Turkey - Power System Operations Assistance Project

Document of The World Bank FOR OFFICIAL USE ONLY js SGe2-TL/ Report No. 5572-TU TURKEY POWER SYSTEM OPERATIONS ASSISTANCE PROJECT STAFF APPRAISAL REPORT May 20, 1985 Projects Department Eurnpe, Middle East and North Africa Regional Office This document has a restricted distribution and may be used by recipients oniv 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) USti = TL 450 TL 1 US$.o02 Currency equivalents are those effective January 1985, unless otherwise indicated. WEIGHTS AND MEASURES KVA = kilovolt ampere kW = 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) Megavar 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 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 ICB - International Competitive Bidding IDA - International Development Association KEPEZ A.S. - Kepez Electric Company KfW - Kreditanstalt fur Wiederaufbau LRMC - Long-Run Marginal Cost MENR - Ministry of Energy and Natural Resources MTA - Mineral Research Institute PEE - Public Economic Establishment PIPMU - Project Implementation and Performance Monitoring Unit PPAR - Project Performance Audit Report PPF - Public Participation Fund SAL - Structural Adjustment Loan SEE - State Economic Enterprise SEI - Southern Electric International SPO - State Planning Organization TEK - Turkiye Electric Kurumu (Turkish Electricity Authority) TRI - Turkiye Komur Isletmeleri Kurumu (Turkish Coal Enterprises) TPAO - Turkiye Petrollerei Anonim Ortakligi (Turkish Petroleum Corporation) Fiscal Year - January 1 to December 31  FOR OMCAL USE ONLY TURKEY SrAFF APPRAISAL REPORT POWER SYSTEM OPERATIONS ASSISTANCE PROJECT TABLE OF CONTENTS Page No. I. THE ENERGY SECTOR .............................................. I The Role of the Energy Sector in the Economy .1 The Resource Base .................., 1 Main Agencies ................... 2 Demand and Supply. 3 Energy Policy. 4 Bank Strategy. 5 II. THE ELECTRIC POWER SUBSECTOR. 7 Background ..................................................... 7 System Characteristics .................................., 7 Sectoral Development 1971-1984 .............................. 9 Government's New Strategy. 9 Institutional Development .................................. 10 Pricing and Demand Management .........................I..... 12 Electricity Planning .....................,.,....... 13 MediumrTerm Investment ......................................... 14 Bank's Role in the Power Subsector ............................. 16 III. THE PROJECT ENTITY: TEK .............. ......................... 19 Legal Context .18 Organization and Management of TEK .18 Manpower Development and Training .21 General Characteristics of the TEK Power System .22 Operational Area of TEK .22 Operational Performance of TEK Power System .23 IV. THE PROJECT .................. , ......................... 28 Project Objectives and Relation to Subsector Strategy . 28 Project Scope and Description .................................. 28 Following a mission to Turkey in January/February, 1985, this report was prepared by: A. Posada (Power Engineer), I. Johnson (Economist), L. Meek Foote (Financial Analyst), Z. Ladhibi (Power Engineer) and J. Chassard-Manibog (Economist). This document has a resticted distrbution and may be used by recipients only in the performance of their ofwicial duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii. - TABLE OF CONTENTS (continued) Page No. IV. THE PROJECT (cont'd) Project Cost Estimate .......................................... 29 Training ................. 31 Project Financing .............................................. 32 Status of Project Preparation .32 Project Supervision and Monitoring .34 Project Implementation .35 Procurement .35 Disbursement and Special Account .37 Retroactive Financing and Advance Contracting .37 Environmental Aspects .38 Risks .38 V. FINANCIAL ASPECTS .39 Introduction .39 Recent Financial Performance ...............................,. 39 Electricity Pricing ......................................... 39 Working Capital ............................................. 40 Debt Service ................................................ 42 Recent Trends in Sector Financing & Internal Cash Generation. 43 Public Participation Fund and Keban Revenue-Sharing Certificates .............................................. 44 Financial Planning and Accounting Practices .................... 45 Financial Planning .......................................... 45 Audits ................,. ................. 46 Asset Revaluation ........................................... 46 Technical Assistance to Improve Accounting .... .............. 47 Future Financial Prospects ..................................... 47 Financing of Medium-Term Power Investment Program .... ....... 47 Future Financial Position of TEK ............................ 52 Agreed Revenue Covenant and Supporting Covenants .... ........ 52 Potential for Private Investment in Power ................... 53 VI. PROJECT JUSTIFICATION .......................................... 54 Relationship to Policy Objectives .54 Relationship of the Project to the Least-Cost Program .54 Rate of Return on the Investment Program .55 Justification of Individual Components .56 VII. AGREENENTS REACHED AND RECOMMENDATION .58  - iii - TABLE OF CONTENTS (continued) ANNEXES 1.1 Energy Balances 2.1 Demand j orecasts 2.2 Electric Power Investment Program (1985-1989) 2.3 Tariff Study 3.1 Legal Framework of TEK and Related Legislation 3.2 Organization Chart of the Turkish Electricity Authority 3.3 Personnel of TEK by Function and Level of Training 3.4 General Characteristics of TEK Power System 3.5 Comparative Performance of Major Steam Power Stations, 1980-1984 4.1 Total Project Cost Per Operational Area 4.2 Procurement Under ICB: Procurement Schedule by Contract Packages 4.3 Operations Performance Monitoring Guidelines 4.4 Project Disbursement Schedule 4.5 Estimated Disbursement Schedule 4.6 Comparison of Disbursement Profiles 5.1 Bulk (High Voltage) Electricity Tariffs; 1983-1985 