Mozambique : Energy Reform and Access Project - restructuring

40191 Documentof The WorldBank FOROFFICIAL USEONLY PROJECT PAPER ONA PROPOSEDRESTRUCTURING OF THE ENERGY REFORMAND ACCESS PROJECT FOR THE REPUBLIC OF MOZAMBIQUE JUNE 21,2007 Energy Team Infrastructure Group Africa Region This documenthas a restricteddistributionandmaybe usedby recipientsonly inthe performanceoftheir official duties. Its contents maynot otherwisebe disclosedwithout WorldBank's authorization.   DATA SHEET MozambiqueEnergyReformand AccessProject FY actual .-... . ..- 07 08 09 10 Annual 20.0 15.0 2.2 Cumulative 7.2 .._ 8.0 28.0 43.0 45.2 Current closing date: December 31, 2007 Revised project development objectives/outcomes [lf applicable] The Project Development Objective i s restated as follows: "Accelerating accessto electricity inunderserved areas ina sustainable and commercially viable manner" Does the scaled-up or restructured project trigger any new safeguard policies? If so, click For Additional Financing [ ] Loan [ ] Credit [ ] Grant For Loans/Credits/Grants: Total Bank financing (US$m.): not applicable Proposed terms: rican Development Fund Global Environment Facility Nordic Development Fund Foreign Private Commercial Sources 1   Mozambique EnergyReformandAccess Project(ERAP)APL I Restructuringof Cr. 3819-MOZand GEFTF 052650 ProjectPaper (PP) I.IntroductoryStatement 1. This Project Paper seeks the approval of the Executive Directors to introduce the changes described below inthe Mozambique Energy Reform and Access Project (ERAP) APL I(Cr. 3819-MOZ, Project ID: PO69183 and the Global Environment Facility Trust Fund Grant Agreement TF 052650). The major modifications proposed for the project, discussed further below, are (i)changing two o f the four triggers for APL I1in line with the Government's revised approach to sector reform and the resulting reallocation o f credit funds, (ii) changing the project description o fthe Power Sector Reform Component based on the Government's new approach, (iii)reallocating about 30% of the credit proceeds to provide additional support for the state-owned electric power utility, Electricidade de Mozambique (EdM) and for operationalization o f the electricity sector regulatory agency, CNELEC. The proposed project restructuring i s designed to align support with the new direction for sector reform as well as to address implementation problems inthe highrisk, private sector-driven component and other areas. All elements o f the proposed restructuring are in accordance with the midterm review (MTR) report producedby the Government and agreements reached during the MTRmission. 2. The original project design was based on a sector reform strategy o f unbundlingEdM into Generation, Transmission and Distribution companies, and concessioning the distribution company to a private concessionaire. In January 2005 a new Ministry o f Energy was established. The new Ministry team reviewed the strategy in light of developments in the power sectors o f neighboring countries and experience in Sub- Saharan Africa and elsewhere. Following extensive discussions with IDA and a stakeholder workshop, in November 2005 the Minister o f Energy wrote to IDA presenting the Government's new approach to power sector reform. Under the new approach, the Government will not seek private participation in EdM at this time. Instead, the strategy focuses on achieving improved performance o f EdM through the combination of an effective Performance Contract for EdM, increased technical and financing support for EdM and operationalizing a Strong, Independent Advisory Regulatory body, CNELEC to monitor EdM's performance. The Government's new strategy i s described further in Section I1 and reflects lessons learned from recent experience in Sub-Saharan Africa (see Section VI). 3. Other changes necessary to support these major modifications and to address implementation problems include: scaling-back the Independent Grid component; adding a pilot activity in the renewable energy component to demonstrate an alternative approach; expanding the scope o f the Grid Intensification Component to provide additional support to EdM (including training and a pilot loss reduction program); corresponding revision o f component descriptions, the results framework and IDA key performance indicators to reflect the design changes; restatement o f the Project 2  Development Objective to make it more precise and measurable during the timeframe of the project, and removal of the counterpart funding requirement for the components implemented by the Ministry o f Energy. Technical revisions required to support the changes include updating o f the Procurement and Implementation Schedules inthe IDA Development Credit Agreement (DCA) and Grant Agreement, inclusion o f Operating Costs category inthe IDA DCA, and extension o f the closing date o f the IDA credit and GEF grant by 24 months. These are described in more detail in Section 111: Proposed Changes. The expected outcome i s to achieve the development objectives through improved support for the Government's new sector reform strategy. The proposed changes are reflected in revisions to the IDA Development Credit Agreement, Project Agreement and the GEF Trust Fund agreement, which provides co-financing for component D o fthe project. 