T7~Mngm t ,Assistance Programme *~ ~ ~ ~ ~ ~ ~ ~ ~~~Rpr ,o .173195'''' JOINT UNDP/WORLD BANK ENERGY SECTOR MANAGEMENT ASSISTANCE PROGRAMME (ESMAP) PURPOSE The Joint UNDP/World Bank Energy Sector Management Assistance Programme (ESMAP) is a special global technical assistance program run by the World Bank's Industry and Energy Department. ESMAP provides advice to governments on sustainable energy development. Established with the support of UNDP and 15 bilateral official donors in 1983, it focuses on policy and institutional reforms designed to promote increased private investment in energy and supply and end-use energy efficiency; natural gas development; and renewable, rural, and household energy. GOVERNANCE AND OPERATIONS ESMAP is governed by a Consultative Group (ESMAP CG), composed of representatives of the UNDP and World Bank, the governments and other institutions providing financial support, and the recipients of ESMAP's assistance. The ESMAP CG is chaired by the World Bank's Vice President, Finance and Private Sector Development, and advised by a Technical Advisory Group (TAG) of independent energy experts that reviews the Programme's strategic agenda, its work program, and other issues. ESMAP is staffed by a cadre of engineers, energy planners, and economists from the Industry and Energy Department of the World Bank. The Director of this Department is also the Manager of ESMAP, responsible for administering the Programme. FUNDING ESMAP is a cooperative effort supported by the World Bank, UNDP and other United Nations agencies, the European Community, Organization of American States (OAS), Latin American Energy Organization (OLADE), and public and private donors from countries including Australia, Belgium, Canada, Denmark, Germany, Finland, France, Iceland, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Sweden, Switzerland, the United Kingdom, and the United States. FURTHER INFORMATION An up-to-date listing of completed ESMAP projects is appended to this report. For further information or copies of completed ESMAP reports, contact: ESMAP c/o Industry and Energy Department The World Bank 1818 H Street N.W. Washington, D.C. 20433 U.S.A. MOROCCO ENERGY SECTOR INSTITUTIONAL DEVELOPMENT STUDY JULY 1995 Power Development, Efficiency and Household Fuels Division Industry and Energy Department The World Bank 1818 H. St., N.W. Washington, D.C. 20433 This document has restricted distribution and may be used by recipients only in the performance of their official duties, Its contents may not otherwise be disclosed without UNDP or World Bank authorization l~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ CURRENCY EQUIVALENTS (as of December 1993) Currency Unit = Moroccan Dirham US$1 = Dh 9.4 MEASUREMENTS Bbl Barrel of oil 0.15899 cubic meter = 42 US gallons BTU British Thermal Unit 0.252 kilocalaries = 1.055 kJ GWh Gigawatt-hour 1,000,000 kilowatt-hours (kWh) kg kilograms 1,000 grams kcal kilocalorie 4.19 x 10-3MJ = 3.968 BTU km kilometer 1,000 meters; 0.62 miles kV kilovolt 1,000 volts kWh kilowatt hours 1,000 Watt hours m3 cubic meter 1,307 cubic yards MJ megajoules 1OGJ = 103kJ MVA megavolt ampere 1,000 kilowatt amperes MW megawatt 1,000 kilowatts; 1,000 kW MWh megawatt hour 1,000 kilowatt hours = 860,000 kcal = 0.248 TOE at 34% efficiency in thermal (oil) generation TOE Tons of Oil Equivalent 10.2 million kcal = 40.5 million BTU = 42.5 GJ t metric tons 1,000 kilograms; 2,204.6 pounds lb pound 0.454 kilograms I liter 1,057 quarts (liquid) ENERGY CONVERSION FACTORS Fuel Bbl/Ton Litre/Ton LPG 11.60 1,852 Kerosene 7.90 1,235 Gasoline 8.50 1,350 Diesel 7.30 1,150 Fuel oil 6.70 1,099 ENERGY CONVERSION FACTORS Fuel GJ = 103MJ/unit Physical Units/TOE Liquid fuels (tons): Crude oil 42.7 1.00 LPG 45.2 0.94 Kerosene 43.1 0.99 Jet fuel 43.5 0.98 Gasoline 44.0 0.97 Gasoil 42.7 1.00 Industrial diesel oil 42.3 1.01 Fuel oil 41.0 1.04 Methane 33.5 Electricity (MWh) 3.6 (per def.) 4.0 Fuelwood (ton) 16 IL 2.91 Charcoal (ton) 30 i 1.46 aL Air-dried wood, 15% moisture content wet basis (m.c.w.b.). ABBREVIATIONS DH Moroccan Dirham GM3 one billion cubic meters GWh Gigawatt hour kg Kilograms ktoe thousand tons of oil equivalent kV Kilovolts kW Kilowatt kWh Kilowatt hour LNG Liquified Natural Gas LRMC Long-run marginal cost Ltd Limited LV Low Voltage M million M 3 cubic meter MM billion MVA Mega-volt ampere MW Megawatt t metric ton toe tons oil equivalent US$ U.S. dollar ACRONYMS CCGT Combined Cycle Gas Turbine CDER Centre de Developpement des Energies Renouvelables/ Renewable Energy Development Center CIPEP Commite Interministeriel Permanent des Entreprises Publiques/ Permanent Interministerial Committee for Public Anterprises DE Direction de l'energie/Directorate of Energy EMPL Europe-Maghreb Pipeline Limited ESMAP Energy Sector Management Assistance Programme GDP Gross Domestic Product GME Gas Maghreb-Europe Pipeline GNP Gross National Product GT Gas Turbine IDA International Development Association IFC International Finance Corporation IPP Independent Power Producer LPG Liquified Petroleum Gas MEM Ministere de 'energie et des mines/Ministry of Energy and Mining MIGA Multilateral Investment Guarantee Agency OCP Office Cherifien des Phosphates (phosphate company) ONAREP Ofice National de Recherche et exploitation PetrolierestNational Office for Petroelum Exploration and Development ONE Office National de l'Electricite (national power utility) PA Purchasing Agency PCE Production Concessionnelle d'Electricite SAMIR Societe Anonyme Marocaine de l'Industrie du Rattinage/ Moraccon Refining Industry Corporation SCP Societe Cherifienne des Petroles (petroleum company) SNPP Societe Nationale des Produits Petroliers (petroleum company) SONATRACH Societe Nationale de Transport, Recherche et Production d'Hydrocarbures (Algerian national petroleum company) SODUGAZ Societe de Developpement et d'Utilisation du Gaz (Gas Development Company) UNDP United Nations Developmen Programme USAID U.S. Agency for Inernational Development FISCAL YEAR January 1 - December 31 I TABLE OF CONTENTS PREFACE EXECUTIVE SUMMARY ..................................................................i I. THE ELECTRICITY SECTOR ..................................................................I INTRODUCTION .................................................................I MAIN ISSUES ..................................................................2 A. Capacity Shortage ..................................................................2 B. Private Investment ..................................................................4 C. Electricity Prices ..................................................................6 D. Management Autonomy and Incentives ..................................................................6 E. Absence of Proper Coordination and Predictable Regulation .................................7 F. Unpaid Bills ..................................................................7 OPTIONS AND RECOMMENDATIONS .................................................................. 8 A. Short-Term Measures ..................................................................8 B. Long-Tern Options ..................................................................9 PLAN OF ACTION ................................................................. 19 A. Specific Measures ................................................................. 20 B. Strategic Measures ................................................................. 20 II. THE PETROLEUM SECTOR ................................................................. 22 INTRODUCTION ................................................................. 22 MAIN ISSUES ................................................................. 23 A. Sector Efficiency ................................................................. 23 B. Market Structure ................................................................. 23 C. Sector Organization ................................................................. 24 D. Petroleum Pricing and Taxation ................................................................. 26 OPTIONS ................................................................. 30 A. Scenario I ................................................................. 32 B. Scenario 2 .................................................................. 33 C. Scenario 3 .................................................................. 35 PLAN OF ACTION ................................................................. 35 A. Specific Measures ................................................................. 35 III. THE NATURAL GAS SECTOR ................................................................. 41 INTRODUCTION ................................................................. 41 ISSUES AND OPTIONS FOR THE DEVELOPMENT OF NATURAL GAS ............... 41 A. Global Approach to a New Energy Policy ............................................................ 41 C. Institutional Issues ................................................................. 49 D. Economic Issues ................................................................. 54 E. Pricing, Tariffs, Taxation ................................................................. 55 PLAN OF ACTION ................................................................. 58 A. Specific Measures ................................................................. 58 B. Strategic Measures ................................................................. 59 IV. ENERGY EFFICIENCY, RENEWABLE ENERGY AND ENERGY PLANNING ..... 60 CURRENT SITUATION ..................................................................... 60 A. Insufficient Energy Supply ..................................................................... 60 B. Crucial Short- and Medium-Term Energy Issues ................................................. 61 C. The National Energy Management Program ......................................................... 62 D. Clear Direction for Renewable Energy ................................................................. 64 MAIN ISSUES ..................................................................... 68 A. Energy Efficiency Strategy ................................. .................................... 68 B. Integrated Energy Planning ..................................... ................................ 72 ORGANIZATIONAL RECOMMENDATIONS ................................................ ............. 75 A. Introduction ..................................................................... 75 B. Strengthening the Energy Planning Unit in the Energy Department ......... .......... 75 C. Energy Efficiency: Broaden the CDER's Role ..................................................... 77 ANNEXES ................................................................ 81 PREFACE In early 1993, the Government of Morocco requested ESMAP assistance to undertake a study on the restructuring and institutional development of the Morocco energy sector. The objective of this activity was to establish an overall framework for the re- organization of the energy sector which needs to be developed in line with the country's economic policies related to privatization, market liberalization, restructuring of the sector and future introduction of natural gas. A reconnaissance mission visited Morocco in March 1993 to define and agree with the Government on the study methodology, work program and schedule. It was agreed that the study would be carried out jointly by an ESMAP/World Bank team and a local Task Force, established by the Ministry of Energy and Mines (MEM). The Task Force was headed by Mr. A. Bouhaouli, advisor to the cabinet, and included Mme. A. Haddouche (Natural Gas), L. Afsahi, (Electricity) S. El Aoufir (Petroleum Products), M. Adyel (Energy Conservation). Mr. R. Filali, (Lawyer, Consultant) was responsible for drafting the natural gas legislation. The main mission visited Morocco in June-July 1993 and included Mr. A. Ferroukhi (Mission Leader, IENPD), Ms. E. Battaglini (Economist, IENPD) and Messrs. J.M. Chevalier (Energy Economist, Consultant), B. Dutkiewicz (Refinery Specialist, Consultant), D. Robinson (Power Specialist, Consultant), B. Laponche (Energy Efficiency Specialist, Consultant), R. Pleasant (Lawyer, Consultant). Messrs. J.P. Charpentier (IENPD), C. Khelil, H. Beaussant (IENOG) and J. Larrieu (MN IIE) provided assistance to the mission team. The study was developed in three phases: (1) diagnostic of the sector and analysis of the main issues; (2) identification of institutional alternatives for reorganizing and strengthening the energy sector; and (3) selection of the most suitable options. The preliminary results of the study were presented during a three-day energy seminar on "Prospects for Development of the Morocco Energy Sector" which was jointly organized by the MEM and ESMAP/World Bank and took place in Rabat on December 13-15, 1993. The seminar was conceived and designed to involve Moroccan high-level decision makers in defining the needs and options for the energy sector restructuring and preparing a plan of action for implementation. The seminar main achievement was reaching the consensus among the parties on a set of recommendations which would constitute the framework for the Government action plan. The seminar conclusions and recommendations, most of which have been endorsed by ESMAP/World Bank, have been incorporated in this report at the end of each chapter. In line with the main conclusions and recommendations of the ESMAP/World Bank study, the Government is already implementing some sector reforms, in particular for what concerns the restructuring of the power sector and, to some extent, of the petroleum sector. The energy sector is leading the process of liberalization and privatization of the Moroccan economy. This process aims at achieving two major objectives of the country energy strategy, namely providing least-cost energy and increasing access to energy in rural areas. In the electricity sector, competitive bidding for private provision of electricity has been recently introduced. The approach adopted by the Government - Production Concessionnelle d 'Electricite (PCE) - is the first step in the process of separating ONE's activities in generation, transmission and distribution. In the petroleum sector, the Government withdrew completely from the distribution of petroleum products, and this activity is now handled by the private sector. The next step will be the privatization of SAMIR. As concerns the recommended regulatory environment, the MEM has set up a committee whose responsibility will be to identify the options and implementation schemes for the establishment of a regulatory agency. The team wishes to express their appreciation to the Government of Morocco, to the many enterprises and organizations in the power and hydrocarbon sectors for the guidance, cooperation and assistance rendered to the ESMAP/World Bank during the preparation of the report and the organization and development of the seminar. This activity has been funded by UNDP, UNDP/Government of Morocco, and the World Bank. This report has been prepared by Ms. Emilia Battaglini with the assistance of Mmes. Gwendolyn White, Linda Walker-Adigwe and Vonica Burroughs. EXECUTIVE SUMMARY OVERVIE-W 1. Morocco is heavily dependent on imported energy to meet its energy demand. This dependence has had an unusually large impact on Morocco's economy and environment, affecting foreign exchange, the national debt, and government revenues and investment budgets. Background Data, 1992 * Population: 26.2 Million * GDP: USS 28.4 Billion (Growti Rate 1980-92: 3.8% . (Growth Rate 1980-92: 4.0% p.a.) * Per Capita GDP: USS 1,084 * Energy Consumption: 10.8 Mtoe . Energy Imports: USS 1,103 Million Commercial: 7.3 Mtoe (15% of Total Imports) Traditional: 3.5 Mtoe Ratio of Energy Dependency: 92% * Energy Consumption Per Capita * Energy Intensity (kgoe per capita) . (kgoe per USS 1000 of GNP) Morocco 278 Morocco 256 Tunisia 567 Tunisia 344 Algeria 614 Algeria 453 Spain 2409 Spain 164 France 4034 France 175 Source: WDR 1994 and mission estimates. 2. Throughout the past decade (1981-90), the government has sought to ameliorate Morocco's oil dependence by converting to other fuels and developing indigenous resources. For the current decade (1991-2000), the Government has established an energy policy emphasizing: optimization of energy supply conditions and investigation of alternative supply strategies; improvement of demand-side management; promotion of private sector participation; protection of the environment. ESMAP recommends that these efforts be supported through projects for natural gas development, gas pricing and institutional restructuring of the energy sector. 3. The process of liberalization of the economy decided by the Government and supported by the Bank is currently being implemented. The law on the liberalization of external trade is being implemented and the Government has called for the improvement of the private/foreign investment environment and for an acceleration of the privatization process. These initiatives are expected to induce significant changes in the energy sector, particularly for what concerns: - jj_- * power sector reform; M the traditional way of supplying petroleum products and the protection of the refining industry; * the reorganization of the petroleum product distribution industry, and, in the medium term, of other public enterprises (refineries, ONE, Regies); * the availability of new sources of financing, especially private and foreign, to meet the growing investment requirements of the sector. 4. The energy sector response to the changing economic/institutional environment requires a combination of short-term and long-term initiatives. In the short term the sector must address the issues of shortages and inefficiencies in the power sub-sector as well as the pricing and taxation regime in the petroleum product sub-sector. These are the major obstacles to the private investment participation and to the development of the sector in general. The sector should also start immediately to develop the institutional framework in which the private investors will operate; as a medium-term objective, the implementation of the most suitable institutional option for the Moroccan energy sector should be considered. In the long-term, the sector should focus on developing the most efficient, least cost option to meet the country energy requirements. THE ELECTRICITY SECTOR ISSUES 5. The Moroccan electricity sector has been experiencing a number of serious problems, including: * power shortages; * a substantial build-up of unpaid bills and debts; * a lack of management autonomy from Government ministries; * absence of competition among enterprises; * a lack of coordination between the enterprises; * absence of a predictable and economically sound approach to tariff regulation; * absence of a clear legal code and regulatory system for the sector. 6. Morocco also faces a number of difficult policy decisions in the electric sector. For instance how to realize the substantial investment program in generation required to meet expected electricity demand, and how to curb demand growth especially at peak. It needs to take advantage of the advent of gas in Morocco as a result of the construction of the gas pipeline linking Algeria with Spain through Morocco (GME). 7. The Government of Morocco has already embarked upon wider economic reforms which favor private investment and liberalization. It has also indicated support for private investment in electricity generation. Different potential reform paths exist, some more radical than others and requiring more substantial changes to the structure and regulation of the sector. More radical reform programs, such as the one in England & Wales, usually claim more substantial benefits in the long term, but at substantial potential cost in terms of the efforts required to make the transition and with uncertainty as to the outcome. Less radical reform, for - iii - instance allowing for independent generation but leaving the industry structure essentially unchanged, may promise less in the longer term but is easier to introduce and the short-term benefits are more certain. It is therefore essential to define the objectives and priorities carefully before embarking on any institutional reform path. OPTfIONS AND RaECOMMENDATIONS Short-Term Measures 8. Competitive Bidding By Private Sector Generators: It has been recommended and agreed by the Government to adopt competitive bidding to select the first (and future) independent generators, rather than negotiating only a direct deal with a single developer. It has also been recommended and agreed that the Government commission a study of the rules and procedures that need to be adopted to encourage independent power production in Morocco. 