For Official Use Only s11

Document of The World Bank

FOR OFFICIAL USE ONLY

Report No: 78249-TZ.

Project paper

PROPOSED GRANT IN THE AMOUNT OF US$6.5 MILLION

the United Republic of Tanzania

TANZANIA DEVELOPMENT AND ACCESS EXPANSION PROJECT - Energy small and medium enterprise grant project

November 14, 2011 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.

CURRENCY EQUIVALENTS

(Exchange Rate Effective as of November 14, 2011)

Currency Unit = Tanzania Shillings (TZS) TZS =1,759 USD1 US$ =1,572 SDR 1

FISCAL YEAR July 1 — June 30

ABBREVIATIONS AND ACRONYMS

AFREA Africa Renewable Energy and Access BOT Bank of Tanzania CDM Clean Development Mechanism CER Carbon Emission Reduction CEIF Clean Energy for Development Investment Framework

CO2 Carbon Dioxide CQS Consultant Qualifications CPF Carbon Partnership Facility EI Environmental Impact Assessment EIRR Economic Internal Rate of Return ENPV Economic net present value ESIA Environmental and Social Impact Assessment ESME Energy Small and Medium Enterprises Environmental and Social Management ESMF Framework Energy and Water Utilities Regulatory EWURA Authority FBS Fixed Budget Selection FIRR Financial Internal Rate of Return FM Financial Management FNPV Financial Net Present Value FRP Financial Recovery Plan

2 FY Fiscal Year GDP Gross Domestic Product GEF Global Environment Facility GHG Greenhouse Gas Government of Tanzania GOT Global Village Energy Partnership GVEP International Bank for Reconstruction and IBRD Development IC Individual Consultant ICB International Competitive Bidding IDA International Development Association IFC International Finance Corporation IFR Interim Financial Report IFRS International Financial Reporting Standards IMF International Monetary Fund IRR Internal Rate of Return ISR Implementation Status Report kWh Kilowatt Hour LCS Least Cost Selection M&E Monitoring and Evaluation MDGs Millennium Development Goals MEM Ministry of Energy and Minerals MOFEA Ministry of Finance and Economic Affairs Mkakati wa Kukuza Uchumi na Kupunguza Umaskini Tanzania (Tanzania National MKUKUTA Strategy for Growth and Reduction of Poverty) MW Megawatt MWh Megawatt hour NCB National Competitive Bidding Non-Governmental Organization NGOs National Environmental Management Council NEMC Norwegian Agency for Development NORAD Cooperation OG Operating Guidelines OP Operational Policy O&M Operations and Maintenance PDO Project Development Objective PFI Participating Financial Institution PMU Procurement Management Unit PoA Program of Activity PV Photovoltaic QCBS Quality and Cost Based Selection

3 QBS Quality–Based Selection RAP Resettlement Action Plan REA Rural Energy Agency RET Renewable Energy Technologies RFP Request for Proposals RPF Resettlement Policy Framework Swedish International Development SIDA Cooperation Agency SIL Specific Investment Loan SME Small and Medium Enterprises SPGD Small Power Generation and Distribution SPP Small Power Projects or Small Power Plants Standardized Small Power Purchase SPPA Agreement Standardized Small Power Purchase Tariff SPPT Scaling-up Renewable Energy Program for SREP Low Income Countries SSMD Sustainable Solar Market Development SSA Sub-Saharan Africa SSMP Sustainable Solar Market Packages SSS Single-Source Selection TA Technical Assistance TANESCO Tanzania Electric Supply Company Limited TEDAP Tanzania Energy Development and Access Expansion Project TOR Terms of Reference TZS Tanzania Shillings UNDB United Nations Development Business UNFCCC United Nations Framework Convention on Climate Change WBG World Bank Group

4 Vice President: Obiageli Katryn Ezekwesili Acting Country Director: Mercy Miyang Tembon Sector Manager: Lucio Monari Task Team Leader: Dana Rysankova

TABLE OF CONTENTS

I. STRATEGIC CONTEXT AND RATIONALE 5 A. Country and sector issues 5 B. Rationale for Bank Involvement 7

II. PROJECT DESCRIPTION 8 A. Project Development Objective 8 B. Project activities 9

III. IMPLEMENTATION 12 A. Partnership Arrangements 12 B. Institutional and implementation arrangements 13 C. Monitoring and evaluation of outcomes/results 14 D. Sustainability 15 E. Critical risks and possible controversial aspects 15

IV. APPRAISAL SUMMARY 17 A. Economic and Financial 17 B. Technical 18 C. Fiduciary 18 D. Social and Environment 19

5 Annex 1: Procurement Arrangements 21 Annex 2: Environmental and Social Safeguards 23 Annex 3: Economic and Financial Analysis 25 Annex 4: Team Composition 33

6 I. STRATEGIC CONTEXT AND RATIONALE A. Country and sector issues

1. Tanzania has abundant renewable energy sources from perennial rivers with steep waterfalls, plentiful biomass and proven strong solar potential. Several studies have also s hown wind and geothermal potential. The Government of Tanzania (GOT) estimates mor e than 8 GW of renewable energy potential in a country that currently has about one GW in national generation capacity. Despite this potential, the renewable energy industry has remained in an infant stage of development, hindered by regulatory, financial and capacit y barriers. 2. Tanzania faces significant power shortages; power supply is unreliable because of Tanzania’s heavy reliance on hydro power, which is highly susceptible to droughts. The r ecent World Bank Africa Infrastructure Diagnostic study estimates that load shedding an d emergency generation cost Tanzania over 5% of GDP annually. The limited power sup ply has been identified by both the World Bank and IMF as one of the main infrastructura l bottlenecks in Tanzania, which impedes development and poverty reduction. Moreover, Tanzania’s current electrification rate of 14% is amongst the lowest in Sub-Saharan Afric a (SSA). The access rates are particularly low in rural areas (below 2%), where most of th e Tanzanian population lives and where poverty rates are the highest. 3. Therefore, the GOT has defined access to modern electricity as a key component of its long-term economic growth plan, and has set a target of 30% electrification rate by 2015. The development and utilization of indigenous renewable energy sources and techn ologies through the participation of the private sector in rural energy development is part of the Government’s access expansion strategy as stipulated in the National Energy Polic y of February 2003. In 2005, Tanzania’s Parliament approved a Rural Energy Act, which established a Rural Energy Agency (REA) to lead the development of rural energy access initiatives and a Rural Energy Fund (REF) to finance them. 4. The Tanzania Energy Development Access Program (TEDAP) has supported the GOT’s efforts to increase access of the poor to modern electricity. The Project objectives are to (i) improve the quality and efficiency of the electricity service provision in the mai n growth centers of Dar es Salaam, Arusha, and Kilimanjaro, and (ii) establish a sustaina ble basis for energy access expansion and renewable energy development in Tanzania. Th e project’s global environmental objective is to abate greenhouse gas emissions by using renewable energy in rural areas to provide electricity. TEDAP consists of three compone nts: (A) a grid component (US$ 85.8M); (B) a small power project (SPP) component (US $42M IDA, including Additional Financing, and US$6.5M GEF) and (C) a technical assi stance component (US$3.2M). TEDAP SPP component has four subcomponents: (i) Sm all Power Generation and Distribution (SPGD) subprojects, including renewable power g eneration and mini-grids as well as a low cost distribution pilot; (ii) Sustainable Solar Ma rket Development (SSMD), supplying solar PV systems for public institutions and for ind ividual households and businesses in rural areas; (iii) Technical Assistance to REA and ot her stakeholders and (iv) Rural/Renewable Energy Credit Line.

