Ukraine - Kiev Public Buildings Energy Efficiency Project

Document of The World Bank Report No.: 19959 UA PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF US$ 18.29 MILLION TO UKRAINE FOR A KIEV PUBLIC BUILDINGS ENERGY EFFICIENCY PROJECT December 28, 1999 Energy Departrnent Europe and Central Asia Region  CURRENCY EQUIVALENTS Currency unit = hrivnya, abbr. UAH (from September 2, 1996) US$1 = 4.5 hrivnyas (as of November 1999) FISCAL YEAR January 1-December 31 ABBREVIATIONS AND ACRONYMS B/C Benefit to Cost CAS Country Assistance Strategy CO2 Carbon Dioxide DH District Heating EBRD European Bank for Reconstruction and Development ERR Economic Rate of Return ESCO Energy Service Company ESMAP Energy Sector Management Assistance Program FRR Financial rate of Return GDP Gross Domestic Product GPN General Procurement Notice HMSAP Housing and Municipal Service Allowance Program ICB International Competitive Bidding ICR Implementation Completion Report LPG Liquified Petroleum Gas NCB National Competitive Bidding NO, Nitride Oxides NPV Net Present Value PIU Project Implementation Unit SOE Statement of Expenditure VAT Value-Added Tax Vice President: Mr. Johannes Linn, ECAVP (Acting) Country Director: Ms. Lily Chu, ECCI1I Energy Director: Mr. Hossein Razavi, ECSEG Task Team Leader: Ms. Carolyn Gochenour, ECSEG  UKRAINE Kiev Public Buildings Energy Efficiency Project TABLE OF CONTENTS Page No. A. Project Development Objective 2 1. Project development objective and key performance indicators 2 B. Strategic Context 3 1. Sector-related CAS goal supported by the project 3 2. Main sector issues and Government strategy 3 3. Sector issues to be addressed by the project and strategic choices 5 C. Project Description Summary 7 1. Project components 7 2. Key policy and institutional reforms supported by the project 7 3. Benefits and target population 7 4. Institutional and implementation arrangements 8 D. Project Rationale 13 1. Project alternatives considered and reasons for rejection 13 2. Major related projects financed by the Bank and/or other development agencies 13 3. Lessons learned and reflected in proposed project design 14 4. Indications of borrower commitment and ownership 15 5. Value added of Bank support in this project 15 E. Summary Project Analyses 16 1. Economic 16 2. Financial 18 3. Technical 20 4. Institutional 20 5. Social 21 6. Environmental assessment 22 7. Participatory approach 22 F. Sustainability and Risks 24 1. Sustainability 24 2. Critical risks 25 3. Possible controversial aspects 25  G. Main Loant Conditions 26 1. Effectiveness conditions 26 2. Conditions for negotiations 26 3. Agreements to be reached during negotiations 26 H. Readiness for Implementation 27 I. Compliance with Bank Policies 27 Annexes Annex 1. Project Design Summary 28 Annex 2. Project Description 29 Annex 3. Estimated Project Costs 31 Annex 4. Cost Benefit Analysis Summary 32 Annex 5. Financial Summary and Assumptions for the Financial Analysis 37 Annex 6. Procurement and Disbursement Arrangements 40 Table A. Project Costs by Procurement Arrangements 41 Table Al. Procurement Arrangements and Time Schedule 42 Table B. Thresholds for Procurement Methods and Prior Review 43 Table C. Allocation of Loan Proceeds 45 Annex 7. Project Processing Budget and Schedule 46 Annex 8. Documents in Project File 47 Annex 9. Social Assessment 48 Annex 10. Statement of Loans and Credits 53 Annex 11. Country at a Glance 54 Map IBRD 30087  Page 1 UKRAINE Kiev Public Buildings Energy Efficiency Project Project Appraisal Document Europe and Central Asia Region Date: December 28, 1999 Task Team Leader: Carolyn Gochenour (Acting) Country Director: Ms. Lily Chu Sector Director: Hossein Razavi Project ID: UA-PE-55739 Program Objective Category: EN Sector: Energy Lending Instrument: SIL Program of Targeted [ ] Yes [X] No Intervention: Project Financing Data [X] Loan [ Credit [ Guarantee [] Other [Specify] For Loans/Credits/Others: Amount (US$m): 18.29 Proposed terms: [] Multi-currency [X] Single currency, specify: US dollar Grace period (years): 6 [] Standard [ ] Fixed [XI LIBOR-based Variable Years to maturity: 18 Commitment fee: 0.75% of which 0.5% is waived Front end fee: 1% Financing plan (US$ m): Source: Local Foreign Total World Bank 4.1 14.2 18.3 Kiev City State Administration 10.0 0.1 10.1 Swedish Government 2.0 2.0 .~~~~3. Total 14.1 16.3 30.4 Borrower: Ukraine Responsible agency: Kiev City State Administration Estimated disbursements 2000 2001 2002 2003 2004 (Bank FY/US$M): Annual 0.3 4.4 4.4 4.5 4.6 Cumulative 0.3 4.7 9.2 13.7 18.3 Project implementation period: 2000-2004 Expected effectiveness date: April 30, 2000 Expected closing date: June 30, 2005  Page 2 A: Project Development Objective 1. Project development objective and key performance indicators (See Annex 1): The proposed Kiev Public Buildings Energy Efficiency Project is designed to support the Government's Comprehensive State Energy Conservation Program announced in August 1996. The Program aims at achieving an annual savings by the year 2010 of about 109 million tons of coal equivalent or about one third of total energy consumption of Ukraine in 1996 through targeted investments. The energy conservation potential is expected to be achievable in relative terms from the following sectors over the period: manufacturing - 57%, power industry - 21%, public services and utilities - 12%, transport - 7% and agriculture - 3%. Within the public services and utilities sector, a number of measures have been identified to improve energy efficiency in public buildings which consume far more energy for heating and hot water than public buildings in Western Europe. This is primarily due to the low quality of construction materials, poor insulation, types of windows, and absence of measurement and control equipment for heating substations in buildings. The main measures to improve energy use in the building sector include the introduction of automation and control systems complemented with energy efficiency measures inside buildings, including heat meters. The energy savings potential from such measures has been estimated to be as high as 45% in buildings once retrofitted. This first energy efficiency project in Kiev would improve energy use in key public buildings owned by Kiev City State Administration through cost-effective measures. About 1,302 buildings, with a floor space of about 5.1 million m2, would be retrofitted under the project. The proposed project would build upon policy reforms already implemented in Kiev during the preparation of the recently-approved, Bank- supported Kiev District Heating Improvement Project to allow for heat tariff setting at cost-recovery levels in order to provide the proper economic signals to consumers to conserve energy as well as upon reforms to improve the billing and collection of heat bills. The key development objective of the proposed project is therefore to improve the energy efficiency of key public buildings in Kiev through a package of technical improvements and sound heat tariff policies. The project is expected to encourage the development of an energy efficiency market and related service industry, capable of supplying and installing energy efficiency projects in Kiev with the potential to serve other areas of Ukraine in the future. The project would further promote public awareness of the need for more efficient use of energy in Kiev. The key project performance indicators, as shown in Annex 1, include: (a) number and square meters of buildings retrofitted; (b) building energy savings after retrofit ( Gcal and US dollars); (c) heat tariffs; (d) settlement of the remaining balance of arrears of heating bills according to the restructured target for 2000; and (e) settlement of annual heating bills of project buildings.  