9. Enrgy Demand: It is recommended that the Government, the power utility ONE (Office National d'Electricit6) and the regional distribution companies (Re'gies) take advantage of the awareness of Moroccan customers to electricity shortages in order to strengthen CDER (Centre de Developpement des Energies Renouvables) as promoter of demand-side management programs aimed at energy efficiency and conservation. 10. Unpaid Bills: Most recently, the introduction of a new system of payment which imposes penalties for late payment has been proposed; the enforcement of such a system is a necessary precondition to improve the enterprises' financial performance. It is clear that the issue is one of discipline, autonomy and management incentives of public sector organizations at all levels. This suggests a need for more fundamental institutional reforms as proposed in the Plan of action (par. 14.). 11. Tariff Reform: The Government should give immediate attention to the introduction of a tariff structure that reflects economic costs, and in particular, to measures discouraging consumption in peak hours and months. The Government has agreed to update the LRMC tariff study, including the design of a system of tariff regulation, and, as a result, implement new tariff level/ structures. Long-Term Options 12. Some of the most beneficial reforms in the electricity sector involve measures aimed at promoting competition in electricity generation, while introducing incentive regulation in those parts of the business with strong elements of natural monopoly (transmission and distribution) . Three possible structural models for introducing competition into generation have been considered: Competitive bidding to supply electricity to ONE. Competitive bidding to supply a Purchasing Agency (PA). Competing generators sell direct to distribution companies. - iv - It is feasible to imagine the first model as an initial step towards a more liberalized electricity system. 13. Reform Options in Electricity Distribution: The Regies (regional distribution companies) do not have the autonomy from political pressures, nor the incentives, to make commercially necessary decisions. These findings lead to recommend a reform of the institutional and regulatory options for the distribution sector. The reforms are related to the following four basic issues: * relationship of the electricity distribution business to other parts of the electricity industry (generation and transmission) and to other municipal services (water and sewerage); * regulatory and other economic incentives to provide more efficient and better quality electricity distribution services; * "retail competition" to supply final customers; * introduction of private capital or management to the electricity distribution business. PLAN OF ACTION 14. During the seminar which took place in December 1993, a consensus among the parties involved in the management and operation of the power sector was reached. Specific measures would be implemented in the short to medium term and, some strategic measures for the restructuring and reforming of the sector would be fully developed over a long-term period. These measures were agreed upon and endorsed by the participants of the seminar who are decision-makers from within the industry and from the administrations concemed. Specific Measures * agree on and enforce a solution for past electricity arrears at the earliest; * introduce and enforce a new system of payment which includes late payment penalties; * adjust the price of electricity up to its economic cost to meet the currently existing gap; * eliminate the fiscal distortion between fuel oil and imported coal which applies to ONE; * submit all IPPs to competitive bidding, in order to ensure real competition in power production; * strengthen ONE demand-side management programs. Strategic Measures * adopt a "gradual" structural reform model, with no major shocks, i.e. corporatization of ONE into three independent and autonomous companies - generation, transmission (power pooling & planning) and distribution * prepare a new law and regulations - Electricity Code - which defines principles and rules for the operation of the sector, with the assistance of local and intemational legal experts; - v - create an independent regulatory body to monitor the law and regulations enforcement. RECENT DEVELOPMENTS 15. Recently, MEM and ONE have decided to implement some of the recommendations described above and the strategy followed includes a set of measures to attract the private sector in power generations. MEM has requested the World Bank's assistance in realizing the following program: corporatization of ONE into three independent agencies; preparation and implementation of the new electricity law and regulations; preparation of bidding documents and power purchase agreements for independent power producers; and update of the LRMC tariff study and implementation of new tariff levels and structures. MEM and ONE have requested the World Bank's advice and assistance and the Bank will provide financial support for preparing the electricity law and code and the IPPs bidding documents and PPAs, and for the updating of the tariff study and the implementation of new tariff level and structure. THE PETROLEUM SECTOR ISSUES 16. For the last eight years the petroleum sector has been under close scrutiny and analysis in an effort to make it more efficient and competitive. The question of international competitiveness of the refining subsector continues to be the focal point of petroleum sector efficiency considerations. Three new exogenous factors are influencing the restructuring of the petroleum sector: * Privatization, which has already begun in the petroleum distribution subsector. * Foreign trade liberalization (loi de liberalisation du commerce exterieur) which will affect petroleum product imports. * Introduction of natural gas from Algeria, which will severely alter the market structure for petroleum products in Morocco. 17. The policy of petroleum sector liberalization is generally supported by the Government and the sector. There is less unanimity, however as to the route and timing that this liberalization should take, and as to what the optimum structure of the sector should be to provide the lowest cost of supply of petroleum products to the country, while at the same time maintaining security of supply. 18. The major issues the petroleum sector is facing can be summarized as follows: Market structure characterized by major distortions in price and taxation and potential severe changes that could be caused by the introduction of natural gas; Sector organization: privatization has begun in the distribution sector but no plan has been made for the overall petroleum supply optimization, including the future of the two domestic refineries; - vi - Petroleum pricing and taxation: prices are controlled, their structure fixed, and the taxation mechanism cumbersome. 19. Some of the above recommendations endorsed by the seminar call for the following observations. The Bank considers that the country would be better served by decontrolling ex-refinery prices and liberalizing imports so that the two domestic refineries would have to compete with oil imports at world prices without any imports barriers. With the elimination of the current import licensing restrictions on the imports of petroleum products, the seminar proposed the establishment of a differential tariff system between crude oil and products for a transitionary period, and subsequent decontrol of imports and prices. The Bank suggests that if this route is taken, the differential tariff imposed on petroleum products be gradually phased out during the duration of the transition period. OPTIONS 20. The Government has started to move in the direction of a more liberal and open petroleum sector under the impetus of the privatization and the liberalization of foreign trade laws. The ultimate stage of liberalization, the timing of implementation, and the intermediate steps taken are not yet well defined. Three scenarios have been envisaged to take into account the impact, in terms of savings and risks, of different policy options on the sector restructuring: * Scenario 1: Liberalization of the petroleum sector in the shortest practical time, consistent with the implementation of the Trade Privatization Law. This scenario envisages the rapid and extensive liberalization of the Moroccan petroleum sector resulting in unrestricted import or export of petroleum products; a domestic industry unrestricted by price or margin controls, and/or taxation distortions. This would meet the immediate objectives of the foreign trade and privatization laws; and establish a free market system where decisions at the supply and consumer levels are set by border prices for tradable petroleum products. * Scenario 2: Progressive decontrol with longer term retention of a domestic refining capability. The objective of this scenario is to provide the lowest cost supply of petroleum products to the country based on internationally dictated border prices, while at the same time retaining the flexibility of supply afforded by maintaining the most efficient domestic refining capability. This scenario explores the operational and investment options that should be considered if the decision is made to retain a long-term domestic refining capability. * Scenario 3: Deregulation. following a transition period to allow the industrv to adapt to the competitive requirements. This scenario falls between Scenario I and 2, in that refineries are protected from excessive competition for a very limited transition period. After a transition period (three years), the refining sector would be decontrolled and expected to fend on the open market. PLAN OF ACTION 21. During the Seminar of December 1993, a set of specific and strategic measures were recommended based on the discussion of the above options. - vii - Specific Measures * eliminate fiscal distortions between gasoline and gasoil by taxation of diesel (vignette); * adopt fiscal harmonization for all fuels; * introduce indexation system in parallel with the application of new trade law; * extend off-shore zone to refinery product and profit; * address the issue of special tariff agreements with selected supplier countries. Strategic Measures * gradually eliminate import monopoly; * allow five year transition period for refineries to adapt to a competitive, unprotected environment; * diversify and vertically integrate refinery upstream and downstream; * strengthen anti-dumping measures; * establish regulatory bod' for petroleum distribution industry using SNPP; * regulate import, storage and distribution of LPG. RECENT DEVELOPMENTS 22. The Government objective is to arrive at the complete decontrol of the petroleum sector and thus ensure the optimization of the petroleum market supply. The privatization of the SAMIR refinery is considered within this global context. The objective is to open the sector to private investors, both national and international. THE NATURAL GAS SECTOR ISSUES AND OPTIONS 23. The introduction of natural gas in Morocco will help achieve broader economic goals, including increasing the competitiveness of domestic industries, stimulate economic growth and attract foreign investment. To maximize these benefits several key issues must be addressed. They include institutional decisions on the structure of the industry as well as the legal framework and creation of a regulatory authority to oversee the industry. The Government needs to develop and continually revise market strategies to enable the economic expansion of the pipeline system and increased use of gas by the electric power utilities. 24. The major areas of analysis for the development of natural gas are: * global approach to a new energy policy: the introduction of large quantities of natural gas into Morocco will introduce major structural changes in the country's energy sector. It implies inter-fuel substitution and increased inter-fuel competition. It brings more flexibility, less pollution, regulation of the industry, and new forms of organization. Therefore, the introduction of natural gas into the economy must be planned carefully, taking into account natural gas' - ViII - characteristics and the role that this new energy source will play in the national energy policy; supply of natural gas includes: transit gas, commercial gas contracted with Algeria, and other potential sources of natural gas; * institutional issues: the organization of the industry in an open market environment, the gas legislation needed for transmission and distribution, gas authority in charge of economic, administration and technical regulation; * economic issues in general and pricing, tariffs and taxation in particular: pricing principles and regulation, fiscal regime, financing, risk and guarantees. PLAN OF ACTION 25. During the Seminar, the following strategic as well as specific measures have been recommended in order to finalize the institutional, financial and legal management necessary to implement and expedite the use of natural gas in Morocco: Specific Measures * define gas tariff principles which allow cost recovery (transport and distribution) and fair profit margins to the investors while protecting the interests of the consumers; * ensure a fair fiscal regime, by considering the impact on fuel diversification, environment infrastructure and industrialization); * promulgate the gas code (under preparation). Strategic Measures * prevent state monopoly and abuse of monopoly power; * grant pipeline concessions for a limited period; * ensure free access to the transmission line; * regulate prices and tariffs; * establish a regulatory body financed by the gas industry itself. RECENT DEVELOPMENTS 26. The draft Gas Code has been ecently completed, and will soon be submitted to the Government. As a follow up of the ESMAP institutional study, ESMAP has launched a Gas Tariff Study, with the active participation of the Task Force and SNPP staff. MEM is in favor of the Wold Bank Group participation in the financing of the domestic Gas Network which should be built with private partners, following the construction of the Gas Maghreb-Europ Pipeline (GME). In line with the conclusions of the ESMAP Gas Development Study (Phase 11), MEM would like to promote gas utilization in the industrial sector. The expected development of the future gas industry implies gas supply to industrial installation along the major economic axis Kenitra-Mohammedia-Casablanca. - ix- ENERGY EFFICIENCY. RENEWABLE ENERGY AND ENERGY PLANNING ISSUES 27. Morocco's energy supply is not sufficient to meet demand, presenting a major impediment to economic and social development. The economic and political constraints of energy dependence are joined by social and environmental constraints. Resource and financial constraints, as well as the increasing difficulty of managing the entire energy system (supply and demand) during a period of transition and uncertain future, could turn the current critical situation into potential crises with: * power supply disruptions and load shedding (as mentioned above) with severe economic production and social repercussions; * woodfuel deficit and environmental consequences, which stress the issue (economic, social and political) related to rural electrification and in general to energy supply to rural communities; * potential crisis due to rapid, uncontrolled increases in LPG consumption (which is the only credible short-term alternative for woodfuels). 28. In order to attenuate the energy supply/demand imbalance it is necessary to: * improve efficiency in energy uses; * develop renewable energy resources, both in the "new energy" sector (such as thermal solar, photovoltaics, wind-power generators and mini-hydro) which are particularly useful for decentralized electrification, and in the use of biomass, through more modem and efficient techniques. 29. The major issues the energy sector must address for the development of an overall energy strategy are: * insufficient energy supply: the country has limited natural resources and a low, imbalanced energy consumption; * considerable, underutilized renewable energy potential; * inefficient use of energy, especially in urban areas and industrial plants. * insufficient resources for an effective energy demand management; * lack of an integrated energy planning. RECOMMENDATIONS 30. Since there is a trend towards greater institutional autonomy, more competition, open markets and greater private sector involvement, the country must strive to create appropriate conditions for developing energy efficiency and renewable energy which stimulate participation by economic agents, yet restrain public sector management of these activities. Two modifications to the current situation will facilitate this objective: - x - * a strong energy planning core should be created within the Energy Department so that the Government has access to all factors essential to developing an energy policy; * CDER (Centre de Developpement des Energies Renouvelables) should be given the responsibility to promote and provide incentives for energy efficiency, in conjunction with its mission to develop renewable energy. 31. These modifications are fundamental to providing a new dynamic within the energy sector, yet will not require a complete overhaul of the existing organizational structure. In fact, they are a logical extension of past activities conducted primarily by the Energy Directorate (Direction de l'Energie). This arrangement makes the Authorities' willingness to advance in the areas of energy efficiency and renewable energy more concrete. 32. The so-called "demand-side" actions currently adopted are in reality "short term actions to manage power shortages by imposing demand reductions and power cuts". The immediate predicament caused by power shortages highlights the need for actions which target improved efficiency in electricity utilization. Such actions should be designed not only to attenuate the immediate effects of the crisis, but to lay the foundation for long-term efficiency conversion throughout power consuming sectors. Focus is needed also on efficiency related issues upstream from demand actions, where it is vital to develop autonomous power generating capacity in key industries (refining, sugar) which could be used for cogeneration. Given the urgency of the current situation, it is essential that the Government take a decision: * to proceed quickly with an inventory of resource supply and availability; * to establish an ONE purchase price with favorable terms for industrial cogenerators; * to have ONE agree to take on the investment expenditures necessary to establish connections with cogenerators, within technically appropriate bounds. RECENT DEVELOPMENTS 33. The planning and studies division has been recently reorganized. Its new responsibilities include formulating energy policies and representing the MEM in its interaction with the institution operating outside the energy sector. Energy efficiency and renewable energy will be one of the main areas of responsibility of this new division. Morocco Energy Sector Strategy | ~~~~~restructuringl * Legal framework LEG * Refinery * Sector restructuring FRAMEWORK restructuring 4 *Deregulation POWER Gas pricing- GAS PETROLEUM INDUSTRY STRUCTURE * LEAST-COST EXPANSION * IMPACT ON REFINERY Gas Development Plan I I I. THE ELECTRICITY SECTOR fNTRODUCTION 1.1 The Moroccan electricity sector has been experiencing a number of serious problems, including: * power shortages which are expected to last until the end of 1994 and which reveal problems related to investment planning and financial constraints; * a substantial build-up of unpaid bills and debts throughout the sector, which has resulted in financial trouble for individual enterprises; * a lack of management autonomy from Government ministries, which in turn leads to political interference and discourages management initiative; * absence of competition among enterprises in the sector and therefore less incentive for enterprises to be efficient; * a lack of coordination between the enterprises in the sector, particularly between the monopoly generation company (ONE) and the municipal distribution companies (Regies); absence of a predictable and economically sound approach to tariff regulation, with the consequence that tariffs do not properly reflect economic costs and do not adjust to reflect inflation rate and fuel cost changes; and absence of a clear legal code and regulatory system for the sector, with instead a complicated set of overlapping ministerial and other controls over the different enterprises in the sector. 1.2 Morocco also faces a number of difficult policy decisions in the electric sector. For instance how to realize the substantial investment program in generation required to meet expected electricity demand, and how to curb demand growth especially at peak. It needs to take advantage of the advent of gas in Morocco as a result of the construction of the gas pipeline linking Algeria with Spain through Morocco (GME). 