7 5. The proposed ESME project will provide parallel financing to one of TEDAP’s su b-components – Small Power Generation and Distribution (SPGD) that has already yielde d important results.. TEDAP has helped lay the groundwork for thriving private investme nts in renewable energy projects by supporting the establishment of a strong REA, develo ping an enabling regulatory framework, improving stakeholders’ capability and addressin g the financing challenges. Therefore, Tanzania has a favorable regulatory framework, w hich includes transparent and standardized power purchase agreements (SPPA) and tariffs (SPPT) for small power projects (SPPs), simplified regulations for SPPs and comprehensi ve guidelines for project developers, which are considered among the best practices in the region. Five SPPAs have been signed for 24 MW and four Letters of Intent for estimated sales of 17.8 MW. Two projects with commitment to supply 10.4 MW are currently sellin g power to the national utility, TANESCO. 6. Several financing windows are provided under TEDAP for SPP development: (a) matching grants for pre-investment support, business and market development, (b) conne ction performance grants for grid-connected and isolated mini-grids to partially offset inv estment costs for new service connections, and (c) a credit line that facilitates long-term l ending (10-15 years) to rural/renewable energy projects through local financial institution s on commercial terms. The activities mentioned above have been supported by capacity building for stakeholders (energy sector institutions, private developers, commercial bank s etc.) involved in the development of the renewable energy program in the country. 7. Therefore, TEDAP activities have resulted in a significant pipeline of potential pr ojects. REA reports that there is a pipeline of 34 confirmed projects developed to sell po wer to TANESCO and/or to individual customers connected to mini-grids. Should all of t hese projects come to fruition, their total capacity is 135 MW with sales to TANESCO of 82 MW. 8. The projects in this pipeline, however, could still be at risk due to the high equity requirements of Tanzania’s commercial banks. Equity requirements commonly set at 30 p ercent and as high as 40 percent of the investment have been documented as a key obstacl e for the development of private sector driven rural and renewable energy in Tanzania. A review of the projects in the pipeline shows that most of the developers are local enterpri ses that find it difficult to meet these high equity requirements. This situation is not uniq ue to Tanzania. High equity requirements are considered one of the main barriers to rene wable energy development in both low-income and middle-income countries. The situati on, however, is even more difficult in Sub-Saharan Africa due to (i) the relative underdev elopment of financial markets (ii) the lack of equity financing (e.g. equity funds that other wise could fill in this equity gap), (iii) the lack of experience of commercial banks with p roject finance in general and renewable energy finance in particular, and (iv) the lack of f unctioning renewable energy projects on the ground that could serve as examples and ben chmarks. The TEDAP project has already been working with the commercial banks to p rovide them training and technical assistance on appraising renewable energy projects, an d as a result, they have been willing to extend loans to Tanzanian SMEs. High equity req uirements, however, are currently one of their risk management strategies for this relative ly new business. It is expected that over time, as more renewable energy projects are dev

8 eloped, the banks will become less risk averse and equity requirements will fall closer to t he levels seen in more mature markets. 9. Since all other necessary preconditions for a successful small renewable energy pr ogram — a favorable institutional and regulatory framework, efficient performance grant s, support for market development, capacity building, and access to long-term financing — are in place, addressing the equity gap is essential to ensure the development of the re newable energy sector on a commercial basis and to increase access of the rural populatio n to modern energy. 10. The proposed ESME project is aimed at addressing the equity challenge for the pr ivate sector driven rural/renewable energy sector. The activity is financed by the Russian Trust Fund for Energy SME development in Sub-Saharan Africa. The Russian Trust Fun d was established in April 2009 to foster local private sector entrepreneurship and invest ment in the provision of energy services in remote, un-served and under-served regions in SSA. The objective of the Russian Trust Fund is to support the establishment and develop ment of stable and viable privately-run enterprise and business models that this will incre ase access to reliable, sustainable and affordable modern energy services. The Trust Fund helps the design of country specific financing mechanisms aimed at promoting domestic entrepreneurship and investment in infrastructure services in support of shared-growth an d poverty reduction. ESME projects funded by the Russian Trust Fund are currently bein g implemented in several countries, including Mali, Rwanda, Kenya, and Senegal. The R ussian Trust Fund is administered by the Bank. The Bank is collaborating with GVEP Int ernational (Global Village Energy Partnership) in the preparation and implementation of t he activities funded by the Russian Trust Fund. GVEP International is a UK charity work ing to reduce poverty by accelerating access to affordable and sustainable energy services with the ultimate objective of increasing energy access in Sub-Saharan Africa. B. Rationale for Bank Involvement

11. The Bank has established itself as one of the key partners to support the Tanzania n government in its efforts to establish conditions for sustainable access scale-up. The Co untry Assistance Strategy for Tanzania highlights energy as one of the key development f ocus areas. 12. TEDAP is the first World Bank project that supports energy development and sust ainable access scale-up in Tanzania through both grid and off-grid interventions. The pro posed ESME project will be implemented as additional parallel grant funding to the TED AP Small Power Project (SPP) Component. Taking into consideration the low electrificat ion rate of Tanzania, particularly in rural areas, and the slow pace of grid extension imple mented by the national utility, TANESCO, the bottom up approaches to rural electrificati on remain essential to accelerate access of the poor to modern electricity and contribute t o poverty reduction. Therefore, the proposed ESME project supports the GOT’s objective to increase access to electricity to 30% by 2015. 13. The ESME project will build on the results of TEDAP’s SPP component and aim to accelerate renewable energy development in the country. TEDAP has led to a robust pi peline of rural/renewable energy projects which is expected to reach 150 MW over the ne

9 xt five to six years. Most of these projects are small, renewable energy projects of less th an 10 MW. In order to support the development of this pipeline, REA is creating a Carbo n Finance Program of Activity (PoA) under the Carbon Partnership Facility (CPF) admini stered by the Bank, which will provide the small scale renewable energy projects access t o carbon revenues that enhance their economic viability and mitigate some of the market barriers to renewable energy technologies in the country. Carbon finance activities in Tan zania are also supported by other donors, particularly SIDA and NORAD. 14. The ESME project will complement the TEDAP financing windows for small po wer projects and Carbon Finance activities by bridging the equity gap faced by developer s. The ESME grant will achieve this by providing “green power performance grants” to p rojects that reduce greenhouse gases and therefore would be eligible for carbon revenues. The grants will be based on MWs of renewable energy installed, and used for financing o f works, goods and consultant services needed to develop and build small renewable ener gy power plants. The proposed ESME project, therefore, represents an important pillar of the financing mechanism developed under TEDAP. This additional grant financing wa s anticipated in the Project Paper for Additional Financing for TEDAP, approved in May 2010, which established the credit line for rural/renewable energy financing. 15. The ESME project also contributes to the higher-level global objective of climate change mitigation by supporting renewable energy projects expected to generate greenho use gas (GHG) emission reductions. Tanzania signed the United Nations Framework Co nvention on Climate Change (UNFCCC) in 1992, and ratified it on April 17, 1996, as a n on-Annex 1 party. The ESME project is also consistent with the World Bank’s Clean Ene rgy for Development Investment Framework (CEIF) adopted in 2007 – particularly its go al of accelerating investments aimed at increasing energy access in developing countries, especially in Sub-Saharan Africa, while reducing global carbon emissions.

II. PROJECT DESCRIPTION A. Project Development Objective

16. The objective of the ESME project is to support the provision of reliable, sustaina ble and affordable modern energy services in rural Tanzania by promoting local entrepren eurship and investment in renewable energy development, while ensuring carbon emissio n reductions. 17. The ESME project is consistent with TEDAP’s development objective related to i ts Small Power Project Component of “establishing a sustainable basis for energy access expansion and renewable energy development in Tanzania.” It is also in line with the TE DAP’s global environmental objective of “abating greenhouse gas emissions through the use of renewable energy in rural areas for electricity”. B. Project activities