Page 3 B: Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project (see Annex 1): CAS document number: R98-39[Rev.] Date of latest CAS discussion: May 21, 1998 The sector-related goal stated in the CAS is to support the restructuring of the public sector through more commercial practices based on cost-recovery tariffs and greater efficiency, leading to the possibility for private sector development. 2. Main sector issues and Government strategy: Sector Issues Energy demand in Ukraine is characterized by high energy intensity of industrial output and the high share of industry in final energy consumption. Energy intensity of official GDP increased 50% in the 1991-98 period reaching 3.1 kilogram oil equivalent/US$, a ratio that is several times higher than in developed countries. Energy consumption per capita was about 2,600 kilogram oil equivalent (koe) in 1998, which is high compared to Western European standards. Ukraine is heavily dependent on high-cost imported fuels. While Ukraine has vast coal resources, important oil and gas resources and significant hydro, wood, peat and uranium resources, domestic energy production, consisting of fossil fuels and primary electricity, represented only 45-50% of consumption in the 1990-98 period, with 50-55% of energy consumption based on imported fuels. The main energy import items include crude oil and oil products mostly from Russia, natural gas from Russia and Turkmenistan and coal from Russia and Poland. The cost of fossil fuel imports reached about US$ 6.2 billion in 1993 and increased to US$ 7.5 billion in 1995 and to US$ 8.7 billion in 1996, creating a demand for foreign exchange that the economy was unable to meet. The difference was financed by payment arrears to Russia and Turkinenistan (the arrears were subsequently converted to debt) and balance-of- payment support from the IMF and the World Bank. The cost of fossil fuel imports decreased to about US$ 7.6 billion in 1997 and to about US$ 6.0 billion in 1998, mainly as a result of the decrease in imports of gas and petroleum products. Fuel prices have increased dramatically since 1991 and now approximate world market levels. The prices of natural gas and crude oil reached levels of $80/1,000 m3 and $106/ton, respectively, during 1996 (but have reduced somewhat during 1998-99), resulting in higher prices for essential services, especially electricity and heat. Electricity, gas and coal prices are set by the central government, while district heating (DH), LPG, heating oil, peat and wood prices are set by local governments. Household energy prices cover 50-80% of costs, with household DH prices, outside of Kiev, currently covering 80% of costs but are expected to cover 100% of costs in the near future. The difference between costs and prices is covered by subsidies from the central and local govermments and/or by cross-subsidies from industrial to household consumers (particularly for DH). In Kiev, DH prices currently cover costs. Non-payment by customers became a major problem for electricity, gas and heat suppliers in 1994-95. A number of government resolutions were issued since 1996, calling for businesses which fail to pay their electricity bills to have their power supply cut off. Earlier in February 1995, the Government introduced the Housing and Municipal Service Allowance Program (HMSAP), which allows families whose monthly payments for housing, water and sewerage, hot water, heating and other municipal services that exceed 15% of monthly income to apply for an allowance equal to the difference. Despite HMSAP, payment discipline in the household sector remains poor as also is the case for the agriculture and budgetary sectors. However, a Government initiative was undertaken during 1997 that now requires budgetary organizations to restructure past debts for utility services over a five-year period 1998-2002 and to implement line-item budgeting for utility services to better ensure payment of future bills. Kiev City has complied with this initiative and formally agreed on a restructuring plan of its past debts for heat,  Page 4 electricity, natural gas, water supply and sewerage and has ensured the timely payment of new utility bills, including heat. Sector Institutions The main government agencies in the sector are the Ministry of Coal Industry, the Ministry of Energy that govems the electricity, oil and gas subsectors, and the State Committee for Energy Conservation, recently subordinated to the Ministry of Energy. The State Committee for Housing and Communal Services also plays a role in overseeing municipal-owned DH enterprises, which are regulated by their municipal owners. In 1994-95. the Government implemented a corporatization program in the oil, gas and power subsectors, with the long-term objective of privatizing most of the assets and activities except those that are considered of strategic importance. The Cabinet of Ministers also has approved a privatization plan of state-owned, joint-stock energy generating and distribution companies, whereby investment competitions could be conducted after passage of a law regulating investors' activities. The corporatization program of the coal industry was started in 1996, parallel with a program to close uneconomic mines. Energy Sector Strategy The "Concept for tlhe Development of the Energy Sector of Ukraine for the Period up to 2010," prepared in 1993, spelled out the following main directions for Ukraine's long-term energy strategy: (a) the development and implementation of a policy that promotes energy savings; (b) economically and environmentally justified utilization of domestic energy sources; (c) restructuring of the economy to reduce the energy intensity of production; and (d) increasing reliance on alternative (renewable) energy sources. In early 1994, the Parliament passed a Law on Energy Conservation, providing economic incentives for investments in energy conservation. Specifically, it calls for the establishment