Tanzania - Songo Songo Gas Development Project

Report No. PID1018 Country and Project Tanzania-Songo Songo Gas Development & Power (@). Generation Region Africa Region Sector Energy Project ID TZPE2797 Implementing Agencies Songas Limited, a new private power and gas company, and the MEM (Ministry of Energy and Minerals) Project Appraisal Date June 1996; Post-Appraisal September 2000 Projected Board Date October 2001 1. Sector Background. Tanzania's power sector has not provided adequate support for economic growth over the past decade. The main sectoral deficiencies are described below. ? Low Access to Electricity. Only about 7 percent of the country's population has access to electricity. About half of electricity consumption in the country is in the Dar es Salaam area. Yet, electricity is an important input for sustaining economic growth and poverty reduction. A significant majority of the population, which depends upon wood and charcoal to meet its energy needs, is not within reach of the electricity network. ? Unreliable Service. Since 1994 there have been several shortages of electricity that had severe consequences on economic activity. In 1994, TANESCO shed about 100 MW of load, equivalent to about one third of maximum demand in the interconnected system at that time. This was caused by poor rainfall in TANESCO's predominantly hydroelectric system when there was no available back-up thermal generation. Even after the addition of about 75 MW of thermal generation in 1995, TANESCO shed load in 1997 due to inadequate rainfall coupled with sub-optimal utilization of its thermal generating plant. Again, in 2000, TANESCO shed about 30t of load (or 90MW) in November and December because of sub-optimal operations of its mixed hydro/thermal system. ? TANESCO's Inefficient Operations and Weak Performance, particularly in customer services (billing, collections and system losses). Despite charging an average tariff that should be adequate (about US $0.093 per kWh excluding 20t VAT), TANESCO has been unable to cover its operation and maintenance costs, debt service requirements and to make a reasonable contribution to its investment program. As a consequence, maintenance has been deferred, system reliability has suffered, and there has been little investment in distribution facilities required to expand access. There have been revenue shortfalls due to delays in tariff increases and poor collection performance (mainly from Government agencies and parastatals). While there has been improved regularity by the Government in paying for electricity consumption, TANESCO has not been able to meet the growing demand for electricity or to increase service coverage. ? Inadequate Financing for Power Infrastructure. During 1990-98, electricity sales increased at an annual growth rate of about 9.9 percent on the interconnected grid. Demand for power is expected to grow on average by about 9t per annum during 2001-04, and around 69 per year during 2005-06; with load growth in the range of 5.2-5.7T during 2007-15. Meeting the power sector's future needs over this period will require  capital expenditures in excess of US $500 million for generation, transmission and distribution facilities. The proposed project forms the first component of Tanzania's least cost generation expansion plan. Tanzania is faced with significant capital constraints in meeting its power investment needs at a time when donor financial resources are limited. In addition, the development of private sector projects has been constrained by both Tanzania's weak balance of payments situation and TANESCO's poor commercial performance. 2. Government Strategy. Until recently, the Government and the donor community have focused their efforts on trying to improve TANESCO's operational and financial performance. The rationale was that a financially healthy TANESCO would be able to provide better service, avoid load shedding, and would be perceived by potential private investors as a reasonable credit risk as a bulk electricity customer. This effort, while having some success, has fallen short of expectations. The Government now believes that it is more beneficial to concentrate on restructuring the power sector, promoting private sector participation, and establishing a multi-sectoral regulatory body, while concurrently ensuring that during the interim period, TANESCO continues to function without load shedding. The Government has embarked on a power sector reform program which involves the unbundling of TANESCO into business units and their divestiture. Legal/regulatory and market trading consultants have been recruited, and the unbundling advisors are expected to be appointed shortly. The Government recently appointed a new Chairman and Board of Directors to oversee the TANESCO unbundling and divestiture program. During the transitional phase until TANESCO divestiture, the Government plans to install a new management team within