10 18. The ESME project will establish a financing mechanism managed by REA to sup port clean, renewable energy generation projects that are expected to generate carbon rev enues in order to address the existing market barriers for local developers, particularly the equity gap, thus accelerating the development of the renewable energy program in Tanza nia. REA will sign green generation performance grants agreements with the eligible pr oject developers for eligible projects, and will disburse green generation performance gra nts based on MWs of renewable energy. These grants will complement the connection performance grant window existing under TEDAP for connections. 19. The new green generation performance grants under the ESME project will be in the value of expected future certified emission reductions (CERs). It is expected that most of the grant beneficiaries will be eligible for carbon credits under the PoA being establish ed by REA to help overcome institutional, financial and structural hurdles for the develop ment of small scale renewable energy projects. 20. The REA’s Performance Grant Facility is expected to be replenished by the carbo n revenues once these are generated by the ESME facility-supported sub-projects. These carbon revenues will then be used as additional REA performance grants to support additi onal small renewable energy projects. 21. Therefore, the ESME project aspires to create a sustainable financing mechanism that will allow the project developers to access their future carbon revenues at the time th ey need them most and thereby i) addressing the equity gap, identified as the one of the m ain market barrier to renewable energy scale up in Tanzania (See Box 1: Typical Equity Gap in Small Renewable Energy Projects) and ii) ensuring climate change mitigation thro ugh support for development of renewable energy technologies. The green generation per formance grant application requirements, process, and payment schedule will be specified in the Operating Guidelines, following the same procedures that are already established f or the connection performance grant for TEDAP. The ESME green generation performan ce grants, however, will differ from TEDAP connection performance grants in terms of th e performance target they are tied to. TEDAP connection performance grants are disburs ed against household connection targets — financing a part of the costs of the distribution network — while ESME green generation performance grants will be disbursed against MW of installed capacity of renewable energy, and financing a part of the costs of the ren ewable energy generation investments. A sub-project may only be eligible for TEDAP c onnection performance grants (e.g. a diesel project that would not be eligible for carbon r evenues but still extends electricity to new households) or for ESME green generation per formance grants (e.g. small hydro projects that will generate GHG reductions and therefo re will be eligible for carbon revenues, but is planning to sell all its power to the national grid, and would not electrify any new households) or both (e.g. a small hydro project that will electrify surrounding communities). The Operating Guidelines will clearly state all t hese cases to make sure that the sub-projects receive only those performance grants they are eligible for under TEDAP and ESME rules. The eligible expenditures under the perfo rmance generation grants are goods, works and consulting services related to investments in renewable generation projects. The developers will present a procurement plan as a par t of their application process to REA. REA will carry out procurement assessment capacit

11 y of the developer to determine if established commercial practices can be followed. TE DAP’s thresholds for prior review will be followed. 22. A project can be awarded both TEDAP connection performance grant and ESME green generation performance grant, as eligible expenses under two grants differ. The exi sting TEDAP connection grant finances goods, works and services related to the distribut ion investments needed to connect rural households and businesses The new ESME gree n performance grant will finance goods, works and services related to the investments in r enewable generation capacity. The procurements will clearly separate the works, goods a nd services to be procured under the connection performance grants and those to be procu red under the green generation performance grants. 23. The Operating Guidelines provide detailed eligibility criteria for projects. The ke y criteria include: the project has to be a renewable energy project under 10 MW; the pro ject developer has to be a legal entity established in Tanzania, the project has to comply with the Bank’s fiduciary and safeguards requirements (to be certified by REA), and the project has to be technically and financially feasible. Three types of renewable energy su b-projects can be eligible for performance generation grants: small renewable power gene ration subprojects selling power to TANESCO’s grid; grid-connected mini-grid subprojec ts and isolated (greenfield) mini-grid subprojects. The amount of the performance generat ion grant under the proposed ESME project, application requirements, process, and paym ent schedule are presented in detail in TEDAP Operating Guidelines 24. The grant is funded by the Russian Trust Fund for SME development in Sub-Saha ran Africa. The Russian Trust Fund is administered by the World Bank and it follows the Bank policies and procedures. 25. The closing date of the ESME project for Tanzania is December 31, 2012. The clo sing date for the TEDAP IDA and GEF is March 31, 2015. 26. 10% of the grant resources (US$650,000) will be used to cover REA’s operating c osts for managing green generation performance grants.

Table 1: Project costs

CategoryBox 1: Typical Equity Gap in SmallAmount Renewable of theEnergy grant Project allocated Percentage of expenditures to be (expressed in USD) financed, inclusive of taxes A typical(1) Green RE project needs generation about 30%5,850,000 of project capital as equity of which100% local developers are able to meet 60-70%.performance The Performance grants Grants provided by the ESME project could play a key role in bridging this equity gap and enabling projects to reach financial closure and start generation. (2) Operating costs 650,000 100% Total 6,500,000 Funding Source % Comments Debt Financing 70% Long term debt enabled by WB TEDAP credit line Equity Requirement 30% Valuation of promoters efforts in getting water rights, In kind equity 5% land, preparatory work etc Typical availability (based on actual data from 3 Cash equity 10-15% sample projects) REA grants to reimburse distribution and connection Connection Performance ~5% grants; 80% paid upfront before project completion; Grants banks12 accept this as part of promoters equity; Equity Gap to be covered by Green Generation 5 - 10% Performance Grants 27. The green generation performance grant is designed to support market developme nt of renewable energy. It is not a subsidy per se, but an acknowledgement of positive gl obal environmental externalities the projects are generating, and to the extent possible tie d to the expected carbon revenues that the project developers are expected to generate. In more mature markets, commercial banks may be willing to accept these future revenues a nd monetize them before they are actually realized. However, experience in Sub-Saharan countries shows that commercial banks are not willing to accept future carbon revenues, e ven with a purchase contract from a credit-worthy buyer such as a World Bank Carbon F und, as a secure source of revenue against which it can confidently lend. Conversely, carb on buyers are also reluctant to assume full operational risk and cap the value of the advan ce payment that they may be willing to provide -- and they are reluctant to disburse such an advanced payment too early in the project cycle. It is therefore critical that project dev elopers find another way to monetize these future carbon revenues. The proposed interve ntion offers a solution to this problem, by using the ESME green generation grant to mon etize up-front the future value of carbon credits and provide them to developers at the mo ment when they are most needed — by the time of financial closure. 28. The details of the calculation of the grant value will be included in the Operating Guidelines. The grant value is expected to equal to up to 100% of carbon revenues expe cted to be generated by the sub-project during up to eight years1 of sub-project’s operatio n, based on the agreement between REA and the developer. 29. The value per MW will be calculated by REA every year, in accordance with the provisions of the Operating Guidelines, and presented to the World Bank for no objection. The value will be based on the existing price of certified emission reductions (CERs) un der the REA’s Program of Activities (PoA) per MW of renewable energy for main grid pr ojects and for isolated grid projects. The table below provides an example of a calculation for a price of Euro 7/tCO2 for a typical project, with REA advancing 70% of carbon reve nues to be generated in 8 years of sub-project operations. In this case, 1 MW grid-conne

1 The period could be increased to 12 years upon an agreement between REA and the developer if REA can find a buyer of carbon credits beyond the eight year period. 13 cted project would qualify (8 * Euro 20,120 = Euro 160,960, corresponding to about US$ 221,420), 2 MW project would qualify for double the amount etc. This will be documente d in each case in the green generation performance grant agreements concluded between REA and the grant recipients, and submitted to the Bank for No Objection.

Table 2 – Expected carbon revenues of SPPs Plants connected to Plants connected to Parameters Unit Main grid Mini grid Plant size MW 1 1 Capacity factor % 60% 60% Production MWh 5256 5256 Emissions factor tCO2/MWh 0.55 0.80 Carbon price Euro / tCO2 7 7 Carbon revenue per MW per year Euro/ year 20,120 29,266

III. IMPLEMENTATION A. Partnership Arrangements

30. The ESME project will be implemented as additional parallel grant funding to the TEDAP project, following TEDAP’s implementation arrangements. 31. The Bank will collaborate with GVEP in the implementation of the ESME project. GVEP will provide technical assistance to SMEs including development of business plan s, pre-investment support and helping SMEs to secure additional financing from TEDAP and other sources. . The technical assistance GVEP will be providing is funded under a se parate grant from the Russian ESME trust fund to GVEP. 32. The contribution of other donors (particularly SIDA and NORAD) to the perform ance grants under the proposed ESME project is also explored. Moreover, Tanzania has been recently selected as one of Tier II beneficiaries of the Scaling-Up Renewable Energ y Program for Low Income Countries (SREP) based on its renewable energy developmen t endeavors. SREP is a multi-donor Trust Fund within the Climate Investment Funds that supports investments in a small number of low income countries for energy efficiency, re newable energy and access to modern sustainable energy. SREP funds could provide addi tional funding to the proposed facility, ensuring its continued operation after the closure o f the ESME project.