1.3 The Government of Morocco has already embarked upon wider economic reforms which favor private investment and liberalization. It has also indicated publicly support for private investment in electricity generation. In order to mobilize private funds, whether foreign or domestic, investors need to be assured that they have adequate guarantees of earning an appropriate return. The best guarantee is a power sector structure which ensures that each enterprise is run as an efficient business; that customers pay enough to cover the costs of the new investment; that incentives are in place to promote the most efficient construction and operation of generation plants and of transmission and distribution services; and that the industry takes advantage of the economies in fuel use created by economic (merit order) despatch and fully - 2 - utilizes other economies available to a network system. A legal and regulatory system needs to be in place to ensure these objectives are met. 1.4 There are many different potential reform paths, some more radical than others and requiring more substantial changes to the structure and regulation of the sector. More radical reform programs, such as the one in England & Wales, usually claim more substantial benefits in the long term, but at substantial potential cost in terms of the efforts required to make the transition and with uncertainty as to the outcome. Less radical reform, for instance allowing for independent generation but leaving the industry structure essentially unchanged, may promise less in the longer term but is easier to introduce and the short-term benefits are more certain. It is therefore essential to define the objectives and priorities carefully before embarking on any institutional reform path. 1.5 This chapter first analyses the most important issues the Moroccan power sector now faces; then it discusses structural and legal/regulatory reform options and finally presents the action plan for the sector development. A description of the sector (demand/supply balance, players, institutional setup, economic and financial overview) and its main trends is given in the Annex 1. MAIN ISSUES 1.6 The most important issues which the sector has to address are: * capacity shortage; * promotion of private investment; * level and structure of electricity prices; * management autonomy and incentives; * lack of coordination and predictable regulation; * unpaid bills. A. Capacity Shortage 1.7 The reasons for the shortage (which is expected to continue until end 1994) are primarily on the supply side, but also related to demand. On the supply side, ONE's planning models have assumed a hydro cycle which has turned out to be too optimistic; indeed, Morocco has had 12 years of dry weather, whereas planning models assume a mixture of dry and wet years. The result is that hydro has provided as little as 60 MW at times, whereas planning models assume that the minimum (in dry years) will be 315 MW. The planning model assumptions are now being reviewed. If the result of that review were to reduce forecasts of the minimum guaranteed hydroelectric capacity, this would have important implications for the size of future capacity requirements and the relative balance between investment in hydroelectric plants and in thermal plants. In effect, it would increase the estimates of necessary investments in coming years. 1.8 Also on the supply side, there have been long delays in the commissioning of plants, for instance Matmata (240 MW, due in service end 1992, but which won't be commissioned until the second semester of 1994). These delays are largely due to the form of - 3 - financing: bilateral country credits which require a considerably longer approval process (mainly in the donor country) than is true for normal supplier-credits. On the other hand, the bilateral country credits are very low cost (10 years grace, payback over next twenty years, interest rate 1.5%) compared to supplier credits (10 year payback at 8-10% interest). This explains why the Ministry of Finance prefers ONE to finance investment with bilateral country credits. The issue here is not simply one of delay, but rather one of weak financial autonomy for ONE. Table I ONE HYDROELECTRICITY CAPACITY AND GENERATION, 1980 - 1991 Hydroelectricity Year Capacity Generation Hydro-Generation MW GWh as % of total 1980 604 1,515 31.8 1981 604 1,024 20.0 1982 604 573 10.5 1983 604 481 8.2 1984 604 367 6.0 1985 610 486 7.5 1986 610 643 9.3 1987 616 825 11.3 1988 616 936 12.1 1989 616 1,157 14.1 1990 616 1,220 13.8 1991 616 1,266 13.5 Sources: World Bank Staff Appraisal Report, Second Rural Electrification Project, # 3262- MOR, August 30, 1990; ONE's 1990 and 1991 Rapports d'Activite 1.9 As a result of these delays and the hydro planning problem, the remaining plants have been pushed harder than is optimal, and consequently there have been serious problems with availability. For instance, the Gas Turbines (GTs) (designed to run on diesel for short periods of time) have been running as if they were base-load plant. Cdnsequently, there has been inadequate time to do daily maintenance (to clean the residue of the heavy diesel fuel from the turbines) and the GTs have broken down. Hence, we see a trend of lower availability leading to maintenance being postponed, which in turn leads to even lower availability. It is difficult to blame this availability problem on poor technical management of plant. The outages are clearly related to the wider planning and financing problems listed above which have led to the overuse of thermal plants. 1.10 On the demand side, demand has grown at about 7% per annum over the past ten years and there have been virtually no efforts to reduce demand in a systematic way, e.g. by discouraging demand at peak through peak tariffs, or by encouraging energy efficiency with the help of programs aimed at promoting conservation (e.g. better insulated refrigerators, low- wattage public lighting). - 4 - 1.11 The short-term measures being taken to deal with the power shortage include measures aimed at reducing demand and others for increasing supply. On the demand side, ONE and the Regies had to cut off customers, often entire industrial zones, as well as stopping television programs between 14.00 and 18.00 hours, reducing public lighting and taking other measures that have more to do with supply restriction than the encouragement of more efficient use and conservation of energy. The cuts are very expensive to the country in lost industrial production, and the other curtailment measures are also highly inconvenient. 1.12 On the supply side, the main measure (apart from intensive use of existing plants) has been to order six gas turbines to be installed at Tetouan (3 X 33) and Tit Mellil (3 X 33) and commissioned in 1994. ONE is considering adding another 3 X 33 MW GT at Casablanca. 1.13 By far the most important question is what lessons to draw from this power shortage and what long-term measures should be taken in order to avoid shortages in the future. We have already mentioned three key issues which deserve serious attention: (1) a review of Morocco's investment plan taking account of the evidence of lower-than-planned "guaranteed" contribution from hydro; (2) the need to provide ONE with greater management autonomy and responsibility (accountability) for planning and financing of investment; and (3) the need to introduce serious demand-side measures to slow the growth in demand at peak. B. Private Investment 1.14 The major issues here have to do with whether to encourage private investment and what changes are required to the planning, institutional and legal framework for that to happen. 1.15 Currently, the legal arrangements give ONE a monopoly of generation above 300 kW, although auto-generators account for about 12% of output. There is now a political commitment to allow and indeed encourage independent private generators. The difficult financial situation is one of the important reasons why the Government has shown considerable interest in the idea of private investment in electricity generation. The other reason is that the private investment could stimulate greater efficiency and dynamism throughout the Moroccan electricity sector. Based on experience in other countries, it is likely that the benefits of private investment will be greatest if competition (e.g. competitive bidding to build new plant) is simultaneously encouraged. 1.16 A number of arguments have been made against private investment. One is that it could actually raise the cost and price of electricity in the country because private investors will require profits that ONE does not require. Experience in many countries suggests that the combination of competition and private investment will actually drive costs down. In any case, if private investment is not economic, then an open competition (on a level playing field) between private investors and ONE will reveal that. We are also unconvinced by the argument that private investors will not respond effectively to emergencies and other commands by central despatchers, although it is true that private investors will expect to have transparent contractual obligations to do so and to be paid for doing so. Finally, we do accept the argument that ONE has been given a heavy public service obligation and is handicapped (compared to potential private investors) because of these obligations and the many taxes it pays to the state. We think that ONE should be treated on the same basis as independent generators, and that the advent of -5 - private capital should be seen as an opportunity for ONE to gain greater financial and management autonomy in order to compete effectively or indeed join private investors. It is also important for the State to recognize that private independent generators may not yield as much tax revenue as ONE currently pays (for instance in the case of import duties which do not apply to a private investor, as initially envisaged). Nevertheless, we conclude that private investment could make an important contribution to Morocco's electricity industry, especially if it is accompanied by competition which obliges private investors to prove that they are indeed more efficient. 1.17 There are two kinds of private investment in generation which are currently under serious consideration. The first concerns cogeneration and auto-production by large industries. Auto-generators currently provide about 12% of Morocco's electricity production, but sell negligible amounts to the public network. Cogeneration is insignificant. The question is whether investment in these sources of electricity could and should be stimulated, for instance by raising purchase tariffs or providing other incentives. The benefits of additional investment, e.g. to meet current shortages and to reduce financial pressures on ONE, must be weighed against the risk of encouraging expensive and uneconomic investment. One way to weigh the benefits and costs is to include auto-generation and cogeneration explicitly in any future competitive bidding and to examine the prices which the competing operators offer. 1.18 The more important potential for private investment is from independent power producers (IPPs) building large conventional thermal generation stations or combined cycle gas turbines (CCGTs). The expectation is that a private investor would raise its own finance for such a project on the basis of expected proceeds from selling the electricity to ONE on a long-term contract. The Government has recently decided to go on competitive bidding for IPPs. 1.19 One of the important questions raised by the Government's initiative in seeking private investment is what sort of institutional arrangements are required to ensure that private investment will bring maximum benefit. On what basis should investors be selected and who should select them if there are a number of options? On what basis should they be paid? Is there a need to restructure the industry or to reform the law in order to permit and encourage private investment? These and other questions should be addressed before taking decisions with respect to the future role of private investment in the Moroccan electricity sector. We consider some of these questions later in this chapter. 1.20 Finally, we raised an issue about the existing expansion plan. It is important to recognize that new generators may offer to supply electricity at prices which make previous plans look outdated. For instance, if IPPs can build CCGT plants that offer electricity at prices well below the costs assumed in the national expansion planning stage, there would be good reason to consider an expansion of gas-fired plant at the expense of other plant. Thus, opening a system to competitive bidding between IPPs may reveal information that raises doubts about planned investments. This in turn may create uncertainty for ONE and for organizations which extend credit to ONE. Any reform to the sector must therefore be carried out carefully so as not jeopardize credits which have already been committed to ONE, but also to allow for an adjustment of the expansion plan to reflect new information about the cost of alternative generation sources that is revealed through competitive bidding. -6 - C. Electricity Prices 1.21 End-user tariffs are set with social, political concerns in mind, and do not reflect economic costs of supplying specific customer groups. This explains the policy of uniform national tariffs, as well as the policy of favoring residential customers. While uniform national tariffs are widely applied in other countries, they do entail some economic costs. Even if one accepts these costs, there are many reforms to tariffs which can be introduced. 1.22 Electricite de France (EdF) has studied Morocco's end-user tariffs and bulk supply tariffs. Within the constraint of uniform national tariffs, they recommend a number of reforms to tariff structure, including: the introduction of a two-part tariff for low voltage (e.g. residential) customers; the introduction of more time-sensitive tariffs for all customers (e.g. three daily periods including peak tariffs and seasonal tariffs for high voltage customers); * fixed capacity charges and kWh charges related to the load factor; * discounts on capacity charges for capacity subscribed off-peak; and * a method for systematically reflecting the different costs of distribution (i.e. either by having different ONE transfer prices to each distribution company, or by having common ONE transfer prices to all distribution companies as well as compensations between the distribution companies). 1.23 These recommendations have been considered by the Government and the Regies as difficult to implement, ostensibly because of metering problems (e.g. all customers paying a peak tariff would need a new meter) and the problem of explaining to customers why there is a peak tariff and how to respond to it. In addition, changing bulk supply tariffs (or introducing compensations between Regies) will be difficult politically if it entails a change from the previous no-win, no-lose policy. 1.24 An additional and important issue has to do with "purchase" tariffs for energy sold to ONE by cogenerators and auto-generators. ONE's view is that the potential for cogeneration is very small in Morocco because of the relatively low level of industrialization and because most potential producers are so small that their costs are bound to be higher than ONE's avoidable costs. Nevertheless, it is also clearly time to consider whether the terms on which ONE has been willing to buy energy from independent producers, auto-generators and cogenerators are reasonable. In particular, the question is whether ONE should offer capacity and energy contracts to cogenerators and auto-generators which can guarantee availability, as well as energy-only prices to suppliers which cannot guarantee availability. D. Management Autonomy and Incentives 1.25 One important issue in the sector is whether the current institutional structure provides the right environment to encourage efficient investment, operations and management. - 7 - 1.26 There is political involvement at all levels of the sector, which reduces management autonomy and effectiveness. For instance, there is lack of compliance by both ONE and the Government of their "Contrat Programme". ONE's investment plan is developed and financed in a way which reflects immediate problems facing the central Government. Financial constraints on the Government lead to a preference for bilateral aid financing, rather than commercial credits, which in turn leads to delay in realizing projects. Moreover, ONE must pay a number of taxes (e.g. douane, import taxes) which private foreign investors would not have to pay and ONE is also obliged to buy domestically produced fuel oil at prices which include substantial taxes. 1.27 The management of individual Regies perceive their roles as partly "social" and that sometimes translates into a lack of autonomy and discipline when it comes to collecting accounts receivable (mainly from publicly owned organizations), paying bills (mainly to ONE) and cutting off customers which do not pay. The decision to connect customers is sometimes also driven by political and "social" pressures rather than by a pursuit of commercial gain. 1.28 There is evidence of poor operating and investment performnance in the broadest sense of the word, including financial performance, payment of bills, losses on the system and delayed construction. It is however difficult to generalize about the reasons for poor performance. Non-payment of electricity bills is partly the responsibility of the Administration (as customer) and partly due to a lack of incentives for electricity managers to insist on payment. The financial problems of the sector are partly due to a reluctance on the part of the Government to raise tariffs. Poor availability of plant may be blamed on a variety of factors, including the enormous pressure to push operating plants harder than normal in order to deal with the supply shortage facing the country. 1.29 Nevertheless, it is important to ensure that the responsibility for improving performance is clearly identified, and that managers have clear incentives and autonomy to carry out their responsibilities. We therefore see the issue of performance as part of the wider question of institutional reform that will provide management autonomy and responsibility. E. Absence of Proper Coordination and Predictable Regulation 1.30 Apart from the question of political intervention and the lack of autonomy of management, there is also a problem of coordination. This is particularly evident at the interface between ONE and the Regie, where interconnection decisions cause considerable difficulties. 1.31 Regulation also seems unduly dispersed and unpredictable; several Ministries are involved (MEM, Finance, Interior, Economic Affairs). And there is no system of independent economic regulation (notably of tariffs) on which investors could rely with confidence. F. Unpaid Bills 1.32 One important issue that could stop private power in Morocco is the tradition of not paying bills. Unpaid debts are one aspect of the wider financing problem facing ONE and other companies in the electricity and petroleum sector. As of end March 1993, ONE's clients were in arrears by approximately 5,000 Million dirhams (approximately US$ 500 Million). Of that amount, the Regies owed ONE about 3,000 Million. The Regies were in turn owed substantial amounts by their customers, mainly those in the public sector. ONE also has - 8 - substantial debts, in particular to the petroleum distribution companies for fuel oil and to the State for service on the debt. The problem of past unpaid debts, and avoiding the build-up of new debts, is widely perceived as a problem that needs to be solved. If it is not solved, it could seriously complicate the entry of private investors into the electricity sector. Independent power producers and their bankers will be inclined not to accept assurances over future payment from ONE if ONE has a history of not collecting money it is owed and in turn not paying its suppliers. 1.33 If the problem of non-payment is not solved convincingly, IPP investors are likely to demand guarantees (e.g. from the Ministry of Finance), and are likely to include a higher risk premium in their calculation of the acceptable price of electricity. Private power could then turn out to be more expensive than ONE power, if investors are seriously worried about the risk of default. OPTIONS AND RECOMMENDATIONS A. Short-Term Measures Competitive Bidding By Private Sector Generators 1.34 It has been recommended and agreed by the Government to adopt competitive bidding to select the first (and future) independent generators, rather than negotiating only a direct deal with a single developer. Competitive bidding will also help to determine the most economic site. The only caveat to this recommendation is that this competition should not delay the commissioning of a combined-cycle gas turbine (CCGT). 