5.2 Bulk (High Voltage) Tariffs Compared with TEK's Annual Revenue and Inflation: 1982-1985 5.3 Retail (Low Voltage) Electricity Tariffs: 1983-1985 5.4 Income Statements for TEK (1981-1990) 5.5 Balance Sheets for TEK (1981-1990) 5.6 Statement of Sources and Uses of Funds for TEK (1981 - 1990) 5.7 Summary of Financial Ratios 5.8 Assumptions used in Financial Forecasts 6.1 Rate of Return Analysis 7.1 Selected Documents and Data Available in the Project File MAPS IBRD 18846 & 18847 May 14, 1985  1. THE ENERGY SECTOR The Role of the Energy Sector in the Economy 1.01 In 1977, four years after the first of the major oil price increases, Turkey's oil import bill was equivalent to 84% of its merchandise export earnings. By 1980, the situation was even more precarious: oil imports stood at 124Z of total merchandise export earnings. Based on remedial actions in line with the Government's structural adjustment program the situation had, by 1984, improved and the above ratio had declined to 53%. The improvement was a result of both strong performance of merchandise exports as well as a policy of holding the growth in imports of crude oil and oil products to a more moderate level (oil imports grew by an average annual rate of 3.6% between 1981 and 1984). However, despite this improvement the need to move away from an excessive reliance on oil imports remains crucial to Turkey's medium-term development strategy, as the latter is dependent on the economy's ability to mobilize foreign exchange. 1/ 1.02 High priority was assigned to the energy sector by Government during the 1980-83 period of structural adjustment. Energy policy was geared to increasing the domestic supply of energy, primarily through increased capital investment to about 35% of total public investment compared to about 20% during the 1970's. In parallel greater attention was given by Government to energy pricing policy as a means of restraining demand and mobilizing resources. In particular Government has ensured that petroleum products reflect economic costs as reflected by world prices, and electricity tariffs have increased in real terms over the period (para. 2.19). Although lignite prices declined slightly in real terms in 1981-83 a turnaround in lignite pricing policy during 1984 resulted in a 30% increase in April 1984 and a further 29.6% in January 1985 thus exceeding inflation over the 12-month period. The Resource Base 1.03 Turkey has substantial untapped lignite and hydropower resources, as vyell as more limited, but still important, oil, gas and coal resources and geothermal potential. Hydropower with potential economic viability is estimated at about 29,500 MW under average hydrological conditions and corresponds to an annual production of about 100,000 GWh. Only 15% has been developed so far, but this is projected to rise to about 30% by 1990. Proven recoverable reserves of oil are about 16 million tons. However, potential reserves that may become economically recoverable using enhanced oil recovery 1/ See "Turkey-The Vth Five Year Plan in the Context of Structural Adjustment: A Review" (Green cover), February 27, 1985.  techniques currently being tested could be as high as 30 million tons. Oil production has been declining over the last decade, as few discoveries have been made in recent years; in 1983 production was about 3 million tons. Proven recoverable gas reserves are about 400 billion standard cubic feet. Domestic gas will, however, be supplemented, beginning in 1987, by large scale imports of natural gas from the USSR. Total known reserves of hard coal are estimated at about 1 billion tons, all located in the north of Turkey (Zonguldak). Coal production has been declining as operations move to deeper, less accessible seams; in 1983 production was about 3.5 million tons, equivalent to 2.2 million tons of oil equivalent (toe). Proven and probable lignite reserves are about 8 billion tons, but about half of this is of extremely low quality (950-1,000 kcal/kg). Lignite production in 1983 was about 20 million tons, equivalent to about 4.6 million toe. The economic costs of domestic lignite appears to be very high, and, in some mines, not competitive with imported coal. There is potential for geothermal development, for both space heating and electricity generation. A foreign company with extensive experience in geothermal power has recently undertaken a technical review of a number of promising geothermal sites, and discussions with the Government on possible terms and conditions for developing one of these sites are currently in progress. Main Agencies 1.04 The energy sector in Turkey is characterized by the dominance of government-owned enterprises and agencies. The Ministry of Energy and Natural Resources (MENR) is responsible for the development of energy resources in Turkey. Under MENR, the Turkish Coal Enterprise (TKI), the Turkish Petroleum Company (TPAO), and the Mineral Research Institute (MTA) have responsibility for the extraction of fossil fuels and radioactive minerals. Identification, design and construction of hydro projects is entrusted to the State Hydraulics Authority (DSI). The Turkish Electricity Authority (TEC) is responsible for the generation, transmission and, since November 1982, the distribution of almost all the electricity sold in Turkey. TEK is also responsible for the implementation of the Government's program for rural electrification and the construction of all generating and transmission facilities, with the exception of hydroelectric plants for which DSI has responsibility (see Chapter III). 1.05 Private sector participation in the supply of electricity was until 1983, cot fined to two small semi-private utilities (CEAS and KEPEZ) and industrial companies which generated power for their own use, often in conjunction with the production of steam for process heat. However, recent shifts in government energy policy now give greater encouragement to private sector participation in the development and production of energy (para. 2.16).  -3- Demand and Supply 1.06 Total gross energy consumption was about 38 million toe in 1983, of which commercial energy consumption amounted to about 30 million toe. Petroleum made up the most significant share of primary commercial energy (60%) with the balance made up of lignite (18%), hydropower (11%), coal (10%) and imported electricity (1Z). About 24% of final commercial energy consumption was in the form of electricity. Non-commercial energy production (primarily fuelwood, but also other biomass) was an important energy source, accounting for 23% of total energy consumption. Imported energy (petroleum, hard coal and electricity) represents about 45% of total energy supply. Annex 1.1 presents energy balances for the period 1978-1983. 1.07 The most notable change in the pattern of energy consumption over the past two decades has been the decrease in the relative share of hard coal in total energy. This was accompanied by a rapid growth in consumption of petroleum until the mid-1970s, peaking at over 50% in 1977/78; and a rapid rise in the share of lignite (primarily for thermal power production) and hydroelectric power consumption starting in the second half of the 1970's. During this period, hard coal consumption stayed relatively constant in absolute terms, while traditional biomass energy sources increased slightly in absolute terms, but decreased steadily as a percentage of total energy consumed. 1.08 The most important factors in the growth of energy demand will be the growth rate of the economy as a whole, the growth rate of the energy-intensive industrial sector of the economy, and the extent to which Government implements an energy conservation and demand management program. Bank estimates indicate that the growth rate of the economy would average about 5.6% per annum during the 1980s and that the industrial sector would grow slightly faster at about 7%. Under these projections and in the absence of a vigorous demand management program, electricity demand is expected to grow by over 200% between 1980 and 1990 to about 60,000 GWh; lignite demand for thermal power plants would grow by almost tenfold to about 50 million tons; and petroleum products demand would grow by 110% to 30 million tons of oil equivalent. In total this would represent approximately 58 million toe, an increase of over 8% per annum from 1983 (38 million toe). Hawever supply constraints, especially in the lignite sector (para. 2.30) and in the power sector (para. 2.03), will result in demand not being met, at least to 1990. The energy deficit is estimated by 1990 to be in the region of 7-8 million toe. 1.09 There is, however, considerable scope for conservation of energy particularly in the industrial sector which currently accounts for 40% of total energy consumption and this is expected to rise to 45% by 1990. The industrial sector also consumes 64% of total electricity supplied. Furthermore eight industries 21 account for 40% of total industrial energy 1/ Iron and steel, cement, fertilizer, pulp and paper, glass, brick, aluminum, copper.  - 4 - consumption, from which it has been estimated that almost 1 million toe could be saved through investment in conservation. The total estimated potential energy savings in the industrial sector, including a large number of eneigy-inefficient small industries, is about 2.4 million toe. There is therefore an urgent requirement for an energy conservation program in Turkey (para. 1.10). 1.10 The Government is in the process of developing a program for the conservation of energy by encouraging efficient use in existing and new industrial enterprises. Energy efficiency programs and legislation have been evaluated by both the MENR and the SPO, and legislation has already been passed which allows for tax credits for various types of investments in energy efficiency improvements. The Government has initiated programs to assist industrial firms to learn how to improve their energy efficiency in existing operations. The Bank included technical assistance for energy audits in selected manufacturing facilities as part of the assistance to the Government under Loan 1916-TU. These audits have now been completed and the Bank is currently reviewing their findings with a view to financing a conservation project. The findings of the energy audit on the Anbarli Electric Power Plant have been used as the basis for preparing a subcomponent of the proposed System Operations Assistance Project. TEK has also hired consultants to assist in the development of an energy conservation and load management program (para. 2.21). Energy Policy 1.11 To meet its energy requirements Turkey launched a massive program in the late 1970's to increase the domestic production of electricity and lignite. This program tended to stretch the implementation capabilities of the state energy agencies, and spread the resources available too thinly over too many projects, with resulting long delays in completion schedules. This has, in turn, resulted in an energy deficit which is likely to remain a feature of the Turkish economy at least through the 1980's (para. 1.08). MENR and TEK are currently in the process of improving their energy planning capabilities (para. 2.21) and MENR has produce/ Turkey's first energy policy paper. The recent Five-Year Development Plan M contains the following energy sector objectives: - priority is to be given to domestic sources of energy, especially, hydro and lignite, provided that they are economically justified; - imported energy including, but not limited to oil, will be considered; - renewable and nonconventional resources such as geothermal, solar and biogas are to be supported; and 1/ V. Bes Yillik Kalkinma Plani 1985-1989, State Planning Organization, June 1984  - private sector financing, both local and foreign, will be sought for participation in energy development. 