B. Institutional and implementation arrangements

33. The REA, which is the implementing agency for TEDAP’s SPP component, will i mplement the proposed ESME project. REA will sign individual green generation perfor mance grant agreements with the project developers. The model performance grant agree ment will be included in the Operating Guidelines and the World Bank will provide a no 14 objection for at least the first two green generation performance grants to be signed betwe en REA and the project developers. The green generation performance grants will specif y rights and responsibilities of both parties, including the reporting and auditing requirem ents. The majority of the funds (at least 70 percent) will be disbursed only when the proj ect reaches financial closure and all other sources of funds are obtained and documented. 34. The green generation performance grants of the ESME Project will follow TEDA P’s procedures for performance grants, including procurement and financial management procedures, as specified in TEDAP’s Operating Guidelines. TEDAP’s Operating Guideli nes will be amended to include the ESME project activities.

Box 2: Institutional and Implementation Arrangements

Rural Energy Agency TEDAP Small Power RE CERs CER buyers Project Component revenues Implementing Agency PoA Managing Entity

Register Project in PoA

Performance Grants for CERs

Developers

35. REA is also the coordinating entity for the PoA and is expected to enter into contr actual arrangements with CER buyers and sellers — private developers for each individu al renewable energy project. The contracts would give REA legal rights to deal with the c arbon credits that will be generated from the sub-projects and which have been advanced to the developers under the ESME facility. REA’s implementation capacity

36. REA is already implementing TEDAP’s Small Power Project Component, and its performance has been satisfactory. In particular, REA is managing the following financi ng instruments available to project developers: 37. TEDAP connection performance grants are currently set at US$500 for every new electricity connection. REA awards performance grants to project developers based on it s evaluation of the performance grant application, including technical, economic and fina ncial feasibility of the projects, eligibility criteria and compliance with the Bank safeguar ds and fiduciary requirements. Connection performance grants are disbursed to the devel opers through REA’s trust agent (Tanzania Investment Bank) in tranches based on progre ss in reaching the connection targets. REA has currently awarded its first two performan ce grants for 2,065 connections. The grants have not yet been disbursed as the sub-projec

15 ts are only starting the construction. Two additional connection performance grants have passed REA’s initial screening and are expected to be signed later this year. 38. TEDAP matching grants are available for pre-investment support financing up 80 % of the costs (20% has to be matched by project developers). REA has awarded six mat ching grants, which are now in progress. About 50% of funds have been disbursed. Six a dditional performance grants are being evaluated. 39. Rural/renewable energy credit line: REA is overseeing implementation of the rur al/renewable energy credit line which is disbursed to commercial banks that comply with eligibility criteria. Commercial banks are responsible for the full appraisal and commerci al risk of their lending decisions. REA verifies that projects meet TEDAP eligibility crite ria, including their compliance with Bank safeguards and fiduciary requirements. Tanzan ia’s central bank, the Bank of Tanzania, verifies the banks’ compliance with the eligibilit y criteria needed to participate in the credit line —compliance with BOT prudential regul ation and the World Bank’s OP8.30 requirements. Currently four banks have been certifi ed by the Bank of Tanzania for a TEDAP credit line. One certified commercial bank has already approved a loan to the project developer for a small hydro project (3MW) and ap plied to REA for refinancing from TEDAP’s credit line. 40. REA also has an active role during the project implementation, monitoring and su pervision of sub-projects (see below) and provides technical assistance to developers to o vercome any potential problems they would have encountered. C. Monitoring and evaluation of outcomes/results

41. The key outcome indicator for monitoring the ESME project is CO2 emission red uction as measured by generation capacity (MW) of renewable energy constructed under the Project. The target at the closing date is 25 MW. 42. A specialized REA unit is charged with monitoring and impact evaluation, and is i n continuous contact with project developers. REA’s monitoring and evaluation unit has t he capacity to track project progress and indicators. REA benefits of monitoring and eval uation training provided under SIDA-financed capacity building program and AFREA-fi nanced Gender and Energy Program that aims at incorporating a gender sensitive approac h into energy projects’ monitoring and evaluation. 43. REA is responsible for carrying out site visits to the projects in order to supervise progress and provide additional guidance. Monitoring will include compliance of the proj ects with the World Bank safeguards policies. 44. The green generation performance grant recipients are responsible for submitting periodic reports to REA describing the implementation progress of the sub-projects. The detailed reporting requirements for the grant recipients are presented in the Operating Gui delines. REA will consolidate the reports received from the performance generation gran t recipients and share the progress implementation report for ESME project activities with the World Bank. The reports will include evidence showing that the funds were used for e ligible expenditures (goods, works and consulting services).

16 D. Sustainability

45. Taking into consideration the national utility’s slow pace of electrification, privat e sector-driven renewable energy development is crucial to increasing access to modern e nergy and ensuring sustainable development of the rural areas. The ESME project innova tively complements the financing mechanism under TEDAP that has already stimulated t he interest of local and international private investor and donors in the renewable energy sector development in Tanzania. Several international investors have already been in cont act with local entrepreneurs to explore business opportunities in the sector. The grant mec hanism linked to the future CERs under the ESME project will speed up the development and implementation of renewable energy projects by addressing existing market barriers and making the projects financially viable. E. Critical risks and possible controversial aspects

Risk Risk Rating Risk Mitigation Measures

All the preconditions for the materialization of the pipeline are in place: comprehensive policies and regulatory frameworks, a supportive institutional structure, efficient connection subsidies, pre- investment support for feasibility studies, business development, environmental and social assessment capacity building for project developers, carbon credit financing etc. A credit line that facilitates access of rural/renewable projects to long Pipeline still does not materialize term loans (10-15 years) through even with additional performance M commercial banks became grants effective on September 1st, 2010. The first loan for a small hydro project (3MW hydro) has already been concluded by a local commercial bank, and a few other developers are in the negotiation process with local banks. The high equity requirement of the commercial banks is the major remaining financing barrier that needs to be addressed. There is a pipeline of projects with confirmed sponsors for over 50MW capacity, which is double the project’s target.

Only a limited number of projects The facility is designed to be

17 self-sustaining (being replenished from carbon revenues), so that more projects can benefit from the performance grant support (beyond the initial 25 MW to be financed by the will get performance grants under M ESME green generation grant). the proposed project Dialogue with other donors to increase funds for the performance grants under the proposed project is actively taking place.

REA is already well advanced in the development of the Program of Activities and the likelihood of its rejection by CDM authorities is low, given that Tanzania is a least developed country, and that the program does not have any particularly risky features (it is based on Carbon revenues do not known technologies, materialize due to (i) CDM not additionality can be registering REA’s Program of demonstrated, the baseline is M Activities or (ii) collapse of known and there is a market after Kyoto Protocol demonstrated pipeline of expires in 2012 potential projects). REA is receiving technical assistance from the World Bank to develop the PoA. In addition, REA is expected to join the World Bank’s Carbon Partnership Facility which will provide REA a guaranteed purchase of Poi’s CERs even in post-Kyoto period after 2012 (up to 2020).