of national and local extra- budgetary funds, based on special taxes on coal and on penalties for inefficient energy use by industrial enterprises, to support energy savings initiatives. In order to prepare the necessary regulations and to coordinate the implementation of the Law, a State Committee for Energy Conservation was established in July 1995. A long-term Comprehensive State Energy Conservation Program was announced in August 1996. As highlighted in the Conservation Program, the main impediment to implementation of the Energy Conservation Program is the lack of investment funds. In mid- 1995, the Govemment prepared and submitted to the Parliament the "National Energy Program of Ukraine up to 2010." The "Program" was approved by the Parliament in early 1996 and follows the main directions established in the "Concept." Bank Involvement in Ukraine's Energy Sector The Bank has been involved in the Ukrainian energy sector since early 1992. An Energy Sector Review (Report No. 11646-UA) was issued in 1993, leading to an Energy Strategy Conference held in Kiev in June 1993. During the Conference, an understanding was reached that the Bank's lending operations should aim primarily at the rehabilitation of existing assets rather than construction of new facilities where existing capacity is sufficient, while supporting initiatives that increase the financial and operating autonomy of enterprises and foster competition. After the Conference, the Govemment, assisted by the Bank and other multi- and bilateral agencies, started the preparation of a number of projects. Energy efficiency and district heating investments were added to the agenda in 1995. The Bank is currently supporting a number of operations, including a Hydropower Rehabilitation and System Control Project (Ln. 3865-UA), a Coal Pilot Project (Ln. 4016-UA), a Coal Sector Adjustment Loan (Ln. 4118-UA), and a Kiev District Heating Improvement Project (Ln. 4324-UA).  Page 5 3. Sector issues to be addressed by the project and strategic choices: The proposed Kiev Public Buildings Energy Efficiency Project aims at addressing the sector issues by: (a) supporting the implementation of a policy that promotes energy savings and reduces the demand for high-cost energy imports, (b) facilitating the implementation of measures within the public services to improve energy efficiency in heating systems, such as introduction of automation and control systems at consumers and energy efficiency measures inside buildings, (c) supporting cost-recovery tariffs and improving payment discipline of energy bills by the municipal budgetary sector; and (d) providing investment funds, the lack of which has been highlighted as the main impediment to implementation of energy efficiency measures. In shaping the strategy which underpins the investment program, the project considered a number of strategic choices related to location, type, ownership and coverage of buildings, number and type of energy efficiency measures and implementation approach: (a) Location. Ukraine has decided to undertake this first Bank-supported energy efficiency project in the capital city of Kiev, in order to reduce energy use in the nation's capital in large public users of district heating, thereby supporting a package of demand side measures to complement the supply side measures in district heating boiler houses and networks under the Bank-financed Kiev District Heating Improvement Project, initiated during early 1999. (b) Industrial, residential or public buildings. Ukraine has decided to direct investments under this first project to key public sector buildings rather than focus on industrial or residential buildings. Industrial buildings are being addressed under the complementary EBRD-supported UkrEsco Project, already approved by EBRD's Board and which is in process of being initiated, and EBRD has a comparative advantage in addressing investment projects in the industrial sector. Ukraine has decided not to include residential buildings in this project, given the slow experience to-date in implementing residential energy efficiency projects in other countries in Eastern and Central Europe which involves investments in a large number of smaller buildings as well as issues related to privatization of buildings, formation of building management organizations, establishment of credit lines and affordability by households. The types of public sector buildings in the program would include schools, hospitals, kindergartens, cultural centers and administration buildings. (c) Ownership of buildings. Ukraine has decided to include public buildings in the project that are under the ownership of the City of Kiev but not to include state-owned public buildings located in Kiev, given the current difficulty in identifying adequate counterpart funds in the state budget. Kiev City State Administration has been judged to have the capability and has confirmed its intention.to provide counterpart funds for its public buildings to be included in the project. (d) Coverage of buildings. Ukraine has decided that the investment program be based on 100% coverage of all schools, kindergartens, hospitals, cultural centers and administration buildings in Kiev under the ownership of Kiev City. Kiev City has confirmed that all public buildings are expected to continue to operate in the future and is already adding buildings to this stock.  Page 6 (e) Energy efficiency measures. Ukraine has evaluated 46 possible retrofit measures and selected 9 measures which were estimated to provide high economic rates of return and could be implemented quickly and easily. The following cost-effective measures have been selected as the highest priority for implementation: (a) building heat meters; (b) substation automation; (c) weather-stripping; (d) radiator reflectors; (e) ceiling fans; (f) faucet flow restrictors; (g) low-flow shower heads; (h) hot water heat exchangers; and (i) riser balancing valves. All buildings would be equipped with heat meters and new substations in order to adequately measure and react to the various retrofit measures undertaken. Without new substations, energy savings measures will only result in overheating of the buildings. Additional energy saving measures would be selected after individual building energy audits are undertaken on the basis of specific building needs and characteristics from among the remaining 7 retrofit measures. Other energy-saving measures would be considered for inclusion during implementation if circumstances change such that these other measures are shown to be economically justified. (f) Implementation approach Ukraine has decided to employ a phased approach to implementation, with installation of equipment and measures to be carried out initially in a limited number of buildings which would allow for the identification and adjustment for necessary modifications in subsequent phases. The initial phase would also establish the scheduling, technical audit, physical installation and acceptance processes which would be utilized in the larger subsequent phases. The first year's investment program would include retrofits of about 30 buildings and about 50 heat meters inunretrofitted buildings. When implementation capacity has been sufficiently developed, the annual amount of retrofits is expected to increase to about 300 buildings per year over the remaining four years of the project.  