation Rehabilitation 0.02 1.47 1.49 C. Institution Strengthening -- 0.60 0.60 Subtotal Power l1.2 49.54 61.82 Interest During Construction 8.58 -- 8.58 Total Power 20.86 49354 75T4T Energy Component D. Charcoal 0.10 1.00 1.10 E. Woodenergy E.02 8.86 14.88 F. Energy Pricing -- 0.50 0.50 TotF. Energy 6.12 10.36 16.48 Total Financing Requirement 26.98 59.90 86.88 PROJECT FINANCING PLAN Local Foreign Total T US$-mI=oIn) Government of Malawi 10.3 - 10.3 ESCOM's Cash Generation 12.3 - 12.3 Austria - 17.6 17.6 IDA 4.4 42.3 46.7 Total 27.0 39.9 86.9 ESTIMATED DISBURSEMENTS OF IDA CREDIT IDA FY 1989 (1) 1990 1991 1992 1993 1994 Annual 1.5 7.5 4.4 10.8 13.6 8.9 Cumulative 1.5 9.0 13.4 24.2 37.8 46.7 1/ PPF of USS1.5 million is expected to be disbursed prior to the effectiveness of the proposed Credit.  MALAWI ENERGY I PROJECT STAFF APPRAISAL REPORT Table of Contents I. THE ENERGY SECTOR .... . . . . . . . . . . . . . . . ..... 1 Energy Resources . . . . . . . . . . . . . . . . . . . . . . 1 Biomass .... . . . . . . . . . . .... . 1 Coal .... . . . . ...... . . . . . . . . . . . 1 Hydropower .... . . . . . . . . . .... . 2 Other Energy Resources ... . . . . . .... . 2 Energy Demand and Suppiy .... . . . . . . . . . . ..... 2 Woodfuels . . . . . . . . . . . . . . . . . . . . . . . 2 Coal . . . . . . . . . . . . . . . . . . . . . . . . . 3 Petroleum Products . . . . . . . . . . . . . . . . . . 3 Electricity . . . . . . . . . . . . . . . . . . . . . . 3 Energy Pricing Study .... ........ . . ..... 3 Organization of the Energy Sector . . . . . . . . . . . . . . 4 Government's Energy Sector Objectives and Strategy . . . . . 4 Experience with Past and Ongoing Lending . . . . . . . . . . 5 II. THE BORROWER AND THE IMPLEMENTING AGENCIES . . . . . . . . . . 7 The Borrower . . . . . . . . . . . . . . . . . . . . . . . 7 The Implementing Agencies ... . . . . . . . . . . . ..... 7 Electricity Supply Commission of Malawi (ESCOM) . . . . 7 Institutional Framework . . . . . . . . . . . . . 7 Management and Staffing . . . . . . . . . . . . . 9 Planning and Engineering . . . . . . . . . . . . . 9 Training ......... .... .... 10 Insurance and Taxes . . . . . . . . . . . . . . . 10 Energy Planning Unit (EPU) ..... . ....... . 11 The Forestry Department. . . . . . . . . . . . . . . . 11 III. THE ENERGY MARKET ...... . . . .. . . . .. . . . . . . 12 The Electricity Market ..... . . . . . . . . . . . . . . 12 Historical ...................... . 12 Demand Projections .. . 13 Capacity and Generation Balances. 14 The Fuelwood Market ....... . .. .. . .. .. . .. . 14 Existing Energy Sector Facilities and Sources . . . . . . . . 15 Existing Power Facilities . . . . . . . . . . . . . . . 15 Generation System ............ ... . 15 Load Dispatch Center . . . . . . . . . . . . . . 16 Transmission and Distribution Systems . . . . . . 17 Existing Sources of Woodfuel . . . . . . . . . . . . . 18 IV. WOOD ENERGY ..... . 18 Background .............. . . 18 Wood Energy I Project ........... .. ..20 The report is based on the findings of two appraisal missions (for power and wood energy) which visited Malawi in June and July/August 1988 respectively, consisting of J. Armitage, E. Bundi, K. McNamara, Z. Mian and A. Telahun. R. Broadfield has also participated in the preparation of the report.  Wood Energy II Project .... . . . . . . ..... . . . . . 21 Overview of the Strategy for Wood Energy . . . . . . . . . . . 22 Pricing Policy Reform . . . . . . . . . . . . . . . . . . . . 22 Indigenous Forest Management ... . . . . . .... . . . . 23 Forest Extension .... . . . . . . . . .... . . . . . . 24 Retail Nurseries .... . . . . . . . . .... . . . . . . 24 Tree Planting Incentive Payment . . . . . . . . . . . . . . . 24 Government Plantations . . . . . . . . . . . . . . . . . . 25 Energy Efficiency Initiatives . . . . . . . . . . . . . . . . 26 Institutional Strengthening and Support Services . . . . . . . 27 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 V. PROGRAM AND PROJECT .... . . . . . . ...... . . . . . . . . . 29 Power Subsector Least Cost Investment Program . . . . . . . . . . . 29 Energy Sector Investment and Source of Financing . . . . . . . . . 30 Works in Progress . . . . . . . . . . . . . . . . . . . . . . 31 The Project . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Project Objectives ..31 Rationale for IDA Involvement ..32 Project Preparation . . . . . . . . . . . . . . . . . . . . . 32 Project Description ..32 Project Cost Estimate ..34 Project Financing ..35 Project Implementation ..36 Implementation of Power Components . . . . . . . . . . . . . 36 Implementation of Energy Components . . . . . . . . . . . . . 37 Consulting Services ..37 Procurement for Power Component . . . . . . . . . . . . . . . 37 Procurement for Wood Energy Component . . . . . . . . . . . 37 Advance Contracting . . . . . . . . . . . . . . . . . . . . 38 Disbursement ..39 Special Accounts ..39 Environmental Aspects ..39 Project Risks . . . . . . . . . . . . . . . . . . . . . . . . 40 Project Monitoring and Supervision . . . . . . . . . . . . . . 41 VI. FINANCIAL ASPECTS AND COST RECOVERY ..42 Electricity Supply Commission of Malawi (ESCOM) . . . . . . . . . . 42 Financial Position and Past Operating Results . . . . . . . . 42 Accounting and Auditing . . . . . . . . . . . . . . . . . . . 43 Tariffs . . . . . . . . . . n .. . . . . . . . . . . . 44 Future Finar1 lal Operations and Position . .44 Proposed Financing Plan . . . . . . . . . . . . . . . . . . . 46 Forestry Department . . . . . . . . . . . . . . . . . . . . . . . . 46 Wood Energy Component ..46 VII. ECONOMIC JUSTIFICATION ..48 Electric Power Components ..48 Charcoal Components. 49 Wood Energy Component ..49 VIII. AGREEMENTS TO BE REACHED ... . . . . . . . . . . . . . . . . . . 51 Prior to Negotiations . . . . . . . . . . . . . . . . . . . . . . . 51 At Negotiations .51 Condition of Board Presentation . . . . . . . . . . . . . . . . . . 53 Conditions of Effectiveness .53 Condition of Disbursements . . . . . . . . . . . . . . . . . . . . 53 Recommendation .53  .IST OF ANNEXES 1.1 Hydroelectric Potential of Malawi 1.2 Energy Balance 1987 2.1 Proposed Organization at Government Level for Medium Term Planning Process (All Parastatals) 2.2 ESCOM Organization Chart 2.3 ESCOM Selected Performance Indicators 3.1 ESCOM Past Sales and Numbers of Consumers 3.2 ESCOM Inerconnected System: Sales and Generation Base Scenario (Actual and Projected) Peak Demand Low Scenario (Actual and Projected) Peak Demand High Scenario (Actual and Projected) 3.3 ESCOM Interconnected System Capacity and Generation Balances 3.4 Existing Facilities 1987: ESCOM's Generating Plant ESCOM's Transmission and Distribution Systems Summary List of Private Generating Plant 5.1 Detailed Project Description 5.2 Energy Sector Investment Program 1989-1994: Power Wood Energy 5.3 Energy I Project Cost Estimates: Contingencies Shown Separately Contingencies included in each Subcomponent 5.4 Summary of Project Implementation Schedule 5.5 Estimated Schedule of Disbursements 5.6 Monitoring Guidelines and Performance Indicators 6.1 ESCOM Income Statements for Years Ending December 31, 1987-1995 6.2 ESCOM Sources and Application of Funds Statement for Years ending December 31, 1987-1995 6.3 ESCOM Balance Sheet for Years Ending December 31, 1987-1995 6.4 Notes and Assumptions for Financial Statements 7.1 Least Cost Power Generation Program 7.2 Economic Analysis of Electric Power Components 7.3 Long Run Average Incremental Cost of Energy 7.4 Economic Analysis of Charcoal Component 7.5 Summary of Output from Direct Wood Production Components 7.6 Total Costs and Benefits of Wood Energy Component MAP IBRD 20917R Malawi Energy I Project Dated December, 1988  I. THE ENERGY SECTOR Energy Resources 1.01 Malawi's main indigenous energy resources are biomass and hydropower. All petroleum products and the major part of coal are imported. Coal mining is at an early stage of development and exploration efforts need to be intensified to assess the economically recoverable coal resources in Malawi. Detailed information on the energy resources is given in the Joint UNDP/World Bank Energy Assessment Report (Malawi: Issues and Options in the Energy Sector, April 1982,. 1.02 Biomass. In 1987 biomass fuels, mainly woodfuel, accounted for more than 95Z of the country's total primary energy supply. In aggregate Malawi's forest resource is still extensive, covering about 38Z of the total land area. However, of the total of about 4 million hectares of forests, almost 48% is in the Northern Region where only 21Z of the population live. In the Southern and Central Regions, population pressure has led to widespread deforestation and the remaining woodlands have very low productivity. It is estimated that the present forest cover is declining at the high rate of 3.5Z per year. Unless action is taken to correct this trend, the environmental consequences are likely to be severe, leading to soil erosion and damage to watershed areas including silting up of water courses and flooding. 1.03 Malawi produces sugar cane molasses and juices which are used in ethanol production. In response to the high cost of petroleum imports accounting for some 22Z of foreign currency earnings, an ethanol plant was commissioned in 1982 to enhance the supply of transport fuels. Currently the plant, operating only during the cane crushing season, produces about 10 million liters of ethanol. Ethanol is mixed with gasoline to obtain a 20:80 alcohol/gasoline ratio and helped to reduce petroleum imports by about 72 in 1987. Ethanol is priced at gasoline import parity to which are added an octane enhancement premium plus local transport and handling costs. As long as the Mozambique route is closed the ethanol plant is expected to remain financially viable. However, once the least cost route is reopened, the plant's viability will need to be reassessed. Possible use of ethanol as a household fuel is under discussion. 1.04 Coal. Malawi is known to have coal deposits in a number of locations. The most promising deposits are in Ngana in the remote north of the country, where some 95t of known coal resources of some 16 million tons are estimated to be present. The other deposits are in geologically disturbed areas and coal quality and seam thickness and continuity appear to rule out further exploration and development effort. To counteract disruption in the supply of coal from Mozambique, Government established the Mining Investment and Development Corporation of Malawi (MIDCOR)in 1985, and opened coal mining at one of the sites in the north at Kaziwiziwi where the mineable coal potential is estimated at about 200,000 tons. Malawi needs to augment the information on its coal deposits before it proceeds to develop a priority investment program in this sector. Towards this end, the Government of Malawi is intensifying exploration efforts in the Southern  - 2 - parts of the country (Lengwe and Mwabvi) where, although speculative reserves are only 10 million tons, coal quality indications are above average compared to the other regions. 1.05 Hydropower. The hydropower potential of Malawi is concentrated on the Shire river on which all the existing hydroelectric power plants are located. Installed hydropower generating capacity amounts to 145 MW at present. The Shire river is known to have a potential of 500MW with generation capability of 3,500 GWh. In addition, a number of other rivers in the country have been identified with hydro potential estimated at 400MW but have not been subject to detailed study. Annex 1.1 lists the hydr,)ower potential of Malawi. 1.06 Other Energy Resources. Data on average number of sunshine hours per year is not yet established. However, from data compiled by the Meteorological Department (MD), the average insolation level is estimated at 18MJ/m2. 1/ Solar photovoltaic panels are used by the Department of Posts and Telecommunications i,nd by the Malawi Broadcasting Corporation. Based on observations made at 19 sites by MD, the proportion of hours with winds is estimated at 67Z per annum. 2/ Some 8-10 windmills are used for water pumping. Although hot springs have been identified, geothermal energy is given low priority as an energy resource. Government is also encouraging the private sector to prospect for petroleum and uranium. Energy Demand and Supply 1.07 The 1987 energy consumption of Malawi is estimated to total 2.9 million toe. Non commercial energy forms account for 93.7Z of this total. The difference is accounted for by imported petroleum (3.9Z), electririty (1.4Z), coal (0.82) and ethanol (0.2?). Per capita consumption of a1l forms of energy amounted to 0.36 toe. 3/ Industry (49.72) is the largest consumer of commercial energy followed by transportation (36.7Z), agriculture (7.2Z), households (6.0%) and power generation (0.4Z). Annex 1.2 gives the 1987 energy balance for Malawi. 1.08 Woodfuels. Biomass fuels, largely woodfuel, account for more than 93% of Malawi's total energy demand. The estimated woodfuel consumption for 1984 is 8.6 m3 million, and the indicative figure for 1987 is 9.8 m3 million. The household sector uses wood or charcoal for cooking and heating and accounts for more than 702 of the total demand for wood, the balance being for curing tobacco and tea. Rural households, who usually collect 1/Source: Energy Planning Unit (EPU). 2/Source: EPU. 3/ Comparative 1985 figures for neighboring countries are: Zambia 0.8; Tanzania 0.4; Kenya 0.5; Mozambique 0.25; Botswana 0.8.  - 3 - rather than purchase their fuel, use some 60Z of the total woodfuel and urban households account for the difference of 102. A major problem for woodfuel supply is the uneven geographical edstribution of resources relative to demand. The underpopulated Norti-ern Regior. is rich in forest resources. In the heavily populated South and Central regions, where 792 of the population live, there is now a substantial gap between the demand for woodfuel and its sustainable supply from customary woodlands which is leading to depletion of the forest stoc' (para 4.03). Measures are being implemented by the Government to reverse this trend (para. 1.18). 1.09 Coal. Coal imports from Mozambique have been unstable due to security problems, and supplies from Zambia and Zimbabwe have proved very expensive for Malawi. To counteract disruptions in the supply of coal from Mozambique, MIDCOR opened a coal mine at Kaziwiziwi in 1985 and is presently substituting some 302 of the 40,000 ton consumption by Malawi industries. '.10 Petroleum Products. Supply of petroleum products in 1987 was 152.2 million liters, of which gasoline was 37.3Z, jet fuel and illuminating kerosene 12.22 and diesel fuel 50.52. To ensure continuA.ty of supply petroleum products are imported into Malawi through d,fferent routes. These are South Africa (through Zimbabwe and Zambia), Northern Corridor (through Tanzania), and Mozambique. Minimizing the impact of the high cost of petroleum and ensuring stability of supply are major issues. The identification of least cost supply options through a petroleum supply and distribution study is a high priority action for Government. An energy pricing study is included in the proposed Project and UNDP is providing support to petroleum exploration. 1.11 Electricity. Electricity generation accovr.ts for about 20? of commercial energy supply in Malawi. The 1987 consumption totalled 466.5 GWh, 58.5 kWh per capita. ESCOM supplies electricity to about 35,200 consumers, and in 1987 about 22 of the total population had access to electricity. 4/ Industry (68.8Z) is the major consumer followed by domestic (16.62) and commercial (14.6Z). During the period 1970 - 1987 (Annex 3.1), consumption grew at the annual rate of 7.82 for domestic consumers, 7.52 for commercial, 9.22 for industry and by 8.62 for all categories. Generation and sales statistics are given in Annex 2.3. Energy Pricing Policy 1.12 Energy prices in Malawi do not reflect economic costs. Appropriate energy pricing policy will optimize the supply and use of energy from various sources. In Malawi the linkages or substitution possibilities between various energy sources are not substantial. Wood is not used for generation of electricity nor does electricity play a leading role as a substitute for woodfuel. Bagasse is used for generation of electricity for sugar estates but presently does not compete with hydro produced electricity. Domestically produced ethanol is used for blending imported petroleum at parity prices with petroleum products. The rational approac1i which fosters economically efficient allocation and use of energy resources 4/ Comparative figures of neighboring countries are: Zambia (1985) 10; Zimbabwe (1980) 5; Tanzania (1980) 4; Kenya (1980) 6.  - 4 - would be to structure energy prices to reflect the costs that would be incurred to meet additional demand, so that prices would signal to consumers the cost of providing them with additional energy supply. Government's social objectives in setting relative prices should be built around economic costs of energy supply. An Energy Pricing Study would be carried out under the proposed Energy I Project, with the objective of determining appropriate pricing policy for liquid fuels, coal and fuelwood. The proposed Project also provides for a study on electricity tariffs. Organization of the Energy Sector 1.13 There are a r.umber of Government organs involved in the energy sector. The Ministry of Forestry and Natural Resources (MFNR) is responsible for forestry and mineral resources. The Forestry Department responsible for the management, development and protection of the forestry resources is under this Ministry. The Geological Survey Department (GSD) of the Ministry is responsible for mineral exploration including petroleum and coal. Coal development and mining is assigned to M!DCOR. 1.14 The Gover,nment has established a number of parastatals (like MIDCOR) to discharge those activities which could not effectively or equitably be handled by the private sector or the civil service. The Government exercises control over parastatals through the Department of Statutory Bodies (DSB) established in 1980 in the Office of the President and Cabinet. In addition to MIDCOR, the Electricity Supply Commission of Malawi (ESCOM) responsible for electricity generation and distribution, and the Petroleum Control Commission (PCC), responsible for petroleum supply and distribution, are energy sector parastatals reporting through their Boar-is to DSB. Board members include a parent ministry (technical ministry having relevance to the activities of the parastatals), Ministry of Finance and other organs or individuals having linkages to or relevant qualification and experience related to the activities of the parastatal. The parent ministries in the energy sector are MFNR (woodfuel, petroleum, coal) and Ministry of Trade, Industry and Tourism (power). Annex 2.1 shows the organization of parastatals at government level. 1.15 The Energy Planning Unit (EPU) under the Department of Economic Planning and Development (EPD) is responsible for energy policy formulation and energy planning and coordination. Each parastatal liaises with EPU through DSB. The initial role of EPU focussed on the establishment of the unit and formulating energy data base and drafting of an energy policy document. EPU was the co-ordinator of the least cost power development study. The future role of EPU will focus on updating from time to time the energy policy document, strengthening energy planning and co-ordination, preparing guidelines for energy planning at parastatal and at Government level, and preparing recomnnendations to GDvernment on energy policy issues. Government's Energy Sector Objectives and Strategy 1.16 Government's objectives in the Energy Sector are to minimize the impact of the high cost and the instability in supply of imported oil and coal, develop a sustainable wood energy program which can meet the future need for fuelwood and poles while conserving the indigenous forest and environment, and increase the supply of low cost electricity to meet the  demands of the economic and social development of the country. Government's strategy to achieve ches.e objectives are: (a) improving policy for petroleum supply and distribution, including the establishment of national reserves; (b) encouraging the production of ethanol for blending in transport fuel; (c) encouraging international companies to explore for and develop petroleum; (d) exploring for and undertaking coal mining activity in the country; (e) encouraging conservation and increased wood production by the private sector and more efficient utilization of existing wood resources including convetsion of industrial forest thinnings to charcoal; (f) undertaking studies of least cost power development options and determining a least cost power development plan; and (g) strengthening energy institutions and Government's capability for energy planning and coordination through training and technical assistance. 