TANESCO under a performance-based management contract. Also Credit 3304-TA is assisting the Government to implement its decision to establish a multi-sectoral Energy and Water Utilities Regulatory Authority which would be responsible for, inter alia, the gas and electricity sub-sectors 3. Project Objectives. The project supports Tanzania's Country Assistance Strategy by promoting sustainable growth and poverty reduction, and expanding the role of the private sector in the provision of infrastructure services. The main objective of the project is to develop indigenous natural gas to produce least-cost power generation for domestic and industrial use, in line with Tanzania's comparative advantage. Natural gas from the Songo Songo reservoir would displace more expensive imported liquid fuel consumed for power generation. Also, it would: (a) diminish the Government's role in the power sector through the privatization of 112MW of TANESCO's thermal generating plant; (b) set the stage for the development of a commercial market for gas; and (c) encourage increased access of the poor to electricity supply by developing financially and institutionally sustainable rural gas-to-electricity schemes not connected to the power grid. 4. Rationale for IDA Involvement. IDA's involvement is crucial to catalyze private foreign investment in the development of Tanzania's indigenous gas reserves by making the risk profile acceptable. Although IDA is assisting the government to implement its power sector reform program, the existing sector framework is in a transient stage. Thus, Songas will rely almost solely on generating revenues from the sale of electricity to TANESOC, a wholly owned Government utility. The project has been structured in a manner to provide mechanisms to ensure the payment performance of TANESCO during this transitory sectoral arrangement for which the underlying risk perceived by the investors is political rather than commercial. 5. Project Description. The proposed project consists of three distinct components. The Songas component is a gas-to-electricity project which - 2 -  encompasses developing the Songo Songo gas field and supplying natural gas to about 112 megawatts (MW) of existing gas turbine plant at TANESCO's Ubungo Power Plant, and supplying natural gas to the Twiga Cement Plant at Wazo Hill. This component includes: (i) installing a gas gathering system and gas processing plant on Songo Songo Island; (ii) constructing 25 km of marine and 217 km of land pipeline from Songo Songo Island to Dar es Salaam and a 16 km spur to the cement factory at Wazo Hill; (iii) upgrading, maintaining, and converting to gas firing the 112MW of existing gas turbines at Ubungo; (iv) a system control and operations center as well as the construction of security fences, storage facilities and other basic infrastructure at Songo Songo Island; (v) workover and testing the gas wells at Songo Songo Island; (vi) project management and training; and ; (vii) privatization of the existing 112 MW of gas turbines at Ubungo. The Environmental, Social and Project Monitoring Component consists of: (i) the provision of energy (solar home systems, and grid-based and gas based electricity) to around 30 villages and 5 townships along the pipeline corridor, which would be created and operated as community-owned and managed village power company; (ii) construction of infrastructure (roads, water, electricity) at the Kinyerezi and Salasala resettlement sites; and (iii) contract compliance advisors; environmental/social compliance advisors; an update of the socio-economic baseline and a resettlement assessment. The MEM capacity building component includes: a gas institutional and regulatory study, an energy management information system, advisory services for sector restructuring and least cost planning, preparation of bidding documents for the next private power project, the recruitment of a project manager, an accountant and project coordinator, vehicles, office set-up and training. 6. Project Costs and Financing. Total project investment costs are about $295.2 million. These costs do not include the privatization of the existing 112MW of gas turbines of the Ubungo Power Plant. The total cost of the Songas component, including contingencies (but excluding interest during construction), is about $273.5 million. IDA's and EIB's contribution to the Songas component (debt financing) is about $161.5 million and $40 million, respectively. Equity contributions equivalent to $72 million include: $50 million from AES (the project Sponsor), $18 million from CDC, and $4 million from EIB (through the Tanganyika Development Finance Corporation Ltd. (TDFL), a local development finance institution). Ownership of the existing 112MW gas turbine facilities at Ubungo and the corresponding outstanding debt obligations will be transferred to Songas. The balance of the $183 million IDA credit (or about US$21.7 million) will support the village electrification scheme and the Ministry of Energy and Minerals' capacity building initiatives. 