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DRocumentof The World Bank Public Disclosure Authorized FOR OFJICIJALUSIE ONLY

MICROFICHE COPY 1eport No. 1OO<-(;IS -ype: (SAR) ReportNo. 10071-CS GRAY, DALE/ X32692 / RI2017 / IA4EE

Public Disclosure Authorized STAFF APPRAISAL REPORT

CZECH AND SLOVAK FEDERNALREPUBLIC

POWER AND ENVIRGNNENTAL IMPROVEMENT PROJECT

FEBRUARY21, 1992 Public Disclosure Authorized Public Disclosure Authorized

Energy and Environment Operations Division Central Europe Department Europe and Central Asia Region

This document has a restricted dIsnibution aid may be a*sedby recipients only in the performance of their official duties. Its contents mnaynot otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENT Currency Unit : Koruna (Kcs) USS1.00 = 28.0 Kcs (September 1991)

WEIGHTS AND MEASURES 1 Megawatt (MW) 1,000 kcilowatts (103 kW) I Gigawatt (GW) = 1,000,000 kilowatts (106 kW) 1 Terawatt (TW) 1 billion kilowatts (109 kW) 1 Megawatt-hour (MWh) 1,000 kilowatt-hours (103 kWh) 1 Gigawatt-hour (GWh) = 1,000,000 kilowatt-hours (106 kWh) 1 Terawatt-hour (TWh) 1 billion kilowatt-hours (109 kWh) 1 Megavolt-ampere (MVA) = 103 kilovolt-Amperes (103 kVA) 1 kilocalorie (kcal) - 3,968 British Thermal Units (btu) 1 Gigacalorie (Gcal) = 1,000,000 kilocalories 1 Joule = 0.24 calories 1 Gigajoule (GJ) - 239,000 kilo-alori.es 1 Petajoule (PJ) = 1015 joule or 34,129 tons of coal equivalent 1 Terajoule (TJ) = 1012 joule or 34.1 tornsof coal equivalent 1 kilogram (kg) = 2.2 pounds (lb) 1 ton (metric ton) = 1,000 kg = 2,205 lb 1 meter (m) = 3.281 feet (ft) 1 cilometer (km) - 1,000 m = 3,281 ft 1 cubic meter (m) - 35.31 ft3

GROSS BEAT VALUES OF FUELS Hard Coal = 25 GJ/Ton = 5,975 kca!/Kg

Lignite - 12 GS/Ton = 2,868 kcal/kg Crude Oil = 11,100 kcal/kg Heavy Fuel Oil = 10,400 kcal/kg Natural Gas = 8,200 kcal/m3

ACRONYMS BCM : Billion Cubic Meters CEZ : Ceske Energeticke Zavody (Czech Power Enterprise) CHP : Combined Heat and Power (plants) CMEA : Council of Mutual Economic Assistance CPP : Czech Gas Company CSFR z Czech and Slovak Federal Republic DH : District Heating EIA : Environmental Impact Assessment ERR : Economic Rate of Return ESP : Electrostatic Precipitators FGD : Flue Gas Desulfurization FME : Federal Ministry of Economy GDP : Gross Domestic Product HOB : Heat Only Boilers ICB : International Competitive Bidding LRMC : Long-Run Marginal Cost mtpy : million tons per year SAL Structural Adjustment Loan SEP Slovensky Energeticky Podnik (Slovak Power Enterprise) SO2 Sulfur Dioxide SPP Slovak Gas Company toe tons of oil equivalent TRANSGAS : Tranzitni Plynovad (Natural Gas Transit Enterprise) UCPTE : Union for the Coordination of Production and Transmission of Electricity VUPEK : Vuzkumny Ustav Palivoeuergetickeho Komplexu (Research Engineering and Consulting Institute)

FISCAL YEAR January 1 - December 31 FOR OFFICIALUSE ONLY

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTAL IMPROVEMENT PROJECT

Table of ContentB

Page No.

LOAN AND PROJECT SUMMARY ...... (i)

I INTRODUCTION ...... * 1

II THE ENERGY SECTOR ...... 4 A. Background...... 4 B. Resources and Status of Development ...... 4 C. Energy Balance ...... 7 D. Energy Sector Institutions ...... 8 E. Pricing Issues .1.0...... lo

ZII THE POWER SUBSECTOR ...... 13 A. Overview ...... 13 B. Organization ...... 14 C. Regulatory Framework ...... 16 D. Existing Electric Power Facilities and Operations. . 17 E. Coal Use and Environmental Impacts. .1 F. Electricity Demand and Demand Management .22 G. Electric Power Investment Program .23 H. Electricity Pricing ...... 25 I. Rationale for Bank Involvement .26 J. Bank Activities in the Energy Sector .27

IV THE BORROWER AND THE BENEFICIARIES .28

V THF PROJECT ...... 31 A. Project Objectives and Scope ...... 31 B. Project Description .31 C. Project Cost and Financing Plan .34 D. Project Preparation .35 E. Project Implementation and Construction Schedule . . 36 F. Environmental Considerations .37 G. Procurement ...... 38 H. Disbursements ...... 39 I. Retroactive Financing .40 J. Risks .40

This report is based on the findings of missions which visited the Czech and Slovak Federal Republic in June 1991 and September/October 1991. The mission comprised Messrs. D. Gray (Task Manager), A. Roa (Power Engineer and Procurement Specialist), A. Halildin (Environmental Specialist), K. Jachoutek (Economist), T. Markus (Financial Analyst) and J. Cai (Economist). The report was issued by the Energy and Environment Division (B. Montfort, Division Chief) of the Central Europe Country Department (K. Dervis, Diiector)

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. VI FINANCIALASPECTS ...... 41 A. Accounting and Auditing Framework...... 41 B. Past-FinancialPerformance ...... 41 C. Financial Projections ...... 42

VII ECONOMIC JUSTIFICATION...... 45

VIII AGREEMENTSREACHED AND RECOMMENDATION ...... 49

ANNEXES

Annex 1.1 DocumentsAvailable in the Project File Annex 2.1 Energy Balance 1990 Annex 2.2 Energy Pricing Policy Portion of SAL Annex 2.3 Energy RegulatoryPortion of SAL Annex 3.1 Planned Capacity Retirement Annex 3.2 Planr:d Installationof FGD's and Improved ESP's Annex 3.3 Emission Standardsfor Power Plants and Draft Environmental Regulations Annex 3.4 List of Power Plants Annex 3.5 Damaging Effects of Air Pollutionon Human Health and Forests Annex 3.6 ElectricitySales 1979-89 (MWh) Annex 3.7 CSFR ElectricityConsumption/Forecast 1991-2000 Annex 3.8 Power Sector InvestmentProgram Annex 3.9 Nuclear Power InvestmentProgram Annex 3.10 Average ElectricityTariffs (1989-91) Annex 3.11 ElectricityPricing and Marginal Cost Annex 3.12 Coal Prices and Costs Annex 4.1 CEZ OrganizationalChart Annex 4.2 Draft Terms of Reference for Accounting and FinancialManagement InformationSystems Study Annex 5.1 Detailed Project Cost Annex 5.2 Detailed Cost Estimate for FGD Installationat Prunerov II Annex 5.3 Project ImplementationSchedule Annex 5.4 DisbursementSchedule Annex 6.1 CEZ - Historical Income Statements,1987-1990 Annex 6.2 CEZ - HistoricalBalance Sheets, 1986-1989 Annex 6.3 Notes and Assumptionsfor FinancialProjections Annex 6.4 Table 1: CEZ - ProjectedIncome Statements,1991-1997 Table 2: CEZ - Projected Fund Flow Statement,1991-1997 Table 3: CEZ - ProjectedBalance Sheets Annex 7.1 Power Sector InvestmentOptions with PollutionReduction Annex 7.2 CEZ InvestmentProgram: InternalRate of Return

MAPS IBRD 23371R IBRD 23372R CZECH AND SLOVAK EgErAL REPUBLIC

POWE AND ENVIRONMENTAL I-MENT PROJECT

STAFF APPRAISAL REPORT

Loan and Proi2et Stumma-

BORROWER: Czech Power Enterprise - Ceske Energeticke Zavody (CEZ)

AMOUNT: US$246 million equivalent

TERMS: Fifteen years, including five years of grace.

PROJECT OBJECTIVES: The objectives of the project are to improve power plant efficiency; to reduce air pollution in northern Bohemia, and thereby improve the environment and health of the local population; to modernize the transmission system; and to facilitate interconnection of the (EZ and German power grido. These objectives will be accomplished in the context of overall reform of the energy sector. To this end, the project will: (a) reduce total consumption of pollution-causing lignite through power plant efficiency improvements; (b) curtail power plant SO2 emissions by means of flue gas desulfurization; (c) reduce dust and fly-ash pollution from power plants; (d) increase the reliability, efficiency and economy of the CEZ transmission system; and (e) assist in improving investment planning and corporate management and organization.

PROJECT DESCRIPTION: The proposed project includes: (a) installation of equipment and operational improvements at the Prunerov II power station and other large CEZ power plants to reduce lignite consumption; (b) installation of flue gas desulfurization ecqipment (FGD) at Prunerov II; (c) improvements and equipment for dust collection, i.e., electrostatic precipitators at the worst polluting CEZ power plants; (d) modernization of five 400-kV substations and construction of a short 400-kV transmission line; and (e) ccn,ulting services and staff training. ii -

BENEFITS: The overall result of the project will be a reduced lignite fuel cost in electricity generation, a large reduction of SO2, a substantial reduction of dust and fly-ash, and lower cost, more reliable power exchanges. The total reduct'.on in SO2 from the proposed installations (FGDs and efficiency improvements) will be about 218,000 - 235,000 tons/year. This reduction will not only help to restore the damaged environment in the northern Bohemia region, but also reduce the total amount of S02 in Czechoslovakia to an amount that will, in corbination with other measures, facilitate adherence to the Helsinki-Protocol and pollution reduction commitments.

Savings Zrom plant efficiency investments are lignite fuel savings of US$20 to 40 million/year from a reduction in lignite use of 1.2 to 1.9 million tons/year, and associated reduction of 28,C00 to 45,000 tons/year of SO2.

The net reduction of S02 emissions at Prunerov II is estimated at around 190,000 tons/yr (out of the total 218,000 to 235,000 tons/year of S02 reduced under the project). Based on the total SO2 emission in CSFR recorded in 1989 (2.65 million tons), the installation of FGDs covered by this project component will reduce emissions in CSFR by about 7%, and in relation to the Czech Republic by about 10%. In northern Bohemia, the most polluted region in CSFR, the proposed FGDs will reduce SO2 emissions by about 20%.

She project also includes plant retrofitting with new electrostatic precipitators (ESP) for effective dust control to improve the environment and health of the population. Where the ESPs are rehabilitated or renewed, the emission will be reduced by 75% to 90%. The transmission component will result in a lotwercost and more reliable electricity supply, and will facilitate power exchanges.

RISKS: The main risks associated with the project are: (a) deterioration of CEZ' financial condition as a result of adverse macro-economic developments caused by delays such as major changes in the internal refnrm process; and (b) implementation delays due to CEZ being a first-time borrower. It is reasonable to expect that the government authorities will continue on their present course of political and economic transformation. So far, the stabilization program has been successful with low inflation rates and sound budgetary policy, but certain federal and republic responsibilities are still being worked out. Since the project is entirely within one republic and given tha technical configuration of the system and joint dispatching operations, there are likely to be minimal affects on the project due to changes in inter- republic relationships. Also, CEZ' financial performance is believed to be adequately safeguarded through the proposed covenants. The proposed close supervision of the procurement process is likely to ensure smooth project imp.Lementation. Therefore, the above risks are considered to be manageable.

ESTIMATED PROJECT COST:

KCS Million US$ Million LC FC Total LC FC Total A. PotlutionControl Al. PrunerovII, FGD 3,836.0 3,136.0 6,972.0 137.0 112.0 249.0 A2. DustControl Installations 924.0 756.0 1,680.0 33.0 27.0 60.0 Subtotal 4,760.0 3,892.0 8,652.0 170.0 139.0 309.0 B. EfficiencyImprovement I1.Prunerov II 280.0 140.0 420.0 10.0 5.0 15.0 B2. OtherPower Stations 1,232.0 616.0 1,848.0 44.0 22.0 66.0 Subtotal 1,512.0 756.0 2,268.0 54.0 27.0 81.0 C. TransmissionNetwork Cl. Substations 407.7 642.5 1,050.2 14.6 22.9 37.5 C2. TransmissionLine u,4.1 38.1 102.1 2.3 1.4 3.7 Subtotal 471.7 680.6 1,152.3 16.9 24.3 41.2 D. Training& Consultancy 224.0 187.6 411.6 8.0 6.7 14.7 Base Cost 6,967.7 5,516.2 12,483.9 248.9 197.0 445.9 PhysicalContingencies 696,8 551.6 1,248.4 24.8 19.8 44.6 PriceContingencies * 1,058.0 818.9 1,876.9 37.8 29.2 67.0 ProjectCost 8,722.5 6,886.7 15,609.2 311.5 246.0 557.5 InterestDuring Construction (IDC) 526.4 1,730.4 2,256.8 18.8 61.8 80.6 GRANDTOTAL 9,248.9 8,617.1 17,886.0 330.3 307.8 638.1

...... ExchangeRate: 28.00KCS/US$

* It is assumedthat the exchangerate will reflectthe differentialbetween localand internationalinflation rates iv

FINANCING PLA: Local Foreign Total

IBRD 246.0 246.0 CEZ 311.5 311.5

TOTAL 311.5 246.0 557.5

ESTIMATED DISBU1iSENT: FY93 FY94 FY95 FY96 FY97

Annual 48.1 85.4 74.1 31.3 7.0 CumuLative 48.1 133.5 207.6 239.0 246.0

ECONOMIC RATE OF RETURN: Economic rate of return is greater than 14% on overall power investment; greater than 20% for plant efficiency component. POWERAND ENVIRONMENT IMPROVEME PROJECT

I. ItrJRQDUCTION

1.01 The Czech and Slovak Federal Republic (CSFR) is classified as an upper middle-income courntrywith an estimated per capita income of US$3,460 in 1989 and a population of 15.6 millio.s. CSFR has undertaken a far-reaching economic reform program to move from a rigid cen.rally planned economy to a market economy. Within a stabilization-oriented macro-economic framework, the tranformation program includes trade and exchange reform, large increases in energy prices, liberalization of most non-energy prices, a tightened monetary policy and initiation of a program for rapid privatization of large and small enterprises. The procesb has been complicated by the need to clearly define the responsibilities and authority of the federal government ana the governments of the Republics. The demise of the CMEA trade structure has resulted in much higher prices for imported oil and gas and has drastically reduced exports on many manufactured goods. Manufactured goods production has declined and GDP, which grew at an annual rate of 1.5% in the 1980e, is estimated to have declined by about 35% ini 1991 and expected to decline about 5% in 1992, but to recover thereafter.

1.02 Czechoslovakia's transformation program has two central objectives: (a) rapid transition to a market economy, and (b) restoration of economic growth towards higher standards of living. In order to achieve theae goals, stabilization and structural reform policies are being Implemented at the same time. Unification of the commercial and tourist exchange rates, and price increases for gasoline and industrial energy as well as for transport, were implemented in the second half of 1990. In September 1990, the Government adopted a radical transformation program consisting of a comprehensive set of reform measures including anti-inflationary financial and incomes policies, change of ownership of enterprises, promotion of private sector activities, price and trade liberalization, "internal convertibility" of the currenoy (unrestricted access by enterprises to foreign exchange for current account purposes), and policies of protecting the population groups most vulnerable during the transition process from undue hardship. The program was launched on a broad scale at the beginning of January 1991. It is supported by an IMF standby agreement, and a World Bank Structural Adjustment Loan (SAL) tor US$450 million.

1.03 The CSFR energy sector is character4zed by heavy dependence on domestically produced hard coal and lignite in the industrial, power and residential sectors; severe air pollution problems from use of high sulfur content hard coal and lignite; a unique position as the principal transit country between former USSR and Western Europe for natural gas pipelines but dependence on oil and gas imported from the former USSR; widespread inefficiency in energy consumption related to past misguided industrialization policies and previously subsidized energy prices; recent large increases in administratively determined energy prices whic:,have eliminated financial subsidies in the energy sector (and have resulted in most industrial prices 2-

being at or above economic cost and most residential prices being about half of economic cost); and a pucrly developed regulatory system for n>ural monopolies (natural gas, power and heat).

1.04 Overall demand for energy ls expected to decline as consumers conserve energy in response to the recent sharp increase in energy prices, and also in responae to shifting industrial structure, interfuel substitution, and ways to use fuels ..n a cleaner and more efficient manner. According to Bank and federal government demand projections, energy consumption is projected to decline until the middle of the decade and then begin to climb but, overall, energy demand is expected to be less in 2000 than in 1990. The largeet drop in demand is expected to be in coal consumption while electricity and gas demand are expected to be back near 1990 levels in 2000.

1.05 The government of CSFR has taken a number of bold stepe to reform the economy and the energy sector, sucn as the recent sharp increases in energy prices, which are being complemented by ongoing and planned regulatory and institution reforms. The role of the government and the institutional structure is in the process of being changed from that of exercising absolute control of the economy to one of oversight through a reconstituted regulatory system. This development of a new regulatory system for energy utilities is reflected in the draft federal energy policy paper. This policy paper also proposes that energy utilities be restructured and partially privatized, with the federal and republic governments retaining majority ownership. These proposed reforms of the energy utilities are scheduled to follow the first phase of ownership reform and priv,.ization of large industries planned for the first half of 1992.

1.06 Air pollution from electricity production causes severe health and environmental damage. The power se-tor relies heavily on coal-fired power plants burning low-quality high-sulphur lignite, and represents the largest polluter in CSFR in regard to SO2 and dust (fly-ash or particulate matter). The extensive use of lignite during the last 40 years has resulted in a large environmental damage, which is especially pronounced in the Northern Bohemia region, where large parts of the forests have died and health of the population is declining. Plans for reducing air pollution are based on cleaning up the stack gases from large point sources, improving the plant efficiency, and substituting less polluting fuels, such as natural gas where justified. Proposed amendments to the Air Pollution Act contain emission standards for new and old power plants were approved during 1991.

1.07 The Bank has had, and continues to have, an active role in assisting in the reform of the energy sector. This began with productive dialogue during the discussion of the Country Economic Memorandum in August 1990, followed by draft energy issues papers and policy conditionality under the SAL (on pricing, regulatory framework and least-cost investment planning and medium term environmental action plan). Energy sector issues have been evaluated in detail in the Bank's Energy Sector Review (Report No. 9768-CS, a draft of which was discussed in October 1991 and used as an input into Fe6sral and Republic Energy policy papers). Environmental issues have been evaluated in the Joint Environmental Survey (jointly completed by the Bank, EEC, US AID - 3 - and CSFR authorities - Report No. 9623-CS). Energy projects for the Slovak gas and power enterprises are currently being prepared, whichi include components for power transmission, power station retrofitting, as well as gas transmission, storage and distribution.

1.08 The Power and Environmental Improvement Project will be the first World Bank loan to be made to the CSFR energy sector and one of the largest environmental projects in Bank histccy. It will include funds for upgrading the power sector generation and delivery oystem; equipment which will substantially reduce air pollution, reaulting in improved living conditions and increased health status, specifically in northern Bohemia where the large lignite mines are located; improvement of power plant efficiency, resulting in reduced lignite consumption; improvement of the economic efficiency of the sector; and technical assistance to provide consulting services and training to facilitate sector restructuring. The proposed project will allow CEZ to keep generating expenses low and to defer investments in new generating capacity without further damaging Northern Bohemia's environment, by retrofitt.4ngexisting plants to enable them to continue using low cost lignite fuel in an environmentally safe manner. The total project cost will be $557.5 million including $249 million for the installation of flue gas desulfurization (FGD) equipment at the Prunerov II power plant; $60 million for installation -,'electrostatic precipitators (ESPs) for reduction of particulates in several power plants; $81 million for improvement of plant thermal eificiency; and $41.1 million for rehabilitation and upgrading of the transmission network. It is proposed that the World Bank provide US$246 million, which represents the foreign exchange cost, approximatel.y44% of the total rroject cost. The funds would be useC to finance portions of the cost of FGD equipment, equipment for the transmission network, and for technical assistance.

1.09 The overall environmental impact of the project is very strongly positive with reduction in S02 as well as other a'r pollutants and dust. However, the installation of the FGDs will at the same time, increase the total amount of waste by the generation of gypsum, which is not a hazardous material, will increase by about 30%. This gypsum and waste water from the FGDs can be easily and safely disposed of and are not expected to cause environmental problems. In accordance with the Operational Directive 4.00, Annex A, Environmental Assessment, this project has been ranked at the level B.

1.10 The project was prepared after a pre-appraisal mission in March 1991; an appraisal mission in June 1991; and a post-appraisal mission in September/October 1991. 4-

1. . E ENXR Y

A. gaSkgXound

2.01 The CSFR energy sector was shaped in the past by the centrally planned program which did not reflect rational economic decisions. The industrial sector is dominated by heavy industry and much of the technology used is highly energy inefficient. A major reason for this inefficiency is the fact that energy prices in the past, for induatry and household consumers, were so heavily subsidized that there was no incent4 'e to economize. As a result, the ratio of energy consumption to GDP is . ' higher than in OECD countries. The recent level of energy use in the C. was approximately 0.7 too/US$1000 of GDP, while industrial consimption was approximately 0.6 toe/US$1000 of GDP. This is more than twice the energy intensity in OECD countries. The Federal Government, which sets energy prices, has moved boldly to increase most energy prices and to eliminate the negative "turnover taxes" on energy. Energy price increases between May 1990 and October 1, 1991 have been very large, ranging from 70% (for residential electricity) to 320% (for residential district heat) and have amouuizedto increased costs to consumers (industrial and residential) of about 50 billion Kcs or about 3% of projected 1991 GDP.

B. Resourc-s and Status of Develonment

2.02 The primary source of energy in the CSFR is coal. In 1990 it provided 55% of the gross energy consumption and recoverable reserves could last more than 40 years at current production rates. However, most of the coal is low quality lignite which is highly polluting. The higher quality hard coal contains a high sulfur level which also contributes to the pollution problems. Coal consumption nas been stagnant over the past decade due to low growth of the economy and increased usu of natural gas. Petroleum consumption has declined as _he country moved to limit the petroleum products use to the transportation and chemicals sector and eliminate its use as boiler fuel. Hydroelectricity, which accounts for less than 4% of total electricity production has declined slightly and the remaining undeveloped potential is limited. Nuclear energy has grown rapidly in importance. In 1990, nuclear power supplied 28% of the electricity produced and CSFR's power sector development program includes the completion of two more large nuclear stations. Steam, produced in industrial boilers and power plants, is distributed to industrial consumers and hot water is distributed to residential consumers through pipeline networks in 70 cities.

2.03 Oil and natural gas resources are very limited. Indigenous oil production provides only about 1% of the nation's requirements and natural gas, less than 5%. Almost all of the crude oil and all natural gas imports come from the forner USSR. Prior to 1990 oil from the former USSR had been priced at well below world prices and payments were made in non-convertible rubles and countertrade. The border price for crude oil now being set at international levels. As yet, there have been no restrictions on natural gas imports. Nonetheless, the changes in the CMEA pricing and trading structure have prompted an effort to try to diversify to non-tormer USSR sourcee of both oil and gas imports.

2.04 Coal is the primary indigenous energy resource. Total production in 1990 was 116 million tons, of whickh about 81% was lignite with a heating value of 12-12.3 MJ/kg. (The ljw cost lignite used in the Prunerov plants has a slightly lower heating value of 10.5 MJ/kg.) Minable lignite resources are estimated to be approximately 3700 million tona, equivalent to 47 years requirements at current conaumption rates. Hard coal reserves total 980 million tons or 43 years' supply at current rates of use. Due to environmental and economic limitations, it is anticipated that consumption of domestically produced coal will decline markedJy and bv 2005 it will provide less than 40% of the total energy requirements. The ':oalmining induetry is characterized by a broad range ot mining conditions. There are large mines which supply Prunerov with low cost lignite. Geological conditions are very difficult at some other mines where coal is mined from very thin (20 inch) seams.

2.05 The coal sector is entering a period of transition, moving from a fully protected and regulated environment to a free market economy where performance will be measured by the sector's ability to compete with imported coal and other energy sources. The course of development will be shaped largely by market forces, which will increasingly include internalized environmental costs. But given the negative factors, such as a general stagnation in the economy, higher environmental penalties and substitution of coal by less polluting fuels, it is clear the industry is entering a period of contraction.

2.06 The CSFR consumed a total of 13.4 million tons of oil in 1990, which was almost entirely imported from the former USSR. Prospects for additional domestic production are very limited. The known potentially productive reservoirs are very deep, over 6000 meters, and will require advanced deep drilling technology which is costly and not presently available in the CSFR. Oil imports from the former USSR were reduced by about one-fourth in 1990 and further supply disruptions are possible. The current efforte are to diversify oil supply sources and to expand the delivterysystem and in-country storage. The need to diversify sources of oil as quickly as possible and to provide adequate storage has intensified because the planned increase in deliveries via the Adria pipeline has been disrupted due to political problems in Yugoslavia. Near-term options, which are under consideration, for increasing deliveries from non-former USSR sources are: (a) expansion of the Adria pipeline capacity up to S million tons/year (if disruptions in Adria supply are overcome); (b) construction of products pipelines connecting the Bratislava Slovnaft and Austrian Schwechat refineries; and (c) construction of the Ingolstadt-Litvnov/Kralupy pipeline linking Germany to Czech Republic refineries. In-country storage capacity should also be increased to a level comparable to that of Western European countries, approximately 90 days consumption. -6-

2.07 Natural gas use has grown steadily since the first pipelines from the former USSR were built in the late-1960s. CSFR location is central to the European gas system as the transit pipelines transfer 60 billion cubic meters per year from former USSR gas fields to Western Europe (which comprises about one-third of Western Europe gas imports). In 1990 total CSFR gas consunption was 13.3 billion cubic meters (BCM) of which less than 1 BCM was produced from fields in the CSFR. Because it is environmentally much more acceptable than lignite, natural gas is considered the fuel of choice for most small dispersed indUBtrial, commercial and residential uses. Expansion plans which were established prior to the political changes were based on continuation of past growth rates and it was estimated that by 2000 the total consumption would be approximately 20 BCM. Other demand growth scenarios, which are based on lower anticipated economic growth project demand in the range of 17-18 BCM in 2000. Essentially all of the gas must be imported from the former USSR in the near- and medium-term. As in the case of oil, diversification of supply sources is a priority goal, both to ensure long-term availability and to provide some bargaining leverage in dealings with the former USSR. Discussions have been held with Norwegian, Algerian, and Iranian authorities to assess the longer- term availability of natural gas. In order to meet the growing demand for natural gas as a replacement for low quality coal in industrial and residential applications, the existing supply infrastructure must be strengthened and expanded. As the residential market becomes a larger portion of the total, temperature-sensitive demand will increase and, in order to meet peak demands, storage capacity will have to be expanded.

2.08 The existing level of generating capacity in the power sub-sector appears to be adequate to meet the projected demands through the 1990s. In 1990 the peak demand was about 13,000 Mw. The installed capacity, including al3owances for retirement and conversion of some generating capacity to district heating use, was about 22,000 MW in the same year, but available capacity is much lower. The reserve will be adequate over the near term. After 1995 electricity demand may increase slowly, but under the most realistic assumptions, demand in 2000 is unlikely to exceed 1990 demand. Assuming the stagnation of electric demand, the existing plants remaining after retirement, together with those under const.rlction-- Temelin, 2000 MW and Mochovce, 1760 MW -- should be adequate to mee. demands through the late 1990s. Introduction of free market principles will affect both the demand growth and the optimum program for meeting the projected demands. The long- range sub-sector development plan has not yut been subiected to a rigorcus analysis based on the latest load forecasting and system development simulation methodologies. Over the near term, the sub-sector development program will focus on reduction of pollutants from the coal-burning stations and upgrading of the transmission and distribution systems. A leaSt-cost investment study is underway as part of the existing SAL operation. The study is being financed by the EEC with consultants beginning work in February 1992. .7-

C. _erLy_Žf.J ance

2.09 Overall, energy consumption changed very little from 1980 to 1990, but the entrgy mix shifted from liquid fuels to other energy forms. Oil consumption declined as heavy fuel oil use was substituted by coal and natural gas. Natural gas consumption ine;reasedat an average rate of approximately 4% from 1980 to 1990 as the network to additi.onalcities and towns was expanded. Total electricity consumption increased from 73 TWh in 1980 l:o 85 TWh in 1990. iluclear power increased most rapidly, growing from 6% of electricity production in 1980 to 27% in 1990. Hydroelectricity supplied a very small portion of electricity supply, less than 4%, and has remained relatively constant throughout the decade. Table 2.1 below shows a condensed version of the energy balance. A more detailed energy balance is in hanex 2.1.

Table2.1: CSFRIRn1rRy BalnLe. 1990 (PJ) Coking Total & Hard Brown Total Crude Other Total Natural Town Total Coal/Oil/Gas Coal Coal Coal Oi, Liidq LiAuid __Ga_ Las Gas Energy Production 547.4 1054.41601.8 5.8 0.0 5.6 23.5 23.5 1631.1 Imports 118.5 3.7 122.2 556.1 25.0 581.1 445.7 445.7 1149.0 Exports -68.2 -37.3 -105.5 -22.4 -22.4 -24.3 -24.3 -152.2 Inventory Adj. 1.4 6.2 7.6 20.1 20.1 27.7

Gross Conswup. 599.1 1027.0 1626.1 561.9 2.6 564.5 465.0 0.0 465.0 2655.6 Non-EnergyUse 45.6 257.0 302.6 123.5 123.5 27.2 27.2 453.3 Electric& *ieat 219.2 -739.5958.7 113.4 113.4 11Y.6 11.2 128.8 1200.9 IndustryUse (1) 199.9 22.9 222.8 87.0 87.0 154.5 76.7 231.2 541.0 Construction 0.5 1.8 2.3 3.7 3.7 0.8 0.3 1.1 7.1 AgricuLture 5.4 13.7 19.1 63,7 63.7 13.2 1.6 14.8 97.6 Transportation 1.6 2.7 4.3 106.0 106.0 1.0 0.1 1.1 111.4 Households(2) 33.6 144.1 177.7 8.4 8.4 67.0 11.5 78.5 264.6 Coffercial(3) 38.4 71.9 110.3 40.1 40,1 74.6 7.1 81.7 232.1

(1)Consumption of 1.7Pd of otherfuels not included, (2)Consumption of 10.6PJ of othersolid fuels not included. (3)Consumption of 2.7 Pi of othersolid fuels not included.