1.35 It has been recommended and agreed that the Government commission a study of the rules and procedures that need to be adopted to encourage independent power production in Morocco. It should consider (a) the institutional and legal changes required to permit and encourage private generation, auto-generation and cogeneration, (b) the process and criteria for selection of independent private generation and (c) the basic contractual terms on which an independent generator would sell to ONE or to the system. Energy Demand 1.36 It is recommended that the Government, ONE and the Regies take advantage of the consciousness of Moroccans to electricity shortages in order to strengthen CDER (Centre de Developpement des Energies Renouvables) as promoter of demand-side management programs aimed at energy efficiency and conservation (see Chapter IV. on Energy Efficiency). Unpaid Bjlls 1.37 The Administration's efforts to solve the problem of past debts and to avoid future debts by allocating vignettes (a form of quasi-money to be spent on electricity only) to public sector managers have not yet yielded positive results. Most recently, the introduction of a new system of payment which imposes penalties for late payment has been suggested; the enforcement of such a system is strongly recommended. - 9 - 1.38 However, it is apparent that the issue is one of discipline, autonomy and management incentives of public sector organizations at all levels. In particular, if Regie managers do not have better incentives to insist on payment of their bills, then they are unlikely to put necessary pressure on their clients, particularly given the important element of political control over the Rfgies. This suggests a need for more fundamental institutional reforms (see par. 1.60 and ff.). Tariff Reform 1.39 Some of the basic elements of a logical tariff structure reform are described in the results of the 1992 EdF study which requires updating. It is here recommended that the Government give immediate attention to the introduction of a tariff structure that reflects economic costs, and in particular, which discourages consumption in peak hours and months. 1.40 Tariff structure reform, however, is only part of the problem. A related and important question is how to establish a regulatory system which will be based upon sound economic principles, allow enterprises to recover the costs of their investment and operations, ensure predictable and automatic changes in electricity tariffs, and which give electricity operators incentives to lower their costs and improve their service quality. It is recommended that the Government commission a study on the design of a system of tariff regulation. ContractPlan 1.41 It is recommended that the Government of Morocco and ONE comply with their Contract Plan (Contrat Programme), by which ONE has agreed to achieve adequate technical and financial performance targets and the Government has agreed to assure appropriate tariff levels. B. Long-Term Options 1.42 The main objectives of longer-term reforms are: improved economic efficiency (in investment, operations, central despatch, management and consumption) and security of supply in the electricity sector. The efficiency objectives include a range of management aims, such as better incentives to collect unpaid bills, to improve availability of generation plant and to keep investment and operating costs to the minimum required to ensure supply security. To achieve security of supply, the Government may wish to ensure diversity of fuel supply types and sources, as well as the development of domestic fuel resources. 1.43 The Government will also have a number of social or political aims which it hopes to achieve through the electricity sector, for instance provision of tax revenue and development of rural electrification. One aim of the reform should be to ensure that the economic costs of achieving these political objectives are clearly identified and that as far as possible these aims are pursued without undermining the commercial viability and incentives of the companies in the sector. For instance, it may be preferable to give direct subsidies to vulnerable customers rather than to set tariffs which are below the costs of supply, and it would certainly be a mistake to set taxes on gas which effectively made gas-fired generation financially unviable. - 10- 1.44 Based upon the experience in many developed and developing countries, some of the most beneficial reforms in the electricity sector involve measures aimed at promoting competition in electricity generation, while introducing incentive regulation in those parts of the business with strong elements of natural monopoly (the transmission and distribution businesses). The following assessment of structural options concentrates first on options that are likely to promote competition in generation, while assuming throughout that distribution companies retain a monopoly over supply to their final customers; it will then examine options for reforming the institutional arrangements in electricity distribution. 1.45 We consider three possible structural models for introducing competition into generation: * Competitive bidding to supply electricity to ONE. * Competitive bidding to supply a Purchasing Agency (PA). * Competing generators sell direct to distribution companies. I. Competitive bidding to supply electricity to ONE. 1.46 Description: Under this model (which corresponds closely to the US model and to most models where developing countries are trying to encourage IPP investment), ONE remains responsible for meeting the country's generation requirements (either as a producer or a buyer), as well as being the company responsible for high voltage transmission and central despatch. The main change of this model compared to the status quo is that while ONE could retain ownership of its existing plants, it would be required to put any future generation capacity and energy needs out to formal and regulated competitive bidding. 1.47 The competition to build new plant would be between IPPs, potential cogenerators and the generation affiliate of ONE. The winner of the competition would sign a long-term electricity supply contract with ONE, which in turn would supply the Regies and its own distribution market. The regulatory authorities would be responsible for ensuring that ONE did not discriminate against non-ONE generation. This would be easier if ONE's transmission and distribution business were at arm's length from its generation affiliate, at least in accounting terms if not as separate companies. 1.48 This model is consistent with leaving the distribution business as it is now (half in ONE's hands, half in the hands of other Regies), but is also consistent with a change to the distribution end of the sector. For instance, to maximize the flexibility with respect to future competition in the sector, it would be preferable for ONE-generation/transmission to sign transparent long-term contracts with ONE-distribution. 1.49 Advantages: The main advantage of the model is that it has a reasonable likelihood of being attractive to foreign investors in the near term, since the latter would be selling to an established monopoly. A second benefit is that this approach is likely to involve minimal costs in terms of disruption to current investment plans or despatch efficiency, and should minimize the costs related to reorganization and competitive bidding. 1.50 Disadvantages: The first is that competitive bidding may not be fair if ONE is both a buyer and a potential seller. Moreover, as a monopsony buyer which also produces electricity, ONE could perhaps use its dominant position to favor its own generation stations or - 11 - to minimize payments to the IPP once the IPP's plant has been built. Investors will therefore seek guarantees to protect themselves. A second problem is that, in view of the limited extent of change, investors may be concerned that the structure will change again in the near future. It will be essential to convince investors that their money will not be put at risk from future changes. 1. COMPETITIVE BIDDING TO SUPPLY ELECTRICITY TO ONE I IPPs Autogenemitor/ I I | C~~~~~~~~ogenerators l F CusOmersS I uFr IPP Independent Power Producers G/T= Generation/Transmission Shaded boxes indicate monopoly 2. COMPETITIVE BIDDING TO SUPPLY A PURCHASING AGENCY (PA) Generator Autogenerstors/ Generators (ONE) ~~~Cogenerstors (PS LVNL~~~ t F Customers IPP = Independent Power Producers PA/T = Purchasing Authority/Transmission Shaded boxes indicate monopoly - 12 - 2. Competitive bidding to supply a Purchasing Agency (PA). 1.51 Description: The PA would be independent of existing generation companies and would be responsible for selecting the companies which would build and operate new plant. The PA would also purchase electricity from existing plants (which may be owned by ONE or which could be sold to private investors). It would have long-term contracts with all generators and those contracts would provide economic incentives for plant owners to be available when needed and to minimize operating costs. The PA would in turn sell wholesale electricity to distribution companies, either at annual bulk supply tariffs (reflecting the full cost of generation and transmission) or on the basis of long-term contracts with the distribution companies. 1.52 This model requires ONE generation to be separated (in terms of management and probably ownership) from transmission so as to ensure that ONE does not use its control over transmission to bias choice in its own favor. As with model 1, it is consistent both with the creation of new regional distribution companies, to take over ONE's previous distribution responsibilities, or with distribution remaining in ONE's hands. In addition, this model shifts planning responsibility for ensuring adequate supply to the Purchasing Agency. This in turn implies that the PA will be closely associated with transmission issues and so the merging of ONE's transmission affiliate with the PA may make sense. 1.53 Advantages: This could be an attractive model for introducing competition in generation. The main attraction of this model over the previous one is that it is more likely to ensure fair competition between potential generators, and is also compatible with the privatization of existing ONE generation stations. A second advantage (which might be considered a disadvantage by some) is that it enables the Government to maintain control over the planning of investment. 1.54 Disadvantages: The main disadvantages are that this model requires substantial changes to the structure and operations of the sector, and in particular requires new contractual relations between an independent transmission company and the independent generation companies. This sort of relationship may be very beneficial, as has proved to be the case in Spain, but it is not straightforward to implement. Another concern is that the decision making is centralized. A third problem is that there may be serious legal and financial problems associated with establishing a Purchasing Agency which carries heavy financial obligations. 3. Competing generators sell direct to distribution companies. 1.55 Description: This model most closely approximates the liberal models of Britain and Chile. Under it, generators and distributors have open access to the transmission network and can contract directly. The model probably requires a full ownership separation of ONE's generation, transmission and distribution businesses. It also requires the development of a pooling or wholesale market mechanism to ensure efficient planning and despatch. 1.56 It may be considered desirable to move the sector towards this model gradually, so as to minimize disruptions. In this case, reform might begin with a move to one of the previous models as an initial stage. It would be preferable (although not absolutely necessary) to transfer distribution assets from ONE to independent distribution companies during the initial stage so that the progression to this model would be smoother. - 13 - 1.57 Advantage: The main advantages of this model over the other two are that it avoids the problems of bias in competitive bidding under model 1 and of centralized decision- taking under model 2. It offers the maximum potential for independent decentralized decision- taking, which can lead to greater innovation and lower costs through competition in the electricity market and in capital markets (where shareholders compare performance). 1.58 Disadvantages: One drawback of the model is that it requires a long time to introduce the substantial structural changes which are implied, including ownership separation of generation, transmission and distribution, and the development of complex contractual relationships to permit open access to the transmission network. A second drawback (not shared with model 2) is that of coordination between companies. Pooling and wholesale market arrangements are required to ensure that the autonomous actions of independent generators and distribution companies are consistent with efficient despatch and generation. A third problem is that direct contracting between generation and distribution will naturally lead distribution companies to select the lowest cost sources of power. This may leave some plant "uncontractable", even if there are security of supply (or political) reasons for keeping such plant open. Finally, this model would only be feasible if distribution companies were perceived as good credit risks by investors. 3. COMPETING GENERATORS SELL DIRECT TO DISTRIBUTION COMPANIES Generator Autogenerators/ Generator (One) Cogenerators (IPPs) All Distribution Companies Residential and Commercial Customers | IPP = Independent Power Producers 1.59 There are many other potential models, for instance which would involve full vertical integration and national monopoly (a la EdF), but the most basic features of an - 14- electricity system allowing for competition in generation are captured in the three models described above. None of these models is inherently better than another, unless one has clearly defined the aims and timetable of the reform. Certainly model 1 is the easiest to introduce and offers potential benefits quickly. The other models promise greater benefits, but over a longer period of time and with substantial cost in the short run. It is feasible to imagine model I as a first step towards a more liberalized electricity system. However, if the aim is to move to model 3, this should be explicitly recognized and planned for at the outset. Reform Options in Electricity Distribution 1.60 The Regies do not appear to have the autonomy from political pressures, nor the incentives, to make commercially necessary decisions. This finding covers such considerations as whether to press harder to collect unpaid bills, whether and when to connect customers, and whose electricity to cut off when load shedding is required. Coordination between the Regies and ONE is poor, for instance when planning interconnection investments. These findings lead to recommend a review of the institutional and regulatory options for the distribution sector. 1.61 The Government may wish to consider reforms related to the following four basic issues: * the relationship of the electricity distribution business to other parts of the electricity industry (generation and transmission) and to other municipal services (water and sewerage); - regulatory and other economic incentives to provide more efficient and better quality electricity distribution services; * "Retail competition" to supply final customers; * introduction of private capital or management to the electricity distribution business. 1.62 The relationship of electricity distribution to other services. There are two important questions: Should the distribution business be vertically integrated with electricity generation and transmission (as at ONE) or separate (as with the Municipal Regies)? Should electricity distribution be separated from water and sewerage? 1.63 On the first of these questions, economic reasoning and international experience suggest that efficiency in distribution is possible with either industry model, i.e. with separate distribution companies or with vertically integrated companies, and that regulatory incentives and history probably matter more than the degree of integration. Many countries, such as Germany and Spain, have mixed systems such as Morocco's, where specialist distribution companies co-exist alongside vertically integrated companies. From the perspective of improving distribution services, therefore, the solution does not lie primarily in changing the degree of vertical integration or separation. However, in order to allow for informed comparisons of the performance of different distribution companies, it is important that ONE's electricity distribution business be identifiably separate from its generation and transmission businesses, at least from an accounting perspective. Furthermore, if the Government wishes to see competition in generation develop as in model 3, where competing generators have the right - 15- to sell directly to distribution companies, then ONE's distribution business would have to be separated fully from its upstream business. 1.64 The second question is whether to separate electricity distribution from water, sewerage and related (e.g. construction) services. Economic theory and international experience once again provides support for both models, i.e. where the services are combined or where they are provided separately. In choosing between these models, the key economic attraction to combining the municipal services is to obtain economies of scale and scope that could not be obtained by contracting between separate organizations. The potential economic benefits of combining these services within one company or probably small and have to be weighed against the potential inefficiency that could result due to the absence of management specialization, especially for services which could more efficiently and economically be provided by outside specialists. For similar reasons to those described above, it is important to introduce maximum transparency and management accountability for the electricity distribution business, and to ensure that ONE and Regie managers have incentives to improve distribution service quality and lower costs, for instance by contracting with outside firms for construction services where that is economic. Creating electricity distribution companies would contribute to achieving these objectives, but is neither a necessary nor sufficient measure. 1.65 Regulatorv and other economic incentives of the Municipal Regies and ONE to provide more efficient, better quality electricity distribution services. One way to improve the efficiency of the distribution business would be to introduce regulatory incentives which would directly link a company's performance to the prices it could charge and to the rewards or penalties for managers. For instance, the Government may wish to consider the potential for a contract okab which could specify service targets related to losses, speed of connection, reduced outages, faster collection of bills and cost reduction. These contracts would specify the Government's undertakings and the way in which the Municipal Comnpany managers would be rewarded or penalized, respectively, for good or bad performance. 1.66 A second reform option is the introduction of yardstick competition. This approach allows the regulatory authority to compare a number of electricity distribution companies and to set prices (or rewards or penalties for management) in terms of an individual company's comparative performance. Inevitably, the distribution companies will begin from very different situations and will face different problems; these must be taken into account when making comparisons. The experience in other countries suggests that this sort of regulation can introduce dynamic efficiency because public or private sector managers are encouraged to compete with each other to improve their performance. In order for this kind of competition to develop, regulators will need consistent information for all of the electricity distribution businesses. This serves to underline the importance of the accounting and management separation ("unbundling") of electricity distribution from other activities. 1.67 A third option, which could be introduced along with the first two, is "price cap" incentive regulation, whereby prices are indexed to a formula (such as inflation minus a productivity improvement factor, x) for a number of years and the regulated company is able to keep any surplus revenue that results from lowering its cost, subject to a service quality threshold. - 16- 1.68 For each of these proposals, the regulatory authority will require good comparative information on service quality indicators. These should be published widely as a way of putting pressure on management. 