Turkey - Elbistan Operation and Maintenance Assistance Project

Docume;.t of The World Bank FOR OFFICIAL USE ONLY At 2Gs s-u Report No. 5774-TU TURKEY ELBI STAN OPERATION & MAINTENANCE ASSISTANCE PROJECT STAFF APPRAISAL REPORT Decembar 31, 1985 Projects Department Europe, Middle East and North Africa Regional Office Tbis 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 EQUIVALENTS Currency Unit = Turkish Lira (TL) TL 1 = 100 Kurus (krs) US$l = TL 500 TL 1 = US$.002 Currency equivalents are those effective June 1, 1985, unless otherwise indicated. WEIGHTS AND MEASURES kVA = kilovolt ampere kl = kilowatt kWh = kilowatt hour GWh (Gigawatt hour) = 1,000,000 kWh HV = High Voltage kV (kilovolt) = 1,000 volts MW (Megawatt) = 1,000 kW MVA (Megavolt-ampere) - 1,000 kVA MVAR (Megavolt-ampere reactive) = 1,000 kVAR One meter (m) - 3.28 feet One kilometer (km) = 0.624 miles One kilogram (kg) (1,000 grams) = 2.2 pounds one ton (metric ton) (1,000 kg) = 2,205 pounds One kilocalorie (kcal) (1,000 calories) = 3.968 BTU toe - ton oil equivalent tce = ton coal equivalent GLOSSARY AND ABBREVIATIONS AGMs - Assistant General Managers CEAS - Cukurova Elektrik A.S. (Cukurova Power Company) DSI - Devlet Su Isleri (State Hydraulic Works) DYB - Devlet Yatirim Bankasi (State Investment Bank) ELTEM-TEK - Elektrik Tesisleri Mishen Dislik Hizmetteri ve Ticaret Anonim Sirketi EdF - Electricite de France EIB - European Investment Bank FRG - Federal Republic of Germany ICB - International Competitive Bidding IDA - International Development Association KEPEZ A.S. - Kepez Electric Company KfW - Kreditanstalt fur Wiederaufbau LRMC - Long-Run Marginal Cost MANTRUST - Manufacturers Hanover Trust Co. MENR - Ministry of Energy and Natural Resources MTA - Mineral Research Institute PEE - Public Economic Establishment PPAR - Project Performance Audit Report SAL - Stnrctural Adjustment Loan SEE - State Economic Enterrrise SEI - Southern Electric International SPO - State Planning Organization TEK - Turkiye Elektrik Kurumu (Turkish Electricity Authority) TKII - Turkiye Komur Isletmeleri Kurumu (Turkish Coal Enterprise) TPAO - Turkiye Petrollerei Anonim Ortakligi (Turkish Petroleum Corporation) Fiscal Year - January 1 to December 31  FOR OMCIAL USE ONLY TURKEY ELBISTAN OPERATION & NAINTENANCE ASSISTANCE PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. I. INTRODUCTION ....1...................................... 1 The 1974 Elbistan Thermal Cower Project ............ 1 Preparation and Appraisal 3f the Original (1974) Elbistan Project .................. 1 Loan Effectiveness, Loan 1023-TU ................ 2 Description of the Original (1974) Elbistan Project ..................... 2 Implementation Problems ................... 3 Changes in Project Scope .................. 3 Past Procurement and Disbursements ................ . 3 Adverse Project Cost Factors ................. 4 Status and Operating Performance of the Original (1974) Elbistan Project ................ 4 Rationale for Continued Bank Involvement ........... 5 II. THE ENERGY SECTOR .................................... 6 Sectoral Context ................................... 6 Role of the Bank and Past Lending Experience in the Power Subsector ................................. 6 III. THE PROJECT ENTITIES ................................. 8 Legal Context ....................................... 8 Organization and Management of TEK . . 9 Manpower Development and Training .................. 10 General Characteristics of the TEK Power System 10 TER's Power System Operation Performance .... ....... 11 Following a mission in Turkey in April/May 1985, the report was prepared by A. Roa (Engineer), E. Baranshamaje (Financial Analyst), C. Warren (Financial Analyst), P. Kotschwar (Engineer), T. B. Russell (Consultant), and D. Bateman (Consulcant). LThis dounmnt has a xrstrid distrbution and may be used by recipients only n fthe performan of their offcl duties Its contents may not otherwac be disclosed without World Bank authorizaion  Page No. IV. THE PW ECT ............................................. 12 Project Objectives ....... ............................ 12 Project Description .............. .................... 12 Project Cost Estimate ...... .......................... 12 Project Financing Plan and Lending Arrangement .... ... 14 Project Implementation ............................... 15 Procurement .......................................... 16 Disbursement .......................................... 18 Special Account ...................................... 18 Environmental Aspects ................................ 19 Project Risks ........................................ 19 V. FINANCIAL ASPECTS ............ .......................... 20 Financial Performance of TEK ......................... 20 Audits ........... .................................... 21 VI. PROJECT JUSTIFICATION .................................. 22 Growth of TEK System ................................. 22 Least-Cost Analysis .................................. 22 Rate of Return on the Project ......................... 22 Recalculation of the Rate of Return on the Original Elbistan Project ....................... 23 Rate of Return on the Overall TEK/DSI Expansion Program ................................... 24 VII. AGREEMENTS TO BE REACHED AND RECOMMfENDATIONS .... ....... 25 ANNEXES 1.1 Summary of Cofinancing Plan for the 1974 (Original) Elbistan Thermal Power Project, Loan 1023-TU .... ......... 26 1.2 Sunnary of Contracts Financed under Loan 1023-TU .... ...... 27 1.3 Cumulative, Estimated and Actual Disbursements Under Loan 1023-TU .28 1.4 Revised Elbistan Project Cost Estimate .................... 29 1.5 Elbistan Operating Data - September 1985 ........................................... 30 2.1 The Energy Sector ......................................... 33 3.1 TEK Organization Chart .................................... 38 3.2 Personnel Statistics of TEK as of October 31, 1985 .... .... 39 4.1 Detailed Cost Estimated by Nature and Purpose of Expenditure .40  - iii- ANNEXES (cont'd) 4.2 Elbistan O&M Assistance Project Cost Estimates (in local currency units) ................................ 41 4.3 Major Issues Faced by the Turkish Authorities in Establishing Appropriate Long-Term Arrangements at Elbistan ........... 44 4.4 Implementation Milestones-Power Station .................. 46 4.5 Estimated Disbursement Schedule .47 4.6 Comparison of Disbursement Profiles ....................... 48 5.1 Financial Statements (1981-1990) .49 6.1 Economic Justification .56 6.2 Rate of Return on TEK/DSI 1985-1990 Expansion Program .65 6.3 Rate of Return on Original Elbistan Project .68 7.1 Selected Reports and Data Available in the Project File ... 69 MAPS IBRD 19045 TEK's Main Generation and Transmission System--1985 IBRD 19081 Elbistan Plant Site  TUJRKEY STAFF APPRAISAL REPORT ELBISTAN OPERATION & MAINTENANCE (O & M) ASSISTANCE PROJECT I. INTRODUCTION The 1974 Elbistan Thermal Power Project 1.01 Lignite and hydro are Turkey's most significant indigenous energy resources. With about three billion tons of proven reserves, Afsin-Elbistan is by far the most important lignite deposit in Turkey. Even before the oil crisis of 1973, the development of Afsin-Elbistan was the centerpiece of Turkey's energy development program. Success or failure of Turkey's energy self-sufficiency policy depends largely on the successful utilization of Afsin-Elbistan lignite. The 1974 integrated Elbistan Thermal Power Project (a 4x300-MW power station-and a 20 million ton/a (Mt/a) associated lignite mine) is the first attempt to exploit Afsin-Elbistan. It accounts for a substantial share of Turkish investment (36% and 132 of investments in the power sector during 1975-1980 and 1981-1985 respectively) and is a highly visible operation. Preparation and Appraisal of the original (1974) Elbistan Project 1.02 The first contacts regarding Elbistan were made in August 1969. The original Project was appraised in October 1973 and subsequent missions visited Turkey again in February and March 1974 to follow up the appraisal and prepare negotiations. Bank representatives also attended meetings of potential multilateral and bilateral financing agencies in Paris in January and March 1974 and in Frankfurt in April 1974 to discuss financing and procurement arrangements. Further discussions on the financing arrangements, followed by negotiations, took place in Mav in Washington. The Bank provided about 24% of the foreign financing through a loan approved on June 27, 1974 (Loan 1023-TU) for US$148 million (US$123 million for the power station to Turkish Electricity Authority (TEK) and US$25 million to Turkish Coal Enterprises (TKI) for the lignite mine). Annex 1.1 shows the total cofinancing package at the time of appraisal, which consisted also of German Aid (KfW), European Investment Bank (EIB), US EXIMBANK, Japanese EXIMBANK, Italy and France. 