1.12 One feature of Government which represents a departure from previous energy policy concerns the expanded role of the private sector in the development and production of energy. Government policy is now quite clearly to encourage private sector participation in the energy sector. There are now no legal constraints to private sector g^neration, and private utilities (KEPEZ and CEAS) have plans to increase their capacities. In addition, the State Planning Organization (SPO) is currently undertaking, with assistance from consultants, preliminary studies to assess whether private financiers could be sought to construct and operate thermal plants based upon imported fuels (coal, nuclear) and geothermal. Over the long term this could have a fundamental bearing on the financing, staffing and planning of the subsector (para. 2.16). Bank Strategy 1.13 The Bank has prepared and discussed with Government an Energy Assessment Study as well as subsector studies on electricity and lignite_1/. In addition, under SAL V Government agreed to develop and discuss with the Bank an energy action plan and MENR has instructed the individual energy institutions to prepare detailed medium term action programs (para. 2.11). As an ongoing part of our policy dialogue the Bank prepared an energy sector strategy paper on strategy and actions required in the energy sector. In discussions of this paper agreement was reached with the Government and related energy institutions on the content, analysis and scope of the issues facing the energy sector (para. 2.12). 1.14 The strategy for Bank lending and operational work in the energy sector is to focus on selected key issues in the medium term in order that projects may be brought on stream as rapidly as possible and the efficiency of existing energy producing facilities be maximized. The magnitude of the looming energy supply gap (para. 1.08) is such that priority should be accorded to projects aimed at reducing the deficit as soon as possible. Projects with relatively short gestation periods such as improvement of efficiency within existing facilities, industrial conservation, reduction of energy leakages, and utilization of energy resources which can be brought on stream rapidly, should have priority. Furthermore the private sector may well offer opportunities for developing energy resources more rapidly than the public sector, and emphasis will be given to investments which may increase private sector participation. 1/ See Turkey: Issues and Options in the Energy Sector (Blue Cover) 3877-TU, dated March 1983 Turkey: Electricity Planning and Investment (Green Cover) 5031-TU, dated June 22, 1984. (EPI) Turkey: Coal and Lignite Subsector:. The Analysis of Sectoral Development Prospects and Main Issues (Green Cover) 5021-TU, dated September 18, 1984.  - 6 - 1.15 In conjunction with the strategy to address the key medium term issues the Bank will also emphasize the strengthening of the various energy institutions through technical assistance in training, manpower development, technical, economic and financial planning and project management. Finally, the open and constructive policy discussions between Government and the Bank undertaken in conjunction with SAL V (para. 1.13) will be continued on a regular and sustained basis and should provide a continuing policy framework within which both project lending and the development of a robust project pipeline can proceed.  - 7 - II. THE ELECTRIC POWER SUBSECTOR A. BACKGROUND System Characteristics 2.01 The present (1984) installed power capacity in Turkey is about 7,600 MW of which 3,500 MW (50%) is thermal and the balance hydro. The share of hydro power has increased over the past ten years from 33% in 1972 to about 502 in 1984. On the thermal side lignite has made an increasing contribution to the production of electricity. Total gross generation in 1984 was about 30,000 GWh, of which 'EK accounted for almost 90X and this was supplemented by 2,500 GWh imported electricity from Bulgaria and the USSR. This was less than the potential effective demand, estimated at 35,000 GWh. There is considerable evidence that power shortages have caused cutbacks in production in industries such as cement, textiles and paper. In addition to the capacity constraint, the high level of total system losses (technical losses plus unaccounted for energy), at about 20%,_ contributed to the supply shortages. 2.02 Demand Forecast. Growth in demand has averaged about 9% per annum over the period 1965-1983. Between 1970 and 1983 the percentage of population with public electricity supply rose from 51% to 78%. Per capita consumption of electricity is currently about 550 kWh. The current medium and long-term forecasts, prepared in connection with TEK's long-term generation plan (1987-2005) are based upon the relationship between electricity consumption and industrial output- They show total energy demand (GWh) growing at about 10% per annum to 1990 and peak demand (MW) increasing at about 8Z. Beyond 1990 TEK project a growth in peak demand of about 9.5% per annum and about 9% per annum in energy. This implies a continuation of the high (1.6-1.8) elasticities with respect to GDP and sectoral (primarily industrial) growth rates. These are higher than in many other industrializing countries (e.g. Korea, Hungary, Singapore) which have been able to reduce electricity demand significantly by implementing a program of demand management. Given the difficulty Turkey has faced in expanding electricity supply (para. 2.09) it is critical that efforts be made to bring about lower demand elasticities. A program of demand management implemented in parallel with a program to improve efficiency and plant availability within the electricity subsector could produce significant savings in investment over the medium to long term (para. 2.17). Annex 2.1 presents a summary of the long term demand forecasts. 2.03 Generation. Annex 2.2 gives details of the forecast electric energy and capacity balances. The forecast was prepared by the Bank on the basis of an updated implementation schedule, likely slippages in the commissioning of 1/ This compares with losses of about 10% in a well designed and operated transmission and distribution network.  