Page 7 C: Project Description Summary 1. Project components (see Annex 2for a detailed description and Annex 3for a detailed cost breakdown): Component Category Cost (US$M) % of Bank- % of Total financing Bank- (US$M) financing Energy Efficiency Improvements in Physical 21.9 72.0 18.0 82 Buildings, excluding Heat Meters Heat Meters Physical 4.3 14.2 0 0 Technical Audits and Design Project 1.9 6.3 0 0 management Institutional Support: Implementation Support Project 1.7 5.5 0 0 management Public Awareness Campaign Other 0.1 0.4 0 0 Training and Equipment Institution 0.1 0.3 0 0 building Kiev Social Assistance Support Institution 0.1 0.3 0 0 building Financial Audits Other 0.1 0.3 0.1 100 Front-End Fee Other 0.2 0.6 0.2 100 Total 30.4 100.0 18.3 60 2. Key policy and institutional reforms supported by the project: The project builds on the existing policy framework, which, in Kiev, has already moved towards full recovery of the costs of heating and hot water services to ensure proper signals to energy consumers, thereby encouraging energy conservation. Maintenance of cost-recovery heat and hot water tariffs is a requirement under the complementary Bank-supported Kiev District Heating Improvement Projectand would be reinforced under this project. Proper billing and payment discipline would be further supported through the Kiev District Heating Improvement Project which would provide heat meters to heat consumers and support billing of heat and hot water services based on meter readings instead of being based on norms. The proposed project would further support improvement of payment discipline of heat and hot water bills through requirements to ensure the elimination of past arrears and timely settlement of future heat bills by Kiev City. In addition, the Bank's new change initiative on reporting requirements and project accounting will strengthen financial management capabilities. 3. Benefits and target population: Benefits. The proposed project would have significant economic, financial and environmental benefits for Ukraine, public building users and Kiev City State Administration from the improved energy efficiency of the public buildings and their heating systems. The increased efficiency in energy use would reduce net energy requirements for the same level of service in the retrofitted buildings. This would reduce fuel imports of gas by about 41 million rn3 and of mazut by about 8,000 tons annually, representing foreign exchange savings for Ukraine of about US$ 2.9 million per year. The improved quality of heat supply would also save users of the buildings from supplementary heating and improve their level of satisfaction. The reduced consumption for the same (or improved) level of service would also mean lower energy bills for paying building owners. Lower fuel consumption would also lower air pollutant emission levels of the order of 259 tons of NO,, 181 tons of SO2 and 66,633 tons of CO2 per year.  Page 8 Additional benefits would occur from the improvement of the service level and reliability of space heating and hot water service in public buildings. A major part of the public buildings are schools and hospitals. Deficient heating and insulation of school buildings creates considerable discomfort in classrooms in winter, increasing sickness rates, and undernines teaching and learning. The causes include deficient insulation of windows, doors and walls, too large windows, inappropriate room temperatures (either too low or too high) in general, and low temperatures in classrooms above basements, on top floors and in building corners. Similar discomfort levels are constraining the provision of health care in polyclinics and hospitals. The energy efficiency improvements are expected to alleviate conditions of underheating that exist due to the current heat production capacity constraints, thereby improving users' comfort and working conditions in the public buildings by raising the overall quality of energy use and by securing sufficient indoor air quality through better control of mechanical air handling units. The energy efficiency program would also have direct and positive employment impacts for retrofit installation work. It is assumed that the ratio of Ukrainian to Westem labor ranges from 5:1 to 8:1, depending on the efficiency measure. While it is not clear to what extent energy retrofit services exist in Kiev, such capabilities are likely to develop. The resulting employment impacts are estimated at 64 full- time equivalents for years 2-5 of the project. It is expected that domestic suppliers and manufacturers of equipment will also develop, but associated employment has not estimated. Target Population. The foreign exchange savings from the project would benefit the general population through an improvement of the Ukrainian economy. The project investments would directly benefit the following groups: (a) children, students and teaching personnel in kindergartens and primary schools; (b) patients, doctors, nurses and other medical personnel in polyclinics and hospitals; (c) employees in hospital administration and support buildings; and (d) visitors and staff in art galleries, museums and theaters. 4. Institutional and implementation arrangements: Institutional Arrangements The Borrower would be Ukraine (represented by the Ministry of Finance) which would on-lend the proceeds of the Bank loan to Kiev City State Administration for public buildings under its jurisdiction. The sub-loan to Kiev City State Administration would be provided with a 12-year maturity (reflecting the period during which sufficient energy savings would be achieved to allow repayment of the sub-loan) including a 5-year grace period on repayment of principal (reflecting the expected implementation period of the project). In accordance with usual practice, the Ministry of Finance would mark-up the on-lending interest rate by up to 1% for its costs of administration. The foreign exchange risk of the sub-loan would be bome directly by Kiev City State Administration.  