Note: Numbersmay not add in thiscondensed table, due to rounding.See Ar.nex 2.1 for the fulldetailed EnergyBalance.

Source: VUPEK,April 1991 -8-

D. Enerav Sector Institutions

2.10 Under the centralized economy of the past 40 ye,rs, a rigid institutional structure was imposed throughout the energy sector. Sector development plans were controlled by the central authority with the primary motivation being to meet pre-established )erformance or production goals. Economic criteria were only considered within the context of overall plans and because of the highly subsidized price structures in the energy sector, they have little meaning in a free market economy. As the nation moves to adapt to the market economy, the institutional structure is also in a state of flux for two reasons. First, as the country moves toward a free market economy, the planning function is being decentralized, so that in the future the enterprises which will rely less on government direction and will increasingly apply conventional economic evaluation criteria when making development plans and investment decisions. To do this, they must adorttnevw accounting methods, adjust costs to reflect international levels and eliminate subsidies. Second, the republics will assume greater authority in energy sector planning while the role of the federal government will be limited to general policy and to those issues affecting both republics. The Ministry for Economic Policy and Development of the Czech Republic will be responsible for sector activities in the republic while the Slovak Ministry of Economy will be responsible for the republic's activities. Proposals are being considered that the natural monopolies in the energy sector, i.e., electricity, natural gas, and district heating services, be subject to a regulatory system which would allow prices to eventually be set based on objective criteria and would ensure that the monopolies do not abuse their monopolistic powers. Options for delegation of authority are being considered whereby each republic would eventually have authority to approve tariffs and conditions of service for each regulated utility.

2.11 The electric sector is comprised of two generating and transmission enterprises, Ceske Energeticke Zavody (CEZ) and Slovensky Energeticky Podnik, (SEP) and 11 distribution utilities. CEZ and SEP, and some of the distribution enterprises will be reorganized as joint stock companies. Options are being considered to sell a minority portion of their shares to private owners while the remaining distribution enterprises are being planned to be operated as autonomous entities wholly owned by the republics or municipal governments.

2.12 The gas sector is primarily concerned with distribution of natural gas but approximately 400,000 customers receive "town gas", a lower heating value gas produced from natura? gas or coal. The town gas systems are being retired and will be essentially eliminated after 1995. The town gas from coal is produced by coa) enterprises but distributed by the gas enterprise. The natural gas sector is comprised of the following principal enterprises:

- The Slovak Gas Enterprise (SPP) receives natural gas from the former USSR via the Brotherhood pipeline and delivers gas to consumers in the Slovak Republic. a- 9 -

The Czech Gas Works (CPP) distributes natural gas in the Czech Republic via six regional centers.

Tranzitni Plynovod (TRANSGAS) is a CPP subsidiary (until the newly formulated plan for formation of a joint stock company is implemented) which delivers gas to CPP and operates the transit gas system from the former USSR border to the delivery points at the Austrian and German borders.

Nafta Gbely is responsible for production of natural gas and oil in the Slovak Republic and operates the Lab natural gas storage field.

2.13 At the beginning of 1990, the coal sector consisted of 21 lignite mines and 9 hard coal mines. The hard coal mines were operated by two enterprises, Ostrava-Karvina (OKD) and Kladno Mining Company (KD). (See Annex 3.12 for mine names and mine regions.) Alternatives for sector restructuring are now under consideration. The principal issue is the extent to which OKD and other companies will be broken into smaller, independent joint stock companies. Several mines, notably the metallurgical (coking) co., mines in the Ostrava region and the underground lignite mines in slovakit and ancillary operations such as construction, manufacture of mining equipment, etc., will be spun off as separate autonomous joint stock companies.

2.14 At present the activities of the oil and chemical industries are the responsibility of the Department of Oil and Chemistry in the CSFR Ministry of Economy. The division of responsibilities with the republic governments has not yet been resolved. The key issue, petroleum product pricing, is the responsibility of the Fede.Lal Price Board in the Ministry of Finance. The state oil concern, CHEMOPETROL has been dissolved with the result that the oil industry is highly fragmented. There are six refining and petrochemical operations, two regional distribution enterprises and two international trading companies. The organizational structure of the oil sub-sector is in transition. The alternatives under discussion include formation of separate joint stock companies to manage the oil pipeline system; the refining operationr; and product marketing. The management and operations of the petrochemicals sector have been very closely integrated with the petroleum sector. These are usually considered to be different types of conmercial operations and this close linkage may make it more difficult to privatize either activity.

2.15 District heating and steam energy play a significant role in the energy sector. In 1990 total consumption was 499 PJ, of which 75% was used by industry; 15% by households; and 10% for other uses. The principal source of heat energy was industry which produced 66% of the total consumed. Combined Heat and Power (CHP) plants and heat-only-boilers (HOB) produced 28%, and 6% was produced by other sources. Major district heating networks have been established in 53 cities in the Czech Republic and 17 in the Slovak Republic. Originally all HOBs connected to the local boiler houses were coal-fired. In the 1960. several HOBs were converted to gai-fired CHP systems but this policy was stopped by the end of the 1960s. Current plans are to replace worn-out units and to contvertpower plants to CHP where appropriate. - 10 -

E. Pricing_Issues

2.16 Policy and Regulation. Under the past centrally planned economy all energy prices were highly distorted when compared to the economin cost of production and delivery. Oil and gas imports from the former USSR were priced much below international levels and were paid for with goods and services valued at arbitrary prices. The lack of meaningful cost accounting methods made it impossible to calculate the true 'economic coat of delivering energy to end-users and government subsidies in the form of negative "turnover" taxes reeulted in a pricing structure which often failed to recover actual costs.

2.17 Through its aggressive program to curtail subsidies and raise moBt energy prices to a level at or near their economic cost, the government has reduced or eliminated many of the distortions in the level of average prices for the primary energy sources. As a result of the price increases adopted in 1990 and 1991, the household usere' prices are now closer to the economic cost. It is estimated that, as of October 1, 1991, current residential energy prices amount to approximately the following percentages of the economic cost: heat energy, 25-30%; lignite, 57%; natural gas, 58%; on-peak electricity, 50%. As a result of these increases, the budgetary subsidies to the utilities and enterprises which provide the energy have beehisignificantly reduced and the distortions between residential and industrial prices have been reduced, but not eliminated. AB shown in Table 2.2, the prices to industrial consumers of electricity and natural gas are higher than the economic cost while the prices to residential consumers are below the economic cost.

Table 2.2 COMPARISONOF COrStUMERPRICES ANDECONOMIC COSTS

katio of W.omina! Approximate Price to Price Oct. 1, 1991 Economic Economic Increase Fuels Prices Cost Cost 5/90-10/91

Lignite, Industrial 340 Kcs/T AZ 755 Kcs/T 45% 94% Lignite, Household 600 Kcs/T EL 1053 Kcs/T 57% 200% District Heat, Household 89 Kcs/GJ 300-400 Kcs/GJ 25-30% 320% Natural Gas, Industrial 3350 Kcs/MCM 3100 Kcs/CM 108% 164% Natural gas, Household 2218 Kcs/MCM 3809 Kcs/CM 58% 150% Electricity, Industrial 1.1-1.8 Kcs/Kwh 1.0-1.2 Kcs/Kwh 110-150% 175% Electricity, Residential 0.85 Kcs/Kwh 1.6 Kcs/Kwh 50-60% 70yb/ a/ estimated average price delivered to consumer b/ increased by 70% on October 1, 1991 - 11 -

2.18 Hard coal and lionite pricina. Retail coal prices increased in May 1990 and industrial steam coal and coking coal prices were more than doubled. Over the long term, the objective is to deregulate coal prices and coal users should be allowed to use the least-cost source of coal -- after taking into account environmental costs --- whether it is locally produced or imported. However, during the transition period some special pricing arrangements will be required. For example, the mine-mouth power plants which use lignite cannot easily switch to another fuel. The appropriate price for these consumers lies between the long-run marginal cost of production and the opportunity cost. The real prices of low quality high sulfur coals and lignite used for household heating should be raised in order to promote the shift to more environmentally acceptable fuels.

2.19 Petroleum and products pricing. Petroleum product prices are set at two points: ex-refinery and at the retail level. Prices are based on crude oil prices plus a fixed margin to cover the cost of refining and marketing. The turnover tax at the retail level has been eliminated and replaced with a fixed tax on selected products. The key pricing issues in the petroleum sub- sector will be the extent to which prices are controlled by the government and the refiners' accessibility to world markets. To have a workable system, refiners must have free access to world crude oil and product markets and competition must be established at the retail level. The government is taking first steps in this direction.

2.20 Electricitv price levels. The average industrial tariff, now about $0.04-0.06/kWh, is above the marginal cost, while the low-voltage consumers continue to pay only about 50% to 60% of their marginal cost. The differentials between the tariffs for customers at different voltage levels and in different service categories has been improved with the recent 70% increase in residential electricity tariffs (on October 1, 1991). Tariff structures of individual consumer categories include low-use and high-use tariffs; time-of-day tariffs; and heat storage tariffs which are available for off-peak (night-time) service. On the whole, this structure is suitable for reflecting cost differentials, which will be determined with greater accuracy in the forthcoming least-cost investment study (para. 2.23).

2.21 Natural gas tariffs. Natural gas tariffs are divided into wholesale (bulk) tariffs which apply to large volume consumers, such as electric power plants and industrial users; and retail tariffs which are paid by residential consumers and some small volume customers. Tariffs are not geographically differentiated and the same price is paid by wholesale or retail consumers in all parts of the CSFR. The bulk tariff is a single price for all volumes sold; while the retail tariff is a two-part structure. After the recent industrial price increases, the wholesale tariff iB higher than the retail. tariff even though the cost of service is less. During the second quarter of 1991, the border price of natural gas increased to 2600 Kcs/MCM. To compensate for this increase, the industrial tariff has been increased to 3420 Kcs/MCM. The residential tariff, which had been 890 Kcs/MCM, includes the allowance of a negative turnover tax (subsidy), was increased by 150% on May 1, 1991 but is still less than the border price. - 12 -

2.22 District heatina tariffs. Residential DH heating customers pay for the service under two tariffs: one for space heating which is based on the number of square meters which the user occupies; the second, for domestic hot water which is based on the number of occupants in the dwelling unit. Usually, neither service is metered so the total quantity used by the block of flats is determined at the secondary meter and allocated among all consumers. New metering methods are being proposed. The co-; of district heating at the point of production has been based on the type of fuel used. Theoretically the wholesale price was calculated as the average production cost plus a profit.

2.23 SAL Enerav Conditionality. The Structural Adjustment Loan (SAL) contains conditions which address key macro and sector pricing, as well as regulatory and least-cost investment planning issues, particularly for the power sub-sector. The SAL required the government to increase residential electricity prices and thus reduce the distortion between residential and industrial prices which has led to a miballocation of rescurces (as described in Annex 2.2). In fact, the federal government satisfied this SAL condition by raising residential electricity tariffs by 70%, on October 1, 1991, well ahead of second tranche release. As a condition of the second tranche release, a preliminary least-cost investment study has been prepared, and a suitable pricing structure action plan is being developed, to be implemented over the next two years. Preparatory work and progress on these studies and action plans is being achieved.

2.24 Prior to the third tranche release a Public Utilities Law will be submitted to the Parliament. The law will establish the legal predicate and procedures for economic regulations (including price setting) of enterprises which produce, transport, and distribute electric energy, natural gas, town gas and thermal (heat) energy. The law is expected to define the scope of regulation; and the structure, powers and jurisdiction of the regulating bodies (see Annex 2.3 and Chapter III (Section C) for more details on the regulatory framework). - 13 -

III. THE POWER SUB3-SE9C-R

A. Overview

3.01 Projectionsof decliningeconomic growth over the near term and introductionof energy-efficienttechnology, point to a growing excess of power generation capacity until the mid-1990o,particularly when new generatingplant capacity coming on stream at that time is taken into account. Currentlyreserve margins are adequate so the added capacity will provide an opportunityto retire at least an equivalentamount of capacity in older coal- fired units which are a primary source of air pollution (see Annex 3.1).

3.02 In 1990, 56% of the ele^tric energy war generatedwith coal and 80% of that was from lignite-fueledplants. Very little fuel oil is used for power generation,and that is being phased out as quickly as possible. Natural gas, because of its environmentalbenefits, has been proposed as a growing source of energy for future new power generationwhen needed. Uncertaintiesabout the availabilityof imports and the higher cost, relative to the lignite from the most efficientmines serving mine-mouthpower stations,may limit its use. It may be the most economic fuel in those stations already equipped for gas firing and may be the least-costchoice for inversionepisode control in some locations. Its longer-termrole is still to be defined in the least-cost investmentstudy (para. 2.23). Hydroelectric resourcesare limited but three major hydro plants (two under construction), which together will add 1400 MW of capacity,are scheduledto come into service before 2000.

3.03 The transition to a free market economy, coupled with a greatly changedperspective of environmentalobjectives, could significantlyimpact the sub-sectorinvestment program over the next decade. Any new nuclear plant investmentswill have to be shown to be the least-costoption. Some of the lignite-firedstations are obsolete and inefficient. These will be among the units replaced by the current capacity expansionprogram. But several of the mine-mouth stations have very low fuel costs. They are the stations which have been identifiedas candidatesfor installationof flue gas desulfurizationunits which will reduce the sulfur dioxide emissionsto locally acceptablelevels (see Annex 3.2).

3.04 The developmentof the sub-sectoris also likely to be affectedby recent organizationalchanges and future changes which result from proposed privatizationof some parts, or all, of the sub-sector. Prior to 1990, CEZ and SEP operated as vertically integratedmonopolies in their respective regions. They operated all the generation,transmission and distribution systems as integratednetworks. In 1990, the distributionsystems were restructuredas autonomous organizations. The first steps toward privatizationhave already been announced. It has been proposed that CEZ and SEP, and probably the distributionenterprisee at a later date, be converted to joint stock corporationswhich will offar up to 49% equity participationby the private sector. - 14 -

3.05 Historically, the operations and investment program of the power sub-sector has been closely linked to that of the district heating sub-sector. CEZ and SEP have operated a number of stations which produce both electricity and heat energy (steam and hot water) which were delivered to consumers through district heating pipeline networks.

3.06 The electricity sector is, as with all the other sectors of the economy, affected by the transformation from a centrally planned economy to a more open, market-oriented economy. Certain major issues have, as noted, yet to be clarified. For example, the governments of the two republics, which have taken on new responsibilities, are not yet sufficiently eqx.ipped for the extended tasks of sector regulation; nor is the allocation of responsibilities between the federal government and the republics fully clear. Nevertheless, these issues are being addressed and the overall electricity sector is sufficiently stable and well-defined to implement the proposed project.

3.07 Another large undertaking will be the consequence of the regulation linked to the Air Pollution Act, which become effective in 1991, in that all power plants with a capacity of more than 300 MW must install flue gas desulfurization equipment within a period of 5 years (see Annex 3.3).

B. Organization

3.08 The power sector of Czechoslovakia consists now of the following enterprises:

Czech Republic

(a) CEZ with its Power Generating Companies and the High-Voltage Transmission Network of 400 kV and 220 kV (also see para. 4.02);

(b) Eight independent Power Distribution Companies, as follows:

(i) Prague Power Works (ii) Middle-Bohemian Power Works (iii) South-Bohemian Power Works (iv) West-Bohemian Power Works (v) North-Bohemian Power Works (vi) East-Bohemian Power Works (vii) South-Moravian Power Works (viii) North-Moravian Power Works; and

(c) Research Institutes, CEZ subsidiaries. Among them is a subordinated department in Ceske Budejovice of Energovod, Prague, which has been transformed into Energetik. Ceske Budejovice. - 15 -

(d) Starting January 1, 1991, three District Heating Enterprises which used to be part of CEZ have been separated out and established as independent companies.

Slovak Re ublic

(a) SEP with its Power Generating Companies and the High-Voltage Network of 400 kV and 220 kV;

(b) Three independent Power Distributin Comp nles which also distribute district heating; and

(c) Research Institutese,SEP subsidiaries.

3.09 The latest decision is that the Czech government owns CZZ and that the Slovak government owns SEP. The responsibilities of the federal government are confined to general policy matters. These recent developments may threaten to separate the integrated system into two parts that could lead to uncoordinated development plans. To ensure orderly development of the oector, during negotiations agreement was reached that CEZ will prepare, under jerms of reference satisfactory to the Bank. and furnish to the Bank and the Guarantor not later than October 15.-1992, a draft federal least cost investment program for the period 1993 through 2003, and afford the Bank and the Guarantor a reasonable onnortunity to exchange views with the Borrower on said least cost investment_rogram.

3.10 The distribution companies will build and operate tha transmission lines operating at less than 220 kV and the distribution networks. They will purchase power from CEZ or SEP (with some limited own generation) and resell it to the end-users.

3.11 In the Czech Republic most of the district heating systems are no longer the responsibility of CEZ but are operated as separate enterprises. CEZ is responsible for operation of the CHP stations and transmission of the hot water to local distribution networks. The heat energy is sold to the local District Heating Enterprise at the secondary heat exchanger situated at the local district level. The District Heating Enterprise then resells the energy to the end-users. The regional and municipally owned enterprises are responsible for smaller heat-producing units and distribution to the end- users. In the Slovak Republic, SEP has retained operating responsibility for the district heating systems.

3.12 CEZ and SEP are responsible for construction and operation of all generation and transmission facilities at the 400-kV and 220-kV level. Both companies operate a dispatching center for ensuring the use of the most economic capacity throughout the respective republic. A country-wide dispatching center, superimposed on the republic internal dispatching centers and owned by both companies, ensures the most economic use of capacity on a nationwide basis. - 16 -

C. Reaulatorv Framework

3.13 As in other market economies, there will be a need to regulate the natural monopolies which supply electricity, natural gas and district heating service to ensure that they do not abuse their monopoly position. The Pricing Law provides a legal basis for public utility regulation but specific legislation will be required to establish the jurisdictional scope of the regulating bodies; to define their authority and responsibilities; and to provide a legal foundation for their actions. However, public utility regulatory bodies have not been set up yet. As described in para. 2.24, Annex 2.3 describes the specific SAL conditionality on regulation of public utilities te begin to address these very important issues described in this section. A study, for which the Bank helped draft the terms of reference, of the public utility regulatory framework is being carried out. The study will be financed by the EEC with consultants beginning work in December 1991.

3.14 The four primary objectives of public utility economic regulation under study are:

- All investments in facilities are needed to serve the public interests and will be "used and useful" in public service.

- All expenditures are prudently incurred and are necessary to ensure that the quality of service is maintained.

- The tariffs for each customer category are reasonable and equitable; they promote economic efficiency; and no customer is unfairly discriminated against.

- Utility service is offered to all consumers who can be economically served.

3.15 The present study is evaluating options whereby the functions of the regulatory body would include the approval of tariffs; approval of construction of facilities; and ensuring the protection of the public health and safety. The regulatory body would monitor the activities of the public utilities to ensure that environmental laws and regulations are met. A standard system of financial accounts and periodic reporting procedures should be followed by all regulated public utilities.

3.16 The legal foundation for the institutional structure is planned to be established in the Public Utilities Regulation legislation (submission to Parliament is a condition of SAL third tranche release). Sep4rate &gulatory bodies are presently being considered by the Czech Republic and the Slovak Republic, each to eventually be responsible for tariff approval and other regalatory activities within their respective republics. The draft federal energy policy (prepared in October 1991) calls for development of an independent system for regulating the suppliers of electricity at the federal, republic, and regional level. The Bank has provided guidelines for a structure which would delegate primary responsibilities for tariff approval - 17 -

and regulation to the republics while the federal government would retain responsibility for matters affecting the national interest.

D. Existing Electric Power aaciltiesand Operations

3.17 The CSFR bulk power system is serviced by the two main electric utilities, CEZ and SEP. A small fraction of the generating system belongs to industries whose plant generates for their own consumption and who Bell any surplus to the system. A detailed list of power plants in the Czech and Slovak Republics is shown in Annex 3.4.

3.18 The CEZ generating system comprises plant totalling about 13,350 MW. Of this about 10,170 MW is based on fossil fuels, 1359 MW on hydro, and 1760 MW on nuclear plants. The main coal power plants are concentrated in the North Bohemia region. The hydro component of CEZ comprises plants at Dales4.ce (450 MW), Orlin (364 MW), and other smaller stations below 150 MW each. Although the hydro capacity represents about 10% of total CEZ capacity, its energy contribution is about 2.6%, indicating that hydro plants operate mostly for peaking service. CEZ has also in operation the nuclear power plant Dukovany with 4x440 MW units. This plant, of the VVER 440, model V213, was commissioned in 1983-87. The nuclear capacity, which represents about 13% of total, generates about 21% of electric energy since it is base-loaded.

3.19 The SEP generating system consists of about 5,600 MW of installed capacity. of this, 2,200 MW is generated from fossil fuel plants, 1,655 MW from hydro, and 1,760 MW from nuclear power plants. The major fossil fuel plants are Vojany 1 and 2 and Novaky A and B. At Vojany 1, 6xllO MW units operate on coal while at Vojany 2, 6xllO MW units have been converted to gas- burning boilers. Because of the high fuel cost, these latter units are usually kept in reserve and are only turned on when inversion conditions in northern Bohemia force the operators to shut down some of the worst polluting units in that region. The hydro component comprises a large number of small plantB that make about 8.5% contribution to total generation. The nuclear component consists of the 4x440 MW units (type VVER 440) at Bohunice, that make up about 21.4% of total SEP capacity. These units are base-loaded and contribute about 40% of SEP's total generation.

3.20 In addition to CEZ and SEP, there exist about 2000 MW of industrial own generating capacity in the Czech, and about 800 MW in the Slovak Republic. Their energy contributions to the systems are about 1% in the Czech, and about 9% in the Slovak Republic.

3.21 The CEZ and SEP transmission systems comprise all transmission lines and substations above 110 kV. They are extensive systems that were developed over many years. The 400-kV level was recently introduced to the system and a conversion of the existing 220-kV level to 400/110-kV is proceeding. The country's transmission network has a length of 17,959 km and consists of 4,010 km of 400-kV lines, 2,429 km of 220-kV lines and 11,520 km of 110-kV lines. The 400-kV and 220-kV installations belong to CEZ and SEP, the 110-kV network is considered part of the distribution facilities and belongs to the Power Distribution Companies. - 18 -

3.22 Two nuclear plants are at present under construction: 2xlOOO MW at Temelin in the Czech Republic and 4x440 MW at Mochovce in Slovakia (para. 3.44). Both plants are of Soviet design. Tho Czechoslovak authorities recognize the shortcomings of the Soviet-type reactors and are taking steps to bring the two plants up to Western technology safety standards. As a first step, CEZ has commissioned a detailed safety audit of the Temelin plant by international consultants to define the improvements required to bring the plant in line with Western safety practices. (This study is to be financed under the consultancy and training portion of the proposeciloan.) The Slovak utility, SEP, is expected to carry out a similar exercise in relation to the Mochovce plant. SEP is also preparing a plan to decommission two of the Bohunice units that have been identified as having safety problems. The Czechoslovak authorities had planned earlier additional nuclear capacity: two additional 1000-MW units at Temelin and new power plants at other unidentified sites. These plants are no longer included in the integrated CSFR investment program because of the forecast slow demand growth attributable to changed economic conditions in the country, the clear perception of deficiencies in the Soviet-designed reactors, and the heightened awareness that pressing issues, such as safety upgrade.,,plant decommissioning and radioactive waste disposal: must be given higher priority. Based on the above, it i3 clear that the Czechoslovak authorities are serious about confronting and resolving the complex safety issues of their nuclear power program. In recent years, the Czechoslovak nuclear authorities have been in frequent contact with IAEA to tap the agency'B technical expertise in helping evaluate the safety needs of Temelin and other CSFR nuclear installations. A report on "Pre-operational Safety of the Nuclear Installations - Temelin Nuclear Power Plant" was issued by IAEA in November 1990. The ongoing comprehensive Temelin safety audit (para. 3.44) is in line with the recomnendations of the IAEA report. In addition, the operational safety of Dukovany nuclear power station iB being greatly enhanced through retrofitting with modern, state-of-the-art monitoring and control instrumentation imported from Germany. Moreover, twinning arrangement are being made with Electricite de France (EDF) and German and Spanish nuclear capable utilities in an effort to secure quick transfer of operational and maintenance know-how.

E. Coal Use and Environmental Impacts

3.23 The Czechoslovak electr'c power system is heavily dependent on the uae of coal for energy generation. In 1989, 12,347 MW out of a total of 19,227 MW (i.e., 64%) was steam thermal plant burning coal. In terms of generated energy, 50,452 GWh (i.e., 56%) was generated by coal. A small quantity of hard coal with a calorific value of about 24.0 GJ/ ' and an average sulfur content of 0.7% is also used in power. Overall, in 1989, about 40 million tons of lignite and about 3.0 million tons of hard coal were used in power generation.

3.24 Nearly the same amount of lignite, 36 million tons, is used for heat generation all over the country. Of total about 76 million tons, 75% is burned in the northern Bohemia region. Up to now, flue gas desulfurization (FGD) has been tried at two plants in northern Bohemia: Tisova and Tusimice. At Tisova; an ineffective (40% S02 removal rating), second-hand FGD installation - 19 - imported from Germany is in partial operation. TI. Tusimice installation is based on MgO Soviet technology and has never operated satisfactorily. In spite of repeated attempts to make it wcrk, it is unlikely that this FGD will ever be economically operated. In addition to the FGD installations proposed for Prunerov II under the project, CEZ iB retrofitting one of the five 200-MW Pocerady units with modern FGD as part of its ongoing pollution control program (see para. 3.30 and Annex 3.2). At present, therefore, nearly all of the S02, as well as the NOx generated by the lignite, is emitted tc the environment together with large amounts of fly-ash resulting from obsolete electrostatic precipitators (ESPs). The total nationwide emission of S02 is estimated to be 2.67 million tons for the year 1990, of which 1.73 is generated by power plants larger than 5 MW. The emission of NOX is estimated to 1/4 - 1/3 of the sulfur oxides and the emission of fly-ash is calculated to be around 1.15 million tons.

3.25 Following the end of the World War II, the government decided to use the indigenous energy resources, consisting mainly of lignite deposited in the northern part of North Bohemia, to meet the increasing energy demand. The excavation of available lignite increased from about 28 million tons/yr by the year 1950 to more than 100 million tons/yr by the year 1985, and has s4 'ce then dropped to about 76 million tons/yr. To reduce the transportation of the lignite, the power plants were erected close to the mines. The heavy concentration of power plants burning lignite in a very small area has resulted in an envirormentally disastrous situation, with adverse consequences on the local population's health and living conditions. The location of the lart3st S02 emission sources in CSFR (in Annex 3.5) shows the large concentration of power plants in the coal-mine basin in North Bohemia.

3.26 The large increase in the use of lignite of relatively high sulfur content (1.8-2.5%) has resulted in the highest specific emission of S02 /person in Europe, which, for Czechoslovakia, is 179 kg/person. The emission of 502 per capita in the northern Bohemia region is more than 1900 kg/person, which is more than 10 times higher than for the rest of the country. The emission of dust for the whole country is 77 kg/person and in this region 550 kg/person. The environmental impact can be summarized as follows:

- The emission of S02 was 2.67 million tons in 1990. Of this 36.1%, or 0.96 million tons, are gene-ated in northern Bohemia. Expressed as tons per km2 per year the figure, for Czechoslovakia is 22.7 aAld for northern Bohemia, 113.4.

- The emission of 1.15 million tons of dust during 1990, of which 24% or 0.28 million tons are generated ir,northern Bohemia.

- The topographical situation in the mining district in northern Bohemia creates extreme meteorological conditions; e.g., in some towns during the winter season, there is little or no wind for about 50% of the time. This, combined with strong inversion, results in very high concentrations of S02 in the air. In towns like Teplice and Litvinov, concenLrations up to 2600 pg/m3 have been recorded. In the winter of 1988, Teplice had a recorded average concentration 20 -

of over 1000 pg/m3 more than 10% of the time, a level that can cause large hoalth problem, specifically for sensitive persons.

- The effect on the population hae during the last decades resulted in an increased sickneEs and mortality in some population groups in some areas, particularly for men in their economically most productive ages. Contrary to most European countries, the mortality rate for cardio-vascular and oncological deceases has increased, specifically in the mining region. Northern Bohemia has the lowest average life expectancy in CSFR, for both men and women. It also has the highest figures for missed workdays and illnesses of the respiratory system. During inveraion conditions, the air quality becomes so toxic that sick and old people cannot survive. The concentration of S02 in the ambient air reaches, under the worst inversion conditions, lethal levels. Peak pollution during times of atmospheric inversion cause the most severe health problems. In addition to overall reduction of SO2, steps should be taken (e.g., stockpiling and use of high-quality coal) to reduce peak pollution problems. Bv December 31. 1992. CEZ aareed to preyare an action plan. includina targets. satisfactory to the Bank to deal with the remainina peak pollution prcblem. Also the action plan shall include an appropriate monitoring system: and _:EZ and che Bank will annually review (on April 1 of each year. starting April 1. 1994) the results of the monitoring system and the agreed recommendations for improvements will ba implemented.

- According to a survey organized by the U.N. Economic Commission for Europe in 1988, a total of 70.5% of the forests in Czechoslevakia are damaged, of which 5.4% re classified as "dying' and 22% as "medium damaged". The mopt zsuere damage is located in East and North Bohemia and North Moravia, where large areas have been completely deforested and the total figure for damaged, dying and dead forest is between 96-100%. The main reasons are the extremely low pH-value in the soil caused by the deposits of SO2 and the emission of fly-ash. A more detailed review of the health situation and the forest damages in the mining districts is presented in Annex 3.5, which also includes a discussion of ambient air quality in the surroundings of EPK Tusimice (including Prunerov plants).

3.27 The necessity to reduce the air pollution related to S02 and duat emiW.sons is obvious to both the power-generating companies and the environmental authorities in Czechoslovakia.

3.28 The current situat"n gives rise to great concern for the health status and the environmental ..4amagesin CSFR and particularly for northern Bohemia. Total S02 and fly-ash emissions in 1990 were about the same as recorded during 1988. See Table 3.1 belowt - 21

Table 3.1:. 990 ESTIMATED TOTAL POLLUANT EXSSIONS IN CSFR

Particula tes Tons/v6 _ Tons/lyr _i

Czech Republic 2,065,800 77.3 840 300 73.4 of which N. Bohermia 964,080 36.1 275, 071 24.0 Slovak Republic Q605,800Q _2L2.7 304,400 26.6

Total CSFR 2,671,600 100.0 1,144,700 100.0

3.29 The Czech and Slovak Federal Republic authorities are committed to reduce the emission of SO2 and fly-ash. The proposed project is urgently required and is part of a program to retire or retrofit plants in this region.