some hydro or thermal power plants and a review of potential fuel supply bottlenecks, especially in the lignite sector. The installed capacity is expected to grow from about 8,000 KW in 1985 to almost 15,000 MW by 1990, with the share of hydropower remaining constant at about 53%. Assuming average water flows, the share of hydropower in total generation is expected to be between 65% and 702 over the period. This estimate is, however, dependent on the extent to which lignite supply constrains the availability of thermal generation. The Bank assumed that it would take up to four years for major lignite mines to meet full power plant requirements. Any improvement in the lignite mines' abilities to supply lignite would have a major impact upon increasing generation from the thermal plants (para. 2.30). However, it is unlikely that the projected generation expansion to 1990 will be able to meet the system's energy requirements (GWh), even under average hydrological conditions and with imports of up to 2,500 GWh per annum from Bulgaria and USSR. 2.04 All new thermal power plants, under construction or proposed in the investment program, would use lignite for power generation, with the exception of a coal-fired plant to replace an old unit at Catalagzi, a small pilot (18 MW) geothermal plant, and a new 600 MW combined cycle plant located near Istanbul to utilize domestic gas (Ramitabat) and imported gas (USSR). 2.05 Given the shortfall in supply (para. 2.03) the forecast of electricity sales has been derived from the Bank's projections of available generation. Under this forecast, TEK's sales would increase at an annual average rate of about 12% to reach almost 50,000 GWh by 1990 (Annex 2.2, Attachment 1). It is estimated that by the early 1990s the electricity system would be in equilibrium and generation would be adequate to meet projected demand. 2.06 Transmission. The salient feature of the Turkish transmission system is that the largest load centers are located at considerable distances from the existing and/or committed major power plants, most of which are to be located in the far east or south west of the country. For technical reasons of system stability and reliability, there is a need for a more geographically balanced system, especially in European Turkey (Thrace) where the system is particularly vulnerable. Greater flexibility could be afforded to the system by the installation of additional capacity in the Istanbul area. Government has recently approved the construction of a combined cycle power plant (600 MW) located at Hamitabat, some 100 kms from Istanbul, to utilize indigenous natural gas. TEK is also to undertake a feasibility study, to be financed under the proposed Power System Operations Assistance Project, for an additional combined cycle power plant of 1,000 MW located in Thrace and fueled by natural gas. 2.07 Distribution and Village Electrification. Since 1982 TEK has been responsible for urban distribution (para. 3.02). Prior to the TEK takeover the municipalities were responsible for urban electrification. During the  - 9 - 1970s there was a sharp decline in the share of investment in urban distribution, from 14% of total subsector investment in 1975 to 6% in 1979 despite an urban population growth rate of almost twice the national average. Problems of underinvestment were compounded by the fact that many municipalities practiced cross subsidization of services, utilizing revenues from urban electricity sales to finance other services. This resulted in a deterioration in the physical condition of the urban networks and high losses. Recent estimates by TEK place losses at 1,500 GWh, of which pilferage and illegal connections account for about 500 GWh and technical losses the balance. Almost 1,000 GWh of total losses occur in the three largest urban areas, Istanbul, Ankara and Izmir. Rehabilitating the urban networks should be accorded greater priority than hitherto since it would provide a cost-effective and rapid way to increase the capacity of the system. TEK has hired consultants (EdF, France) to assist in identifying losses and to prepare an investment program for the urban networks. Izmir has been selected by TEK for the development of the first comprehensive investment masterplan. 2.08 The village electrification program forms part of Government's social policy of providing basic services to rural areas, especially to those provinces designated as least developed and most impoverished. As such, Government objectives are geared to regional development, equity considerations and poverty alleviation rather than either financial cost recovery or economic efficiency. By the end of 1984, about 70% of the villages had been connected to the national system, and the target is to electrify the balance by the end of 1990. Sectoral Development 1971-1984 2.09 The Turkish power sub-sector has been confronted with problems of major proportions. Electricity supply has been insufficient to meet demand in every year since 1971, resulting in high costs to the economy, as imports increased and supply interruptions became more frequent. The shortfalls in supply are attributed mainly to institutional problems, especially the shortage of qualified staff in the public sector agencies responsible for planning and implementing the development of the electricity sub-sector, and shortages of local funding resources. This has resulted in project delays, consequent substantial cost escalations, chronic power shortages, frequent and protracted power plant breakdowns due to inadequate maintenance, and high system losses. The shortages of qualified staff in TEK has resulted in resources, spread too thinly over too many projects in the investment program. Government has, however, now recognized many of these problems and is actively addressing them. B. GOVERNMENT'S NEW STRATEGY 2.10 Meeting electricity demand in Turkey will require a major coordinated effort on behalf of the major agencies in the subsector since it will require  - 10 - that the country bring on stream three times more capacity in the 1980s than in the 1970s and sustain that momentum throughout most of the 1990s. Furthermore it will require that scarce resources be tied up in technologies new to the country (e.g. gas based generation, geothermal, nuclear) and in projects of a size unprecedented in the country. 