Capacity and coordination issues M REA is responsible for by the implementing agency. coordinating all rural electrification activities in Tanzania. REA has been coordinating several projects and activities with a large number of donors involved in rural electrification. REA has a proven implementation capacity regarding WB TEDAP’s SPP component (US$ 42 million) and Lighting Rural Tanzania (US$ 1 million). REA has shown a strong commitment for the development of the PoA (a signed letter of commitment) and

18 benefited from institutional capacity building, including carbon finance training provided by the WB Carbon Finance Assist

M Overall Risk Rating L – Low, M- Moderate, S – Significant

IV. APPRAISAL SUMMARY

A. Economic and Financial 46. The activity is expected to yield positive economic and social benefits, including t he scale up of rural electrification and contribute to local rural development and economi c growth since most of project sponsors are local rural SMEs . It will also alleviate recurr ent power shortages and improve energy security by diversifying generation sources and contribute to global CO2 emissions reductions and the goal of averting environmental and economic threats from climate change Access to electricity leads to improved health, edu cation, productivity and general well–being of rural Tanzanians, with a more significant p ositive impact on women. 47. Some of these economic benefits, although significant, are difficult to quantify. T herefore, a conservative economic analysis was conducted that takes into account only qu antifiable and verifiable benefits that accrue from: (a) displacing higher-cost fossil fuel ge neration; (b) reducing greenhouse gas emissions, and (c) expanding rural access to clean energy. 48. The proposed green generation performance grants under the ESME project that r ecognize positive environmental externalities and leverage future carbon credits are expe cted to enhance the economic viability of the projects. Economic analysis was carried out on a representative sample of SPPs similar to those anticipated for TEDAP connection pe rformance grants and credit lines. SPPs demonstrate robust Economic Internal Rate of Re turn (EIRR) ranging from 17 to 39 percent. 49. Financial analysis was carried out on the same representative project sample to co nfirm the commercial viability of the proposed investments. Financial analysis was done on 12 representative projects based on information available from REA. This was further validated using detailed financial models from business plans of four actual projects that are under development in 2011. 50. The Financial Internal Rate of Return (FIRR) ranges from 12.5 to 23.6 percent, a nd equity FIRR ranges from 17.7 to 28 percent. B. Technical

19 51. Renewable Energy Technologies considered for the proposed project are proven g lobally and pose no major technical concerns. The identified priority projects that use ren ewable energy technologies with the greatest potential for small power generation in Tan zania are small hydro and biomass. C. Fiduciary 52. Procurement: REA has demonstrated satisfactory procurement capacity in imple menting the SPP component of TEDAP since it took over this responsibility from MEM i n March 2010. REA procurement staff has benefited from procurement training provided by the Bank. 53. Procurement for the green generation performance grants will follow World Bank “Guidelines: Procurement of Goods, Works and Non Consulting Services under IBRD Lo ans and IDA Credits & Grants by World Bank Borrowers" dated January 2011 (Procurem ent Guidelines); "Guidelines: Selection and Employment of Consultants under IBRD Loa ns and IDA Credits & Grants by World Bank Borrowers" dated January 2011 (Consultant Guidelines); “Guidelines on Preventing and Combating Fraud and Corruption in Projects Financed by IBRD Loans and IDA Credits and Grants,” dated October 15, 2006 and revis ed in January 2011 and the provisions stipulated in the Grant Agreement. Subprojects that will benefit from green generation performance grants under the proposed ESME project will be allowed to use established commercial practices under procedures and thresholds established in TEDAP (Annex 1). The REA will monitor SPP subproject procurement. . The sub-projects will present procurement plans which will require REA’s approval, in a ccordance with the procedures established in the Operating Guidelines. REA will carry out procurement assessment of the grant recipients. Commercial practices will be allowed as one of the procurement methods for those grant recipients that pass the procurement as sessment. Prior review thresholds of TEDAP project will apply. See Annex 1 for more d etails. 54. Financial Management: The financial management arrangements and the reporti ng procedures under the ESME project will follow the mechanism established under TE DAP. As part of the preparation for the ESME project, REA’s financial management ass essment was carried out in accordance with the Financial Management Practices Manual i ssued by the Financial Management Sector Board on November 3, 2005, and as updated i n March 2010. The objective of the assessment was to ensure that the implementing agen cy of this proposed grant, REA, has adequate financial management arrangements to ensu re that (a) the funds will be used for the purposes intended in an efficient and economic w ay; (b) TEDAP financial reports will continue to be prepared in an accurate, reliable and t imely manner; and external audit report will be prepared in line with internationally-acce pted audit standards and issued on time. The Financial Management Team’s work include d a visit to REA. The conclusion of the assessment is that project’s financial management arrangement satisfies the Bank’s minimum requirement under OP/BP 10.02 and the existi ng system is adequate to provide, with reasonable assurance, accurate and timely informa tion on the status of the project as required by the IDA. The Financial Management risk r ating remains modest. Based on the findings of this review, the FM risk rating remains m oderate and SIR FM rating also remains satisfactory.

20 55. Expenditures on performance grants will be eligible for financing only payments f or underlying expenditures on goods, works, and services and these will be accounted for by grant beneficiaries and reported to REA. Disbursement. will continue to be made on th e basis of quarterly unaudited Interim Financial Reports (IFRs), with supplementary finan cial information on green generation performance grants disbursed, spent and balances ou tstanding for each beneficiary. However, a new segregated Designated Account and Oper ating Accounts will be opened for the ESME project and authorized to receive advances u nder the ESME project. A flexible ceiling will be authorized, to be determined based on r olling expenditure forecasts for 2 quarters. A disbursement condition will be applied unde r which withdrawals for expenditure on green generation performance grants maybe mad e only after at least one performance grant agreement has been signed between REA and a grant recipient. Additional instructions are provided in the World Bank Disbursement G uidelines for Projects, dated May 1, 2006 and the Disbursement Letter. 56. In case that funds provided based on the performance grant agreements remain un spent by the closing date of the grant agreement the Bank may consider approving an ext ension of the period needed for documenting the expenditures by a few months. D. Social and Environment 57. The ESME project is intended to contribute to the social and economic developme nt of rural areas in Tanzania, as most of the project sponsors are local SMEs and the bene ficiaries are poor people in remote and underserved areas. In addition, by promoting rene wable energy development displacing fossil fuels, the project contributes to global efforts to reduce CO2 emissions and avert negative environmental and economic impacts of clim ate change. 58. The proposed activity is not expected to trigger additional safeguard policies to th ose incorporated in the TEDAP SPP component because it supports projects of a similar s ize and type. The ESME project would apply the same instruments and procedures in pla ce for TEDAP: the Environmental and Social Management Framework (ESMF) and the Resettlement Policy Framework (RPF), publicly disclosed on July 1, 2007 and re-disclos ed on July 26, 2010 and the Riparian Notification letter, sent on August 10, 2007, for whi ch no objections were received. TEDAP is a Category B Project. The proposed project is expected to retain this status. The projects’ compliance with the World Bank safeguards will be monitored by REA with support from qualified consultants. REA will provide earl y guidance to project sponsors on the Bank safeguards policies and outsourced expertise t hat could be accessed from funds provided under a TEDAP matching grant window. Deta ils are presented in Annex 2.

21 Annex 1: Procurement Arrangements 59. ESME project procurement will maintain existing arrangements for TEDAP. Proc urement will be carried out according to World Bank “Guidelines: Procurement of Goods, Works and Non Consulting Services under IBRD Loans and IDA Credits & Grants by W orld Bank Borrowers" dated January 2011 (Procurement Guidelines); "Guidelines: Select ion and Employment of Consultants under IBRD Loans and IDA Credits & Grants by W orld Bank Borrowers" dated January 2011 (Consultant Guidelines); and the provisions sti pulated in the Grant Agreement. Subprojects that will benefit from green generation perfo rmance grants under the proposed ESME project will be allowed to use established comm ercial practices under procedures and thresholds established by TEDAP and described bel ow. 60. REA will monitor SPP subprojects’ procurement. Since it took over the implemen tation responsibilities of TEDAP’s small power component from MEM, REA has shown that it has satisfactory procurement capacity. Private developers, suppliers, and contracto rs will be expected to observe the highest ethical standard during procurement and execut ion of contracts financed under subprojects. Project implementation will adhere to “Guide lines on Preventing and Combating Fraud and Corruption in Projects Financed by IBRD Loans and IDA Credits and Grants”, dated October 15, 2006 and revised in January 2011. 61. Frequency of Procurement Supervision: Prior review supervision will be carrie d out from IDA offices; in addition, it is recommended that one supervision mission be ca rried out every six months for post review of procurement actions. 62. Thresholds for Procurement Methods and Prior Review: Procurement plan up dates will apply the thresholds below for procurements carried out by the REA.