1.03 During the early stages of preparation of the 1974 Project, a mine output of up to 15 Mt/a and a 600-MW power plant (4 x 150 MW) were considered. In an effort to achieve economies of scale--a necessary move to reach the economic threshold of acceptability at a time when fuel oil price projections were only a fraction of present levels-TEK, with support of its consultants, decided to increase the power plant rating to 1200 MW (4x3OO MW) and the mine design output to 20 Mt/a, with most of the lignite intended for power generation.  (2728P) - 2 - 1.04 Because of its size and conplexity, anl intensive scrutiny of the technical aspects of the Project was completed before appraisal. The appraisal concentrated on organizational, managerial, financial and economic aspects. The preappraisal work included, inter alia, engineering studies subject to independent technical opinion by a Bank consultant, additional geological and hydrological investigations and lignite burnability tests, and endorsement by independent consultants of methods of excavation recommended by the engineering consultants. The boiler design was based on solid experience gained elsewhere with low grade lignite. Loan Effectiveness, Loan 1023-TU 1.05 The loan was signed on June 28, 1974. Loan effectiveness was delayed by about two years (from the original date of November 1, 1974 to June 1, 1976) on account of non-compliance with conditions of effectiveness which related to (i) improving TEK's finances (revaluation of TEK's assets, increase in tariffs); (ii) establishment of satisfactory project coordination arrangements; (iii) cross-effectiveness clauses because of joint financing of discrete project components with other agencies; and (iv) submission of legal opinion. Of all these, the tariff issue held up the effectiveness condition the longest, followed by the cross-effectiveness clause. After much deliberation, a tariff increase was eventually enacted in May 1976 and, after extending the deadline six times, the loan was declared effective June 1, 1976. Description of the original (1974) Elbistan Project 1.06 The 1974 Elbistan Thermal Power Project was designed to supply electric power using low grade lignite from the Kislakoy mine in Afsin-Elbistan as part of a balanced program of power development utilizing Turkey's fuel and hydropower resources. It also provided an opportunity for the Bank's first involvement in the mining sector. Other project objectives were to address institutional problems (organization, management, personnel and finances) that were apparent in TEK and TKI and which proved to be the main causes of delays in the execution of the Project. The original Project included the following components-. (a) a thermal power station with four 30e-MI lignite-fired units delivering, after meeting the pno;er station and mine loads, an estimated 1,048 MW and 7,030 ,Wh p.a. to TEK's interconnected system; (b) 380-kV transmission lines, about 540 km long, connecting Elbistan with Kayseri and Ankara by 1978 and 1979 respectively; (c) an open-cast lignite mine with a planned capacity of 20.7 Mt/a, 17.9 Mt/a for the power station and 2.8 Mt/a for processing for sale as domestic fuel; the Project included the cost of land and restoration of the worked-out mining area; (d) separate pennanent housing for power station and mine staff and roads between these and the works as well as Afsin-Elbistan towns; and (e) consultancy services.  2728P - 3 - The domestic fuel drying plant estimated to cost about US$75 million in 1974, intended for processing lignite for sale as domestic fuel, was excluded frcu the Project at appraisal for lack of sufficient engineering information. Implementation Problems 1.07 Several agencies were involved in the execution of the supporting infrastructure, e.g., roads, telecommunications, etc. Since each of the involved agencies had its own identity, commitments and priorities, the coordination required to successfully implement a project as large and complex as Elbistan, probably the largest single project in Turkey, became difficult to achieve. The coordinating committee set up by Government to coordinate activities of all organizations associated with the Project proved to be ineffective. 1.08 TEK and TKI had difficulties in recruiting and retaining sufficient numbers of suitably qualified and experienced salaried personnfl for the execution of the Project because of the remoteness and poor living conditions of the site and the low and rigid civil service salary structure. Project site supervision ran into difficulties due to inexperience of the site staff of TEK and TKI, their limited executive authority, since the project management remained essentially in the hands of headquarter's staff in Ankara, and poor coordination between the two entities. These root problems led to technical and administrative problems such as delavs in procurement of equipment for the lignite mine and in payment to contractors for work carried out, lack of supervision and control of civil works, and failure to develop and implement dewatering procedures. 1.09 Moreover, delays in the provision of local funds by the Government have seriously affected implementation of the Projezt. This state of affairs was a result of both shortage of funds and unsatisfactory disbursement arrangements. Changes in Project Scope 1.10 Aside from increasing the nameplate rating of the power units from 300 MW to 340 MW to accommodate a standard design and adding a 30-km water supply pipeline, no major changes were made in project scope. However, in 1981 TEK agreed to increase expatriate support for: (i) construction supervision, (ii) project management, and (iii) startup, operation and maintenance (0 & M) activities. Lately there have been slight design modifications to the boiler and ash handling plants to reflect operating experience with Units 1 and 2. Past Procurement and Disbursements 1.11 All procurement under the Bank loan (Loan 1023-TU) took place through ICB in accordance with the Bank's Guidelines for Procurement. No major procurement issues arose. Annex 1.2 shows a summary of the contracts financed under the loan and Annex 1.3 compares the actual disbursements with the appraisal estimate. Due to delays in loan effectiveness and project implementation, actual disbursements lagged behind estimates by about three years. The loan Closing Date was June 30, 1983. The Loan Account was kept  2728P - 4 - open to permit TEK and TKI to complete disbursements against contracts awarded before the closing date. The loan was fully disbursed by September 15, 1983. Ongoing contracts have been financed in 1983-1985 by KfW, EIB and the Government. Adverse Project Cost Factors 1.12 The severe delays in