2.11 The Government is however, comnitted to a program to deal with the issues faced by the electricity sector and plans to focus particularly on the medium term issues of expanding output, maximizing efficiency and, in line with the Government's structural adjustment program, curtailing the country's oil import bill. MENR has instructed all the individual energy institutions to prepare detailed medium term action programs to address the following priority issues: (a) managerial aad institutional improvements, in particular the strengthening of planning, project selection and project management capabilities through increased training and technical assistance; (b) the completion of ongoing priority projects in the electricity subsector and in lignite mines to supply key thermal plants; (c) the upgrading of existing facilities with special reference to improving operational efficiency, retrofitting of plant and provision of adequate spare parts; (d) evaluation and implementation of a broader range of alternative energy supplies including natural gas, imported coal, and geothermal; (e) energy conservation, including the identification of investments and pricing policies to increase the efficiency with which energy is both produced and consumed; and (f) an increased role for the private sector, particularly in the construction and operation of power plants and operation of lignite mines. 2.12 In the electric power subsector both Government and TEK have recognized the nature and scope of the issues outlined in para. 2.09 and progress toward resolving many issues has been made. Paras. 2.13 to 2.31 below indicate actions taken or planned. Institutional Development 2.13 Maintenance and operation of the power system. The exigencies of maintaining supply at all costs has resulted in TEK abandoning a systematic maintenance plan for thermal power stations. This in turn has led to frequent and often protracted outages as well as major losses in plant efficiency and output. TEK has increased the allocation for equipment for operations,  - 11 - maintenance and spare parts, as well as speciaLized training in power plant and network maintenance. The proposed Bank financed Power Systpms Operations Assistance Project will result in improved operational efficiency and will develop manpower skills for operations and maintenance within TEK. 2.14 Project management. Inadequate project management has resulted in considerable delays in implementation and consequent high costs to the economy as project costs have escalated and supply shortages increased. Greater emphasis is being placed upon the development of strong project management teams utilizing both local and foreign expertise, increased autonomy at the project management level, especially on financial, procurement and personnel matters, and greater selectivity to ensure that high caliber teams are recruited. Initiatives taken by TEK have included a full project management contract for the construction of the Thrace Combined Cycle Plant and greater management autonomy at the Elbistan site. Furthermore, the establishment of ELTEM-TEK, a publicly owned local consulting firm which remains outside civil service payscales, offers opportunities to recruit experienced engineering manpower, both local and foreign, for specific tasks including project management. 2.15 Manpower Development. Inadequate manpower planning, including the lack of a comprehensive training staff improvement program, has hindered both the recruitment and retention of qualified staff. In addition TEK's training centers are in poor condition and suffer from inadequate and outdated equipment. TEK has recently hired consultants (Ontario Hydro, Canada) under Bank Loan 2322-TU to assist in the development of a manpower and training plan focusing particularly on power plant operations and maintenance. Further details on manpower development and training including Bank assistance are given in paras. 3.08 to 3.11. 2.16 An Increased Role for the Private Sector. Government policy is now directed towards encouraging a greater role for the private sector in all aspects of the electricity subsector activities. The objectives are to ease the manpower and staffing problems in the public sector, improve project management, and mobilize private financing. TEK can now share ownership in electric power and mining projects through "participations", in which TEK would hold from 15% to 50Z of shares, or in "affilitate partnerships", in which TEK would hold a majority of the shares. As of early 1985, TEK had received about twenty proposals from the private sector to enter into these types of joint ventures, mostly for construction of hydropower plants. Construction of an imported coal-fired station, for which the Government has requested proposals from three foreign comDanies, may also be financed through this mechanism, with TEK taking part as a minority shareholder. Decisions on these proposals are pending the Goverrment establishing a policy for setting the electricity tariffs for sales from the public/private ventures to TEK. Furthermore a recent law (Law 3096) allows utilities and other companies, designated as entrusted companies, to construct and operate generating facilities and to have full responsibility for electricity distribution and  - 12 - sales within a concession area. The pilot case for the creation of an entrusted company is the application of CEAS to become a fully integrated utility. A decision on this matter is expected from Government in mid-1985. Pricing and Demand Management 2.17 Studies on the potential for demand management and load shedding, including the effect on peak demand and growth in connections by TEK, have just been started (para. 2.21). While load management policies would have relatively little impact upon energy demand, they could affect peak demand by up to 10%. This would represent a major investment saving and a load management program is an urgent requirement. Demand management can be achieved through both an appropriate pricing policy (para. 2.19-2.20) and by non-pricing mechanisms (e.g., ripple control, contracted interruptible supplies). 