1.17 In the area of commercial energy, Government has initiated appropriate action in pursuit of these strategies. EPU is coordinating energy planning at Government level. PCC has been established to supervise petroleum supply, distribution and procurement policies. Coal production is contributing to reduce coal imports and has the aim of eventually substituting all imports of coal. Ethanol blending with petroleum is reducing petroleum product imports. A least cost power development study has been completed and updated by the Government. The actions Government is taking will be further enhanced with the realization of the Energy I Project. 1.18 The Government has also developed a variety of initiatives for the management of wood energy on a cost-effective and environmentally sustainable basis. These include measuree to promote tree planting by smallholders and estates through provision of subsidized seedlings, extension services and tree planting incentive payments. A pilot project to convert pine thinnings into charcoal in the large Viphya Forest in the North, using improved charcoaling techniques, is attracting potential markets in the urban household sector, tobacco estates and industry. The Government is disseminating simple but more fuel-efficient technologies for tobacco curing, charcoal making and domestic cooking stoves. The Government is also implementing substantial increases in wood royalties, and improvements in the system for revenue collection and protection and management of the natural forest. The forestry institutions are being strengthened to enable them to carry out the program satisfactorily. The proposed Energy I Project will continue to support the Government's strategy in this sector. Experience with Past and Ongoing Lending 1.19 The World Bank has made three Credits and one loan for power to Malawi. The first IDA credit (178-MAI) for US$ 5.25 million made in 1970 helped to finance the foreign exchange costs of the first stage of Tedzani hydroelectric development. A second IDA credit (426-MAI) of US$ 7.5 million was made in 1973 to help in financing the second stage of Tedzani Falls development as well as the 15MW standby gas turbine plant in Blantyre. The Commonwealth Development Corporation (CDC) assisted with an additional amount of US$6 million. The third loan/credit made in April 1977 had three components. The first component (Loan 1387-MAI) of US$ 9 millio:A was supplemented by a second loan (No. 1388-MAI) of US$ 8 million and a credit  - 6 - (No. 391-MAI) of US$ 8 million. The total loan of US$ 25 million was used in financing the foreign portion of the civil works construction of Nkula B hydroelectric power station. The electro-mechanical equipment of the US$ 82 million 88MW project was financed by CDC, African Development Bank (AFDB) and Kreditansalt fur Wiederaufbau (KfW). The World Bank also provided a Special Project Preparation Facility in 1986 to carry out a least cost power development study, demand forecasting and load management and energy efficiency studies, which have all been completed. 1.20 Technical Assistance II financed by Credit 1428-MAI assisted the Government in establishing and strengthening a planning unit in the Department of Planning and Development of the Office of the President as well as in woodfuel conservation in the tobacco industry. The first Bank group assistance to the forestry sub-sector was Credit 992-MAI (US$13.8 million) under the National Rural Development Program (NRDP) II (First Wood Energy) Project which began in 1980. The main focus of the Project was on establishing Government fuelwood plantations of fast-growing exotic species close to urban areas and setting up a network of retail nurseries to sell seedlings to farmers. The second phase of the wood energy program was the Second Wood Energy Project (Loan 2670 - US$16.7 million) which became effective at the end of 1986. The principal objective of the Project is to reorient the Forestry Department away from direct production of wood and towards the creation of an institutional and policy environment that encourages private wood production and conservation and more efficient utilization of existing resources. Implementation of Wood Energy II is proceeding satisfactorily. However, given Malawi's current external debt situation, the Bank and Government have agreed that IBRD financing is no longer appropriate and have decided to cancel the loan. The main components of the Wood Energy II Project were reappraised and are Included with some modifications under the proposed Energy I Credit. 1.21 The Project Completion Report for Credit 691-MAI, Loans 1387 and 1388-MAI referred to above (para 1.18) concludes that the main objectives of the projects have been achieved, contributing significantly to efficient and reliable power supply in Malawi. Institution building efforts have had a marked influence on the operations of ESCOM. The lessons identified emphasized the following points: (i) the need to make due allowances for impact of Malawi's transport difficulties on project implementation schedules and on cost estimates; (ii) the impact of bad rock conditions even on short tunnels; and (iii) the influence of economic development and price increases on load forecasts. The positive role an experienced consultant can play in averting delays through changes in project design and construction methods is also highlighted in the report. The proposed Project provides for confirmatory drilling along the route of the proposed short tunnel and in the power house area (Annex 5.1). The Summary Implementation Schedule (Annex 5.4) assumes total transport time of 4 months (compared to a recent experience of less than two months) for delivery of major machinery and equipment. The sensitivity of power demand growth to GDP changes has been investigated by the consultant and reviewed in this report (para. 3.06). The proposed Project also provides for an electricity tariff study in which the impact a possible tariff increase on growth of demand would be analysed. According to the Project Completion Report for the National Rural Development Program (NRDP) II (First Wood Energy) Project, the achievements of the Project were rather disappointing  due to its emphasis on Government plantations which proved to have poor wood yields and high establishment costs. Further, seedling sales from the retail nurseries were rather low, due partly to the lack of tree planting extension services to smallholders but mainly because farmers did not find tree planting financially attractive given the low producer prices for wood and availability of free wood in the virtually uncontrolled and unprotected natural forest. The lessons learned under the first Project were incorporated into the design of the Second Wood Energy Project, which was reappraised in July 1988 for inclusion as a component of the proposed Energy I Credit. II. THE BORROWER AND THE IMPLEMENTING AGENCIES The Borrower 2.01 The Government of Malawi would be the Borrower of the proposed IDA credit of SDR 34.8 million (US$46.7 million equivalent). 2.02 The proceeds of the credit would be used as follows: US$31.9 million would be on-lent to ESCOM at the current IBRD rate (paras. 5.16 and 5.17) to finance the foreign exchange costs of the power components of the project; US$ 1.0 million would be spent by the Forestry Department under the Ministry of Forestry and Natural Resources for the charcoal production and marketing components of the project; US$13.3 million would also be spent by the Forestry Department under the Ministry of Forestry and Natural Resources for the wood energy component; and US$0.5 million would be assigned to the Energy Planning Unit (EPU) in the Economic Planning and Development (EP&D) under the Office of the President and Cabinet (OPC) to carry out the energy pricing study (para 5.17). The Implementing Agencies Electricity Supply Commission of Malawi (ESCOM) 2.03 Institut'onal Framework. ESCOM is a state owned corporation (parastatal) established by the Electricity Act of 1963 when it took over the assets, liabilities and staff of the Nyasaland Electricity Supply Commission. ESCOM is the sole producer of electricity which it generates, transmits and distributes to the public. ESCOM exercises control on electricity produced by others (small captive plants for self consumption) by its influential role in the licensing of other suppliers. 2.04 ESCOM's Board consists of a Chairman and eight members, including two ex-officio members. The two ex-officio members are the Secretary to the Treasury and the Secretary of the Ministry of Trade, Industry and Tourism (MTIT), the parent ministry. The six other members, representing most interest grcups of the Malawi society, consist of the CDC representative in Lilongwe, the Secretary of Community Services, the General Manager of the  Reserve Bank, a partner of an accountant firm, an officer of the Bureau of Standards and a business man. The Board of Directors are appointed by the President for a two year term. 2.05 The principal entity responsible for the oversight of ESCOM (and all parastatals) is the Department of Statutory Bodies (DSB). The reporting framework of ESCOM is shown in Annex 2.1. DSB was created in 1980 under the Office of the President and Cabinet (OPC) as a central unit to assist parastatals in financial management, planning and staffing as well as to act as an oversight agency for parastatals activities. DSB's principal focus to date has been on the review of ESCOM's budget in coordination with EPU, prior to submission to the Ministry oi Finance, and on administrative decisions, especially those affecting personnel hiring, firing, salaries, fringe benefits, travel, vehicle use, technical assistance and the like. EPU's principal function is to coordinate an' review all energy projects, including those in the power sub-sector, and to establish their economic viability at a macro level. ESCOM's parent ministry is the Ministry of Trade, Industry and Tourism (MTIT) and its Principal Secretary sits on ESCOM's Board (para. 2.04). MTIT is consulted on projects under implementation, major new investments and tariff issues and represents ESCOM's interest in Cabinet meetings. Final approval of investments requiring loans and/or Government guarantee for borrowed funds as well as tariff increases are made by the Ministry of Finance which works closely with DSB. 2.06 Under the present arrangement, most decisions made at Board levels are referred to Government authorities for final approval, which tends to undermine the powers of the Board. Furthermore, DSB's involvement in ESCOM's activities has become excessive over the years with apparently no major positive impact, since it tends to focus on bureaucratic details at the expense of bigger issues, insufficient attention is paid to efficiency and there is over-centralization of decisions which might better be made at other levels. 2.07 The Government recognizes the weakness of the present institutional arrangement and has, with Bank and UNDP assistance, identified reforms which are expected to be implemented within the next year. Unde: the proposed system, DSB's role would be mainly that of monitoring and evaluating results, while giving ESCOM's Board and management the autonomy to decide on administrative matters and to react flexibly to changing circumstances. In particular, ESCOM's management with the approval of the Board would be given the authority to set renumerations for its staff, hire, fire, promote and take disciplinary actions without Government interference (para. 2.10). ESCOM's annual as well as medium term budget, capital investment program and tariff proposals would be submitted to DSB prior to seeking approval by the Ministry of Finance. EPU would continue to liaise with DSB on the economic viability of ESCOM's capital investment program. The parent ministry's role would remain the same (para. 2.05). With the implementation of the institutional reform program, it is expected that DSB's new role would be legalized under an Act and that ESCOM's Act along with other parastatals would be revised accordingly. During negotiations, it was agreed with the Government that the views of IDA shall be taken into consideration prior to implementing any reform in ESCOM.  - 9 - 2.08 Management and Staffing. ESCOM is a well managed utility with experienced and competent staff in its senior management positions. The post of General Manager, approved by the Minister, has been filled by an expatriate since the establishment of ESCOM, except for the last two years when a Malawian national (the Deputy General Manager) has been acting as General Manager pending recruitment of an expatriate. Government has plans to train and appoint a Malawian to the post as soon as feasible. Of the three senior managers reporting to the General Manager through his deputy, namely the Financial Controller, Chief Engineer and Commission Secretary, one (the Financial Controller) is an expatriate. The posts of Deputy General Manager and the senior managers are approved by the Secretary to the President and Cabinet (SPC) after a selection committee has been formed to advise on the appointment. ESCOM's organizational structure is shown in Annex 2.2. 2.09 ESCOM's total staff at the end of 1987 was 2,475, including 772 temporary laborers. Of the 169 senior positions, only four were occupied by expatriates including the Financial Controller. Through a well considered training program, the number of expatriates has been gradually reduced from 25 to 4 over the last ten years. For an electricity supply undertaking of ESCOM's size, a staff of 2,475 is rather high. Efforts are being made to control staff additions and ESCOM plans to release about 400 temporary laborers by end 1988 who will no longer be needed. The success of these efforts will be monitored through performance indicators shown in Annex 2.3. 2.10 ESCOM has difficulties in attracting and retaining qualified staff in the field of accounting and finance due to the low salary scale in ESCOM compared to the private sector. 5/ Attracting and retaining qualified engineers also appear to be problems but to a lesser extent since their demand in the private sector is more limited. It is estimated that the salary of senior accountants in ESCOM is about 55? of the salary of a senior accountant in a mid-sized private firm. The effe-t of this differential is a loss of skilled senior accountants to the private sector and lack of suitable candidates to groom for the post of Financial Controller. The top financial positiorn in ESCOM has therefore always been filled by an expatriate who is not subject to the same limits. With the implementation of the Government's reform program, ESCOM would be allowed to reward its staff according to performance and set salary scales more competitive with the private sector (para. 2.07). In the future, therefore, it is expected that ESCOM would be able to retain its qualified accounting and finance staff. 2.11 Planning and EngineerinR. Planning is presently a part time function within the engineering unit and performed by an engineer (the head of the unit) and a statistician. Apart from preparing programs for ESCOM's new projects, the engineer and statistician are also involved in procurement activities and in design and specification of distribution works. ESCOM is in the process of hiring an economist and establishing a separate planning unit, making the planning function into a full time activity. The planning unit will prepare load forecasts on a monthly basis, design and analyze the 5/Salary scales for all parastatals, including ESCOM, are standardized by the Government.  - 10 - technical and economic aspect of distribution expansion and together with consultants, prepare least cost power investment programs. In order to sttengthen the planning unit, three of ESCOM's staff (two engineers and an eco,iomist) will receive training at a consultant's office abroad for a period of three to six months each. Financing of this training is provided by UNDP. 2.12 ESCOM has developed expertise in the design and construction of distribution lines and distribution sul-stations and would be able to carry out this part of their investment program in-house. With the use of engineering consultants, ESCOM's staff is competent to carry out the proposed project. To ensure the continuation of ESCOM's management capability, new appointments to the positions of General Manager, Deputy General Manager, Financial Controller, Chief Engineer and Commission Secretary would not be made before taking into consideration the views expressed by IDA on the proposed appointments. 2.13 Training. ESCOM has a training center for distribution artisans where presently 12 of ESCOM staff are in attendance. Training in other fields is catered for by local institutions or abroad. Presently two engineers are receiving specialized training in the field of power system protection at GEC and Brown Boveri in Europe; three engineers are attending post graduate courses abroad in power engineering; and two of ESCOM's staff will be studying abroad next year for under graduate degrees in electrical engineering. Most of ESCOM's engineers and technicians are now being recruited from the University of Malawi and the utility's policy is to provide on-the-job training for the technicians and send abroad about three engineers per year for specialized training. 2.14 On the finance side, ESCOM sponsors two students per year (graduates from the prestigious Kamuzu Academy) for studies leading to a degree in accounting and for employment in ESCOM upon successful completion of their studies. One of ESCOM's accountants is studying abroad for professional accounting qualifications. Several of ESCOM's staff are pursuing part time courses in fields relevant to the utility at local institutions and get their fees reimbursed by ESCOM upon successful completion of their courses. 2.15 ESCOM's training program is well prepared and relevant to the utility's needs. However, ESCOM needs to develop expertise in planning, engineering design and in preparing feasibility studies. While three of ESCOM's staff will receive training in planning under UNDP financing (para. 2.11), the proposed Project provides for on the job training with consultants, contractors and suppliers (para. 5.20 and Annex 5.1). ESCOM will continue to finance training provided locally from its own revenues. 2.16 Insurance and Taxes. ESCOM has adequate insurance coverage for its dams, plants and equipment against the risks of machinery breakdown, fire, loss, and damage in transit and public liability. ESCOM is exempt from the levy of import duties on materials, equipment and machinery financed by foreign lenders but is liable for import duties of about 30? on goods (mostly line materials) financed through its own sources. ESCOM is liable for corporate taxes of 50? on its income. However, with capital investment allowances of 45-55? per year (carried forward) on new projects  - 11 - in operation, ESCOM does not expect to pay corporate taxes until 1993. ESCOM is not subject tc dividend payments to the Government. Energy Planning Unit (EPU) 2.17 EPU, headed by a principal economibt and assisted by an Energy Advisor (financed by UNDP), is the planning organ of the Government on energy matters. The unit, formally established in 1983, consists of four economists, of which two are presently on long term study programs abroad. The energy pricing study (excluding electricity tariffs) would be carried out by consultants reporting to EPU. During negotiations, it was agreed that the two vacant positions of principal and senior economists in EPU will be filled prior to disbursing IDA funds to finance the energy study. 2.18 The Government was assisted by IDA funding of an expatriate Energy Advisor for a period of two years ending June 30, 1988, and a UNDP grant from July through September 1988. To strengthen EPU's future role (para 1.15) and to ensure sustainability of planning operations by EPU, the Government would require an Energy Advisor for a further period of two years. UNDP is expected to provide an additional grant for energy planning and training (para 5.06). The Forestry Department 2.19 The Forestry Department was reorganized under the Second Wood Energy Project to enable it to implement the Government's comprehensive program for the management of wood energy. The new Organization Chart is shown in Annex 2.2. Under the Chief Forestry Officer, who is the head of the overall Forestry Department, are three Deputy Chief Forestry Officers who head the three main divisions: Forestry Development, Forestry Extension and Forestry Support Services. The Project Coordinator for the Second Wood Energy Project is also the head of the Forestry Extension Division which includes the Project's core activities such as management and protection of the indigenous forest on customary lands, revenue collection, extension, retail nurseries, small holders tree planting incentive scheme, government fuelwood plantations, project accounting and staffing. The units for Monitoring and Evaluation and Planning and the research and training components of the Project are under the Forestry Support Services Division. The ongoing program to strengthen the implementation capabilities of the Forestry Department, which will be continued under the proposed project, is described in para 4.13 to 4.21. An enhanced training program will be implemented by the Malawi College of Forestry. An expanded research program will be carried out by the Forestry Research Institute of Malawi in close cooperation with staff from the Forestry Department and from the Agricultural Research Department. During negotiations agreement was reached that the post of Project Co-ordinator established under the Second Wood Energy Project will be maintained under the Energy I Project, with terms of reference, qualifications and experience satisfactory to IDA.  - 12 - III. THE ENERGY MARKET The Electricity Market 3.01 Historical. The 1970's was a period of high real income growth (6Z per annum) and this was reflected in high electricity growth rates which averaged 11.7X during the period 1970 - 1979. Reflecting the economic and transportation problems experienced during the 1980's, both the real GDP and the power consumption growth rates dropped significantly over the period 1980 to 1987 (in 1981 the electricity growth rate was -2.4Z). In that period electricity consumption grew at an -erege rate of only 4% per annum and real GDP at 1.4Z. For the 1980's the -ome elasticity for electricity demand is estimated at 2.9. 3.02 Annex 3.1 gives the historical growth in public electricity sales in Malawi. In 1987 the interconnected system accounted for 99.8% of total electricity sales. The main electricity consumption centers are Blantyre accounting for 41.3% of 1987 sales and Lilongwe accounting for 27.7Z. Zomba accounts for only 6.7X of sales. The four largest consumers (Sucoma Sugar Estates, Blantyre Water Board, Portland Cement, David Whitehead Textiles) account for 32% of the total sales and 19% of the peak load in the grid system or almost two thirds of the industrial sales of ESCOM. The residential sales have two categories. The low density residential sales represent the high ranking civil servants and expatriates. The high density consumers represent the remaining residential consumers. Although they are about equal in number, the low density account for about 84% of the residential 1987 electricity sales. Table 3.1 gives the breakdown of sales by consumer categories. Table 3.1 Pattern of Demand for Electricity (GWh) and Forecasted Growth Rates a/ Annual Growth Rate. N 1970 1975 1980 1987 70-87 89-94 1989-2000 Residential Low Density 20.33 33.19 46.49 64.55 7.0 7.1 8.3 X of Total 17.7 14.2 13.1 13.9 -- -- High Density 1.37 5.47 7.96 12.49 14.4 9.6 8.0 X of Total 1.1 2.3 2.3 2.7 -- -- Commercial 19.91 24.04 37.70 68.27 7.e 9.8 11.1 X of Total 17.4 10.3 10.8 14.7 -- -- Small Industries 19.84 67.78 90.62 170.91 7.6 9.1 10.9 X of Total 17.3 24.6 26.0 86.7 -- -- Large Industries 62.10 112.58 184.94 149.30 18.6 3.1 2.6 X of Total 45.4 48.0 47.4 32.0 -- -- Exports 1.28 1.46 1.86 -- 8.4 2.7 2.7 X of Total 1.1 0.6 0.4 -- -- -- Total 114.73 234.62 847.96 486.62 8.8 7.3 8.6 X of Total 100.0 100.0 100.0 100.0 -- -- = = = _- = */ ESCOM's interconnected system only.  - 13 - 3.03 Demand Proiections. In 1984, TAMS completed a study on the least cost power development program. 6/ This study included a power market survey and electricity demand projections. These projections were updated in 1986 and subsequently in 1987 by Kennedy and Donkin. 7/ The base case demand projections assume GDP growth rates of 2.32 for 1987, 3.2Z for 1988, 3.51 for 1989, 3.9X for 1990 and 4.62 for 1991. Thereafter GDP is projected to grow at about 42 per annum. These GDP figures were given by the Government. 3.04 The forecast methodology involved a combination of detailed analysis of the factors influencing the historical demand. A comprehensive market survey particularly of the industrial consumers was carried out by the consultant. Measurements were taken to derive load shapes, load factor and coincidence factors for each of the main consumer category and allowances were made for system losses. During 1989-94, the demand for the residential consumers is expected to grow at the rate of 7.12 for the low density and 9.52 for the high density consumers (Table 3.1). Commercial demand will grow at 7.82, small industries at 7.52 and large industries at 3.1X, resulting in a total anticipated growt'h rate of 8.6Z for the grid system. The base case scenario forecast is given in Annex 3.2. The consultants have also considered low and high scenarios (Annex 3.2). The low scenario for maximum demand gives an overall average growth rate of 5.52 for the period 1989-2000 (3.72 for 1989-94), and the high scenario 10.9Z (7.62 for 1989-95); compared to 9.22Z (6.82 for 1989-94) for the base case scenario. Demand growth would be mainly due to small industries, and commercial and residential consumers. 3.05 More recent analysis by IDA staff in co-operation with the Government indicate that the GDP growth assumptions for the base case scenario should be revised as below: 1987 1988 1989 1990 1991 1992 1993 1994 Consultants 2.3 3.2 3.5 3.9 4.6 4.0 4.0 4.2 IDA -0.2 1.5 4.0 4.3 4.6 4.9 5.1 5.1 3.06 This revision in the GDP growth will not affect the base case load projections significantly. Variations in the system demand will be within the confidence level of 52 and the timing of the proposed units (para 3.07) will remain unchanged. However, if demand grows following the unlikely low scenario forecast (para 3.04), corresponding to GDP growth of 22 in 1988 increasing to 3.22 by 1996, the commissioning date of Tedzani III would be postponed from 1994 to about 1996/97. 6/ Power Development Study, Phase 1: Least Cost Solution February 1985, by TAMS (Tippets- Abbet- McCarthy- Stratton), Engineers, Architects and Planners. 7/ Study to Update ESCOM's Least Cost Development Program, April 1988, Kennedy and Donkin Power Systems Ltd.  - 14 - 3.07 Capacity and Generation Balances. The base case scenario for maximum demand is frojected to increase from about 106MW in 1988 to about 158MW in 1994 and 210MW in 1997. The generation requirement will increase from about 592 GWh in 1988 to 873 GWh in 1994 and 1254 GWh in 1998. However, the appraisal mission considers Kennedy and Donkin's assumption for the rate of reduction of percentage losses optimistic and has made upward adjustments to the maximum demand and generation figures (Annex 2.3). The grid system's dependable capacity is currently constrained at 140MW. This includes the 15MW gas turbine in Blantyre. The dependable energy capability is estimated at 860 GWh. Kennedy and Donkin have concluded that the fifth 20MW unit at Nkula B should be commissioned by 1991 and two 25MW units at Tedzani III by 1994. Commissioning of Kapichira would be needed by 1997. These conclusions are apparent from Annex 3.3. 3.08 Firm dependable generation capacity has been detenmined from operational records for existing hydroplants (Annex 3.3). Firm energy is based on Shire's firm flow of 136 m3/sec given in TAMS' study. 8/ During the period 1989-92, the generation capacity balance for the existing system shows surpluses ranging from 19 to 4Z for the base scenario, and increasing deficits beginning from 1993. Capacity deficits will begin in 1993 for the base scenario, 1997 for the low and 1992 for the high scenarios. Energy requirements will be met by the output of the existing plants up to 1993 for the base, 1997 for the low and 1994 for the high scenario. The planned additional installation of new generating units will provide additional capacity and generation surpluses for the base scenario up to 1995. (There will be deficits from 1994 through 2000 for the high scenario.) However, the hydro system capability is based on the extreme case of 1 in 80 probability for the availability of water and the possible output of the existing gas turbine plant is not included. In the event of consecutive dry years commencing from early 1990's, options considered include: (i) construction of a thermal plant; (ii) interconnection with a neighboring country; and (iii) dredging the channel at the beginning of the Shire river. Dredging would provide a rapid response due to the short period needed for its implementation and would also be the least cost solution. Under average year conditions, the system would have surplus energy, the possible utilization of which would be evaluated together with the tariff study included in the Project. The Fuelvood Market 3.09 The major consumers of wood are tabulated in Table 4.1. The estimated total fuelwood consumption for 1984 is 8.6 million m3. The rural population uses fuelwood for cooking and heating as well as poles for building, and accounts for around 60Z of the total demand. Urban households, who utilize mainly charcoal, account for a further 10Z. The tobacco and tea industries utilize most of the balance of wood consumption for curing and barn construction. Demand for fuelwood is increasing rapidly due to population growth of around 3.7Z per annum, compounded in recent 8/ ESCOM Power Development Study, Least Cost Solution Volume I, by TAMS (Tippetts-Abbat-McCarthy-Stratton), November 1984.  - 15 - years by an influx of several hundred thousand refugees from Mozambique. The urbar, population with 75? higher specific fuelwood consumption than the rural population is growing at over 62 a year. Under current trends it is estimated that the indigenous forest on customary land will have totally disappeared within less than ten years in the South and less than fifteen years in the Central Region. This has very serious long run implications for energy supply and the environment. The Government's objective is, therefore, to deve:op a sustainable wood energy program that can meet the future need for fuelwood and poles while conserving the natural forest and the environment (see Chapter 4). 3.10 The market potential for softwood charcoal for 1988/89 is estimated by IPC 9/ at about 18,000 tons per annum taking market penetration into account. About 77? of this demand is accounted for by the industrial sector, and the remainder by the tobacco estates and households. Substantial increases are anticipated in subsequent years. On the basis of a refugee population of 526,000, IPC has (in a separate UNDP sponsored study) 10/ also estimated a potential demand of about 20,000 tpy for household fuel use by the Mozambican refugees, together with 105,000 charcoal stoves. The total estimate for supplying the refugees for a period of three and one half years is US$18,169,000, of which 40? is accounted for by transport costs. The Project provides for consultancy services to assist in the further enhancement of charcoal production and marketing and in providing advice to Government to meet the household fuel demands of refugees. Existing Energy Sector Facilities and Sources Existing Power Facilities 3.12 Generation System. ESCOM's main system is an interconnected system supplied by hydroelectric power plants, with total installed capacity of 145MW, on the Shire river. A 15MW gas turbine plant in Blantyre, a 5.4MW diesel plant in Lilongwe and a 2.2MW diesel plant in Mzuzu serve as standby, and are located at the extreme ends of the relatively long transmission lines. Almost 99.9? of the energy is supplied by the hydroelectric power plants. The northern township of Karonga is supplied by a 560KW isolated diesel station. The generation facilities of ESCOM are summarizea on the next page in Table 3.4 and are specified in Annex 3.4. The attached map (IBRD Map No. 20917R) shows the location of existing and planned power plants and the transmission facilities of ESCOM. Rural electrification 9/ Solid Fuels in Malawi, Options and Constraints for Charcoal and Coal (Vol II Charcoal) by Interdisziplinare Project Consult (IPC) (Nov. 1987). 10/ Fuel Supply for Displaced persons in Malawi Preliminary Draft, June 1988, by IPC.  - 16 - schemes are implemented by extending the grid where such extensions are proven to be financially viable. Such schemes are implemented only if they can cover their expenses and concessionary funds are available for the capital costs of the extensions. Table 3.4 ESCOM's Generating Capacity in 1987 Type of Installed Dependable Production Dependable Plant Capacity MW Capacity MW GWh GWh Hydro 144.6 130.0(a) 560.4 860.0 (b) Standby diesels 8.0 -- 0.5 -- Standby gas turbine 15.0 12.0 -- -- Total 167.6 142.0 560.9 860.0 (a) Assumes 25 MW reserve. (b) Based on 136 m3/sec and 92% availabilit.y. 3.13 A number of tobacco and sugar estates a'id religious missions produce electricity for their own use. The installed capacity is estimated at about 26MW. About 50% of this capacity uses bagasse from the sugar estates. The remaining capacity is diesel based. A summary list of the private plants is given in Annex 3.4. Where viable, the grid system is being extended by ESCOM to replace the diesel based captive plants. 3.14 Nkula A hydroelectric plant with an installed capacity of 3x8MW, was commissioned in 1966 and 1967. Nkula B (4x2OMW) is the latest power plant, with the fourth unit of 20MW commissioned in 1986. Nkula A station is due for major overhaul following over 20 years of reliable service. Due to cavitation the turbine runners may require either reconditioning or replacement. Test on one generator has given a good indication of the condition of the insultaion. Additional checks on the remaining two units and special tests on all will be needed to establish the need for rehabilitation measures on the generators. The 4 x 10 MW Tedzani units, commissioned in 1973 (2 x 10 MW), 1976 (1 x 10 MW) and 1977 (1 x 10 MW) respectively, are showing deterioration in frequency of unplanned outages due to the design of the cooling water system, instability of turbine governors and damaged automatic voltage regulators. Recommendations for rehabilitation have been made by a separate study. 11/ The Project makes provision for Tedzani and ESCOM is getting assistance for Nkula A, possibly from EIB and other sources. 11/ Capacity Utilization Study Kennedy and Donkin, 1986.  - 17 - 3.15 Load Dispatch Center. ESCOM has a load dispatch center, located in Blantyre. The center monitors, records and controls the generation plants and the 132/66/33kV substations with the help of the SCADA (System Control and Data Acquisition) system. Under the Project the Load Dispatch Center will be extended to respond to the planned expansion of the generation and transmission systems. Additional power line carrier equipment will be installed. 3.16 Transmission and Distribution Systems. ESCOM's transmission system consists of about 228km of 132kV and about 1063km of 66kV lines. The backbone of the distribution network consists of 1352km of 33kV and 1734km of llkV overhead lines with additional 49km and 5Okm of underground cables respectively. The substation transformer capacity, excluding generation stations, totals 201MVA. The corresponding figure for distribution transformer capacity is 305MVA which appears low in relation to installed generating capacity. Most of the 66kV transmission and the distribution network use locally impregnated wooden poles. 3.17 Outages of the transmission and distribution systems are comparatively low relative to many African countries. However, for the capital city of Lilongwe, some 250km away from the generation centers, and some of the big industries, interruptions of the main lines from Nkula would result in load shedding or low voltages, there being insufficient standby generation capacity. The 66kV lines are designed for 132kV and uprating the portion of the line from Salima to Lilongwe, which is included in the investment program will improve the quality and the reliability of supply to the northern region. The capacity of this line will reach its limit by 1990 if present demand trends of the northern region continue. The investment program provides for an additional 132kV line to Lilongwe, for commissioning by 1992. The Government and ESCOM are seeking financing for the construction of this line. Further extensions of the transmission and subtransmission lines require detailed study with regard to voltage and short circuit levels, protection coordination, and active and reactive load flows. The proposed Project provides funds for a transmission system study. During negotiations, agreement was reached that prior to December 31, 1989, ESCOM and the Government will conclude financing arrangements for the 132 kV line from Nkula to Lilongwe. 3.18 The system losses of ESCOM were reasonable at under 1OZ up to about 1980. Since then, however, the losses have been growing at an increasing rate and presently stand at the high figure of 16.52 (Annex 3.4). The losses have increased much faster than the square of the maximum demand for an eight year period ending 1987. It is thus evident that non - technical losses are contributing appreciably (some 2 - 4Z) to the total losses of 16.5Z in 1987. ESCOM also attributes most of the increase to non- technical losses and is taking administrative steps to reduce their impact. There are also identified overloaded distribution networks particularly in Blantyre and Lilongwe. The investment program provides funds for reinforcement. A loss reduction study needs to be cerried out before embarking on a major investment for distribution and subtransmission network reinforcement. ESCOM's investment program for 1989-94 provides for transmission expansion to Lilongwe which would contribute to reduction of losses at transmission level. ESCOM's general development also provides for distribution expansion to meet the growing load in ESCOM's distribution  - 18 - system. The proposed Project provides for a transmission and distribution system study, and technical assistance support would be provided by ESMAP in establishing the methodology for a loss reduction study. Existing Sources of Woodfuel 3.19 Table 4.2 shows that indigenous forest on customary lands accounts for almost 77? of total forest area of Malawi, followed by forest reserves (212), with the remainder accounted 'or by government and private plantations. Gazetted forest reserves, Game Reserves and National Parks are protected by the Forest Department (FD) and only limited wood cutting is licensed. Forests on customary land supply the bulk of woodfuel currently utilized. The productivity of the national forest is very low and it is being depleted very rapidly, particularly in the South. Wood is free for domestic use. Commercial cutting is theoretically subject to licensing and payment of stumpage fees, however widespread illegal cutting occurs. The FD is currently setting up an improved system for revenue collection and protection and management of the natural forest. industral plantations, established and managed by the FD, are located mostly in the Northern Region of the country (e.g. the 53,100 Viphya pine plantations) and up till now have been largely unutilized. IV. WOOD ENERGY Background 4.01 Forests play a vital role in the Malawian economy, providing over 901 of the nation's domestic and industrial energy requirements, a substantial volume of timber and significant environmental benefits. The major consumers of wood are presented in Table 4.1 below. The rural population uses fuelwood for cooking and heating as well as poles for building, and accounts for around 602 of the total demand. The principal source of energy for urban households is charcoal, which is made from indigenous wood using very inefficient conversion methods. The tobacco and tea industries, which represent Malawi's chief sources of foreign exchange earnings, are critically dependent on large supplies of fuelwood for curing and barn construction. In addition, village industries within the informal sector use wood for a variety of purposes, including brick making, smoking of fish and meat, beer brewing and lime burning. TABLE 4.1. Estimated Wood Consumption, 1984 Market Segment Consumption (million m3) (Z) Rural Households 5.1 60 Urban Households 1.0 11 Tobacco and Tea Estates 2.0 23 Village Industries 0.4 5 Urban Services and Industry 0.1 1 TOTAL 8.6 100  - 19 - 4.02 In aggregate, Malawi's total forest resource is still extensive, occupying about 402 of the total land area. In 1987, approximately 4 million hectares were estimated to be under forest (see Table 4.2). Indigenous forest on customary lands accounts for around 77% of this area, followed by forest reserves (212) with the remainder accounted for by government and private plantations. National parks and game reserves occupy a further 1 million hectares However, less than 2Z of the parks and game reserves are under closed forest cover and they cannot really be considered as a source of woodfuel as they are protected to provide an undisturbed environment for the natural fauna and flora. The forest reserves are also protected by the Forestry Department and only very limited cutting is licensed. The natural forests on customary lands supply the bulk of woodfuel currently utilized. These forests have very low stock value and low sustained yield, due partly to local ecological conditions but also to indiscriminate cutting and uncontrolled burning for pasture and browsing by animals. Cultivated wood represents only around 2? of the total forest area. Government plantations cover about 90,000 hectares, of which about 80? are industrial pulpwood and timber plantations, 15? are fuelwood/poles plantations and the remaining 5? are research plots. Private plantations include about 10,000 hectares on tea estates which are more or less self- sufficient in wood, around 10,000 hectares on some tobacco estates which are far from self-sufficient, and an unknown area of smallholder woodlots. TABLE 4.2 Distribution of-Population and Forest Resources by Region, 1981 Northern Central Southern Population (million) 0.91 3.11 3.96 Forests (million hectares): indigenous: On Customary Land 1.64 0.91 0.50 Forest Reserves 0.20 0.33 0.29 Cultivated Government Plantations 0.05 0.02 0.02 Private Plantations - 0.01 0.01 4.03 Recent estimates suggest that, in aggregate, current global flows would be sufficient to meet actual demand for wood without depletion of the forest stock (footnote 12). However, this aggregate picture hides very significant regional imbalances in supply and demand. The basic problem stems from the highly unequal geographical distribution of population which is concentrated in the South and Central Regions while the bulk of the forests are in the relatively underpopulated North (see Table 4.2). In the South and much of the Central region there is now a substantial gap between the demand for fuelwood and its sustainable supply from customary woodlands. This deficit is being met by depletion of the stocks which further widens the gap between demand and the sustainable flow of wood, leading to ever more rapid destruction of stocks. At the same time, demand for wood energy is increasing rapidly due to population growth of around 3.7? per annum, compounded in recent years by an influx of several hundred thousand refugees  - 20 - from Mozambique. The urban population is growing at over 62 a year which further increases demand because wood consumption per capita is higher in urban areas (1.4 m31yr) than in rural areas (0.8 m3/yr). Deforestation is exacerbated by widespread land clearing for agricultural purposes, due to population pressure and the traditional practice of shifting cultivation. Under current trends it is estimated .hat the indigenous forest on customary land will have totally disappeared within less than ten years in the South and less than fifteen years in the Central Region. 