11. BackgroundandReasonsfor Restructuring 4. The ERAP APL Program was approved by the Board on August 19, 2003 and APL I was declared effective on March 30, 2004. The original credit amount was SDR29.7 million (US$40.26 million equivalent). Due to exchange rate fluctuations, the USD equivalent o f the credit i s currently US$45.2 million. Current disbursement o f the IDA Credit is about SDR 5.4 (18%, as o f May 31,2007). The original GEF Grant amount was US$3.09 million. Current disbursement on the GEF Grant is about US$0.64 million (21%, as of May 31,2007), includingUS$150,000 advance to the Special Account. 5. The Project has the following project components: (A) Power Sector Reform (US$6.12 million o f which US$2.65 million is IDA); (B) Grid-based Peri-Urban Electrification (US$41.OO million o f which US$17.35 million i s IDA); (C) Independent Grid Rural Electrification (US$16.38, of which US$10.60 million is IDA); (D) Renewable Energy and Cross-sectoral Linkages (US$4.12 million is IDA and US$3.09 million i s GEF); (E) Institutional Development and Capacity Building (US$8.47 million o f which US$5.54 million is IDA).The original development objective o f the credit is: (i) to accelerate the use o f electricity for economic growth and improved quality o f life in underserved areas in a commercially viable manner; and (ii) strengthen Mozambican to capacity to expand the energy sector. The objective remains valid during the restructuring; however, it has been restated to make it more precise and measurable duringthe timeframe o fthe project. 6. The Government's New Power Sector Reform Strategy. The Government's decision not to unbundle EdM and not to seek private participation at this time i s based on assessment of experience in Sub-SaharanAfrica where the risks and potential drawbacks o f this approach have become apparent over the past decade (discussed further in Section IV). The new sector reform approach inMozambique incorporates lessons learned from successful publicly-owned, vertically integrated electric power utilities in Sub-Saharan Africa and elsewhere. The Government's new strategy is to improve the efficiency and implementation capacity o f EdM so that EdM can play a key role in expanding access to affordable, reliable, sustainable electricity supply throughout Mozambique. 3  7. Implementation o f the strategy involves (i)defining monitorable technical and financial performance targets for EdMthrough a new EdMPerformance Contract jointly signed by Ministry o f Finance, Ministry o f Energy and EdM; (ii) renewed support to EdM for technical assistance, training and investments needed to meet the performance targets; and (iii)effective oversight o f the actual performance relative to the target. Effective oversight will be achieved through the operationalization o f CNELEC as a Strong, IndependentAdvisory Regulatory body, with the mandate and resources to focus initially on (i) monitoring and reporting publicly on EdM performance as laid out inthe EdM Performance Contract; (ii)developing recommendations on revised regulations on technical and commercial quality o f service after public hearings; and (iii) developing recommendations on possible future revisions to the current tariff-setting methodology with more emphasis onbenchmarks for EdM's operations andcosts. 8. The Government has now completed key steps in implementing the new reform program demonstrating strong Government commitment: (i)In November 2005, the Board and Senior Management o f EdM were replaced, (ii) in August 2006 Minister of Energy publicly issued instructions to CNELEC giving CNELEC the responsibility to monitor the EdMPerformance Contract; (iii) InJanuary 2007 the Government advertised for Expressions o f Interest for the CNELEC Commissioner positions. Response was unsatisfactory and the Government i s inthe process o f developing a stronger short-list o f candidates; (iv) EdM, the Ministry o f Energy and Ministry o f Finance have reached agreement regarding the 3-year EdMPerformance Contract with monitorable results, and signature by these three parties i s anticipated by July 2007; (v) Ministry o f Finance has approved a debt restructuring plan to address EdM's overdue, long-term debt to the Government, thereby strengthening EdM's financial position. In addition, EdM has demonstrated significant progress toward meeting access expansion goals: EdM connected approximately 80,000 new customers in 2006, about double the connection rate inprevious years. 9. Project Performance. In May 2006, the project performance rating fell to unsatisfactory. Implementation o f the project was significantly behind schedule due to delays in credit effectiveness and initial procurement activities, problems inprovision o f Government counterpart funds, weak financial management arrangements, difficulties in implementing the high risk, private sector-driven activities, and the time required for rethinkingthe sector reform approach. This situationwas reflected inlow disbursements. However the Government and implementing agencies have taken a number o f actions to address the causes o fthe unsatisfactory rating. 