Ghana - National Electrification Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 11256-GH STAFF APPRAISAL REPORT REPUBLIC OF GHANA NATIONAL ELECTRIFICATION PROJECT FEBRUARY 4, 1993 Industry and Energy Division Western Africa Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENT (Average 1992) Currency Unit = Cedi US$1 = C442 el = US$0.002 WEIGHTS AND MEASURES Kilowatt (kW) = 1,000 watts Megawatt (MW) = 1,000 kilowatt (kW) Kilowatt hour (kWh) = 1,000 watt hour Gigawatt hour (GWh) = 1 million kilowatt hour (kWh) Kilometer (km) = 1,000 m or 0.62 miles Kilovolt ampere (kVa) = 1,000 volt ampere Megavolt ampere (MVA) = 1,000 kilovolt ampere (kVA) One barrel (bbl) = 0. 16 cubic meters One ton of oil equiv. (TOE) = about 7 bbl of crude oil PRINCIPAL ABBREVIATIONS AND ACRONYMS USED CCCE = Caisse Centrale de Cooperation Economique, France CEB = Communaute Electrique du Benin CIDA = Canadian International Development Agency DANIDA = Danish International Development Agency ECG = Electricity Corporation of Ghana EECI = Energie Electrique de la Cote d'Ivoire EDF = Electricite du France EIB = European Investment Bank ESB = Electricity Supply Board of Ireland GOG = Government of Ghana MOE = Ministry of Energy NED = Northern Electricity Department, VRA NEF = National Electrification Fundy PNDC = Provisional National Defence Council SONABEL = Societe National d'Electricite du Burkina UNDP = United Nations Development Program VALCO = Volta Aluminum Company VRA = Volta River Authority FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY GHANA NATIONAL ELECTRIFICATION PROJECT Table of Contents Page No. CREDIT AND PROJECT SUMMARY ................................ iv I. THE ENERGY AND POWER SECTORS ........... ..1................ A. Energy Resources and Consumption ............................. 1 B. Energy Sector Organization .................................. 2 C. Energy Policy and Pricing ................................... 2 D. Existing Electricity Supply Facilities ............................. 3 E. Trends and Pattern of Electricity Consumption and Exports .............. 3 F. Access to Electricity Service .................................. 4 G. Power Sector Objectives, Strategy and Development ................... 5 H. Private Sector Participation .................................. 6 I. Electricity Tariffs ........................................ 7 J. Bank Role in the Power Sector ............................... 10 -1. THE IMPLEMENTING AGENCIES ....................11........... 1 A. Volta River Authority ..................................... 11 1. Organization, Management and Staffing ....................... 11 2. Accounting and Audit .................................. 12 3. Recent Financial Performance ............................. 12 4. NED Finances .16 5. Financing Plan (1992-99) ................................ 17 6. Future Financial Position ................................ 18 B. Electricity Corporation of Ghana ............................. . 18 1. Organization and Management ............................. 19 2. Manpower Planning, Staff Development and Training .............. 19 3. Accounting and Audit .................................. 20 4. Customers Receivables ................................. 21 5. Recent Financial Performance ............................. 21 6. Tariffs ............................................ 24 7. Financing Plan (1992-99) and Future Financial Position .... ......... 24 This report is based on the findings of a preappraisal mission to Ghana in May of 1992, and an appraisal mission in August/September of 1992. The preappraisal mission consisted of Messrs. J. Borounand (Task Manager/Economist), L. Cosenza (Senior Power Engineer), C. Algandona (Power Engineer), and A. Chandramani (Financial Analyst). The appraisal mission consisted of Messr. J. Boroumand (Task Manager/Economist), K. K. Franji (Principal Financial Analyst), M. Segal (Senior Economist), C. Algandona (Power Engineer), Mmes. M. Manalo (Operations Assistant), sad L- Cruz (Sr. Staff Assistant). Mr. James Bond reviewed the institutitional strengthening component, and Mr. John Besant- Jones reviewed the economics of the project. Secretarial and administrative support was provided by Ms. L. Cruz. Ms. Mary Oakes Smith and Mr. Edwin Lim were the managing Division Chief, and Department Director, respectively, for the operation. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Page No. IH. THE PROmC . ...................................... 26 A. Project Objectives ................ .. ..................... 26 B. Project Description ................ .. .................... 26 C. Project Cost ........................................... 27 D. Project Financing Plan ................. ................... 30 E. Project Implementation ............... .. ................... 31 1. Status of Preparation and Execution .......................... 31 2. Monitoring and Reporting Requirements ....................... 33 3. Procurement . ....................................... 34 4. Disbursements ........................................ 36 F. Environmental Aspects ............... .. ................... 38 G. Project Justification, Benefits and Risks .......... .. .............. 38 1. Project Justification ........... ........................ 38 2. Project Risks . ...................................... 40 IV. AGREEMENTS REACHED AND RECOMMENDATIO. ................ 40  ANNEXES 1-1 Energy Balance 1990 1-2 Electricity Consumption 1-3 Load Forecast and Energy Balance (GWh), 1991-2001 1-4 Load Forecast and Capacity Balance (MW), 1991-2001 1-5 Letter of Power Sector Development Policy 1-6 VRA's Capital Investment Program, 1992-1999 1-7 ECG's Capital Investment Program, 1993-1999 1-8 Structure of the Customer Service Directorate 1-9(a) Terms of Reference for Preparation of the Management Contract 1-9(b) Draft Terms of Reference for an Expert to Assist ECG in the Hiring of a Management Contractor 1-10 Electricity Tariff Schedule 1-11 An Electricity Tariff Formula 2-1 VRA's Corporate Organizational Structure 2-2 VRA's Income Statements, Balance Sheets, Funds Flow Statements (1989-1999) 2-3 VRA's Assumptions for Financial Projections 2-4 ECG's Organizational Structure 2-5 ECG's Proposed Organizational Structure 2-6 ECG's Income Statements, Balance Sheets, Funds Flow Statements (1989-1999) 2-7 ECG's Assumptions for Financial Projections 3-1 Detailed Project Description 3-2 Sub-Projects in VRA Service Area 3-3 Sub-Projects in ECG Service Area 3-4 Project