1.69 The introduction of competition to supply final customers. Some countries have introduced or are considering the introduction of "retail competition". For instance, in England & Wales, the Government has separated the distribution business (access to local wires) from the retailing of electricity services to final customers. Competing retailers then sell to final customers, and pay the distribution companies for the use of the local wires. 1.70 In principle, the idea of separating natural monopoly segments of the electricity business (such as the wires used in local distribution) from the inherently competitive segments of the business when there are no economies of scope associated with integrating these segments should be supported. In that way, competition can achieve maximum results in terms of lower costs and improved customer service quality, and the inefficiencies of administrative regulation are confined to those segments of the business where regulation appears necessary to protect customers from unregulated monopoly. However, the calculus of benefits and costs is complicated when there are economies of scope from vertical and multi-product integration, which is the case between electricity distribution and retail sales. The appropriate policy in any country therefore requires a balancing of the costs and benefits of introducing retail competition. 1.71 Experience in other countries suggests that to achieve the benefits of retail competition, the organization and regulation of the electricity system has to change radically. For instance, it would be necessary to reach agreements over access to the transmission and distribution networks, to develop wholesale market mechanisms, and generally to adapt to a situation where customers were unlikely to face uniform national tariffs. The cost of introducing a policy of retail competition in Morocco outweighs the likely benefits in terms of service quality and improved efficiency. Although the possibility that some very large customers could have the choice to buy from competing suppliers (ONE, a Regie or an independent generator) should not be ruled out, a full-scale separation of the distribution and retail functions, as in Bolivia, is not recommended, nor would be recommended the introduction of retail competition for the majority of customers. 1.72 Introduction of private capital or management of the electricity distribution business The reforms described above are all consistent with continued Municipal ownership of the electricity distribution business, under the supervision of the Ministry of the Interior and Information. A more radical reform would be the introduction of private sector management or "ownership". 1.73 There are, broadly speaking, two models that should be considered (in addition to contracting out an increasing number of non-core services, such as construction). The first approach is to sell shares in distribution companies to institutional and small private shareholders. This has been the basis for utility sector reform in Britain for over a decade and is increasingly being adopted throughout the world. According to this model, private shareholders will exert pressure on distribution company managers to meet profit expectations. Provided the regulatory system is properly designed (e.g. using yardstick comparisons and price cap incentives), profitability will rise as distribution company costs fall and service quality improves. - 17 - 1.74 The successful introduction of private capital is dependent upon having an industry structure in place so that the incentives on private providers of services are aligned as closely as possible with the wider public interest. This requires careful attention to the competitive, structural and regulatory framework prior to any sale. The main economic advantage offered by private equity is the introduction of capital market regulation. Performance incentives and sanctions for industry managers are generally heightened under private ownership. The value of independent performance monitoring by the providers of debt and equity capital is dependent to some extent on the presence of a hard constraint on companies in the form of either competitive pressures or a regulatory regime that does not allow poor performance to be passed on to consumers. It is hard to imagine this approach working in Morocco at this stage, in part because of the undeveloped capital market. 1.75 A second and more feasible approach in the Moroccan context involves the awarding of limited-duration franchises to private firms. This form of privatization would involve competition between private companies fQr the market (i.e. for the right to supply services under conditions of monopoly for, say, 15-25 years), rather than competition in the market. The company which provides distribution services would sign a franchise agreement or license that specified the obligations (service quality, investment, etc.) of the company and the basis on which it would be paid. This contract could incorporate the incentives which were discussed earlier, perhaps along with price caps and yardstick competition. 1.76 This model has been common in the French water sector for many years, and is becoming increasingly popular in countries such as Argentina, Mexico, Malaysia, and in Eastern Europe. Although franchising usually involves no transfer of ownership, the private sector franchisee typically must bear some of the risks, such as revenue risk. In theory, the tendering procedure should lead to a competitive bidding process, and subsequent incentives to operate efficiently. In reality, experience in France has shown that the bompetitive process needs nurturing. For long term contracts, there may be strong biases towards the incumbent when it comes time to re-award a concession or franchise contract. Specialist skills for the monitoring of the private contractor are also required, to ensure that undertakings on prices, service quality and asset maintenance, for example, are properly fulfilled. Legal and Regulatory Framework 1.77 At present there is no comprehensive legislation covering Morocco's electricity sector. Instead, the sector remains under the direct supervision of central Government, but with responsibility divided between several different ministries and committees. This situation results in a number of problems, including: * a lack of management autonomy from Government, for instance with respect to financing investment; the absence of a clearly defined and predictable regulatory structure for setting tariffs contributing to financial problems; * a lack of co-ordination between the different organizations in the sector, notably between ONE and the Regies; and - 18- difficulty to attract foreign investors since the latter will not feel confident that they know the "rules of the game". 1.78 Aside from the legal framework, the power sector also lacks a system of explicit economic regulation. The purpose of such regulation is to encourage economic efficiency and service quality in those parts of the electricity sector where competition is not possible (transmission), as well as to ensure that prices to consumers and returns to investors are both considered reasonable. 1.79 Morocco should consider enacting a comprehensive law for the electricity sector, and should develop a system of economic regulation which will help to give practical effect to the aims of the law. Options related to (1) the regulatory institutions, (2) the nature of such institutions' responsibilities, and (3) legal and regulatory reforms that could help to encourage private sector investment and competitive market forces in the electricity sector are considered below. 1.80 The choice of regulatory institutions is an important consideration. Three main options should be considered: to create an independent regulatory authority that would be independent of other electricity sector organizations and that would experience minimal political interference especially on day-to-day sector management issues; to create separate regulatory divisions within existing ministries (or inside one ministry, say MEM); to leave general regulatory responsibilities with thhe ministries (or ministry) without setting up a separate division with them. 1.81 Although regulators are never entirely unaffected by political pressures, the idea of creating as firm a separation as is possible between regulatory responsibilities and the day-to- day political pressures that are inevitably exerted on ministries is firmly supported. This normally translates into a preference for the first option. However, it is just as important to ensure that the principles that guide regulations are predictable and transparent, and that the roles/responsibilities of the regulator and ministries are clearly specified. 1.82 The new electricity sector law should define clearly the policy responsibilities of the Government, the regulatory authority and the organizations being regulated. This should help to reduce unnecessary Government interference in the management of enterprises. A precise definition of responsibilities will depend on the industry structure which is chosen and on the degree of competition permitted. However, the main responsibilities which a regulatory authority could be assigned might include: * setting tariffs which are based upon strict pricing principles defined by law and regulation; * issuing licenses for generators and franchises for distributors that specify the responsibilities of enterprises consistent with structural reforms, e.g. the franchising of distribution if that reform were adopted; - 19 - * developing technical and performance standards designed to ensure system reliability and efficient performance; * contributing to the implementation of national energy policies, such as rural electrification and demand-side management; * reviewing and approving investment plans and power project proposals developed by enterprises; and * reviewing and approving transmission, pooling and despatch arrangements (if they exist). 1.83 If the Govemment wishes to encourage private sector investment in generation, the law and regulatory framework must explicitly do so. For instance, the law, regulations and contracts should clearly specify the rights and obligations of private investors in power projects. The legal and regulatory regime should also specify how disputes will be resolved. It would also be wise to consider developing model transaction documents (e.g. power purchase agreements). 1.84 If the aim is to encourage competition as well as private investment, the law and regulations should reduce the barriers to competition. For instance, the law could encourage the use of competitive bidding for new generation capacity. Model bidding and evaluation procedures and criteria could be developed. Depending on the structural reforms undertaken, it may also be desirable that the legal and regulatory framework prohibit the cross-subsidy by an integrated utility of one competitive activity (e.g. generation) using resources from another monopoly activity (e.g. distribution). 1.85 Finally, an electricity law and regulatory system cannot be created ovemight, and it is probably not necessary to introduce a fully developed legal and regulatory system before private investment in generation begins. However, there are priorities that should be studied urgently. These include the rules for price regulation, as well as the essential preconditions for private investment in generation. PLAN OF ACTION 1.86 During the seminar which took place in December 1993 a consensus among the parties involved in the management and operation of the power sector was reached on the following main causes of the financial difficulties faced by ONE: * high level of arrears accumulated by the utilities (both owed by the Regies to ONE and by the public sector to ONE and the Regies); * excessive taxation of heavy fuel used for power generation; * excessive control of electricity prices and utilities budgets by the central Government; * lack of managerial autonomy. - 20 - 1.87 It was also recognized that in the current situation of: * lack of adequate legal and regulatory framework; * lack of financial reliability of ONE and Regies; * monopoly position of ONE, the solution represented by the introduction of independent power production could results in other distortions and inefficiencies (for examples if Government guarantees and/or non-competitive bidding were pursued). A. Specific Measures 1.88 In order to improve the sector efficiency the seminar recommended a series of specific measures to be implemented in the short-medium term: * to agree on a solution for past electricity arrears at the earliest; * to introduce and enforce a new system of payment which includes late payment penalties; * to adjust the price of electricity up to its economic cost; * to revise the fiscal regime which applies to ONE on fuel; * to submit all IPPs to competitive bidding, in order to ensure real competition in power production; * to strengthen ONE demand-side management programs. B. Strategic Measures 1.89 A consensus was also reached on some strategic measures for the restructuring and reforming of the sector, which would fully develop over a long-term period. The rationale behind it should be the establishment of a truly competitive environment in which all parties are treated equally (particularly in the fiscal context). The reform process should apply to all three parts of the electricity chain, generation, transmission and distribution. It should follow a three- step path which would determine the organizational structure, define the legal framework (electricity code) and establish an independent regulatory body in charge of monitoring the sector operations and enforcing the law. Sector Structure 1.90 The seminar envisaged a "gradual" structural reform model, with no major shocks, as the most suitable option for Morocco. The model adopted by Portugal has been considered the best example. It implies the corporatization of ONE into three independent and autonomous agencies - generation, transmission (power pooling&planning) and distribution. Power generation will be provided by ONE and new independent producers. All new generation capacity and energy needs will be met through formal and regulated competitive bidding. Legal and Regulatory Framework 1.91 It was agreed that, once defined the structure, the Government should start preparing a new law and regulations - Electricity Code - which defines principles and rules for - 21 - the operation of the sector. The seminar recommended the assistance of legal experts, local and international. Regulatory Agency 1.92 An independent regulatory body should be created to monitor the law and regulations enforcement. The possibility of expanding the agency competence to the whole energy sector (and not only to electricity) was discussed. Further analysis is required to define which regulatory set-up is most suitable to the Moroccan energy sector. 1.93 The seminar achieved a major consensus on the need for reforms in the power sector and on the specific structure to be adopted, particularly for generation. A few issues, however, were not exhaustively discussed and no agreement was reached on recommending implementation steps. This concerns particularly the reform of the distribution system; the legal and regulatory framework (incentive/sanction system; the tariff setting) and the risk analysis, for which the study provided recommendations in the previous paragraphs (see "Options" section). RFCFNT DEVFLOPMENTS 1.94 The moroccan authorities have embarked on a comprehensive power sector restructuring process which includes a national rural electrification program. Some of the concrete measures being considered are based on the recommendations of the December seminar. The strategy followed includes a set of measures inviting the private sector to: a) take over new coal-fired power generation units under completion (Jorf 1 and 2, i.e. 2*330 MW); b) build, own and operate new thermal power generation units, either coal-fired (Jorf 3 and 4, i.e. 2*330 MW) or gas-based combined cycle (350 to 450 MW); and c) get transferred part of the disribution grid. MEM is convinced that IPP (i.e. PCE) is the best solution for Morocco to meet its electricity needs. The Ministry is curently discussing the possibility to grant concessions of local distribution grids operated by ONE (Agadir). 1.95 MEM has requested the assistance of the Bank for the realization of this program. The Bank provides advice and financial support for: the evaluation of bids for prequalification of two combined cycle units, firing Algerian gas and to be commissioned by 1997-98; the preparation of bid documents for the take over and construction of power generation units; the preparation and negotiation of Power Purchase Agreement (PPA); the preparation of the Electricity Code; the electricity tariff study updating; and the reorganization of ONE. - 22 - II. THE PETROLEUM SECTOR INTRODUCTION 2.1 For the last eight years the petroleum sector has been under close scrutiny and analysis in an effort to make it more efficient and competitive. The size and processing configuration of the two refineries, SAMIR (Societe Morocaine de l'Industrie du Raffinage) and SCP (Societe, Cherifienne des Petroles) has raised the issue of whether the two refineries were efficient in an intemationally competitive environment. The conclusions were that the refineries would have a slight economic disadvantage (approximately 6% of border prices) if they had to compete at world oil market prices, and that based on national security of supply considerations, it was considered justifiable to maintain an operating domestic refining industry, rather than relying on imported products. A modification to the method of petroleum price control was recommended to bring domestic oil prices closer to border prices and modify other distortions that existed due to differential taxation. The question of international competitiveness of the refining subsector continues to be the focal point of petroleum sector efficiency considerations. The changes that are now taking place both in the Moroccan economy and the energy sector, dictates a reassessment of the issues and options facing the whole petroleum sector including the refinery subsector. 2.2 Three new exogenous factors are influencing the potential restructuring of the petroleum sector. They are: * Privatization Law Privatization of the petroleum sector has already begun with the privatization of the distribution subsector. * Eoreiadrade The new foreign trade liberalization law (Loi de Liberalization du Commerce Exterieur) dictates the opening of Moroccan Markets. * Impact of Natural Gas The introduction of Natural Gas from the Maghreb Europe pipeline will severely alter the market structure for petroleum products in Morocco. 