10. Procurement issues have now been resolved and all major contracts have been awarded. The restructuring will address design issues related to the sector reform approach, private-sector driven components and the counterpart funding issue (paragraph 14). The unsatisfactory Financial Management performance has been addressedthrough a combination o f capacity buildingand training. Financial management for the project i s now handled by two recently-appointed accountants who will receive relevant training. The Ministry of Energy has hired an experienced Financial Management consultant to conduct on-the-job training o f the two accountants and support them on financial management issues o f the project. An action plan to have the accounting software fully 4  operational was agreed with the Ministry o f Energy. There i s provision for additional technical assistance inthis area should it be deemed necessary at any stage inthe future. The project audit status for both the IDA Credit and GEF Trust Fund Grant is current. The rating will returnto satisfactory when the EDMPerformance is signed and following substantial progress inselection of the CNELEC Commissioners. 11. Rationale for Restructuring. Implementation of the restructuring is essential to effectively support the Government's sector reform strategy and to achieve the project development objective. Specifically, implementation o f the restructuring will make available sufficient financing for the start-up o f CNELEC while a sustainable financing mechanism is put in place. The restructuring will support EdM's efforts to meet targets under the EdM Performance contract, through increased support for grid intensification which will lead to an increased number o f commercially-viable customer connections, support for a new pilot loss reduction activity which will assist EdM in designing a broader loss reductionprogram, and training o f EdMtechnical andmanagement staff. 12. The restructuring will also address important constraints which have become apparent during project implementation. Inthe Project Appraisal Document, the private sector-driven sub-projects approach. planned for the IndependentGrid was recognized as high risk due to uncertainty about interest from private sector investors and consumer response to higher tariffs. Currently one independent grid concession is operating. Recent studies and experience in Mozambique indicate that there are no other strong candidate locations for another independent grid at this time. This assessment was reflected in the Government's Mid-Term Review (MTR) report and was reviewed and agreed during the MTR mission. It is therefore proposed to reallocate the funds from this component to other activities, while assessing the experience to date to derive lessons for the future. Since private sector response under the Renewable Energy activities has been lower than anticipated, the restructuring will support a village electrification pilot program in five villages to test an alternative approach for sustainable provision o f renewable energy services in remote areas. The restructuring will also eliminate the requirement for Government counterpart funding which will facilitate smooth implementation o f Ministry o f Energy activities. 111. ProposedChanges 13. Proposed Revision of Triggers for APL 11. It i s proposed to replace the trigger related to private participation in EdM's Distribution Business, which is no longer relevant given the new approach to sector reform, with a new trigger as shown in the table below. The second trigger to be revised i s the trigger related to the Independent Grid Concessions. Following the difficulties in implementing the Independent Grid component, and the decision to put on hold attempts to award further Independent Grid Concessions until the experience and lessons learned from the first concession have been assessed, it i s proposed to revise the trigger as described in the table below. The IDA Key Performance Indicatorswhich mirror these triggerswould be similarly revised. 5  Original Trigger Proposed Replacement Separationo f EdM's core functions o f EdMperformance contract inplace and at Distribution, Transmission, Generation and least one performance monitoring cycle implementationo f a private participation including review by CNELEC has been option inEdM's Distribution business, completed as per instructionsissuedby with independent management control. Minister o f Energyin2006. CNELEC gives advice and recommendations inan open andtransparent manner so that the general public and stakeholders inthe electricity sector are aware o f CNELEC's views. Successful completion of at least 3 Continued operation o f the N.Inhambane independent grid concessions, one o f which Independent GridConcession according to will bebasedon a renewable energy the concession agreement, and assessment source, and another be bulk-suppliedfrom of