Mozambique - Gas Engineering Project

Dcumcnt of The World Bank FOR OFFICIAL USE ONLY Report No. P-6299-MOZ MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT IN THE AMOUNT EQUIVALENT TO US$30 MILLION TO THE REPUBLIC OF MOZAMBIQUE FOR A GAS ENGINEERING PROJECT MAY 19, 1994 Ml CROGRAPH I CS Report No: P- 6299 MZ Type: PR This document has a restricted distribution and sna be used bv recipients only in the perfornance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EOUIVALENTS US$1 = 5359 Meticais 1 Metical = S$0.0002 WEIGHTS AND MEASURES 1 cubic foot of gas = 1,000 British Thermal Units 1 kilometer (Kl ) = 0.6 miles 1 trillion cubic feet (tcf) = 1,000,000,000,000 cubic feet (1012) 1 billion cubic meters (BCM) = 1,000,000,000 cubic meters (l09) ABBREVIATTONS CAS Country Assistance Strategy CIR Country Implementation Review EA Environmental Assessment ENH Empresa Nacional de Hidrocarbonetos ERP Economic Recovery Program ESMAP Energy Sector Management Assistance Programme GRM Government of Mozambique GSA Gas Sales Agreement IAPSO Inter Agency Procurement Supply Office (UNDP) JOA Joint Operating Ageement ICB International Competitive Bidding LCB Local Competitive Bidding MIE Ministry of Industry and Energy MMR Ministry of Mineral Resources NDCH National Directorate for Coal and Hydrocarbons PPF Project Preparation Facility PSA Production Sharing Agreement PWVf Pretoria - Witwatersrand Vereenigin region of Soath Africa TA Technical Assistance TOR Terms of Reference SOE Statements of Expenditure UNDP United Nations Development Programme FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY MOZAMBIQUE GAS ENGINEERING PROJECT CREDIT AND PROJECT SUNMARY Borrower Republic of Mozambique Beneficiaries Ministry of Mineral Resources Empresa Nacional de Hidrocarbonetos Credit Amount SDR 21.3 million (US$30 Million Equivalent) Terms Standard IDA terms with a maturity of 40 years, including 10 years of grace. Onlending Terms Initially interest free and repayments deferred. Once the gas development project is committed, for 15 years including four years' grace and an interest rate of 1.1 times the IBRD rate. US$m Financing Plan IDA 30.0 (foreign costs) Norway TBD (foreign costs) ENH 1.1 (local costs) Private Sector 17.6 (foreign costs) Total 48.7 Economic Rate of Return Not applicable. Staff Appraisal Report None Poverty Category Indirect poverty reduction through long-term growth Map IBRD 25703 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. l  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO MOZAMBIQUE FOR A GAS ENGINEERING PROJECT 1. I submit for your apprcval the following memorandum and recommendation on a proposed credit to the Republic of Mozambique for SDR 21.3 million, the equivalent of US$30 million on standard IDA terms with a maturity of 40 years to help finance the Gas Engineering Project. The main part of the proceeds (US$27.9 million) would be to support the implementing agency, Empresa Nacio..al de Hidrocarbonetos (ENH), in preparation of a development project for the Pande gas field and in strengthening the company in its negctiations with foreign investors. The other part of the proceeds (US$2.1 million) would be used to strengthen the Ministry of Mineral Resources. As ENH has currently no significant revenues, the formal on-lending arrangement will only require interest to be charged and the funds to be repaid to the Government if the planned development project proceeds. Parallel financing of US$3.0 million equivalent is possible from the Government of Norway, but there is as yet no confirmation. Private sector investors are expected to contribute US$17.6 million. 2. BACKGROUND. In 1975 Mozambique was a relatively prosperous country, but today its per capita income (around US$ 80) is one of the lowest of the world and its social indicators are among the worst in Sub-Saharan Africa. Factors which account for this deterioration include a colonial legacy of very low investment in human resources, inappropriate economic policies, weak civil service capacity, and most debilitating, the civil war. To address these problems, the Government launched the Economic Rehabilitation Program (ERP) in 1987, which led to a marked increase in production. From 1987 to 1989, real GDP growth averaged 5.4 percent per annum. Fiscal adjustment under the ERP and the subsequent Economic and Social Rehabilitation Program (ESRP) doubled domestic revenues, reduced budgetary deficits to 6 of GDP, and improved the composition of the investment program. 