Cost 3-5(a) VRA's Project Financing Plan 3-5(b) ECG's Project Financing Plan 3-6(a) Project Implementation Schedule 3-6(b) Estimated Procurement Schedule 3-7 Terms of Reference for Project Monitoring and Control Consultants 3-8 Organizational Chart for Project Management, VRA 3-9 Organizational Chart for Project Management, ECG 3-10 Terms of Reference for Productive Users of Electricity 3-11 Supervision Plan and Key Performance Indicator 3-12 Guidelines for NES Data Base Update 3-13 Estimate Disburesment Schedule 3-14 Economic Analysis of the Electrification Component 3-15 Economic Analysis of Improvements to the Existing System 4-1 Document Contained in the Project File Ma IBRD NO. 24315   - iv - GHANA NATIONAL ELECTRIFICATION PROJECT CREDIT AND PROJECT SUMMARY Borrower: Republic of Ghana Beneficiary: The Electricity Corporation of Ghana (ECG) and The Volta River Authority (VRA) Amount SDR 55.2 million (US$80 million equivalent) Terms: Standard IDA, with 40 year maturity Relending Terms: The Government would relend SDR 28.44 million (US$41.22 million equivalent) to ECG and SDR 26.21 million (US$37.98 million equivalent) to VRA for 20 years, including 5-year grace period at the prevailing IBRD interest rate. ECG and VRA , ould bear the foreign exchange risk. Project Description: The project is comprised of three main components: (i) a portion of a time slice (1993 to 1997) of the investment program defined under an IDA-financed National Electrification Planning Study (NEPS), which would include connection to the national power grid of all of the district capitals that are not supplied from the grid; (ii) re-inforcement of the ECG's existing distribution network by expanding substations, and building or replacing major links between substations; and (iii) institutional strengthening of ECu through regrouping of all its commercial activities under one Directorate and hiring an outside firm under a performance-based management contract to run this new Directorate. Project Benefits and Risks: The proposed project will help: (a) provide the relatively inexpensive hydro-generated electricity from the national grid to small urban centers and rural areas in different regions of the country, which would assist the Government to bring more of the benefits of the recent economic growth to the regions, and accelerate the socio-economic development of areas outside of the major urban centers; (b) improve the reliability of ECG's existing distribution network which is being constrained by rapid growth in demand for electricity; and (c) implement institutional reform of ECG to improve its efficiency which is required to make the utility a commercially viable entity. One major risk of the project is that it may overburden ECG's commercial operations and further contribute to ECG's weak financial position. This is being addressed through proposed institutional reform. Also, adequate and timely tariff increases is a potential risk which is being addressed through an upfront tariff increase and establishment of a tariff formula.  Estimated Project Cost: US S Million Equivalent Component Local Foreign Total I. National Electrification Component 294.4 71i33 100.73 ECG Service Area Sub-Stations 0.27 1.94 2.21 Transmission 7.50 15.87 23.37 Distribution 4.43 15.70 20.13 Engineering 3.04 2.29 5.33 Offices and Equipment 0,60 2AQ3.0 Subtotal 15.83 38.20 54.03 VWANED Service Area Sub-Stations 0.23 1.71 1.94 Transmission 6.81 14.46 21.27 Distribution 3.84 13.63 17.47 Engineering 2.29 1.73 4.01 Offices and Equipment 0A4 1.60 2.0 Subtotal 13.57 33.12 46.70 II. Distribution Reinforcement 5.51 21.04 26.55 Sub-Stations and Sub-Transmission 1.95 2.79 9.74 Distribution Development 3.11 12.45 15.56 Engineering 0.45 0.80 1.25 III. Management Contract 0.50 4.50 5.00 IV. Training and Studies 0 8 4.00 4.80 V. PPF Refund 0 80 0 80 Base Cost 36.21 100.67 137.87 Contingencies 7.57 20.79 28.36 Total Project Cost 43.78 122.46 166.23 Interest During Construction 19.10 19.10 Total Financing Required _2.8 122.46 185.33  - vi - US S Million Equivalent Local Foreign Total Flnandiny Plan IDA - 80.00 80.00 VRA 13.86 - 13.86 ECG 24.01 - 24.01 NEF 12.62 - 12.62 DANIDA ,I 5.20 14.32 19.52 CCCE A/ 0.50 4.50 5.00 Netherlands g/ 6.69 18.41 25.10 Others.A/ _ 5 2 2 Total 62.88 122.45 185.33 Estimat Disbursements IDA Fiscal Year - ~(US$ million equivalent) 1223 1994 1995 1226 1227 1998 Annual 1.3 6.7 20.5 27.5 18.5 5.5 Cumulative 1.3 8.0 28.5 56.0 74.5 80.0 Economic Rate of Return: National Electrification Component 12% Distribution Reinforcement 36% 3/ Amounts indicated are subject to confirmation.   GHANA NATIONAL ELECTRIFICATION PROJECT I. THE ENERGY AND POWER SECTORS A. Energy Resources and Consumption 1.01 Ghana has substantial energy resources, of which fuelwood and hydropower are the most important. About 18.3 million hectares are under tree cover, equivalent to three quarters of the country's land area, of which about 8.8 million hectares is forest. The high forest zone is concentrated in the southwest, where most of the timber industry is located. The northern savanna woodland has less timber potential, but is the most important source of domestic fuelwood. Deforestation is a growing problem in this area and fuelwood scarcities are beginning to develop as a result. This issue is being addressed under the Ghana Environmental Action Plan and the Ghana Forest Resource Management Project. 1.02 Ghana's hydroelectric potential has been the subject of many studies, some dating from the 1920s but which have mainly covered specific projects or regions. The country's total technically exploitable hydro potential is estimated at 10,000 GWh annually (2,300 MW installed capacity), derived mainly from three major river systems (Volta, Tano, Pra) in the central and western regions. The presently installed hydro plant capacity is 1,072 MW, based on two dams on the Volta River. Other sites on the Black Volta, Pra, Tano and Oti rivers have been studied to pre-feasibility stage and one of these, Bui (300 MW and 1,175 GWh) has been studied to full feasibility level. There has been a comprehensive, country-wide survey of small hydro potential, and some recently identified sites could possibly provide an economic supply to isolated centers. Offshore deposits of both crude oil and natural gas have been identified, but their size and commercial viability remains to be confirmed. Ghana has no known deposits of coal. Solar energy is plentiful with most regions receiving in excess of 1,900 hours of annual sunshine. This potential has not yet been exploited to any extent. Wind regimes are moderate, and insufficient for energy purposes based on existing technology. 