lessons learned. the national grid. 14. Proposed Changes inProjectDescription and Reallocationo f Funds. The description of each component would be revisedto reflect the proposed restructuringas follows: 0 Component A: Power Sector Reform: This component was originally designed to support activities required to concession the distribution business and to establish a separate transmission company. A first step business unit has been completed. - - the separation of accounts by Given the new approach to sector reform (paragraph 6), the other activities inthe original description o f this component are no longer relevant. These activities are replaced by support for establishment and initial operations o f CNELEC. The level o f support for CNELEC i s greater than in the original project design due to clearer definition of the tasks and resources needed, and reduction in counterpart funds. Support for CNELEC is now included inComponent A: Power Sector Reform (rather thanComponent Eas inthe original project) as it is a key element o fthe new reform strategy. 0 Component B: Grid-Based Peri-Urban Electricifation. An additional US$11 million will be allocated to this component. These additional funds will cover (i) support for an increased number o f connections in the grid intensification supply and install package, due to identification during the detailed design phase o f a much higher number of new connections than was initially estimated. The Key Performance Indicator for number of new connections would be adjusted upwards to reflect the additional funding allocated to this activity; (ii) addition o f a new pilot activity aimed at demonstrating methods for reducing losses and improving customer service, two important aspects o f improving EdM's commercial and financial performance. This so-called Commercial Reorientation o f the Electricty 6  Sector Toolkit (CREST) program will be piloted in some districts o f Maputo; and (iii)provisiono f technical andmanagement training for EdMstaff. 0 Component C: Independent Grid Rural ElectriJication. It i s proposed to limit this component to support for continued implementation o f the on-going Independent Grid Concession since no further concessions appear viable usingthis model at this time. The proposed scaling-back o f this high risk component reflects agreement between Government and World Bank that there is a need to review this approach before attempting any further independent grid concessions. 0 Component D (Co-Jnanced with GEF Grant): Renewable Energy and Cross- Sectoral Linkages: Due to a lower-than-anticipated response from the private sector for the output-based funding available under the project to co-finance renewable energy investments by the private sector, a new activity - a pilot village electrification scheme to be tested in five villages - would be added to this component to demonstrate an alternative delivery mechanism that may be attractive to the private sector. 0 Component E: Institutional Development and Capacity Building: The component still includes training, studies and technical assistance as per the original project design. The increased allocation reflects increased training and capacity-building requirements following the establishment of the new Ministry o f Energy, and a reduction incounterpart funds. 15. No change in the overall IDA and GEF funding amount is proposed. No change in the allocation of GEF funds is proposed. The tables below summarize the proposed reallocation o f IDA funds by component and by disbursement category: The authorized allocations for the Special Accounts will be adjusted accordingly. Component Original ProposedNew Change Allocation Allocation (PAD) A. Power sector reform 2.65 2.67 +0.02 B.Grid-based peri-urban 17.35 29.21 +11.86 electrification C. Independent Grid Rural 10.60 2.22 -8.38 Electrification D.Renewable Energyand 4.12 3.94 -0.18 Cross-sectoral Linkages E. InstitutionalDevelopment 5.54 7.21 +1.67 and Capacity Building Total 40.26 45.26 +5.00 7  SUMMARY OF PROPOSED REALLOCATION OF IDA FUNDS BY DISBURSEMENT CATEGORY (SDR Equivalent) Original ProposedNew Change Allocation Allocation (DCA) (1) Civil works for Part B o f the Project 1,083,000 1,100,000 +17,000 (2) Supply and Installation (a) Part B o fthe Project 7,097,000 13,500,000 +6,403,000 (b) Part D o f the project 825,400 0 -825,000 (8) Operating Costs for Parts A, CyD,andE 0 356,000 +356,000 (9) Unallocated 2,704,800 1,355,000 -1,349,800 Total 29,700,000 29,700,000 0 16. Elimination o f Requirement for Ministry o f Energy Counterpart Funds. The Government's commitment to the project has been demonstrated by the level o f effort that has gone into reformulating the reform approach, and by concrete reform actions noted above. Problems with counterpart funding reflect severe constraints on the overall Government budget rather than a lack o f commitment to the energy sector or the project. The Government has written to IDA (Annex 2) requestingthat the project be amended to remove the requirement for Ministry of Energy counterpart funds as a step to addressing one o f the causes o f delays in implementation. The proposed change i s consistent with the Country Financing Parameters. This change will not impact the overall level of IDA fundingfor the project. 