2.3 The liberalization trend of the Moroccan economy embodied in the Foreign Trade Law, and the directives on privatization of the State Companies and their application to the petroleum sector are consistent with the World Bank's policy of opening the sector to foreign trade and improving the sector's efficiency. These policies and their ultimate objectives are supported by the Govemment agencies with responsibility for the oversight on energy, as well as by the various petroleum companies. There is less unanimity, however as to the route and timing that this liberalization should take, and as to what the optimum structure of the sector should be to provide the lowest cost of supply of petroleum products to the country, while at the same time maintaining security of supply. The ultimate structure of the sector and the degree of continuing Government intervention and control that may be needed to assure a competitive petroleum sector is still under discussion. The distribution and marketing subsector is in the process of being privatized. The other major areas under discussion are a) the rate and timing of import/export decontrol needed to allow the refinery subsector to readjust to the new more open - 23 - environment, b) the timing of decontrol of domestic petroleum product prices at the ex-refinery and consumer levels, and c) the best institutional structure for the refining subsector. MAIN ISSUS A. Sector Efficiency Potential Savinys 2.4 There are three major areas of the petroleum sector where efficiency improvement could be realized: Supply Side Optimization - Recent studies of the refining subsector indicated that the Moroccan refineries while efficient by world standards, had certain inherent inflexibilities and inabilities to meet domestic demand. An analysis of the performnance of the refineries for the period 1980 through 1988 indicated that the cost of supply by the refineries on average amounted to some 6% above border prices, equivalent to 540 million Dh per year. A recent study carried out by Beicip indicates that this inefficiency in current operations could be (i) eliminated by changes in refinery operations (alternative choice of crudes) and/or (ii) a further reduction of approximately 3% (300 million Dh) could be achieved by upgrading the refinery processing flexibility. QOptimum Market Structure - There are a number of areas where artificial market distortions are created through the pricing mechanism, discriminatory taxation and /or product subsidy. These are: (i) transportation fuels which favor diesel oil over gasoline, (ii) differential taxation of heavy fuel oil relative to coal and (iii) subsidies of LPG. * Company Structure - It is expected that the privatization of the distribution companies and ensuring market competition will enhance the efficiency of the distribution and marketing sectors. While significant savings are expected through the consolidation of the industry it will be offset by higher margin requirements which are currently deemed inadequate. The net result will thus be in improved service and safety rather than monetary or price terms to the end consumer. B. Market Structure Impact of Natural Gas 2.5 The introduction of natural gas into the Moroccan energy sector in the 1997 to 2000 time-frame will have a significant impact on the refining subsector. Preliminary studies of the impact of gas introduction conclude that: (i) the proportion of heavy fuel oil in the overall petroleum slate will drop from 40% today to 25% by the year 2000; and (ii) current refinery capacity limits will be extended from the currently forecasted date of 1997 to early in the next century. The main uncertainty in the petroleum product forecasts are an assessment of the extent - 24 - to which natural gas will displace current fuels used in the power sector, i.e. whether natural gas entry will come at the expense of coal or heavy fuel oil. SAMIR currently estimates that the refinery will loose about half of the heavy oil market to natural gas, while the balance of the gas market will come at the expense of coal. In all cases, the result will be a lightening up of the refinery product slate, making it more difficult for the refineries to balance out petroleum product supply and demand through refining alone, without some modification or adjustments. Thus the pricing policy of natural gas as well as investment decisions relative to gas based power projects adopted by the Government will have very significant impact on SAMIR and SCP's future operational plans and viability. Price and Tax Distortions 2.6 The major distortions impacting the structure and efficiency of the petroleum sector are (i) different import duties and taxes on crude oil and petroleum products which favor the importation of crude oil ; (ii) taxes on regular and premium gasoline higher than on diesel have resulted in the dieselification of the motor pool; and (iii) high taxes and import duties and price inducted distortions on heavy fuel oil hide the true competitive position of fuel oil and imported coal. The differential pricing of crude oil, petroleum products and coal, has been recognized by the Government, and it is the intent of the Government to rectify these distortions with the adoption of a new border price related pricing system. LPG 2.7 The LPG market has become a very important part of the petroleum sector in Morocco, both as a source of conveniently distributed fuels and as a replacement of depleting renewable energy sources especially wood, thus playing an important social and environmental role in the country's energy mix. In recent years the consumption has increased dramatically, from an average rate of 5 % prior to 1985, to in excess of 10% today. The current demand far exceeds the supply from the two refineries resulting in increasing imports which now account for over 67% of demand. This rapid demand has lead to a confusing picture of the future development of the supply and demand of LPG. Current forecasts of demand growth vary between 3 and 10% per year for the next decade. The upper growth would translate into a consumption in excess of 2 million MT/Y by the end of the decade. A clearer picture of the future growth expectations, sources of supply, and the need for demand side management of this rapidly growing sector is necessary. C. Sector Organization Privatization 2.8 The privatization of the petroleum sector has already started with the privatization plans of SNPP (Societe Nationale des Produits Petroliers). Three tail distribution companies (CMH, Petrom and Shell) have already been privatized. Negotiations are currently underway for the privatization of the other companies. Petrom and CMH were purchased by domestic investors. No plans however have been made for the privatization of the refining companies SAMIR and SCP, nor have any decisions yet been made on the limitation of concentration of the industry and restraint of trade. This raises a number of questions as to the future structure of the industry. One concern is the potential for excessive control of the distribution system by a private monopoly. Three distribution companies - Shell, Mobil and - 25 - Total would control 60% of the market on privatization of their SNPP affiliates and current participation in other private companies. Another yet undefined question is to what extent the refining companies will be allowed to diversify into distribution and marketing (either through acquisition or diversification). SCP is considering downstream diversification as a potential pre- requisite for long term viability. Refinery Sector Options 2.9 An recent analysis of the impact of the introduction of natural gas and the implementation of the privatization law leads to the consideration of three refining operational options: * Option 1: Continuation of current refinery configuration and mode of operation. Option 2: Continuation of the current refinery configuration with a more flexible approach to the choice of crude oils. Option 3: Upgrading the refinery processing flexibility by the installation of hydrocracking capacity in SAMIR. 2.10 The analysis of these options arrived at the following general conclusions. The continuation of the current mode of operation and configuration (Option 1) will require refinery sector protection (or subsidies) from foreign imports both in the short and long term. The subsidy requirement calculated were of the order of $4 per ton for SAMIR and $8 per ton for SCP. With the proper choice of crude oils (Option 2) both SCP and SAMIR would be marginally competitive with imported products. Option 3 would require a significant bottoms upgrading facility investment in SAMIR of the order of $300-400 million, which would make SAMIR competitive with imported products. The conclusions are not materially impacted by the introduction of natural gas. Thus the major issues facing the Moroccan refinery sector are that a) for the long term operation of domestic refineries, significant investments must be made to remain competitive or b) protection from international imports will be continually needed. A resolution of the long term choices facing the refineries need to be defined prior to defining a short term strategy. In all cases a more flexible approach to refinery operational flexibility appears to have both short and long term impact on petroleum supply efficiency. 2.11 The liberalization of the petroleum sector is based on the privatization of the refining and distribution companies, liberalization of imports, and decontrol of margins and prices. Apart from the privatization of the distribution companies which has already begun, neither the timing nor extent of the other actions have been addressed. As far as timing is concerned it is generally agreed that complete opening of the domestic market to the uncontrolled import of foreign products would probably result in the flood of imports resulting in the shut down of the domestic refineries. Conversely privatization of the refineries without continued Government support will be difficult if not impossible. The choices facing the country are a) rapid decontrol with unknown outcome; b) a managed transition period leading to a clearly defined objective that includes an efficient refining sector; or c) short-term reactive response to current policy directives which may neither meet short term efficiency improvements nor the long term objectives. - 26 - D. Petroleum Pricing and Taxation 2.12 Petroleum Prices have been fixed by the Government for the last two decades. The current system of price control fixes petroleum product prices at the ex-refinery, wholesale and at the retail levels. Ex-refinery prices have been determined historically by setting individual petroleum prices relative to the proportional ratio on the international market and the dictates of allowing the refineries a fixed operating margin. Wholesale and retail petroleum prices are set by a rigid price structure that allows for predetermined fixed margin at both the wholesale and retail levels. Regional price differences are controlled through the allowance of controlled transportation differentials from the two main refinery points of supply. Cross subsidization of petroleum product by the pricing mechanism is limited to the subsidization of LPG by the control of ex-refinery (or import) prices with compensation at the distribution level. Differences experienced between crude oil price fluctuation and the fixed domestic product prices are reconciled and adjusted annually between the refiners and the Government through the Compensation Fund and/or changes in ex-refinery prices in the case of large price deviations. The current price levels have been in effect with only minor modifications since 1986. 2.13 The fiscal revenues from the petroleum sector came from ten different levies of petroleum refining and distribution. Total revenues derived from petroleum operations in 1992 and forecasted for 1993 are shown in Table 2.1. At the refinery subsector level these are: import duties on crude oil and products, special import duties on crude oil, normal excise tax , special excise tax, consumer Tax (TIC), and excess accumulation. Revenue from the distribution sector consists of: Value added tax (TVA), Tax on domestic Consumption (TIC), Credit de Droit, and adjustments through the Compensation Fund. The Special Import Duty on crude oil is tied into crude oil prices with the intent on recapturing windfall profits when crude oil prices drop below 18 US$ per barrel. Differential taxation is also used as a demand side management tool primarily in the form of higher consumer taxes on gasoline relative to that on diesel fuels. 2.14 The current system of petroleum price determination and taxation is recognized to be deficient in that: a) it does not foster the least cost supply options through refinery optimization and/or the importation of products, b) does not provide adequate incentive for the refineries, c) the system is difficult to administer, d) lacks transparency and does not give the necessary signals to the petroleum sector, and e) induces distortions in the price between petroleum products and between petroleum and competing energy sources such as coal. A critical analysis of the system, operation and the alternative solutions was carried out in the mid- eighties with the assistance of the World Bank. At that time it was recommended that a pricing system be adopted that would link domestic petroleum product ex-refinery prices to intemational based border prices, and that taxation induced distortions between crude oil and products and between heavy fuel oil and coal be eliminated. Because of the processing configuration of the existing Moroccan refinery and the market requirements (characterized by a high heavy fuel oil demand), it was suggested at that time (1986) that a degree of protection be provided to the domestic refining subsector through the application of an indexed pricing system. Opposition to the adoption of this system hinged primarily on the fear that this would result in a loss of revenue to the Government. The adoption of this Indexation system is still under discussion and reevaluated in view of the current environment. - 27 - Table 2.1 Petroleum Product Taxes and Revenues 1992 1993 Million Dh % Million Dh. % Refining Import Duties 178 2.0 187 1.9 Special Import Duties 407 4.5 151 1.6 Excise Tax 890 9.8 936 9.7 Special Excise Tax 2,033 22.4 757 7.8 Domestic Consumption Tax 1,688 18.6 2,941 30.3 Excess Earnings 1,050 11.6 1,264 13.1 Total Refining Operations 6,246 68.9 6,237 64.4 Distribution Domestic Consumption Tax 2,084 23.0 2,275 23.5 Credit de Droit 10 0.1 11 0.1 Value Added Tax 1,130 12.5 1,256 13.0 Compensation Fund 299 3.3 251 2.6 Refunds and Subsidies (700) (7.7) (350) -3.6 Total Distribution 2,823 31.1 3,443 35.6 Total Petroleum Sector 9,069 100.0 9,680 100.0 Price Level and Structure 2.15 The price structure of the major petroleum products sold in Morocco are based on a fixed pricing structure. Starting with an fixed ex-refinery price, allowances are made for the addition of fixed costs and margins for distribution and marketing for each individual product to establish a base price. Govemment determined transportation costs are then allowed on top of the base price to arrive at the allowable retail and wholesale prices in the different geographical regions. The buildup of allowable marketing and distribution costs for the major petroleum products is shown in Table 2.2 and for the LPG products in Table 2.3. 2.16 A comparison of end user price levels in Morocco with the corresponding prices in some European countries in 1993 is shown in Table 2.4. In 1993 the prices in Morocco for gasoline were approximately 80% of the average price for the selected European countries. Diesel oil prices, the main transportation fuel in Morocco, was about 30% lower than the average price in European countries. Heavy fuel oil prices in Morocco were significantly higher (160%) than corresponding oil prices in Europe. This difference in price is due to a) the different levels of taxation and b) the distorted of inter-product prices at the ex-refinery level in Morocco. A comparison of the tax rates on petroleum fuels for the main products in Morocco and selected European countries is shown in Table 2.5. In absolute terms, in 1993 the tax burden on gasoline and diesel in Morocco was comparable to that in Europe, but substantially higher on HIFO. - 28 - Table 2.2 Price Structure of Major Products Premium Regular Illuminating Gasoline Gasoline Kerosene Gas Oil Fuel No.2 (d=0.739) (d=0.722) (d=0.792) (d-0.832) (DH/HL) DH/HL) (DH/HL) (DH/HL) (DHT) 1. Ex-Refinery Price 404.92 367.61 291.84 278.11 1,607.80 2. Domestic Consumption Tax 130.38 126.70 59.81 64.05 16.50 3. VAT (7% 1+2) 37.47 34.60 24.62 23.95 113.70 4. Credit de Droit (0.34% 2+3) 0.57 0.55 0.29 0.30 0.44 5. Losses (1.25% I to 4) 7.17 6.62 4.71 4.58 6. Distribution Costs and Margins 14.70 13.70 8.50 8.60 90.00 7. Special Allowance for Inventory 4.00 4.00 4.00 4.00 25.00 599.21 553.78 393.77 383.59 1,853.44 Less VAT (3) 37.47 34.60 24.62 23.95 113.70 561.74 519.18 369.15 359.64 1,739.74 8 Caisse de Compensation 70.57 89.51 (43.91) 1.02 13.06 9 Wholesale Price ex VAT 632.31 608.69 325.24 360.66 1,752.80 10. VAT (7% of 9) 44.26 42.61 22.77 25.25 122.70 11. Wholesale Price inc. VAT. 676.57 651.30 348.01 385.91 1,875.50 12. Retail Losses (0.3% 11) 2.03 1.95 1.04 1.16 13. Retail Margin 17.40 16.75 8.95 9.93 14. Retail Sales Price (Base Price) 696.00 670.00 358.00 397.00 - 29 - Table 23 LPG Price Structure (DHIMT) Containers Containers Bulk Quantities over 5kg Below 5 kg Filling 1. Ex Reftnery (Import) Price 1,950.00 1,950.00 1,950.00 2. Domestic Consumption Tax 46.00 46.00 46.00 3. VAT (7% of 1+2) 139.72 139.72 139.72 4. Filling Losses (2% of I thru 3) 42.71 42.71 42.71 5. Cost and Margin 200.00 200.00 200.00 6. Special allowance for Inventory 30.00 30.00 30.00 7. Bulk Transportation 50.00 50.00 8. Bottling Cost 20.00 50.00 9. VAT(7%of4thru8) 23.99 26.09 16.01 10. Sales Price to Distributors 2,502.42 2,534.52 2,380.44 Distribution 11. Purchase Price from Filling 2,502.42 2,534.52 2,380.44 12. Cost and Margin Distributor 278.33 346.67 432.00 13. Cost and Margin "Depositary" 278.33 346.67 3,059.08 3,227.86 2,812.44 Last VAT (3+9) 163.71 165.81 155.73 2,895.37 3,062.05 2,656.71 14. Compensation Fund (224.03) (351.77) (39.89) 15. Wholesale Price ex VAT 2,671.34 2,710.28 2,616.82 16. VAT (7% of 15) 186.99 189.72 183.18 17. Wholesale inc. VAT 2,858.33 2,900.00 2,800.00 18. Retail Margin 100.00 150.00 19. Retail Price (Base Price) 2,958.33 3,050.00 Table 2.4 Energy End-Use Prices - 1993 Country Gasoline Diesel Fuel Oil (USStLitre (USS/Litre) (USSIMT) ) Germany 0.922 0.565 118.76 Belgium 0.962 0.597 104.18 Spain 0.821 0.555 118.17 France 0.959 0.546 104.99 Italy 1.027 0.658 152.15 Portugal 0.941 0.610 165.98 U.K. 0.807 0.625 98.61 Average 0.920 0.594 123.26 Morocco 0.733 0.418 197.42 % of Average 79.7 70.4 160.2 Source: 1) IEA Statistics, 1994 2) MEM Exchange Rate: Dh/USS = 9.5 - 30 - Table 2.5 Tax on Petroleum Product - 1993 Percentage on Consumer Prices Gasoline Diesel Fuel Oil Countryv Industry Power Germany 73.5 59.0 15.3 26.1 Belgium 71.8 54.9 20.8 20.8 Spain 68.2 54.6 23.0 12.0 France 78.6 59.9 24.5 n.a Italy 74.6 64.0 18.8 n.a Portugal 73.2 59.2 39.8 0.0 U.K. 70.6 59.2 15.7 n.a Average 72.9 58.7 21.0 14.7 Morocco 66.3 60.2 53.8 53.8 % of Average 90.9 102.5 256.2 365.0 Source: 1) IEA Statistics, 1994 2) MEM Exchange Rate: Dh/US$ = 9.5 2.17 Under the current system it is difficult to accurately estimate the actual level of taxation on each of the individual products due to a) the complexity of the tax structure, b) the distortions in pricing mechanism between petroleum products and between crude oil and products, and c) the cross subsidization and compensation mechanism. The direct taxes and duties imposed on the importation of crude oil and products are shown in the following table: Table 2.6 Import Duties and Taxes on Petroleum (as per March 1994) Crude Oil Product Coal Normal Customs Duty 2.5% 35% 2.5% Normal Excise Tax 15% 15% 15% Special Customs Duty 500 Dh/T Domestic Consumer T ax 2.5%*6*(1445-VI) Special Excise Tax 15%*6*(1445-VI) - VAT 7% 19% OPTIONS 2.18 Morocco has started to move in the direction of a more liberal and open petroleum economy under the impetus of the privatization and foreign trade laws. The ultimate stage of liberalization, the timing of implementation, and the intermediate steps taken are not yet well defined. The focus of these options is to a) clearly define the long term objectives for the restructuring of the petroleum sector and to b) focus on the actions, decisions and options needed to implement the current laws consistent with the long term objectives for the sector. There are many components and options that will have to be implemented in achieving the goal of a - 31 - liberalized petroleum sector. Most of these actions are inter-related and must be carried out at the same time if the ultimate saving are to be realized. The timing of such decisions is also important if the lowest cost option of supply to the consumer is to be achieved. A list of the main areas that have to be addressed and decisions made, either by the Government and/or private enterprise is shown in Table 2.7. Table 2.7 Decision Areas 1. Privatization Distribution Companies Refining Companies 2. Import Restrictions 3. Price Controls Ex Refinery Prices Consumer Prices Price Volatility 4. Taxation Government Revenue Distortions 5. Investment Requirements By the Government By Private Enterprise 6. Security of Supply 2.19 To illustrate the inter-relationship and impact of the various decision options listed in Table 3.1, three hypothetical scenarios have been postulated and will be analyzed. These span a wide range of policy options, potential saving and risk, not necessarily all desirable or feasible, but are presented for illustrative purposes. These scenarios and their goals are: * Scenario 1: Liberalization of the Petroleum sector in the shortest practical time, consistent with the implementation of the privatization law. * Scenario 2: Progressive decontrol with longer term retention of a domestic refining capability. * Scenario 3: Deregulation, following a transition period to allow the industry to adapt to the competitive requirements. - 32 - A. Scenario 1. 