1.03 Net domestic energy consumption in 1990 1/ is estimated at 4.165 million toe, rather low given the structure of the economy and its favorable energy resource endowment. The bulk of consumption is woodfuel and agricultural residues (69.5%) followed by petroleum products (20.4%), and electricity (9.9%). Households and commerce accounted for 65 percent of domestic energy consumption, industry/mining 17.4 percent, and transportation 12.6 percent. An overall energy balance for Ghana is contained in Annex 1-1. Petroleum products and electricity consumption increased steadily throughout the 1970s and early 1980s despite the deteriorating economy, spurred by subsidized petroleum products and low real prices for electricity. However, consumption declined sharply after 1982 because of shortages of both petroleum and electricity, but have since recovered as supply conditions returned to normal. 1/ 1990 is the most recent year of consolidated energy supply and demand data for Ghana.  -2 - B. Energy Sector Organization 1.04 The Ministry of Energy (MOE) has principal responsibility for petroleum and electricity; it establishes and implements sector policy. MOE supervises the state-owned Ghana National Petroleum Corporation (GNPC), Ghana Oil Corporation (GOIL), and the refining company Ghanaian Italian Petroleum Corporation (GHAIP), as well as the two power sector entities -- the Volta River Authority (VRA) and the Electricity Corporation of Ghana (ECG). VRA supplies electricity in bulk to ECG, the Volta Aluminum Company (VALCO), several mines, the Akosombo Textile Company, and Akosombo Township. VRA also exports electricity to Communaute Electrique du Benin (CEB) and Energie Electrique de la Cote d'Ivoire (EECI). Under the IDA-assisted Northern Grid Extension Project (Credit 1759-GH) of February 1987, the responsibility for generating and distributing electricity in Northern Ghana was transferred to VRA from ECG. These responsibilities are handled by VRA's Northern Electricity Department (NED). ECG distributes the electricity it receives from VRA throughout the rest of Ghana. 1.05 Since its foundation in 1961, VRA has operated as a quasi-enclave within Ghana, enjoying a high degree of autonomy. VRA is a relatively well-run public utility with few institutional and financial problems. ECG, which is a much larger organization, was set up in 1967 to succeed the Electricity Division of the Ministry of Works and Housing, but has never satisfactorily made the transition from a Government department to a commercially viable enterprise, and it is yet to establish itself as an autonomous and effective public utility. In an effort to improve performance of the power sector, the Electricity Supply Board of Ireland (ESB), acting as consultant to GOG, studied the situation in 1985 and concluded that a merger of VRA and ECG offered the best prospect for the future development of the sector. GOG, with the concurrence of IDA, considered that a merger would have strained VRA's capabilities, particularly at a time when it was embarking upon a major expansion program in northern Ghana. ECG's position was extremely weak, both financially and managerially, and required major reforms and external assistance to establish it as a sound public utility. Consequently, the merger did not proceed but was retained as one of several sector organization options, to be considered in the light of ECG's performance over the next few years. Meanwhile, attention has been focussed upon sector reforms and other measures needed to strengthen ECG. With ESB's assistance, progress has been made in technical operations under the Power System Rehabilitation Project (Credit 1628-GH) and ECG Fifth Power Project (Credit 2061-GH). However, ECG's commercial operations needs substantial improvement. To improve commercial operations of ECG, a performance-based management contract with a private firm will be financed under the proposed project (para. 1.21). C. Energy Policy and Pricingi 1.06 Government policy in the energy sector is designed to: (i) reduce the cost of energy supplies to the economy through rehabilitation and proper maintenance of installations in the petroleum and electricity sub-sectors; (ii) reduce dependence on petroleum imports through promotion of more efficient energy use and proper pricing; (iii) improve forestry management to provide an adequate long-term supply of fuelwood; and (iv) strengthen sector institutions through a program of public enterprise reform focusing on commercialization. 1.07 Prices of petroleum products and electricity fell sharply in real terms from the mid-1970s till 1983, as a result of Governmental energy pricing management, which failed to fully reflect in petroleum product and electricity prices the extent of high domestic inflation or to  - 3 - adjust for over-valued exchange rates during that period. After the major devaluation of the cedi in 1983, domestic energy prices were increased very sharply to bring them back into line with their international equivalents. Subsequent increases in petroleum prices have kept up with the successive devaluations until early 1991. Petroleum product prices are now within the range of international levels and are unsubsidized. Electricity pricing is discussed below (paras. 1.22). D. Existing Electricity Supplv Facilities 1.08 Ghana's total installed public generating capacity is about 1,122 MW of which 1,072 MW (95%) is hydroelectric from two stations on the Volta River at Akosombo (912 MW), and Kpong (160 MW). Both stations are owned by VRA and are capable of providing firm energy (in 49 years out of 50) of about 4800 GWh/year and can deliver 6100 GWh/year on average. The Akosombo Power Stations will be retrofitted under the ongoing VRA Sixth Power Project. Total diesel capacity is less than 50 MW of which Tema (30 MW) is the largest and is currently being rehabilitated with U.K. financing and is expected to become operational in 1993. The remainder comprises a number of small isolated stations which are being retired under the ECG Fifth Power project. 