8  17. Restatement of Project Development Obiective and Revised Results Framework. It i s proposed to restate the Project Development Objective (PDO) as follows: "Accelerating access to electricity inunderservedareas ina sustainable and commercially viable manner". While the original overall goal o f improving the quality of life of beneficiaries by facilitating access to energy remains valid, the PDO as restated i s more precise and measurable within the timeframe o f the project. Note also that while capacity building i s a specific outcome o f components A and E, this i s considered an intermediate outcome that contributes to the overall PDO. The proposed revisedresults framework i s attached inAnnex 1. 18. Addition o fNew IDA DisbursementCateaorv and Adiustment o f IDA Allocations to Disbursement Categories. A new disbursement category has been added to cover incremental operating costs. The addition o f this category is required to cover the following additional costs arising from the restructuring: (i) initial operating costs for CNELEC, (ii)Ministry of Energy costs in monitoring the program o f Photovoltaic systems in schools and clinics under Component D, (iii) FUNAE (Fundo Nacional da Energia) Energy Fund costs in monitoring the pilot village electrification program in Component D, (iv) Ministry of Energy and ENH (Empresa Nacional de Hidrocarbonetos de Mozambique) costs in working closely with the consultants undertaking the development o f the Gas Market Strategy. Operating costs include office supplies, operation and maintenance costs for vehicles and equipment, travel expenses and subsistence, among others. The revised categories and allocations are shown in the table above. 19. Revision o f Procurement Schedule (IDA and GEF). The prior review threshold for goods and services (other than consultant services) has been increased from US$lOO,OOO to US$200,000 and the prior review threshold for works and supply and installation of equipment has been increased from US$300,000 to US$500,000. The higher thresholds are deemed appropriate based on the improved performance on procurement by the implementing agencies, The thresholds for usingthe National Competitive Bidding for goods and works contracts have been increased from US$lOO,OOO and US$lOO,OOO to US$200,000 and US$500,000 respectively, based on recent experience on World Bank- financed projects in Mozambique. The applicable guidelines for procurement and selection o f consultants have been specified as the most recent guidelines, i.e. "Guidelines: Procurement under IBRD Loans and IDA Credits dated May 2004, revised October 2006 and "Guidelines: Selection and Employment o f Consultants by World Bank Borrowers" dated May 2004, revisedOctober 2006. The overall presentation o f the Procurement Schedule has beenrevisedto reflect the current standard format. 20. Revision o f Implementation Schedule. Previously, responsibility for the energy sector came under the Ministryo f Mineral Resources and Energy. Following the creation ofthe Ministryo f Energy (paragraph 2), responsibility for the overall coordination o f this project i s assigned to the Directorate o f Planning, within the Ministry o f Energy. This change i s reflected in revision o f the Implementation Schedule. A clarification on the procedures for sub-projects implementedby line ministriesis also included. 9  21. Closing; Date. It is proposed to extend the project closing date o f both the Development Credit Agreement and the GEF Trust Fund Grant Agreement by 24 months to December 31, 2009. This extension i s needed because initial delays in effectiveness and delays inhiring consultants for the design and supervision of the grid intensification component, as well as the significant increase in the number o f new connections now planned, indicate that the major investment activity will not be completed untilmid-2009. Inaddition, the project will be a major source of funding for CNELEC in the start-up phase through mid-2009. This extension o f the closing date will allow sufficient time to complete all activities under the restructured project. IV. Analysis 22. The major effect o f the proposed changes on the project as appraised i s on technical aspects, specifically, the approach to sector reform. The decision not to unbundle EdM and not to seek private participation at this time is based on assessment of experience in Sub-Saharan Africa which has demonstrated difficulties and potential drawbacks of implementingthis approach. A recent stock-taking exercise of private participation in power sectors in SSA, undertaken by the Africa Region at the World Bank, shows that despite a decade of focus on private participation in electric power sectors in Sub- Saharan Africa, as o f 2003, 50% o f countries had formally sought Private Sector Management Control (PSMC which includes concession, affermage, and management contracts), but fewer than five countries still had successfully-operating