7. Project Implementation. The proposed Songas component will be structured as a build-own-operate arrangement underpinned by a Power Purchase Agreement (PPA) between Songas and TANESCO for a term of 20 years. Songas has been created as a limited liability company with shares held by AES, CDC, the EIB via the TDFL, and TANESCO/TPDC, and majority controlled by the private investors. Songas will be responsible for project construction, gas field and pipeline development, management and operation of thell2MW power plant at Ubungo, and provision of gas to the cement plant at Wazo Hill. The Sponsor will have day-to-day responsibility for management and operations, and responsibility for procurement during the construction phase, in accordance with procedures agreed with IDA. The Sponsor will be responsible for the commercial risks associated with the project (construction, project completion, and operations). TANESCO will dispatch power according to economic dispatch principles, and will pay Songas monthly fixed (capacity) and variable (energy) payments. A schedule of penalties and bonuses has been designed to ensure that -3 -  the Songas facilities are operated following efficient and prudent utility practices and in accordance with the agreed technical performance specifications, staffing profile, and operation and maintenance budgets. If the Sponsor fails to operate the plant efficiently in accordance with the agreed operation and maintenance budget, and/or if there are cost overruns during construction or delays in plant commissioning not due to the Government's fault, it will erode the Sponsor's return on equity. 8. Songas Commercial and Contractual Arrangements and the Risk/Reward Profile. Financing is to be raised on a limited recourse basis. Under this structure, the Sponsor will assume the completion and operational risks and will look primarily to the expected cash flow/operating revenues of the project as the basis for Songas to service its debt and provide a return on equity. The project contractual agreements prescribe remedies to deal with a range of risks faced by the project. In this way, the contractual framework of the project safeguards the interests of the Government and Investors. The four principal contractual agreements between Government, AES, CDC, TDFL, and TDFL are the PPA, the Shareholder's Agreement, Implementation Agreement, and various Gas Agreements. 9. A Songas security package has been designed to help to mitigate the sovereign risks against which the Investors are unable to hedge. The project has been structured so that the Sponsor is responsible for the construction and commercial risks of the project, but is partially protected from the sovereign risks of currency convertibility and non-payment by TANESCO of its obligations under the terms of the PPA. 10. Project Sustainability. Electricity end-users and industry will benefit from lower cost and more environmentally friendly power supply. Also, the project will generate annual fiscal revenues from gas sales of about US $8 million from the project, which could be directed to activities benefiting the poor. In addition, since the Government's local contribution is limited, the project will not crowd out expenditures for other important development programs, for example in the social sectors. The sustainability of the project will be underpinned through a combination of the following features: ? The structure of the proposed project which places the Sponsor's equity and returns at risk for poor performance. The Contractual Agreements signed between the Government and the equity participants spell out their respective responsibilities and the remedial/preventative measures to protect their mutual interests during the construction and operational phases of the project. The project relies heavily on private sector management and technical expertise; ? The design of the project which ensures that the Sponsor is responsible for the commercial risks associated with the project, while receiving a limited amount of protection against sovereign risks against which they cannot hedge. The escrow account would provide limited protection to the Sponsor against a Government default serious enough to lead to termination of the Songas Contractual Agreements. Similarly, AES has backed its commitment to finance its share of cost overruns through a US$50 million parent company guarantee; ? The potential risk of non-payment by TANESCO (or its successor) of its capacity and energy payments to Songas is mitigated through the ability to offset loan repayments by Songas to the Government under the project's subsidiary loan agreements, and through the establishment of a revolving liquidity facility that would also help to ensure prompt and complete payments by TANESCO. In parallel, the Government is unbundling TANESCO and