3. In the next four years the government accelerated the adjustment process freeing the foreign exchange market, domestic trade and prices while pressing enterprise and financial reforms and reigning in public expenditures. Despite severe external shocks - worsening civil war, loss of aid and trade from the Soviet Union, and catastrophic drought - by 1993 the outlook brightened with growth of GDP and agricultural production at 19t and 21t respectively. The peace accord of 1992, the demobilization of the opposing armies and the prospect of free and fair elections later in 1994 auger well for continued social, political and economic progress.  1 4. However, the uneven flows and general lack of foreign exchange remain key issues for Mozambique. 1992 merchandise exports amounted to only $196 million against merchandise imports of $911 million. The net cost of services (including interest) required a further $150 million. in this situation, encouragement of foreign exchange earning investments is vital to lifting Mozambique from ics exceptional dependence on donors. Mozambique's besc prospects for exports lie in agriculture, mining and energy. Now that the armed attacks have ceased it should be possible for Mozambique to attract private investment in these areas, while reconstruction of the agricultural sector will be of high priority to improve the welfare of much of the population. 5. To manage the energy sector, the Government has shifted from the centially-planned approach it adopted in the early post-independence years and is reshaping its institutions along market-oriented lines. In this spirit, it recently made important changes in the institutions dealing with the petroleum sector by separating ENH from the Ministry of Mineral Resources (MMR) and will shortly convert it into a public corporation that will follow commercial practices. A new National Directorate of Coal and Hydrocarbons (NDCH) of the Ministry was established to handle the Government role in hydrocarbon development which was previously managed by ENH. One of first tasks of NDCH will be to reform the legal and regulatory framework and the tax and incentives structures of the hydrocarbons sector. 6. The Pande gas field, which is on-shore some 600 km North-East of Maputo, was disccvered in 1961 by the Gulf Oil Company while exploring, unsuccessfully, for oil. The concession was relinquished because of lack of market at that time. Since then ENH has done addvLional exploration work with financial assistance mostly from Norway and the former Soviet Union. The development of the field was hampered by blow-outs during exploration drilling and the unstable political situation in the country. The last blowout was capped in 1991, following the re-commencement of exploration in 1989 when the political climate began to improve. Altogether, 11 successful exploration wells have been drilled at Pande and have proven the initial existence of some 70 bcm (nearly 2 tcf) of very pure and dry natural gas. Taking account of the blow outs, about 55bcm (1.5tcf) of proven recoverable reserves remain. 7. The Bank/ESMAP was asked by the government in 1991 to help it determine the best way to utilize the gas resource. A prefeasibility study of the question was approved by the Government iri May 1992. The study showed, and subsequent work confirms, that the best use of the gas is to transport it by high pressure pipeline to buyers in the industrial heartland of South Africa, the so-called PW%' area, with a branch line to Maputo. Other promising South African markets include the industrial area of Natal. The alternatives of producing ammonia for fertilizer, or of transporting gas to Maputo only are unrealistic because of marginal economics and the lack of interest by foreign investors. 8. In 1990, ENH contacted 25 international oil companies to seek partners to invest in Pande, but without immediate result. Since then interest in the project has developed, and ENH has signed joint cooperation agreements with two potential partners, Sasol of South Africa and Pluspetrol of Argentina. These agreements do not require financial contributions from the partners. However, the three companies are now actively negotiating a Production Sharing Agreement  (PSA) and a Joint Operating Agreement (JOA) and expect to start negotiating a Gas Sales Agreement (GSA) soon. Sasol is a large oil-from-coal and chemicals company and could be a key player because it has the capacity to be the 'anchor' consumer. It also owns the PWV gas system. Its main role in developing the project will be in estimating and developing the market for natural gas in South Africa and attracting experienced international petroleum investors. Pluspetrol is an oil and gas producer and in time may become the technical partner, providing gas development experience which neither ENH nor Sasol has. At least one more partner will be required to bring pipeline skills to the joint venture. 