12/ 4.04 Destruction of the forestry resource would have serious implications for the future energy supply for the bulk of the population. In addition, the environmental consequences would likely be severe, leading to soil erosion and damage to watershed areas including silting up of water courses and flooding. This would have long term negative and possibly irreversible implications for agricultural productivity and then for economic growth and welfare. In the last few years, therefore, the Government has turned its attention to the development of a sustainable wood energy program. The NRDP II (First Wood Energy) Project (CR 992-MAI) which became effective in June 1980 represented the first important step in this process. 4.05 Wood Energy I Project. The principal objectives of the First Wood Energy Project were to establish Government fuelwood plantations close to urban areas and set up a network of retail nurseries to sell seedlings to farmers. Between 1980 and 1987 approximately 15,000 hectares of fuelwood plantations of eucalyptus were established by the Forestry Department. However, the yields from these plantations are very disappointing -- the average mean annual increment (MAI) is about 4.7 m^/halannum against a potential 10-14 m3/ha/annum. While wood yields are low, the per hectare costs of establishing the Government plantations are high. The ultimate financial cost per cubic meter of wood produced is therefore extremely high (see para 4.10). By the end of the Project period, the average seedling production level from the retail nurseries had reached the original target, but seedling sales remained rather low, resulting in substantial carry-over of stock from one year to the next. Inadequate extension services to smallholders for tree planting may provide a partial explanation for this. Hcwever, planting trees was found to be well accepted and practised where there existed a nearby cash market for poles. This suggests that the problem was not that farmers did not know how to grow trees, but that they did not find it financially attractive to grow trees for fuelwood given the low producer prices for wood and availability of free wood in the virtually uncontrolled and unprotected natural forests. 4.06 The reforestation effort under the First Wood Energy Project did little to slow the destruction of the natural forest. However, the efforts were part of a learning process which has contributed to the evolution of a broad-based strategy for the management of wood energy on a cost-effective, sustainable and environmentally safe basis. The experience with Government 32/ Interdisziplinare Projekt Consult (IPC). National Energy Master Plan Biomass Sector Position Papers (Supply and Demand Analysis and Summary Report, 3 volumes), Lilongwe, 1988.  - 21 - plantations demonstrated that principal reliance on the Forestry Department to produce fuelwood is technically and fiscally infeasible, and economically undesirable. There are severe shortages of qualified manpower in the Forestry Department. Planting even 15,000 hectares over the last few years overwhelmed the capacity of the staff to implement the program effectively, yet the annual wood flow from these plantations represents less than 1Z of total annual demand. In addition, Malawi is currently undergoing a period of severe public expenditure cuts and hence budgetary constraints preclude the Forestry Department planting on a sufficient scale to make a substantial contribution to sustainable supply. Furthermore, this would be inefficient as the Government has proved to be a very high cost producer of wood. Wood can be produced at much lower cost by the private sector, particularly by smallholders. 4.07 Wood Energy II Project. The objective of the Second Wood Energv Project (Ln 2670-MAI, US$16.7 million) is therefore to reorient the Forestry Department away from direct production of wood and towards the creation of an institutional and policy environment that encourages private production and conservation and more efficient utilization of existing resources. Under the project, the Government is implementing a comprehensive package designed to promote tree planting by both smallholders and commercial users, through provision of subsidized seedlings, extension services and tree planting incentive payments, pricing reform including substantial increases in wood prices, and increased protection and revenue collection activities in the natural forest. Provision is also made for a limited area of Government plantations in environmentally fragile areas. Besides promoting tree planting, the Government is also exploring ways to utilize existing low-cost sources of fuelwood such as thinnings and over- mature trees from industrial plantations and waste wood from land clearing operations. In addition, the program includes several components to promote wood conservation through introduction of simple but more fuel-efficient technologies for tobacco curing, charcoal making, and domestic cooking stoves. 4.08 The Second Wood Energy Project became effective in December 1986 and to date approximately US$1.5 million have been disbursed from the loan. Implementation of the Project is proceeding smoothly. The Forestry Department has been reorganized to enable it to carry out its increased responsibilities. The Monitoring and Evaluation Unit has been set up and a computerized system put into place. A training program has been developed and agreed on and the plans and procurement documents for the expansion of the facilities at the Malawi College of Forestry are under preparation. The curriculum has been modified to take into account the wider scope of work of forestry field staff under the Project. The Planning Unit has been established although many of the positions are still vacant and a work program has still to be developed. A research program has been designed and agreed on which is well focused on project objectives and does not overload FRIM's limited implementation capacity. Under the Indigenous Forest Management component, 44 Area Control Units have been established. Ten Forest Produce Checkpoints have been set up at major transport roads into Blantyre, Lilongwe and other urban centers. Six pilot extension units were set up during 1987/88 and 3 more will be established in 1988/89. 40 new retail nurseries were established in 1987/88 and 20 more will be established in 88/89. The tree planting incentive scheme was introduced on  - 22 - a pilot basis in 9 districts during 1987188. The concept was accepted enthusiastically by farmers and 3.9 million seedlings were registered for the incentive payment in the first year. Most of the infrastructure for the Government plantation on Mulanje mountain has been put into place and 800 hectares were established during 1987/88, with a further 500 to be established in 1988/89. Three pilot production centers for improved household stoves have been set up. Trials carried out under the Tobacco Industry Energy Efficiency Pilot Project have demonstrated the wood consumption in tobacco curing can be reduced very substantially. Pilot charcoal production centers using more efficient kilns and waste wood from industrial plantations have been set up and potential markets in the tobacco estates, urban household sector and industry identified. The stumpage rate was raised to MK4.50 per stacked m3 in 1988. 4.09 Both the Bank and the Government continue to support strongly the objectives and elements of the Second Wood Energy Project. However, Malawi's external debt situation has deteriorated significantly in the last few years and neither the Bank nor the Government consider financing on IBRD terms to be appropriate for Malawi at the present time. The Bank and the Government have therefore decided to cancel the IBRD loan for the Second Wood Energy Project. Under the proposed Energy I IDA Credit the components were reappraised by a Bank mission in July 1988, modifications introduced where appropriate, and the cost tables updated to cover the period 1989/90 to 1993/94 (see Annex 5.2). The detailed discussion of the various components can be found in the Second Wood Energy Staff Appraisal Report (Report No. 5914-MAI, February 1986); the main points, and any changes in scope or design, are summarized below. Overview of the Strategy for Wood Energy 4.10 Pricing Policy Refonm. One of the main reasons that individuals do not act to conserve or produce wood stems from the absence of private ownership of trees (or at least some well-defined and enforceable system of user rights). In Malawi, as in much of Africa, forests are traditionally considered as open-access, common property resources. Wood for domestic purposes is free and there are no restrictions on access. Wood for commercial purposes is subject to a very low stumpage rate which in practice is rarely enforced. The official stumpage rate for commercial fuelwood was only MR1.80 (US$1.03) per stacked cubic meter of wood until March 1986, when it was raised to MK2.70. This is extremely low in comparison to the cost of producing wood. For example, the cost of wood produced by the Government under the NRDP II First Wood Energy Project is estimated at around MK21.9 per stacked cubic meter (in 1986/87 prices). 13/ The low administered stumpage rate does not provide individuals with incentives to produce their own wood supply and also impl.4as that the Government as a major producer of wood cannot recover its investment costs. In addition, the existing stumpage rate encourages excessive consumption of fuelwood and leads to low public revenues which prevent the Government from financing measures to control forest depletion. Under the Project, the Government is implementing a phased increase in stumpage fees for wood cut for commercial purposes with 13/ See Project Completion Report,  - 23 - a view to reaching replacement cost by the end of 1994. The proposed Energy Pricing Study will recommend the appropriate level of stumpage fees. The increase in price is essential for both supply and demand management of wood energy because it sends a signaL that wood is not a "free resource," and should induce greater conservation through adoption of more energy-efficient technologies as well as creating incentives for private production of wood. 4.11 Indigenous Forest Management. The increase in stumpage fees will clearly have no impact if payment of fees is not enfor..ed. Therefore undcr the Project the Government is also putting into place an improved forest protection and revenue collection system for wood from forest reserves and customary lands. The numbers of foresters, forest guards and patrolmen are being substantially increased. Part of their duties will be to license wood and collect st-umpage fees, principally directly from the major commercial users, backed up by a system of spot checks and a few strategic checkpoints on roads leading So the main markets. The checkpoints would confiscate all commercial wood produce which had not been licensed and paid for. In addition, the forestry staff will provide protection of forests in heavily depleted or environmentally fragile areas where commercial cutting has been restricted or prohibited. In these areas they direct major users to environmentally safe sources of wood, such as government fuelwood and industrial plantations, iorest reserves with surplus yields or waste wood from land clearing activities. Finally, the forestry staff will work with the local inhabitants to educate them on the sustainable utilization of the indigenous forests. They will provide advice on improved silvicultural techniques including cutting practices, enrichment plantings and fire control, so as to ensure regeneration and optimal yields over time. 4.12 Wood cut for domestic purposes will continue to be free of charge. Most rural households are subsistence farmers who are largely outside the cash economy and would be unable to pay for wood they need to survive. It would also be excessively costly, if not impossible, to enforce payment of stumpage fees for small volumes of wood extracted daily by millions of rural households. However, given the fact that rural households account for the bulk of wood utilized, the Project supports other measures to promote self- sufficiency in fuelwood for this group. 4.13 Forest Extension. The extension units would be organized on a district level and concentrated in areas with acute fuelwood shortage and where planting by farmers needs to be intensified. The extension staff would focus on small and medium size farmers and provide them with seed or seedlings, register them for the tree planting incentive payment and give them simple technical assistance in raising seedlings, tree planting, harvesting and wood usage. They will also teach the local people how to utilize the indigenous forest on a sustainable basis. Wood Energy I made recommendations strengthening the linkages between the Government's Forestry Department and Agricultural Extension Services and making better use of contact farmers to encourage the spread of improved tree planting practices. The project will give special attention to monitoring the progress being made in strengthening these extension linkages. A review of the effectiveness of the forestry extension program will be an integral component of the terms of reference of the Monitoring and Evaluation Unit (para 5.34).  - 24 - 4.14 Retail Nurseries. Each nursery's production would start with 100,000 seedlings a year and would then be increased in response to demand up to the production capacity of 200,000 seedlings per nursery. Under the first Wood Energy Project, nurseries generally only supplied eucalyptus seedlings. However, there appears to be demand by farmers for indigenous species such as Mbawa, and for fruit tree and other multi-purpose trees. Therefore, under the Project, tihe intention is to supply much wider variety of species including multi-purpose trees, agro-forestry trees and indigenous species. The nurseries seedling production and sales would be complemented by distribution of seedling production packages containing seeds and polythene tubes to "contact farmers' identified by the extensionists as successful and interested in raising seedlings. Demonstration woodlots would also be established in some retail nurseries and on surplus land of "contact farmers." 4.15 Tree Planting Incentive Payment. The tree planting incentive scheme evolved from the early experience with the nurseries established under the First Wood Energy Project from which it was clear that farmers had littla financial incentive to plant trees even when provided with seedlings at subsidized prices. Farmers face a choice between using their land and labor for tree planting or agricultural crops. Growing trees requires tying up land for many years, with the costs incurred principally in the first year and the benefits occurring only later. Small farmers also tend to have high private discount rates. These factors, combined with the current low stumpage rates and widespread free access to wood, mean that financial returns to fuelwood production are very low or negative. In order to compensate for the impact of price distortions on the profitability of establishing woodlots by individual farmers, an investment incentive is required. Under the tree planting incentive scheme, farmers will receive payments of five tambala for each tree surviving two years (after which trees require almost no maintenance) which will help make tree planting financially attractive relative to agricultural crop production on marginal land. (This figure is considered too low to be an effective incentive, and during negotiations it was agreed with the Government to review it from time to time.) Over time, as the stumpage rate for wood increases and restrictions on cutting in the indigenous forest are implemented, the need for the tree planting subsidies should decline. However, in the short run, production subsidies are economically ju.tifiable as a way to correct the existing market distortion in which wood is widely available free or at a very low price which reduces the incentives for private production. Encouraging smallholders to plant trees through provision of subsidized seedlings and incentive payments is a much more cost-effective way for the Government to promote wood production than its earlier approach of directly establishing plantations (see Table 4.3). In the first place, farmers can produce fuelwood at approximately one-third of the total economic cost of wood from Government plantations. Secondly, the fiscal burden on the Government is much less. The financial cost to the Government of the subsidies for each hectare planted by farmers is only around a quarter of the cost per hectare of Forestry Department plantations.  - 25 - TABLE 4.3 Present Discounted Value of Total Costs of Escablishing One Hectare of Trees (1986 prices) Economic Costs: MK Government Plantations 894 Small Farmer Woodlots 258 Fiscal Cost Small Farmer Woodlot (1) 198 (1) Cost to Government of small farmer wood lots includes subsidies to seedlings, transportation, extension, monitoring, and tree planting incentive payment. Transfer payments such as the incentive payment are not included in calculating economic costs of woodlots. For further explanation of calculation see SAR for the Wood Energy Project. 