3.30 CEZ currently has an installed capacity of 10,170 MW, of which 1952 MW would be reduced by retirement of whole plants or certain boilers, and another 4,500-5,000 MW will be equipped with flue gas desulfurizatioll equipment in accordance with the program. The result of the planned program will be that about 19% of the current installed capacity will be retired and about 45-50% will be retrofitted with FGD and other environmental protection equipment. With an expected efficiency of more than 90% SO2 reduction, the program will reduce the SO2 emission from CEZ operated plants by about 50%. The total SO2 from the CEZ operated plants is estimated to be more than 1200 ktons/yr. The program will achieve a reductlon of more than 600 ktona/yr.

3.31 The Bank has reviewed this program, which needs to be confirmed through the ongoing least-cost investment study. Some plants date from the 1950s and the 1960s and will need to be closed down; it is not, therefore, worthwhile to spend large sums on environmental control for such plants. Others are relatively new and burn low-cost lignite and will definitely not be affected by the conclusions of the least-cost study. Prunerov II, the plant included in the project, is one of those plants.

3.32 The FGDs and ESPs at Prunerov 1I, part of the proposed project, will result in a reduction of 190,000 tons of S02 and about 36,000 tons of fly-ash per year. The project will also include measures to improve plant thermal efficiency at Prunerov II and other large CEZ plants to reduce consumption of lignite. Consequently, the emission of SO2 and f3y-ash will be reduced by an additional 28,000 - 45,000 tons of SO2 and around 3,000 tons of fly-ash per year. An a whole, the project will contribute with about 35-40% of the intended SO2 reduction and about 10% of the fly-ash reduction in the heavily polluted northern Bohemia region. - 22 -

F. Electricity Demand and Demand Manageient

3.33 During the ten years 1979-89, electricity demand under the command economy system grew at about 3% per year. The growth rate of small consumers, particularly households, was significantly higher, at about 4.5% per year, while large consumers such as industry, who account for the bulk of electricity consumption, increased their purchases only at about 2.5% p.a., Annex 3.6. As a consequence, by 1989 small consumers had increased their share of total final electricity consumption (excluding electricity consumers within the energy-producing sector) to about 30%, of which almost 20% was accounted for by households. Much of this vigorous growth in the household sector is attributable to the spread of night-storage heating encouraged by low tariffs. The industrial sector retains by far the largest share of electricity consumption: it amounts to about 60% of final consumption, and (together with the energy industry) to almost 70% of electricity delivered to all users.

3.34 Until 1990, industrial electricity use was determined by the output requirements of the planned economy, projected according to input- output relationships. Although the tariff structure was designed rationally to reflect different costs at different times, price was not a tool of demsand management. On the other hand, households responded to the incentive of low off-peak tariffs in the establishment of storage heating: during the 1980s, sales at the low night tariff grew at about 6% p.a. The change in household consumption patterns had a significant effect in many urban locations, and became virible in the daily system load curve by creating new peak times in previously off-peak periods such as winter nights (Annex 3.6). As a result, the load curve has lost its pronounced peaks, and the winter difference between daily minimum and maximum load is about 2,000 MW out of a 13,000 MW peak demand. Seasonality is an important demand feature, and winter demand levels lie about 2,000 MWabove summer ones: on an annual basis, therefore, there is a 4,000 MW difference between the summer minimum and the winter maximum.

3.35 The relatively flat load curve within each season makes it necessary to control the potential shifting of peak periods through more direct means than price alone. Low off-peak tariffs are now associated with remote-control switching-off of appliances such as storage heating, to be triggered at the times when more costly generating plant enters into operation. As tariffs rise over time in real terms, both demand management tools will be effective instruments to flatten tne load curve. Initial evidence in 1991 already indicates that industrial consumers are reacting to the significantly increased industrial tariff levels by shifting some of their consumption to shoulder and off-peak periods.

3.36 Projections for future demand development are based on a radical break with past growth patterns. The transformation of the economy to a market-oriented one implies a strong decline in the output of lheavy industry, and an overall GDP decrease for several years, followed by a gradual economic recovery based on a different industrial structure. Although household - 23 electricity consumption iB expected to show continued growth as residential consumers switch out of poor-quality lignite for home heating, the dominant effect of the economic slowdown and industrial decline is likely to be a slump in overall electricity aales, Annex_3.7. As the pace of the economic decline and revival is uncertain, the power utilities are assuming high and low scenarios of electricity demand development: the high scenario expects a shallow recession, with recovery beginning in 1994. In the low scenario, the recession is deeper. Total electricity consumption in 1995 is projected to still be well below the peak 1989 level, with industry showing a decline in consumption of 15-30%. After 1995, the economic recovery is expected to lead to a renewed power demand growth of about 2% p.a., resulting in a total requirement of 87-100 TWhi in the year 2000, compared to 92 TWh in 1989.

G. Electric Power Investment Proaram

3.3. Investment program scenarios for the borrower, CEZ, outlining their proposed plane in each of the years 1992-2000 are presented in Annex 3.8. Whereas the individual enterprises (CEZ, SEP and the Power Distribution Companies) prepare their investment programs independently, the Federal Ministry of Economy (FME) prepares a strategic development plan for the power sub-sector. This plan integrates the individual plans taking also into cOnsideration broader issues of the expected rate of economic growth in the country, availability of financial resources, management capabilities, and environmental requirements. A thorough optimization of the system investment program will be conducted under the ongoing least-cost investment study.

3.38 For a rational choice of the optimal system development strategy, alternative investment sequences will be carefully costed, using capital and variable costs that reflect international price levels for equipment and fuels, and compared to obtain a least-cost sequence of system investments. This sequence, calculated on a discounted cash flow basis with shadow-priced economic costs, should be consistent with (i) a realistic demand forecast, which takes into account the probable decline of energy-intensive industrial output in the CSFR and the uncertainty involved; (ii) the new pricing regime that will depress demand for electricity and heat; (iii) system operation requirements to meet loads and sales commitments reliably; and (iv) applicable new limits for emissions of pollutants.

3.39 The choice of a least-cost system development sequence for the CEZ/SEP grid will, in turn, influence the decision on the future of the steam coal mining industry, depending on the optimal fuel mix in the system. Rather than starting from a decision to phase out lignite mining (forcing a retirement of coal-fired plant), the analysis should arrive at a conclusion about lignite only after a thorough cost comparison on how to satisfy projected demand under strict environmental requirements.

3.40 In this system optimization exercise, load forecasts will be firmed up using modern methodologies. A least-cost development program which will consider all viable options, including increased end-use efficiency and combined cycle plants using imported natural gas, will be developed with up- to-date analytical tools. Use of imported natural gas for power generation as - 24 - a long-term alternative to expanding nuclear capacity would be explored on economic grounds in line with the acknowledged need for diversification of energy supplies and the need for flexible expansion options to meet uncertain demand.

3.41 The environmental improvement requirements are large, and can be met only gradually, and after examination of the economically optimal way of doing so. Although international agreements call for the reduction of S02 emissions (from the current 1.2 million tons p.a.) by 30% by 1993, even radical measures would reduce 502 output of the power syetem only to just under 1 million tons by 1995. Where economically justifiable, existing coal- fired power stations should be rehabilitated and retrofitted with flue gas desulfurization (FGD) equipment to conform with environmental protection regulations. In this regard, options such as conversion of existing boilers to gas firing and substitution of poor quality local coal with higher quality imported coal (or blended coal) should be explored and compared to the continuing use of lignite. In the case of Prunerov II (the plant selected for the project) these options were explored, and FGD retrofitting is the clear economic choice (para. 7.07). A decision to move to a high share of nuclear generation should only be taken if it is demonstrated to be the least-cost option for reducing emissions and satisfying future demand.

3.42 A related issue is the justification of expanding district heating through the conversion of existing coal-fired power plants to supply bulk heating. Further economic analysis should ascertain the economic merit of the proposed district heating as compared with an increase of natural gas use for production of heat at local boiler plants, or for direct distribution of piped gas to individual residential consumers. To the extent that additional supplies of natural gas become available from the former USSR, Western Europe, etc., this option may well result in a reduced rate of power station conversion and a lower need for additions to district heating capacity during the present decade.

3.43 The total currently planned CEZ investment in the period 1992-2000 is about Kcs 180 billion (US$6.4 billion), with the major categories of investments shown in Annex 3.8. The phasing of the investment depends on (a) the pace of demand development, and (b) the potential for exporting temporary surpluses. Both size of investment program and phasing are subject to confirmation following the ongoing least-cost investment study. Preliminary capacity balance estimates (Annex 3.8) indicate more than adequace capacity margins throughout the 1990s (although the current CEZ definition of "installed capacity" covers significantly more than actually available capacity). In energy (kWh) terms, the margin may be less comfortable. If domestic demand development will take place about midway between the two forecasting scenarios, major new capacity additions such as the Temelin nuclear plant can be delayed by several years, unless firm export contracts for the mid-1990. can be entered into. In the low-demand scenario, a delay of Temelin commissioning may postpone the need for new capacity immediately after the year 2000, thus reducing the CEZ investment expenditure 1992-2000 to about Kcs 165 billion (USS5.9 billion). - 25 -

3.44 Completion of Nuclear Plants. The completion of well advanced nuclear plants is one of the largest parts of the overall investment. Under the CEZ and SEP investment programs, two power plants, one at Temelin (2x1000 MW) and one at Mochovce (4x440 MW) are to be completed (Annex 3.9). The program is examined in terms of incremental expenditures, since the sunk cost can be ignored in economic terms in the situation of a complete re-appraisal of the program. Costs need to be re-estimated due to price and excihange rate distortions in the past, and special arrangements within CMEA. The estimated incremental costs for the Temelin plant are equivalent to a unit price of about US$900-1,000/kW, as the plant is at an advanced stage of implementation, with the first unit 60% and the second unit about 40% complete. The incremental capital cost is higher than the cost of alternative (e.g., gas- fired) capacity, but implies a total cost of only about US¢ 3.2/kWh, well below the gas option. The Mochovce plant consists of 4x440 MW units of Soviet design. Incremental cost for the four units are about Kcs 29 billion, or US$1 billion, which correspond to US5500-600/kW. The plant is at an advanced stage of construction with commissioning possible in 1992-95. A decision to complete the plant is pending. A comprehensive safety audit being carried out by CEZ will help determine the desirability to complete the Temelin plant as originally planned (see para. 3.22).

3.45 Hydro Development. The total share of hydro development represents about 10% of the overall CSFR investment proQram, and about 1-2% of the CEZ program. The plan includes the development of three major hydro plants: Dlouhe Strane, 650 Ml in 1995; Gabcikovo, 2x360 MW in 1993-94; and Zilina, 2x44 MW in 1998-99. It also foresees the development of a number of small hydro plants of a total capacity of 30 MW. The Dlouhe Strane project (600 MW) is well advanced and commissioning is expected in 1995. The Gabcikovo project has been caught in a bitter dispute with Hunaary on environmental grounds but is well advanced on the Slovak side and is likely to be completed in 1995. The remaining planned hydro projects need to be evaluated in the framework of the overall least-cost study to determine the need for this capacity.

H. Electricity Pricing

3.46 The retail electricity tariff structure is complex (see para. 4.07). While the structure of moat tariff categories reflects the costs of supply in different pricing periods, tariff levels until 1990 did not keep up with costs. Tariffs for industrial and other large consumers increased only slowly, and the tariffs for households and other small consumers remained constant in nominal terms since 1981, a decline in real terms. The tariff levels for high-voltage and low-voltage consumers were about equ&l, a feature that did not reflect the cost structure. This distortion worsened in the price adjustments of December 1990 and April 1991, as industrial tariffs were increased by 180%, but residential tariffs were left unchanged. The :.ncreases of residential tariffs in October 1991 by 70% have diminished the gap, but have not yet reversed the distortion: the new industrial tariffs of about US¢ 5/kWh now compare to residential tariffs of about US¢ 3/kwh. See Annex3.10U. - 26 -

3.47 P-aliminary estimates of the long-run marginal cost (LRMC) of electricity supply indicate that high-voltage consumers impose a marginal cost of about USt 4-5/kWh on the system, a level which has been reached by recent tariff increases. on the other hand, household and other small consumers incur an LRMC of about US¢ 6/kWh, a level about double the present tariff. Major tariff increases for umall and low-voltage consumers will be necessary to approach marginal costs even slowly. This issue is being addressed under the SAL pricing action plan (see para. 2.23). Annex 3.11 summarizes the LRMC estimates, and Annex 3.12 illustrates costs and prices of coal.

I. Rationale for Bank Involvement

3.48 The Bank's overall objectives in Czechoslovakia are to support the transformation to a market economy, increase efficiency, and improve the environment. The SAL supports these objectives, as does this first Bank investment project. The Bank's objectives in energy and environment is to introduce principles of efficiency and economy that were not used in past years under a centrally controlled economy; to reduce pollution and improve public health; to rationalize the investment program under conditions of decreasing or flat demand; to introduce financial profitability, accountability, financial autonomy, and responsibility; to raise the level of cr,ability at the management and technical levels by introducing modern methodologies and technologies; to support government privatization plans; and to diversify and increase reliability of energy supplies. This project supports these objectives, and in particular, the immediate need to rehabilitate and modernize power plants by using technologies that improve efficiency on the very poor environmental situation in northern Bohemia, which is causing Berious health problems in the local population and severe environmental degradation. Also, the transmission component of the project facilitates exchanges of electricity with neighboring countries, thereby satisfying Bank objectives by bringing higher reliability and lower cost to the interconnected system of Central Europe.

3.49 The general movement toward market oriented economiks is expected to affect the energy sector in much the same way as other areas of trade and technology exchange. Currently, the CEE countries have a significant dependence on imports of energy from the Soviet Union. While this dependency is most significant in terms of raw energy, in the form of coal, oil and gas, there is a considerable dependency upon the Soviet Union for electricity imports. This is reflected in the numerous ties, at 750,400- and 220-kV, from the southern Soviet system to Bulgaria, Czechoslovakia, Hungary, Romania, and Poland. Ties from the west, on the other hand, are limited to one HVDC tie between Austria and Czechoslovakia and several AC ties to electrically isolated areas. While limited cooperation already takes place between the CEE and Western European (UCPTE) electrical systems, the political climate now allows a more comprehensive assessment and consideration of a greater degree of interconnection along with associated benefits to all parties. The CEE countries (especially Hungary, Czechoslovakia and Poland) are in a geographically strategic position relative to an increase in electrical energy traIe between themselves, the former USSR and the western systems. Consequently, the strengthening of interconnections, specifically to the West, - 27 - could have a considsrable and positive impact on health in both the CEE countries and the Southern former USSR energy sector. This could make a significant contribution to the continuing success of the reform processes. Furthermore, the opportunities for wheeling are a potential source of foreign exchange, albeit possibly in kind. A pre-requisite of strengthened transmission ties to UCPTE is that of improved power quality and reliability in the CEE systems. This is the near-term challenge; one of modernizing the central and eastern European supply to the point where large-scale cooperation with the weBtern systems will be practicable. A comprehensive study on East- West electric power interconnection and trade has been proposed by the Bank and others under the auspices of the Central and Eastern Europe Network for Regional Energy (CEENERGY).

J. Bank Activities in the Energy ector

3.50 The Bank is in a unique position, based on experience elsewhere, to assist CSFR develop a comprehensive energy strategy. To this end, the Bank began its involvement in the energy sector in August 1990 (as described in para. 1.08) and has discussed and reviewed with the government the Bank's report on thf CSFR Energy Sector, Report No. 9768-CS (Gray Cover finalized in January 1992). Moreover, the Bank can play a catalytic role in helping CSFR integrate its energy system with those of Western Europe and in attracting private sector participation. The Czech and Slovak Federal Republic rejoined the Bretton Woods institutions in September 1990. The first operation from these institutions was the 14-month IMF standby of SDR 620 million and financing under the CCFF for SDR 484 million. A Structural Adjustment Loan of US$450 million was also approved in 1990. Energy policy conditionality, relating to energy pricing and regulatory policy, is a prominent part of the SAL. Several energy studies have been agreed upon by the government, and are planned to go ahead under grant financing. These include: (a) Comprehensive Energy Study, (b) Regulatory and Institutional Reform of Power and Gas Sub- sector, (c) Least-Cost Power Expansion Plan, and Long-Run Marginal Cost, (d) Coal Sub-sector Restructuring, and (e) Gas and Oil Storage.

3.51 This proposed project is the first energy (and first investment) project for CSFR, but it is seen as the first of a number of operations in this sector covering both the Czech and Slovak Republics. The proposed project comprises a number of high-priority investments, mainly environmental in nature, that are ready to go ahead at this time. Other investment proposals, notably projects in the gas sub-sector and for the Slovak power sector, are under preparation. These will be brought forward as soon as they are ready. The coal and petroleum sub-sect.rs may be the focus of future energy loans, but certain questions must be first resolved, regarding the implementation procedures under the Large Scale Privatization Law and feasibility studies to resolve technical, environmental and other cyuestions. - 28

IV. THB ORROWER

4.01 The Borrower for the proposed Bank loan will be Czech Power Enterprise (CEZ). The objectives, functions, organization and managemenit of the borrower are summarized below.

4.02 Before July 1, 1990 CEZ was solely responsible for the supply of public electricity throughout Czech Republic. CEZ was also responsible for supplying district heating in Prague and northern Bohemia. In addition, the CEZ corporate organization also included related research, manufacturing and construction activities. After July 1, 1990 CEZ statutory responsibilities were altered to include mainly construction and operation of power plants and 400-kV and 220-kV transmission lines and substations. Sub-transmission, distribution activities and district heating were transferred to separate independent enterprises with the exception of three co-generation power plants which continue to supply district heating.

4.03 CEZ, an independent state-owned enterprise, has wide autonomy in its operational, financial and managerial decisions. Its management is free to hire and fire personnel, to approve annual budget and investment plans, and to decide on imports and on domestic borrowing. The supervising agency of CEZ is the Department of Electricity in the Ministry of Economic and Development of the Czech Republic; while it does not interfere witn the company's day-to-day operation, it appoints the General Director. It also approves the year end accounts and, should needs arise, acts as mediator in disputes between CEZ and other energy enterprises such as distribution companies. In addition, the ministry reserves the right to approve CEZ's foreign borrowings.

4.04 By the end of 1991, CEZ staff numbered just over 31,000. If the restructuring and privatization program including the separation of CEZ's non- electric generation activities will be implemented over next 3-4 years, then the number of employees will be reduced to about 20,000. CEZ is currently managed by a General Director assisted by four Deputy Directors, one each for Generation and Transmission; Development; Economics and Trade; and Personnel and Social Development. The present organization chart of CEZ is shown in Annex 4.1. While CEZ's staff can carry out their tasks competently and efficiently in the technical field, there is a definite need for improvement in the field of corporate policy development, financial management, planning, accounting, and personnel administration (including remuneration policies). The need for improvements in these fields can be traced directly to the absence of a market economy and lack of business-oriented management during the previous decades.

4.05 Until recently, in CSFR, financial information was neither kept nor disclosed on the basis of generally accepted accounting standards; basic information derived from conceptually different accounting systems which have been in existence in the country for decades. While a substantial amount of information was collected according to the requirements of various local, state, or federal regulations, there has been less emphasis on developing a basis for management decisions; for budget preparation and control; for general performance analysis, and those of cost and profit centers; for financial planning; and for fund flow and working capital management. In addition, as accounting and financial functions are spread among various units - 29 - within CEZ, coordination botween these units need to be otrengthened within a framework of comprehensive corporate plan. Also, internal audit is limited both in scope and content, and needs considerable strengthening (also see paras. 6.01 and 6.02). Recognizing this need, the management of CEZ has agreed that an appropriate action program should be undertaken to improve the accounting and financial management system. Conceptual Terms of Reference (Annex 4.2) have been agreed upon and the work will be undertaken in three phases with the assistance of consultants acceptable to the Bank. Phase I will include a diagnostic study with the objective of identifying and recommending necessary actions for appropriate changes in the organization of accounting and management functions, and of improving the accountina and financial management information system. In Phase 1I the recommendations will be reviewed with the Bank and, for the agreed recommendations, an implementation plan will be prepared and will include the necessary training and human resource development program. Phase III will be the actual implementation of the agreed program. In particular, the work would cover: general and cost accounting; capital and operating budgets; budget control and analysis; development of coot and profit centers; short- and medium-term financial planning; revenue and expenditure forecasts; cashflow and working capital management; project evaluation; fixed assets management; and internal audit and control. To address these areas, during loan negotiations. agreement was reached that CEZ will carry out a diagnostic studv to: (a) identify, evaluate and recommend measures to strengthen the companv's financial manaaement caDabilitv including imRrovements to the Management Information System and staff training: (b) develop an action plan for the implementation of the recommended measures and present this plan not later than March 31. 1993 for Bank review and comments: and (c) thereafter, taking into account Bank comments. commence implementing the Plan. In addition. it was agreed that not later than January 1. 1993. CEZ will establish an internal audit section with oraanization. human and financial resources and terms of reference, all accentable to the Bank.

4.06 Most of the electricity that CEZ generates is sold to distribution companies and SEP on the basis of annually negotiated contracts. The annual contracts set the bulk tariffs, inter alia, on the basis of the demand, production costs, production mix, and investment needs.

4.07 Retail tariffs of electricity in CSFR are controlled by the federal government. The structure is complex and includes about 30 categories, many with multi-part characters. Tariffs generally are designed to provide signals to consumers about different costs incurred at different periods of operation, distinguishing between peak, shoulder and off-peak periods. These periods are defined in terms of time of day as well as the seaeon to coincide with the plant merit order in the load duration curve. Due both to changes in the market during the last few years and to lack of appropriate tariff actions, some of the tariff categories may not correspond to the cost differences incurred. Also, tariff levels may not have kept up with costs and increasing distortions developed between residential and industrial tariffs. The need to diminish the distortion and to update the tariff structure to bring it in line with costs is evident. A Tariff and Marginal Cout Study, together with an Action Program to implement the findings of the study, is to be undertaken under the SAL (para. 2.23). 30 -

4.08 With the current contractual arrangements, the distribution companies retain about 20%-30% of the total retail revenues and about 70%-80% is received by the generating and transmission company, CEZ. In order to safeguard the financial viability of CEZ aareement was reached drina loan neaotiationB that CEZ will: (i) furnish to the Bank. not later than November 1 each year,the terms and conditions on which it pro oses to supl.l electricity to the distribution companies and to larae consumers and which are desianed to achieve optimal utilization of CEZ's supplv fucilities: (ii) aive the Bank reasonable o=portunity to exchange views regarding the mentioned terms and conditions: and-Liii) take all the necessary measures within its nower, to conclude sunplv contracts with the distribution companies and with the large consumers. takina into account the Bank's comments. Also, during loan negotiations agreement was reached with the Federal Government that it will take all measures, as mav be required within its power to enable CEZ to carry out the project and to comply with its other obligations under the Loan Aareement. - 31 -

V. THE PROJECT

A. Proiect Obiective and ScoDe

5.01 The objectivesof the project are to improvepower plant efficiency;to reduce air pollution in northern Bohemia, and thereby improve the environmentand health of the local population;to modernize the transmissionsystem; and to facilitate interconnectionof the CEZ and German power grids. These objectiveswill be accomplishedin the context of overall reform of the energy sector. To this end, the project will: (a) reduce total consumptionof pollution-causinglignite through power plant efficiency improvements;(b) curtail power plant SO2 emissionsby means of flue gas desulfurization;(c) reduce dust and fly-ash pollution from power plants; (d) increase the reliability,efficiency, and economy of the CEZ transmission system; and te) assist in improviniginvestment planning and corporate management and organization.

B. Project Description

5.02 The proposed project includes: (a) installationof equipmentand operationalimprovements at Prunerov II power station and other large CEZ power plants to reduce lignite consumption;(b) installationof flue gas desulfurizationequipment (FGD) at Prunerov II; (c) improvementsand equipment for dust collection,i.e., electrostaticprecipitators at the worst polluting CEZ power plants; (d) modernizationof five 400-kV substationsand constructionof a short 400-kV transmissionline; and (e) consultingservices and staff training. The componentsof the project are described in more detail below (and their location is shown in Maps IBRD 23371R and 23372R):

(i) Plant EfficiencyImprovement

5.03 Through a recent study on "NecessaryMeasures for Future Mitigation of SO2 Emissions"from the power plants in CSFR, it has been establishedthat by means of small changes in operatingpractices and installationof measuring devices, it is possible to increase the plants' thermal efficiency and thereby reduce both the consumptionof lignite and the emission of SO2. CEZ has already started a program for this purpose. A calculationmade for the larger units, between 100-500 MW, shows that the lignite savings could be estimatedat 1.2 to 1.9 million tons/year.

5.04 The measures mentioned above will be supportedunder the project by additional actions that are also aimed, directly or indirectly,cr control pollution,namely: (i) the addition of equipment to measure the actual oxygen content in the flue gases by installationof measuring devices; (ii) the reduction of the air pre-heaterleakage by improved mainteranceand by applying an improved central sealing system; (iii) the sealing of boilers, flue gas ducts and the ESP casing; (iv) the training and educationof the power plant staff; (v) the installationof fine grinding and pre-drying equipment for the lignite; (vi) the optimizationof the start-up and shut-down operation;and (vii) improvementof net heat rate of the power station through reduced internalpower consumption. (The current CEZ program for environmentalimprovement does include installationof DENOX system, exchange to low-NO,burners.) The costs associatedwith items (i)-(iii)and (v)-(vii) - 32 -

are included under this subcomponent of the project. See Annex 5.3. Item (iL) will be included in subcomponent D - Training and Consulting (see Table 5.1). The project will provide special monitoring equipment and training both in CSFR and abroad for staff responsible for maintenance and operation of the power plants included in the project.

(ii) Flue Gae Desulfurization

5.05 Out of a total capacity of about 3790 MW planned by CEZ for retrofitting by 1999 (see para. 3.03) the project will finance a total of about 1050 MW at Prunerov II with state-of-the-art, high removal efficiency FGD systems (wet-limestone process). According to an independent consultant's report (referred to in para. 5.03), Prunerov II will achieve the lowest cost/ton of SO2 removal, lower than the rest of the plants in the FGD program, and is, therefore, being given the highest priority.

5.06 Prunerov II is the largest single source of SO2 emissions in CSFR. The fuel used at Prunerov II is lignite of low calorific value (10.5 GJ/ton) and high average sulfur content (1.7%). FGD retrofitting of Prunerov II is the least-cost option to meet the CSFR emission mitigation targets (para. 7.07).

5.07 At Prunerov II, five units rated 210 MW each will be retrofitted with wet limestone FGD. The net reduction of S02 emissions at Prunerov II is estimated at around 190,000 tons/yr. Based on the total S02 emission in CSFR recorded in 1990 (2.67 million tons), the installation of FGD covered by this project component will reduce emissions in CSFR by about 7%, and in relation to the Czech Republic by about 10%. In Northern Bohemia,the most polluted region in CSFR, the proposed FGD will reduce SO2 emissions by about 20%.

(iii) Dust Control

5.08 The project also includes plant retrofitting with new electrostatic precipitators (ESP) for effective dust control. This retrofitting will be done at power plants and combined heat and power (CHP) plants, which are not currently scheduled for retrofitting with FGD systems, as the FGD systems will indirectly reduce the fly-ash to an acceptable level. A total of about 1650 MW would be rehabilitated at the worst polluting units. Through this project component, dust emissions will be .-uced from 400-450 mg/Nm3 to 50-100 mg/Nm3 (milligrams per cubic meter of dry gases at normal conditions of temperature and pressure).

5.09 The project will finance ESP retrofitting of the following plants:

Pocerady Unit 1,2 and 6 3*200 MW Ledvice I 1 1*200 " Trebovice K13-14 2*161 " Prerov Kl-3 3* 82.5" Krnov " K3-5 3* 33.6' Olomouc K3-4 2* 42 " Frydec-Mistek " K1-2 2* 51 " - 33 -

(iv) Transmission System Improvement

5.10 An important part of CSFR's energy development program is strengthening of interconnections with neighboring countries to enhance electricity trade. Following the introduction of 400-kV high voltage transmission, CEZ is in the process of gradually eliminating the 220-kV network and enhancing its interconnections with neighboring countries. Given the reunification of Germany, the alternating current (AC) connection to the former East Germany will be discontinued, and a new interconnection will be established to Bavaria through an alternating current-to-direct current (AC/DC), back-to-back conversion station. The new interconnection will be the second tie-line to the UCPTE network. Along with the existing interconnection through Austria, it will facilitate further power exchanges, lower the cost of service, increase reliability of supply, and help establish a unified and competitive European market for electricity. Through this compcnent, the project will finance:

(a) construction of a 13.6 km sece.ionof 400-kV, double circuit transmission line, to loop the existing Chrast-Temelin line into the Prestice substation; and

(b) modernization of five existing substations to reduce losses. The work includes installation of new 3¢O-MVA, 400/110-kV power transformers and associate- switchgear and protection and control equipment at each of the following substations: Prestice, Sokolnice, Prosenice, Cechy Stred, ard Bezdecin.

(v) Train!.np& Consultancy

5.11 Although technical training at CEZ is extensive with a number of training schools, the level of training has not been kept abreast of the technological developments in industrialized nations. Therefore, training is needed in mode-n techniques of plant operation, maintenance, fuel eourcing, and purchasing. Training in modern finance, commercial, and planning techniques would require special emphasis owing to their long absence from CSFR under a centrally planned economy. Such training will be supported under the project. The project also includes about 35 manmontha of consultancy services to assist CEZ in carrying out a comprehensive safety audit at Temelin nuclear power station, under constructior - 34 -

C. Project_Cost and Financinc Plan

5.12 The total estimated cost, excluding initerestduring construction (IDC), is ITS $557.5 million equivalent (Kcs 15,609.2 million) as shown in Table 5.1.