1.09 Ghana's transmission system comprises over 2,100 km of 161 kV lines. Eight circuits of 67 km each connect the Akosombo and Kpong hydro plants to the VALCO smelter at Tema and to other industrial loads, while a 650 km transmission loop supplies ECG and mines in southern Ghana. A 161 kV double circuit line provides an interconnection with CEB, connecting Akosombo to Lome, Togo. The Cote d'Ivoire was interconnected in 1983 through a 225 kV transmission line capable of supplying a demand of 100 MW. 1.10 ECG distributes power in the urban centers located within an interconnected grid in the southern part of Ghana. ECG's facilities comprise a number of 33 kV subtransmission systems, feeding power from VRA's transmission system, and a number of 11 kV distribution systems. In recent years, service within the distribution system has deteriorated due largely to poor maintenance and inadequate reinforcement of the distribution system. These problems are now being addressed under ECG Fifth Power Project and the distribution system rehabilitation would be completed by 1994. E. Trends and Pattern of Electricity Consumption and Exports 1.11 Domestic and export sales of electricity since 1985 are detailed in Annex 1-2. The main categories of electricity sales are VRA's sales to ECG and NED, VRA's sales to VALCO, VRA's sales to neighboring countries and ECG and NED retail sales to domestic consumers. Until the severe drought of 1982/84, when electricity supplies were seriously curtailed, about 75 percent of sales were for export to neighboring countries and to the VALCO aluminum smelter. During the drought the latter was completely shutdown and supplies to CEB and to ECG were reduced. Total system sales fell from 5071 GWh in 1981 to 1594 GWh in 1984. Since 1985 supplies have been restored to all customers. 1.12 Sales to VALCO recovered from very low levels over 1984 and 1985 to exceed 2100 GWh from 1986 onward. Maximum energy assigned to VALCO is now 2760 GWh annually, for four potlines, with the right of first refusal for any additional available energy, at a price to be negotiated. VALCO's expected annual consumption is about 2760 GWh. ECG's sales fell sharply as a result of supply restrictions from 1005 GWh in 1981 to 723 GWh in 1984,  - 4 - but have since recovered to about 1500 GWh in 1991, in part assisted by the improvements under the ongoing rehabilitation project. ECG's total system losses (i.e., technical and non-technical losses) in 1991 were reported to be 20 percent of energy purchased from VRA. This is expected to be reduced as a result of the ongoing rehabilitation of the ECG's network and the improvements in its commercial operations expected under the project (para. 1.21). 1.13 VRA pioneered electricity supply across national boundaries in Western Africa and established links with CEB in Togo/Benin (1972) and with EECI in Cote d'Ivoire (1984). Sales to neighboring countries declined from 684 GWh in 1985 to 301 GWh in 1988, following the commissioning of CEB's Nangbeto hydrostation, but grew to 526 GWh in 1989, 737 GWh in 1990, and 788 GWh in 1991. These exports are covered by two contracts: (i) a firm contract with CEB (expiring in 1994) providing CEB with up to 438 GWh per year, and (ii) a contract with CIE in Cote d'Ivoire (to be renegotiated in 1993) providing for annual determination of the contract volume. The future volume of these exports depends upon VRA's ability to supply energy and capacity, CEB's and CIE's internal supply capability, the continuation of a large enough cost advantage in VRA's favor to make the continuation of this trade worthwhile, and the importers' confidence in the reliability of the supply arrangement, which to date has not been a problem. Over the next several years, there is a question about the adequacy of supply to sustain recently experienced export volumes, given high domestic load growth and the forthcoming Akosombo retrofit. Cote d'Ivoire is also contemplating the development of its off-shore natural gas resource and gas turbine electricity generators, which could displace VRA sales to CIE; however, the evolution of this project may be slow. These exports make an important contribution to VRA's revenues, insofar as export prices are about five times greater than the bulk supply tariff to ECG. Hence, as domestic loads grow relative to export loads, the adequacy of domestic pricing arrangements becomes a more important consideration for VRA's financial health. 1.14 The domestic load has experienced high growth from the mid-1980s to now, and this upward pressure of demand is expected to continue through the mid-1990s, as the system is progressively improved and the economy continues to grow. With the electrification of northern Ghana, NED demand is expected to quadruple by the year 2000. VRA's and ECG's forecast of the load growth and the corresponding energy (GWh) and capacity (MW) balances through year 2001 are detailed at Annex 1-3 and Annex 1-4. F. Access to Electricity Service 1.15 In Ghana about 24 percent of the population has access to electricity.3/ ECG has about 324,000 customers, 67 percent of whom are concentrated in the three cities of Accra, Kumasi and Tema. VRA has about 30,000 customers in northern Ghana and also supplies a small number of major customers directly from the grid. About 78 percent of ECG's customers are classified as residential and 22 percent are non-residential, with less than one percent classified as industrial. ECG's sales (kWh) are about 51 percent to residential, 14 percent to non-residential and 33 percent to industrial customers. Residential customers generate about 38 percent of ECG's sales revenues, while non-residential and industrial customers account for 28 percent and 34 percent, respectively. 3/ Using a total population of about 15.0 million and a 10 person household.  -5 - G. Power Sector Objectives. Strategy and Development 1.16 Energy sector issues were examined in considerable detail in a recently completed Energy Sector Review prepared by IDA. This sector review report was discussed with the Government of Ghana in June 1992. During appraisal, a draft Letter of Power Sector Development Policy dealing with various issues identified and analyzed in the Energy Sector Report was reviewed with the Government. Before negotiations, the Government submitted to IDA a Letter of Power Sector Development Policy which is given in Annex 1-5. Ghana Government has embarked upon an ambitious program of economic growth, a major element of which is the reform of the public enterprise sector. Under this program ECG and VRA are key public utilities to be commercialized. For many years VRA has been a relatively autonomous, financially viable and well-run entity; attention is now focussed upon bringing ECG to a similar standard. The ultimate objective is a financially viable, well-managed sector, whose institutions enjoy a high degree of autonomy and are capable of delivering a reliable and economic supply of electricity. Specific measures identified in the Letter of Sector Development Policy to facilitate the achievement of these commercialization objectives include: (a) Depoliticizing the tariff making process using a formula-based approval (para. 1.26 and Annex 1-10); the Government should also consider establishing a regulatory approach operating at arms length from the political process; (b) Improving the internal efficiency of critical commercial operations in ECG, by ECG engaging a contractor on the basis of a performance-based management contract to revamp billing, collection and customer relations; (c) Engaging a consultant to recommend a scheme of service for both utilities, including matters such as staff deployment, renumeration levels, incentive schemes, sanctions, and any other such matters likely to affect the motivation and efficiency of the utilities' personnel. 1.17 Improving the sector's efficiency and delivery capability is now of the highest priority. As a result of a renegotiated contract with VALCO in 1984, VRA is now better able to protect the domestic market against power restrictions than in the past, by reducing supplies to VALCO in years of poor rainfall. Reliability of the present Akosombo units has deteriorated in recent years and studies confirmed that VRA needed to undertake a major retrofitting of the 25 year-old Akosombo hydroplant to avoid the risk of major breakdowns. This work is now being carried out under the VRA Sixth Power Project. VRA's investment program (1992-1999) totalling about US$870 million equivalent is set out at Annex 1-6. A major component of this investment program is an addition of up to 400 MW of thermal capacity (combustion turbines) to VRA's generation capacity. To clearly demonstrate the economic and technical viability of this investment, VRA has prepared a feasibility study which is under review. To improve the service reliability and development of the sub-transmission and distribution network which had deteriorated because of poor maintenance and under investment caused by lack of access to foreign exchange, with the assistance from IDA, ECG has embarked on a major rehabilitation of its system under the ongoing ECG 5th Power Project. The proposed project also includes a component to complement the rehabilitation work to be carried out under ECG 5th Power Project and provide for system reinforcement to meet the larger than expected growth in demand for electricity. The ECG's investment program (1992-1999) totalling about US$470 million equivalent is set out in Annex 1-7.  - 6 - 1.18 A major GOG long-term (30 year) goal is to provide electricity to most of the population, by extending the interconnected transmission grid to small towns and rural areas throughout Ghana under a National Electrification Scheme (NES) . The implementation of NES which began in earnest in 1989, has focussed on the District Capital Electrification Program (DCEP) which aims at connecting all the 110 district capitals in the country to the national electricity grid; and on the Self-Help Electrification Program (SHEP) under which villages/towns within 20 km of the national grid are connected to the grid after they have made material contributions (poles, labor) to the construction of the lines. With mainly bilateral assistance from other countries (e.g., Japanese and India), twenty district capitals have been provided with electricity supply from the national grid, in addition to sixty other towns/villages along the supply routes and surrounding areas of these district capitals. In addition to this, about 180 towns and villages have also been connected to the national electricity grid through the SHEP program. In order to establish a sound framework for development of NES, including appropriate policies and standards, and to identify priority programs for the extension of the grid to unelectrified areas of Ghana in accordance with satisfactory economic criteria, a National Electrification Planning Study (NEPS) was prepared under the ECG Fifth Power Project. The electrification component of the proposed project is based on the NEPS and comprises investment identified in the early phase of the study, by taking into account not only the economically optimal timing of the electrification of each area within the program, but also the Government's priority to electrify district capitals and maintain some regional balance in the progress of electrification. H. Private Sector ParticiDation 1.19 One major institutional issue facing the power sector is the management of ECG's commercial operations (i.e., metering, billing, revenue collections) which need be strengthened substantially. In line with the Government's objective of commercializing ECG mentioned above, ECG's management has now focused on improving ECG's commercial operations through participation of the private sector in these areas of its operations. ECG with the assistance of ESB, with whom it has a twinning arrangement, has examined the problem and identified shortcomings in: (i) meter control (compliance with the customer recording and control system); (ii) customer data base (accuracy, application of proper tariff, elimination of unmetered supplies, independent testing of SLT metering and clearance of queries/rejections from data processing); (iii) meter reading (observance of reading cycles, and minimization of no-access cases); (iv) billing system (inability to generate appropriate customer information); and (v) disconnection of non-paying customers (timely and indiscriminate disconnection). The addition of new and widely dispersed customers through the expansion of the ECG network under the proposed project may over-burden ECG and further contribute to weakening ECG's financial position if its commercial operations do not improve. 