4.16 Government Plantations. The Project also provides for a limited area of Government plantations. The original intention was to establish 3,000 hectares on Mulanje mountain and 3,000 hectares just outside Lilongwe. However, given the poor yields and high costs of the Government plantations established under the NRDP II Wood Energy Project, the proposed plartations were re-appraised in July 1988. At Mulanje, the soil and rainfall are very favorable for rapid growth of eucalyptus while the altitude is sufficiently high to eliminate the problem of termite damage which is very severe at lower altitudes. Also, the trees will be planted on very steep and fragile slopes which are unsuitable for crop cultivation and hence the opportunity cost of the land in terms of agricultural output foregone is minimal. In addition, there will be significant environmental benefits from reforestation of the mountain, including protection of the water catchment area and reduction of soil erosion. Therefore, the mission concluded that the plantation program on Mulanje mountain should be supported. The proposed site at Lilongwe has much less favorable rainfall and soil quality and the small number (90) of hectares planted so far show poor growth and extensive termite damage. Further, the land is currently being cultivated by over 2,100 families. The Government proposed to resettle these fami'ies and provide a compensation package to them. The economic costs of the plantation would therefore also include the social and financial costs of resettlement and compensation and the opportunity cost of the food crops foregone each year. Under these circumstances, the mission concluded that the Lilongwe plantation would show very low economic returns and should be dropped from the proposed Project. The Government however believes the Lilongwe plantation should still be established in order to provide a cheap fuel source to the growing urban population. The site inhabitants are considered squatters as the Government had previously decided to move them from the designated plantation area. Without the plantation the Government envisages extensive ecological damage due to deforestation of the peri urban areas of Lilongwe, which would be very costly to reverse. The Government also believes that the proposed site is capable of supporting a healthy tree crop of species other than the eucalyptus species currently planted. The Government is therefore committed to seeking alternatI.ve financing for the Lilongwe plantation.  - 26 - 4.17 Energy Efficiency Initiatives. The actions on wood pricing and revenue collection indirectly create incentives for greater wood onservation. However, increased stumpage rates in the absence of the availability of low-cost techniques to reduce wood consumption would merely be inflationary and cause hardship to consumers. The Project is therefore also supporting the introduction of more fuel-efficient technologies in areas of high wood consumption. The fuel-cured tobacco industry utilizes the bulk of commercial fuelwood extracted from the natural forests and has caused severe deforestation in many areas. A survey of estates carried out in 1984 found that the national average fuelwood consumption was 42 stacked m3 per tone of tobacco cured. However, research trials at the Malawi Tobacco Research Authority (MTRA) have demonstrated that wood consumption can be reduced to between 10-15 stacked m3 per ton by utilizing an improved (but low cost) furnace and better management and curing techniques. Efforts are now directed to disseminating the research findings and training estate managers, furnace builders and furnace stokers/operators in the new techniques. MTRA will gradually take over fully these extension costs. However, given MTRA's limited budget and to ensure adequte financing for the critical first few years, the Energy I Project will provide MK75,000 annually for the first two years to finance the costs of dissemination and training. 4.18 The Project will also support the introduction of more efficient household stoves in urban areas. Urban households account for a large and growing share of wood consumption, mainly in the form of charcoal. An impro-,ed stove has been developed which can achieve fuel savings of between 30-45%. The stoves can be produced by small-scale artisans using scrap metal from used oil drums for the metal casings and local clay for the ceramic liners. Production costs are low and at current charcoal prices the pay-back to stove purchasers is less than three months. Three pilot production centers have been set up in Blantyre and are operating successfully. A sample of households have tested the improved stoves in their homes and preliminary indications are that consumers are reacting very positively to them. Local entrepreneurs interested in marketing the stove have been identified and stoves are now being sold in local hardware stores in Blantyre. Under the Project, the objective is to establish additional pilot production units in the Lilongwe and Mzuzu areas and to facilitate the move from pilot production, which has been run with technical assistance from Kenya, to full-scale commercial operations without Government subsidies or assistance. 4.19 Another component on the energy conservation side is introducing more efficient charcoal making methods. Pilot charcoal production sites have been set up using beehive brick kilns. These kilns convert wood into charcoal at an efficiency rate (by weight) of about 32Z under normal operating conditions, which is about three times higher than the conversion rate of the traditionally used earth kilns. They are built using local materials and operated at very low cost with local labor assisted by oxen, with minimal requirements for training, capital or foreign exchange. The production centers are located in the 55,000 hectare pulpwood plantation in the Viphya mountains in the Norch and in an old timber plantation in the South, Pulp and timber schemes require regular silvicultural treatment which generates a steady flow of wood from thinnings which up till now has  - 27 - been largely wasted. Because the bulk of the thinnings (i.e., in the Viphya) is not located in close proximity to the major demand centers for fuel, charcoal production is the most economic way to utilize the wr;te wood as it minimizes transportation costs. Preliminary results from the pilot charcoal component indicate the potential for meeting a substantial part of the commercial demand for wood energy from tobacco estates and urban households (and at least part of the demand from refugees) with charcoal produced from surplus wood from industrial plantations for example at Viphya and Dezda 14/ at a lower cost than by establishing peri-urban Government fuelwood plantations (see Table 4.4). While for Blantyre costs of charcoal from the Viphya seem about the same as costs of peri-urban plantations, the latter costs do not include an opportunity costs of land which in the Southern Region is likly to be substantial. TABLE 4.4 Landed Costs of Charcoal from Different Sources (1) Sources Viphya Dedza Lilongwe Blantyre Thinnings Wood Peri-Urban Peri-Urban Waste (2) Eucalyptus Eucalyptus outlet Lilongwe 125 90 147 - Blantyre 165 113 - 160 (1) MK per landed ton of charcoal. 4.20 Institutional Strengthening and Support Services. The Government's strategy for wood energy implies a substantial increase in the scope and complexity of the responsibilities of the Forestry Department. The Project therefore provides resources to reorganize and strengthen the Forestry Department Headquarters to enable it to carry out the program satisfactorily. The Project contains a number of new features, particularly the tree planting incentive scheme, which require constant monitoring during implementation. Therefore a Monitoring and Evaluation (M & E) unit has been set up and a computerized system put in place to assist management in assessing progress of implementation as well as in monitoring responses of the target population. The M & E unit would enable corrective measures to be taken at early stages and decisions to be made about the possible redesign of these pilot efforts before completion. In addition, a Planning Unit has been established which is responsible for formulating objectives, setting priorities, and preparing work plans and budgets is essential. In compiling basic resource data, the planning unit would establish a forest inventory and land survey capability to determine land use of forest areas, including the potential for wood production, encroachment, and deforestation rate. 14/ Dedza is a small (7,000 hectare) pine plantation in the Central Region which would be a lower cost supply option for Blantyre than the Viphya due to lower transportation costs and hence should be utilized first.  - 28 - 4.21 Under the Project, the responsibilities and activities of forestry field staff are significantly increased beyond the traditional focus of foresters on establishing Government plantations. It is essential that all forestry field staff are adequately trained for their extensive new duties 'hich include management and control of the indigenous forest areas, issuing wood licences and levying stumpage fees, implementing extension programs, administering the tree planting incentive program, providing technical assistance for the wood conservation for the wood conservation programs and monitoring and evaluating the various Project components. Technical level training is provided by the Malawi College of Forestry. However, the facilities are not adequate to cope with the major increases in training necessary particularly at the sub-professional level (forest guards, nurserymen and patrolmen) and for in-service refresher courses essential to equip existing field staff for their broader duties under the Project. Some expansion of facilities is necessary and, in addition, many of the existing facilities are in need of repairs. The Project therefore provides for the rehabilitation and expansion of facilities at the College. 4.22 The Project also provides resources to strengthen forestry research. The research program at FRIM has been streamlined to ensure that it is focused on Project objectives and does not exceed the limited staff capacity to implement research activities. Given the objectives of the wood energy program, the priority topics include the following: Plantations: (a) research on improved seed sources of eucalyptus and manipulation of hybrids of that genus; (b) development of a formal planting site survey methodology; (c) review of fertilizer research program concentrating on evaluation of the relative cost-effectiveness of different levels of borate and NPK application as well as possible local low-cost substitutes for imported fertilizers; (d) implementation of espacement trial plots; (e) identification of permanent inventory plots and a formalized system of collecting infermation on felling yields and coppicing vigor. Agroforestry: (a) diversification of multi-purpose species appropriate for smallholder farmers; (b) on-farm research on the range of technical interventions and design of such interventions to assist small farmers. Indigenous Woodland: (a) social/anthrolopogical analysis of local people's utilization of the natural forest and options for their participation in indigenous woodland management; (b) detailed inventory of indigenous forest resources, growth and yields. 4.23 Summary. The wood energy strategy involves the simultaneous implementation of a comprehensive package of policies and programs. Few if any of the individual elements can have an impact alone - each is mutually dependent on and, in turn reinforces the impact of the other components. Thus, the fuel-efficient technologies being developed might not be adopted without the financial incentives for energy conservation created by increases in stumpage rates and improved revenue collection. Conversely, increased stumpage fees in the absence of low-cost techniques to conserve wood would merely be inflationary and cause hardship to consumers. Restrictions on commercial cutting and prohibition of charcoal making in heavily depleted and environmentally fragile areas are essential to prevent total destruction of Malawi's indigenous forest and serious environmental damage. However, these actions have to be complemented by efforts to provide environmentally safe and inexpensive energy alternatives to users.  - 29 - Charcoal production is a key element in this strategy as it permits immediate use of distant sources of surplus wood at relatively low cost. While pine charcoal offers an environmentally safe alternative source of energy, its production has to be accompanied by the development of inexpensive technologies to enable users such as urban households and tobacco estates to switch from indigenous charcoal or wood to softwood charcoal and by the development of reliable and low-cost distribution channels. The tree planting incentives, subsidized seedlings and forestry extension are other essential ingredients in the long term strategy to shift users away from the natural forest to cultivated wood sources. These efforts to promote tree planting by the private sector are in turn reinforced by the actions on stumpage fees and revenue collection. V. PROGRAM AND PROJECT Power Subsector Least Cost Investment Program 5.01 Malawi's power system development has been well conceived and implemented by ESCOM and the Government with the assistance of recognized consultants. The latest Least Cost ESCOM Power Development Program to the year 2000, recently completed by Kennedy and Donkin for the Government, has helped to establish priorities and key dates for program implementatior. for the power sub-sector. The least cost options for power supply are based on Malawi's indigenous hydroelectric power resources, and do not include power imports from neighboring countries or thermal plant. Discussions are underway between Malawi and Zambia on possible interconnection of the two systems. Indications are that base load supply from Zambia may not be feasible from mid-nineties due to Zambia's need of the present excess capacity. However, studies to assess its viability is in progress under the auspices of SADCC and with the assistance of NORAD. The security situation in Mozambique renders consideration of interconnection as an unlikely option in the short/medium term. Thermal options are ruled out by the high cost of fuel. 5.02 ESCOM's least cost development program includes installation in 1991 of a fifth unit of 20MW at Nkula B; construction of a 50MW hydroelectric power plant at Tedzani III for commissioning in 1994; construction of Kapichira hydroelectric project with two units of 25MW each for commissioning by 1997 and the remaining three units by 1999; generation rehabilitation of the existing hydro and standby thermal plants; construction of a 260km 132kV line from Nkula B hydroelectric power plant to Lilongwe and associated substations; reinforcement and expansion of sub- transmission and distribution systems including rural electrification. 5.03 In addition to the power sub-component, the investment program for the energy sector includes charcoal production; coal exoloration and mining; energy planning and training; fuelwood programs; and establishment of national fuel reserve. These are planned by Government with the assistance of consultants and donor agencies.  - 30 - 5.04 The mission has had constructive discussions with ESCOM and the Government on the least cost power sector development program as well as on the other energy sub-components during project preparation and appraisal. Energy Sector Investment and Source of Financing 5.05 The overall investment program for the energy sector is given in Annex 5.2 and is summarized in Table 5.1 below. It includes ESCOM's least cost expansion program for the period 1989-94 as well as Government's plans for the other energy sub-components. The total Investment requirement for the period 1989-94 is estimated at K816 million (US$224 million) of which K605 million (US$167 million) is foreign exchange with an additional in.:~stment of K633 million (US$114 million) for Kapichira during 1995-99. Table 5.1 Suammsry of Energy Sector Investment Program 1989-1994 Total Expenditures Locol Foreign Totel Local Fori'n Total sT11r70n K) WmiliOn l) Power Proposed Project (a) 47.0 188.6 236.6 12.3 49.6 61.8 Generation (b) 44.1 153.0 197.1 11.1 40.2 61.8 Transmission 23.8 79.2 103.0 8.7 22.6 29.2 Distribution (c) 4.6 22.6 27.1 1.3 8.6 7.8 Rural Electrification 5.3 26.9 31.2 1.4 8.9 8.3 ESCOM General (d) 64.6 _ 64.8 17.5 -- 17.6 Subtotal Power 189.3 4a.3 658.68 60.3 126.6 175.9 Energy Energy Planning -- 6.2 6.2 -- 1.6 1.6 Charcoal and Wood Energy 21.3 33.1 64.4 8 1 9.9 16.0 Fuel Reserve -- 29.9 29.9 -- 13.4 13.4 Fuelwood e/ -- 60.2 60.2 -- 14.0 14.0 Coal Production -- 8.2 6.2 -- 2.6 2.6 Pricing Study - 1.6 1.5 -- 0.6 0.6 Sub Total Energy 21.3 136.1 17.4 8.1 41.8 47.9 Grand Total 210.8 806.4 816.0 65.4 167.4 223.8 a) Detailed in Annex 6.3. b) Includes investment on Kapichira hydro up to 1994. c) Includes mainly distribution reinforcement. d) Includes mainly distribution expansion. e) EEC and NORAD supported project. 5.06 The power investments to be financed under the proposed project include civil works and equipment at Tedzani III, rehabilitation works at Tedzani stages I and II, consulting services and computer equipment for ESCOM (see Annex 5.1). The project will also finance the charcoal and wood energy components. The additional 20MW unit at Nkula B is expected to be financed by KfW. EIB is financing 132kV substations and distribution reinforcements. The Italian Government is considering financing Kapichira. CDC has expressed interest to finance the 132kV transmission line. UNDP intends to finance energy planning and training, coal exploration and mining  - 31 - as well as support Government's efforts in promoting petroleum exploration. EEC is financing national petroleum reserve physical facilities, while the Government is providing a foreign exchange revolving fund to procure the petroleum. ESCOM's financial position will enable it to contribute more than the local currency requirements of the investment program if the Government's foreign currency reserve position can be assumed to permit procurement from abroad with ESCOM's own funds. 5.07 During negotiations agreement was reached that: (i) ESCOM will not undertake any major expansion in excess of US$5 million not included in the ESCOM's Power Subsector Investment Program (PSIP) agreed with IDA unless ESCOM shall have furnished to the Association satisfactory evidence that sucn a major project is economically and technically justified; and (ii) the PSIP shall be reviewed annually and revised if found necessary. 5.08 Works in Progress. ESCOM has transmission and distribution works under construction as follows: (i) construction of a 112km 132kV line from Nkula to Sucoma Sugar Estate via future sites of Kapichira and Blantyre West Substations, with 132/llkV 25MVA substation at Sucoma; (ii) construction of 66kV line from Chinteche to Chikangawa and neighboring areas; (iii) distribution works in the grid system; (iv) construction of buildings and provision of facilities related thereto; and (v) completion of the first phase of the rural electrification program. Implementation progress for the wood energy component is described in para 4.08. 5.09 Charcoal production and marketing activities of a pilot IDA supported project terminated in January 198.8. The main objective of the activities covered by the pilot phase is to convert thinnings from Government pine plantations (mainly Viphya plantations) into charcoal for fuel use by the urban households and agro-industrial consumers. The pilot phase established production capacity of 6000 tons per year (tpy) and a demand from the tobacco curing industry, industrial consumers and urban households. In the meantime, however, the installed capacity has deteriorated and charcoal sales have dropped considerably. The cause of this deterioration was lack of profeesional project management which has since been rectified with the extension of the services of the consultant previously engaged on the charcoal component. This is rendered possible with the provision of US$750,000 Project Preparation Facility (PPF). In view of the growing potential demand for charcoal both by the industrial and domestic consumers, including demand by refugees from Mozambique, the PPF will also assist to expand the production capacity to 15000 tpy as well as establish a more efficient wholesale and retail infrastructure. These activities would be enhanced and sustainability would be ensured with the support to be provided by the proposed Energy I Project. In February 1989, the Government published the proposed concession agreement for the privatization of the charcoal production and marketing operations. The Project 5.10 Project Obiectives. The overall objectives of the proposed Energy I Project is to assist the Government to formulate and implement an integrated program to make the most economic use of Malawi's domestic and imported energy resources. The specific objectives of the Project are (i) to assist the Government and ESCOM implement the priority components of the  - 32 - least cost power development plan adopted by the Government; (ii) to assist the Government and the Forestry Department to implement their comprehensive strategy for the management of wood energy on a cost-effective and environmentally sustainable basis; (iii) to ensure energy pricing policy signals economic cost of supply; and (iv) to strengthen energy planning capability and enhance the management information system of ESCOM. 