TABLE5.1 CZECHOSLOV'AKIA POWERAND ENVIRONMENTALIMPROVEMENT PROJECT

SUMMARYPROJECT COST (October1591 constant prices)

KCS Mitlion USS Million --.-.-...---.-...... -...... LC FC Total LC FC Total A. PollutionControl Al. Prunerov11, FPD 3,836.0 3,136.0 6,972.0 137.0 112.0 249.0 A2. DustControl Instaltations 924.0 756.0 1,680.0 33.0 27.0 60.0 ------...... Subtotal 4,760.0 3,892.0 8,652.0 170.0 139.0 309.0 ...... - - -- ...... B. EfficiencyImprovement 81. Prunerov11 280.0 140.0 420.0 10.0 5.0 15.0 B2.Other Power Stations 1,232.0 616.0 1,848.0 44.0 22.0 66.0 ---- ...... Subtotal 1,512.0 756.0 2,268.0 54.0 27.0 81.0 ...... C. TransmissionNetwork

Cl. Substations 407.7 642.5 1,050.2 14.6 22.9 37.5 C2. TransmissionLine 64.1 38.1 102.1 2.3 1.4 3.7 ...... Subtotal 471.7 680.6 1,152.3 16.9 24.3 41.2 D...... D. Training& Consultancy 224.0 187.6 411.6 8.0 6.7 14.7 ~~~~~...... ------...... BaseCost 6,967.7 5,516.2 12,483.9 248.9 197.0 445.9 PhysicalContingencies 696.8 551.6 1,248.4 24.3 19.8 44.6 PriceContingencies * 1,058.0 818.9 1,876.9 37.8 29.2 67.0 ...... ProjectCost 8,722.5 6,886.7 15,609.2 311.5 246.0 557.5

c===r=: ======c M=_== = = z_M==_.. ==_ .. :=n_==_= InterestDuring Construction (IDC) 526.4 1,730.4 2,256.8 18.8 61.8 80.6 ...... GRANDTOTAL 9,248.9 8,617.1 17,886.0 330.3 307.8 638.1

...... ExchangeRate: 25.00KCS/USS

* It is asssumedthat theexchange rate will reficctthe differential between localand internationalinflation rates. - 35 -

5.13 Nearly 70% of project costs are for actions directly related to the environment -- reduction of S02 emissions and control of dust. US$249.0 million are for the FGD installations, yielding an estimated unit cost of about US$237 per inBtalled kW. This unit cost is reasonable for high- efficiency S02 removal installations, based on recent experiencing in CSFR and neighboring countries. The cost of ESP and transmission and substation equipment was estimated on th& basis of recent procurement of similar types of equipment in CSFR. Physical contingencies were estinated at 10%. Price contingencies are based on the assumption of a 4.9% escalation of foreign costs in 1991-95 and 3.7% thereafter. The escalation of local costs was assumed to be 34.4% in 1991, 8.8% in 1992, 6.7% in 1993, 4.4% in 1994, 3.8% in 1995, and 3.4% in 1996. Detailed project costs are given in Annex 5.1 and a break-down of the cost of the FGD installations is given in Annex 5.2.

5.14 The proposed Bank loan of USi246 million would finance 100 % of the foreign exchange cost of the project, i.e., 44% of the total cost. Interest during construction, taxes and duties, and any other local costs would be financed through CEZ internal cash generation and local loans.

Table 5.2 Project Financing Plan/1 (Us $ Millions)

Local Foreign Total

Proposed Bank Loan - 246.0 246.0 CEZ 311.5 - 311.5

Total 311.5 246.0 557.5

/1 excluding interest during construction.

5.15 The loan would be made directly to CEZ for fifteen years, including five years of grace. The loan would be guaranteed by the federal government. CEZ would bear the foreign exchange risk.

D. Proiect Prenaration

5.16 The technical and economic preparation of the various components of the project have been advanced to a satisfactory degree, although not all components are at the same level of preparation. The FGD components have been prepared by local consultants (Chemopro4ekt) and the bidding documents have been largely completed. Bidding documents are scheduled for distribution to interested bidders atarting in early 1992. In addition, an experienced consultant was recruited by the Bank to study the overall FGD program and to recommend a long-term leact-cost strategy for sulfur removal based on efficiervcyand rccnomny (occ para. 5.03). fliureport wan nubmittvd irnJuly 1991 and is part of the project file. The plants to be retrofitted with ESPn - 36 - under the project have been identified(see para. 5.09). The transmissionand substation componenthas been preparedby local consultants (Energovod)to an advanced degree of detail. Projectpreparation is, for the most part, satisfactory;no delays are anticipatedstemming from the lack of adequate project preparation.

E. Proiect Implementationand CgpLtXugjILn Schedule

5.17 The preparationof des.gn and rrocurementpackages for most project components is well advanced. An implementationschedule has been establishedfor each componentand subcomponent,according to which all componentswill be completedby the end of 1996. The schedule allows for anticipateddelays in the procurementprocess that may be experiencedowing to the novelty of Bank proceduresfor Czechoslovakauthorities. The preparation of bidding documentshas started; thus, CEZ would be in a position to sign a contract shortly after loan-signing. The FGD-technologymust be imported,and it is foreseen that foreign companieswill be responsiblefor implementation. However, the skilled and experiencedlocal manufacturingindustries will probably do all site preparationand constructionof parts of the equipment. Similarly,Czechoslovak companies have already establishedcooperation with foreign companies to produce ESPs under license. Therefore, significantlocal contributionto this component is expected. Although the pressure to install FGD systems is high, ample allowancefor the necessaryprocedures and possible delays in constructiontime has been made. Similarly,the implementation schedule for the transmissionand substationscomponents are staggeredfrom 1992 to 1996 to accommodateboth the availabilityof financialand human resources and the electric power system growth. The followingcontract packages are planned for the principalproject components:

FGDs

A single responsibilityturnkey contract covering engineering design, project management and coordination,and supply, erection and commissioning. A two-stepbidding procedure will be followed.

TransmissionLine

Supply contracts for: ;_eltowers, conductors and hardware, shied wire, and insulators.

Ubsta-tions

Supply contractsfor the five substationsin the project.

Plant Efficiency Imorovement

Supply contractsfor this componentwill be mostly plant specific and will be developedas each plant is identifiedand evaluated. - 37 -

The project is scheduledfor completionby December 31, 1996. The loan closing date is expected to be June 30,1997. A summary implementation schedule is shown in Annex 53.

5.18 The supervision"f constructionof the proposed project would be performed by CEZ through Chemoprojektand Energovod. CEZ, Chemoprojektand Energovod are adequatelystaffed with experiencedpersonnel in project constructionsupervisioni and management. The mission reviewed the capabilitiesof CEZ, Chemoprojektand Energovodand found them satisfactory.

5.19 The novelty of procuring equipmentunder Bank guidelinesposes a special challenge to CEZ and may be critical in project implementation. The technical specificationsof the proposed equipmentare well known to CEZ from past experienceand no difficultyis anticipatedin preparing the needed documentation.

F. EnvironmentalConsiderations

5.20 The project will undoubtedlybring about a substantialimprovement of the environmentin the northern Bohemia region, which is regarded as one of the most polluted regions in the world and part of the so-calledBlack Triangle. As such, the overall impact of the project will be strongly positive. In accordanceto the Bank's OperationalDirective 4.00, Annex 4, "EnvironmentalAssessment," this project has been ranked as level B, taking into account the project'spositive impact on the environment.

5.21 The total environmentalbenefit from the proposed installations would be a reductionof about 218,000 - 235,000 tons/yr of S02 and about 36,000 tons/yr of fly-ash. Dependingon the specificmeteorological conditions in the area where the power plants are located, the positive effect from this reductionwould be effectiveeven during the worst inversion incidents. Since the emissionsoccur at specific spots, the project will have considerablelocal impact and be of the greatest importancefor the improvementof the environmentand living conditions.

5.22 The additionalamount of waste generatedby the FGDs at Prunerov II is calculated to be about 30% of the current waste volume. Taking into account that the additionalwaste consistsmainly of gypsum (CaSO4), which is not regarded as hazardous, the disposal problem will be hardly affected by the proposed FGD and ESP installations. The additionalfly-ash from the more efficientESPs is estimatedat about 0.2-0.3% of the current ash amount collected,which is a minimal incrementalimpact. As a result of Decree No. 166 issued by the Czech Republic GovernmentMay 15, 1991, the ash must be disposed of from 1997 in the mined out excavatedarea of the open pit-mine DNT Nastup and in a way that the ground water resources are protected from further contaminationfronm the ash. In the meantime, the ash and gypsun will be used to stabilize existing ash-pondsby mixing the ash with the overburden. The coal-mine organization(DNT) has officiallyagreed to the disposal of a mixture of ash, waste water and gypsum to stabilize the overburdendeposits, st arting from t1ue very beg,inning of operation of the FGD syrtem nt Prnnerov II. - 38

5.23 The existing water supply is ample enough to support the installationof planned FGDs at Prunerov II without crowding out other users. The wastewater dischargefrom the FGD system is not expected to create any environmentalproblems since the transportof the ash is performed hydraulicallyand the water dischargefrom the FGD plant will be used as make- up water for the ash-transportsystem.

G. Procurement

5.24 A concertedeffort is being made to familiarizeCEZ with the Bank's procurementprocedures and Sample Bidding Documents,copies of which have been provided to CEZ. A prc-urementseminar was conductedin Prague in the week of April 8, 1991. It was well attendedby CEZ and other potential borrowers. Follow-up seminars are planned early in the procurementprocess.

5.25 All works, equipmentand materials to be financed from the Bank loan proceeds would be procured in accordancewith the Bank's "Guidelinesfor Procurementof Equipment." Goods manufacturedin Czechoslovakiaprocured under InternationalCompetitive Bidding (ICB),would receive a preference in bid evaluationof 15% of the CIF price or the prevailing custom duty applicableto non-exempt importers,whichever is less, provided they can prove that the value added to the product in Czechoslovakiaexceeds 20% of ex- factorybid price. All ICE bidding packages estimatedto cost $250,000 equivalent or more would be subject to the Bank's prior review of procurement documentation. Other contractswould be subject to ex-post review in accordancewith the guidelines. Consultingservices to be financed from the loan proceeds would be procured in accordancewith the Bank's "Guidelinesfor the Use of Consultants." All documentsrelating to procurementof consulting services would be subject to the Bank's prior review.

5.26 Procurementarrangements are slimmarizedin Table 5.3. ICB would be used for the FGD packages (US$311.3million), dust control installations (US$75.0million), transmissionline (US$4.5million), substations (US$46.9 million), and most of the contractsfor plant efficiencyimprovement (US$101.3 million). For items of a proprietarynature or where compatibilitywith installedequipment is required,direct contractingwould be applied. Internationalshopping, based on at least three price quotationsfrom at least two countries,would be used for items of small value and having an estimated value of up to US $200,000 equivalenteach, with an aggregate limit of US$10 million. Installationservices for dust control equipmentand the transmissionline and substations,and plant efficiencyimprovements would be provided locally and would not be financedby the Bank. - 39

TabLe5.3 ProcurementArr/ngements

------(USSMilt-io. ICB/2 Other Total 1. FGD Facilities 311.3 311.3 (139.8) (139.8) 2. Dust ControtInstallations 75.0 75.0 (33.7) (33.7) 3. EfficiencyImprovement 76.3 25.0 101.3 (21.3) (12.5) (33.7) 4. TransmissionLine 4.5 4.5 (1.8) (1.8) 5. Substations 46.9 46.9 (28.6) (28.6) 6. Consultingand Training 18.5 18.5 (8.4) (8.4)

Sub-Total 514.0 43.5 557.5 (Bank) (225.1) (20.9) (246.0)

...... /1 The figuresin parenthesesare the respectiveamounts which would be financedby the Benk. /2 ICB: InternationalCompetitive Bidding /3 Other: Other ProcurementArrangements (International Shopping, Negotiated Contract, Consultation, etc.)

H. Disbursements

5.27 The proceeds of the loan would finance up to 100 percent of the eligible direct foreign expenditures for goods, works, services and training, as well as up to 100 percent of the eligible ex-factory costs of locally procured goods. Disbursements would be against Statement of Expenditures for eligible expenditures under equipment and material contracts valued at US$200,000 or less. Supporting documentation for these expenditures would be retained by CEZ for at least one year after receipt by the bank of the audit reports for the year in which the last disbursement was made. The documentation would be audited by independent auditors and be made available for review by bank staff upon request. The annual audits would include a separate opinion on this disbursement made under the Special Account (SA) and Statements o4 Expenditure (SOE) procedure. All other expenditures would be fully documen'ed.

5.28 To facilitate disbursements, it is proposed that the borrower establish, maintain and operate, under terms and conditions satisfactory to the Bank, a USDollar (or any freely convertible currency) denominated SA. The amount deposited would represent about four months of projected Bank expenditures (US$16 million). The depository bank and currency of the Special Account will be communicated to the Bank for its approval before opening the account. The Special Account will be replenished on a timely basis not to exceed every four months or when the balance of the SA is half the initial - 40 - deposit, whichever occurs first. Documentation for replenishment of the SA would follow the same procedure as in para. 5.27. In addition, monthly bank statements would accompany replenishment requests. The minimum size replenishment request acceptable to the Bank will be about 10 percent of the initial deposit. Modalities concerning the use of SOEs and SAB were agreed to at negotiations.

5.29 A detailed disbursements schedule is provided in Annex 5.4. The Bank's disbursement profiles do not include FGD projects, and disbursement experience with CSFR is limited.

I. Retroactive Financing

5.30 Up to US$0.750 million of the loan proceeds would be disbursed for retroactive financing of the Temelin Nuclear Power Plant Audit Study. Work on the study started in July 1991 and is being carried out by CEZ with the help of foreign consultants. This provision will allow CEZ to make disbursements for the study and apply for reimbursement as soon as the loan becomes effective.

J. Risks

5.31 The main risks associated with the project are: (a) deterioration of CEZ' financial condition as a result of adverse macro-economic developments caused by delays such as major changes in the internal reform process; and (b) implementation delays due to CEZ being a first-time borrower. It is reasonable to expect that the government authorities will continue on their present course of political and economic transformation. So far, the stabilization program has been successful with low inflation rates and sound budgetary policy, but certain federal and republic responsibilities are still being worked out. Since the project is entirely within one republic and given the technical configuration of the electro power system and joint dispatching operations, there are likely to be minimal effects on the project due to changes in inter-republic relationships. Also, CEZ' financial performance is believed to be adequately safeguarded through the proposed covenants (para. 8.01). The proposed close supervision of the procurement process is likely to ensure smooth project implementation. Therefore, the above risks are considered to be manageable. - 41 -

VI. FEIANCIALLASECTS

A. Accountina and Auditina Framework

6.01 Due to the characteristicsof the centrallyplanned economic system, in the past, accounting in Czechoslovakiadiffered significantlyfrom internationallyaccepted norms. By and large, accountingpractices havs aimed more at external reporting for statisticaland regulatorypurposes rather than on providing financialinformation for decision-making,which is required from the management of commercially-orientedenterprises. Consequentlymanagers and staff of the various enterpriseswere not adequatelytrained and experiencedin generally accepted accountingmethods and, more important,in financialmanagement. Internal auditing was more of a verificationprocess, restrictedto checking the use of approvedbudgets and complianceswith regulations. Financial and managementaudits by outside, independent auditors,the type found in most of the market economies,did not exist. Even the verificationof complianceswith regulatoryrequirements, usually was carried out by "peer" audit type of process or by special investigations carried out by appointeesof the Ministry of Finance or other line ministries.

6.02 Both the federal and the state governmentshave recognizedthat internationalstandards in accountingand auditing legislations,institutions and practices are vital for meeting the objectivesof the country'seconomic reform. Gradual improvementsare being introducedthrough establishing compulsoryaudit requirements. Parallel with this, basicallyto support the government'sprivatization program, the companiesare being gradually requestedto and trained to disclose financialinformation by use of generally accepted accountingprinciples. The balance sheets, income statementsand other financialreports of a growing number of companiesare now based on the generally accepted accountingprinciples. Financial informationis increasinglybeing adapted to Western practiceswith the aim of improving commercial control, betteringcommercial performance, and increasing usefulnese for outside investorsas well as for internalmanagement. Also, the increasingnumber of accountingfirms of internationalrepute, which are preaentlyopening offices in the countrywith trained accountantsand providing on-the-jobtraining to local professionals,are also instrumentalin the introductionof internationallyaccepted accounting systems.

B. Pe-t FinancialPerformance

6.03 During the last two years, drastic organizationalchanges were introducedin the power sector,re-grouping the production,transmission and distributionfunctions, and changing the hierarchial-relationsof the various entities considerably. one of the effects of the changes was that the enterprises'activity profiles were altered, largely destroying the possibilityof historic comparisonsof physical institutional,or financial performances. This, combined with the frequent changes in evolutionin the accountingpractices, makes it extremelydifficult, if not impossible,to reconstructhistorical financial statementsof the power enterprisestor meaningful comparisonsor as basis for projections. Even if this could be done, the usefulnessof such informationfor analyzingcurrent and future performanceswould be substantiallymitigated by the fact that the entire centrallyplanned economy of the country is changing to that of a market - 42 - economy. The consequent structural changes will have drastLc impact, for example, on the demand for energy, rendering the historical data for projections largely meaningless.

6.04 Due to the organizational and structural changes in the economy referred to above, the pre-1991 financial information has little relevance for developing an analysis for future financial performance or for providing direct comparisons. Nevertheless, an overview of the pre-1991 financial situation is presented in the following paragraph, details are in Annexes 6.1 and 6.2.

6.05 Historically, CEZ was the largest electricity supplier in the country. Electricity oaleB during the last three years were about 52.6 GWh per annum, providing over 90% of CEZ's operating revenues. Between 1987 and 1990, the company's operating revenues increased by 23% from 24.5 billion KcB to 30.2 billion Kcs; while during the same period, operating expenses increased by 32% from 19 billion KCB in 1987 to 25 billion Kcs in 1990. Between 1987 and 1990, annual net operating incomes varied between 5.0 to 5.7 billion Kcs and CEZ' annual profits (after income tax) were between 1.1 to 1.7 billion Kcs, representing about 5 to 7% of the total revenues. Historically, the borrowings of CEZ were modest; the company did not inherit any substantial long-term financial debt from earlier years. The debt/equity ratios, between 1987 and 1990 were around 20:80; the sizeable investment programs were largely financed from internally generated funds and capital contributions. However, the reported operating results are somewhat misleading. Since 1962, the fixed assets of CEZ have not been revalued on an appropriate techno/commercial basis. Consequently, the asset values in the balance sheets are non-representative and the annual depreciation costs charged against the operating revenues are too low to permit the companies to accumulate sufficient funds for replacing the assets at the end of their useful life. Therefore, durina loan neaotiations, aareement was reached with CEZ that the company's fixed assets will be revalued by June 30. 1994 and that the revaluation will be in accordance with methods satisfactory to the Bank.

C. Financial Projections

6.06 One of the objectives of the project is to safeguard the financial stability of CEZ while ensuring appropriate power-generating capacity. In the past, the cost of investment programs and inflationary or real cost increases were not necessarily concurrent with appropriate adjustments in retail and bulk tariffs. The lack of cost recovery often led to undesirable reliance on government funds in the forms of operational subsidies or non-economical investment support. Any undesirable reliance on government funds should be avoided in the future by assuring adequate operating margins and cash generating capacity for CEZ. The financial targets (para. 6.10) aim to ensure this. - 43 -

6.07 Based upon the projected power generation, transmission and distribution levels for the next 7 years, financial forecasts were prepared in constant (1991) values. The projections reflect future operations including those associated with the proposed project as well as with other action plans, investment programs, and renewals, all aiming at capacity and efficiency improvements. In order to assess the extent of fund generation and the various actions that may be needed to ensure the financial stability of the company, the projected revenues are based on October 1991 tariffs plus future adjustments that the government is preparing to introduce in 1993. Costs, while varying with the power generating mix and with the level of projected supply, are also based on 1991 values. The sensitivity of the forecast performance to changes in costs and revenues have been tested (para. 6.11). A summary of the forecast assumptions is in Annex 6.3.

6.08 Between 1992 and 1998 the operating revenues of CEZ are expected to grow by some 31% from 49 billion Kcs to 64 billion Kcs. The bulk of the revenues would derive from supplying electricity: 93% of it to the distribution companies, 3% to SEP, the Slovakian Power Company, about 1% to large industrial and commercial customers, and about 3% for export. The importance of the sale of heat will remain constant, between 3%-4% of total operating revenues during the next seven years.

6.09 Operating expenses are expected to increase by 46% or 12.4 billion Kcs between 1992 and 1998. The largest single cost item will remain the cost of fuel, representing some 39% of the 1998 operating costs. Depreciation, while increasing from 13% of the 1992 operatinigcosts to 21% in 1998, iB Still considered to be too low as fixed assets have not been revalued since 1962. Due to its fairly modest past borrowings the company's interest payments will remain relatively low, representing no more than 12% of the 1998 net income. Corporate tax payments are forecasted at 56% of the net operating income or about 18% of the operating revenues. Taking into account both the operating and non-operating revenues and expenses, taxes and other obligatory payments, CEZ, during the forecast period will have regular net profits in the order of 8 to 11 billion KCB. As for its liquidity, between 1992 and 1998, CEZ is expected to generate regularly from its operation funds at a level of about 50% of its total revenues or on the average, about 60% of its investment requirements. Detailed projected financial statements are shown in Annex 6.4.

6.10 From the point of view of operation, the forecast profitability is considered satisfactory. Also on account of the proposed project and CEZ's investment program, the forecasted (internal) cash generation is sufficient. Nevertheless, to ensure the timely availability of funds and to provide a cushion for possible delays in future revenue adjustments to offset cost increases and to ensure the company's continued financial stability, durinq negotiations, aareement was reached that CEZ will take all steps necessary to maintain (i) annual ratios of cash operating costs to operating revenues not more than 0.6 from 1992: (ii) from 1992. internally Qenerated annual cash surpluses not less than 40% of the (3 vears movina averaael canital expenditure incurred and : (iii) debt service coverace (internally aenerated cash surpluses in relation to servicino lona term borrowina) not lower than - 44 -

.0 in 1992 through 1994. 3.5 in 1995 and 2.2 in 1996 and thereafter. The progress towards achievina the annual taraets mentioned (i) and (ii) above will be monitored on a semi-annual basis and if it ap eared that using a combination of actual and prolected data the achievement of the annual taroets would lag, CEZ would immediatelv take all recessarv remedial actions to ensure achievement of the annual targets. I addition. agreement was reached that CEZ will forward to the Bank each year, not later than 5 months after the end of its financial year. annual financial statements audited by independent auditors acceptable to the Bank together with the auditor's report on. inter alia. la) the financial statements: (b) the operation of all accounts including the Special Account and Statements of Expenditure (SOEs): and (c) the eligibility of withdrawals made on the basis of SOEs for reimbursement by the Bank. Also. aoreement was reached that CEZ will forward to the Bank every year, by March 31. its investment program together with the financing plan covering the next five years.

6.11 The major financial risk that could adversely affect CEZ' capability to support the proposed project and maintain its financial viability could be adverse macro-economic conditions. For example, if due to economic recessions the distribution companies would have difficulties in collecting revenues from their customers and therefore, in turn, to pay CEZ in a timely manner for the electricity purchased, or if due to inflation the real values of the contractual bulk tariffs would erode or adjustments to maintain the revenue levels in real terms would be delayed and/or be insufficient to match cost increases, CEZ' financial strength would be eroded. For example, a 10% increase in cash operating costs would reduce annual profits by about 7%. To offset such a negative impact, revenues would have to be increased by about 5%. Similarly, if revenues from electricity were to be about 10% lower than forecasted, without commensurate cost reductions, profits would be reduced by about 20%. - 45 -

VII. ECONOMIC JUSTIFICATION

7.01 All project components are justified as the lowest cost option to meet the required objectives. The Prunerov II plant will be utilized ae an integral part of CEZ base-load generation and will be required under all foreseeable demand scenarios. None of the project components is an investment in expansion of system generation. Moreover, the preliminary CEZ overall investment program, which includes proposed investments under the project, yields an overall internal rate of return of 13% to 17%, under low and high demand scenarios, respectively. A consultant's report "Necessary Measures for Future Mitigation of SO2 Emissions," July 1991, confirmed the selection of Prunerov II and benefits of plant efficiency improvements.

7.02 Desulfurization and Dust Control Investments. As described in Chapter III, the environmental conditions in northern Bohemia are very poor, resulting in severe impact on the local population's health and expected life span, causing severe degradation of forests, acidification of water bodies and streams, and economic losses to agriculture. It is clear that some measures must be taken to improve the existing conditions quickly. Air pollution in Notthern Bohemia is a localized problem caused mainly by the large concentration of power plants burning local, low cost, high sulfur lignite. Least-cost analysis demonstrates that retrofitting with FGDs at Prunerov II is the lowest cost, most practical and timely solution as alternative options are clearly more expensive, as described in the following paragraphs.

7.03 The available options to achieve an externally mandated objective of emission reductions while maintaining power supply in line with projected demand are: (i) shutting down of a number of heavily polluting plants and replacing the supply by electricity imports into the CEZ system; (ii) switching the operation of the existing boilers to gas, a cleaner fuel; (iii) switching to low-sulfur imported coal for at least the periods of severe atmospheric inversion conditions; and (iv) retrofitting suitable plants with flue-gas desulfurization equipment. Annex 7.1 summarizes the comparative costs of all the system options.

7.04 Option (i) is already being partially implemented to alleviate atmospheric pollution during the worst atmospheric inversions, utilizing the gas-fired Vojany plant in eastern Slovakia to make up the shortfall. However, to go further and shut down major facilities immediately would deprive the system of needed capacity that could not be removed without decreasing the reliability or service and increasing the imports of electricity that are estimated to be more costly (close to US¢ 5/kWh compared to about US¢ 4- 4.6/kWh for lignite in general, including the cost of environmental safeguards and about US¢ 2.8-3.8/kWh at Prunerov II). The new CEZ nuclear capacity, now scheduled to come on-line gradually in the years 1995-1998 at a cost of about US¢ 3.2/kWh, will enable the retirement of some old, polluting units that are not scheduled for retrofitting.

7.05 Option (ii), i.e., switching to gas, would entail shutting the boilers for a period necessary for retrofitting. This would incur Additional capital cost for the boiler modifications and additional safety facilities, and would depend on adequate oupplies of gas. These would depend, in turn, on the construction of new transmission facilities and on secure, long-term - 46 - contracts for the supply of gas. The preliminary analysiS indicates that the economic incremental cost of continued generation from lignite including FGD retrofitting at about ¢4.0-4.6/kWh iB well below the incremental supply cost from new gas-based combined cycle plant at similar load factors (¢6-8/kWh) and somewhat below tl.e cost range of supply from converted plants. In addition, the gas-based cost does not include gas transmission investments: the lignite/FGD option appears clearly preferable at this time.

7.06 Option (iii) must depend on the availability of imported coal with a low sulfur content. Assuming that it would be possible to obtain coal with a sulfur content below 1%, this option will still require the installation of FGD equipment to meet the target of 400 mg/Nm3 dry gas as an emission level. (Without FGD, the use of available low sulfur coal ^would result in emissions of > 2000 mg/m3). In addition, provisions would have to be made for transporting large quantities of coal to the power plants now burning lignite from nearby mines via dedicated transportation systems. The cost of generation based on imported low-sulfur coal at about 44.1-5.2/kWh, plus the necessary transport investments, would be higher than the cost of lignite including the investment cost after FGD retrofitting.

7.07 In conclusion, the FGD retrofitting of 1,050 MW lignite-fired capacity at Prunerov II (at about US$240/kW) is the least-cost, practical, and timely solution to the pressing need for quick improvement to air quality conditions in that region and a major step in a program of reducing air pollution. The present value of investment and recurrent CostB of the retrofit is significantly lower than that of the import alternative, even at a power import price lower than that currently available from the former USSR. By the same token, it is lower in cost than the options of using low-sulfur coal, or of converting to natural gas. As the LRMC of lignite supply to Prunerov lies well below the weighted average LRMC of lignite in northern Bohemian mines, the incremental unit cost of maintaining generation of Prunerov after retrofitting is only about US¢ 2.8-3.8/kWh (,Anpex7.1). Thus, this solution takes advantage of the low cost domestic lignite produced from mines adjacent to the Prunerov plant.

7.08 The project will retrofit several power plants with ESPB for effective dust control (para. 5.09). The reduction in dust emission will be 75% to 90% (see para. 5.08) which iB clearly justified to improve health and improve the environment. Annex 3.5 documents tne severe health problems from dust, which will be improved following installation of ESPs.

7.09 Plant Efficiency Improvements. Simple cust benefit calculations demonstrate that investments of US$81 million for plant efficiency improvements would achieve lignite savings of 1.2 to 1.9 million tons/year (para. 5.03), which is equal to about US$20 to 40 million/year in fuel cost savings. This results in internal rates of return greater tnan 20% for this component. - 47 -

7.10 Transmission and Distribution. The project components for transmission and distribution constitute needed extensions and reinforcements to an existing system that, in ivostcases, allows little flexibility of choice. The configuration of the existing system requires the addition of transformer stations and high-voltage transmission and subtransmission lines to increase system reliability and flexibility for optimal dispatch, and to reconfigure the transmission network for new capacity location and links to Western Europe.

7.11 A CEZ least-cost analysis of the optimal high-voltage transmission investment strategy has established that it is more advantageous to replace the aging 220-kV system by direct transformation from 400-kV to 110-kV. Assuming the same projected system load for the alternative strategies of (i) reinforcement and rehabilitation of the 220-kV system, and (ii) replacement of the 220-Kv system by 400/lln-kV, all demand scenarios yield a lower present value for the replacement alternative. The substation and transmission line components of the proposed project are part of this strategy.

7.12 Internal Rate of Return on Preliminary CEZ Investment Program. Given the need for retaining retrofitted thermal capac;.ty,the preliminary 10- year investment program of CEZ for 1991-2000 was evaluated to estimate the internal rate of return on the overall investment program.

7.13 Investment expenditures, operating Costs, and fuel costs are expressed in terms of international costs or border price equivalents. Distorted domeatic cost figures have been re-estimated to approximate international cost levels, while maintaining the real cost differentials such as labor costs. Benefits are defined as (i) the sales to consumers that are made possible b; replacing or rehabilitating old generating capacity, by retrofitting remaining lignite capacity with FGD, and by maintaining transmission and distribution capacity, and (ii) net fuel savings from the capacity replacement and from the replacement of heat-only boilers by repowered combined heat and power facilities. Essentially, new nuclear capacity now in an advanced state of implementation is seen as replacing old nuclear and lignite-fired units that are being retired (see para. 3.44 and Annex 3.9). The remaining thermal units are assumed as being rehabilitated, converted to CHP, and retrofitted with flue gas desulfurization, if justified.