2.18 Pricing Policy. Bulk electricity tariffs are close to the long-run marginal costs of bulk supply (LRMC) but do not yet fully reflect the structure of LRHC. TEK has hired consultants (EdF, France) to assist them in preparing a tariff study on the long run marginal cost of supplying electricity at both the bulk and retail level. The Bank has monitored closely progress of the study and its preliminary findings were discussed with TEK in the course of project supervision. The consultants have prepared a draft report on bulk supply tariffs and are currently analyzing the retail tariff level and structure, although no preliminary re?ort has yet been prepared. Annex 2.3 presents a summary of tne study's findings so far. The final results and recommendations on an appropriate level and structure of electricity tariffs (including those at the retail level) are expected in July 1985, and will be implemented fully following discussion with the Bank, as already agreed under Loan 2322-TU. 2.19 However, in line with Government policy to price energy products closer to their respective economic costs, bulk tariffs were increased from 1982 to 1984 by about 13% in real terms. TEK's consultants (para. 2.18) estimated that average bulk supply tariff (TL 19/kWh as of January 1985) represented about 65Z-70% of the LRMC of electricity supply at high voltage, estimated at about TL 26/kWh (adjusted to January 1985 prices). Following further tariff increases effective January 1, March 1 and April 1, 1985, bulk tariffs (including all taxes and charges collected by TEK) were estimated at 85%-902 of LRHC as of April 1, 1985 (Annexes 5.1 and 5.2). This represents a considerable improvement over the past two years; at the time of the previous Bank appraisal in May 1983 (TEK Transmission III, Loan 2232-TU), bulk tariffs were about 50% of LRMC. Furthermore, the introduction in June, 1984 of a time-of-day differential in the tariff schedule also brings tariffs closer to the structure of marginal costs and, once fully implemented, should help correct imbalances in the pattern of electricity consumption. The Bank will continue to discuss with Government required increases to maintain and improve the structure and level of electricity tariffs.  - 13 - 2.20 Load Research and Demand Management. A major constraint in identifying the costs and benefits of a load management program has been the inadequate data base upon which to prepare demand projections. Furthermore TEK staff has not been adequately trained in demand forecasting techniques nor in identifying and analyzing various demand management strategies. To address this problem TEK recently hired consultants (GOPA Consortium, Germany) under Bank Loan 2322-TU to assist them in developing a program of load research, demand management and conservation. The technical assistance includes the design of a system for the collection and storage of data, the development and testing of models to project energy and peak demand (short, medium and long term projections), the simulation of load management strategies including measurement of likely costs and benefits of alternative strategies, training of TEK staff and the preparation of recommended actions for a load management program. The work of the consultants is to be closely coordinated with the tariff study (para. 2.18) so that the impact of pricing policiee on growth in demand may be estimated. The consultants started work in March 1985 and completion is expected by the end of 1987, although progress reports during the various phases of the work will provide recommendations for specific actions. The Bank will work closely with TEK and the consultants to ensure that pricing policy, demand management and system planning (demand forecasting and supply analysis) are fully integrated. Electricity Planning 2.21 TEK is, and has been since its creation, overwhelmed by the immediate problems of coping with increasing demand, problems that have preoccupied senior management to the detriment of forward looking strategies. As a consequence little effort has, in the past, been made to upgrade TEK's planning skills. However, agreement has been reached with the Bank on a comprehensive system planning training program with MENR and TEK. Training is to be given in system planning using the WASP!' model and in demand forecasting using the MAED!/ model. Both models have been developed by the International Atomic Energy Agency (IAEA) and the training program is provided under their auspices. The latter will be fully coordinated by TEK's Planning and Coordination Department with the demand management study outlined in para. 2.20. 2.22 Results of the exercises are expected in early 1986 and the task force selected for training has completed its training using the WASP model. LAEA experts will visit TEK periodically throughout 1985 to assist in the implementation of the training program. Improved planning would ensure that significant opportunities to maximize supply over the medium term are realized (e.g., reduction of system losses, coordination of the investment program, 1/ WASP - Wien Automatic System Planning Model. 2/ MAED - Model for Analysis of Energy Demand.  - 14 - demand management, rehabilitation of plant currently derated, etc.) as well as identifying a long-term least-cost expansion program for the subsector. TEK is to prepare a report by early 1986 of the proposed long term generation plan. 2.23 One area of system planning where technical and cost data could be significantly improved is in the hydro sub-sector. System planning is hampered by the lack of a systematic inventory of hydroelectric resources and a ranking of these resources based upon uniform technical criteria and comparable economic and cost criteria. A hydro inventory study will be included in a forthcoming Bank project (Kayraktepe, FY86) and once completed would allow the optimal design and development, scheduling and construction of hydro plants with consequent major savings in investment. The results of this study would provide additional information to a subsequent round of expansion planning exercises. C. MEDIUM-TERM INVESTMENT 2.24 There is considerable uncertainty surrounding likely resource availability for power investment in the period up to 1990. In view of this a set of investment scenarios was developed for the appraisal on the basis of information available to the Bank on physical progress and likely costs of ongoing projects as well as new projects likely to enter the investment program. The investment scenarios will also be used for discussion with the Turkish authorities, to assist them in formulating and understanding the financial implications of subsector requirements and to improve their investment planning. The financial implications of the investment scenarios are discussed fully in paras. 5.25 to 5.34. 2.25 Scenario "A". As part of the short- to medium-term planning process both TEK and DSI prepare annual investment budgets for submission to SPO and Government. Currently there is no requirement for TEK and DSI to prepare a medium-term (e.g., three to five years) projection of expenditures. However, TEK and DSI were requested by the Bank to provide projections, in line with the timing of the 5th Five-Year Plan, of capital investment requirements to cover the period 1985-1989. (See Scenario "A" in Table 2.1). The projections were discussed in detail with the Bank and a summary and commentary on this Scenario "A", are given in Annex 2.2. On the basis of these discussions the Bank prepared alternative scenarios of projected investment. 2.26 Scenario "B" was based upon the national investment requirements for electric power during the 1985-1989 period and did not distinguish between public and private investment. This was prepared in view of the current uncertainty regarding the scope and likely role of public versus private investment in electric power development. While the projections of required investment in Scenario "B" are consistent with present demand estimates, it was not constrained by resource availability, nor by the implementation capacity of either the public or private sector.  - 15 - 2.27 Scenario "C" was based upon the minimum requirements for completion of high priority projects and took into account likely completion dates of generation projects, a limited number of potential new generation projects entering the program and the requirements for the components of the program other than generation. 2.29 Scenario "D" was developed, based not upon a detailed project by project review of investment requirements but rather on the estimated availability of resources. It was assumed that the increases in both Government contributions to investment and foreign borrowing would be restrained to about 4% per annum in real terms and that, in line with Government's pricing policy (para. 2.18), tariffs would continue to increase in real terms to reach and maintain levels equivalent to LRMC. As shown in Table 2.1, on this basis TEK would be able to finance the completion of all ongoing projects (Scenario "C") and provide funds for expansion although not up to the full requirements of the sector (Scenario "B"). Scenario "D" was considered the base case for the financial projections (paras. 5.31-5.34). Table 2.1 Electric Power Investment Scenarios (TL billions)a/ (In Mid-1984 Prices) 1985-89 Scenario 1985 1986 1987 1988 1989 Total A. TEK/DSI projection 600 973 936 987 1,195 4,691 B. National Investment to meet Demand 600 850 1,075 1,200 1,300 5,025 C. Adjusted to ensure, at minimum, completion of high priority projects 600 698 674 702 741 3,415 D. Public investment based upon estimated resource availability 589 684 810 974 1,054 4,111 a/ TL 350 = US$1  - 16 - 2.29 There is inadequate coordination of the investment programs of TEK and TKI. Further delays in the implementation of several lignite mining projects to supply fuel fo-r thermal power plants remain a problem. Unless resolved this would result in substantial delays in electric power availability and consequent' perpetuation of supply shortages continuing into the early 1990s and beyond. The Bank has prepared a subsector study on the lignite subsector (op cit) which identified the major problems faced by the subsector (poor planning, inadequate project management and inadequate financial management). The study has not yet been discussed with Government. The recent Technical Assistance Project for State Economic Enterprises (Loan 2400-TU) includes funds for two studies to improve TKI's project management and implementation capabilities, although consultants have not yet been hired. 2.30 To ensure the rational design of the medium term investment program, agreement was be reached during negotiations to undertake, as part of the ongoing energy policy dialogue, an annual joint Bank and Government review of the electric power investment program and related financing plans. This would include a review, by October 31 of each year, with Bank and representatives of MENR, TEK, SPO and Treasury of the proposed annual investment program for the power subsector and the required investments and related financing plans for the medium-term (five-year) period. The format and content of the information for such a review would be discussed between the Bank and MENR during supervision and would be undertaken with a view to identifying project priorities, realistic completion dates and adequacy of electric power investment levels and finance. D. BANK'S ROLE IN THE POWER SUBSECTOR -.31 The two proposed Projects being processed in parallel!/ would be the sixteenth and seventeenth Bank operations in the power subsector in Turkey. The Bank has made eleven loans and a technical assistance grant (total US