Table 3: Thresholds for Procurement Methods and Prior Review Contract Value Procurement/ Selection Contracts Subject to Expenditure Category Threshold (US$) Method Prior Review Works >5,000,000 ICB All None (Post review) unless <5,000,000 NCB specified in the PP <50,000 Shopping None (Post review) All values Direct Contracting All Goods >500,000 ICB All

None (Post review) unless <500,000 NCB specified in the PP <50,000 Shopping None (Post review) All values Direct Contracting All Consulting Services - QCBS/ Other2 > 200,000 All Firms1 (QBS/FBS/LCS) CQS/ Other2 < 200,000 None (Post Review) (QBS/FBS/LCS) All values SSS All

22 Consulting Services – >100,000 IC - Qualification All Individuals (IC) <100,000 IC – Qualification None (Post review) All Values IC – SSS All NOTES:

General – TORs for all contracts shall be cleared by IDA 1. (a) Shortlists for consultancy services for contracts estimated to be less than US$200,000 equivalent per contract may be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. (b) Consultancy services for contracts estimated to cost more than US$200,000 equivalent per contract shall be advertised in United Nations Development Business - UNDB online and dgMarket in addition to advertising in national newspaper(s) in accordance with the provisions of paragraph 2.5 of the Consultant Guidelines. 2. QBS, FBS, and LCS for assignments meeting requirements of paragraphs 3.2, 3.5, and 3.6 respectively of the Consultant Guidelines.

Procurement Arrangements: Private sector participation

63. The ESME project is expected to provide grants to small renewable energy sub-pr ojects. The application for Performance Grants under the ESME project shall include a pr ocurement plan, which will be reviewed by REA. 64. Contracts estimated to cost below US$5.0 million and US$1.0 million equivalent per contract for works and goods respectively to be procured by private entities will be do ne through established commercial practices acceptable to IDA (Section 3.12 of the Proc urement Guidelines). Contracts estimated to cost US$5.0 million and US$1.0 million or more equivalent per contract for works and goods respectively to be procured by private e ntities will be done through International Competitive Bidding (ICB) as provided in Secti on II of Bank Procurement Guidelines. Bank Standard Bidding Documents and Standard Bid Evaluation Report will be used for ICB contracts. 65. Contracts for consultancy services estimated to cost below US$0.2 million equiva lent per contract to be procured by the private entities will be done through established co mmercial practices acceptable to IDA (Section 3.14 of the Consultants Guidelines). Large consulting assignments estimated to cost US$0.2 million or more equivalent per contract to be procured by private entities will be done through competitive selection methods in Bank Consultant Guidelines. For these contracts, Bank Standard Request for Proposals (RFP) and Sample Form of Bid Evaluation Report will be used. 66. IDA will review private developers’ procurement practices, including procuremen t manuals and processes, to conform to IDA transparency and efficiency requirements. Th e following requirements for IDA procurement prior review are: (i) all works and goods c ontract to be procured under ICB by private developers, and (ii) all contracts for procure ment of consultant’s services estimated to cost US$ 0.2 million or more equivalent per co ntract to be procured by private developers. Contracts other than those mentioned above s hall be subject to annual review by independent auditors selected by REA; audit reports s

23 hall be shared with IDA. IDA reserves the right to review private developers’ procuremen t.

24 Annex 2: Environmental and Social Safeguards

67. The ESME project will complement REA’s connection performance grant windo w under TEDAP by supporting local rural/renewable energy project developers to fill the equity gap, which has been identified as one of the key barriers to the sector development on a commercial basis. The key benefits include:

 Reduced and avoided CO2 emissions and other pollutants from fossil fuel-fired generation plants;  Increased access to modern energy services in rural areas;  Contribution to local rural development as most of the project sponsors are local SMEs situated in rural areas.

68. The ESME project is not expected to trigger safeguards policies in addition to the safeguards policies related to TEDAP:

 Environmental Assessment (OP/BP 4.01)  Natural Habitats (OP/BP 4.04)  Physical Cultural Resources (OP/BP 4.11)  Involuntary Resettlement (OP/BP 4.12)  Safety of Dams (OP/BP 4.37)  Projects on International Waterways (OP/BP 7.50)

69. As the type and size of projects supported by the proposed green generation grant s are the same as those already included in TEDAP’s SPP component, the ESME project will apply the same instruments and procedures already in place for TEDAP’s SPP comp onent. 70. Environmental/social impact and resettlement. It is anticipated that the ESME pro ject would not result in any additional potential negative impact, and therefore the followi ng safeguards instruments approved under TEDAP will be used: the Environmental and S ocial Management Framework (ESMF) and the Resettlement Policy Framework (RPF) p ublicly disclosed on July 1, 2007. These documents were re-disclosed under TEDAP Ad ditional Financing on July 26, 2010. Following outreach and consultations with local com munities and mini-hydro project developers during the initial years of project implementa tion, it was agreed at TEDAP Mid Term Review that there would be additional value crea ted by preparing summaries of the ESMF and RPF (for TEDAP’s off-grid component) so that the documents are more easily accessible and understood by stakeholders who are bo th benefitting from and being affected by the mini-hydro sub-projects. GOT through RE A has engaged a local consultant and an international advisor to reformat these document s, which will also be disclosed in-country (in English and Kiswahili) and through the Info Shop, once finalized. 71. REA is responsible for reviewing and monitoring the compliance of the proposed grant project with the safeguards requirements. REA has recently hired an environmental and social specialist and receives safeguards training under the capacity building program

25 implemented by SIDA. Until the capacity of REA is fully built, REA outsources the eval uation and screening of the proposed investments to specialized consultants to ensure ade quate compliance monitoring and prompt execution of the project activities. The local de velopers and NEMC local offices have benefited from safeguards training funded by the SIDA trust fund for capacity building of REA and EWURA.

26 Annex 3: Economic and Financial Analysis

Financial analysis

72. The financial analysis from a corporate perspective was carried out for 12 projects included in the possible credit line portfolio. A comprehensive financial model was devel oped, which captures all elements of a robust commercial analysis including construction periods, loan grace periods, cost and revenue inflation, distribution and collection losses, carbon credits, accelerated depreciation and tax holidays. Out of the 12 projects, four sa mple projects were created for a more detailed economic and financial analysis. These pr ojects are broadly representative of the possible performance grant and credit line portfoli o, although clearly, each new project would need to be considered on its own merits. The four projects include a small hydro of 10MW, a mini-hydro of 1 MW, co-generation of 1 0MW and a mini-biomass of 1 MW. Three projects are selling a part of the power to the grid under SPPA/T and another part to an independent mini-grid, with a separate retail tar iff, one project (mini-biomass) is selling power to the Tanesco’s isolated grid (under the SPPA/T for isolated grids). Names of the projects are not provided because the financial information is confidential. 73. Key assumptions are included in the table 3.2. The project revenues consist of th e tariff under the SPPA/T framework, retail tariff (for those projects that sell power direct ly to independent mini-grids), and carbon revenues (conservatively, only 70% of total esti mated revenues are assumed). The projects that include mini-grids connecting new custo mers are also eligible to receive connection performance grants from REA. 74. The project costs are based on the actual cost estimate of the proposed projects an d international benchmarks where local cost estimates are not available. One striking feat ure of the cost structure is the high costs of transmission and distribution networks, which appear to be high even for Sub-Saharan Africa standards. Lowering construction costs wo uld positively affect the project’s financial viability. NRECA International is now assistin g REA to develop new low-cost distribution approaches, to be piloted under the TEDAP project. 75. The analysis assumes a 15-year loan rate (facilitated by a TEDAP credit line) for t he projects. The hydro projects require this longer loan term to enable recovery of higher capital costs while the biomass co-generation projects could still yield attractive returns i n a shorter 8-10 year loan period. 76. The analysis has resulted in Project IRR ranges from 11.7% to 37% for main-grid projects. Equity IRR also ranges from 16.1% to 46.5% for main-grid projects. Projects s elling directly to isolated mini-grids have even higher IRRs due to a substantially higher t ariff, since such projects are displacing high-cost diesel. The results are included in Tabl e 3.1. 77. Based on the financial analysis we would rate project attractiveness in the followi ng order (from highest to lowest):

27  Small (~10MW) biomass co-generation projects are the most attractive provided they have grid connectivity to offtake the generated surplus power. The ready availability of fuel ensures high capital efficiency and since these plants are an extension of an existing manufacturing setup they have relatively low capital and overhead costs. The steady quality of fuel keeps maintenance low while the cost of fuel collection is also fairly low. These result is a very attractive 20% Project FIRR that can support the current commercial loan terms.  Small Hydro projects (~10MW) have very low operating costs, overheads and maintenance. They need long-term loans (15 years), however — preferably at a fixed rate to overcome high construction costs — to be financially attractive to equity investors. Typical project IRR is in the order of 12-14%. Typical equity IRR is around 18%  Mini- hydro projects can be attractive investments provided the resource availability allows a higher capacity factor (>60%). Due to its smaller scale, the capital and overhead costs can be high and so they have a more modest FIRR. Given that a number of these projects, however, are expected to be built by cooperatives, their expectations of returns are likely to be lower than in pure commercial projects.  Mini-biomass projects have a difficult financial profile due to high fuel gathering costs and higher capital and maintenance costs. At current, commercial lending rates, they are only viable if selling power to Tanesco’s isolated mini-grid under the SPPA, as the tariff in this case is high, reflecting Tanesco’s avoided costs of diesel generation in these isolated grids. In this case, the project is highly viable with 37% project IRR. The same project selling power to the main grid would barely be viable at 5.7% project IRR.