7.14 The individual components of the proposed project are integral parto of the larger power sector investment program. The CEZ program, in its preliminary optimized form as evaluated above (para. 3.43, base case investment scenario), hae an internal rate of return of about 14%, based on tariff levels as proxies for program benefits (_nex 7.2). Sales to consumero are valued at the 1992 tariff levels averaging about KCs 1.34/kWh (US04.8/kWh). The preliminary program, relyii.gon retirement of old thermal plant, retrofitting remaining thermal plant with environmental safeguards, conversions to combined heat and power operations, and completing the Temelin nuclear plant in the mid-1990s, appears sound. In addition, the analysis indicates that tariff levels are adequate to re+Covci2 .n :ciiiit.ai ivllntVdwent in the 1990s. If the high-investment scenario is imblmnbA, hut dcitnnd - 48 -

development unexpectedly follows the low demand scenario (see para. 3.36), the overinvestment in new and rehabilitated capacity during the early years depresses the internal rate of return of the program to about 13%. The risk of overinvestment, therefore, is not great enough to render the overall program infeasible. If a pronounced and sustained low-demand scenario would become likely, the CEZ strategy would be to delay some of the lumpy investment packages, such as the completion of new nuclear capacity. A delay of the investment in Temelin completion, either for financial reason6 or as reaction to slower demand growth, would increase the IRR to about 15-17% (Annex 7.2). In either case, however, there is no question that the retrofitted Prunero, II plant would be retained in the future. The components of the proposed project appear in all scenarios as parts of the optimized system investment program. The agreed leapt-cost investment study will form the basis for a firm optimized long-term investment program. - 49 -

VIII. AGREEMENTS REACHED AND RECOMMENDATION

8.01 During negotiations the following agreements were reacled:

(i) with the Federal Government that it:

will take all measures, as may be required within its power, to enable CEZ to carry out the project and to comply with its obligations under the Loan Agreement (para 4.08);

(ii) with CEZ that it:

(a) will prepare, under terms of reference satisfactory to the Bank, anid furnieh to the Bank and the Guarantor not later than October 15, 1992, a draft federal least cost investrmentprogram for the period 1993 through 2003; and afford the Bank and the Guarantor a reasonable opportunity Xo exchange views with the Borrower on said least cost investment program (para. 3.09);

(b) will prepare an action plan satisfactory to the Bank, by December 31, 1992, to deal with the remaining peak pollution problem. The action plan shall incltudean appropriate monitoring system. CEZ and the Bank will annually review by April 1 of each year, starting from April 1, 1994, the results of the monitoring system and the agreed recommendations for improvements will be implemented (para. 3.26);

(c) will carry out a diagnostic study to: identify, evaluate and recommend measures to strengthen the Company'B financial management capability; develop an action plan for implementation of the recommended measures and preaent thiB plan not later than March 31, 1993 for Bank review and comments; and thereafter taking into account the Bank's comments commence implementing the plan (para 4.05);

(d) will establish by January 1, 1993, an Internal Audit Section with organization resources and terms of reference all acceptable to the Bank (para 4.05);

(e) will furnish to the Bank by November 1 each year the proposed terms and conditions designed to achieve optimal utilization of CEZ's supply facilities for supplying electricity to distribution companies and large consumers; give the opportunity to the Bank to exchange views regard3ng these termm and conditions; and tamk the necessary measures within its power to conclude the supply contracts taking into account the Bank's comments (para 4.08); - 50 -

(f) will revalue CEZ's fixed assets by June 30, 1994 (para 6.05);

(g) will take all steps necessary to maintain annual ratios of cash operating costs to operating revenues not more than 0.6 after 1992; internally generate annual cash surpluses of not less than 40% of the capital expenditures after 1992; debt service coverage not lower than 5.0 in 1992 through 1994, 3.5 in 1995 and 2.2 in 1996 and thereafter (para 6.10);

(h) will forward to the Bank each year, not later than five months after the end of the financial year, annual financial statements audited by independent auditors (para. 6.10); and

(i) will forward to the Bank for review by March 31 each year the investment program along with the financial plan covering the next five years (para. 6.10).

8.02 With the above agreements, the project would constitute a suitable basis for a Bank loan of US$246 million equivalent to CEZ, under terms and conditions applicable for CSFR, with the guarantee of the Czech and Slovak Federal Republic. - 51 -

Annex 1.1 Page 1 of 2

CZECH AND SLOVAK FEDERAL,REPUBLIC

POWER AND ENVIRONMENTALTMPROVEMENT_PROJECT

Documents Available in the Project File

1. CzechoslovakElectric Power System and East-West Interconnection, February 1991.

2. CSFR Study of Nuclear and Coal-firedExperience and ProjectedCosts of ElectricityGeneration, May 1990.

3 Report on Flue Gas DesulfurizationProgram, January 1991.

4. Scenarios for Demand Forecasts,January, 1991.

5. Proposal for Short-TermSimulation of the CEZ GenerationSystem, November, 1990.

6. Brochures of CEZ Power Plants.

7. StatisticalTables for CEZ and SEP for the year 1980-1990.

8. Report on the Instrumentationand Control of the Tenelin Nuclear Power Plant. 1UV, January, 1991.

9. The Environinent:in Czechoslovakia,Dcpartment of the EnvironmentState Commission for ScieniceTechnology anled Investments, Prague, lMay3.990.

10. Report onithe InstruLientation and Conitrol of the TeimelinNuclear Power Plant. Colenco, January, 1991.

11. Descriptiull of the Bollunicu Nuleaclr 'olwer llnillt.

12. Clharter of the Czecho!;lovak Atomic Energy Comnmi5;!Jionl.

13. Preoperational Safety of the Nuiclear Installations - Temelin Nuclear Power Plantt. IAEA November 1990.

1/4. Necessary Measures for Future Mitigation of S02 Emissionls in CzechoslovakiA, STYAG AG, Essen, Germany, Jul.y 1991.

15. F'sIh111t\ Stt'd' trpnrrni . - 52 -

Annex 1.1 Page 2 of 2

16. Project Cost Estimate and ConstructionSchedule TransmissionLines and Substations.

17. FeasibilityStudy on Czech TransmissionGrid PerformanceWithin Next Ten Years, CEZ, September1991.

18. About the Intended Project in the CSFR 420-kV Power TransmissionSystem, CEZ/Energovod,September 26, 1991

19. Study on Power Plants EPF Tusimice Influenceon S02 and Fly-ash Emissions in the Region. Energy Project, Prague,July 1991.

20. Study of Justificationusing FGD units at Power Plants in the North Bohemia - Part 1 Fuel Research Institute,Prague, July 1991.

21. Air Pollutionin Northern Bohemia, Fuel Research Institute,Usti n.l., April 1991.

22. The Report on the EnvironmentStatus and its Impact on the Health Status of Teplied District Inhabitants,Ebrforum and In&:tpendentExperts Commission,Teplice, January 1990.

23. Environmentand Health in Czeclhoslovakia,Department of Health Care and Epidemorlogy,Vancouver, November 1990. CZECH AND SLOVAK ._JERAL REPUBLIC POWERAND ENVIRONMENTALIMPROVEMENT PROJECT

ENERGYBALANCE - YEAR 1990 UNIT:PJ

CRUDE NATURALHEAT& ELECTRI TOTAL ENERGY HARDCOAL UGNIE OIL GASOUNEDIESEL FUELOIL GAS STEAM OIlY i Notes (1) (2) (3) (4)

PRODUCnON 547.4 1096.1 5.9 23.5 11.5 104.0 1788.4 630A # IMPORTS l18.5 3.7 556.1 8.7 8.5 7.8 445.7 0.0 86.4 1235.4 430A -EXPORTS -68.2 -37.3 -0.7 -11.6 -10.1 -24.3 0.0 -41.9 -194.1 -7f STOCKCHANGES 1.4 6.2 20.1 0.0 0.0 27.7 1O

NETTO TRANSFORMATION 599.1 1068.7 562.0 8.0 -3.1 -2.3 465.0 11.5 148.5 2857.4 1OO

ENCA-Y R . A

ELECTRCITY AND HEAT -219.2 -764.6 -113.4 -79.0 503.0 165.0 -508.2 NON-ENERGYUSES -123.5 -11.2 -3.7 -138.4 u TRANSFORMATIONINDUSTRY -57.0 -28.6 -562.0 67.7 163.7 310.0 4.4 -101.8 LOSSES -37.0 -8.6 -11.8 -35.0 -92.4 UNACCOUNTEDDIFFERENCE -6.5 37.8 -25.4 5.9

INET TO CONSUMPTICN 279.4 275.5 0.0 75.7 160.6 70.8 408.4 499.0 253.1 2022.5 1

FINALCONSUMPTMON

INDUSTRY 199.9 24.6 0.0 6.0 36.0 45.1 231.1 373.8 145.5 1062.0 53% METALLURGICAL 172.9 3.7 0.2 0.3 16.3 84.0 46.0 28.2 351.6 170A NON-FERROUSMETALS 0.9 0.8 7.1 6.1 6.7 21.6 1 CHEMICAL 2.3 0.3 0.6 0.3 2.7 46.1 90.3 24.4 167.0 8A OTHERS 23.8 20.6 5.2 35.4 25.3 93.9 231.4 86.2 521.8 26A CONSTRUCTION 0.5 1.8 0.0 2.3 1.3 1.1 6.7 2.1 15.8 19 AGRiCULTURE 5.4 15.4 3.5 50.5 9.7 14.8 8.4 16.3 124.0 6 TRANSPORT 1.6 27 521 53.0 1.0 1.1 4.0 12.5 128.0 > DOMESTIC. 33.6 154.7 5.0 3.4 0.0 78.5 72.4 47.9 395.5 COMMERCiAL 38.4 74.6 9.1 15.3 15.7 81.6 33.8 28.7 297.2 15

Notes: . (1) Includescoking coal (2) Includespeat and other solid residualfuels (3) Includes LPG (4) Includeslubricants and other non-energeticcomponents AiNNEX2.1 - 54 Page 2 of 2

CZECHOSLOVAKIA Energy Consumption (1990) in PJ

Brown Coal

551 ¢Gw

HIard Coal Conicuruct. su 11 547 By Energy Source By C:onsumer

1 PJ = 34,130 tce = 18,451 toe - 55 -

Annex 2.2 Page 1 of 2

CZECH AND SLOVAK FEDERAL REPUJBLIC

POWER AND ENVIRONMENTALIMPROVEMENT PROJECT

Energy Pricing Policy Portion of SAL

1. An integral part of becoming an efficientmarket economy is letting energy prices reflect the costs of energy. Czechoslovakia'seconomy is two to three times more energy-intensivethan Western European economies, due to (a) low energy prices and central energy allocations;(b) the emphasis on physical targets and the lack of market incentivesto improve efficiency; (c) the emphasis on heavy industries;and (d) the use of outdated equipment. Inefficientenergy use and the heavy reliance on high-sulphurcoal and lignite have also been major pollutioncauses, especiallyin Northern Bohemia. Many ..sidential energy prices are too low, and the structureof energy prices is distorted, strongly influencedby the low CMEA prices. Virtually the entire petroleumand natural gas needs and about 7 percent of electricityneeds have been met through imports from the USSR under bilateral arrangements.

2. Pricing Policies. The Government'smedium-term goal is (a) to deregulateall prices for oil, oil products and coal, and allow free imports and exports of these products; and (b) to establishan autonomousregulatory process for utilities (electricity,heat, and natural gas), whereby tariffs will be set equal to economic costs. Tariffs for tradeables (e.g., coal) will be set equal to internationalprices plus transportation,storage and distributioncosts, with automaticpass through of changes in international prices; and tariffs for non-tradeablegoods and services (e.g., electricity and heat) will be set equal to long run marginal costs (includingproduction/ generation,transportation/transmission, and distributioncosts), passing through changes in input fuel prices based on an automaticfuel adjustment clause. All energy products shall be subject to the Value Added Tax (VAT) when it is established Additional consumptiontaxes on transport fuels will remain in place. The Government is also consideringto charge additional environmentaltaxes on coal, and possibly on some other fuels (e.g., gasoline, diesel, and fuel oil). All environmentalcosts related to the production, transportationand distributionof energy shall be borne entirely by the enterprisescausing the damage, and be covered by tariffs and prices whenever they are regulated. During an initialtransition period prices and tariffs will be progressivelyadjusted towards economic cost levels. Increases shall be made in such a way that the relative structureof prices for different types of consumers reflect the relative structureof estimatedeconomic costs to avoid inefficientinter-fuel substitution. - 56 -

Annex 2.2 Page 2 of 2

3. Progress to date. Prices for oil and petroleumproducts were increasedin July, October, and December 1990, reaching the equivalentof US$30 per barrel of crude oil at the then prevailingexchange rate of Kcs 24 per US$1. Import price changes for oil and oil products will be passed through on a monthly basis. Bi-annualrevisions of transport and distribution costs, to take into account inflationand other cost changes, will enable the Government to adjust these prices as appropriate. Taxes were changed from an ad-valorem (330 percent over previous prices) to a specific rate, so as to have stable government revenue and to limit the increase in consumer prices to the increase in ex-refineryprices. Taxes are high by internationalstandards and produce nearly 5 percent of GDP in budgetarv revenue. At the current exchange rate of Kcs28 per US$1, ex-refineryprices are equivalentto US$26 per barrel; should internationalprices continue to decline, the Government may be advised to increase taxes slightly.

4. Followingthe energy price increasesin December 1990, most energy sales to industry are now close to their economic cost, with the exception of heat. Fuel coal (steam coal and lignite)prices for industry were increased by 50 percent to levels around 60-80 percent of equivalent international (border)prices. Electricityand natural gas tariffs for industrywere increasedby 53 percent and 143 percent, respectively. In March 1991, the Governmentand the Bank conductedjointly a preliminaryreview of estimated long-run marginal costs of electricitysupply. It was found that electricity tariffs for industry (and other large high-voltagecustomers) and for householdsamounted to about 90 percent and 50 percent of estimated LRMC respectively. The Government increasedindustrial electricity prices in April 1991, which will raise high-voltageprices to about 100-130 percent of estimated LRMC. This is the reverse of the efficientpricing structurethat would be indicatedby LRMC.

5. Action to be taken and supportedunder the SAL for Energy Pricing. Prior to the second tranche release, significantsteps towards the preparation of a least-costinvestment program for the electricpower sector were completed. On the basis of this study a suitable pricing study will be developed. Average tariffs for industrialcustomers will be at least equal to their calculated long-runmarginal cost. Tariffs for household consumerswire increasedby about 70% as compared to May 1990 price levels.1 These changes result in a narrowing of the distortionsbetween industrialand household tariffs.

1 The price was increasedby 70% on October 1, 1991. - 57 - ANNEX 2,l3

CZECH AND SLOVAK FEDERAL REPUBLIC

POWERAND ENVIRONMENTALIMPROVEMENT PROJECT

Energy Regulatory Portion of SAL

Action to be taken and supportedunder SAL for regulationof utilities. Utilities in charge of supplyingelectricity, heat, and natural gas to consumers enjoy natural monopolisticpowers and thus require some type of governmentalsupervision, though not operationalcontrol. A system of "economicregulation" shall be put into place, whereby the companies' financialsoundness and operationalautonomy will be assured, but at the same time preserving the qualit) of serviceprovided and the rights of consumers. Health, safety, and environmentalimpact shall also be regulated through this system. The governmentwill prepare and review with the Bank a plan of action for establishingregulatory institutions, processes and methods for the power, heat and gas. A Public Utilities Law would establishthe legal predicateand procedures for economic regulationsof enterpriseswhich produce, transport, and distribute electric energy, natural gas, town gas and thermal (heat) energy. The law would define the scope of regulation;the procedures for implementingthe legislation;and the structure,powers and jurisdictionof the regulatingbodias. The draft law, after review with the Bank, will be submitted to Parliamentprior to third tranche release. Their first assignmentwill be the adoption of a code of regulations,that would define the procedures to be used to establishand update tariffs and to monitor operationsof the regulatedutilities, as well as the system of accounts and reports to be used by such enterprises. The regulating agencieswill also codify regulationsfor the protectionof public health, safety, and the environment. - 58 -ANNEX 3,1

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER At'D ENVIRONMENTALIMPROVEMENT PROJECT

CEZ Planned Capacitv Retirement (MW)

1991 1992 1993 1994 1995 1996 1997

Prunerov I lx11o lx11O

Tisova lx103 1x103

Tusimice I 1x11O Ix110 1xl1O 1xl1O 2x110

Ledvics II 2x110

Oslavany 21+50

Hodonin 1x50 1x50

Melnik I 1x55 1x55

Tisova I 1x54 1x54

Trebovi ce 1x50

Opatovice lx55

Malesice II 1x50

Ledvice 1 1x90

Forici 1x55

TOTAL 394 323 110 160 379 364 485

Source: CEZ - 59- ANNEX 3.2

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTALIMPROVEMENT PROJECT

CEZ Planned Installationof FGDs and Improved ESPs

Plannedinstallation of FGDs and inmprovedESPe

1991 1992 1993 1994 1995 1996 1997 1998

PrunerovI *------FGD 4xI10 __n PrunerovII /1 *------FGD 5x210 ------* TusimiceII /2 *------FGD 4x200 ------* Pocerady/3 ------FGD 4x200 + ESP 3x200 ------* Molnick III * FGD lx500 ------* Melnik II *------4xllO ------* Ledvice 4 II * FGD+ ESP lx200 ------* TisovsJ *------FGD lxllO + 2x50 ------* Chvaletic- 4x200 ------* Detmarovice *---- 4x20O ------* Opatovice 6x55---* Bodonin *----2x55 ------* iorici -- 7X55------Other minor - ----

Total capacity equipped with FGDs: ,720 HE

Although Prunerov II FGDs are amply justified, the overall plan is subject to the results of the ongoing Least Cost Development Study.

During the former communist government, decision was made to install FGDs equipment at the PPs Pocerady and Tusimice II. In the latter case, an unproved technologybased on the Magnesite process was installed by the Soviets. They had based the technology on a system aeveloped in the US; but due to the Soviet intervention in Afghanistan, the transfer of technology from the US was stopped. The result was that the installed system at PP Tusimice II never worked, and today the equipment is regarded to be unable to operate. In the case of Pocerady, the first unit is just under constructionand is supposed to be in operation during 1993 based on the wet-limestondprocess. At the plant Tisova, a FGD system based on dry injection of limestone is under construction. In this case, the plant was chosen by the German utility that transferred surplus FGD equipment to CEZ as a gift.

/1 Part of the proposed project.

/2 Partially equipped with MgO2 FGD based on Soviet technology,not yet operational.

/3 FGD for 200-MW under construction.

/4 Partially equipped with low effectiveness (40% SO? removal), seLnd-hand FGD imported from Germany.

Source: CEZ - 60 -

ANNEX 3.3 Page 1 of 5

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTAL. IMPROVEMENT PROJECT

Emission Standards for Coal Fired PowAr and Heating Plants and Draft Environmental Regulations

In an amendment to the Air Pollution Act the following standards are regulated. The amendment has been effective since October 1, 1992.

Plant size SO2 NOX CO Fly-ash (dust)

3 3 3 3 a 300 MWt * 500 mg/Nm 650 mg/Nm 250 mg/Nm 100 mg/Nm

50 - 300 MWt **1700 " 650 " 250 " 100

5 - 50 MWt 2500 650 " N.A. 150 2- 5 MWt N.A. N.A. N.A. N.A.

The obtained concentration after mitigation measures should be minimum 15% of basic value.

** The obtained concentration after mitigation measures should be minimum 30% of basic value.

The standards are mandatory for new plants and old plante will obtain a grace period of 5 years. A translation of the regulations concerning emissions from coal fired power and heating plants are enclosed on the pages 2-5. -61- ANNEX 3.3 Page 2 of 5 1. SPCIFIC LIMITS FOR EMISSION 1.1 Production p1hdte Cal energy by means oi luel combustion - eower and healtinc Ilants The maximum amount of emissions discharged into atmosphere during luel combustion in energetic, company's and municipai power and heat plants in order to produce steam, heat and electrical energy is determined by emission limits given under this paragraph. D)uring fuel combustion in order to produce steam, heat or eiectrical energy in power and heat plants the emission limits for contaminants selected according to paragraph 2.2 do not apply. When other types of solid or liquid fuel than fossil fuel and fuel derived (bituminous coal, brown coal, lignite, coke, wood, luel oil and heating oil) are burned in boilers installed in energetic, company's and municipal power and heat plants, the limits for emission from refuse incinerating plant must be observed (see paragraph 3.19).

1.1.1 Combustion of solid luels 1.1.1.1 Limits for solid particle emissions on new plants - Orn boilers running on solid fuels having a heat performance over 5u MW tne weight concentration oi solid particles in the waste gas must not exceed 100 mg/mB. - On boilers running on solid fuels and having a heaL output in the range from 2 to 50 MW the weight concentration must not exceed 250 mg/m9.

1.1.1.2 Limits for sulphur dioxide emissions on new plants - On boilers running on solid fuels having a heat output over 300 MW.r the weight concentration of sulphur dioxide in the waste gas must not exceed 500 mg/m 3. If this value cannot be achieved without waste gas desulphurization, the emission of sulphur dioxLde must be reduced to a level that will not be higher thar. 15% of the ir.itial level. On boilers running on solid fuels and having a heat output ir. the ranoe arom 50 to 3u'J MWT¶,the weight concentration of sulphur dioxide in the waste gas must not exceed 1700 mg/ma. If this value cannot be achieved without waste gaH desulphurization, the sulphur dioxide emiseion must be reduced to a level that will not be higher than 30 of initial level. - On boilers running on solid fuels and lhaving a heat output in the range from 5 to 50 MW.V the sulphur dioxide weight concentration in the waste gas must not exceed 2500 mg/m 3 . - In case of failure of the equipment to limit the emissions the combustion equipment can be operated only if the failure period does not exceed 96 continuous hours and 360 hours in total during a calendar year.

1.1.1.3 Limits for oxides of nitrogen emissions on new plantu on boilers ru;lning on solid fuelB having a heat output over 5 MW the concentration of oxides of nitrogen recalculated to nitrogren dioxide NO2 in the waste gaR must not exceed 650 mg/m. - 62 - ANNEX3.3 Page 3 of 5

1.1.1.4 Limits for carbon monoxiide emissions Or, boiiers runrn,.ng on solid fuels and having a heat output over 50 MW, the concentratior, of carbon monoxide in the waste gas must not exceed 2bO m9/rm3 .

1.1.1.5 L.imitrs for organic compoundl emissions on ne-w plants 1f bark. wood and wooden waste are b,urned in an equiPment havinar a heat ouitput over and includino 2 MW, the organic compounci errission, expressed as concentratior, oi hydrocarborn C in the waste gas murzt not. exceed E50 mg/rin, .

1.1.1.6 General conditions lir- equiprment operation - All the limits for emissions, stated under Paragraph 1..1., apply Ior concentrations recalculated to dr- gas under normal conditions: 101.32 kPa and uo' and for oxygen volume ol 6s% ir, the waste gas. If only wooder, waste is burned the concer.trations are recalculated tc tne oxygen volume of 11'.' irn thie waste cras.

1.1.1.7 Limits Icr emi!sions orn current, plantF Equipment whict is currently an oPeration rc-lorE this edict bccomes efilective, muct ae oPerates an such way that all emissions are minimizecd ar.a within . 'ear- aitei this ecjicT becomcs C-l1CCtikE thc. Jimits giiver; lnde- Paracirarzh 1.1.1 ol thii edict must be observed. The atmosrphere protc-ct)on chec1.c nuthorit. r,as trho right to lix individual errission liI, its ior individual courceo ioi a limitecd period. - II 7 years aIter the date oi eIlectivenor,o oI thirs cdict an equipment would not be operated more tharn 13000 hours, the indivicual c-mircion limits will bc dc-tormined rby the .atinolohere protecto.on chc-cX authority baLsed or, application of kocrce ci the equirmcnt tsour;. of Pollution).

:..1.2 Liquid fuel cornbuutiori 1.1.2.1 Limits lor colid particle emisCiors oi, nro-wpliar.ti;

- rn boalerr rur,ning or, iquoad luelc navir.cz theat output cuer 50 M1WrthL w¢,,inht concrnttration ol cuoid pzarticlcc it, the wartc- gaG musut not c-xcec-d tIJ rimg/rn'-. Or, boi loer- running on ii quid lucel nava r,c a h1eat out put in the rangc from , to 'O MWTrthc- Wfeitht concentratiorn ir. thf waite gaf: must not c>coccd 101) i,0 , .

1.1.2.2 Limi.trz ,or rulphur diox:ido emisrioni on new plantu - On boileriz rur,ning on liquidJ fuels and havinqz a hefa output over 300 MW the conccntr^ation ol uulphur dioxide in the wastc .zau must not excr'c'd bOO mu/m`3 11 this; valuc- cannol be achleve'a without wiakte yuj derul phuriX at ion, thc sulphur dioxlde (:Cncentration inkuit hr reduce-i to aw levol Lhat wi; l not bc- higher thar, 15F of tho initi al lesvcl. COnboilerr runra n on l iicvii ±ucI ;anci navytnci

total during a calendar year.

1.1.2.3 Limits for oxide;s oi nitrogren emissions on new plants; - On boilerB running on liquid fuels and having a heat output cver 5 MW the weight concentration of oxides of nitrogen recalculated to nitrogen clioxide- NO2 in the waste gas must not exceed 45t0 mg/mrn .

1.1.2.4 Limits lor carbor. rmonoxide emissions on new plants -- On boilers running or, 'liquid fjels th-e weight concentration of carbon monoxice must not exceed 175 mg/ml%.

1.1.2.5 General conditions lor equipment operation All the limits for emissions, stated under paragraph 1.1.2 . apply for concentrations re-calculated to dr', gas (after subtracting humidity.) under normal conditions: 101.32 kPa and UrRC and for oxyger, volume of 36- ir, hthe waste gas.

1.1.2.6 Limits iobr emissions on current plants - Equjipment which ir currently in operatior, bcforc- this edicT. becomes effectlve, must t- operated ir, such wav that all emiscionz ar-- minimimzecd ar,d vjitnir. ; yeaars altc-r thic edict becomes elfectivej t.hc- lmitL giver, ir, this edict musf. be obseorved. The atmosFphere protection check authority nas the right tc fIix individuaI em Isicir, liImits for individual courcesr. lor a iimited period. - Il 7 years alte:r thr- date ol ellectivenesto oi thiu edict arn equipment would not hr-o operatc-d more than 13,0t0 hours, the individual emisciorn lirnit,- vill be detorminedc by tho atmoophorc- protectioion chlec) authority baf;ed or, application of )ecper ol the equipmer,t.

1.1.3 Gat,I fuel cornbuntion or, boloiern hIavinci i-.o5.t out pjt u. M.W and hiihc-,i

1.1.3.1 imlmtr. l or :-lidi pP;d txctlci cI L t:i:ons;i *,; new i-). llt!: -r, L.cilIerr: runnroIl' on T'a!: f tiu Il; 1.1ht Wt ight, (::or.cAit-r;ati or ol rol id t' -itlrr In t ho wxr;t r- 'ar: mAurt not (*XC-Or(c I' 'J m/,ril

1.1. *. 2 ].Amitc lc7r i.ulphkn di id Iii I:i;i on IltWCollow oIlnlti: t)i .,c'i I or-; rt)i,i. !j orsi,. I Ut-I!; tho wexrqi't Uoflc(. ut rat or c I ',u I hur di oxxi CV in t(t.- Wart't_ '- l: mu[; t net exce(t- .c Ld uro I

1.1.3.3 Limniti: tcor oxideC; of ni' rocren mrnilri:ionl: on) new pl,Ttlti; 0n boi 1 t' !' r'Unr-,riti Ox I tic 1!- t h Wi i;; ,t c:t'Iivtcelt rat tioh1i of oxi drc oi nit.rovenl roveal cul;ited to mitro'Ttn di ox i dr N0Q. in thr wvint; g,tra rnr; t riot o?:C 'edC1 0(1 r)I / m'

1.1.3.4 I.inl ti: I;'}-t'r 7(;1 0 ZIi)C>i' orIi u;lf: thr-i (1n nIy J1F)antI0n o (t'n boi(U!iri 1 C'1rS'7 I''t eli rtl '1 Ut' I7tl ! t (cncL ra,t iCoXn cf ~:;Irbut) Irront>x i00 lI, tt'io w~L;d>t0 c*ti ; I;:Ut;t nutt cx :c 'd''t ((U I iit/ In

1 1&.3.5 G(nez^t l t?U,(0 ititll 10)- ' i l-IALIIt OT':>t'eit (?lh P.1 t i0- in;:tt!, ;I1 1.1 ! .' Ni * I tt, t ; i I ijij(i 1.1.2, iapply or- conc(- nt rat Ior ! rf "Ilit(xIU d t C) v y (aIteyr t0rCtraCtizitiu,ria;; hUInidity I under II1r 'tVCidvto. i!.() II . :-I ;XIlCI

0r t i;nd ICo' oi:yecn vC)LtlI.s of ?it 1 I t.1,C W4rLtt I- ,'~; - - 64- ANNEX 3.3 Page 5 of 5

1.1.3.6 Limits for emissions on current plants Equipment which is currentl1 in operation before this edict becomes effective, must be operated in such way that all emissions are minimized and within 7 ytears after this edizt becomes eifective the limits given in this edict must be obeerved.

1.1.4 Combustion ol more kinds of fuel a) When burning more kindB of fuel simultaneoucly in an equipment the limit lor emissionB is determined by that kind of fuel that has the highest share orn the heat output. b) When burning more kinds of fuel in an equipment but always only one kind of fuel is burned at a time, the limits for the used fuel applies. 65 - Annex 3.4 Page 1 of 2

CZECH AND SLOVAAKFEDER-L REPUBLIC

POWER AND EhNVIRONMENTALIMPROVEMENT PROJECT

List of Power Plants (December 31, 1989)

Tot.Cap Comm'g A. CEZ Units (MW) Yr2

1. Fossil Fuel Plants

Melnik I 6x 55 330 x 1961 Melnik II 4xllO 440 x 1971 Melnik III 1x500 500 x 1982 Pocerady 6x200 1200 x 1977 Prunerov I 2xllO 220 x 1968 4xlO0 440 x 1983 PrulnerovII 5x210 1050 x 1983

Tusimice I 6xllO 660 x 1963 Tus imice II 4x200 800 x 1976 CUvalet:ice 4x200 800 x 1978 Detmiarovice 4x200 800 1976 L.e(lvice I lx200 200 1967

],(!(vi.ct' II 4x100 440 x 1969 'iFsovaI 4x 50 200 x 1959 TLi!;ovaII 3xlO0 300 x 1902 Opatovice 6x 55 330 x 1960 Porici I1 3x 55 165 x 1958 lI;lelolill 4x 50 2.00 x 1954; Pt 1hU, 1 969

ltlel plinit:s 10,171

2 .IYdI,. V141t0A. Dillt'e.ve' {4x\112.5 45() Orlik 4x 91 364 Liplo 2x 60 120 X.my,k 4x 10 40 Slapy 3x 40 144 Stechoviev I 2x11.25 2 2. Stecliovibp II 2x 20 40 Ot lier 118*

tot:jal FCZ.hIdro pliitis 1,359.0

/l (:(0~1,liedhei.it. widl(Ipower Statt iOIN - 66 - Annex 3.4 Page 2 of 2

Tot.Cap Comm'g CEZ Units (MW) CHP Yr Comments

3. Nuclear Plants

Dukovany 4x440 1 760 1983-87

4. Other Power Plant 64

Total CEZ 13.354

SEP

B. 1. Fossil Fuel .hermal Plants

Vojany 1 6xllO 660 Coal Vojany 2 6xllO 660 x Gas to be converted Novaky A 103 x Novaky B 440 Zilina 49 Kosice 121

Other 167

Tota). Fossil Fuel 2200

2, ,ly0 q

A t:ot:nlof 11/ p)lantn 1651,

3. ~'ei

Bolimdxc '%XW/&sO 17(0

4, Other

Tut:al SE'I' 5)000

Iit('7e(wh Reptiblic 2000 III ('7rch RepmMix 8o00

(.1A ID) 10(JAi/ij1 / - 67 - ANNEX 3.5 Page 1 of 14 CZECH AND SLOVAK FEDERAL REPUBLIC

POWERAND ENVIRONMENTAL IMPROVEMENTPROJECT

Dama 2n Effects of Air Pollution on Human Health and Forests

A. Health Status of lnhab!tants

1. Environment is composed of external factors which decisively influence human health. In comparison to other countries, the health status of CSFR inhabitants is unsatisfactory,and the North Bohemian Region is especially problematic. The environment there is characterizedby a high level of air pollution resulting from power plants and open coal mines. Thus the most polluted areas are the "coal-basincounties", Chomutov, Most, Teplice, Usti n.L. and part of Decin, which are particularlyaffected during the winter season, November through March.