PSMC in the electric utilities. Only one Sub-Saharan Africa utility comparable to EdM in terms of size and country risk perception has recently implemented this approach (concessioning o f distribution) and at this time it is too early to assess the results. Conversely, some of the more successful electricity utility companies in Sub-Saharan Africa have achieved good results as vertically integrated companies without private participation. Critical factors o f success in these cases include strong technical and commercial skills o f the staff and management, arms-length relationship with the Government including clear targets for performance and efficiency, an effective mechanism for monitoring and evaluating performance, and tariffs (combined where necessary with funded subsidy) sufficient to make the sector financially viable. Mozambique's new strategy for power sector reform i s designed to incorporate these success factors. 23. Other technical changes proposed are the inclusion of two demonstration activities: the pilot CREST programunder component B andthe pilot village electrificationscheme under component D. 24. The economic impact o f the proposed changes will be positive. Funding will be increased for the Grid Intensification activity which has the highest Economic Internal Rate o f Return (EIRR) (23% at appraisal). Funding for the Independent grid concession component (EIRR at appraisal o f 16%) is being reduced. The proposed changes do not raise the environmental category o f the project and do not trigger any new safeguard policies. The restructuringdoes not involve any exceptions to Bank policies. 10  V. ExpectedOutcomes 25. The expected outcomes o fthe restructuring include: An effective institutional arrangement to effectively measure and monitor EdM commercial and technical performance. This will be grounded in increased transparency inthe electricity sector interms o f reporting and communications, so that interested stakeholders including current and future customers have accurate information on plans and performance in the sector and opportunity to express concerns at public hearings; 0 Demonstration o f new initiatives which could improve commercial performance o f EdM; 0 The initial targets for number of new connections and cost per connection will be exceeded; 0 A new commercially-viable model for community-driven village electrification based on renewable energy technologies will be demonstrated. This model inthe futurecouldbereplicatedbythe private sector, NGOsor localauthorities. VI. BenefitsandRisks 26. Risks. Overall, the proposed changes substantially reduce the project risk. Activity on the highest risk component will be scaled back. Funding i s being reallocated to expandthe lowest risk activity. Specific newrisks andmitigation strategies include: 27. Risk of slow or non-implementation of sector reform. The new approach to sector reform has full Government ownership. Key implementation steps have already been completed (paragraph 8). All key stakeholders including EdM and development partners have beenfully involved inthe development o f the new approach. 28. Risk of Government interference in EdM without private participation. This risk i s mitigated by (i)clear Government commitment to reform, (ii)emphasis in the new reform strategy on transparency. For example, the CNELEC evaluation o f EdM performance as per the Performance Contract will be publicly available and the subject o f public hearings. If there are issues related to Government interference this will be recognized in the evaluation; (iii) Minister o f Finance and Minister o f Energy are Both signatories to the EdM Performance Contract on behalf o f Government. Sectoral issues which may prompt interference from the line ministry will be counter-balanced by considerations o f financial viability which will be a major concern o f the Finance Ministry. 29. Risk that the CNELECfunding mechanism is not inplace by end of support under the project. The approach to the funding mechanism has been discussed and agreed. The Government strategy for operationalizingCNELEC specifies "financial independence" as a key characteristic and states that the source o f funding should be a small surcharge based on the number o f kilowatt-hours sold to domestic customers or the number o f grid- connected customers in Mozambique. By design, during the first years of start-up 11  CNELEC will be small and focused with emphasis on demonstrating value-added. This will reduce the size ofthe levy requiredto meet the costs. 30. Benefits. Interms o f immediate benefits, the project will support household access to grid-based electricity for almost twice the number o f new households initially envisaged. The plannedpilot village electrificationscheme will provide benefits o f direct and indirect access to electricity services (including street lighting, water pumping, electricity for schools, clinics and administrative posts) for 28,000 additional people. Longer term benefits include putting in place a robust mechanism for monitoring and continuedperformance improvement inthe power sector. 12