1.20 ECG has already taken or is considering a number of measures to address these problems. It has accepted a proposal from ESB to adapt ESB's own billing system to suit ECG's requirements. The new system would require approximately 18 months to be operational. Also with bilateral financing from France, ECG intends to clean up its consumer data base. To address the other issues, ECG has begun to hire private contractors for meter reading, and it is contemplating contracting out some other functions, such as meter installation and bill distribution. Nevertheless, the process is painstakingly slow, it dilutes responsibility among several parties and leaves some issues unresolved, notably those referring to the validation of the customer data base, revenue collection and disconnection for non-payment. Although entrusting more commercial functions to different private parties would improve the present state of affairs, _ _-- - -  -7- appropriate incentives are needed to achieve adequate and sustainable improvements in reducing losses and disconnect those who do not pay for the service that they receive. 1.21 During the appraisal agreement was reached with the Government and ECG that adequate and sustainable improvements can be achieved by involving the private sector in a more comprehensive fashion, through a performance-based management contract to run the commercial operations of ECG. ECG's management has proposed: (i) to reorganize the utility by grouping all the commercial activities which are now under two different Directors (i.e Operations and Finance) under a new Directorate of Customer Services, and (ii) with bilateral financing from France hire the Electricite du France (EDF) under a performance-based management contract to run the new Directorate of Customer Services. See Annex 1-8 for the proposed organizational structure of the new Directorate of Customer Services. Under the performance-based management contract, the contractor (i.e. EDF team) will be given the necessary and sufficient authority to manage the commercial operations of ECG, and the contractor's remuneration will be linked to its performance. The management contractor will be under the overall direction of the ECG's Managing Director. With bilateral financing from CCCE, ECG expects to have the management contractor in place in a relatively short time. ECG also requested IDA to finance under the project's PPF, services of an expert or a consultancy firm to advise and assist ECG on the management contract and in negotiations with the contractor. ECG's proposal and request were reviewed favorably by the appraisal team. During negotiations, agreement was reached on the main elements of the performance contract and the nature of the performance indicators to be used, as well as a draft terms of reference for the services of the expert to assist ECG with the management contract. These documents are provided in Annex 1-9. An expert to assist ECG with review and negotiations of the management contract has been hired with financing from the project's PPF. Signing of a performance-based management contract satisfactory to IDA is a condition of Credit effectiveness. I. Electricity Tariffs 1.22 Consistent with GOG's goal to provide an efficient, economic, and affordable supply of electricity to the whole country, a high priority is accorded to the mobilization of resources from within the sector by charging tariffs sufficient to cover supply costs, to contribute a reasonable portion of investment costs and to earn a reasonable return on invested capital. Hence, under their respective statutes, ECG and VRA are required to operate in a commercial manner. However, the Government must approve tariff changes and in recent years, electricity tariffs have not kept pace with the substantial increases in costs associated, in particular, with major Cedi devaluations. Partly for this reason, ECG has experienced difficulties in meeting its financial obligations, including those to VRA, whose position has been cushioned by its substantial foreign currency earnings from VALCO, CEB and EECI. 1.23 In an attempt to put the sector on a sound financial footing, consultants (Coopers & Lybrand, U.K.) were commissioned in 1986 to undertake a tariff study of the power sector. The objective was to develop tariffs which reflect the economic, i.e., long run marginal costs (LRMC) of supply, and which at the same time are affordable, generate sufficient revenue to ensure financial viability, and are easy to administer. GOG agreed to adopt a uniform national tariff structure, based on LRMC principles. For 1988, the level of tariffs recommended by the consultants were substantially adopted following a review by MOE, ECG and VRA and approximated about 75 percent of LRMC. In order to ensure the financial viability of the power sector, GOG has also established a target rate of return of at least 8 percent on currently valued  - 8 - net fixed assets in operation. Tariffs adopted for 1989 were designed to enable VRA to continue to earn an 8 percent and ECG a 6 percent rate of return, as agreed under the Fifth Power Project. Increases ranged from 6 percent for low-income consumers to 20 percent for non-residential users. In fixing tariffs for 1989 GOG expressed serious concern at the prospect of further adjustments to domestic tariffs to reflect recent devaluation and inflationary pressures at a time when the service remains unreliable. While maintaining its commitment to previously agreed tariff objectives, GOG wished to re-examine certain aspects of the 1986 tariff study in the light of developments since then. A comprehensive tariff study, financed by CIDA, was undertaken to address the GOG's concerns and was completed in February 1992. 4/ 1.24 The study calculated the LRMC of Ghana's power system on the basis of a load forecast similar to that in this report, tested the sensitivity of LRMC to the implementation of the NES, and determined that there are very large gaps between current tariffs and tariffs which would reflect LRMC with or without the NES. These alternative tariffs are shown in Table 1-1. The gap between actual and LRMC tariffs is very large. The "Full Financial" tariff shown in Table 1-1 is that needed for the utilities to strictly meet all of the conditions of their current financial covenants. There is very little difference between the LRMC tariff and the "Full Financial" tariff. Approximately 27 percent of LV LRMC is incremental generation cost, and the remainder is HV and LV transmission and distribution cost, and other expenses for rehabilitation, maintenance and system improvements. 4/ 'Ghana Power Sector Tariff Study, February 1992", Acres International, Niagara Falls Ontario, in association with Ontario Hydro.  -9 - Table 1-1: G - ALTERNATE TARDY STiAEGS AVERAGE CUSTOMER COSTS (CkW%) Current Tariff Strategy Tariff Levels Level Level Strict Full LRMC Tariff Class 1991 1992 LRMC Financial US Cents/KWH Residential 8.1 11.8 39.9 39.5 10.9 Non Residential 20.4 28.8 28.7 28.7 7.9 ECG Industrial LV 9.5 25.2 36.1 35.7 9.9 ECG Industrial HV 8.8 16.3 26.2 25.9 7.2 VRA Industrial HV 7.8 17.6 24.3 20.2 6.7 Bulk Supply 3.6 3.9 17.7 15.4 4.8 Source: "Ghana Power Sector Tariff Study": ECG, VRA for 1992 tariff levels. Acres International, Niagara Falls, February 1992, Table 8.2, except for last column. Note: The price to VALCO is based on a fonnula in part related to the world aluminum market and varies according to a basket of international aluminum prices. 1.25 The tariff study spells out the consequences of "deferring the problem", that is, not implementing any tariff change: - The utilities would be unable to meet even their most basic financial requirements. - It would be difficult, if not impossible, to raise money to cover expansion or basic cash flow needs. " - The power sector would face the risk of defaulting on loans unless government bailouts could be ensured..." This is a realistic prognosis. 1.26 The process of preparing the tariff study and its recommendations has resulted in Ghana Government implementing positive steps to reduce the identified gap between the 1991 tariff and the LRMC of supply. As of January 1992, new electricity tariffs were introduced (see Annex 1-10) which have the following main features: (i) the residential tariff increased from about 20 percent to 30 percent of LRMC; (ii) ECG's non-residential tariff reflects LRMC; and  - 10- (iii) the LV and HV industrial tariffs moved from 26 percent and 33 percent of LRMC to about 42 percent and 54 percent of LRMC respectively in the case of ECG, and to about 70 percent of LRMC in the case of VRA. Furthermore, Ghana Government has asked the utilities to construct a tariff formula for making further progress toward overall attainment and maintenance of electricity prices at LRMC. The Government has also welcomed IDA's advice on this matter. Tariff formulas presented in Annex 1- 11 were discussed with the Government and the Utilities during the appraisal. The formulas provide for phasing-in current tariffs to LRMC adjusting for inflation and exchange rate movement from 1991 onward. Apart from these adjustments, the 1991 LRMC calculation could change, particularly on account of changes in projections of load growth and thermal energy requirements. Azreement has been reached (a) upon a formula procedure to set and adjust electricity tariffs; and, (b) that beyond 1993, each year's tariff must be high enough so that each utility earns at least 8 percent rate of return on net revalued assets in operation (see paras. 2.11 and 2.33). It is the Government's intention that the tariff approximate LRMC by 1996 and remain at LRMC thereafter. J. Bank Role in the Power Sector 1.27 The Bank Group has been closely involved in the development of Ghana's power sector, with eight lending operations in the past 30 years. Since 1961, three Bank loans to VRA have assisted in the financing of the Akosombo and Kpong dams and power plants and recent Credits (1628-GH and 1759-GH) have helped VRA rehabilitate its system and extend grid supply to northern Ghana. Under the ongoing VRA Sixth Power Project (Credit 2109-GH), assistance is provided for a major overhaul of Akosombo hydro generation facilities. Lending to ECG began soon after its formation in 1967 and currently, the ECG Fifth Power Project (Credit 2061-GH) is assisting with improvement of ECG's network in the major urban centers. Bank Group lending for power projects in Ghana has helped finance virtually all the major sector investments since Ghana's independence. The Bank's participation in the Akosombo and Kpong hydro generation projects and the ongoing Northern Grid Extension Project was especially important in mobilizing the large amounts of cofinancing needed for these ambitious projects. 1.28 The Bank Group has been closely associated with Ghana's power sector for almost 30 years. Since Ghana embarked on its economic recovery program in mid-1980s, IDA's objective has been to help remove the power sector as a potential constraint to the country's economic development and to assist the Government in developing a financially viable and well- managed sector, whose institutions enjoy a high degree of autonomy and are capable of delivering a reliable and economic supply of electricity. In recent years, under several completed and ongoing projects financed by IDA, the Government has embarked on rehabilitating and improving Ghana's power generation and distribution facilities and it is very keen on IDA's further assistance to extend the benefits of power supply to more of the population. IDA's continued participation in the sector through the proposed project is justified in order to assist the authorities to develop a sound national electrification program, to expand the social and developmental benefits of electricity to more of the population, facilitate the development of a more balanced distribution of economic productive activity across the country, act as catalyst to facilitate co- financing, and encourage the strengthening of utility commercial structures essential for the health of the power sector in general and the electrification program in particular.  - 11 - II. THE IMPLEMENTING AGENCIES A. Volta River Authority 2.01 The 1961 Volta River Development Act requires VRA not only to operate its plant according to sound public utility practices but also to develop the Volta Lake for transportation, fishing and tourism. VRA is authorized to sell the electricity it generates in bulk to any public corporation, including power utilities in neighboring countries and to Government departments. By a recent amendment, to reflect its extended responsibility agreed under the Northern Grid Extension Project, VRA is also authorized to distribute electricity in Ghana. 1. Oryanization. Management and Stafrin2 2.02 VRA is governed by a Board, whose members are appointed by the Head of State, and is composed of a Chairman (currently the PNDC Secretary for Energy) and seven others, including VRA's Chief Executive and the Managing Directors of ECG and of VALCO. The Board, by tradition, is composed of persons from outside Government services, and its quality has successfully preserved for VRA the essential autonomy from undue interference by Government endowed from the earliest days of VRA's creation. 