2. There is a smog warning and control system operated in the region, which can help to minimize acute impacts on health, but it cannot have a positive influence on long-term negative impacts on the health of the inhabitants. Data will be presented below for the following: average life expectancy in the CSFR and comparisotnof the CSFR with other countries; mortality ratec in coal-basin counties compared with other counties in Northern Bohemia; decailed mortality rates for Teplice and Most counties; number of newly recorded illnesses (total and oncological). Although other factors such as nutrition,living standard and personal attitudes influence general health, evaluationof the data provided is also important for an understanding of the effects of ai.rpollution.

Figure 1-A Average Life Expectancy by Country ME-N Country Japan S weden .i_ Holland Switzerland Norway Canada Cuba Denmark Italy An. Wal - France 1E1980-1984 USA FRG 1970-1974 Belgium F n andunmd Austria GDR _ Bullaria Yt19061avia _0 Czechoslovakia Pol'; Hungary 2 65 67 6; 71 73 75 Age Figure1-B 6 Averago Life Expectancy by Country N68NEX 3.5 WOMEN Page 2 of 14 Country Japan Holland 111 Norway llhE I Sweden Switzerland France Canada Finland USA Italy Denmar= m 1980-1984 An. Wal* - 1970-1974 FRG 9017 Belgium Austria Cuba GDR * MMM Poland Czechoslovakia Bulgaria Yugosiavia Hungaria Rumania 70 72 74 78 78 80 Age Pot*: In 1986, the average lifespan in Europe was 70.6 years for mer.and 77.4 for women. The lifespan is CSFR Was three years less for both sexes

Table 1: ASraze life expectancy in the Czech Republic - 1988

Czech Reoublic Men Women

68.24 75.45

North Bohemian counties Women

Coal-mine counties

Chomutov 66.01 73.96 Most 66.19 72.97 Teplice 64.64 73.60 Usti n/L. 67.64 74.56

Other

Ceska Lipa 67.80 73.46 Decin 67.10 74.93 Jablonec n/N. 66.78 75.89 Liberec 67.93 75.18 Litomerice 66.61 73.53 Louny 65.44 74.49

Average - Coal-mine counties 66.12 73.77 Other counties 66.94 74.58

South Moravia Rejion* k Women

Vyskov 69.91 76.74

* for comparison,a county with clean air The average life expectancyfor North Bohemian inhabitantscorresponds generally to permanent trends in the CSFR, but is significantlylower for men. - 6 9 _ ANNEX3. 5 Page 3 of 14 COMPARISON OF MORTALITY RATES IN COAL-MINE COUNTIES AND OTHER COUNTIES IN NORTHERN BOHEMIA

Figure 2-A Standardized mortality rates 1983-1987 MEN % (100%-CzechRep. avg. value) 125 total onoologlcal 120 . _ _-

110-

100 ------95t* -. .. _ .. _ 85 -*~ -- - -- .- ~~ _ _..- .~ -_>

90 - -

80 -I- 75 1983 1984 1985 1986 1987 1983 1984 1985 1986 1987 Years

_ Coal-mine counties l Others Usti n.L., Teplice, Most. Louny, Litomerice, Libarsc Chonmutov, Decin Jablonec, Cooka Lips

Figure 2-B Standardized mortality rates 1983-1987 WOMEN % (100%,CzechRep. avg. value) 120 10total onoologlcal

110 ------

100 -- - - -!----

90 - - .- - -

80 - -

70 - - - -

60 1983 1984 1985 1986 1987 1983 1984 1985 1986 1987 Years

Coal-mine counties S Others Usti n.L., Tepilce, Most, Louny, Litomerloe. Libereo Chomutov. Decin Jeblonec, Ceaska Lips ANNEX 3.5 Page 4 of 14

- 70 -

3. The most frequent causes of death are cardiovasculardiseases (54% in 1987) and oncologicaldiseases (21%). Together these diagnoses represent 75% of all the causes of death. The standardizedrate of mortality due to cardiovascularand oncologicaldiseases in the North Bohemia Region and the coal-basincounties is the highest in the Czech Republic and has remained stable. The gravity of this situationis particularlyapparent in the rate of premature mortality, that is between 20 and 65 years, or the productiveage (see Figs. 21-22). The standardizedmortality for inhabitantsof the region inL1980-1985 is statisticallysignificantly higher than the rate for CSFR inhabitantsas a whole (10% for men, 13% for women). This is also the case for prematuremortality. ANNEX 3.5 ~73 - Page 5 of 14

Figure 3-A Standardized mortality rate - Teplice MEN 140- 135-

130 - 125 120--

110- 105- 100 Total 8 R Total OUR Canoor Cardiovascular lochevnilc heart 20-SB yro 20-56 yr. 20-66 yro 20-SO yre

1980-1 3 1981-2 El 1982-3 1 1983-4 L 1984-5 L 1985-6 1986-7

100 - Czech Rep. avg. value

Figure 3-B Standardized mortality rate - Teplice WOMEN 180- 170-- 160-

150 .l 140-

130- .

120 _

100-

Total SMft Total 8UR CAAcOr Cardiovascular lichorwic hcart 20S6 yrr 20-6O yra 20 e6yrto 20-1S6yr

- 1980-t W *881-2 [Li 1982-3 1983-4 ICElI1984-5 0I 1986-0 -1988-7

100 - Cz*ch Rep. avg. value - 72 ANNEX3.5 Page 6 of 14

Figure 4-A Standardized mortality rat6 - MOST MEN 160_

140

130

1120

100 Ibtol SUJl Totl V;MR CaoIof Cardlovasoular ooherlo heart 20-66 yra 20-S6 yre 20-06 yre 20-0S yr.

1960-1 E 1981-2 Ca 1982-3 1983-4 I3 1984-58Lo i 18- M 1986-7

100 Czech Rep.avg. value

Figure 4-B Standardized mortality rate - MOST WOMEN 200

190-

160K

160- 140-

130 -- _ _ _

120 --

100t,oDo Total$MR Itral uR Cancer catdeve@Ocur laehoaleil heart 20-S6 yea 20t66 yre Y.' 20-So S0-s6 yre

_ 19ebO1 :; 19g1-2 CM962-3 7V6U41 [:31984-51986 1966-7

100 * Czech Rep. Avg. vaija ANNEX 3.5 Page 7 of 14 - 73 -

4. The 1987 statisticson the health status of children from the coal- basin counties are particularlyalarming. Two thirds of all diseases studied in children of pre-school age living in these counties were reported as occurringat a higher rate than in the Czech Republic as a whole. The greatest differencesare found for the followingdiseases:

Table 2: Disease prevalence in pre-schoolage children

Number of cases per 100 children Czech Republic Coal-basin counties

Chronic urological illnesses 0.89 1.12 Unspecifiedlung and respiratory 0.54 2.90 Allergologicdiseases 1.70 2.93 Mental diseases and defects 0.53 1.06 Skin diseases 0.65 1.29

The situationis similar for school age children:

Table 3: Disease prevalence in school age chjldr n

Number of cases per 100 children Czech Republic Coal-basin counties

Chronic urologicaland kidney diseases 1.42 1.68 Unspecifiedlung and respiratory 0.45 1.40 Mental diseases and defects 2.00 4.09 Skin dfseases 0.73 1.09

B.

1. Roughly one third of CSFR territory (33.3% of the Czech Republic and 39.9% of the Slovak Republic) is covered by forests. Forest growth is influencedby air pollution as well as climate and other natural phenomena. Nearly all forest on state territoryis significantlyaffected by gaseous pollutantsand both wet and dry deposits of harmful substances,in the form of acid rain, fog, snow and ice. Even the impact of short term exposure to harmful substancescannot be ignored,particularly at peak concentrations,for example during inversions,when S02 concentrationscan reach levels of several mg/mi3 . AtrEX 3.5 - 74-N Page 8 of 14

Table 4: Pedcen forest dh aofesand T znnud1J&.* kig.jeu .2.22.Q 1.22E 12&g 12_8 1..22Q )9_5 200- Central Bohemia 2-1.6 39.7 47.9 53.5 58.4 30.7 South Bohemia - 4.7 21.7 27.8 6.0.4 44.2 46.7 West Bohemia - t.5 1q.' 29,4 East Bohemia 9.5 14.0 26.3 71.9 '1304 100.0 100.0 NqorthBohemia 33.4 55.6 73.7 80.7 98.0 100.0 100.0 21.4 South Moravia - - 9,5 19.2 20.2 North Moravia 3.6 12.9 51.g 96.0 96.4 96.4 96.3

Czech Republic total 4.1 10.5 25.3 46.0 58.9 61.4 63.0

^_ s toveairs

CI40. 60 J^ .~~~~~~~~~~~~~~~~~~~~~~~~~d.w

Fig. 25 Forest damaged in the Czech Republic, caused by air pollution. Division into groups A and B accordingto life expectancyfor grown spruce stands (as of June 30, 1988). of The sicuscion is especiallycritical in the Ore Mounrains,on che borders and Germany, in the North Bohemia Region, where there Is tllegreatest BohoeiA the a.iount of industrialand mining activity. At che highest elevations, to forest, primarilyspruce, is dead or dying snd the damage is spreading stands other regions. It is probably the most serio.usdegradation of forest on the European continent. ANNEX 3.5 Page 9 of 14

v R G ST t.

@;~~~~~~~EPLICE

1960 UTYOT

-- @ H~~~~~~~~POST

1970 ST

neasvy ., ages

Fig. 26 Developmentof foreststand damagesin Krusnehory.

* Total values of foreststands damaged. dying or dead. Forestbelonging to the FederalHinistry of Defenseexcluded. Coal-mine basin counties (498 t',Oinhabitans Fi&, 5 Location of biggest emission 2 276 km ) sources in CSFR Counties: Chomutov, Most, Tpli Ceti ntLio irc Note .\~~~~~~~~~~xpPr-,vailing wind dlirection 1 8 \. i t n b.4z;. tJ 0 ~~~~~~thehei ght of chimey 7aG4 c X ; corrospondss2S /'° I>'v-. ~~~~~~~~~~~emissions/y

> 9 symbol corresponds to the flue ash emissions

, zie 26 "3O 13 ,. 8T6 Regions

Iit 22 I: f S1. SS

_ \ 28~~~~~~~~~~~~~~~323-

3 -.. IC Z ; 11410P; . 1 2e'33J' - S tl. i"il. I ;* w 3

it3, l. st- * t 31 24.3 2 itn |w b}s iS El ~.oElt 1

..7 imc ,-1 , ... I 3,_. -.

33 1G.. . 3031 MiUW S...,*.....II. .. __ 3s~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ _ Ser E331.1 nis. 7 ' (D - 77 - ANNEX 3.5 Page 13 of 14

Ambient Air Quality in the Surroundingsto_EPK Tusimice Background

1. The EPK Tusimice consists of the four power plants Prunerov I, Prunerov II, Tusimice I and Tusimice II. They are all located in a very small area with a distance of less than 6 km between any of the plants. The area is located in the NW part of the Northern BohemiaRegion and is part of the coal- mine counties within the North Bohemia Basin, which covers the counties Chumotov,Most, Teplice and Usti nad Ledem. The basin is surroundedby the mountains Krusne Hory, Dupovske Hory, Ceske Stredohoiand Decinska Vrchovina. The topographicalconditions create specificmeteorological situation resulting in a comparativelyhigh frequencyof inversionincidents and ponr dispersionopportunities. Due to the high emission levels from the actual power plants the ventilationshould be good, but unfortunatelythe existing topographyprevents this essentialventilation, and instead creates a very severe situationwith regard to the ambientair quality.

Occurrence of Inversions

2. An attempt to evaluate the frequencyof inversionsduring the year 1989- 1990 has been done by the Fuel Research Institute. Their findings are briefly mentionedbelow. The year is divided in the followingperiods of meteorologicalconditions:

A Good Dispersion. Well ventilatedconditions and no build up of high ambient air concentrations.

B Impaired dispersionconditions during half the day. Inversion situationwill remain for half a day, normally from the early morning to noon.

C Impaired dispersionthe whole day. Inversionsituation will remain for one or more whole days.

D Unfavorabledispersion conditions. Strong inversionand weak wind.

Number of days 1989 Number of days 1990 Total days A 95 106 201 B 180 196 376 c 65 49 114 D 25 13 38

3. The most unfavorablesituations are obtained during inversionsfor one or more days which has occurred in the followingway during 1989 - 1990

22 days Once 7 days Once 3 days lOx 12 " " 6 " 4x 2 " 6x 9 f " 5 " Once 1 day l9x 8 it to 4 toto" ANNEX 3.5 Page 12 of 14 - 78

4. The wlholedays with impairedor unfavorableconditions occur practically only during the winter season, when the energy consumptionis largest and the burning of lignite is maximum in the actual power plants.

5. In table 1, below the monitoredSO 2 concentrationin the different counties in the Northern Bohemia Region compared with the Southeln Bohemia Region is shown. Table 2 describesthe average annual concentrationin selected Czech localitiesduring 1983 - 1988.

TABLE 1. Air Pollution in 1989

Region No of Ann. Ann. Ann. Max No of Ar;.uaI County meeasuring avg. arith geom. value over- stations avg. avg. comes winter of KD gLg/m3 pg/m3 MS/M3 pg/m 3 No of S IZ casea North Bohemia 143 66 98 42 1,534 4,435 10.0 433 Ceska Lipa 6 58 85 41 574 113 5.5 161 Decin 10 85 131 54 1,045 425 14.0 545 Chomutov 18 69 91 42 1,160 657 10.9 516 Jablor.ecn. Nis 12 32 49 19 433 75 1.8 104 Liberec 23 51 76 32 1,534 342 4.5 156 Litomerice 9 52 80 38 482 482 4.9 124 Louny 9 56 79 30 1,026 16.. 5.7 399 Most 13 80 114 52 1,184 462 11.6 406 Teplice 16 94 146 57 1,408 669 13.2 1,324 Usti n.I.. 27 85 128 56 1,308 1,046 12.9 597

ComparisonDate South Bohemian Region Jihocesky 11 17 26 8 442 24 0.9 102 C. Budejevice 3 34 60 15 442 19 2.8 ln6 Pelhrimov 1 18 24 9 204 2 0.6 100 Prachatice 1 8 10 3 85 0 0.0 100 Strakonic. 3 12 18 5 107 0 0.0 100 Tabor 3 13 19 6 175 3 0.4 100

Winter Season: October - March 3 Kd * 150 ug.m/24hro ANNEX 3.5 Page 13 of 14

- 79 -

3 TABLE 2. Average annual S02 concentrations / ug/m in selected localities - 1983-1988

Region Station 1983 1984 1985 1986 1987 1988 Praha Karlov 84 45 93 86 59 42 nam.14. rina 81 - 85 81 100 - Rytirska 140 134 217 161 133 71 Alzirake - - 82 80 59 6D Dukelskychhrdinu 76 98 104 113 120 - Rude armady 71 92 - - - 33 Novovysocanska 86 74 - 86 111 - Sokolov Hory 44 44 15 2/ 27 23 Podlesi 69 94 85 98 114 56 North Bohs.ian Chorutov 115 137 134 157 141 70 Coal-mine Kadan 61 58 78 116 115 64 Rfegion Most 132 112 141 164 169 84 Teplice 156 129 122 118 131 83 Usti-Kockov 89 69 90 117 124 70 Nova Veo v.H. 73 91 78 108 115 75 Andelka 52 42 - 67 71 54 Frydlant 62 64 66 68 66 54 Liberec Liberec 52 52 50 69 71 5e Hr. Kralove Hr.Kral.-Suk.sedy 66 53 73 - 51 42 Pardubice-Polabiny 76 30 67 57 58 45 Doubravicen.Lab. 31 33 73 57 60 35 Brno Kroftova 35 '.0 45 <7 35 25 Radlas 37 35 61 41 45 31 Poruba 32 32 59 34 '1 35 Ostrava PFruba 32 32 59 34 41 35 Malenovice 22 24 24 30 35 22 Kojkovice 39 31 49 41 45 41

6. The tables emphasizesthe severe situation in the Northern Bohemi.aRegion and specificallyin the coal-minecounties, where the ambient air quality is over the acceptable level 150 pg/M3 for more than 10% of the time.

7. During July 1991 Energoprojekttogether with the Czech Hydrometeorological Institutedid a study of the ambient air quality in the nearest region to EPK Tusimice before and after retrofittingthe power plants Prunerov I, Prunerov II, and Tusimice II with FGD equipment. The study shows that retrofittingwill achieve a substantialreduction of the mean annual value. The maximum concentrationduring 30 minutes is shown with isolinesand the differencewith or without FGDs is extremely obvious (see Attachment ).

8. The relation between alnual loads (mean value) on the territoryfor the alternativesare as follows:

Current situation 398 pg/rT3 100.0% FGD at PP Prunerov l and TusimniceII 197 " 49.5% FGD at PP Prunerov I, Prunerov II and Tusimice II 110 27.6% ANNEX 3.5 Page 14 of 14

- 80 -

9. As the emission from the PP Prunerov II is larger than the total emission from the PPs Prunerov I and Tusimice II, the resultingeffect afterfretrofitting only PP Prunerov II should be at least a reductionwith 50% in the surroundings. The levels shown above should be compared to the acceptablemean value in accordancethe existing hygienic standardswhich is 150 ug/m3. In referenceto this value it is obvious that further installationof FGD equipment is necessaryat the remaining plants Prunerov I and Tusimice II. CZECH AND SLOVAK FEDERAL REPUBLIC

POWAERAND ENVIRONMIENTALIMPROVEMENT PROJECT

Electricity Sales 1979-89 (¶Wh) V

Large and Small Consumers Total M1edium Agricultural Year Sales Consumers Total and Commercial Residential

1979 50,666,406 36,830,494 13,835,912 5,665,066 8,170,846 1980 53,326,194 38,929,779 14,396,415 5,901,2F8 8,495,127 1981 54,385,397 39,527,055 14,858,342 6,030,719 8,827,623 1982 54,907,400 39,660,218 15,247,182 6,038,381 9,208,801 1 1983 58,245,281 40,452,933 15,792,348 6,148,995 9,643,353 X 1984 58,332,253 41,373,248 16,959,005 6,653,056 10,305,949 1985 61,125,361 42,934,558 18,190,803 7,125,905 11,06'.,898 1986 63,151,344 44,382,381 18,768,963 7,297,896 11,471,067 1987 65,688,649 45,861,335 19,827,314 7,727,801 12,099,513 1988 66,799,918 46,656,401 20,143,517 7,828,956 12,314,561 1989 68,170,404 47,256,160 20,914,244 8,098,987 12,815,257

~tT1> (D x / Excluding electricity consumption by energy sector enterprises, and excluding industrial own generation. o CzechoslovakiaEnergy Project I Daily Load Curve December 1970 and 1990 mw 14000 -

13000 ,

12000 4 1990 11000 -

10000 9000 -

8000

7000 --- 1970 6000

5000 1I II~'______21222324 1 2 3 4 5 6 7 8 9 10 11 12 1314151617181 92021 HOURS Czechoslovakia Energy Project I Daily Load Curve June 1970 and 1990

MW 12000

11000 ,

10000

19000 C , I

8000 X

7000-

6000 9

1970 5000

4000 -

3000 , , I I I ,I , I , I ,I , ,I , , I 21222324 1 2 3 4 5 6 7 8 9 10 11 12 13 1415 16 17 18 192021 Hours x ANNEX 3.7 - 84 - Page 1 of 2

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER ND ENVIRONMENTALIMPROVEMENT PROJECT

CSFR Electricity ConsumPtion'l Forecast 1995 and 2000 (TWh)

Actual ___ Forecast Consumer Categorv 1989 /3 1995 2000 Hloh Low Hich Low

Energy and Chemicals 25.9 24.9 20.5 25.8 20.4 Metal industry 10.6 8.7 7.3 8.8 7.6 Medium industry 11.4 9.3 7.3 10.7 8.2 Light industry 9.5 9.3 8.3 10.7 9.2 Small ind./agric. 5.2 5.1 4.5 5.9 5.0 Transport 3.8 3.5 3.3 4.0 3.5 Residential 12.8 15.5 15.0 18.7 17.8 Other small cons. 6.6 7.9 7.9 9.4 9.3

Total cons. 86.0 84.2 74.1 94.0 81.0 Losses 5.9 5.9 5.2 6.5 5.6 Total requirement/2 91.9 90.1 79.3 100.5 86.6

Source: CEZ, VUPEK, Mission estimates

/1 Including industrial consumption saticfied from own generation (about 2000 MW installed). Czech and Slovak Republics combined.

/2 Including net import/export balance.

/3 Highest consumption level before start of decline. ANNEX 3.7 -85- Page 2 of 2

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTAL IMPROVEMENT PROJECT

Czech Republic Electricity Consumption Forecast 1992-2000 (TWhJ.

High Low Scenario/l Scenario' 1

Actual: 1989 62.4 62.4 1990 61.9 61.9 1991 56.5 56.5 Forecast: 1992 53.0 53.0 1993 54.0 51.1 1994 55.0 52.2 1995 56.9 53.3 1996 58.7 55.3 1997 60.9 56.3 1998 61.7 57.3 1999 62.9 58.3 2000 64.0 59.3

Decline of consumption to 1993, then renewed growth after industrial restructuring.

Source: CEZ CZECHAND SLOVAKFEDERAL REPUBLIC

POUERAND ENVIRONMENTALIMPROVEMENT PROJECT

Power Sector Investment Program

1. Czech Repubtic: Eneroy snd capacity 1992-2000 1992 1993 1994 1995 1996 1997 1998 1999 2000

'. Demand: Energy (TWh) - High 53.0 54.0 55.0 57.0 59.0 61.0 62.0 63.0 64.0 - Low 53.0 51.0 52.0 53.0 55.0 56.0 57.0 58.0 Peak capacity (GW) - 59.0 High 8.1 8.2 8.4 8.7 8.9 9.1 9.3 9.5 9.7 - Low 1 8.1 7.8 8.0 8.2 8.4 8.5 8.7 Peak requirement(GW)/ - High 8.8 9.0 10.1 10.3 10.5 10.9 11.1 11.4 11.6 11.9 12.1 Low - 10.1 9.8 10.0 10.3 10.5 10.6 10.9 11.0 11.3

2. Existing Ca,acity (GW) 14.5 14.2 14.1 13.9 13.5 13.1 o2.6 12.6 12.6

3. Scenario A

0' New CEZ capacity (GW) 0.0 0.0 0.7 1.0 1.0 0.0 0.C 0.0 Total instalted capacity (Gw) 0.0 2 14.5 14.2 14.8 15.6 16.2 15.8 15.3 15.3 15.3 Capacitymargin/ X high demand 79.0 73.0 76.0 79.0 82.0 74.0 65.0 61.0 lowdemand 59.0 79.0 82.0 85.0 90.0 93.0 86.0 76.0 74.0 70.0

4. Scenario B

New CEZ capacity(GW) 0.0 0.0 0.7 0.0 0.0 0.0 1.0 1.0 0.0 Total installedcapacity (GU) 2 14.5 14.2 14.8 14.6 14.2 13.8 14.3 15.3 15.3 Capacitymargin/ (X) - high demand 79.0 73.0 76.0 68.0 60.0 52.0 54.0 61.0 59.0 - low demand 79.0 82.0 85.0 78.0 69.0 62.0 64.0 74.0 70.0

/1 Peak capacitydemand plus 25% margin. /2 As % of peak capacitydemand. I-.

0 . OD0 l!. CEZInvestment Exvenditure 1,92-2000 (Kcs million)

Total Total IS CrloA (high growth plus exports, 1992 1993 1994 1995 1996 92-96 1997 1998 1999 2000 97-2000 early capecity dditions)

7ielin nuclear 9099 11287 12719 12879 7794 53778 1500 0 0 0 1500 Spent fuelstorage 773 1315 386 0 0 2474 0 0 0 0 0 Retrofitof Sukovanryracletr 894 712 392 259 50 2307 998 1010 1050 1000 4058 Dl. Straiehydro 85? 660 604 514 0 2665 0 0 0 0 0 Envirormental retrofit 2980 7161 12384 16159 14524 53208 5972 474 180 328 6954 Rehabilitationlconversion 1864 1802 1583 1897 1959 9405 1841 1602 1457 1063 5963 District heat 619 508 379 207 559 2272 608 785 658 500 2551 Transmission 948 1109 1011 824 548 4440 624 871 995 947 3437 Niscselgneous 1588 1341 1180 1005 1156 6270 IG76 1051 1282 1453 4862 Neewgeneration 0 0 0 0 0 a 0 850 4412 892 14154 TOTAL 19652 25893 30938 33'44. 26590 136819 12619 6643 10034 14183 43479

Total Total Scenario S (low growth, latercapeci:V additions) 199Z 1993 1994 1995 1996 t 1997 1998 1999 2Q 97-2000

Temelinmrclear 9099 9652 9783 9656 9265 47455 6323 1500 0 0 7823 Spentfuel storage 773 1315 386 0 0 2474 0 0 0 9 0 Retrofit of Sukovnny maclear 894 712 392 259 50 2307 698 810 1350 1542 4400 Dl. Stranehydro 887 660 604 514 0 2665 0 0 0 0 0 Envirorewntalretrofit 2980 7161 12384 16159 14524 53208 5972 474 180 328 6954 Rehabilitation/conversion 1864 1802 1883 1897 1959 9405 1841 1602 1457 1063 5963 District heat 619 508 379 207 559 2272 608 785 658 500 2551 Transeission 948 1109 1011 824 548 4440 624 871 995 947 3437 Miscsotlaneous 1588 1337 1180 1005 1156 6266 1076 1051 1282 1453 4862

'OTAL 19652 24256 28002 30521 28061 130492 17142 7093 5922 5833 35990

0th r X o ,0 - 88 - Annex 3.9 Page 1 of 2

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTALIMPROVEMENT PROJECT

Nuclear Power InvestmentProgram

1. The nuclear program is by far the largest p&rt of the overall investmentprogram. It envisagesthe completionof the two 1,000-MW units at Temelin (PressurizedWater Reactors of the Soviet VVER - 1000 model) in the Czech Republic, the completionof four 440-MW units at Mochovce (Pressurized Water Reactors of the Soviet VVER-213 model) in the Slovak Republic, and additional investmentsfor the decommissioningof the two early 440-MW units at Bohunice (in the Slovak Republic) starting in 1995 and thi constructionof a centralizedfacility for the storage of nuclear spent fuel. At Temelin, about Kcs 12,900 million has been spent so far and an additLonalKcs 55,300 million is required to complete construction. Future expected costs are, at an exchange rate of Kcs 28/UF$, equivalent to US$1,975 million. Taking into account the total capacity of 2000 MW, this amounts to about US$990/kW. Assuming that this figure is correct, it is not clear that discontinuing constructionand substitutingthe two 1000 MW units with another technology would be economicallypreferable, since alternativetechnology would be equal or more expensive. The overall cost of the plant, as estimatedby the CEZ management,seems low compared with internationalexperience. However, if one takes into account that a large portion of the cost is due to civil works and labor, wlhichin Czechoslovakiahave been priced low, the estimated cost is not surprising. Constructionat the site is proceedingwith the first unit about 60% and the second about 40% complete. Also, the Temelinmanagement has decided to replace the instrumentationand control (I&C) system of the plant with western technologyand bids were rece5ved on April 15, 1991 from six internationalsuppliers. The cost of the .&C system, estimatedat about US$120 million, has been taken into account in the future cost estimates.

2. The Mochovce plant, at which 4x440 MW units are under construction,is at an advanced stage of implementation. About Kcs 16,500 million have been expended and an additionalKcs 29 billion is expected to be invested for plant completionnow scheduled for 1995. Again, the remaining cost is equivalent to about US$1,000 million which, for a 1760-MIWplant, correspcndsto a unit cost of US$588/kW. It should be noted that the Mochovee plant managementhas also contractedwith a major German firm for the upgrading of the instrumentationand control equipmentat the plant.

3. If we apply the same cost rationale as for the Temelin plant, we conclude that the planned complctionof the Temelin and Mochovee plants, which will add about 3760 MW of capacity, is an economicallyjustifiable component of the investmentprogram, provided that demand developmentjustifies this glUscity. The added capacity (scheduledas follows: 440 MW in 1992; 440 MW in 1993; 440 MW in 1994; 440 MW in 1995; 1000 MW in 1995 and 1000 MW in 1996) will enable Czechoslovakiato retire an equivalentcapacity of old and air polluting units (both lignite and nuclear), sustain the production of adequate -89 Annex 3.9 Page 2 of 2

electricityfor the needs of the economy at reasonablecost, and reduce the dependei.ceon imports. (It might be possible to make availablea certain amount of electricityfor export to the interconnectedEuropean electricity network).