2.20 This scenario envisages the rapid and extensive liberalization of the Moroccan petroleum sector resulting in unrestricted import or export of petroleum products; a domestic industry unrestricted by price or margin controls, and/or taxation distortions. This would meet the immediate objectives of the foreign trade and privatization laws; and establish a free market system where decisions at the supply and consumer levels are set by border prices for tradeable petroleum products. Actions 2.21 The major decisions that would be needed in this scenario are: * the privatization of the two refining companies; * import/export decontrol * the abolishment of differential taxation and/or import duties on crude oil, products and coal; * the decontrol of ex-refinery prices and the retail price controls; a The restructuring of the taxation structure to generate the same Government revenue. Results 2.22 The abolishment of import restrictions over a period of time would require the implementation of new import management mechanism consistent with the implementation of the law of privatization and foreign trade, i.e. a tariffs differentiating between crude oil and products. SCP, SAMIR and the retail distribution companies would then become importers of petroleum products based on the strength of their port facilities, storage and infrastructure. Longer term viability for the two refineries could depend on them integrating into marketing and distribution and/or upgrading their refining processing capabilities. Savings 2.23 Based on the historical experience of the petroleum sector in the eighties, the average savings in importing all petroleum products rather than refining crude oil domestically would amount to some 6% of the wholesale petroleum product cost. This amount translates into a saving of 540 million Dh per year at current prices. Longer term savings would be realized in demand side optimization between gasoline and diesel utilization in the transportation sector, and HFO and coal in the power sector. Short term Government revenues would be enhanced through the sale of the SNPP, SCP and SAMIR. On the negative side the social cost implications would have to be considered. - 33 - Risks 2.24 There is a high degree of probability that the refineries would close with the phase out of controls. The security of supply of petroleum products based on imports rather than the domestic refining of imported crude oil is the major question. This has been studied extensively without any clear-cut conclusion. It is the Government position that the closing of the refineries would decrease the flexibility of source of supply for Morocco both in normal times as well as during disruptions. Secondly, it would eliminate the single point responsibility, for assuring the countries supply of petroleum products now assigned to the refineries. B. Scenario 2. 2.25 The objective of this scenario is to provide the lowest cost supply of petroleum products to the country based on internationally dictated border prices, while at the same time retaining the flexibility of supply afforded by maintaining the most efficient domestic refining capability. This scenario explores the operational and investment options that should be considered if the decision is made to retain a long-tern domestic refining capability. Short Term Actions 2.26 The immediate (one to three year) options that could be considered to improve sector efficiency are as follows: * Progressive decontrol of import restrictions, allowing access to imports by both distributors and refiners. * Completion of the privatization of the Distribution companies. * Abolition of differential taxation and/or import duties on crude oil, products and coal; * Protection of refinery viability through ex-refinery price control (Indexation System), direct subsidy or other control mechanisms. Deregulation of distribution price and margin controls. * Optimization of Refinery Operations with the objectives of optimum short tern efficiency and long term viability. Long Term Actions 2.27 The longer term options to be considered include: * Investment in upgrading the Refineries to remove the current rigidities of processing capability. * Privatization or progressive private participation in the refining sector. - 34 - * Optimization of Demand Side Management of Petroleum Market (Diesel/Gasoline, LPG, and Natural Gas/CoaV/Oil use). * Phase-out of Refinery protection. Refinely Options 2.28 The current refining sector economic inefficiencies result from (i) the restrictions and dictates of the domestic pricing and taxation system, and (ii) the technical inflexibility of the refineries, especially that of SAMIR. The first can be diminished by short term actions including the following: * The current taxation system and country to country agreements favors the import of crude oils from certain sources (Saudi Arabia, Kuwait, and Iraq). This results in the importation of relatively heavy crude oils which prevents the expansion of the gasoil market. Solutions to these imbalance are (i) the importation of reconstituted or spiked crudes more suited to the Moroccan market and/or (ii) more aggressive net-back pricing on existing crude oils. * Removal of the dictate that the refineries be responsible for the supply of the domestic market, allowing refiners to optimize their product slate by balancing refinery runs with imports. * Allow the refineries to enter into joint venture/tolling agreements with distributing companies. 2.29 Secondly, if a longer term perspective is assured for the refineries, they will be in a position to contemplate the necessary investment alternative to modify their processing capability to meet future petroleum market requirements. Options for consideration include: * Maximization of Diesel Fuel through Heavy Oil upgrading through the cat cracking, hydrocracking or coking of the bottom of the barrel. Options currently being considered in similar situations around the world are both captive facilities and stand alone private equity participation cracking facilities (Cresent Hydrockracker Project in Pakistan, and Valero Oil in the US). * Facilities to maximize the efficiency of utilization of residual fuel oil in power generation. The options include cogeneration; the integration of flexicoking; coking and fluid bed combustion (Chile, Mexico); and/or gasification and combined cycle IPP (Italy, China) facilities. 2.30 The Task Force study estimates that subsidy for SAMIR could be eliminated once the necessary processing investments are made. This could also be the case for SCP. The savings realized are estimated to be at least 6% of border refinery sales. Hence in this scenario the net savings realized by the country above today's operations would amount to approximately 540 million Dh per year, in addition to the amount realized from the sale of the SNPP. - 35 - Risk 2.31 This scenario would retain the flexibility of refining crude oil domestically or importing oil while at the same time retaining the core refining complex for future expansion. The technical investments required to upgrade the refineries are very significant if the hydrocracking route were to be taken of the order of $300-400 million. Private funding of the project should be considered. C. Scenario 3. 2.32 The third scenario falls between Scenario I and 2, in that refineries are protected from excessive competition for a very limited transition period. After some period of the refining sector would be decontrolled and expected to fend on the open market. One variant currently being studied entails the implementation of the indexation system, readjustment of the taxation system, and continued control of distribution margins and consumer prices. Imports would be limited through differential tariffs on crude oil and products. The advantage of this scenario over scenario I is that it would give the refiners a longer period of time to adapt to their new role. The disadvantages are: (i) a complicated system of controls has to be implemented only to be soon abandoned, and (ii) unless the transition period is well defined and it's demise is perceived to be real there will be a tendency to avoid the hard decisions that have to be made in the long term. PLAN OF ACTION 2.33 During the December 1993 seminar a number of options were discussed related to the future development of the petroleum subsector. From the many options discussed a number of specific and strategic measures were recommended to implement a plan of action for the petroleum subsector. The recommended measures are summarized in Table 2.9. A. Specific Measures 2.34 Morocco currently imposes a larger tax on the consumption of motor gasoline than on that of diesel fuels, on the basis that diesel is used for essential agricultural and heavy transportation purposes, while gasoline is primarily used for personal and non-essential needs. This lead to distortions in fuel use in Morocco where much of the automotive pool is now diesel based. This further leads to product imbalances at the refinery level, necessitating the export of excess naphtha into Europe at a substantial economic loss to the country. The seminar recognized the need to harmonize the taxation structure of gasoline and diesel to reverse this dieselification trend and recommended that this be done through the application of a vignette tax on private diesel-fueled automobiles. The Bank considers that this would be a step in the right direction in that it will equalize the tax burden for the two fuels in the private automotive sector. However it would leave the distortion in place for the agricultural and heavy transportation sector which account for a major portion of these fuels in Morocco, and considers that the long- term objective should be equal tax treatment for both fuels in all applications, so that consumers can make the least cost choice for their particular application. 2.35 The price of different fuels (coal, gas and heavy fuel oil) vary substantially at the consumer level due to different levels of taxation and distortions through price control. It was recommended that all fuels should bear the same tax so that the consumer would be faced with - 36- prices free of fiscal distortions, resulting in the least cost choice for all consumers. The need to implement tax harmonization for the three fuels has unanimous agreement. Table 2.8: Restructuring of the Petroleum Sector - Options Scenario I Scenario 2 Scenario 3 Objective Liberalize Petroleum sector Progressive decontrol while Progressive decontrol without in shortest time consistent investing in Refinery upgrading commitment to Refinery Sector with the Law of Privatization and Exterior Trade. Actions 1. Decontrol of Short Term (I year) Short Term (I Year) imports/Exports 2. Abolish differential taxes I . Progressive decontrol of I . Progressive decontrol of import on coaUoil/ products. import restrictions. restrictions. 2. Abolish differential taxes on 2. Abolish differential taxes on coal/oil/ products. coal/oil/products. 3. Protect Refinery viability 3. Protect Refinery viability through ex- through ex-refinery price refinery price indexation, and control, direct subsidy, or differential tariffs between crude oil other means. and product imports. 4. Deregulation of distribution 4. Deregulation of distribution prices prices and margins. and margins. 5. Complete privatization of 5. Complete privatization of Distribution. Distribution. 6. DSM of petroleum sector. 6. DSM of petroleum sector. Long Term (3 years) Long Term (5 Years) 1. Invest in upgrading Refineries I . Phase out refinery protection after 5 2. Phaseout refinery protection. years. 3. Privatize Refineries. 2. Integration of refineries up and downstream. 3. Privatize Refineries. 4. Create regulatory agency out of SNPP. Risks Possibility that refineries None. Could result in a 5 year transition period would shut down. with status quo at the end of period. Savings Minimum saving of 540 Minimum saving for three year Minimum saving for five year period. million Dhs per year based period, maximum savings Savings thereafter unknown on imported product prices thereafter. Seminar Rejected by Seminar Did not address upgrading Advocated transition period, did not Conclusion participants, which refineries. address privatization of refineries. concluded need for transition period prior to privatization of refineries. World Bank Immediate privatization of Bank should consider viability of Transition period excessive and should Position refineries should be investment in refineries prior to consider decreasing to I year for considered privatization implementation of policies, and 2 years for privatization. Direct subsidy to the refineries from Treasury preferred over indexation system and differential tariffs ._____________ .________________________ . ___...... ________________.._ during transition period 2.36 Currently the import of petroleum products is strictly controlled by the MiEM which issues limited import authorization to the two domestic refiners. Several import taxes are imposed on crude oil and products, and further distortions between individual products result from the application of the existing pricing structure. The reform of the petroleum regime to - 37 - comply with the new trade liberalization law is necessary. However, a transition period between the existing system and complete decontrol was recommended, during which the domestic refineries would be protected from excessive foreign competition by imposing a differential tariff between crude oil and products. The imposition of an ad valorem tariff on product imports and duty-free imports of crude oil, was recommended. The Banks considered that the country would be better served by immediately decontrolling ex-refinery prices and liberalizing imports so that the two domestic refineries would have to compete with oil imports at world prices without any import barriers. If the refineries were to suffer losses as a result of decontrol, these should be covered by payments directly from the Treasury. This would ensure the least cost supply of petroleum products for the domestic consumer; continue to provide the country with the security of supply associated with the operation of a domestic refining sector; while at the same time providing a transparent system of refinery subsidy. 2.37 The seminar recommended that the current system of controlling ex-refinery prices, which has been in effect for twenty years, be replaced with an indexation system. The indexation system proposed would fix ex-refinery prices equal to border prices plus a fixed percentage or coefficient. This increase would make allowance for the disparity of Moroccan product slate, and the domestic refineries lack of flexibility to respond to changing product prices. Based on prior analysis a coefficient of 6.5% was considered adequate to allow the refineries a reasonable rate of return on their operations. Border prices, under the indexation system, would be calculated from Rotterdam petroleum product prices, adding the necessary freight and other import costs. A comparison of the indexation system with the current pricing system was carried out in the mid 1980's with the Banks assistance. The conclusion was that, under the then prevalent conditions, the indexation system had some advantages over the current pricing mechanism. The advantages were not sufficiently attractive to result in the systems immediate adoption. It is not expected that the relative merits of the two systems will be significantly changed during the transition period now proposed. l 2.38 The seminar recommended that consideration be given to establishing an off- shore zone treatment for the two domestic refineries in effect giving the refineries tariff-free access to petroleum product imports. This would allow the refiners to optimize their processing operations without distortion of differential crude oil/petroleum product tariffs. A review of this recommendation indicates that the treatment of the refineries as off-shore installations would negate the protective mechanism intended by establishing a differential tariff protection for the refineries in the first place. Alternatively, the establishment of a special tariff free import situation for the refineries would be counter to the intent of the liberalization law. The Bank suggests that the import tariffs be equally applied to all importers, including the refineries, consistent with the requirements of the statute of importers. - 38 - Table 2.9 Petroleum Sector Restructuring Policy and Program Seminar Recommendations World Bank Position MEM Position Specific Measures I Eliminate fiscal distortions Vignette considered an impractical solution; Same as World Bank between gasoline and gasoil target should be to apply equal taxation for by taxation of diesel diesel and gasoline for all applications (vignettes) 2 Fiscal harmonization for all Agreed Agreed fuels (fuel oil/coal and gas) 3 Introduce indexation system Decontrol ex-refinery prices, eliminate tariff in parallel with the application differentials between products and crude oil of new law on trade liberalization 4 Extend Off-shore zone to Import tariffs on products should be equally A new scheme considered refinery product and profit applied to all importers, including refineries consisting of an "off-shore platform" which includes SAMIR's refinery, storage and port receiving facilities 5 Define a statute for importers Agreed, but contingent on acceptable To be revised according to regulating the right to import definition of importers the MEM's proposal (see 4.) 6 Address the issue of special Eliminate special treatment of both crude oil Same as World Bank tariff agreements with selected and petroleum products from all sources supplier countries Strategic Measures Gradually eliminate import Eliminate import licenses; phase out Same as World Bank monopoly progressively differential tariff between crude Recommendations under oil and products during transition period implementation effective (1/1/95) 2 Allow a five year transition Limit transition period to three years 5 year transition period period for refineries to adapt to a competitive, unprotected environment 3 Diversify and vertically No objection Agreed integrate refinery upstream and downstream 4 Strengthen anti-dumping Implement anti-dumping measures as defined Same as World Bank measures by Trade Liberalization Law 5 Establish regulatory body for MEM should continue oversight under Same as World Bank petroleum distribution existing laws; abolish margin control industry using SNPP 6 Regulate import, storage and After decontrol, LPG trade should be treated Same of World Bank distribution of LPG identically to all other products. Any subsidy should come directly from the Treasury and go to the benefit of the consumer - 39 - 2.39 The recommendations of the seminar called for the establishment of a statute regulating the right to import petroleum products into Morocco. Four specific conditions were considered important in defining a qualifying importer. The regulations would require that the importer a) imports products with product specifications consistent with Moroccan standards; b) has the capabilities and infrastructure to handle petroleum products; c) has port facilities capable of handling petroleum products and d) maintains a defined level of strategic storage of the imported product. The Bank agrees with these requirements contingent on the final definition of the qualifying importer, which should be sufficient to safeguard the safe operations of petroleum product imports into the country, while at the same time not being excessively restrictive and resulting in an import monopoly. 2.40 Morocco has special agreements with a number of Middle East and North African countries on the preferential duty-free import of crude oil and petroleum products. In complying with the new law governing exterior trade, and the optimum operation of the refining subsector, it is recommended that the tariffs for crude oil and products be made identical regardless of origin. B. Strategic Measures 2.41 The seminar proposed the elimination of the current import licensing restrictions on the import of petroleum products as a means of eliminating the domestic refiner's effective import monopoly in line with the new law; and the establishment of a differential tariff system between crude oil and products for a transitionary period, and subsequent decontrol of imports and prices. The Bank suggests that if this route is taken that all non-tariff restrictions on the import of crude oil or petroleum products be eliminated; and that the differential tariff imposed on petroleum products at that time be progressively decreased during the duration of the transition period. I 2.42 A five year transition period was proposed to allow the domestic refineries to adapt to a competitive unprotected environment resulting from the eventual decontrol of petroleum imports and prices. The Bank recommends limiting the transition period to three years, a period having proved to be adequate to make the transition in other countries. 2.43 The seminar recommended that the domestic refineries be allowed and encouraged to integrate their operations vertically upstream into oil exploration and downstream in marketing and distribution. 2.44 The seminar proposed that a new regulatory body be established to regulate the petroleum distribution industry once the remaining portions of SNPP are privatized. This proposed regulatory body could be an independent agency; or operate within the SNPP structure. The Bank questions the need for such an additional regulatory body; and whether the continued oversight of petroleum distribution would not be better handled under the existing MEM structure. Furthermore, the need to decontrol distribution and marketing margins should be addressed. 