78. A detailed sensitivity analysis was carried out for mini and small hydros demonstr ating high sensitivity to the following factors:

 tariff and cost inflation  capacity factor  construction schedule and cost overruns  hydrology variability (for hydro projects)  interest rate variability  availability of carbon credit

28 Table 3.1: Summary Results: Prospective Performance Grant and Credit Line Pipeline

Small biomass Small hydro Mini-hydro cogen Mini-biomass Alt. A Mini-biomass Alt. B

Size 10 MW 1MW 10MW 1 MW 1 MW Capacity factor 55% 60% 80% 80% 80% Annual output 45.77 MWh 4.99 MWh 66.58 MWh 6.66 MWh 6.66 MWh Type of SPPA/T main grid main grid main grid Tanesco isolated grid main grid Independent mini-grid included? yes yes yes no no Number of mini-grid connections 600 600 600

Costs Plant CAPEX 16.8 M US$ 2.6 M US$ 17.2 M US$ 2.45 M US$ 2.45 M US$ Mini-grid 2.9 M US$ 0.8 M US$ Performance grant ($500/connection) 0.3 M US$ 0.3 M US$ 0.3 M US$ Operating costs 0.78 c/kWh 0.81 c/kWh 2.6 c/kWh 4 c/kWh 4 c/kWh

Revenues Average tariff 0.071 US$/kWh 0.072 US$/kWh 0.071 US$/kWh 0.28 US$/kWh 0.071 US$/kWh Carbon revenues 0.014 US$/kWh 0.014 US$/kWh 0.014 US$/kWh 0.014 US$/kWh 0.014 US$/kWh Carbon revenue shares to the developer 70% 70% 70% 70% 70%

Financing Maturity 15 years 15 years 15 years 15 years 15 years Grace period 2.5 years 2 years 1.5 years 1.5 years 1.5 years Interest rate 15% 14% 16% 16% 16%

Project IRR 12.90% 11.70% 20.9 37% 5.70% Equity IRR 18% 16.10% 46.5 130% 2.70%

29 Table 3.2 Assumptions

Cost Assumptions

$ / W (p) CF Gassification 1.50 80% Cogen 1.25 80% SHP >3MW $2.25 45% SHP < 1MW 2.25 40%

c/ kwh Op costs OverheadsFuel costs O&M Gassification 4.1 0.5 2.6 5.00% Cogen 2.6 0.2 1.7 4.00% SHP >3MW 1.1 0.5 0 1.00% SHP < 3MW 2.0 1.0 0 1.50%

Default Schedule 1 2 3 4 5 Capital disbursement 50% 50% 0% 0% 0% Operations 0% 0% 100% 100% 100%

Revenues LB UB National Grid FIT 95 TZH / kwh Isolated minigrid FIT 385 TZH / kwh Retail tariff 85 TZH / kwh Carbon Credits $0.014 $ / kwh Collection efficiency 90%

Other assumptions Corporate tax rate 30% Construction schedule 2 Years Tax holiday 0 Years Depreciation schedule 20 Years Exchange Rate 1,348 TZS / US $ Connections Subsidy $500 per connection Loan Grace Period 2 Years Loan term 15 Years Developer share of Carbon Credit 70% Tariff inflation 2.0% CPI 6.0%

30 Table 3.3: Sensitivity Analysis Key Factors Captial Structure Retail Tariff Tariff Cost Capacity Carbon Construction Net Opex Retail Supportable Equity Scenario Project IRR TZH / kwh Inflation Inflation Factor Credits* Schedule Capex c /kwh Share Debt Rate DSCR IRR Hydro < 1MW*** Base Case 1.1 8.04% 100.0 2% 6% 60% 1 2 2.25 2.0 45% 12.0% 1.14 8.4% Worst Case 1.2 0.66% 100.0 0% 5% 50% 0 2.5 2.50 2.0 45% 1.5% 1.16 0.5% Zero tariff inflation 1.3 6.13% 100.0 0% 4% 60% 1 2 2.25 2.0 45% 12.0% 1.09 2.6% Low Capaciity Factor 1.4 5.52% 100.0 2% 5% 45% 1 2 2.25 2.0 45% 7.5% 1.11 6.8% No Carbon Credits 1.5 3.44% 100.0 2% 4% 60% 0 2 3.00 2.3 45% 3.5% 1.14 5.7% Construction & Cost overruns 1.6 3.58% 100.0 2% 6% 60% 1 3 3.00 2.3 45% 6.5% 1.03 2.8% Best Case Scenario 1.7 16.01% 120.0 2% 5% 65% 1 1.75 2.00 1.2 45% 17.0% 1.35 25.4% Andoya Project 1.8 11.87% 95.0 2% 6% 75% 1 2 2.34 1.4 45% 12.0% 1.49 19.1%

Hydro - 10 MW*** Base Case 2.1 12.52% 100.0 2% 6% 55% 1 2.5 2.00 0.8 15% 15.5% 1.10 15.8% Worst Case 2.2 0.77% 95.0 0% 6% 40% 0 3 2.50 1.3 15% 1.3% 1.13 0.2% Zero tariff inflation 2.3 10.38% 100.0 0% 4% 55% 1 2.5 2.00 0.8 15% 14.0% 1.12 11.6% Low Capaciity Factor 2.4 8.54% 100.0 2% 6% 40% 1 2.5 2.00 0.8 15% 10.0% 1.09 11.8% No Carbon Credits 2.5 10.52% 100.0 2% 6% 55% 0 2.5 2.00 0.8 15% 13.0% 1.09 13.4% Construction & Cost overruns 2.6 8.78% 100.0 2% 6% 55% 1 3 2.50 1.0 15% 11.0% 1.11 9.8% Best Case Scenario 2.7 16.16% 120.0 2% 5% 60% 1 2 1.75 0.7 15% 17.0% 1.49 23.8% Njombe 2.8 13.99% 100.0 2% 6% 58% 1 2 1.86 0.8 15% 16.0% 1.30 19.8%

Large Biomass Cogen - 10 MW*** Base Case 3.1 20.72% 100.0 2% 6% 80% 1 1.5 1.25 2.6 15% 16.0% 1.97 45.6% Worst Case 3.2 3.75% 95.0 0% 4% 50% 1 2 1.50 3.3 15% 7.0% 1.40 2.95% High input fuel costs 3.3 18.31% 100.0 2% 6% 80% 1 1.5 1.25 3.0 15% 16.0% 1.81 38.1% Zero tariff inflation 3.4 18.36% 100.0 0% 4% 80% 1 1.5 1.25 2.6 15% 16.0% 1.89 40.1% Low Capaciity Factor 3.5 10.08% 100.0 2% 6% 50% 1 1.5 1.25 3.0 15% 16.0% 1.12 7.4% No Carbon Credits 3.6 16.44% 100.0 2% 6% 80% 0 1.5 1.25 2.6 15% 16.0% 1.59 32.7% Construction & Cost overruns 3.7 14.57% 100.0 2% 6% 80% 1 2 1.50 2.8 15% 16.0% 1.63 22.4%