privatizing it distribution facilities as a basis to improve the efficiency and performance of the sector. During the interim period until - 4 -  the sector is unbundled and privatized, the Government plans to recruit a new management team to run TANESCO on a daily basis under a performance- based management contract. Also, the Government is establishing an Energy and Water Utilities Regulatory Agency which will be responsible, inter alia, for the electricity and gas sectors. ? the commercial and economic benefits that flow to the Government and to the Sponsor. These include increased fiscal revenues to the Government noted above, and the potential to develop a domestic gas market for commercial and industrial use including possibly for export to neighboring countries; and ? The wayleave village electrification scheme includes the establishment of a community owned and managed power utility. Its sustainability is enhanced since the customers would have a direct stake in the scheme, and thus a strong incentive to ensure the systems are managed and operated efficiently. The technical assistance and training component will support capacity building within the MEM. 11. Poverty Category. Not applicable. 12. Lessons Learned from Previous Bank/IDA Experience in the Energy Sector. Three main lessons emerge from the Bank's power and gas sub-sector operations. First, it is important to commercialize energy sector operations and promote private sector participation. Second, it is important to make investment decisions based on technical, financial and economic merits, consistent with macro-economic and sector development objectives including minimizing costs and maximizing benefits to stakeholders. This has been taken into account in the design of the proposed project: new investments and entrants (IPPs) to the sector would be contingent upon the maintenance of adequate sector cash flows and certain financial ratios for the sector. The third lesson has been the importance to establish an experienced, knowledgeable team to manage project implementation. The proposed project will be managed by experienced private sector operators, and the incentive package associated with the PPA and IA makes it attractive for the Investors to manage and operate Songas effectively. Finally, experience indicates that it is important to provide adequate training to counterpart staff. The incentive package associated with the PPA has provisions to reward the Sponsor for training and employing local staff. 13. Environmental and Social Aspects. The project is classified as Category A. In total about 27 environmental and social research studies, investigations and impact assessments have been carried out on the project. The Sponsor has prepared an Environmental and Social Assessments and Management Plan. The key environmental mitigation activities under the project include the following: (a) Biodiversity: While the pipeline corridor is not a prime area for mammal species of conservation interest, appropriate mitigation measures to minimize direct and induced impacts on biodiversity have been specified in the ESMP; (b) Forestry: The pipeline right-of-way passes through some stretches of natural vegetation (500 meters of the Mohoro Forest Reserve). In such sensitive areas Songas will use all practical means to minimize the affected right-of-way area and tree cutting (not all the right-of-way will be cleared); (c) Water: Clean drinking water is a scarce resource on Songo Songo Island. Songas will provide residents with potable water and electricity from the plant gate; (d) Soil Erosion (access roads and sensitive areas): Songas will ensure that areas prone to soil erosion are stabilized after being disturbed. Any access roads adjacent to sensitive areas will be closed after construction and rehabilitated; (e) Waste: Songas will implement a solid waste management strategy ensuring waste is disposed of in the most environmentally benign way and in compliance with World Bank - 5 -  guidelines; (f) Air: The existing 112MW of liquid fired thermal plant will be converted to gas firing. Air emissions will comply with World Bank guidelines. Freon 22 which is currently used at the power plant will be phased out. Songas will manage the emission of fugitive methane gas through a preventive maintenance program for the pipeline and valves; (g) Health and Safety: Songas has prepared a gas leak and emergency response plan. Also health and safety conditions will be in line with international industry standards; and (h) Community Development Support: In line with its social and corporate responsibilities, AES will publish annually a report on its community development efforts, including the level of contributions (cash and in kind) to foundations and efforts to protect biodiversity, etc. 15. The project involves the construction of a 25 km marine pipeline from Songo Songo Island to the mainland, and a 207 km land pipeline from Somanga Funga to Dar es Salaam, with a 16 km spur up to Wazo Hill. Every effort has been made to establish a route that minimizes the resettlement of residents along the land portion of the pipeline. The resettlement of 33 households was required along the rural section of the pipeline wayleave between Somanga Funga to the outskirts of Dar es Salaam. The affected households were those who were left with less than half an acre untouched after the creation of the gas pipeline wayleave of 60 meters. All 33 households have already participated in the selection of alternative rural sites and have been relocated. 