4. The Czechoslovakpower authe_itieshad included earlier additional nuclear units: two additional1000-MW units at Temelin and new power plants at other identifiedsites. These plarts are currentlynot included in the investmentprogram owing to the forecast slow demand growth due to the new economic conditions in the country, the perception of serious deficienciesin the Soviet designed reactors,the financialconstraints, and the heightened awareness that pressing issues such as safety upgrades,plant decommissioning, and a comprehensiveplan for low-, medium- and high-level radioactivewastes, must be solved first. In addition,the work on eivanced, simplified, standardized,safer reactor designs,now proceedingby several international consortia,mandate that any plans for new nuclear plants must be postponed until after the year 2000. The existenceof separate investment items for the likely decommissioningof Bohunice units 1 and 2 and the establishmentof spenb fuel storage facilities indicatesthat th. Czechoslovakpower authoritiesare serious about confrontingand solving the complexitiesof their nuclear-powerprogram. Future new generatingcapacity will have to be selected from a number of options (gas combined cycle, nuclear, etc.), using least-costcriteria. _ 90 - ANNEX 3.10

Czech and Slovak Federal Republi

Power and Enviromental Improvement Prolect

Averace Electricity Tariffs 1989-91

Kca/KWh USc/KWh

Consumer Tariff Voltacae Cateaorv Cate_qorv 1989 ARril'91 Oct '91 Oct'911

HV: Large industrial A2 0.39 1.10 1.10 3.9

Railways A3 0.35 1.10 1.10 3.9

Large consumer A4 0.56 1.59 1.59 5.7 AS 0.45 1.31 1.31 4.7 A6 0.38 1.19 1.19 4.3

MV: Medium consumer B1 0.76 1.75 1.75 6.3

B2 0.53 1.23 1.23 4.4

LV: Regular commercial SM/SV 1.06 2.96 2.96 10.6 Night commercial NH 0.35 0.73 0.73 2.6 Public lighting Vs 0.40 1.26 1.26 4.5

Average non-reside..tial consumaere 0.53 1.46 1.46 5.2

Residential Day VT 0.52-1.11 0.48-1.11 0.81-1.89 2.9-6.8 Residentiel w/ night storaUe NT 0.18-0.27 0.18-0.27 0.30-0.45 1.1-1.6

Average residential 0.50 0.50 0.85 3.0

Total average 0.52 1.27 1.34 4.8

1/ KcB 28 = US$1 - 91 ANNEX 3.11 Page 1 of 5

CZECH A?'D SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTAL IMPROVEMENT PROJJCT

Electricity Pricing and CEZ Marginal Cost

Main AssumptionB for Mar1inal Cost Estimates

The preliminary estimates of LRMC use the following simplified assumptions:

(i) The demand forecast for the CFZ grid has been taken as the most recent central scenario within the range of demand projections, indicating a dec-lineof overall demand for several years (decline in industrial consumption, modest increase in residential consumption), followed by slow growth in the outer years of the ten-year period.

(ii) A "no growth" investment program was developed, essentially based on the replacement or rehabilitation of existing generating capacity, utilizing mostly work in progress and retrofitting/repowering. A maintenance of existing levels of available capacity was achieved by replacing the retired capacity in Northwest Bohemia (lignite) with the commissioning of the nuclear capacity at Temelin, and the repowering of remaining lignite-fired steam plant for combined heat and power. Environmental expenditures were represented by investment in flue gas desulfurization, spent nuclear fuel disposal, and decomnissioning. Some additional hydro capacity for pumped storage was included. This preliminary investment program needs to be updated and revised in the light of new forecasts as they become available.

(iii) i"*

(iv) Marginal cost of energy is estimated from incremental fuel use and operation/maintenance expenditures. LRMC of capacity was primarily established as A'verage Incremental Cost (AIC), representing the ratio between the discounted investment and discounted MW streams for the decade until 2000. As very little tradeoff between base- load capacity cost and peak fuel cost is involved, this simplified method is sufficient for a first estimate. - 92 - AINEX 3.11 Page 2 of 5

Samle Calculation

Marginal Enerov Cost: given the relatively small difference between peak and off-peak load levels, the marginal energy for each pricing period is assumed to be obtained from lignite-fired thermal plant.

Peak Shoulder Off-Peak

Fuel use GJ/kWh 13 12 11 Marginal Cost of Lignite at $1.20/GJ 0.43 0.40 0.36 or Kcs 33/GJ 1/ (Kcs/kWh) O&M cost of generation (Kcs/kWh) 0.44 0.44 0.44 Total at generation 0.87 0.84 0.80

Losses in the grids 1%): 400/220 grid 1.4 1 0.8 110 grid 2.7 2 1.6 Medium voltage (MV) grid 4.1 3 2.4 Low Voltage (LV) grid 9.6 7 5.7

Energy cost (Rcs/kWh) 400 KV grid 0.88 0.85 0.81 MV grid 0.94 0.89 0.84 LV 1.03 0.95 0.89

Marainal capacity cost: the investment cost necessary to maintain peak generating capacity in the system while providing for essential environmental measures, includes the remaining cost of pumped storage hydro plant, rehabilitation of remaining thermal plant, ash disposal, and FGD. Sunk CostB are not taken into account, as the investment program is being re-optimized on the basis of incremental costs only, within the framework of radical economic reform. The low CEZ scenario is used.

/ If the opportunity cost of lignite (i.e. cost equivalent per GJ of imported coal minus penalty for higher sulphur content of lignite) is used, the fuel cost amounts to $1.70/GJ or Kcs 48/GJ, implying a fuel cost about 40% higher than that used in this preliminary estimate. However, if the production cost of the more efficient lignite mines (US$0.60/GI) is used, the fuel cost decreases by about 50%. - 93 - AN X3.11 Paget 3 of 5

Year Increment&l MW 2J Peak CaRacitv COst (Kcs billion-

92 5.7 93 - 9.6 94 650 14.9 95 440 18.6 96 2,980 16.5 97 2,730 7.8 98 440 2.1

PV at 10% 4,846 58.0

Average Increm. Cost: Xcs 12.0 m./MW Annuity at 20 years: Kcs 1.4 m./MW/year or Kca 118,i'(W/month.

Marginal calacitv cost of transmission and distribution: assumiea cost ratio of about 1:1 between the 400/220 KV grid, and the MV/LV grid. The high- voltage investment cost is estimated by CEZ. Average Incremental Cost for each grid is calculated as in the generation case, decreasing the stream of MW in accordance withlpeak system losses.

400/220 KV grid: PV at 10% 4779 MW Kco 4,661 m. AIC Xco 975/kW Annuity Kcs 9.50/kW/month

110/MV grid: Annuity Kcs 10.20/kw/month

LV grid: Annuity Kcs 11.20/kW/month

Total marginal capacitv cost (Kcs/kW/month):

Generation 400/220 110iMV LV

At 400/220 kV 120 9.5 - - At MV 128 10.2 10.2 - At LV 140 11.2 11.2 11.2

2/ New capacity at Dlouhe Strane hydro, and FGD/deNOx retrofitted and rehabilitated lignite capacity. - 94 - ANNEX 3r11 Page 4 of 5

Total Marainal Cost Matrix

Capacity Energy (Kce/kWh) (Xcs/KW/Mgi Peak Shoulder Off-Peak

At generation 118 0.87 0.84 0.80 At 400/220 kV 130 0.88 0.85 0.81 At MV 148 0.94 0.89 0.84 At LV 174 1.03 0.95 0.89

Tariffs and Marginal Cost

Tariffs valid in early 1992 provide for multi-part tariffs for larger consumers, and simpler one- or two-part tariffs for residential and other small conBumers. Typical tariffs for high voltage consumers consist of a monthly KW charge of about Kcs 254-302, plus a three-part energy charge per kWh ranging from Kcs 0.66 to 1.19, according to the pricing period. The average revenue per kWh obtained from such consumers on the basis of this tariff amounts to about Kcs 1.23-1.75. This compares to a hypothetical marginal cost-based revenue for an MV consumer with about 50% load factor, 70% coincidence, and mostly shoulder period consumption of about Kcs 1.20/kWh. It is evident that, even if marginal capacity cost estimates are underestimated, MV consumers' tariffs are fairly close to LRMC levels.

On the other hand, end-1991 average revenue from householQ consumers amounts to about Kcs 0.85/kWh, ranging from 0.30 to 1.70. The LRMC-based hypothetical revenue from a comparable LV consumer with a, say, 40% load factor and high coincidence would amount to about Kcs 1.60/kWh, about double the current price. A lower load factor of, say, 20% would result in a cost of Kcs 2.00/kWh, Significant price increases are planned for 1992/93 to approach LV marginal cost levels.

Conclusions

The judgements at this point are qualitative, and the numbers employed represent an order of magnitude. More precise estimates have to be made when more detailed information on investment costs, demand forecasts, and consumer ':haracteriaticsare available.

Notwithstanding the imperfect cost figures entering into the analysis, the following p-eliminary conclusions can be drawn:

(i) After the December 1990 and April 1991 increases in the tariffs of industrial high-voltage consumers, the price levels for thekse consumer categories are approximately equivalent to their category- specific LRMC levels, and are unlikely to need substantial increases in real terms to reach economically sound levels. - 95 - ANNEX 3.11 Page 5 of 5

(ii) The tariffs of residential consumers, are well below their LRMC levels, reaching a maximum of 50% of LRMC. Significant increases in the prices for these consumers will be necessary to come closer to LRMC.

(iii) The main issue concerning power pricing is the inefficient relation between high-voltage and low-voltage price levels, i.e. an increasing distortion of the price structure. While the prices of residential consumers have been increased by 70% (and current government proposals call for further increases only in later 1992 and 1993), the prices for industrial and high-voltage consumers have risen by almost 200%. This pricing strategy has created a reversal of the optimal cost-related structure, making high-voltage consumption significantly more oxpensive than low-voltage. This imbalance needs to be rectified by further price increases for the residential categories which should be both more frequent and higher than those for industrial/commercial consumers. Social hardships in the implementation of this strategy can be mitigated by introducing a modest first block of monthly kWh consumption at below-cost prices, to protect the affordability of essential minimal consumption levels ("lifeline rate"), with the remainder of the consumption priced at cost.

(iv' In the medium term, financial needs of the power supply companies are likely to require even greater price increases than would be mandated by LRMC considerations. In pursuing this aim, care needs to be taken to increase the price levels of low-voltage consumers, to contribute to a steady reversal of the distorted pricing structure. - 96 - ANNEX 3.12 Page 1 of 6

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTALIMPROVEMENT OROJECT

Coal Prices and Costs

PresentDomestic Coal Prices

1. After the December1990 and Hay 1991 price increases,the present situation of domesticprices for coal in the three major market segments is as follows:

Lignite for Power Plants. The present a ge price for ligi&..Le deliveredat the power plant is 340 K/t, or 12$/t. En a heat basis, this price amounts to 1 $/GJ, or 60X lower than the price of heat in imported steam coal (Tables2.1 and 2.2). If the plant operatorhas to cover the cost of desulphurizingthe flue gas when using lignite, and consideringfurther the lower efficiency of using lignite, the presentlignite price is about 30X lower than the cust of importedhard coal.

Coking Coal for Steel Plants. The present average price for coking coal deliveredat the steel plant is 1,470 K/t, or 53 $/t. This price is approximatelyin line with internationalcoking coal prices.

Lignite for Small Consumers. The present average pri-E for lignite delivered at households and other small scale consumers is 600 K/t, or 21 $/t. On a heat basis, this price amounts to 1.3 $/GJ, or only 57X of the cost of importedhard coal.

2. Other coal types account for only about 10 of the coal market. They include primarilyhard coal for power plants and small consumers,but also processed coal, in the form of lignitebriquettes and hard coal coke, for small consumers. On a heat basis, hard coal for power plants is presentlypriced at 1.0 $/GJ, or 372 of import cost. To small consumers,hard coal is sold at 802 of the hard coal price to large consumers. In line with their higher production costs, processedcoals are sold at higher prices. However,these prices are stillbelow the cost of production.

Coal IMoRQt Costs

3. Czechoslovakiacurrently imports some 5 million tons per year of steam coal. Current importsof coal come from Poland and former USSR. Both these suppliers have a locationaladvantage. However, the future availabilityof coal from these sources is uncertain, given the economic changes underway in both countries. The Polish coal mining industry, being base in the same coal basin as the Czechoslovakhard coal mines, and subjectto similarpressures due to risingreal 9.7 - ANNEX 3.12

costs and concern with the environment,is likely to undergo substantial contraction in the coming years. Coal from the Americas, Auscralia,South Africa, or even East Asia, landed at North Sea or Baltic Sea ports and transportedthrough Germany or Polandmay become a competitivesource of supply if the transportinfrastructure is able to handle the volumes required.Other possible routes, in the longer term, are via the Yugoslavianport of Rijeka on the Adriatic Sea and then by rail to Czechoslovakia,and from the Black sea up the Danube throughRomania, Yugoslavia and Hungary to Bratislava.

.. The currentborder price is still determinedby the border price of Pdlish and Soviet coal. Assuming 10 S/t transportcost from Katovice to Gdansk, and 3 $/t from Katowice to Czechoslovakia(Ostrava) this would be $43/t (50-10+3). However,Polish coal may soon ceaseto be a significantdetermining factor. Based on data providedby VUPEK, transportcosts for alternativeoverseas coal landed at North Sea or Baltic Sea ports and transportedto Czechoslovakiaby rail or barge on the Elbe river, are estimatedto be in the 12-18 $/t range, with the lower and upper estimatesbeing for rail transportthrough eastern and western Germany, respectively. Given the economic changes underway in Germany, these estimateshave to be revisitedin any study of coal pricing. More information is also required on the technicalfeasibility of coal transporton these and other routes, includingavailability of stockyardsand coal handlingequipment. Assuminga North Sea deliveredsteam coal price of $50/t and a transportcost to Czechoslovakiaof 15 $/t,a price of 65 $/t in Czechoslovakiawould result.This price has been used to determinethe economic cost of coal in Czechoslovakia (Lii-) .

LignitgORnorrunity os

5. Determinationof ligniteopportunity costs requiresanalysis of the economics of the power system, in particularthe least cost loading order of generating plant. Technicalparameters of lignite-firedpower stationsare designedaround the characteristicsof the lignitesupply (e.g.calorific value, ash and sulphur contents, ash fusion temperature)and are located close to their source of lignite supply. If technicalparameters do not permit much variation in cosl quality,alternative sources of coal are not a feasiblefuel supplyalternative. Consequently,direct market-basedpricing of lignits,in a situationwhere mines and generatingplant are already in place, is not possible.l

6. In such cases, it can be shown that the economicallyefficient price of lignite from a given mine lies somewherebetween the cost of productionof the mine and the opportunitycost of lignite. To determinethe opportunitycost it would be necessary to analyze the combinedcosts of each joint lignitemine and power plant complex. The opportunitycost of lignite from a mine then is determinedby the cost of generationat the next more costly plant.

l Pr1oe to delomnt of the fciltln, W e poer se operator is bl to choo betwwn verioua types of poww plant mm fuet soue, mket-boad pricing of Slgniteis po"ible through nWetiation of long term lignite supply contracts. - 98 - ANNEX 3.12 Page 3 of 6

7. A hypotheticalexample is shown below for the case where the highestcost generatingplant is runningon importedsteam coal costing2.0 $/GJ (the current approximateprice of Polish steam coal). The plant merit and loading order is determinedby-their respectivelong run marginal costs, includingthe cost of lignite. The opportunitycost of power generationat the highest cost lignite

Power Planr Loading Generation Opportunity Fuel Cost Opportunity Cost Cost of Power Cost of Fuel (c/kWh) (c/kWh) ($/GJ) ($1GJ) Coal 20% 5 1.6 1.6 Lignite I 70% 4 5 1.1 1.6 LigniteII 100% 3 4 0.7 1.1

-fired plant is determinedby the cost of generatingmore energy at the hard coal-firedplant. Consequently,the opportunitycost of ligniteis determinedby the cost of importedfuel. Adjustmentswould be made for the higher capitaland operatingcosts for lignite based power plants, includingcosts for necessary flue gas desulphurization.The appropriateprice for lignite from the mine attached to the Lignite I power plant lies in the 1.1-1.6 $/GJ range. Similar reasoningleads to a price range of 0.7-1.1$/GJ for lignitefrom the LigniteII mine.

8. In a free market economy.determination of the positionof the actual lignite price within the marginal cost/opportunitycost range would result from the bargainingprocess borween the mine developerand the power generator,who must sell his output to the electricitygrid at a competitiveprice, while following environmentalregulation. In the Czechoslovaksituation, the price determination would likely be a matter of Governmentregulatory policy.

9. In Tabie_ a hypotheticalopportunity cost of lignitefor power plants has been estimated on the assumptionthat in a first stop the heat containedin ligniteis valued at the cost of heat containedin importedcoal from overseas sources, and that then deductionsare made from the lignite price f3r lower efficiency of lignite in combustionand plant capacity utilization and for covering the extra cost of flue gas desulphurizationwhich is required f.r Czechoslovakianlignite but not for importedcoal

ProductionCosts

10. Presentaverage production costs are 8.7 $/t, or 0,7 $/GJ, for lignite,and 47.2 $/t, or 2.0 $/GJ, for herd coal (Table 3)2. These are financialcosts as reported,without detailed analysis. Lignite costs range from about 6 to 33 $/t, or from 0.5 to 2.6 $1GJ. About 80 % of the lignite is mined at costsnot higher than 10 $/t, or 0.6 $/0J. There are two lignitemines at Prievidzawhich produce at costs equal to or higher than the estimatedcost of steam coal importsfrom overseas sources (2.5 $/GJ). Czechoslovakianhard coal productioncosts range

21T latest pro$action cot fiwges adeavaitable refer to the r 19w6.Corrtfprm ingly, the erae 1969xchange rate of 15 KIShs been usd forconersion into Us dollars. 99 - ANNEX 3.12 Page 4 of 6

from about 35 to 90 $/t, or from 1.3 to 4.2 $/GJ. Four mines in the Ostrava region and one mine in the Kladno region have productionCOStS higher than the estimatedcost of steam coal importsfrom overseassources.

11. Only relativelyminor increasesfor input prices to coal productionwill cause many mines to become uneconomic.This is in particularthe case for the Ostravaand Kladno hard coal mints and the Prievidzalignite mines. Some input price increasesmay be compensatedby productirityincreases and cost reductions at the mines. Based on the experienceof similarmines in western Europe,it is likely that only very few undergroundmines can remain competitivein che long run, despite the productivityincreases and cost reductions.

12. For firm decisions on mine closures,more detailed analysis is needed of productioncosts, in particularfuture cash operatingcosts on a sunk cost basis, markets, transportand other infrastructure,distribution costs, environmental impact,and developmentpotential of the mines concerned.Such analyticalwork could be executedby local institutionsseparately for each of the six regional group of mines. ANNEX3.12 Page 5 of 6

Table 2.1: Doesetic Coal Prices

Coal Type & Categorieo 1959 Beat Pric -Domestio Priose------Sales Value Cat. a t PresenteAnri2. 1Q91) du1 19 ..4ILL&...Ml a of as I of ,rof Q= Ni la V.Qzu ELcon.Cgot [z; LQMLGQ^ mL zslea-cst A. FUEL COAL

Fin. Lignite 74 13 W 340 12 lM 45X 340 451 430 571 wexdCoal 12 20 H 540 19 1.0 37X 540 371 800 452 Coarse Lignite 15 16 R 180 6 0.4 171 800 57X 600 57X Hard coal 2 21 fi 130 5 0.2 eX 420 282 420 261 Pfo*essedLign.Briquettea 2 21 R 230 8 0.4 121 780 411 78f 41X Bard Coal Coke aL 2 27 R 4a. 17 0.6 11- 2240 811 2240 I.

S. COKINGCOAL 14 28 w 1420 51 1 . 552 1470 672 1470 671 C. TOTAL 120 15 462 17 1.0 521 556 591 626 691 at 1989 sales, including 4.5 Ht imports from PolandI end US5Z H Wholesale, I Retatl, wholesale price to large comsumerm (powr, steel 6 heating plnto, other industry). retal price to smel consunrs (minly househ.) L average price delivored oonsimer, including averago transport cost of 3 $/t for wholesale and 6 5/t for retail, exchange rate 28 K/V OL May 1991 inorease of 240Z for housahold coal */ contemplated June 49V1 increase of 251 for industrial coal economic cost as per Table 2 below. cost of coal imports from overseas souros used as bencluark AL coke for household use only, in addition Lh-rw are about 3 Ht/a of coke sold to steel plants (starting May 1, 1991, a: scrW price)

Table 2.2: Present Economic Cost of Coal

QLL Ti &ACteores Cost of Imorted Coal

A. FUEL COAL Fine Lignite - - - 2.2 Hard Coal 65 25 2.6 2.6 Coarse Lignite - - - 2.4 lard Coal 75 27 2.8 2.8

Processed LiSnu.3iqu*ttea - - - 3.1 lard Coal Coke 107 29 3.7 3.7

D. COKINGCOAL 78 23 2.3 2.8

AL estimated presaet cost of coal imported from overseas deUlverod to CSFR conscuor k economic cost of bard coal has been ascued equal to cost of imported coal; eoonomic cost of lignite has been asu med to be 152 lower due to lower efficiency (penalty for higbhr eu'.rhur emissions has not been applied) - 101 - ANNEX 3.12 Page 6 of 6 TAULIM3 QpROCTIOHQdOS3TS OP CQAL-1N&f (yw I 966.wo9em ISIKM5

HoM C-a Type Wn. Gifs Mie Pv.dee value P_.dued. Cet ______~~ PA"" Ma CWA / 8/ tIe NS S 9mia 10.0 11.0 0.3 0.5 No S N~ST OW 20.0 10.? 5.9 0.6 No S Vrmy 7.0 10.1 5.7 0.6 NG S CSA 9.0 17.1 10.6 0.6 NO S MoCco*v 3.0 14.7 9.0 0.7 N8 S CI8aWc * 3.5 12.6 Z t .0 0.9 NG U O 0.6 13.0 13.2 1.0 Ng U cUvf A"UW * 0.5 17.5 16.6 ,t NO U K*lMwt * 0.7 19.3 223 1.2 NI U Muimak"Go 1.0 14.0 19.1 1.4 Sue"l 56. 12.4 7.9 o.s Ukolov WS a id to 1t7 7.0 0.5 We S med6 Ubi * 4.6 11.1 e.9 0.6 We S M1e M*Vws 1.5 1la 10.4 0.9 We S0* e 0.8 11.5 12.8 1.1 SUbeetal 14.3 12.1 7.6 0.6 hdp gSlm U ' * 0.6 6.7 14.2 1.6 SM U Dia * 0.6 S.7 16.6 1.7 -* U ut4o * 0.6 8.9 17.3 1.9 sebew 2.0 9.1 15.L 1.7 .;WT4g u DOAN * 0.8 .9 204 21 S U Ogl * 0.1 11.0 26.2 .4 S NuHgev t.0 133 33.1 2u S U NeulY 0.3 14 27.2 Ls SeuM.tl ^2.6 11.6 27.2 2.4 boUaeb 4.3 12.2 - 8.7 0.71