Small Biomass - 1 MW*** Base Case 4.1 6.19% 100.0 2% 6% 80% 1 1.5 1.50 4.1 45% 10.0% 1.52 6.0% Worst Case 4.2 - VE 100.0 0% 5% 50% 1 2 1.75 5.0 45% 10.0% 0.54 - VE High input fuel costs 4.3 - VE 100.0 2% 6% 80% 1 1.5 1.50 4.7 45% 8.0% 1.39 - VE Zero tariff inflation 4.4 3.94% 100.0 0% 4% 80% 1 1.5 1.50 4.1 45% 10.0% 1.46 - VE Low Capaciity Factor 4.5 - VE 100.0 2% 6% 50% 1 1.5 1.50 4.7 45% 10.0% 0.76 - VE No Carbon Credits 4.6 - VE 100.0 2% 6% 80% 0 1.5 1.50 4.1 45% 10.0% 1.09 - VE Construction & Cost overruns 4.7 0.87% 100.0 2% 6% 80% 1 2 1.75 4.2 45% 10.0% 1.25 - VE

Economic analysis

79. The ESME complements the existing TEDAP financing mechanism that is expect ed to yield significant development outcomes and impact. First, new households, especial ly in the rural areas, will gain access to electricity. Improved access to electricity is expec ted to result in economic and social benefits for Tanzania’s rural population, including im proved health, education, productivity, and general well being of the people. 80. Second, the increased generation capacity, the diversification of the power supply and the infusion of renewable technology are expected to improve the reliability of grid el ectricity, particularly in rural areas. The recent World Bank Africa Infrastructure Diagnos tic study estimates that load shedding and emergency generation cost Tanzania over 5% o f GDP annually. Studies show that inadequate power supplies take a heavy toll on the pri vate sector. Tanzanian enterprises experience on average 63 days of outages. Such outag es represent high costs for enterprises (6 percent of turnover on average for formal enterp rises, and as much as 16 percent of turnover for informal enterprises). 81. Third, renewable energy generation is expected to displace fossil fuels, contributi ng to the global efforts to reduce CO2 emissions and avert the environmental and econom ic threats of climate change. The proposed ESME project directly contributes to CO2 avo idance since the green generation performance grants are set against CERs. 82. Finally, the financing mechanism will contribute to local rural development as mo st of the project sponsors are local SMEs situated in rural areas. The proposed grant and GVEP executed TA are aimed at developing local entrepreneurship. Together with TA as sistance under TEDAP, the proposed grant project will foster productive uses in rural are as.

31 83. Some of these economic benefits, although significant, are difficult to quantify. T he economic analysis, therefore, was conducted on conservative terms, taking into accoun t only quantifiable and verifiable benefits, including

(a) Displacement of higher cost fossil fuel generation. It is assumed, that most of the time, the projects selling to the grid will displace the thermal generation on the margin, typically gas (the avoided cost is estimated at about US$0.07 per kWh). However, such an assumption does not take into account the high economic costs of frequent load-shedding, which renewable energy generation can help prevent. Therefore, it is assumed that one month a year the SPPs will displace emergency diesel units (at US$0.49 per kWh). This is a conservative assumption, given, as noted above, that surveys show that Tanzanian enterprises experience on average 63 days of outages per year.

(b) Environmental benefits due to greenhouse gas reduction are priced per current carbon market conditions, resulting in US$0.015/kWh in the Tanzanian conditions.

(c) Household connection benefits are estimated based on their willingness to pay, using a consumer surplus method. The benefits are based on the consumer surplus calculation for mini-grids carried out for the original TEDAP project based on household willingness to pay surveys. (See the original TEDAP PAD for details.) The study estimates US$170 annual benefits for lower-income households and US$191 for higher-income households. It is assumed that about 2/3 of beneficiaries will be lower income households, and 1/3 higher income households.

84. The economic analysis was carried out for the same four sample projects included in the financial analysis. See financial analysis for their description. 85. All projects show very robust EIRR, ranging from 17% to 39% for projects conne cted to the main grid. Those selling power to an isolated grid are especially attractive eco nomically, as they displace expensive and polluting diesel generation. The only project s elling power to the isolated grid, included in the sample, results in extremely high EIRR o f 94% (although such a project is more likely the exception rather than the norm for the f inancing portfolio).

32 Table 3.4: Economic Analysis Results

Small biomass Small hydro Mini-hydro cogen Mini-biomass Alt. A Mini-biomass Alt. B

Size 10 MW 1MW 10MW 1 MW 1 MW Capacity factor 55% 60% 80% 80% 80% Annual output 45.77 MWh 4.99 MWh 66.58 MWh 6.66 MWh 6.66 MWh Type of SPPA/T main grid main grid main grid Tanesco isolated grid main grid Independent mini-grid included? yes yes yes no no Number of mini-grid connections 600 600 600

Costs Plant CAPEX 16.8 M US$ 2.6 M US$ 17.2 M US$ 2.45 M US$ 2.45 M US$ Mini-grid 2.9 M US$ 0.8 M US$ Performance grant ($500/connection) 0.3 M US$ 0.3 M US$ 0.3 M US$ Operating costs 0.78 c/kWh 0.81 c/kWh 2.6 c/kWh 4 c/kWh 4 c/kWh

Benefits Avoided tariff 0.109 US$/kWh 0.109 US$/kWh 0.109 US$/kWh 0.496 US$/kWh 0.109 US$/kWh Environmental externalities 0.015 US$/kWh 0.015 US$/kWh 0.015 US$/kWh 0.015 US$/kWh 0.015 US$/kWh Electrified households 177 p.a/hh 177 p.a/hh 177 p.a/hh

Economic IRR 20% 17% 39% 94% 28.00%

33 Validation of Financial and Economic Model using data from actual projects in 2011

86. Subsequent to the financial modeling and sensitivity analysis, the team was able t o get actual data from four projects based on their detailed business plans. The results fro m these projects based on their actual financial projections is within the range of the origi nal modeling. The data from these four projects are summarized below. The actual projec t identification is masked for confidentiality reasons.

Table 3.5: Financial Summary of an Actual Project Developed in 2011

Financial summary of Actual projects being developed in 2011 Project Size 0.5 MW 10 MW 1.6 MW 1 MW Description SHP, mini-grid SHP, main- grid SHP, main- grid Biogas, main- grid Capital Investment USD 2.9 Mn USD 24.1 Mn USD 3.8 Mn USD 3.5 Mn Capacity Factor 67.9% 57.3% 74.0% 74.0% Tarrif* TSH 380 (25.3 USc) TSH 110 (7.3 US c) TSH 110 (7.3 US c) TSH 110 (7.3 US c) Fuel Cost N/A N/A N/A 10 $ / ton Operating Costs USD 60,000 USD 342,000 10% assumed 10-15% EBITDA** USD 323,000 USD 4.1 Mn USD 690,000 Project IRR*** 23.6% 15.9% 18.30% 12.5% Equity IRR 28.0% 20.9% ~23% 14.0%

* 2011 tarifs, avg tariff used for main grids there is difference of wet and dry tariffs. ** EBITDA in first operating year *** IRR for all capital employed in projects including grants and other money.

34 Annex 4: Team Composition

Team Composition Name Title Unit Sr. Energy Specialist, Task Dana Rysankova AFTEG Team Leader Raluca Golumbeanu Operations Officer AFTEG Robert Schlotterer Senior Financial Specialist AFTEG Krishnan Raghunatan Financial Specialist, Consultant AFTEG Kirtan Chandra Sahoo Technical Specialist ENVCF Renewable Energy Specialist, Anil Cabraal Consultant Mohammad Nadeem Paralegal LEGAF Philip Beauregard Senior Counsel LEGAF Environmental Specialist, Thomas Walton AFTEG Consultant Helen Shahriari Sr. Social Scientist AFTCS Donald Paul Mneney Sr. Procurement Specialist AFTPC Mercy Mataro Sabai Sr. Financial Specialist AFTFM Mengi Hubert Financial Specialist, Consultant AFTFM Sr. Energy Specialist, Peer Mohua Mukherjee SASDE Reviewer Sr. Carbon Finance Specialist, Brice Jean Marie Quesnel ENVCF Peer Reviewer Sr. Power Engineer, Peer Issa Diaw AFTEG Reviewer Marie Lolo Sow Program Assistant AFTEG Ruth Selegebu Team Assistant AFCE1