16. Around the outskirts of Dar es Salaam, 155 households were relocated from the pipeline corridor. Two resettlement sites were selected for the 155 families that required relocation from the pipeline corridor in the Dar es Salaam area Kinyerezi in the South and Sala sala in the North. Both of these sites were unplanned settlements. Complete town plans have been developed and the project has surveyed both sites. The Ministry of Lands and Human Settlements Development and the Dar es Salaam City Commission have approved these town plans. In addition to the resettlement of 155 households that had to be relocated from the pipeline wayleave, another 155 households had to be moved within the Sala sala and Kinyerezi resettlement areas. The proposed resettlement infrastructure component under the project will allow these 310 households to enjoy a level of service (roads, water and electricity) that is at least equivalent to that enjoyed in their former neighborhoods. Moreover, the proposed site upgrades represent a significant improvement in the level of infrastructure for a much greater number of families already living in these communities. 17. In addition to those households that needed to be relocated, the pipeline corridor affected another 2,602 households in some way, including loss of crops and/or productive capacity, damage, disturbance and/or inconvenience that will occur during the construction period within the 30-meter way leave in the urban areas, and within the 60-meter way-leave route in the rural areas. As of December 2000, 98 percent of all 2,945 households affected had been compensated including 243 involving resettlement. The wayleave for the Songo Songo project pipeline was granted to TPDC on May 3, 1999. A certificate of occupancy for the wayleave will be transferred to Songas at financial closure, as part of TPDC's equity contribution in-kind to the project. Since the resettlement plan has been substantially completed, the Government will carry out a resettlement assessment and a comprehensive socio-economic baseline survey of the resettlement activities to monitor compliance with World Bank guidelines. 18. Project Benefits. The economic analysis confirms that Tanzania will derive significant benefits from the proposed project. The analysis follows a three part procedure: (i) a demonstration that the project is the next - 6-  least cost generation option for Tanzania; (ii) the cost benefit analysis has estimated the economic rate of return of the project in the range of 26 percent. A sensitivity analysis has been performed on key input parameters (changes in capital costs and in liquid fuel savings which are based on crude oil forecasts). The sensitivity analysis shows that the economic rate of return is robust even to highly pessimistic scenarios. Also, the proposed project will generate foreign exchange savings of about US$42 million per year from domestic fuel substitution; and (iii) a fiscal analysis shows that the net average increase in annual revenues (in nominal terms) from gas revenues the over the 20-year term of the PPA is about $8 million. 19. In addition, other benefits which are difficult to quantify in monetary terms include: (i) environmental benefits from the use of gas instead of diesel oil; (ii) the building of private investor confidence in Tanzania; (iii) improving efficiency through the introduction of private sector management techniques; (iv) strengthening of capabilities in the gas sector; and (v) fostering development of a capital market in Tanzania. Contact Points: Mr. Jim McCardle, Managing Director, Songas Third Floor, Maarifa House Ohio Street, P.O. Box 6342 Dar es Salaam, Tanzania Phone: (255 22) 2117313; Fax: (255 22) 2113614 Email: jim mccardle@songas.com The Permanent Secretary, Ministry of Energy and Minerals Attention: Mr. Bashir Mrindoko, Commissioner for Energy and Petroleum Affairs Samora Avenue, P.O. Box 9024 Dar es Salaam, Tanzania Phone: (255 22) 2139455; Fax: (255 22) 2120799 Email: mrindoko-mem@raha.com Ms. Karen Rasmussen, Task Manager, World Bank 1818 H Street N.W. Washington, D.C. USA Phone: (202) 473 4168; Fax: (202) 473-5123 Email : krasmussen@worldbank.org September 7, 2001 The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop This PID was processed by the InfoShop during the week ending September 14, 2001. -7 -