9. The Pande Gas Project is expected to lead to annual gas exports to South Africa of $150 million and to a supply of gas to Maputo and other Mozambique towns. The project is expected to cost $600 million to $1 billion and will include development of the Pande field, trunk pipelines to major industrial markets in the Transvaal and Natal, and distribution systems in Maputo and towns along the pipeline routes. The Mozambique state, through ENH, is expected to have a non-operational role in this scheme and will receive dividends from this participation. Moreover, it is envisaged that annual taxes and royalties will amount to about $40 million, which will have a major impact on the national budget. ENH will receive a carried interest in the development phase, based on its sunk costs and/or asset value, and will also have a contributing share in the development. South Africa also expects to benefit significantly through access to this new source of energy, and is encouraging South African companies to become positively involved. 10. OBJECTIVES OF THE GLS ENGINEERING PROJECT. The primary objective is to undertake all work necessary to enable the Government, ENH and the private sector investors to make a firm decision to develop the Pande gas reserves for export and for use in Mozambique. Secondary objectives include a minor environmental clean-up relating to previous operations, preparing for gas supplies to suitably located Mozambican towns and the consequent opportunity for power supplies, training and institutional strengthening to prepare for a substantial Mozambican role in futrre gas operations. 11. GAS ENGINEERING PROJECT DESCRIPTION. The engineering project is to be undertaken in two phases. Phase I is to ensure sufficient sas reserves and clear away some project uncertainties. Some of the Phase I work - seismic shooting and intrepretation - is already substantially complete, having been financed with a US$1.5 million advance from the Project Preparation Facility (PPF). The objective is to take the project to a stage in which the private sector will invest pari passu in the pre-development costs. Phase II will cover the remaining predevelopment work and will include those tasks in which a joint venture partner will wish to have an input to the work, and where ENH's costs will be shared with the private sector partner. There are several conditions to be achieved before Phase II can proceed, including the signing of suitable joint venture agreements (such as the PSA, JOA and GSA - para 7), the approval of the Council of Ministers of a satisfactory legal and regulatory framework, an, the proving up of sufficient reserves for the project to be able to succeed. 12. Phase I of the engineering project is likely to cost USS20.2 million, and includes:  3 (a) gas reserves enhancement through drilling of three wells (US$10.1 million) and shooting and processing 1200 km of seismic (US$2.3 million), which should bring the remaining recoverable reserves to 2 tcf; and technical assistance (US$0.3 million) for a study on financing options; (b) technical assistance and some equipment & materials to enhance ENH's proposed role as a joint venture partner and to strengthen it internally (US$6.4 million), including work on project management, assistance in negotiations, a range of studies to better prepare the gas development project and ENH's position, strengthening the ENH accounting and management information systems, a structured training program, the work related to gas supplies to towns near to Pande, and environmental support. (c) technical assistance to strengthen the Hydrocarbons Directorate (US$1.1 million), including defining environmental standards, formulating the relevant institutional and regulatory framework, tax and incentive systems and appropriate training. 13. Phase II is less fully defined and the major part has to be agreed with the joint venture partners. Detailed TOR will be agreed at the mid-term review in late 1995. In summary, the work (totalling US$28.5 million) will include : (a) activities related to the joint venture the cost of which will be shared between the partners (US$22.5 million) consisting of a project management team, a full environmental assessment and mitigation plan, (including equipment for monitoring), arranging the finance, further engineering of the development project and operational training. The major cost items are for arranging the finance and for engineering work (US$6.2 and 8.5 million respectively, excluding contingencies). (b) support to ENH (US$5.0 million) including materials in negotiating its participation and benefits from the project, in firming up its knowl':dge of issues related to its role in the project, detailed work relating to gas supplies to Maputo and other towns, and implementation of a new accounting system related to its joint venture role. (c) further strengthening of the Hydrocarbons Directorate and assistance in finalizing the institutional, tax and incentive systems (US$1.0 million). 