5.11 Rationale for IDA Involvement. The proposed project addresses the principal issues across the energy sector. Rationalization of the energy sector, including decreasing dependence on imported oil and coal and reversing the depletion of indigenous fuelwood sources, is a key component of the Government's structural adjustment program which the Bank is supporting. The Bank has helped finance three power projects in Malawi, the last one of which was completed in 1982. Assistance to the energy sector has continued through projects in wood energy as well as through technical assistance vnd studies. The Bank's involvement at this time would support the implementation of the least cost power development program; assist on- going activities on charcoal production and encourage its commercialization; support woodfuel management and devalopment; and enhance institution building, thus ensuring sustainability of on-going Bank assistance on woodfuel and energy planning and training. The Bank would also play an important role in aid coordination. 5.12 Project Preparation. A Bank preparation mission visited Malawi in March 1988, and reviewed and agreed with the Government on the study to update ESCOM's least cost development program prepared for the Government by Kennedy and Donkin in association with WLPU consultants. The study covers extensively the sequence of development of the generation component and has updated the urgent transmission requirement of ESCOM's system. The mission prepared the other subcomponents after discussion with ESCOM, EPD, MFNR and other Government departments dealing with the energy sector. The findings of the least cost-study and the input of the March 1988 preparation mission revised during appraisal in June and July 1988, constitute the Energy I Project. The report was discussed in detail with Government and ESCOM during appraisal including the estimated project costs, the period of implementation and the priority of components. 5.13 Project Description. Detailed description of the Project is given in Annex 5.1 and is summarized as follows: A. Tedzani III Hydroelectric Power Scheme (i) Construction of an additional intake structure to Tedzani III, a 1052 m headrace tunnel and surge chamber, a reinforced concrete boy structured power house, a tailrace outlet system, and installation of two Francis turbines coupled to two 25MW generators and associated electromechanical equipment, switchyard, additional 132 kV transmission link to Nkula B, additional SCADA and PLC systems; (ii) A 132/ 66kV substation at Blantyre West; and  - 33 - (iii)Engineering services for the design and supervision of the power scheme. B. Generation Rehabilitation (i) Increasing the reliability of Tedzani 1 and II power plants through (a) the systematic replacement of direct cooling by closed circuit water cooling, (b) changing turbine governor parts to improve stability of Tedzani I and (c) replacing existing mechanical voltage regulators of Tedzani I by electronic automatic voltage regulators. (ii) Acquisition of spaces for the existing hydro, gas turbine and diesel power plants. C. Institution Strengthening ESCOM (ij Provision of computers to be installed in ESCOM's various branches to enhance the speed of information flow to headquarters and to strengthen its in-house planning capability; (ii) Electricity tariff and asset revaluation studies; (iii)Transmission and distribution system studies. D. Charcoal (i) Provision for consultancy services to (a) advise on and monitor the performance and marketing of softwood charcoal production from forest thinnings; (b) advise on commercialization of charcoal production and marketing; (c) advise potential industrial and agro-industrial consumers as well as the Government on charcoal utilization; and (d) prepare specifications for procurement of vehicles and equipment for charcoal production and performance monitoring; (ii) Procurment of vehicles and equipment for charcoal production and performance monitoring. E. Wood Energy The Wood Energy component of the proposed Energy I Project would include: (i) Institutional development: involving: (a) establishment of an improved system for management and protection of the indigenous forest and revenue collection; (b) setting up pilot extension schemes in nine districts with acute fuelwood shortages; and (c) establishment of a Monitoring and Evaluation Unit and a Planning Unit in t1e Forestry Department and strengthening of the existing units. (ii) Wood production: (a) measures to promote tree planting by the private sector including the establishment of 60 retail nurseries  - 34 - to sell seedlings to smallholders and estates and provision of tree planting incentives payments to smallholders; and (b) establishment of about 2,800 hectares of Government fuelwood plantations on the environmentally fragile slopes of Mount Mulanje; (iii) Wood conservation: including: (a) initiating the pilot production and marketing of more fuel-efficient household cooking stoves; and (b) dissemination of research findings and training of estate operators in techniques to reduce wood consumption in tobacco curing; (iv) Support services: consisting of support to the training and research programs. F. Energy Pricing Study Consultancy services for energy pricing study covering liquid fuels, woodfuel and coal and interfuel substitution possibilities particularly in industry, households and transport. Project Cost Estimate 5.14 Project costs are detailed in Annex 5.3 and summarized in Table 5.2 below. Table 5.2 Sumnary of Project Costs Local Foreign Total Local Foreign Total (Kuachas millIon) (US$ million) Power Component A. Tedzani III Main civil works 32.60 68.38 90.86 8.49 16.22 23.71 Electromechanical 4.05 87.68 71.68 1.04 17.68 18.69 Substations 7.83 88.16 46.79 1.99 9.94 11.93 Engineering 2.77 17.88 20.16 0.74 4.88 6.40 Suttotal Tedzani III 46.98 181.48 228.44 12.26 47.47 69.73 B. Generation Rehabilitation 0.10 5.21 6.31 0.02 1.47 1.49 C. Institution Strengthening -- 1.94 1.94 _ 0.80 0.60 Subtotal Power 47.08 188.63 236.69 12.28 49.64 61.82 Interest During Construction 83.69 -- 33.69 8.68 -- 8.68 Total Power 80.76 188.63 269.38 20.88 49.64 70.40 Energy Component D. Charcoal 0.26 2.96 8.22 0.10 1.00 1.10 E. Woodenergy 20.99 30.18 61.17 6.02 8.86 14.88 F. Energy Pricing -- 1.60 1.60 - 0.60 0.0 Total Energy 21.26 84.64 66.89 6.12 10. 8 16.48 Total Financing Requirement 102.00 223.27 325.27 26.98 69.90 86.88  - 35 - 5.15 The cost estimate is based on the study carried out by Kennedy and Donkin for the major power component and on information furnished by Government and its consultants for the energy components. The total cost of the Project including physical and price contingencies, but excluding duties and taxes and interest during construction, is estimated at US$78.3 millior, of which the foreigni exchange cost would be US$59.9 million (762). Total financing required including interest during construction, is estimated at US$86.9 million equivalent. For the power component, base costs are at July 1987 price level. Physical contingencies are 10? for electromechanical equipment and engineering services and 15? of base costs for civil works. Price contingencies were computed assuming annual local inflation rates of 152 in 1989, 10 in 1990, 7.5Z in 1991, and 52 in 1992 through 1994. The corresponding international inflation rates are 3? in 1989 and 1990, and 42 for 1991 through 1994. For the wood energy component base costs were estimated at prices as of July 1988. A physical contingency of 10? was included for civil works, furniture and equipment to allow for possible design changes and 15? for small farmer tree planting incentive scheme because of uncertainty about the level of demand for seedlings and their survival rate. No physical contingency was provided for all other categories. The rates for price contingencies were the same as for the power component. 5.16 Proiect Financing. The project financing plan ie shown in Table 5.3 below. The total foreign exchange requirement of the project is estimated at US$59.9 million of which US$49.5 million will be expended by ESCOM on the power component and US$10.4 million by the Government on the other energy components of the project. Of the total foreign exchange cost, IDA will finance US$42.3 equivalent, and Austria US$17.6 million. Of the total local currency requirement amounting to K80.8 million for the power component, K47.1 million will be provided by ESCOM from funds generated from its operations. The Government is assumed to be financing the remaining K33.7 million of local cost which represents interest during construct3on on loans on-lent by it to ESCOM. The total local currency requirement of K21.2 million for the energy component will be financed by IDA (X15.1 million) and by the Government (K6.1 million). 5.17 US$14.8 million from the proposed IDA credit will be passed or. by the Government to the Forestry Department of the MFNR and to EPU of EPD for the charcoal, wcodfuel and energy pricing study subcomponents respectively. Agreement was reached during negotiations that (i) the Government shall on lend to ESCOM US$31.9 million from the proposed credit at 7.65Z interest rate and 20 years repayment period including 5 years of grace, ESCOM to bear the foreign exchange risks; and (ii) the execution of the onlending agreements between ESCOM and the Government is a condition of effectiveness of the IDA credit. 5.18 The notification by Austria that all conditions precedent to the first disbursement of the Austrian loan have been fulfilled is a condition of effectiveness of the proposed Credit.  - 36 - Table 5.3 Financing Plan Local Cost Forelgn Cost IDA ESCOM COM TOTAL IDA AUSTRIAN TOTAL (Kwachas millIon) (USI millon) Power A. Tedzani III -- 47.A -- 4'.1 29.8 17.8 47.4 B. Generation Rehabilitation -- -- -- -- 1.6 -- 1.6 C. Institution strengthening -- -- -- -- 0.8 -- 0.8 Subtotal -- t 1 -- 47.1 31.9 17.8 49.5 Interest during Construction -- -- 33.7 33.7 -- -- -- Subtotal Power -- 47.1 33.7 80.8 31.9 17.8 49.5 Energy D. Charcoal Production -- -- 0.3 0.3 1.0 -- 1.0 E. Woodfu.l 16.1 -- 6.8 20.9 8.9 -- 8.9 F. Energy Pricing -- -- -- -- 0.6 -- 0.6 Subtotal Energy 15.1 -- 6.1 21.2 10.4 -- 10.4 Total Financing Requirement 16.1 47.1 39.8 102.0 42.3 17.6 69.9 5.19 Project Implementation. Procurement activities will commence from mid.-1989. The physical execution of the major power components of the project will start in mid-1990, and will be completed in April 1994. On- going activities on wood energy program will be accelerated as soon as the proposed credit is declared effective, expected by June 1989. A project implementation schedule summary is attached as Annex 5.4. 5.20 Implementation of Power Components. ESCOM will be responsible for the implementation of the power components of the project and will appoint a Project Manager whose qualifications and experience are satisfactory to IDA to coordinate the supervision of the executior of the power components of the project. The Project Manager will be the local counterpart for IDA and cofinancing agencies, consultants and contractors of the power component of the project, and will deal with all correspondence, progress reports and procurement activities. Consultants will be employed at the latest by June 30, 1989, to prepare tender documents and issue tenders to render possible timely commencement of construction. Confirmatory drilling and hydraulic model testing will also be undertaken in 1989. Project design and preparation of bid documents will be undertaken during 1990. The construction of Tedzani III will be undertaken by contractors under the supervision of consulting engineers and ESCOM. The rehabilitation of Tedzani I and II and the standby thermal plants will be carried out by manufacturers under the supervision of ESCOM assisted as required by consultants. On-the-job training for ESCOM staff will be provided in the bid documents of the proposed Project during Project design, construction and supervision (Annex 5.1). Appointment of a Project Manager for the power component is a condition of disbursement of the proposed Credit. 5.21 Implementation of Energy Components. EPU will be responsible for coordinating the implementation of the energy components of the proposed  - 37 - Project. The Forestry Department of the MFNR will be responsible for the charcoal production and woodfuel and the EPU for energy pricing study. The Forestry Department and EPU will be assisted by consultants to be employed under the project with terms of reference satisfactory to IDA. 5.22 Consulting Services. The execution of the project will require consulting services for studies, design and preparation of bidding documents, evaluation of tenders and supervision of construction, installation and commissioning of maiui plant and equipment. 5.23 Procurement for the Power and Components other than Wood Energy. The component of main civil works, machinery and equipment to be financed by IDA will be purchased through international competitive bidding in accordance with IDA guidelines for procurement. Direct contracting (US$1.49 million) with the original suppliers will apply for the generation rehabilitation. Margins of preference to domestic manufactures will not apply because equipment and materials required for the power component of the proposed project are not produced ,ocally. All contracts for amounts equal to or larger than US$100,000 equivalent will be subject to IDA's prior review. Consultancy services to be financed under the proposed IDA credit will be selected on the basis of the quality of service, in accordance with IDA guidelines for selecting consultants. 5.24 Procurement for Wood Energy Component. Vehicles, equipment, machinery and materials would be bulked as far as possible into orders of US$O.l million and over and procured through ICB; orders for less than US$0.1 million for items of small value needed throughout the life of the Project will be procured in accordance with LCB procedures acceptable to the Bank - these would not exceed US$0.5 million in aggregate; items costing less than US$0.03 million will be procured through local shopping procedures with a minimum of three quotations - these orders will not exceed US$0.1 million in aggregate. Technical assistance consultants will be procured in accordance with IDA guidelines for selecting consultants. Civil works for the expansion of facilities at Malawi College of Forestry will be procured through LCB (US$0.67 million). The remainder of civil works (US$2.54 million) consists of a large number of low value units, with an average cost of around US$5,000, which are scattered widely over several hundred different and remotely located sites. Based on past experience of forestry projects in Malawi, it is considered unlikely that any bids would be received for competitive tender for these works. Therefore these works would be procured either through Force Account of the Ministry of Forestry and Natural Resources, or through negotiations with contractors working in the vicinity, or through local competitive bidding as appropriate for thene types of very small and scattered works. The specific method would be agreed with Bank supervision missions. The proportion of contract which will be subject to prior review by the Bank is estimated at 75? for the whole project.  - 38 - TABLE 5.4 Procurement Method a/ Power Component ICB LCB nutent b Oth-rlc DC(d) MA e) Tote l Civil Works 23.71 23.71 (16.22) (16.22) Electromechanical 1.03 17.68 18.89 Substations 11.93 11.93 ( 9.94) t 9.94) Generation Rehabilitation 1.49 1.49 (1.47) (1.47) Institution Strengthening Computers 0.36 0.36 ( 0.35) ( 0.36) Studies 0.26 0.26 (0.26) ( 0.26) Engineering 6.40 6.40 Services (4.68) ( 4.66) Total Power U 51. .65 17.68 . 17.49 61.82 (26.61) (4.91) (1.47) (31.9) Eneray Components Charcoal Production 1.10 1.10 (1.00) (1.00) Wood energy Vehicles, equipment and materials 2.07 0.60 1.10 2.87 ( 2.07) (0.60) (0.10) ( 2.67) Technical AssIstance 0.40 0.40 (0.40) ( 0.40) Civil works 0.67 2.54 8.21 (0.87) (2.64) ( 3.21) Operating costs etc. 8.60 8.60 (6.97) ( 6.97) Energy Pricing Study 0.50 0.60 (0.60) ( 0.60) Total Energy 8.7I T . 171 -77 2.64 1.49 8.60 16.48 ( 3.07) (1.17) (0.9) ( 2.84) (1.47) (6.97) (14.76) Total Project 39.16 2.20 6.66 20.30 1.49 8.60 78.30 (28.68) (1.17) (6.81) ( 2.64) (1.47) (6.97) (46.7 ) a) Amounts In brackets are IDA financed. b) Consulting sorvices and technical assistance under IDA guidelines. c) Tied to Austrian suppliers for the power component. Force account or negotiations with contractor, and local shopping for the energy component. d) Proprietary spare parts that can only be purchased through direct contracting with manufacturers of original equipment. e) N.A. a not applicable. 5.25 Advance Contracting. A PPF of US$750,000 equivalent has been provided to help the Government finance consulting services and technical assistance to implement the charcoal production and marketing component of the proposed Project. A supplementary PPF of the same amount has also been  - 39 - approved to continue wood energy activities initiated under IBRD Loan No. 2670-MAI (Wood Energy II) pending the effectiveness of the proposed Credit. 5.26 Disbursement. The proceeds from the credit would be disbursed over a period of about 60 months from June 1989 through June 1994. For the power component, disbursements from the credit would be made for 100? of foreign expenditures for all project components except for consulting services, for which disbursements will be made for 80? of local expenditures for services of consultants domiciled in Malawi and 100Z of foreign expenditures for services of other consultants. For the charcoal component, 100? of foreign expenditures and 90Z of local expenditures would be disbursed from the Credit. For the wood energy component, 100Z disbursement will be made for the total costs (foreign and local) for all items of expenditure except for the category of salaries and allowances for which no disbursements will be made. The anticipated schedule of disbur.sements (Annex 5.5) from the proposed IDA credit is based on the annual estimated project costs and are in compliance with standara profiles for Bank loans and IDA credits for energy projects in the Africa region. Disbursements may be made on the basis of Statement of Expenditures (SOEs) for contracts below $20,000, including for expenses related to civil works carried out on Force Account (para. 5.23). Supporting documents thereof would not be submitted to the Bank for reimbursement of su.h expenditures, but would be properly filed and kept by ESCOM and the Forestry Department for auditing purposes (paras. 5.33 and 6.05). The closing date for the proposed credit would be December 31, 1994. 5.27 Special Accounts. In order to expedite the execution of the project and give implementing agencies rapid access to the credit, the Government will open two Special Accounts at the Reserve Bank of Malawi. Special Account A for ESCOM would have an initial deposit of US$1,500,000 and Account B for the Forestry Department an initial amount of US$2,000,000 Payments from the special accounts shall be made exclusively for eligible expenditures. IDA will replenish the Special Accounts as needed, in accordance with established procedures. 5.28 Environmental Aspects. The power components do not involve any significant negative environmental impact, Tedzani III being an extension of the existing group of power plants. No new dam will be constructed and there will be no inundation in the area. Tedzani III will use an existing daily regulating dam and the major construction features include the intake, the power tunnel and the power house. The power plant will be located in a gorge and, together with the surge tank, will be the main visible feature of the scheme. The scheme is relatively small and construction activities will not utilize large areas and disrupt any local activity of which there is very little. Construction activities will not disrupt in a permanent way the small population living in the area, the majority of whom are ESCOM employees. No resettlement would be involved. Construction activities will, however, result in a temporary retreat of the wild life in the area. Temporary labor will exert additional pressure on the scarce woodfuel resources of the locality. The Engineer would advise ESCOM on the need to maintain, to the extent possible, the existing balance between fuelwood supply and demand. The river flow at Tedzani Falls will also be reduced when Tedzani III becomes operational, becominL evident only if the flow in the river Shire were to diminish significantly below the present average.  - 40 - During construction the Engineer would ensure that any surplus spoil would be disposed of in an environmentally acceptable manner. The other subcomponents of the power component, the substations and transmission facilities, will have negligible effect on the environment. 5.29 Shire is an international river flowing into Mozambique. Consequently, the Government of Malawi has notified the Government of Mozambique of the proposed development of Tedzani III, indicating that its implementation will not affect the interests of Mozambique, and requesting a positive response on the subject. IDA has satisfied itself that the development of Tedzani III will not in any way adversely affect the quantity or the quality of water flowing into Mozambique. The Government of Mozambique has responded affirmatively to the development of Tedzani III. 5.30 The fuelwood component of the Project is expected to have a positive environmental impact. The Government plantations at Mulanje are on very steep and fragile slopes that were covered with natural forest until the early eighties but are now virtually denuded. Reforestation slould have significant environmental benefits, including protection of the water catchment area for the densely populated district of Mulanje and reduction of soil erosion. On the conservation side, the introduction of more fuei- efficient technologies for household stoves and tobacco curing should result in savings of wood equivalent to clearfelling up to 12,500 hectares of natural forest annually. If, in addition, under the charcoal component, tobacco estates and urban households switch to using pine charcoal produced from surplus wood (thinnings) from industrial plantations, this could further reduce the clearfelling of the indigenous forest by between 10- 15,000 hectares a year. The various measures to promote wood production by the private sector should have direct environmental benefits for the soil and water in the areas where trees are planted, as well as in reducing the pressure on the natural forests as cultivated wood replaces indigenous wood. Finally, forestry staff will provide protect.;on of the natural forest in heavily depleted or environmentally fragile areas where commercial cutting has been restricted or prohibited. In these areas they will direct major users to environmentally safe sources of wood, such as government fuelwood or industrial plantations, forest reserves with surplus yields or waste wood from land clearing activities. They will also work with the local inhabitants to educate them on the sustainable utilization of the indigenous forest, providing advice on improved silvicultural techniques including cutting practices, enrichment plantings, protection from animals and fire control, so as to ensure regeneration and optimal yields over time. 5.31 Proiect Risks. The civil works of the proposed Project involve construction of a short tunnel. In view of the experience gained from the nearby tunnelling works, no major constructional difficulty which would extend construction period or result in additional expenditures is envisaged. To minimize this risk, confirmatory drilling would be carried out in suspected fault zones of the tunnel route and at the power house site- Similar civil works have been successfully carried out by ESCOM and its contractors. The political and security situation in Southern Africa may disrupt transport and delay delivery of machinery and equipment. As a safeguard, in addition to providing double the normal transportation time in assessing project implementation schedules, ESCOM would provide for alternative routes of delivery in the bid documents. The risk of energy  - 41 - deficits resulting from probable consecutive dry years would be mitigated through the contingent plan of dredging the entry channel from Lake Malawi to the Shire river in order to have access to additional live storage of the Lake. There is also the risk that new generating capacity may be brought on stream too early or too late if demand forecasts prove inaccurate or are adversely affected by the political situation in the region thus affecting the Project return. Likewise, the economic viability of softwood charcoal would be affected if the market response to the availability of charcoal proves modest or slows down. Howeve:, demand is unlikely to be a constraint in the light of the experience gained during the pilot phase of charcoal production and in the light of demands by Mozambican refugees on Malawi's woodfuel resources. The institutional risks which may hamper implementation of project objectives particularly of the charcoal component are related to the placement of suitably qualified staff for transfer of know-how and project execution and eventual management ob. project output. The above risks would in general be mitigated through the assistance of consultants and through the planning and manpower training support of UNDP to the work of the EPU. 5.32 The principal risk for the wood energy component lies in the siniultaneous implementation of a multi-faceted package of policies and programs which has not been tried before in such a comprehensive way in Africa. Few, if any of the individual e'lements can have an impact alone - each is dependent on and, in turn reinforces the impact of the other components. Implementation of the strategy implies a significant increases in the scope and complexity of the responsibilities of the Forestry Department. Provision has therefore been made to strengthen the forestry institutions and also to establish a Monitoring and Eva'luation Unit to follow closely the progress of the various initiatives and take corrective measures at an early stage. It is also intended to carry out an joint indepth midterm review in 1990/91 which will allow for possible redesign of the various pilot efforts as necessary. 5.33 Project Monitoring and Supervision. Records and reports necessary to monitor the progress of the Project and the achievement of its objectives were discussed during project preparation and are agreed upon with the Government and ESCOM during negotiations. Target dates for tendering, contract awards, construction and erection phases of the Project as per Annex 5.4 as well as relevant information and performance indicators per Annexes 2.3 and 5.6 would be closely monitored by supervision missions. ESCOM would prepare Project Completion Report for the power component within six months of the Project completion. 5.34 The major tool for supervising the wood energy component of the Project is the Monitoring and Evaluation Unit which will provide the data and analysis essential for project management and Bank supervision. The M&E Unit will prepare detailed annual reports covering the physical implementation of the respective components in the previous year and annual budgets for the ensuring year to be submitted to the Bank within three months of the end of the fiscal year. As part of the supervision and review process, the Forestry Planning Unit will set the targets against which the M&E Unit will measure effectiveness. In addition, the Forestry Planning Unit will provide the annual work plan, staffing targets and cost estimates well before the beginning of the fiscal year. The M&E Unit will be  - 42 - responsible for submission of the Project Completion report for the wood energy component within six months of Project completion. The audit accounts for the wood energy component including the auditing of the Special Accounts (5.27) and the Statement of Expenditures (5.26) together with the Auditor's Report will be submitted to the Bank within nine months of the end of each financial year. VI. FINANCIAL ASPECTS AND COST RECOVERY Electricity Supply Commission of Malawi (ESCOM) 6.01 Financial Position and Past Operating Results. The operating result and cash flow of ESCOM for 1987 are based on audited accounts and shown in detail in Annexes 6.1-6.2. The following table summarizes ESCOM's financial performance over the past three years. Table 6.1 Summary Cash Flow 1985 1986 1987 Units sold (GWh.) 399 427 467 Average revenue (Tambala/kWh) 8.07 8.12 8.53 (Kwacha mln.) Operating Revenues 33.0 35.5 40.7 Operating Expenses (excl. depr.) 8.1 9.4 11.8 Net Internal Cash Generation 24.9 26.1 28.9 Borrowing 4.8 3.3 6.9 Debt Service 17.5 18.9 18.1 Capital Investment 12.0 11.2 17.5 Net Cash Generation/Constr. (2) 70 76 53 6.02 During the past three years ESCOM's financial performance was good. Adequate tariff increases were implemented regularly and together with good cost control and excellent collection record (para. 6.04), the company's cash flow position has been good. During the 1985-1987 period ESCOM financed on the average about 66Z of its capital expenditures from internally generated funds. This is a high level. However, ESCOM's capital expenditures were rather low during this period, with no large projects under coastruction. As a consequence of the good level of net income and high self-financing of capital expenditures, ESCOM's debt/equity ratio decreasfd from 67/33 in 1985 to 62/38 at the end of 1987. The following table stumarizes ESCOM's financial position over the past three years which is shown in detail in Annex 6.3.  - 43 - Table 6.2 Summary Balance Sheet 1985 1986 1987 Assets Net Fixed Assets in Operation 136.7 156.8 174.6 Works in Progress 10.4 4.5 13.2 Current Assets Cash 1.8 2.3 0.9 Receivables 5.5 5.9 6.6 Other 5.7 7.0 9.9 Total Assets 160.1 176.5 205.2 Equity & Liabilities Equity 39.6 49.2 63.5 Long-term Debt 102.7 110.0 122.2 Current and Other Liabilities 17.8 17.3 19.5 Total Equity & Liabilities 160.1 176.5 205.2 Rate of Return (on assets) (Z) a/ 14.7 13.9 12.4 Debt/Equity Ratio a/ 67:33 65:35 62:38 a/ Based on partially revalued assets 6.03 The rate of return on average net fixed assets valued at historical cost and adjusted for foreign exchange losses was at a high level os 14.7% in 1985 declining to 12.42 in 1987 reflecting the large increase in asset base due mainly to devaluation of the Kwacha of 22% that year. ESCOM estimates that its assets are undervalued by about 75Z and.has requested IDA to finance an asset revaluation study (para. 4.13 c (ii)). The rate of return on revalued assets would then be around 7% in 1987 which is considered satisfactory. During negotiations, agreements were reached with ESCOM that (i) IDA's view will be taken into consideration in finalizing the asset revaluation study proposals; (ii) the recommendations of the study as so agreed with IDA will be implemented by March 31, 1991; and (iii) ESCOM will revalue its assets annually thereafter according to a method to be agreed upon with IDA. 6.04 Accounting and Auditing. ESCOM's accounting records are well maintained and the books are closed within two months after the financial year ends. Budgeted performance seems to be well monitored and financial reports to management are prepared monthly. Electricity bills are issued monthly and collection is one of the best in the region, at about 60 days of sales revenues. During negotiations, agreement was reached that ESCOM continues to keep its accounts receivable to no more than 60 days of sales. 6.05 ESCOM's accounts are audited yearly by the international firm Deloitte Haskins & Sells, and the arrangement is satisfactory. Audited accounts are usually prepared within a month after closing of the books. During negotiations, agreement was reached that ESCOM will continue to have its accounts audited, including the Special Account (para 5.27) and the Statement of Expenditures (para. 5.26), by independent accountants and sent to the Bank within four months after ESCOM's financial year ends. 6.06 Tariffs. The present tariff structure does not give appropriate signals to electricity users about the difference in the costs of meeting  - 44 - their demands in critical and non-critical periods of the day and of the year. ESCOM has therefore requested the Bank to finance the preparation of a tariff study to determine the appropriate structure and level of tariffs at different delivery voltage levels. During negotiations agreement was reached with ESCOM that the view of IDA will be taken into account in finalizing the tariff study proposals and that the recommendations of the study as so agreed with IDA will be implemented within the following 12 months, or such later date as may be acceptable to the Borrower and IDA. 6.07 ESCOM's average tariff level was increased by about 141 effective April 1, 1988. The present average tariff at t9.85 (USc3.83 per KWh) is sufficient to meet operating expenses, working capital requirements, debt service and to finance a reasonable proportion of ESCOM's capital expenditures from internally generated funds. The present average tariff is among the lowest in Africa and reflects the efficiency of ESCOM together with a mostly hydro based operation. Over the longer term the need for increases in tariffs in real terms should be minimal (para. 6.10). 6.08 As an indication of the correct tariff level according to economic principles, an estimate of the long run marginal cost (LRMC) has been derived based on the identified least-cost development program (Annex 7.3). The LRMC has been calculated as the average incremental cost of meeting increases in demand and is estimated to be tlO.40 (USc4.04) per kWh sold in early 1988 price terms at 8Z discount rate. The LRMC is close to the present average financial yield. However, the present tariff structure is not an accurate reflection of the structure of cost, particularly the demand charge which is a large proportion of the economic cost of providing additional system capacity. This aspect will be examined in the tariff study (para. 6.06). 6.09 Future Financial Operations and Position. The projected financial statements of ESCOM for 1988 through 1995, together with notes and assumptions used in these statements, are shown in Annexes 6.1 through 6.4. Major financial indicators for selected years are shown in table 6.3. These projections are based on a number of assumptions with respect to revalued asset base, domestic inflation, currency exchange rates and load growth, which are subject to considerable uncertainty (Annex 6.4). In particular, assumptions with respect to load growth and future devaluations reflect trends that may not prevail in the future. Additional adjustments may be needed if these projected values change. Projected balance sheets for the years ending December 31, 1988, through 1995 show, under the above assumptions, that the debt/equity ratio 15/ will remain at the 43:57 level during the latter years of the 1988-95 period reflecting the need for steady borrowing in view of the continued implementation of large projects. ESCOM's debt/equity ratio is considered conservative. 15/ Based on revalued assets.  - 45 - Table 6.3 ESCOM FinaialIii7Tndicators 1989 1992 1995 Average tariff (t/kWh) 11.1 14.7 21.7 Average tariff (USc//kWh) 3.6 3.9 5.2 Debt Service Coverage 1.6 2.1 1.8 Net Cash Generation/Constr. (Z) 42 35 31 Rate of Return (2) 6.1 6.4 7.1 Debt Equity Ratio 37:63 43:57 43:57 Accounts Receivable (days) 60 60 60 6.10 To meet future operating costs, working capital and debt requirements, as well as financing a reasonable part of its investment program, ESCOM would require timely tariff revisions. Based on the assumptions explained in Annex 6.4 and the resulting financial projections detailed in Annex 6.1, tariff increases would require to be implemented at the rates of 12X, 15?, 72, 82, and 12? for 1989 through IL93, respectively, and 15? for 1994 and 1995. After adjustment for projected domestic inflation, the tariff increases (expressed in tambala/kWh) would be on average less than 32 p.a. between 1988 and 1995. Such increases in constant terms ire quite modest, given the large investment program. 6.11 The proposed tariff revisions, coupled with projected sales, operating cost a"d capital investments, are expected to generate adequate funds to finance about 30? of ESCOM's capital investments from internally generated funds during the 1989-1995 period. The pro,ected operations of ESCOM indicate that its future financial performance would be satisfactory with a debt service coverage varying between 1.6 and 2.4 during this period. Because these projected results are subject to considerable variations given the uncertainties surrounding the projected macro-economic variables and the future availability of foreign exchange to finance the large investment program, ESCOM will need to review regularly the level of its tariffs (para. 6.12). During negotiations, agreements were reached that ESCOM will not incur any debt unless a reasonable forecast of its revenues and expenditures show that the projected internal cash generation is at least 1.5 times the projected debt service requirement on all debt, including the debt to be incurred. 6.12 Under the previous lending operation to ESCOM in 1977 (Ln. 1387/1388 and Cr.691), ESCOM's financial performance was linked to an 8Z rate of return on average revalued net fixed assets in operation. In view of the uncertainty of the current value of ESCOM's assets (para 6.03), it is preferable to monitor ESCOM's future financial performance to a cash generation covenant. Therefore, during negotiations, agreements were reached that (i) ESCOM shall generate sufficient cash to finance yearly from internal sources the equivalent of not less than 302 of the average annual capital expenditures incurred or expected to be incurred over a three year period, comprising the year in question, and the ones immediately preceding and following such year; (ii) each year, no later than 90 days prior to the end of the fiscal year ESCOM and the Government shall review with IDA whether ESCOM will meet the requirements set out in (i); and (iii) in the event such review shows that the requirement set out in (i) will not be met,  - 46 - ESCOM and the Government shall promptly take all necessary measures in order to meet such requirements. 6.13 Proposed Financing Plan. A detailed funds flow statement for ESCOM is shown in Annex 6 2. Summary financing plan for 1989 through 1994 is shown in Table 6.4. Table 6.4 ESCOM Financing Plan: 1989-1994 ---Million---- Percent of K US$ a/ Total Application of Funds Construction Expenditures Proposed Project 235.6 61.8 32 Other 423.1 114.0 58 Total 658.7 175.8 WE Interest During Constr. (IDC) Proposed Project 33.7 8.6 5 Other 35.9 9.4 5 Total 69.6 18.0 l- Total Requirements 728.3 193.8 100 Sources of Funds Internal Generation 434.6 116.6 60 Less: Debt Service 198.0 53.7 27 Incr. in working capital 12.2 3.3 2 Net Internal Generation 224.4 3W.9 Ty Consumers' Dep. & Contr. 29.3 7.9 4 Borrowing 474.6 126.3 65 Total Sources 728.3 193.8 100 a/ Expressed in current US$ at variable exchange rates (Annex 6.4, para 4). 6.14 During the project period from 1989 through 1994, ESCOM's construction program is expected to cost K728 million (US$194 million), including interest during construction of K70 million (US$18 million). The proposed project (of which construction of the Tedzani hydro plant constitutes 98Z of total project costs) represents about 37Z or K269 million (US$70 million) of the total investment program during this period. Internal cash generation, after covering debt service and increases in working capital, will produce about 31Z of the funds required for construction expenditures during the 1989-1994 period. Borrowing is expectea to provide 65Z (US$126 million) of ESCOM's total requirements of funds of which about 60Z of total borrowing required have been committed and 35Z are in the process of being agreed upon (para. 5.06). Consumers' deposit and contribution totaling 4Z are e-rpected to close the financing gap. Forestry Department 6.15 Wood Energy Component. No financial rate of return has been computed for the wood energy component of the Project as the bulk of  - 47 - expenditures for the program do not yield an output that is sola. However, it is estimated that the cost recovery stumpage rate for the Government plantation at Mulanje is MR13.60/stacked m3. Hence, if the stumpage rate were merely maintained at its current level in real terms (i.e., increases only compensated for inflation) - the financial rate of return on the plantation would be -8.4Z. This demonstrates the urgent necessity for stumpage rate increases in real terms so that incentives exist for wood production by the private sector and the Government can recover more of the cost of its investments in plantations. Therefore, under the Project, the Government is implementing a phased increase in stumpage fees for wood cut for commercial purposes with the objective of reaching replacement cost by 1996. The proposed Energy Pricing Study will recommend the appropriate level of stumpage fees based on the costs that would be incurred to meet additional demand for wood (Para 1.12). 