the execution of the Project (para. 1.13) are in great part attributable to labor disputes and periods of political and social unrest during 1977-1980, particularly in the remote Kahramanmaras province where the Project is located. The delays resulted in cost overruns, more than doubling the original cost estimate. A revised cost estimate is shown in Annex 1.4. The following factors also contributed: (a) Exchange Rate Variation: The bulk of equipment was procured from countries whose currencies appreciated substantially during project implementation: DM during the late 70's and Yen in the 80's. (b) Increased Cost of Engineering and Administration: When the project ran into difficulties, additional expatriate technical assistance was brought in starting in 1981 (para. 1.10); actual man months of engineering and administration are more than double the appraisal estimate. This is further reflected in the relatively large amount estimated for Engineering and Administration in Table 4.1. (c) Interest During Construction: The length of the execution period for the Project coupled with massive borrowings to cover the financing gap substantially increased the amount of interest during construction. Status and Operating Performance of -he Original (1974) Elbistan Project 1.13 The Project is about seven years behind schedule but there has been no slippage since 1983. The present situ.tion can be summarized as follows: (a) Power Station; All the main plant and equipment for the four 340-MW units are procured and on site. The cooling towers, chimney and the bulk of the civil works are complete. Since July 1982, erection work has been proceeding satisfactorily. Unit 1 went into commercial operation in January 1985. Unit 2 went into trial operation in May 1985 and is going into commercial operation in January 1986. Units 3 and 4 are to follow at one year intervals. Operating performance data for Units 1 and 2 in September 1985 is given in Annex 1.5. (b) Lignite Mine: The mine is fully operational, but the quantities of material moved at the mine over the past three years have been well below planned levels. However, by March 1985, the mine had thoroughly uncovered the lignite seam for the first time, with an inventory of about 4.3 Mt available for immediate mining. Data gained from the seam showed improved geological conditions compared to those previously assumed from exploration results, resulting in more lignite available within power station specifications and a lower overall stripping ratio. Although no mine planning based on  (2728P) -5- the new parameters has been done as yet and further verification is required, the Bank is satisfied that the design of the existing main equipment is adequate to handle the required quantities of material without major overburden backlogs over the next two-three years provided, however, that corrective action is taken to renmve the following major operational constraints: insufficient numbers of managerial and skilled personnel, lack of training personnel and programs, insufficient spare and wear parts, inadequate maintenance arrangements, and inefficient removal of hard strata. (c) Domestic Fuel Drying Plant: In the light of the problems encountered to supply lignite for the power station, TKI has decided not to proceed with the lignite drying plant associated with the original Project (para. 1.06(c)). The Bank has agreed to this decision. (d) Transmission Lines; Of the two 380-kV lines under the original Project, Elbistan-Kayseri has been in operation since 1983. The other, Elbistan-Ankara, is under construction and scheduled for completion in time to accommodate commercial operation of Unit 3 starting in January 1987 (see Map IBRD 19045). Rationale for Continued Bank Involvement 1.14 The Elbistan Project is almost complete. Project implementation is under control and progressing well. The mine is fully operational and construction on the fourth and last unit in the power station is scheduled for completion by the end of 1986. Moreover, in line with the agreed energy sector strategy (para. 2.01), the government is committed to introducing adequate measures at the lignite mine to ensure the long term availability of sufficient lignite for efficient operation of the power plant (para. 4.14). 1.15 Throughout the implementation of Elbistan, starting in 1974, the three major cofinanciers, KfW, EIB and IBRD, have acted in close coordination, always maintaining a common, unified position. A great deal of the recent favorable turn of events can be attributed to the persistent, concerted efforts of the Bank, KfW and EIB. In addition to participating with the Bank in the proposed project, KfW and EIB also plan to fund a parallel project to assist TKI carry out operation and maintenance improvements at the lignite mine (para. 4.06). Now that a solution to Elbistan's long standing technical and institutional problems is, at last, in sight, it would be highly desirable for the Bank to stay on with KfW and EIB to see the project through. Although modest in financial terms (US$10 million), the proposed project would provide for the Bank's continued presence in this key thermal power project in Turkey, consistent with the ongoing effective sector dialogue (para. 2.05).  (2728P) - 6 - II. THE ENERGY SECTOR Sectoral Context 2.01 The importance of Elbistan to Turkey's energy development is still high in spite of the severe delays experienced in the Project. Furthermore, present Bank strategy in the energy sector is to focus on projects that can be brought on stream rapidly. The proposed Project fits in well with the energy policy of the current Five-Year Development Plan. Turkey's present energy policy, as endorsed by the Bank, establishes, inter alia, that priority is to be given to development of domestic sources of energy, especially hydro and lignite, provided that they are economically justified. The magnitude of the looming energy supply gap dictates that priority be given to completion of projects at an advanced stage of construction, such as Elbistan Units 3 and 4. An in-depth discussion of the Turkish energy s :ctor and the current Bank strategy for energy lending is given in Annex 2.1. Role of the Bank and Past Lending Experience in the Power Subsector 2.02 The proposed Project would be the eighteenth Bank operation in the power subsector in Turkey. The Bank has made thirteen loans and a technical assistance grant (total US$921.7 million), and IDA has granted three credits (total US$55.7 million). These comprise loans/credits for four hydroelectric projects; two thermal power stations (oil- and lignite-fired); a lignite mine; and several for transmission and distribution networks. The technical assistance grant helped reorganize Turkey's power subsector. The first five loans/credits were for projects in the Cukurova Electric Company (CEAS) concession area. The Bank has made six previous loans to TEK, for the First, Second Third and Faurth Power Transmission Projects, for System Operations Assistance, and for the 1974 Elbistan Thermal Power Project (Loan 1023-TU). 2.03 A Project Performance Audit Report (PPAR), distributed to the Board in November 1981, on the Keban Transmission (Loan 568-TU) and the first TEK Power Transmission (Loan 763-TU) projects found that these projects had met their physical objectives despite implementation delays and cost overruns. A Project Completion Report on the Istanbul Power Distribution Project (Loan 892-TU), distributed to the Board in December 1982, also reported physical completion of the Project after considerable delay. Major constraints to timely project completion were identified as shortage of local counterpart finance and, in the case of Loan 892-TU, late preparation of bidding documents. A major conclusion of the TEK II (Loan 1194-TU) Project Completion Report circulated to the Executive Directors on October 29, 1984 was the clear need for a single project management unit within TEK to be accountable for project implementation. Such a monitoring unit has now become a feature of project design in Bank-financed power projects in Turkey. For example, ELTEM-TEK, a Turkish consultant assisted by foreign specialists, was hired by TEK to assist in monitoring all aspects of the Third TEK Transmission Project (Loan 2232-TU). Procurement and physical implementation of this project, which includes about 1500 km of 380-kV lines, are proceeding with only minor delays.  (2728P) - 7 - 2.04 The Bank played a major role in the consolidation of the power sector and in the creation of TEK. The Bank has since then continued to advocate needed institutional reforms and has met with some success in its endeavors to assist in strengthening the institutional capabilities of the subsector. Substantial progress has been made in some areas, e.g., improvements in TEK's accounting system, in system planning, and in procurement procedures. Furthermore, the Bank has assisted in attracting funds from other bilateral and international financing agencies (e.g., EIB, US EXIMBANK). 2.05 The Bank has, through its sector work program, provided guidance and assistance in sector planning and pricing policy, including discussions with the Government and energy sector agencies (e.g., TEK). These have provided a useful forum for a policy dialogue on the issues and constraints facing the subsector. Policy level discussions with MENR, TEK and State Planning Organization (SPO) have continued to increase the awareness of those problems; and Bank guidance and advice have frequently been sought on a number of operational and policy questions. 2.06 Since it is not possible to address the full range of issues facing the subsector it was recommended that attention be given to a selected number of high priority issues where the Bank could have an appreciable impact. T.ie strategy for assisting the power subsector is in line with the overall planned strategy for the energy sector as outlined in Annex 2.1 (para. 15) and includes focusing resources on investments which yield quick returns (e.g., completion of priority ongoing investments, upgrading of existing facilities, reduction in losses, improvements in efficiency etc.); ensuring a balanced electric power development program with respect to adequate investment in generation, transmission, distribution and general plant; strengthening, through technical assistance, capabilities in planning, financial management and manpower development; investment in new generation options such as those based upon imported coal and natural gas; and increasing the role of the private sector in the production of electricity. 2.07 The Bank has made a major effort at defining jointly with Government a series of potential investments which would address the above medium-term issues. In particular the Bank proposes to finance, inter alia, an urban distribution component of a proposed Energy Policy Loan, a project (Sir Hydro) with a private utility, Cukurova Elektrik A.S. (CEAS), and a high priority hydropower pr-cW: (Kayraktepe). Project lending aimed at alleviating the medium-term' problems faced by the subsector will be supported judiciously by technical assistance and sector work in a number of key areas such as planning and financial management.  (2728P) -8- III. THE PROJECT ENTITY:TEK 3.01 TEK has primary responsibility in Turkey for design and construction of thermal generating plants, for operation of both thermal and hydroelectric generating plants, and for design, construction and operation of the national transmission system and distribution systems. The organization and scope of responsibilities of TEK have been altered recently by a number of significant legal changes. TEK is now authorized to invest in and operate lignite mines and geothermal fields to supply its power plants; previously TKI was the only public enterprise authorized to own and operate lignite mines. In parallel, the opportunities for private sector investment in electric power have been expanded, removing TEK's previous near monopoly on electricity generation and sales. TEK will continue to require the Bank's assistance in institution-building. TEK is presently receiving technical assistance in four areas as part of Loan 2322-TU (TEK Transmission III), as follows: demand management and load analysis; administration and standardization of distribution operations; manpower planning and training; and, improvements in accounting and management information systems. Legal Context 3.02 TEK presently operates as a Public Economic Establishment (PEE) defined under Law 233 as a venture owned entirely by the Government which is "public service-oriented and founded to produce and market basic goods and services of a monopoly nature". As part of the reform in public enterprises, TEK's legal structure and organization were redefined effective January 1, 1985. TEK was originally established in 1970 with its current mandate, but excluding urban electricity distribution, which had been the respousibility of the municipalities. Urban distribution was then legally transferred to TEK in 1982, with actual operation and control of these distribution facilities being assumed in stages during 1983 and 1984. The objective of public enterprise reform in Turkey has been to permit greater aut.miomy and improved productivity, and in fact the Government has recently been taking significant steps toward increasing TEK's financial self-sufficiency. However, TEK continues to be subject to the State Personnel Law (No. 657), which restricts management decisions on hiring, firing, salaries, and internal transfer of staff. Revised legislation for government employees is being drafted but the timing for implementation is uncertain.  (2728P) - 9 - Organization and Management of TEK 3.03 Notwithstanding the recent reforms affecting public enterprises, important managerial and organizational decisions continue to require Government approval, and thus are not dealt with as quickly as would be the case in a more autonomous utility. Furthermore, there are no board members from the private sector who could represent the concerns of TEK's industrial and private consumers. In the past fifteen years, TEK has had seven general managers, normally appointed from within the company. The Board of Directors of TEX is chaired by the General Manager, and includes five members; two nominated by the MENR, one nominated by the Minister of Finance and two nominated from among the six Assistant General Managers (AGMs) of TEK by the Minister of Energy. The present organization of TEK is shown in Annex 3.1. The responsibilities of the six AGMs were shifted in early 1985, and are currently divided as follows: (a) Operations: Generation, Transmission and Distribution; (b) Design and Construction of Generating Plants; (c) Design and Installation of Transmission Lines and Substations; (d) General Administration and Distribution Studies; (e) Planning, Training and Data Processing; and (f) Finance. 3.04 Some of the activities reporting to the AGM for Operations have recently been classified as part of an "Operations Enterprise" within TEK, which is to include generation and transmission operations and responsibility for wholesale electricity sales to high voltage customers and to TEK's distribution enterprises. It is too soon to determine whether this recent change will have a visible impact on TEK's operations. 