2.03 Following a review of departmental responsibilities in 1990, VRA's senior management structure has been modified. Three Deputy Chief Executives (DCEs) - for Corporate Planning and Finance, Engineering and Operations, and Resources and Services - now report to the Chief Executive. The Board Secretary/Legal Adviser, the Director of Internal Audit and the Corporate Relations Officer also report to the Chief Executive. Each functional area is the responsibility of a Director, with appropriate supporting staff. An organization chart is at Annex 2-1. VRA is a well-run utility with a local staff of about 2850, including 450 personnel engaged in power distribution in Northern Ghana. Of the rest, about 400 are engaged in the provision of support services in Akosombo and Akuse townships. 2.04 Since its establishment more than 25 years ago, VRA has enjoyed a "twinning" arrangement with Ontario Hydro of Canada under which it has obtained a whole range of specialist advice and management services, including term assignment in Ghana, and training facilities for its own staff in Canada. VRA currently employs, at its own expense, several senior Ontario Hydro managers in specialist areas of system planning, materials management, management information systems, vehicle workshop maintenance, and general management consultancy. VRA also makes use of overseas consultants in engineering, management and finance to assist it in developing and designing new systems or to undertake sophisticated system planning tasks. VRA staff are always assigned to such tasks in order to ensure in time full "technology transfer". In addition, under the ongoing Northern Grid Extension Project, VRA has engaged a number of key expatriate project engineering staff, financed under Credit 1759-GH. 2.05 While Engineering, Systems Operations and Administration Services are well- established, the Corporate Planning and Finance function has recently been reorganized. In the past there has been a division of responsibilities between Accounting and Finance for financial matters. Accounting and Finance have now been brought together under one Director, which has improved the quality of service to senior management and the Board.  - 12 - 2.06 In addition to an extensive overseas training program VRA has a local training facility to meet its non-specialist training needs. However, its present buildings are cramped and there are no residential facilities. In order to remedy these problems and to provide for the necessary expansion of local training, VRA has proposed to provide a training center with donor assistance. VRA has received DANIDA's assistance to undertake a full feasibility study of this project. The feasibility study is expected to be completed by end-1992. 2. Accounting and Audit 2.07 The accounting and budgeting systems used by VRA are generally satisfactory and provide timely and reliable financial information. The reorganization of the Corporate Planning and Finance function in 1990-91 has been completed and the key managerial positions filled. Improvements in financial management and information systems, corporate planning and reporting have been made following the full computerization of VRA's accounts. Other improvements are expected as a result of the full integration of financial management. VRA's electricity operations are financially separate from the other activities--resettlement, lake research and lake transport-- for which separate accounts are kept. NED's activities are also kept separate from those of electricity generation/transmission, but are consolidated at the year-end. VRA maintains its accounts in accordance with appropriate international standards. Each year its fixed assets are revalued, using a satisfactory indexation formula, following the latest physical inspection and valuation in 1991. Depreciation and rate of return are calculated on the full replacement cost of VRA's fixed assets. The Cedi value of foreign currency loans is also adjusted annually at prevailing exchange rates. 2.08 VRA has an independent internal auditing department which forms part of its system of internal control. The Director of the internal auditing department reports to the Chief Executive and is independent in the discharge of this function and in the expression of opinions and findings. Following a reorganization of the department in mid-1991, when the present Director was appointed, the department has made good progress in improving its effectiveness in VRA. The immediate objectives are to strengthen the financial and computer audit functions. Over the longer term, the department's objectives are to enhance capacity through staff recruitment and training and to enable it to carry out operational and management audits and increasingly focus on efficiency, effectiveness and value for money auditing. Building the required capacity in the department would need technical assistance and logistic support through overseas and local training and the acquisition of computers and a vehicle. 2.09 VRA's auditing arrangements are satisfactory. Its accounts and auditors' report are submitted within the 6 month period agreed with IDA under the ongoing Sixth Power Project. VRA's auditors (Coopers and Lybrand, Accra) have never had occasion to qualify VRA's accounts. In the future, VRA would continue to submit to IDA satisfactory audited accounts within six months of its fiscal year end, as agreed during negotiations. 3. Recent Financial Perrormance 2.10 Since the drought of the early 1980s which caused VRA to curtail supplies to all customers between 1983/85, VRA's financial position has continued to show a steady recovery. From a low 1670 GWh in 1984, sales in 1991 increased to 5,912 GWh, an increase of 254 percent, and have since continued to rise. The earlier renegotiation of the VALCO agreement and subsequent increases in export (to CEB) and domestic tariffs has enabled VRA's revenue/kWh  - 13 - to increase significantly, to offset higher operating costs arising from cedi devaluations and local inflation. Notwithstanding the difficult circumstances of the mid-1980s, VRA's recent financial performance measured by its profitability has been generally satisfactory. However, its rate of return on revalued average net fixed assets (ANFA) in operation, has declined from about 11.2 percent in 1989 to about 8.3 percent in 1991.5/ In 1987, VRA took over the responsibility for power distribution in Northern Ghana as a result of which it agreed to absorb an operating loss on the activities of NED in 1988 of about