6.16 Project related expenditures of revenue collected by the Forestry Department is shown in Table 6.5 below. Average annual recurrent expenditure associated with the wood energy component is around MX 4.1 million (in July 1988 constant prices), and total expenditure after the first year of the Project averages about MK 5.5 million per annum. It is anticipated that revenue collection by the Forestry Department should increase substantially from its present very low levels (around MK 2.6 million in 1987/88) given the improved revenue collection system and the increases in stumpage fees for commercial wood. Wood used by rural households will continue to be free. This leaves roughly 3.5 million solid m3 per annum, or 40Z of total consumption, potentially subject to stumpage fees (see Table 4.1). It is assumed that, under the new revenue collection system, fees can be collected for 60Z of urban domestic consumption, urban and rural industries, and 10 of estates consumption, yeilding a total of 1.1 million solid m3 on which fees would be collected (see Working Paper No. 2 in Second Wood Energy Project Files). If the stum3age rate were merely to be maintained at its current level of MK6.43/solid mj (equivalent to MK4.50/stacked m3) revenue collected would be around MK7.1 million annually (in July 1988 prices). Assuming that the stumpage fee will increase by 10% a year in real terms, annual revenue collection should be over MK10 million by the final year of Project implementation. From a budgetary perspective, therefore, revenues under the wood energy component should comfortably exceed expenditures. Table 6.5 Prolect Related Forestry Department Cash Flow 1990 1991 1992 1993 1994 (million MK in July 1988 prices) Recurrent Expenditure 4.4 4.1 4.1 4.0 4.2 Total Expenditure 14.5 4.8 4.9 5.5 6.5 Revenue Collection 7.1 7.8 8.5 9.4 10.3  - 48 - VII. ECONOMIC JUSTIFICATION Electric Power Components 7.01 The updated forecast of electricity demand in Malawi shows that, for the base case scenario and after installation of the fifth 20MW unit at the existing Nkula B hydroelectric power plant in 1991, additional generating capacity will be needed by 1994. The two options for satisfying this demand are: (a) the installation of additional hydroelectric generating capacity on the Shire River, where all the existing hydro capacity is located: and (b) imports from a neighboring country, either Zambia or Mozambique. Zambia would need its present excess capacity from mid-nineties and delivery of firm power to Malawi might not be possible. The security situation in Mozambique makes it difficult to consider interconnection at tle present stage. A third possibility is a thermal alternative in the form of a gas turbine (US$400/kW) or a diesel plant (US$800/kW). The very high cost of fuel in Malawi rules out the thermal alternative. (On the basis of information on a 20MW gas turbine, recently quoted for Bolivia, fuel cost for Malawi is estimated at US cents 27/KWh generated. Maintenance charges, including spares, are estimated at US$750,000 per year). In addition, in light of Malawi's experience on the instability of supply for imported energy resource (coal and petroleum), neither the thermal option nor the interconnection is a politically viable solution. Under option (a), the two main alternatives are the Tedzani ,.1 and Kapichira hydro projects. Analysis of the present value of the costs for different sizes and sequencing of these two projects, using alternative demand scenarios and interest rates, shows that the least-cost solution is the commissioning of Tedzani III in advance of Kapichira, and that the least-cost configuration for Tedzani III is 2 x 25 MW (Annex 7.1). The electric power components of the project therefore are consistent with the least-cost power development plan for Malawi. 7.02 The economic rate of return of the power system investments is the discount rate at which the present value of their capital and operating costs equals the present value of their incremental benefits! For the purposes of the economic analysis, a percentage of the cost of planned transmission and distribution investment is added to the project cost stream. Since the transmission and distribution investment is also needed to improve the reliability and efficiency of the existing system, the proportion of Tedzani capacity to total system capacity is used in deriving this percentage. The foreign exchange components are converted at a shadow exchange rate of MK 2.65/ US$1.0, equivalent to a shadow exchange rate premium of 5?. This adjusts for the estimated over-valuation of the Kwacha in early 1988. The benefits are taken to be the additional energy demands that the investments are able to satisfy over their useful life (35 years). The energy benefits are valued at Tambala ll/Kwh (USc4.2/kWh), the average tariff that ESCOM will need to charge from 1995 to cover its financial costs, expressed in 1988 constant prices. Because it does not reflect consumers' willingness to pay, the tariff yield is considered to be an extremely conservative measure of the project's economic benefits. On this basis, the electric power components of the project are estimated to have an economic rate of return of 10.72 (Annex 7.2) which is above the opportunity cost of capital, estimated to be about 8? (which is between the  - 49 - international coRt of capital and cost of capital in neighboring countries not subject to similar transport constraints). Charcoal Components 7.03 The economic benefit of the charcoal component is best approximated by the economic value of 'he fuel or fuels for which the charcoal will substitute. In the industrial sector, which is the major potential market in the short-to-medium term, this substitute fuel is imported coal. The 1988 market price of coal in Blantyre, the most distant major charcoal market, was K185/ton. At a shadow exchange rate premium of 5Z, the economic cost of coal ts K200/ton. The cost of charcoal transport from the Viphya plantation to Blantyre is K120. Hence the economic netback value of charcoal ex-Viphya to Blantyre is K200-K120 - K80/ton. 7.04 The production system to be established and maintained by the project will have a capacity of 11,000 tons per annum (tpa). Sales under an earlier pilot project were running at a rate of 6,000 tpa in 1987. Industrial coal demand is currently over 40,000 tpa, 70? of which is met by unreliable imports. Softwood charcoal could potentially capture a significant portion of this market. In,addition, it is a cost-effective potential substitute for hardwood charcoal in household use, and a possible substitute for fuelwood in tobacco curing and tea drying. Sales are therefore likely to be close or equal to production capacity. Sales are conservatively forecast at 3,000 tpa in 1988, rising to 7,000 tpa in 1989, and to 10,000 tpa in 1990 and for the balance of the assumed 10-year life of the project component. 7.05 The economic costs of the project component total K4.9 million (1988 constant prices). These exclude K1.8 million in sunk costs for the preparatory phase, which were financed from the IDA Wood Energy II project. The foreign exchange components of the cost (the consultants' fees and vehicles) were converted at a shadow exchange rate of K2.65/US$1.0 to adjust for the estimated overvaluation of the Kwacha in early 1988. Based on these costs and the estimated netback value of the benefits, the charcoal component has an economic rate of return of about 18? (Annex 7.4). Wood Energy Component 7.06 The principal benefits from the wood energy component of the Project would be the stimulation of private fuelwood production and wood conservation. Directly the project would provide for the establishment of about 17,150 hectares of smallholder woodlots (supported by a network of 60 nurseries) and around 2,750 hectares of Government plantations at Mulanje, producing a total of 212,000 m3 of wood per annum (see Annex 7.5). However, these estimates of wood production that result directly from the nursery and plantation components would likely represent the minimum levels of wood production attributable to the Project. In addition, it is anticipated that wood production by the private sector (e.g. schools, farmers, tobacco estates, charcoal makers) will increase substantially in response to other measures under the Project such as the stumpage rate increase and improvements in revenue collection, the increased restrictions/prohibitions on commercial cutting in the natural forest, publicity campaigns about the importance of tree planting, extension activities and tree planting  - 50 - incentives. Overall, therefore, the output of wood resulting from the Project is expected to exceed significantly as shown in Annex 7.5. 7.07 In calculating the economic rate of return, the woodoutput from the Project is valued at the economic cost of supplying the same quantity of fuel through the most likely alternative. 16/ Continued depletion of the existing natural forest is most likely alternative way for users to obtain their energy needs. There are significant environmental costs resulting from depletion of the natural forest. While these are difficult to quantify, a rough estimate is made in terms of the possible losses in agricultural productivity (see Annex 7.5). Output from the smallholder woodlots is valued at the environmental costs of depletion plus the opportunity costs of the labor spent gatherirg wood rather than in other productive activities. Output from the plantation is valued at the environmental costs of depletion plus the transportation costs of fetching wood. For the smallholder woodlots, the economic rate of return is estimated at 19.5Z (Annex 7.6) and for the plantation at Mulanje, the rate of return is estimated at 14.4? (Annex 7.6). In fact, the returns wouild be higher because the woodlots and plantations would help control environmental degrada-ion in the planted areas, (particularly at Mulanje where deforestation has caused soil erosion and landslides and is threatening the watershed) and these benefits have not been taken into account. Stimulation of small-holder multi-purpose tree planting will provide a ready on-form source of fuelwood supply and discourage the burning of crop residues and/or animal dung which instead can be used for feeding to livestock and/or contributing to soil fertility thereby improving crop yields. No rate of return has been calculated for the institutional development and support services due to difficulties in quantifying the value of the benefits of these components. 17/ 7.08 No attempt has been made to calculate the rate of return on the energy conservation component, because of the pilot nature of the stove component and because the bulk of the costs of the tobacco curing energy efficiency initiative have been meft from other projects. However, the introduction of more energy efficient technologies for household stoves and tobacco curing has the potential to yield substantial wood savings. The improved stoves can achieve fuel savings of between 30-45Z, resulting in annual savings of around 285 kg of charcoal per stove. Assuming that approximately 500 stoves per month are produced and marketed during the pilot production stage, this would imply annual savings of around 1,700 tons of charcoal, resulting in savings of wood equivalent to clearfelling about 310 hectares of indigenous forest annually. However, if stove production and marketing becomes fully commercialized, the potential demand for stoves and associated fuel savings are much greater. Current charcoal consumption 16/ The existing local market for fuelwood is distorted - the price of fuelwood reflects the present low private costs of clearing the forest rather than the long-term cost of replacement. 17/ Indigenous forest management, extension, strengthening of FD, Monitoring and Evaluation and Planning units, research and training.  - 51 - by urban households is around 50,000 tons a year, necessitating the clearfelling of about 9,000 hectares of natural forest annually. If eventually all households were to switch to the improved stoves, clearfellings of the natural forest would be reduced by around 3,150 hectares per year. In tobacco curing, wood consumption can be reduced from a national average of 43 stacked m3 per ton of tobacco cured to between 10- 15 stacked m3 by utilizing an improved furnace and better management and curing techniques. If eventually the entire crop of Virginia tobacco were to be cured using the improved techniques, this would result in a saving of around 600,000 stacked m3 per year - equivalent to clearfelling 10,500 hectares of natural forest each year. 7.09 Successful large-scale commercialization of softwood charcoal production would assist further in reducing the depletion of the natural forest. The improved stoves have been designed for use with pine charcoal. Although consumers prefer indigenous charcoal, supplies are drying up due to the Government's restrictions on charcoal making in the natural forest which is facilitating the market penetration of-pine charcoal. If eventually all 50,000 tons of houshold charcoal made from indigenous hardwood were substituted by soft wood charcoal, deforestation would be reduced substantially. In addition, recent trials demonstrated the technical feasibility of using pine charcoal rather than wood in tobacco curing. About 402 of estates have serious fuel supply problems, implying a potential annual market for softwood charcoal of about 20,000 tons. If around 40Z of the total Virginia tobacco crop were to be cured using softwood charcoal this would reduce clearfelling of natural woodlands by between 2-6,000 hectares annually. VIII. AGREEMENTS REACHED AXD RECOMMENDATION Agreements 8.01 During negotiations agreements were reached by IDA, the Government and ESCOM that: a) IDA's view will be taken into consideration prior to the Government implementing any major reform in ESCOM (para. 2.07); b) ESCOM and the Government will conclude agreements by December 31, 1989 for financing the construction of the 132 kV line from Nkula to Lilongwe (para 3.17); c) ESCOM and the Government will: (i) review the power investment program yearly with IDA and revise it according to agreements between ESCOM, the Government and IDA; and (ii) not undertake any major project not included in the investment program in excess of USS 5 million, unless such major project is economically and technically justified (para. 5.07); d) IDA's view will be taken into consideration in finalizing the asset revaluation study proposals and the recommendations or the study as so agreed with IDA will be implemented by March 31,  - 52 - 1991, and ESCOM will revalue its assets annually thereafter according to a method to be agreed with IDA (para 6.03); e) ESCOM will continue to keep its accounts receivable to no more than 60 days of sales (para 6.04); f) ESCOH will continue to have its accounts audited, including the Special Account and the Statement of Expenditures, by independenc accountants and sent to the Bank within four months after ESCOM's financial year ends (para. 6.05); g) IDA's view will be taken into consideration in finalizing the tariff study and the recommendations of the study so agreed with IDA will be implemented within the following 12 months or such later date as may be acceptable to the Borrower and IDA (para. 6.06); h) ESCOM will not incur any debt unless a reasonable forecast of its revenues and expenditures shows that the projected internal cash generation is at least 1.5 times the projected debt service requirement on all debt, including the debt to be incurred (para. 6.11); i) ESCOM shall: (i) finance yearly from internal sources the equivalent of not less than 30Z of its average capital expenditures incurred or expected to be incurred over a three year period; (ii) review annually with the Government and IDA whether ESCOM will meet the requirement set out in (i); and (iii) together with the Government take all necessary measures in the event such reviews show that the requirement set out in (i) will not be met (para. 6.12); j) The Forestry Department will continue to maintain a coordinator with qualifications, experience and terms of reference satisfactory to IDA (Para. 2.19); k) The Government will make regular increases in the stumpage rate as recommended in the Energy Pricing Study in order to reach a full cost recovery stumpage rate by end 1994 (para 4.10); 1) In order to encourage farmers to plant more trees the Government will provide an incentive to smallholder farmers who register their seedlings with the FD consisting of payment of five tambala for each tree, or such other amount as may be agreed upon by the Borrower and the Association from time to time, which survived two years after planting (para 4.15); m) A joint mid-term review of the wood energy component will be carried out by IDA and the Government after two years of project implementation (para. 5:32); and n) The Forestry Department will have the accounts for the wood energy component audited, including the Special Account and Statements of Expenditures, and sent to IDA together with the  - 53 - Auditor's Reports within nine months of the end of each financial year (para 5.34). 8.02 Conditions of Effectiveness a) Execution of an onlending agreement for the proposed IDA credit between the Government and ESCOM (para 5.17); and b) Notification by Austria that all conditions precedent to initial disbursement of the Austria loan have been fulfilled (para. 5.18). 8.03 Conditions of Disbursements a) The two vacant positions of principal and senior economists in EPU will be filled prior to disbursing IDA funds to finance the energy study (para. 2.17); and b) Appointment of a Project Manager for the power component (para. 5.20). 8.04 Recommendation With the above agreements, the Project is suitable for an IDA credit of SDR34.8 million (US$46.7 million equivalent) to the Republic of Malawi at standard terms, with a 40 year repayment period.  - 54 - ANNEX 1.1 MALAWI ENERGY I PROJECT HYDROELECTRIC POTENTIAL OF MALAWI Potential Status, Installed Basin MW MW Shire Valley Nkula Falls 124 104 Tedzani Falls 90 40 Kholombidzo 140 Kapichira Falls 120 Mpatamanga Gorge 120 Subtotal 594 144 Others South Rukuru I 102 South Rukuru II 125 Bua 87 Subtotal 314 Grand Total 908 144  MALAWI ENERGY I-PROJECT ENERCY BALANCE 1987 ('000 too) PRIMARY TOTAL NON TOTAL COMPOSITION ENERGY PETROLEUM ELECTRICITY ETHANOL COAL COMMERCIAL COMMERCIAL ENERGY (4) X -----------------------------------------------------------------------__----__--------------------------------- Production -- 468. 8.3 11.1 88.0 3,042.0 3,108.0 95.8 Imports 128.6 -- -- 16.7 143.3 -- 143.3 4.4 Change in Stocks (1) (1. 1) __ (1.0) (4.0) (8.1) __ (8.1) __ --------------------------------------------------------------------__-------__-------- TOTAL 125.6 48.6 8.3 27.8 203.2 3,042.0 3,245 2 100.0 ---------------------------------------------------------------------__------__-------- Transf.& Other Losses (2) (4.2) (7.7) __ (0.S) (12.4) (386.5) (378.9) (11.6) NET SUPPLY 121.3 38.9 7.3 23.3 190.8 2,875.5 2,888.3 88.4 ----------------------------------------------------------------__-----------__-------- Exports (3) 11.1 -- -- -- 11.1 -- 11.1 0.3 FINAL CONSUMPTION 110.2 38.9 7.3 23.3 179.7 2,675.6 2,865.2 88.1 Ind/Commerce 34.1 32.3 __ 23.0 89.4 168.3 247.7 8.6 Transport 58.8 -- 7.3 -- 65.9 -- e6.9 2.6 Agriculture 12.9 -- -- -- 12.9 820.6 833.5 22.1 Household 4.1 6.4 -- 0.3 10.8 1,898.8 1,907.4 6.86 Power 0.5 0.2 -- -- 0.7 __ 0.7 -- EGY CONS. MIX (X) 3.9 1.4 0.2 0.8 6.3 93.7 100.0 100.0 COM.EGY CONS. MIX (X) 61.3 21.7 4.0 13.0 100.0 NOTES: (1) Figures in brackets indicate an increase in stocks. (2) Figures in brackets indicate losses due to transformation or transmission (both technical and non-technical). Diesel generation transformation losses are included here. (3) Petroleum exports indicate bunker sales to aviation. (4) Non-Commercial energy calculations are based on data quoted in Economic Report 2988, Malawi Government SOURCES: Mission estimates based on data collected from Oil Companies, Petroleum Commission, MIDCOR, ESCOM, and ETHCO  MALAVW PROPOSED ORGANIZATION AT GOVERNMENT LEVEL FOR MEDIUM TERM PLANNING PROCESS (ALL PARASTATALS) |Committee considers plan and LTE's fct DSB coordlnktes meeth' of Teosuy. Parent Ministry. Parstatal Management and EP & D representative Attenckwc Att"endance PARENT ~~~~~~~~~DEPARTMENT OF STA1PJTORY BODIES Trexsur Informs DSBove ofmlb to D58 financial constraints opessubmission toDS Parent Minitry provides DSB ciculotes p stras:tal with sectorl pdicy guidelines Imedhterm Inftotn on BOAQD OF IRTSTEES financial constraints Parastata deveops plan and financial forecast 4PARASTATAL. MANAGEMENT World Bank-42646 2 lrJ  MALAYA ENERGY I PROJECT ELECTRICllY SUPPLY COMMISSION OF MALANW Orgnization Chart I Genw mnw , . F * ~~~~~~~~~~~~~~~~~~~~~~~~AleO Ma- (S-1h) r cbl Er av0 n0 MOrKor (cnothw) L clmftonw E &M notew A-0 monoo. P~~~~~cfeci~~~~~~~. ___________ _ ______ ______ Il-I~~~~~~~~~~~~~ l ~ ~~~~ l l I 5 $ [ = |~~~~~~~~~~~omo I T I_ I I | | |I _ v b~~~~~~~~~~~~NR El.5Zb 1hlCC & I