Page 9 The Bank loan of US$ 18.29 million would cover about 60% of project costs or 72% of project costs net of taxes and duties. Excluding a US$ 2 million grant, amounting to about 7% of project costs net of taxes and duties, to be provided by the Swedish Government, Kiev City State Adrministration would cover the remaining 21% of project costs as well as the taxes (VAT of 20%) and import duties (about 2%). As a condition for negotiations, Kiev City State Administration submitted a plan showing its counterpart contribution to the project cost would be provided from own resources, which are judged to be sufficient for carrying out the Project. The costs of heat meters which Kiev City has been installing in the public buildings included in the project (UAH 14 million) during 1998 and 1999 would be considered as part of its contribution to the project cost. As of October 1, 1999, 613 heat meters have been installed in educational buildings, 70 in health protection institutions and 30 in cultural organizations. Implementation Arrangements A Project Implementation Unit (PIU) would be established within Kiev City State Administration to be responsible for implementing the key project functions including: (a) screening individual buildings and scheduling the priority objects for the first and each subsequent year's programs; (b) developing energy auditing and technical design procedures; (c) contracting suitable organizations to perform energy audits and technical designs; (d) preparing technical specifications and bidding documents; (e) tendering, contract supervision and final inspection; (f) training of building managers in operations and maintenance; (g) disbursement requests, financial management, project accounting and reporting; (h) monitoring and verification of energy savings; (i) conducting a public awareness campaign; and (j) monitoring Kiev City's payment of past and current heat bills. Local consultants and design institutes would be retained by the PIU to assist with the screening, preparation of technical audits and detailed designs, where required. Foreign consultants would assist the PTU during the project period in the areas of project management, technical assessment, procurement, accounting, financial management and disbursements and would, during the initial phases, provide on- the-job training for technical auditors and design consultants. The project would be implemented over the five-year period 2000-2004. Status of Preparation of Energy Audit Procedures, Designs, Technical Specifications and Bidding Documents. Draft energy audit procedures have been designed to screen and select buildings qualified for the installation of measures and to specify the types and quantities of applicable measures in the buildings, including target energy consumption after rehabilitation. The audit procedures would be tested and refined during the initiation phase of the project by performing 10 sample energy audits with the foreign consultants' assistance. The 10 buildings would be selected from a list of 86 buildings, of which 30 buildings are scheduled for the first year's implementation program. Draft design principles have been prepared by the Kiev Research and Design Institute for Residential and Civil Construction (KievZNIIEP). The consultants have prepared 3 typical designs for each of the 7 different sizes of heat substations, which are the key energy efficiency measures to be implemented. These typical designs have been coordinated with the respective authorities to ensure their compatibility with the building code (SNiP), and the designs have been discussed with and approved by the district heating enterprise, Kievenergo. The designs have subsequently been submitted to the Bank for its review and comments. The draft designs are satisfactory to the Bank.  Page 10 Draft typical technical specifications have been developed as part of the feasibility study. Specifications were developed for: radiator reflectors; weatherstripping (3 types); heat substations; low-flow showerheads; faucet flow restrictors; heat meters; hot water heat exchangers and ceiling fans. The draft typical specifications were found to be satisfactory to the Bank. The precise requirements for quantities and sizes of energy efficiency equipment for the 86 buildings included in the first year's program would be determined during the detailed energy audits which would be performed during the initiation phase prior to effectiveness of the Bank loan. After the energy audits are completed, the bidding documents would be prepared. Therefore, as a condition of effectiveness of the Loan, Kiev City State Administration would submit draft bidding documents for the first group (30) of buildings to be addressed by the Project during the first year of implementation. Procurement. Kiev City State Administration has limited experience in international procurement. Its PIU would therefore be assisted by experienced foreign implementation and procurement advisors for at least the first three years of implementation. The building retrofits would be procured under supply and install contracts for the majority of the energy efficiency measures in accordance with World Bank Procurement Guidelines (January 1995, revised January and August 1996 and September 1997). For a smaller share of the energy efficiency measures, mainly during the first two years of the project, the procurement would be implemented by using separate contracts for goods supply and works in order for Kiev City and the contracting industry to gain experience for the more complicated supply and install procurement method that would be used later on. The separate works contracts to be implemented under national competitive bidding procedures would utilize the Bank's regional standardized bidding documents for small works. Local contractors alone or in joint ventures with international firms are likely to win some of these contracts. In the beginning, the PIU will arrange seminars for the participating firms to explain requirements for preparation of bids and procurement procedures. Based on experience in other energy efficiency projects, it is expected that the implementation capacity of the potential local contractors and the willingness of foreign contractors to participate in large contracts would be limited in the beginning. Therefore, the size of the contracts issued, at least in the first years, would not be too large. The number of contracts to be financed by the Bank is estimated to be about 28. The technical audits and retrofit designs, as well as the heat mete:rs, which would be financed by Kiev City out of its own funds, would be procured by the PIU in accordance with Kiev City's procurement procedures. The Public Awareness Campaign and Social Assistance Support consultancies would be procured by the PIU in accordance with the procurement requirements of the Swedish Government. Financial audits, which would be financed by the Bank, would be contracted by using the least-cost selection method (LCS). The procurement arrangements and procurement plan are shown in Annex 6. Disbursement. The proceeds of the Bank loan would be disbursed against: (a) 100% of foreign goods, 100% of local goods (ex-factory), and 80% of other goods obtained locally; (b) 80% of works, (c) 100% of foreign goods, 100% of local goods (ex-factory), 80% of other goods obtained locally, and 80% of works under supply and install contracts; (d) 100% of incremental audits; and (e) 100% of the front-end fee. Kiev City has expressed a preference for disbursement against standard Bank documentation rather than disbursement based on project management reporting on a quarterly basis. Only goods contracts of up to US$ 300,000 equivalent, works contracts of up to US$ 500,000 equivalent, supply and install contracts up to US$ 500,000 equivalent and auditing contracts up to US$ 50,000 equivalent would be made against statements of expenditures (SOE). The supporting documents for these contracts would not be sent to the Bank but would be retained by Kiev City for inspection by visiting Bank missions and by external auditors.  