2.45 The regulation of LPG imports storage and distribution is considered to be separate from the other petroleum products due to the special position of LPG as a subsidized fuel in the Moroccan market. The Bank suggests that after petroleum product decontrol that the - 40 - GPL trade should be treated identically to all other products. If any subsidy is deemed necessary then it should come directly from the Treasury and go to the benefit of the ultimate consumer. RECENT DEVELOPMENTS 2.46 The Government objective is to arrive at the complete decontrol of the petroleum sector and thus ensure the optimizaiton of the petroleum market supply. The privatization of the SAMIR refinery is considered within this global context. The object is to open the sector to private investors, both national and international. 2.47 The following measures have been taken: privatization of SNPP's distribution companies; implementation of the indexation of petroleum product prices and the related fiscal reforms (January 1, 1995); Government's decision to privatize SAMIR. - 41 - m. THE NATURAL GAS SECTOR INTRODLCTION 3.1 Morocco will soon embark on a new energy era with the completion of the Maghreb European Gasoduc (North Africa Gas Pipeline). Because the pipeline from Algeria to Europe transits through Morocco, the country will be able to purchase gas on a commercial basis from Sonatrach. The introduction of natural gas into the economy will help achieve broader economic goals, including increasing the competitiveness of domestic industries, stimulate economic growth and attract foreign investment. 3.2 To maximize the benefits to the energy sector and the economy, key issues must be addressed. They include institutional decisions on the structure of the industry as well as the legal framework and creation of a regulatory authority to oversee the industry. Care must be taken to prevent the abuse of monopoly power and protect the interests of all parties, including investors as well as consumers. Commercial gas purchase contracts, rules on access to the pipelines, pricing and tariff mechanisms have to be decided and implemented. The Government needs to develop and continually revise market strategies to enable the economic expansion of the pipeline system and increased use of gas by the electric power utilities in order that they become more cost efficient and environmentally sound with the reduction of harmful emissions caused by fuels that are not as clean burning as natural gas. The World Bank, through its loan and technical assistance programs, is assisting the Government to address these issues. ISSUES AND OPTIONS FOR THE DEVELOPMENT OF NATURAL GAS A. Global Approach to a New Energy Policy 3.3 The introduction of large quantities of natural gas into Morocco will introduce major structural changes in the country's energy sector. It implies inter-fuel substitution and increased inter-fuel competition. It brings more flexibility, less pollution, regulation of the industry, and new forms of organization. Therefore, the introduction of natural gas into the economy must be planned carefully, taking into account natural gas' characteristics and the role that this new energy source will play in the national energy policy. Characteristics of Natural Gas 3.4 Natural gas is a primary energy resource which has very unique characteristics: it is close to oil at the upstream level because exploration activity and risks are similar; it is close to power at the downstream level because a fixed link or a dedicated line is needed to transport the gas from the field to the final users. Natural gas' characteristics may be summarized as follows: * Gas has relatively low energy density but high volatility. As a consequence, gas must be transported by pipelines (LNG is an exception). - 42 - Western European energy transportation costs (by large pipeline or high-voltage cables) are as follows: Gas is more expensive than oil by a factor of five to ten. * Electricity is more expensive than gas by a factor of about ten. * Gas transportation has large economies-of-scale. * The share of transportation/distribution costs to the gas end-user in overall supply costs is large. * Storage costs of natural gas are high and are economic only for medium and large volumes, except in specific cases. * Environmental and efficiency advantages can be realized in burning gas, compared with oil products and coal. Gas is particularly efficient in terms of power generation. * Nevertheless, gas can often be substituted by other fuels at costs that may be higher but not prohibitive. Gas is not an indispensable fuel. Natural Gas and Enerzy Policy in Morocco 3.5 The development of natural gas, as a new energy source in Morocco, appears to be consistent with the national energy policy aimed at (i) least cost energy supply, (ii) encouraging the most economic inter-fuel substitutions (iii) mobilizing the domestic resources (transit fee gas can be considered as a domestic resource), (iv) enhancing efficiency in energy consumption. 3.6 Beyond these goals, the energy future of Morocco as in many countries, is marked by a number of uncertainties: the economic cost of new energy technologies, (for example shale oil, which exist in large quantities in Morocco, and clean coal technologies), the world price of energy fuels in terms of level, trends, and stability, the expected level of energy consumption, the potential for domestic discoveries of oil and gas, and environmental constraints. 3.7 In the process of defining an energy policy, meeting these goals and challenging these uncertainties, the introduction of a new source of energy such as natural gas, offers a number of advantages: * Allow more diversity in the energy balance, i.e. less dependency on each fuel and less vulnerability to uncertainties. Introduce more flexibility due to inter-fuel substitution options which may be modified as necessary in the future. - 43 - Improve energy efficiency through the implementation of technologies such as gas turbines, combined cycles and combined heat and power production (CHP)or co-generation. These new technologies, coupled with a demand-sided management which can reduce the additional power capacity requirements under a traditional approach thereby reducing substantially the financial resource requirements. Indicate increased commitment of the country to protect and improve the environment. * Foster economic development by attracting investment in industries that need a reliable and fairly priced source of energy. * Stimulate job creation in the new natural gas industry The Organization of Natural Gas Monopolies 3.8 The transmission and distribution of natural gas are generally considered as natural monopolies in a given area, subject to various forms of regulations. Gas transmission over long distance necessitates large investments and a natural monopoly stems from the fact that no more than one (or a few) transmission lines can be economically justified. A number of countries have given a national monopoly over the transmission business, while other countries have granted concessions to a number of companies (Table 2). Generally a geographic monopoly (sometimes for the entire country) is granted to gas distribution companies. This monopoly covers all gas sales, with the exception of some specified consumers (e.g. power plants). Natural monopolies call for Government regulation in order to: Protect investors against the occurrence of competing investments and assume adequate compensation for their investments, Protect consumers against discrimination, abuse of monopoly power, and predatory practices. * Ensure the public interest in terms of safety and stability of supply. 3.9 Various models for the organization of the gas industry have been set up in different countries (Table 2). Among these different models, not one has proven to be the most efficient. Today, in both developed and developing countries, including east Europe - the gas sectors are undergoing great structural changes. The main trends of evolution are (i) the increasing role of the private sector and private investors, (ii) changes in regulation to promote more competition and more efficiency, (iii) challenging legal monopolies over imports/exports and transmission, (iv) emergence of open access procedures to transmission networks (v) changes in regulation to encourage independent power production and cogeneration, (vi) increased attention to gas value at the burner's tip, inter-fuel substitution, gas-to-gas competition and the resulting level of prices, (vii) emphasize on demand side management, and (viii) environmental considerations. - 44 - Table 3.1 FORMS OF ORGANIZATION OF THE GAS INDUSTRY A) STATE OWNERSHIP BELGIUM DISTRIGAZ, 50 % State owned, has a monopoly over transmission, imports and exports. Distribution by local companies. DENMARK DONG, a State owned company, has a monopoly over transmission, imports and exports. Distribution by 5 municipal companies. Regulation by the Danish Parliament. FRANCE GAZ de FRANCE, a State owned company, has a monopoly over imports, 85% of the gas transmission business, 95% of the gas distribution (Joint distribution of gas and electricity with EDF). Regulation by the Ministry of Industry (Tutelle) through a Contrat d'Objectif which includes an efficiency factor (close to the British formula). GREECE DEPA, a State owned company, has a monopoly over imports and transmission. Distribution by municipal companies. Control of tariffs by the Government. IRELAND BOARD GAS EIREEN (BGE) a State owned company has a monopoly over imports and transmission. Distribution by local companies controlled by BGE. Control of tariffs by the Government. ITALY SNAM, a State owned company of ENI group has monopoly over imports, exports and transmission. 55% of gas distributipn by ITALGAS (controlled by SNAM). Local distribution companies. SPAIN ENAGAS, a State owned company, has a monopoly over imports and exports and a dominant position in transmission. Gas distribution is made by ENAGAS or affiliates (55% of the market) and by local companies. Control of tariffs by the Government. B) PRIVATE OWNERSHIP GERMANY Production of natural gas by oil companies. Imports and transmission by private transmission companies: RUHRGAS (57% of imports) THYSSENGAS, VEW, BEB, VNG. Most of the distribution by municipal companies. No price controls. Regulation through the Federal Cartel Office. UNITED KINGDOM BRITISH GAS, created as a State owned vertically integrated monopoly, was privatized in 1986. BGC keeps a dominant position in transmission (with open access) distribution and sales of appliances. Regulation by an independent authority (Ofgas) and through retail prices index. UNITED STATES More than 7 000 companies are involved in the natural gas business. Most of them are private. A few of them are vertically integrated (Columbia Gas System, ENRON, Consolidated Natural Gas). Federal and State regulatory bodies introduced in the 80's price deregulation with a very competitive situation including direct sales and open access. - 45 - 3.10 Regardless of the organizational model, some form of regulation covering the major elements gas activity is required (granting of the pipeline, authorizations, conditions of access to the network, and tariffs and pricing principles). Among these issues, price regulation is a major element to check monopoly power. 3.11 Three major types of price regulation of natural monopolies are found. Sometimes they are combined: Price cap regulation is a regulatory system aimed at encouraging efficiency and technical progress and reducing costs. An example is given by the formula implemented in the UK in 1987, with the privatization of British Gas, which links gas tariffs to the cost of gas supply but also to an efficiency factor (X), negotiated between the regulator and the company. The price must increase less than the Retail Price Index (RPI -X formula) if the cost of supply is constant. In other countries, price monitoring with an agreement on costs that may be included in the rate base is frequently used. * Rate of return regulation limits the profit of the company to a "fair rate of return" computed on value of assets or on equity. The objective of the system is also to avoid monopoly profits but its basic default is to encourage over- investment and inefficiency unless costs are strictly monitored. * Obiective contracts are most frequently (but not exclusively) signed between State-owned companies and their shareholder (The State). On a negotiated basis, they tend to formalize, over a period of 3 to 5 years, major objectives in terms of performances, investments, employment, tariffs, and financial structure of the industry or company. * Regulation of natural monopolies is ensured either by the Government (representing the State interest) or by an independent entity which is given regulatory power. Each of these types of regulation have their own costs, advantages and disadvantages. In theory, price cap regulation is the most efficient but its implementation and operation is not easy. In the case of Morocco, regulation of the gas industry will be ensured by the Government. The form of price regulation to be adopted has not yet been decided. Major Requirements for the Development of Natural Gas 3.12 The experiences of various countries demonstrate that some factors determine the successful introduction and the gradual development of natural gas as a new energy source: The political willingness to develop gas is the key element, because a number of decisions have to be made concerning the organization of industry, the role of present and potential participants, and the implication of gas development for the rest of the economy. A gas market study which reviews systematically potential markets for gas and assesses the range of costs which would be acceptable to major groups of consumers. In most cases, a large base load, such as power production, is - 46 - needed to justify the pipeline and infrastructure investment (Portugal, Thailand, Malaysia). The existence of well defined "rules of the game" which provides the gas industry with the technical, legal, economic and financial regulations. These rules may be defined within a Gas Code or by individual statutes. Their purpose is to establish the initial rules but also to take into account new developments such as local gas discoveries, new sources of supply and new markets. Having well defined rules of the game is a prerequisite for attracting private investments. 3.13 In the case of Morocco, the political willingness to develop gas as a new fuel, has been clearly demonstrated. A gas market study and the legal framework for the natural gas industry are presently under review. B. The Supply of Natural Gas in Morocco Transit Fees 3.14 According to the Record of the meeting of the Moroccan and Spanish Energy Ministers, April 30, 1991 (Proces Verbal de la r6union des Ministres Marocain et Espagnol charges de l'energie du 30 avril 1991), the transit fee which has to be paid to Morocco represents a fair compensation for the constraints imposed by the pipeline and reasonable profit sharing. In the spirit of proces verbal, this transit fee represents compensation for a favorable fiscal regime given to the companies, Moroccan and foreign, involved in the construction and the operation of the pipeline. l 3.15 Several important issues concerning this transit fee have to be clarified. The decision-making process between cash and payment in-kind has not yet been agreed upon (to the World Bank's knowledge). Several elements must be taken into consideration: The results of the Gas Development Plan Phase 2 will show the volume of gas needed for the domestic market and the expected build-up of the market. One possibility would be to utilize the gas earned as the transit fee for the build-up of the market until additional volumes are required. This gas can be considered equivalent to domestic energy resource but it is not free. It belongs to the Moroccan State and must be paid by the user to the Treasury at a price which covers its opportunity cost. * If the fee is taken in-kind, the question of transit cost has to be settled. As agreed at the ministerial meeting, transit is free for the royalty gas, if gas is taken from the GME, not further than the Fes-Meknes area. Since the meeting, the initial route has changed. The place of off-take will be west of Meknes. Therefore, transit costs must be clarified. The Moroccan Treasury should examine carefully how it may maximize its take by shifting between payment in-kind and cash. This decision is based upon a comparison between the value of the transit fee and the market value of the gas on the Moroccan market. The process involves: the Moroccan Treasury (who - 47 - owns the gas); ENAGAS, who may propose to buy the gas; SODUGAZ, who may buy the gas but not be obliged to take it; and end-users. The decision should be directly related to the degree of flexibility which is given to Morocco to take cash or in-kind payment but may be limited by the technical rigidity of the end-users or by the commercial rigidity of SODUGAZ.I If the Moroccan Government wishes to keep the possibility of choosing the method of payment between kind and cash, and if a commercial contract is needed for the domestic market, the negotiation of this commercial contract must take into account the agreed conditions on which payment is decided. Conflicting interests may arise between the purchaser of commercial gas (SODUGAZ) and the Moroccan State. Commercial Contract of Gas Supply with Algeria 3.16 The Gas Development Plan Phase 2 has established the volume of gas which can be used by the Moroccan market with the appropriate build up of the market. The mission's recommendation is that a commercial contract with Algeria should be negotiated once the results of the study are known. 3.17 A gas contract is the result of a negotiation whereby each party is legally committed and bound by the terms and conditions of the contract. The main elements of a long- term gas contract are: 3.18 In the negotiation of a commercial gas purchase contract with Algeria, the following elements must be considered: It had been postulated that the contract would be signed before December 31, 1993, but this posed too much of a time constraint to clarify and reach agreement on the elements. A delay is recommended. It is important to keep in mind that the projected combined cycle can be perfectly started with the royalty gas as a fuel. * In the price negotiations, special attention must be given to the competition and inter-fuel substitution in the Moroccan market. If industrial boilers are converted from fuel oil to natural gas, they may remain technically flexible to burn both fuels. Initial contractual price, index clause, price revision and flexibility must be taken into account. In other words, the commercial terms, including the possibility of interruptible volumes, must accommodate both the buyer's and seller's needs. The Algerian contract is the first link of a series of contractual arrangements. To sign a gas purchase contract (with take-or pay provisions) with SONATRACH, The experience of Tunisia on this matter is interesting. By excersising its flexibility to shift from cash to in-kind payment, the country is making substantial cost savings because over 80% of its installed power generation capacity may use natural gas or fuel oil, and the flexibility allowed enables a rapid switch to the cheapest fuel. - 48 - the purchaser (SODUGAZ or another company) must have a contract with the transmission company (EMPL) and a take or pay contract with the principal customer (s). The owners of the combined cycle plant must have a contract concerning the sale of power to ONE. Since private capital is involved, all these contractual arrangements have to be clearly stated and will require review by financial authorities. The mission emphasizes the necessity of setting out the guidelines for resolution of these problems for negotiation. All of these intricate elements will reveal conflicting interests between project participants: EMPL, SODUGAZ, ONE and other potential users, as well as private investors, national and foreign, and the Government. Arbitration at the highest level might be needed to reinforce the stated political willingness to develop gas. Table 3.2 MAIN ELEMENTS FOR A LONG TERM GAS CONTRACT PARTNERS Balance of interests between the partners Financial and technical capability of the partners to carry out the deal RULES FOR HANDLING THE CONTRACT Start and duration of the contract Changing the rules of the contract Interpretation of the contract (definition, language, applicable law) Dispute settlement VOLUMES Seller's commitment to making supply available Buyer's commitment to take the gas AnnualVQuarterly/Monthly/Daily Volume Flexibility - Nominations Process Take-or-Pay obligations Make up provisions Force majeure PRICE Determination of initial price Review of price formula or price index Payment terms Default penalties Source: World Bank (ESMAP. Long Term Gas Contracts Principles and Application. Report N
Группа Всемирного банка · ESMAP Paper
Morocco - Energy sector institutional development study
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