3.05 Having historically emphasized centralized operations and construction of new generating facilities in particular, the management of TFK is still adjusting to the new requirements of overseeing distribution where highly centralized decision-making is not desirable. Eighteen regional electricity distribution enterprises were created in 1983 as separate departments of TEK after the takeover of distribution from the runicipalities. While, officially, each enterprise manager reports directly to the General Manager, in practice they are required to report to two AGMs, to one with regard to operations and to the other with regard to distribution studies and project design. It would be advantageous to reallocate the responsibilities of the AGMs so that one would be fully responsible for coordinating distribution activities. 3.06 TEK's central office provides continuous monitoring and inspection of the distribution caterprises, approves all personnel decisions, and determines the allocation of investment resources among the regions. The distribution enterprises are presently not authorized to seek outside financing. They are charged by the parent company for electricity purchased at wholesale tariff rates and for part of the overhead headquarters expenses associated with distribution. Each enterpri-e is responsible for preparation of its annual operating budget, drafting annual and long-term investment and plans, and preparation of annual financial statements. Full responsibility for the design, execution and control of urban distribution and rural  (2728P) - 10 - 3.07 A number of distribution enterprises are presently receiving technical assistance on a pilot basis. A master plan for reduction of losses and network expansion is being developed for the. te Enterprise (Izmir); improvement of the customer billing system is being introduced in one district of the Bosphorus Enterprise (Istanbul); and, improvements in stock control, general and customer accounting are being introduced to two enterprises, Ege and Central Anatolia (Ankara). Manpower Development and Training 3.08 The rapid expansion of electricity supply in Turkey has been accompanied by an almost equally rapid increase in the number of people employed by TEK. The total number of staff as of October 1984, was just over 55,000, of which 33,000 worked for TEK's Distribution Enterprises. This represents an increase in staff of 15,000 over a two-year period, of which 11,000 were new distribution staff and 4,000 were added to other departments of the utility. After distribution the next largest group, about 13,500, work in operations. A breakdown of TEK's staff by department and by level of training is shown in Annex 3.2. 3.09 Manpower planning for TEK as a whole is presently carried out only one year at a time, although staffing requirements for new generating plants are identified further in advance. The Personnel Department and the Training Department do not report to the same ACM, which complicates coordination. TEK has three technical training centers, the largest of which is located in Soma and has extensive laboratory capacity and models related to thermal electricity generation. However, much of the equipment is out of date and the training center is used at less than full capacity largely due to the shortage of instructors. Training materials dealing with transmission, distribution and overall system reliability are lacking. 3.10 Some of these weaknesses are being addressed under TEK Transmission III (Loan 2322-TU) which includes a thirty-four man-month contract with Ontario Hydro. This technical assistance component is addressing: mnwpower planning for generation, overseas training of master instructors (in operation of generating plants, transmission and control), training on plant commissioning; Lnd improvement of t':e equipment at the Soma training center. General Characteristics of the TEK Power System 3.11. The large magnitude of the TEK power system can be appreciated by considering the volume of the electric load supplied and the extension and size of its physical facilities. In 1984 the peak load in TEX power system reached 5,450 MW and gross generation was 26,000 GWh (net 23,600 GWh). In the same year TEK imported 2,500 GWh from Bulgaria and the USSR which gave a total electric energy delivered to the TEK power transmission grid of 26,100 CWh. Total rated capacity of TEK power plants in commercial operation in 1984 amounted to 6,330 MW. Adding the peak supply from Bulgaria and the USSR - 285 MW - the total capacity available reached 6,615 MW, to meet a system constrained peak demand of 5,450 MW.  (2728P) - 11 - 3.12 TEK's bulk transport system consists of a 380-kV National Grid System that feeds into 154-kV grids. These 154-kV grids supply major power users and feed into 66-kV, 35-kV, and 15-kV subtransmission grids. In 1984 there was a total of 46,135 km of transmission and subtransmission lines. TEK's substation plant in the transmission grids consists in 1984 of 368 transformer substations with 593 transformers, having an aggregated capacity of 15,798 MVA. Besides power transformers, in these substations there were in 1984 a total of 34,569 major switchgear apparatus. 3.13 Low voltage distribution throughout Turkey is done at 50 Hz 220/380 V three-phase with neutral grounded. Primary distribution voltages are 35 kV, 15 kV, 6 kV and 3 kV. In the 18 regional distribution enterprises under TEK, the distribution systems consisted in 1984 of: 19,500 km of primary distribution feeders at 35 kV, 15 kV and 6 kV; 64,000 km of secondarLes at 220/380 V; and 6,289 distribution transformers with an aggregated capacity of 4 730 MVA (more than half of this distribution transformer capacity is installed in the Bogazici Distribution Enterprise, which includes the city of Istanbul with 1,600,000 consumers). 3.14 The level of technical losses in distribution is between 12% and 15%, which is high by modern standards 1/. These losses can be reduced by increasing the capacity of the distribution facilities, particularly distribution transformer and feeders. Preparation of master plans is underway for reduction of losses and expansion of the distribution systems. It is considered economically feasible to reduce losses to about half of wnat they are now, but this will require considerable investment in the coming years. TEK is already programming substantial investments in this area in the next five years. TEK's Power System Operation Performance 3.15 During the last ten years, TEK's transmission system proved stable in spite of the long transmission distance; voltage and reactive power were satisfactory. Operation experience with the substations equipment has been satisfactory, although maintenance problems have led to a considerable number of outages. A major problem was in connection with the lightning arresters but TEK has taken measures to improve insulation coordination and lightning protection in the subst-tions. With regard to transmission lines, TEK faced a more serious problems of mechanical failure during the first 5-year operation of the 380-kV system, due to insufficient knowledge of the very severe weather conditions in certain areas where there was no prior experience of transmission line operation. Since then, TEK has introduced more adequate mechanical design for the lines, as well as the reinforcement of the existing lines exposed to heavy ice and wind loads in winter. 1/ In most developed countries, the level of technical losses in the well operated distribution systems is about 6%.  (2728P) - 12 - IV. THE PROJECT Project Objectives 4.01 The proposed Project would provide for the Bank's continued supervision oZ Elbistan. The main objectives of the proposed Project would be to complete the Elbistan power station (4 x 340 MW) and to ensure the station's adequate operating availability and efficient operation. Project Description 4.02 The proposed Project includes: (a) completion of construction and commissioning of Elbistan's Units 3 and 4; and (b) improvement in the Borrower's project management and operation and maintenance capabilities at Elbistan. Project Cost Estimate 4.03 The total cost of the proposed Project, including physical and price contingencies but excluding interest during construction, is about TL 152.7 billion (US$237.8 million), of which US$87.6 million is in foreign exchange. Details of the project cost estimate are given in Annex 4.1 and a sumnary is shown in Table 4.1. The project cost estimate is based on early 1985 prices from detailed data provided by TEK, TKI and their consultants. The resulting figures were reviewed and found reasonable by the Bank. Total physical contingencies are about 3.0% of base cost. This is reasonable given the advanced state of construction of the power plant. Price contingencies have been calculated assuming a three-year implementation period (1985-1987) consistent with the latest estimates of TEK and their consultants as reviewed and found reasonable by the Bank. Specific annual increases in domestic and international prices were applied as follows: 1985 1986 1987 Domestic (Z) 35 30 25 International (Z) 5 7.5 8 The resulting price contingency expressed in US$ equivalent is about 5.7% of the total base cost plus physical contingencies and reflects the relatively large expenditures projected for 1985 compared to the last two years, 1986 and 1987. Annex 4.2 shows details of the price contingency calculations.  (2728P) - 13 Table 4.1 Summary-o-f roject Cost Foreign as x Local Foreign Total Local Foreign Total of Total ---TL Biilion- ----UUS Million---- Plant and equipment(incl- uding spare parts) 3.9 16.6 20.5 7.9 33.1 41.0 80.7 Civil Works 5.9 - 5.9 11.9 - 11.9 0.0 General Erection Contract 31.2 16.3 47.5 62.3 32.7 95.0 34.4 Engineering 0.2 6.9 7.1 0.4 13.7 14.1 97.2 Administration 28.3 - 28.3 56.6 - 56.6 0.0 Base Cost (early 1985 prices) 69.5 39.8 109.3 139.1 79.5 218.6 36.4 Physical Contingencies 1.9 1.3 3.2 3.7 2.7 6.4 42.2 Price Contingencies 23.6 16.6 40.2 7.4 5.4 12.8 42.2 Total Project Cost 95.0 57.7 152.7 150.2 87.6 237.8 36.8 Interest During Construction on - Bank Loan - 0.5 0.5 - 1.0 1.0 100.0 - Other Loans - 4.5 4.5 9.0 9.0 100.0 Total Financing Required 95.0 62.7 157.7 150.2 97.6 247.8 39.4 4.04 Identifiable taxes and duties are about TL 28.3 billion and the total Project cost, net of taxes, is TL 124.4 billion (US$193.7 million). As indicated in para. 1.10, Engineering and Administration was increased considerably to strengthen the site organization starting in 1981. Table 4.2 shows the large number of expatriate and local Engineering and Admainistration personnel required at the job site to ensure adequate implementation p'ogress.  (2728P) - 14 - Table 4.2 Engineering & Ad-winistration Manpower at Elbistan Power Plant Job Site End of End of Second Quarter First Quarter Increase/ 1985 1985 (Decrease) TEK Site Management 440 445 (5) STEAG 1/ 31 38 (7) ESO 2/ 15 17 (2) Total 486 500 (14) 1/ Management Assistance Team (MAT) and Operations and Maintenance Assistance Team (OMAT) 2-/ Engineering Site Organization--The Engineer of Record, a consortium of the following consulting firms: Fichtner (FRG), Sofrelec (France) and Gemas (Turkey). Although the reduction indicated above will continue gradually a number of Engineering and Administration personnel will stay on right to the end of construction and commissioning. Project Financing Plan and Lending Arrangement 4.05 The proposed Bank loan of US$10 million would be made to TEK with the guarantee of the Republic of Turkey on standard Bank terms. The proposed loan would finance about 4% of the total financing required (US$247.8 million) and about 102 of the foreign exchange portion (US$97.6 million). The remaining US$87.6 million would be covered from loans and credits being provided by EIB, KfW, MANTRUST, and own resources from TEK and Government. A summary of the Project financing plan is shown in Table 4.3. The foreign exchange risk on the Bank loan would be borne by TEK.  (2728P) - 15 - Table 4.3 Project Financing Plan (US$ Million) Local Foreign Currency Currency Total Proposed IBRD Loan - 10.0 10.0 EIB - 14.5/1 14.5 KfW 30 772 30.7 MANTRUST - 30.oZ! 30.0 TEK 35.0 - 35.0 Government 115.2 12.4/4 127.6 Total 150.2 97.6 247.8 /1 Released from blocked ECU 45 million loan. /2 From remaining DU 25 million in Loan No. 5 and DM 50 million in Loan No. 6. 73 From available Manufacturers Hanover Trust facility. 7Z Includes US$10 million interest during construction. Given the recent improvements in TEK's financial performance (para. 5.04), no difficulties are foreseen in TEK's meeting its share of the local currency costs of the Project. The Goverment is deeply committed to complete Elbistan. No shortages of Government funds for the Project are anticipated. During negotiations, the Government gave adequate assurances that local currency funds will be made available to TEK as required. Project Implementation 4.06 Success of the proposed Project depends on the availability of adequate supply of lignite to the power station from the Kislakoy mine at Afsin-Elbistan. To this effect, TKI is carrying out during 1985 certain improvements at the mine with financial assistance from KfW and EIB. A cost estimate of the KI project is shown in Table 4.4. EIB and KfW are co-financing the foreign exchange requirements. Now that the mine is fully operational (para. 1.13), TKI should have no problem meeting the relatively modest local currency (TL4.2 billion) required.  2728P - 16 - Table 4.4 Cost Estimate of TKI 1985ihslakoy Mine Improvement Project Local Foreign Total Local Foreign Total --TLBi:llion--- ----US S Mi on = Main Mining Equipment - 2.9 2.9 - 5.8 5.8 Maintenance Contracts 0.5 2.2 2.7 1.0 4.4 5.4 Spare Parts 2.5 2.8 5.3 5.0 5.5 10.5 Consultants 0.5 4.1 4.6 1.0 8.2 9.2 Base Cost (early 1985 prices) 3.5 12.0 15.5 7.0 23.9 30.9 Contingencies 0.7 2.7 3.4 0.4 1.7 1.8 Total 4.2 14.7 18.9 7.4 25.6 32.7 4.07 TEK would continue to implement the construction and commissioning of the Power Station and has agreed to continue to employ project management consultants (STEAG, FRG) under terms and conditions acceptable to the Bank up to commercial operation of Unit 4, or December 31, 1987, whichever comes later, to assist in the construction and conuissioning of Units 3 and 4 and to train the operation and maintenance crews. The Turkish authorities have indicated to the Bank their intention to involve the private sector to provide a permanent eolution to Elbistan's technical and institutional problems. Major issues faced by the Turkish authorities in establishing appropriate long-term arrangements at Elbistan are outlined in Annex 4.3. The Project would be implemented over three years (1985-1987) and is expected to be completed by December 31, 1987. Annex 4.4 shows an estimated implementatior. schedule. Procurement 4.08 Procurement arrangements are summarized in Table 4.5.  (2728P) - 17 - Table 4.5 Procurement Arrangements (USS millions) Procurement Method Project Element ICB LCB Other NA Total Cost Plant & Equipment 0.5 45.6 46.1 including spares (0.5) (2.5) (3.0) Civil Works - 12.7 12.7 Installation & - 103.4 103.4 Erection - (5.0) (5.0) Engineering - 15.4 15.4 (2.0) (2.0) Administration - 60.2 60.2 Total 0.5 237.3 237.8 (0.5) (9.5) (10.0) Notet Figures in parentheses are the respective amounts financed by the Bank. Plant and Equipment up to an amount of US$ 45.6 million equivalent will be co-financed by KfW and EIB and procured through extension of existing contracts with eligible suppliers under KfW and EIB rules. Spare parts (US$ 2.5 million) are proprietary items obtainable only from one source and will be procured through direct contracting with each applicable supplier, in accordance with procedures satisfactory to the Bank in accordance with Bank guidelines. Installation and Erection services (US$103.4 million) will be procured through extension of existing contracts awarded through ICB in accordance with Bank guidelines. Civil works (US$ 12.7 million) will be procured as extension of existing local contracts. Contracts for miscellaneous items costing the equivalent of US$ 50,000 or less, up to an aggregate of US$ 1,000,000 equivalent may be procured under contracts awarded on the basis of comparison of price quotations solicited from a list of at least three suppliers eligible under the Bank's guidelines, in accordance with procedures acceptable to the Bank. Engineering services (US$15.4 million) will be procured through extension of existing consultancy contracts awarded under the Bank's guidelines. Administration will be done by force account. All bidding packages for goods over US$ 250,000 equivalent would be subject to the Bank's prior review of procurement documents, resulting in about 90% coverage of goods contracts. The balance of contracts would be subject to selective post review by the Bank after contract award. No retroactive financing will be required.  2728P - 18 - Disbursement 4.09 Disbursement of proceeds of the proposed Bank loan would be made for: Z of Expenditures Category to be Financed (a) Goods 100% of foreign expendi- tures and 100% of local expenditures (ex-factory cost) (b) Installation & Erection Services 100% of foreign expenditures (c) Consulting services 100% of foreign expenditures An estimated disbursement schedule is shown in Annex 4.5. This profile takes into consideration the special nature of the proposed Project. Given the specific nature of the Project, no significant comparison with power project profiles in EMENA as a whole is possible (Annex 4.6). Special Account 4.10 The establishment of a Special Account in the Central Bank will permit payment of Bank-financed expenditures with a minimum administrative delay. This Special Account would be replenished in the same currency, and would have a ceiling of US$2.0 million, which is equivalent to a four-month average of the total expenditures to be financed out of the proceeds of the Bank loan. The procedure for withdrawal of funds from the Special Account was agreed during negotiations. Central Bank statements showing the transactions in the Special Account will be submitted to the Bank. Applications for replenishment will be accompanied by appropriate documentation or Statements of Expenditures. Replenishment will be made in the amount equal to payments made out of the Special Acco'mt for eligible expenditures, but only to the extent that the amount of any such deposit together with any amount remaining on the deposit in the Special Account as of the date of such request, does not exceed the equivalent of the agreed ceiling.  2728P - 19 - Environmental Aspects 4.11 The Elbistan power station is located in a sparsely inhabited area (see Map IBRD 19081). The power plant provides for ash removal from flue gases by means of electrostatic precipitators designed for 992 removal efficiencies. At this level, fly ash emissions are in compliance with World Bank Guidelines for Dust and Electrostatic Precipitators. In addition, the plant will meet Bank Guidelines for Sulfur Dioxide and Nitrogen Oxides. Under Loan 1023-TU, TEX has agreed to establish pollution monitoring stations and to inform the Bank of recorded pollution levels and any corrective actions taken should they be necessary. The covenant is being complied with and the Government has agreed to take measures to ensure the continued application of these pollution controls. 4.12 The mine site area is treeless and at best sparsely cultivated. It affords no shelter to wildlife such as would need to be conserved, and TKI under Loan 1023-TU is carrying out necessary reclamation to allow resettlement and reuse. 4.13 The lowering of the water table in the mining activity has produced no ill effects and extracted water is used for irrigation. Sewage is being treated appropriately. Noise pollution does not arise. Project Risks 4.14 Except for uncertainty as to the mine's ability to meet the lignite needs of the power station beyond 1986, no major project risks remain. Although the lignite supply situation is at present satisfactory and likely to remain so at least through end-1986, continued satisfactory supply beyond that date will be dependent a great deal upon the improvements being made in the mining operation in parallel with the proposed project (para. 4.06). Moreover, the Government confirmed during negotiations that it will take all measures necessary to ensure that minimum requirements acceptable to the Bank for the supply of lignite to the Borrower are fulfilled.  (2728P) - 20 - V. FINANCIAL ASPECTS Financial Performance of TEK 5.01 At the time of the Elbistan Project in 1973, TEK had been in existence only a few years, having been formed in 1970 to centralize planning and operation of Turkey's power generation and transmission facilities. At that time TEK's financial position was weak, due, inter alia, to: the Government's decision not to approve adequate tariff increases, less than expected load growth and delays in the completion of a major hydroeLectric station (Keban). Earning about a 3Z return on revalued assets in 1973, TEK was far from meeting the 8% return set out in its law and agreed to in previous Bank loans. Furthermore, TEK had begun to encounter difficulties in collecting payments from municipalities and from Government enterprises, and receivables were equivalent to four months of sales revenues. 5.02 Establishment of TEK's financial viability was one of the goals of the Elbistan Project. With this in mind, the following financial objectives were agreed upon during negotiations for Loan 1023-TU: (i) two tariff increases of 22% in nominal terms in 1974 (a condition of loan effectiveness) and 31% in 1975; (ii) an 8% rate of return on revalued assets from 1976 onwards; (iii) reduction of accounts receivable from municipalities. The Government was to cause municipalities and its own agencies to pay outstanding debts to TEK promptly in order to ease the working capital shortfall. It was estimated at the time that fulfillment of these objectives would have enabled TEK to cover 56% of its capital expansion requirements--of which Elbistan represented a major share (67%)-from internal sources after taxes, on average over the project implementation period. Adding the State Hydraulic Works (DSI) construction program for hydroelectric plants to TEK'S forecast investments, power subsector self-financing was expected to average 39% for the period 1973-1981. Debt service coverage was forecast to increase from 1.3 in 1973 to 3.2 by 1981. The anticipated level of internal cash generation would also have eliminated the need for direct Government transfers to TEK to finance the investment program after 1975. 5.03 During the 1970's, TEK's actual financial performance was far from meeting these targets. This period was characterized by dramatically rising international fuel prices, higher than expected inflation in Turkey rising to a peak of over 10OX in 1980, and an unstable political situation which made it difficult for the Government to implement tariff increases. From 1973-1981, tariffs increased only 11Z in real terms as compared with the appraisal estimate of 47%. Although the Bank ultimately agreed to lower return on assets targets in the light of the Government's economic stabilization program, the return on revalued assets averaged less than 3Z during the 1970's. TEK continued to rely on injections of Government equity to meet its expanding construction requirements, with the Government contribution reaching 50% of TEK's investments by 1981. The municipalities continued the practice of retaining revenues from retail electricity customers to divert to other public services, and TEK's receivables reached a high of nine months of salesat the end of 1982. In the face of a serious cash shortage, TEK had few options but to postpone payments to its own suppliers, including TKI.  (2728P) - 21 - 5.04 A two-stage turnaround in TEK's deteriorating financial situation started in 1982. First, to resolve the problem of arrears from municipalities, the Government transferred electricity distribution to TEK, allowing it to collect directly from retail customers. TEK's working capital situation did not immediately improve however. Electricity tariffs dropped in real terms by almost 20Z in 1983, and TEK continued to divert available cash to its investment program instead of paying its fuel suppliers. Then, in 1984-85, the Government launched a program of regular real tariff increases, which more than offset the preceding drop in electricity prices. By April 1985, the average bulk electricity tariff was estimated to have reached about 85-90Z of the long-run marginal cost of supply. Debts between TEK and other State Economic Enterprises (SEEs) including TKI, were converted to equity by the Government in mid-1984, clearing up TEK's balance sheet, and TEK began paying for lignite and fuel oil on a timely basis. The self-financing level for power subsector investments (including both TEK and DSI) is estimated to reach about 162 in 1984 and over 35% in 1985. Annex 5.1 gives a su! ry of TEK's most recent financial forecasts Audits 5.05 As with other public enterprises, TEK's financial statements follow the Uniform Chart of Accounts, and are audited by tue High Control Board connected with the Prime Ministry. TEK is required by Law 233 to submit its balance sheets and final accounts to the Prime Ministry for auditing no later than the third month following the year to which they pertain. TEK is then meant to submit its annual audited accounts to the Bank no later than five months after the close of the year. However, there are shortcomings with both the scope and the timing of the present audit reports. The auditors rarely coimment on the reliability of the presentation of the accounts, or on significant events which occurred during the year. The audit reports concerning 1981 and 1982 were received more than a year after the close of the fiscal year. Similarly, the audit report for 1983 had not yet been received as of April 1985. 5.06 Most likely it will not be possible to meet the five month target for submission of the audit report, until the 1987 report. Under Loan 2322-TU, TEK consultants are giving priority to improving the timeliness and accuracy of TEK's financial statements. Furthermore, an upgrading of TEX's computer center, presently being studied, should improve TEK's ability to prepare and correct the annual financial reports. During negotiations agreement was reached on a gradual schedule of improvement for submitting audit reports, with the 1985 and 1986 audit reports being expected within 10 and 8 months, respectively, after the end of the given fiscal year, and within 5 months for 1987 and afterwards. I/ For a detailed assessment of TEK's recent financial performance and of financial issues affecting the power subsector, see: Turkey- Fourth Transmission Project Staff Appraisal Report, May 20, 1985, Report No. 5571-TU.  (2728P) - 22 - VI. PROJECT JUSTIFICATION Growth of TEK's System 6.01 The proposed Project would form part of the interconnected power system operated by TEK. TEK's system is projected to expand rapidly over the next ten years in order to meet a fast-growing demand and close the still prevailing electrical energy deficit. In connection with Bank sector work, a set of demand projections was prepared for discussions with TEK. These projections were updated for the purpose of this appraisal. A base case was derived assuaing that a limited demand management program would be implemented by TEK through direct load management and tariff increases. Results for the 1985-1995 period indicated an annual growth in peak demand and energy of 6.5Z and 8.5Z respectively. A low-demand case was also considered assuming a more dramatic improvement in energy efficiency (through reduction in losses) and resulted in an overall growth of 5.9Z p.a. in peak demand and 7.9% p.a. in energy. 6.02 The latter scenario was used to develop TEK's balance of energy and capacity (Annex 6.1, Attachment 1). It is very unlikely that the projected generation expansion to 1990, which includes Elbistan units 3 and 4, will be able to meet the system's energy requirements (GWh), even under average hydrological conditions and with continued imports from Bulgaria and the USSR. Any delay in commissioning of Elbistan 3 and 4 would therefore increase the projected supply gap. The proposed Project is thus justified as necessary to meet projected incremental demand on TEK system. Least-Cost Analysis 6.03 The remaining question is whether any other type of plant could meet the projected requirements at less cost than the Project. Of the available alternatives, only combustion turbines could conceivably be installed in time to avoid the energy deficits which would prevail in 1988 and later years without the Project. Adoption of one of the other feasible options would be justified, therefore, only if it showed sufficient economic advantage over the Project to offset the costs to the economy in terms of unserved demand which its longer completion time would involve. Evaluation of all the alternatives showed that, on the contrary, both the capital and operating costs of the Project were lower than those of any alternative (Annex 6.1, Attachment 2). Sensitivity testing confirmed that the Project would still be the least-cost option on the TEK projection of system growth, and even on the highly improbable assumption of a doubling of all its costs (capital, fuel, O&M), without any change in the costs of the alternatives. Rate oc Return on the Overall Sector TEK/DSI Expansion Program 6.04 The overall TEK/DSI expansion program for 1985-1990 (Annex 6.2), which includes the proposed Project, was evaluated in conjunction with the appraisal of the Fourth TEK Transmission and the Power System Operations Assistance projects (Loans 2586-TU and 2602-TU respectively) and indicated a rate of return of 11.3%, marginally below the estimated opportunity cost of capital of 12Z; reflecting the fact that electricit;- tariffs are slightly below the economic cost of supply as measured by the loig-run marginal cost.  (2728P) - 23 - However, it understated the real economic return on the program since the measurement of benefits underestimated the willingness to pay for electricity (para. 6.06). Recalculation of the Rate of Return on the 1974 Elbistan Project 6.05 The rate of return on the Elbistan project was recalculated. The period used for the calculation was 1973-2014, covering the start of construction of the power station and mine and their estimated economic lives of 30 years from the start of commercial operation in 1985. The costs are the capital and operating costs of the mine and power station together with the associated transmission facilities. The benefits comprise the revenues from the incremental bulk sales of electricity attributable to the power station. 6.06 Incremental sales were valued at the average prices projected for bulk consumers (at 1985 prices), which are as follows: 1985 1986 1987 1988 1989 1990 onwards TL/kWh 26.87 28.21 29.62 31.10 33.10 36.83 Electricity tariffs were assumed to increase at regular intervals to reach and maintain LRMC, and to ensure an adequate level of self-financing for the power subsector, reflecting the Government's commitment to reduce public expenditures. Since the tariffs used in the calculation were estimated as a proxy for consumers' willingness to pay, all taxes