Page 11 In order to ensure the timely provision of funds available to finance small costs of the project, a Special Account in US dollars could be established in a foreign commercial bank by the Ministry of Finance for Kiev City State Administration in the amount of up to US$ 500,000. Funds in the Special Account would be available to finance only eligible expenditures under the project. During the early stage of the project, the initial allocation to the Special Account would be limited to US$ 250,000. However, when the aggregate disbursements under the Loan have reached the level of US$ 5 million, the initial allocation may be increased up to the authorized allocation of US$ 500,000. Replenishment applications should be submitted at least every three months and must include reconciled bank statements as well as other appropriate supporting documents. The minimum size of a disbursement application for direct payment would be 20% of the current deposit to the Special Account (US$ 50,000 or US$ 100,000). During negotiations, agreement was obtained regarding the arrangements for establishing and operating the Special Account. Accounting, Financial Management and Auditing. In order to provide accurate and timely information regarding project sources and uses of funds, the PITU would establish, not later than March 31, 2000, and thereafter maintain a project accounting system, as a separate system from the City's overall accounting system. The PIJ would have full responsibility for project accounting but would work in close cooperation with the City's Finance Department. Project management reports would be designed in accordance with the Bank's new loan administration change initiative (LACI). The project financial statements would be prepared in accordance with international accounting standards and audited by an independent auditor acceptable to the Bank, and the audit report would be submitted to the Bank within six months of the end of the fiscal year. The audit report would also contain a separate opinion on the statement of expenditure (SOE) procedure, when utilized, and on the operation of the Special Account. The format for recording of accounting information for the project financial statements and the internal control system have been discussed and agreed with Kiev City, and the present accounting system, with minor revisions, has been judged to be able to produce the data needed for project accounting. The outcome of the review of Kiev City's financial management systems and the draft format for project financial management reports are included in the Project Implementation Plan. Energy Savings Verification. At present, baseline information on actual energy consumption by each building is not available, since buildings are generally not equipped with heat meters. In addition, heat supply is currently rationed due to inadequate production capacity in Kiev but will be gradually improved during the next 5 years under the upcoming Kiev District Heating Improvement Project. Even if heat consumption were currently being measured, changing energy use patterns would render the present heat consumption figures unsuitable to be used as the baseline for comparison with performance after retrofit measures are installed. Since energy savings cannot be precisely measured, they would rather be estimated during the detailed technical audit of each building based on engineering calculations. The specific building energy consumption calculated during the technical audits would also be compared with the consumption estimated from norms during the feasibility study phase to verify the consultant's assumptions of energy use and benefits. Thus, for each building there will be an energy consumption target. Actual consumption after improvements would be compared with the target as part of the evaluation and verification process. Draft monitoring and verification procedures have been developed during the preparation phase and are described in detail in the Project Implementation Plan. Supervision and Reporting. As this is the first Bank-supported building energy efficiency investment project in Ukraine, a significant supervision effort would be required particularly during the first two years when energy audits and procurement practices would be established and confirmed. Therefore, it is planned that about 15 staff-weeks of effort each year for the first two years and about 12 staff-weeks each year thereafter would required for supervision.  Page 12 The PIU would prepare semi-annual progress reports, with inputs from Kiev City State Administration, which would be submitted to the Bank within 45 days after the end of each semester. The progress reports would include, among other things, information regarding: (a) overall progress of the project, (b) costs for each contract and for the total project, (c) procurement actions, (d) financial performance of the PIU, (e) compliance with covenants under the legal agreements, (f) issues affecting project implementation and (g) performance monitoring indicators. The first progress report covering the period ending December 31, 2000 would be sent to the Bank by February 15, 2001. An outline of the proposed format, including the performance indicators, has been discussed and agreed. The proposed perfornance monitoring indicators are presented in Annex 1 and in the Project Implementation Plan. The Bank would carry out a mid-term review of the project and review the report with the Bank not later than March 31, 2002. In addition to the topics covered under the semi-annual progress reports, the mid- tern review would include an in-depth review of the economic viability of the project components, based on actual costs and benefits achieved to-date, and of the overall institutional and financial viability of the PIU. Based on the outcome of the mid-term review, measures would be taken to ensure the efficient completion of the project. The timing of the mid-term review was agreed during negotiations. An Implementation Completion Report (ICR) would be prepared by the Bank with inputs from the PIU and Kiev City State Administration not later than six months after completion of the project. The ICR would evaluate how well the objectives of the project have been met, the overall performance of the project, the performance of the PIU and lessons learned. During negotiations, agreement was obtained regarding the reporting and monitoring requirements of the project.  