14. Should ENH fail to find a joint venture partner within 30 months of credit effectiveness (i.e., by approximately January 1997) IDA will review and may cancel the remaining funds. 15. Further information on the project is provided in the Technical Annex. Of the estimated US$28.5 million for technical assistance excluding contingencies, US$1.7 million is for policy development, US$0.7 for capacity building, and the balance for project implementation. A breakdown of the costs  4 and financing is in Schedule A. The methods of procurement and the disbursement schedule are shown in Schedule B. A timetable of key processing events and the status of Bank Group is shown in Schedules C and D. Map number IBRD 25703 shows the overall plans for pipeline routes and tt.e location of the Pande field. 16. It is expected that the Mozambican contribution to the costs will continue at approximately US$250,000 per year to pay for local costs, counterpart staff and Mozambican project management. This could amount to US$1.1 million over the life of the project. The balance if the Mozambican share (including support to MMR) will be US$30 million assumii.g that common costs are shared with only one joint venture partner. This will be financed by IDA or donors. No account has been taken of the premium that ENH would expect from its "pioneer" expenditure, as this may be reflected in the profit share rather than as a cost reimbursement. The Government of Norway has expressed interest in cofinancing but has not indicated how firm is this interest. Based on preliminary discussions, Norway could contribute $1.7 million equivalent to Phase I and $1.3 million equivalent to Phase II. In the absence of cofinancing and recognizing the costs that cannot be shared with the private sector, IDA would be paying 63% of the foreign exchange costs with the private sector paying 37% and ENH paying local costs. IDA's financing would represent 62% of the total cost. 17. PROJECT IMPLEMENTATION. Phase I of the project would be managed by the Project Management Team already established by ENH to manage current Pande gas developments. The Government component would be managed by the NDCH with support from ENH. ENH's staff of 250 is almost solely working on the Pande project, and more than 200 of these are undertaking field operations. In the longer term, the size of ENH will diminish as the joint venture takes over the operations. The remaining ENH staff are expected to be about 40-50. Since 1989 a consulting firm has been giving implementation support focusing on technical advice on joint venture agreements, gas sales contracts, markets and other specialized support; and ENH intends for this arrangement to continue through to the end of Phase I. ENH sees its role as facilitator of a national development project and is keen to see Mozambicans learn through the project and eventually take operational responsibility. 18. Both ENH and the NDCH will need strengthening to cope with the demands of the Pande project, especially to deal with the private sector which is to undertake all commercially-oriented hydrocarbon investments to the extent that it is willing to do so. Government is looking into ways to streamline its procedures, such as speeding up contract approvals, which now typically take six months from the time the implementing agency decides on an award. This change is needed so as to enhance the promotional role of ENH, and accelerate the Pande project. 19. Implementation arrangements for Phase II will be negotiated with the joint venture partners. Fundamental to such agreement will be the need for a new, expanded Project Management Team to coordinate the partners, and for ENH staff to continue to take an important role in project development. External assistance will be needed for managing the Phase II process and advising on technical matters.  5 20. PROJECT SUSTAINABILITY. As the first stage of a long gas development project, the engineering project is not intended to be independently sustainable. It is dependent on the installation of a high-quality Project Management Team and the provision of adequate funding. The gas development project will proceed only with the participation of experienced foreign partners. 21. A high-priority objective of the engineering project is the development of Mozambican skills to ensare that there will be a significant Mozambi an involvement in the longer term. The project components have been reviewed A