Osirwa. K U Ogeubr 1.7 20.4 34.7 1.3 K-ine K U Zapseoky 20 2.3 3O 1.4 K U C6A 2. 24.6 30.1 1.4 K U DUNG 1.4 25.3 41.4 1.6 COldg K U C nAdAef 1.6 2" 48.2 I.? cow(C) K U 1. 4.1 24.3 42.E 1.6 C K U Fuik * '. 23.4 42.7 1.6 C 0 UI s * 1.3 31.0 Su I.$ c 0 u Pkw * 0. 26.8 54.5 20 C K U.Frw*ee * 0.8 210 5S.5 2.3 c 0 U wme 0.5 24.5 67.8 3.6 C 0 u Ow" 1.0 22.0 W4 4.1 C 0 U 0 0.1 1005 6I07 4.1 C 0 UIN" - 0. 20.4 S0 42 SW*" 24 26. 4L. 1.6 IKb6 We UOJAW 0.3 24 804 2.1 Cs U 1e 0.8 18 35. 2I CB U Tuswe * 0A 18 33.4 2.1 * U _hmev * 0. 11.8 27. 2.3 Cs U 0u 10 462 2.U WM 2 17 3 22

~~~~ - es"_ ~~~~ 45wprO#"~UwpemEni Awr i*!oavgt

Wf A..__ grKmA,e o a - 102 - ANNEX 4,1

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTALIMPROVEMENT PROJECT

CZECH POWER ENTEPRISI CEZ) QRGANIZATIONALC4aRT

CZECH POWIR WOR3S , STQTE ENTERPRISE ...... ,@9- HEADQUAR4TER4S

' ~ ~~~~~~ ~~~~ H,¶Aqu?tzO ......

MVCLZAAPNEASTATIONS~ ~ ~ ~ ~~ LZZJ~

HO."AATwElSTATIN iOil0ss 3. 3 4 :

CLO3HU3£AM A POE SAIONS OHINt3. t.>~~~~~~~~~~~~~~ClACOD'J.0UJ. 3?40 TREHNICE~ ~ ~ ~ ~~IhAOVC

IFOUELMIOX oL ;~:oLf.

4 pa|tD0 0EASTTOMS

corso iplme tationof the'0V

restuctrinan priatizataion roram"DHkt.n___EESRGYASSEASLY 000)15

l.1:1 1StAION : s_ nsits Voon-.o mt7.£CJ Sourc~~tes:9CEZndB kIIXO~~. Missio .=_ O Septmbe1991iI . .XHhQ1 Toe parted fro CZ ncthe courseof implementation of the~~~~~~~~~~~~~~~~~~~~ restuctrin an privtiztio program.uQKS Sources:~~ C andlAo0Z Ban MissionE * S

Septmbe 199 ANNEX 4,2 - 103- Page 1 of 3

CZECHAND SLOVAKFEDERAL REPUBLIC

POWERAND ENVIRONMENTALIMPROVEMENT PROJECT

Draft Terms of Reference for Accountina and

FinancialManagement InformationSystems Studv

Obiectives

1. As a result of the new laws on enterprisesand accountingregulations supportingthe government'spolicy to restructurethe economy, the Czech and Slovak enterpriseswill have to carry out changes in their organization, accounting systems and financialfunctions. CEZ thereforewishes to carry out the appropriatechanges in the organizationof accountingand financial management functionsand to improve the accountingand financialmanagement informationsystems.

Scope of Work

2. The study should cover CEZ's organization,and in particular,the followingareas:

(i) general and cost accounting;

(ii) project cost estimation,monitoring and control;

(iii) annual capital and operatingbudget preparation;

(iv) budget monitoring,control, and analysis of variances between actual and planned performances;

(v) cost/profitcenter performancemonitoring;

(vi) short-term (up to 1 year) and medium-term (up to 3 years) financialplanning and management includingpreparation of detailed revenue and expenditureforecasts, cash flow forecasts (monthly,quarterly, semiannual and annual);

(vii) medium- and long-termreceivables and payables management;

(viii) working capital management;and

(ix) internal audit and control. -104 - Page 2 of 3

3. The study is expected to include 3 phases consistingof diagnostics, design and installation,and imaplementation,as follows:

Rhase I: Diagnostic

(a) Descriptionof, and analyticalassessment of, the stret,gthsand weakness of the existing accotntingand financialorganization and systems including:

(i) division of responsibilitiesfor the accountingand financialfunctions between different units;

(ii) data and informationcollcction and processing practicesand procedures;

(iii) types of analyses performedand reports prepared for external reportingto governmentand other agencies and for internaluse in the organization;

(iv) existing staffing levels and skills;

(v) existing electronicdata processingcapabilities includinghardware and software.

(b) Based on discussionswith the relevantmanagement and staff, identificationof the informationalneeds of the various levels of managementand staff; and

(c) Identificationof alternativesto be consideredfor examinationin Phase II.

Phase II. _Design and Installation

(a) Examinationof alternativeways of meeting the informational requirementsidentified in Phase I, includingthe assessmentof the costs and benefits of ircreasedcomputer-based processing, taking into account hardware, software,and related costs;

(b) Recommendationsfor an appropriatestrategy for developmentof the accountingand financialmanagement information system;

(c) Recommendationsfor appropriateorganization of the accountingand financialmanagement functionsand division of responsibilities between the differentwork units;

(d) Design of the appropriateformats for accountingand financ4 al analyticalreports for differentlevels of managementand staff;

(e) Recommendationsfor the practicesand proceduresto be used in data collection and processing; dEEX 4.2 -105 Page 3 of 3

(f) Recommendationsfor th.eappropriate electronic data processing arrangementsincluding hardware and soitware;

(g) Recommendationsfor managementand staff training in the republic and abroad; and

(h) Recommendationsfor a phased program of implementationincluding time schedulesfor specific steps and definitionof responsibilitiesfor achievementof the steps.

Phase III Ilementation

4. Assistance in implementationof the recommendedprogram includingthe training of managementand staff.

Stuy Qrg&&izRLtLn

5. The study is expected to be carried out by consultantsacceptable to the Bank and selected on the basis of the Bank's guidelines. Phase I is expected to take about 6 months and Phase II about 9 months. Followinga review of the study's recommendations,implementation of the recommendationsis expected to commence soon thereafter.

6. CEZ will establish a Committeeto guide the overall work and appoint appropriate,qualified counterpartsto work with the consultants.

SntudyOutpiLt

7. The consultantswill be expected to submit to CEZ a work plan for the study which should be -eviewedwith the Bank prior to conmencementof the substantivework on Phase i. The consultantswill be expected to provide periodic oral and written reports of the progress of the work. A draft report will be submittedat the end of Phase I. During Phase II, an interim report will be provided in mid-Phase and a draft report at the end. Translationsin English of all these reportswill be sent to the World Bank for its review and comments. A final report will be prepared at the end of Phase II taking into account the comments of the World Bank. During the preparation of the study, brief monthly reports will also be sent to cne Bank to cover the progress. Regular quarterly reportswill be prepared during Phase III.

Source: Bank Mission September1991 CZECHAND SLOVAK FEDERAL REPUBLIC POWERAND ENVIR0WIENTAL IWPROVENENT PROJECT

DETAILEDPROJECT COST

C October 1991 constant USSthousand )

1992 1993 1994 1995 1996 Total Grand Tot

LC FC LC FC LC FC LC FC LC FC LC FC LC+FC A. PollutionControl

Prunerov Al. II, 5'210=1050NW, FGD 12,000 12.000 30,000 30,000 45,000 40,000 30,000 18,000 20,000 12,000 137,000 A2. DustControl Installations 112,000 249,000 0 0 10,000 7,000 20,000 17,000 3,000 3,000 0 0 33,000 27,000 60,000 Subtotatl 12,000 12,000 40,000 37,000 65,000 57,000 33,000 21,000 20,000 12,000 170,000 139,000 309,000 B. Efficiency Improvement B1. Pr.aerov Il 4,000 2,000 6,000 3,000 0 0 0 0 0 0 10,000 5,00 15,000 82. Other Power Stations 0 0 a,ooo 5,000 30,000 15,000 D.000 2,000 0 0 44,000 22,000 66,000 Stbtotal 4,000 2,000 14,000 8,000 30,000 15,000 6,000 2,000 0 0 54,000 27,000 81,000 C. Transmission Network Cl. Substations 1,Z30 0 5,745 4,693 5,348 9,419 2,236 8,836 0 0 Sh,559 22,948 37,507 CZ. TransmissionLine 200 0 0 250 0 730 0 1,108 1,359 0 C 2,288 1,359 3,647 0' Subtotat ,4,0 0 5,995 4,693 6,078 9,419 3,344 10,195 0 0 16,847 24,307 41,154 0. Training & Consultancy 2,000 2,000 2,5CO 2,780 2,500 1,000 SOO 1,000 500 0 8,000 6,780 14,780 Base Cost 19,430 16,000 62,495 52,473 103,578 82,419 42,844 34,195 20,500 12,000 248,847 197,087 445,934 Physical Contingencies 1,943 1,600 6,253 5,247 10,358 8,242 4,284 3,420 2,050 1,200 Price Contingencies z4,8a5 19,709 44,593 * 952 784 6,275 5,268 15,984 12,719 9,035 7,211 5,539 3,243 37,785 29,225 67,010 Project Cost 22,325 18,384 75,019 62,989 129,920 103,380 56,163 44,826 28,089 16,443 311,517 246,021 557,538 Interest During Construction (IDC) 447 2,415 1,947 7,112 4,545 14,788 5,669 18,116 6,230 19,337 18,838 61,768 84,'- GRANDTOTAL 22,772 20,799 76,966 70,101 134,465 118,168 61,832 62,942 34,319 35,780 330,355 307,789 638,144

ExchangeRate: 28.00 KCS/USS

e Is is asstmed that the exchange rate wilt reflectthe differential between locat and international inflation rates Scurce: CEZ and Bank Estimates October 1991 - 107 - Annex 5..2

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTAL IMPROVEMENT PROJECT

Detailed Cost Estimate for FGD Installation at PRUNEROV II POWER PLANT

USS Million

Scrubber Systems 97.7 Reheater (Heat Transfer System) 38.2 Ducts 12.4 Electrical Equipment (Scrubbers) 8.8 C & I (Scrubbers) 7.1 ID Fan (Raw Gas Side) 9.9 Silos, Tanks 7.1 Gypsum Dewatering 6.2 Limestone Preparation 4.4 Wastewater Treatment 3.1 Electrical Equipment (Common Plant) 7.6 C & I (Common Plant) 8.8 Civil Works 4.1 Structural Steelwork 5.4 Auxiliaries and Common Plant Retrofitting 11.8 Engineering and Administration 16.4

TOTAL 249.0

Source: CEZ October 1991 - 108 - Annex 5.3 Page 1 of 2

CZECH AND SLOVAk FEDEPAL REPUBLIC

POWER AND ENVIRONMENTAL IMP_OVEMENT PROJECT

Project Implementation Schedule

1992 1993 1994 1995 1996

FGD Prunerov II

Basicand detalted engineering *---*

Manufactureand supply *--...... *

Mountingand assembly *------*

Civil works *------*

Commissioning *------*

TriaL run *--*

Electrostatic precivitators *------

Efficiency Improvement

Prunerov 11 . . .

Other plants ...

TransmisBion Imnrovement

Cechy Stred Substation *-...... ------°------.--.- *

Prestice Substation * . -..---.------.------*

SokolniceSubstation * .....-...... -.-...-- . - *

ProseniceSubstation * --.. --..--..-..------*

6ezdecin Substation * ------..-.-.------*

TransmissionLine, *''' PresticeSubstation to Chrast-Temetin400-kV Line - 109 - Annex 5.3 Page 2 of 2

List of Power Planto fr Imnroving Efficiency of Power Generation Units in CEZ

Power Stations:

- Prunerov - Pocerady - Ledvice - Melnik - Tusimice 2 - Chvaletice - Detmarovice - Tisova - Hodonin - Orgrez - 110 -

CZECHAND SLOVAKFEDERAL REPUBLIC

POWERAND ENVIRONMENTAL IMPROVEtENT PROJECT

DisbursemenitSchadule

IBRD Cum. Disbursement Disbursement Cumulative Fiscal Semester Profile a During Semester Disbursement 'Year Endina__ _ USmillion million

1993 December 1992 7.2 17.7 17.7 June 1993 19.5 30.4 48.1

1994 December 1993 33.2 33.7 81.8 June 1994 54.2 51.7 133.5

1995 December 1994 75.2 51.7 185.2 June 1995 84.3 22.4 207.6

1996 December 1995 93.4 22.4 230.0 June 1996 97.0 9.0 239.0

1997 December 1996 100.0 7.0 246.0

/a Based on a compositeof profiles for similarprojects and onibest engineeringjudgement. It must be noted that there is no prior Bank experiencewith Flue Gas Desulfurizationprojects. i111- ANNEX 6.1

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTAL IMPROVEME.NTPROJECT

CEZ - Income Statements (Million Kcs)

1/ 1987 1988 1989 1990

Revenues AverageRevenue (Kcs/KWH) 0.461 0.466 0.474 0.525 Revenuefrsn Sate of Power 23,339 24,360 25,553 27,603 OtherOperating Revenues 1,245 1,356 1,780 2,636 TotalRevenues 24,584 25,716 27,333 30,239 ...... Expenses Fuel 8,655 9,370 9,129 10,550 Purchaseof Power 839 1,124 1,628 1,812 Repairand Maintenence 1,532 1,484 1,476 1,929 Adninistration 963 1,043 1,150 1,282 Depreciation 2,040 3,491 3,385 3,692 Otheroperating Expenses 3,925 4,177 4,835 5,548 TotalExpenses 18,854 20,689 21,603 24,813 ...... OperatingIncome 5,730 5,027 5,730 5,426

InterestPayments 481 483 511 681

Taxes 3,980 2,881 3,478 3,641

Profit 1,269 1,663 1,741 1,104

1/ For6 monthsinclude district heating companies saparated from CEZon July 1, 1990.

Source: CEZand BankMission, January 1992. - 112 ANNEX 6.2

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTAL IMPROVEMENTPROJECT

CEZ - Balance Sheets (Million Kcs)

1986 1987 1988 1989 1990

2/ Totat Not FixedAssets 70,192 73,739 75,344 77,461 58,510

Current Assets Cash at Bank 456 465 1,005 1,096 1,428 FuelStock 1,788 2,136 2,419 2,699 2,949 OtherStocks 2,452 2,520 2,242 2,371 1,505 Receivables 922 863 728 700 1,120 other CurrentAssets 819 895 804 750 387 TotalCurrent Assets 6,437 6,879 7,198 7,616 7,389

TotalAssets 76,629 80,618 82,542 85,077 65,899 ......

Long-TermLoans 11,185 12,022 12,487 12,704 13,593 ......

CurrentLiabilities Pay2bles 1,314 1,316 850 950 873 ConsumerDeposits 353 407 115 128 45 OtherShort-Term Liabilities 807 1,144 954 1,146 1,458 Total CurrentLiabilities 2,474 2,867 1,919 2,224 2,376

TotalLiabilities 13,659 14,889 14,406 14,928 15,969 ...... 3/ Equity 62,970 65,729 68,136 70,149 49,930 ......

TotalEquity + Total Liabilities 76,629 80,618 82,542 85,077 65,899 ......

1/ Excludingdistrict heating coqpanies saparAted from CEZ on July 1, 1990. 2/ Includingwork in progress. 3/ After appropriations.

Source: CEZ and BankMislsion, January 1992. -113 - Annex 6.3 Page 1 of 2

CZECH AND SLOVAK FEDERAL REPUBLXC

POWER AND ENVIRONMENTAL IMPROVEMENTPROJECT

Notes and Assunitions for Financial Prolections

1. All projections are in constant 1991 values.

jncome Statements

2. The sale of electricity is projected on the basis of expected macroeconomic situation throughout 1998. It is assumed that: (i) total demand for electricity in short-run will drop by about 9% from 1991 to 1993 mainly because of restructuring and ownership changes in the industrial sector, and (ii) export/import is the result of surplus/deficit after meeting domestic demand. CEZ has signed a contract to export 910 GWH per year to Italy through 1997.

3. Station consumption, transmission and distribution loses are assumed to stay at a similar level as 1991.

4. The average revenues per KWH from 1992 to 1998 are forecasted on the basis of 1991 year end tariffs plus 60% domestic tariff increase in 1993.

5. In forecasting the revenue from the sale of heat, the level of sale corresponding to the 1991 year end reorganization and the 1991 year end tariff were used.

6. Other operating revenues include revenues from activities in construction, engineering and research and development.

7. Fuel expenses are estimated on tha basis of current structure of usage in production and current purchase prices: 827 Kcs/t for hard coal and 4436 Kcs/t for heating oil, in parity with international prices. Transportation costs are included in the "other operating costs".

8. Depreciation is calculated according to the permissible rates set by the Ministry of Finance:

Buildings - 4.0% Heating and steaming pipes - 3.3% Transmission lines - 5.0% Transformer station - 5.0% Boilers - 6.0% Substations - 6.0% Steam turbines - 4.0% Nuclear reactors - 5.0%

9. Other costs of operations, including wages, water, transportation, administrative costs and fines for environmental pollution etc., are forecasted on current level, commensurate with production levels. 114 - Annex 6.3 Page 2 of 2

10. Interest payments related to other than the Bank's loans are calculated by assuming 10% annual interest rate, 10 year repayment period with 3 years grace period.

11. Tax rate is assumed to stay at current level (about 56% of net profit).

12. Calculation of IDC (not financed under the Bank's loan) is on the basis of 7.8% annual interest rate, 0.75% rate for commitment fee.

Balance Sheet

13. Projection of fuel and other stock levels are based on past experience, and related to production needs at 1991 price level.

14. Accounts receivables are estimated on the basis of current schedule of collections from distribution companies. Each month the distribution companies pay CEZ 85% of electricity delivered in four installments, the balance is paid after four weeks.

15. Projection of account payables schedule (including trade and investment accounts) is assumed at the current (about two weeks) level.

Fund Flow Statements

16. Capitalized interests are included in borrowing and investment.

Source: CEZ and Bank Mission, January 1992 - J1S - ANNEX 6.4 Table 1

CZECH AND SLOVAK FEDERAI, REPUBLIC

POWER AND ENVIRONMENTALIMPROVEMENT PROJECT

CEZ - Projected Income Statements (Million Kcs)

1/ 1991 1992 1993 1994 1995 1996 1997 1998

Revenues AverageRevenue (Kcs/KWH) 1.023 1.146 1.190 1.198 1.194 1.194 1.194 1.194 Revenuefrom Sale of Power 48,500 45,520 45,905 48,643 52,055 56,776 58,498 60,892 Revenuefrom Sate of Heat 8,436 1,521 1,572 1,609 1,684 1,700 1,738 1,770 OtherOperating Revenue 2,535 1,795 1,272 1,302 1,312 1,272 1,302 1,312

TotalOperating Revenue 59,471 48,836 48,749 51,554 55,051 59,748 61,538 63,974

Expenses Fuel 16,226 10,779 10,732 11,905 13,219 14,011 14,859 15,362 Purchaseof Power 2,097 1,667 1,456 1,456 1,456 380 380 380 Purchaseof Heat 632 7 10 10 10 10 10 10 Repairand Maintenence 2,463 1,770 2,210 2,455 2,313 2,520 2,680 2,850 Adninistration 1,200 1,143 1,208 ',226 1,287 1,389 1,444 1,494 Depreciation 3,907 3,475 3,790 4,180 4,470 5,187 6,797 8,177 OtherOperatirg Expenses 9,639 8,251 8,078 8,780 10,000 10,817 11,080 11,249

TotalOperating Expenses 36,164 27,092 27,484 30,012 32,755 34,314 37,250 39,522

OperatingIncome 23,307 21,744 21,265 21,542 22,296 25,434 24,288 24,452

InterestPayments 539 511 518 531 642 1,228 2,360 2,731

Taxes 12,522 12,026 11,728 12,802 12,559 12,626 11,721 12,160

Profit 10,246 9,207 9,019 8,209 9,095 11,580 10,207 9,561

1/ Includingdistrict heating companies separated from CEZ at the end of 1991.

Source:CEZ and Bank Mission, January1992. - 116~- ANNEX 6.4 Table 2

CZECIhAND SLOVAK FEDERAL REPUBLIC POWER AND ENVIRONMENTAL IMPROVEMENT PROJECT

CEZ - Projected Fund Flow Statements (Million Kcs)

1/ 1991 1992 1993 1994 1995 1996 1997 1998

Sources Operating Income 23,307 21,744 21,265 21,542 22,296 25,434 24,288 24,452 Add Depreciation 1,558 3,475 3,790 4,180 4,470 5,187 6,797 8,177 InternallyGenerated Funds 24,865 25,219 25,055 25,722 26,766 30,621 31,085 32,629

Borrowing 3,927 8,189 17,012 17,238 25,718 17,234 13,252 5,195 Capital Contributions 0 71 126 140 167 161 160 161

TotalSources 28,792 33,479 42,193 43,100 52,651 48,016 44,497 37,985

Apptications Investments 15,505 18,378 25,895 28,002 33,138 26,0(9 21,142 12,943 1axes 12,522 12,026 11,728 12,802 12v559 12,626 11,721 12,160 SocialContributions 370 290 299 299 299 308 308 308 Loan Payments 3,561 2,570 2,216 2,416 4,486 7,611 8,911 9,911 InterestPayments 539 511 518 531 642 1,228 2,360 2,731

Increase/Decreasein Cash (3,705) (1,025) 1,318 (792) 769 (791) (175) (44) Changesin WorkingCapitaL 0 729 219 (158) 758 955 230 (24)

Totat Applications 28,792 33,479 42,193 43,100 52,651 48,016 44,497 37,985 ......

1/ Includingdistrict heating coeqpanies separated from CE2at the end of 1991.

Source:CEZ and 3ankMission, January1992 - 117 - ANNEX 6.4 Table 3

CZECH AND SLOVAK FEDER" REPUBLIC

POWER AND ENVIRONMENTALIMPROVEMENT PROJECT

CEZ - Projected Balance Sheets (Million Kcs)

1/ 1991 1992 1993 1994 1995 1996 1997 1998 Assets Fixed Assets Gross Fixed Assets 73,961 77,261 80,761 84,761 95,261 112,761 147,761 177,761 LessAccuiaulated Depreciation (33,263)(41,738) (45,528) (49,708) (54,178) (59,365) (66,162) (74,339) Net FixedAssets 35,698 35,523 35,233 35,053 41,083 53,396 81,599 103,422 Work In Progress 28,542 43,620 66,015 90,017 112,655 121,234 107,376 90,319 TotalNet FixedAssets 64,240 79,143 101,248 125,070 153,738 174,630 188,975 193,741

CurrentAssets Cashat Bank 1,614 589 1,907 1,115 1,884 1,093 918 873 FuelStock 3,569 4,581 4,850 4,742 5,800 7,005 7,222 7,198 OtherStock 1,574 1,542 1,542 1,542 1,542 1,542 1,670 ,S70 Receivables 1,298 1,298 1,298 1,298 1,298 1,298 1,298 1,298 TotalCurrent Assets 8,055 8,010 9,597 8,697 10,524 10,938 11,108 11,039

TotatAssets 72,295 87,153 110,845 133,767 164,262 185,568 200,083 204,780

Liabilities Long-TermLoans 12,213 17,832 32,628 47,450 68,682 78,305 82,646 77,930

CurrentLiabilities Payebles 854 904 954 1,0C4 1,054 1,054 1,100 1,100 ConsumerDeposits 45 45 45 45 45 45 45 45 OtherShort-Term Liabilities 2,710 2,911 2,911 2,911 3,161 3,411 3,480 3,480 TotalCurrent Liabilities 3,609 3,860 3,910 3,960 4,260 4,510 4,625 4,625

TotaLLiabilities 15,822 21,692 36,538 51,410 72,942 82,815 87,271 82,555

Equity AccujmlatedCapital 53,330 53,401 53,527 53,667 53,834 53,995 54,155 54,316 AccumulatedProfit 3,143 12,060 20,780 28,690 37,486 48,758 58,657 67,909 TotalEquity 56,473 65,461 74,307 82,357 91,320 102,753 112,812 122,225

T%talEquity + Total Liabilities 72,295 87,153 110,845 133,767 164,262 185,568 200,083 204,7r) ......

1/ Excludingdistrict heating companies separated from CB at the end of i991.

Source:CEZ and Bank Mission,January 1992 - 118 -

ANNEX 7.1 Page 1 of 6

CZECH AND SLOVAK FEDERAL REPUBLIC

POWER AND ENVIRONMENTALIMPROVEMENT PROJECT

Power Sector Investment Options with Pollution Reduction

I. Economic Cost of Continued Lianite Use With Environmental Safeguards

Lignite energy content: about 11.13 MJ/kg Large power plant fuel use: about 12-13 GJ/MWh

International opportunitv cost: EEC importers' CIF price early 1991 for low-sulphur (less than 1%) coal: about

$1.70-2.00/GJ. t S/GJ NW Europe CIF price May 1991 for low-S, 6,000 kcal/kg steam coal: 44 1.76 Additional freight to CSFR: about 21 0.84 Total at CSFR consumer: 65 2.60

Adjustment for high sulphur content: usual discount about 15-20% for coal with 0.5 percentage points higher sulphur. Assume CSFR lignite at least 1 percentage point above international steam coal, therefore reduce by 35%: Si.70/GJ

Mar nal cost: Domestic marginal cost of lignite production: about $1.20/GJ delivered to consumer. (At efficient surface mines: about $0.60-1.00/GJ.)

Ranae of economic cost of lionite fuel: $1.20-1.70/GJ. At 12-13 GJ fuel per MWh plant output: US¢ 1.6-2.2/kWh.

st of desul3hurizatign and other environmental mitigation exuipment inptallation: Average $300/KW, including FGD, de-NOx, dust control and ash disposal. At 30% plant factor, 20-year life, 10% discount rate: US¢ 1.3/kWh.

Total cost of maintaining lignite operation (fuel plus incremental capital cost): USS. 2.-3.5/kWh outDut.

With O&M (say 10% of investment or USC 1.1/kWh): tot&l cost US¢ 4.0-4.6/kWh. (With low-cost lignite: USS3.5/kWh) - 119 -

ANNEX 7.1 Page 2 of 6

II. ElectricitymISorts

The paBt arbitrarily low export and import prices of electricity within Eastern Europe have now been changed to prlces based on market considerations. The current price of importing from the USSR at high voltage isASL 4.8/kwh. Imports from Western Europe (even before the necessary investments in transmission reinforcement) are likely -tobe available at similar prices.

III. Low-sulfur Coal Xm prts

As the lignite-fired thermal plants in NW Bohemia are equipped to handle low-quality lignite, no major plant investments would be necessary to handle higher-quality, low-sulfur (less than 1%) coal. Import options are:

(i) Overseas imports through NW Europe (US or South African coals) available at about US$1.80/GJ CIF and about US$2.60/GJ delivered at the plants. 0

(ii) Polish coal (subject to capacity constraint): available at about US$45/t (USS1.80/GJ) FOB Baltic ports. Rail transport cost from Polish mines to NW Bohemia generating plants may make Polish coal available there at a similar price, if such transport capacities can be made available.

Based on the current fuel efficiency of the generating plants (12-13 GJ/MWh), the fuel cost of imported coal alone would be in the range of US¢ 2.3 - 3.4/kWh output.

FGD equipment has to be installed even with lower-sulfur coal use (to reach the target of 400 mg/m3 dry gas), but the higher-quality coal allows a lower-cost solution, say US¢ 1.0/kWh. O&M would add about 1 0.8/kWh. Total incremental cost of using imported coal would then be USt__4.1-_52/kWh. Non- marginal investments in rail or barge transport would have to be added.

IV. Switch to natural gaa-fired aeneration

(i) N as-fired combined cvcle nlant

Capital cost: US$700/kW at 30% plant factor: USO 3.1/kWh at 50% plant factor: US¢ 1.9/kwh O&M: US$70/kW/year Total cost excluding fuel: US¢ 3.5-5.7/kWh Fuel: USSR border price $100/MCM 37,000 Btu/CM 8,500 Btu/kWh Fuel cost US¢ 2.3/kWh at border Total cost excluding gas transmission investment: 5.88./khkSW - 120 -

ANNEX 7.1 Page 3 of 6

(ii) Conversion of existing lignite plant to gas

Fuel conversion of existing lignite fired boilers to natural gas firing is technically feasible without derating.

Major items of design modifications are as follows:

(a) adjustments and modifications in heating surfaces in furnace water walls, superheaters and reheaters, if necessary;

(b) additional provision of gas firing facilities and gas burners;

(c) explosion proof facilities;

(d) modifications in control equipment including purge interlocks; and

(e) modificiations in fire fighting facilities, etc.

Significant reduction in auxiliary power consumption is obtained. (Auxiliaries for lignite facilities and ash handling equipment ae not used). (Existing forced and induced draft fans can be used for gas firing boilesj.

Environmental emissions will be reduced:

(a) NOX: 100 to 200 ppm for conventional gas burners, 50 to 100 ppm for low-nox burners;

(b) S02: 0

(c) Dust: 0

Cost for the modification of the existing lignite fired boilers to natural fired boilers is estimated to approximately 35% of new gas fired conventional boilers (about US$300/kW), subject to confirmation of various local conditions.

Capital cost: US¢ 1.3/kWh O&Mcost: USC 1.1/kWh Fuel: assume lower efficiency, say 9,000 Btu/kWh Fuel cost US¢ 2.4/kWh Total cost excluding gas transmission: US¢ 4.8/kWh - 121 -

ANNEX 7.1 Page 4 of 6

V. completion of Nuclear Plant

Temelin: (2 x 1,000 MW) Remaining cost: Rcs 55,000 million ($1,786 million).

Cost per KW: $ 980 Annual plant factor: 100% Unit cost of investment: ¢ 1.2/kwh O&M and fuel: ¢ 2.0/kWh Total incremental cost: k_1.2/kWh

Mochovce: (4 x 400 MW):

Remaining cost: KCS 29,000 million ($1,030 million) Cost per KW: $645 Unit cost at 100% plant factor: ¢ 0.9/kwh o&M and fuel: e 2.0/kwh Total incremental cost:

VI. Summary of Incremental Cost US¢tkWh Continued Lignite use with Environmental Safeguards 4.0-4.6 (lignite S1.20-1.70/GJ) 3.5 (lignite $0.80/GJ) Electricity Imports 4.8 Low-sulfur Coal Imports 4.1-5.2 1 Natural Gas-based Generation New CC 5.8-8.0 2 Conversion to gao 4.8 2 Nuclear completion 2.9-3.2

The comparison indicates that (i) the completion of the nuclear plants under construction for base load operation is economically attractive, and (ii) the retrofitting of the remaining lignite-fired plant. with FGD and other environmental safeguard. is a competitive option for non-base-load system operation: the incremental cost per kWh in at the lower end of the range of options much as power imports, change to low-sulfur coal, or boiler conversion to gas firing.

1/ Excluding transport investment.

2/ Excluding gas transmission investment. - 122 -

ANNEX 7.1 Page 5 of 6

VII. Prunerov FGD Investment

Prunerov II capacity: 1,050 MW Generation at 30% LF: 2,759 GWh/year Lignite consumption at 13 GJ/MWH; 35.9 million GJ Lignite economic coat: $1.20/GJ (average Northern Bohemia) $0.80/GJ (efficient surface mines) Unit cost of generation: 30% LF and $1.20/GJ lignite: USC3.8/kWh 50% LF and $0.80/GJ lignite: US¢2.8/kWh

Retrofit of Prunerov II I/ -Power Imports

Increm. Investment O&M Fuel Total ¢4/kWh p51kwh (US$m) (USSm) (US$m) (USSm) (US$:i') (USSm)

1992 24 - 24 - - - 1993 60 - 60 - - - 1994 85 - 85 - - - 1995 48 - 48 - - - 1996 32 - 32 - - - 1997- 2017 - 25 43 68 110 138

PV at 10% 602 2, 640 802 Equalizing Discount Rate - at 30% L.F. (Load Factor) 12% 19% - at 50% L.F. 23% 30% - at 50% L.F. and $0.80/GJ lignite 27% 34%

1/ During Prunerov II FGD construction, both options continue to generate from the existing lignite-fired plant. From 1996 onwards, the alternative to FGD retrofitting is imports from the USSR or the Went at US¢ 4-5/kwh, while retiring Prunerov II.

1/ With a lignite opportunity cost of S1.70/GJ (equivalent to the cost of an alternative fuel) rather than the marginal cost of $1.20/GJ, the PV of Prunerov II operation rises to US$707 m. With a mine-specific LRMC of lignite of about US$0.80/GJ, it falls to US$520 m. - 123 -

ANNEX 7.1 Page 6 of 6

VIII. Transmission Investment Alternatives:

Alternative 1: Replace 220 kV system by direct transformation 400/110 kV.

Alternative 2: Reinforce 200 kV system, including new 400/200 and 220/110 transformers.

Costs of alternatives are compared by designing both to allow the same maximum load in the system.

Costs (USS m)

Alternative 1 Alternative 2 Inv. O&M Inv. O&M

1993 12.33 12.65 1994 12.33 - 12.65 - 1995 12.33 0.10 12.65 0.08 1996-2016 0.10 0.08 PV at 10% ?4.5 35.2 CZECH AND SLOVAK FEDERAL REPUBLIC

POUER AND ENVIRONMENTAL IMPROVEMENTPROJECT

CEZ Investment Program: Internal Rate of Return

Benefits Costs Generation Fuel Fuel andcOU& Generation replaced by saving savings from Totat energy Incremental eliminated Fuel retrofitting Incremental from Incremental retired plant Requirement change ard O&H from by and new sales after retired sales of thermal at generation Total Investment of new Total 1990 retirement caacit losses Hog Kcs 1.34/kWh (TWh,IZ! 1 power H08 benefits cost cacitY cost (7Wh) (TWh)/h (TWh)/ (1Wh) _ (TJ) 7 (IKcs bo) (Kcs bn) (Kcs bn) (Kcs bn) (Kcs bn)'' (Kcs bn)/ tyKcs bn) 1991 56.5 -5.5 0.4 - - - 1992 53.0 -9.0 - - - 0.8 - - - - 1993 - - - 18.4 - 18.4 54.0 -8.5 0.9 0.5 - 3,300 1994 - 0.3 0.3 25.2 - 25.2 55.0 -7.5 1.1 2.7 - 6,600 - 0.5 0.5 30.4 - 30.4 1995 56.9 -5.6 1.5 6.5 2.2 9,900 2.9 0.8 3.7 33.4 - 33.4 1996 58.7 -3.8 1.9 16.0 3.9 13,200 1997 5.2 1.0 6.2 25.4 - 25.4 60.9 -1.1 2.4 25.0 13.3 15,400 1998 17.8 1.0 1.3 20.1 11.6 11.6 61.7 -0.3 2.4 25.0 14.0 19,800 18.8 1999 1.5 1.5 21.8 4.8 0.5 5.3 62.9 0.9 2.4 25.0 15.2 23,100 2000 20.4 1.8 1.8 24.0 4.7 1.1 5.8 64.0 2.0 2.4 25.0 16.2 26,400 21.7 1.8 2.0 25.5 4.3 1.6 5.9 2001 65.4 3.4 2.4 25.0 17.5 26,400 23.5 1.8 2.0 27.3 - 2002 66.7 4.7 2.4 2.3 2.3 25.0 18.7 26,400 25.1 1.8 2.0 28.9 2003 68.0 6.0 2.4 - 29 2.9 25.0 19.9 26,400 26.7 1.8 2.0 30.5 2004 69.4 7.4 2.4 - 3.5 3.5 25.0 21.2 26,400 28.4 1.8 2.0 32.2 2005 70.8 8.8 2.4 25.0 4.1 4.1 22.5 26,400 30.2 1.8 2.0 34.0 - 4.8 2006-2026 72.2 10.2 2.4 25.0 .8 23.8 26,400 31.9 1.8 2.0 35.7 * 5.4 5.4

Internal Rate of Return: 1. Base Case (Temelin 1995/96, high demand scenario): 14.0% 2. Demand 10% tower than in base case ("Low Demand Scenario") with Temelin in 1995/96: 12.8% 3. Temelin nuclear delayed by 5 years, Base Case demnandscenario: 16.5% 4. Temelin delayed, low and demand scenario: 15.0X

/1 CEZ program to retrofit and add generating capacity, plus CEZ transmission, plus distribution. /2 Domestic consLmption, energy sector own consumption, losses, and net external trade: high scenario. Including 400/20D kY transmission. /3 Based on CEZ retirementschedule for old lignite-fired plant. Plant factor assuted to be about 15%. Nameplate capacity derated to 80%. /4 Based on CEZ program of FGD/de-N0x retrofitting, Cuamlative. lerwlin 1,000 MW in 1995 and 1996, Dlouhe Strane hydro in 1994. assuTed to be about 50%. Cumulative. Plant factor of replaced plant /5 Including .he maintenance of domestic sales as well as temporary exports, by retrofitting remaining lignite-fired plant with enviromentat safeguards, and adding nuclear capacity. Systemwide losses about 7%. /6 Assume conversion to CHP of about 220 MW per year from 1992 onwards, replacing old HOB facilities of equivalent size. Average heat output about 11.5 TJ/MW/year, at efficiency of about 1.3 GJ fie( per GJ heat output. /7 Average revenue at end-1991 tariff levels for domestic consumers, approximfately equivalent to revenue from teenporary exports. /8 13 GJ lignite per MWh, economic cost of lignite $1.20/GJ: fuet expenditure saved $15.60/MWh or Kcs 436 mitlio/TWh. OUM Kcs savings Kcs 736 million/TWh. cost 0.30/kIh. Total /9 Sl.20/FG or Kcs IZ 33,600/Ti. O&M about $1.50/GJ or Kcs 42,000/TJ. Total savings Kcs 75,600/TJ. /10 Temelin 2 x 1000 MW. USc 2/kUh or Kcs 0.50/kWh applied to energy x replaced in retired plant, and to net demanrdincrease after 1998. Weighted recurrent costs of retrofitted and nuclear plant are approximately average equivalent to the recurrent cost of pre-retrofitting plant and are therefore taken into account in the incremental analysis. not 1 '4' 1'd18- 2?2 C Z E C H O S L O V A K I A GERMANY>h POLANDPOWER AND ENVIRONMENTAL POLAND IMPROVEMENTPROJECT

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