Page 13 D: Project Rationale 1. Project alternatives considered and reasons for rejection: In addition to the various energy efficiency measures considered described previously, the project design considered a number of possible altematives for the institutional arrangements for implementing the project, which initially was to include public buildings owned by Kiev City State Administration as well as the Ministries of Health and Education. The alternatives considered included: (a) creatingPIUs within the owning budgetary organizations; (b) creating a new body outside of Kiev City State Administration and the concerned ministries, which could later be transformed into an energy service company (ESCO)- type organization; (c) utilizing the ESCO to be established for the EBRD-supported UkrEsco Project focused on energy efficiency in industrial buildings also for the purposes of this project; (d) creating a body within existing public structures, acting on a contractual basis for Kiev City State Administration and the concerned Ministries; or (e) utilizing the key existing heating utility in Kiev (Kievenergo). After the Ministries of Health and Education dropped out of the project due to difficulties in identifying adequate counterpart funds in the state budget, it was decided to create a PIU within Kiev City as the most straightforward and expeditious way to implement the project. Creating a new public sector organization outside of Kiev City was ruled out as the Government is in process of reducing the size of the public sector and also since it was not possible to secure a grant from the donor community to support a separate public sector organization. The EBRD-supported UkrEsco organization was ruled out as it has not yet effectively commenced its operation and would be focusing on EBRD's requirements initially. Similarly, heating utilities were ruled out as introduction of demand side energy savings measures would reduce their heat sales which would likely generate a low level of interest for successful implementation. 2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned): Sector issue Project Latest Supervision (Form 590) Ratings (Bank-financed projects only) Implementation Development Progress (IP) Objective (DO) Bank-financed Heat production capacity and Ukraine Kiev District Heating S S efficiency of heat supply in Kiev Improvement Project (FY98) Energy efficiency in residential Russia Enterprise Housing S S buildings Divestiture Project Lithuania Energy S S Efficiency/Housing Pilot Project Other development agencies Energy efficiency in industrial Ukraine UkrEsco Project (CY98) buildings (EBRD) I IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory), N/A (Not Yet Applicable)  Page 14 3. Lessons learned and reflected in the project design: The project would be the first Bank-financed investment project in Ukraine that is focused on demand side measures designed to improve energy use in key public buildings. During the preparation phase of the project, a demonstration project was implemented by Honeywell under funding of the United States Department of Energy. The demonstration project included the installation of weatherization measures and control measures/heat meters in four typical school buildings in Kiev. School buildings of this type comprise 30% of the approximately 1,300 buildings selected for inclusion in the project and represent 55% of the floor space and 34% of the energy efficiency potential. The energy efficiency improvement estimated at the demonstration stage was compared with the estimates in the feasibility study and were shown to be even higher than expected at 29% for the four buildings versus the original estimate of about 23%, with a simple payback of about 3.3 years. The demonstration project has shown that substantial energy savings can be achieved through a few simple and cost-effective measures. The demonstration project has also been instrumental in promoting public awareness. The Bank's experience in implementing similar energy efficiency projects in Eastern and Central Europe is somewhat limited to two projects in Lithuania and Russia focused mainly on residential buildings, currently ongoing. The Lithuania project has shown that implementing energy efficiency investments in residential buildings is a long and slow process, especially whe-re housing privatization is advanced and there is a need to form homeowner associations and reach agreement with all households prior to project start-up, establish and promote credit line facilities, and organize building-level energy audits and contractors. The Lithuania project also included a small ($2.2 million) component to support energy efficiency measures in schools in Vilnius and Kaunas. The Kaunas component has been implemented in three schools and has resulted in considerably increased comfort levels, with energy savings currently being monitored. This effort has confirmed that energy savings through investments directed at larger buildings under single ownership can be achieved more quickly and easily. The Russia project included a program of installing heat meters during the first year of the project in selected residential buildings in order to establish baseline data on energy use. The installation of meters before the retrofits showed that actual heat consumption was about 10-20% less than design values, which was useful for designing subsequent phases. Another lesson learned is that utility companies typically do not read meters, as billing has been based on norms with bills prepared by municipal house maintenance organizations. Installation of meters must therefore be accompanied by support for utilities to change their billing and meter reading practices in order for energy savings to be realized by the end-user. The Russia project was able to reach agreement with the beneficiary municipalities to agree with their heat utilities to base billing on meter readings. Also, establishment of clear steps for monitoring energy savings were lacking up-front which required some time to develop during implementation. These lessons were considered during the preparation period of the proposed project.  Page 15 4. Indications of borrower commitment and ownership: Borrower commitment and ownTership is demonstrated by the following: (a) official request from the State Committee for Energy Conservation for an energy efficiency project; (b) appointment of counterpart personnel by the State Committee for Energy Conservation and Kiev City State Administration to work with the Bank and engineering consultants in the preparation requirements; (c) establishment by Order No. 644 signed by the Prime Minister on November 6, 1997, of a high-level Steering Committee, chaired by the Deputy Chairman, State Committee for Energy Conservation, and including representatives of all the key agencies involved in the project, which actively directed the preparation of the project; (d) adjustment of heat tariffs to cost recovery levels in Kiev City during 1997; (e) formal restructuring the past debts of UAH 182 million of heat bills, as well as other utility bills, owed by Kiev City State Administration prior to January 1, 1998, of which all but UAH 21.8 million of past heat bills have been settled, well in advance of the agreed timetable; (f) payment of new heat bills received by Kiev City during 1998 and 1999 in a timely manner; and (g) commencement by Kiev City State Administration, in advance of the project, of the program of installing heat meters in public buildings, with 713 installations undertaken as of October 1999. 5. Value added of Bank support in this project: The Bank's involvement is regarded as important in supporting the development of priority investment programs under the present conditions of severe resource constraints and in supporting the development of an institution involved in the delivery of energy savings services. The Bank is well positioned to respond to the opportunity and challenges posed by Ukraine today, by (a) providing capital needed to support the much-needed energy savings investments until the energy sector is able to attract a sufficient volume of private capital; (b) providing the lessons of its global experience in energy efficiency to help Ukraine deal with the issues of design, implementation and adaptation of its energy savings program to a larger scale nationwide; and (c) using the leverage of its lending and advisory capability to further and accelerate the establishment of sustainable energy efficiency institutional mechanisms for eventual privatization.  Page 16 E: Summary Project Analysis 1. Economic (supported by Annex 4): [XI Cost-Benefit Analysis: NPV=US$ 6.2 million and ERR= 20.2% with 54% certainty; NPV=US$4.3 million and ERR=17.1% with a 75% certainty [ ] Cost Effectiveness Analysis: [XI Other: Distributive and risk analyses: With a 75% certainty, Equity Coefficient=23.7% of the net benefits would help the poor and Fiscal Coefficient=7.1 1% of the net benefits would assist the Government in the form of added fiscal revenue A cost-benefit analysis was undertaken based on the economic costs, net of financial and fiscal transfers, and the economic benefits, as measured by fuel import savings and the increase in consumers' willingness to pay. Willingness to pay arises from the reduction in expenditures in the public buildings due to less heat requirements. Other benefits that were not included in the analysis would arise from the improvement in the quality of heat supply, improvement in the public building stock and increased health of buildings' users. Also, non-quantifiable benefits would result from lower air pollution levels in affected areas and from the generation of technical employment required for the design, fabrication and installation of equipment. For the purposes of the economic analysis, the project has been grouped into 7 types of buildings: hospitals, polyclinics, administration, kindergartens, schools, theaters, and art galleries/museums. Each type of building was subjected to a least-cost analysis, particularly for those energy saving measures that were most suited technically and economically for each type of building, verifying in all cases that the investments were the least-cost options. The economic analysis, in turn, shows that the proposed mneasures generate sufficient benefits to justify their costs. The overall energy efficiency program has a reasonable economic rate of return (ERR) of 20.2%, with a net present value (NPV) of US$ 6.2 million at 1999 prices with a 10% discount rate and a 54% certainty. However, with a 75% certainty, the project would achieve an NPV of at least US$ 4.3 million and an ERR of 17.1%, which are very good and robust returns on the proposed investments. These results are consistent with these types of energy efficiency projects which, for small expenditures, bring about substantial energy savings and improvements in heating quality, with a large degree of certainty. The table below summarizes the main results of the economic appraisal of the different building types in descending order of their ERRs. The best projects are educational and health facilities, with schools toping the list with an ERR of 39.5%. The fact that education and health are among the key social priorities in Ukraine and that these activities are the main beneficiaries further reinforces the energy efficiency program's relevance and attractiveness.  Page 17 Economic Project Indicators Building Type ERR (%) ENPV (S million) 1. Schools 39.5 5.28 2. Kindergartens 20.8 2.01 3. Hospitals 19.6 0.70 4. Theaters 18.7 0.06 5. Polyclinics 15.6 0.21 6. Administration 10.5 0.01 7. Art Galleries/Museums 10.2 0.01 Total 20.2 6.18 Net present values discounted to 1999 with a 10% discount rate. Risk and Sensitivity Analysis. Projects in Ukraine face a considerable degree of risk. Several of the risks are associated with the macroeconomic and political uncertainties facing all transition economies. Others are specific to the nature of the project, including the uncertainties related to the effects on the existing heat utility. A risk analysis was carried out to examine the project risks and to estimate the likelihood that these would have an adverse effect on the economic indicators of the project. The sensitivity analysis examined how the ERR varies according to changes in key variables in the cost and benefit streams. The results indicate that the proposed investments have attractive and robust economic indicators, as only with very large increases in investment costs or substantial decreases in benefits would the ERR fall to levels below the opportunity cost of capital of about 10%. For example, more than a 42% increase in investment costs would be required before the ERR would fall below 10%. Also, fuel prices would need to decline by more than 34% before the ERR would fall below 10%. The project would have an ERR above 15% even if the increase in consumers' willingness to pay was not considered. The results of the sensitivity analysis are shown in the figure below. The assumptions for the economic analysis are elaborated in Annex 4. 1 00% Investment 7 , 75%. ----- Fuel Savings ............... C 50% - --Wilingne Ss to ,2y- -- -- -- -- -- -- -- --- 25